CIFL-When the chicken flew the coop

The Business Times today publishes two interesting reports - both dealing with the role of directors, their behaviour, ethics, values and good governance. The first is an audit carried by the Central Bank in 2011 of the crisis-hit CIFL finance company while the second is a voluntary code of ethics and best practices for corporates and their board of directors presented by CA Sri Lanka and the Securities and Exchange Commission (SEC). This report is now available on the website of the Colombo Stock Exchange and is a document for public consumption.

The voluntary code is a classic case of ‘Physician heal thyself” for, the current drivers of the code themselves are not entirely free of accusations of unethical activities. For example, SEC Chief Nalaka Godahewa is under a cloud of suspicion over allegedly, irregular dealings in the Krrish development project while CA Sri Lanka former President Asite Talwatte, Co-Chairman of the institute’s Corporate Governance Committee, also had his share of problems many years ago.

Reverting back to the CIFL crisis, the Central Bank audit report is a case study of how not to run a finance company or for that matter, how a corrupt management ran a finance company raking in millions of rupees from hapless depositors.

Central Bank rules were blatantly broken so much so that at one point the regulator says the company was operating like a dreaded ‘PONZI’ scheme. Ponzi is a scam promising high returns to investors.

For the record here are some of the significant points in the CIFL audit: A major part of the reported income comprised unearned income, which actually should have been eliminated when accounting for profits. Therefore at present CIFL’s performance is exaggerated by accruing unearned income from joint venture projects carried out in collaboration with ASPIC Homes. The Board of Directors of a RFC is responsible for ensuring the strength, safety and soundness of the company. Our overall conclusion is that the Board of CIFL has failed in achieving this objective. CIFL major shareholder Deepthi Perera played a dominant role in the decisions made of the Board Meetings held in 2009. His excessive-influence is viewed as hindering the independence of the Board, which curtails progressive decision-making towards the well-being of all stake holders. Though his presence is not visible at subsequent Board Meetings, we feel that his dominance is still present in most of the major decisions made by the company, especially as he’s the Aspic Group Chairman, and the extent of fraudulent related party transactions done by CIFL and fraudulent accounting entries passed by CIFL in relation to parties related to the Aspic Group. The Chairman has exceeded the maximum number of eligible years that a director can be in service, by serving as a Director on the Board for the past 33 years. Excess recruitment of marketing staff merely for the purpose of increasing the deposit base. The marketing staff amounted to 160 members, which exceed 50 per cent of the total staff that is viewed as a superfluous expenditure. Also the lack of training received, lack of integrity and dire need to achieve deposits targets has lead to uncontrollable and unethical behaviour by staff, which includes customer deception. The overall risk exposure of CIFL was considered very high, given the inadequacy of resources to mitigate the risks. Currently with no earnings from 61.4 per cent assets concentrated in real estate, CIFL is dependent on new deposits to meet expenses and repayments, thus operating as a ponzi scheme. CIFL, part of the Aspic Group, continues unethical, fraudulent business practices specifically with respect to real estate transactions similar to those found in the other group companies such as Industrial Finance Ltd (IFL), a distressed RFC. This is only the tip of the iceberg in the way business was conducted at the CIFL, a company that is now before courts in a dispute over the terms of the repayment plan.

While the Central Bank’s audit report is very revealing and has tackled the core of the crisis – mismanagement and abuse of power -, it also made a set of recommendations to resurrect the company which included immediate action to infuse new capital or find a strategic investor to meet core capital requirements.

Thus two years ago the regulator was aware of the evolving crisis at CIFL but various attempts to bring in new investments failed as the new investors themselves were not ‘above board’. The last-named, the Maloney’s of Touchwood fame, promised to infuse foreign capital but that too didn’t work and desperate depositors then sought solace in the judiciary to right the wrongs of the directors. The Maloney’s have also run away from Touchwood which is facing its own crisis.

This brings us back to the CA Sri LankaSEC Corporate Governance Code which in the backdrop of the happenings in many companies, listed or otherwise, is unlikely to make any impact in the shift towards a more morally and ethically responsible corporate culture.

Voluntary codes are fine as long as professionals ensure their implementation. Unfortunately, in many cases, these codes are just mouthed at conferences or seminars dealing with good governance. Hardly put into practice or practice by the book!