China looking into PwC's role in $78 billion Evergrande fraud case

By Bloomberg News

Chinese authorities are examining the role of PricewaterhouseCoopers LLP in China Evergrande Group’s accounting practices after the developer was accused of a $78 billion fraud, ramping up pressure on the global accounting giant that audited a slew of developers before the sector’s meltdown.
 

The country’s securities regulator this week accused Evergrande’s main onshore subsidiary Hengda Real Estate Group of recognizing sales in advance and massively overstating its revenue in the two years through 2020, prior to Evergrande’s default.

Chinese officials are now looking into PwC as they continue their probes of the developer’s founder Hui Ka Yan, according to people familiar with the matter. They are in contact with some former PwC accountants who handled Evergrande’s audit, one of the people said, asking not to be identified discussing a private matter.

 

No decision has been made on whether to penalize the auditor, said the people, adding that officials are still investigating other suspected crimes of Hui, who was detained last year. PwC declined to comment.

Beijing’s fresh revelations of Evergrande’s fraud come at a difficult time for PwC, which is dealing with the fallout of scandals in other parts of its global network, and has cut jobs from the UK to Canada. The firm’s practice in Australia — which is also slashing jobs — came under fire for leaking confidential government tax plans to clients. PwC’s UK arm was hit with a £5.6 million fine last year for failures in its work on Babcock International Group Plc’s books.

“There are serious questions about PwC’s role in the Evergrande fraud, specifically what it knew about the improper revenue recognition,” said Nigel Stevenson, an analyst at accounting research firm GMT Research Ltd. in Hong Kong.

GMT has previously questioned the accuracy of Evergrande’s financial reporting, and alleged in December 2023 that the developer may have never been profitable. In response, Evergrande said the research firm’s recent report was “without basis.” 

By inflating revenue, Hengda also overstated a total of 91.9 billion yuan ($12.7 billion) in profit, or more than three-quarters of its reported income between 2019 and 2020, according to the China Securities Regulatory Commission. That’s about 20 times the inflated profit at Enron Corp.’s 2001 scandal, which ultimately brought down its auditor Arthur Andersen.

“Checking for this type of misstatement is one of the most basic of audit routines,” said Richard Murphy, professor of accounting practice at Sheffield University in the UK. “The risk to PWC’s reputation, not just in China but more broadly, is very real.”

Prior to 2021, Evergrande recorded revenue from contracted sales of many projects before completing and delivering the homes to buyers. Its aggressive revenue-recognition tactics enabled the developer to report lower liabilities and leverage ratios during those years, which facilitated its sales of domestic and international bonds. The world’s most indebted developer began having cash-flow problems in 2021 and spiraled into default, imperiling millions of apartment units that it had pre-sold to buyers but hadn’t completed. 

While Chinese regulators laid much of the blame on Evergrande’s Hui, their allegation could create legal trouble for PwC. Evergrande is currently going through liquidation proceedings in Hong Kong, and liquidators that are trying to recover money for the company’s creditors may go after deep-pocketed PwC for compensation, according to several lawyers and insolvency practitioners, who asked not to be identified discussing a sensitive matter.

The regulator’s fine of 4.18 billion yuan on Hengda also means Evergrande will have even less money to pay off its creditors. The Chinese developer was saddled with about $332 billion in liabilities as of June 2023.

Chinese authorities have previously come down hard on accounting firms for lapses in their audits of domestic companies. Last year, the Ministry of Finance slapped a record 212 million yuan fine on Deloitte’s China unit and suspended the operations of its Beijing office for three months for “serious audit deficiencies” in its work on state-owned China Huarong Asset Management Co. between 2014 and 2019. The bad-debt manager received a $6.6 billion bailout in 2021 after reporting massive losses. 

PricewaterhouseCoopers Zhong Tian LLP, a Shanghai-registered firm that is part of PwC’s global network, was Hengda’s auditor during the period in question. PwC was Evergrande’s auditor for more than a decade until the global accounting firm resigned in January 2023, due to what the developer said were audit-related disagreements. 

PwC’s onshore arm, with more than 1,600 certified accountants, reported revenue of 7.9 billion yuan in 2022, making it the top earner among more than 9,000 local rivals, according to official data. Still, that’s a fraction of its global revenue of $50.3 billion during the year.

