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Nakumatt’s fall linked to money laundering, poor corporate governance

Thursday January 09 2020
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Auctioneers clear away goods at a Nakumatt branch in Nyali, Mombasa, on March 7, 2018. PHOTO | FILE | NATION MEDIA GROUP

By JAINDI KISERO

The curtain finally fell on Nakumatt Supermarkets after creditors of the company resolved to dissolve what, until recently, was the leading retail chain and brand in East Africa.

Before the company was finally dissolved, doubts lingered on whether Mr Peter Kahi and Mr Atul Shah, the two receivers who have been running the distressed company for more than one year, would even scratch the surface and provide answers to the biggest question surrounding the Nakumatt saga: How billions of shillings from goods and inventory disappeared into thin air.

Mr Kahi and Mr Shah (not to be confused with Nakumatt’s managing director Atul Shah) from PKF Consulting are now headed to the courts in a bid to liquidate the company.

Imminent liquidation

Whichever way you look at it, the imminent liquidation is an unfair outcome for suppliers and other creditors, parties who, in good faith, gave the supermarket chain inventory, capital, and accommodation, and innocent investors who bought the company’s commercial paper from the capital markets.

And, in a bitter twist, the perpetrators of the fraud will ride off into the sunset.

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SPECIAL AUDIT

Nakumatt was no ordinary company. It more or less operated as one of the main cogs of a complex money laundering syndicate that had operated in the country for more than 30 years.

Perhaps the most authoritative source linking Nakumatt to money laundering are confidential reports and audits that the Central Bank of Kenya (CBK) conducted in the build-up to the closure of the defunct Charterhouse Bank in 2006.

It is from these reports that one gets not only a rare glimpse into the shady operations of Nakumatt, but also shows clear connections between the supermarket chain and the money laundering syndicate, whose operations led the authorities to shut down Charterhouse.

From these reports, and a special audit by PricewaterhouseCoopers (PwC) conducted on behalf of CBK, it emerges that Charterhouse was another integral cog in the veritable nexus of institutions that formed an expansive money laundering machine.

The lender operated like Nakumatt’s in-house bank, with branches situated within the premises of the supermarket chain.

FAKE PAYMENTS

How was the money laundering game played?

In contemporary literature on money laundering — and what appears in the reports — Nakumatt and the money laundering ran what is described as “trade-based money laundering”, which requires the following elements be in place.

First, you create an elaborate system and network of related businesses that trade with one another.

Second, you target companies and businesses that generate lots of cash such as supermarket chains, forex bureaus and oil companies, and entities that sell lots of imported products.

With a good proportion of your suppliers based abroad, it becomes easy to launder money through bogus invoices and to move money in and out of the country through fake payments -- trade misinvoicing.

These money laundering syndicates work perfectly where the network owns a commercial bank.

Indeed, the CBK audit reports contain sensational accounts of how such a syndicate is able to move funds across borders even as it engages in seemingly legitimate international trading businesses.

Enough of theory. What evidence of money laundering by Nakumatt is reported in the audit reports?

LEGAL SAFETY NET

Nakumatt’s main money laundering innovation was the use of lawyer’s client accounts as trading accounts.

Simply stated, Nakumatt came up with a system whereby money for trading and paying creditors was banked in a lawyer’s client account.

Such accounts enjoy some of the highest legal protections because of the principle of lawyer-client confidentiality.

They are even exempted from compliance under the Proceeds of Crime and Anti-Money Laundering Law.

This way, Nakumatt managed to convert trading transactions that would ordinarily be open to scrutiny by auditors into confidential transactions.

The reports show how torrents of cash from Nakumatt and other sources would be deposited into these accounts and then moved around in accounts belonging to companies in the network.

Since the Kenya Revenue Authority does not have powers to place receiving orders on lawyer client account, the billions running through the accounts remained beyond the taxman’s scrutiny.

