Corporate fraud in the vietnam upcom stock market, a case study of the central mining, mineral exporting and importing company

TEACHING PROGRAMANH NGUYEN NHAT CORPORATE FRAUD IN THE VIETNAM UPCOM STOCK MARKET: A CASE STUDY OF THE CENTRAL MINING, MINERAL EXPORTING AND IMPORTING COMPANY MASTER IN PUBLIC POLICY THE

TEACHING PROGRAM

ANH NGUYEN NHAT

CORPORATE FRAUD IN THE VIETNAM UPCOM STOCK MARKET: A CASE STUDY OF THE CENTRAL MINING, MINERAL EXPORTING AND IMPORTING COMPANY

MASTER IN PUBLIC POLICY THESIS

HO CHI MINH CITY - 2017

MINISTRY OF EDUCATION UNIVERSITY OF ECONOMICS HO

CHI MINH CITY FULBRIGHT ECONOMICS TEACHING

PROGRAM

ANH NGUYEN NHAT

CORPORATE FRAUD IN THE VIETNAM UPCOM STOCK MARKET: A CASE STUDY OF THE CENTRAL MINING, MINERAL EXPORTING AND IMPORTING COMPANY

MASTER THESIS Major: Public Policy

Code: 06340402

THESIS ADVISORS Prof David O Dapice Thanh Nguyen Xuan

Ho Chi Minh City, 2017

CERTIFICATE OF ORIGINALITY

I hereby declare that the thesis entitled: "Corporate fraud in the Vietnam Upcom

stock market: A case study of the Central Mining, Mineral Exporting and Importing Company" is my own original work carried out as a Master's student at Fulbright Economics

Teaching Program (FETP) except to the extend that assistance from others in the thesisdesign and conception or in style, presentation and linguistic expression are dulyacknowledged

All sources used for the thesis have been fully and properly cited It contains nomaterial which to a substantial extent has been accepted for the award of any other degree

at FETP or any other educational institution in any language fully or partly except wheredue acknowledgement is made in the thesis

The thesis does not reflect the views of the University of Economics Ho Chi MinhCity or FETP

Hanoi, 08/09/2017

Author

Nguyen Nhat Anh

ACKNOWLEDGEMENT

Studying in FETP seems to be the hardest way to get Master degree, however it isthe fastest way that you can learn every things about how our society is going on I am notable to complete the coursework as well as the thesis without elegant supports by FETPstaff, my classmates and family

I would first like to thank my thesis advisor Mr Thanh Nguyen Xuan of theFulbright School of Public Policy and Management at Fulbright University Vietnam Heconsistently allowed this thesis is my own work and steered me in the right direction when

I lost my way Without his adjustments, I do not think that I can have my own perfecttheoretical framework to solve a case study

I would also like to thank experts in the Committee of my thesis defense: Dr KhaiDinh Cong as Chairman, Dr Giang Tran Thi Que and Dr Du Huynh The as the secondreaders of my thesis, and I am deeply indebted to your valuable comments and corrections

on my thesis I very much want to thanks again Dr Du who is my second tutor in thefinalize stage of my thesis His suggestion about the second framework is a brilliant idea towake me up to see what happened in the real life

I do not know how to thank MPP7 members enough for your physical and mentalbackup Many challenges and accomplishments would not have been possible without ourteamwork I also have a big thank to Mr An Bui Quoc in particular, who sat next to me inthe 1st year and provide tremendous assistance to me in the finalize stage

Finally, I owe my wife a great debt of gratitude for unfailing support andcontinuous encouragement throughout my years of studying and researching

Hanoi, 08/09/2017

Author

Anh Nguyen Nhat

The Central Mining, Mineral Exporting and Importing Company (MTM) is thetypical case that illustrates clearly the situation of agency cost and fraudulent behaviors inthe Vietnam Upcom stock market The first part reveals the weaknesses of regulation andcurrent policies in Vietnam by using the principal-principal agency perspective of Young(2008) particularly with regard to the mechanisms of stock scanning, no controlling thechanges of regulated capital, the undemanding capital contribution and no legalresponsibilities of former majority shareholders The second part of thesis uses themodified fraud of triangle of Soltani (2014) as a theoretical framework with severaladjustments to adapt the current circumstance of MTM The case of MTM shows a number

of fraudulent behaviors by controlling shareholders including: (1) The reconstruction ofhuman resource before listing; (2) Having no major shareholder - holding more than 5% ofthe chartered capital - but the power is concentrated; (3) Using the brand and picturesmakes confusion with another company; (4) Increasing the regulated capital in the shortterm; (5) No core business or production, mainly the joint venture or capital contribution;(6) The external audit accepted despite of the fact that financial statements have theproblems; (7) The business situation is not good but the price and volume of stock trading is stillhigh; (8) Tax obligation and social insurance are not completed In conclusion, the thesisstrongly recommends the policies to reduce the likelihood of expropriation of minorityshareholders due to the principal-principal agency conflicts and these fraudulent behaviors

