Qihoo 360’s Head of Audit Committee Caught in Accounting Scandal

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Deloitte abruptly resigns as auditor of former billion dollar HK apparel maker Boshiwa — stock plunges, remains halted

  Before you think this can't happen to you … better think twice.

Deloitte's Boshiwa exit a precursor to more China auditor resignations (Reuters)

Trading in Boshiwa, the Hong Kong listed (1698.HK), Chinese apparel maker that owns a license for the Harry Potter brand, was halted yesterday following a 42% price plunge upon the abrupt resignation of its auditor Deloitte. 

http://www.forbes.com/sites/forbesasia/2012/03/15/shares-in-boshiwa-suspended-as-auditor-resigns/

Some information requested by Deloitte is “outstanding or explanations provided by the company’s management are not to their satisfaction,” read the company's statement.  Details were quite a bit more specific here:

http://hk.todayir.com/en/fileview.php?file=/todayirattachment_hk/boshiwa/attachment/20120315123201001370466_en.pdf&lang=0&code=1698

Citron notes that the largest investor in Boshiwa is Trustridge Partners, whose co-founder and Senior Partner Shujun Li is a director of Boshiwa and he is also an "independent" director and heads Qihoo 360's audit committee.  Trustbridge, Boshiwa's largest investor, holds nearly 5.8% of Qihoo's stock as of its most recent SC 13G filing with the SEC, signed by Shujun Li himself.

We believe Boshiwa is a precursor for Qihoo as Citron has just realized that CEO Zhou Hongyi has been accused in the past of falsifying financials by numerous entities…including an agency of the Chinese Government.

History of Financial Information Falsified by Qihoo 360's Founder Hongyi Zhou

 

The balance of this post will not rehash the exhaustive work published by Citron on Qihoo 360's nonsensical financial reports for the year 2011.  This report focuses on the history of its CEO's flagrant financial misdeeds.  

Exposed material misstatements while being sued by China Ministry of Information Agency

In this well-publicized case, Zhou was sued by the China Internet Network Information Center  (http://www1.cnnic.cn/en/index/index.htm) , the state network information center of China.  But did anyone read the details?  This is not a Citron allegation.  The CNNIC takes orders directly from China's Ministry of Information.

The lawsuit claimed that Zhou and his company 3721.com misused the media to claim CNNIC was a privately owned monopoly, and was interfering with its lawful duties.  But when CNNIC went to research 3721's capacity to pay damages, it uncovered that Zhou had been falsely claiming his company attracted investments from Japan's JAFCO and IDG, as well as CIV and MassMutual.  Meanwhile SAIC business filings stated he owned 60% of the company's stock, and his wife the other 40%.  

Even worse, the "About Us" section of 3721.com's company website claimed that the business had achieved "monthly income growth in excess of 20% since October 2001."  However, its annual business inspection records stated its retained earnings were negative. 

The article states that the representative of the CNNIC, Mr. Liu, suggested that there were only two possibilities.  Either 3721.com had falsely disseminated information to investors or they had lied to the Chinese government.

http://home.donews.com/donews/article/4/47444.html

http://www.eweb.cn/news/newsshow.php?Id=63

Zhou lost the case in 2005, and had to pay CNNIC and issue a public apology.  http://tech.qq.com/a/20050624/000140.htm

What happened then?

Zhou went on to sell 3721.com to Yahoo, with a contract tied to financial performance.  But Zhou was rapidly forced out of Yahoo China when it became clear that his software product was essentially malware.  More importantly Zhou was accused of embezzling and defrauding Yahoo.

http://archive.webpronews.com//topnews/topnews/wpn-60-20061103YahooChinaWagesWarOnQihoo.html

Citron has now obtained credible evidence about the triggering event that caused Zhou to be fired from Yahoo.  He falsified the financial results of his division, upon which his own compensation was being based!!!  Citron invites the opportunity to prove this statement with its unimpeachable evidence in a California court – the sooner the better. 

Note-:  In addition to Zhou, most of the Qihoo 360 management was taken out of 3721 and into Qihoo 360 by Zhou. 

He's So Sorry

It occurs to Citron that Hongyi Zhou has been required by the misdeeds that landed him in court to have to issue no less than 4 public apologies in the last 4 years.

To CNNIC:

http://ccnso.icann.org/mailing-lists/archives/registrars/msg00915.html

To Kingsoft:

http://www.menafn.com/qn_news_story.asp?storyid=%7Bceec62aa-566d-44c6-906e-a4c687679b0e%7D

To: Tencent

http://en.21cbh.com/HTML/2010-11-22/tencent-369-qihoo-qq.html

To Yahoo:

http://www.iresearchchina.com/views/2862.html

Citron has been publishing this blog for 11 years — more years than 3721.com and Qihoo 360 have been in business combined.  During that time Citron has been sued four times, and has lost none, and has never had to issue a single apology.

   Auditor Note

 

Character is an acknowledged predictor of fraud, so much so that the PCAOB, audit standards-setting board established by the US Congress, states:

" …  the auditor who becomes aware of the existence of such information should consider it in identifying the risks of material misstatement arising from fraudulent financial reporting. For example, auditors may become aware of the following information that may indicate a risk factor: ''

       …

  • Known history of violations of securities laws or other laws and regulations, or claims against the entity, its senior management, or board members alleging fraud or violations of laws and regulations."

http://pcaobus.org/Standards/Auditing/Pages/AU316.aspx

 

 

Why should you care?

Just last year, Deloitte was forced to re-examine its audit of Longtop Financial after Citron reported on the CEO's former financial misdeeds:

http://citronresearch.com/index.php/2011/04/26/citron-reports-on-longtop-financial-nyselft/   

Before shareholders dismiss this note with "it can never happen to us", consider that Longtop had passed 4 prior audits before Deloitte was prodded to look deeper by disclosure of management's seamy track record and financial metrics that nobody else in the industry could match.

The outcome is now history, and a disaster for investors, including numerous top-tier Wall Street analysts who rallied to the company's defense.

In light of yesterday's news with Boshiwa, Citron thinks shareholders ought to consider whether Deloitte is willing to stake the goodwill of its 165-year reputation on this company, all of whose statements about its business operations contradict every major player in the industry, including numerous other Deloitte clients.

It is Citron's opinion that Qihoo 360's stock is being managed by a powerful group of insiders, but the net is closing around that conspiracy.   

Today Boshiwa – Tomorrow Qihoo

A copy of this report has been forwarded to Deloitte and the SEC.   

Cautious investing to all.