The last few months have unearthed a huge number of accounting scams in the world and especially in USA. Although this is not a new phenomenon what has come as a rude shock to markets and investors is the scale and the blatancy involved in these recent scandals. Most of these cases belong to the erstwhile reputed and giant companies and the ‘cooking’ done by them has surely left the investor with a very bad taste in his mouth. What has certainly not helped is the fact that the numbers involved are in billions and the fall of the company so meteoric that the investor had no time to take corrective action.

        

This note aims to provide the reader with a deeper understanding of some of the critical issues involved in this subject and the entire discussion has been presented with a clear focus on the Indian context. The key issues covered in this note are:
· Spread of scams: Are the recent discoveries just small blots on a largely clean slate or is there sufficient data to suspect that the practices are more prevalent?
· Methods used in these scams: Are these scams a manifestation of the loopholes present in the current accounting standards or is it a case of illegal accounting done in connivance with the auditors?
· Reasons for these scams: What are the basic reasons for the occurrence of these scams? Is the market itself partly responsible for these scams?
· Possible solutions: Now that these scams have surfaced, what are the various options available with the government and the regulatory authorities to protect the interest of the investor in future?
Spread of scams – How deep does it go
The following facts give an idea about the prevalence of such cases of:
· A recent study conducted last year by Global Data Services, a subsidiary of the credit rating agency CRISIL, has come out with alarming figures related to misreporting of figures. Out of 639 companies included for the study, 139 companies were found to have overstated their profits, some to the extent of 1000 per cent over the norms set by CRISIL.
· Department of Company Affairs (DCA) charged as many as 73 companies last year of fund-diversion, inadequate disclosure of information in balance sheets, misleading reports on utilization of funds/cash-flows and violation of accounting standards.
· Kanpur based Midas Touch Investors’ Association has prepared a list of 229 companies that have been identified as ‘having vanished ‘ with investors’ funds in the post 1993 IPO mania.

So even though some of the high-profile cases capture the attention of the investor, the problem is deep-rooted.

Methods used - the art of ‘creative accounting’
An understanding of the various ways in which the accounts are fudged, is helpful for investors so that they can take a well informed decision. Some of these methods are discussed here:
· The big path ploy: Taking a large write-off to book costs now and report earnings in the future
· The vendor financing ploy: Overstating revenues by lending to the fragile customers so that they buy more products and the sales are boosted
· The ‘before its time’ ploy: Treating pending sales as if they have already occurred and booking sales without reducing the rebates
· The backdoor bargains ploy: Promoting sales by buying a big customer’s stock or granting it cheap warrants

The list is not exhaustive and presents only the most common and easy ways to ‘cook the books’. The following is a description of some cases related to misreporting in the Indian context:
· Nestle India’s contingency provision swelled from Rs 42.08 crore in 1998 to Rs 103.8 crore in 2001 accounting for around 12% of Nestle’s total assets. This helped Nestle present a more stable growth in profit in that period and also left a sufficient buffer to cover up for a bad year in future.
· Hindustan Level Limited (HLL) has been using a method of accounting whereby it proportionately allocates the “restructuring charge” (charge related to mergers and disposals etc) to all the four quarters of a year to smoothen the profits. Also interestingly, in the forth quarter HLL finds that the restructuring costs have been lower than estimates and hence it is able to show better figures for year-end profits.
· Proctor and Gamble (P&G) Hygiene division explained its 42% slide in net profits in 2001-2002 compared to the previous year by mentioning in the annual report that the previous year’s figures contained an exceptional income of Rs 10.05 crore. Interestingly this fact was never mentioned in the annual report of 2000-2001 when the income was actually realized.

The list of cases that can be presented here is endless and contains renowned companies like Reliance, Ranbaxy, Dr Reddy’s Labs etc. It can be seen that if the so-called pioneers of the industry are indulging in such activities, then the state of affairs at the relatively overlooked second rung companies is not difficult to imagine.

