Orient Paper: Not All BDOs Are the Same

by: Chinese Company Analyst

Editor's note: The author of this article calls into question the integrity of BDO Limited's audits, and its adherence to PCAOB standards. We received a reply to the author's assertions from BDO Limited's CEO, which can be found following the article.

In this article, I’m going to discuss why BDO Limited, the Hong Kong branch of the BDO International network of auditors, should not be considered a top tier auditor, and is not comparable with the separate U.S.-based BDO Seidman. Not all BDO member firms are the same.

A glaring red flag among some Chinese RTO (“reverse takeover”) smallcaps is their poor choices for auditors – many firms have hired unheard-of firms to act as their public auditor. In my articles on China Marine Food, I have questioned the quality of the company’s audit firm, ZYCPA, and wondered why a $70m revenue business would hire an auditor that has only 2 partners and 25 personnel; audits no other exchange-listed public U.S. company; and has its main partner being sued for a HKD$125m fraud involving a European investor.

Some RTO Chinese companies have tried to avoid controversy by hiring BDO Limited as their auditor. Investors see “BDO” in the audit firm’s name, and assume that all BDO’s abide by the same strict audit standards as BDO Seidman, the U.S.-based and most well-known BDO member firm. That’s not true.

I’m going to provide several data points that provide evidence that investors should be cautious around companies audited by BDO Limited:

  1. BDO Limited was the auditor of China Expert Technology, an infamous Chinese fraud that blew up in 2007
  2. BDO Limited is not inspected by the PCAOB
  3. The SAIC and SEC financial statements match for a BDO Seidman-audited chinese company, Tongxin International, but do not match for two BDO Limited-audited firms, Orient Paper and China-Biotics, Inc.

The BDO International Network

BDO International is a sprawling international network of audit firms that has more than 1,000 offices in more than 100 countries. Like many international auditors, the firm is comprised of individual member firms. The main member firm in the United States is BDO Seidman LLP. The main member firm in Hong Kong is BDO Limited. While both carry the BDO affiliation, they are completely separate audit firms.

BDO Limited was the auditor of China Expert Technology

One of the most illustrious frauds in the U.S.-listed Chinese RTO smallcap space is China Expert Technology (OTC:CXTI). CXTI claimed to provide information technology network and infrastructure consulting services to governments and corporations. It had stunning financials – from 2003 to 2006, its revenue allegedly grew from $6m to $66m, and its net income grew from $1m to $8m, with smooth revenue and earnings growth in each year.

Then one day, it stopped filings it financial statements. Its CFO quit and its CEO disappeared. Its stock dropped from $7 to 50 cents in two months. The company vanished. The widespread consensus is that the company was a hoax, and that the financial statements were fabricated. Its story has been documented in several places, such as here and here.

China Expert Technology’s auditor was none other than BDO Limited. Technically, it was BDO McCabe Lo Limited at the time, but the two firms are the same - BDO McCabe Lo Limited changed its name to BDO Limited when it merged with Shu Lun Pan Horwath Hong Kong CPA Limited in May 2009.

The implication for investors currently holding shares in companies audited by BDO Limited is troubling. If BDO Limited could not detect fraud at a company that appeared to be entirely fabricated, can we rely on it to detect fraud at Orient Paper, a company that at least has some production lines and some semblance of operations? I believe that Orient Paper is falsifying its financial statements, and that the actual underlying company is materially smaller than its SEC financial statements indicate. In contrast, CXTI appeared to be entirely a hoax – essentially, it appears to have been 100% fraudulent whereas ONP may only be 80% fraudulent.

BDO Limited is not inspected by the PCAOB

The PCAOB is the accounting industry’s self regulatory organization – it is comprised of accountants from different PCAOB member firms that do annual inspection audits on other PCAOB member firms. It’s referred to as “the auditor of the auditors” because it double-checks selected audits and provides reports on its findings.

BDO Seidman allows the PCAOB to inspect its books, and its 2009 inspection report is included here.

BDO Limited does not allow the PCAOB to inspect its books, because it is Hong Kong-based whereas the PCAOB is U.S.-based.

Granted, just because BDO Limited is not audited by the PCAOB doesn’t mean that its audit standards are subpar. But when comparing BDO Seidman and BDO Limited, I would be more comfortable with BDO Seidman-audited financial statements because the firm is inspected annually by the PCAOB.

