Ideas for curbing abusive related-party transactions

September 26, 2022 | 11:00
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A related-party transaction occurs when a deal is entered into by at least two parties, where one has control or significant influence over the other or where the parties come under the same controlling owner.
Bernard Wang Toon Kim-Partner, Audit Services KPMG in Vietnam
Bernard Wang Toon Kim-Partner, Audit Services KPMG in Vietnam

Family business groups and the informal nature of business relationships typical in the Asian and Vietnam business landscape facilitate related-party transactions (RPT). Not all RPT are abusive. Some of these transactions help to achieve a better economy of scale and are recurring and unavoidable.

Abusive RPT can be in the form of tunnelling or propping up. Tunnelling is the expropriation of assets, whereby dominant shareholders extract values from the controlled corporations through transactions with favourable terms for themselves or nominees controlled by them.

When business owners want to avoid delisting or achieving certain financial results for specific reasons, their results may be propped up by abnormal RPT. Propped-up firms tend to have worse operating performance in the fiscal year preceding the announcement of the RPT.

Abusive RPT may include overpriced and overpayment for an asset or assets disposed at a lower price. They may also involve sales transactions to related parties who do not have the ability to consume, process, sell or utilise the asset.

Other examples are significant cash advanced under the appearance of project implementation and capital tunnelled out for the dominant shareholders, directors, nominees, or their controlling companies to use.

Independent director roles in approving RPT is essential. However, a potential doubt may arise over their independence from a controlling shareholder as the controlling shareholder often nominates and elects these directors. These independent directors may receive significant fees. Thus, they may have an element of loyalty to the controlling shareholder.

While the board is charged with making decisions in the interests of all shareholders, it is common for listed companies in Vietnam to circulate draft resolutions requesting shareholders to authorise chairman, CEO, or general director to decide on specific terms and conditions of the RPT and agreements and to sign and implement those agreements on the context of achieving greater synergies.

These include the transaction of sales and purchase of goods or transactions of borrowings, loans and sale and purchase of bonds. While efficient for business decision-making, such practices could also open up potential abusive transactions as the chairman, CEO, or general director has been given the blank cheque to decide on the terms.

In addition, these circulars to shareholders may be too general and lack sufficient information for “non-related parties” shareholders to make an informed evaluation before they approve the resolution.

Here is the example from Singapore. Singapore-listed companies may only seek a general mandate from shareholders for recurrent transactions of a revenue or trading nature or those necessary for its day-to-day operations, such as the purchase and sale of supplies and materials, but not in respect of the purchase or sale of assets, undertakings or businesses.

A general mandate is subject to annual renewal. When requesting approval for a general mandate for RPT, Singapore-listed companies (or issuers) must make reference to: (i) the class of interested persons with which the entity at risk will be transacting; (ii) the nature of the transactions contemplated under the mandate; (iii) the rationale for, and benefit to, the entity at risk; (iv) the methods or procedures for determining transaction prices; (v) the independent financial adviser's opinion on whether the methods or procedures in (iv) are sufficient to ensure that the transactions will be carried out on normal commercial terms and will not be prejudicial to the interests of the issuer and its minority shareholders; (vi) an opinion from the audit committee if it takes a different view to the independent financial adviser; (vii) a statement from the issuer that it will obtain a fresh mandate from shareholders if the methods or procedures in (iv) become inappropriate; (viii) and a statement that the interested person will abstain, and has undertaken to ensure that its associates will abstain, from voting on the resolution approving the transaction.

There are key recommendations that can be offered. Firstly, companies may only seek a general mandate from shareholders for recurring transactions of revenue or trading or those necessary for their day-to-day operations. Non-recurrent transactions should be approved separately after proper evaluation.

Secondly, where a motion is forwarded to the shareholders for approval of the RPT during an annual shareholders’ general meeting, a voting system (including storage of evidence for future inspections) should be established so that only shareholders not involved in the transaction can vote. There should also be communication to the shareholders not involved in the transactions regarding how those RPT have been evaluated.

Objective judgement in the decision-making process of the board should be ensured. This would include giving sufficient information to the board for evaluation, and giving non-controlling shareholders sufficient influence over the nomination and election of directors.

It also includes the enhancement of the role of independent directors as central actors in the process, (approval of procedures, the conduct of negotiations, approval of the transaction, and the possibility of obtaining advice from independent experts at all stages) with the award of decision-making power to the board of directors.

Enhancing the corporate governance of the company is necessary. This includes improving the process of capturing, evaluating, checking, reporting, and disclosing RPT. Other enhancements may involve the communication between those in charge of governance and external auditors.

The external auditor provides an assurance to the board and shareholders as to whether material information concerning RPT is fairly disclosed in the financial statements and alerts them to any significant concerns concerning internal control. Finally, there should be an increase in inspections by enforcing agencies.

Abusive RPT have increasingly become a challenge to the integrity of Vietnam and many other capital markets. The costs of abusive transactions are high (including the potential loss of government revenue), whether in the form of one-off material expropriations of wealth, the slow expropriation of wealth via continuous operational transactions, or the propping up of results and share price.

In the current environment, effective monitoring and curbing of abusive RPT need to be high on the agenda of policymakers, enforcing agencies, boards of directors, and other relevant stakeholders. Proper rules, policies, governance, inspection, and audits are required to avoid such a situation.

By Bernard Wang Toon Kim

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