SECRETIVE ACCOUNTS

In one case, an account was opened and on the very same day reflected a cash deposit of Sh32 million. In the following days and months, millions were channelled through the account.

In other cases, huge cash payments channelled through some of these secret accounts would be disguised as payments to legitimate suppliers of Nakumatt.

This begs the question: Why would you pay your regular suppliers through lawyer client accounts if your intention isn’t to misrepresent and deceive?

The CBK audit also catalogued several instances where related parties — companies with which Nakumatt had common owners — had transferred huge amounts of cash among them within the lawyer client accounts.

Also detected in the accounts were significant foreign currency transactions. It emerged that Nakumatt was using the shady accounts as proxy accounts for related parties -- especially an entity by the name of Nakumatt Investments Ltd.

When CBK decided to do a deep dive into these secretive accounts, the findings were damning.

There were cases where large cash transactions were made on the secretive accounts without the requisite vouchers, making it impossible to know who was being paid and the reason for payment.

In a number of cases, large cash deposits would be made only to be withdrawn the following day.

NEW BUSINESS MODEL

Like a Ponzi scheme, the exploits of the money laundering syndicate, in which Nakumatt was a key player, had to unravel at some point.

While opinion remains divided on just where the rain started beating the retail chain, the disruption that happened following the closure of Charterhouse was a major factor.

The closure of the bank dealt the money laundering network a near-fatal blow as no other bank would provide the secretive services Charterhouse had been providing.

Nakumatt was forced to operate transparently. The business model had to be changed since transactions would now be done in the open.

The lawyer-client accounts model had to be dropped. For 10 years after the Charterhouse collapse, the Nakumatt playbook changed completely.

The first thing the group did was to go into a massive expansion drive, opening stores and branches all over the country and within the region, in the process creating a giant cash generating machine.

The new business model was to run as follows: own no assets, own no stocks, sell for cash what you don’t own, hold on to supplier cash for between six and nine months, and keep trading with money belonging to suppliers while making sure that you remain completely asset-light.

CREDIT PERIOD

Nakumatt also applied and stretched leasing as a model to its elastic limit. In the new playbook, even the supermarket shelves, stores fixtures, cash tills and other equipment were acquired on lease.

The business model followed by Nakumatt was based on four main planks: first, sell and receive cash for stock and inventory that you don’t own.

Second, don’t pay the suppliers for extended periods. A confidential independent review and audit commissioned by Nakumatt’s lenders and conducted by KPMG in August 2017 found that the length of the average credit period had moved well beyond the normal period of 30 days to 196 days between 2014 and 2017.

So, as a supplier, if you delivered your goods to Nakumatt in January, you were not paid until June, a classic case of abuse of buyer power.

By holding and keeping cash belonging to suppliers for between six and nine months, Nakumatt was at any one point sitting on a huge pile of cash it easily topped up with short-term borrowing from banks to finance expansion.

And the cash held from suppliers was massive considering that this was a business which, at its height, was turning over billions of shillings every month.

Information gleaned from minutes of a meeting between Nakumatt’s receivers and suppliers held last March reveals that the annual turnover of the Nakumatt Westgate branch alone was at one time a whopping Sh4 billion.

CONCEALED ACCOUNTING RECORDS

An independent business review and audit by KPMG put the annual turnover of the retailer in 2016 at Sh50.1 billion.

Which brings me to the third plank of the Nakumatt playbook: keep saddling the company’s book with short-term debt from commercial banks.

Even as the going started getting tough, with the company mysteriously and consistently haemorrhaging billions, and the gap between turnover and capital growing wider, they did not put in any equity of their own.

By issuing the commercial paper, the retail giant raised more billions by pretending that the borrowings were going into expansion while, in reality, it was getting the liquidity to hide its weak and consistently declining working capital position.

The retail chain’s entrenched market dominance was such that big suppliers had no option but to keep supplying the supermarket even when it was holding on to money for goods already sold for months on end.

The fourth plank: conceal accounting records so that any auditor looking at your books has to rely on incomplete records.

