This subject is highly relevant right now as a potential fraud has emerged at mobile phone software provider Globo (GBO: 28p) and one that the Serious Fraud Office (SFO) and City of London Police have to investigate. Not only that, but there has been an apparent case of market abuse by Globo's chief executive, Costis Papadimitrakopoulos, and breaches of the London Stock Exchange rules governing companies listed on the Alternative Investment Market. This prompted me to contact the Financial Conduct Authority (FCA) which governs insider trading and market abuse on the London Stock Market. Subsequent to those discussions on Monday this week the company is now under investigation by the FCA.
Globo's business unravels
Prior to trading on Friday, 23 October, Globo issued a statement to the London Stock Exchange requesting that its shares be suspended following the release the previous evening of a scathing research report by New York-based hedge fund Quintessential Capital Management (QCM), which raised serious doubts about some of its trading activities. For balance of reporting, I would point out that QCM has a short position in the shares.
In the report, QCM alleges that Globo massively overstates its "revenue and profit by generating fictitious sales invoices from shell companies created and controlled by Globo that pose as legitimate clients of the company. In order to justify the resulting cash shortfall, other shell companies pose as suppliers to Globo and generate fictitious expenses, part of which are then capitalised."
The authors of the report also claim that the most important part of the scheme involves "20 suspected empty shell companies, located in eight different countries (including Cyprus, Panama and Greece), which Globo uses to generate fictitious sales and costs in order to inflate revenue and profitability. The resulting fictitious financials are then mixed up with legitimate ones to give the impression of a larger and rapidly growing company."
QCM acknowledges that clearly "customer balances can't stay overdue indefinitely without arising the auditor's suspicions," and alleges that Globo circumvents this by getting the satellite companies "to pose as suppliers, in effect invoicing Globo for a certain amount to offset part of the receivables." QCM even believes that "the same shell company may act as both customer and supplier, or in some cases two separate shell companies trade with each other to offset the transactions without services or cash changing hands."
QCM alleges that all bar €38m of Globo's reported annual revenues of €106m in 2014 were fictitious. If that's the case then the pre-tax profit figure of €35.7m signed off by the company's auditors would be fiction too.
QCM also claims that: "According to the evidence we analysed, the alleged scheme was probably engineered in 2007 or earlier."
Emergency board meeting
Clearly, the board of Globo had to meet to discuss the QCM report. However, I have found out that both Mr Papadimitrakopoulos and finance director Dimitris Gryparis decided to request the suspension of the shares last Friday without showing the statement (to be released to the London Stock Exchange) to any other members of the board. The other four directors were unaware of the QCM report and only became aware of the share suspension later that morning.
At the subsequent emergency board meeting on Saturday, 24 October, attended by all six directors, Mr Papadimitrakopoulos dropped his first bombshell by revealing that he was aware of "certain matters regarding the falsification of data and the misrepresentation of the company's financial situation". He offered his resignation, as did chief finance officer Dimitris Gryparis. A committee of the board was set up, consisting of the three independent non-executive directors. The resignations of Mr Papadimitrakopoulos and Mr Gryparis were accepted with immediate effect and chief operating officer Gerasimos Bonanos was suspended from his duties, pending the outcome of appropriate investigations.
Although we will have to wait for forensic accountants to produce a report to determine the precise nature of the falsification of data and the misrepresentation of the company's financial situation, I understand from a contact close to the company that the falsification activity has been going on not for weeks, nor months, but for years. This timing issue is critical for when the SFO, CFA and City of London Police investigate, as I explain below.
Securities dealings
Following the emergency board meeting, Mr Papadimitrakopoulos dropped another bombshell on Sunday 25 October by disclosing to the board that he had previously sold 42m of his 69.78m shares and pledged 10m shares under a personal loan agreement with stock lending specialist Lantau Holdings. That loan subsequently defaulted on Monday, 26 October 2015 after the shares had been suspended for two consecutive days. However, none of these share transactions had been notified to the London Stock Exchange, so breaching Aim listing rules. The 42m shares sold represented 11.25 per cent of Globo's issued share capital. The board has requested additional details about these share dealings, but has yet to receive this information.
The important point being, and as I outlined to the FCA when I requested they investigate this matter on Monday, if he was dumping stock without issuing a London Stock Exchange notice while at the same time being aware of "falsification of data and misrepresentation of the company's financial situation", Mr Papadimitrakopoulos was selling while also withholding price-sensitive information to the market. The FCA was not aware of this, or at least didn't appear to be, and is now looking into the matter.
The other point I would make is that prior to the suspension of Globo's shares on Friday, 23 October, the company announced two days earlier that it had pulled a $120m fundraising for the issue of a high-yield bond. If any of Mr Papadimitrakopoulos' undisclosed share sales took place during the marketing of the bond to investors then the FCA would need to look into this too.
Bond issue and role of auditors
The pulled bond issue is worth flagging up for another reason because I understand from a contact close to the company that the only individuals involved in the marketing to potential bond investors were Mr Papadimitrakopoulos, who has admitted he was aware of the falsification of data and misrepresentation of the company's financial situation, and Mr Gryparis. The fact that the bond issue failed saved bond investors from the losses shareholders are now facing. It may have saved rating agencies Standard & Poor's and Moody's blushes as they gave the company credit ratings of BB- and B2, respectively, but they would also have been provided with misleading financial information on which they made their assessment of Globo's creditworthiness.
