SEC charges AgFeed and top executives with massive accounting fraud

By Caroline Salls

Pittsburgh, March 11 - The Securities and Exchange Commission charged AgFeed Industries, Inc. and top executives with conducting a massive accounting fraud in which they repeatedly reported roughly $239 million in fake revenues from their China operations in order to meet financial targets and prop up the stock price, according to an SEC news release.

The SEC alleges that four executives in China orchestrated the scheme at AgFeed, which was based in China and publicly traded in the United States before merging with a U.S. company in September 2010 and spreading its operations between the two countries.

With the bulk of its hog production operations in China, the SEC said executives used a variety of methods to inflate revenue from 2008 to mid-2011, including fake invoices for the sale of feed and purported sales of hogs that didn't really exist.

They later tried to cover up their actions by saying the fake hogs died, the SEC alleges. Because fatter hogs bring higher market prices, the SEC said the executives also inflated the weights of actual hogs sold and correspondingly inflated the sales revenues for those hogs.

U.S. executive charges

The SEC also charged a company executive and a company director in the United States with scheming to avoid or delay disclosure of the accounting fraud once they learned about it in 2011 while engaging in efforts to raise capital for expansion and acquisitions.

The director, K. Ivan (Van) Gothner, was chair of AgFeed's audit committee, according to the release. The SEC said he sought advice from a former director and company adviser who responded in e-mail communications that there was "not just smoke but fire" and recommended that AgFeed hire professional investigators guided by outside legal counsel.

However, the SEC said Gothner ignored the recommendation and internalized the situation while false financial reporting continued.

The SEC also reached a settlement with another U.S.-based company executive and a cooperation agreement with a different executive in the United States. The eight executives involved in the SEC's case are no longer at AgFeed, the release said.

"AgFeed's accounting misdeeds started in China, and U.S. executives failed to properly investigate and disclose them to investors," Andrew J. Ceresney, director of the SEC's Division of Enforcement, said in the release.

"This is a cautionary tale of what happens when an audit committee chair fails to perform his gatekeeper function in the face of massive red flags."

Scheme history

According to the release, the SEC's complaint filed in the U.S. District Court for the Middle District of Tennessee charges executive chairman Songyan Li, chief executive officer Junhong Xiong, chief financial officer Selina Jin and controller Shaobo Ouyang as the management in China behind the scheme, which the SEC alleges began in 2008 after AgFeed acquired 29 Chinese farms for its new hog production division.

The SEC said the inflated numbers that included sales of fake hogs and bloated weights of actual hogs were recorded in a fake "outside" set of books that the company provided to its outside auditors. The "inside" real set of books contained accurate, lower revenue numbers that were hidden from auditors, the SEC said. Li, Xiong, Jin and Ouyang caused AgFeed to report about $239 million in false revenues, the complaint said.

Failure to disclose

According to the SEC's complaint, U.S. management learned of the accounting fraud by early June 2011 but failed to take adequate steps to investigate and disclose it to investors.

The SEC alleges that Gothner and the CFO who replaced Jin after the merger, Edward J. Pazdro, specifically learned that AgFeed's China operations kept two sets of accounting books and that Ouyang had admitted to the fraud.

Gothner and Pazdro even obtained a partial copy of the two sets of books as well as a memo from AgFeed's in-house counsel from China that concluded, based on witness accounts and documentary evidence, that the company was involved in a widespread accounting fraud, the release said.

The SEC said the memo noted that two sets of accounting books were maintained, "in order to make AgFeed's revenue and net income look better." The memo concluded that Xiong and Jin had directed the accounting fraud and Xiong had ordered the destruction of the second set of books.

The SEC alleges that instead of fulfilling their responsibilities as the company's stewards of financial reporting, Gothner and Pazdro failed to conduct or prompt the company to conduct any further meaningful investigation into the misconduct.

Not only did they fail to disclose the fraud to investors or law enforcement, but the SEC said Gothner and Pazdro instead engaged in efforts to spin off the company's feed division and raise capital for expansion and acquisitions that would enable profits for AgFeed and them personally.

Even as additional red flags arose in June and July of 2011, the SEC said the executives failed to take appropriate actions. They misled AgFeed's outside auditor and caused the company to issue false and misleading press releases and SEC filings, the release said.

Specific charges

The SEC's complaint charges AgFeed, Xiong, Li, Jin, Ouyang, Gothner and Pazdro with violating or aiding and abetting violations of the anti-fraud, reporting, books and records and internal controls provisions of the federal securities laws.

Xiong, Li, Jin, Ouyang, Gothner and Pazdro also are charged with making false statements to AgFeed's outside auditors.

The SEC's complaint seeks disgorgement of ill-gotten gains plus prejudgment interest, as well as financial penalties and officer-and-director bars.

The SEC also seeks to suspend Jin, Ouyang, and Pazdro from practicing as accountants on behalf of any publicly traded company or other entity regulated by the SEC.

Agreements reached

AgFeed's former chairman and interim CEO John A. Stadler separately consented to an SEC order barring him from acting as an officer or director and requiring him to pay a $100,000 penalty and cease and desist from committing or causing any violations and any future violations of the Securities Act of 1933 and the Securities Exchange Act of 1934.

AgFeed's former CFO Clayton T. Marshall, who replaced Pazdro, entered into a cooperation agreement with the SEC. The terms of his settlement reflect his assistance in the SEC's investigation and anticipated cooperation in the pending court action.

The SEC said Marshall agreed to be suspended from practicing as an accountant on behalf of any publicly traded company or other entity regulated by the SEC for a period of at least five years. Without admitting to or denying the findings, he consented to an SEC order requiring him to cease and desist from committing or causing any violations and any future violations of specified sections of the Securities Act and the Exchange Act.

The SEC said it would determine at a later date whether a financial penalty should be imposed against Marshall.

AgFeed consented to an SEC order under Section 12(j) of the Exchange Act that revokes the registration of each class of its securities. The SEC's case against AgFeed in federal court is continuing.

AgFeed USA, an Ames, Iowa-based producer of animal feed, filed for bankruptcy on July 15, 2013 in the U.S. Bankruptcy Court for the District of Delaware. Its Chapter 11 case number is 13-11761.

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