Case Overview

Ever since its SESDAQ1 listing at a price of 32 cents per share in

March 2004, New Lakeside Holdings Limited (New Lakeside) had
issued a number of profit warnings and had been plagued by corporate
governance issues and audit qualifications. Things worsened when its
statutory auditor, LTC LLP (LTC), claimed that the Group had made
“fraudulent misrepresentations”2 in their 2009 financial statements. By
the time LTC reported the matter to the Minister of Finance for possible
breach of the Companies Act in September 2010, the share price had
plunged to 2 cents per share3. Despite a major restructuring exercise,
the situation was beyond salvage for New Lakeside. On 1 November
2010, New Lakeside filed with the High Court to be placed under judicial
management. The objective of this case is to allow a discussion of
issues such as challenges for independent directors in a management-
controlled company, accounting and auditing issues, and the roles of
directors, auditors, regulators and other intermediaries.

The Beginnings of New Lakeside

Incorporated in Singapore in 2002, New Lakeside produced and sold apple
juice concentrate to multinational corporations in the food & beverages
industry. The Group had two wholly-owned subsidiaries - Sanmenxia
Lakeside Fruit Juice Co. Ltd (LFJ) and New Lakeside (Sanmenxia) Co.

This is the abridged version of a case prepared by Athena Chan, Elaine Ang, Elicia Ng, Emily Sim, and Regina
Lin under the supervision of Professor Mak Yuen Teen. The case was developed from published sources
solely for class discussion and is not intended to serve as illustrations of effective or ineffective management.
Consequently, the interpretations and perspectives in this case are not necessarily those of the organisations
named in the case, or any of their directors or employees. This abridged version was prepared by Amanda Aw
Yong under the supervision of Professor Mak Yuen Teen.

Copyright © 2016 Mak Yuen Teen and CPA Australia

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Ltd (NLS). The apple juice concentrate produced was used to make
packet juice drinks, soft drinks, cider, yoghurt and candies. The Group
also produced animal feed using apple pomace from the production of
apple juice concentrate to supplement its main business. New Lakeside
had customers in North America, Southeast Asia and Western Europe.

In March 2004, New Lakeside became the first company (since August
2003) to close below its initial public offer (IPO) price, at 30.5 cents per
share compared to its IPO price of 32 cents per share. Several other
listings also fell below their IPO prices. Poor market confidence after
a terrorist attack in Spain, a political standstill in Taiwan and correction
on Wall Street were cited as reasons for the bearish Singapore market.
Other analysts, however, attributed New Lakeside’s low IPO price to
inherent problems with its business model – a single-product business
which was highly leveraged.

Absence of Profit Warning

As 30 June 2004 approached, many Chinese companies listed on the
Singapore Exchange began to issue profit warnings. As New Lakeside
did not issue a profit warning, its reported net loss of RMB 9.4 million
(S$1.95 million) for the six-month period ended 30 June 2004 shocked
the market. In a statement to the SGX4, New Lakeside attributed the
loss to the increase in administrative expenses, selling and distributing
expenses, and finance costs. Revenue also decreased due to the
unusually higher sales for financial year (FY) 2003, which in turn was
due to U.S. orders taken in 2002 but fulfilled in 2003.

The independent directors (IDs) – Chairman Alan Yeo, Hwang Soo

Chin and Leong Siew Loon – were unaware of the loss until four days
before the release of the financial results. In reaction to the shock loss,
the directors commissioned a special audit, carried out by China-based
auditors Henan Chenghe Accounting Firm, to review the circumstances
surrounding the loss. They also commissioned a physical stock count in
the Group’s subsidiaries.

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The First Special Audit
The special audit uncovered numerous accounting irregularities, and
reactions from Moore Stephens (the external auditors) and the directors
of New Lakeside in response to the irregularities, were as follows:

Special Audit Findings Responses from Moore Stephens

by Chenghe and Directors
Failure of subsidiary LFJ to Moore Stephens: Chenghe had not computed
abide by China’s enterprise the COS on a consolidated basis. With the
accounting system resulted in an exclusion of the accounts of Lingyi factory,
understatement of cost of sales a branch of LFJ, it was difficult to prove a
(COS) and overstatement of substantial misstatement of COS.
profits amounting to RMB 24.4
Directors: Agreed.
million (S$4.9 million).

