Top American executives concealed massive fraud at a U.S.-Chinese hog operation that’s now bankrupt, according to federal financial regulators.
The company, AgFeed Industries, previously blamed “accounting improprieties” on its managers and accountants in China.
However, two Americans running the hog-and-feed producer — former board member Ivan Gothner and former chief financial officer Edward Pazdro — knew about the fraud but failed to disclose it, the U.S. Securities and Exchange Commission alleges in court documents.
AgFeed Industries, which is now being sold off in pieces in bankruptcy proceedings, was a rising star in international hog production several years ago.
The China-based company raised money by selling shares to the public in the U.S. and eventually merged with a large U.S. hog farming company.
However, the company’s finances began declining in 2010, which soon led to litigation accusing the company of misleading investors.
The shareholder lawsuits alleged that AgFeed had minimized the amount of unrecoverable bad debt owed to the company.
The fraud was actually much more far-reaching, according to the SEC’s recently filed complaint.
For years, AgFeed’s executives in China reported revenues roughly twice as high as they were in reality, the complaint said.
Chinese executives inflated the earnings through “fake invoices for the sale of feed, the sale of fake hogs (and) inflating the weights of hogs sold,” the complaint said.
In all, the company overstated its revenues by nearly $240 million between 2008 and 2011, the SEC said.
Pumping up the financial results allowed AgFeed to boost its stock price, but it also created a problem — the company had to pay taxes on fat profits that it didn’t actually generate, the complaint said.
By 2010, some Chinese executives concluded “there is too much falsification” and tried to reconcile AgFeed’s fake and actual accounts, according to SEC.
This “digestion” process was accomplished in part by claiming that the company had lost large numbers of hogs to flooding and disease, when the animals had never really existed, the SEC said.
These deaths caught the attention of U.S. executives, who found the huge financial losses “absurd” given the relatively small size of certain Chinese farms, the complaint said.
These questions led Pazdro, the CFO, and Gothner, chair of the board’s audit committee, too look more deeply into the situation, according to SEC.
The two men were “directly involved” with AgFeed’s merger with the U.S. hog operation and “had strong financial incentives to ensure that the company’s transformation succeeded,” the complaint said.
The SEC complaint claims that Pazdro obtained a USB device with evidence of fraud in May 2012 and that the company’s attorney in China sent a comprehensive “fraud memo” to him and Gothner the following month.
The two executives received other corroborating reports of fraud, but didn’t disclose the problem to outside auditors, the agency said.
Despite their knowledge of the problem, Pazdro and Gothner signed off on a quarterly financial report that relied on the fake revenue data, the complaint said.
Gother also helped deliver a “materially misleading” presentation to investors that projected sales of $150 million in 2011 and $300 million in 2012 based on the fake data, the SEC said.
The agency said it wasn’t until September 2011 that AgFeed acknowledged launching an investigation and December 2011 that it announced “accounting improprieties” by managers in China.
The SEC has asked a federal judge to bar Gothner, Pazdro and the Chinese executives from serving as executives or directors of any public company.
The agency also wants them ordered to “disgorge any and all ill-gotten gains” from the improper conduct, plus civil penalties.
Capital Press was unable to reach Gothner, Pazdro or an attorney who represents the company in the shareholder litigation.
John Stadler, formerly interim CEO of AgFeed, signed a settlement with SEC under which he is prohibited from serving as a corporate officer or director and must pay a $100,000 penalty.
Clayton Marshall, who served as CFO after Pazdro, agreed to cooperate with SEC’s investigation and the lawsuit against AgFeed and several executives.
He will be suspended from working as an accountant for publicly traded firms for at least five years.
The SEC alleged that Marshall and Stadler violated financial rules by failing to disclose their knowledge of the fraud.