Abdullah Badawi should also focus on private sector corruption

by Anil Netto

What do the external auditors of Perwaja Steel have to say for themselves?

In his much-hyped war on graft, Abdullah should not ignore corruption in the private sector. Many people tend to think that private sector corruption does not hurt national interests but this is not true.

As the Enron case in the United States revealed, corruption undermines outside investors’ confidence in the national economy, hurts genuine retail shareholders and undermines confidence in corporate governance and external auditors. The effect of a big firm going down due to fraud can be devastating to the national economy as well. Private sector corruption also eats up corporate profits and may reduce public revenue from taxes.

"Creative accounting"

Unscrupulous accountants use all kinds of tricks to manipulate profit figures. These include making subjective and arbitary provisions for obsolescence of stock and provisions for doubtful debts.

Devious accountants can also manipulate financial results by bringing forward or deferring the recording of expenses in the accounts. Thus, a firm’s management is able to show a higher or a lower profit figure to suit its circumstances. It may want to show a lower profit figure - to save taxes or to provide a cushion for future years. Or it may want to disclose a higher profit figure for the year - to match overly optimistic profit forecasts that were issued earlier to entice investors to buy shares in the firm. This kind of unethical accounting practice is often cynically referred to as “creative accounting” or window-dressing.

Within companies, corruption most often occurs in the purchasing, equipment procurement, personnel, and store departments. Executives are often tempted with kickbacks in the purchase of goods, equipment or services at inflated prices. Quite often, a company’s system of internal control (checks and balances) can be subverted or over-ridden when staff from different departments conspire to commit fraud. For example, if staff in the accounting department and the store work together to approve payment for goods that were never received, they can get away with major fraud.

You may have all the best measures to prevent corruption and unethical practices, but the crucial question is: will the authorities act against a top-ranking Cabinet member, well-connected firm or prominent tycoon suspected of fraud or corruption?

Marketing department personnel and traders can also manipulate financial results by issuing dummy contracts or by hiding losses in “suspense accounts”. This was illustrated in the case of the spectacular collapse of Barings Bank - thanks to the activities of a rogue trader who had too much power and too little supervision.

In some cases, the directors of listed companies allow their private business interests to get mixed up with the public firms they are involved in, thus hurting minority shareholders’ interests. For instance, a director of a publicly listed steel firm may also be involved in a private property development firm. If the property development firm finds it difficult to sell its expensive condominiums, the director might be tempted to sell the condominiums to the subsidiaries of the publicly listed steel firm – in which case the shareholders of the public firm suffer. The condominiums tie up the financial resources of the listed steel firm and its subsidiaries, which don’t really need those condominiums.

All these unethical practices reduce profits and ultimately hurt shareholders’ interests.

Hot tips

Another area of concern is insider trading of shares where those in positions of trust make use of inside information of a company’s potential to profit from share trading, as the Enron case revealed. In the end, it is the minority shareholders who suffer.

Directors of listed firms can also mislead their staff, the media, and the public into buying their firm’s shares by providing “hot tips” while they (the directors) themselves are selling the shares. By the time the staff and the public find out that the “hot tips” were not so hot after all, it would be too late and they would be left holding the “baby” (shares that have dramatically fallen in value)..

To protect minority shareholders, there is a need to review and reform the Securities Commission to ensure it is totally independent.

Some firms hire people who are well-connected to the ruling politicians solely to “open doors” in the government bureaucracy and to make it easier to secure licences and contracts. Why should this be the case if our civil service is honest and professional? Again, any war on corruption must extend to these areas.

Watching the watchdogs

When discussing corporate corruption, we need to take a long hard look at the auditing profession and the role played by auditors. In Malaysia, we have had so many banking and financial scandals involving billions of ringgit, but can anyone remember the last time where an audit firm exposed major corruption and fraud or when an audit firm was charged with negligence for not exposing major fraud?

True, external auditors are only supposed to be watchdogs (to certify that a firm’s accounts reflect a “true and fair” view of its performance) and not bloodhounds (out to detect all corrupt practices). Nonetheless, they should be able to detect obvious and major fraud staring in their face.

Auditors are supposed to be independent and professional. Far too often though, the partners of audit firms develop a cosy relationship with their clients. Auditors rely for their income on audit and consultancy fees paid by their clients. In these circumstances, how independent can auditors be if one of their major clients decides to “massage” the figures and indulge in “creative accounting”? Will auditors be willing to act as whistleblowers if prominent politicians are involved in dubious corporate practices?

Enron exposed how even so respected a firm of auditors as Anderson could work hand-in-glove with their clients in destroying evidence. On the local front, what do the external auditors of Perwaja Steel, for instance, have to say for themselves for not signalling that something was seriously wrong with the firm?

In this regard, it is heartening to note that whistleblowers will be protected if a proposal to review the Companies Act 1965 goes through. Domestic Trade and Consumer Affairs Minister Muhyiddin Yassin said recently the Companies Commission had submitted a series of proposals on amending the Act aimed at improving corporate governance. But it is not enough for whistleblowers only in the private sector to be protected. What is needed is a comprehensive Whistleblowers Act to provide wide-ranging protection for whistleblowers in all sectors - whether in political parties, NGOs, the private sector or the government.

You may have all the best measures to prevent corruption and unethical practices, but the crucial question is: will the authorities act against a top-ranking Cabinet member, well-connected firm or prominent tycoon suspected of fraud or corruption? Or will the usual foot-dragging take place?

Now e-mail us and tell us what you think. Your comments might be published in the Letters section of our print magazine, Aliran Monthly.

Alternatively, post your comments to the message board.