A finance manager in China reached out to her bosses, concerned that auditors would discover AgFeed Industries Inc. (FEEDQ:US) was reporting bogus revenue.
“Sometimes I really want to work well on the real stuff, but the need to balance the falsified data often takes up my time,” Wu Jiangqi wrote to supervisors at the Nanchang, China-based animal-feed company in 2009, according to a copy of an e-mail she sent.
Wu’s e-mail focused on top management’s “most serious headache, which can only be resolved by money,” then-Chief Executive Officer Xiong Junhong responded. Officials were “thinking of ways to get 30 to 40 million to resolve this!” he wrote.
The e-mails, which were translated from Chinese, and other documents obtained by Bloomberg News provide the first detailed glimpses behind what a U.S. Trustee in bankruptcy court called “massive fraud” in AgFeed’s Chinese operations. Managers in China openly discussed their methods for doctoring results, according to the e-mails. As evidence of irregularities began accumulating, executives and directors waited at least four months before disclosing any of it to investors, corporate documents show.
As U.S. markets warm to China stocks again, with at least eight initial public offerings this year, investors have reason to be wary, said Lynn Turner, a former chief accountant at the Securities and Exchange Commission. The scam AgFeed is accused of -- undetected by such gatekeepers of U.S. markets as auditors and underwriters -- shows the risks for American shareholders, he said.
“What’s the difference between investing in a Chinese company where you can’t do your homework and going to Las Vegas to play at the craps table?” he said. “At least at Las Vegas you get some entertainment value.”
More than $100 million that AgFeed raised (FEEDQ:US) in the U.S. from 2007 through 2009 was sent to China with little real oversight, the documents indicate. The SEC told AgFeed on Aug. 29 that it plans enforcement action against the company for alleged violations of securities law. That was a month after the company filed for bankruptcy and six years to the day from its launch on the Nasdaq exchange.
Documents and details of the alleged fraud are emerging courtesy of a former AgFeed director who cooperated with shareholders suing the company. Milton Webster, who joined the board in February 2011, had led an investigation into accounting issues in the Chinese operations. He resigned in February 2012, frustrated that the findings weren’t made public, he said.
When Webster testified about the reasons for AgFeed’s failure in a July deposition for the shareholder suit, several AgFeed e-mails and corporate documents were introduced as exhibits in the proceeding. He provided the exhibits to Bloomberg News. Webster, 66, died this month, said his son, Michael Webster.
“Management didn’t give a damn about corporate governance,” Milton Webster said in a November interview. “If I had known Day 1 what I know today, then I never would have agreed to join the board.”
Xiong, the former CEO, declined to comment about his e-mail exchange with Wu, the finance manager. Wu couldn’t be reached for comment.
On Dec. 18, AgFeed filed a disclosure statement in bankruptcy court confirming that some of its Chinese operations reported “fictitious” sales from 2008 through the first half of 2011. Keith Maib, appointed chief restructuring officer for AgFeed in May, didn’t respond to telephone messages and an e-mailed request for comment.
AgFeed was among more than 370 Chinese companies that listed in the U.S. from 2004 to 2011 via reverse mergers. In such transactions, a private company acquires a shell company that’s already listed instead of holding an IPO. Since 2010, when a handful of research firms began publishing claims of fraud against some of the companies, the SEC has deregistered 60 China-based issuers.
AgFeed did a reverse merger in 2006 and listed on Nasdaq the next year, after reporting a six-fold quarterly revenue increase in August 2007. Soon, the company was moving into hog production. By April 2008, AgFeed was forecasting sales would almost quadruple to $135 million as it aimed to become China’s No. 1 live hog producer. The company pitched itself as an aggregator, bringing professional management and a board of senior Wall Street executives to an industry of backyard producers, according to an investor presentation.
Thomas Snodgrass, a financial adviser in Houston at the time, was sold on the idea. He invested $169,332 in June and August of 2008, according to filings in the shareholder lawsuit.
