Reminiscence of an Asian accounting fraud case – Australia’s ABC Learning
Posted by Amy CHAN Wen Yi, final year undergrad at the School of Accountancy, Singapore Management University
http://www.abc.net.au/news/2008-08-27/fast-eddy-leaves-abc-learning-investors-reeling/490536
http://www.wsws.org/en/articles/2008/09/abcl-s30.html
‘Fast Eddy’ leaves ABC Learning investors reeling
Greg Hoy
Updated 28 Aug 2008, 10:26amThu 28 Aug 2008, 10:26am
Until six months ago, the world’s biggest child care operator, ABC Learning, looked like one of Australia’s great corporate success stories.
Looks can be deceiving, as ABC’s investors discovered the hard way.Beneath the smiling veneer there is deep trouble in the kids’ kingdom, Australia’s most heavily Federal Government-subsidised company.
ABC Learning requested a trading halt on its shares four days ago, as a deadline loomed for its latest financial results.
Bear in mind the company had already flagged that it would have to declare a pre-tax loss of $437 million – information that triggered a further slump in the share price.
That has now fallen from last year’s high of $8.80 to just 57 cents at the latest trading halt.
No doubt investors can expect more soothing rhetoric from the multi-millionaire founder and CEO Eddy Groves, but there are many who are no longer listening.
The rise and rise of enigmatic founder, known to many market analysts as ‘Fast Eddy’ for the speed of his speech, now seems somewhat souffle-esque, as bank lenders, government, prominent Australian investors and thousands of small shareholders awake to the painful reality they may have been taken for one of the biggest rides in Australian corporate history.
Deborah Brennan, a professor at the University of NSW Social Policy Research Centre, says ABC Learning could be one of the most spectacular public policy disasters seen in recent time.
“[It] is something that could become a case study, I think, in many business schools and public policy schools around the world,” she said.
IMF Australia’s John Walker says his company was approached by shareholders involved in ABC Learning, and was asked to look at whether or not there were potential breaches of the Corporations Act.
He found that the company never really made money over the last four years.
Mr Groves managed to attract finance to spawn an empire of 1,136 ABC child care centres across Australia, 2,000 across the globe, and in so doing, mislead the market, the nation and the world as to the company’s financial viability.
“I didn’t buy it five years ago, I didn’t buy it three years ago, I didn’t buy it last year and I wouldn’t buy it today,” Clime Capital’s Roger Montgomery said.
‘Fast Eddy’, the man
Mr Groves is a gambler with a high-rolling history in casinos from the Gold Coast to Las Vegas.
But his ballooning child care corporation, established in partnership with his wife Le Neve, from whom he separated, gambled mainly with other people’s money – and lots of it.
Behind the facade was a massive real estate play, but on the surface a listed child care service, which attracted a total of $3.5 billion in bank securities, investors’ money, and heavy federal government subsidies.
It was the equivalent of $1 million a day in child care rebates. All of which were then filtered through a labyrinth of private companies closely related to Mr Groves himself.
The first ABC Learning acquisitions and the 1, 2, 3 Global group of companies were privately owned by the elusive Don Jones and his wife Heather, until this month when she ceased to be a director.
As Mr Jones’ company individually employs less than 50 people, they are not required to lodge financial returns with ASIC.
Professor Brennan says as business analysts and researchers dig more deeply into ABC Learning, it is becoming clear that the company did not make the profits it did in the past through bulk-buying nappies.
“We are actually talking about a very complex corporate structure, and I think that the guardians of the public purse have really not been watching closely enough what has been happening,” she said.
Sadly, Mr Groves was not available for interview.
We hoped to ask him why, having raised almost $3.5 billion over 3.5 years, ABC needed to raise even more money in June just to pay the interest on its bank securities.
Where has the money gone? Has profitability been an illusion, given the costly questions the new auditors have posed about previous accounting practices?
It appears from 2005 until 2007 ABC paid about $1,040 million to buy leases and childcare licences from so-called developers – particularly Mr Jones’ companies – who would return funds back to the centre to achieve its budgeted revenue.
