The Financial Services Tribunal has upheld the JSE’s directive that Namibia-based Trustco must restate its financial statements for the year to 31 March 2019 and its interim results to 30 September 2019, because they did not comply with the International Financial Reporting Standards (IFRS).
The accounting “errors” pushed up Trustco’s profits by N$2.1 billion.
The financial services and resources company has a primary listing on the JSE and a secondary listing in the US.
The JSE told Trustco to correct the “errors” in November 2020 after the exchange’s Financial Reporting Investigations Panel (Frip) looked into Trustco’s books.
The issues that came before the tribunal concerned the waiver of two loans by Trustco chief executive and majority shareholder Dr Quinton van Rooyen, and the reclassification of a portion of land from “inventory” to “investment property”.
The loan waivers resulted in a Trustco recording a N$1.5 billion gain, while the property reclassification resulted in a N$693 million gain.
According to media reports at the time, without the waivers, Trustco’s 2020 interim profit would have been lower, and, without the land reclassification and N$693m gain, Trustco would have made a loss before tax of about N$88m.
The JSE said there had been no commercial rationale for Van Rooyen to forgive the loans.
The loan waivers also triggered earn-out provisions in a share-sale agreement that saw Van Rooyen (or his investment vehicle, Next Investments) benefiting “handsomely” from the allocation of Trustco shares.
‘Substance over form’
Argument before the tribunal over the treatment of the loans concerned what Trustco called the JSE’s insistence on “substance over form”.
According to the JSE, the IFRS require “financial statements to be a faithful representation of the underlying economic substance and events. This means that financial statements must consider the economic substance and financial reality of the underlying transactions, and not merely their legal form.”
Trustco contended that compliance with the requirements of the IFRS will, ipso facto, result in the financial statements faithfully representing the financial effects of transactions.
It submitted that the JSE had elevated the Conceptual Framework for Financial Reporting issued by the International Accounting Standards Board to a standard and overrode the IFRS requirements.
The tribunal disagreed with Trustco’s view, saying the JSE had used the Conceptual Framework to understand and interpret the IFRS.
The first loan
In its 2019 financial statements, Trustco recognised a N$545.6m gain with respect to Van Rooyen’s wavier of a loan to Huso Investments.
The JSE directed Trustco to restate its financial statements, reversing the N$545.6m gain and recognising the “credit amount” to reduce the common control reserve initially recognised as equity as a result of Trustco’s acquisition of Huso.
Van Rooyen, the sole shareholder of Huso, advanced a loan to fund Huso’s operations.
The repayment of the loan was at the discretion of the borrower. The loan was recorded as equity in Huso’s books.
Trustco bought Huso, effective 4 September 2018.
However, in March 2018, the terms of the Huso loan had been changed: repayment was no longer at the discretion of the borrower but due within 12 months. As a result, the loan was reclassified as a liability.
The agreement for Trustco’s purchase of Huso’s shares included an earn-out mechanism (based on earnings before interest, tax, depreciation, amortisation and after stock adjustments) in favour of Van Rooyen or Next Investments, in terms of which Trustco shares were to be allotted if profit thresholds were met.
Twenty-six days after Trusto acquired the shares, Van Rooyen forgave the loan.
As a result, Trustco recognised a gain of N$546m in its 2019 financial statements.
The conversion of the loan from equity to liability and its subsequent forgiveness converted a loss-making resources segment to a profit, which triggered the earn-out mechanism in Van Rooyen’s favour, the tribunal found.
“Trustco did not allege, nor did it argue […] that the transaction was, as a matter of substance, not a composite transaction or that the financials reflect the substance of the transaction,” the tribunal said.
“On balance, the loan reclassification, waiver and acquisition transaction(s) should not have been treated as separate and distinct transactions, in order to reflect their economic substance and not merely their legal form.”
The second loan
In its interim results to 30 September 2019, Trustco recognised a N$1bn gain with respect to Van Rooyen’s waiver of a N$1bn loan to Trustco.
The unsecured, subordinated loan became effective on 29 March 2019. The repayment date was 31 March 2024. Van Rooyen waived the loan on 30 September 2019.
As with the first loan, the waiver triggered the earn-out provisions in terms of the Huso sales agreement, benefiting Van Rooyen (or Next) in the form of Trustco shares.
Trustco did not dispute the JSE’s contention that the waiver had been predetermined.
In its 2019 financial statements, Trustco reclassified certain properties in its Elisenheim development from “inventory” to “investment property”, thereby recognising a gain of N$693m (revenue of N$984m and cost of sales of N$91m).
The JSE instructed Trustco to reverse the reclassification and, consequently, reverse the N$693m gain.
Trustco said there was a slowdown in the Namibian residential property market in 2018. As a result, in March 2019, the board decided not to develop a portion of the land, but to hold it as a long-term asset for capital appreciation. Therefore, the land was reclassified for accounting purposes.
At issue was whether there had, in fact, been “a change in use” in relation to the land.
The tribunal was not convinced that there had.
It quoted from the minutes of Trustco’s board: “The current economic slowdown in the property market has forced the group to reconsider its development timetable in order to optimally allocate resources and maximise its return on its investments. Based on this review, a decision was taken to defer various development projects.”
The tribunal commented that a different timetable and a deferment of projects do not amount to a change in use.
Cost order against Trustco
When it came to awarding costs, the tribunal said Trustco’s “repeated failure” to take the Frip, the JSE and the tribunal into its confidence by explaining the economic rationale for Van Rooyen’s waivers of the loans amounted to “exceptional circumstances” per section 234(2) of the Financial Sector Regulation Act.
It ordered Trustco to pay 50% of the JSE’s costs, including the costs of two counsel on the High Court scale.