The Securities and Exchange Commission charged an animal feed company and top executives with conducting a massive accounting fraud in which they repeatedly reported fake revenues from their China operations in order to meet financial targets and prop up the stock price.
The SEC alleges that four executives in China orchestrated the scheme at AgFeed Industries Inc. The company was based in China and was publicly traded in the United States before merging with a U.S. company in September 2010. At that time, its operations were spread between the two countries. With the bulk of its hog production operations in China, the SEC claims that “executives used a variety of methods to inflate revenue from 2008 to mid-2011, including fake invoices for the sale of feed and purported sales of hogs that didn’t really exist. They later tried to cover up their actions by saying the fake hogs died. Because [heavier] hogs bring higher market prices, they also inflated the weights of actual hogs sold and correspondingly inflated the sales revenues for those hogs.”
The SEC also charged a company executive and a company director in the United States with scheming to avoid or delay disclosure of the accounting fraud once they learned about it in 2011 while engaged in efforts to raise capital for expansion and acquisitions.
The SEC notes that the director, K. Ivan (Van) Gothner, was chair of AgFeed’s audit committee. He sought advice from a former director and company advisor who responded in e-mail communications that there was “not just smoke but fire” and recommended that AgFeed hire professional investigators guided by outside legal counsel. However, Gothner ignored the recommendation and internalized the situation while false financial reporting continued.
The SEC also reached a settlement with another U.S.-based company executive and a cooperation agreement with a different executive. The eight executives involved in the SEC’s case are no longer with AgFeed, which is headquartered in Hendersonville, Tenn., and has filed for bankruptcy.
“AgFeed’s accounting misdeeds started in China, and U.S. executives failed to properly investigate and disclose them to investors,” said Andrew J. Ceresney, director of the SEC’s Division of Enforcement. “This is a cautionary tale of what happens when an audit committee chair fails to perform his gatekeeper function in the face of massive red flags.”
According to the SEC, the scheme began in 2008 after AgFeed acquired 29 Chinese farms for its new hog production division. The inflated numbers, which included sales of fake hogs and embellished weights of actual hogs, were recorded in a fake “outside” set of books that the company provided to its outside auditors. The “inside” real set of books contained accurate, lower revenue numbers that were hidden from auditors. As a result of the deception, the company reported false revenues of approximately $239 million.
Allegedly, AdFeed’s U.S. management learned of the accounting fraud by early June 2011, but failed to take adequate steps to investigate and disclose it to investors.
The SEC alleges that instead of fulfilling their responsibilities as the company’s stewards of financial reporting, company employees failed to conduct or prompt the company to conduct any further meaningful investigation into the misconduct. The SEC states they misled AgFeed’s outside auditor and caused the company to issue false and misleading press releases and SEC filings.
“Officers and directors have an obligation to exercise diligence and ensure that their financial reporting is accurate,” said Julie Lutz, director of the SEC’s Denver Regional Office. “Despite learning about false and misleading financial information, AgFeed executives failed to come clean with investors or law enforcement.”
The SEC’s case against AgFeed in federal court is continuing.