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the a-share market has seen another incident of financial fraud by a merger and acquisition target.

in august 2024, qingshuiyuan (300437) disclosed an announcement involving a civil lawsuit, in which it sued the former management of its wholly-owned subsidiary henan tongsheng environmental engineering co., ltd. (hereinafter referred to as "tongsheng environment"), zhong sheng and song yingbiao, as the plaintiff, and demanded that the defendants return to the company the stock consideration, cash consideration and interest on funds that were overpaid due to inflated revenue, and compensate for the stocks and return the cash dividends and interest already received in accordance with the "profit forecast compensation agreement", with a total amount exceeding 400 million yuan.

according to the facts and reasons listed in the complaint, the two defendants provided false 2015 financial information to the plaintiff when tongsheng environment was acquired, resulting in an inflated valuation of tongsheng environment's equity. the actual value of the equity was far lower than the equity transaction price of 495 million yuan, which violated the provisions of the "agreement on issuing shares and paying cash to purchase assets" and constituted a breach of contract.

in addition, according to the provisions of the "profit forecast compensation agreement" signed by the plaintiff and the defendant, and the fact that tongsheng environment committed financial fraud during the performance commitment period as recognized in the "criminal judgment" made by the henan provincial higher people's court, the two defendants should make profit compensation to qingshuiyuan.

three-year honeymoon

qingshuiyuan, which successfully entered the capital market in 2015, mainly engages in water treatment agents and derivatives.

shortly after its listing, the company disclosed in 2016 that it intended to acquire 100% of the equity of tongsheng environment held by zhong sheng and song yingbiao through a major asset reorganization. the target company tongsheng environment's main business is the system design, construction, installation and commissioning of industrial water treatment and reclaimed water reuse, and its industry is also the water treatment industry under the environmental protection industry.

according to the data disclosed at that time, in 2014 and 2015, tongsheng environment's operating income was 55.1467 million yuan and 134 million yuan respectively, an annual increase of 143.66%; the net profit was 11.666 million yuan and 28.3399 million yuan respectively, with both revenue and profitability increasing significantly.

according to the "asset appraisal report" of the m&a transaction, as of the valuation base date (december 31, 2015), the book value of tongsheng environment's shareholders' equity was rmb 68.3477 million (parent company), the valuation was rmb 495 million, the assessed value-added was rmb 427 million, and the assessed value-added rate was 624%.

finally, the transaction price of the target was determined to be rmb 495 million, of which the listed company paid rmb 173 million in cash and the remaining rmb 322 million was paid by issuing 14 million shares to song yingbiao and zhong sheng at a price of rmb 23.02 per share.

the "profit forecast compensation agreement" signed by qingshuiyuan, zhong sheng and song yingbiao at the time of the transaction stipulated that the counterparty promised that the target company's net profit from 2016 to 2018 would not be less than rmb 35.2 million, rmb 56 million and rmb 66.8 million respectively, totaling rmb 158 million in three years. during the profit commitment period, if tongsheng environment fails to achieve the promised net profit, song yingbiao and zhong sheng shall compensate for the net profit difference in the form of share compensation.

in addition, the agreement stipulates that zhong sheng and song yingbiao will be actually responsible for the operation and management of tongsheng environment during the three-year profit commitment period from 2016 to 2018.

after the transaction was successfully completed and consolidated, qingshuiyuan disclosed that tongsheng environment had completed its three-year performance commitment: net profits reached 35.64 million yuan, 60.659 million yuan, and 82.7588 million yuan respectively.

during this period, song yingbiao continued to serve as the vice chairman of tongsheng environment, and zhong sheng served as the general manager and legal representative of tongsheng environment. from 2017 to 2019, song yingbiao also served as a director of qingshuiyuan.

in dispute

after three years of "honeymoon period", in 2019, qingshuiyuan revealed a discord between its parent and subsidiary companies.

in august 2019, qingshuiyuan announced that tongsheng environment received a response notice and subpoena from the people's court of zhaoling district, luohe city. plaintiffs zhong sheng and song yingbiao believed that tongsheng environment did not convene a shareholders' meeting in accordance with legal procedures and illegally made a shareholder decision to remove the two from their directorships when their terms of office had not yet expired.

the announcement at that time showed that tongsheng environment also issued a "notice on requesting the return of all company seals including the company's official seal, financial seal, business license, etc.", requiring zhong sheng and song yingbiao to return all the company's seals.

qingshuiyuan also refuted that since the term of the first board of directors of tongsheng environment had expired, qingshuiyuan exercised its shareholder rights in accordance with the law and re-elected the board of directors of tongsheng environment. however, after the new management took office, it was discovered that all the official seals, business licenses, financial seals and bank u-shiels of tongsheng environment and its subsidiaries were lost, and some production and operation materials and financial vouchers were missing. zhong sheng and song yingbiao refused to handle the handover of work and the transfer of materials and seals.

