The key issue; was Cytech held available for sale in the short term?
Faced with tough questions the executives seem to Frangos to have fabricated an explanation to justify their use of the mark-to-market accounting method. The Corpcapital executives gave evidence under oath that the investment in Cytech was held exclusively for sale in the short term, one of the pre-conditions for the use of mark-to-market. However a different and opposite version regarding the intention of Corpcapital with respect to Cytech was conveyed by the same executives to the South African Reserve Bank at the time that Cytech was formed in 1999, intentions which were clearly set out in the application by Corpcapital to the SARB to approve sending 550,000 sterling to invest in Cytech. The letter to the SARB leaves no doubt that the intention of the investment was long term. Much turns on this contradiction. Both versions cannot be right. See the Report of CA Stride 071207, pages 27 to 39, Letter of intent to set up Cytech 290798, Reserve Bank application by Corpcapital, and Collett SAB&T response to Cytech evidence 170407.

It was stated in the application to the SARB that the new investment for which approval was sought constituted an integral part of Corpcapital’s Specialized Outsourcing Division which was intended to provide, to commerce and the formal banking sector, specialized financial services through focused business units in close partnership with management. Corpcapital intended to hold its interests in the e-commerce industry and then list separately on the JSE. Permission was not requested for a short-term investment to be “held available for sale”. Stride confirmed personally with the senior representatives of the SARB that permission would not have been granted to make a short-term investment “held available for sale”. Stride notes that a listing would also imply that Corpgro retained control and that the investment would not be “held available for sale” in the short term. He thus concludes that the statement that the minority 47.5% holding in Cytech was being “held available for sale” was false.

Stride further concludes that in his opinion;

  • that the inspectors must have negligently failed as experts to obtain and review both the SARB application and the approval granted,
  • that the inspectors must have failed to apply their minds as to what documentation a buyer would require, its availability and the ability to sell an unlisted minority shareholding to an investor,
  • that they must also have failed to apply their minds to what could possibly have induced a buyer to pay hundreds of millions of rands for something that could readily have been established from scratch for a fraction of that price. There were no super profits, proprietary rights, specialized software, contracted customers or any other asset that would justify the values arrived at. He comments that no cognizance appears to have been taken by the inspectors of the almost sole financing and security provided by Corpcapital before considering that there was no “significant influence”, bearing in mind also that the remaining shareholders were mainly employees.
  • that the inspectors failed in their duty to determine that a fraudulent scheme had in fact been perpetrated
  • that a fraud had been perpetrated on the investing public and that earnings were inflated to avoid disclosure of a substantial loss in Corpcapital;

While Stride’s conclusions have not been tested in court, they raise a number of significant questions. Why did the executives give conflicting versions? How does this impact on their credibility? What supporting evidence did the executives furnish to the inspectors to back up their claim that Cytech was held exclusively for sale in the short term? Was the executive’s version supported by other members of the board? Are there any board papers to evidence a discussion on the matter, or a decision to invest in the short term? Are there any audit papers on the subject? There is no evidence in the Myburgh Report that any of these questions were addressed by the inspectors.

Since there are no board or audit papers supporting authority for a short-term investment it seems probable that the version conveyed to the SARB was correct, having regard to the circumstances around Cytech highlighted in the various reports. Cytech was thus in the same category of investment as all others, long-term. This would mean that mark-to-market was not justified and lead to the next forensic phase.

As contradictory versions were presented to the SARB and to the inspectors, the inspectors should have treated evidence given by Corpcapital executives with great circumspection. If the version presented to the SARB was correct, then all the arguments made by the executives about the accounting treatment of Cytech to the inspectors fall away. This implies the accounting treatment was wrong, that the justifications found by the inspectors for the accounting treatment that was adopted were false and that the inspectors’ conclusions with respect to Cytech are wrong. Such a conclusion should have led the investigation into the related issued of possible fraudulent misrepresentation. Instead, the issue appears to have passed the inspectors by.