Profitability
Everything looked rosy as, under the old auditors, payments from these developers were not disclosed but were shown as revenue, without which ABC’s profitability was poor to non-existent. Take, for example, 2006.
The IMF’s Mr Walker says that 20 to 25 per cent of that year’s profit earnings were derived from the sale of the right to provide employees to ABC-owned centres.
“About 20 odd per cent of that year’s profit, by way of example, just wasn’t as stated,” he said.
“Similarly, the financial transactions that the company’s entered into with developers, it turns out – and only recently disclosed – that a big portion of earnings is being derived by transactions with developers.”
Though Mr Groves denies these are related party transactions, Mr Jones’ companies have principally operated from ABC headquarters or offices. ABC’s CEO was known to have been active in establishing at least one of them.
Mr Jones’ companies appear to have received at least $880 million from ABC Learning.
If Mr Jones’ companies are not related to Mr Groves’, Queensland Maintenance Services (QMS), formerly known as Groves Corporation 2, run by Mr Groves’ brother-in-law Frank Zullo, is.
QMS, listed at the same address as Mr Groves, was awarded $74 million for un-tendered work for ABC in 2006 alone – $100 million between 2003 and 2006.
When accounting issues began to emerge and the new auditors in February revealed a 42 per cent slump in half yearly profits, triggering a 70 per cent fall in shares, Mr Groves berated hedge funds for short selling his company stock.
Sadly that day, shareholders of this great Australian company got their first glimpse of ABC’s modus operandi.
But ABC Learning centres soon set about re-branding many of its child care facilities, delegating their operation to a company called Neighbourhood Early Learning Centres, a private company owned by Mr Groves’ brother-in-law.
Mr Walker says there was speculation as to whether or not they were arm’s-length transactions.
“The concern of the market though, is that it wasn’t informed of the fact that these transactions were generating or purporting to generate revenue being derived from the transaction rather than from fees being paid by parents,” he said.
Domination
Before the new auditors lanced Mr Groves’ burgeoning balloon, forcing a sale of assets, ABC was gluttonously gobbling up child care centres from the UK to America.
Last year, Mr Jones’ 1, 2, 3 Global companies began approaching child care centres across Canada, triggering a wave of protests. ABC Learning denied any involvement, but the Canadians didn’t believe them.
Professor Brennan was flown to Canada to talk about ABC Learning in Australia.
“It was a very strong activist and early childhood community in Canada that really wanted to ensure that public money is used for the benefit of children, and not for the growth of enormous private and corporate profits,” she said.
“Canadians were asking me when I was over there ‘How come you have designed a system that’s allowed one individual to become the richest person in Australia under 40, and yet you have a system with poor quality standards, where 40 per cent of the staff have no qualifications whatsoever?'”
Huge losses
But there are many who have bought the Mr Groves story completely.
The Singapore Government’s investment company last year spent $400 million buying shares at $7.30, to buy 12 per cent of the company, which has so far lost around $350 million in value.
And the Commonwealth Bank is believed to have almost a half a billion dollar exposure to ABC in loan securities or convertible notes, and another several $100 million more in senior debt.
And the Commonwealth is not alone. The total debt due for repayment in just two years is $1.45 billion.
In 2005, when he was with Merrill Lynch, Invesco’s investment manager Andrew Perks was attacked after expressing concerns about ABC’s tendency to overpay for acquisitions and how the company inflated the values of intangibles or non-physical assets such as brands.
“It was a market darling, it was fast growing, it was raising lots of equity, it was raising lots of debt, that’s very attractive to bankers and to stockbrokers. But when I looked at it I was concerned that the ultimate shareholder might not have been sharing in that upside,” he said.
“The asset side was largely intangible. I think it got up to almost $3 billion Aussie dollars at the end of June 2007.
“I am not sure what it would be at the end of ’08, we are still waiting on that. And to put that into perspective that’s almost three times the level of BHP.”
Strong concerns about ABC’s questionable revenues were directly brought to the attention of the regulator ASIC in 2006, but ASIC chose not to act.
