MONEY, INVESTORS in Touchwood Investments have found, does not grow on trees. Timber valuation methods used by Touchwood, which used to boast of being one of Sri Lanka’s most valuable brands by being ranked within the Top 100 Brand Index, have been branded unreliable by regulators and unverifiable by auditors. The firm is floundering, unable to pay liabilities on agarwood contracts taken on from a Thai forestry firm set up by its former chairman who has dumped his shares on the Colombo bourse and disappeared abroad. Touchwood faces allegations of mismanagement and a winding up motion. New investors have pledged to infuse funds. But larger liabilities loom ahead when contracts mature on local mahogany trees whose values are alleged to have been inflated to pump up profits and the value of its biological assets.
The timber investments products sold by Touchwood Investments always seemed as exotic as the species of trees it grew. At face value, mahogany, teak and sandalwood seemed fair investments, given the high regard for these types of timber along with their equally high demand and prices. Touchwood’s founder and former chairman Roscoe Maloney was fond of saying that investment in forestry was as sturdy as the timber products yielded by the trees the company cultivated and that, in the face of uncertainties, from global financial crises to climate change, Touchwood gave an alternative opportunity for sustainable investments also able to yield high returns.
Although the firm’s fair value accounting tactics were seen as exotic as its timber, because it was factoring tree growth in its profits, that did not deter many investors. The company conjured up high profits in its early days, firing the investing public’s imagination and sending its share price soaring to heights equivalent to those occupied at the top of jungle canopies by the type of trees it grew. Soon, more and more investors were persuaded to put down money on timber plots promoted as a sure path to profits plotted by Roscoe Maloney. It did not take long, though, for auditors and regulators to brand Maloney’s fair value accounting approach at Touchwood, the only pure forestry firm listed on the Colombo Stock Exchange and registered under the Board of Investment, as pure baloney.
Doubts about the exotic nature of forestry investments and the difficulties of accurately estimating tree growth and their future valuations as well as discounting methods to arrive at present values had always deterred some investors. These doubts gained added significance when, in April 2006, the Sri Lanka Accounting and Auditing Standards Monitoring Board determined that estimates of fair value of biological assets used by Touchwood Investments in 2005 and 2006 were “clearly unreliable”. The regulators were probing a sharp, unexpected increase in Touchwood profit after its adoption of International Accounting Standard, IAS 41 Agriculture that was yet to be adopted in Sri Lanka, instead of using the local standard. The company, the Board which monitors compliance with accounting and auditing standards said, was also not able to provide any other estimates of discount rates and the future cash flows used in the valuation of its forestry assets which were reliable. Further, SLAASMB maintained that under IAS 41 Agriculture, the trees, which had long to mature, should have been valued at historical cost as it is not possible to value them reliably at fair value. Under International Financial Reporting Standards (IFRS), the new global set of accounting standards, fair value is the price at which a transaction can usually take place and is used to determine the market value of an asset or liability for which a market price is not readily available, such as when there is no established market for the asset, in this case plants.
“Based on such valuation the company would not show a net profit for the relevant financial periods,” SLAASMB said, adding that the Board has also decided to investigate the compliance with auditing standards by the auditors KPMG Ford, Rhodes, Thornton & Co. Touchwood was then directed by the Securities and Exchange Commission in March 2007 to restate its financial statements for 2005 and 2006 on a historic cost basis. The company, however, challenged the order in the Appeal Court. Around the same time, KPMG qualified the accounts for 2006-2007, accusing the firm of overstating its sales, net profit and biological assets by some Rs783 million. The auditors disputed the discount rate used by Touchwood, which had used a low discount rate that effectively increased the value of the forestry assets and profits. Touchwood’s discounted cash flow method used a discount rate of 12% for mahogany while KPMG argued under IAS 41Agriculture future cash flows should be discounted using a current market-determined pre-tax rate of 17%. KPMG refused to express an opinion on Touchwood’s financial statements.
