Stories of Fraudulent Companies
Apart from knowing how to analyze a company, I wish to highlight to my readers on possible ways on how any management could use their listed companies to cheat minority shareholders like you and me. I don’t like to write such content but it’d be extremely beneficial for you to know that things are not always what it seems.
When you read and understand, you’ll gain the knowledge to safeguard yourself.
All characters are fictitious and any resemblances are pure coincidence.
- The Mystery of the Missing Furniture
Jacob started his furniture company in New Mexico. After 5 years of operation, he was blessed to have continued growth and expanding margins in his company. But lately, the business climate became tough and Jacob wondered how can he pay himself more. Since he is a listed company’s director, his remuneration would be disclosed in the annual report. He felt stuck however he was advised by his bankers that he could pledge his shares in exchange for a loan. He decided to be creative. He took his 23% ownership of the company and pledged it to a bank as collateral. In exchange, the bank extended him 70% value of his shares in cash with reasonable interest rates. He purchased houses and cars around the globe. Bad business climate befalls him and his company’s share price fell. The bankers requested him to top-up the difference between the loan amount and the value of the shares.
Cash-strapped, he paid his security guard in his company to keep quiet about an illegal operation he was about to commit. He instructed a few individuals to shift the furniture from the company’s warehouse to another private location. He did it gradually so his own employees didn’t notice. During the quarterly reporting, the stocktaker could not reconcile the inventories in the warehouse. The listed company did an impairment of inventories to write off the value. Jacob sold the furniture quietly and pocketed away the money from the market.
Soon, it was discovered and the law took care of the rest. When the news broke out, the share plunged and the bankers with his pledged shares also sold, adding immense pressure to the share price. The shareholders’ wealth literally vanished because of the greed of Jacob.
Beware of excessive impairments and write-offs of assets.
2. Extracting Money the “Legal” Way.
Caleb is the founder of listed property developer company in an Asian exchange. His family members run their respective businesses such as house furnishing, cement, and architecture — outside of Caleb’s business. He decided to fill his board with independent directors who are his close buddies. When the property developer called for bids, Caleb’s siblings won the bid despite bidding 40% higher. Caleb argued that his siblings’ companies have an excellent track record and they would be able to complete the job much faster than others. The board of directors did not question it. The money was paid to their siblings’ companies.
Behind the corporate walls, Caleb instructed his siblings to transfer some of their profits back to one of his personal account located in the Caymans. Is Caleb performing his duty well and taking care of his shareholders? This is a form of money tunneling.
Beware of huge related party transactions including purchase/acquisitions.
3. Now You See Me, Now You Don’t
As an executive director of a listed apparel company, Christina wondered how she could let the investors know her shares are undervalued. She decided to collaborate with her China’s corporate banker in which her banker would type official letters that “verified” the funds in the company’s corporate account. In reality, the amount in the bank account is a lot lesser than what was stated in the letter.
The business continued to grow and Christina knew the company was cash-strapped again. She started to issue bonds and rights to raise the cash which was needed urgently to pay off her suppliers and employees.
Some of her investors sense something amiss. How can a company that is supposedly flushed with cash, requesting to raise cash from the stock market?
A brilliant investor called Sunny computed the interest income received against the total cash in the company to derive the average deposits interest rates that the company was receiving from the bank. It turned out to have a very low deposit rate. There was a suspicion that the cash was not there.
Soon, forensic accountants are called into the picture and the law took care of the culprits.
Beware of companies with a huge amount of cash, raising further cash.
4. Create Fictitious Sales without Cash Flow
James wanted to push up sales of his listed firm called FakeLeader Ltd.
James set-up a Caymans Island firm called NoMoney Ltd privately and it purchase goods from FakeLeader Ltd. In fact, NoMoney Ltd does not have real intention to pay FakeLeader Ltd at all.
However, since the invoices were being issued and duly received, James was happy. He can book in accounting profits on the profit and loss, yet on the cash flow, the money is not coming in. Shareholders were excited and the share price rallied.
But not for long…
Subsequently, on its accounts, there is a growing and alarming amount of “trade receivables”. Investors are growing concerned whether the money could be collected, eventually.
James sought to ease their worries by acquiring NoMoney Ltd which owes money to FakeLeader Ltd. In return, the “trade receivables” is being canceled as it becomes an inter-company receivable. It is turned into goodwill for the excess money the listed company paid for the subsidiary. Furthermore, James who is the director of FakeLeader Ltd, also gets some bonus because he is the owner of the NoMoney Ltd. It is totally not right and shareholders were being misled by this series of transactions.
Beware of companies with rising trade receivables and acquisitions of suppliers/customers.