Reasons for the irregularities – Do we look inwards?
It is not difficult to find out the reasons why companies resort to such practices. Some of the explanations are:
· Accountability of auditors: There is an inherent contradiction in this system that the auditors are paid by the companies themselves and hence the auditors are reluctant to present the actual figures due to the fear of the loss of the long term contact with the company.
· Misplaced priorities: Stock markets lay too much emphasis on the short term parameters of performance like ‘sales’ and ‘net profit’ of any company without giving adequate importance to the measures taken by the company to improve long term profitability. So companies are tempted to be short sighted to present good figures for the current period putting at stake the long term profitability of the company.
· Personal gains for Managers: Most of the managers at top positions have an ESOP component to their salaries which means that they gain directly by an increase in the share price. So they are tempted to present better figures in the markets.

It is fair that any instance of malpractice by a company should be condemned in the harshest of words and penalized by punitive action. But the markets and investors should also look inwards and see their contribution to the present state of affairs. May be there is a case for giving more importance to the long term steps taken by the company to increase profitability even if these steps result in slightly poor results in the short run.

Possible solutions – Belling the cat
There is an urgent need to restore confidence amongst the investor community by taking immediate and strong actions to curb the use of unfair practices used by companies in reporting financial figures. Some of the areas for improvement and the possible solutions are:
· Improving the accountability of audits: This can be improved by implementing a system where the auditors are not paid by the companies but by the stock exchanges as they have larger interest in getting the credible figures from the companies. Another option to look for is to implement a system where no auditor is allowed to audit the same company again in the next 5 years so that the business considerations do not come into the picture for the auditors. Also there is a need to stop the consultancy services offered by the auditors as the companies use it as a carrot to make the auditors close their eyes.
· Reworking the standards: Indian accounting standards are based on the Companies Act 1956. There is a need for a complete overhaul of the accounting standards and making them binding on all audit firms. Best practices from all over the world should be studied and the act should be changed to enforce stricter laws. SEBI should also be a part of this ‘overhaul’ committee to include the interest of the investors.
· New regulator: The Institute of Chartered Accountants of India (ICAI) has failed miserably in its role as the regulator and there is a need to create a separate regulating body which could comprise members from the RBI, SEBI, Comptroller General of India and of course ICAI. This regulating body should be given adequate power and the authority to enforce the rules of the game.

Accounting information can be used to assist both financial and managerial oriented decisions. In order to come to effective financial or managerial decisions, many factors other than accounting should be duly considered.

Accounting information is extremely vital in/and for all enterprises though it does have certain limitations.

        

I. Accounting is only one source of information and primarily provides information based on financial terms: Although this information is vital, decisions cannot be based solely on a monetary basis. Various decisions depend upon a diverse range of issues being considered. A unique combination of Quantitative as well as Qualitative factors should be considered to ensure an effective decision making process.

II. The historical perspective of financial accounting: In order to obtain a recent estimate of an entity’s financial performance, the corporate managers carefully scrutinize financial accounting information. In retrospect, this information is based on past performance. The information does provide clarity on the monetary issues but does not provide a definite insight into the strategic future; as the future holds various changes in terms of technology, economic situations as well as political scenarios etc. Such factors in relation to accounting are unpredictable. Therefore, a careful balance between historical accounting as well as the future forecasted outlook is required.

III. Historical cost accounting vs. underlying value in use: Some items loose their monetary value over a period of time, but under the financial accounting rules need to be included in financial reports. Though mentioned year after year in the books as monetary figures, the information may be unreliable due to the historical assumptions made on the item’s measurability criterion. For example, a machine in a textile factory is considered to have a useful life which extends over a period of ten years in monetary terms; however, after the period of ten years, the machine may still have the same value as prior years and contribute significantly to the overall operability of the factory.

IV. Inability to reflect the true value of strategic management: Various factors such as goodwill and natural circumstances influence the operations of an enterprise; however, these elements are difficult to measure thus, leading to their unavoidable exclusion from financial reports. For example companies depend upon their shareholders, who in turn depend on the performance of the Chief Executive Officers. Although the CEOs may have been hired by the company based upon prior performance, their future performances are not reliably measurable as they may continually vary. In the initial stages, it may be impossible to measure whether the CEO’s presence will deter or appeal to the shareholders, which in turn will influence the profitability of the enterprise.

