SEC Charges China-Based Company and Top Executive with Inflating Financial Results through Phony Sales
The Securities and Exchange Commission today charged a China-based company and its chief executive with fraud for recording fake sales of a weight loss product to inflate revenues in the company’s financial statements by millions of dollars.
The SEC alleges that China Sky One Medical Inc. (CSKI) falsely stated in 2007 annual and quarterly reports that it had entered into a strategic distribution agreement with a Malaysian company that would become the “exclusive” distributor of CSKI’s “slim patch” in Malaysia and generate $1 million per month in sales. However, the company never actually entered into any such agreement. CSKI instead created approximately $19.8 million in phony export sales to Malaysia that were recorded as revenue in its financial results for 2007 and 2008. CEO Yan-qing Liu certified the overstated financial results, which appear in CSKI’s financial statements through 2010 and continue to impact the company’s retained earnings on its balance sheet.
“Accurate and reliable financial reporting is the bedrock of our capital markets, but CSKI made a mockery of that by blatantly fabricating sales and overstating its financial results,” said John M. McCoy III, Associate Director of the SEC’s Los Angeles Regional Office
According to the SEC’s complaint filed in U.S. District Court for the Central District of California, CSKI is based Harbin, China. In addition to weight loss patches, the company produces and sells sprays, ointments, and other Chinese traditional pain relief and health and beauty products. CSKI became a public company trading on the U.S. markets through a reverse merger in May 2006.
The SEC alleges that after CSKI devised the purported strategic distribution agreement with Takasima Industries – which is a Malaysian fitness equipment manufacturer and retailer – CSKI went on to falsely report export sales to Malaysia of more than $12.2 million for 2007, which constituted 25 percent of its total revenues. CSKI then falsely recorded $7.5 million (8.2 percent of total revenues) in such sales for 2008. Virtually all of CSKI’s reported sales to Malaysia via Takasima were bogus. Takasima only purchased $167,542 in slim patches from CSKI in 2007, and none in 2008. And it never entered into any distribution agreement with CSKI and never undertook – much less satisfied – any minimum purchase commitment.
According to the SEC’s complaint, CSKI also falsely claimed in its public filings that its top two customers for 2007 were sales agents for Takasima. CSKI identified those customers as Ningbo Yuehua International Trading Company and Guangzhou Xinghe International Trading Company, which collectively accounted for the phony 25 percent of CSKI’s total revenues for 2007. CSKI claimed that all of these purported sales to Ningbo Yuehua and Guangzhou Xinghe went through Takasima, while in fact Takasima never had any relationship with these two entities.
CSKI and Liu are charged with violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and various Exchange Act provisions including corporate reporting, recordkeeping, internal controls, and false statements to auditors.
The SEC’s complaint seeks financial penalties against CSKI and Liu as well as disgorgement of ill-gotten gains by Liu, who personally benefited from the overstated financial statements through the company’s 2008 private placement of securities. The SEC also seeks to have Liu reimburse CSKI for certain incentive-based compensation he received during the period affected by the fraud pursuant to Section 304 of the Sarbanes-Oxley Act, and to have Liu barred from acting as an officer or director of a public company. The SEC also seeks to have CSKI and Liu permanently enjoined from future violations of these provisions of the federal securities laws
In addition to the court action, the SEC instituted administrative proceedings to determine whether to revoke or suspend registration of CSKI’s securities due to the company’s failure to file its annual report for 2011 or any quarterly reports for 2012.
The SEC’s investigation, which is continuing, has been conducted by Junling Ma, Rhoda Chang, and Marshall S. Sprung of the SEC’s Los Angeles Regional Office. The SEC’s Cross Border Working Group – which focuses on U.S. companies with substantial foreign operations – and the SEC’s Office of International Affairs assisted in the investigation. The SEC’s litigation will be led by David Van Havermaat.