Recently, *ST Dongfang Communication (or Dongfang Tong) announced that the China Securities Regulatory Commission (CSRC) plans to impose a fine of 229 million yuan on the company due to false statements in its annual reports from 2019-2022 and fraudulent issuance in its 2022 private placement. Additionally, *ST Dongfang Communication announced that it may face mandatory delisting for major violations.
What's particularly noteworthy is that 2019-2022 was both the reporting period for *ST Dongfang Communication's private placement fundraising and the sponsorship period of First Capital Securities Co.,Ltd. Remarkably, First Capital Securities Co.,Ltd. failed to detect *ST Dongfang Communication's serious financial fraud, especially in 2022 when *ST Dongfang Communication inflated its total profit by 219.43% of the disclosed value.
More interestingly, Taice Technology, the main entity behind *ST Dongfang Communication's financial fraud, prematurely or fictitiously recognized over 100 million yuan in revenue in 2022. The corresponding bidding information for this revenue only appeared online as late as 2024, raising questions about whether First Capital Securities Co.,Ltd. conducted sufficient due diligence. Furthermore, Taice Technology was a target acquired by *ST Dongfang Communication at a high premium. After Taice Technology completed its performance commitments in 2021, it quickly "changed face" in 2022, which should have prompted First Capital Securities Co.,Ltd. to maintain high vigilance regarding the authenticity of Taice Technology's performance.
**Serious Financial Fraud During Private Placement Period - First Capital Securities Co.,Ltd. Failed to Detect and Objectively Assisted Fraudulent Issuance**
According to the "Administrative Penalty Pre-Notice" recently issued by the CSRC, in December 2018, Dongfang Tong acquired 100% equity of Taice Technology, making Taice Technology a wholly-owned subsidiary of Dongfang Tong. From 2019 to 2022, Dongfang Tong inflated revenue and profits through Taice Technology by fabricating business and prematurely recognizing revenue, resulting in false statements in Dongfang Tong's annual reports from 2019 to 2022. From 2019 to 2022, Dongfang Tong inflated revenue by 61.451 million yuan, 84.8506 million yuan, 125.5058 million yuan, and 160.5295 million yuan respectively, accounting for 12.29%, 13.25%, 14.54%, and 17.68% of the company's disclosed operating revenue for each period. From 2019 to 2022, it inflated profits by 52.2279 million yuan, 58.7742 million yuan, 79.4822 million yuan, and 123.692 million yuan respectively, accounting for 34.11%, 22.72%, 30.35%, and 219.43% of the company's disclosed total profit for each period.
*ST Dongfang Communication not only had false statements in its annual report disclosures from 2019-2022, but its 2022 private placement also constituted fraudulent issuance. This is because *ST Dongfang Communication's disclosed private placement "Offering Memorandum" referenced false financial data including operating revenue and total profit from the company's 2019-2021 annual reports, fabricating major false content in the announced securities issuance documents. In June 2023, *ST Dongfang Communication raised 2.2 billion yuan under the sponsorship of First Capital Securities Co.,Ltd.
What deserves investors' attention is that First Capital Securities Co.,Ltd. was the sponsor for *ST Dongfang Communication's 2022 private placement fundraising. First Capital Securities Co.,Ltd. not only failed to discover *ST Dongfang Communication's serious financial fraud during the private placement reporting period, but was particularly oblivious to the fact that the 2022 inflated total profit exceeded twice the disclosed value.
First Capital Securities Co.,Ltd. even promised in its "Securities Issuance Sponsorship Letter for Dongfang Tong's Private Placement of A-Shares to Specific Targets": "There are sufficient reasons to believe that the issuer's application documents and information disclosure materials do not contain false statements, misleading statements, or material omissions."
However, in reality, *ST Dongfang Communication's private placement application documents contained major false content, with four consecutive years of financial fraud. Whether First Capital Securities Co.,Ltd. was subjectively at fault requires regulatory determination, but objectively it did assist *ST Dongfang Communication's fraudulent issuance to raise 2.2 billion yuan.
**The Fraud Entity Was Full of Suspicious Points with Traceable Clues - Whether First Capital Securities Co.,Ltd. Was Diligent Remains to Be Examined**
First Capital Securities Co.,Ltd. was completely unaware of *ST Dongfang Communication's serious financial fraud and fraudulent issuance during the private placement period. Was this because *ST Dongfang Communication's financial fraud was too concealed to discover, or because First Capital Securities Co.,Ltd.'s due diligence was inadequate?
As mentioned above, Taice Technology committed financial fraud through fabricating business and prematurely recognizing revenue. Taice Technology was acquired by *ST Dongfang Communication for 600 million yuan in cash at a premium of 1341.28%. At that time, the counterparty promised that from 2018 to 2021, Taice Technology's net profit should be no less than 40 million yuan, 52 million yuan, 67.6 million yuan, and 67.6 million yuan respectively. The actual performance commitment completion rates were 102.9%, 102.94%, 104.34%, and 108.58% respectively.
