The Securities and Exchange Commission has charged a China-based company and the CEO with fraudulently misleading investors about its financial condition by touting cash balances that were millions of dollars higher than actual amounts.
The case is the latest from the SEC's Cross-Border Working Group that focuses on companies with substantial foreign operations that are publicly traded in the U.S.
The Working Group has enabled the SEC to file fraud cases against more than 65 foreign issuers or executives and deregister the securities of more than 50 companies.
The SEC alleges that China MediaExpress, which purports to operate a television advertising network on inter-city and airport express buses in the People's Republic of China, began falsely reporting significant increases in its business operations, financial condition, and profits almost immediately upon becoming a publicly-traded company through a reverse merger.
In addition to grossly overstating its cash balances, China MediaExpress also falsely stated in public filings and press releases that two multi-national corporations were its advertising clients when, in fact, they were not.
The company's chairman and CEO Zheng Cheng signed the public filings and attested to their accuracy. After suspicions of fraud were raised by the company's external auditor and an internal investigation ensued, Zheng attempted to pay off a senior accountant assigned to the case.
"Investor confidence in the representations made by publicly-traded companies is critically important to the proper functioning of our financial markets," said Antonia Chion, Associate Director in the SEC's Division of Enforcement. "China MediaExpress and Zheng falsely reported whopping increases in its cash balances and deceptively raised money from stock sales. Today's action demonstrates the Commission's commitment to policing financial fraud in the U.S. markets, regardless of whether it is perpetrated by persons who live here or abroad."
According to the SEC's complaint filed in Washington D.C., China MediaExpress became a publicly-traded company in October 2009 and began materially overstating its cash balances in press releases and SEC filings. For example, its 2009 annual report filed on March 31, 2010, reported $57 million in cash on hand when it actually had a cash balance of merely $141,000. Later that year on November 9, 2010, China MediaExpress issued a press release boasting a cash balance of $170 million at the end of the third quarter of its fiscal year. The actual cash balance was just $10 million.
According to the SEC's complaint, after China Media materially misrepresented its financial condition, its stock price tripled to more than $20 per share. At the same time, China Media received $53 million from a hedge fund pursuant to a sale of the company's preferred and common stock to that fund.
Zheng was financially incentivized to misrepresent China MediaExpress' financial condition, as he had agreements to receive stock if the company met certain net income targets. For instance, when China Media met net income targets for fiscal year 2009, Zheng personally received 600,000 shares of China MediaExpress stock that were worth approximately $6 million at the time.
According to the SEC's complaint, China MediaExpress' external auditor resigned in March 2011 due to suspicions about fraudulent bank confirmations and statements. The company's audit committee then retained a law firm to conduct an internal investigation. The law firm hired a Hong Kong forensic accounting firm to assist in obtaining bank statements from China MediaExpress' banks to verify the publicly reported cash balances.
The evening before a planned visit to the banks by the accounting firm's team, Zheng called a senior accountant assigned to the team and told him that he had the authorisation letters necessary to obtain China MediaExpress' bank statements. He asked the accountant to meet him alone to obtain the authorisation letters.
During the meeting, Zheng admitted that there would be discrepancies dating back one to two years between China MediaExpress' reported and actual cash balances. Zheng offered the accountant approximately $1.5 million to "assist with the investigation." The accountant refused the offer. Approximately one month later, the bank statements were obtained, and they showed substantial discrepancies between publicly reported and actual cash balances.
The SEC's complaint charges Zheng and China MediaExpress with violations of the antifraud provisions of the federal securities laws. The complaint charges China MediaExpress with violations of the reporting, books and records, and internal control provisions, and charges Zheng with violating the SEC's rules prohibiting lying to auditors and making false certifications required under the Sarbanes-Oxley Act. The complaint seeks financial penalties, permanent injunctions, disgorgement, and an officer and director bar against Zheng.