Was there proper disclosure?
Frangos believes on the strength of the expert evidence that Corpcapital under the hand of Liebesman failed to disclose the true situation and thus misled investors. See the Corpcapital Limited 2000 Annual Report to assess the level of disclosure. Charles Stride, page 98 says “The failure to disclose the materiality and sustainability of the profit was misleading and contrary to GAAP. There is in my opinion no basis upon which the revaluation surplus could ever have been legitimately included in income or as an addition to the value of the investment.” This fact was also attested to by HP Strauss, an investment analyst at Investec Bank, in the only independent evidence on the subject given to the state’s investigation in 2003. The inspectors noted in their report: “Strauss, the author of the Investec Securities research note, testified that he could not have written the note by looking only at the publicly available information – he was obliged to obtain information from management”, this is taken from the Myburgh report on Cytech. If an expert could not decipher the accounts what chance did a normal shareholder have?

Readers are invited to study the Annual Financial statements of Corpcapital especially 2000, 2001 and 2002. They are contained on the website. Abrahams covers this facet in detail in his report of 5 June 2007. The following are relevant extracts;

“The annual financial statements for 2000 set out on pages 26 to 49 make no mention of Netainment. It was accordingly not possible for the reader to establish that the revaluation surplus included in the income for the year was mainly attributable to the revaluation of a single unlisted investment which was a closely held related party.” A clear cut statement that there was no disclosure.
“The revaluation of Netainment contributed some 57% of the profits of the group for the year.” An equally clear statement that the profits were material, and therefore should have been disclosed.

“The inspectors do not highlight the above as specific non-disclosures. The fact that the majority of the reported income came from the revaluation of a single unlisted related-party investment was, in his opinion on its own, clearly material to the affairs of the group, indicating a significant concentration of risk and exposure to related-party considerations which in turn were significant to an appreciation of the sustainability of future cash flows and income streams.” Further, confirmation that the inspectors missed crucial pointers.

Abrahams then outlines the requirements of GAAP. Paragraph 15 of the Accounting Framework indicates that “The economic decisions that are taken by users of financial statements require an evaluation of the ability of an enterprise to generate cash and cash equivalents and of the timing and certainty of their generation.” The follows with a test against these requirements, “The above information was extremely relevant to any evaluation of the ability of Corpcapital to generate cash and cash equivalents from the investment in Netainment and the timing and certainty of their generation and as such would have influenced economic decisions. As indicated, it was important information impacting on the sustainability and quality of income and cash generation. Without the disclosures, the reader was not in a position to assess properly the sustainability and quality of the declared income or cash generation. (In this regard it is relevant to note that in the 2000 annual financial statements the Executive review indicates at page 8 that Growth has been entirely organic, driven by the recognition and exploitation of the group’s core competencies.)”

Abrahams spells out in simple terms why a normal reader of the accounts could not have interpreted the real situation, “In the event, Netainment accounted for some R144.5 million of this unrealized investment income and the reader had no way of establishing the quantum of the unrealized income attributable to Netainment a related party or to the revaluation of unlisted investments or how many investments had been revalued, upwards or downwards. In regard to item 1) above (see Abrahams report), a detailed analysis of the deferred-tax note could have permitted the more-sophisticated reader to unearth the fact that the revaluation surplus included in income arising from the revaluation of unlisted investments and securities amounted to R58m/30% or some R193m which amounted to 80% of the net income for the period and the notes to the income statement indicated that income included some R173million of unrealized investment income, no further information was provided. This information would, however, not be readily apparent to an ordinary shareholder or investor. It is trite to point out that information should be presented in a clear and transparent manner and the detection of information important for the appreciation of the affairs of the entity should not be a treasure hunt.” If Abrahams is correct this would mean that the true position was misrepresented.

Disclosure was never Liebesman’s strong suit. See Abrahams Appendix II Compliance with GAAP and Companies Act re disclosure.

