Auditors between the Devil and the Deep Blue Sea [Sunday Times, 14 August 2005]
Some three years ago, the Fiji Times published two of my articles: “The ATH monopoly: between the Devil and theDeepBlueSea” (FT,6 March 2002) and “The Reserve Bank, Government and FNPF: conflicts of interest” (FT,12 March 2002). A couple of months ago there was another article (“who audits the auditors?”) which drew some flack from an accounting honcho.
This month, Professor Mick White’s article “Returns from FNPF: Accounting Myth vs. Economic Reality” throws a much bigger cat amongst the pigeons in the accounting and auditing world, and in the FNPF boulevard.
The crux of the matter is the accounting treatment of the large premium (some $200 millions) which FNPF paid for its purchase of ATH shares, now treated as “goodwill” in the FNPF accounts.
Professor White argues that before 2002, the FNPF Board “chose not to follow” accepted accounting practice in relation to the profits recorded from ATH; they chose not to consolidate the accounts (which they should have); they chose not to write down the “goodwill” value of the ATH monopolies at the then required 20%. Had they done so, the ATH shares would have contributed massive losses for 2000, 2001 and 2002 to FNPF.
White argues that FNPF only followed the accounting rules when they were changed in 2002, and only because the results appeared better; and he argues that even today, the accounts are still overstating profits because the 5% write-down of the good-will is too low.
Very seriously, Professor White questions not only the “reliability of “FNPF’s financial reports” but also “the propriety of KPMG’s operations and by extension, that of the whole audit industry”.
These are serious allegations which can only be answered by the FNPF Board, FNPF’s auditors (KPMG) and the FIA.
But there are also very serious underlying issues which all FNPF stakeholders must be aware of.
In my 2002 articles (which may be found in my recently published book To Level the Playing Fields, sold at Post Fiji bookshops, or USP Book Centre) I argued that the SVT Minister of Finance in 1998 took the easy way out to pay for the NBF disaster.
Government combined its shares in the telecommunications industry into a super monopoly (ATH) which they then sold to the FNPF for an inflated price of $250 millions.
Government “encouraged” FNPF to pay the inflated price by granting continued monopoly for FINTEL, Telecom, and Vodaphone. Even though this meant that the consumers (businesses, households, students) would be denied the benefits of lower prices for telecommunications and especially Internet.
My articles pointed out that FNPF’s long term interests as the largest investor in the economy lay in reducing telecommunications charges and bringing in competition so as to encourage the economy to grow faster, so that private sector investment could absorb a larger share of FNPF investments (instead of all going into Government bonds).
But if FNPF took this progressive long term approach, in the short term its returns from its investments in ATH must fall, as would FNPF earnings. Effectively, FNPF had put itself “between the Devil and theDeepBlueSea”.
The accounting side to this
Professor White’s article primarily examines the accounting side to this conundrum, with its many grey debatable areas.
He argues that FNPF paid too large a premium for the ATH shares (how much extra can be debated); this premium or “goodwill” arose from its monopoly status (the source can be debated); accounting regulations require that this goodwill has to be “written off” over some period (the number of years can be debated); and the ATH results (with the amortisation) should have been shown in “consolidated” FNPF accounts for 2000 to 2002 (which can be debated); and that the write-down currently should be higher than the 5% it currently is (which the auditors would debate too).
Professor White argues that the premium originally paid was $198 millions, and it rose to $226 millions in 2002 when FNPF bought more ATH shares. According to his reading of theFijiaccounting regulations, the “goodwill” representing this premium should have been written down by 20% every year before 2002. Thus FNPF’s accounts should have shown some $40 millions less in profits for 2000 and 2001, and $45 millions less for 2002.
Therefore, instead of ATH contributing “profits” of around $9 million in the FNPF accounts, should have shown “losses” of around $25 millions.
White argues that FNPF only consolidated the ATH interests into FNPF accounts after 2002, when the “write-down” was brought down to a guideline of 5% (i.e. writing it off over 20 years). This enabled FNPF to follow the accounting regulations and show a healthy return of around 5% in 2004 on its ATH investments.
But in his view, even the 5% is wrong, since the monopoly rights of the ATH subsidiaries are unlikely to go beyond 2014, and may even end sooner if the Commerce Commission has its way.
Were FNPF to use a higher amortisation rate (of say 10%) then the return on the ATH investments would drop to below 2%. Not particularly great.
But from FNPF’s point of view, not necessarily bad either, if it has lots of cash lying around earning nothing. As it did then. And as it probably still does, because of Reserve Bank restrictions.
There are pros and cons for FNPF
At the time FNPF bought the shares, the public understanding was that it had hundreds of millions of idle funds earning zero rates of interest, largely because Government itself, through the Reserve Bank, banned it from investing abroad.
In that situation, buying ATH shares which could and did earn some returns was better than earning nothing.
The price paid might even be vaguely justified if FNPF could be justified in using a low discount rate (say 7%) to value the expected future profit flows. It could even be argued that FNPF was bailing out Government at the time by keeping a national asset in local hands.
And while the “goodwill” could and should be amortised over time, FNPF might also argue that it paid the price it did for the ATH shares on Government guarantee of continued monopoly.
If government wished to remove the monopoly status then it had to repay the FNPF for some agreed upon portion of the goodwill. So not only would there be an accounting write-down on paper, but there would also be a real cash inflow to represent the loss of monopoly.
Pros and cons for the auditors
The accountants and auditors will no doubt enter into a debate with Professor White over the issues raised, and there are indeed many grey areas which allow plausible arguments for and against. And the debate is not just about accounting semantics or “appearances”.
Did FNPF have controlling interest over ATH (remember FNPF found it could not even buy part of Government’s FINTEL shares – only something called “management rights”)? Did FNPF intend to sell a large part of its ATH shares to strategic partners like NZ Telecom (in which case it might not have to consolidate its accounts)?
Was it mandatory to amortise at 20% or could other more realistic figures have been used?
How independent were the auditors in going along with what FNPF chose to do? Were they also “between the devil and the deep blue sea” like all the disastrous international auditing failures that Professor White refers to in his article – like Enron, WorldCom and Parmalat?
This debate is surely important forFiji’s accounting and auditing profession, which cannot take lightly the criticisms of the respected but usually reticent Professor of Accounting.
But as important as this debate, the public must also pay attention to the very real underlying issues which have given rise to the criticisms.
Need to strengthen FNPF
We should not lose sight that amidst all this cross-fire and smoke, by and large FNPF has managed its operations reasonably well. There is certainly no hint of corruption or likelihood of collapse that has characterised many other pension funds in the Pacific. The FNPF management over the years can take full credit for that.
But FNPF is currently under stress because of one judgment call made seven years ago to purchase ATH shares at a price that no private sector organisation would have paid- and this was done under considerable pressure from the Government of the day.
The first is how reduce the vulnerability of the FNPF rate of return to the fate of the market value of ATH shares, and what can Government do about that?
The second is the unhealthy control of the FNPF Board by the Fiji Government when the Fiji Government itself is the main borrower from the FNPF (where on earth does the main borrower from a bank control the Bank Board?).
A third is the lack of independent representation on the FNPF Board which might strengthen the ability of the FNPF management to be more independent of pressure from Government.
And perhaps the most important: what should be FNPF’s policy towards the deregulation of the telecommunications industry, given that FNPF’s short term interests conflict with its long-term interests in the Fiji economy at large?
These problems are too severe for any one party to resolve independently.
A collective approach seems called for amongst all the stakeholders, rather than one allocating blame for past mistakes.