Keywords: corporate fraud, fraud triangle, MTM, principal-principal agency conflicts

LIST OF ABBREVIATIONS

MTM The Central Mining, mineral Exporting and Importing Joint

Stock Company

SFP Statement of Financial Position

SSC State Securities Commission of Vietnam

Upcom Unlisted Public company market

TABLE OF CONTENT

CERTIFICATE OF ORIGINALITY i

ACKNOWLEDGEMENT ii

ABSTRACT iii

LIST OF ABBREVIATIONS iv

LIST OF FIGURES viii

LIST OF APPENDICES viii

LIST OF TABLES ix

Chapter 1 Introduction 1

1.1 Background 1

1.2 Thesis motivation and contribution 3

1.3 Research questions 4

1.4 Research Methodology 4

1.5 The structure of thesis 5

Chapter 2 Theoretical frameworks 6

2.1 The Principal-Principal Agency Perspective 6

2.2 Fraud triangle 8

2.2.1 Incentives/pressures 9

2.2.2 Fraudulent Opportunity 10

2.2.3 Attitudes/Rationalization 10

2.2.4 Transformation of Fraud triangles 10

Chapter 3 The weaknesses of regulations in Upcom market 13

3.1 Overview of regulatory framework in the Vietnam stock markets 13

3.2 No scanning fraudulent companies in the Upcom market 15

3.2.1 The easy and quick process to be listed 16

3.2.2 Audit companies are not the market guardians 17

3.2.3 Ranking is not enough 17

3.3 The increase of the registered capital without controlling 19

3.4 The undemanding capital contribution 20

3.4.1 The capital contribution through investment 20

3.4.2 The capital contribution though invoices 21

3.5 The legal responsibilities of former majority shareholders 21

Chapter 4 The fraudulent behaviors that led to the collapse of MTM 23

4.1 Overview of MTM 23

4.1.1 Stealing the brand name of unlisted company 23

4.1.2 No tax payment 25

4.1.3 A ghost company and its address 25

4.1.4 Be a public company 26

4.2 Fraudulent opportunities 28

4.2.1 The capital contributions 29

4.2.2 Fake invoices and manipulating the financial statements 30

4.3 Incentives 34

4.3.1 The high profit in the harsh economic 35

4.3.2 Selling the stock of the valueless company 36

4.3.3 The collusion of the former BoD 37

4.4 Ethical problems 40

4.5 The fraudulent behaviors in the case of MTM: 42

Chapter 5 Conclusion, policy recommendation, limitation 43

5.1 Conclusion 43

5.2 Policy recommendations 43

5.3 Limitations 44

References 45Appendix 1 Market capitalization of the Upcom market since 2013 to 1st quarter 2017

47Appendix 2 The trading detail of MTM stock 47Appendix 3 The detail of Market Capitalization and trading value on the Upcom

Appendix 4 The reform of Vietnam in Business report over time 49Appendix 5 The highlighted fraudulent cases in the Vietnam stock market 49Appendix 6 The business license of MTM 52

LIST OF FIGURES

Figure 1 Market capitalization of the Upcom market since 2013 to 2rd quarter 2017 2

Figure 2.Trading value and volume of the Upcom market annually 2

Figure 3 Principal-agent conflicts versus Principal-principal conflicts (Young, Peng, Ahlstrom, Bruton, & Jiang, 2008) 8

Figure 4 Classification of incentives for fraud-committing 9

Figure 5 Fraud Triangle 11

Figure 6 Modified Fraud Triangle 11

Figure 7 The components of ethical problems 11

Figure 8 The modified fraud triangle with several adjustments 11

Figure 9 Legal Matrix System 14

Figure 10 The timeline of the MTM collapse 27

Figure 11 The continuous process of selling and issuing stocks of FID and MTM 34

Figure 12 Trading price and volume of MTM stock since 15/4 to 20/6/2016 37

LIST OF APPENDICES Appendix 1 Market capitalization of the Upcom market since 2013 to 1st quarter 2017 47 Appendix 2 The trading detail of MTM stock 47

Appendix 3 The detail of Market Capitalization and trading value on the Upcom market 48 Appendix 4 The reform of Vietnam in Business report over time 49

Appendix 5 The highlighted fraudulent cases in the Vietnam stock market 49

Appendix 6 The business license of MTM 52

LIST OF TABLES

Table 1.Comparison of traditional principal-agent model and principal-principal model 7