Among the Big Four accounting firms, PwC was one of the most commonly used by Chinese real estate firms listed in Hong Kong, according to data compiled by Bloomberg. It audited the books of some of the nation’s largest developers, including Country Garden Holdings Co. and Sunac China Holdings Ltd., before they also defaulted on their debt. 

Over the past two years, however, PwC has resigned from at least 10 Chinese property companies including Sunac and Shimao Group Holdings Ltd., data compiled by Bloomberg showed.

During the housing boom, most Chinese property developers raked in cash by selling partially built homes and promising to deliver them in a few years. Home buyers put down deposits and took out mortgages to buy the properties. Their money was supposed to be put in escrow accounts, and released to the developers when construction was completed. 

It is unclear if other property developers that were clients of PwC recognized revenue the same way as Evergrande. The Guangzhou-based company said last year that prior to 2021, it had recognized revenue when a property was accepted by a customer, or “deemed to have been accepted by the customer” based on the sales contract, whichever was earlier. 

After Evergrande ran into cash-flow problems, it decided that it should book revenue after the projects it pre-sold were completed, or occupied by their owners. It reported sharply higher liabilities for 2021 and 2022 — reflecting what it owed to those homebuyers  — after changing its policies. 

“We weren’t aware that Evergrande was doing anything different from the rest of the industry,” said Tyran Kam, head of China property at Fitch Ratings. “Based on the information available to us, Evergrande’s revenue recognition and other accounting policies were generally perceived to be similar to the accounting practices to many of its listed peers,” he added. 

Credit-ratings firms, along with other market participants, would have relied on the audited financial statements when analyzing the companies, Kam said. 

While many Chinese developers have stated in their annual reports similar revenue-recognition policies, Evergrande may have pushed the limits further. 

China Vanke Co., whose auditor is KPMG LLP, said in its 2022 annual report that it recognizes revenue from property sales when three criteria are met. That includes when “the property is accepted by the customer, or deemed as accepted according to the sale and purchase agreement, whichever is earlier.” 

PwC is also being investigated by Hong Kong’s Financial Reporting Council in 2021, after it failed to identify Evergrande’s inability to operate as a going concern. The inquiry by the city’s accounting watchdog was on Evergrande’s 2020 annual accounts and 2021 interim report.

“The issue is that the auditing process is fundamentally broken, conflicted, and at times corrupted.” said Tom Kirchmaier, professor at the Centre of Economic Performance at the London School of Economics. “Hence, the problem might be bigger than PwC.”

Tesla trims China output as sales growth slows

Tesla has reduced production at its plant in China, according to people familiar with the matter, amid sluggish growth in electric-vehicle sales and intense competition in the world’s biggest auto market. The US carmaker earlier this month instructed employees at its Shanghai facility to lower production of both the Model Y and Model 3 — the two vehicles Tesla makes in China — by working five days a week instead of the usual 6 1/2 days, the people said, asking not to be identified because they’re not authorized to speak publicly.
 

The production lines run on two 11.5-hour shifts per day, which remains unchanged. Output has been trimmed starting earlier this month, the people said, and staff haven’t been given clear indication of when production will go back to normal.
 

The carmaker’s stock — already the worst performer in the S&P 500 Index this year — slumped as much as 3.9 per cent before the start of regular trading Friday.

Foreign investment flows shrink 19.9% in Jan-Feb 
 

Foreign investment flows into China shrank 19.9 per cent in January-February from a year earlier to ¥ 215.1 billion, data from the commerce ministry showed, even as the government gears up to woo foreign firms. China's cabinet on Tuesday  unveiled new steps to arrest a  slowdown in foreign investment, including expanding market access and relaxing some rules. Overseas firms have turned sour on China since it enacted ultra-strict Covid curbs during the pandemic. Reuters

China launches surprise inspections of MFs 
 

China's securities regulator has launched onsite inspections of some mutual fund companies as part of efforts to strengthen management of the industry, media reported, unnerving fund managers.
 

The securities watchdog, under newly appointed Chairman Wu Qing, vowed a week ago to set up a "textbook-style" supervision model to regulate China's $3.8 trillion mutual fund industry. Reuters