By Deon Basson

This email address is being protected from spambots. You need JavaScript enabled to view it.

DURING the past week, Sharemax stubbornly fought to prevent the whole truth about its property syndication scheme coming to light.

Finance Week obtained summarised financial statements of the Van Riebeeckshof syndication in Bellville. These show clearly why the directors aren’t keen for FW to conduct an analysis of the cream they skimmed off under a previous dispensation (see also FW, 27 October 2004).

Frans Viljoen, a director of Sharemax, promised in a letter to FW editor Rikus Delport: "On request we are glad to supply you. . . with the financial statements, as also discussed with you by André Brand (Sharemax’s marketing director)."

Sharemax then changed tack and set the condition that Delport must undertake not to give the financial statements to the writer of this report. Delport refused to comply, and at the time of going to press, Viljoen had not yet fulfilled his promise.

The summarised Van Riebeeckshof financial statements, which FW obtained from a different source, confirm a trend that was apparent last year when FW analysed all the financial statements of a number of property trusts: that value for shareholders has been considerably diluted as a result of cost factors that were not known to investors at the time that most of the investments were made.

In conjunction with information that’s known, it’s clear that the pickings were rich for Sharemax, its directors and commission agents who marketed units in the various property trusts. Of course, that was to the detriment of the investors.

However, Sharemax pretends innocence and claims to be the white knight after its property trusts were converted into public companies earlier this year.

Viljoen gives a long account in his letter of "active steps" taken by Sharemax to convert its trust structure into a public company structure.

The simple reality is that the initiative only started bearing fruit after FW and stablemate Sake began writing about Sharemax last year and the Financial Services Board (FSB) shortly afterwards stopped the marketing of units by way of the trust structure.

Viljoen now holds Sharemax up as "a leader in the property syndication industry" and taking the lead in compiling a code of conduct for the industry.

However, there’s no mention of what Sharemax is doing to restore the losses investors have suffered as a result of the excessive skimming off the cream by the trust structure.

Van Riebeeckshof is a good example of a trust marketed by Sharemax shortly ahead of FW’s reports. This property in Bellville was syndicated for R35,9m after a wholly-owned subsidiary of the trust, Nightfire Investments, had bought it shortly before for R27m.

Within a short period, the property’s value was therefore pushed up by 33%. Conversely, the value at which the property was bought was 25% lower than the syndication value. For the sake of convenience, FW will refer to the latter as the dilution factor.

According to the financial statements, the dilution factor of R8,9m was written off as goodwill. The fact that the value of the property, according to the summarised balance sheet, increased by about 11% – from R27m to R29,9m – in the nine months to 29 February could probably have been expected in the current bull market.

However, that’s not the point: R29,9m is still significantly less than the R35,9m for which the property was syndicated. Even in a bull market, it’s difficult to quickly make up the loss originally created by undisclosed skimming off the cream.

The name of the valuator is not disclosed in the summarised financial statements. FW has established that the well-known valuator Erwin Rode did not value the properties as he did in 2003. Last year Viljoen felt Rode was "too conservative".

No further details on the nature of the writing off of goodwill are given in Van Riebeeckshof’s financial statements. However, according to historical statements of other trusts, goodwill consists of transfer duties, promoter fees, broker fees, legal fees and general marketing costs (FW, 22 October 2003).

In prospectuses of later public companies, the reasons for the dilution factor (unlike the situation for the historical trusts) are set out in detail (see also tables). It’s clear that the skimming in this company scenario has so far been considerably less than with the trust structure previously.

FW estimates that Sharemax probably made a profit of at least R50m in the old trust structure with the syndication of the 14 properties for R412m. That conservative profit estimate is based on information available to FW. The total dilution factor for investors is probably more than R100m (see table) and was probably helped along nicely with marketing costs, which included substantial commissions to marketers.

With three later properties where prospectuses were used, investments of R321m were collected, out of which Sharemax probably made a further profit of about R22m.

