Sunday, September 29, 2013

Touchwood, Sri Lanka's listed Ponzi scheme and IFRS accounting

I have been biding my time for some years, patiently waiting for Touchwood to collapse. That it was a Ponzi scheme was immediately obvious from a glance at the prospectus that they issued when they listed, somewhere in 2001. I spent some time trying to explain this to people but after making little headway, except amongst friends, gave up.

The benefit of listing is the transparency that results: companies are required to publish accounts and if used correctly can prove to be a useful source of information. Thus a scam that could have lain hidden for years was exposed.

As I recall, the things that raised my suspicions at the time were:

  1. The first auditors, a well known firm were sacked after the very first year and an unknown firm appointed. The reason for the sacking? The auditors had qualified their opinion, stating that they were unable to verify preliminary expenses! Sacking an auditor is an action that arouses immediate suspicion, when it is done for something as trivial as this, one knows that something fishy is going on.
  2. The directors never invested in the shares of the company. Initial expenses were funded through a directors loan (which could be repaid at will. Share capital cannot be returned). Why were the directors unwilling to invest in their own company? To be sure, there was quite a large sum appearing in the accounts as issued share capital but they had not been issued for cash. Instead these were free "bonus" shares that were issued by revaluing the trees that the company supposedly owned.
  3. The Company did not recognise the liability for the deposits being accepted - they were instead treated as income and the cash raised used for expenses.
  4. The publicity material promised supposedly "guaranteed" returns as in a bank deposit- on an investment in a commodity. No one can ever promise guaranteed returns on such an investment as no one has the ability to predict where commodity markets are going to head, especially over a 15 year period. People can invest, but they must know the risk that they take is on the commodity market and there can be no guaranteed returns.
  5. They were promising people a title to a tree, some of which was on rented land. Does such a title confer any valid claim under the law?  

In response to criticism  some of these were later changed, land was supposedly offered and the liabilities were recognised on the balance sheet (under IFRS) accounting rules. The fundamental scheme however , built on unrealistic promises and designed to defraud, did not change.

That the regulators and the auditors did not recognise it as such is a question that needs to be asked, but ultimately it is only we who must be responsible for our actions and for people who wanted to know, enough information was available. At the time, I was very annoyed that the CSE would allow such a scam to list and I complained (informally) to both the CSE, and later the SEC but with hindsight, at least the disclosure requirements of the CSE served some good purpose.

In general, do not rely on a regulator or still less, the Government. When it comes to investing it is safer to take the attitude of "guilty until proven innocent" and avoid any investment scheme that one does not understand fully.

The Australian regulator has a useful guide to investment scams. Another useful guide is here. Under normal circumstances I would also have added that one should talk to a trusted financial advisor or accountant as well, but in this instance given the embarrassment that the auditor was duped as well, one is rather hesitant to make this recommendation.

The problem with the auditor has something to do with the fact that they seemed to have believed that Touchwood would be an excellent test case to prove the value of IFRS, the new system of accounting that I dislike. IFRS has some merits but goes overboard on a lot of things and does much to complicate the life of the accountant while generating some pretty useful consultancy work for auditors.

My biggest grouse with IFRS is that they have abandoned the fundamental accounting concept of "prudence" and it is now possible to recognise on the income statement unrealised (and in the case of Touchwood what would prove to be unrealiseable) gains. I have no problem with making provisions for potential losses, but gains, unless real must never be recognised.

This was the basis of Touchwood's accounting. Had this been an honest forestry scheme, one would have the assets-the trees to fall back on. If the Company had planted the correct number of trees and had in place the insurance policies and the extra trees (supposedly planted to deal with fluctuations) the investors would have been left with a stock of trees that could have been disposed of. They would have earned a profit or a loss, depending on how the market for teak had performed.

Since the scheme was obviously set up to defraud there is very little left in the way of trees or anything else of saleable value, the money being siphoned out by the owners. In other words, another “Golden Key” case.

People who have money in other forestry/plantation schemes should beware, this country is a haven for crooks and criminals, many who start such things do so with the same intent as Touchwood.The same goes for finance companies-read the ratings reports issued by Fitch or RAM, available on their websites and study their accounts beore investing. One also needs to read the definitions of the ratings in order to understand them, the scoring sustem differs from agency to agency.

