SEC Says AgFeed Case Shows Focus on Accounting Fraud

The U.S. Securities and Exchange Commission sued four Chinese executives of an animal feed company and the chairman of its audit committee in connection with a fraud involving $239 million in bogus revenues.

The SEC accused AgFeed Industries Inc. and its Chinese executives of fabricating earnings between 2008 and 2011. The agency also sued K. Ivan Gothner, a director, and Edward Pazdro, the chief financial officer, for allegedly ignoring the fraud.

“Financial reporting simply cannot ignore reality even when the truth may be inconvenient,” Andrew Ceresney, the SEC’s enforcement director, said on a conference call. “Today’s enforcement action is a cautionary tale about what happens when an audit committee chair fails to perform his gatekeeper function in the face of massive red flags.”

The fraud began in 2008 when AgFeed’s top management acquired 29 Chinese farms for its new hog production division, according to the SEC complaint, which was filed in federal court in Nashville, Tennessee. In order to show strong growth, the Chinese executives allegedly inflated not only the weight of the hogs they sold, but the actual number of hogs sold, the SEC said.

Four former members of AgFeed’s Chinese management: Songyan Li, former executive chairman; Junhong Xiong, former chief executive officer; Selina Jin, former chief financial officer; and Shaobo Ouyang, former controller, orchestrated the fraud, according to the SEC’s complaint.

Not Possible

Xiong and Jin live in Nanchang, China, according to the SEC, while Li and Ouyang are residents of Shanghai. The SEC said it had didn’t have information about defense counsel for the former executives.

When reached by phone, Xiong said he hadn’t heard of the SEC allegations and no one had contacted him about them. Asked if there was merit to the fraud claim, he said, “It isn’t possible.”

Bloomberg News wasn’t immediately able to contact the other former executives for comment.

Management in the U.S. learned of the fraud in 2011, but failed to investigate and inform investors in a timely fashion, the SEC said.

Lawyers for Gothner and Pazdro said their clients didn’t do anything wrong and plan to fight the SEC’s accusations.

Gregory Bruch of Bruch Hanna LLP said Gothner acted appropriately when informed of potential fraudulent activity in China by ordering an internal review and hiring Latham & Watkins to conduct an outside investigation.

‘Investigating Misconduct’

Pazdro’s lawyer, Lyle Roberts of Cooley LLP, said his client didn’t participate in the alleged fraud and was instead “instrumental in investigating the misconduct and bringing it to the attention of the company,” according to an e-mailed statement.

John Stadler, former chairman and interim chief executive officer of AgFeed, which is based in Hendersonville, Tennessee, consented to an SEC order barring him from acting as an officer or director and agreed to pay $100,000. He neither admitted nor denied the findings in the SEC order. His attorney didn’t respond to a request for comment.

Bloomberg News in 2013 obtained e-mails by managers in China openly discussing their methods for doctoring results.

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.

Reverse Merger

AgFeed did a reverse merger in 2006 and listed on Nasdaq the next year, raising more than $100 million in the U.S. between 2007 and 2009 to fund expansion into modern hog farming. Allegations of fraudulent accounting in the Chinese operations eventually hit AgFeed’s share price and its ability to raise money in the U.S. In July 2013, the company filed for bankruptcy, citing debt as much as $100 million.

The case is U.S. Securities and Exchange Commission v. AgFeed Industries, Inc., 14-cv-00663, U.S. District Court, Middle District of Tennessee (Nashville).

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