V. Measuring Volatility of external factors: Financial accounting information does not take into consideration volatile and ever increasing changes in the natural and commercial environment. Although scarcely measurable in monetary terms, their unstable nature may have adverse effects if included within the financial reports and have a volatile and cosmetic impact upon the earnings of the firm. For example, tariffs on trade, duties and other environmental issues can have significant short-term volatile effects on the organisation.

VI. The effect of non-stable monetary unit: Based from region to region, accounting information is generated at all enterprises based on the assumption that the monetary unit is stable over a period of time. In the real world scenario, the unit fluctuates on a daily basis. Enterprises usually decide on a flat rate to calculate their financing and investing needs. However, this can have adverse impacts which cannot be communicated to shareholders, if the unit has high fluctuations. For example: Indonesia 1995 US$ 1 = RP 6000, 1997 US$ 1 = RP 12000, 1999 US$ 1 = RP 9000. (Figures are approximates, just to provide an insight into the argument about the effects of the fluctuations)

From the answer above, it is evident that certain limitations of accounting information have to be taken into consideration before enterprises use merely financial information to aid their decision making process.

What are the challenges for ethics in business? Are they different for accountants?

Ethics is defined as that branch of philosophy concerned with the moral life and consisting of consideration of one’s ordinary actions, judgments and justification as a means of discovering what one ought to do and of determining what actions are morally good, acceptable, or right and what actions are unacceptable or wrong (Campbell, 1989).

A manager within an organisation always faces a conflict of interest between short term profitability and long term sustainability of the entity. If the manager chooses to implement decisions that are beneficial to the entity in the long term, his behaviour is primarily considered to be ethical. However, the goal of achieving short-term profit maximization has been duly compromised. According to self-interest theory an individual seeks to maximize his/her personal utility whereby short-term profit maximization motives could be thought dominate managerial incentives.

Ethicists have developed two frameworks relevant to businesses. They are the Utilitarian and Deontology frameworks. Utilitarianism is defined as the moral correctness of an action based entirely on its consequences whereas Deontology defines moral correctness of an action through the underlying nature of its correctness. Deontology can be divided into two parts where one part considers that action itself is measured thus lying is always unacceptable, on the other hand, the other part considers the cumulative nature of action as well as the consequences and thereby deems that lying could be acceptable under certain circumstances.

Ethics within the scenario of businesses are largely determined by the frameworks outlined above. Business ethics have a large impact upon the global society as fraud and embezzlement can impose large dead-weight losses within the world economy. In Australia, business ethics are primarily defined by the Corporations Law and Accounting Professional Codes Of Conduct such as the ICAA which govern the professional behaviour of the relevant professional members.

Ethical rules for accountants are subtly more stringent than for normal business professionals. Under the assumption, that the ethical behaviour of accountants mirrors the behaviour of the company auditors, I seek to explain the underlying dilemma. The Chief Financial Officer works under the supervision of the Chief Executive Officer of the organisation. His/her primary responsibility is to ensure that the financial reports prepared under his supervision mirrors the true and fair view about the financial. operating and investing decisions of the entity. He is directly accountable to the shareholders for his actions. However, his actions are determined by the leadership of the CEO. If the CEO demands the CFO to incorrectly manipulate the financial reports of the organisation, the individual faces a dilemma. He has a dual sense of responsibility and an ethical situation arises whereby, he/she can either pursue his own self-interests (financial security) or disobey the commands of the CEO and report fairly to the share-holders. Thereby, following the correct spirit of ethical behaviour, his role entails reporting fairly to the shareholders and whistle blowing against the CEO.

Is there a conflict between self-interest and ethical behaviour?

In classical terms, self interest theory and ethical behaviour are deemed to have an eternal conflict. In accounting literature this conflict is termed as “Compensation Plans”

The plan states that managers who have a short-term time horizon with an enterprise and have their bonuses based upon the short-term profitability of the enterprise will be motivated to pursue their personal agendas (wealth) rather than enhance the long-term sustainability of the enterprise. In deontology terms, there is a significant conflict of interest in terms of the ethical behaviour of the manager which could be compromised by the self-interests of the manager who might manipulate the true underlying profitability of the going-concern.

What are the economic consequences of accounting policy choice?

Accounting policies affect the reported figures which appear in the financial statements which affect the wealth of managers.

