‘Profits’ From Imaginary Hogs in China

NASHVILLE (CN) - A "massive accounting fraud at AgFeed Industries," planned and carried out in China, overstated revenue from the company, which also has operations in the United States, by more than 100 percent, the SEC claims in court.

The federal lawsuit begins: "This case involves a massive accounting fraud at AgFeed Industries, Inc. ('AgFeed' or the 'company'), an animal nutrition and hog production company with operations in the United States and China. AgFeed reported fictitious revenues from its China operations from 2008 through June 30, 2011. The fraud caused AgFeed's publicly-reported revenues to be inflated by approximately $239 million over this period. On an annual basis, the fraud caused overstated revenue ranging from approximately 71 percent to 103 percent.

"The fraud was orchestrated by four former members of AgFeed's Chinese management named as defendants in this complaint: Songyan Li, former executive chairman, Junhong Xiong, former chief executive officer ('CEO'), Selina Jin, former chief financial officer ('CFO'), and Shaobo Ouyang, former controller of the company's Chinese hog operation (the 'Chinese Defendants'). As described more fully below, Xiong, Jin, Li, and Ouyang inflated revenues by, among other things, booking sales of non-existent hogs and by manipulating hog weights, and later covered it up by, among other things, reporting that the fake hogs had died."

American board members and directors discovered that the company kept two sets of books, "that the accounting fraud was widespread, that Xiong and Jin had directed the accounting fraud, and that Xiong had ordered the destruction of the second set of books," the SEC claims.

But the Americans - defendants Edward J. Pazdro and K. Ivan Gothner - trying to raise money for expansion, "engaged in a scheme to avoid or delay disclosure of the fraud," the SEC says in the complaint, "including: (1) failure to disclose to the company's auditors key evidence of the fraud, including the internal memo describing the fraud and the USB drive which contained two sets of books; (2) failure to disclose the internal memo or USB drive to key personnel in management, such as the company's new CFO; (3) with respect to Pazdro, misrepresenting his knowledge of the fraud in the August 9, 2011 management representation letter to the outside auditors; (4) with respect to Gothner, misrepresenting to counsel that a third-party expert had been engaged to analyze the USB drive when no such expert had been hired; and (5) failure to conduct further meaningful inquiries into the fraud even as additional red flags arose. Gothner's and Pazdro's actions and failures to act on the fraud caused AgFeed to make false and misleading public statements, including a Form 10-Q on August 9, 2011 that reported the falsely inflated earnings.

"As a result of the conduct described herein, AgFeed, the Chinese Defendants, Gothner, and Pazdro violated the federal securities laws and, unless restrained and enjoined, will continue to do so."

AgFeed trades on the NASDAQ. Shares were going for a quarter this morning.

The SEC seeks disgorgement, penalties and injunctions.

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