“I thought, ‘Oh my God, with an under-industrialized society and the emergence of that industry, well then they should be well positioned to capture a whole lot more market share,’” said Snodgrass, now a consultant in the hospitality industry.
AgFeed embarked on a hog-farm buying spree in China with proceeds from $76 million in sales of shares and convertible debt -- transactions that also benefited Wall Street firms. One February 2008 sale of $19 million in convertible debt rewarded Deutsche Bank Securities Inc. with 8.6 percent of the proceeds for advising, records show. Deutsche Bank spokeswoman Mayura Hooper declined to comment.
On June 4, 2008, after AgFeed executives rang Nasdaq’s opening bell, the stock closed at $15.54, almost doubling from the end of 2007. Overseas, an alternate reality was unfolding.
The farm purchases -- 29 in five provinces by October 2008 -- were a nest of hasty, overpriced transactions done to justify the company’s U.S. fundraising, according to e-mails shared among members of the investigative committee that Webster headed. He provided the e-mails to Bloomberg News.
Then-CEO Xiong appealed to a friend, Tu Yaoliang, to let AgFeed buy his farm near Shanghai, according to interviews that Tu gave the board investigators. The sale price, 35 million yuan ($5.8 million), included 6.6 million yuan of profit for Tu that was instead recorded as fees and funding for a building project, Tu said in the interviews. Tu, who joined AgFeed as an employee after the sale, declined to comment for this story.
Xiong disputed that account, saying “I don’t think that’s what happened.” The company had to pay top dollar to induce landowners to sell the farms, he said.
“Our strategy then was to acquire many farms in order to make money,” Xiong said in a telephone interview. “That was the right strategy, although the cost was high.”
The hog-farm purchases showed “extreme mismanagement” by the board, wrote Glenn McClelland, who was the company’s chief operating officer for about six months beginning in July 2011 and did his own investigation of the Chinese operations. McClelland, whose report to the board was included as an exhibit in Webster’s deposition, declined to comment.
During an eight-hour meeting in Nanchang, famed as the birthplace of the Peopleâs Liberation Army, AgFeed’s Chinese founders insisted to McClelland that they were urged to make the farm purchases by unnamed “Wall Street Guys,” according to the report.
“The founders told the ‘Wall Street Guys’ this whole deal is crazy,” McClelland wrote. “But nobody listened to them. Instead daily and weekly they were instructed to acquire more hog farms regardless of the price.”
The “Wall Street Guys” were never identified in the board’s documents.
AgFeed’s entry into the U.S. market was aided by New York Global Group, a firm with offices in New York and Beijing that focused on Chinese companies. Benjamin Wey, a Chinese-born entrepreneur who heads NYGG, advised AgFeed on stock offerings for a one-time fee of $300,000, according to a company filing. His firm helped AgFeed raise $86 million, according to a NYGG press release in 2008.
Wey didn’t respond to telephone messages and e-mails requesting comment.
Fredric Rittereiser, a former AgFeed board member and chairman of the audit committee who stepped down in 2009, said he doesn’t think Wey was aware of any fraud in the China operations. Rittereiser said he wasn’t either.
“I had no idea of a fraud, and I’m not a stupid guy,” said Rittereiser, a former police officer and former CEO of Ashton Technology Group Inc., an electronic trading systems company. He said many of the farm purchases were negotiated before he joined the board in late 2007. Rittereiser, who had hired Wey as a consultant at Ashton, said he became an AgFeed board member through Wey.
Rittereiser said he ended AgFeed’s relationship with Wey in October 2008 because the consultant was too aggressive in pushing the Chinese executives to expand and hit financial targets.
AgFeed’s reports to U.S. investors contained largely positive news until November 2008, when AgFeed withdrew its earnings targets for 2009, cut its estimated 2008 earnings (FEEDQ:US) by half and said it was scaling back acquisition plans. The company blamed falling hog prices, increasing swine supply and the global economic downturn. Shares ended 2008 at $1.61, an 81 percent drop for the year.
Still, AgFeed kept raising money: $8.75 million in a private placement in December 2008, $10 million more in May 2009. In September 2009, the company announced a $50 million equity credit agreement with an institutional investor, Southridge Partners II LP.
