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Negligence makes it easy for fraud

`It is rare in Taiwan to hear of auditors and company supervisors sitting down to discuss a company's financial problems. In short, company-managed internal controls are fraught with problems in Taiwan's corporate governance. This is a systemic problem.'

Following the exposure of the Sinovision fraud, we see the authorities and auditors blaming each other. It seems there is little else to do apart from suggesting that investors not purchase stock in companies traded neither on the stock exchange nor on the over-the-counter (OTC) market. But such suggestions violate the function of securities markets.

Since a company can't be immediately traded on the stock exchange, investors purchasing stock on the primary market must -- unless they are powerful corporate investors who may be able to use the advantage of their capital to force a company to give up important information -- rely on the legally required disclosure of information, accountants' audits and attestations and effective law enforcement. Simply telling investors not to buy stock that is not traded on the stock exchange is unfair to the needs of corporate capital.

The authorities neglected their responsibilities in the Sinovision fraud. The Securities Exchange Law (證券交易法) specifies that even a company whose stock is traded on neither the stock exchange nor the OTC market must submit an annual financial report, an audited semi-annual report, an audited quarterly report and a monthly report of the business situation to the authorities.

In 1988, however, the Securities and Exchange Commission -- which became the Securities and Futures Commission in 1997 -- issued a written order exempting companies traded on neither the stock exchange nor the OTC market from these reporting requirements. Not until this May did the commission announce that the reporting requirements for these companies as specified in the Securities Exchange Law would be reinstated beginning next year.

This makes it impossible for investors to obtain timely company information or for auditors to carry out timely reviews of a company's finances. These immoral practices originated when the authorities ignored the management of these companies that do not trade on the stock or OTC markets.

Investors are also unable to get information about these companies on stock-index observation Web sites unless they pay for access to the Securities and Futures Institute database or visit the institute's library in Taipei. What's more, they will only find the annual financial report and the public statement issued at a company's initial public offering.

When regulations forcing a public offering when a company's capitalization reaches NT$500 million were abolished by an amendment to the Company Law (公司法) last year, hundreds of companies applied to the commission to have their public company status cancelled. Obtaining public status is a major event and it is strange that it can be cancelled. After cancellation, a company loses all transparency. There are no related regulations in the Securities Exchange Law -- this is left to the Company Law -- and the only information channel left for investors is the annual shareholders' meeting. There is no way to protect investors.

In the US, information has to be continuously made public once a company's assets reach a value of US$10 million or if there are 500 or more investors in the company. It is not possible to automatically cancel a company's public status as can be done in Taiwan.

Even though Sinovision auditors did not falsify any documents related to Sinovision's accounts, they can't avoid legal responsibility by saying that the problem was with the accounts. Auditors followed basic procedures and the degree of involvement of Sinovision's auditing team can be exposed by human and material evidence. We of course have to wait for the results of the prosecutors' investigation.

The accounting scandals at Enron and WorldCom in the US resulted from neglect or communication problems between external auditors and the companies' boards of directors or personnel related to internal auditing.

It is rare in Taiwan to hear of auditors and company supervisors sitting down to discuss a company's financial problems. In short, company-managed internal controls are fraught with problems in Taiwan's corporate governance. This is a systemic problem. Possibly due to personnel restrictions, the authorities do not normally want to take the initiative to monitor the situation, and they also give auditors many duties beyond legal requirements, even though auditors do not necessarily carry legal responsibility.

This poses a dilemma for auditors, but the investor is the loser.

It is surprising that this scandal was exposed by a legislator rather than the authorities. In theory, when the authorities encounter similar cases of companies delaying the reporting of information -- in particular with regard to companies that do not trade on the stock or OTC markets -- they should take the initiative to investigate further. If they are certain in their suspicions of criminal activity, they should hurry to report these suspicions to prosecutors and investigators. Otherwise they will only add to society's loss and lose the prestige that comes with public power.

Yie Ming-chiu is an assistant professor in the department of business administration at Shih Chien University.

Translated by Perry Svensson
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