There are three economic consequences of accounting policy choice:
I. Compensations Plans: In this case the organisational bonus scheme is used to bring the interests of both the managers and the shareholders together. However an economic consequence of the bonus scheme is that managers may also be motivated to cosmetically increase reported profit by the appropriate selection of income-increasing accounting policies which might not mirror the true underlying increase in the reported profits of the entity.

II. Debt contracts: If an entity is approaching the limits of a clause in a debt contract, there are incentives for managers to select appropriate accounting policies which allow the company to avoid being in violation of the debt contract, by income-increasing accounting policies.

III. Political costs: refer to the costs imposed on a company via regulatory bodies. Political costs are hypothesized to be a function of size measured in terms of net profit, total assets or total sales. Political costs create incentives for managers of large organizations to select income-decreasing accounting policies in order to reduce political visibility.

        

What is Forensic Accounting?
To fully understand the definition of forensic accounting, we can use parts of the definition of forensic medicine and accounting, both taken from Webster’s Dictionary, to produce a clear definition. Forensic medicine is a “science that deals with the relation and application of facts to legal problems. ” Accounting is “the system of recording and summarizing business and financial transactions and analyzing, verifying, and reporting the result.” So, the combination of these two definitions would yield forensic accounting as an accounting method that deals with the relation and application of system used to record and summarize business and financial transactions to a legal problem. Within this area of accounting, there are two general categories of accountants or areas of practice. They are the following: litigation support specialists and investigative or fraud accountants (Crumbly, New Accountant).

The Historic Forensic Accountant
This profession has not been around for long. However, this line of work is nothing new, as there were people dealing with “employee” crime thousands of years ago. Back in the 3300 and 3500 BC, the world’s first accountants, or scribes, can be found in Mesopotamia and Egypt. These “accountants” recorded commercial transactions onto damp clay tablets or papyrus. Fast forward to the 19th century, Scotland introduces the first official chartered accounting profession. It started out as a profession where legal work accounted for a large portion of an accountant’s job. However, by the early 20th century, chartered accountants expanded their services to a much wider field and court appearances shrank relative to the size of their business. As one can see, forensic accounting is not a new and exciting field in accounting; rather it is a return to where accounting had all started.

The Modern Forensic Accountant
The demand for forensic accountants with CFE or CIRA credentials is increasing approximately 100% per year. Their average pay range is between $70 000 - $200 000. A reason for this increased demand for forensic accounting can be credited to the increase in white collar crime associated with society’s up and rising technology and expanded use of computers to handle increasingly complex private and business transactions.

Who are litigation support specialists?
Litigation support specialists provide professional assistance of an accounting nature in matters to laywers involving existing or pending litigation in the litigation process. Within the litigation support specialists, there are the following categories: business valuation, revenue analysis, expert witness testimony, and future earnings’ evaluation (”Forensics,” New Accountant). Litigation support specialists deal primarily with issues related to the computations of economic damages. A typical litigation support assignment would be calculating the economic loss resulting from a breach of contract, or a fairly recent example would be the economic loss due to the damages resulting from September 11, 2001.

Who are investigative accountants?
Investigative accountants, or sometimes referred to as fraud accountants, are associated with investigations of criminal matters. The investigative or fraud accountant have two areas of emphasis. They are to seek out evidence of criminal conduct and dispelling or supporting of damages (Crumbly, New Accountant). Examples of typical investigative accounting assignments would include the following: an investigation of employee theft, securities fraud, insurance fraud, kickbacks, and proceeds of crime investigations.

What do Forensic Accountants do?
Forensic accountants are often retained to analyze, interpret, summarize, and present complex financial and business related issues in a manner which is both understandable and properly supported. Forensic accountants also have the option of being engaged in a public practice or being employed by organizations such as banks, insurance companies, police forces, government agencies, etc.
A Forensic Accountant is often involved in the following:
• Investigating and analyzing financial evidence
• Developing computerized applications to assist in the analysis and presentation of financial evidence
• Communicating their findings in the form of reports, exhibits, and collections of documents
• Assisting in legal proceedings, including testifying in court as an expert witness and preparing visual aids to support trial evidence.
Forensic accountants must be familiar with legal concepts and procedures in order to properly perform these services. Also, forensic accountants must be able to identify “substance over form” when dealing with a given issue.

