Business Times - 20101227 - Souring of an apple juice maker - 新湖滨控股: 发酸的苹果汁

http://www.businesstimes.com.sg/sub/companies/story/0,4574,419126,00.html?

Published December 27, 2010

UNTICKING THE BOX

Souring of an apple juice maker The debacle that is New Lakeside Holdings holds many corporate governance lessons for regulators, auditors and directors By MAK YUEN TEEN THE recent news that New Lakeside has gone into judicial management marks the beginning of the end for what must be a contender for the worst listing on the Singapore Exchange (SGX), based on the sheer number of corporate governance issues that have plagued the company since its listing. In this commentary, I will focus on those issues relating to internal controls, financial reporting and auditing. New Lakeside Holdings is a producer and seller of apple juice with its operations based in China. It was incorporated in Singapore and is therefore subject to Singapore's Companies Act. It was listed on Sesdaq in March 2004. Just months after it was listed, it reported an unexpected half-year net loss of 9.4 million yuan (S$1.84 million). After it was criticised for not issuing a profit warning, it was reported that the losses were only discovered four days before the results. If this was true, it was an early warning sign that the company did not have a proper internal reporting system in place, including the provision of timely management accounts to the board. The independent directors ordered a special audit that reportedly discovered irregularities relating to revenue, costs of goods and receivables, suggesting poor internal controls, which affected financial reporting. The service agreements of the managing director (MD) and chief financial officer (CFO) were terminated, but the MD was later reinstated and a joint-MD was appointed. Both MDs were substantial shareholders and controlled the company, so the independent directors were really in no position to overrule them. Profit warnings became regular affairs. The company issued profit warnings in July 2005, January 2006 and July 2006 in anticipation of half-yearly and annual losses. Things appeared to improve somewhat between the second half of 2006 and the middle of 2008 - when it reported half-yearly and annual profits - before the profit warnings started again. However, no reliance can be placed on the reported results because of the poor internal controls and the lack of clean external auditors' reports during its entire period of listing. In any case, it later issued another three more profit warnings and did not report any profits again. In April 2005, when the company reported a net loss of 3.1 million yuan for FY2004, the external auditors, Moore Stephens, issued an opinion with an emphasis of matter relating to trade debtors of 7.3 million yuan which had been outstanding for more than a year. Qualified opinions The auditors stated that the trade debtors had been reduced to 4.4 million yuan at the date of the auditors' report. However, in April 2006, the new auditors, TeoFoongWongLCLoong, stated that no receipts had in fact been received from specific trade debtors and, therefore, the directors had made provision for the full amount. They also qualified their opinion for FY2005, citing going-concern issues and their inability to form an opinion on the existence of inventories which were written off, write-off of freight charges and validity and treatment of certain expenses. In April 2007, Baker Tilly also qualified their opinion, citing going-concern issues and inability to verify unaudited management accounts of subsidiaries, which had been disposed of during the year. In October 2007, the company announced a change in its financial year-end from December to June, and its next set of accounts issued in October 2008 were again qualified by Baker Tilly, this time citing their inability to verify financial guarantees given by a subsidiary and the recoverability of sundry receivables. Their report also contained an emphasis of matter relating to the company's ability to meet its financial obligations. In April 2009, the company announced its plan to change its auditors to MGI Singapore PAC, citing cost reasons, but later appointed LTC instead. In October 2009, the company reported a net loss of 84.9 million yuan. This time, the external auditors' opinion contained only an emphasis of matter, albeit an important one relating to 'material uncertainty which may cast significant doubt about ability to continue as going concern'. However, in September 2010, LTC informed the audit committee chairman that fraudulent representations may have been made in the course of the 2009 audit and therefore their audit opinion for 2009 could no longer be relied upon. LTC also made a report to the Minister of Finance. In December 2010, the company announced that a special audit by Stone Forest Corporate Advisory found serious lapses and deficiencies in internal controls and corporate governance that, among other things, led to a failure to comply with SGX listing rules, improper accounting treatments and non-compliance with the Companies Act provisions in relation to accounting standards and the presentation of a true and fair view. Some of the findings in the special audit were particularly serious, including alleged cover-up of certain liabilities. Based on the history of the company, the findings of the special auditor were hardly