Flight Of Fund Essay
Flight Of Fund
In 2010, Mr. Idris was hired as the Chief Operation Executive (CEO) of Travel Investment Holdings Berhad (TIH), a government linked company (GLC) in logistics and travel related business. The first task as the CEO of TIH was to identify solutions to recover the losses of the company due to the economic crisis in 2009. In order to diagnosis the problem, Mr. Idris called for a meeting among senior managements. He found out that there was no-result investment made by one of the subsidiaries, Malaysian Travels Sdn Bhd (MTSB).
In 2006, MTSB had a joint ventures with Turkistan Global Services Sdn Bhd (TGS) to form a new entity, Malaysian Turkistan Travel Sdn Bhd (MTT), in the purpose of exploring travel business opportunities in Turkistan. In this entity, MTSB holds 40% of the shares whereas the others held by TGS. However, there was no progress after the forming of MTT. He recalled that his friend, Norehan who had worked in MTT before. She told Mr. Idris that the company may have been established under fraudulent circumstances and the staff’s morale was very low due to late salary payment.
Therefore, Mr. Idris decided to have a detailed investigation on MTT by outsourcing to external auditor, Mr. Agoos Bagoos. During investigation, Agoos found out that MTSB only had a few staff and the company operations were severely curtailed due to lack of funds. Besides, there were no relevant documents related to investment in MTT and MTSB did not have any effort to contact MTT to enquire any documents.
Based on the Memorandum of Understanding (MoU), MTSB paid RM8 per share for 100,000 units to represents its 40% shareholding in MTT. Through the investment, Agoos realized that MTT’s paid up capital have increased from RM 2 to RM 250,000 on July 2006 and there were no audited accounts had been issued to shareholders, nor any filing made with Companies Commision of Malaysia (CCM). In order to solve these problems, the root causes of the problems are identified and solutions are proposed in this study.
2.0 PROBLEM 1: LACK OF INTERNAL CONTROL
2.1 Root cause
There are several root causes to this problem. First is the misconception of association and joint venture. In this case, MTSB has mistaken MTT as its association rather than joint venture. The main difference between joint venture and association is in terms of control. Based on IAS 28- Investments in Associates and Joint Ventures, an association is an entity over which an investor has significant influence over the investee, but not control or joint control of those policies. As for joint venture, it is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.
On the other hand, internal controls are the mechanism adopted in a business to protect its assets, ensure the accuracy and reliability of the financial information, ensure compliance with all financial operational requirements, achieve operational efficiency and generally assist in achieving business’s objectives. The various types of controls, manage the risks to an organization. In accounting controls, the purposes include to ensure financial transactions are properly authorized and reported, access to assets is properly authorized, financial statements are prepared correctly and recorded assets are periodically compared and reconciled with existing assets.
It is clearly stated in the MoU that MTT is a subsidiary to MTSB, and therefore MTT is a joint venture between MTSB with 40% shares and TGS with 60% shares. Thus, MTSB has the responsibility to control over MTT. It is a jointly-controlled entity or incorporated joint venture with each venturer having respective interest in MTT. With joint-control, it encompasses the contractually agreed sharing of control and arrangements.
However, the office manager of MTSB had been instructed to inform the auditors, which in this case, Agoos Bagoos that MTT was as an associate company formed on equity-base and the amount invested was immaterial for consolidation. With this misconception, no wonder there was no internal controls been taken on accounting such as no documents on proper recording and authorization of financial transactions to prove the investment of RM 800,000 in MTT. Since it is a joint venture, the financial reporting can be consolidated.
Another reason caused this problem could be possible fraud. Norehan had told Mr. Idris that the boss of MTT was the son-in law to the previous director of MTSB director, Mr. Yatim Noor, and MTT was founded on contract using their relationship. Perhaps, MTT’s side claimed itself to be an association was to cover up the missing RM 800,000 investment, or MTSB intentionally lack of internal control due to the relationship between both companies’ bosses.
Moreover, the share capital of Balance Sheet of MTT in 2007 shows only RM 120,000 instead of RM 2 million capitals into the company; neither did it record the RM 800,000 investment, which is suspicious. Also, the senior management team in TIH was trying to conceal something when Mr. Idris seek for explanations. There was even no audited accounts issued to shareholders when the paid up capital in MTT increased to RM 250,000. That was why both Norehan and Agoos Bagoos both felt that MTSB was cheated and formed under fraudulent circumstances.
2.2 Possible solutions
Pertaining to the root causes mentioned, the first step to be taken is for MTSB to recognize MTT as a joint venture company according to the MoU and not an associate. At such, MTSB will have joint control with TGS over the matters in MTT such as financial/ economic activities and make strategic financial as well as operating decisions. For instance, oversee the RM 800,000 investment made by MTSB on the feasibility of the proposals and other projects. Consolidation of financial statements can be carried out, and the owner’s equity of MTSB will increase as well as the assets.
The control structure of MTSB should also be improved in all significant functions in MTSB in order to manage the risks faced by MTSB and to protect its assets like the RM 800,000 investment to achieve its objective in expanding the tourism business. Since MTSB has joint control over MTT, the audit committee from MTSB should monitor the progress in MTT at least twice a year to update the financial status/ positions like the cash flow for projects undertaken in MTT. In this case, the parent company, which is TIH should also impose a strict guideline regarding audit process.