Table 2 The strength of minority investor protections in Vienam and some countries in 2017 13

Table 3.The market capitalization and the value matching monthly in Upcom 18

Table 4 The document of changing the regulated capital 19

Table 5 Some highlighted contents in Decree 71/2017/Dec-Gov 22

Table 6 The information of tax payer - MTM 25

Table 7 The submitting document of MTM to HNX to list 27

Table 8 The increase of regulated capital 29

Table 9 The fake invoices of MTM 31

Table 10 The first part of the note of the financial statement 32

Table 11 The short-term receivables in 2014 audited financial statement 33

Table 12 The capital construction in process 33

Table 13 The warning list in the Announcement of HNX 35

Table 14 The list of MTM members 37

Table 15 The money transactions to another companies/bank of the former MTM BoD 38

Table 16 The structure of the shareholders in MTM 41

Table 17 The characteristics of new leaders of MTM 41

Table 18 The fraudulent behaviors in the case of MTM 42

it should be considered the warning signal for the financial consequences that has directimpact on the economic progress and dampen a confidence of investors According toGiannertti and Wang, if the corporate frauds are revealed in a state, the householddecreases the holdings in both the fraudulent and non-fraudulent firms (Giannetti & Wang,2016) It means that investors intend to reduce their saving on stocks of both good and badcompanies as a way to have negative impacts to the capital market In case of MTM,hundred billions VND were gone with the scammers while thousands of investors had torebuild this valueless company1 with the hope that the regulatory bodies can bring theirvaluable investment back.

Upcom market, the abbreviations of a stock exchange that "is the stock market ofpublic unlisted or delisted companies" (Ministry of Finance, 01/2015) The Upcom Marketwas permitted by HNX to operate officially on 24/06/2006 with 10 registered firms and themarket capitalization was 1231.4 billion VND2 As shown in figure 1 below, the marketcapitalization has increased dramatically around 400 times with 600 registered firms (at31/07/2017) With the high volume and value in trading (Figure 2), Upcom has become anactive market for investors The Upcom stock used to attract the money flows such asWSB, GEX, etc HNX has increased the transparency, attracted the capital flows, extendedthe trading time up to 03:00 pm and to ease the reference price up to ±15% To reduce thegap between the free and listed markets, HNX has operated the Upcom premium ranking3

to direct the investors

1 Mr Phuong Chu Danh, who is one of the minority investors of MTM, were elected to the BoD Chairman of MTM He knew that his investment was lost and he attempts to rebuild MTM which was no core business or money to become a real company.

3 Upcom premium is the companies that has the regulated capital in the last year up to 120 billions dong, EBIT> 30 billions dong and ROE ≥5%.

Figure 1 Market capitalization of the Upcom Figure 2.Trading value and volume of the Upcom market since 2013 to 2 rd quarter 2017 market annually

35,000,000,000

30,000,000,000

Trading

Volume 25,000,000,000

20,000,000,000 15,000,000,000 Trading Value 10,000,000,000

5,000,000,000 - 2013 2014 2015

Trading Volume

2016 2017

Source: Upcom data on website

Apart from the active efforts to protect the minority investors, the stock market stillhas a series of firms that register to trade with the purpose of appropriating the property ofthe dispersed investors The most typical case is in the beginning of July - 2016, PhuongChu Danh filed a lawsuit against HNX because HNX made the damage to the investorswho bought the share of MTM In detail, HNX issued Decision 201/QD-HNX4 based onthe inadequate documents It is an opportunity for the top of MTM and foundingshareholders to appropriate 70 billion VND5 of the investors With the evidences of fraud,

on 19/09/2016, Bureau of Security and Investigation (A92) initiated the indictment andtemporarily detained Tiep Tran Huu, the current Chairman of MTM The fraudulentprocess of MTM prolonged since its establishment, becoming a public company, trading onUpcom and suspension of trading Each ladder is not in compliance with the law andregulation After the suspension, the minority investors are the most vulnerable partieswhile the entire investment would not be recovered

In the process of reclaiming the amount of investment, the shareholder, Phuong ChuDanh, joined the MTM as the role of the Chief accountant He has attempted to organizethe extraordinary shareholder meeting to find out a remedial solution Simultaneously, he

has cooperated with the police offices and regulatory bodies to provide evidences of fraudactivities Even he had been threatened with death by the anonymous people who claimed

themselves as the representatives of A92, HNX and another mining companies6 Thus, thecase of MTM is the pioneer which the minority investors sued and took a part in thecompany instead of being disadvantaged so far Additionally, this case scandalized due tothe prolonged fraudulent process and massive damage to related parties The laxmanagement of HNX leaves the doors open for fraudulent behaviors and raises theconfusion in the investing communities With all points above, the thesis is going toanalyze the case of MTM in order to recommend a policy to strengthen the weaknesses ofregulation in Upcom market as well as avoiding the fraudulent firms.

