Litigation Release No. 22470 / September 4, 2012
Accounting and Auditing Enforcement Release No. 3404 / September 4, 2012
SEC v. China Sky One Medical, Inc. and Yan-qing Liu, United States District Court for the Central District of California (Civil Action No. CV12-7543 MWF (MANx)
SEC Charges China Sky One Medical and Top Executive with Inflating Financial Results through Phony Sales
The Securities and Exchange Commission today filed suit in U.S. District Court for the Central District of California, charging China-based China Sky One Medical, Inc. (CSKI) and its CEO and chairman Yan-qing Liu 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 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.
According to the SEC’s complaint, 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.
The complaint alleges that CSKI and/or Liu violated, aided and abetted, or is liable as a control person for, violations of Section 17(a)(2) of the Securities Act of 1933 and Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Exchange Act Rules 10b-5(b), 12b-20, 13a-1, 13a-11, and 13a-13. The complaint further alleges that Liu violated Exchange Act Section 13(b)(5) and Rules 13a-14, 13b2-1 and 13b2-2. 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 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 Commission issued an Order Instituting Administrative Proceedings and Notice of Hearing Pursuant to Section 12(j) of the Securities Exchange Act of 1934 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.