The traders of good soles appear to have sold their souls. Adidas has filed a criminal complaint for euro 125 million irregularities reported in Indian operations in the first quarter results of 2012. The complaint mentions “commercial irregularities uncovered at Reebok India”. After Satyam, this is the biggest fraud reported in a private sector organization in India.
Briefly, Adidas acquired Reebok a few years back, however, the Indian operations were merged in 2011. Subhinder Prem Singh, head of Reebok India was appointed as the managing director of the merged entity. In March 2012, both Subhinder Prem Singh and the chief operating officer Vishnu Bhagat left the company. Very few details are available of the case till date, but the twists and turns are interesting. From the looks of it, this is going to be full-blown war and a lot of skeletons are coming out. Below are the events till date.
1. Adidas announcement on 30 April 2012
Following extract is from the Adidas press release. The statement states that commercial irregularities to the tune of euro 125 million ( Rs 870 crore, USD 161 million) have occurred prior to 2012 and prior year financial statements may require re-statement.
“In addition, Management also announces that commercial irregularities discovered at Reebok India Company, in India, will likely affect the consolidated financial statements of the adidas Group. The currently estimated maximum negative impact could be up to a pre-tax amount of € 125 million. Due to the sensitivity of the on-going investigation, specific details will be disclosed as appropriate in due course. As these irregularities have been deemed to have occurred prior to the 2012 financial year, the adidas Group might have to restate prior-year consolidated financial statements in line with the requirements of IAS 8. The financial statements of adidas AG will not be affected by this issue. Management assures its stakeholders that it has, and will continue to, vigorously pursue a course of action to protect the Group’s interests, which has already resulted in the appointment of a new local leadership team in India at the end of March.
Under this new leadership team, Management is further planning an accelerated restructuring of its business activities in India, including significant changes to its commercial business practices. This could lead to additional one-time charges in the remaining quarters of 2012 in an estimated amount of up to € 70 million.“
2. Counter attack by Subhinder Prem Singh
After this announcement, Mr. Singh who initially reported that he left the organization on his own, clearly stated that he was terminated. He filed a case for damages of Rs 15 crore (USD 2.83 million, Euro 2.19 million) against Adidas. The Economic Times gave his version of the story. He says:
a) Adidas headquarters were “fully in the loop” on how Indian operations are run and it is not a one-man show. The finance chief of Indian operations was appointed by Adidas group last year.
b) He was called to Arizona, US on March 25, 2012 and after he presented the annual business plan, he was forced to leave and promised a severance package. Adidas did not give him a reason at the time of termination and he received a mail from Adidas subsequently that he was terminated due to “financial irregularities”. He denied any involvement in financial irregularities.
3) Further on he alleges that he exposed three major frauds in Adidas. He has given this statement on record – “The biggest scam was the scavenger deal (dumping rejects) running into Rs 200 crore, where about Rs 20 crore was illegally made by senior officials. However, the scam was brushed under the carpet because it related to Adidas and not Reebok, and the request to notify the fraud to the auditors at the year-end was turned down by the headquarters.” .
3. A few quick ones
a) Previous Frauds – While details are still not known, Mr. Singh’s statement about three previous frauds is definitely jaw dropping. He mentions Rs 200 crore (USD 37.36 million, Euro 28.15 million)) fraud in which senior officials made money. He doesn’t mention whether he terminated the senior officials or took legal action against them. As the managing director of the organization, he was required to investigate the frauds, take action and report the same to headquarters and auditors. He mentions that he sought permission from head office to report fraud to auditors. How can that nullify his responsibility as the head of the entity?
b) Dumping rejects – In Indian organizations sometimes, in rejects sales there is a percentage cut taken by the management. The modus operandi is that some good stuff is passed by the quality inspection team as sub-standard or rejects. These rejects are then sold at nominal values to previously selected vendors. The vendors unofficially give a percentage of the real value of the products to the management. This risk can be easily mitigated by frequently checking the quantum and quality of rejects and getting an independent valuation done of the products. Ideally, Mr Singh should have initiated these risk mitigation steps if he knew the problem. He doesn’t mention this, so can he escape liability?
c) Auditors Role – An Indian firm N. Narasimham & Co. is the auditor of Reebok India. In this case, KPMG is the group auditor, and till now neither of the auditors have made any statements. However, KPMG has stated that they did not audit Adidas or Reebok India for the past several years. But, as per recent reports in 2010 KPMG was appointed as a forensic investigator for Reebok and gave a clean report. If so many frauds were occurring in the organization, how come they did not detect and report anything previously?
In India, sometimes auditors take kickbacks to hide frauds, or don’t report frauds because they wish to maintain client relationships. Hence, again the question of auditor independence, liability and involvement are likely to arise. One has to wait and see whether this becomes another incident similar to Satyam PWC case.
d) Risk Management– The 2011 annual report of Adidas states that they upgraded the risk management IT solution in 2011. The Group Risk Management department maintains the risk and opportunity management system. The description of risk management process and techniques used is at par with the best-in-class. The supervisory board is responsible for monitoring the risk management system. According to the annual report, the audit committee in September 2011 checked group wide effectiveness of risk management, internal control system, internal audit and compliance organization. In November 2011, it discussed the internal audit report for the year and then also planned scope for 2012. The question is that if the frauds relate to previous years, then how come with all this narration in the annual report, the frauds remained undetected. Is the description risk management practices for the consumption of the investors, or do these practices actually function?
On May 2, 2012 Transworld Business reported that a former senior marketing manager of Adidas, Britney Obstar, was sentenced for master-minding a fraud scheme of USD 336,000. She got payments made to her husband’s company for services that were never rendered. She continued the fraud for over a year. This definitely shows that there are some loop holes in internal control systems for monitoring senior management activities and transactions.
This will be an interesting case to watch. It is apparent that global organizations face challenges in managing local subsidiaries. Without an efficient management and effective internal control and risk management systems, the corporate office will remain blissfully ignorant until it is too late. In India, the corporate governance practices applicable to public listed companies do not apply to private limited subsidiaries of international companies. Hence, the practices that are strictly followed at head offices may not be adhered to at local Indian offices, unless the organization is culturally and technologically integrated. This case will bring out a number of risk management lessons for global organizations. Hence, let us wait for the story to unfold further.