On Tuesday, the US Securities and Exchange Commission (SEC) accused four AgFeed Chinese executives and two members of the US management team of reporting fake revenues between 2008 and 2011 to meet financial targets and boost the stock price.
In a regulatory filing on the settlement move yesterday, the animal feed firm said it cannot predict the outcome of any discussions with the commission.
AgFeed was delisted from the Nasdaq Stock Market in 2012 and filed for bankruptcy protection in 2013.
The company was previously based in China and publicly traded in the US before amalgamating with a US company in September 2010 and spreading its operations between the two countries.
Bogus scheme orchestration
The SEC alleges that the four executives in China orchestrated the bogus scheme at AgFeed.
The complaint, filed in the US District Court for the Middle District of Tennessee, charges executive chairman Songyan Li, CEO Junhong Xiong, CFO Selina Jin, and controller Shaobo Ouyang as the management in China behind the scheme, which began in 2008 after AgFeed acquired 29 Chinese farms for its new hog production division.
The agency says the Chinese executives used a variety of methods to inflate revenue over the four years, including fake invoices for the sale of feed and purported sales of hogs that didn’t really exist.
Because fatter hogs bring higher market prices, the executives also inflated the weights of actual hogs sold as well as providing bogus sales revenues for those hogs, alleges the agency.
Failure to come clean
The commission is also suing AgFeed Industries director and chair of AgFeed’s audit committee, K Ivan Gothner, along with its former CFO, Edward Pazdro, for allegedly ignoring the fraud.
A spokesperson for Cooley LLP, the law firm representing Pazdro, told FeedNavigator.com today that the AgFeed director has not entered into a settlement agreement with the SEC.
And Sandra Hanna, attorney for Gothner, said he has not entered into settlement talks with the SEC either. She told this publication that the executive is set to vigorously fight the accusations.
According to the SEC’s complaint, US management learned of the accounting fraud by early June 2011, but failed to take adequate steps to investigate and disclose it to investors.
Not just smoke but fire
The commission claims that Gothner sought advice from a former director and company advisor who responded in e-mails that there was “not just smoke but fire” and recommended that AgFeed hire professional investigators guided by outside legal counsel.
However, the SEC alleges that Gothner ignored the recommendation.
The US regulator claims that Gothner and Pazdro specifically learned that AgFeed’s China operations kept two sets of accounting books and that Ouyang had admitted to the fraud.
Instead of fulfilling their responsibilities as the feed company’s stewards of financial reporting, claims the SEC, the two US executives failed to conduct or prompt the company to carry out any further meaningful investigation into the misconduct.
“This is a cautionary tale of what happens when an audit committee chair fails to perform his gatekeeper function in the face of massive red flags,” said Andrew Ceresney, director of the SEC’s Division of Enforcement.
“Officers and directors have an obligation to exercise diligence and ensure that their financial reporting is accurate,” said Julie Lutz, director of the SEC’s Denver Regional Office.
“Despite learning about false and misleading financial information, AgFeed executives failed to come clean with investors or law enforcement,” she claims.
Settlements with former AgFeed executives
The SEC also announced settlements with two other former officers of the company.
AgFeed’s former chairman and interim CEO, John Stadler, separately consented to an SEC order barring him from acting as an officer or director and requiring him to pay a $100,000 penalty.
He neither admitted nor denied the SEC’s findings, said the regulator.
AgFeed’s former CFO Clayton Marshall, who replaced Pazdro, entered into a cooperation agreement with the SEC.
“The terms of his settlement reflect his assistance in the SEC’s investigation and anticipated cooperation in the pending court action,” said the US agency.
Marshall, who also did not deny or admit wrongdoing, agreed to be suspended from practicing as an accountant on behalf of any publicly-traded company or other entity regulated by the SEC for a period of at least five years.
SEC’s warning on reverse mergers
AgFeed was one of about 370 Chinese firms that listed in the US from 2004 to 2011 using the reverse merger approach.
The reverse merger deal involves a private company acquiring a shell company that is already listed instead of holding an IPO.
The SEC issued an alert in June 2011 warning investors of the risk of investing in foreign companies who enter the US markets through reverse merger transactions.
The regulator’s warning cited a number of China based operating companies that has recently been suspended from trading by the SEC as a result of discoveries of false or misleading financial statements.
The AgFeed regulatory filing can be read here.
The SEC case can be read here.