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BWRR3123/ CORPORATE

GOVERNANCE

CHAPTER 8
CORPORATE GOVERNANCE
FAILURE
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Question of the Day - CNN

Q : Do you trust the way big corporations do


business

Yes 10% 906 votes


No 90% 8174 votes
CNN question of the day on 7 July 2004

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Financial scandals and collapses

 Barings Bank
 Enron
 Parmalat
 Satyam
 Royal Bank of Scotland
 Securency
 China Forestry
 Olympus Corporation
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Some key questions

 Why have such scandals and collapses


occurred?
 What might be done to prevent them
happening again?
 How can investor confidence be restored?

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The answers?

 The answers to these questions are all linked


to corporate governance
 So what is corporate governance and how
might it improve corporate accountability?

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Studies on Corporate Failures

 Studies have shown that a majority of those


corporate failures were traceable to the
predominance of one individual or several
working in concert in the board.
 Invariably fraudulent practices were found.
 Failure of checks and balances mechanism.

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Reasons of Companies Failure
 Questionable ethics
 Behaviour at the top
 Aggressive earnings management
 Weak internal control
 Risk management
 boards did not fully understand risk and therefore did
not manage it appropriately
 excessive risk-taking

 inadequate monitoring of risk

 executive remuneration not linked effectively to


corporate performance
 Shortcomings in accounting and reporting
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Each Party’s Responsibility
 Directors - Issues of compliance & profitability
 Directors - Issues of conformance &
performance
 Shareholders - Questions at AGM & EGM on
company’s performance
 Shareholders – Nomination of independent
directors?
 External auditors
 Independence
 Change of auditors
 Who audits the auditors?
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What Went Wrong?
Spectacular corporate accounting scandals
and failures include:
 Parmalat
 HIH
 OneTel
Enron
Tyco
WorldCom

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Parmalat
Italian dairy-foods giant Parmalat has
prosecutors scrambling to find out what
happened to $8.5 billion to $12 billion in vanished
assets. Some 38% of Parmalat's assets were
supposedly held in a $4.9 billion Bank of America
(BAC) account of a Parmalat subsidiary in the
Cayman Islands.
Business Week

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Parmalat
But Bank of America reported that no such
account existed. In the ensuing investigation,
Italian prosecutors say they've discovered that
managers simply invented assets to offset as
much as $16.2 billion in liabilities and falsified
accounts over a 15-year period, forcing the $9.2
billion company into bankruptcy on 27 Dec 2003.

Business Week

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Parmalat
 Parmalat is an Italian multinational dairy and
food corporation with more than 36,000
employees
 • Parmalat became the leading global
company in the production of UHT (Ultra High
Temperature) milk.
 • The company collapsed in 2003 with a 14bn
euro hole in its accounts. It still represents
Europe's biggest bankruptcy.
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Parmalat
 Accounting manipulation:
 – Debt hidden in shell companies in the Enron spirit
 – Outright falsifying of sales figures
 – Grant Thornton’s accountants were intimately aware of the shell
games being played by Parmalat’s executives.
 – Fausto Tonna, Parmalat CFO, has told interrogators that he
participated in a “cut and paste” forgery, in which a document with
Bank of America letterhead was scanned and then added to a
document verifying a deposit account with that bank holding over
$4.98billion

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Parmalat
 Calisto Tanzi, the founder and CEO of
Parmalat
 Tanzi founded Parmalat in 1961
afterdropping out of college.
 In 2008 Tanzi has been sentenced to10
years in prison for fraud and fined80,000
euros.

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OneTel: The Collapse

Factors of collapse included poor management,


trading while insolvent and other breaches of the
Australian Corporations Act 2001. Directors paid
themselves large bonuses while the company was
insolvent.

http://www.lawbookco.com.au/academic/CorporateMisconductezine/pdf/Gerald%20Minimizing%20Corporate%20Collapses.pdf

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OneTel: Quotes from
Brad Keeling (Director)

“Sometimes you can be good at promoting


something. It becomes very big and you still
might be good at promoting but not good
enough at managing ”
Brad Keeling in his interview with Herald

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OneTel: Quotes from
Brad Keeling (Director)

“It probably happens a lot. Whether you're an


engineer or a marketer, when things start to
boom people feel they're invincible and that
feeling of invincibility has to be countered.
Everybody is fallible and you have to realise
what your capabilities are.”
Brad Keeling in his interview with Herald

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Enron, The Indictment:
Richard Causey (Chief Accountant),
Jeffrey Skilling (CEO),
Kenneth Lay (Chairman)
Amongst other things:
 manipulating Enron's publicly reported
financial results, making public statements
and representations about Enron's financial
performance and results that were false and
misleading

http://news.findlaw.com/hdocs/docs/enron/usvlay70704ind.pdf
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Enron: Defendants' Profit
as a Result of the Scheme

 Enriched themselves through salary,


bonuses, grants of stocks and stock options,
other profits.
 Skilling received approximately US$200
million from sale of Enron stock options,
netting over US$89 million in profit and was
paid more than US$14 million in salary and
bonuses.
http://news.findlaw.com/hdocs/docs/enron/usvlay70704ind.pdf