1.2 Thesis motivation and contribution

The thesis explores the case of corporate fraud by using the principal-principalagency perspective and fraud triangle with the broader context The first motivation ofresearch is to describe the weaknesses of regulation in the Upcom market and fraudulentbehaviors that caused the MTM collapse Although the research only focuses on onefraudulent company but the analysis is set up in the legal environment of the frontierfinancial market Corporate fraud is a topic that mentioned in the larger number ofpublished paper and professional journals However, most of cases happened in the UnitedStates and Europe and a small number of cases happened in China and other countries InVietnam, the research could not find any case related to corporate fraud, to my bestknowledge A single featured case with the broader framework, the anatomy of MTMreveals the weaknesses and fraudulent behaviors of a collapse in the Vietnam Upcom stockmarket

Contribution of the thesis is to understand the fraudulent behaviors and weaknesses

of regulation that led to the collapse of MTM in the context of Vietnam Upcom stockmarket With broader view, these evidences will have practical implications for regulatorybodies and policy makers to reduce the likelihood of expropriation of dispersed minorityshareholders due to agency cost and fraudulent firms

1.3 Research questions

Because the prosecution against the former BoD members and CEO of MTM is inprocess, the thesis is not able to declare that MTM is the case of fraud without theconclusion of regulatory agencies Therefore, the lesser extent focuses on current evidences

to identify the fraudulent behaviors and the weaknesses of regulation The thesis willattempt to answer the following research question:

(1) What were the weaknesses in the Upcom stock market regulation that led to the

defined as "explore and investigate contemporary real-life phenomenon through the detail

contextual analysis of a limited number of events or conditions, and their relationships" (Zainal, 2007) MTM is considered the phenomenon in the Upcom market due to the active

role of minority shareholders and show the groups of fraudulent behaviors Instead ofwaiting for the response from the regulatory bodies after submitting their petitions, thegroup of investors take part in the BoD to provide the evidences and to reborn the MTM

The case study is selected due to the advantages of data collecting and analysis.MTM is rewritten based on the stories, the history of company collected in the annualfinancial statements, the official documents, research and press information As the author

Yin mentioned that "when the boundaries between phenomenon and context are not

clearly evident; and in which multiple sources of evidence are used" (Yin, 2013) All

fraudulent behaviors had done due to a weakness of regulation or a mechanism of investorprotection These interactions of MTM and the legal environment were strong andcomplicated As the result, the case study seems to be the most suitable method in thiscircumstance

1.5 The structure of thesis

The thesis consists of five chapters After the introduction in the first chapter, thesecond chapter describes two theoretical frameworks The third chapter presents theweaknesses of regulation in the Upcom market The fourth chapter intends to describe thefraudulent behaviors that caused the collapse of MTM The final chapter concludes allpoints above and suggests policy recommendations

Chapter 2 Theoretical frameworks

To analyze the case study of fraudulent behaviors in the Upcom stock market, thethesis uses frameworks including the principal-principal agent perspective and Fraudtriangle The principal-principal agent theory applies to show the relations betweenmajority and minority shareholders in the Upcom market as well as the case of MTM

In emerging economies, the controlling shareholders thus have the motive and means toexploit their positions Therefore, fraud triangle is a framework that uses to analyze thecase of MTM and determine the fraudulent behaviors that dominate the regulatoryweaknesses

2.1 The Principal-Principal Agency Perspective

The separation of ownership and control in joint stock companies had mentioned byAdam Smith since 1776 He had raised concerns about related organizational and publicpolicy consequences (Smith, 1827) After 150 years later, Berle and Means hadconceptualized the concern of Adam Smith in terms of a theory of governance in themodern corporation in the United States that have dispersed ownership and separation ofownership and control (Adolf A Berle & Means, 1932) As the result, the divergence ofinterests led to the phenomenon that often called "agency cost" by Jensen and Meckling(Jensen & Meckling, 1976) Although principal-agent relations have been published widely

in a developed economy context, and agency theory becomes one of the most influentialperspectives that explained the relationship in modern joint stock company and corporategovernance (Awasthi, 2017), but in the emerging context, a different kind of interestconflict between majority shareholders (control) and minority shareholders, known asprincipal-principal relations, has not been covered However, it was the groundbreakingwork of Young et al (2008), providing a first major conceptual view of principal-principalresearch in emerging and transitional economies (Young et al., 2008)

Both of agency models show the relations that involve the principal, the agent, andthe contractual relationship between them The huge differences between them areinstitutional and national contexts The traditional model, known as the principal-agentmodel, is applicable in the developed countries where have the powerful enforcement ofproperty rights In contrast, the emerging-market institutional contexts have concentrated

ownership, weak enforcement of agency contracts and legal protection of minorityshareholders, full of business group structures As the result, there are more frequentlyconflicts of interests between controlling shareholders and minority shareholders Theadditional differences are shown the Table 1 and Figure 3 below.