In addition to the improved internal control, one of the considerations is by having an effective in-house internal audit-function as it 3rd-line of defence. Senior management and the audit committee must consider the competency and the leadership of internal audit and the head of internal audit department should be part of the senior management team. Nevertheless, the person holding this position should report directly to the audit committee and administratively to the CEO. MTSB could also consider setting up an independent team to monitor and oversee the progress of MTT as its subsidiary. As for incapable directors, TIH should restructure MTSB and appoint capable and reliable directors to restore MTSB so that positive working culture/ environment can be infused into the company for long-term sustainability.
3.0 PROBLEM 2: CONFLICT OF INTEREST
The second issue revolves around the conflict of interest among the three companies. Conflicts of interest arise when an individual or organization’s personal interest conflict with their other conflict-related responsibilities. These conflicts could arise as a result of intentional corruptions but in most cases, they occur as an effect of unintentional biases. However, since it is treated as a norm, especially if involving the higher management, people will underestimate the severity of bias caused by such conflict.
3.1 Root cause
A relationship-based style of management has long been established among the joint venture companies. During the venture’s setup, the executive director of MTSB had been Yatim Nor and his son, Omar Yatim had been the board member in TGS. It was later confirmed by former human resource manager of sub-subsidiary of TIH, Norehan that the boss of the joint ventures company, MTT had been the son-in-law of the MTSB’s director.
Figure 1 Relationship-based management style arise within MTSB, TGS and MTT
When a management system conflicted with relationship issues, the higher up’s decision making is jeopardized. The decision made is now to satisfy a personal need rather than the betterment of the company. This is proven by the swift agreement in establishing MTT. The MoU was too brief and lack justification of operational control. Such permission to a lacking memorandum depicts favourability among the family-based joint venture setup.
Lack of documentation and portfolio of monitoring MTT further portray the MTSB’s management style. Indistinctly, MTSB had loosened off their grip on MTT’s lacking management. A crucial portfolio such as subsidiary’s monitoring and issues with the Companies Commission of Malaysia are inexcusable mismanagement and surely had been done not by the capability of a leader in management control but an unintentional bias resulted from a relationship-based management.
Further ethical issue such as the prolonged mistreatment towards MTT’s staff highlights the conflict. The passive action towards this issue shows lack of coordination as well as lack of internal control between MTT and MTSB. Ultimately, many staffs will leave and overhead expenses will definitely increase.
3.2 Possible solutions
In strengthening the monitoring and preventive system, MTSB and MTT are proposed to oblige disclosing all management related issues and decisions during a frequent board of directors’ internal meetings and most importantly during managerial meetings with TIH. This would allow the holding company to audit the performance and tendency of subsidiaries’ management.
MTSB is also required to submit a clear and unbiased report to TIH regarding all of their current and future investments as well as businesses. MTSB is strictly commanded to abide by transparency, accuracy and objectivity of management as obligation of subsidiary company towards the holding company. These are seen as strong independent variables in improving the quality of corporate governance practices in the company.
4.0 PROBLEM 3: UNCLEAR LEADERSHIP AND POOR MANAGEMENT
Unclear leadership, conflicting values and an unclear vision are points that need to be addressed. Incapable director(s), be it in terms of administrative, operational, preventive, detective or even accounting, exhibit indecisiveness and fail to inspire confidence in subordinates and pass on very little information to the employees. The directors did not practice internal controls on preventive and detective measures that had caused MTSB suffered from stricken cash flow and still no actions was taken by the respective managers or directors to solve this issue. This led to the negative working environment with low employee morale for the past 3 years. Incompetent MTT leader may also be unable to answer queries raised by the employees, leaving subordinates in the dark over what to do. This is the main problem which leads to communication breakdown in the MTT and consequently affecting MTSB and TIH.
4.1 Root cause
Insufficient planning during the company building phase like surging forward with plans without taking the time to realize that the base assumption of the business plan is not adequate which could bound the company to fail. At the very beginning, TGS and MTSB didn’t have clear agreement about who will be in charge of the day to day operational control in MTT and how fundamental decision will be made. Leader is not aware of firm’s objectives also lead to the problem due to intemperate and inexperienced leader running the MTT’s operation.
4.2 Possible solutions
A frequent meeting among TGS and MTSB management team needs to be done in determining the operational control in MTT. Minutes of meeting should be kept, distributed and acknowledged. The issue arises which can’t be solved within the MTSB team shall be highlighted to TIH for necessary action.
As for incapable directors, TIH should restructure MTSB and appoint capable and reliable directors to restore MTSB so that positive working culture/ environment can be infused into the company for long-term sustainability.
Without discipline and accountability, optimal results are difficult to achieve, personally or corporately. Personal accountable shall be identified. If anyone was found to involve in any action related to fraud, appropriate actions shall be taken for the individual. After detail investigation, MTSB might discover some amount of money which could be recovering from previous paid in capital or remaining operational revenues and therefore increase in asset value.