Kaisa Group details findings of 2014 financial statement investigation

By Caroline Salls

Pittsburgh, Dec. 19 – Kaisa Group Holdings Ltd. announced the findings of an investigation conducted by an independent committee established by its board of directors, according to a news release.

Former auditor PricewaterhouseCoopers LLP identified six issues from its audit of the company’s financial statements for fiscal year 2014 that should be investigated. FTI Consulting was hired to conduct the investigation.

The audit issues include identification of agreements during 2014 and the authenticity of accounting records; the identification of unexplained cash payments and receipts; repurchases, sales, cancellation of sales and purchases of properties under development, complete properties held for sale in bulk and a proposed development project; the disposal of subsidiaries located in Dongguan and Huizhou; the re-designation of advance proceeds received to other payables; and the blockage of property projects.

In connection with the first issue, FTI reported that 41 borrowing agreements with non-bank financial institutions, for which the group had RMB 30.8 billion of debt outstanding as of Dec. 31, 2014, were not previously disclosed or provided to the group’s auditor, and led to the identification by the company of significant accounting errors and were misclassified.

FTI said it found that some former employees of the Kaisa Group attempted to obscure the existence of the borrowing agreements through an elaborate scheme, creating the illusion that RMB 15.4 billion of the funds from some of the borrowing agreements originated instead from cash deposits received by the group arising from the purported sale of property projects to a number of third-party buyers.

“Nevertheless, these purported sale transactions were, based on FTI Consulting’s enquiries, not genuine,” the release said.

FTI said Kaisa’s management also identified an additional 14 borrowing agreements entered in other years that had not been identified and disclosure to the former auditor.

The independent committee recommended that the company seek legal advice on Chinese law regarding the appropriate action to be taken against the former employees identified by FTI as being involved in the fraudulent scheme against the former members/employees and the third parties, including both criminal and civil actions.

Transactions questioned

In connection with the second investigation issue, FTI said the group was involved in transactions with 12 parties in the 2013 and 2014 fiscal years, and 96% of the RMB 24.l billion in payments made to these parties “were found to have no clear business purpose.”

FTI said representatives of fund remittance agents stated that the transactions in which they were involved were initiated under instructions by former Kaisa employees, who provided them with the necessary account details in order for them to complete the transactions.

The independent committee said there is no evidence that the management in Hong Kong had any knowledge of these improper transactions, but the police should be notified of the possibility of impropriety including possible embezzlement of the unaccounted for funds.

Property project concerns

In connection with the third issue, FTI said it established that the group acquired the equity interests of 19 project companies in 2014 for a total consideration of RMB 8.1 billion, and 16 of the 19 project companies had previously been owned and sold by the group.

FTI said Kaisa claimed that 16 disposal transactions were properly authorized, but no approval records can now be located.

Based on its enquiries, FTI said a former employee of the group was identified as being responsible for instigating, negotiating and completing all of the 16 disposal transactions, and this former employee persuaded the sellers to enter into the transactions by providing them with a verbal and unconditional guarantee that the group would repurchase the project companies, if requested.

However, the company said its current management was not aware of this guarantee.

Similarly, under the fourth issue, FTI said its work indicates that the disposal of nine Kaisa subsidiaries in Dongguan and one in Huizhou in December 2014 for RMB 559 million were authorized, but there is “limited contemporaneous documentation explaining the background to and the commercial rationale for a number of the key disposal features” because the transactions were negotiated and executed hastily.

According to the release, the legal ownership of the Dongguan and Huizhou subsidiaries was subsequently transferred back to the group by July 2016. As a result, no legal action is being recommended by the special committee.

Loans improperly recorded

In connection with the fifth investigation issue, the outstanding financial liabilities related to loan facilities totaling RMB 1.1 billion was incorrectly recorded in the group’s accounting records as other payables, as opposed to debt.

In addition, FTI said three fictitious agreements were created when the loan facilities were drawn down by the group to show that Kaisa received cash advances in the amounts of the loan facilities from a number of third parties.

FTI said it further identified that, in order to obscure the cash flow associated with the loan drawdowns, a former employee of the group instructed a third party to remit RMB 491 million in cash to the group on the pretense that the receipt was originated from one of the three fictitious agreements.

The independent committee recommended that report be made to the police regarding the wrongdoings that involve suspected embezzlement of the company’s fund, false accounting and forgeries by creation of fictitious documents. In addition, the committee said Kaisa should consider taking civil action against the wrongdoers if FTI’s further findings confirm that the group suffered financial loss under this audit issue.

Project restrictions

Finally, FTI said it found that 39 of the company’s property projects were subject to different types of restrictions imposed by the local government authorities in Shenzhen and/or the Chinese courts since November 2014.

As of Sept. 30, three of those 39 property projects remained partially restricted. The total net book value of these three property projects was RMB 3.4 billion at Dec. 31, 2014.

FTI has not identified any evidence of fraud that was involved in those restrictions and as such, no legal action has to be taken, the release said.

Kaisa Group, a Shenzhen, China-based property development company, filed for bankruptcy on May 5, 2016 to gain U.S. court recognition of its Hong Kong scheme proceedings. The Chapter 15 case number is 16-11303.

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