KPMG has been accused of “appalling” audit work that allowed a US-listed Chinese biotechnology company to carry out a “brazen” $400 million (€403 million) accounting fraud, the Hong Kong High Court heard on Monday.
The liquidator of China Medical Technologies, which collapsed in 2012 and whose senior executives are wanted on fraud charges in the US, said the Big Four audit firm failed to ask “obvious” questions that would have “easily” exposed the fraud.
These included not questioning a large related-party transaction by the group in 2006, when it acquired a Chinese diagnostics business worth $155,000 for $176 million, according to the liquidator.
It is suing KPMG on the grounds that losses at China Medical “flowed from” its negligent audit work, which gave the company accounts a clean bill of health in 2007 and 2008, according to Monday’s hearing. It is asking for as much as $454 million to cover allegedly misappropriated cash and dividends that were paid out to shareholders while the company was operating under a negligent audit, plus interest of more than $376 million, according to a person close to the matter.
China Medical raised $426 million from international investors in two convertible bonds in 2008 and 2010. The company filed for liquidation in 2012, and in 2017 US prosecutors charged its founder and chief executive Xiaodong Wu and chief financial officer Samson Tsang with fraud, saying they had “made off” with the bulk of the proceeds. The former executives lived in China and have not faced trial in the US.
The company’s liquidators at Borrelli Walsh had previously alleged that the wife of one senior executive gambled more than $100mn of the bond proceeds in Las Vegas casinos.
KPMG has denied the allegations. Documents detailing its defence said the claims were “without merit ...[and] fail to demonstrate a plausible link between KPMG’s alleged breaches and the losses”. It has filed a counterclaim that alleges that China Medical made “false representations” to its auditors.
The China Medical case is the latest to have drawn attention to the audits of Chinese companies that list outside mainland China.
The Big Four auditors — which also include PwC, Deloitte and EY — have faced scrutiny over their work checking the accounts of heavily indebted Chinese property developers and a string of US-listed groups that have been targeted by short sellers over their accounting practices or alleged stock manipulation.
Last year, KPMG settled a separate case in Hong Kong for $84 million after it failed to identify fraud at a Chinese timber company, China Forestry.
The China Medical case has also become a key episode in the long-running battle between China and foreign regulators and investors over the production of Chinese audit files. It has taken years to go to trial because Borrelli Walsh was forced into a lengthy court battle with KPMG in both Hong Kong and mainland China to force it to hand over its audit work papers.
KPMG, which had audited the company from Hong Kong and Beijing since it listed in New York in 2005, eventually granted Borrelli Walsh access in order to prevent the liquidators suing 91 of its partners for ignoring a court order to hand over the documents.
China Medical was one of dozens of Chinese groups that were scrutinised by short sellers in the early 2010s. Beijing was opening up its equity markets and capital flooded from the mainland into Hong Kong, while there was a boom in Chinese companies listing in the US.
In 2020, a $300 million fraud at Nasdaq-listed Chinese coffee chain Luckin Coffee added to worsening geopolitical tensions between the US and China. It resulted in new legislation to force Chinese companies off New York exchanges unless they allowed their audit files to be examined by US regulators.
Borrelli Walsh declined to comment on the case and KPMG said it was unable to comment while the hearing was still in progress, but was “defending the claim”. — Copyright The Financial Times Limited 2022
