China’s Taomee sees control gaps as US IPO pricing

By David Gaffen and Clare Baldwin

NEW YORK (Reuters) – A Chinese company operating a website for children, which plans to sell shares in an initial public offering on Wednesday night, has disclosed its auditors found major gaps in its internal controls.

The admission from Taomee Holdings Limited , in its offering prospectus under the risk factors section, comes at a time when heightened scrutiny of many U.S.-listed Chinese companies and the reliability of their accounts has caused investors to flee their shares.

The company, which operates the site www.61.com is seeking to sell 7.2 million American depositary shares for $9 to $11 each before a planned listing on the New York Stock Exchange on Thursday.

In the prospectus, the company says that the company and its auditors found “significant deficiencies in our internal control over financial reporting” and that it lacked enough expertise to comply with U.S. accounting rules.

“The material weakness observed was our lack of sufficient accounting resources and expertise necessary to comply with U.S. GAAP (Generally Accepted Accounting Principles) and to prepare and review financial statements and related financial disclosures under U.S. GAAP for SEC reporting and compliance purposes,” Taomee said.

That is not unusual for a Chinese company but could raise eyebrows among investors who have been shunning an increasing number of Chinese companies listed on the New York Stock Exchange and Nasdaq markets due to growing worry about accounting scandals.

The concerns have been exacerbated in recent days as some U.S. brokerages have started to restrict investors from using borrowed money to buy such shares.

Renren, another Chinese social networking company that came public in the United States in May, announced that its audit committee chairman quit just before the IPO was priced. That company also found a “material weakness” and a “significant deficiency” in its internal financial controls.

Among the problems Taomee found in a review of its internal financial controls were errors in the “algorithm of the software program we used to compile operating data.” Among the steps Taomee took to remedy the problems was hiring a chief financial officer, which it did just three months ago.

Taomee, which is domiciled in the Cayman Islands and conducts the majority of its business in China, also said in its prospectus that the majority of its officers and directors reside outside the United States and have their assets outside of the United States, and it may be difficult to sue them.

“The laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers,” the company also wrote in the risk factors section.

Renren, sometimes called the Facebook of China, went public in early May. Its shares gained 29 percent on their debut day, but have since fallen, closing at $10.51, or 25 percent below their IPO price, on Wednesday. (Reporting by David Gaffen and Clare Baldwin, editing by Martin Howell)