In 2022, the first year after Taice Technology completed its performance commitments, Taice Technology achieved revenue of 256 million yuan (before accounting error corrections and before financial fraud was discovered; the corrected figure was 139 million yuan), a year-on-year decrease of 87.38% compared to 2.029 billion yuan in 2021.
With Taice Technology, acquired at a high premium, experiencing a dramatic "change of face" in the first year after completing its performance commitments, shouldn't First Capital Securities Co.,Ltd. have maintained high vigilance regarding Taice Technology and the authenticity of its performance? Shouldn't it have conducted sufficient due diligence?
According to *ST Dongfang Communication's accounting error announcement and administrative regulatory measures by Beijing Securities Regulatory Bureau, Taice Technology recognized partial revenue from the "Linyi Lingang Economic Development Zone Smart Cloud Brain Project" and "Linyi Lingang Public Security Skynet Project Upgrade and Renovation Project" in 2022. Due to fiscal funding issues of the end users, the relevant contracts could not continue to be executed, and both parties decided to terminate the original contracts with no further rights and obligations. These matters resulted in insufficient basis for revenue recognition in 2022, and *ST Dongfang Communication decided to reduce the 2022 operating revenue related to the above projects by 116.7146 million yuan. Due to the insufficient basis for the above revenue recognition, Beijing Securities Regulatory Bureau took administrative regulatory measures against *ST Dongfang Communication, ordering corrections and recording it in the securities and futures market integrity file.
According to the CSRC's "Administrative Penalty Pre-Notice," Taice Technology committed fraud through fabricating business or prematurely recognizing revenue. Whether through fabrication or premature revenue recognition, the "Linyi Lingang Public Security Skynet Project Upgrade and Renovation Project" would have been difficult to cross-verify through public information at the end of 2022.
According to available information, Taice Technology was established in 2003 and is a provider of data application security and emergency safety products. Its main products include Domain Name System (DNS), emergency communication systems, and data security systems.
According to public information, *ST Dongfang Communication and Taice Technology included 116.7146 million yuan in revenue from the "Linyi Lingang Economic Development Zone Smart Cloud Brain Project" and "Linyi Lingang Public Security Skynet Project Upgrade and Renovation Project" in their initial version of the 2022 annual report through "premature" or other non-compliant methods, inflating or prematurely recognizing 116.7146 million yuan in revenue. The question is: did First Capital Securities Co.,Ltd. conduct sufficient due diligence on this portion of revenue?
According to an announcement by Linyi Public Resource Trading Center on February 6, 2024, the "Lingang Public Security Branch Skynet Project Upgrade and Renovation Project" was first published on January 22, 2024. If the "Lingang Public Security Branch Skynet Project Upgrade and Renovation Project" shown in this announcement is the same project mentioned in Dongfang Tong's announcement, then the traces of Taice Technology's premature or inflated revenue recognition would be quite obvious, and First Capital Securities Co.,Ltd. should not have found it difficult to discover.
According to the CSRC's "Sponsor Due Diligence Guidelines," sponsor securities firms should "investigate and understand major customers and their basic situations, transaction amounts with major customers in each year of the reporting period, time of establishing cooperative relationships, pricing methods, settlement methods, final sales realization, etc., and analyze whether business indicators are consistent with changes in sales revenue." The question is: did First Capital Securities Co.,Ltd. exercise professional skepticism regarding the 116.7146 million yuan in revenue that *ST Dongfang Communication "prematurely or fictitiously" recognized at the end of 2022? Did it conduct due diligence on settlement methods and final sales realization?
**Should a Pre-Compensation Fund Be Established?**
In the Amethyst Data Storage IPO fraudulent issuance case, sponsor CITIC Securities quickly joined with auditing firms, law firms, and other intermediary entities after the CSRC initiated investigation procedures to jointly establish a special compensation fund, ultimately completing approximately 1.086 billion yuan in effective compensation, becoming the first full compensation case under the registration system.
After the fraudulent IPO issuance case of Zeda Yisheng, which Orient Securities sponsored, broke out, Orient Securities worked with other intermediary institutions to raise a 340 million yuan compensation fund pool.
Entering 2025, China Minmetals Securities' actions in the *ST Guangdao financial fraud incident reflected the maturation of industry disposal mechanisms. In response to the company's continuous 8 years of inflated revenue fraud, China Minmetals Securities, as the sponsor and continuous supervision institution, jointly established a 220 million yuan advance compensation fund with other intermediaries during the investigation stage.
Currently, *ST Dongfang Communication may face mandatory delisting due to consecutive years of profit inflation, and First Capital Securities Co.,Ltd., as its sponsor, is facing similar responsibility tests. Establishing a special compensation fund has dual positive value: on one hand, timely loss compensation can repair investor confidence and avoid systemic trust crises; on the other hand, regulators have continuously strengthened "gatekeeper" responsibility accountability in recent years, and institutions that proactively assume responsibility often receive more trust points in subsequent business qualification approvals and innovative business pilot programs. At this time, should First Capital Securities Co.,Ltd. also establish an advance compensation fund to actively address investor losses and thereby maintain its reputation?
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