SINGAPORE (Feb 4): On Jan 25, Singapore Exchange Regulation (SGX RegCo) briefed several journalists about its plans to play a more active role in determining the scope of statutory audits of locally listed companies, and beef up its capabilities to scrutinise the value of corporate assets.

These new initiatives were at least partly spurred by the collapse of Noble Group amid allegations that it had been cooking its books, and attempts by ISR Capital to acquire a major stake in a rare earths mine in Madagascar supported by two dodgy valuation reports. Yet, questions have been raised about the valuation of assets on the books of companies that have pristine reputations too.

Only four days before the SGX RegCo briefing, The Straits Times published a letter from a member of the public, calling on the authorities to investigate the significant difference between the book value of Ascott Raffles Place Singapore and the price at which it is being sold. On Jan 9, Ascott Residence Trust announced plans to sell the property for $353.3 million, which is 64.3% more than the book value of the asset as at Dec 31, 2018 of $215 million. The sale is expected to result in a net gain of $134 million for Ascott REIT.

“Besides entrusting the companies’ managements and boards of directors to do a good job for them, investors have to also rely on various professional firms, including, in this instance, the property valuation company as well as the accounting firm in charge of the audit,” complained the letter to The Straits Times. “The huge valuation discrepancy in this case is a serious red flag that something is amiss in the process.”

Experienced REIT investors might well have rolled their eyes at the letter. REITs typically own income-generating properties, and they are designed to deliver the bulk of total return through regular cash distributions. Hence, the valuations of the properties on their books are based on their ability to generate recurring income. The sale of a property at more than book value is generally viewed as a bonus of sorts, as the proceeds could be used to acquire higher-yielding properties that ultimately generate stronger income.

The manager of Ascott REIT issued a clarification announcement in response to the letter, explaining that the valuation of Ascott Raffles Place Singapore had been done as part of an annual exercise for the entire portfolio. The valuation was conducted by Colliers International, using the discounted cash flow method, which is consistently applied by Ascott REIT and generally in line with market practice. The manager added that Cushman & Wakefield had been engaged to conduct a marketing exercise for the divestment of Ascott Raffles Place Singapore.

Nevertheless, it is understandable that the wide difference in the chosen basis of valuation for Ascott Raffles Place Singapore and its realisable market value would raise questions in the minds of some people. What proportion of Ascott REIT’s portfolio would achieve a similar premium over book value in the event of a sale to third parties? Would unitholders of Ascott REIT be interested in having the entire portfolio liquidated if a significant premium over book value could be achieved, keeping in mind that most of them invested in the REIT for income? More importantly, can Ascott REIT’s manager be relied upon to present such an opportunity to the unitholders, given that the manager is earning fees from the portfolio?

Dealing with a ‘trust deficit’

Tan Boon Gin, CEO of SGX RegCo, warned in a speech this past week that the level of trust in companies, directors and the work of auditors has waned, affecting trust in the market. “We must all, as companies, directors, audit committees, auditors and regulators, act in the face of this trust deficit,” he said, according to a text of the speech that was made available to reporters. “Consider the effects if we don’t: valuations may suffer, the cost of funding may go up and confidence in both the capital market industry and the audit profession may be lost.”

Tan’s speech outlined several initiatives SGX RegCo is pursuing to boost confidence in the financial statements of companies and the work of auditors. Notably, SGX RegCo has been engaging the audit committees and auditors of individual companies. “The purpose of these meetings is to highlight to audit committees and auditors, issues that we are concerned about based on our own review of the company, what we expect the audit to cover and discuss in the key audit matters of the annual reports,” according to Tan’s speech.

SGX RegCo is also calling on special auditors appointed to look into specific problems to have the “gumption to take a professional stance on matters of concern” instead of “hiding behind their terms of engagement or expressing themselves in language so vague that the resulting report is non-actionable”. According to Tan, SGX RegCo now intervenes to change any terms of reference that are not to its satisfaction.