Table 1.Comparison of traditional principal-agent model and principal-principal model

Corporate Principal-agent agency Principal-principal agency model

Agency cost Due to divergence of Due to possibility of expropriation of

interests between minority shareholders by the controllingshareholders (principal) and shareholder group

managers(agent)Institutional Majorly developed countries Majorly emerging/transition economiescontext

Assumptions Bounded rationality, Controlling shareholders maximizing

opportunism and self- wealth even at the cost of minorityinterest, maximizing agents shareholders, managers follow majority

owners' objectivesReasons for Opportunism and self- Expropriation of minority shareholdersconflict interest behavior by by large shareholders and their appointed

managers in dispersed managers due to weak minorityownership shareholder protection

Concept of Homogeneous group Heterogeneous (controlling and minority)shareholders

Largest Hardly visible, no too strong State-owned enterprises, family

Role of boards Monitor agents Negligible, facilitating majority

shareholder's interestForms of Managerial entrenchment, Below market value asset transfers to

expropriation empire building, private controlling owner, personal/private

benefit to managers benefits of large controlling shareholders

Liquid of stock Usually high Generally low

Source: Taking Stock of the Principal–Principal Agency Perspective: A Review and the Way Ahead (p 21)

As shown in Figure 3, the dashed arrow depicts the relationships between the controllingshareholders and their affiliated managers The solid arrow is drawn the conflicts of theminority shareholders and the affiliated managers, who are representing the majorityshareholders.

Figure 3 Principal-agent conflicts versus Principal-principal conflicts (Young, Peng, Ahlstrom,

Principal-Principal Conflicts Managers affiliated

with controlling shareholder Controlling

(Principals) Shareholder

In the case of MTM, the thesis goes through the lens of principal- principal agencymodel of Young (2008) showed the relationships that facilitate fraudulent behaviors in thefrontier market like the stock market in Vietnam To examine the agency cost, the thesisuse the conceptualization of Jensen and Meckling (Jensen & Meckling, 1976): (1)monitoring costs – costs incurred by principals including measuring or observing thebehaviour of agents; and (2) bonding costs – costs incurred by agents to guarantee they willnot take actions to harm the principal

2.2 Fraud triangle

The corporate scandals are so diverse that many different methods and levelsmentioned in the literature Even the small acts of employee as thieve, improper uses of

company assets to the fraudulent behaviors of directors, BoD member such asmisappropriating funds and fraudulent financial statement, are affecting directly theinterests of investors All fraudulent behaviors are discussed extensively in the literaturebut the major of analyses used the fraud triangle of SAS No 997 (AICPA, 2002): "Fraud is

an intentional act that results in a material misstatement in financial statements that are the subject of an audit".

The fraud triangle involves three conditions which are enable to be fraud incompany: (1) Incentives/pressures, (2) Opportunities, (3) Attitudes/Rationalizations (Wilks

& Zimbelman, 2004) These components are defined by Sutherland (Sutherland & Geis,1949) and developed by Cressey (Cressey, 1953) and Albrecht et al (Albrecht, Albrecht,Albrecht, & Zimbelman, 2011) while applied this framework to the fraud accounting, thenreinforced three components by assessing 1500 fraud cases, as shown in figure 4 below

2.2.1 Incentives/pressures

Despite many practical approaches toward the components of Fraud triangle bydifferent researchers, three fundamental components seem to be unchanged for 70 years.Cressey suggested that pressure to commit fraud could be identified with a personalincentive As shown in Figure 3 below, these pressures are caused by personal problemslike a pressure from employers or external forces such as fear of loose job, low wage Inaddition, all these variables are considered as the incentives to commit fraud

Figure 4 Classification of incentives for fraud-committing

Source: (Mackevičius & Giriūnas, 2013)

Personal (e.g, debts)

Financial

External (e.g, fierce business competition, economic stability of

Personal (e.g, inner dissatisfaction with work, greed)

Non-financial

Company’s (e.g, fear of loose job, low wage)

