Polly Peck Collapse - Polly Peck International grew rapidly in the 1980s from a small British textiles

company to a vast FTSE 100 conglomerate corporation, but imploded in 1990 with debts of £1.3bn amid
claims of gross mismanagement and fraud.

WHO IS ASIL NADIR?

Asil Nadir is a turkish Cypriot businessman who made his fortune in London. His meteoric rise and
flamboyant style epitomized the Thatcher years; his downfall in the early 1990s was the hangover at the
end of the yuppie party. After the boom, he went bust.

Nadir arrived in London in the 1960s and started in the rag trade. In 1980 he bought a small east London
garment business that barely turned a profit. Within a decade, Polly Peck was valued at £1.7bn and had
diversified into fruit packing, hotels and electronics. Some investors saw astonishing returns of 1,000 per
cent – the highest share price rise ever recorded.

Nadir enjoyed his success to the full, buying an Aegean island, stately homes, racehorses and cars. He
hobnobbed with Princess Margaret among others – and donated £500,000 to the Conservative party. He
was a household name in the UK, a figure who ranked alongside Robert Maxwell as a self-made, hard-
nosed, slick-haired, big-suited symbol of the Thatcher decade.

ORIGIN OF POLLY PECK AND WHAT EVENTUALLY LED TO THE COLLAPSE

In 1980, a company known as Restro Investment which was controlled by Asil Nadir bought 58% of the
shares of Polly Peck, a small company in the textile industry for £270,000. With this, he had control over
the company and within 10 years of purchase, Polly Peck grew into a big company (Wearing, 2005).
Within the years 1982 – 1989, turnover, pre-tax profit, and net assets rose from £21 million to £1.16
billion, £9 million to £161 million, and £12 million to £845 million respectively (Jones, 2011).

However, despite its excellent results, Polly Peck was unable to pay its creditors. What was surprising
was that although Nadir had only 25% of the shares as at 1989, he still controlled and dominated the
board and the company as a whole. Nadir extracted cash from Polly Peck and transferred it into its
subsidiary companies like Uni-Pac before he eventually transferred it out for his personal use. These
withdrawals would appear in Polly Peck’s accounts as amount owed by subsidiaries and would
subsequently be cancelled out as inter-company balance (Jones, 2011).

An investigation by the Serious Fraud Office (SFO) also revealed that Polly Peck cooked up its assets in
some of its subsidiaries so as to cancel out the amount owed by these subsidiaries to Polly Peck.

What also made the scandal worse were the accounting policies adopted by Polly Peck which were in
accordance to the requirement of accounting standards at that time. In 1983, Polly Peck adopted the
SSAP 20 (Foreign Currency Translation) and chose to use the average rate to translate its profitless
items. Thus, when it restated its 1982 financial statement in line with SSAP, there was an increase of
£2.7 million in turnover and £1.5 million in net assets for that year only. Hence, Polly Peck continued
with its average method in translating profit and loss items, and from 1983-1989, Polly Peck made a
profit before interest and tax of £599 million and within the same period, debited £415 million to the
profit and loss account due to the movements on exchange. Of this £415 million, £56 million was as a
result of the use of the average method in converting its profit and loss items, while the remainder was
due to the translation of its opening net investments. Hence, Polly Peck continued to grow each year, as
movement on the exchange was adverse.

In addition, there was an accounting trick in an overseas operation. At the heart of the company was a
citrus fruit packaging operation. This was fabulously profitable and there were many (Private Eye
puzzled over it for years) who just couldn't work out how or why it was so. The simple answer is that
they were booking the profits as profits while the losses were hidden around the back of the accounts.
In order to get the citrus fruits to package, the company would lend money at the beginning of the
growing season to the farmers. There's nothing unusual about this: it's a common system of funding the
growing of agricultural commodities. These loans would be made in Turkish Lira and the interest rate,
given Turkey's inflation at the time, would be very high – 50pc and above (memory at this distance isn't
all that good, I seem to recall 130pc at times). This wasn't an extortionate(expensive/ extravagant/high)
rate; this was actually, given the general level of interest in Turkish Lira, a good deal for the farmers.To
fund these loans the company would borrow in Deutschmarks (DM), perhaps Swiss Francs (CHF), where
they were paying 3 and 4pc interest rates. The difference between borrowing at 4pc and lending at 50pc
is substantial and it's entirely normal accounting practice to book such interest differentials as profit.
However, the reason that there were such high interest rates in Turkish Lira was that the country had
very high inflation. Very high inflation usually also means that the currency will be falling in value. So
when, after the harvest the farmers shipped their fruit to the packaging plant and paid back their loans,
the principal they paid back was worth very much less in DM or CHF than they had borrowed. There are
several ways you can deal with such currency losses. You could run them through the profit and loss
account, and if these losses were expected, or if they were likely to be a regular feature of trading, then
perhaps you should. If these losses were something unusual, an "extraordinary event", then it's
perfectly legitimate (that is, legal, even if not very informative) to instead write them off against
reserves without them going through the profit and loss account. This is what Polly Peck did.

The lovely profits on that interest rate spread went through the P&L. The horrendous losses on the
currencies were knocked off reserves and didn't cross the P&L.

