Troubled Frazer Frost

As we all know, Frazer Frost LLC, a rather small accounting firm with many U.S.-listed Chinese clients, has come under severe pressure since the RINO fraud story unfolded. I came across the wonderful China Accounting Blog by Paul Gillis from Beijing University - a must read for anyone interested in Chinese accounting - where Mr. Gillis had some more details on how things work at Frazer Frost.

"Frazer Frost audited 15 Chinese companies, 1 on the NYSE, 12 on NASDAQ and 2 OTCBB, earning fees of $6.1 million. According to partner Susan Woo, she is the engagement partner on all of this work, a sizable portfolio for a single partner. According to her firm resume, Woo has more than 13 years of accounting and auditing experience and specializes in providing financial and international tax consulting for multinational businesses. The tax work makes sense, since she has a Master of Science in International Taxation from Golden Gate University. She was licensed as a CPA in California in 1999. International tax practice is a pretty tough field by itself, so it is remarkable that she had the time to also develop the skills to audit public companies." (Source: Audit Scandals in China, Paul Gillis)

Mr. Gillis further explained that Frazer Frost does not have an office in China, though they have staff working there all year round, assigned from FF's California office. Let's have a look at recent developments with two other clients of the firm:

China Biologic Products (CBPO) intends to reaffirm Frazer Frost for the fiscal year ending December 31, 2010 and the interim periods through 2011, later this month on their Annual Meeting of Stockholders. The company has been accused of fraud in January and subsequently formed a special committee to conduct an independent investigation into the allegations.

Last Friday, December 3rd, CBPO filed the findings of this special committee in a Form 8-K with the SEC. The committee "reported that the investigation had been constrained by substantial limitations on access to relevant official records from Chinese military and governmental authorities and the availability of other relevant information in China," but while it found no evidence for some of the allegations, others could be confirmed or the results were inconclusive. It was filed that with respect to the allegation that Mr. Tung Lam, CEO of China Biologic's primary operating subsidiary, was previously known under a different name and imprisoned for smuggling in China, the committee "found evidence supporting Mr. Lam's denial of the allegation, as well as conflicting evidence with respect to this claim." However, in connection with the same smuggling activities, the committee said it found support for the allegation that Mr. Ze Qin Lin, husband of current CBPO director Ms. Lin Ling Li, was indeed sentenced to imprisonment in China.

Harbin Electric (HRBN) has not officially commented on auditor-related issues since the RINO disaster, however the company is actively working on a going private deal and has engaged high-profile names like Goldman Sachs, Morgan Stanley and Baring Private Equity for these matters. Big-4 auditor Deloitte has been retained to perform due diligence, but it seems the market has doubts that the Frazer Frost-audited HRBN will pass this test. The stock has dropped to new lows below $15 after announcement of the buyout proposal and is currently trading at $16.27 or 33% below the proposed $24 buyout price.

Roth Capital has been vigorously defending the company for the past few weeks. They pointed out that Harbin is the first U.S.-listed non-state-owned Chinese company that received loans from China Development Bank, which means they passed the bank's due diligence process which should add credibility (but didn't after all if we are going to judge by the reaction of the market). It certainly didn't help that the buyout proposal was modified soon after the loan was announced.

It will be interesting to see what the next steps of currently Frazer Frost-audited companies will be. Frost PLLC of Arkansas called off the merger with Stephens Wurth Frazer & Torbet LLP immediately after the RINO scandal became public. Of course this could be merely coincidental, but really? That means Frazer Frost will not exist for much longer, and all their current Chinese clients will have to appoint a successor firm or at least file the status of their auditor with the SEC. In my opinion, both CBPO and HRBN have long outgrown such a small firm with no permanent presence in China and they should upgrade their auditor as soon as possible. We'll see what happens. It is always a good idea to judge a company by its management's actions.