These pressures have formulated before the fraudulent plan Hence, it is verydifficult to identify the pressures without doing an in-depth interview with the former BoDmembers and CEO of MTM However, their missing is the biggest challenge to revealthese pressures In addition, the purpose of thesis evaluates the fraudulent aspects ratherthan personal problems Therefore, the pressure should be out the extent of discussion

2.2.2 Fraudulent Opportunity

The comparative lack of the suitable management, control and administration into

the stock market could create a chance for a scammer Dormine et al said: "the triangle

alone is an adequate tool for deterring, preventing, and detecting fraud because two of the characteristics of pressure and rationalization-cannot be observed" and "All the predator seeks is an opportunity The predator requires no pressure and needs no rationalization"

(Dorminey, Fleming, Kranacher, & Riley, 2010) Any shortage of control, inefficientmanagement and overlapping is creating opportunities for fraud Or lacking of efficientcontrol for the tone of top in this company would produce the vulnerability (Soltani, 2014)

In the case of MTM, it is too many gaps for the plunders to fraud

2.2.3 Attitudes/Rationalization

Some individuals have attitudes/rationalization, characteristics or unethical values

so that they can rationalize their frauds to be acceptable norms The bigger incentives orpressures, the more possibility these people rationalize their fraud or scam Cressey

suggested that "Perepetrator must formulate some type of morally acceptable

rationalization that the unethical behaviors is something other than criminal activity If an individual cannot justify unethical actions, it is unlikely that he or she engage in fraud".

Therefore, unethical behaviors are a top of an iceberg that the thesis can observe as well ascollecting information It is very difficult, even impossible to read the perpetrator's mind(Mansor, 2015) As a result, the thesis should focus on the ethical problems of MTM andthe parts that related to attitudes/rationalization require an independent research (Figure 7)

2.2.4 Transformation of Fraud triangles

Many researches adjusted the fraud triangle framework because of disadvantages inanalyzing a fraud company, especially the research of Soltani (Soltani, 2014), he said thatthis framework has several critical gaps: Firstly, the framework should be placed in thecontrol environment Secondly, all listed companies tightly control by government and

regulatory agencies In this way, it is essential to put the framework in the context ofregulation Thirdly, the framework should be examined in the ethical climate/businessethics Therefore, the environmental factors in this triangle are regulatory framework,control environment and ethical climate/business ethics, as shown in Figure 5 below.

Figure 5 Fraud Triangle Figure 6 Modified Fraud Triangle

Incentives/

Incentives/

Pressures Pressures

Figure 8 The modified fraud Figure 7 The components of ethical problems

triangle with several adjustments

Incentives

Ethical problems

Ethics Opportunities

Attitudes Rationalization

Regulatory Framework

Source: author's construction

the Upcom market is just two months In addition, the initial purposes of MTM is try tofraud the minority investors, so that the impacts of the ethical climate/ business ethics toMTM is trivial As a result, this thesis mainly focuses on the regulatory framework Theinteraction of MTM with regulatory bodies and another partners are the extent of theenvironment parts For a comprehensive analysis, the thesis will use the modified fraudtriangle with these adjustments, as shown in Figure 8 above

The strength of each component would reinforce the others People who have morethe number of ethical problems would have greater incentives when they saw theopportunities to fraud Or Howe and Malgwi agreed that a bridge between incentives andopportunity is created when an individual is able to rationalize the fraudulent behavior(Howe & Malgwi, 2006)

Chapter 3 The weaknesses of regulations in Upcom market

3.1 Overview of regulatory framework in the Vietnam stock markets

The stock market of Vietnam ranked in the lowest group as the frontier market8.The sustainability of institutional framework is modest These weaknesses are the chancesfor the firm to fraud the minority investors in Vietnam The stock market is operating asthe market mechanism under the control of the regulatory bodies If not work efficiently,the market failures should be detected and intervened by public policies

Law foster economic activities (exclusively) by protecting property rights (a rule oflaw) (Milhaupt & Pistor, 2008) "Properties are protected by law" that is the precondition

to develope the economic The simple equation could interpret the relationship betweenlaw and economic development by two authors Milhaupt and Pistor In the stock market,the following equation shows the future work for policy markers to strengthen investorprotection as well as developing the share market as the main funding channel (Nguyen,Oates, & Dunkley, 2014)

good law + good enforcement = good economic outcomesThe first content is how to build a good law The legal system of the stock market inVietnam is strengthened to adapt the new challenge of the economic development.Especially, the strength of minority shareholder investor protection index of Vietnam hasimproved over time The rank in 2016 was 118th and then moved to 87th in 2017 (seedetails in Appendix 4)

Table 2 The strength of minority investor protections in Vienam and some countries in 2017

