Term Paper

On
A Case on China Metal Recycling (Holdings) Limited
Course: Ethical Issues in Accounting

Prepared By:
Name & Id:
Emtiaz Ahmed Anik [17211017]
Nahian Al Fattah [17211019]
Fatema Bin Womme Akter [17211029]
Eshfaque Alam Dastagir [17211061]
Faiyana Sharmin [17211069]
Azharul Haque Mazumder [17211075]
Section :A
Batch : BBA (AIS) 2017

Prepared For:
Name : Md. Jamil Sharif
Designation: Dr.
Department: Business Administration in Accounting & Information Systems
Faculty : Business Studies

Date of Submission: June 01, 2020

 Abstract

This case provides a basic understanding of financial-report fraud, particularly where there are
such typical red flags as: improbable growth rate; improbable revenue per employee figures;
improbable inventory turnover compared with peers; improbable return on capital not in line
with the business involved; abnormal resignations and moves by top company officials. It
examines the difference between corporate governance "on paper" and corporate governance as
actually implemented and the role of regulators in financial markets. The case also emphasizes
the importance of professional ethics and identifies the role of short-sellers in financial markets.

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 Letter of Transmittal

June 01, 2020

Md. Jamil Sharif, Dr.

Lecturer
Department of Accounting & Information Systems
Bangladesh University of Professionals

Dear Sir,

As agreed we are submitting the term paper based on a case on China Metal Recycling
(Holdings) Limited.

This case provides a basic understanding of financial-report fraud. It examines the difference
between corporate governance and corporate governance as actually implemented and the role of
regulators in financial markets. The case also emphasizes the importance of professional ethics
and identifies the role of short-sellers in financial markets.

I hope you find this paper satisfactory. 

Sincerely yours, 

Emtiaz Ahmed Anik [17211017]

Nahian Al Fattah [17211019]
Fatema Bin Womme Akter [17211029]
Eshfaque Alam Dastagir [17211061]
Faiyana Sharmin [17211069]
Azharul Haque Mazumder [17211075]
Section :A
Department: Accounting & Information Systems
Batch : BBA (AIS) 2017

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 Table of Contents

Abstract.......................................................................................................................................................1
Letter of Transmittal....................................................................................................................................2
Question No: 01...........................................................................................................................................4
Question No: 02...........................................................................................................................................4
Question No: 03...........................................................................................................................................7
Question No: 04...........................................................................................................................................9
Question No: 05.........................................................................................................................................10

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Question No: 01

What issues does this case pertain to? Who are the key players in this case?

This study pertains to the dissolution of China Metal Recycling Holding Ltd., the so called
largest business in recycle of scrap metal. This case mainly focuses four things, fraudulent
activities done by China Metal Recycling Holding Ltd, the report of a watch dog entity which is
Glaucus Research Group, followed by several investigations conducted by Securities and
Exchange Commission, delisting of CMR and finally liquidation of CMR. The key players in
this case were:

 China Metal Recycling Holding Ltd

The company itself is the center of the study. This study is all about how the company got
involved into fraudulent activities and how its fraudulent business activities finally got
uncovered.

 Glaucus Research Group/watch dog

Here Glaucus Research Group worked as a watch dog. The management of China Metal
Recycling Holding Ltd showed aggressive growth of its revenue, which had drawn the attention
of Glaucus Research Group. The watch dog group published a report on CMR which accused
CMR of fraudulent acts.

 Securities and Exchange Commission

Following the report of Glaucus Research Group, the Securities and Exchange Commission
conducted an investigation which finally uncovered the frauds the management committed.

 Whistle blower

When the CFO of CMR wanted to have full access to the financial information, he was not
allowed to some portion of the information. This caused him to resign from the position.

 Independent auditor

Deloitte Touché Tohmatsu worked as an auditor for CMR.

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Question No: 02

Discuss the signs of potential frauds indicated in the case.

Existing fraudulent activities

Followed by a report from Glaucus Research Group, several investigations were led by
Securities and futures commission of Hong Kong which uncovered a number of fraudulent
activities conducted by the Management of China Metal Recycling Holdings Limited. Some of
the findings are as follows:

 IPO through unethical means, illegal listing in stock exchange

Companies that meet the requirements of Securities and Exchange Commission are allowed to be
listed in stock exchanges. However in the case of China Metal Recycling Holdings Limited, the
company didn’t have proper listing criteria. That is why the management of China Metal
Recycling Holdings Limited adopted unethical measures to show the regulatory bodies that it
had the qualification to be enlisted in the Stock exchanges, while in reality they didn’t have the
qualification to be so.

 Overvaluing assets

Overvaluation of asset is one of the most common types of fraud in business history. Most
corporate management aims to overvalue the assets of the company to deceive present and
potential investors. The management of China Metal Recycling Holdings Limited did no less.
They overstated the assets in the balance sheet so that they can attract more investors.

