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Wirecard Bites The Dust

In the midst of this whole Covid-19 brouhaha, it’s good to know that there is business as usual still being undertaken in uncovering corporate malfeasance. This year’s mega scandal emerged in Germany, when the blue chip company Wirecard’s CEO was arrested last month on suspicion of accounting fraud and market manipulation. Wirecard is a German payments services provider with offices across the world providing mobile payments, e-commerce, digitization and finance technology. Its clients included large multinational insurance companies, airlines and public transport utilities. In an August 2019 press release to the Business Insider magazine, Wirecard reported half year revenues of € 1.2 billion in revenues compared to € 882 million in half year 2018 and a 50% increase in earnings after tax of € 237 million over the same period in 2018. The company also claimed in the press release that transaction volume processed via its platform grew 37.5% to €77.3 billion in the first half of 2019 compared to €56.2 billion over the same period in 2018.

But all these numbers had already started to raise doubts after a January 2019 expose by the Financial Times (FT), a globally recognized and well respected British business newspaper, based on whistleblower reports. The FT reported on 30th January 2019 that a presentation had been made to Wirecard executives, including the CEO Markus Braun, on a string of suspicious transactions using forged and backdated contracts that led to falsification of accounts and money laundering. The whistleblower was concerned that no action had been taken against the perpetrator of the acts undertaken by Eco Kurniawan who was responsible for the payment group’s accounting in the Asia Pacific region. Wirecard took great umbrage at the FT’s reporting and sued the newspaper for unethical reporting and market manipulation as the company’s share price took a plunge on the German Stock Exchange.

Responding to the market’s reaction, the company asked KPMG, one of the Big Four global auditors, to undertake an independent audit of the firm’s Asian operations and was quick to announce in March 2019 that the audit firm had not found any discrepancies in the audit and that it would not restate its accounts for the years between 2016 and 2018. However an article by Reuters in April 2019, revealed that the independent investigation by KPMG into Wirecard had concluded that the company did not provide sufficient documentation to address all the allegations of accounting irregularities made by the FT, who continued to stand by their view that Wirecard had booked half of its worldwide revenues and much of its profits from three obscure third party acquiring partners.

In June 2020, it all went pear shaped for the CEO Markus Braun. After the delayed announcement of Wirecard’s 2019 results three times since their expected release in March 2020, the FT reported that Ernst and Young, Wirecard’s auditors, had warned that € 1.9 billion was missing from the company’s accounts. The auditors told the company that there were indications that a trustee of the company’s bank accounts had attempted “to deceive the auditor” and may have provided “spurious cash balances.” Consequently, the auditor was unable to release the much awaited 2019 financial results to the company’s board and management.

Late last month, Markus Braun was arrested on suspicion of inflating the company’s balance sheet and revenues to make it stronger and more attractive for investors and customers. He was released after his bail was set at €5 million. Another gleaming company and CEO’s reputations have bitten the dust. The academic beauty of this case is that it has followed the same trajectory of many other large ignominious corporate scandals like Enron in the United States and Satyam in India: phenomenal financial growth that leaves investors dizzy in the share price appreciation and promise of even more profits all at the expense of murky internal controls and risk management. The common thread is a leadership that more often than not gets high on its own supply having been recognized on multiple stages for having innovative and trailblazing expertise, which is ordinarily a façade that is difficult to maintain in the long run. As the disgraced Satyam CEO Ramalinga Raju aptly quoted, following his fall from disgrace after confession that nearly $ 1 billion dollars in cash was missing from the company’s balance sheet, “It was like riding a tiger, not knowing how to get off without being eaten.” How many boards are sitting ringside at a circus, watching a tiger riding CEO string them along?

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Twitter: @carolmusyoka

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A Day Long and a Dollar short for Imperial Shareholders