What types of assignments to Forensic Accountants perform?
Forensic accountant become involved in a broad range of investigations spanning many different industries. Forensic accountants provide practical and in-depth analysis to cases which help uncover fraudulant trends and also bring light to the relevant issues. Forensic accountants are often involved in the following: criminal investigations, shareholders’ and partnership disputes, personal injury claims or motor vehicle accidents, business interruption or other types of insurance claims, business or employee fraud investigations, matrimonial disputes, business economic losses, professional negligance, and mediation and arbitration.

How do I become a Forensic Accountant?
In order to become a qualified forensic accountant, there are several degrees, certifications, and positions that an accountant can choose to attain in order to be considered an “expert” in this field. Forensic accountants, who are usually involved in litigation support or investigative accounting, must have some form of credentials to consider them capable of the work or career they are pursuing. First of all, they must complete the basic requirements for an undergraduate degree. After that, there are two main professionals certifications that are available to them. They are the Certified Fraud Examiner (CFE) and the Certified Insolvency and Reorganization Accountant (CIRA).

In order to obtain the CFE certification, they must have a bachelor’s degree in accounting, complete one or two years of professional accounting experience, and successfully pass all four portions of the CFE Examination. The examination includes four sections which are the following: financial transactions, investigation, legal elements, and criminology.
In order to obtain the CIRA certification, the accountant must have attained at least five years of professional accounting experience. Of these five years, 4 000 hours must be accumulated in insolvency and reorganizational accounting. There are three parts to the CIRA exam. They are the following: financial reporting and taxes, managing turnaround and bankruptcy cases, and plan development and accounting.

Other than a certificate to acknowledge that one is a forensic accountant, a forensic accountant should also possess the following characteristics: curiosity, persistence, creativity, discretion, organization, confidence, and sound professional judgement. A forensic accountant must also be open to consider all alternatives and options, be able to dissect the fine details and at the same time, see the big picture. Forensic scientists must also have excellent communication skills because they must be able to listen effectively and communicate clearly and concisely.
Case Studies on Forensic Accounting

Al Capone, a name that has been infamous for many decades, was never convicted for any of the criminal activities normally associated with mobsters. The courts never caught him for assaults, murders, robbery’s etc, but rather he was jailed for what seems to be such a small crime in comparison: tax evasion. Back in the early 1900’s, the IRS Special Intelligence Unit was formed primarily to combat employee crime. An accountant by the name of Elmer Irey, the head of the IRS and the US Treasury Enforcement Branch, was a key component in pursuing Capone for his tax crimes. Irey was essentially America’s first well known forensic accountant. He and his team were named “the silent investigators”, due to their superior investigative and analytical skills which in the end cracked Capone’s financial scandals.

In the 1950’s and 1960’s, Atlantic Acceptance was one of Canada’s leading financial firms. It had 105 small loans offices and 35 sales finance offices across the country. The company collapsed in June of 1965 with $150 million of receivables still outstanding. Introducer, Tedd Avey, a pioneer of forensic accounting in Canada, recalling the scandal:

“Atlantic Acceptance was one of the first cases in which forensic accountants were used to present evidence in a Canadian court,” he says. “The enormous complexity of the financial documents — dozens of companies were either implicated or impacted — made the situation difficult for people to grasp. But the forensic accountants were able to take a roomful of complicated financial documents and boil them down. The evidence came to life through a series of charts and simple explanations.”

Without these scientific-minded accountants, such breakthroughs in the case would have been improbable. Being able to scientifically sort through complex accounting documents is not a skill many people have, and must go a lot of training in order to get to that stage.

In another case, forensic accountants were expert witnesses in some major court cases. In the murder trial of Helmuth Buxbaum, a millionaire from Komoka, Ontario, crown attorneys determined that his bankbook was as important to the case as his marriage bed. His financial records followed the motive for the murder, and were essential in confirming his guilt to the jury.