Asset inflation - Assets bought for Moore Stephens: A reversal for the difference
RMB 6.4 million were recorded at was done.
about RMB 47.4 million. Directors: Satisfied at the reversal of the entry.

Prepaid freight charges (on behalf Moore Stephen: Made a provision of RMB 4.1
of customers) of RMB 16.3 million million for long outstanding receivables.
were classified as receivables in Directors: To continue to monitor the
LFJ’s accounts when the recovery recoverability of these receivables and review
was uncertain. the policy of freight prepayment.

(a) Two unusual sales transactions (a) Directors believed those sales were
(b) A physical stock count showed provided for by Moore Stephens.
an overstatement of LFJ’s stock (b) Directors assured that measures have
of approximately RMB 2.8 million. been taken to ensure proper bookkeeping.

Trouble Brewing in the Boardroom

The IDs called for a meeting to review the findings of the special audit.
Unconvinced by the “inadequate explanations”5 provided by the then-
MD Sun Jiwei and Chief Financial Officer (CFO) Xu Lixin, the IDs
discharged them from their duties to avoid “a dereliction of our duties
for all shareholders”6. However, later in the same month, Sun was
unexpectedly reinstated as the joint-MD, together with the appointment
of another MD Go Twan Heng, who was also the majority shareholder.

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The directors of the subsidiaries were also reappointed, together with
other new directors on the New Lakeside board7. In the end, the IDs did
not cast their vote to oust Sun and the directors of the subsidiaries, as
they realised that their votes could not influence the decisions made as
the executive directors held the majority of the Group’s shares8.

Joint-MD Sun Sacked Over First Profit Warning

Though New Lakeside appeared to be heading towards better times
with the new structure, the Group released its first profit warning for the
half-year ended 30 June 2005. While sales had increased, the larger
increase in cost of production had eroded its profits. The Group expected
the losses to persist in the subsequent half-year. Believing that its loss
of RMB 66.2 million (S$13.7 million) in the first half of 2005 was due to
Sun’s incompetence, the board of directors terminated Sun’s position as
the joint-MD9. Go then assumed the post of the sole MD. Following that,
Professor Wang Sixin, an executive director, and general manager and
director of two subsidiaries, also resigned.

Shaken Confidence
To make matters worse, the Group reported that it might suffer an
estimated loss of RMB10 million in its second half-year due to the
shortage in raw materials and unfavourable weather conditions. In the
end, FY2005 ended with an accumulated loss of RMB98 million (S$19.7
million). External auditors TeoFoongWongLCLoong also raised going
concern issues, suggesting that New Lakeside might not be able to meet
its financial obligations.

The profit warnings continued into the first half of 2006, with a reported
net loss of RMB12 million. However, the Group incurred lower losses,
as compared to the first half of 2005, due to the measures taken by the
new management to minimise costs. Despite having implemented those
steps, the Group still performed below market expectations. Coupled with
the unauthorised RMB250 million guarantees made by LFJ (approved by
MD Sun), the financial position of New Lakeside could not be any worse.

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Restructuring Exercise
In 2006, Go implemented a major restructuring strategy across the firm in
hopes of turning things around. Two loss-making subsidiaries in China10
were sold for a token amount of RMB5 (S$1) each, along with their net
liabilities. The gain on disposal of the two subsidiaries totalled RMB86.96
million, which more than offset the loss from operations for FY2006.
Under the SGX listing rules, companies which suffered losses for three
consecutive years would be placed on its watchlist, while those which
reported losses for five consecutive years would be delisted11. Due to
the gain from disposals, New Lakeside saw its first profit in three years.

The other business of manufacturing animal feed, which required coal to dry
the apple pulp, was closed down to limit the risk exposure of the escalating
cost of coal. The fiscal year end was also changed from 31 December to
30 June - the reason given was to align the fiscal year to the apple pressing
season in order to better reflect the Group’s operating cycles12.

Joint Venture with Zhonglu

Go’s efforts in rebuilding the Group initially appeared to be effective,
based on the return to profitability in 2006 and 2007. Good news came in
July 2008 when Shanghai-listed SDIC Zhonglu Fruit Juice Co. (Zhonglu)
decided to invest S$12.25 million of its manufacturing assets in New
Lakeside, thereby acquiring a 24.57 per cent stake (98 million shares).
As a producer and seller of fruit juice concentrates, Zhonglu was a
leading player in the apple juice concentrate industry, with 14 per cent of
the Chinese market13. Having an established industry player as a major
shareholder could potentially help resolve New Lakeside’s financing
woes, improve its management support, and significantly increase its
production in the short-run. New Lakeside, in turn, was able to offer
Zhonglu better access to international capital through its SGX listing.