As for the auditors, having previously signed off on the accounts of the failed Pramuka Bank, Hayleys MGT (which reported a massive fraud) perhaps they need to ask themselves some commonsense questions?

Court Jester - not accessible via SLT?

I seem to be having some difficulty accessing my blog through SLT. It works if one goes through a proxy or accesses it via some other provider. Can anyone tell me if it can be accessed through Mobitel?

Sunday, September 22, 2013

Revisiting the Arab Spring: Revolutions and liberty

The last time I looked at the Arab Spring I was not particularly hopeful of the prospects of the revolution resulting in a democratic form of Government.

About two years on the situation in Libya seems quite dreadful so at least one conclusion is clear: a repressive state is probably better than complete anarchy. Neither is desirable but in a repressive state ordinary citizens are only under threat from the state and its agents.

In a situation where the state collapses through a popular revolution there are likely to be many different militias competing for power. Unless one group is firmly in charge, citizens may be under threat on several fronts instead of from one monolithic entity. Services collapse and with no one to hold the ring, things degenerate  into a free-for-all.

Therefore the crucial factor is some form of orderly transition. Ideally a dictator should be deposed  in a backroom deal, where he or she leaves quietly and a transitional leader takes over. How can this be engineered?

The problem is that dictators are deaf to the concerns of the public and resist any attempts at correction. Unrest mounts, frustrated people take to the streets and the resulting mass revolution brings too many actors and competing interests to the table.

Bad leaders need to be persuaded to leave quietly, more sane advisers within the inner ruling circle need to read the signs and work together to persuade a ruler to leave. This is what seems to have happened in the transitions in Eastern Europe. (see also here)

One deposed, the trickier process of institution building must begin.

The liberty of citizens can only be guaranteed by institutions, but building these from scratch can take, literally a generation or two. It is possible to build them faster, depending on the extent of any foundations that may exist, the best being any left in the wake of the British Empire.

The attitude of the people will also help. A friend once explained that he felt that the people of Eastern Europe looked to Western Europe as a model and were willing to accept Western European help in building institutions.

Their people were not distracted by devious rulers proclaiming "monarchical democracy", "no party democracy" or some mysterious "Asian Way". These distractions need to be identified and countered early and constantly, to focus public opinion on the real issues of liberty and governance. Education, beginning initially with the elites, who may be woefully ignorant, is a must for this to be successful.

Transitioning from dictator ship is a complex and delicate process that is all too easy to get wrong. Identifying competent people who can persuade the leader to go and serve in a transitional government; a commitment to institution building, with outside help if necessary are factors that can make a crucial difference to the ultimate outcome.  

Thursday, September 19, 2013

What does the Northern Provincial Council election tell us?

Much acrimony and confusion surrounds the impending Northern Provincial Council election. Its quite wearying to wade through the issues and controversies but the process itself exposes a few truths.

That it was with much reluctance that the Government went ahead with it is obvious. It was long overdue and they had resisted all previous calls to hold the polls. Local events being unchanged, it is most likely therefore, that foreign pressure, more effective these days because of the upcoming CHOGM conference that caused the poll to be called. The fact that we must rely on external forces to hold a Government to its constitution says a lot about the state of Governance.

There has been scare mongering by the Government about the Provincial Councils but  this has not barred it from holding similar elections elsewhere. In many instances they have been called early, signalling a positive eagerness on the part of the Government. Why then the special problem with the Northern province?

If the system itself seems acceptable by the Government in other provinces, the only problem must be the Tamils. It is not a provincial council per-se that is the issue, it is a Tamil provincial council. This exposes the latent  suspicion that the GoSL has of the Tamils. The question is, if there is so little trust can any meaningful relationship exist?

The controversial proclamations by the TNA, which are apparently popular, expose the fault-lines that exist within society. All this time they lay hidden, beneath the happy veneer being painted by the propaganda. Now exposed, no one seems to be posing the fundamental question as to where the reconciliation stands.

Right or wrong, there appears to be yawning chasm in expectations. Has this widened or diminished since the war? We have absolutely no idea. 

This leads to the conclusion that basic questions have not been addressed properly. If no resolution has taken place, will these not resurface? Is the only solution a suppression of the issues? Is this what reconcilation and normalcy is about?

A sensible Government should be asking themselves some serious questions. Unfortunately, no one, least of all the Government, seems to be doing this.