Compliance with accounting standards.
Corpcapital focused most of its attention on a hyper-technical defense of the Company’s actions in relation to the technical requirements of GAAP and the Companies Act. To do so they brought on board at least ten ”experts” to provide opinions. This approach does not pass the tests of investigative integrity for several reasons. Each expert was given an extremely narrow briefing on specific hyper-technical issues. The information provided to the experts was clearly limited and selective. In no case was an expert asked to investigate “all” of the facts and report on the macro issues of principle. This is not a criticism of the experts, whom it must be assumed were all in good faith and acting on information and a brief provided to them by Corpcapital. Nonetheless, the maxim “garbage in garbage out” was evident in the close scrutiny of the reports. The intent was obvious, to deflect attention away from the main issues. The evidence in this regard is referred to extensively in the section headed “A series of investigations takes place.” The matter is also extensively dealt with in the Abrahams report June 2003 , Collett SAB&T report June 2003 , and Abrahams response to Myburgh report and Corpcapital experts 050607.

According to Stride, Collett, and SAB&T, it has been shown that;
– Cytech was not “held for sale in the near term”, and
– There was no disclosure of the real position to shareholders.

Had the inspectors reached these conclusions it would have taken them into the next phase of a fraud investigation. Instead, the inspectors were deflected by the hyper-technical defenses of Corpcapital. These had to do with technical compliances with GAAP and the Companies Act, and focused on the following accounting concepts;
– Could Cytech be “measured reliably”?
– Is “discounted cash flow” an appropriate method of valuation?
– Changes in accounting policy

Statements presented on these issues by Corpcapital evidently waylaid the inspectors, and much of their report is devoted to these peripheral issues. No argument is presented in this paper on these issues, because they are not relevant. Interested readers can follow the hyper-technical discussions in the various annexures to this report. See Relevant accounting standards AC000, and Collett Annexure F Companies Act – relevant sections.

Fair presentation, an overriding requirement of the Companies Act was not achieved
Of more concern is the issue of “fair presentation.” The conceptual bases on which financial statements are prepared are set out in a framework which indicates that the objective of financial statements is to provide objective information, free from bias and inconsistency, about the financial position, performance and changes in the financial position of an enterprise that is useful and reliable to a wide range of the users in making economic decisions. See Abrahams Appendix II compliance with GAAP and Companies Act.

The Companies Act requires that annual financial statements (AFS) shall, in conformity with generally accepted accounting practice, fairly present the state of affairs of the company and its business as at the end of the financial year concerned and the profit or loss of the company for that financial year.

Generally accepted accounting practice for public companies is defined by the Statement of Generally Accepted Accounting Practice (GAAP) issued by the South African Institute of Chartered Accountants. These are termed the Accounting Rules.
Accordingly, fair presentation cannot be considered in isolation, it must be considered in relation to the accounting policies / practices being used and absent full disclosure of these policies and practices it is difficult to contend that fair presentation is achieved.

The unrelated NASDAQ argument used by Corpcapital
The executives argued that the volatility of its valuations of Cytech was attributable to the “tech bubble” on NASDAQ, and the same fate befell many other companies. They quoted Dimension Data as an example. Dimension Data is a technology company listed on the Johannesburg and London stock exchanges.

Cytech was a small start-up company based in the tax haven of Belize, in which Corpcapital held a reputed 47.5%. Cytech could never have been listed on NASDAQ, gambling is strictly regulated in the United States. It is difficult to understand, therefore, why NASDAQ would be relevant, other than as a feeble attempt to justify the spectacular rise and fall in the valuations of Cytech in a short period of time. Dimension Data is a listed company on the JSE, whose value is set by the market, not at the whim of executives without any check and balance. The illogical hypothesis perhaps falls down most when the litmus test is applied to the actual market events shown below. NASDAQ goes down, but the valuations of the executives of Cytech continues to ascend? So much for the bubble.

See Nasdaq and AIM indexes vs Cytech valuation 090103 , and Netainment valuations 090103

Interesting discoveries in the fine print
“One-off adjustments” in the accounts are at best suspicious because they generally seem to have the effect of increasing profits. In the case of Cytech 72% of the purported profits before tax for 2001 came through adjustments. Adjustments were also made in 2000 and 2002. It was these profits that were used by the executives as the base for a discounted cash flow (DCF) calculation to arrive at a valuation. It is a characteristic of the DCF method that the base year profit is compounded in the future projections. In a nutshell this means that if an amount of R1 million is fudged in the beginning it will have at least a 10 times effect on the valuation. And, in this case, the valuation of Cytech was taken into the publicly listed Corpcapital income statement as profit, so the requirement for integrity was high.

