Muddy Waters Scores a Big Win for the Short-Sellers
(Bloomberg Opinion) -- In 2018 NMC Health Plc commissioned an external review of its board’s effectiveness. The idea of this box-ticking exercise was to assure investors that the directors of the United Arab Emirates hospital operator were working “in the interests of all key stakeholders.”
The unsurprising conclusion was that the board was “operating effectively and healthily,” NMC’s last annual report revealed. That finding clearly wasn’t worth the paper it was written on.
On Wednesday evening the FTSE-100 company ousted its chief executive officer and revealed that its chief financial officer was on sick leave. An inquiry into a laundry list of allegations published by short-seller Muddy Waters Capital LLC in December has revealed potential discrepancies in the company’s bank statements and accounting ledger entries.
Furthermore, NMC has been acting as guarantor for $335 million of supply-chain financing used by other entities owned by the company’s founder, Bavaguthu Raghuram Shetty, without the board being aware of it (the arrangements weren’t disclosed in the accounts either).
The shares were suspended on Thursday, pending clarity on the company’s true financial position. If they hadn’t been, the rout in NMC’s stock would doubtless have continued. CEO Prasanth Manghat’s departure means all the board’s executive directors and those with ties to the controlling shareholders have stepped down, leaving it to the remaining non-executives to clear up the mess.
At a company with dominant shareholders, it’s especially important that independent directors are on the ball (in NMC’s case several are City of London grandees). Turfing out the executives shows they’ve woken up at last, but they’ve failed spectacularly to protect minority investors’ interests up till now.
It was shocking enough to discover earlier this month that Shetty, NMC’s former co-chairman, didn’t know how many of his shares he still controlled, raising the possibility that some of them had been sold to settle margin calls. NMC’s latest update confirms that the rot goes deeper than his and other directors’ failure to structure their financial arrangements so as not to imperil other investors.
NMC’s governance and controls have failed and its brokers, bankers, auditors and advisers all look mightily foolish (at best). The stain on the City’s reputation won’t be easily erased.
Whenever there’s a financial scandal, the auditors — in this case Ernst & Young — are quick to point out that they cannot offer a 100% guarantee that accounts are free from misstatement. But, as with the external review of the NMC board’s effectiveness, shareholders must wonder what the point of an audit is, if it cannot detect that the company’s cash position is potentially false.
As I’ve written before, supply chain finance arrangements — whereby a bank or financial intermediary pays a company’s suppliers up front — often aren’t clearly disclosed in accounts, raising the possibility that debt is understated. While the NMC case seems to involve outright omission, it’s far from the only company to have taken advantage of the flabby disclosure rules around this form of financing.
There’s one party that emerges from this scandal with its credibility intact. Short-sellers are often maligned but they serve an important function in keeping the market honest. If a stock is heavily shorted, as NMC was, it’s incumbent on the board to find out why. Many of the specifics of Muddy Waters’s allegations haven’t been confirmed. But its doubts about NMC’s governance and financial reporting were well-founded.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Chris Bryant is a Bloomberg Opinion columnist covering industrial companies. He previously worked for the Financial Times.
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