Another Happy Day for Destructive Accounting

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

The shares of OHL Mexico, the Mexican subsidiary of Spanish construction behemoth OHL, soared over 10% to 26.72 pesos on Monday morning. It was the stock’s biggest climb in over 8 months.

The reason for the market’s new-found enthusiasm for the shares was somewhat counter intuitive: the company had just announced that it had been hit by the biggest fine ever imposed by Mexico’s securities authority, the CNBV. The company had been penalized for irregular accounting practices and was forced to pay 71.7 million pesos in damages — a $4-million slap on the wrist.

“The market did not award the company, it awarded the fact that the fine was less drastic than it could have been,” said Juan Carlos Minero, director of the investment fund Black Wallstreet Capital.

Even more important than the size of the fine were the market’s fears that the company could be forced to change its accounting practices. Those fears were well grounded given that the CNBV had already unearthed a number of serious accounting irregularities dating back at least five years. Yet despite that, no mention has been made of OHL Mexico needing to correct its ways, to the market’s obvious delight.

The Commission’s inquiry was triggered in 2014 when Infraiber, an infrastructure design company that lost a government contract to monitor traffic on highways, apparently at OHL’s behest, began writing letters to regulators questioning OHL’s accounting. A number of YouTube videos then began surfacing purporting to show OHL executives discussing ways to inflate toll rates, bribe judges, pay for a state official’s Christmas-week stay at a swanky Caribbean beach hotel, and even get the president of Mexico, Enrique Peña Nieto, to intervene on the company’s behalf in its dispute with Infraiber.

As the spotlight began to shine on OHL Mexico’s accounts, it became apparent that the company had not only been liberally oiling the wheels of government, but had also been exaggerating its spending reports for a State of Mexico toll road project, defrauding investors and the state government of billions of pesos, reports El Daily Post:

Documents obtained by the Spanish-language news site Animal Político (El Daily Post’s sister publication) indicate that from 2011-2015 there is a significant difference in the spending approved by the State of Mexico and the spending reported to the stock market. Each year, the difference in spending costs increased.

The financial statement audited by Deloitte shows that in 2012 Conmex – one of OHL’s Mexican subsidiaries – had already invested 33.3 billion pesos in the project, almost 11 billion pesos more than in the State of Mexico’s books. In 2014, the Conmex financial statement says overall spending had exceeded 52 billion pesos, 22 billion pesos more than had been verified by the State of Mexico via OHL statements.

The apparent reason for this gaping, and growing, gap between the State of Mexico’s accounts and the spending OHL reported to the stock market was that the latter included the expected guaranteed revenues from operating the as-yet unfinished toll road. In other words, the company was using the revenues it was contractually bound to earn in the future to buff up its results in the present. Between 2010 and 2014 — the years for which financial reports have been published — that translated into a 53 billion peso ($3.1 billion) boost to earnings.

Granted, none of OHL’s magic accounting would have been possible without the assistance of big-four auditor Deloitte, which is already implicated in two huge corporate scandals in Spain, including the bankruptcy of Abengoa [read: Deloitte About to Pay for its Spanish Sins?].

According to a public statement released by OHL Mexico last year, the auditor had determined that the “expected guaranteed revenues” listed in the company’s investment report is “in accordance” with international accounting rules.

Apparently Deloitte does not completely agree. As the law firm Diez Gazcari points out, the auditor clearly states in its own “practical guide,” the so-called “IFRIC 12 Deloitte, anticipated revenues from a concession cannot be declared as financial assets. Anticipated revenues can be described as “intangible assets” but not as material assets, the guidebook states. In other words, Deloitte signed off on accounts that directly contravened its own guidelines.

As the allegations stacked up against OHL Mexico, the word of honor of one big-four auditor was apparently not enough to straighten things out. So OHL went a step further: it commissioned a report by all four of the big-four auditors — Deloitte, PwC, EY and KPMG — who between them were apparently unable to unearth anything untoward in OHL’s Mexican accounts. The company was also given a clean bill of health by three respected international law firms, Mijares Angoitia, Garrigues and Jones Day.

Just months later, Mexico’s securities authority detected a series of violations of stock market law, including in OHL’s accounting record of “guaranteed revenues”; the publication of “misleading” information about traffic levels on OHL’s highways; and the lack of “verifiability” of certain expenses in the financial reports of two of OHL Mexico’s subsidiaries [Conmex y OPI].

Mexico’s securities authority did not go the full hog and find the company guilty of fraud. More important still, no mention has been made of the need for OHL Mexico to correct its accounts from the last five years. Instead, the company will apparently be able to continue operating on the basis of five years’ worth of financial accounts that Mexico’s market regulators and investors know have been substantially inflated.

At least we can rest assured that the $4-million slap on the wrist — the equivalent of just 2.2% of the operational cash flow OHL Mexico earned last year from its toll-road operations — will deter the company’s management from overstating revenues and profits in the future. As for the so-called markets, rather than feeling cheated or deceived by the company’s accounting practices, they roared with applause and cheers as investors plowed their funds back into the firm. Confirmation that financial reality no longer has a place in today’s markets. By Don Quijones, Raging Bull-Shit

The earnings warning Monsanto issued was just a precursor. Read…  Monsanto Losing its Grip?

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.