Comparison of SAIC and SEC financial statements for companies audited by BDO Limited vs BDO Seidman

Over the past few months, I and other investors have compared Chinese companies’ SEC filings with the local financial statements that the companies’ main operating subsidiaries must file with the Chinese government. My articles/posts are here, here, here and here. “Waldomushman” has compared CSKI’s and SOLF’s SEC and SAIC financial statements on his website. Muddywatersresearch.com has done the same for ONP, though it has not yet released its copies of the SAIC financial statements.

In total, comparisons of SEC and SAIC filings have been posted for OTCPK:CSKI, OTC:CMFO, LIWA, ONP, OTC:YUII, OTCPK:FUQI, and SOLF. For OTCPK:CSKI, OTC:CMFO, LIWA and ONP, the numbers don’t match and there is additional evidence that the companies are falsifying their SEC financial statements. For OTC:YUII, OTCPK:FUQI and SOLF, the numbers do match (or, more accurately, are in the same ballpark).

In the following, I compare SEC and SAIC financial statements for a BDO Seidman-audited company, Tongxin International, and show how the SEC and SAIC financials match. Then I compare the SEC and SAIC financial statements for a BDO Limited-audited firm, China-Biotics Inc., and show how they don’t match. As Muddy Waters has explained, the ONP numbers don’t match either (ONP disputes whether Muddy Waters has the correct subsidiary, but I believe that Muddy Waters has the correct subsidiary based on their July 2 2010 response to ONP).

First, let’s look at BDO Seidman-audited Tongxin International (OTCPK:TXIC). TXIC is a Chinese auto parts company that was purchased by a SPAC in 2008. Its SAIC financial statements are here:

  • Click here for TXIC's SAIC Financial Statements in Chinese.
  • Click here for TXIC's SAIC Financial Statements in English.

Here is a comparison of the SAIC and SEC financial statements for TXIC:

As we can see, the numbers match, for the most part.

Next, let’s look at BDO Limited-audited China-Biotics, Inc. (OTC:CHBT):

  • Click here for CHBT's SAIC Financial Statements in Chinese.
  • Click here for CHBT's SAIC Financial Statements in English.
  • Also, here is CHBT's full 2008 SAIC annual inspection report in Chinese.

Here is a comparison of the SAIC and SEC financial statements for CHBT:

CHBT’s numbers do not match - the SAIC financial statements show a far smaller business than the SEC financials indicate.

In terms of Orient Paper, as Muddywaters has discussed, ONP’s historical SEC and SAIC financials also do not match.

Therefore, our BDO Seidman-audited company has matching financial statements, whereas two BDO Limited-audited companies do not have matching financial statements. This provides evidence for our thesis that investors should remain cautious around firms audited by BDO Limited. BDO Limited is a different firm than BDO Seidman and there is evidence that BDO Limited does not subscribe to the same audit standards as BDO Seidman.

Given its history with China Expert Technology, BDO Limited has demonstrated that it has not been able to prevent frauds in the past. Given that ONP and CHBT do not have matching SEC and SAIC financial statements, and that there are numerous other signs that ONP is falsifying its SEC financial statements, there is evidence that BDO Limited is also not preventing frauds in the present.

Disclosure: Author is short OTC:CMFO and ONP and long OTCPK:TXIC

Reply from Albert Au, Chairman & CEO, BDO Limited:

BDO Limited, a Hong Kong limited company, is a member of BDO International Limited, and forms part of the international BDO network of independent member firms. As a member firm, BDO Limited abides by the network’s strictest and most rigorous standards.

BDO Limited is registered with the U.S. Public Company Accounting Oversight Board and cooperates and complies with the rules and standards of that body to the fullest extent possible. The only exception is where there is a contradiction with the laws of Hong Kong and the People’s Republic of China, jurisdictions in which we and some of our clients operate. Such restrictions of course apply to all firms operating in these jurisdictions.

However all BDO limited’s audits of the financial statements of our SEC registrant clients are conducted in accordance with the standards of the PCAOB.

Contrary to the statement made in the article, the PCAOB is a private-sector, nonprofit corporation created as a result of the Sarbanes-Oxley Act to oversee the auditors of public companies. The Act required that auditors of U.S. public companies be subject to external and independent oversight, and removed self-regulation from the profession. The members of the PCAOB Board, including the Chairman, are appointed by the Securities and Exchange Commission (SEC), after consultation with the Chairman of the Board of Governors of the Federal Reserve System and the Secretary of the Treasury. The SEC has oversight authority over the PCAOB.