The Commission brought another fraud action against a China based issuer and its chairman. This time the case focuses on the lack of internal control and a series of unauthorized cash transactions that were repaid. SEC v. Fuqi International, Inc., Civil Action No. 1:13-cv-995 (D.D.C. Filed July 1, 2013).

Fuqi is a PRC based jewelry company whose chairman, president and CEO is defendant Yu Kwai Chong, a Chinese national. The company made a public offering of securities in March 2010. Its shares were traded on the NASDAQ Global Market. Eight months after the stock sale the company announced it would restate the first three quarters of 2009 due to accounting errors. Its earnings had been overstated by 12% to 23%.

While completing the restatement the outside auditors discovered that between September 2009 and November 2010 Mr. Chong had directed the transfer of about $134 million in over 50 transactions from firm bank accounts to accounts at other banks for three jewelry companies in China. The transfers were booked as “other payables” or “prepaids.” The board of directors was unaware of the transactions.

Subsequently, outside counsel was retained by the company and an internal investigation was conducted. During the inquiry Mr. Chong explained that he authorized the transactions at the request of a local bank manager despite the fact that he did not know the three companies to which the funds were transferred. The firm was able to furnish the staff with documentation for about 19% of the transactions. Although the funds were returned to the company, not all of the money was returned to the same bank accounts or in the same amounts as the initial transfers.

The company lacked adequate internal accounting controls, according to the SEC’s complaint. During the period of the transfers, Fuqi’s treasury controls did not require that internal fund transfer applications identify any specific business purpose or be supported by documentation. The company also did not have an effective reconciliation process.

The transactions were not disclosed by Fuqi until March 2011 when a press release was issued. That occurred after the outside auditors sent the board of directors a six page letter providing notice of a potential fraud and violations of internal controls and accounting irregularities surrounding the transactions. The company has not filed any periodic reports with the Commission since November 2009. The SEC’s complaint alleges violations of Exchange Act Section 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5).

Fuqi and Mr. Chong settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of the federal securities laws. In addition, the company and Mr. Chong were directed to pay civil penalties of, respectively, $1 million and $150,000. Mr. Chong was also barred from serving as an officer and director of a public company for five years. See also Lit. Rel. No. 22739 (July 1, 2013).