The Federal Government also remains amongst the believers, even after its recent announcement the child care rebate would be increased to help parents cope with the increasing cost of child care, only to see ABC increase its fees.
There was little anyone could do. ABC remains Australia’s biggest child care provider. But what happens if, in the worst-case scenario, it was to collapse? Assuming, of course, the banks allowed that to happen.
“I’m also quite critical of a number of politicians and policy makers, who I think have really turned a blind eye to what’s been happening in child care in Australia, and who have not been very effective guardians of the public purse,” Professor Brennan said.
“Without wanting to speculate at all about the future of ABC Learning, I would just make the point that such a level of exposure to a single company is a matter of great concern.”
Five-year suspension for former ABC Learning auditor
August 9, 2012
THE corporate watchdog has finally claimed a scalp from the collapse of ABC Learning Centres.
The Australian Securities and Investments Commission said yesterday it had received an enforceable undertaking from the company’s former auditor, Simon Green, which suspends him from audit work for five years.
Last month ASIC dropped charges against ABC founder Eddy Groves and refused to say if it would take further action. ”Our investigations … are continuing,” said an ASIC spokesman.
Yesterday the commission said that following an investigation into Mr Green’s conduct of the audit of the 2007 financial report of ABC Learning, it formed the view that he failed to perform adequately and properly his duties as an auditor. In the enforceable undertaking, Mr Green acknowledges ASIC’s views are reasonably held.
The commission said Mr Green failed to obtain sufficient audit evidence in relation to the correct accounting treatment for various fees that resulted in a significantly material overstatement of ABC’s revenue.
Among other issues, it said he also failed to obtain sufficient evidence to enable a reasonably competent auditor to conclude that ABC was a going concern.
At the time, Mr Green was a partner with the former Brisbane firm of Pitcher Partners, which was dissolved on November 28, 2008.
The firm resigned as ABC’s auditor after the fateful 2007 engagement. The new auditors, led by Ernst & Young’s Brian Long, challenged the company’s treatment of revenue and earnings in its interim and end of financial year accounts for 2008. This revealed a vastly different picture.
ABC collapsed in the November.
”Auditors are important gatekeepers who are relied upon to provide assurance and market confidence in the quality of financial reports,” said ASIC chairman Greg Medcraft.
”ASIC continues to focus auditors on the importance of applying professional scepticism … It is vital that auditors apply appropriate skills, experience and scepticism in identifying and responding to risks, reviewing accounting treatments, gathering audit evidence and in judgment areas such as going-concern assessments,” he said.
Following the conclusion of Mr Green’s suspension, he is required to submit his first five audits for review by a registered company auditor approved by ASIC.
Amid Allegations of Enron-style Fraud
Major Australian child care corporation at risk of bankruptcy
By Katrina Morrison
30 September 2008
Australia’s largest child care provider ABC Learning, also the world’s largest publicly traded child care corporation, stands on the brink of collapse. The company’s crisis, first triggered by the world financial markets’ turmoil, has exposed a series of allegedly improper accounting practices, recalling the Enron scandal.
Shares in the company sold for just 54 cents each, down from last year’s peak price of $8.80, before trading was suspended on August 21. ABC requested the suspension shortly before it announced that it would be unable to meet a deadline to submit information on its 2008 earnings. This is expected to reflect an even greater loss than the $470 million forecast a month earlier. The company’s new auditors, Ernst & Young, reportedly may also force a restatement of ABC’s accounts over the last two years. ABC Learning had promised to release the updated earnings figures by the end of September but it remains unclear whether this will be further postponed. Only when the share trading suspension is lifted will it become clear whether the company can avoid insolvency.
Whatever the immediate outcome, the crisis underscores the destructive irrationality of the private child care industry, which has been promoted by successive Labor and Liberal governments. The care of young children is a vital social service for working parents that ought to be freely provided and universally accessible. Moreover, children’s early experiences and the quality of their interactions with adults are crucial to their long-term well being and future intellectual, emotional, and cultural development. But child care is now a business like any other, based on maximising profit and the private wealth of a few corporate CEOs and major investors.
