Critical to any exchange transaction is the value given and received. It is axiomatic that the firm must conduct appropriate due diligence to determine the appropriate value and properly account for the transaction. A failure to account for the transaction can result in accounting errors. Ignoring obvious and significant flaws and red flags regarding the transaction strongly suggests not just a valuation error but something more. That clearly seems to be the situation underlying the Commission’s latest corporate valuation case. In the Matter of Agria Corporation, Adm. Proc. File No. 3-18917 (Dec. 10, 2018).
Agria is a Cayman Island firm based in Hong Kong engaged in the agricultural business. Its American Depository Shares were listed on the New York Stock Exchange. The firm had significant business interests in the Peoples Republic of China, New Zealand and Australia. The operations in China – corn seed, sheep breeding and seedlings – were operated by Taiyuan Primalights III Modernized Agriculture Development Co., Ltd., known as P3A, a limited liability firm whose results were consolidated with Agria.
In early 2010 Agria negotiated an agreement with P3A’s president under which the firm would divest ownership of the limited liability firm, ending the sheep breeding operations to focus on the seed business. Under the terms of the transaction Agria transferred 100% ownership interest in P3A to that firm’s president. P3A’s president in turn transferred his ownership of 11.5% of Agria’s outstanding shares and added the land use rights held by the firm.
To assess the fairness of the transaction Agria retained three external advisory firms. First, a Chinese law firm offered an opinion which identified defects relating to the legality of the leases that P3A obtained. Those included the fact that eight of the nine lessors did not hold valid title. Second, a consulting firm advised that the fair value of the assets based on the assumption that the properties could be legally leased without any legal defects in terms of relevant tenancy. Finally, a financial advisory firm assessed the impact of the divestiture on Agria’s fair market value by calculating the fair value of the P3A net assets as Agria instructed. The instructions dictated that the amount be determined by netting the fair value of P3A’s total assets and the calculated value of the land use rights rental prepayments. Based on these reports the board approved the transaction.
During the preparation of Agria’s 2010 financial statements no impairment analysis was conduct. This ignored the fact that the senior management of the firm knew two impairment indicators. If the impairment analysis had been conducted the assets would have been written down significantly. Yet no write down was taken in 2010, 2011 and 2012.
Finally, in 2013 the firm was forced to write down the assets secured in the deal with P3A. The decision was based on the fact that the land leases had no expected future economic viability and were not useful to the firm since it changed its line of business and the legal defects. Both factors were known to senior management of the firm in 2010. GAAP required that the financial statements be restated under these circumstances – a write down as taken by the firm was not sufficient. By overvaluing the assets and ignoring market value of the stock received as priced on the NYSE in favor of assigning a value to the shares based on the assets which approximately doubled the share value, Agria concealed a loss of about $17.45 million. If that loss had been properly recorded it would have tripled the net reported loss in 2010. The delay in properly reporting the transaction had a similar impact in 2011 and 2012. The Order alleges violations of Exchange Act sections 10(b), 13(a), 13(b)(2)A) and 13(b)(2)(B).
To resolve the proceedings the firm agreed to fully cooperate with the staff in any action or related judicial or administrative proceeding or investigation. The firm also consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, Agria agreed to pay a penalty of $3 million. See also In the Matter of Laiguanglin (Alan), Adm. Proc. File No. 3-18918 (Dec. 10, 2018)(Action against the executive chairman of the firm for manipulating the share price of the stock to keep it above the $1.00 price limit below which it could be delisted beginning before the period of the action above and continuing through it; settled with a consent to the entry of a cease and desist order based on Exchange Act section 10(b), an order prohibiting Respondent from acting as an officer or director of a public firm for five years and the payment of a $400,000 penalty).