In turn that raises another issue with regards to the role of Globo's auditors in the unfolding scandal. That's because, in early January last year, the board of Globo informed the company's auditors, BDO, that they were being replaced by Grant Thornton. In a letter to shareholders in March 2014 the board stated that this decision was made on the basis of "the firm's international reputation, its competitive fee quote and the efficiency of having its London team project-manage Globo's audit where Grant Thornton already audits the group's Greek subsidiaries".
However, in BDO's resignation letter dated 3 February 2014, and in a statement made under Section 519 Companies Act 2014, the accountancy firm detailed the following circumstances connected with ceasing to hold office as auditors of Globo plc, which it considered should be brought to the attention of members and/or creditors of the company. Namely, that "the directors asked us to resign as group auditors following our inability to agree a mutually acceptable audit scope in relation to our involvement in the work of component auditors, needed to obtain sufficient appropriate audit evidence on which to base the audit opinion on the group financial statements".
It’s worth noting that BDO never in fact offered an audit opinion on Globo as the 2012 accounts were signed off by Littlejohn LLP who audited all of Globo's annual accounts between 2007 and 2012. QCM claims in its research report that BDO demanded as part of its activity to audit not only Globo plc accounts, but also those of its foreign subsidiaries. If this was the real reason for changing auditor in March 2014, it would certainly support QCM’s claims of the use of bogus transactions being carried out by Globo’s foreign subsidiaries. Grant Thornton subsequently audited the fiscal 2013 accounts and signed off the 2014 annual report earlier this year.
Clearly, it’s down to the appropriate authorities to ascertain why the audit work and due diligence carried out by the auditors failed to uncover the falsification of data and the misrepresentation of the company's financial situation, which in turn enabled the company to access bank funding. Indeed, it was also a stipulation of Globo’s banking arrangement with Barclays that a recognised firm of auditors of international standing be appointed.
At the last balance sheet date the company's auditors stated Globo had €104m of cash on its balance sheet and outstanding bank debt of €57m. That implies net funds of €47.4m, a sum worth 9p a share, all of which was meant to be held in investment-grade banks in the UK, US and Switzerland. The financial institutions supposedly holding Globo's cash need to be looked at by the forensic accountants as a matter of urgency.
Seeking shareholders redress
Since the scandal broke, Globo’s independent committee of the board and its lawyers have reported this matter to the appropriate law enforcement agencies in the UK, Greece and Cyprus and are in the process of appointing advisers to ascertain the true financial position of the company.
However, with the chief executive confirming to the board that he was aware of certain matters regarding the falsification of data and the misrepresentation of the company's financial position, then the UK authorities - SFO, FCA, The Financial Reporting Council and The City of London Police - simply have to throw the book at the perpetrators. The reputation of the London Stock Exchange and joint house broker Canaccord Genuity, who resigned with immediate effect on Monday this week, have been tarnished too. And some high-profile fund managers will have taken a hit on their holdings: funds run by Standard Life Investments own more than 4 per cent of the shares, and Forum European Small Caps and Forum Venture Capital recently increased their stakes to 5.02 per cent and 6.29 per cent, respectively.
However, the fact that City firms, financial institutions and myself included, have been duped is scant consolation for those readers facing losses on their holdings. It's time for the regulators and authorities to act, and I am determined that they will.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies in the past two weeks:
■ Gresham House: Buy at 320p, target 450p ('A mandate for strong growth', 12 October 2015)
■ Tristel: Run profits at 123p, new target 130p to 135p ('Cleaning up', 13 October 2015)
■ AB Dynamics: Run profits at 267p ('Under-promising, over delivering', 13 October 2015)
■ Trakm8: Run profits at 245p ('Motoring ahead', 13 October 2015)
■ PROACTIS: Buy at 102p, new target 130p ('Secured growth for re-rating', 13 October 2015)
■ Avation: Buy at 148p, target 200p ('Flying higher', 14 October 2015)
■ Cohort: Run profits at 400p ('Cohort on a roll', 14 October 2015)
■ Vertu Motors: Buy at 68p, target 80p to 85p ('The virtue of Vertu', 15 October 2015)
■ Urban&Civic: Buy at 274p, target 325p ('Plotting a breakout', 15 October 2015)
■ MS International: Buy at 180p, initial target price 240p ('Making waves', 19 October 2015)
■ Pure Wafer: Buy at 175p, new target 200p ('Valuation anomaly worth exploiting', 20 October 2015)
■ Greenko: Hold at 87p, new target 100p ('Greenko's cash return', 20 October 2015)
■ Elegant Hotels: Buy at 108p, target range 130p to 135p ('An elegant investment', 20 October 2015)
■ BP Marsh & Partners: Buy at 157p, target 180p ('Cash-rich value play', 21 October 2015)
■ Crystal Amber: Buy at 170p; Dart Group: three month trading buy at 468p; Grainger: three month trading buy at 247p; Leaf Clean Energy: await news on Invenergy asset sale ('A quadruple play', 22 October 2015)
■ UTV Media: Buy at 184.5p, target 215p ('On the right wavelength', 26 October 2015)
■ Globo: shares suspended at 28p ('Globo bombshells', 26 October 2015)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
