Suspected "reverse accounting fraud": Shandong Zhanggu artificially reduced profits by 8.46 million yuan. Where did the money go?

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Reprinted from: China Business News

An economy reporter, Sun Ruxiang, and Xia Xin, Beijing

Shandong Zhanggu (Rights Protection) (002598.SZ) announced on the evening of April 3: due to the company’s alleged false statements in its 2024 annual report, the Shandong Securities Regulatory Bureau plans to impose a total fine of RMB 2.6M on the company and relevant responsible persons. Among them, Fang Runjin and Fang Shupeng, father and son, are jointly proposed to be fined RMB 2.5M.

It is worth noting that, unlike the common type of financial fraud that artificially inflates profits, Shandong Zhanggu is alleged to have artificially reduced profits by RMB 8.4627 million. As for the motivations behind the company’s alleged artificial profit reduction and where the funds actually went, neither the “Notice of Advance Written Information on Administrative Penalties” nor the company’s announcements disclosed this.

Experts interviewed by reporters from China Business News said that common possible motivations for listed companies to artificially reduce profits include‌: avoiding tax payable; hiding profit to form a “performance reservoir” and smoothing future performance volatility; concealing the true destinations of funds to achieve benefit transfers; and concealing illegal uses of raised funds, unlawful occupation of funds by related parties, and other such conduct.

Artificially reduced profits of RMB 8.46 million

The “Notice of Advance Written Information on Administrative Penalties” shows that the alleged illegal facts for Shandong Zhanggu are: in 2024, without the actual occurrence of accepting businesses such as repair and technical services, Shandong Zhanggu recognized sales expenses and management expenses totaling RMB 8.4627 million, leading to false records in Shandong Zhanggu’s 2024 annual report. The total amount of artificially reduced profits was RMB 8.4627 million, accounting for 10.37% of the total profit disclosed to the outside for the period.

Accordingly, the Shandong Securities Regulatory Bureau plans to decide to order Shandong Zhanggu to make corrections, issue a warning, and impose a fine of RMB 1.8M; for four individuals including Fang Shupeng, Shen Chunfeng, Fang Runjin, Zhao Xiafen, issue warnings and impose fines of RMB 1M, RMB 800k, RMB 800k, and RMB 8 million, respectively.

Among them, Fang Shupeng was the former co-chairman of the board, general manager, and legal representative; he made decisions and implemented the above expense handling matters. Shen Chunfeng was the former person in charge of the Turbine Division and the Electrical Division; he organized and implemented the above expense handling matters. Fang Runjin was the former chairman of the board; he failed to perform his duties diligently and could not ensure that Shandong Zhanggu’s 2024 annual report was true, accurate, and complete. Zhao Xiafen was the former chief financial officer; knowing about the above expense handling matters, she failed to faithfully and diligently perform her duties.

It is worth mentioning that Fang Runjin and Fang Shupeng are father and son, and the two have long dominated Shandong Zhanggu’s corporate governance framework. The company’s 2024 annual report shows that Jinan Zhangqiu District State-Owned Assets Operation Co., Ltd. holds 29.80% of Shandong Zhanggu’s shares, making it the largest shareholder. Fang Runjin is the second largest shareholder, holding 9.85%; his son Fang Shupeng holds 0.10%.

On April 3, Shandong Zhanggu also disclosed that the Shenzhen Stock Exchange will apply other risk warnings to the company’s stock. Trading will be halted for 1 day on April 7 (Tuesday), and trading will resume from the opening on April 8 (Wednesday). The stock abbreviation will change from “Shandong Zhanggu” to “ST Zhanggu,” and the daily trading price increase/decrease limit will be 5%.

Liu Zhigeng, a well-known expert in finance and taxation, told reporters that “reverse fraud” actions in the capital market that artificially reduce profits severely destroy the authenticity of financial reports, send the market the wrong signal that the company’s operations are poor, may mislead investors, undermine investors’ confidence, lead to the company’s stock price being undervalued, and affect investors’ rational judgments and resource allocation.

“Whether it’s artificially inflating or artificially reducing profits, it is a violation of the principles that information disclosure must be true, accurate, and complete. It undermines capital market integrity‌ and harms the fairness and efficiency of the capital market,” Liu Zhigeng emphasized.

