Overnight, Deloitte Touche Tohmatsu resigned as auditors to a Hong Kong-listed Chinese company Tianhe Chemicals Group Limited (HKG: 1619).
What has that got to do with anything on the ASX I hear you ask.
Plenty, as I'll explain.
Tianhe Chemicals has been accused by research firm Anonymous Analytics of fraud in a highly-detailed report (PDF), which has been corroborated by Associated Press (AP), which even added new charges.
What makes Tianhe different is that this is not some small company. The company's shares have been suspended since March this year, but with a HK$29 billion market cap, is the equivalent of A$5.2 billion – or a similar size to Computershare Limited (ASX: CPU), Spark New Zealand Ltd (ASX: SPK), Orica Ltd (ASX: ORI) and Tatts Group Limited (ASX: TTS).
Tianhe had a market cap north of A$10 billion dollars at one stage.
Anonymous Analytics claims it's the biggest fraud since Canadian-listed Sino-Forrest collapsed. The resignation of auditor Deloitte came after Tianhe's board declined to accept a draft report from the auditors. That could imply that the auditors didn't agree with the company's financials – and increases the likelihood that the company's financials are fraudulent.
As has often been the case in Chinese fraudulent cases, research firms have compared official financial reports filed with the Chinese State Administration for Industry & Commerce (SAIC) and official reports filed with their listed stock exchange.
In many cases, Chinese companies have been found to have filed two sets of completely different reports – and in some cases, created fraudulent SAIC reports. Anonymous Analytics managed to get hold of Tianhe's official SAIC reports, which the research firm says shows the company is wildly overstating its revenues and profits.
This raises an issue for every single Chinese-based company listed on the ASX or preparing to list on the ASX. It's incredibly hard to get hold of those original SAIC reports – with China regarding them virtually as state secrets.
But without those reports, investors are forced to rely on the auditors to prove that the financials reported to the ASX are true and accurate. But time and time again, Chinese companies have managed to fool foreign auditors, which leads to a question Australian investors need to ask.
Why do they think Australian auditors of Chinese companies are any different to US or other auditing companies and are they being fooled (lower case 'f') as well?
In many cases of Chinese fraudulent companies, the auditors have been one of the top four or five auditing firms in the world, showing that audits offer no protection from fraudulent activity.
As a result, investors have no basis for confidence in the stated financials of ASX-listed Chinese stocks.
Now before you think that I'm biased or that I'm tarring every Chinese company with the 'fraudulent' brush, I'm not. I'm simply highlighting the risks as I see them. As we see more Chinese-based companies listing on the ASX, the chances of one or more of them proving to be fraudulent rise. To go with that – the chances of investors losing a bundle also rise.
Additionally, the ASX and the corporate regulator the Australian Securities and Investments Commission (ASIC) have virtually no experience in how to deal with a fraudulent offshore-listed company, unlike their colleagues in the US, Singapore, Germany and Hong Kong. So another level of protection for investors is also missing.
Here's a list of current China-based companies or those with extensive operations in China including subsidiaries, listed on the ASX – although there are likely more.
China Integrated Media Corporation Ltd (ASX: CIK)
China Magnesium Corp Ltd (ASX: CMC)
China Waste Corporation Ltd (ASX: CWC)
99 Wuxian Ltd (ASX: NNW)
Premiere Eastern Energy Ltd (ASX: PEZ)
Richfield International Limited (ASX: RIS)
Sino Australia Oil and Gas Ltd (ASX: SAO) – (Currently in liquidation, after director Tianpeng Shao attempted to transfer $7.5 million to an unknown Chinese bank account).
Sunbridge Group Ltd (ASX: SBB)
Sino Gas & Energy Holdings Limited (ASX: SEH)
Shenhua International Ltd (ASX: SHU)
TTG Fintech Ltd (ASX: TUP)
Treyo Leisure and Entertainment Ltd (ASX: TYO)
Victor Group Holdings Ltd (ASX: VIG)
XPD Soccer Gear Group Ltd (ASX: XPD)
And some new companies with upcoming IPOs
Dongfang Modern Agriculture Holding Group Limited (ASX: DFM)
Wonhe Multimedia Commerce Ltd (ASX: WMC)
Enice Holding Company Limited (ASX: ENC)
Foolish takeaway
I'll repeat that I am not accusing any of the above companies of fraudulent activity – merely warning investors that investing in Chinese-based companies carries much higher risks.
Before investing in any of the companies above, Australian investors need to understand they are on their own. The regulators are unlikely to be able to protect them and recover any of their funds should any of the above blow up.
You have been warned…again.