The “stroke of genius”: when the house of cards comes tumbling down, walk away free, leaving behind a receiver-manager, bitter suppliers and taxpayers to suffer the consequences.

SUPPLIERS' REVOLT

Is it not the height of irony that there was a point when the owners of the supermarket chain were lobbying the government to bail out the company using taxpayer money?

Throughout this saga, suppliers were being pressed to enter into debt-equity swap arrangements that caused them to suffer double jeopardy.

It’s noteworthy that when the receivers entered the fray, the first piece of news they delivered to suppliers was a reminder that Nakumatt had no assets to be sold to raise the money to pay them.

At the meeting between the suppliers and receivers in March last year, Mr Atul Shah, the receiver, stated: “As we well know, Nakumatt does not have assets as such, because the stocks which should have been assets are supplied under consignment and therefore belong to suppliers”.

As at December 31, 2017, and as the company was going into administration, money owed to suppliers stood at a staggering Sh18.5 billion, almost half of Nakumatt’s total liabilities of Sh35.8 billion.

Commercial banks were owed Sh6.9 billion, commercial paper holders Sh4.8 billion, KRA Sh1.8 billion and staff Sh1.4 billion.

The company started suffering financial difficulties near the end of 2016, with the decline accelerating around May 2017.

The trigger was a suppliers’ revolt that appears to have started in early 2016.

As the problem of delayed payments worsened, suppliers started seeing through Nakumatt’s gimmicks.

MISSING BILLIONS

It dawned on them that Nakumatt was a house of cards, a fraud scheme in which fraudsters had been siphoning billions of shillings from the business while masking its financial blemishes by sucking the blood out of vulnerable and defenceless suppliers to finance working capital.

For years, the suppliers had allowed Nakumatt to build a massive cash machine using their money, until they said no more.

From around May 2017, many suppliers stopped supplying goods to the retailer, while others sought legal action.

With empty shelves becoming a common thing in Nakumatt’s stores, the elephant’s thundering footfall faded into the tiptoe of a thief in the night.

The company was facing multiple winding up petitions and proclamations from landlords, suppliers and other service providers.

As Nakumatt was closing branch after branch, the most pertinent questions were: where did the billions that suppliers entrusted to Nakumatt disappear to?

Did the cash they collected from the goods entrusted to them by suppliers just disappear into thin air? Theory has it that the money was stolen by insiders.

In the audit by KPMG, it was reported that during interviews with Nakumatt’s lenders, some of the banks had expressed the view that the money had been diverted from the business by insiders.

KPMG’s auditors explained that the only reason they did not delve deeply into the riddle of the disappearance of the billions of cash for goods that were actually sold by Nakumatt was because the scope of their work did not include having to conduct a forensic audit on the business.

WEAK FINANCIAL INFORMATION

But chances remain slim that any of the funds could be recovered because despite its size, the billions it was turning over every year, the brand and the publicity, the Nakumatt business was under a corporate governance regime akin to that of a kiosk.

To make sure that its deep operations remained concealed, Nakumatt did not keep updated audited accounts.

It means that all the receivers and auditors who have examined the books of Nakumatt have been like pilots flying blind.

Before the receivers took over in January 2018, the last audited accounts for Nakumatt were prepared and published way back in February 2016.

Hence, all the receivers could get were management accounts for the period ending December 2017.

In the business review report by KPMG, the auditors lamented that Nakumatt was not able to produce regular audited accounts despite the fact that it had an end-to-end enterprise resource planning (ERP) top of the range software from Oracle.

KPMG’s verdict was that the reliability of Nakumatt’s financial information was questionable due to too many inaccuracies in the management accounts.

The audit firm also reported that the management accounts presented to them by Nakumatt’s management did not have breakdowns of key financial statement captions such as fixed asset movement schedules and inventory ageing analysis.