[vc_row][vc_column width=”2/3″][vc_column_text]To understand the recent actions by Central Bank (CBK) in appointing third parties to manage Chase and Imperial Banks, a little history is required. In 1986 the Moi Government decided to get into the 20th financial century and created the Deposit Protection Fund Board (DPFB), which was only operationalized four years later in 1989. The purpose of the DPFB was twofold: To create a fund to offer protection to depositors in Kenyan banks and to take on the role of liquidator for failed banks. Between 1989 and 2012 DPFB had managed 24 banks in liquidation, the earliest being Inter Africa Credit Finance which was put under liquidation on 31st January 1993 and the latest being Daima Bank on 13th June 2005. There is no documented successful revival of any bank in those 26 years of the DPFB’s existence since the prevailing regulatory framework provided for statutory management leading to liquidation. The results speak for themselves: 24 banks in question had Kes 22 billion in deposits of which only Kes 1.5 billion were protected deposits. (Remember that the law provides insurance of up to Kes 100,000 per depositor). The DPFB in that period managed to pay out Kes 1.1bn or 74% of the protected deposits by the end of the financial year June 2012. It is noteworthy that the DPFB has an excellent record of publishing its accounts via its website since 2003, which accounts are audited by KPMG on behalf of the auditor general. The organization has been profit making from inception and by the end of FY June 2012 recorded a surplus of Kes 5.1 billion. Cash was certainly not what prevented DPFB from making 100% payment to protected depositors. One conclusion that can easily be drawn therefore is that the 26% protected depositors that weren’t paid simply didn’t make a claim for their money. Now let’s take a look at the loan recovery. In the same period the 24 banks had Kes 41.1 bn in loans outstanding, of which DPFB managed to recover Kes 6.4bn or 15.5% of the loan stock. Either DPFB was very inefficient or they quite simply couldn’t make the offending borrowers repay their (insider) loans and couldn’t find quality securities that would realize some value to extinguish those debts. My money is on the latter reason. As a result of clawing back a little in the form of loan repayments, DPFB managed to pay some depositors over and above the statutory minimum of Kes 100,000/-. Referring to this as “dividends” in their annual report, up until FY 2012 DPFB had paid only 28% or a total of Kes 5.6 bn cumulatively to depositors out of Kes 19.9 bn in unprotected deposits. In light of this less than stellar history of recovering the distressed assets and liabilities of the banking sector, the Kenya Deposit Insurance Act 2012 was enacted, which replaced the DPFB with the Kenya Deposit Insurance Corporation (KDIC).

KDIC-with-power-foam was created to make whites whiter and colors brighter. This piece of legislation gave the new institution far more operational discretion and a solution driven approach to managing failed banks than its predecessor. KDIC was now motivated to breathe life into failed banks rather than play the lugubrious mortician role of its predecessor. Through Section 53 of the Act, KDIC is given a tight timeframe – 12 months to be precise with a window to extend for a further 6 months- to either cure the bank of the matters that caused it to go under receivership or put the bank in liquidation. Twenty six years of experience had also led the former DPFB team to realize that perhaps the solution to keeping a bank open is to outsource receivership to a third party (with the necessary operational capacity) who would be nimbler in putting the structures in place to begin assessing loan viability and recovery thereof in order to pay suffering depositors and creditors. We have a different perspective now on how to manage failed banks, a perspective that allows for industry experts to step in and help KDIC execute its mandate. A perspective that allows for employees to continue working, borrowers to continue paying and depositors to receive funds over and above the historical statutory minimum.

The aim to maintain a going concern would be an unprecedented win for CBK as it would stabilize jittery depositors, calm foreign investors who were now having doubts about the wisdom of investing in Kenya and allow legitimate borrowers to continue utilizing much needed working capital facilities that were the lifeblood of their businesses. The first trial of the KDIC’s going concern experiment was with the appointment of KCB in April 2016 under S. 44 (2)(b) (iii) of the KDI Act that essentially allows KDIC to appoint a third party to manage the assets, liabilities and affairs of the institution. That KCB has a fully-fledged debt recoveries department that can land on errant borrowers like a ton of bricks is without question. This is business as usual for them. It is only through the active management of the loan book that depositors and creditors will get paid, and, hopefully a going concern is maintained. More importantly, the credit risk team at KCB should also be able to actively manage the performing loan book with a view to ensuring that businesses are not starved of the loan facilities that are needed to keep their businesses afloat. Providing mirror loan facilities on KCB’s own books provides an obvious solution to legitimate and well performing businesses. Operational capacity and deep industry experience is what third parties appointed by the KDIC under S. 44 (2) (b) of the Act bring to the table. But it’s a day long and a dollar short for the shareholders of Imperial Bank when energetically stating righteous indignation at CBK’s actions to appoint third parties to help recover the bank’s assets. Those energies should have been better placed keeping a tighter lid on the co-shareholder who led them down the rabbit hole of fraud in the first place.