Following Touchwood’s court challenge and inquiries from stakeholders relating to the level of unreliability of the valuations, SLAASMB clarified its ruling, revealing how the firm had inflated its asset values. Touchwood’s model used for valuation in 2006 gives a valuation in excess of Rs.5,000 per plant at the time of planting, whereas the replacement cost is likely to be around Rs 500, the Board said, noting that the standard indicates that cost may approximate fair value, particularly when the impact of the biological transformation on price is not expected to be material. Touchwood Investments was also not able to justify the discount rate of 12% a year used to discount the proceeds on maturity of the trees even though the model is highly sensitive to the discount rate used, it said. In comparison, the rate used by Touchwood Investments to discount future expenses was 22% a year. SLAASMB noted that the accounting standard requires firms to use a discount rate which excludes any increases in value from additional biological transformation and future activities of the entity. Touchwood’s long-standing auditors KPMG Ford Rhodes Thornton & Company last year were replaced by Dayananda Samarawickrama & Company who reported on the financial year ended 31st March 2013 without any qualification.
Touchwood directors told the SEC at an inquiry in July 2013 that KPMG resigned as shareholders wanted them removed when, at the last AGM, the auditors were unable to answer shareholder queries to their satisfaction.
“The key issue,” explained an official familiar with the matter, “is in the valuation of biological assets. What the regulators found was that there was a huge profit recorded in those years that led to the share price shooting up. This was because of upfront gains shown by Touchwood giving a valuation of Rs.5,000 per plant although the replacement cost was around Rs 500. This can amount to millions. Furthermore, Touchwood Investments had to follow Sri Lanka Accounting Standards at that time and could not arbitrarily use foreign standards.”
The Appeal Court, however, in January 2010 ruled in favour of Touchwood Investments on a technicality, saying that as IAS 41 was not adopted in Sri Lanka at the time, SLAASMB did not have the power to monitor compliance with IAS 41. SLAASMB immediately appealed to the Supreme Court. When the case came up, however, it kept getting postponed. Inexplicably, on several occasions, it was put before the wrong bench of judges. The Supreme Court finally granted leave to appeal in July 2011. The case is pending.
While Touchwood was embroiled in a dispute over its accounting techniques, the Institute of Chartered Accountants of Sri Lanka, the accounting standards body, unwittingly lent the company credibility by giving it a Certificate of Compliance in its 2010 Annual Report Awards. This was for essentially a ‘tick-box’ type checklist exercise in which companies get marks based on disclosure and those above a certain threshold get compliance certificates. But it was used by Touchwood to give the public an impression its accounts had got ICASL approval while the court case was on.
The Appeal Court ruling had effectively stalled further monitoring of Touchwood by SLAASMB. Now, however, the Board is free to resume its reviews as Sri Lanka has adopted IFRS. IAS 41 is now known as LKAS 41 according to which Touchwood must do its valuations. LKAS 41 says that biological assets are normally valued at fair value and any gains or losses are normally taken into the profit and loss statement, unless on initial recognition, if fair value cannot be reliably measured, then the firm has to value at cost.
According to Touchwood’s 2013 annual report, Roscoe Maloney, whose whereabouts are unknown, had a 16.4% stake (17.5 million shares) as at March 31, 2013 but since then is known to have considerably reduced his holding. The company had started with only a small public shareholding following its IPO but this had changed to 70% public by May 2013, according to the evidence of two directors given at an SEC inquiry in July 2013.
Touchwood directors questioned by the SEC say the missing Maloney has a migratory business mindset, where he comes to one country, sets up different business models and hands them over to a professional CEO and migrates to another country to start another company. True to form, Maloney has moved, leaving behind unpaid debts and a bunch of investors hopping mad at the man who took their money and now does not even bother to meet them. From selling mahogany trees in Sri Lanka, Maloney migrated to selling agarwood in Thailand. Now the man is rumoured to be in Cambodia selling even more trees. The SEC stepped in and took the unprecedented step of freezing Touchwood’s non-current assets after allegations of irregularities and the Thai payment problem surfaced. One of the constraints faced by the regulator is that the markets operate on a disclosure-based system, forcing it to intervene only when disclosure is not adequate.
Touchwood’s latest problem flared up when news spread of a winding up action filed in the Commercial High Court of Colombo by one of its customer, K.A.D.L. Priyanka Nanayakkara who’s claiming Rs3.8 million as due on his investments in agarwood timber plots in Thailand which the company had promoted here. Nanayakkara declined to be interviewed, saying the new management’s offer to honour the Thai contracts has given them hope of getting a return on their Thai investments. The anguish over agarwood stems from a mismatch between the length of the investment contracts and the projected growth of the trees and portends an even bigger problem for Touchwood Investments here in the next few years.