Source: http://www.doingbusiness.org/Reforms/Overview/Topic/protecting-minority-investors#vietnam accessed on 25/03/2017

https://www.msci.com/documents/1296102/1330218/MSCI_Market_Classification_Framework.pdf/d93e536f-cee1-4e12-9b69-ec3886ab8cc8 accessed on 23/03/2017

Despite the fact that system is improved with the changing of market, series of scandalshappened to the outside investors before MTM The stories of DVD9, BBT10, KSS risethe warning of how good law we have Two major concerns about the system that are acivil law and a centralized and signaling legal system

One of disadvantage for investors in Vietnam is a civil law, especially a Frenchcivil law The extent of protection in the common law market is greater than the civil one.With the better law equipment, their rights are protected from the dominant groups ormajority shareholders and they comfortably to diversify their portfolios (La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 2001) As shown in Table 2, Hong Kong and Singapore areleading the world in the indicator of minority shareholder protections Two countries havecommon law systems instead of a civil law

The protective and decentralized system gives the individual investors (and theirlawyers) more weapon rather government agencies to against the fraud firms (Figure 12).However, in the context of Vietnam, the system considers as the centralized andsignaling11 With these characteristics, the minority shareholders are less protective andpassive The case of MTM reinforces the point that the shareholder protection in Vietnamjust stops at the signaling level

Figure 9 Legal Matrix System

Centralized

Decentralized

Source: Milhaupt and Pistor, 2008

Suspecting the operation of MTM, the group of investors comes to the head office ofMTM With the address on the 2016 prospectus, all of them are shocked because there isthe cheap restaurant instead of the mining company The news is spread widely and HNXknow they had a big mistake They rush to do the quick investigation and recognize that it

is the ghost company HNX quickly enacts the decision to stop trading for the MTM stock.The reason briefly is to protect the investors and wait the results of the police investigation.The signal that HNX send to investors is that investors are protected, but how can theyprotect This is very complicated and no answers yet.

Without the protection from law, investors can rely on the liquidity by a stockmarket Liquidity is a natural exit for disappointed investors However, HNX closes thisdoor for all MTM investors with the band "For your protection" The former leaders ofMTM take advantage of this situation and approach all MTM investors by private talks,financial forums, phone calls to buy MTM at around 100 dong per share Happy endingfor both sides, investors take money back and the scammers have enough stock to do theshareholder meeting and announce the bankruptcy

Like the argument of Sheifer & Vishny, dispersed shareholders rely heavily onlegal of protection because they lack of other means of ensuring a return on theirinvestment (Shleifer & Vishny, 1997) On the same point of view, Berle & Means statedthat the separation of ownership and control required legal interventions to ensure thatshareholders are not misled or abused by distant managers (Adolf Augustus Berle &Means, 1991) Law is the most important part for minority investors to have safeinvestment In the absence of significant reforms of the Italian private enforcement system,corporate governance abuses and the potential for accounting scandals may still bepersistent (Sorensen & Miller, 2017)

The current regulatory system shows several weaknesses As the result, publicpolicies can intervene in some contents to reduce the principal-principal conflicts Themost important point here is to explore the weaknesses of the current regulation Althoughthe policies in the area has implemented more than before, however in the Upcom market,these conflicts still exist If the regulatory bodies enhance public governance, firms areless likely to commit fraud (Zhang, 2016)

3.2 No scanning fraudulent companies in the Upcom market

The dominance of majority shareholders is one of the disadvantages for minorityshareholders in the Upcom market Because of the asymmetric information, the controllingshareholders are able to fraud all investments of other investors by colluding with authorityagencies, audit companies, especially the immature regulation The weaknesses of the

regulation increase the agency cost of the principal-principal agency relations as well asincreasing the possibility of fraudulent behaviors Although HNX announced policesincluding ranking the stocks, the list of the approved audit companies, but the fraudulentcompanies overcome these barriers by selling all their shares in the short period, under ayear They do not have to produce an audited report anymore or be ranked in the warninglist of HNX

3.2.1 The easy and quick process to be listed

Upcom is known as the transaction of OTC and the listed market As the result, theprocedure to be listed in this market is simple, quick According to the Circular 180/2015/MoF below, all documents had been prepared by this company The unique externalagency that rechecks all information in these documents is the external audit company Theauthenticity of these documents is depended mainly on a firm's self-awareness

Circular 180/2015/MoF:

Article 4 The procedure and document for trading registration:

1 For the Public Company which has the stock registration at the Vietnam VSD:

1.1 The document for stock trading including:

a) The registration form to stock trading in the form prescribed in the 1st Appendix

attached in this Circular;

b) The information summary in the form prescribed in the 8th Appendix attached in the Decree 58th/2012/Decree-Gov

c) The audited financial Statement of the last of the registered year and the equity report (inthe case that the change of the registered capital in the same year that submittingdocuments to list)