Conclusion
The field of forensic accounting seems to be becoming a very popular and demanding occupation for many. It is not a career that just anyone can choose to puruse because it requires a lot of hard work, effort, and personal characteristics that not many people possess. This career appears to be very appealing because it is not the ordinary “behind-the-desk” job. Although it is a subdivision of accounting, it is not what most people would consider the stereotypical form of accounting. Forensic accounting provides both a legal and accounting aspect in the career; therefore, probably appealing to many who may be interested in both law and accounting. After completing this report, I discovered another branch of accounting that I was unaware of that also appealed to me, and I will consider it as a potential future occupation.

        

The gain on the portfolio could be recognized in the year in which it occurs or when the shares are sold. To postpone taxes, revenue should be recognized when the shares are sold. That can be supported based on the fact that the selling prices of the shares are quite volatile and may very well fall back to, or even below, the original cost. In other words, the amount earned is not known until the sale actually takes place. This treatment is consistent with the requirements of the Income Tax Act which only requires that income from investments be recognized on disposition.

Revenue could be recognized when the passes are sold, over the 60 days from the initial usage, when the travelers actually use the passes to ride on the bus, or when they expire. To postpone taxes, revenue would be recognized as late as possible. The preferred time would be when the pass expires because this is the latest possible point. While preferable, recognition on expiry is probably not acceptable since it is very conservative. In addition, since most of the costs associated with the pass will be expensed as they incur (it will be difficult to match fuel and the cost of the driver, for example, to the specific pass), deferring recognition until expiry would result in mismatching of expenses and revenue (which would be good for tax purposes). Probably, the most realistic time would be evenly over the life of the pass. On the other hand, expiry of the pass can be viewed as equivalent to when the contract is completed, which would be allowable for tax purposes.

Revenue could be recognized at the original sale, could be allocated partially to the technical support and to the three versions of the product, and conceivably could be recognized when the support period expires. To postpone taxes, the company would want to recognize revenue as late as possible. Waiting until the end of the support period would be unduly conservative, especially given that the initial product is delivered and paid for by the customer long before the 18 month service period has expired. It could be argued that instead of one bundle of goods being sold (which would argue for recognition on delivery), four products are being sold—the initial software plus the technical support plus the two upgrades. In this case revenue would be recognized separately for each component (upgrades when delivered to the customer, technical support over the life of the service contract).

Revenue could be recognized when the fee is paid, which presumably is in advance, it could be recognized over time, on the basis that the fee is compensation for being available, not for actually providing any services, or at the completion of the period of coverage. If the firm was not going to be compensated additionally for any work that was provided, an argument could be made that the costs of providing the services are not known until the time expires. Given the facts of the situation, the latest alternative that could be defended for tax postponement purposes is a monthly recognition of the revenue as it is earned. At this point the revenue is earned since the client has had access to a lawyer if and when required, the amount of revenue is known and costs (which would be mainly period costs) would have been incurred and expensed in the period.

Australian companies, particularly the larger multinational companies, are always seeking ways to expand their operations and find ways into new capital markets both nationally and internationally. Expansion strategies that are currently available to these companies include the merger and acquisition of not only domestic companies/competitors and assets, but also international ones. Companies that are in such positions are more often than not Australia’s larger companies, with multinational operations and are at the forefront of their respective industries. However, the problems that face these companies in their plans for expansion are varied and multifaceted. One expansion strategy to overcome these problems that is available to these companies is the adoption of dual-listed company (DLC) structures.

        

Dual-listed company structures are not a new concept, however they are growing in popularity with Australian companies. The first two companies that banded together to form a DLC structure were the Shell Transport and Trading Co. (United Kingdom) and Royal Dutch Petroleum (Netherlands) at the turn of the century in 1903. Since then a further 11 DLC company structures have been created of which five still remain. The popularity of DLC structures amongst Australian companies is emphasised by the fact that of the six well-known DLC’s three involve Australian companies, Rio Tinto Limited, BHP Billiton Limited and Brambles Industries Limited.

Dual-Listed Company structures are effectively contractual agreements between two companies, who agree to combine their management and operations, cash flows and assets, as if they were a single economic enterprise but keeping their own separate shareholders, exchange listings, tax residencies and are still considered separate legal entities. Due to this definition, dual listing, it should be noted differs significantly from cross listing. Whereas dual listing is the quasi merger of two companies, and the subsequent “merged” company listing on two stock exchanges, cross listing, is the listing of an individual company not only on the Australian Stock Exchange (ASX) but also on some secondary foreign exchange.

