By Mak Yuen Teen
On 21 January 2019, Y Ventures Group, which listed on Catalist in July 2017, announced material errors in its unaudited results for the six months ended 30 June 2018. The cumulative effect of these errors resulted in the profit and loss position being overstated by about US$1,303,463. The “profit” of US$143,330 announced back in August 2018 has now turned into a loss of US$1,160,133. The company disclosed that US$1,453,873 was erroneously recorded as inventories (or an overstatement of nearly 25%); US$20,453 was erroneously recorded as property, plant and equipment; US$172,238 was erroneously omitted as trade and other receivables; and US$196,869 was erroneously omitted as administrative expenses.
The company said that its audit committee and board “have observed that there were certain inadequacies in the Company’s internal controls which led to the lapses in recording of transactions”.
Y Ventures blamed the errors on “administrative inadvertences”, which therefore joined terms such as “administrative oversight” and “inadvertent omission” into the lexicon of excuses when companies make erroneous disclosures.
SGX Queries
Following the announcement of the errors and the release of the restated results, SGX Regco issued two detailed sets of queries.
In response to the first set of queries, Y Ventures said that there was an entry of incorrect unit costs for inventories as at 30 June 2018, which it explained was due to the company using Excel to reconcile inventory on a monthly basis. It said that such a system was adequate at listing as the company had one key supplier which accounted for a majority of the Group’s purchases. According to the company, it has now developed an in-house computerised Inventory Management System (IMS).
For the understatement of administrative expenses, it said that certain intercompany transactions and balances were not fully reconciled and eliminated as at 30 June 2018, but it now carries out consolidation of accounts on a monthly basis instead of half-yearly, which will enable management to detect any discrepancies in a more timely manner.
The company also said that insufficient manpower and expertise in the Finance and Accounting department had contributed to the errors, and that manpower has now been increased.
Catalist rule 719 requires an issuer to have adequate and effective systems of internal controls (including financial, operational, compliance and information technology controls) and risk management systems. Section 199(2A) of the Companies Act requires “every public company and every subsidiary company of a public company to devise and maintain a system of internal accounting controls sufficient to provide a reasonable assurance that —
| (a) | assets are safeguarded against loss from unauthorised use or disposition; and |
| (b) | transactions are properly authorised and that they are recorded as necessary to permit the preparation of true and fair financial statements and to maintain accountability of assets.” |
Inventory errors
Let us look more closely at the circumstances surrounding the errors and the company’s explanations. First, it is quite surprising that for a company which calls itself a “data analytics driven e-commerce retailer and distributor with presence on multiple online marketplaces in different jurisdictions” and which repeatedly touts its data analytics capabilities in its offer document, to be using Excel to reconcile its inventory on a monthly basis with unit costs manually keyed in. This was apparently the case until as late as about one year after its listing, and possibly later.
While the offer document disclosed that a substantial portion of its purchases under third party brands in the books publishing product category is from one supplier, there were 5,500 SKUs (stock keeping units, which are product identification codes to track individual inventory items) and 12,000 listings of active merchandises. Further, the company’s inventories had increased from US$1.14 million to US$6.06 million between FY2014 and FY2017, with inventories accounting for between 20% to 62% of total assets. It is surprising that there was no proper inventory management system (IMS) in place at the time of listing.
External and internal auditors
The company said that the company’s external auditors, Baker Tilly LLP, “have confirmed that they are not aware of any material misstatements relating to the prior periods that will require them to modify or withdraw their audit opinions for the financial years ended 31 December 2014, 2015, 2016 and 2017”. Did the external auditors do additional work in order to provide this confirmation in light of the errors that have now being discovered by management? In its disclosures and responses to queries on how the errors were discovered and what transpired after that, there was no mention about the external auditors being asked to review the past audited financial statements – the actions described by the company were focused on the results for the half-year ended 30 June 2018.
Should the weak internal controls, particularly in inventory management, have been highlighted as a key audit matter by the external auditors, especially as inventories represented 62% of total assets as at 31 December 2017?
Y Ventures also said that in preparing for the company’s IPO, “PricewaterhouseCoopers Risk Services Pte Ltd (“PWC”) was engaged to perform an internal controls review….which included the review of the inventory management of the Company”. After listing, Crowe Howarth First Trust Risk Advisory Pte Ltd (“Crowe Howarth”) was appointed as its internal auditors. However, the scope of the two rounds of internal audits up to the financial year ended 31 December 2018 following the listing excluded the inventory management processes because “all the recommendations of PWC at that time had been adequately addressed and implemented which included the inventory management processes”.
