Chinese Audits – More Scrutiny on the Way For Auditors

As a follow-up to my blog last week on Sino-Forest Corp. I read where Thomson Reuters reported,

“U.S. regulators, reeling from a series of scandals over U.S.-listed Chinese companies, will head to Beijing to discuss launching audit inspections while regulators in Canada announced a probe of foreign issuers.

“U.S. audit watchdog PCAOB and the SEC confirmed they would send a delegation to talk to authorities in Beijing about the oversight of China-based auditors. Neither said when the meetings would take place, but Bloomberg News reported from Beijing they would take place on July 11 and 12.

“Meanwhile, the Ontario Securities Commission on Tuesday said it would review companies listed on Canadian exchanges with significant business operations in emerging markets. It said it would focus on the roles played by auditors and underwriters and would take enforcement actions as needed.

“Concern about Chinese companies has risen in the United States and Canada where stocks have been de-listed, trading has stopped, share prices have collapsed, auditors have resigned and regulatory probes have been launched.”

As one more example of the need for auditors to step up their efforts to find fraud, The Securities Exchange Commission announced that it has obtained a court order freezing the assets of China Voice Holding Corp., which trades in over-the-counter markets and has claimed to have a portfolio of telecommunications products and services in both the U.S. and China. The SEC alleges that China Voice's co-founder and his two associates are operating an $8.6 million Ponzi scheme and misusing its proceeds, in part, to help fund the company's operations.


The SEC alleges that David Ronald Allen, who also was China voice's chief financial officer, and his associates Alex Dowlatshahi and Christopher Mills promised investors in a series of offerings of limited partnerships that they would earn returns of at least 25 percent on their investments. Investors were falsely told that their money would be loaned to companies with a demonstrated track record and large profit margins. Instead, Allen and his cohorts used investor funds to pay back investors in earlier partnerships and funneled investor money to China Voice and a complicated web of other companies that Allen controls. Allen and his associates also siphoned investor money to enrich themselves and family members.


In light of this enforcement action, I wondered what the auditor had said?

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China Voice Holding Corp. and subsidiaries as of June 30, 2009 and 2008 and the results of its operations and its cash flows for the years ended June 30, 2009 and 2008, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has incurred net losses of approximately $6,370,697 and $5,277,203 for the years ended June 30, 2009 and 2008, respectively.  Additionally, during the years ended June 30, 2009 and 2008, the Company has used cash flow in operations of approximately $2,519,395 and $4,170,590 in 2009 and 2008, respectively.  Accumulated deficit amounted to $29,576,504 and $22,483,047 as of June 30, 2009 and 2008, respectively. These factors raise substantial doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also described in Note 2. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/S/JIMMY C.H. CHEUNG & CO

Certified Public Accountants

Hong Kong

Date:  October 27, 2009

Audit fees for the years ended June 30, 2008 and 2009, and review of financial statements for the initial Form 10Q for the period ended December 31, 2008 and the Form 10Q for the Quarter Ended March 31, 2009 totaled $376,970.


The following year the Company has not been able to produce an audit because of material uncertainties regarding its viability and asset valuations.


Audit fees for the years ended June 30, 2009 and 2010, and review of quarterly financial statements totaled $353,431.


Good for the auditor to have the courage to not issue an opinion! Unfortunately, the auditors were again not able to find the fraud that existed and it took the efforts of an outside regulator to uncover the potential fraud.


But wasn’t there at least one red flag that the auditor should have spotted and pursued? When the CFO promises investors in a series of offerings of limited partnerships that they would earn returns of at least 25 percent on their investments – shouldn’t all sorts of bells gone off for the auditors?


I learned that simple concept when I was in college and I brought an investment opportunity I was considering to my friend, a former vice-president of Merrill Lynch. He said the rate of return was too good to be true and to steer clear of this fraudulent transaction. Shortly thereafter, he was proven right!


Auditors have to listen and to increase their level of professional skepticism if they have any hope of finding the fraud that may exist in the companies they audit.