at the second extraordinary shareholders' meeting held by tongsheng environment in october of that year, the "proposal to remove wang zhiqing from the board" and the "proposal to remove song yingbiao from the board" were reviewed together. in the end, the proposal to remove wang zhiqing (chairman of qingshuiyuan) from the board seat was not passed, and song yingbiao was removed from the board of directors.

but the dispute is far from over.

in 2019, qingshuiyuan disclosed that during the routine audit process, it was discovered that the former management of tongsheng environment had used their position to illegally infringe on the company's interests, so it reported the case to the public security authorities.

afterwards, the jiyuan branch of the henan provincial people's procuratorate charged zhong sheng, song yingbiao and others with crimes such as embezzlement and breach of trust that damaged the interests of listed companies, and filed a public prosecution with the jiyuan intermediate people's court.

inflated valuations

the criminal indictment obtained by a securities times reporter shows that the prosecution presented evidence that in order to raise the acquisition price, zhong sheng and song yingbiao, as the actual controllers of tongsheng environment at the time, manipulated tongsheng environment to prepare false financial statements, alter project completion acceptance reports, provide false invoices, and issue false revenue confirmation statements. they deliberately violated accounting standards, delayed the recognition of revenue and costs incurred before 2015 in 2015, and inflated the 2015 revenue, costs, operating profit and net profit.

the evidence presented in the case also confirmed that the merger and acquisition valuation of tongsheng environment was inflated.

according to the "appraisal opinion notice" issued by the public security department, when tongsheng environment was acquired by qingshuiyuan, the public security department conducted a "forensic accounting appraisal" based on the agreed base date of december 31, 2015, the revenue and net profit that should be recognized for projects such as the luyi county sewage treatment plant, as well as the impact on the acquisition valuation.

the appraisal opinion notice shows that in 2015, the luyi project, guowei project, jinkai second branch equipment procurement project, taikang project, changge project, shengyuan mining project, songjiang pipeline network project, and piaohe yinge project falsely increased revenue by 99.0493 million yuan, cost by 73.166 million yuan, operating profit by 25.8833 million yuan, and net profit by 19.4125 million yuan. the equity valuation of tongsheng environment on the valuation base date was falsely increased by 299 million yuan.

in terms of the specific method of inflating the project, taking the luyi project as an example, the evidence in the case proves that the luyi project signed a bt engineering contract in 2012, but it was actually changed to a general engineering construction mode in the early stage of construction. the project started in july 2013, was completed in 2014, and was completed and accepted in 2015. according to accounting standards, this project is a multi-year project, and the income should be recorded in 2012 to 2014 according to the percentage of completion method based on the progress of the project. tongsheng environment recognized the income of the project in 2015 according to the acceptance time, and inflated the income of 2015 by 65.0066 million yuan and the net profit by 11.6718 million yuan.

in july 2024, the case was finally judged, and the "criminal judgment" confirmed the appraisal opinion. the "criminal judgment" clearly stated: "the evidence in the case can prove that tongsheng environment violated accounting standards and wrongly recognized the income of the project involved in 2015, which inflated the profit."

fraud continues

the problem of tongsheng environment's performance fraud not only existed before the acquisition, but also continued after the acquisition.

in the criminal case indictment, the prosecution also presented evidence that in order to achieve the net profit performance indicators for the three-year commitment period and thus obtain possession of all the purchase funds including the inflated portion, zhong sheng and song yingbiao concealed subcontracting contracts, deceived the supervision party into issuing false project progress certificates, overestimated revenues, underestimated costs, overestimated gross profit margins, recognized revenues in advance, and delayed the recognition of costs, thereby inflating the annual revenues and net profits of the three-year profit commitment period.

according to the "profit forecast compensation agreement" signed by qingshuiyuan and zhong sheng and song yingbiao, tongsheng environment's net profit from 2016 to 2018 should reach 35.2 million yuan, 56 million yuan and 66.8 million yuan respectively. if the above-mentioned promised net profit is not reached, the two must compensate for the difference in net profit.

the "appraisal opinion notice" issued by the public security department shows that tongsheng environment falsely increased its revenue by 17.5238 million yuan and its net profit by 5.1855 million yuan in 2016; falsely increased its revenue by 39.8119 million yuan and its net profit by 16.8715 million yuan in 2017; and falsely increased its revenue by 34.6977 million yuan and its net profit by 33.0818 million yuan in 2018.

after deducting the inflated part, tongsheng environment has not achieved the promised performance. the company's net profit and performance completion rate in the three years were: 31.1719 million yuan, 88.56%, 43.6659 million yuan, 77.97%, 49.0825 million yuan, 73.48%, and a total net profit of 124 million yuan in three years, with a cumulative completion rate of 78.43%.