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Enron: Defendants' Profit
as a Result of the Scheme

 Lay received US$300 million from sale of


Enron stock options, netting over US$217
million profit and paid more than US$19
million in salary and bonuses
 Causey received more than US$14 million
from sale of Enron stock and options, netting
over US$5 million profit and paid more than
US$4 million in salary and bonuses.
http://news.findlaw.com/hdocs/docs/enron/usvlay70704ind.pdf

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 • Enron is founded in 1985 (as the result of a merger) as an operator
of natural-gas pipelines based in Houston, Texas.
 • In 1985 Enron enters natural-gas trading and becomes the largest
player in the U.S. and U.K. energy market within few years.
 • Fortune named Enron "America's Most Innovative Company" for
six (!) consecutive years, from 1996 to 2001.
 – Revenues in 2001: 138 billion USD > GDP of Finland or Greece
 – Employees in 2001: 20,000

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 Enron's accounting manipulation:
– Enron's recorded assets and profits were inflated, or even wholly
fraudulent and nonexistent.
– Debts and losses were put (through fake transactions) into entities
formed "offshore" that were not included in the firm's financial
statements.
– In 2000, for example, 96% of Enron‘s earnings were the result of
accounting manipulation.
 • When these practices were discovered this had severe
consequences:
– Enron filed for bankruptcy on December 2, 2001. It was the so far
largest Chapter 11 bankruptcy.
– Dissolution of Arthur Andersen as accounting firm.
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 Jeffrey Skilling, Enron‘s former President and CEO, Harvard M.B.A.
and former McKinsey & Co. Consultant
 • On February 12, 2001, Skilling was named CEO of Enron,
receiving $132 million in a single year.
 • On May 25, 2006, the jury returned with the following findings
regarding Skilling:
– guilty on one count of conspiracy
– guilty on one count of insider trading
– guilty on five counts of making false statements to auditors
– guilty on twelve counts of security fraud
 • On October 23, 2006, Skilling was sentenced to 24 years and 4
months in prison and fined $45 million.

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 Andrew Fastow, Enron’s former CFO
 • Fastow was hired in 1990 by Jeffrey Skilling at Enron Finance
Corp.
 • He was named CFO at Enron in 1998.
 • Fastow was able to design a complex web of companies with the
dual purpose of raising money for the company and also hiding its
massive losses in their quarterly balance sheets. This effectively
allowed Enron to appear debt free to investors and analysts, while in
reality it owed more than 30 billion dollars at the height of its debt.
 • On 26 September 2006, Fastow was sentenced to six years,
ollowed by two years of probation.

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WorldCom, The Indictment:
Bernard Ebbers (CEO),
Scott Sullivan (CFO)

Amongst other things:


 Fraudulent adjustment to WorldCom’s
expenses and revenue.
 False statements
http://news.findlaw.com/hdocs/docs/enron/usvlay70704ind.pdf

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Enron collapsed in large part because the rules didn't
accomplish what the experts hoped they would. For
example:
 Paying directors with stock may have aligned their
interests with shareholders', but it's just as likely to have
created a motive for not asking the tough questions.
 Disclosure rules may have alerted investors to the fact
that one audit committee member had a potential conflict
of interest, but not that two others did as well.
 The Enron audit committee may have been exactly what
the stock exchanges had in mind in December, 1999,
when they required that members demonstrate financial
know-how--but the expertise may have been out of date
following the changes Enron went through in the 1990s.
In any case, it didn't help the committee make sense of
Enron's tangled finances. 26
WorldCom, The Indictment:
Bernard Ebbers (CEO),
Scott Sullivan (CFO)
 WorldCom is a telecommunication company based in Clinton,
Missouri
 Accounting manipulation:
 Reclassify $3.85 billion in operating expenses as long-term investment. This
manipulation had the effect of boosting earnings while leaving cash flows
unaffected (actually, lowering them a bit – wasted tax shield). By theend of
2003, it was estimated that the company's total assets had been inflated by
around $11 billion.
 WorldCom filed for bankruptcy on July 21, 2002. It was the so far
largestChapter 11 bankruptcy.

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 Bernard Ebbers, former WorldCom CEO.
 In 1985 Ebbers became CEO of Long Distance Discount
Services (LDDS).
 In 1985 LDDS was renamed to WorldCom
 In September 1998 Ebbers successfully completed the
acquisition of MCI Communications.
 On July 13, 2005, Ebbers was sentenced to twenty-five
years in a federal prison in Louisiana.