There are possibly many benefits from companies agreeing to combine under a DLC structure rather than merging or one company acquiring another. For two major Australian corporations, BHP and Brambles, to undertake such a venture with Billiton and GKN in 2001, implicitly implies there are advantages to be gained. Tax advantages include; there are no transfers of shares or assets, therefore shareholders are not subjected to capital gains tax and the company is not required to make any stamp duty payments. Usually the amortisation of the goodwill of the merged or acquired company is obligatory; however, this is not usually the case with a DLC set-up. The perceived National identity of the local twin, by potential investors, shareholders and the general public is not affected, as the company is still essential Australian, also if the companies are of similar size their corporate status is not altered as they avoid the appearance of having been taken over. The formation of a DLC structure possibly could avoid the fulfillment of pre-emptive rights, such as options in debt contracts, that third parties may have, due to existing contracts with either of the companies, that otherwise would be triggered by a conventional merger.

Another main motivation for Australian Companies to pursue dual listing is that it gives the company greater exposure in foreign capital markets. Rather than relying on foreign investors wanting to invest in Australian companies on the ASX, if the company is listed along side another company, as is the case with BHP Billtion, the combined company has access to not only Australian investors but also English investors. Dual listing is also advantageous for companies that are have large amounts of surplus cash to expand but cannot afford to do so due to the relative weakness of the Australian dollar against other currencies. By dual listing these companies have access to a choice of foreign currencies to initiate future acquisitions.

There are many advantages to forming a DLC structure, however, the fact that the majority of international mergers have not been structured thus, and the recent disbanding of a number of DLC’s alludes to the possibility that there are a number of disadvantages in the adoption of this structure. The existence of two independent sets of shareholders may at some times constrain the flexibility of management and at times may adversely affect their decisions and actions.

The existence of the DLC in two countries means that the company will have to conform to the accounting and the regulatory framework of both countries which is likely to be very costly. Complexity also arises in the governance and the administration of the company. Another disadvantage, that is especially important to the financial and banking sector is that, cross guarantees that the companies undertake with each other mean that they are exposed to each others credit risks and liabilities. This is not the only risk that the companies absorb. They also face the risk of exposure to new shareholders, markets, assets and territories that they may not have had any previous experience with. Share market liquidity is also believed to decrease as the investors are less likely to look favourably upon the DLC as the structure is quite complex and will thus be deemed as being less transparent and less attractive to the average investor.

As a part of its expansion strategy in the UK market, National Australia Bank has considered the possibility of adopting a DLC structure with a bank in the UK. This kind of deal will undoubtedly bring with it implications for the NAB; some advantageous to its operations and others not.

The NAB emerged the strongest and in the best position of the big four Australian banks after the debt frenzy of the late 1980s. In the 80’s ad 90’s, NAB began acquiring and broadening its assets in the UK market. Firstly it purchased three subsidiaries of Midland Bank in the UK and Ireland and then later acquired the Yorkshire Bank. These acquisitions resulted in the United Kingdom becoming the NAB group’s second largest market. In 1991, the UK accounted for 32% of the bank’s assets.

In 1997 the NAB reviewed and reconsidered the focus of the group’s banking and adopted a new vision and strategies to meet that goal. This was “To be the world’s leading financial services company.” This vision emphasised the desire of the group to truly become an international bank. The bank was well on the way as by this time the group’s overseas activities had grown to account for 46.7% of the group’s assets. In 2000, NAB sold one of its American acquisitions; it had purchased earlier for the substantial amount of $5.3billion, and was described as having “a healthy war chest”.

However, the problem that NAB faced is that the weakness of the Australian dollar against the English pound prevented the NAB from being able to acquire large companies in the UK, thus fuelling their expansion. The NAB also has the restriction placed on it under the Australian Government’s four-pillar policy that the NAB can not acquire any of the other larger Australian banks as a means for expansion. These reasons have prompted the group to adopt a dual-listed company structure approach with an appropriate partner in the UK should the opportunity present itself.