the above evidence was also confirmed in the final judgment of the case. from 2016 to 2018, the accounting of revenue recognition and cost transfer of 13 engineering projects of tongsheng environment was incorrect, with overestimation of revenue, underestimation of cost, overestimation of gross profit margin, early or delayed recognition of revenue and cost, and falsely increased the revenue, cost, operating profit and net profit of each year during the gambling period.

job embezzlement

the criminal judgment in july 2024 also ruled that song yingbiao, the former shareholder of tongsheng environment, was guilty of embezzlement and breach of trust to damage the interests of the listed company, while zhong sheng was guilty of embezzlement.

as for the confirmed criminal facts, the indictment of the case contains the detailed process of the two persons' embezzlement of office.

during the profit commitment period, song yingbiao and zhong sheng signed two false "construction project construction contracts" in the name of tongsheng environment with henan taikun construction and installation engineering co., ltd. (hereinafter referred to as "taikun company"), with a total contract price of 12.8465 million yuan.

on july 11 and 25, 2016, song yingbiao and zhong sheng arranged for relevant staff to transfer a total of 820,900 yuan (including invoice taxes and kickbacks) to taikun company twice. taikun company issued a total of 12.8465 million yuan in general value-added tax invoices to tongsheng environment on july 18 and 29, 2016.

in december 2016 and september 2018, song yingbiao arranged for relevant staff to issue acceptance bills of 9.3033 million yuan and 2.7223 million yuan respectively, with tongsheng environment as the issuer and taikun company as the payee, totaling 12.0256 million yuan. song yingbiao and zhong sheng arranged for staff to stamp the forged seal of taikun company on the acceptance bills for endorsement, and finally discounted 11.7466 million yuan and transferred it to the personal accounts controlled by song yingbiao and zhong sheng.

in order to create the illusion that the acceptance bill was collected by taikun company, song yingbiao and zhong sheng arranged for the staff of tongsheng environment to use the identity documents of a third party and forge the "power of attorney" of taikun company and the "receipt" of the acceptance bill signed by the third party as the basis for tongsheng environment to enter the account. later, song yingbiao instructed the staff to destroy the forged seals.

upon investigation, it was found that taikun company had not received the above-mentioned acceptance bills, nor had it ever carried out construction work on the above-mentioned contract projects. according to the judicial accounting appraisal of henan kejian accounting firm co., ltd., song yingbiao and zhong sheng had embezzled a total of 12.8465 million yuan from tongsheng environment.

recovery of losses

the criminal verdict shows that song yingbiao and zhong sheng were sentenced to varying terms in prison for the crime of embezzlement or breach of trust causing damage to the interests of listed companies.

as for the losses caused to the listed company by tongsheng environment's continued inflated performance, qingshuiyuan disclosed in an announcement in august this year that it had formally filed a civil lawsuit against song yingbiao and zhong sheng to recover their unjust enrichment.

qingshuiyuan mentioned in the facts and reasons for the lawsuit that according to the "agreement on the issuance of shares and payment of cash to purchase assets" signed by the parties previously, tongsheng environment's audited financial reports will truly, accurately, completely and fairly reflect its financial position, operating results and cash flows in all material aspects, without any false records, misleading statements or material omissions.

according to the facts confirmed in the criminal judgment and the judicial accounting appraisal opinion, the two defendants violated the above statements and guarantees, and the financial information of tongsheng environment in 2015 provided by them during the equity transaction contained false records, resulting in an inflated valuation of 100% of tongsheng environment's equity. according to preliminary confirmation, the inflated amount of the equity valuation was about 300 million yuan.

therefore, qingshuiyuan requested that song yingbiao and zhong sheng return an amount equivalent to rmb 300 million and corresponding interest. according to the transaction plan at the time, the two should return rmb 105 million in cash and 8.4872 million shares to the listed company, as well as the corresponding capital occupation fee for the cash and the corresponding dividends paid for the shares. the relevant shares were repurchased at a total price of rmb 1 and cancelled.

in addition, during the three-year performance commitment period, tongsheng environment's cumulative completion rate of promised performance was 78.43%, excluding the inflated part. according to the "profit forecast compensation agreement", qingshuiyuan requested that the two be ordered to compensate for the performance difference. it is estimated that the amount to be compensated for the performance difference is about 106 million yuan, and according to the transaction price at the time, 4.6402 million shares should be compensated. qingshuiyuan repurchased the shares at a total price of 1 yuan and cancelled them. at the same time, the two also need to return the cash dividends received and the interest on the funds occupied.

while seeking compensation for profit forecasts, qingshuiyuan also faces adjustments to its past financial reports.

in an announcement released on august 28, qingshuiyuan stated that the company will subsequently make comprehensive corrections to the financial statements of the accounting years involved in previous years in a timely and accurate manner based on the facts determined in the final judgment and in strict accordance with relevant regulations, and fulfill relevant review procedures and information disclosure obligations.