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Deloitte faces double trouble in China

By Zhang Ran (China Daily)
Updated: 2006-03-31 06:56
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Accounting firm Deloitte, facing a lawsuit in Shanghai and administrative hearing in Beijing over its alleged failure to alert investors to a client's worrisome finances, may be in for a double dose of pressure next week.

A source close to the China Securities Regulatory Commission (CSRC) revealed that it would likely hold an administrative hearing on April 7 to investigate the firm's role in a 2005 scandal involving Chinese refrigerator maker Guangdong Kelon Electrical Holdings Co, a former Deloitte client.

At the same time, a lawsuit was brought to Huangpu District Court in Shanghai on Wednesday, claiming Kelon investors had suffered losses because Deloitte issued unqualified financial reports while auditing Kelon's finances in 2004.

If the accusation is accepted next week, Deloitte will face trouble from both the court and the industry regulator.

Deloitte yesterday refused to comment on the lawsuit that accused the accounting firm of not issuing objective reports about Kelon.

"We did not hear any news about the accusation," Deloitte partner Liao Hanwen said yesterday.

The accusation, if accepted by the court, will be the country's first lawsuit led by investors against an accounting firm and also the first case involving public investors and related financial service parties since the enacting of the New Securities Law on January 1, 2006.

Last year, former Kelon executives were accused of inflating sales and embezzling at least 592 million yuan (US$73 million).

Kelon reported a net loss of 44.7 million yuan (US$5.52 million) in 2004, after posting profit of 84.2 million yuan (US$10.4 million) in 2002 and 197.3 million yuan (US$24.36 million) in 2003.

Kelon managers allegedly inflated profits since 2002 and violated securities laws. Its Hong Kong-traded shares fell 45 per cent since the scandal broke.

Deloitte was the company's auditor for the financial years of 2002 to 2004. The public accounting firm issued qualified opinions in the first two years and an unqualified opinion in 2004. The public blamed Deloitte for not disclosing the internal fraud during its auditing.

"Public investors used to accuse listed firms of cheating and manipulating in a scandal. But this is the first time investors only bring the accounting firms to court," said Tu Yong, attorney at Shanghai Brilliance Law Firm.

Tu emphasized that the accusation was based on the New Securities Law and the Certified Public Accountant Law, which state securities service institutions should investigate the truth of the materials relating to listed firms.

"If the paper report issued by a service institution contains falsehood, misleading and material omit, the service institution should undertake the related obligation unless it could prove it is faultless," the law stipulates.

Deloitte recently wrote a letter to its staff announcing there are no CSRC findings or opinions that any of its auditors participated in, or facilitated, the alleged illegal activities of the former Kelon management or any others.

"We are confident that our audit of Kelon adhered in all material respects to the audit standards of China and those of Deloitte," the letter said. "In fact, in this case, we were one of the victims of the fraud carried out by a number of parties both inside and outside the company".

The letter also said that it was indeed Deloitte that signalled to the market the serious financial problems of Kelon by issuing qualified opinions for two out of the three years and dropping the company as a client.

(China Daily 03/31/2006 page9)