China Green Agriculture: Why This Chinese Class Action Lawsuit Is Different Than the Rest

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 |  Includes: CGA, CHBT, CHNG, CXTI, DGWIY, DYP, ONP
by: Alfred Little

Click to enlargeOn Friday a highly regarded law firm, Saxena White P.A., announced it has commenced a class action lawsuit on behalf of shareholders of China Green Agriculture (NYSE:CGA), by filing a detailed 46 page complaint (available for downloading here) with the US District Court of Nevada. What makes this lawsuit stand out from previous cases is that it is supported by much stronger evidence (see the table below) resulting in some very serious allegations made by an experienced team of lawyers (Saxena White’s partners came from Milberg Weiss, the nation’s first and formerly largest class action outfit that won over $45 billion for defrauded shareholders over its 30 year history; including $7.2 billion from Enron). Since leaving Milberg, Saxena White attorneys have won large settlements over the past several years, most notably $53.3 million from Sirva, Inc. and $34.4 million from Cablevision Systems.

I will now summarize the major findings laid out in great detail in Saxena White’s complaint along with CGA management’s explanations:

  1. Value Added Tax (VAT) Paid. According to its press release dated September 13, 2010 (available here), CGA management stated that during the two-year period ending June 2010, it made VAT payments totaling approximately $9.4 million to the Chinese State Administration of Taxation (SAT). However, SAT records Saxena White cites in its lawsuit clearly show miniscule VAT payments made over this period totaling less than $100,000 (a copy of the records and the due diligence report prepared by IFRA is available for download here). CGA management’s explanation to date simply describes these records as “incomplete.” Despite the falling stock price, analyst downgrades and resignation of their IR firm CGA management has not produced any evidence to counter this claim. Intelligent investors must assume at this point that these were phantom payments and over $9 million in company funds are plainly missing.
  2. Corporate Income Tax (CIT) Paid. In this same press release, CGA management stated it paid “RMB 14,466,731.61 (approximately $2.1 million) in March 2009 for the CIT incurred for calendar 2008” and “RMB21,040,562.21 (approximately $3.1 million) in March 2010 for the CIT incurred for calendar 2009.” First of all, this statement that corporate tax was paid in March of the year following its accrual is inconsistent with Chinese tax regulation requiring quarterly pre-payment of CIT. More importantly, IFRA’s due diligence report included the official SAT record, which showed no income taxes paid by CGA. Management once again has produced no evidence to the contrary. Therefore investors can only conclude that another $5.2 million is unaccounted for.
  3. Greenhouse Land Purchase. On September 25, 2009, at the depths of the global financial crisis, CGA management stated the company paid approximately $10.8 million to purchase 88 acres of rural farmland in Shaanxi Province (an economically less developed Province in Western China). Detailed records obtain by IFRA (available here) from multiple government sources (including the deed tax paid on the transaction) all clearly show that the actual price paid was only $2.7 million. Management responded to the evidence by claiming that the $8.1 million difference was paid to an undisclosed state-owned company they identify as the “seller” of the land, despite no public record of this payment and existence of the aforementioned “seller”. Once again, management failed to offer any proof of this payment and investors must add another $8.1 to the growing pile of unaccounted money.
  4. Gufeng Acquisition. On July 2, 2010, CGA management closed the acquisition of Beijing Gufeng Chemical Products Co., Ltd., ("Gufeng"), for a total consideration, cash plus stock, of $31.8 million plus a commitment to fund another $14.7 million toward Gufeng’s working capital needs. Gufeng’s selling shareholder, in return, promised the company would make at least $10.6 million net income in the 12 months following the sale or else give back some of the CGA shares paid. This acquisition makes no financial sense for CGA shareholders. Gufeng was historically unprofitable, poorly managed, with production lines that CGA plans to replace and upgrade at significant cost to produce an entirely different type of organic fertilizer that CGA must then find a market for. IFRA calculated the replacement cost of Gufeng’s plant at less than half the price CGA paid. The $10.6 million net income “guarantee” is completely unobtainable. CGA significantly overpaid untold millions for Gufeng. Investors should consider at least $10 million in wasted money. Combined with the missing tax and land payments mentioned above there is over $32 million unaccounted for.

By comparison, the following table shows that other Chinese securities class action suits filed in the last three months are based on much less evidence:

Date

Company

Law Firm

Description

10/15/2010

CGA

Saxena White
Rosen Law Firm

CGA overstated its revenue and earnings, VAT payments, income tax payments, land purchase price and acquisition price of a competitor. At least $32 million of company funds are unaccounted for.

9/13/2010

DYP

Howard G. Smith
Bronstein, Gewirtz & Grossman
Robbins Umeda LLP
Pomerantz Law Firm
Izard Noble LLP
Federman and Sherwood
Glancy Binkow & Goldberg
Hagens Berman Abraham, Fruchter & Twersky, LLP
Lieff Cabraser Heimann & Bernstein
Brower Piven
Khang & Khang LLP
Rosen Law Firm

Deloitte disputed DYP’s advertising and tradeshow costs and noted improper relationships with certain vendors and distributors.

9/13/2010

DGW

Pomerantz Law Firm
Brower Piven
Glancy Binkow & Goldberg
Robbins Umeda LLP
Howard G. Smith

Substantial interconnections to DYP’s scandal affected DGW’s stock price.

9/3/2010

OTCQB:CHBT

Rosen Law Firm
Bower Piven
Saxena White

CHBT exaggerated the scope of its retail operations.

9/1/2010

OTC:CHNG

Rosen Law Firm
Dyer & Berens LLP
Brower Piven
Kendall Law Group
Robbins Umeda LLP
Shapiro Haber & Urmy LLP

CHNG admitted accounting errors related to an undisclosed $17.7 million loan.

8/6/2010

ONP

Rosen Law Firm
Robbins Umeda LLP
Brower Piven
Shuman Law Firm

ONP exaggerated its production and revenues by at least three times.

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So what happens next? CGA management has been dodging the issues for over two months now, leaving me little reason to believe they can ever explain these discrepancies. Even CGA’s former highly paid and well-regarded IR firm quit out of frustration over management’s inability to address the issues. Will a court date force CGA management to defend themselves or will they just “go dark” and stop reporting to their investors as in the case of China Expert Tech (OTC:CXTI)? In that case investors will lose everything and the lawyers get nothing. Alternatively and more likely, CGA management will fight the charges but still lose, resulting in a mess of earnings restatements and eventual financial settlement with the plaintiffs. To prevent further loss, shareholders should band together to insist that CGA’s Board appoint a controller to make sure the company’s cash and other assets are secure.

Thankfully the analyst community got CGA right. They have more or less been consistently cautious in their research reports thus protecting their clients in a way they rarely do. This time those suffering loss are mainly the “quant” funds and others who never performed any real due diligence or read my prior articles on Seeking Alpha.

Disclosure: No positions