CORPORATE GOVERNANCE

With the dodgy and opaque accounting environment in which Nakumatt operated, it did not surprise the auditors that the company had tried to cover another Big Black hole in its books by claiming an unexplainable loss of a whopping Sh18 billion from the business.

Apparently, Nakumatt had, for a long time, been asking auditors and receivers to accept write down inventory balances amounting to Sh18 billion.

Note that this amount represents loss of suppliers’ money over and above the Sh18.5 billion recorded in the official management accounts.

The management of Nakumatt stuck to the unconvincing position that this massive loss of suppliers’ money came about as a result of theft, stock shrinkage and stock obsolescence.

The company claimed that the Sh18 billion disappeared during tragedies the company had suffered over the years, including demolition of the Thika Road branch, the Nakumatt Downtown fire of 2012 and the Westgate attack.

But neither the receivers nor the suppliers are prepared to buy and accept the arguments by the retail chain’s management at face value.

This is how Atul Shah put it during the March 17 meeting with creditors: “These explanations are clearly unsatisfactory and raise more questions than answers.”

During the March meeting, the creditors forced the receivers into giving an undertaking that they would hire the services of forensic auditors and task them to get to the bottom of the matter.

Poor corporate governance was clearly one of the biggest problems for Nakumatt.

OWNERSHIP STAKE

The KPMG audit found that the company did not have an independent board in place.

All key decisions were made at family level, mainly by CEO Atul Shah and his two sons — Mr Neel Shah, the commercial director, and Ankoor Shah, the head of supply chain management and expansion.

KPMG reported that by the time it was conducting the review, the family had more or less left the company to be run by the CEO of Kingsway Motors, Mr Sanjay Shah, who was the former managing director of the defunct Charterhouse.

The involvement of the CEO of Kingsway Tyres in the day-to-day management of Nakumatt is an intriguing aside because in the CBK documents, Sanjay Shah is listed as a director of both Nakumatt Holdings Ltd and Nakumatt Investments Ltd.

The murky and secretive operations of Nakumatt are compounded by the fact that even beneficial ownership of the company remains mysterious.

On paper, the company is a private business that is owned by Mr Atul Shah through a 100 per cent ownership stake in the entity Nakumatt Group, Mauritius Ltd.

In turn, Nakumatt Group Ltd is owned 100 per cent by Nakumatt Holdings Kenya Ltd.

The CBK reports on Charterhouse Bank also mention a company by the name Snowdale Capital Ltd, which is said to own 100 per cent of the shares of Nakumatt Investments Ltd which, in turn, owned 10 per cent of Charterhouse Bank.

KEY ACQUISITIONS

It is recorded in the KPMG report that in 2016, Mr Atul Shah, the CEO, bought out a minority shareholder by the name of Hotnet Ltd who is reported have owned 3.3 per cent shares in Nakumatt.

KPMG was informed that the transaction was done at a consideration of $7 million (about Sh700 million at the current exchange rate).

The report says that as per the share purchase agreement entered between Atul Shah and Hotnet Ltd in that year, the consideration was to be paid by way of deferred instalments.

KPMG reported that while Hotnet transferred all its shares to Mr Shah in 2016, consideration had not been paid by the time KPMG was publishing its report in August 2017.

The audit firm’s reports also state that Atul had informed them that he had no capacity to make any of the payments.

Nakumatt was established in 1987. As at February 2017, the company had an authorised share capital of Sh950 million.

It reported a turnover of Sh51 billion and a net loss of Sh508 million for the financial year ended February 28, 2016.

Until February 2017, Nakumatt was the largest retailer by revenue and market share in East Africa with 60 branches — 44 in Kenya, eight in Uganda, five in Tanzania, and three in Rwanda.

Over the last decade, the company acquired four entities — Woolmatt and Yako in Kenya, Payless in Uganda and Shoprite in Tanzania at a total cost of Sh646 million.

The acquisitions were financed through operating cash flows which, in reality, was cash held from suppliers and short-term borrowings.

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