ABC Learning operates more than 1,100 child care centres—30 percent of the national total—in Australia. Their future, along with that of the company’s employees, is now in doubt. It is reportedly more likely, however, that the centres will be sold off to other private investors rather than shut down in the event that receivers are called in.
ABC Learning’s troubles were first exposed in February after the company announced half yearly profits that were lower than anticipated. This triggered a massive sell-off, with share prices down by more than 40 percent, because investors feared the company would be unable to service its debt under conditions of the deepening global credit crunch, triggered by the US sub-prime mortgage sector collapse. ABC subsequently negotiated an emergency sale of its US assets (valued at $250 million) to reduce debt and interest costs.
These moves staved off bankruptcy but were also accompanied by greater scrutiny from investors and regulators. Litigation firm IMF Australia is now considering whether to launch a class action on behalf of shareholders. IMF’s John Walker claimed that, contrary to ABC Learning’s rosy financial reports, “we found that the company never really made money over the last four years”.
According to the Fairfax press, ABC is also under investigation by the Australian Securities and Investments Commission (ASIC) for potential violations of its continuous disclosure requirements.
It has also been revealed that ASIC received a letter of complaint in May 2006 from an unnamed source, alleging that ABC’s practice of claiming its child care licences as an asset—despite these licences having no intrinsic value—“may be misleading to potential advisors in the company”. The dubious accounting method added an additional $390 million to the company’s value between 2001 and 2005. “The apparent strength of its balance sheet played a major role in ABC’s subsequent expansion,” the Agenoted, with its expansion into the US based on taking on debts that increased from $380 million to $1.8 billion in 2006. “The strategy played a leading role in ABC’s subsequent downfall.”
ASIC declined to investigate the 2006 complaint.
The Australian Broadcasting Corporation’s “7.30 Report” program, broadcast on August 26, shed further light on ABC’s valuation of child care licences. The program reported that the company paid more than $1 billion to buy leases and child care licences from “so-called developers” who “would return funds back to the centre to achieve its budgeted revenue”. What ABC later described as “fees paid by child-care developers” to “support centres during occupancy growth” totalled 20 percent of the company’s revenue.
An article in the Fairfax business press on September 5 explained: “The current system works like this: a developer buys the land and builds a child-care centre. On most occasions, the land would be sold off to a listed real estate trust which would have a long-term lease from the centre’s operator, ABC Learning. ABC then buys the business, but receives payments from the developers akin to ‘rental guarantees’ paid to property investors. In basic terms, loss-making centres are subsidised by developers until they hit certain occupancy levels.”
Developers are supposedly independent from child care operators. But the bulk of ABC’s revenues flowing to and from the developers went to Don Jones, a former army lieutenant colonel turned child care developer. Some of Jones’s companies operated from ABC’s headquarters or premises.
The end result of these financial manoeuvres was that ABC earnings, which the markets believed had been generated from parents’ child care fees, were in fact “restated value” from property developers. There seems little doubt that ABC Learning encouraged the lack of clarity—in 2004 it ceased reporting the occupancy rate of its child care centres, a key measure of their profitability.
Further revelations of ABC’s “unorthodox” methods are likely to emerge. Last month it became known that the company operated with what the Fairfax press described as a “labyrinthine” corporate structure involving hundreds of regional management sub-companies. These were designed to be small enough to fall under the payroll tax threshold. As a result, the company paid no payroll tax despite employing 16,000 staff in more than 1,100 child care centres in Australia.
Child care privatisation
ABC Learning’s senior executives are certainly responsible for the company’s crisis, and for whatever criminal practices—if any—have been carried out. But true responsibility for the debacle lies with the Labor and Liberal parties, who jointly established a profit-driven child care system.
Prior to 1991, all government funding was directed to child care providers operating specifically on a non-profit basis. Then the Labor government of Prime Minister Paul Keating began funding private operators under the banner of providing parents with greater “choice”. The Keating government also introduced the Child Care Cash Rebate in 1994, which provided parents with a rebate for their child care costs. The measure further promoted the rise of private operators while doing nothing to alleviate the growing costs faced by parents. Child care companies simply increased their fees, swallowing up the value of the public rebate.