surprising. The New Lakeside case raises a number of issues relating to regulation in Singapore and the actions (or lack thereof) of regulators, external auditors and directors. Let me start with regulation. Section 199 (1) of the Companies Act states: 'Every company and the directors and managers thereof shall cause to be kept such accounting and other records as will sufficiently explain the transactions and financial position of the company and enable true and fair profit and loss accounts and balance-sheets and any documents required to be attached thereto to be prepared from time to time, and shall cause those records to be kept in such manner as to enable them to be conveniently and properly audited.' In addition, Section 201 requires the profit-and-loss accounts and balance sheets of the company and group to comply with accounting standards and to present a true and fair view. Regulation gap Given the serious concerns raised by the auditors, especially those related to their inability to verify transactions, can the company be said to have complied with the Companies Act, notwithstanding the statement in the auditors' reports that the accounting and other records required to be kept are properly kept in accordance with the provisions of the Act? While the introduction of XBRL (eXtensible Business Reporting Language) reporting has improved the reporting of audit qualifications to the Accounting and Corporate Regulatory Authority (Acra), there is a need to consider more timely regulatory intervention when audit opinions are qualified, especially when they involve significant internal control and accounting-related issues. It seems counterintuitive that we have a regime that legally mandates compliance with accounting standards, yet a company is allowed to have a qualified auditors' opinion relating to significant accounting-related issues without the company being expected to address these issues in a timely fashion - let alone three successive qualified auditors' opinions. While the SGX listing rules require an immediate announcement if the auditors' opinion of an issuer includes any qualification or emphasis of matter, they do not include specific requirements to address the issues raised by the auditors. In contrast, under Bursa Malaysia's listing rules, issuers that receive an adverse or disclaimer opinion from the auditors, or a modified opinion with an emphasis on the issuer's going concern and where consolidated shareholders' equity of the issuer is 50 per cent or less of its issued and paid-up capital, must undertake a regularisation plan to resolve the problems and announce such a plan. Failure to meet the requirements prescribed by Bursa Malaysia may result in suspension or delisting, or both (readers interested in further details can refer to paragraph 8.04 and practice note 17 available on Bursa Malaysia's website). Let's now consider the external auditors. I think Baker Tilly (including its predecessor) had acted admirably in issuing three successive qualified opinions before it was replaced. Since the company had three successive qualified opinions, the company must be a particularly risky client for LTC - which took over as auditor in 2009 - although I would expect that LTC would have client acceptance procedures in place and would have done a proper risk assessment. The company had publicly stated that it was changing auditors for cost reasons. From the last published annual accounts under Baker Tilly, the audit fees were 47,000 yuan paid to 'auditors of the company' and 118,000 yuan for 'other auditors'. Unfortunately, the company stopped disclosing audit fees after it changed auditors, and therefore it was not possible to know how much audit fees it 'saved'. This raises a general question for auditors: Is there always a 'clearing price' where there would be a willing buyer (company) and seller (auditor) for external audit services, even though there are strict professional and ethical standards for auditors? While I have seen questionable companies changing auditors - sometimes rather regularly - I have never seen one that is unable to find a replacement auditor. Finally, the actions of the independent directors in 2004, when they responded to the surprise loss by commissioning a special audit and seeking to terminate the service contracts of the senior executives, were commendable. Board inaction However, one must question how the board could allow poor internal controls and accounting-related issues to persist over such a prolonged period. Audit committee members and directors should ensure that issues giving rise to emphasis of matter or qualification in the auditors' reports are promptly addressed. Furthermore, shouldn't the directors be concerned that the company could have been insolvent or facing insolvency with the going concern issues raised by the external auditors, in light of the Companies Act provisions on trading while insolvent? For the last few years, wasn't it a bit like driving when all the dashboard indicators were not working, and one did not know how fast one was going, whether the engine was overheating, and when the petrol (or apple juice in this case) ran out? I believe that there are many lessons that regulators, auditors and directors can learn from the New Lakeside case. The writer is associate professor of accounting at NUS Business School, where he teaches corporate governance and ethics