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?


maf said...

This is brilliant JP, by far the best report i have read on Touchwood.

Jack Point said...

Well, thank you maf, and welcome to the blog.

Anonymous said...

See the below link, how much 1 share cost for the initial investor and how the board of directors dispose their shares before the rights issue and recently.

Jack Point said...

Thanks for that Anon.