NQ Mobile (NYSE:NQ) fired auditor PwC Zhong Tian and replaced them with Marcum Bernstein Pinchuk LLP (MBP). MBP is a joint venture between 14th ranked U.S. CPA firm Marcum and unranked Bernstein Pinchuk. The joint venture audits 18 SEC registrants, ranking it 4th by number of SEC registered clients in China (but much smaller if ranked by revenue). I have considered MBP to be among the best of the small firms working the China market. Unlike some of their peers they understand China and actually do audits. The 2013 PCOAB inspection of MBP found no deficiencies in their audit work.
NQ Mobile was the subject of a report by Muddy Waters last October alleging widespread fraud. Some of Muddy Waters allegations were easily dispelled. A special investigation by Deloitte and Shearman & Sterling failed to uncover evidence of fraud, but did report missing data.
The company missed the deadline (April 30) for producing its annual report on Form 20F apparently because PwC would not sign the required audit report. The company announced that its audit committee chairman had resigned (ostensibly for personal reasons). The stock was badly beaten up.
On Friday, July 18, NQ announced it had fired PwC and replaced it with MBP. The company claims there are no disagreements between the company and PwC over accounting and auditing matters. NQ will have to file a statement to this effect with the SEC within the next few days and PwC will have to tell the SEC whether it agrees. Both parties were likely careful to not let their differences escalate to the level of a “disagreement”, but I expect the SEC will probe this matter extensively. This will all play out on Edgar in the coming days.
The firing announcement gives some clues as to why PwC was fired. NQ says PwC said it needed to expand its work because of the questions related to electronic data raised in the special investigation. Deloitte had observed that data was missing from multiple devices. PwC apparently also told the company that the additional work “may cause it to be unwilling to rely on management representations in connection with its audit work”. What that suggests is that PwC suspects that management has purposely deleted the missing data. If PwC proves that, they would have no choice but to resign since management cannot be trusted.
The company also indicted that PwC demanded to see original bank statements of third parties. Obviously it can be difficult for a company to convince custom-ers and vendors to supply bank statements. It does suggest that PwC is con-cerned about round tripping of revenue. Round tripping involves cash leaving a company in one form (often to pay for an acquisition) and then returning as revenue. While round tripping is commonly alleged against Chinese companies, it is very difficult to prove because of the limited access to records outside the company.
So now MBP will have to re-audit 2013. Then, before the company can file the Form 20F, they will need consent from PwC to use the audit reports for 2012 and 2011. PwC may not agree to this. If PwC will not consent to the use of its re-ports, then NQ has no alternative but to have the 2011 and 2012 financial state-ments re-audited. That might take a year.
MBP is likely to face its own problems before those audits are completed. MBP is a New York-based CPA firm. China has proposed to block foreign accounting firms from coming to China to audit U.S. listed Chinese companies, requiring instead that the firms outsource local audit work to Chinese CPA firms ranked among the top 100 Chinese CPA firms. MBP has opened up several offices in China, but those offices are consulting WFOEs that are not licensed as CPA firms. I understand MBP does have a local CPA firm made up of its local man-agers who are Chinese CPAs, but that firm does not rank in the top 100. So NQ may soon be shopping for auditors again.