An examination of the financial information which came to light on Cytech showed that each year an adjustment was made to Cytech’s profits (upwards) and downwards for Cyber Finance Inc in the last month of the year, the company which managed Cytech’s credit card transactions. This had the effect of increasing Cytech’s profits. Both CFI and Cytech had common ownership. This graph reveals a telling story. See Collett Forensic report 2 chart E1 and E2 adj between CFI and Cytech to inflate profits 1999-2001.

An analysis of Cytech’s structure showed a level of complexity which was astounding, a picture which is also telling. The question arises as to why if not to deliberately create confusion and difficulty should there be an investigation. See Structural evolution of Cytech, Collett SAB&T forensic report, and Complex Cytech structure and related entities.

Possible exchange control violations
The legal framework of exchange control is one of total prohibition to deal in foreign exchange except with the permission of and on the conditions set by the Treasury.

During the course of the investigations it seems that the inspectors suspected that there may have been violations of exchange control regulations by Corpcapital relative to Cytech. The inspectors intended to bring the matter to the attention of the South African Reserve Bank but were persuaded not to do so by Corpcapital. Corpcapital submitted to the inspectors that the SARB had conducted an investigation and the matter had been settled, the settlement agreement, on or about 9 October 2003, negating any need to again refer the matter to the SARB. Nonetheless, it seems that the inspectors remained of the prima facie view that Corpcapital had breached the regulations in at least three respects, and referred their findings to the Minister with a recommendation that the matter be referred to the SARB for its attention.

While all possible breaches appear to be serious one of them is particularly interesting because it relates to the ownership of Cytech, covered earlier. According to the inspectors, the original share certificates of Cytech and related entities were not lodged with an authorized dealer “until about July 2003”. This raises questions about which certificates were lodged, were they authentic, and why the delay?

Nowhere in the inspectors report does the Moss evidence feature. At face value this evidence appears to indicate possible breaches of exchange control regulation by Liebesman, Liebmann, Grolman, and perhaps others. There is no indication that the inspectors reported on this matter, even though Stride and SAB&T found that the amounts involved appeared to be in the R billions. If it is found that there was no disclosure by those allegedly implicated it would raise grounds for further action by the SARB on the basis of material non-disclosures. These repetitive issues are troubling and raise more questions than answers.

Martin Luther King “Injustice anywhere affects justice everywhere.”

In summary
In many respects the Corpcapital saga was about fiduciary duties and the role of directors. These facets are essential to a proper understanding of the relationships between shareholders, boards of directors, and executives, and are covered below. The role of Gatekeepers, especially the auditors, is fundamental. But, it was also suggestive of much more. Underneath the imposition of such intense fiduciary responsibility lies an acknowledgment of human frailty – the danger that those entrusted with others’ wealth might, absent such duties, be more prone to succumb to the temptations of infidelity by taking some of that wealth for themselves (a loyalty problem) and/or laziness/casual indifference (a care problem). This leads directly to the subject of ethics, of trying to understand why some, entrusted with such duties, nevertheless flagrantly breach the rules. It also leads to a comparison of sophisticated corporate crime to organized and common crime in society at large. And finally, are there the tell-tale signs which warn of impending problems and, what to do about it?

Fiduciary duties
Directors are custodians of shareholders wealth and are bound by their fiduciary duties.

Corporate and civil law impose on directors and corporate officers the obligation to act in circumstances where misconduct is suspected. They are fiduciaries, custodians for the wealth of others. There is no discretion in fulfilling their duties. Fiduciary duties are immutable. This duty explicitly includes reporting misconduct to the board of directors. Fiduciary duties do not operate intermittently; they are immutable and are the constant compass that guides conduct. No director or corporate governance expert can dispute these principles.

