How to spot a fraud in the wake of the Steinhoff debacle
Leaked e-mails indicate Markus Jooste was manipulating the company’s financials as far back as 2014
As the facts trickle out about the extent of accounting irregularities at Steinhoff, investors are pondering how not to get caught out again.
The share price hit a new low on Friday, falling almost 20% on the day to R4.11, a fraction of the R56 it traded at before the wheels came off in December.
The renewed share price pressure came after reports by Moneyweb and the German press on leaked e-mails between former CEO Markus Jooste and what look like co-conspirators. Those e-mails make it clear that Jooste was manipulating the company’s financials as far back as 2014, and probably earlier, by round-tripping balance sheet disposals through a separate company into Steinhoff’s income statement.
While the e-mails are fragmentary, it looks like Jooste worked with Siegmar Schmidt, the former chief financial officer of Steinhoff Europe, to manipulate Steinhoff’s earnings. Schmidt was at the time head of the ostensibly independent Genesis Investment Holdings.
The e-mails show that Jooste proposed paying Genesis €130-million for negotiating the sale of the JD consumer finance book to BNP Paribas, a huge commission on the R4.6-billion sale price. But then Jooste tells Genesis to pay €100-million to Steinhoff to “reduce cost of sales”.
And he tells Schmidt to pay an additional €30-million “on all debit loans to reduce nett finance costs”, which he adds “would make sense because of the growth in investments and short-term loans”.The e-mails also refer to several entries in previous years that still need to be “cleaned up”.
Schmidt at one point e-mails Jooste: “You will remember all the balances we pushed up in the last years. I can follow Dirk’s concerns how this will all be eliminated.” The reference is to Dirk Schreiber, CFO of Steinhoff Europe until his resignation last December.
The JD consumer finance transaction was conveniently dated June 30 2014, the last day of the financial year. That timing meant Jooste could avoid a R3.6-billion write-off to the book, which he says in the e-mails he would have to do.But in the 2015 annual report Steinhoff quietly says the transaction with BNP Paribas fell apart in the following year. We don’t know what that meant for the revenue that was booked or the commissions that were to be paid on the deal.
It is notable in the e-mails how keen Jooste is to present to the market the financials it was expecting. He is conscious of maintaining gross margins for the group at 35%, which he did from 2013 to 2014. He is conscious of not letting the group’s debt figures move in a way that would raise questions. He clearly understands accounting conventions and wants the manipulation to avoid being caught out by them.
As others have pointed out, an analysis of Steinhoff’s financial statements for obvious red flags doesn’t easily reveal anything. Cash flow figures seem to match the claimed earnings. While we can now see the problematic businesses were reclassified as discontinued and available for sale, at the time there were credible transactions on the table with entities such as BNP Paribas.
To catch a fraud
There are two ways we might have detected the Steinhoff fraud in advance. One is to have paid much closer attention to German regulators’ concerns, which were raised several times over the years.
As late as August 2017 German prosecutors were known to be investigating Jooste for booking excessive revenue. This would have dragged analysts out of the comfort zone of only looking at the numbers, and into territory normally occupied by financial journalists: examining allegations and the character of individuals involved.The other is to work harder on just what analysis could have revealed more from the numbers. There are many uncommon probability-based analytical tools that aim to detect when managers are manipulating financial figures.
I think the most effective tool would be to walk a line that understands the personalities involved and in turn alerts one to the risks of manipulation of the numbers.
Jooste was ruthlessly ambitious. He took massive risks in debt-funded acquisitions. He needed Steinhoff to keep generating growth figures that would keep funders content. Any disappointment would have shattered the illusion that Steinhoff, under Jooste’s leadership, was a masterful acquirer of businesses.When the underlying operating performance of the businesses did not fit the picture Jooste wanted to present, he was under pressure to find ways to recolour it. The amount of pressure, on its own, is a red flag. Any business with charismatic leadership strongly personally invested in it that needs to keep delivering high growth, has a strong incentive to engage in manipulation when performance doesn’t support the story.
We should be much more trusting of companies that take it on the chin and clearly report bad news when it comes, than companies that seemingly never have a bad year.
Jooste was so eager to keep the market convinced about his genius that he constructed a deliberate fraud, using close associates, to manipulate revenue. He wanted to stay true to his story, no matter the cost.