 Inflating revenue, profits, fake transactions

When an investor wants to invest in a company, he goes through the financial statements of the
company before anything else. If he finds the financial statements to be positive enough, he is
highly likely to invest in that company. Unfortunately, this is where management becomes very
successful in deceiving the potential investor. The same happened in the case of China Metal
Recycling. The revenue from transactions was abnormally higher than the other competitor.
After investigation conducted by SEC it was found that many fake transactions were created to
inflate revenue.

 Restricting access to top executives

Top executives such as CFO, COO, COO or other C level executives have full right review the
financial statements anytime they want. Sometimes what happens is that there is management
conflicts meaning one part of management is trying to adopt illegal or unethical means to report
higher revenue, while the other party is trying to remain neutral. That is what happened in this

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case, CFO was not allowed to access some portion of financial information, this event alone tells
us about the possible fraud inside the company.

 Influencing auditors

Auditors are the most important factor in maintaining investors trust. If investors don’t see any
red flag in the auditor’s report, they will feel more secure in investing. Sadly many top auditors
also involve themselves in complex fraudulent activities. If auditors give a clean report on any
business that has been practicing fraudulent activities, then investors will lose their trusts in both
parties. In case of China Metal Recycling Holdings Limited exactly the same thing happened.
Here Deloitte Touché Tohmatsu, the auditor gave clean report on the financial report of CMR.

 False advertisement

The management of China Metal Recycling Holdings Limited even advertised the company
falsely. They claimed CMR to be the largest trading company in China, while the reality was far
from it.

 Hide or forge material information

Hiding material information or forging material information is one of the most common
techniques adopted by fraudulent businesses to deceive public. The management in CMR
showed positive images of the company by inflating revenue figures, placing fake transactions,
overstating assets in the financial statements.

Potential Frauds

Apart from the frauds which were already uncovered by SEC investigation followed by a report
from Glaucus Research Group, there could be some other fraudulent activities that could have
taken place.

These hypothetical fraudulent activities might include:

 Possibility of insider trading

Insider trading involves trade of shares using material information which are not public. This
gives the trader of shares unfair advantages in the market. In case of CMR, the possibilities of
insider trading are quite high. For example MR. Chun Chi Wai, chairman and CEO alone held
more than 52 percent of shares of the company, this opens the opportunity to insider trading,
through which he turn the market to his favor.

 Possibility of making shell companies

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Shell companies are considered unethical means of transferring debts as bankruptcy due to debt
falls on the shell company, not on the holding company. Since China Metal Recycling had huge
amount of debt, it could hide its debt to shell companies so that the impact of bankruptcy won’t
fall on China Metal Recycling.

 Practice of mark to market accounting

Mark to market accounting involves overstating asset values by analyzing some key attributes
like future possible earnings. It is the opposite of historical accounting where cost price is
recorded in balance sheet. Since the Management of CMR was overstating assets value, there is a
chance that they could have used mark to market method in asset valuation.

 Showing less debt capital

Since CMR had large amount of debt capital, it could use special purpose vehicle or shell
companies to hide its huge debts by transferring the debts to the shell companies so that the
holding company remains untouched by debts impact.

Question No: 03

Discuss the roles and responsibilities of an audit committee and external auditor as well as
what an external auditor should do to ensure financials is correctly reported.

Roles and responsibilities of audit committee

In the case of China metal recycling ltd., the audit committee is seemed to be adopting unethical
measures. The roles of audit committee include:

 Monitoring financial reporting of the company. Here in case of CMR the financial
statements were manipulated severely.

 Adopting proper accounting policies and principals. Again the audit committee neglected
this core principal by adopting such policies which overinflated the revenue and assets.

 Monitoring both hiring and performance of external auditors. The external auditors gave
clean opinion despite many fraudulent activities. This should have been a concern for the
audit committee.

 Before financial statements are published they are reviewed by both audit committee and
managements. Here in this case of CMR, both of the parties failed to do so.

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Roles and responsibilities of external auditors

In this case, Deloitte Touché Tohmatsu, auditor of China Metal Recycling Ltd. Gave cleans
opinion despite the fraudulent activities committed by the management. This could raise two
questions: either the auditor was influenced by management of CMR or the independent auditor
lacked professionalism. Roles and responsibilities of the auditor in this case would be:

 Setting proper audit plan.

 Giving proper audit opinion based on the findings. In case of CMR, the auditor gave
clean report fraudulent acts. This indicates that the audit team has not made proper
inquiry or was influenced by management.

 Collecting relevant examples. If an auditor can’t collect relevant material information, his
audit report will be baseless.

 Reviewing the collected evidence with time and sincerity.

