Identify and explain the factors that might lead institutional investors to attempt to intervene directly in the management.

Corporate Governance
Assignment Two- RSTL Case study
RSTL Case Study
In the 2009 results presentation to analysts, the chief executive of RSTL, a global internet communications company, announced an excellent set of results to the waiting audience. Chief executive as well as Chairman, Mr Rob Yu announced that, compared to 2008, sales had increased by 50%, profits by 100% and total assets by 80%. The dividend was to be doubled from the previous year. He also announced that based on their outstanding performance, the executive directors would be paid large bonuses in line with their contracts. His own bonus as chief executive would be £20 million. When one of the analysts asked if the bonus was excessive, Mr Yu reminded the audience that the share price had risen 45% over the course of the year because of his efforts in skilfully guiding the company. He said that he expected the share price to rise further on the results announcement, which it duly did. Because the results exceeded market expectation, the share price rose another 25% to £52.
Three months later, Rob Yu called a press conference to announce a restatement of the 2009 results. This was necessary, he said, because of some ‘regrettable accounting errors’. This followed a meeting between RSTL and the legal authorities who were investigating a possible fraud at RSTL. He disclosed that in fact the figures for 2009 were increases of 10% for sales, 20% for profits and 15% for total assets which were all significantly below market expectations. The proposed dividend would now only be a modest 10% more than last year. He said that he expected a market reaction to the restatement but hoped that it would only be a short-term effect.
The first questioner from the audience asked why the auditors had not spotted and corrected the fundamental accounting errors and the second questioner asked whether such a disparity between initial and restated results was due to fraud rather than ‘accounting errors’. When a journalist asked Rob Yu if he intended to return back the £20 million bonus that he received based on the previous results, Mr Yu said he did not and he is not planning to return the money. The share price fell dramatically upon the restatement announcement and, because RSTL was such a large company, it made headlines in the business pages in many countries.
Later that month, the company announced that following an internal investigation, there would be further restatements, all dramatically downwards, for the years 2006 and 2007. This caused another mass selling of RSTL shares resulting in a final share value the following day of £1. This represented a loss of shareholder value of £12 billion from the peak share price. Rob Yu resigned and the government regulator for business ordered an investigation into what had happened at RSTL. The shares were suspended by the stock exchange. A month later, having failed to gain protection from its creditors in the courts, RSTL was declared bankrupt. Nothing was paid out to shareholders whilst suppliers received a fraction of the amounts due to them. Some non-current assets were acquired by competitors but all of RSTL’s 54,000 employees lost their jobs, mostly with little or no termination payment. Because the RSTL employees’ pension fund was not protected from creditors, the value of that was also severely reduced to pay debts which meant that employees with many years of service would have a greatly reduced pension to rely on in old age.
The government investigation found that RSTL had been maintaining false accounting records for several years. This was done by developing an overly-complicated company structure that contained a network of international branches and a business model that was difficult to understand. Whereas RSTL had begun as a simple telecommunications company, Rob Yu had increased the complexity of the company so that he could ‘hide’ losses and mis-report profits. In the company’s reporting, he also substantially overestimated the value of future customer supply contracts. The investigation also found a number of significant internal control deficiencies including no effective management oversight of the external reporting process and a disregard of the relevant accounting standards.
In addition to Mr Yu, several other directors’ close friends with MR Yu were complicit in the activities. Although Elly Lo, a senior qualified accountant working for the financial director, had been unhappy about the situation for some time. She had approached the finance director with her concerns but having failed to get the answers she felt she needed, had threatened to tell the press that future customer supply contract values had been intentionally and materially overstated (the change in fair value would have had a profit impact). When her threat came to the attention of the board, she was intimidated in the hope that she would keep quiet. She finally accepted a large personal bonus in exchange for her silence in late 2008.
The investigation later found that Elly Lo had been continually instructed, against her judgement, to report figures she knew to be grossly optimistic. When she was offered the large personal bonus in exchange for her silence, she accepted it because she needed the money to meet several expenses related to her mother who was suffering a long-term illness and for whom no state health care was available. The money was used to pay for a lifesaving operation for her mother and also to rehouse her in a healthier environment. Elly Lo made no personal financial gain from the bonus at all (the money was all used to help her mother) but her behaviour was widely reported and criticised in the press after the collapse of the company. 2
The investigation found that the auditor, JJC partnership (one of the largest in the country), had its independence compromised by a large audit fee but also through receiving consultancy income from RSTL worth several times the audit fee. Because RSTL was such an important client for JJC, it had many resources and jobs entirely committed to the RSTL account. JJC had, it was found, knowingly signed off inaccurate accounts in order to protect the management of RSTL and their own senior partners engaged with the RSTL account. After the investigation, JJC’s other clients gradually changed auditor, not wanting to be seen to have any connection with JJC. Accordingly, JJC’s audit business has since closed down. This caused significant disturbance and upheaval in the audit industry.
Because RSTL was regarded for many years as a high performing company in a growing market, many institutional investors had increased the number of RSTL shares in their investment portfolios. When the share price lost its value, it meant that the overall value of their funds was reduced and some individual shareholders demanded to know why the institutional investors had not intervened sooner to either find out what was really going on in RSTL or divest RSTL shares. Some were especially angry that even after the first restatement was announced, the institutional investors did not make any attempt to intervene. One small investor said he wanted to see more ‘shareholder activism’, especially among the large institutional investors.
Sometime later, Mr Yu argued that one of the reasons for the development of the complex RSTL business model was that it was thought to be necessary to manage the many risks that RSTL faced in its complex and turbulent business environment. He said that a multiplicity of overseas offices was necessary to address exchange rate risks, a belief challenged by some observers who said it was just to enable the RSTL board to make their internal controls and risk management less transparent.
The RSTL case came to the attention of Robert Nie, a senior national legislator in the country where RSTL had its head office. The country did not have any statutory corporate governance legislation and Mr Nie was furious at the RSTL situation because many of his voters had been badly financially affected by it. He believed that legislation was needed to ensure that a similar situation could not happen again. Mr Nie intends to make a brief speech in the national legislative assembly outlining the case for his proposed legislation and some of its proposed provisions.

Case Questions:
Because of their large shareholdings, institutional investors are sometimes able to intervene directly in the companies they hold shares in. By referring to the case study, Identify and explain the factors that might lead institutional investors to attempt to intervene directly in the management. Your answer should be structured as follows (30 Marks)
Case for institutional investors intervention Explanations Justifications and implications for RSTL

Mention 5 examples of bad corporate governance and Explain the importance of sound corporate governance by explaining the consequences of the corporate governance failures at RSTL as well as offer recommendations to the board of RSTL on how they could have maintained a good governance practices (20 Marks)
Examples of Bad Corporate Governance Practice Consequences for RSTL Recommendation

Mention 10 weaknesses in RSTL Company’s internal control system. Relate each weakness to COSO internal Control framework. Explain the implication of each weakness on the company’s success (30 marks)
Weakness in RSTL Company’s internal Control systems Violation of COSO Component Implications of weakness on RSTL continuity

Cite 10 examples of disciplining excessive Pay and explain how RSTL could have used these to encounter Mr Rob Yu high Remuneration (20 marks)
Example of remuneration discipline Implications and justifications