The 1996 election of the John Howard Liberal government saw the further extension of the privatisation drive. Howard’s government removed the last vestiges of public support for non-profit child care operators by abolishing operational subsidies to community-based long-day centres in 1997. Four years later, Howard combined child care subsidies into a single payment called the Child Care Benefit (CCB), which was paid either directly to the private provider, who was then supposed to reduce the fee by the appropriate amount, or to families at the end of the financial year. The CCB marked an essential step towards the complete privatisation of child care in Australia, with government funding disconnected from infrastructure development and directly issued to private operators.
In 2004, the Howard government offered a pre-election bribe of a 30 percent Child Care Tax Rebate (CCTR) on top of the Child Care Benefit. The CCTR is now paid to families up to 18 months after costs have been incurred.
The new Labor government under Prime Minister Kevin Rudd has committed to accelerating the privatisation drive, with the CCTR boosted to 50 percent and the Child Care Benefit maintained in full.
As a result of these processes, since 1991, child care provision has been entirely transformed. Whereas 85 percent of child care was delivered on a non-profit basis in 1990, by 2005, 70 percent was controlled by private companies. This proportion increases each year as non-profit centres struggle to survive with grossly inadequate government support, while private operators continue to expand their operations.
Demand for child care has greatly increased in recent years, with most families now pressured to have both parents in paid employment in order to survive financially. More than 700,000 Australian families have their children in formal care, with 600,000 children now attending long-day care, 150,000 in family day care, and a further 15,000 in occasional care. Demand continues to outstrip supply, with an estimated 50,000 children missing out each day.
Parents are faced with escalating fees, now typically ranging between $55 and $105 per day. From June 2006 to June 2007, fees rose by 12.8 percent. This was the fifth consecutive year in which costs rose by more than 10 percent, and represents a cumulative five-year increase of 88 percent—an inflation rate far higher than for other goods and services.
ABC Learning positioned itself as the prime beneficiary of the privatisation drive. In 2001 the company was floated on the Australian stock exchange and embarked on an aggressive expansion strategy, based on eliminating smaller and non-profit providers.
ABC’s rise was a direct result of the billions of dollars in public money funnelled into the private child care industry. It derived nearly half of its $1 billion annual income from the guaranteed stream of Child Care Benefits paid by the federal government. Business Review Weekly noted in 2003: “With profit margins of up to 50% and $1.6 billion of taxpayers’ money flowing into the sector, everyone wants a piece of the child care action. Diamond-miners, dot-com pioneers and real estate agents are getting on board.”
ABC Learning’s founder Eddie Groves amassed an enormous personal fortune through this process. He first made it onto Business Review Weekly’s annual Rich 200 List in 2002, and by 2006 had topped the “Young Rich List” (for those aged under 40). His personal wealth was last year estimated at $295 million, though this is understood to have since plunged along with ABC’s share price. Groves, nicknamed “Fast Eddy” in financial circles, was described in a 2006 Sydney Morning Herald profile as a “colourful Queensland businessman who favours alligator-skin boots, commutes by helicopter, drives a Ferrari and has impeccable Coalition connections”.
ABC Learning also boosted profits by suppressing its workers’ wages. Child care employees throughout the sector are among the lowest paid section of the Australian working class, usually earning between $13.90 and $17 per hour, with junior child care workers paid as little as $6.50 per hour. In a notorious episode in 2003, Groves sued the child care workers’ union for defamation after being criticised for forcing his lowly paid child care workers to clean toilets and purchase their own uniforms.
ABC staff have reported being grossly overworked. A survey conducted by the Australia Institute in 2006 revealed that ABC centres mostly operated with an adult-to-child ratio at the bare legal minimum limit (one to five). Staff said that they did not have the opportunity to develop meaningful relationships with the children in their care, due to the lack of staff and ABC’s additional duties such as paperwork and cleaning.
The rise and fall of ABC Learning underscores the disastrous impact of the relentless drive by the ruling elite to subject every sphere of social life to the dictates of the market.
AsianExtractor: Unearthing Accounting Fraud in Asia 