China Must Crack Down on Earnings Manipulation at Public Companies
Xu Yunfeng
/SOURCE : Yicai
China Must Crack Down on Earnings Manipulation at Public Companies

(Yicai Global) Feb. 1 -- Several companies listed on the A-share market announced a swing into the red in their latest earnings reports. Fluctuations in financials are normal on the capital market, but these groups tried to justify unexpected losses with rather dramatic reasons, putting themselves under the spotlight for suspected manipulation practices. 

Zoneco Group Co. is one of the groups. The firm updated its 2017 forecast Jan. 30, adjusting it from a profit of up to CNY530 million (USD84.2 million) to a loss of CNY530 million to CNY720 million due to damages to its scallop stock in some areas.

The company claimed it faced a similar situation in 2014. That year a rare cold water current allegedly wiped out some 66,667 hectares of scallop stock in the north Yellow Sea, resulting in losses of over CNY800 million in the third quarter and heavy losses for the year.

"Scallops are growing normally in line with expectations, and there is no sign of asset impairment risks," the company wrote in a statement in June 2015 that coincided with an announcement of a proposed private share placement. The timing sparked speculation that the statement was issued to facilitate the share issuance.

Bus Online Co. slashed its full-year earnings forecast from a profit of up to CNY210 million (disclosed in the third quarter report) to between CNY1.5 billion and CNY1.8 billion on Jan. 30. The reason it gave, to investors' surprise, was that Wang Xianshu, the firm's general manager and legal representative, unexpectedly disappeared last month.

Leshi Internet Information & Technology Corp. projected a yearly loss of CNY11.6, setting a record on the Shenzhen Stock Exchange. Unlike those of the other two companies, its loss was not caused entirely by ineffective operations or mismanagement, and all the potential risks facing the company have been factored into its calculations.

Accounting manipulation is a common practice on the A-share market. To a certain extent, eliminating this phenomenon altogether is not possible. However, overdoing it or attempting to justify losses with unconvincing reasons may constitute regulatory violations, and the companies will be brought to justice in the end.

If a listed company has lost the ability to generate a sustainable profit due to changes in market conditions or mismanagement, it no longer conforms to the listing criteria and should therefore be delisted. Some A-share firms have been in the red for many years, but they concealed operating losses by intentionally misrepresenting financial information so that they could stay on the stock market.

Public companies are supposed to be guideposts for Chinese enterprises, because floating on the stock market is a transformative opportunity for most companies. While foreseeing risks and maintaining high-quality growth is sometimes impossible for public companies, all businesses must comply with the basic code of conduct once they are listed as a 'minimum requirement.'

Therefore, issues related to profit manipulation should be subject to thorough scrutiny by regulators. Authorities should particularly pay attention to firms that tampered with profit results through year-end asset disposal and debt restructuring transactions. They should work to strengthen regulations of assets sales, debt restructuring, accounting estimates and policy adjustments, and withdrawals and reversals of impairment provisions that cannot be justified by business motives, focusing on high-risk companies with substantial losses that have received a delisting warning and those whose earnings results investors question.

The China Securities Regulatory Commission set out nine priority tasks at the national securities and futures regulation conference yesterday. It identified financial risk prevention and control as the top priority. Widespread earnings manipulation among A-share companies makes investors feel that they are 'minesweepers' -- they may step on a 'landmine' laid by a public company at any moment.

To minimize risk, the CSRC, as the top-level regulator for listed firms, has always prioritized "small investor protection" as one of its three fundamental responsibilities. Relevant CSRC departments should react swiftly to threats posed by Zoneco and other high-risk companies, ordering them to disclose full details about suspected accounting irregularities. Authorities should impose severe penalties on managers found to be violating the law, regulations or information disclosure rules, otherwise the market will see more 'drama' in the future.

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Keywords: LISTED COMPANIES , Profit Manipulation