It therefore looks as if disclosure in terms of SA’s Companies Act restricted Sharemax’s high profit margin. However, it’s still high (see second table), and prospective investors should consider that there’s still a significant dilution factor.

Though Viljoen emphatically denies that the creation of the trust structure constitutes a violation of Section 30(1) of the Companies Act, it would be fair comment to say that Sharemax has succeeded for four years in smartly bypassing the Act.

Section 30(1) prohibits associations or partnerships exceeding 20 members (quoted fully in the box). It’s common knowledge that all Sharemax’s syndications involve far more than 20 people as investors.

Sharemax’s historical use of the trust structure was based on legal advice obtained by its lawyer, Eckard le Roux of Weavind & Weavind. The eventual change to a company structure has nothing to do with Section 30(1), but it does relate to the FSB’s opinion that the scheme violates the new Collective Investment Schemes Control Act.

The auditors of the 14 trusts, PricewaterhouseCoopers, confirmed that unqualified audit reports had been signed for 2004.

PwC discussed the section 30 (1) issue with its client and believes that the particular section in the Companies Act is not relevant to trusts. A qualified audit opinion and reporting the matter to the Public Accountants & Auditors’ Board were not necessary, in the opinion of PwC, and had been confirmed by internal technical advice.

However, PwC did not get independent legal advice on the matter. University of Pretoria auditing professor Herman de Jager says that he accepts that the trust has more than 20 members and profit is the motive. The use of trusts therefore looks like a violation of the Companies Act.

He says the auditors should have considered whether the trust structure constituted a material irregularity. With the limited information at his disposal it looked as if it indeed was essentially a material irregularity because it had all the characteristics of one.

"Once again, with the limited information, I believe that the possible violation of Section 30(1) should have appeared alternatively as an information paragraph in the audit report," De Jager says.

In their book Ondernemingsreg, Cilliers, Benadé & others state that Section 143(1) of the Companies Act stipulates that no person is allowed to offer shares to the public in any other way than in accordance with the provisions of the Act. They say that the provisions of the Act are so comprehensive that they also cover the offer of interests in some trusts.

Even if one gives Sharemax the benefit of the doubt, investors who invested more than R400m did not have the benefit of prospectuses, as required by the Act.

If indeed Sharemax legally succeeded in circumventing the Act, the implications are far-reaching.

The summarised Van Riebeeckshof financial statements state: "On request a complete consolidated financial statement will be provided."

In terms of Section 302(4) of the Act, it’s illegal for a public company not to send financial statements to the Registrar of Companies.

The object of this subsection is simply to facilitate scrutiny by the public.

However, with its trust structure, Sharemax sidestepped this and other important provisions of the Act, as FW’s experience proved.

Public access is important because investors’ shares in the various Sharemax units trade on a secondary market. In addition to current investors, it should also be possible for potential investors, brokers, analysts and investment advisers to have easy access to the financial statements if Sharemax should prove obstructive, as it did with FW.

Investors and potential investors should ask for full financial statements and obtain expert opinions regarding them. Viljoen, Brand, financial director Stefan Schoeman and MD Willie Botha owe it to investors to spell out exactly how much undisclosed profit they made through the trust structure using investors’ money.

Marketers should explain to their clients how much commission they earned and why they didn’t choose alternative property investments where the dilution factor was lower. Was it because of the attractive commission structure and the luxury trips overseas and elsewhere in Africa that Sharemax used to tempt them?

Section 30 (1):

No company, association, syndicate or partnership consisting of more than 20 persons shall be permitted or formed in the Republic for the purpose of carrying on any business that has for its object the acquisition of gain by the company, association, syndicate or partnership, or by the individual members thereof, unless it is registered as a company under this Act or is formed in pursuance of some other law or was before the 31st day of May 1962 formed in pursuance of Letters Patent or Royal Charter.