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S-Chip Scandals

Ji Kin's ppt
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Maria Teo

on 3 September 2014

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Transcript of S-Chip Scandals

S-Chip Scandals -
Lessons Learnt

September 2014

Agenda
Background of S-Chips
Case Studies – Recent scandals
Red flags
Lessons learnt
Responses of various parties

What is an S-Chip?
Chinese companies listed in Singapore
Incorporated mainly in Singapore, British Virgin Islands, Cayman Islands or Bermuda
Main operations and management in China
FTSE ST China Index covers the prices of S-Chips

Other common China shares
A Shares
B Shares
L Shares
N Shares
H Shares / P-Chips / Red Chips
Definitions
Origins of S-Chips
China-based companies first “woo-ed” by SGX in the late 1990s
SGX signed MOUs with provincial /municipal governments to facilitate the listing of companies from those areas in Singapore
China Aviation Oil scandal in 2004
Opening of doors in 2006 by China
Domestic investment funds allowed to invest abroad (Qualified Domestic Institutional Investors, “QDII”))
Quota of US$14 billion (approx. RMB50 billion)
History of S-Chips
S-Chips the new “darlings” of the Singapore Stock Exchange in 2006 / 2007

In 2007, approximately 170 S-Chips listed on the mainboard / subsidiary board of SGX-ST

Three S-Chips included in the STI Index
First wave of S-Chip scandals in 2008 / 2009
FerroChina (Unable to settle debts and loans despite significant profits)
Fibrechem Technologies (Discrepancies between trade receivables and bank balances)
Beauty China (Force-sell of shares of controlling shareholder, which were pledged for Company’s bank loans)
Sino-Environment (Questionable cash transactions)
Oriental Century (Inflated sales and cash balances)
China Printing & Dyeing (Unable to settle debts)
A little more about Sino-Environment
S$14 million disappeared, and reappeared in a different bank account
Invoices for fictitious sales had been raised
Top management resigned en masse
Suspended trading in September 2009, placed under judicial management in June 2010
Subsequently, probe by the Fujian Public Security Bureau did not find the Group guilty of any wrongdoing
In 2011, entered into asset recovery and implementation agreement, winding-up of subsidiary etc
Scheme of compromise and arrangement in August 2011
SGX held meetings with audit firms, issue managers and independent directors to step up checks