It is not clear from the company’s response what concerns, if any, did PWC in fact raise about the inventory management system. Further, if PWC’s internal controls review was a comprehensive one, it ought to have also covered those areas such as bank and cash management and sales, receivables and collections that were later covered by Crowe Howarth’s internal audits for the periods up to 31 December 2018. Therefore, the company’s explanation still does not provide sufficient clarity as to why the inventory management processes were not included within the scope of the two rounds of internal audit of Crowe Howarth.
According to the company, the internal audit for the year ended 31 December 2018 covered only two areas: human resource management and payroll, and follow-up review on prior year’s findings. If a risk-based approach to developing the internal audit plan had been used, one would have expected the inventory management process to be identified as high risk, given the importance of inventories, the previous Excel-based system and the changeover to the new IMS.
Given that the company disclosed that the internal audits by Crowe Howarth after listing included follow-up reviews of prior year’s findings, did these follow-up reviews include reviews of the recommendations of PWC and follow-up action, and provide the basis for the company’s view that all the PWC recommendations had been adequately addressed and implemented?
Audit committee
The company also said that the “Audit Committee was of the view that the internal controls were adequate and sufficient for the Company, including the inventory management processes, taking into account the volume of transactions at that time”. It added that “the Management and the Audit Committee was expecting a stable growth in the transaction volume and business operations of the Company in line with prior years, and were thus of the view that the internal controls continued to remain adequate and sufficient for the Company”.
On page 113 of the offer document, the company said that for FY2017, its directors have observed that “revenue is expected to increase due to the expansion of its product range, product mix and addition of new third party brands to our existing portfolio of third party brands, as well as the expansion of geographical market and online platform coverage for the sale of existing products on online marketplaces.” Further, under “investment merits” in the offer document, it highlighted its “track record of increasing sales with revenue almost doubling in two years, to US$12.1 million in FY2016”. Wasn’t the company expecting and conveying increasing growth through these statements and shouldn’t this have raised concerns about the inventory management processes?
Sales and inventories have been increasing year-on-year since FY2014, with inventories increasing sharply by 130% between FY2016 and FY2017.
Dividend policy
There are other concerns with certain statements by the company. Under “investment merits” in the offer document, it said that “For FY2017 and FY2018, [it] intends to declare an annual dividend of not less than 20.0% of our net profits after tax attributable to our shareholders for the respective financial year”. The company reported profits attributable to shareholders of the company of US$0.29 million, US$1.67 million and US$1.53 million in FY2014, FY2015 and FY2016 respectively before its listing, and then reported a loss of US$0.79 million in FY2017 after listing.
Was there a reasonable expectation that there would be profits for FY2017 since it had warned in the offer document that its financial results for FY2017 would be weighed down by ongoing compliance costs as a publicly-listed company, as well as the listing expenses for the placement in conjunction with its listing which was estimated to be S$1.68 million in the offer document? If there was not, it could arguably give the wrong impression to investors when the company said that it intended to declare an annual dividend of 20% of profits.
Since the company made a loss in FY2017, no dividend was in fact paid. In the FY2017 annual report, the company changed its tune about the dividend policy as it now said: “The company does not have a fixed dividend policy. The issue of payment of dividends is deliberated by the Board annually, having regards to various factors (e.g., Company’s profit, cash flow, capital requirements for investment and growth, general business conditions and other factors as the Board deems appropriate)”. So, was the “dividend policy” expressed in the offer document inaccurate, or an administrative inadvertence?
Independent directors’ access to information
The 2012 Code of Corporate Governance (which the company used as the basis for its reporting on corporate governance in its FY2017 annual report) recommends that “Management should provide all members of the Board with management accounts and such explanation and information on a monthly basis”. Y Ventures said that its management provides the executive directors with management accounts on a monthly basis but the independent directors are updated on a half-yearly basis. It did not explain why independent directors are given information less frequently than the executive directors. Did the independent directors ask for monthly management accounts but were not given, or did they not see a need to be updated on a timely basis? Would this hinder their ability to keep abreast of what is happening on a timely basis and discharging their duties?