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

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Chasing The Truth In Parliament

[vc_row][vc_column width=”2/3″][vc_column_text]Last week, an unlikely source in the form of a Parliamentary Committee helped to unseal the tightly held lips of the Chase Bank’s board of directors. The directors had been summoned to assist the Committee to understand the challenges that faced the Bank, resulting in the same being placed under receivership by the Central Bank of Kenya. This was an opportunity for the board to give its side of a controversial story, a tale that has as many versions as there are heads to the Greek mythical hydra. The story caught my attention for one reason only: The directors called the auditors professionally ignorant. Actually let me quote the exact statement here: “The Musharakah Agreements for each of the SPVs clearly show Chase Bank’s 99% interest in the Musharakah assets. Deloitte’s insistence on treating this as a normal loan or advance can only be labelled as professional ignorance at best.” Part of the dispute between the auditors, Deloitte in this case, and the board of directors has been on the treatment of a series of real estate transactions either as internal loans to a key shareholder (according to the auditor) or as Musharakah assets (Islamic financing terms according to the directors). So I pored over the submissions made by the directors in their vigorous defence of these assets.
Banking is premised on the fact that there are depositors who want a safe place to put their money, and there are borrowers who require to borrow funds for consumption. The bank is simply an intermediary. In the case of Islamic banking, the institution applies Sharia compliant procedures in the booking of those deposits and loans. The key point here is: there must be a customer. Period. Finito. Whether it is mainstream or Islamic banking there must be an individual or an entity who is the customer. But the directors state thus in their parliamentary submissions:
“Subsequently, Deloitte rejected the Musharakah Agreements and Deloitte insisted that the Musharakah properties be charged to the bank, thus effectively classifying the SPVs as Loans and Advances rather than Islamic investments as documented. These loans would then become technical insider loans, as the shares in the SPVs were held by the two directors, albeit held in trust for the Bank. Chase Bank’s Management emphasised to Deloitte that treatment of the Musharakah assets as Loans and Advances would be in contravention of not only the principles of Islamic banking (and therefore a breach of trust with Islamic depositors), but also of Section 12(c) of the Banking Act and
would incorrectly treat these as an insider loan. It was evident that Deloitte were simply not interested in appreciating the nature and substance of the Musharakah Assets or the principles of Islamic banking.”

I scratched my head and read the report twice over. At no point did the directors say who the ultimate customer was. I mean, a bank doesn’t wake up and decide to give a loan out to a customer, whether Islamic or otherwise. Why was there no attempt to say that this was an unfair treatment of a yet-to-be-named customer who had borrowed from the bank in good (Islamic) faith? That the assets were bought in the name of the SPV is not in doubt. That the SPV has two Chase directors as the shareholders is not in doubt. But where the shareholders were holding the shares “in trust” for the bank is where it starts to get “grab-a-bag-of-popcorn” interesting. The directors fail to mention if a “deed of trust” was provided to the auditors as evidence of that understanding between Chase Bank on the one hand and the SPV shareholders on the other. I mean, one doesn’t assume trust falls off the back of the Kisumu express train, it must be documented somewhere, right? The directors beat their Islamic financing drum further by dragging in the regulator into their drama: “On 26th July 2012, Chase bank wrote to the Director of Bank Supervision at CBK requesting CBK to revise the Central Bank Prudential Guideline on Publication of Financial Statements and Other Disclosures to accommodate Islamic products and
specifically:
(i) the Islamic Banking Income received to be reflected separately in the Profit and Loss
Account;
(ii) The Islamic Banking Expenses also to be reflected separately in the Profit and Loss
Account;
(iii) The Islamic Banking investments or Financing Activities as a separate Asset line in the
Balance Sheet;
(iv) The Islamic Deposits or Liabilities as a separate Liability item in the balance Sheet; and
(v) A separate Off Balance Sheet line item for Islamic banking.
The CBK has not objected, in the absence of any changes to the Prudential Guidelines, to the classification and treatment in any of its reports to the Bank.”

I have to admit, that this submission by the directors stumped me. If you wrote to the regulator and asked to be reporting Islamic Banking products separately, and the regulator did not object, then why do your 2014 and 2015 financial accounts not reflect the same? I zoomed across to the only fully-fledged Islamic Banks in Kenya, Gulf African Bank and First Community Bank (FCB) websites to see how their Islamic assets are recorded. Their professionally competent auditors in the name of KPMG and PriceWaterhouseCoopers (PWC) respectively reported loans as “financing activities (net)” exactly as Chase had requested the CBK to do in (iii) above. (It’s noteworthy that PWC audited the FCB accounts in 2014 but the 2015 published accounts are silent on who their auditors were) If Chase directors had knowledge as far back as July 2012 on how “Musharakah Assets” should be recorded on the balance sheet why wait until June 2016, or four years later, to call their auditors professionally ignorant? And why are the Islamic depositor funds not separately recorded yet the directors have vigorously highlighted the potential breach of trust for the Islamic depositors if Musharakah Assets are treated as loans and advances?

