Case Study: COMCO Communications
In the 2013 results presentation to analysts, the chief executive of COMCO, a global internet communications company, announced an excellent set of results to the waiting audience. Chief executive CliveThomas announced that, compared to 2012, sales had increased by 50%, profits by 100% and total assets by 80%. The dividend was to be doubled from the previous year. He also announced that based on their outstanding performance, the executive directors would be paid large bonuses in line with their contracts. His own bonus as chief executive would be $20 million. When one of the analysts asked if the bonus was excessive, Mr Thomas reminded the audience that the share price had risen 45% over the course of the year because of his efforts in skilfully guiding the company. He said that he expected the share price to rise further on the results announcement, which it duly did. Because the results exceeded market expectation, the share price rose another 25% to $52.
Three months later, Clive Thomas called a press conference to announce a restatement of the 2013 results. This was necessary, he said, because of some ‘regrettable accounting errors'. This followed a meeting between COMCO and the legal authorities who were investigating a possible fraud at COMCO. He disclosed that in fact the figures for 2013 were increases of 10% for sales, 20% for profits and 15% for total assets which were all significantly below market expectations. The proposed dividend would now only be a modest 10% more than last year. He said that he expected a market reaction to the restatement but hoped that it would only be a short-term effect.
The first questioner from the audience asked why the auditors had not spotted and corrected the fundamental accounting errors and the second questioner asked whether such a disparity between initial and restated results was due to fraud rather than ‘accounting errors'. When a journalist asked Clive Thomas if he intended to pay back the $20 million bonus that had been based on the previous results, Mr Thomas said he did not. The share price fell dramatically upon the restatement announcement and, because COMCO was such a large company, it made headlines in the business pages in many countries.
Later that month, the company announced that following an internal investigation, there would be further restatements, all dramatically downwards, for the years 2011 and 2012. This caused another mass selling of COMCO shares resultingin a final share value the following day of $1. This represented a loss of shareholder value of $12 billion from the peak share price. Clive Thomas resigned and the government regulator for business ordered an investigation into what had happened at COMCO.
The shares were suspended by the stock exchange. A month later, having failed to gain protectionfrom its creditors in the courts, COMCO was declared bankrupt. Nothing was paid out to shareholders whilst suppliersreceived a fraction of the amounts due to them. Some non-current assets were acquired by competitors but all of COMCO's 54,000 employees lost their jobs, mostly with little or no termination payment. Because the COMCO employees' pension fund was not protected from creditors, the value of that was also severely reduced to pay debts which meant that employees with many years of service would have a greatly reduced pension to rely on in old age.
The government investigation found that COMCO had been maintaining false accounting records for several years. This was done by developing an overly-complicated company structure that contained a network of international branches and a business model that was difficult to understand. Whereas COMCO had begun as a simple telecommunications company, Clive Thomas had increased the complexity of the company so that he could ‘hide' losses and mis-report profits.
In the company's reporting, he also substantially overestimated the value of future customer supply contracts. The investigation also found a number of significant internal control deficiencies including no effective management oversight of the external reporting process and a disregard of the relevant accounting standards.
In addition to Mr Thomas, several other directors were complicit in the activities although Sarah Lo, a senior qualified accountant working for the financial director, had been unhappy about the situation for some time. She had approached the finance director with her concerns but having failed to get the answers she felt she needed, had threatened to tell the press that future customer supply contract values had been intentionally and materially overstated (the change in fair value would have had a profit impact). When her threat came to the attention of the board, she was intimidated in the hope that she would keep quiet. She finally accepted a large personal bonus in exchange for her silence in late2012.
The investigation later found that Sarah Lo had been continually instructed, against her judgement, to report figures she knew to be grossly optimistic. When she was offered the large personal bonus in exchange for her silence, she accepted it because she needed the money to meet several expenses related to her mother who was suffering a long-term illness and for whom no private health care was available. The money was used to pay for a lifesaving operation for her mother and also to rehouse her in a healthier environment. Sarah Lo made no personal financial gain from the bonus at all (the money was all used to help her mother) but her behaviour was widely reported and criticised in the press after the collapse of the company.
The investigation found that the auditor, RBC partnership (one of the largest in the country), had had its independence compromised by a large audit fee but also through receiving consultancy income from COMCO worth several times the audit fee. Because COMCO was such an important client for RBC, it had many resources and jobs entirely committed to the COMCO account. RBC had, it was found, knowingly signed off inaccurate accounts in order to protect the management of COMCO and their own senior partners engaged with the COMCO account. After the investigation, RBC's other clients gradually changed auditor, not wanting to be seen to have any connection with RBC. Accordingly,RBC's audit business has since closed down. This caused significant disturbance and upheaval in the audit industry.
Because COMCO was regarded for many years as a high performing company in a growing market, many institutional investors had increased the number of COMCO shares in their investment portfolios. When the share price lost its value, it meant that the overall value of their funds was reduced and some individual shareholders demanded to know why the institutional investors had not intervened sooner to either find out what was really going on in COMCO or to divest COMCOshares. Some were especially angry that even after the first restatement was announced, the institutional investors did not make any attempt to intervene. One small investor said he wanted to see more ‘shareholder activism', especially among the large institutional investors.
Sometime later, Mr Thomas argued that one of the reasons for the development of the complex COMCO business model was that it was thought to be necessary to manage the many risks that COMCO faced in its complex and turbulent business environment. He said that a multiplicity of overseas offices was necessary to address exchange rate risks, a belief challenged by some observers who said it was just to enable the COMCO board to make their internal controls and risk management less transparent.
Recently the COMCO case has come to the attention of Robert Johnson, a member of parliamentfor the district where COMCO had its head office.
Mr Johnson was furious at the COMCO situation because many of his constituents had been badly financially affected by it.
He believes that something needs to be done to ensure that a similar situation could not happen again.
Mr Johnsonhas been invited to be partof a Parliamentary select committeeset up to investigate the COMCO failure.
In preparation for joining the committee Mr Johnson wants answers to questions such as:
- How did the COMCO failure happen when the company was externally audited?
- How did the COMCO failure happen when the company appeared to comply with regulatory reporting requirements?
- Why did the large institutional investors not intervene sooner?
- How could the collapse have been prevented?
References : 2
Number of Words : 750 Words/ 3 Pages