Chemical burns

3 Sep 2014 By John Foley

Fraud allegations and China are seemingly inseparable. Tianhe Chemicals, an industrial group that listed in Hong Kong less than three months ago, is under fire from a group alleging it cooked its books. This challenges not just the company’s integrity, but investors’ belief that when big names have pored over an initial public offering, they don’t have to.

As its name suggests, Anonymous Analytics doesn’t identify its researchers. Nonetheless it has come up with some detailed allegations. Among them: the profit that Tianhe reports to Chinese regulators differs from what’s in its financial statements; local tax data suggests Tianhe overstated its payments; and big customers are related parties. The company says the report has “errors of fact”, though hasn’t yet given a detailed rebuttal. Its shares remain suspended from trading.

China always offers huge room for ambiguity. Filings to local regulators are often fragmented and rely on different accounting treatment from more transparent foreign markets. Local governments, which get big subsidies from Beijing, have reason to understate their tax revenue.

All of this should have been easy for the company’s underwriters, led by Morgan Stanley, Bank of America and UBS, to verify. Regulatory accounts are publicly available. It’s easy to visit big customers. The suggestion that Tianhe’s reported sales of a substance called anti-mar are twice the size of the global market should be simple for one of the many chemicals industry specialists employed by big banks to assess.

Anonymous may therefore be proved wrong. If its allegations are confirmed, however, the effect will be explosive. Under new Hong Kong rules, public offering sponsors can be criminally liable for what goes into a prospectus. Morgan Stanley is also a shareholder, which prides itself on detailed private equity due diligence. Its $300 million Tianhe investment in 2012 is one of the firm’s biggest in Asia.

Investors who don’t already know that Chinese accounting is a slippery business should not be in the market. But the suggestion that Wall Street’s finest got it wrong is more destabilizing. Faced with China’s weak institutions, investors often treat the presence of big names as a form of insurance. If their faith proves unjustified, China will suddenly look a lot less investible.


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