Hands in the Till at Dah Hwa

The controlling family shareholder of HK-listed leather trader Dah Hwa International helped themselves to 32% of the shareholders' funds as unsecured interest-free "advances" and the independent directors did not prevent it. This story shows you just how ineffective INEDs can be when they are appointed by controlling shareholders.

Hands in theTill at Dah Hwa
4th February 2002

On 24-Jan-02 HK-listed Dah Hwa International (Holdings) Ltd (Dah Hwa) announced that it had "made advances" amounting to HK$49.3m to its controlling shareholder, D. H. International Ltd (DHI).

This wasn't petty cash - the advances amounted to 32.15% of shareholders' funds as at 31-Mar-01. Under the Listing Rules on connected transactions, the advances should have been subject to independent shareholders' approval. In other words, when the family wants to put its hands in the till, you have a right to say no. Pretty basic stuff.

Dah Hwa claims that "due to the oversight of the Company" it failed to comply with that fundamental rule. It must be pure coincidence that the advances were made "between the period of 4th April 2000 to 31st March 2001". That means they began right after the year end of 31-Mar-00 (and hence did not appear on the balance sheet at that date). The first working day of that fiscal year was 3-Apr-00, and the next day (when the advances purportedly started) was Ching Ming bank holiday in Hong Kong.

The "advances" did not appear separately on the unaudited interim report balance sheet at 30-Sep-00 either.

At 31-Mar-01, Dah Hwa was 58.26% owned by DHI, which was owned by a foundation under which the late Chairman and Founder, Mr Lee Deh, his wife Mrs Lee Shiao Yu Cho and their son Mr John Lee Sam Yuen (John Lee) were beneficiaries. In other words, the family foundation. These people were 3 of the 4 executive directors of Dah Hwa. Mr Lee Deh passed away on 17-Dec-01.

Noted in annual report

The Dah Hwa annual report for 31-Mar-01 discloses the advances to DHI for the first time, but makes no mention of the fact that they broke the listing rules and were not subjected to independent shareholders' approval. The advances were unsecured, interest-free and had no fixed terms of repayment. Fortunately, they were subsequently repaid (presumably without interest) on 30-Jul-01.

It must be pure coincidence that the advances were repaid on 30-Jul-01, just one day before the announcement of final audited results for 31-Mar-01. That allows note 18 to the balance sheet to state that the amounts were "subsequently repaid". Interestingly, the board meeting to consider and release the final results was originally scheduled for Sat-28-Jul-01 but was "postponed" to Tues-31-Jul-01, the day after the advances were repaid.

Failure of INEDs

The two independent non-executive directors (INEDs) of Dah Hwa were appointed in 1993, the year of the IPO. They are Mr William Sung Yuen Lam (Mr Sung) and Mr Cheng Shu Wing (Mr Cheng). Mr Sung is "sole proprietor of an accountancy firm and has more than 24 years of auditing experience". Mr Cheng "holds a bachelor degree in business administration from Chinese University of Hong Kong and has extensive experience in the banking and securities industries in Hong Kong".

So they are pretty qualified, and between them, you would think they would be well aware of the Listing Rules and the common sense fact that there is a conflict of interest when a controlling shareholder takes money out of the company. They should have objected. They should have notified the Stock Exchange and raised it with the auditors, Deloitte Touche Tohmatsu.

We also believe that auditors in general should have some responsibility for checking, in the course of their audit, that in respect of financial matters, the listing rules have been complied with. After all, audited accounts include some disclosures required under Listing Rules.

These two INEDs, together with non-executive director Dr Samson Sun Ping Hsu (Dr Sun), formed the audit committee. The report says:

What kind of "processes and internal controls" could allow this to happen? The report also states, in standard terms:

Um, right - perhaps that should be renamed the "Code of Worst Allowable Practice". For investors who are counting on their INEDs to look after their interests, you should know that Mr Cheng is also an independent non-executive director of Texwinca Holdings Ltd, and an executive director of Yanion International Holdings Ltd.

Investors can be grateful for small mercies - DHI did put the money back, although Dah Hwa lost interest while it was away and has not been compensated. But that's not the point. They might never have repaid it, there was no security, and that is why advances to connected parties require minority shareholders' approval.

It took nearly 10 months after the year end, and 22 months after the first advance, for the company to make an announcement regarding this - presumably when someone pointed out the omission to the Stock Exchange. It seems that a lot of people, including the audit committee, were asleep at the wheel.

Heavy provisions

Dah Hwa has become somewhat accident prone in the last two years to 31-Mar-01, making provisions for bad and doubtful debts totalling HK$81.71m on turnover of $482.7m, or 16.9% of sales, and contributing to a net loss of $120.6m. The audit committee should take a close look at the nature of these debtors and the credit controls applied. Have they not heard of letters of credit?

Previous offence

This is not the first time Dah Hwa has been in the news. On 16-Oct-01, the SFC successfully prosecuted John Lee, who is the Managing Director of Dah Hwa, and DHI for breach of the Securities (Disclosure of Interests) Ordinance. They each pleaded guilty to 6 cases of failing to report to the Stock Exchange transactions in massive numbers of shares between Jun-98 and May-00.

Conclusion

We have called in the past for independent directors to be elected by independent shareholders, the people they are supposed to look out for. With DHI holding more than 50% of Dah Hwa, outside investors have no choice on whether to re-elect the INEDs next time they come up for re-election. It is entirely up to DHI as to whether they are retained. So we would call for a vote of no confidence, but it would be pointless. Instead, we just call on the INEDs to resign.

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