Published November 17, 2008

Advance Modules: Could trouble have been detected earlier?

By LYNETTE KHOO
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THE report released by special auditors KPMG on Advance Modules last week presented several stunning findings - fake records of sales were used to meet an internal profit target and subsequent actions were taken to cover up the matter.

Many market watchers were probably perplexed to see a second company come under probe by the Commercial Affairs Department so soon after the well-profiled Jade Technologies debacle this year.

One wonders if alarm bells could have sounded earlier. For if one had cared to dig deeper into the affairs of the group, one would have noticed that signs of trouble emerged three years back.

Barely nine months after its listing in September 2005, the Malaysian semicon company had its FY05 accounts qualified by its external auditors, Deloitte & Touche.

Deloitte had, in May 2006, refused to give the accounts a clean bill of health, as it was not satisfied with the validity of a transaction between Advance Modules and Hong Kong-incorporated Long Gain Technology, which later became the focal point of the KPMG findings.

Advance Modules purportedly agreed to sell memory modules to Long Gain for US$14.4 million. Though this was booked into its FY05 profits, the outstanding trade receivable was not settled as of the first half of 2006. The unpaid debt, among other things, prompted a query from the SGX. The group founder and managing director Vincent Tan, in an unusual move, personally indemnified the US$14.4 million owed to the group by the customer. There were also concerns over any breach of Companies Act then.

Last year, the group's new auditors, Horwath First Trust, were also unable to give the FY06 accounts a clean bill, echoing similar concerns over the validity of the Long Gain sales, among other things.

In April this year, Horwath said that it could not form an opinion on the payments of US$12.1 million made during FY07 for new machines by the group.

SGX decided to take action, asking the group to appoint special auditors to look into this.

Let's pause here for a while. The first qualification by Deloitte may not have raised a flag. But a second qualification by a different auditor Horwath should have suggested a need to probe further into the Long Gain sales.

It took a third audit qualification to get things moving, with the Singapore Exchange directing the appointment of special auditors.

So far, the findings of KPMG have confirmed the worst. According to KPMG, the sales record was said to be fabricated in order for the group to meet its targeted net profit after tax of RM17 million (S$7.2 million) for the year ended Dec 31, 2005. Without the sales record, the group would have incurred a net loss for that year.

Revenues from these sales were accounted for in FY05 although shipments were made in 2006. KPMG also found that instead of memory modules, the group had shipped integrated circuits to Long Gain to avoid writing down losses on its inventory. The ICs were shipped back from the end-customer to the group's Malaysian unit AMSB. But they were booked as ICs from AMPS Trading, which is believed to be controlled by Mr Tan.

In order to create the illusion that it is receiving payment from Long Gain for the purported sales, Advance Modules sought in vain to procure letters of credit from various parties.

The group then entered into 'round-tripping' transactions to make it seem like it was receiving payment from Long Gain Sales. But in reality, funds were disbursed from the group through a round-about transaction to Long Gain and then back to the group, according to KPMG.

This 'temporary' cash that Advance Modules received was immediately disbursed as payments for 14 new machines from Diviner Technology Corp at US$17 million, KPMG said. But the value of the machines was found to be inflated from the original cost of US$3 million.

Looking at the complex series of transactions involving several parties, one wonders how this could happen over a period of three years without detection, leaving the market inadequately informed.

Could independent directors play a greater role in asserting more pressure on the management to come clean with the payments in question? Some initial payments for the new machines were said to be made without prior approval or knowledge of the board. KPMG said that the board approved a wafer project during a meeting in August 2007 'only on the grounds that the group had, based on the group's books, already paid more than US$10 million for the new machines'.

Could employees be the whistle-blower to the regulators? According to the KPMG report, an e-mail correspondence shows that an employee at the group's Malaysian unit AMSB had raised concerns about 'the lack of documentation to substantiate the purported purchase of the Long Gain ICs from AMPS'.

According to KPMG, the then group accountant was understood to have asked employees at AMSB to fabricate warehouse records and production records.

Clearly, there were early signs of trouble at the group. Audit qualification was but one. So, it's a shame that it took three full years before someone smelt a rat and went about catching it.