Sat, May 04, 2002 page19

• The story of a company that was not there

  That a German company managed to make up millions of dollars worth of sales without anyone noticing is testament to the malaise in auditing and, perhaps, in the financial system itself

  • By Matthew Lynn / BLOOMBERG
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  The rogue's gallery of companies that dupe investors is filling up. There have been companies with unaccountable partnerships, companies that renege on their bonds, and auditors who failed to add. Yet for audacity and scale, few can match ComRoad AG, a maker of tracking devices for cars and trucks formerly listed on Germany's Neuer Markt.

  Two years ago, ComRoad looked like a successful business. At its peak, it was valued at 1.2 billion euros (US$1.08 billion). It had heavyweight bankers offering it credits, international auditors signing off on its accounts, and respectable analysts touting its shares. Yet for much of that time, ComRoad was a phantom, a ghost. It was a company that wasn't really there.

  Earlier this year a firm of special auditors, Roedl & Partner GmbH, was appointed to look over ComRoad's books. Roedl found that in the past financial year, 97 percent of ComRoad's 93 million euros in sales were fictitious. Actually it had sales of only about 3 million euros. The other 90 million were made up.

  ComRoad is a story full of humor and pathos. But it is also a story that poses tough questions. How were they undetected for so long? And if they got away with it, what might others also be getting away with? It is a story from which several different lessons should be learned, none of them comforting.

  The first, most striking point about ComRoad is just how unsophisticated the people in charge of it were. ComRoad was run by Bodo Schnabel, who has since been arrested, though not charged. His wife Ingrid was also on the board. Whatever it might have been that Bodo and Ingrid talked about in the evenings, it probably wasn't how to work the perfect scam. Their trick was more Mickey Mouse than Moriarty.

  Since sales were not quite what they were hoping for -- indeed in the final year they were virtually non-existent -- ComRoad just invented a company in Hong Kong to which they said they were selling loads of stuff, according to Roedl. Between 1998 and 2000, ComRoad claimed that a company called VT Electronics Ltd placed orders of US$470 million. On closer examination by the special auditors, VT turned out not to exist.

  No such company.

  The deception reflects not just indolence on the part of the management. What was the point of creating an elaborate, complex deception when an artless, inept one would serve just as well? After all, it worked for three years.

  Another question posed by ComRoad is, what were the regular auditors KPMG up to? In the wake of the Enron Corp/Arthur Andersen scandal, it has become common to heap blame on Andersen.

  This story suggests the malaise in the auditing profession goes much wider than that.

  In February this year, KPMG resigned as auditors of the company. Boerse Online reported in Germany that on questioning by KPMG, the ComRoad management couldn't actually locate the address or the phone number of the customer that by then accounted for 97 percent of sales. A KPMG spokesman confirmed the report. Wouldn't an auditor wonder about how a company could order almost US$500 million of stuff, and not even leave a return number? KPMG deserves some credit for resigning -- although they would have gotten more if they had told shareholders why they resigned, and what they uncovered. But more importantly, KPMG had for two consecutive years signed off on accounts where more than half the sales were to a company that didn't exist, a fact that could have been uncovered by calling international directory enquiries. What is it that KPMG auditors do exactly? Eventually ComRoad started inflating its imaginary sales.

  Just this past January, ComRoad said its annual sales were growing at 114 percent -- proof, perhaps, of the adage that if you are going to tell a lie, you might as well make it a big one.

  Analysts covering the company didn't appear to spot the deception. Dresdner Kleinwort Wasserstein, to its credit, slapped a sell note on the firm last year, but several other banks, including Deutsche Bank AG, rated it a neutral or a buy. Nor did any of the journalists covering the company report that anything was amiss.

  What of ComRoad's 24 employees? After all, in a company with almost no sales, there can't have been a great deal to do all day.

  Likewise the bankers. Wouldn't they have expected to see some evidence in the company's bank account that sales were doubling every year? ComRoad was brought to the market by Concord Effekten AG and Hauck & Aufhaeuser, two small but well-known German banks. HVB Group, Germany's second largest bank, was involved when the company sold more shares in November 2000 (after it started making up sales). Does HVB check a company before it starts selling its shares? (Concord says on its Web site that it carried out due diligence on the ComRoad IPO and feels "cunningly deceived."

  A spokesman for Hauck & Aufhaeuser said the bank relied on information from Concord, the lead manager, and didn't undertake further checks. A spokesman for HVB said the bank relied on positive reports from accountants and lawyers it hired to check ComRoad.) ComRoad is by no means alone. Last week Advanced Medien AG, a German film licensing company, announced it had re-calculated its accounts for 1999 and 2000. It turned out to be making losses without realizing it -- the 1.3 million-euro profit it reported for 1999 was now a 11.1 million euro loss. Likewise, Phenomedia AG has also asked for a special audit of its old books.

  Catherine the Great of Russia, on her tours of her empire, used to be shown Potemkin villages: brightly colored shells, with actors playing happy, prosperous peasants. These days we have Potemkin companies.

  Any system in which glossy confident facades are used to conceal empty, hollow shells is in a deep state of decay. That it allowed ComRoad to flourish suggests there is little future for Germany's Neuer Markt -- and it may suggest as well a much deeper malaise across the financial markets that could yet take a long time to cure.
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