Audit discovers Jonathan Ciano’s wife among biggest vegetable suppliers at troubled Uchumi

Former Uchumi Chief Executive Officer Dr. Jonathan Ciano
NAIROBI: An audit report has finally lifted the corporate veil on the mess at Uchumi Supermarkets.

In one of the startling discoveries, audit firm KPMG’s Factual Findings Report details how the wife of the retail chain’s former boss, Jonathan Ciano, became Uchumi’s fresh produce supplier.

Despite the conflict of interest, and her being found to have over-invoiced the retailer, she was allowed to continue supplying the supermarket.

The report further notes that Mr Ciano, who is one of Kenya’s most celebrated turnaround CEOs, failed to disclose that he was related to the fresh produce supplier.

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KPMG says Ciano’s spouse was a director at Eliehon, based on Registrar of Companies records and her identification card found on the former CEO’s official computer.

But when this information was presented to the security manager, he instructed that the matter be “put to rest and no further action needs to be taken on the staff concerned”.

Business Beat sought out Ciano for comment on the allegations for two weeks. When he finally responded, he said he had not seen the draft report.

“Please give me a copy as Uchumi has never sent me the draft report and I will give you a comment,” he said in a text message. We shared the report, but he has yet to respond, five days later.

The audit, which has been kept top-secret since December 2015, was commissioned by the retailer’s board.

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It lists Ciano and his former chief finance officer, Chadwick Okumu, as some of the people with a case to answer, alongside three other employees.

The board dismissed Ciano and Mr Okumu in June last year on allegations of fraud and misconduct.

Sub-standard products

The KPMG report unearthed Uchumi’s lack of adequate background and quality checks that led to the acceptance of conflicted suppliers, sub-standard products and unfavourable trade agreements.

The audit adds that 46 per cent of procurement staff did not meet the minimum qualifications set in the retailer’s human resource manual.

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Further, from November 2013, the Uchumi board had six members, who included Ciano and five other directors.

“The three committees of the board, therefore, had common members, and due to the small size of the board, matters discussed in a committee were known to more than half of the full board,” the report notes.

Though a lean board had its advantages, including flexibility and saving costs, its downside was that it exposed members to conflicts of interest and denied them independence.

“We found instances where the board and its committees failed to get adequate and accurate information on management activities,” the report said.

KPMG auditors also did not find any evidence where the board probed, challenged or requested the management for better quality information, and in most instances accepted management presentations.

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Further, none of the board members managed to attend the minimum number of meetings in the 2013-14 and 2014-15 financial years.

The strategies and business development committee had only two meetings. In these sittings, they did not discuss the sale and lease-back arrangement with RentCo, the most significant transaction the retail chain entered into in 2013-14, KPMG says.

The retailer entered into two agreements to sell and lease back its fixed assets, excluding land, with RentCo in a deal worth a total Sh1.6 billion. The first agreement of Sh350 million was approved via a series of emails.

“We have no evidence that the main board approved the first tranche of the sale and lease-back deal. We noted that the company lacked a formal authority and approval process with appropriate safeguards,” the report notes.

CASH-FLOW PROBLEMS

Ciano approved all agreements with RentCo of Sh1.5 billion, with various persons as witnesses. The agreements were financed by Co-operative Bank and KCB.

Firms usually enter into deals to sell their assets and then lease them back when they are experiencing cash-flow problems.

By the time of the audit, Uchumi had sold assets valued on its books of Sh1.1 billion to RentCo. It had received the funds and was paying a quarterly lease amount of Sh99.5 million, exclusive of VAT, to RentCo.

But the audit found that the same person was involved in bidding for the deal at the same time on behalf of both RentCo and Rentworks, two of three firms presented to the board as potential providers of the deal.

“We also found that Okumu had discussions with RentCo on leasing of assets, which began in January 2014 ... before the board approved a tender process in March 2014,” the report adds.

The strategies and business development committee approved the transaction on the basis of an interest rate of 12.75 per cent, but the final agreement signed by Ciano had an implied interest rate of 16 per cent.

KPMG says it was unable to find a ratification of this change in interest rate.

In justifying the deal, Okumu had told the committee members that the quarterly lease repayments would be lower than the depreciation charge on the properties, which would improve the profitability of the retailer.

When contacted, RentCo said the audit was about Uchumi, and the retailer was better placed to respond to the report’s findings.

“Uchumi is a public listed company that has competent managers and board of directors and they must have undertaken a cost-benefit analysis before tendering for the sale and lease-back of their equipment,” the firm said.

The report adds that board did not maintain a regular register of meetings and resolutions. Further, minutes of meetings held between June 2014 and June 2015 were not signed. Minutes of four meetings held between July 2014 and March 2015 were signed and backdated by the chairperson, Khadija Mire, during the course of the KPMG investigation.

The audit also unearthed two instances where staff in the finance department reported the manipulation of financial accounts and other allegations of fraud to Ciano.

The staff had raised the alarm over colleagues who were demanding bribes from suppliers to process payments, and noted that the finance department was “crafting” figures to suit the books and confuse the board.

