Creative accounting is used to make a company seem to be performing well than it actually is. This scheme is applied especially where accounting figures do not look attractive or appealing to the investors, current and potential. This creativity is perpetuated by the senior management through support of directors making it difficult to detect where there are no proper fraud investigations are done.
In the case of Deutsche Bank, its former executives are accused of obstructing regulators from looking into loss cover up in an investment dubbed Alexandria. The deals were a major cover up as alleged during a financial crisis that sae Monte Paschi in great troubles. The investigation carried out brought into attention massive losses that Monte Paschi had been misrepresented between 2008 and 2012.
“The fraud first came to light in January 2013, when Bloomberg News reported that Monte Paschi used the transaction with Deutsche Bank, dubbed Santorini, to mask losses from an earlier derivative contract. The world’s oldest bank restated its accounts and has since been forced to tap investors to replenish capital amid a slump in its shares. It’s now attempting to convince investors to buy billions of bad loans before a fresh stock sale.” It is possible that the findings by the regulator are accurate since they are able to bring out a proper investigation on the matter presented to it. The bank was even required to account for differences in its carrying value on the stake at San Paulo bank and the amount they paid for the shares to have a stake there. The use of revaluation reserve to increase par value was not the right thing to do to absorb losses. This is because revaluation reserve per se is not counting towards Tier one capital. This was just a scheme to maintain its core capital as required by the regulator in the industry.
Santorini Investment was also a bad move meant to serve a special purpose, to do an equity swap. The bank controlled a huge stake in this business where it had majority shares for controlling its Interest-Santorini was majority owned (51%) by Deutsche Bank – Monte Paschi controlled 49%. They used some amount that were proceeds in the sale of San Paolo to Deutsche in financing Monte Paschi’s shares in Santorini investment. Monte Paschi was taking shelter in reducing exposure of its share from constant price fluctuations. “Typically, in such a deal, there is either a floating rate or a fixed rate of interest paid over the life of the swap to the entity to which the shares were sold (in this case Deutsche) based on the notional amount of the shares traded (so 785 million euros here. When the swap matures, the original seller of the shares (Monte Paschi here will receive the difference between the price of the shares when the swap was originated and the price of the shares at maturity.
Obviously, if the shares rise over time the original seller makes a profit on the swap (minus any interest payments made along the way). Of course the stock could go up or down over the life of the transaction so there is a very real possibility that the original seller of the shares will have to make a payment at maturity in addition to the interest payments made along the way. Note also that if the stock drops over the course of the deal, the original seller may be forced to post collateral to the buyer of the shares.” It is therefore was a scheme that should have been controlled before it got too late to save the shareholder