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China Stock Losers: Duoyuan

Stocks in this article: DGW DYP

(Chinese stock accounting scandal, Duoyuan Global water story updated for Tuesday trading)

NEW YORK ( TheStreet) -- It's quickly becoming a market cliché to say that if there's an accounting scandal to be uncovered, look to recent IPO Chinese companies. The Enrons and Worldcoms and Tyco Internationals of the 1990s have given way to the mass wave of Chinese IPOs.

There have been too many accounting scandals from China to not find at least a shred of truth in the fear that an investment in a Chinese stock doesn't just hold the potential for rapid growth, but also equal potential for an accounting scandal. In at least one regard -- not being associated with accounting disasters -- the U.S. is beating China.

The latest Chinese stock disaster related to accounting issues surfaced on Monday, and it concerns not just one, but two affiliated Chinese companies, Duoyuan Printing (DYP) and Duoyuan Global Water (DGW).

To be clear, the accounting issues are specific to Duoyuan Printing, which was down 54% on Monday. However, Duoyuan Printing and Duoyuan Global Water share the same chairman, who serve on the boards of both companies. As a result, shares of Duoyuan Global Water tanked by 41% on Monday. Both companies have seen massive amounts of selling on Monday, with a combined 10 million shares traded. On a typical day, the combined trading volume for these companies is 200,000.

Trading action remained heavy in the linked Chinese stocks on Tuesday morning, but the bleeding had ended, even as the inevitable class-action lawsuit press releases on behalf of Duoyuan shareholders began to be issued.

Shares of Duoyuan Global Water had rallied by as much as 5% in early Tuesday action, and more than 1.5 million shares were traded in the first half hour after the opening bell. Shares of Duoyuan Printing, directly implicated in the accounting issues, were also rallying early, and continued to see high volume, passing one million shares traded within the first hour of the Tuesday market open. Of course, a 5% rally is not much of a victory when following a drop of 50% on the day previous to the rally.

Duoyuan Printing announced a number of changes on Monday that led to the selloff. The chairman announced that the CEO and CFO of the company were being replaced, and the Deloitte Touche Tohmatsu had been fired as auditor. Duoyuan Chairman Wenhua Guo stated in the release announcing the changes, "The audit committee's decision to change auditing firms was based on its desire to resolve open issues and file our 10-K on a timely basis. We will work closely with our new auditors to address the open issues aired by Deloitte."

One analyst familiar with the company said that's not necessarily the case, and that the firing of Deloitte & Touche could be read as the classic tussle between an auditor requesting access to information that a company refuses to provide. Deloitte may have refused to sign off on financial statements without access to certain records, which the Duoyuan CEO and CFO refused to make available. There were open issues with Deloitte over permission to look at bank statements, expenses and relationships with distributors, which the CEO and CFO of Duoyuan Printing reportedly could not or would not provide to Deloitte.

Regardless, firing the CEO and CFO won't likely solve any of these issues, as the market reaction attested to on Monday, as investors don't see the accounting issues at Duoyuan Printing as necessarily the result of a few bad apples in management.

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