Other allegations in a whistleblower email included misappropriation of funds in Uganda, miscalculations in branch openings and mistreatment of landlords. Ciano forwarded the emails to his finance boss, Okumu, but there was no evidence of follow up or independent investigation, KPMG found.

Demanding bribes

And as regards its financial reporting, Uchumi was found to have manipulated accounting entries, contributing to a situation where management accounts and the financial information distributed no longer agreed with the underlying ledgers.

For instance, KPMG was provided with two different versions of trial balances as at December 31, 2014. After analysing them, the management accounts revealed significant differences between the three-year and the half-year results released to Nairobi Securities Exchange (NSE) shareholders. KPMG says these numbers could be factually incorrect.

“We found on Okumu’s computer for the half year with a worse position in terms of the net loss for the period,” the report notes.

The firm presented a Sh262 million net loss to its board on February 2015. This was the same figure submitted to the NSE. However, management accounts retrieved from Okumu’s computer showed that the retailer was actually Sh501 million in the red.

And when KPMG computed the results based on the trial balances, the firm had made a Sh1.98 billion net loss for the six months.

The draft year-end results as at June 30, 2015 also showed a deterioration in trading results, with a loss of Sh3 billion, and were significantly different from the half-year results.

KPMG argues that this lends credibility to its finding that the half-year results may have been manipulated.

“In addition, our analysis of payments made by the group from January 2015 after the rights issues and sale and lease-back monies were received, once again suggests the liability position at the half-year could have been understated,” the report notes.

Business Beat sought comment from Okumu on the KPMG audit, but he declined to respond to the allegations on the grounds that they may jeopardise investigations.

He added that he is waiting for the conclusion of an ongoing independent audit being conducted by the Institute of Certified Public Accountants (ICPAK), the professional body that regulates accountants.

“The issues highlighted in the report are being investigated by credible professional and independent institutions, among them the professional body to which we subscribe. As such, I do not wish to comment so as to allow for their seamless conclusion,” he said.

“Besides, we do not want to engage in exchanges through the media (it’s too unprofessional) or make any comments whose interpretation may further dent the turnaround credentials of the competent current management team, and subsequently negatively impact on their share price, which we worked hard over the years to grow.”

He also dismissed claims that the rights issue was a scam.

“There is nothing tangible in that report. Why has it taken more than one year? I believe everyone will know the truth after the independent audit is completed,” he said.

Rights issue

KPMG’s report also raised questions on how the proceeds of the retailer’s rights issue were utilised.

The first signs of trouble came in July 2014 when the retailer’s management told the board they were anticipating a shortfall in proceeds due to a fall in share price.

The Government, which is also a shareholder, gave the letter on April 8, 2014, and a condition that the rights issue be conducted within the 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 had dropped in the intervening period,” the report adds.

At the 2014 AGM, Ciano bravely told shareholders his team expected to meet a Sh1 billion target, with the funds to be used in working capital financing for new branches and refurbishment of various branches.

The opening date for the rights was set for November 10, 2014 to close on November 28. However, the management had not yet presented a detailed budget for the proceeds of the cash call to the firm’s board or its shareholders.

Contradictory statements

Another problem with the cash call, KPMG pointed out, was that Faida Investment Bank, the transaction advisors, had prepared an information memorandum based on 2013 financial results. Due to delays, this was overtaken by events and was in breach of Capital Markets Authority (CMA) regulations that require accounts to 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.

A number of contradictory statements were also made by Ciano and Okumu regarding the purpose of the funds. At a finance and buying meeting on January 27 last year, Okumu informed members that Sh675 million of the proceeds would be used to finance working capital.

However, at a press briefing the following month, Ciano announced the retailer would use the money to open 13 new branches in Kenya, Uganda, Tanzania and Rwanda.

This set the stage for the misuse of the Sh895 million eventually raised from the rights issue.

The money was received through an account at Equity Bank set up by Faida. The funds were then wired to Uchumi’s account at KCB. They were then 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 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.

But whereas the guidelines on operating a special-purpose escrow account require that special accounts 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.

Supplier payments

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 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.

Uchumi, which had 27 branches in Kenya, six branches in Uganda, and four branches in Tanzania last year, has since shut down its outlets in the last two countries and filed for bankruptcy in Uganda after it hit its latest financial turbulence.

And as the retailer waits on the Government to jumpstart it for a second time in a decade, history seems about to repeat itself.

The Government first invited the public to invest in Uchumi Supermarkets in 1992 through an initial public offering. At its height, Uchumi was supporting more than 2,500 suppliers and had 2,000 employees directly or indirectly on its payroll.

In early 2000, however, Uchumi started to experience financial and operational difficulties. As a consequence, the CMA suspended the trading of the retailer’s shares in June 2006.

President Mwai Kibaki’s Government appointed a task force to steer an Uchumi rescue mission. It also pumped in Sh675 million to facilitate the revival. The Government further restructured its loan into equity, cleaning up the balance sheet.

At the time it was placed under receivership, Uchumi had more than Sh1 billion in debts owed to suppliers, landlords and former staff.

But the people who brought down the retail chain the first time round continue to walk free. And now, those who sank it a second time appear to be engineering a process that will see them exit unscathed, even as the Government readies a Sh500 million cheque in a second bailout package.

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