A bankrupt Tennessee animal feed company, AgFeed Industries, has agreed to pay back $18 million in illicit profits from an accounting fraud that resulted in a Securities and Exchange Commission enforcement action earlier this year.

AgFeed and some of its top executives were charged by the SEC in March with repeatedly reporting fake revenues from the company’s China operations in order to meet financial targets and prop up AgFeed’s stock price. 

The Hendersonville, Tenn.-based company obtained illicit gains in stock offerings to investors at the inflated prices resulting from the accounting scheme, according to the SEC. The SEC also alleged that U.S. managers learned of the accounting fraud, but failed to take adequate steps to investigate and disclose it to investors.

The $18 million to be paid by AgFeed to settle the SEC’s case will be distributed to victims of the company’s fraud. Details of the settlement were presented to the bankruptcy court in Delaware earlier today, and the settlement is subject to court approval by the bankruptcy court as well as the district court in Tennessee where the case was filed.

The SEC’s case continues against five former company executives and a former audit committee chairman, K. Ivan Gothner.

The SEC’s complaint, which was filed in March in the U.S. District Court for the Middle District of Tennessee, charged executive chairman Songyan Li, CEO Junhong Xiong, CFO Selina Jin, and controller Shaobo Ouyang as the management in China behind the scheme, which began in 2008 after AgFeed acquired 29 Chinese farms for its new hog production division.  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.  Li, Xiong, Jin, and Ouyang caused AgFeed to report false revenues of approximately $239 million.

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. 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 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 alleged 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 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 2011, they failed to take appropriate actions. They also allegedly misled AgFeed’s outside auditor and caused the company to issue false and misleading press releases and SEC filings.

“This settlement holds AgFeed accountable for its accounting fraud and deprives the company of ill-gotten gains,” said Julie Lutz, director of the SEC’s Denver Regional Office, in a statement.  “This provides the most expedient and effective way to provide a substantial recovery to victims of AgFeed’s fraud while the company remains in bankruptcy.”

Under the proposed settlement, AgFeed has also agreed to the entry of a permanent injunction enjoining it from the antifraud, periodic reporting, and recordkeeping and internal control provisions of the federal securities laws. AgFeed is neither admitting nor denying the charges in the settlement.

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