In China, managers struggled to meet U.S. investors’ expectations in 2009, e-mails show. To boost the feed division’s second-quarter profit of 3.8 million yuan, managers created non-existent business, according to e-mails written by Wu, the finance manager.
“The profits of the non-existing businesses are all kept in the accounts receivables,” she wrote, referring to an accounting category for uncollected customer payments. “This can be easily detected by external auditors.”
It wasn’t detected by AgFeed’s auditor. Goldman Parks Kurland Mohidin LLP, a California firm with no China operations, was the company’s independent auditor from 2006 through 2010. Goldman Parks farmed out the auditing work in China to a Chinese firm, according to public filings. Goldman Parks signed off on the 2009 financial statements as AgFeed reported its revenue increased 21 percent to $173.2 million.
Ahmed Mohidin, a partner in the accounting firm, now known as Goldman Kurland and Mohidin LLP, declined to comment.
Shares tripled in 2009. By mid-2010, AgFeed’s shareholders numbered more than 22,000. The company announced plans to sell 20 percent of its feed business to raise $25 million. That August, AgFeed purchased Ames, Iowa-based M2P2 LLC, the biggest hog supplier to Hormel Foods Corp. (HRL:US), for $22 million. With M2P2 came U.S. executives with experience in swine production, including Glenn McClelland, who would soon be investigating the Chinese operations.
At the same time, short-sellers -- investors who hope to profit when stocks decline in value -- began slamming some Chinese firms’ accounting in published reports.
AgFeed reported dismal news in November 2010, taking a $16.8 million write-off in the value of its hog farms. During the next four months, the company replaced its auditor, chief financial officer, chairman and CEO. The new auditor, McGladrey & Pullen LLP, proposed delaying the required 10K filing (FEEDQ:US).
“ABSOLUTELY NOT,” wrote Rittereiser, who’d stayed on as a consultant after leaving the board in 2009. A delay would scuttle his attempt to raise $20 million in a convertible debt sale and hurt the prospects for the feed division’s IPO, he wrote in capital letters in an e-mail.
“THE MARKET, THE INVESTORS AND THE PRESS WILL KILL US WITH THE FACT OF DELAY AND INNUENDO LIKE ALL THE OTHER CHINESE PHONEY STOCKS,” he wrote.
The annual report went out on time, with bad news for shareholders: For the year, AgFeed lost $42.7 million on revenue of $243.6 million and wrote off $30.6 million of the $66.7 million it spent acquiring Chinese hog farms.
Bad news kept coming, behind closed doors. In the second quarter of 2011, an unnamed whistle-blower told AgFeed managers that its China operations were keeping multiple sets of books to inflate results, according to exhibits in Webster’s deposition.
Farms did indeed keep two sets of books, Thomas Yang, a lawyer whom AgFeed sent to investigate, concluded in a report to the board in early June 2011. There were actual books and “adjusted books in order to make AgFeed’s revenue and net income look better,” according to Yang’s memo to board members.
With credible allegations of wrongdoing in hand, directors should have warned shareholders and begun an independent investigation, said Joseph Carcello, co-founder of the Corporate Governance Center at the University of Tennessee in Knoxville, after he was briefed on the outlines of the allegations and Yang’s report. Shareholders have a right to know about such issues, and the standard for disclosure is whether the allegations are credible, not whether they’re proven, he said.
“If there are credible allegations of financial-statement fraud or improprieties, and there’s an investigation being done, the capital markets need to know,” Carcello said.
AgFeed’s board got the opposite advice during a July 8 telephone conference, meeting minutes show. Despite Yang’s memo, AgFeed’s company counsel, Sunjeet Gill, told the board members the allegations weren’t substantiated, and they didn’t have to be disclosed, though the decision would have to be revisited as more information was gathered.
Gill gave AgFeed advice that was proper based on the facts and circumstances known to him at the time, said Peter Glenn, a lawyer for Gill’s firm, Stevens & Lee, who responded to a request for comment.
