How Investors Can Protect Themselves Against Fraudulent S-Chips Such As Eratat Lifestyle Limited

It has been confirmed yesterday that Eratat Lifestyle Limited (SGX: FO8) had indeed forged certain bank statements. According to Eratat Lifestyle’s filings with stock exchange operator Singapore Exchange Limited, the Fujian branch of the China Banking Regulatory Commission (CBRC) had found a forged bank confirmation linked to the company’s main subsidiary, HMW.

Shares of Eratat Lifestyle have been suspended from trading since this January after it had defaulted on interest payments on its high-yield bonds (more on the bonds to come shortly) despite seemingly having a huge cash pile on its balance sheet.

Of course, with the CBRC’s latest revelation, it’s now known that whatever cash amounts Eratat Lifestyle had displayed on its balance sheet really wasn’t there. HMW had earlier claimed to have RMB577 million worth of cash in its account as of 31 December 2013, but it has since been confirmed by the CBRC that HMW only had RMB73 thousand in cash.

Eratat Lifestyle’s Chief Financial Officer Ho Ker Chern, who has held the post since 2007, had resigned in June this year. Ho had also taken on the position of Interim Chief Executive Officer in January after former CEO Lin Jiancheng got suspended from the post following the company’s own trading suspension and debt-default.

With all that’s happened since 29 January 2014 – the day Eratat Lifestyle got suspended from trading – what does it mean for the company’s investors in Singapore?

Nothing Much

Unfortunately, there is not much the Singapore Exchange can do at this point besides maybe delisting Eratat Lifestyle. There’s almost no reprieve for investors who still own the company’s shares – they would be left with a big loss in that particular investment. Although it is really unfair to investors who were affected by this particular despicable fraudulent act by Eratat Lifestyle, there are fortunately ways you can protect yourself against such future incidents.

The red flags

Prior to the company’s default on its interest payments, there were a few red flags that had appeared. For example, although Eratat Lifestyle’s cash holdings had averaged around RMB270 million in 2012, it earned interest income of only RMB1.4 million, which worked out to an average interest rate of only 0.5%. That seemed really low as RMB-denominated deposit rates were easily 3% during that period.

The second major red flag concerns its high-yield bonds. In July 2013, Eratat Lifestyle issued RMB100.5 million worth of bonds to a Hong Kong-based finance outfit Sun Hung Kai & Co. Limited. The effective interest rate on those bonds came up to 16.7% a year despite the company apparently holding RMB545 million in cash (we now know that just wasn’t true) just prior to the issue of the bonds. My colleague Ser Jing explained how expensive that debt was:

“Even without any reference, that’s an unduly high amount of interest to be paid for a bond that has a maturity of only 2 years. Usually, bonds with higher interests are ones with longer maturity dates, in which the long time-span from issue-to-maturity would mean that the creditor is exposed to more risks.”

Back when I was an investor in Eratat Lifestyle (it was a bad mistake on my part), I was present at an investor’s meeting with the company regarding the bond issue. The company’s then-CFO Ho failed to offer any plausible reason as to why the company could not use its rich cash hoard; instead, he kept insisting that the company had “no choice” but to issue those bonds. Till this day, I have no idea what Ho meant when he said the company had “no choice.”

Foolish Summary

If you’re an investor, you have to realize that the best steward of your own finances is yourself. And being armed with investing knowledge is really the main weapon you’d need to have before attempting to invest in the share market.

If you are just starting out in investing and eager to learn, I’d recommend you take a look at our 13 steps to financial freedom to learn the basics on investing. After which - and for those who are already more experienced - feel free to click here for a FREE subscription to Take Stock Singapore, The Motley Fool’s weekly investing newsletter for more investing insights from us. Written by David Kuo, Take Stock Singapore tells you exactly what's happening in today's markets, and shows how you can grow your wealth in the years ahead.  

Also, like us on Facebook to keep up-to-date with our latest news and articles. The Motley Fool's purpose is to help the world invest, better. Fool on!

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn't own any shares of companies mention above