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Malaysian Cases

 Perwaja Steel Sdn Bhd


 Technology Resources Industries Berhad
(TRI)
 Transmile
 Megan Medi

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Perwaja Steel
 Time Magazine quoted an economist at
Morgan Stanley in Singapore as saying
that Malaysia might have lost as much as
US$100 billion since the early 1980s to
corruption.
 One of these scandals is the Perwaja
Steel project which is associated with a
loss of RM10 billion.
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Perwaja Steel
 Perwaja Steel started in 1982 as a joint venture
between the government-owned Heavy Industries
Corporation and the Japanese company Nippon Steel
Corporation.
 A steel plant costing RM1 billion was built in
Terengganu to supply the domestic needs for steel
products.
 However, Perwaja encountered production problems
and was saddled with large debts. Since the
borrowings were in yen – which appreciated
significantly at that time – interest payments were
getting higher.
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Perwaja Steel
 In 1987 Nippon Steel pulled out of the project. The
Prime Minister appointed Eric Chia in 1988 to run
Perwaja and to turn it around.
 He was given full authority to do what was necessary
to reverse Perwaja’s performance and reported
directly to PM.
 Another RM2 billion was pumped into Perwaja with
government funding and loans from Bank Bumiputra
(RM860 million) and EPF (RM130 million). New
facilities were built in Terengganu and in Kedah. Eric
Chia helmed Perwaja for seven years.

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Perwaja Steel
 Total losses had increased to RM2.49 billion from RM1
billion when Eric Chia took over. Perwaja was crippled
by additional debts amounting to RM5.7 billion.
 Eric Chia was finally charged for dishonestly authorizing
(not pocketing) a payment of RM76 million (0.076 billion)
in 2004.

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Perwaja Steel Sdn Bhd
The new management of Perwaja prepared an internal
report where it claimed the following among others:
 inaccurate accounting records

 unauthorised contracts amounting to hundreds of


millions of ringgit
 alleged misappropriation of funds

 dubious maintenance contracts amounting to RM292


million (including a contract amount of RM200,000 per
month to a company for gardening, cleaning and vehicle
maintenance)
 award of RM957 million contract to companies of a long
time associate of Eric Chia
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Technology Resources Industries
Berhad (TRI)
 Another example of corporate governance failure in
Malaysia is the corporate misconduct at Technology
Resources Industries Berhad (TRI).
 The problem began in 1993 when TRI acquired Celcom
from Telekom Malaysia Berhad.
 TRI had placed foreign debt to raise the fund needed in
acquiring Celcom. TRI faced millions of foreign
exchange loss and high cost of borrowing when the
Asian Financial Crisis happened in 1997.
 TRI made an internal restructuring and debt refinancing
to settle the borrowing.
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Technology Resources Industries
Berhad (TRI)
 The governance failure occurred when the major
shareholder of Celcom and executive chairman was the
same person which is Tan Sri Tajuddin Ramli. He was
also the major shareholder of TRI but was removed in
July 2002 when Telekom purchased a large block of TRI
shares from Danaharta. In August 2002, Celcom has
made legal proceeding with regards to the payment of
RM55.8 million paid to three previous directors of
Celcom which they claim as unauthorized payments.
 TRI was discovered to have issued fictitious invoices
totaling nearly RM260 million in 1998 and 1999. Those
fictitious invoices misleading the financial statement
whereby it reflect that the company has derived high
revenue. 36
Transmile
 Transmile was another organization that faced the
governance failure. The company was alleged to have
overstated its revenue by a total of RM522 million in
financial years 2004, 2005 and 2006.
 In addition, RM341 million in its property, plant and
equipment account appear to have been fabricated as
the amount was little supported by documents.
 In another occasion, Lim Guan Eng in his press release
mentioned that “accounting scandals in Transmile group
where revenue and profits are falsified through creative
accounting indicates 3 structural failures in regulatory
oversight and full disclosure of our capital markets,
unreliability of financial statements and poor corporate
governance in Malaysia”. 37
Megan Media
 Megan Media the governance failure began
when it two subsidiaries namely Memory Tech
and MJC Pte Ltd. defaulted on a RM47 million
payment to bondholders.
 This failure drove to reporting failure whereby a
preliminary report found that “substantial
irregularities” and financial position of the
company‟s financial position had been misstated
and RM211 million deposits for 13 production
lines was fictitious.

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Megan Media
 Consequently it resulted to the receivables
amounting RM334.3 million. On top of that the
payments made to creditors were actually made
to other parties in a move to channel cash out of
Memory Tech.
 In April 2007, the loss of Megan Media reported
amounting to RM1.3 billion compared to a profit
of RM60 million in the previous year.

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Conclusion
The key to good corporate governance lies in
substance, not form. It is about the way the
directors :
 create and develop a model to fit the
circumstances of that company and then test
it periodically for its practical effectiveness.
 take control of a regime they have
established and for which they are
responsible.
The Hon Justice Owen
Royal Commissioner in HIH Enquiry
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Conclusion
Whatever the model, the public must know
about it and about how it is operating in
practice. Disclosure should be a central feature
of any corporate governance regime.
Shareholders, potential shareholders and the
wider public are entitled to real, meaningful
detail about the way the directors say they are
carrying out their stewardship role.
The Hon Justice Owen
Royal Commissioner in HIH Enquiry

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Some key points

 Financial scandals and collapses have been


the impetus for many companies to improve
their corporate governance
 A sound corporate governance system helps
restore/maintain investor confidence

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