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In recent years, some listed companies have taken various measures to manipulate their business performance in order to cooperate with major shareholder in share reduction, fulfill performance commitments or achieve business targets, which has seriously mislead investors. After carefully studying typical cases and common means to that end, SZSE broke the cover-up and used a mix of serious measures to protect the legitimate rights and interest of investors.
Seeing Through the Game of Performance Manipulation
Abusing accounting judgment to adjust profits, and unfair or fraudulent transactions are common measures of performance manipulation of listed companies.
First, abusing accounting judgment to adjust profits. Listed companies manipulate their business performance by subjectively choosing the accounting judgment in their favor.
For instance, the return rate of a company soared to 52% for the year prior to the disclosure of the periodic report, and the commodities sold by the company was losing competiveness. Yet the company opted for an average of 22% over the last three years when making estimation for the underlying year, hence the possibility of seriously underestimating the rate of return.
SZSE issued a letter of query to the listed company, questioning the underrating of the possibility of a high rate of return for the year in its annual report, requesting the auditors to issue a statement on the audit procedure for the truthfulness of the company’s revenue, and urging the company to evaluate the return rate in a more prudent manner. In the end, the company estimated the return rate by choosing the higher of the return rate for the last operating years and the three-year average. It turned out that the actual return rate was 37%, way higher than the original estimation.
Second, unfair transactions. Related parties or un-related parties having actual beneficial arrangements were funneling benefits into listed companies.
For example, a listed company sold the equities in its subsidiaries whose book value was CNY1 million at the evaluated price of CNY200 million and CNY700 million externally, and recognized proceeds from equity disposal in the total amount of CNY110 million. The discrepancy between the balance of the stake, which was recognized at fair value, and the book value was added to capital gains, which totaled CNY175 million.
As a result of the above, SZSE sent several letters of query to the company, and requested auditors to verify relevant transactions. After gaining some clues, SZSE took further effective regulatory measures.
Third, fraudulent transactions. Listed companies inflated their assets and transferred cash externally in the name of asset purchase, and the money was transferred back to the company on the excuse of client payments.
Some financial indicators turned abnormal if a company’s earnings were inflated via the means mentioned above, SZSE got to the bottom of the issue based on the clues in hand, tried to search for the causes, and proved that some listed companies had manipulated their profits by way of false transactions. SZSE thus had punished several companies accordingly.
Cracking Down on Performance Manipulation with a Combination of Measures
To crack down on performance manipulation, SZSE had built a multi-dimensional regulatory system of measures such as reminding and warning, risk monitoring, investigation and tracking, and disciplinary action, which had effectively addressed violations of profit manipulation.
First, SZSE had issued letters to auditors prior to the disclosure of annual reports, and reminded them to focus on the risks. Before the 2018 annual reports were release, SZSE conducted an overhaul on listed companies featuring risks of substantial goodwill impairment or who might conduct unexpected year-end transactions, or who might fail to fulfill performance commitments or to achieve business targets precisely as promised. SZSE issued over 110 letters of concern to relevant auditors, reminding them to focus on the risks and urging them to duly perform their auditing duties.
Second, SZSE established a financial alarm indicator system and conducted multi-dimensional investigations of performance manipulation risks. From the perspective of trading methods, we focused on risks such as false returned money and false increase in revenue at the end of the period, large-amount abnormal related party transactions, large-amount abnormal asset disposal, and large-amount overseas sales etc. From the perspective of the possible results of performance manipulation, we focused on abnormal fluctuations of assets such as prepayments, construction in progress, inventory, accounts receivable, and the abnormalities of provision for diminution in value.
In response to clues of abnormalities, SZSE investigated thoroughly and sent annual report letters of query to relevant companies for several times. For a company with more doubts and greater risks, SZSE issued letters of query for 4 consecutive times, requesting for sale contracts and corresponding original documents. SZSE also met up with senior executives and intermediary institutions of companies with greater risks, so as to clearly communicate supervision requirements and enhance supervision deterrence.
Third, SZSE actively carried out joint supervision, and built a sound 3D supervision network. A company signed a concerted action agreement with the shareholders of an e-commerce company to control the latter and incorporate it into the former's consolidated statement. The former's annual financial data therefore underwent major changes. According to analysis, SZSE believed that the agreement was weakly binding and the transaction lacked commercial substance, and that there were suspect false transaction and profit manipulation. We took a series of actions such as issuing letters, meeting up with listed companies and their annual auditors, reporting violation clues to CSRC, and conducting supervision together with CSRC's Department of Accounting and the local CSRC office etc. Besides, we promoted and unveiled supervision advice for such transactions. Under constant supervision pressure, the company eventually made corrections in its annual report.
In 2018, SZSE reported 41 violation clues found during audits and evaluations to CSRC, issued 39 letters of request for investigation assistance to CSRC, and sent 36 letters of request for investigation to Inspection Department.
Fourth, SZSE promoted standardization by strict supervision, and guided relevant market entities to fulfill their responsibilities. For parties of financial frauds and intermediaries that failed to perform their duty and obligations, SZSE took disciplinary actions to relevant responsible entities in strict accordance with the Rules Governing Share Listing on Shenzhen Stock Exchange. In 2018, SZSE carried out disciplinary actions to a number of companies that failed to disclose periodic reports on time and had false records in financial data, and 8 CPAs from 4 accounting firms.
An SZSE officer said that accounting supervision has always been the key of SZSE's information disclosure supervision, and it is important to our goal to "show investors the real listed companies". In order to do a good job in the supervision of 2018 annual report disclosure, SZSE developed a detailed annual report review plan. Besides, we developed targeted investigation and inquiry plans for risk points such as precise performance target reaching of companies with large goodwill balance. For companies with great risks, we paid close attention and implemented double audits. We rationally applied the supervision toolbox, reported violation clues in time, strengthened joint supervision, and resolutely curbed profit manipulation so as to purify the market environment.
