Auditors, fund managers and rating agencies failed investors in Steinhoff saga
It was phenomenal, wasn’t it? A "darling" South African retailer with 12,000 stores in 30 countries employing more than 130,000 people, with a market value of more than R200bn and ranking among the 10 biggest companies in the JSE Top 100.
A retailer popular with investors, becoming the fifth most popular share for fund managers to invest in.
A Steinhoff share was considered, as one fund manager put it, a quality stock.
Then the Steinhoff facade was exposed and the company incurred the market’s wrath. Steinhoff was repeatedly battered, and in just two days, it had lost 80% of its market value. The bleeding continued and it eventually lost R194bn of its market value. Naturally, everyone wanted to know, how did it all go so horribly wrong?
It all went wrong when the Steinhoff executives including the CEO, were overpowered by the greed gene. Make no mistake, we are all born with the gene. Some have the capacity to suppress it, others simply allow the gene to take control. As you might remember, CEO Markus Jooste believed a man of his stature could not have two, five or even 10 racehorses – oh no, he must have 300!
Remember how the cheeky Jooste went to Absa and said he wanted money, which the bank foolishly gave him? They gave him (through his company, Mayfair Speculators) an overdraft facility of R335m and bank guarantees of R14m. In return, Jooste handed over his Steinhoff shares as surety. As he did so, he knew those shares were not worth much, certainly not anywhere close to the price they were trading for at the time (December 2016), which was about R70 per share.
Jooste knew this because he was well aware of the accounting shenanigans taking place at Steinhoff. He pulled the Absa stunt on Investec, ending up owing the bank R250m, and on Sanlam Capital Markets, ending up owing them R800m.
But let’s talk about the gatekeepers, the auditors, the fund managers and the credit rating agencies. They all had a role in the Steinhoff debacle. Let me start, though, by saying that none of what Steinhoff did was new, or unique. It has all been done before. Remember Worldcom and Enron? We have our own South African examples — African Bank, which collapsed in August 2014 where Deloitte were the auditors.
What Steinhoff, Worldcom and Enron did was creative accounting stuff: the improper booking of revenues, improper capitalisation of losses and expenses, and the creation of off-balance sheet structures to conceal losses, out of control debt and risk.
Creative accounting is designed to misinform. It involves manipulating accounting figures to transform financial statements from what they should be to what preparers would want to see reported. It is essentially a process of making financial statements look either somewhat or entirely different from what was intended by the accounting rules and standards.
Creative accounting has an inseparable cousin called creative compliance, which makes it possible for creative accounting to go undetected, at least for a while. Creative compliance is about accounting standards avoidance. It involves working around the accounting rules without necessarily breaking them. And this is where the auditors come in handy, as they make a company’s statements look compliant even when the spirit, if not the law, of open disclosure of accounting performance has been violated.
The Worldcom and Enron auditors were Arthur Andersen. All three are history now, but every now and again we visit their gravesites to brush up on what led to their demise.
The Steinhoff auditors were Deloitte. In December 2017, Steinhoff said a restatement of its 2017, 2016 and 2015 financial statements were needed as they could not be relied on. The company indicated that statements for the years prior to 2015 might also require restatement.
As auditors, Deloitte were expected to ensure the robustness of Steinhoff’s accounting systems and to verify the accuracy of the accounting reports.
Until 2017, Deloitte had approved Steinhoff’s annual financial statements without qualification — which means that while Deloitte had confirmed that the statements gave a true and fair view of the company’s financial performance and financial position, that was in fact not true.
As auditors, Deloitte were expected to ensure the robustness of Steinhoff’s accounting systems and to verify the accuracy of the accounting reports. Deloitte appears to have failed miserably. The firm now faces probes in several jurisdictions, including SA, involving its role in the accounting irregularities at Steinhoff. Deloitte may have opened itself up to a civil claim by Steinhoff investors.
The following, and other, fund managers invested their clients’ money in Steinhoff shares: Coronation, Allan Gray, Investec, Sanlam, Old Mutual, Discovery, Nedbank Private Wealth and the Public Investment Corporation.
Regrettably, the fund managers all appeared to display a herd mentality, neglecting their duty to conduct proper research on Steinhoff.
A breathtaking admission of neglect of duty was made by Nedbank Private Wealth in a note to its clients, when it said the fund manager drew comfort from the fact that many highly regarded individuals with strong track records served on the Steinhoff supervisory board. This has to be the clearest admission of gross negligence.
The fund managers were expected to ensure an objective analysis of Steinhoff’s financial figures by piercing any appearance the company might have put up in its numbers.
The managers were expec-ted to clinically and independently interrogate the numbers. It’s not as if the information was not there. They just needed to do their work.
Moody’s Investors Service gave Steinhoff’s debt securities a comfortable rating – Baa3 with a stable outlook. No doubt the agency’s credit metric used to determine Steinhoff’s probability of default on those securities allowed it to adopt a more robust approach, but it didn’t. We now know Steinhoff’s debt securities contained more risk than Moody’s recognised. The agency failed investors.
Corporate governance only works when boards do their work. The Steinhoff board failed this standard. Investors in other jurisdictions have explored civil claims against Steinhoff. South African investors have, for no rational reason, chosen to adopt a wait-and-see attitude, although one labour union has threatened the firm with a class action.
• Dauds is a practicing member of the Johannesburg Society of Advocates.