WASHINGTON – The auditor of a major Chinese chemical company that was the subject of an Associated Press investigation and is backed by Morgan Stanley has resigned amid accounting concerns, further damaging the prospects of Morgan Stanley’s largest investment by its Asian private equity arm.
In November, the AP report cited discrepancies in the tax records and customer relationships of Tianhe Chemicals Group Ltd. Hong Kong regulators suspended trading in Tianhe (pronounced TYEN’-huh) four months after concerns by auditor Deloitte Touche Tohmatsu Ltd. prevented the company from releasing its 2014 financial report.
The concerns surrounding Tianhe highlight the risks of investments in mainland China firms that existed before the recent plunges in the Chinese stock market and may still exist. Even basic details of companies’ operations are sometimes challenged, and in the event of trouble foreign investors have little recourse. In both Hong Kong and the United States, regulators are heavily dependent on investment banks to vet companies that want to sell their shares to the public.
Deloitte Touche resigned after Tianhe’s board refused to accept an auditor disclaimer saying that Deloitte did not stand behind the accuracy of Tianhe’s financials. Tianhe said it will seek a new auditor to approve its financials. But auditor departures after disagreements have often preceded significant financial restatements or corporate failures.
Most of the $300 million invested in Tianhe by Morgan Stanley’s Asian private equity arm came from pension funds, educational institutions and philanthropic endowments such as an organization funding public health and education in Appalachia. Morgan put little of its own money at risk, but continued woes for Tianhe would pose other perils for the bank.
Morgan Stanley said it had conducted millions of dollars’ worth of due diligence before investing other people’s money in Tianhe, and it put a managing director, Homer Sun, on the company’s board. Morgan Stanley took the company public on the Hong Kong Stock Exchange in June of last year, and its analysts recommended the stock.
Should Tianhe’s troubles persist, Morgan Stanley’s sponsorship of the company’s initial public offering — one of Hong Kong’s largest in 2014 — could prove more than embarrassing. After years of questioning whether investment banks were sufficiently vetting the companies they sold to the public, Hong Kong regulators pledged to crack down last year.
Morgan Stanley did not respond to phone or email messages from the AP. Deloitte also did not respond to a phone message and email.
The AP investigation found that Tianhe’s research budget was unusually low for a high-tech chemical manufacturer, and versions of its finances available through domestic Chinese business data providers contradicted figures in its prospectus. Key Tianhe customers did not appear to have the financial capacity to buy the expensive products that Tianhe reported selling. Additionally, the AP found that Tianhe’s predecessor company was owned by the Chinese government, even though the company’s founders had told investors they long owned it.
Other companies in Morgan Stanley’s Asian private equity portfolio have had also trouble. Two previously failed amid allegations of fraud. And earlier this month, a Morgan Stanley investment called Sihuan Pharmaceutical Holdings Group Ltd. Announced it will hire a forensic investigator after its auditor, PriceWaterhouseCoopers LLC, disclaimed its 2014 financials. Homer Sun sits on the board of Sihuan as well.