Audit: The scam that was Uchumi Supermarkets’ Sh895m rights issue

Former Uchumi Supermarkets Chief Executive Officer Jonathan Ciano walked into a boardroom in September 2012 for an important meeting with the retailer’s board of directors.

The man, who at the time was still one of the most celebrated turnaround CEOs, was accompanied by his right hand man, Mr Chadwick Okumu, the firm’s Chief Finance Officer (CFO). The two were to root for support from the board to endorse the retailers plan to raise money from the market.

The duo, who were however sent home after the scandal at Uchumi erupted last year, explained to the board that the firm was in urgent need of additional capital to support its expansion and counter competition from other retailers. It was easy to see the need at the time, their competitors including Nakumatt and Tuskys were aggressively expanding into the region and opening malls across the country. South African and French retail chains such as Massmart and Carrefour were angling for the bigger Kenyan supermarket pie.

Ciano and his management team present at the meeting reported that the retailer wanted to position itself in Tanzania, Uganda and Kenya ‘within the medium term.’ “Management hence proposed equity financing through a rights issue. The board requested Okumu (the then finance boss) to prepare a board paper that detailed the rights issue,” the Factual Findings Report by audit firm KPMG reads in part.

Signs of trouble

The report marked private and confidential notes that Ciano and Okumu were present at the meeting. Several weeks later, the management tabled the board paper on the rights issue on November 1, 2012 at a board meeting. The minutes also indicated that the breakdown of the funding required was on attached sheet. In the proposal, Okumu explained that Uchumi Supermarkets Uganda and Tanzania unit were not able to meet their financial obligations due to ‘the supply chain dynamic challenges’ hence Uchumi Supermarkets Limited (USL) Kenya diverted funds to these subsidiaries for support.

“Okumu informed the Board that USL Uganda and USL Tanzania averaged a monthly overdue of Sh300 million and Sh120 million respectively for trade and service payables which was necessitated by growth in USL branch networks. Okumu projected that the overdue payments would double in Uganda and Tanzania as USL progressed to sustain the business in the short to medium term,” the KPMG report says.

Satisfied, the board resolved to recommend the proposed rights issue of up to 100 million shares to the Annual General Meeting (AGM) for approval.

This was done on December 11, 2012 at the retailer’s 32nd AGM. A week after the AGM approved it, the retailer swiftly formed the rights issue steering committee. The steering committee comprised of Mr Okumu, who was appointed the Project manager. Ms Pauline Kimotho, the company secretary was named that project co-manager while Charles Thuku, the ICT manager, was named a member of the Rights Issue project. Other members included Mr Francis Kiragu (marketing manager) and Alex Kagua, who was a financial accountant at the retailer.

It was agreed that Ciano would consult with the chairperson of the board before inviting Mr James Murigu, who was the chairman of the audit committee to chair the steering committee. This was also done and by January 21, 2013, Murigu was named the chairman of the committee. The team settled down to work.

The first signs of trouble came in July 2014 when the retailer’s management told the board that they were anticipating a shortfall in proceeds due to a fall in share price. “Management explained that this was caused by a delay in receiving a letter of undertaking from the Government of Kenya,” the report adds. The Government gave the letter on April 8, 2014 but gave a condition that the rights issue must be conducted within the National Treasury’s 2014/15 financial year.

“This delay had led to a shortfall of the expected proceeds from the rights issue as the share price of USL (Uchumi Supermarkets Limited) had dropped in the intervening period,” the report adds. There was a drop in share price from the time of the proposal to the Board, in November 2012, the price was Sh19.65 while in November 2014 the price was Sh8 creating a potential deficit of Sh600 million of the expected Sh1.5 billion. Uchumi then revised the estimate and planned to raise Sh895 million from the rights issue.

At the 2014 AGM held in November that year, Ciano put up a brave face and explained to shareholders that his team anticipated to meet a Sh1 billion target to be used in working capital financing for new branches and refurbishment of various branches.

Opening date for the rights was set for November 10, 2014 and the closing date 28th of the same month. But even as this went on, the management had not yet presented a detailed budget for the proceeds of the cash call to the firm’s board or its shareholders.

Another problem with the cash call was that Faida Investment Bank, the transaction advisors, had prepared an information memorandum based on the 2013 financial results. But due to the delays, this was overtaken by events and in breach of the Capital Markets Authority regulations that required accounts not be more than six months old. “We found that USL was inconsistent in its communication to the public, shareholders and staff regarding the purpose of the rights issue,” the report adds.

Whereas the memorandum was unclear on the purpose of the issue, a number of contradictory assertions were made by Ciano and Okumu regarding the purpose of the funds. At a finance and buying meeting on January 27, 2015, the KMPG report says Okumu informed members present that Sh675 million of the proceeds would be used to finance working capital. However, during a press briefing the following month, Ciano announced that the retailer would use the money to open 13 new branches in Kenya, Uganda, Tanzania and Rwanda.

It is this confusion and misinformation that set the stage for the misuse of the Sh895 million raised from the rights issue. The money was received through an account at Equity Bank set up by Faida Investment Bank. Some Sh876.8 million was deposited into this account in December 2014. Another Sh19 million was received in January bringing the total to Sh895 million. The account had a balance of Sh2 million before the installments were received.

The funds were then wired to Uchumi Supermarkets’ account at the Kenya Commercial Bank (KCB). This was not the end of the transfers. They were once more moved to the company’s main trading account, also held at KCB. Okumu did not ensure that a separate bank account was set up for the rights issue proceeds.

The reconciliation accountant at Uchumi told auditors that the finance boss issued a directive that the funds should be transferred to its receivership account instead of opening an escrow account. Okumu later asked his finance team to familiarise themselves with the guidelines and ensure all escrow account transactions were separated from normal trading transactions.

Only one branch

But whereas the guidelines on operating a special purpose escrow account requires that special accounts must not be used for trading activities or to reimburse branch expenditures, the audit found that Sh812 million of the proceeds were used in financing trading activities. The firm used Sh412 million to settle outstanding supplier payment and rights issue expenses in Kenya.

Another Sh150 million and Sh250 million was used in Tanzania and Uganda respectively, mainly to also settle outstanding supplier payments. “The purpose of the rights issue as communicated to the public was to finance the opening of 13 new branches and refurbish existing stores. From our review, we found that only one branch was opened after the rights issue proceeds were received,” the report adds.

In actual fact, the 13 branches said to have been opened had already been opened before the rights issue was completed. Also, Sh220 million set aside for refurbishments in Kenya was also utilised in paying suppliers.