The Legal Infrastructure of Business: Are Accounting Standards a ...

Background

Empresas La Polar S.A is the fourth largest Chilean retail company in terms of number of locations, with 42 stores in Chile and 4 stores in Colombia. The company was founded in 1920 and went public in 2003.

The Latin American retail markets are divided into ?traditional? and ?modern? retail. Traditional retail chains include the classic ?moms & pops? as well as the informal sector. Modern retail refers to supermarket chains, department stores and homecenters; and their market penetration varies by country. Chile is the economy with the highest modern retail penetration in Latin America (most players are fully integrated, owning the three basic retail concepts). The main reason for these players to achieve this higher penetration has been the use of consumer financing. Chilean retailers are one of the Latin American pioneers in bundling consumer finance with modern retail. These firms rely on their financing subsidiaries to boost retail sales and most importantly gain additional revenues through interest earned on their proprietary credit cards and consumer loans. This practice gave rise to a huge conflict of interest, which if not properly managed, could lead to severe consequences (i.e. providing credit to low income consumers who could not afford it).???????????

On 1999 La Polar was bought by the PE firm Southern Cross, and decided to change La Polar strategy targeting the low and middle income sectors by initially offering ?lower name? brands at affordable prices as well as initiating its consumer financing business segment. ?From 2003 to 2008 La Polar outperformed its peers, resulting in a significant ?market share growth and a constant stock price increase. This ?led to lower funding costs, allowing the company to further expand its business to lower income sectors. In addition, in 2009 La Polar?s CEO was elected the ?executive of the decade? by its peers.

Situation

As the economic crisis was damaging the Chilean Economy in 2011, many analysts were concerned about La Polar?s credit risk and their clients? ability to pay their debt. On the other hand, company executives declared the situation was stable and they were not experiencing relevant decreases in the quality of their portfolio.

But this was eventually proven to be false. The company?s executives managed a way to show a healthy and current portfolio under the accounting standards, hiding the increasing defaulted accounts from their credit portfolio. The company unilaterally renegotiated more than 400,000 accounts by extending lines of credit, and restructured their dates of payment. PriceWaterhouseCoopers as auditor of the company approved the financial statements as adhering to the current accounting standards. At this moment, both PwC and La Polar?s executives were selling their stock positions in La Polar through the stock market.

Once the situation went public and became a scandal, La Polar announced a deep credit department restructure.

Aftermath

After the company?s announcement, La Polar?s stock price declined by more than 80% and the yield on its 2016 bonds increased from 3.8% to 37.6%. To avoid bankruptcy and finance working capital the shareholders of the company approved a share issuance plan that raised US$200 million. Some of the larger investors in La Polar were the private pension funds from Chile, reason why this scandal and decrease in stock value had a direct impact in the pensions of millions of Chileans.

Up to date, 18 former La Polar executives, including 11 senior officials, have been charged by the SVS (Chilean Securities and Insurance Supervisor) with providing false information regarding the financial situation of the company to the SVS and to the market in general. La Polar executives have also been charged with failing to abide by due diligence and inappropriate use of privileged information. Moreover, the majority of the members of the board and senior managers has been fired or tendered their resignations.

Furthermore, PwC has also been charged for selling shares of La Polar, while knowing about the company?s financial problems.

In addition, Sernac (Chilean government?s consumer defense agency) filed a class-action suit against La Polar for unilaterally refinancing customers? debt. La Polar has agreed to compensate all customers that were affected by the unilateral renegotiations by paying a total amount of $651 million.

After this scandal, La Polar has changed the members of its Board of Directors and senior management. These new executives are trying to regain its business by changing their image, attracting new customers and taking advantage of its retail business in Colombia (higher growth market).

Thoughts

There are few doubts that the management of La Polar engaged in illegal actions by unilaterally refinancing their delinquent accounts and providing false information to the public. Thus, one of the big questions that have to be raised is how effective are the current rules for disclosure of information worldwide. Current requirements are focused on specific accounting rules that can be met strictly by applying IFRS or US GAAP, but the useful disclosure of information for investors sometimes deviates from these standards.

La Polar was able to easily reclassify its ?delinquent accounts? as ?current? in accordance with accounting principles, just by extending credit limits and renegotiating those accounts. According to the accounting rules, those accounts were not ?delinquent? anymore, and no write-off or special disclosure was required for these cases. This was further approved by PwC, which as an auditor, focused on the correct application of the accounting rules. Thus, it is clear that La Polar investors were not able to assess the company?s financial problems. There was no disclosure of relevant information for the investors.

This is not a particular case of the emerging markets, as similar cases have been seen in Enron, WorldCom, Sunbeam, Tyco and many others throughout the last decade in different countries. Enron was able to hide relevant information to its investors by using SPV?s and still apply current accounting standards. It is not clear that the accounting standards are strictly related to the relevant disclosure of information for shareholders; thus, further reforms have to be taken to demand disclosure of information focused on principles and duties of the senior executives in the company, in addition to accounting rules, in search for a broader scope.

The second question relates to the role of the board of directors. Public companies are run to maximize shareholder value but are not actually run by the shareholders themselves. The essence of good corporate governance is to let an effective board of directors run the company and maximize shareholder value. The board is responsible for policymaking, while management is responsible for day-to-day running of the business. The extent to which the board is accountable for unauthorized management actions is questionable. In La Polar, board members have been accused of failing in their legal duties and thus held liable for the actions of managers, even when these actions were unauthorized. Board members claim they were provided with irregular, false and incomplete information. ?

According to US law, the role of the Board of Directors is to safeguard shareholder interests. In the Enron case, the Board of Directors was accused of fiduciary failure as members knowingly allowed Enron to engage in high risk and fraudulent accounting practices. However, in La Polar case, the Board of Directors was unaware of the practices held by management and even more, had not authorized such policies. Is the board then just in place to provide oversight and not become involved in day-to-day operations? Should a board be held liable for prohibited management actions? Should members be responsible even if management provided inaccurate information and did not disclose their fraudulent practices??

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Sources

http://www.elmostrador.cl/noticias/pais/2011/07/14/caso-la-polar-los-antecedentes-con-los-que-la-svs-acuso-a-18-ex-directivos-y-al-auditor-de-la-compania/

http://www.sernac.cl/sernac/db_images/fckuploaded/SERNAC%20presenta%20demanda%20contra%20La%20Polar.pdf

http://www.santiagotimes.cl/business/economy-a-trade/23844-chilean-retailer-agrees-to-pay-up-after-credit-scandal

http://www.businessweek.com/news/2012-09-12/chile-s-la-polar-plans-to-double-sales-by-2014-after-share-sale

http://www.lapolar.cl/img/corporativo/memorias/memoria_2011.pdf

http://www.lapolar.cl/mipolar/empresa/historia.htm

http://es.wikipedia.org/wiki/La_Polar

http://www.americaeconomia.com/analisis-opinion/la-polar-estafa-financiera-en-chile

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Authors?

Amadeo Ibarra Flores

Juan Pardo

Marcelo Ramos

Felipe Silva

Source: http://picker.typepad.com/legalinfrastructure/2012/10/are-accounting-standards-a-relevant-disclosure-of-information-for-investors-la-polar-case.html

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