The fundamental problem facing the NAB is devising a DLC structure model that will not only be accepted by a UK bank, but also by the Australian Prudential Regulation Authority (APRA) and the British equivalent, the Financial Services Authority. The NAB is confident that they have devised a DLC model that would meet these requirements and be sanctioned by the aforementioned authorities. The regulatory authorities have concerns with a bank adopting a DLC structure, due to the bank making cross guarantees with another bank, exposing the NAB to new risks. This is particularly relevant as the increased risk exposure may place affect the bank’s ability to protect their depositors’ funds.

If the NAB did have a model that was accepted by APRA and the FSA, the bank would have an excellent opportunity to increase their market presence in the UK. During 2000 and 2001 it was reported that the NAB was in discussions with the UK bank Abbey National. The banks were of similar market capitalisation requiring NAB to raise in excess of an estimated amount of $47.6billion to acquire Abbey. However under a DLC structure the need to raise such a large amount of capital would not be required. If the banks did enter into a DLC structure this would have exposed the NAB to the southern region of the UK and raised their market presence in the UK from 4% of the market share to an estimated 15% of the competitive UK market. The first deal that the NAB first presented to Abbey management was rejected.

If the NAB could find a suitable UK bank to undertake a DLC arrangement it would give the group a new source of acquisition currency. If the deal with Abbey did proceed it would have given the NAB an increased opportunity to turn over greater profits than are currently accessible in the bank’s UK operations. This would give the combined DLC greater levels of excess profits in a stronger currency than the Australian dollar (English pound) enabling the bank to acquire more and more international assets. This would allow the NAB further expansion opportunities and aid the group in achieving its goal of being a truly international financial institution.

The decrease of the NAB’s share price liquidity may have a negative impact on the company if it were to adopt a DLC structure. During the late 90’s, the share market boom was mainly attributed to the large number of “mum and dad” investors investing in Australian blue chip companies including the NAB. If these investors felt that the transparency of the company was decreased as a result of a DLC structure, the lack of information available on the UK bank, may cause the average investor to invest in another of Australia’s big four banks.

A report released by the Reserve Bank of Australia stated that the formation of a DLC is beneficial in the sense that no assets or shares are traded between the two companies. This would be advantageous to the NAB as they would not required to pay stamp duties, and investors would not be subjected to Capital gains tax. The formation of the DLC is also advantageous to the NAB as the cross border dividend payments are subjected to excessive tax, whereas by forming a DLC the foreign investors in the company are not subjected to these taxes. The system also allows shareholders in both countries the advantage of being able to still undertake dividend imputation tax credits.

The NAB may find that the share price differential that has been historically noted in DLC structures may be a negative implication of adopting such a strategy. Theoretically, it is believed that such differentials should not exist, as the shares of the DLC should trade at the same price after currency conversions. In some DLC’s the differential has been as great as 30%. This was a contributing to factor to a number of the DLC’s that disbanded. The implication of this to the NAB is that if the company had a premium differential on the ASX, shareholders and investors in the UK would be less likely to invest in the company on the London Stock Exchange and would consider other investments.

The undertaking of a dual listed company by the National Australia Bank, as part of its expansion strategy would be a huge undertaking. The structure enables the bank to access new capital markets, without out-laying substantial amounts of capital. It allows the NAB to raise capital in a stronger currency for future acquisitions. The structure would also give the bank a much larger market share in the competitive UK banking sector, enabling the NAB to access more customers, and fuel expansion of the bank in the UK. However, the bank would face many hurdles along the way. The conformation to the requirements of APRA and the British FSA, would be a costly and time-consuming process. Not only would this requirement need to be met, but also the shareholders of not only the NAB, but also the management and the shareholders of the UK bank would need to be convinced of the advantages to be had by both companies. This could prove to be an arduous task given the implication to the pricing of the shares on both exchanges and the historical trend of companies disbanding from a DLC structure.

The NAB undertaking a dual listing structure, should the right opportunity present itself, could prove to be a fantastic opportunity for the bank to reach it’s goal of being a world leading financial institution. Should the union of the NAB with an UK bank prove to be an advantageous and profitable strategy, the implications for the rest of the Australian banking sector would be significant. It would be interesting to see whether any of the other four major Australian banks follow in the unprecedented footsteps of the country’s largest bank, the National Australia Bank.