NIGERIA: Halting Creative Accounting via Tougher Regulations

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Eromosele Abiodun writes on the need for capital market regulators to be tougher on quoted companies who delay or manipulate their results to mislead investors

In 2005, after a scandal on insurance and mutual funds a year before, AIG was investigated for accounting fraud. As result of the scandal, the company lost over $45 billion worth of market capitalisation.

Investigations also discovered over $1billion worth of errors in the company’s accounting transactions. The investigation led to a $1.6 billion fine for AIG and criminal charges for some of its executives.

A similar development occurred in Nigeria in October 2006, when the board of Cadbury Nigeria Plc notified the world of the discovery of “overstatements” in its accounts, which according to it, has spanned many years.

Consequently, more than 300 shareholders sued the board of Cadbury Nigeria and its auditor for breach of duty. It was alleged that the shareholders suffered huge losses due to deliberate overstatement of Cadbury Nigeria’s financial position over a number of years to the tune of N15 billion ($122 million).

Last year, The Federal Government of Nigeria sacked two accounting firms responsible for certifying fuel subsidy claims by marketers. Sacked were Akintola Williams and Co and Adekanola and Co.

Corporate accounting scandals arise from disclosures of misdeeds by trusted executives of large public corporations.

Such misdeeds typically involve complex methods for misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of corporate assets or underreporting the existence of liabilities, sometimes with the cooperation of officials in other corporations or affiliates.

Taking a stand
Recently, the management of the Nigerian Stock Exchange (NSE) sanctioned some quoted companies for violating its listing rules that demand companies to make their results available on time for scrutiny.

While it is not known whether these companies were delaying their results for ulterior motives, experts say the action is a welcome development now that investors’ confidence is gradually returning to the market.

The experts noted that as awareness in investment in the stock market increases, a lot of necessary steps needed to be observed. This, they added, was lacking in the era gone by where investors were not given adequate education before investing in the capital market, especially in public offerings that were sold at inflated prices.

The Investment and Securities Act (ISA) 1999 provides that companies intending to raise funds made available a prospectus for prospective investors.

However, the Act provides only limited protection from fraudsters. But under the law any company that wants to sell its shares to the public must issue a prospectus, a document that is supposed to provide extensive information about a prospective investment, including its financial health, its risks, and what it intends to do with the money.

In an effort to protect investors, the ISA places all sorts of obligations on people who are registering their companies, particularly when they want to sell shares to other people to raise money as working capital for the company.

Despite these obligations, scams have been perpetrated under the "protection" of the ISA. For instance, Coral Properties Plc came to the stock market a few years ago to raise funds and was unable to reach the percentage for an offer to be said as successful. Till today, investors’ monies are yet to be returned.

National Coordinator, Independent Shareholders Association of Nigeria (ISAN), Sir Sunny Nwosu, believe regulators and stakeholders in the capital market have failed to protect investors over the years.

According to him: “These things happen because the issuing houses and registrar of companies do not proactively investigate whether a scam is underway. Most scams involving companies are often revealed only when the company goes belly up. And then you will have lost all or part of your money.”

He however, noted that most quoted companies are free from these crimes stating that the situation is worse with unlisted securities.

“The reason why unlisted companies are the chosen vehicle of casters is that far more scrutiny is given to a company that is listed on a stock exchange. Among other things, a listed company has to have more of a track record and it is going to be scrutinised by a lot more people, many of whom are well trained at spotting a confidence trick.

”This does not mean that horrific frauds do not take place through listed companies. They do. You need look no further than the Cadbury issue that happened recently. But far less stringent checks are applied to unlisted companies.

"The other problem with unlisted companies is that once you have bought the shares it becomes difficult to trade those shares and most of them do not keep to their time table for listing.”

He added that what the ISA does is provide investors with some tools that will help them check activities of quoted companies and to keep eyes on their workings.

“For example, the ISA Act 1999 provides for civil and criminal liabilities against companies which provide false or misleading information. The Act, however, does not ensure that you as an investor will, in fact, be told the truth. Someone who is out to separate you from your money is not going to tell you or the issuing house and registrar of companies the truth.

“The tools by which the ISA attempts to put a brake on bad people include the requirement that audited financial statements must be submitted to the regulators and investors annually; quoted companies are required to have annual meetings and shareholders are entitled to attend the meetings and have the right to vote on any proposals.

"Also, directors and a company secretary must be appointed who, among other things, must confirm the correctness of the financial statements. However, you should not regard the requirement of an auditor as a guarantee against a potential scam," he said.

Understanding financial statement
The financial statements, he said, are investors primary source of financial information and are essential to determine a fair value or price of shares.

“As an investor, read the auditor's statement, study the income statement, balance sheet, cash-flow statements and the notes to these financial statements to understand how your company makes money.

"Take account of any off balance sheet liabilities, such as contingent liabilities, that may be hidden away in the notes to the financial statements," he advised.

He stated that high levels of debt on the balance sheet increase the inherent risk of the business.

Nwosu stated that besides the annual report, a company has to provide a financial history of the growth and development of the business.
He added that long financial and operating history provides a certain degree of comfort about the sustainability of the business.

”Use ratios to understand a business. Ratios are normally included in the notes to the financial statements. If they are not, you should do the calculations yourself.

The most important ratios are: those related to cash flow, particularly operating cash flow per share and free cash flow per share; price earnings and the quality of earnings, which is calculated by dividing headline earnings by free cash flow. This last ratio is useful in determining what proportion of earnings is converted into actual cash flow," he added

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