Accounting for Past Mistakes

It all started, according to MaloneBailey's Qin, when the firm instituted a more-rigorous process for examining Chinese companies for the fiscal 2010 audit cycle.

As allegations and revelations of fraud hit one Chinese reverse-merger stock after another last year -- often brought to light by short sellers who profit when share prices decline -- the resulting scandals sparked the SEC and its auditor regulator, the PCAOB, to launch a broad inquiry into the matter.

The SEC set up a task force to investigate fraud allegations directed at Chinese reverse-merger companies, and to examine the role of the U.S.-based firms that help bring them public here -- the so-called gatekeepers -- including promoters, investment banks and auditors. No such firms have been accused of wrongdoing by federal officials.

The scene, however, has intensified this year, with explosive fraud allegations and company-specific SEC probes leading to a handful of trading halts and/or delistings, such as China MediaExpress ( CCME), Duoyuan Printing ( DYP) and Fuqi International ( FUQI).

(Defenders of Chinese listings in the U.S. maintain that the incidence of fraud among Chinese companies is no greater or lesser than it is among American companies. Still, of the 13 stocks with trading halts currently in place on major U.S. exchanges, nine are Chinese -- or 70% of them.)
MaloneBailey's head of China auditing, George Qin

With the scandal widening, Qin says that MaloneBailey decided to adopt a new "procedure" for the 2010 audits of its Chinese clients. Instead of relying merely on documents provided to auditors by the companies themselves, MaloneBailey would now obtain original bank statements and analyze them for their authenticity. "The PCAOB doesn't even require that," Qin said.

(Though the PCAOB's rules don't specifically require auditors to fetch original statements from a client's bank, if something makes the auditor question the reliability of available information, then the auditor might obtain original bank-account statements as part of its audit procedures, said PCAOB spokeswoman Colleen Brennan.)

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