Caterpillar's Siwei Problem
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Caterpillar's Siwei Problem

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As previously covered on Pacific Money, accounting and reporting standards in mainland China have been under intense scrutiny in recent years following a string of scandals involving small Chinese firms listed overseas.  The accounting issue raised its head again this week, this time sucking in a Fortune 500 Company in relation to its recent acquisition of a Chinese group.

Last year Caterpillar Inc. was ranked among the top 50 businesses in the Fortune 500. It operates directly and through numerous subsidiaries across North and South America, Japan and Europe, and has also made acquisitions in emerging markets – notably China and India – where construction booms have provided numerous opportunities for the company. 

Caterpillar last June acquired ERA Mining Machinery Ltd, a HK-listed company that was in fact the result of a “backdoor listing” of Siwei, a Zhengzhou-based company which provides equipment for the mining industry.  Siwei had undertaken a “reverse merger” with ERA Holdings Global Ltd (a “secretarial services” company listed on HK that had no relation to mining or construction) in 2010, and had thus been effectively trading on HK’s Growth Enterprise Market.  Reverse mergers, which rose to infamy during recent short-seller provoked attacks on such firms trading in the United States and Canada, are a common way for companies to be listed without going through the more expensive (and revealing) regulatory and media scrutiny of an Initial Public Offering (IPO).

According to statements from the multi-national Caterpillar, in November 2012 “discrepancies” were discovered between Siwei’s physical inventory and its accounts.  The investigation discovered what Caterpillar described as a “deliberate, multi-year, coordinated accounting misconduct” at Siwei.  The “misconduct” (read “fraud”), involved deliberate miscounting of both costs and revenues.  As a result, Caterpillar has taken an impairment charge (loss of value) of more than 80 percent the value of the deal, or nearly 10 percent of its expected 2012 earnings-per-share (EPS).

The Siwei debacle has probably taught Caterpillar a tough lesson about accounting standards in China which, as previously mentioned on this blog, can sometimes be lacking.  Obviously questions are being asked about whether enough due diligence had been performed on Siwei before the acquisition.  In Caterpillar’s defense, as the company has pointed out, “Siwei was a publicly traded company with audited financial statements.”

This last statement resonates particularly for those who have been following the events covered in the earlier Pacific Money posting. For the U.S. Securities and Exchange Commission (SEC), which is still involved in a stand-off with the China Securities Regulatory Commission (CSRC) about access to audit records, this latest incident will only bolster its case.  It is significant that ERA Mining Machinery Ltd was listed in Hong Kong, not the United States, confirming that the issue is not just a U.S.-China problem, but a reverse-merger, and indeed, China-wide problem. Rather than obstructing the SEC and other foreign regulators, cooperation should be encouraged to allow Chinese firms to establish more solid reputations and higher standards, which will benefit not only foreign investors and companies, but also investors inside China.   

Comments
4
viv
January 25, 2013 at 06:42

Who is really responsible in this story? No one as all business deals rely only on disclaimers. But now who will pay for that? Management? Employee? Shareholders and customers of course. Common sense in due diligence is to respect several steps  and if a risk is there, make provisions before placing a bid. Siwei was already known in the past having creative financing and accounting practices. Before taking a deal, management should think how much money out of their pocket they would put on the table and not just rely on reports like we do at school.
At least few ones made a good deal!

vic
January 22, 2013 at 21:51

The same mistake – never trust accounting firms to do audits.  Fraud is only just beneath the surface which can be unearthed if there is "due diligence".  However would you trust an accounting firm to do your work if vast amounts are involved and if a percentage is paid to brokers and auditing firms if the deal is done.  The CEO should do "due diligence".

Errol
January 22, 2013 at 08:38

Playing by the rules? Others would say why should they play by the rules that a certain direction in the map (left) made up? A country should should follow that country's own rules, especially if it has had a very long history of doing so.

Bertdel
January 22, 2013 at 06:11

It's called greed.  Western greed.  Anytime someone does not want to be scrutinized fully or independently, something is up.  Common sense.  Whoever fell for this scheme deserves it.  Caterpillar included.

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