The Chase Bank saga is a case study of corporate governance failure, weak internal controls, questions on the auditors’ scope and depth of review and a passionate to almost rabid love for the brand by its most loyal customers. But on the back of all of that are innocent depositors who must always remain in the minds of all bank directors whose oversight role gets heavier with each passing day.

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

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Entitled and Uncouth Heirs to the throne

[vc_row][vc_column width=”2/3″][vc_column_text]Last Tuesday, a video of a nauseating scene at the Tuskys management offices went viral on social media. In case you missed it, an entitled, uncouth and mealy mouthed ragtag of young family members burst their way into the Tuskys CEO’s office and demanded that he leave the premises immediately. Having engaged some media journalists to film this Mexican soap opera in its full but cheap theatric version, the posse used choice epithets and kindergarten taunts to push the CEO out of his office, into his car and out of the premises. What they did was, to say the least, a childish but very public display of corporate ignorance. Legend has it that many years ago, the grandfather, Joram Kamau, started the business as a small provisional store called Tusker Mattresses in Rongai, Nakuru county. He grew the business slowly and eventually expanded by opening the first store in Nairobi’s Tom Mboya Street, as his some of his sons joined and helped to grow it into the successful enterprise that it has become. He passed away but ensured that the shareholding of the business, which had been formally structured into a private company, was distributed amongst his seven children. However, since early 2012, the public has been treated to sibling fistfights and courtroom battles for control of the multi billion shilling turnover business.

Let me tell you young rabble-rousers what no one else will tell you: the business may have been started by your grandfather, but now has multiple stakeholders who are deeply invested in its success. The first of these stakeholders are the employees who wake up at the crack of dawn every morning, while you turn on your mattress in blissful slumber, to walk or ride to work in the supermarket branches and at the head office. Their daily labor output helps to serve customers who purchase the goods that produce the revenue that eventually filters into dividends that line your mealy mouthed pockets. The second key stakeholders are the suppliers of the stocks on the shelves of the supermarkets. If no products are delivered, no sales will be generated. The third key stakeholders are the banks that lend the working capital to the business. They monitor the cash flow with beady eyes, ensuring that money generated from goods sold is not diverted to other non commercial uses, as that will spell disaster in the form of non-repayment of loans. The business is no longer a small, rural kiosk. It’s a corporate entity.
A typical family business goes from rags to riches and back to rags in three generations. Research has shown that only about 10% of family businesses make it to the fourth generation. Once you rabble-rousers have deposited your juvenile theatrics at the left luggage counter at the Tom Mboya Street branch, you urgently need to put together a family constitution that is an instrument often used by wealthy families to avoid future disputes. According to a KPMG Canada advisory paper titled “Constructing a Family Constitution” a family constitution serves three purposes. Firstly, it documents the values and principles that will underpin the conduct of the family business. Secondly, it defines the strategic objectives of the business. Finally it sets out the way in which the family will make the decisions affecting the ownership and management of the business.

The fact is that many family businesses don’t fail because the business has become unsound; rather they fail because the family member disputes derail the business from the successful track laid out by the original founder. The KPMG paper finds that from their own research there are five common issues for family businesses namely balancing family concerns and business interests, compensating family members involved in the business, maintaining family control of the business, preparing and training a successor and finally, selecting a successor. What we witnessed on television last week, was clearly a dispute over the last point, that is, some family members clearly have not accepted the current external successor that was appointed primarily to dilute the dispute about an internal successor running the business as was previously the case. That this fight was going to happen was inevitable. The KPMG research paper finds that as any family business grows into the second generation, the demands of the business and the demands of the family members working in it begin to diverge. The family dynamic may be that while not all the children or grandchildren are interested in running the business, all are highly interested in receiving the benefits in the form of dividends therefrom. The family constitution therefore helps to address these issues for current and future generations. A good constitution thus takes into consideration a number of issues such as the strategic business objectives that should reflect agreed family values and aspirations for the business. It should also include the process for hiring, assessing and remunerating family members employed in the business together with the rules for nominating and appointing management successors and the process for nominating and assessing individuals for appointments to the company’s board of directors or family council. Further, it should cover the composition and rules of conduct for a family council, communication and disclosure policies between the company and family, the process for resolving conflicts about the business between members of the family, rights and obligations of shareholders as well as the recommended or compulsory retirement age for family directors and managers. Finally, the constitution should also include the process for buying out family shareholders in the business, and clearly articulate policies concerning external, non-family ownership and management of the business as well as procedures for amendments to the constitution.

It’s never too late to write a family constitution but it is best done during the lifetime of the founder to ensure that his or her values are distinctively captured for posterity. It then helps to avoid the despicable television drama that the Tusky’s grandchildren have sullied their grandfather’s name and memory with.

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]