An Update of Adidas India Euro 125 Million Fraud Story

In the last couple of weeks, some startling information was revealed by the media about the fraud. To recap, Adidas global management disclosed euro 125 million (Rs 870 crore, USD 157.68 million) fraud in India operations in the first quarter end report of 2012. Subsequently, Adidas India management filed a police complaint against the ex-CEO Subhinder Prem Singh and ex-COO Vishnu Bhagat. Now the battle lines are drawn and allegations are flying. Here are some surprising revelations of the case so far.

Adidas management is alleging “commercial irregularities” and mismanagement of Reebok operations for last five years. Reebok and Adidas India operations were merged under Mr. Singh last year. Mr. Singh portrayed it that the allegations are more about a power struggle between the two groups and Adidas India operations has similar number of unreported frauds, as mentioned in the earlier post.

Some financial numbers and other details that were reported by the media are:

1) Profitability of Adidas & Reebok India

An Economic Times article stated that Reebok India March 2010 reported Rs 786.1 crore (USD 142 million) total income with a loss of Rs 40 lakhs (USD 72,000) . On the other hand, Adidas India operations showed a profit of Rs 455.6 crore (USD 82.75 million) for the year ending March 2010, with a profit after tax of Rs 9.01 crore (Rs 1.63 million). Mr. Singh attributed the difference to two aspects. First, Reebok India had a share capital of Rs 23 crore (USD 4.16 million) in comparison to Adidas India’s share capital of Rs 99 crore (USD 17.94 million), hence has to pay interest on borrowed funds. Second, Reebok India paid a royalty of 5% on sales, that amounted to Rs 110 crore ( USD 19.93 million), whereas Adidas India isn’t required to pay royalty. Hence, Mr. Singh’s contention is that Reebok India  performed better than Adidas India.

This practice of charging royalty to one arm of the company and not the other in the same country, is somewhat controversial. It raises questions on the transfer pricing practices followed by the company.  The Income Tax department may view it as an intentional strategy to deflate profits to avoid taxation.

Subsequent to the story breaking, the Income Tax department has commenced an inquiry and issued notices to executives for probing financial wrong-doing in last four years to determine tax evasion.

2) Police Complaint

The FIR, which has been seen by Bloomberg UTV says that: 

– Irregularities include over-invoicing to the tune of Rs 147 crore (USD 26.64 million)
– Running a false franchisee referral programme, receipts from which were about Rs 114 crore (USD 20.66 million)
– Maintaining four secret warehouses where company goods were diverted, all of which have been sealed and goods confiscated
– Raising fake invoices of about Rs 98 crore (USD 17.76 million) to show higher sales and claim promotions, bonus and incentives
– And collusion with some customers to aid the two officers in the scam”

Behind the allegations, the details when pieced together give the following story.

According to the Economic Times story, Mr. Singh started gunning for the top job of the merged entity from 2008, knowing that merger was inevitable. He pursued expansion plans to show numbers and beat internal competition, at the expense of profitability.

The source of the problems appears to be the minimum guarantee strategy adopted for store franchises.  Reebok had 100 stores in 2003, and grew to 800 stores. As per the minimum guarantee program, the franchisee was given a specific sum, irrespective whether the company earned any money from the store. Small time business persons were invited by Reebok to open stores and these stores didn’t make any money. Hence, the costs ran high, with no revenues. Rumors are that some money was earned by Mr. Singh privately for opening these stores.

Another information shared by police is that Adidas management claim that Mr. Singh and Mr. Bhagat diverted stock to four secret warehouses near Delhi doesn’t hold much water as no stocks were found in the warehouses. Adidas India claims to have confiscated goods worth Rs 63 crores (USD 11.41 million) from these warehouses. According to the police, three of the four warehouses were empty, and the fourth the new management has taken the goods.

However, from the information available so far, it appears that sales figures may have been inflated, and closing stock deflated to show higher profitability and meet the growth targets. It is possible, that false sales invoices were created and the goods transferred to the warehouses. There are allegations from store owners also that there are discrepancies between statement of accounts. The debit and credit balances significantly differ. Hence, the sale invoices may have been made in the franchises name without an actual sale. If this is true, most of the internal controls were over ridden by management.

Another aspect reported was that German management at headquarters was aware of the complaints and various issues cropping up, however chose to ignore the same due the great performance being shown. They apparently didn’t take proper action on the auditors report also. Of course, there are likely to be questions raised as to quality of work done external and internal auditors.

With all the information available till date, the fraud figures don’t add up to Rs 870 crore (USD 157.68 million). The police investigators are stating that beside the complaint, no evidence has been provided by Adidas management till date. Reading the corporate boxing match, Registrar of Companies under Ministry of Corporate Affairs has commenced an investigation.

Closing Thoughts

With all the dirty linen being washed in public domain by Adidas group, it has attracted regulators attention. If the plan was to browbeat Mr. Singh, without adequate evidence the prosecution will fail. If in reality all the allegations can be proved, then Mr. Singh along with a number of senior executives are in hot soup. Till date it is the largest fraud case reported by a multinational company in India. Let us wait and watch to get some more juicy information.

References:

  1. How Adidas Slipped in India – Economic Times
  2. Reebok under tax lens, Adidas seizes goods from warehouses
  3. The Reebok Adidas scam – another corporate saga in courts
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