 Continuously discussing with audit committees for collecting information, so that

auditors can give clean report.

External auditors’ roles to ensure that financial statements remain correct

Management always wants clean report from external auditors. But auditors give clean report
only when certain criteria are met in the financial statement. Management may accidentally skip
any of the criteria, resulting in an unexpected report that is where auditors come into play.
Auditors do various strategies to ensure financial statements remain correct at the same time
remaining neutral. Some of them are:

 Auditors can ensure proper financial statements by analyzing the internal control system
of the company as well as Suggesting changes to internal control system if there is high
chance of fraud or error.

 Discussing financial reporting procedures with audit committee. Auditors will not
prepare financial report but they can suggest the audit committee in preparation of the
financial report.

 Suggesting probable solutions to reduce errors. While conducting audit the auditors may
encounter several errors, therefore, the audit team will discuss the issue with audit
committee.

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Question No: 04

Discuss the corporate governance structures and the effectiveness of the board and board
committees for reducing the likelihood of fraud.

Corporate governance structures

 CMR’s board of directors consisted of seven members. In a board of committee

chairperson & CEO cannot be same person. But at a time CHUN chi-wai was the
executive directors, CEO, chairperson of the company. He had the all responsibilities of
the company like-strategic plan & business management. The CEO of the company
CHUN chi-wai cashed out money by selling shares that he held in the CRM Company
which largest amount was 56% of his own. But he should not have done this.
 Out of 7 people, 3 were independent non-executive director which are not consistent with
global best standard majority board. Their responsibilities were to give proper access but
they did not do that.
 The Company also had an audit committee consisting of all independent members of the
board. Audit committee had power to remove independent auditor if they thought they
did not do their work. But audit committee gave priority to themself & boards of
directors’ interest.
 There were 75% independent directors in a remuneration committee. But in a
remuneration committee, all of whom shall be independent non-executive directors they
formulated the criteria for evaluation of performance of independent directors & the
board. They would be accountable to the shareholders. They all should have done the
work for the betterment of the shareholder. But CRM directors all of them tried for their
own interest rather than shareholder interest.

The effectiveness of the board and board committees

Board of the directors

 CEO& CFO should have certified to the board that they had reviewed the financial
statements for the year & he would be responsible for strategic, management planning.
 They should have represented actual financial report to their shareholders, creditors to get
investment.

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  Other officers & directors of the boards should have overseen the financial report
properly & all actual information regarding the market share of the company.
 The CEO & chairman of the company should not hold the 29% of the share of the
company. But the CEO held that. They also calculated their asset in historical cost based.
 When the CEO was doing the fraud, the CFO should not have involved himself as a fraud
–like last CFO.

The audit committee

 The audit committee should have given true & fair view of the company.
 They should have monitored, reviewed the financial statements before submission to the
board .they should have also reviewed related party transaction. When they got fraud,
they should have discussed with the board of directors, shareholders creditors.
 They should have monitor the internal audit, & compliance plan & review of the internal
audit procedure & break out all the estimation, assumptions, methods which they used in
their financial statement.
 They should have break out the estimations, market strategy, IPO of the company to the
shareholders.

Independent auditors

 They gave overall information of the company regarding all shareholders & shareholders
which would be believable. But they all failed to provide true information of the
company.
 They also should have exposed all fraud before the shareholders, investors etc.
 After knowing the facts of the company, the company doing the fraud, they should have
given qualified audit opinion. If they did not give unqualified opinion, they would not
success to do fraud.
 When the auditors founds companies fraud they should have discuss this fraud with the
audit committee but they failed to do that.
 After all, independent audits should have cancelled their agreement.

Question No: 05

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Discuss the resignation of Mr. Wong Hok Leung, CFO and Deputy Chief Executive
Officer, with respect to professional and ethical conduct.

The roles of Chief Financial Officer in mitigating risks are immense. Apart from preparing
financial plans, monitoring cash flow, preparing financial reports he or she also has to check
whether everything is going smoothly or not, for example checking compatibility of financial
reporting with relevant rules and regulations. Investors’ decisions are based on the report of the
financial reports of the business. So management can deceive the investors by manipulating the
financial reports. So, without a doubt CFO plays the biggest role here.

Unfortunately Mr. Wong Hok Leung who was the CFO of China Metal Recycling during the
whole IPO process could not perform his role due to conflict and fraudulent nature of the
management body in CMR. Most apparent example of the fraudulent management is when Mr.
Wong Hok Leung, CFO wanted to access some financial information, he was denied by other
parties in the management. After that he resigned voluntarily. He could have stayed in the
business to take advantage of the situation, instead he acted as a whistle blower and this event
alone raised many questions. Following his resign, after several investigations the company was
delisted from Hong kong stock exchange. Without such professionalism from MR. Wong, the
whole event would not have come to light.

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