AUDITING ISSUES IN POLLY PECK

Summary of auditing issues;

Conflict of interest; In the case of Polly Peck, the conflict of interest that arose was on the part of
Coopers & Lybrand, who were responsible for the administration and receivership of Polly Peck. There
was a conflict of interest as they had shares in Polly Peck, audited its subsidiaries, served as advisors to
the directors and reported on the company’s prospectus (Sikka, 2004). Also as Polly Peck was one of
Stoy Hayward’s most established customers, there was the possibility of conflict of interest as Stoy
Hayward would not want to lose a major source of their income.
The role of external auditors and an assessment as to whether their duties were fulfilled; The auditors
of Polly Peck were Erdal & co. (Turkish subsidiaries auditors) and Stoy Hayward (UK- based group
auditors). Erdal & co. collaborated with Polly Peck in the manipulations of their accounts and this led to
the exclusion of Erdal partners from the Institute of Charted Accountants of England and Wales, while
Stoy Hayward was criticized on the basis of inefficiency in the assessment of Erdal in carrying out the
audit of the Turkish subsidiaries of Polly Peck; inefficiency in reviewing Erdal’s working papers; and
failure to investigate the causes of the abnormal growth in its subsidiaries.

Detailed explanation of conflict of interest

With pre-tax profits of £161.4 million, net assets of £845 million and 17,227 employees, the Polly Peck
group was one of Britain's top one hundred quoted companies. In October 1990, it collapsed.
Accountants from Coopers & Lybrand (now part of PriceWaterhouseCoopers) together with Touche Ross
(now part of Deloitte & Touche) were appointed joint administrators of the company. By June 1991, the
firms had received £2.56 and £5.8 million respectively in fees. Before accepting the position of
administrator, Coopers did not reveal its extensive links with Polly Peck and its chairman Asil Nadir. Its
links were as follows:

 Coopers & Lybrand acted as joint reporting accountants when Polly Peck originally went public
(Accountancy Age, 23rd April 1992, page 11).
 Cooper's Channel Islands practice had acted as auditor of Restro Investments through which Asil
Nadir held his (at one time majority) stake in Polly Peck.
 Coopers had also been involved with the Polly Peck group through consultancy assignments
(Accountancy Age, 20th June 1991, page 1).
 Three of the firm's partners were reported to be shareholders and acted as directors of Vemak
(Jersey), a company that ran Asil Nadir's (stately) home and other property investments.
Coopers also acted as personal tax adviser to Asil Nadir (Accountancy Age, 6th December 1990,
page 1).
 A recommendation from Coopers led to the appointment of Polly Peck's finance director
(Accountancy Age, 19th March 1992, page 3).Coopers' special work income from the Polly Peck
group is estimated to have been £1.5 million from 1985 to 1989. The firm received £262,000
from auditing Polly Peck's far East operations (Accountancy Age, 27th February 1992, page 1).

IMPLICATIONS ON CORPORATE GOVERNANCE

It can be said that there was weak governance at Polly Peck as Nadir was able to move large sums of
money without any employees or directors questioning him. This was probably due to the fact that
Nadir was acting as both chairman and CEO, thereby giving him absolute power and control and also
due to the lack of effective control system within Polly Peck’s head office in London. The control systems
were so weak to the extent that even the need for dual signatures on bank withdrawals was absent.
Implication on CG: The board of directors are those who are responsible for ensuring that the company
is being managed by the managers in the interest of the shareholders, and they are responsible for
holding the ethical code of the organization. Board of directors are also meant to oversee accounting
practices in order to ensure compliance with accounting standards, review remuneration schemes of top
executives in order to prevent conflict of interest arising, and ensure independence of company’s
auditors by rotating the audit firm after every few years and preventing the audit firm from providing
both internal and external audit services.This was not the case at Enron as the improper governance of
its board of directors was one of the major problems which led to its fall.

The auditors of Polly Peck were Erdal & co. (Turkish subsidiaries auditors) and Stoy Hayward (UK- based
group auditors). Erdal & co. collaborated with Polly Peck in the manipulations of their accounts and this
led to the exclusion of Erdal partners from the Institute of Charted Accountants of England and Wales,
while Stoy Hayward was criticized on the basis of inefficiency in the assessment of Erdal in carrying out
the audit of the Turkish subsidiaries of Polly Peck; inefficiency in reviewing Erdal’s working papers; and
failure to investigate the causes of the abnormal growth in its subsidiaries.

LESSONS LEARNT FROM THE SCANDALS

Before the collapse of Polly Peck, stakeholders and the general public found it hard to understand how
the company was making its money even though it had no cash, but no one was doing or saying
anything about it, and there were no questions asked. Therefore, an important lesson learnt is that
questions should be raised and investigations should be carried out when there is doubt, in order to
identify the possibility of a fraud before it’s too late. Also, Asil Nadir was acting as both the chairman and
CEO of Polly Peck, thereby having so much authority and power which means there was hardly any
segregation of duties, making it difficult to recognize the fraud from the beginning. Hence, another
lesson learnt is to have two different individuals acting as CEO and chairman, as stated in the Cadbury
report.

The Cadbury report was published in 1992 after the collapse of some prominent UK companies,
including Polly Peck. The collapse was mainly as a result of board oversight and weak governance
systems. The Cadbury report is a report of a committee chaired by Adrian Cadbury which focuses on the
arrangement of company boards and accounting systems to reduce corporate governance risks and
failures. It recommends the establishment of a non-statutory code of best practice and governance
issues in listed companies. This was known as the combined code which was to become the backbone of
corporate governance. The code recommends that board of UK corporations or publicly traded
companies should include at least three outside non-executive directors effective internal control
systems should be put in place, there should be transparency in its financial reporting, and that positions
of Chairman of the Board (COB) and Chief Executive Officer (CEO) be held by two different individuals.