Roles of independent directors, auditors back in spotlight

RECENT corporate controversies have again put the role of independent directors in the spotlight.

The quality of book-keeping by auditors has also come under criticism by minority shareholders left bruised from allegations of fraud.

Last week, Midas Holdings, once a billion-dollar market capitalisation company, told shareholders that it could be insolvent within the next month if creditors push the rail-part maker towards liquidation. Its share price last traded at around 19 Singapore cents, a far cry from the S$2 plus during its heyday. The company is now being investigated in Singapore and China for fraud. It has also been slapped with law suits filed in China over unauthorised loans by its former chairman Chen Wei Ping, and guarantees involving its Chinese subsidiaries.

What shocked investors was that Midas' cash holdings now stand at about S$700,000 (before legal fees and salaries due) compared to the one billion yuan (S$209 million) reflected in the audited results for the year ended Dec 31, 2016. Where did the money go? Did it even exist?

Investors are demanding answers from auditors and past independent directors - gatekeepers who are supposed to provide the moral compass for an effective board. What were they doing that allowed, not one, but multiple fraudulent acts to go undetected? How could the auditors, who had conducted the due diligence, give their positive verifications of bank statements? What about the audited results, which investors trusted and relied on to make their investment calls? Where was the accountability?

Midas blamed the sorry state of affairs on the lack of control over one of the two jurisdictions that the company operates in, that is, China. Auditors Mazars claimed that they had done their audits based on required audit procedures, but they too had been deceived. On Friday, Mazars said that its auditors' reports issued for 2012, 2013, 2014, 2015 and 2016 may no longer be relied upon.

Unhappy shareholders

Over at shipbuilder Vard Holdings, the takeover target by Italy's Fincantieri O&G, were more unhappy shareholders.

Its extraordinary general meeting (EGM) calling for its delisting plans resurrected concerns over the concept of "independence". Vard insisted that its chief executive officer, Roy Reite, qualifies as an independent director to advise on the planned delisting and exit offer. It said that the "mere fact that Mr Reite has been in the company's employment for a long period of time or that the company is a subsidiary of Fincantieri Oil & Gas SpA does not, in and of itself, mean that Mr Reite faces an irreconcilable conflict of interest".

Minority shareholders disagree. Mr Reite could not reply to shareholders' queries on why he felt investors should now sell at 25 Singapore cents a share when he previously rejected Fincantieri's offer at S$1.22 a share back in 2013 as inadequate, and recommended that shareholders hold on for a better price.

Aggrieved shareholders are lobbying authorities for a revision of the takeover rules, requiring parties with commanding stakes to abstain from voting at the EGM. At the end of the EGM, Vard declared the delisting resolution passed with 96.54 per cent for and 3.46 per cent against. The 982.67 million "yes" votes equate to Fincantieri's stake as at the middle of last week before the EGM. The 35.19 million "against" votes cast represented 100 per cent of the minorities who managed to vote, and 18 per cent of the remaining free float. "If this were a Hong Kong company, it would remain listed," investor Apollo Investment Management commented on what it called a forced and unfair delisting.

Minority shareholders are protesting that the independent directors in these two cases should have done better.

A more active role

In the case of Midas, independent directors should have taken a more active role in the prevention and deterrence of fraud, as well as ensuring regulatory compliance. They should have constantly challenged management and auditors to ensure appropriate anti-fraud programmes and controls are in place and that investigations are undertaken promptly.

It can be argued that auditors visit their clients' premises usually only twice a year - to perform an interim audit, and then a final one. On these occasions, audit staff operate under tight time and budgetary constraints. Equally, independent directors don't work at the company, and it may not be fair to expect them to know the nuts and bolts of company operations.

Still, given that it is almost impossible for auditors to detect wrongdoing if there is collusion between key functions, and any fraud can pass undetected, it is even more crucial that independent directors ask the right questions. It is shocking that Mazar could not even verify simple bank balances - something sacrosanct in auditing, shareholders bemoaned.

In the case of Vard's delisting, independent directors should have demanded from the independent financial adviser hard valuations, taking into account the company's future earnings potential, and the improved conditions in the market it operates in. That would have been more meaningful than a list of threats a delisting may have on the stock price and liquidity.