Before this, due to issues such as violations of related-party transaction review and information disclosure, violations in the use of raised funds, and non-standard corporate governance, Shandong Zhanggu was ordered to make corrections by the Shandong Securities Regulatory Bureau in December 2025.

“This alleged financial fraud also exposes that the company’s corporate governance has major flaws. Internal controls are essentially a mere formality, and there is a risk that management is acting above internal controls,” Liu Zhigeng said.

Yue Qiang, a senior partner at Beijing Huiren Tianrui Law Firm, believes that Shandong Zhanggu’s conduct of artificially reducing profits has already allegedly constituted an information disclosure violation prohibited by the explicit provisions of the Securities Law of the People’s Republic of China. It directly led to the company being subject to ST status and losing eligibility for refinancing, and at the same time faces huge compensation liabilities from a collective lawsuit by investors. It will also cause the company’s internal controls to completely fail, triggering the risk of state-owned asset loss, and disrupting information disclosure order and tax collection and administration rules in the capital market.

“Based on the facts to be determined in the subsequent investigation, this conduct may also possibly constitute the crime of illegal disclosure of material information, tax evasion, the crime of issuing false invoices, the crime of issuing false VAT special invoices, the crime of embezzlement of one’s position, misappropriation of funds, bribery, or bribery of non-state functionaries, and so on,” Yue Qiang said.

Where did the money go?

Regarding the motivations for Shandong Zhanggu’s alleged artificial profit reduction and where the funds actually went, neither the “Notice of Advance Written Information on Administrative Penalties” nor the company’s announcements disclosed this.

In Liu Zhigeng’s view, a listed company’s behavior of proactively suppressing book profits may conceal three types of motivations.

First is the motivation to evade taxes‌: by artificially inflating costs and artificially reducing profits, it directly lowers taxable income, thereby reducing corporate income tax expenses for the current period. This is the most direct and most common motive behind “artificial profit reduction” in financial fraud by enterprises.

Second is to conceal its true profitability for future “charging up the reservoir”‌: hide true profitability so that the current financial statements look mediocre or even poor, thereby reserving room for a “breakout” in performance in future years. When the company needs to boost its stock price or meet certain performance commitments, it can achieve this through retrospective adjustments or by releasing “hidden profits,” creating a reversal effect after “financial washing.”

Third is to conceal the true destinations of funds and achieve benefit transfers‌: “This is the motive that deserves the most warning. The hidden expenses may be paid to related parties or shell companies through false contracts, causing the company’s funds to be siphoned and transferred.” Liu Zhigeng said that such operations, in essence, transfer the company’s assets in disguise to specific individuals or entities, thereby seriously harming the interests of minority shareholders.

Yue Qiang also believes there are the above three possibilities. He said that the management team that actually controls the company’s operations may take advantage of governance loopholes in the family-style management of a listed company, using fabricated businesses with no real transactions to extract funds from the listed company and transfer benefits to its own related parties.

Yue Qiang added that other possible motivations include: lowering the base figure for annual performance evaluation of state-owned assets to avoid performance evaluation pressure and profit distribution obligations in subsequent years; breaking through controls on the total remuneration of state-owned enterprises and achieving excessive benefit distribution through off-the-books funds; and if there are historical gaps such as prior illegal use of raised funds and unlawful occupation of funds by related parties, this conduct could conceal the above illegal activities.

“The involved funds may possibly flow into shell companies controlled by related parties of management, or may be used for illegal and criminal activities such as commercial bribery and embezzlement of duty, or for filling historical capital gaps,” Yue Qiang said.

“A company pays money, and it needs to see invoices. If there was no real acceptance of services, then the invoice is fake. If you take a fake invoice to seek reimbursement, the company might be a ‘patsy,’ and the money may ultimately end up in someone’s pocket,” said Chen Bo, a partner at Deheng Shanghai Law Offices.

Liu Zhigeng believes that the operating model in which a listed company artificially inflates expenses and artificially reduces profits makes it highly likely that funds flow, through fabricated transaction contracts, to related parties or off-balance-sheet companies that have not been disclosed, forming an off-balance-sheet funds pool used for off-the-books circulation, benefit transfers, or management’s private use. However, the specific company and specific case should be investigated and verified by competent authorities.

(Editor: Xia Xin Review: Li Huimin Proofreading: Chen Li)

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