An auditor's report claimed on Tuesday that beleaguered China Aviation Oil (Singapore) Corp (CAO) overstated its profits in the past two years.

The debacle at CAO, on the verge of bankruptcy since losing US$550 billion in speculative trading, was largely a result of a weak risk management mechanism.

That was the finding of an investigation by PricewaterhouseCoopers, probing the scandal on behalf of the Singapore Stock Exchange since December.

In its interim investigation report, PricewaterhouseCoopers said CAO, once China's major aviation oil supplier, used inaccurate accounting to inflate its profits.

Had the firm abided by industry standards, it would have reported a pre-tax loss of 379 million Singapore dollars (US$229 million) for the nine months ended in September 2004, instead of its claimed profit of 49.6 million Singapore dollars (US$39.4 million), according to the report.

Similarly, the company exaggerated its 2003 profit by 0.6 million Singapore dollars (US$476,190).

But CAO was quick to deny any wrongdoing. It claimed PricewaterhouseCoopers had been "subjective" in its evaluation methodology.

CAO, which controls most aviation oil imports to the Chinese mainland, is seeking bankruptcy protection from its creditors.

In the largest financial scandal since the collapse of Barings Bank in 1995, the company racked up huge losses after it bet on the wrong movement of oil prices during speculative trading last year.

PricewaterhouseCoopers said CAO collapsed because it took "imprudent and unwarranted risks," while being slack in its corporate governance.

CAO failed in "the absence of proper and stringent, and in some instances basic, risk management procedures and controls specifically for speculative options trading," the report said.

To avoid collapse, CAO offered a restructuring plan in January to write off 58.5 per cent of its outstanding debt of US$530 million.

But the firm's creditors claimed the payment was too small and that the payback period was too long.

Should the bailout plan fail to win the support of over half of its more than 100 creditors in June, CAO will be liquidated.

PricewaterhouseCoopers' report will have a limited impact on the negotiation of the restructuring plan, according to a Singapore-based oil broker.

CAO said it is investigating the option contracts which led to its collapse, and will decide whether to pursue a lawsuit against its trading partners after the evaluation is completed.

CAO sued one of its creditors, a subsidiary of Goldman Sachs Group Inc, earlier this month for "misrepresentation, negligence, breach of statutory duties and/or deceit" in contracts. Goldman Sachs denied the charge.

Speculation has been rife that CAO may sue more trading partners, according to a Singapore oil broker who wished to remain anonymous.

CAO said it is working with its mainland-based parent, China Aviation Oil Holding, and Singapore's state investment agency Temasek to inject cash to restructure the company.

But the cash-injection will not occur unless the restructuring plan is approved by the creditors.

In the wake of CAO's collapse, China Banking Regulatory Commission, China's banking industry watchdog, alerted lenders to the potential risks in derivative trading on Monday. In rarely used harsh language, the commission urged banks to strictly abide by the rules.

(China Daily March 31, 2005)