Delay in disclosure
In its first response to SGX’s queries, the company said: “Following the consolidation review by the Management of group financials for the year up to 30 September 2018 being performed, the Management detected certain accounting inadvertences in the accounting records for the nine months period ended 30 September 2018, when the preliminary set of financial figures were ready in late October 2018. The Company’s Executive Directors conducted further checks and reviews with the assistance of the new CFO, and subsequently discovered the accounting inadvertences around mid-November 2018. At the stage, there was still additional work required to be conducted in order to verify the financial figures against the source records and to assess the impact of the administrative inadvertences.”
In the second response to SGX’s queries, the company said that the audit committee and the sponsor were made aware of the “administrative inadvertences” around mid-November 2018.
Therefore, the errors were first detected in late October 2018, and then reported to the audit committee and sponsor in mid-November 2018. Management, the audit committee and the sponsor then apparently decided that it was not necessary to immediately inform the market. The fact that there were errors in the accounts and the extent of the errors were only made known to the market after the close of trading on 21 January 2019.
Catalist Rule 703 requires the immediate announcement of material information which is necessary to avoid the establishment of a false market in the issuer’s securities or would be likely to materially affect the price or value of its securities. Section 203 of the Securities and Futures Act (SFA) states that “a person…must not intentionally, recklessly or negligently fail to notify the approved exchange of such information as is required to be disclosed by the approved exchange under the listing rules”.
Some thought should be spared for those investors who bought shares of the company during this period, when they were trading as high as 30 cents. The day after the errors were announced, the shares closed at 18.7 cents and continued to tumble to 8.1 cents by 1 February 2018.
On 1 November and 2 November 2018, Prism Investment Ventures Limited, a pre-listing investor whose moratorium ended in July 2018, sold two blocks of shares at 28 cents and 22 cents per share respectively, reducing its total stake from 11.11% to 4.03%. The share price had closed at 30 cents on 31 October 2018. Investors may be concerned as to whether this substantial shareholder was aware of the undisclosed material information when it sold the shares. Regulators need to investigate to ensure that this was not the case.
Change in CFO
The circumstances surrounding the resignation of the former chief financial officer (CFO) “to pursue other career opportunities”, which was announced by the company on 31 August, may also warrant scrutiny. Assuming that the company had announced as soon he gave notice of his resignation (which is required by the listing rules), the fact that he left the next day without serving any notice period may raise questions as to whether it was related to the errors in the accounts – especially since it was only 17 days after the incorrect results announcement. This is notwithstanding the fact that the continuing sponsor, RHT Capital, had stated that, based on its enquiries, there are no other material reasons for his resignation other than as disclosed in the announcement. Did the sponsor do an exit interview with the CFO? Key officers such as CFOs often have notice periods of three months or more in their employment contracts.
The company said that it has now increased the manpower in its Finance and Accounting Department from four to six staff, with a new 36 year-old CFO appointed the same day the former CFO left. Based on information disclosed at the time of his appointment and available online, the new CFO had joined the company as Head of Investment and Strategy four months prior to his CFO appointment, has a degree in business specialising in finance, and with prior working experience in business development and investment roles. Given the accounting and internal control issues in the company, and the small size of the Finance and Accounting Department, there may be questions as to whether he would be able to provide the leadership and expertise necessary to handle the accounting and internal control issues faced by the company.
More timely action needed
The company has said that it will appoint an independent reviewer in consultation with SGX Regco to review the internal controls of the Group and assess the impact of the adjustments on prior period financial statements. The reviewer is to report to the audit committee, sponsor and SGX Regco.
My view is that trading in the stock should have been suspended immediately once the material errors were discovered and a thorough special audit ordered then by SGX Regco. While queries can be useful to elicit additional explanations from issuers, in this case, there has been a serious misstatement of prior results, which was only disclosed more than five months after the results were released and about three months after the existence of errors apparently became known to management.
The internal control weaknesses appear to be systems and process-related, which in turn increase the risks of human errors and fraud.
There must therefore be doubt about the accuracy of the previous unaudited and audited financial statements of the company, including those prior to listing, notwithstanding the confirmations received from the external auditors and others.
Given the circumstances, I also believe the special auditor should only report to SGX Regco to ensure absolute objectivity in its findings.
The relevant regulators must then follow up timely with any necessary action for breaches in the listing rules, Securities and Futures Act and even Companies Act.