It is accepted by most that to speak up about things which are patently wrong is the moral right and duty of any citizen. To do so where the law requires it, as is the case with fiduciary duties in corporate matters, is an obligation, and should not be the subject of debate.
The company and its shareholders are not entitled to good outcomes on business risks. They are entitled to directors and a board that makes decisions independently, on the merits, and with appropriate information in light of the magnitude of the decisions and issues before them. And they are entitled to expect that directors will do their duty, regardless of the consequences. It is this failure of fiduciary responsibility that triggers director liability, not the simple fact that the decision turns out poorly, or that it is sometimes difficult to prove prejudice. The failure to act in these circumstances undermines the rule of law. Where this happens routinely and as a matter of course society begins to accept that evasion of the law and the rules is the norm.

It is a sine qua non that directors are bound to report on misconduct. The related question is when does this duty terminate? The simple answer is that it terminates only when the matter has been properly disposed of in the interests of shareholders.

See WWB legal notes on fiduciary duties.

The roadmap for directors
One of the key questions which the Corpcapital saga has posed is; What is the course of action to be taken by directors or corporate officers (who have the same fiduciary duties as directors) when they encounter misconduct? This website has comprehensively covered the question, but a summary is in order.

In most cases directors simply resign and walk away. This approach takes the least line of resistance, but seriously breaches the director’s fiduciary duty to shareholders. Shareholders are then alerted that a problem exists, but the directors who bring it to their intention signal that they do not have the stomach to do what is right. So shareholders are left stranded. More common are directors who take the view that the perks and benefits outweigh their duty and remain silent on the board with their head in the sand, or who fear the wrath of their colleagues. Neither of these characterizations are what shareholders pay for, expect, or are entitled to.

In fact, in ethical and legal terms, there is only one appropriate course of action. It is tough and may place the director in contention with his fellow directors, some of whom may be his/her close friends. That course is to speak out, and to continue doing so until the facts are revealed and appropriate action is taken, and to ensure that due process is followed in every way. That inevitably there will be retaliation is a reflection of the value system of the offenders, who either have engaged in misconduct, or chosen to remain silent, not the one who does his/her duty.

No-one ever said that being a director is easy. What is clear is that the enormous personal benefits of directorships also carry responsibilities.

In the case of Corpcapital the previously unchartered roadmap was based on an important principle objective which is required of directors by their fiduciary obligations. That objective is to speak out in order to give the company an opportunity to get the real facts out and if necessary to take action. I raised my suspicions initially with Liebesman, the CEO, to give him an opportunity of explaining the complaint. The response was to isolate me from the board, and to make access to information difficult. The next step in the roadmap was to take the matter to the board. Before doing so, I conducted an investigation of Cytech for myself in order to verify my suspicions. The matter was placed in the hands of the board, but proved to be futile because the board were suborned, and no action was taken to investigate the conduct of Liebesman and the executives. The next step was to take the issue to shareholders, and the largest institutional shareholder, Old Mutual, pressured the board to conduct an external investigation. The consequent Payne investigation, and its “whitewash” has been fully covered on this website. What to do then? The position had remained unchanged. A mechanism is in place for Directors to place such matters in the hands of the Minister of Trade and Industry, the custodian of the Companies Act, with a request for a state investigation. Before doing so I commissioned, at great personal expense, two independent forensic teams to report on the Payne investigation and to study all of the available evidence. The findings of these two investigators confirmed my suspicions, and provided great substance to the submission to the Minister. My attorneys, WWB, carefully prepared the submission.

The Companies Act requires no more than reporting a suspicion to the Minister. I went considerably further to satisfy myself on the facts. When the Myburgh investigation eventually was completed and released, I and my advisors were not comfortable that a proper investigation had been investigated. The reasons for this conclusion have been fully documented on this website. At great expense, teams of forensic investigators were mandated by my lawyers, WWB, to study the Myburgh report. The exercise took a year to complete and has now been submitted with a report by WWB to the Minister of Trade and Industry.

The roadmap is the result of a long saga, personally experienced by me and my advisors. It is my belief that these experiences will serve to change the way in which directors and corporate officers act in these circumstances, and in the way in which investigations are conducted. If they do, it is unlikely that a director will in future have to travel along the roadmap which has been explained on this website. That in itself will make the time and energy devoted to this matter worthwhile