“The pros were saying, ‘It’s not there, and until it’s there, it’s not a problem,’” said Rittereiser. “They said we can’t redo our financial statements unless we can prove or disprove the allegation.”
Another troubling item emerged during the July discussion, according to the minutes: That April, AgFeed’s Chinese founders sold $22 million of the accounts receivable -- the accounting category that Wu’s e-mail had referenced -- to collections agents at a 40 percent discount.
During the July teleconference, the board appointed an independent board member, K. Ivan F. Gothner, as vice president in charge of investor relations and capital market transactions. Gothner, who’d served on the board and as head of the audit committee since December 2009, also remained a director, the minutes show.
Gothner and Rittereiser were business partners; in 2009, they co-founded Covenant Group of China (CVGC:US), which aims to make private investments in China-based companies. Gothner didn’t respond to telephone messages and an e-mail seeking comment.
While AgFeed announced some personnel changes in a July news release, it didn’t disclose any of the operational issues in China. On Aug. 9, 2011, in a quarterly filing known as a 10-Q, it reported a second-quarter net loss of $15.9 million and canceled the feed division’s IPO. The company tapped its equity credit agreement with Southridge to raise $6 million later that month.
SEC investigators believe AgFeed’s U.S. management was “apprised of a number of ‘red flags,’ which show the existence of fraud” and that managers were “aware of the falsity of AgFeed Industries financial statements” when they filed the August 10-Q, the company said in a Dec. 18 bankruptcy filing. John Nester, an SEC spokesman, declined to comment.
It wasn’t until Sept. 29, 2011, that AgFeed announced that a special committee would investigate the Chinese farm purchases and the feed division’s accounts receivable.
On Dec. 16, 2011, the company disclosed that the investigation found China-based staff members “engaged in accounting improprieties” and said there was no indication that any U.S. employees or managers were involved. The company withdrew its financial statements for 2009, 2010 and 2011.
John Stadler, a swine industry executive who served as chairman and interim CEO since February 2011, resigned that month, citing personal reasons, according to a company news release. Gothner replaced him. McClelland, the COO who’d investigated much of the alleged wrongdoing, left next, in January 2012.
Webster, who led the board’s formal investigation, summed up his findings in an e-mail that month: failed corporate governance, apparent fraud in the Chinese feed operation, accounting restatements and perhaps $100 million in losses and impairments going back to 2009. He lobbied to release those conclusions publicly, without success, and resigned in February 2012. That month, the company voluntarily delisted from Nasdaq.
This past August, AgFeed terminated Gothner, who was making $500,000 a year, citing in a filing to the SEC the bankruptcy and his diminished role as CEO. He continued serving as chairman of the board until last month, when he resigned.
The U.S. Trustee, the Justice Department’s bankruptcy watchdog, in November asked the bankruptcy court to appoint an independent party to manage the case, based on evidence of fraud, incompetence and mismanagement by AgFeed’s leaders. The judge rejected the request.
In its disclosure statement last week, the company gave the first accounting -- albeit unaudited -- of its Chinese operations since it withdrew its financial statements in late 2011. AgFeed reduced the revenue from its hog farms by more than $50 million in both 2008 and 2009 and by $21.3 million in 2010.
The disclosure statement also said the company now believes its Chinese feed division “created fraudulent account receivables” and then sold them at a discount. AgFeed lowered that division’s revenue by $19.5 million for 2008, $21.4 million for 2009 and $56.8 million for 2010.
Snodgrass, the Houston investor, isn’t planning to buy any more stock in U.S.-listed Chinese companies.
“It’s just out and out fraud when it comes down to it,” he said. “And by the time we hear it, you’re screwed, because the price is already moving; it’s going to tank. You can’t get out of it.”
The case is In re AgFeed USA LLC, 13-bk-11761, U.S. Bankruptcy Court, District of Delaware (Wilmington).
To contact the reporter on this story: Dune Lawrence in New York at firstname.lastname@example.org
To contact the editor responsible for this story: John Voskuhl at email@example.com