The Thai agarwood contracts sold to Sri Lankan investors matured in 2012 after six years, although the trees mature in nine years. Customers then clamoured for their money. Touchwood Investments in Sri Lanka has now taken over the Thai contracts and paid off some investors here, in effect becoming the owner of the Thai liabilities. “They got a dud asset in Thailand,” was how one observer described it.
Buyers in Thailand have not been paid either and blame Maloney. Thai investors and shareholders of Touchwood Forestry Company have reportedly been told the firm had run out of money and that money for forestry investment had been diverted to Touchwood Ltd. Hong Kong. The CEO of the Thai firm Touchwood Forestry Co., Arunee Tippilar who is also a director of Touchwood Hong Kong, is no stranger to Sri Lanka, having visited the island several times. In March 2012 as the new president of the Thai-Sri Lanka Chamber of Commerce she led a Thai business delegation to the Expo in Colombo.
It is not clear whether or how Touchwood sent money overseas to buy Thai timber plots with money raised from Sri Lankan investors. Central Bank officials say they’ don’t know if the firm sent money abroad or raised funds overseas. There is no record of Touchwood taking out money or asking for Central Bank approval to do so. However, Maloney is an Australian national and foreigners are allowed to bring and take out money without Central bank approval. The banking regulator does monitor capital flows but these are mainly aggregates that banks report. Banks do have an obligation to flag suspicious transactions but appear to have had no reason to do so in this case, although subsequent investigations might necessitate more rigorous probing, especially if ordered by courts.
During inquiries by the SEC, Charles Jeffery Ebert, former CEO of Touchwood Investments and Prageeth Bandara Herath, former Plantation Director of Touchwood Investments revealed alleged malpractices by Roscoe Maloney and his wife Swarna, who till recently was deputy chairman and managing director of the firm. The Maloneys have set up similar businesses in Thailand, Hong Kong and Cambodia, as well as a firm called Touchwood (Pvt) Ltd. in Sri Lanka. According to an SEC motion filed in court giving the evidence of former directors, the Maloneys are alleged to have transferred assets with inflated values to Touchwood Investments causing a loss of about Rs140 million to the company. These directors allege the Maloneys owe Touchwood Investments Rs200-300 million and that they tried to dispose of a 40-acre land with 7,000 tea trees held as a buffer stock.
When Touchwood Forestry Company Ltd., Thailand faced difficulties in honouring the agarwood contracts when they matured, the Maloneys made out to Sri Lankan investors in the product that the Thai firm was part of the same group and that the Sri Lankan company would resolve matters. Touchwood Investments in Sri Lanka used Rs70 million to buy the certificates of Sri Lankan clients who invested in Thai agarwood but even this proved not enough to meet the liabilities of the Sri Lankan investors. Then, Touchwood (Pvt) Ltd. issued debentures to the public and raised over Rs200 million to pay the agarwood clients with sandalwood and vanilla buffer stock belonging to Touchwood Investments offered as collateral for the debentures. These debentures will mature in 2015.
The new Chairman of Touchwood Investments, Lanka Wijendra Kiwlegedara, has appeared as a kind of ‘white knight’ willing to save the company in distress. Kiwlegedera says he has faith in the company’s business model, and that he wants to revive and restructure the company under a different name. He acknowledges the huge risk he’s taking in pledging to infuse Rs200 million into the firm immediately and more later on but believes there is long-term potential. “I have a network of friends and investors overseas and aim to bring in foreign funds, perhaps from Britain and Singapore,” Kiwlegedera, who joined Touchwood Investments as Business Development Manager and also runs his own, separate quartz powder export business, told Echelon in an interview.
He says he is no associate of the Maloneys and claims he does not know where they are now, having last met Roscoe Maloney in Cambodia during a visit there earlier this year. He believes they are no longer in Cambodia and says he does not know how to contact Roscoe Maloney. Kiwlegedera believes the Maloneys had mismanaged Touchwood Investments, using their power as majority shareholders at the time and not keeping the then-board properly informed.
Kiwlegedera has started a fresh, independent audit of the firm’s accounts, is doing a revaluation of its plantation assets and is telling investors to stay put, that the new management will revive the business and repay them, even though right now all promotional activity is stopped and the firm has no revenue. Touchwood Investments revenue came mostly from the sale of tree plots. Once these trees mature in the years ahead, they can be harvested and investors given their money, Kiwlegedera says.
