Ignorant Non-Sequitur of the Day: China MediaExpress Holdings Edition

This article is from Stone Street Advisors

The most popular day on our site was when I tore apart a post from
an aspiring "investor" named Glen Bradford, who clearly has very little
- if any - knowledge of business history, wherein he listed several reasons he's long China MediaExpress Holdings. I strongly suggest you go back and read that post, entitled "Fuzzy Logic, or: Those Who Fail to Learn From History..." where I showed how NOT to go about building an investment thesis.

Mr. Bradford does not seem to know what auditors actually do or how
they go about doing it.  Nor is he apparently aware of the oodles and
oodles of times auditors have not just failed to uncover/report fraud,
but were actually complicit therein.  This week, he claims
- in his apparently infinite experience and wisdom - that not only
would Deloitte step down if they thought CCME was a fraud, but that
Deloitte is THE best auditor out there, so clearly, if they sign-off on
the co's financials, there can't possibly be any fraud.

This is a massive, ignorant, and lazy non-sequitur of impressive
proportions, to the point that I'm tempted to put the preceding clause
in all caps and bold font.

Deloitte was the auditor of record at Bear Stearns, where they're accused of effectively "performing no audit at all," at Adelphia
during the Rigas scandal that drove the firm into bankruptcy, at
Merrill Lynch during the Blodget/conflict of interest years, at a
number of Energy companies who engaged in "round-trip trading" to boost
volumes/revenue, and a number of other companies embroiled in
accounting scandals.  The California Board of Accountancy also reports
that Deloitte is responsible for more restatements than any other CPA firm (23% of total from 2003-2009)!

From what experience and/or personal knowledge does Bradford get his nonsensical views about auditors?  Serious question.

I have received tons of messages that can be summarized
by the belief that auditors do not look for fraud and that all they do
is make sure things line up in the reports. I can say that this is not
true simply by being practical. If we didn't have auditors to verify
the claims that companies make, then companies could claim whatever
they want to. The purpose of auditors is completely, entirely, and
wholly to look for indications of fraudulant activity --- and to do
their best to remove all possible doubt that the company is
misrepresenting itself on its financial statements.

Then, if things are OK, they sign off on them. Some auditors are
better than others. Deloitte is the best. Period. End of Statement.

I suggest Glen start reading Francine McKenna at Forbes and at her site, Re: The Auditors
ASAP.  At the very-least, he really should read a few books or do a
google search about accounting scandals and auditors' role therein.

You'd be hard-pressed to find a management team that consistently
uses conservative accounting assumptions and treatments even here in
the U.S. Why, then, would anyone expect a potentially shady Chinese
company with a former Chinese auditor among its senior ranks to be any
better?  I'd be very, very surprised if CCME's management is being
appropriately up-front with their Auditors, despite the public scrutiny
Bradford believes will incentivize Deloitte to be fantastically
diligent lest their reputation take a hit.  I also doubt Deloitte's
ability and inclination to do the type of thorough audit that would
definitively prove or disprove whether there's any fraud at CCME.

Large-company audit is an oligopoly business.  These guys pay fines
all the time, but the big 4 still continue to dominate the market.  Do
you really think Deloitte is that worried about their
reputation/business taking a hit because they were "duped" by
management at a small Chinese mid-cap?  I hope and wish the answer is
"yes," but history suggests otherwise.

More often than not, auditors pull the "we were duped by
management/there was no way for us to know" excuse and walk-away with a
veritable slap on the wrist, at most paying a relatively small fine
without admitting guilt, although with Bear Stearns, Deloitte may
suffer a far-greater punishment (see link above "performing no audit at
all").

I'm neither long nor short CCME (never have been, either), but
Bradford's long rationale continue to be out-of-touch with reality.  As
I said in my prior response, it's like he's been living in a cave for
the past 10+ years, like he's never heard of an accounting scandal
before or never took a financial analysis or accounting class where
even the worst professors and textbooks mention the myriad ways that
management can mislead auditors/investors several dozen times. 
Deloitte can conduct a full audit, up to standards and all, and there
can still be Fraud.

Let's be clear, though: I am not supporting Muddy Waters' (etc) short rationale, but rather critiquing how weak Bradford's is.

Maybe CCME is legit, maybe they're not, but if I'm even considering
getting long, you bet your ass my investment thesis is going to be ALOT
stronger than Bradford's!

Happy Investing!

The Analyst

Stone Street Advisors

Comments

[beastie]

So Toilet and Douche signed off on another piece of junk.

This comment has been added becasue I like saying Toilet and Douche.

[wcvarones]

At least Bradford has nice pubes on his face. 

http://www.thestreet.com/author/1144364/GlenBradford,%20Contributor/all.html