In December 2009, SGX tabled a 70-page consultation paper to propose amending listing rules. Recommendations include:
Requiring controlling shareholders to disclose any arrangements to pledge their shares
Having investors hold their shares in custody in Singapore
Appointing governance advisers for newly listed companies
Before the SGX consultation paper could be finalised and issued...
SECOND WAVE!
Case Study - China Hongxing Sports
Case Facts
Backdrop #1 : Company announced combined order book of RMB1.8 billion secured in trade fairs in August & October 2010
Backdrop #2 : Independent auditor changed in October 2010
On 25 February 2011, Company announced that the independent auditor noted irregularities in the cash and bank balances, accounts receivables, accounts payables and other expenses of two China subsidiaries
Request for trading halt and suspension in late February 2011
Special auditor appointed on 1 March 2011
Case Study - China Hongxing Sports
Updates
Company secretary resignation announced in May 2011
Grant of extension to announce full-year financial results (1 December 2011), AGM (31 January 2012), and 2011 quarterly results obtained on 9 August 2011
Controls over financial seals and payment approvals implemented
Number of authorised signatories increased to include AC members
Pending investigation and report from special auditors
Case Study - Hongwei Technologies
Case Facts
On 26 February 2011, Company announced that the independent auditor had raised issues pertaining to cash and balances’ confirmations in its subsidiary company in China
Request for trading halt two days earlier, and request for suspension on the same date above
Change of board composition, appointment of contract CEO, and transfer of finance seals in March 2011
Special auditors appointed in end-March 2011 to investigate into the affairs of the Group
Updates
On 6 May 2011, Company made announcement regarding a disclaimer of opinion by independent auditor, in relation to the Group’s cash and bank balances amounting to RMB130.5 million
In June & July 2011, announcements made w.r.t. changes in board composition, including resignation of non-executive director
Application for extension of release of unaudited results for Q2 on 12 August 2011
Pending further investigation
Case Study - Hongwei Technologies
Case Study - China Gaoxian
Case Facts
Backdrop # 1 : Listed only 18 months ago, being one of the largest IPOs in 2009
Backdrop # 2: Company dual-listed on Korea Exchange (KRX) in January 2011, raising RMB1.13 billion, to expand its business and build its “Huaxiang Project”, a plant in Huzhou City, Zhejiang
RMB1.1 billion (S$190 million) of cash and bank balances reported as at 31 December 2010
Independent auditor unable to verify the bank balances of two subsidiaries in China
Company informed the independent directors that it had entered into several contracts with equipment suppliers and contractors in connection with the Huaxiang Project with a total contract value of RMB1.2 billion, of which they had paid RMB391 million, and another RMB95 million is due for payment
Independent directors instructed management to suspend payments
Trading of shares suspended on both the SGX and KRX in end-March 2011
Case Study - China Gaoxian
Updates
Special auditor appointed in April 2011, and announcement made on 30 June 2011 that aggregate cash and bank balances was only RMB93 million. Additionally, outstanding bank liabilities were understated by RMB130 million
As at 31 March 2011, RMB699 million of RMB714 million cash and cash balances verified
Cessation of key management personnel announced in April 2011, changing board and committee composition
Extensions on AGM (now no later than 31 October 2011) and quarterly announcements sought from SGX
On 18 August 2011, financial advisor for Huaxiang Project appointed, to assess financial viability of the project
Case Facts
On 14 April 2011, independent auditor reported discrepancies in invoices issued by the firm and its suppliers, questioning the authenticity of certain invoices
Sales manager linked to these invoices not contactable since end of March 2011 for inquiries
One week after the above announcement, the office and administrative premises mysteriously caught fire, destroying all accounting and financial records
On 19 April 2011, trading of shares suspended on the SGX
Case Study - Sino Techfibre
Updates
On 21 April 2011, existing CEO “re-designated”, independent director appointed as interim CEO and Audit Committee Chairman appointed as interim non-executive Chairperson of the Company
On 19 May 2011, update announcement on the fire outbreak, presumably caused by electrical short circuit, case officially closed
Special auditor engaged on 24 May 2011 to perform a full and complete verification exercise on all the sales invoices
On 15 August 2011, the Company announced the cessation of the appointments of 3 executive officers
Case Study - Sino Techfibre
Case Study - Falmac
Case Facts
For financial year ended 31 December 2009, directors and auditors were denied access to critical accounting records by the legal representative, who held the Company Seal and had the power to transfer assets and execute transactions
For financial year ended 31 December 2010, legal representative refused to allow the directors access to the factory premises and financial records
Independent auditor issued a disclaimer of opinion for both financial years
Updates
Announcements made throughout 2009 and 2010 as if it’s “business as usual”
Submission of resumption proposal of trading on Catalist on 28 April 2011
Proposed disposal of active subsidiaries and proposed RTO of a gold-mining entity announced in July and August 2011
Unaudited results for half-year ended 30 June 2011 announced on 8 August 2011
Case Study - Falmac
Case Study - Celestial NutriFoods
Updates
Suspended from trading on the SGX in 2009
“Negative revenue” of RMB161 million reported for quarterly results for 30 June 2010
Provisional liquidator appointed on 28 December 2010
On 13 July 2011, the liquidator confirmed that outflows of assets represented “unusual and, most likely, fraudulent conveyances”
Case Study - Celestial NutriFoods
Case Facts
In June 2009, the Group defaulted on liabilities amounting to S$235 million in zero-coupon convertible bonds
Earlier, its independent auditor had stated in March 2009 that the Group would have a going concern issue if the convertible bonds were redeemed during the year
Cash shortage exacerbated by several large and unexplained cash outflows from the bank accounts in 2009 and 2010, immediately preceding the bond default and appointment of provisional liquidator respectively
Ownership of the subsidiaries transferred to third parties in stages without disclosure to SGX
Case Study - China Milk Products Group
Case Facts
Backdrop : Listed in 2006, significant profits noted each financial year, and commanded a market capitalisation of S$1 billion
Convertible bond holders wanted to redeem their bonds on 5 January 2010, amounting to US$170 million
The Group assured the bond holders it had enough to meet its obligations, but there was “administrative” delay in remitting funds out of China
Case Facts (Cont'd)
CFO and Company Secretary resigned on 1 February 2010
Subsequently responded to SGX via announcement on the progress of obtaining funds, which was, at best, evasive, triggering a special audit
Trading halt and suspension in February 2010
Two special auditors appointed in April 2010
Case Study - China Milk Products Group
Case Study - China Milk Products Group
Executive summary of special auditor released on 9 June 2011. Key points were :
Consolidated bank balances as at 12 February 2010 stood at US$85 million
Acquisition of joint venture uncompleted, despite significant transfer of funds (US$20.6 million)
Significant purchase of land use rights and alfafa crops not announced (US$72.8 million)
Expenditure on improvements work on farm facilities (US$72.9 million)
Purchase of replacement cattle (US$37.1 million)
No evidence of board approval or management deliberation of merits of above transactions
Case Study - China Milk Products Group
Other salient observations :
Uncooperative bank manager
Incompetent main contractor who didn’t own a construction company
Canadian or Australian cattle?
Visits to China subsidiary after June 2010 thwarted by CEO
“Failed to reach the high prudential standards expected by the Exchange of a public-listed company”
Case Study - General Comments
Scripts of recent scandals generally similar
Inter-relation between revenue, trade receivables and cash
The “Satyam Syndrome”
Have S-Chips been dealt an unfair reputation?
Case Study - General Comments
Inherent limitations
Operations are based in China, hence management rarely in Singapore
Analysts and investors have limited visibility
Reliance on companies’ own disclosures (difficult to verify the authenticity of such information)
“Dropping off the radar”

