Putting the FRC in Farcical
16th April 2015
All is not well at the Financial Reporting Council (FRC), HK’s auditor investigator, which would also like (correctly, in our view) to take disciplinary matters away from the self-regulatory HK Institute of Certified Public Accountants. Browsing through freshly released annual reports last Friday (10-Apr-2015), we came upon the 2014 annual report of China Yunnan Tin Minerals Group Co Ltd (CYTM, 0263). This is a member of what we call the “Chung Nam Network” of companies that we would never own, so it won’t surprise you to know that its main assets consist of shares in other companies in the network. In 2014, CYTM booked net gains of HK$330.5m on its portfolio, and at the year end it had the following financial assets held as current assets, shown in note 24 of the audited financial statements:
Now, read the words we highlighted carefully. It states that CYTM’s holding in Heritage International Holdings Limited (Heritage, 0412) is more than 10% of CYTM’s total assets, but represents 0.03% of the ordinary shares of Heritage. “FVTPL” is accounting-speak for “Fair Value Through Profit or Loss” and means that the listed shares are valued at market prices at the year-end.
CYTM had total assets of HK$1488.6m, so 10% of that is HK$148.86m, so that implies that the stake in Heritage is at least HK$148.86m. However, if it is only 0.03% of Heritage, then that implies that Heritage had a year-end market value of at least HK$496.2 billion, making it bigger than say, Hutchison Whampoa Ltd. In fact, although we regard Heritage as a bubble stock, its market value at 31-Dec-2014 was HK$6.48bn, nowhere near the implied figure. So CYTM’s stake can’t have been 0.03%, and must have been more like 3% of Heritage, a stake that would be substantially harder to liquidate in a hurry, so the error is material to readers of the accounts, particularly investors.This was such a glaring error that we spotted it within minutes. At 17:08 on Friday, 44 minutes after the annual report was filed at HKEx, we filed a complaint with the Stock Exchange requesting a correction, and we also filed the complaint with the FRC, because the auditor of CYTM, Pan-China (H.K.) CPA Limited, should have spotted such as basic error, so we called on the FRC to investigate the accounting firm. The person who signed off the audit is Mr Lee Ping Kai. We gave the FRC the same facts stated above.
The response from the FRC, received on Tuesday (14-Apr-2015) afternoon, was a rejection of our complaint that is so breathtakingly stupid that we feel obliged to publish it in full:
Dear Mr Webb
I refer to your complaint dated 10 April 2015 relating to the consolidated financial statements of China Yunnan Tin Minerals Group Company Limited (stock code: 00263) (the Company) and its subsidiaries for the year ended 31 December 2014 (the 2014 Financial Statements).
Note 24 to the 2014 Financial Statements stated that the percentage of the Company’s holding in Heritage International Holding Limited was determined based on the issued share capital of the investment instead of market capitalization and therefore there is no evidence suggesting that the percentage is inappropriate. Accordingly, we consider that there is no auditing irregularity in this respect and we will not pursue your complaint further at this stage.
Thank you for your attention.
Investigation & Compliance
We find it shocking that the FRC, when presented with a basic and obvious accounting and auditing error and all the facts to prove it, could not understand it, and even worse, inferred an irrelevant comparison with the issued share capital when none had been made. At least the Stock Exchange agreed with our complaint, because yesterday evening (15-Apr-2015), CYTM published a “clarification” announcement. The audited accounts were indeed wrong, and the figure should have been 3.2% of Heritage, not 0.03%. Incidentally, CYTM again misnamed the investee, omitting the “s” from “Holdings”.
We wonder how many other complaints have been wrongly rejected by the FRC, and we call on the Process Review Panel of the FRC to look into the process by which complaints from the public are handled, including the quality control and the number of persons involved in reviewing a complaint and reviewing the proposed response before a response is issued.