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Originally published August 25, 2012 at 8:16 PM | Page modified September 10, 2012 at 11:00 AM

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Settlement near in suit over alleged fraud at HQ Sustainable Maritime

Plenty of red flags emerged when auditors looked at HQ Sustainable Maritime Industries, the Seattle company that collapsed last year.

Seattle Times deputy business editor

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No one is in jail yet for this fraud. Why? MORE

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HQ Sustainable Maritime Industries practically sank without a trace after the Seattle-based public company's auditing firm and audit-committee chairman resigned in the spring of 2011 and blasted the company's management for obstructing inquiries into its finances.

The company, which sold food and health products made from tilapia fish raised in China, disclosed resignation letters that hinted at major problems. For instance, the accounting firm said it had "encountered difficulties" in confirming HQ's claimed bank balances and customers. And there was some blunt language from the departing director about management's "uncooperative conduct."

But no details emerged.

Still, without audited 2010 financials HQ soon lost its Amex stock listing, and later shut its website. Its shares, $15 at their peak, were trading for about a dime before the Securities and Exchange Commission deregistered the stock this April.

CEO Nobert Sporns closed HQ's downtown Seattle office and now operates from an unmarked office and warehouse 65 miles north in Burlington, selling the company's Omojo-brand beauty aids online.

Now a settlement between burned stockholders and HQ, its key officers and its investment bankers is imminent, according to court filings.

The lawsuit reveals the red flags that surfaced when the auditors -- no doubt alarmed by the wave of fraud emerging at other companies with Chinese operations and U.S. stock listings -- got serious about examining HQ's finances.

The list of alleged improprieties -- what the federal class-action lawsuit calls "substantial evidence of fraud" -- is lengthy:

  • — The auditor, Toronto-based Schwartz Levitsky Feldman (SLF), tried to reach major customers claimed by HQ, but "was not able to speak to any of them," according to one email cited in the suit. In another email, the auditor told audit-committee chair Andrew Intrater that "we called customers from the updated list provided by Norbert (Sporns), with no answer or numbers were not connected or not valid."
  • — SLF's suspicions were first aroused when it attempted to verify the cash balances at HQ's Chinese bank -- a key step in any audit. A confirmation query to the bank was supposed to be returned directly to SLF via messenger "so that no other party could forge or alter" the paperwork, says the suit. But the auditor discovered the document had been sent from the bank to another location first, and only later delivered to the auditor. Despite further efforts, "the company prevented SLF from satisfactorily completing the full confirmation of that cash balances," the audit firm's resignation letter said.
  • — The auditor asked a Chinese law firm to investigate five of the tax invoices HQ had provided as proof of its revenues; companies in China record their sales on such invoices and pay a value-added tax accordingly. The firm declared the "5 VAT invoices are probably fake" and said tax authorities had no record of them.
  • — HQ couldn't document $5.5 million supposedly spent on advertising in 2010 at three TV stations -- virtually its entire ad budget.
  • — According to the suit, the company's chief financial officer, Jean-Pierre Dallaire, told an unnamed former director in April 2011 that a U.S. bank account for the company "held several hundred thousand dollars less" than he thought it should. He also said "his ability to verify the accuracy of the company's financial statements was limited" because he relied on numbers from HQ's China-based accounting personnel and "was largely unable to communicate directly with those individuals because he did not speak Chinese."

The SEC began a formal investigation of HQ in mid-2011, according to a company filing. The agency won't comment on the inquiry's current status.

Along with Sporns and his wife Lillian Wang Li, the company's board chairman, the class-action suit names the chief financial officer and two investment banks, Ladenburg Thalmann and Roth Capital Partners, that underwrote stock offerings that raised about $23 million in 2009 and 2010.

Attorneys for several of the parties did not respond to calls seeking comment.

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