The Steinhoff audit stumbles, again

The latest Steinhoff International Holdings NV (Steinhoff) Sens announcement refers to the PwC forensic report as being a “critical milestone” in finalising the group’s financial statements.

How so?

This unpublished report has clearly opened up yet another rabbit warren, which has delayed the release of the group’s 2018 results to June 2019.

Mind you, the auditors are optimistic that “significant progress” has been made in “analysing, assessing and finalising the accounting treatment required for the numerous transactions”.

That is quite sad. Hopefully they are trying to follow the cash flows as well, and getting to the economic substance of the transactions. This could paint a different picture.

Deals can be technically correct but create a false impression. Being stuck in robotic accounting mode and being concerned only with ticking the IFRS boxes may prevent the auditors from seeing the wood for the trees.

Auditors are usually only privy to the first leg of a transaction, between the company being audited and the counter-party. They cannot see the multitude of transactions that came after that, in a split second, zipping through various entities (partnerships, trusts, anstalts, hybrids, among others) incorporated or resident (and even this has different repercussions) in various jurisdictions across the world.

The Sens comment confirms this view: “The track and trace process required to ensure that all appropriate adjustments and journals are audited at each subsidiary and sub-consolidation level, however, is proving to be far more complex and time consuming than expected.”

Does this mean that there is no investigation beyond this first level, and that the auditors will not get a holistic picture of all the transactions? Are the Hawks up to it? Will the investors ever get the true picture?

The proliferation of offshore financial centres and tax havens has created a dense, complex jungle for the uninitiated to wade through. During the apartheid era, South Africans (companies, lawyers and accountants) became world experts in making origin and ownership. This makes for a potent combination.

An investigation like this requires international tax experts as well but, as mentioned above, the auditors are unlikely to go this far. The tax status will impact the balance sheet, even if only the finalised deferred tax asset on the likely group accumulated loss.

Steinhoff does have its own internal international tax experts, surely they knew what was going on? These experts should have an in-depth understanding of how a partnership structure can magically take a debt off-balance sheet, even better, transmogrify the so-called debt into sales revenue.

And why am I speaking of tax structuring and financial structuring in the same breath? Because they very often go hand in hand.

Tax authorities can obtain information that no one else can, if they know what to ask for. But they may not share this because taxpayer information is confidential. The tax investigation being carried out in Germany may only be a transfer pricing investigation, which may or may not be an aggressive transfer pricing scheme, but wouldn’t amount to financial fraud. One would hope that Sars has commenced an investigation.

Enron wasn’t unravelled through the brilliance of the investigators and prosecutors alone, there were many whistle blowers. Jeffrey Skilling, former chief executive of Enron, was responsible for bending the accounting rules, for example, by accounting for future profits by estimating their present value rather than historical costs, and booking income upfront that would only be earned over, say, 30 years, if at all. He was convicted with the help of whistle blowers.

Andrew Fastow, former Enron CFO and convicted fraudster, who designed the partnership structures to get Enron’s debt off balance sheet, was coerced into pleading guilty by the prosecutors who resorted to strong arm tactics.

To get to the bottom of his complex web of partnerships, the US prosecutors went for his wife. She was jailed for one year on criminal tax evasion charges. The Fastow’s had two children, and this broke Fastow. He pleaded guilty to two counts of wire and securities fraud, and was sentenced to six years in prison, which took effect after his wife was released.

Since his release from prison, Fastow gives presentations on ethics and corporate fraud. He has made some insightful observations about accounting geeks who get caught up in playing the game. And this is the lesson for everyone, to be more critical and cynical of companies that appear to be doing too well, and not let accounting geeks pull the wool over our eyes.
Are there any whistle blowers waiting in the wings?

Steinhoff’s latest estimates for publishing its audited financial statements are:

•  Group 2017 financial results – 7 May 2019,
•  Group 2018 financial results – 18 June 2019,
•  Steinhoff Investment Holdings Ltd 2017 – 28 June 2019, and
•  Steinhoff Investment Holdings 2018 – 28 June 2019

If we ever reach the end of this saga, the Steinhoff internal audit department as well as the Steinhoff tax department is going to have a lot to answer for. It is not possible to “take debt off balance sheet”, nor “create” fictitious income, without someone processing the journal entries, no matter how intricate and complex. Further, fictitious income is taxable, unless the tax department removes it from the taxable income computation. Someone should have had the balls to stand up and say this is wrong.

Brought to you by Moneyweb