Tracking Down Perpetrators of Corporate Misdemeanors

The controlling shareholders in publicly traded companies inflate equity and profitability figures in order to meet the criteria of the banks and to present better financial results to the shareholders. So says accountant Aliza Sharon, whose office assists and sometimes manages companies in financial straits.

Some 85 percent of the firms that her office worked with had falsified their equity figures, she says. Sharon's office works with dozens of companies, including large privately owned and publicly traded firms.

"A very positive equity on a balance sheet turns into a negative equity immediately after we redo the balance sheet," says Sharon. This often happens because the high-priced inventory recorded on the balance sheet is either not viable or nonexistent, and equipment is frequently over-valued. Sharon notes that the accountants who sign the financial reports are usually unaware of the inflated balance sheet because they randomly check a sampling of the figures and have no in-depth knowledge of the real situation.

"Sometimes accounting rules also do not help present a true balance sheet," explains Sharon. "Once, one could trust financial reports, but the problem of the accounting profession today is in reflecting a future situation, not what happened in the past. Ninety percent of accountants are still dealing with [a company's financial] history and not with presenting the true situation that a company is facing."

Sharon notes different criteria for the calculation of asset values. The inventory of a firm that is shutting down is lower than the value seen by the company's accountants when the company is a going concern.

Sharon's office provides "silent escort" services to banks that have financed failing companies. These are large companies that owe the banks between NIS 100 million and NIS 1 billion, and whose financial stability is very important to the banks. Sharon notes that this type of service is becoming more common because debtors often lose more from liquidating a company than from keeping it going.

"When the banks detect a cash-flow problem, they `persuade' the controlling shareholders to accept our services. This is also better for the controlling shareholders than hitting the headlines and ending up in court, because the moment news of the appointment of a receiver spreads, the value of a company's assets plummets all at once, clients become suspicious and suppliers raise their prices."

No hurry to liquidate

A company encountering temporary difficulties may be escorted for a matter of weeks. In other cases, the external accountants remain as comptrollers for much longer periods. In many cases, Sharon effectively becomes the company's manager, laying off workers, implementing recovery plans and signing contracts.

"This `quiet management' is not exposed to the public," explains Sharon, "so clients and suppliers know nothing about it. It does not appear in the reports, nor does it receive expression in the courts - so no one else knows about it until the actual moment when a company reaches liquidation."

Sharon's goal is the recovery of a company, and only when she reaches the conclusion that a company is beyond help - when the controlling shareholders are uncooperative, for example, or if expenses are very high - will she commence liquidation proceedings.

"One of the problems is that the directors and owners of a company do not realize how bad their situation is," says Sharon. They do not internalize the severity of the crisis, and are convinced that their cash-flow problems are temporary. "They say things like, `We have a client who delayed his payment by a few days,' or `Things will work out after we sign the new contract next month.'" In such situations the banks often extend more credit.

Sharon notes that there are two main causes for a company's failure: the economic situation, which is harming the business sector; and shareholders who siphon off money illegally and reduce profitability.

Hidden accounts

Sharon harshly criticizes controlling shareholders who empty their companies' coffers, brining the firms to the point of ruin. "People are constantly juggling the books and surprising us with new ploys," she says. Sometimes contractors sell apartments and pocket the money instead of registering it in the company's books, for example.

"At one company we found that the value added tax reimbursements were being deposited in a separate account, and the company's accountants did not even know about it," recalls Sharon. "There was NIS 3 million in that account, while the company had no ready cash to pay workers' wages."

Another type of fraud was perpetrated by a housing development company that raised much-needed cash by asking its shareholders to buy apartments in the complex it was building. The records showed that the apartments purchased by the shareholders at a discount were 100 square meters, but they were actually 200 square meters. The shareholders then sold the apartments on the open market for a huge profit and were actually draining money out of their own company instead of doing the opposite.

Sharon says that much of the fraud involves foreign workers, whose wages are paid in cash and are hard to trace. "There was even a company that we were already managing and was going through liquidation, and the owner still took us for a ride," she says. "We gave him cash to pay 200 foreign workers, but most of them were already not working for him. He had provided us with the details of every foreign worker who had ever worked for him. They were all fictitiously paid their wages on the same day, but the contractor was actually left with NIS 200,000 in his hand, which he stole in the blink of an eye."

Another method used by building contractors is to obtain bank financing to buy surplus raw materials, which are then sold on the black market. Sharon explains that the banks approve the paperwork for each acquisition, but usually do not physically check the quantities purchased or what happens to them.

"A month ago a subcontractor telephoned us to let us know he had just purchased metal from a publicly traded company that we are escorting," relates Sharon. "Two days after we started helping this company we already knew they were pulling one over on us."

One method of getting money from the banks is to open an account at each of several banks, obtain credit and deposit money borrowed from one bank into an account in another bank. Thus more credit is obtained and the debt grows while the money is rolled over and one bank does not know about the others. "There's no chance the money will ever be returned," says Sharon.

"Even though the banks know that in many cases they are being deceived, they don't want to treat their clients as swindlers. As long as the companies pay interest on the credit extended to them and keep up their loan repayments, the banks don't do a thing."