In addition, SGX RegCo is seeking the power to require in exceptional circumstances the appointment of a second auditor, on top of the existing statutory auditor. “This will complement SGX’s current power to require the appointment of a special auditor, who will typically only look into a specific area, whereas the second auditor will jointly sign off on the year-end audit together with the first auditor,” Tan said. SGX RegCo also wants all listed companies to appoint either a Singapore-based auditor, or have a Singapore-based auditor jointly sign off on annual audits conducted by foreign auditors.

SGX RegCo has also entered into a memorandum of understanding with the Singapore Accountancy Commission and the Institute of Valuers and Appraisers of Singapore to promote the integrity of business valuations involving listed companies. “Last year, we worked with the Singapore Institute of Surveyors and Valuers to produce a guide on real estate valuation for REITs and IPOs, which we intend to incorporate into our rules,” Tan said. “We expect our MOU with IVAS to result in similar developments, which will raise the overall standard of both business and real estate valuations, reporting and disclosures in Singapore.”

Leaning on auditors, valuers

These initiatives represent a heartening shift in Singapore’s regulatory approach, in my view. SGX RegCo appears to be indicating that professional firms engaged by companies to perform audits and valuations will not be left entirely to their own devices, and that they will be held accountable after the fact. Complacency or deliberate wrongdoing might now be disrupted before too much damage is done.

One sticking point that reportedly prevented the authorities from launching a full investigation into Noble when allegations that the company had inflated its reported earnings first emerged in 2015 was that EY Hong Kong had signed off on its accounts. Noble had also published a review of its accounting and management practices by PwC, which concluded that the company had recorded profits on long-term sales and marketing deals in a manner consistent with industry practice. In addition, EY Hong Kong reviewed at least 80% of the company’s contracts that were under scrutiny and found nothing amiss.

In the end, substantial writedowns by Noble in 2017 and 2018 provided the basis for a probe by the authorities. On Nov 20, 2018, the Commercial Affairs Department (CAD), the Monetary Authority of Singapore and the Accounting and Corporate Regulatory Authority (ACRA) said they were jointly investigating suspected false and misleading statements and breaches of disclosure requirements by Noble, and potential non-compliance with accounting standards by its subsidiary, Noble Resources International. The company’s auditor EY has been directed to produce documents related to the audit of NRI.

The big question is how far SGX RegCo will ultimately go. One criticism of Singapore’s handling of the Noble affair is that the company’s key critics, Iceberg Research and Michael Dee, were not taken seriously initially. So, would SGX RegCo now immediately lean on the auditors of the next company that is a target of a negative research report? Would it immediately haul up the auditors of any company that unexpectedly writes down the value of its assets?

Then, there is the apparent bewilderment of some members of the public about the wide difference between the book value of Ascott Raffles Place Singapore and the price at which it is being sold. What should the authorities do? Is there really anything wrong with the manner in which properties held by REITs are valued? Should listed companies and REITs be required to provide more than one basis for the valuation of their assets? Would a failure on the part of the authorities to address this issue worsen the trust deficit in the market?

More generally, there is the question of how much auditors can really be expected to do. This column previously noted that auditors are sometimes said to be watchdogs rather than bloodhounds. Their role is to bark when they spot something that does not look right instead of relentlessly hunting for evidence of misconduct by their clients. Indeed, it is not possible to have a good working relationship with people you are convinced are up to no good.

In the end, regulators cannot absolve themselves of their own responsibilities by turning up the pressure on the directors and auditors of companies. The joint investigation now underway by CAD, MAS and ACRA into Noble is an indication that going after companies that artificially inflate their earnings is not currently the responsibility of any single agency. And, it is perhaps why it took so long before any action was actually taken. That should change. As SGX RegCo leverages its partnership with IVAS to strengthen its ability to scrutinise business and real estate valuations, a dedicated capital markets regulatory agency capable of dealing with any wrongdoing in that field ought to be created.

This story appears in The Edge Singapore (Issue 867, week of Feb 4) which is on sale now. Subscribe here