At the beginning, Touchwood was offering investments with a down payment of around Rs5,000 for a mahogany tree and promising to pay Rs200,000 at the end of 18 years when the tree is harvested. “They were saying the trees will be harvested in 18 years time and were guaranteeing a certain value,” says one official familiar with the scheme. “Investors were assured because of the company guarantee. It was more or less like a deposit.”
Touchwood’s 2013 annual report features mahogany investments with an initial down payment of about Rs400,000 for 40 trees (Rs10,000 per tree) followed by annual maintenance fees and showing returns of 17% amounting to Rs10 million when harvested after 18 years.
Although tree ownership certificates were given to investors, Touchwood is allowed to show the trees as assets in its balance sheet. That’s because even though the trees technically do not belong to the firm, since it assumes the risks (and rewards) of maintaining the trees, it can bring the value of the trees into its books (just as much as its liabilities – what it has promised to pay clients).
“The problem is that when the 18-year period is over and when the contracts mature, the trees will not be matured,” says the official. “This is the same problem Touchwood faced with agarwood in Thailand.” Forestry experts believe mahogany takes 25 – 30 years to fully mature to a level where the wood yield can be optimised. Regulators have been demanding Touchwood show evidence of mahogany trees maturing in 18 years. All Touchwood had to do was to show such growth in an existing plantations. But the company could show only calculations.
“The other problem is that even if the trees do mature in 18 years, it is unlikely they’ll be worth Rs200,000 each,” says the official. “Current values according to Touchwood’s own annual reports for the last six or seven years has been around Rs 45-50,000. It has not grown at the rate they projected. The problem is the asset is not properly valued. Now there won’t be any deposits coming in because people have realised the game. So the asset value will keep going down.”That means a looming cash flow problem for Touchwood when these initial contracts mature in another nine years time, around 2022 or so. “The company is liable to pay Rs200,000 at that point and they will get into difficulty then when they don’t have that money. That will be when the real problem will start. It will be bigger than the Thai problem. The Thai sickness was caused by the same disease – promising returns in six years on an asset that matures in nine. Here it is 18 years, instead of 25. It will be similar to finance companies going bust by promising high returns. They have promised something that the tree will not deliver. That’s why there are such big liabilities in Touchwood’s balance sheet amounting to billions.”
Critics says Sri Lanka’s capital markets and retail investors are not mature enough for pure, hard-core, disclosure-based regulation as found in developed markets and instead needs a mix of disclosure- and merit-based regulation. “Saying ‘let the buyer beware’ is simply not good enough for markets at our stage of maturity,” was how one former regulator put it.
The Touchwood scandal comes at a time when the authorities are trying to encourage more listings and attract foreign investment. If not handled properly, it could undermine investor confidence and hurt growth prospects.
The Touchwood saga highlights many things that are wrong with Sri Lanka’s capital markets. All regulatory, oversight and standards bodies involved appear to have done their job, albeit within their respective, limited ambit. Unfortunately, there’s no regulation to cover forestry investments of the type Touchwood does. Maloney was able to operate right under the noses of a phalanx of regulators because of legal delays and the absence of regulation for biological assets, which now seems a dire need given the other forestry investment firms which grew after Touchwood.
Investors blame the regulatory and oversight bodies for letting the situation deteriorate to the extent it has but these organisations maintain they did what they could within the scope of their powers and were hamstrung by regulatory loopholes and legal delays. To be sure, there were plenty of early warning signs that something was wrong. The promised high returns just seemed too good to be true. The company’s aggressive marketing methods triggered much talk about this new type of investment. Touchwood’s tree valuation methods were questioned early on. Even a cursory glance at the accounts showed profits inflated by unrealised gains from revaluation of trees. And there were reports from other countries like India where regulators cracked down on forestry investment scams.
Regulators acknowledge that public awareness of the capital markets and its risks is still inadequate. But they point out they cannot micromanage businesses or get involved in management. Investors must share the blame for their own plight if they are blinded by greed, ignore basic precautions and bet on high-risk investments, when the promised high returns don’t materialise.
Although Touchwood appears to be asset-rich, that’s misleading as the trees are believed to have been over-valued and the assets shown in the balance sheet are unlikely to be realised. Even if the asset valuation is corrected, that does not mean the liability goes off. If the company is liquidated, creditors will get only a small portion of what’s owed them. That’s because Touchwood would be forced to sell its land and whatever timber is available at normal market prices, not fancy prices. Selling the land might be difficult if road access is limited while its plantations still have a lot of plants and saplings. Shareholders are unlikely to get anything if the firm is liquidated.