Absence of extradition treaty between China & Singapore
SGX-ST / ACRA has limited ability to sanction key management and other personnel committing these frauds

Legal representative more powerful than the Board
Company / Finance Seal held is the company’s official symbol and gives the holder the legal capacity to execute agreements, transfer assets and provide guarantees
Case Study - General Comments
Which S-Chips to invest in?
Difficult to distinguish between the sound companies and the empty coffers

Are S-Chips second-rate stocks?
Bigger and “better” companies opting for HK or mainland
“Big fishes in a smaller pond”

Has SGX “compromised” on the quality of companies to attract IPOs from China?
Duality of roles of SGX (conflict between profit-oriented entity vs regulator of stock market)
Red Flags
Significant levels of cash and cash equivalents
Major shareholder selling off shares


Independent auditor resigning in the absence of any disagreements with management
Dividends not declared despite net profits position
Significant capital expenditure with no apparent upgrade in plant & equipment or increase in production capacity
Below IPO price; and / or
Immediately after moratorium period
Red Flags
High turnover in key management positions
Understaffed accounting department
Profits generated not translating to “net cash from operations”
Drawdown of bank credit lines when there is a positive cash balance
Net non-cash settlement of trade debts and payables
Trade receivables long outstanding (not converted to cash)
Lessons Learnt
Need for companies to rise beyond the minimum level of corporate governance
Need to expend resources for investment relations and for greater transparency
Role of audit committee and independent auditors
Going back to fundamentals
Opportunity for the other companies (even non-S-Chips) to show their mettle
How SGX has responded
SGX tasked the Audit Committees and Directors of S-Chips to check and ensure the internal control is adequate to safeguard cash balances and other assets and to report to SGX by 31st May 2011
Comment # 1 : First instance in Singapore where the Audit Committee is directly instructed by SGX-ST
Comment # 2 : Actual implementation of additional, if any, internal control will vary in terms of expediency
SGX asked the Audit Committees and Directors of S-Chips to ensure that the Articles of Association of their Chinese units allow them to appoint and remove legal representatives
Comment : May be moot, as under Chinese commerce rules, the representative cannot be removed unless he / she resigns
How the regulators should respond
Increase level of scrutiny for listing aspirants, in particular for entities which have little or no previous business dealings in Singapore or the region
Be more decisive in implementing reforms, rather than a long-drawn consultation process to obtain views of too many parties
Consider electronic confirmations of bank balances
Split the audit committee and independent directors composition
Consider mandatory rotation of audit firms / engagement partner assigned
How the Board/management should respond
Set the tone at the top
Appoint audit committee members and independent directors who are truly independent (China Sky Chemical Fibre)
Engage professional investment relations firm to increase transparency and ensure completeness and quality of announcements
Appoint a Singapore-resident executive director to provide oversight
Set up an anti-fraud oversight team
Implement a fraud investigation protocol framework
How the AC / IDs should respond
Going back to basics (refer to requirements of Singapore Standards on Auditing 315 for internal control framework)
Reinforce a “zero-tolerance of fraud” message
Re-look at the effectiveness of current whistle-blowing processes, including regular communications
Request for regular updates of business, including querying nature of significant or unusual transactions (not only IPTs)
Engage professional internal auditors based in Singapore rather than rely on internal function, or professional firms based in China
Focus on control environment, on top of internal control validation and substantive tests the details
Assess the “tone in the middle”
Include elements of unpredictability in the nature, timing and extent of audit procedures
Undertake additional audit procedures for S-Chip audits
Maintain independence, both in appearance and in fact
Adopt a “heightened” sense of professional skepticism
How the auditors should respond
Concluding Comments
Elsewhere, in USA, since March 2011, > 20 China-based companies have disclosed auditor resignations or accounting irregularities
China government has interest in limiting the number of such scandals involving China-based companies listed overseas
Everyone must remain vigilant
REACHING US
THANK YOU

Mr. LOH JI KIN
Email: lohjikin@nexiats.com.sg
Website: www.nexiats.com.sg
History of S-Chips
“When the tide goes out, you can see who is not wearing swimming trunks”
- Warren Buffet
Full transcript