Go expected the joint venture to generate immediate cost savings and

increased profits through the ability to buy cheaper apples. Together with
tighter cost control and a commercially - profitable arrangement, FY2008
was the second profitable year for New Lakeside since its 2004 listing.

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The Point of No Return
However, the joint venture with Zhonglu was not able to turn the situation
around for the Group. More profit warnings came in July 2009 and again
in January 2010. New Lakeside’s financial statements raised a red flag,
with net current liabilities reported at RMB93.16 million (S$19.1 million)
and negative operating cashflows of RMB12.74 million. This prompted
the newly-appointed auditors, LTC, to warn investors of potential going
concern risks.

The situation worsened in January 2010 when the Group could not pay
its debts. NLX was under pressure from a claim of RMB22.75 million
arising from a guarantee given to a former subsidiary of the Group,
LFJ. This reduced NLX to a state of insolvency, which sparked further
immediate claims amounting to RMB24.5 million from two other banks14.
To make matters worse, two other individual lenders15 also demanded
the repayment of a S$6.56 million loan they had given to the Group in
2006. This raised significant going concern issues for New Lakeside.

Amid the mounting cash flow problems, CFO Oh Gim Teck resigned on
11 June 2010, after the failure to reach a consensus among the executive
directors on how to resolve the issue16.

A Trail of Audit Qualifications

New Lakeside had several qualified auditors’ opinions relating to
significant accounting-related issues17. However, New Lakeside was not
required to take mandatory courses of action to address those issues.
Regulators also did not act.

In April 2005, Moore Stephens issued an opinion with an emphasis

of matter relating to trade debtors of RMB7.3 million which had been
outstanding for more than a year. In April 2006, the new auditors,
TeoFoongWongLCLoong, qualified their opinion for FY2005, citing going-
concern issues and their inability to form an opinion on the existence of
inventories which were written off, write-off of freight charges, and validity
and treatment of certain expenses. In April 2007, Baker Tilly also qualified

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their opinion, citing going-concern issues and inability to verify unaudited
management accounts of subsidiaries, which had been disposed of
during the year. In October 2007, New Lakeside changed its financial
year-end from December to June.The set of accounts issued in October
2008 were again qualified by Baker Tilly, this time citing their inability to
verify financial guarantees given by a subsidiary and the recoverability
of sundry receivables. Their report also contained an emphasis of matter
relating to the company’s ability to meet its financial obligations.

In April 2009, New Lakeside changed its auditors to LTC, and in October
2009, when the company reported a net loss of RMB84.9 million, the
external auditors’ opinion contained only an emphasis of matter, albeit
an important one relating to ‘material uncertainty which may cast
significant doubt about ability to continue as going concern’. However,
in September 2010, LTC informed the audit committee chairman that
fraudulent representations may have been made in the course of the
2009 audit and therefore their audit opinion for 2009 could no longer be
relied upon. LTC also made a report to the Minister of Finance.

No More Juice
With a net loss of RMB84.9 million in FY2009 followed by another net
loss of RMB64.1 million for the following financial year, the situation
spiralled out of control. New Lakeside finally filed with the Court to be
placed under judicial management18, and the Group’s shares were
officially suspended from trading.

“We are of the view that the company will be unable to pay its
debts as a result of recent developments.”
— Board of New Lakeside in its filing to SGX,
2 November 2010 (The Business Times)

This spelt the end of New Lakeside’s precarious, short-lived existence.

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Questions
1. What are the challenges faced by independent directors in a company like New
Lakeside, where management are also significant shareholders?

2. “The tone of at the top significantly influences a company’s corporate governance.” How much
would you attribute the downfall of New Lakeside to the weak tone at the top? Who do you think
was ultimately responsible for the demise of the Group?
3. What actions could have been taken after the first Special Audit findings were revealed?

4. Given the legal requirement for companies to comply with accounting standards and the
accounting-related provisions in the Companies Act, do you think the company has broken
any laws?

5. Given the trail of audit qualifications before New Lakeside was placed under judicial
management, could more have been done? If so, what and by whom?
6. Discuss the roles of the auditors, regulators and New Lakeside’s sponsor, CNP Compliance,
in this case. Do you believe they had performed their roles effectively?

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