The SEC reminded foreign issuers on December 10 that accounting misdeeds not only constitute securities fraud, they can violate the Foreign Corrupt Practices Act.
In an enforcement action that did not involve bribery of any kind, the SEC charged Agria Corporation, a Cayman Islands company headquartered in Hong Kong, with securities fraud for failure to properly value gains and losses in a transaction with an affiliated company in mainland China.
The SEC also charged Agria with running afoul of the FCPA’s books and records and internal controls provisions. The SEC fined Agria $3 million. In addition, the SEC imposed a fine of $400,000 on Agria’s chairman, Guanglin Lai, and banned him from acting as an officer or director of any public company for five years. Though the problematic transaction took place entirely in China, the SEC had jurisdiction over Agria for one simple reason — the company had American Depositary Shares listed on the New York Stock Exchange.
Agria’s story is one of old-fashioned accounting fraud to conceal losses, boost revenues and inflate the company’s share price. Agria sold its interest in a wholly-owned subsidiary in China known as Taiyuan Primalights III Modernized Agriculture Development Co., Ltd. (Primalights) to Primalights’ chairman. In return, the chairman transferred outstanding Agria shares that he held to Agria. As part of the deal, Primalights also transferred land use rights to nine parcels in Shanxi Province to Agria. However, Primalights’ rights to use the parcels suffered from significant legal defects, which in turn severely impaired Agria’s ability to do anything with the land.
In particular, Primalights had originally leased the Shanxi parcels from local village collectives, but it had failed to obtain the consent of the original owners when it transferred its use rights to Agria. In addition, several of the leases were not registered with the local government, while others exceeded the duration for leases contained in Chinese law. Indeed, because of the numerous defects with the transaction, Agria’s outside counsel concluded that the transfers of the use rights from Primalights to Agria were neither legal nor effective. Ultimately, because of these problems, Agria’s ability to use, and generate income from, the Shanxi parcels was severely limited.
Without getting too far into the accounting weeds, Agria ignored Generally Accepted Accounting Principles (GAAP) when calculating the value of the Primalights divestiture. First, GAAP would have required Agria to consider its limited ability to use and derive profits from the Shanxi parcels when recording their value on its financial statements.
However, Agria failed to do so, and ascribed the parcels an inflated value on its financial statements. In addition, when recording the value of the shares it obtained from Primalights’ chairman, under GAAP Agria should have considered the market value of its American Depositary Shares. Instead, Agria ascribed a higher value to the shares. By ignoring GAAP, Agria concealed losses in the Primalights divestiture of more than $17 million, which improved the company’s balance sheet and helped to inflate its share price on the NYSE. Thus, the SEC charged Agria with securities fraud.
It also charged Agria for failing to adhere to the FCPA’s accounting provisions. In particular, the SEC claimed that the entries in Agria’s books related to the Primalights transaction were false and misleading, resulting in a violation of the FCPA’s books and records provision. And, all of this showed that Agria failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP.
As we noted in an earlier post, roughly 2,000 foreign companies have American Depositary Shares traded on U.S. exchanges, including almost 300 Chinese companies. Agria’s woes, as well as those of its former chairman, underscore to foreign issuers that access to U.S. capital markets comes at a price.
“Creative” accounting on foreign transactions can land a foreign issuer in hot water in the United States.
Bill Steinman, pictured above left, is a Contributing Editor of the FCPA Blog. He’s the senior partner at Steinman & Rodgers LLP, a boutique law firm in Washington DC focused exclusively on international anti-corruption law.
Nan Wang, above right, is an associate at Steinman & Rodgers. She earned her LL.B. from China University of Political Science and Law, and her J.D. at George Washington University Law School. She’s fluent in both Mandarin and English. Among other things, she specializes in assisting Chinese issuers develop and implement anti-corruption compliance programs.