Longtop Financial Fraud Investigation Reaches ‘Final Step’


On Monday August 29, Longtop Financial Technologies Ltd. (OTC: LGFTY.PK) stated that it had received a Wells notice from the U.S. Securities and Exchange Commission.

“The Wells Notice typically is the final step in the investigation.  The Staff of the Enforcement Division has determined that it believes civil violations of United States federal securities laws have occurred,” writes Mr. Jacob S. Frenkel, a Partner at Shulman Rogers in Potomac, Maryland and a former SEC enforcement lawyer who is an expert in securities law matters. The notice invites Longtop to prepare a legal defence.

Longtop, a provider of financial software, is one of a string of overseas-listed Chinese firms to face fraud allegations this year. A cottage industry of short-sellers of Chinese stocks, particularly reverse mergers, has arisen led by firms such as Muddy Waters and Citron Research.

Longtop, however, has had one of the most spectacular falls, including Maverick Capital and Tiger Global. It was not a reverse merger firm, its 2007 IPO was underwritten by Goldman Sachs and Deutsche Bank. It had investment from seven major global hedge funds. It had a market capitalisation of $1.08 billion at the time that trading was suspended on May 17.

To address the fraud and accounting irregularities among Chinese firms, the SEC and Public Company Accounting Oversight Board (PCAOB) visited Beijing. Yet the two sides were failed to agree upon cross-border auditing standards, with the Chinese side rejecting joint inspections by U.S. and Chinese auditors on sovereignty grounds.

Mr. Frenkel states that the SEC investigation and trial of Longtop will continue as follows:

The Staff cannot bring charges directly; it first must obtain authorization from a majority the Commissioners of the SEC to file charges.  So the Staff notifies the company or person, whom it will ask the SEC to charge, that the company or person can make a written or video submission to make an argument to the SEC why the charges should not be brought.  If a company, or a person, then chooses to make a Wells Submission, that argument goes to the SEC as well for consideration.  There is a significant amount of strategy involved in deciding whether to make a Wells submission.  Experienced SEC defence lawyers are particularly careful about the Wells process, as the decision about a submission and what to say is not simple.

The important news for the company is that the SEC likely has completed its investigation of the company, but not necessarily all of the individuals.  That means for the company it probably will settle charges by the SEC, and will settle without admitting or denying the allegations.  As a result, the completion of the investigation will enable the company to return to focusing on the business of the company.

It is somewhat common when an investigation of a company comes to an end that the price of the stock rebounds, meaning it goes up again.  If a company has real businesses and real contracts, then the completion of the investigation and bringing of civil charges provides for an explanation of what went wrong.  The end of the investigation can eliminate the uncertainty in the market.  The reason stock prices can go up again is investors can better understand what concerned the regulators and what survived scrutiny.  That is why concluding investigations always is good for companies, and why companies want to see investigations finish as fast as possible.

In all likelihood, when the SEC brings civil charges, the SEC also will say that its investigation is continuing.  What that means is that it is continuing to investigate officers, directors, and others whom it believes may be responsible for violating civil law, causing corporate violations to occur or making it possible for the violations to occur.  Almost always, the SEC brings charges once against the company, so the continuing investigation generally does not mean additional charges against the company.

Mr. Frenkel also addressed the SEC and the crisis of trust in Chinese firms in an earlier interview with iChinaStock.



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