Where to look, what to look for

One of the key areas to examine is related party transactions, which involve a business deal or arrangement between any two parties who are joined by a special relationship. This could be a deal between a major shareholder and the corporation, or between the corporation and a relative of senior management or a director.

Listed corporations are required to disclose such relationships in the annual report, and all companies should disclose related party relationships to shareholders.

Related-party transactions might not be abusive, but companies can use these transactions to inflate sales or lower costs and show higher profits on their financial statements.

Such transactions can also be used to transfer funds or assets out of a publicly owned business to insiders who control or own privately held companies (see “[tunneling]"(http://www.icfj.org/resources/who%E2%80%99s-running-company-guide-report...) in [Chapter 4).

Red flags for journalists include ties of board members to other companies that are vendors; family members in key positions of the companies doing business with one another; and disproportionately high costs for supplies of goods and services.

Boardroom infighting can also be a tipoff to suspicious related party transactions. That was the case at Kenya’s Cooper Motor Corporation (CMC), where the company’s managing director alleged that two directors had formed a syndicate to siphon off funds to offshore accounts. The chairman of the Capital Markets Authority in Kenya admitted that the regulator originally heard about the charges from the press, and said the board did not fully disclose its financial position in regulatory filings.

CMC’s shares were suspended from trading while the regulator investigated the various internal allegations, which included allegations that a former board member had overcharged the company for its services. Such conflicts of interest led to the boardroom wars, according to an analysis of the CMC situation and its implications for investor confidence in The Daily Nation, Nairobi.

Read the story at: http://bit.ly/HDSWOd

The basic documents required by many regulators and exchanges worldwide are similar to those required by the U.S. Securities and Exchange Commission (SEC).

Unaudited periodic (often quarterly) financial statements (Form 10-Q). Look for:

  • Abrupt shifts in revenue, profits, expenses, cash flow, assets and liabilities. What accounts for the change?

  • Share purchases — Has the company increased or decreased its share buying? Why?

  • Current litigation — Are there any new lawsuits, or cash reserved for a possible loss? If so, what is the nature of the anticipated loss?

  • Spending plans — Are major purchases ahead?

  • M&A update — What is the impact of a recent merger or acquisition? Is there a sound explanation for the change in revenues and profits?

Audited annual financial statements (Form 10-K). All items listed above will also appear in the 10-K.

Current information, including major events that shareholders should know about (Form 8-K), including:

  • Departure or illness of a key executive or board member

  • Auditing firm changes

  • Major acquisition or divestiture

  • Change in fiscal year

  • Delisting of company shares

  • Regulatory actions

  • Bankruptcy or receivership

Annual proxy statement (Schedule 14A), which discloses questions to be put to a shareholder vote, including election of directors, along with information on executive compensation

Registration statements, including prospectuses for share offerings (Form S-1, or Form F-1, for foreign private companies going public)

Insider holdings and transactions (Forms 3, 4, and 5), including initial holdings of stock by the company’s executives, changes in ownership and purchases or sales

For a thorough explanation of each filing requirement and how to find filings for companies in the SEC’s free EDGAR (Electronic Data Gathering, Analysis and Retrieval) database, see: http://1.usa.gov/Ivpgae

(For a more detailed discussion of how to read and interpret numbers in periodic and annual financial filings, see Chapter 6. For an explanation of proxy statements, see Chapter 3.)