If this company colludes with the audit company to cook the financial statements, they canlist their stocks and sell to minority investors in the Upcom market easily

3.2.2 Audit companies are not the market guardians

Nowadays, finalizing the procedure to be listed in Upcom stock market is quicklysimple and mainly based on the conscious sense of firm Only the financial statements ofthe last year are audited by the external party The remaining of the Upcom-listingprocedure is the responsibility of firm without the checking or controlling of the externalagencies In addition, the price for the first trading day is the suggestion by the firm.Therefore, the audited financial statement, especially the real capital contribution is theprime gatekeepers to prevent the fraud company to be listed

However, if the audit company and the firm have the collusion, this technicalbarrier is easily fallen Annually, SSC regularly reviews and provides the approved auditcompany In addition, each audit company has many branches so the quality and ethicalclimate are inconsistent Some arguments stated that the low-quality audit companies thatcollude with the firms are the small number However, one scabbed sheep is enough tospoil the whole flock There is no report that investigates the fraudulent financial statementyet The detection and dealing with the violation is the small number of cases In China, thereport of National Audit Office has investigated 32 financial statements audited by 16different audit companies in 2001 The result shows that 14 audit companies with 23financial statements have the serious inconsistent opinion and the total amount offabricated figures up to RMB 7.1 billion But there is the tip of the iceberg (Bai, Yen, &Yang, 2008)

To sum up, the policies to control the quality and the collusive behaviors betweenthe audit companies and firms in Vietnam are missing Instead of considering the approves

by the audit companies as the gold standard, the regulatory bodies need more aggressivepolicies to punish the law violations, recovery the damages for the investors, etc

3.2.3 Ranking is not enough

According to the Decision No 282 at 09/05/2016 of HNX, the Upcom Premiumranking and the investor alert are officially valid on 24/06/2016 Companies which qualifythe financial criteria and comply with the regulation of the corporate disclosure would beselected to the Upcom premium list In the other hand, companies would be considered torank in the warning list by HNX if they violate the Article 9, point 3 of the Decision No

78/Decision-HNX12 With the size of 577 registered firmed13, the stock ranking systembased on the financial indicators and the information disclosure would contributesignificantly to enhance the transparency and the property right of the investors

The benefits of the ranking seem to be perfect in theory After 6-monthimplementation, this system does not increase the liquidity in spite of the fact that theUpcom capitalization is over HNX up to 12/2016 Even the stock which are on thePremium list are allowed to margin but the liquidity stays lower than the expectations That

is the risk avoidance of the investors to the Upcom market

Table 3.The market capitalization and the value matching monthly in Upcom

2,500,000,000 400,000,000,000

2,000,000,000 300,000,000,000

1,500,000,000 200,000,000,000

12 Article 9 To stop trading for the registered firm

1 HNX should consider to stop trading the register stock if one of below scenarios happen: a) The volatility of price and volume are unusal.

b) The serious violation of regulation in the information disclosure.

c) Performing the split, be splited and merge of share

d) In case of protecting the rights of investors with the approve of SSC

Another consequence of the ranking policy that effects seriously to the minorityinvestor is the price making and creating the false liquidity Taking advantage of theimmature disclosure enforcement, controlling shareholders makes collusion with the BoDand broker to make the price of stock to fraud the investors, especially in the marginablestock The more resource supporting for BB, the loss the investors would get Detectingand penalizing is the complicated and time-consuming process while the property rights ofinvestor are dampened.

3.3 The increase of the registered capital without controlling

To increase the amount of fraudulent money, the number of trading stocks wouldissue as much as possible Therefore, fraudulent firms have to expand their regulatedcapitals The process in the rise of the regulated capital had been split into few sections toavoid the regulatory agencies and minority investors The rise of the regulated capital oftenstops when the size of capital is big enough to afford the attractive projects in the financialstatements According to Enterprise Law in 2014, Decree 78/2015/Gov, the loneadministrative processes are the documents related to the business license, as shown inTable 4 below

Table 4 The document of changing the regulated capital.

1 Announcement about the adjusted content in the business license x

2 The meeting report of changing the regulated capital

3 The Decision of changing the regulated capital

4 The list of shareholders

5 Request for changing information in the business license x

Source: Enterprise Law in 2014, Decree 78/2015/Gov

Fraudulent companies intend to finish all the process of the rise of the regulated capitalbefore becoming a public company According to the Circular 180/2015/MoF, they wouldhave to submit the equity report if they changed the regulated capital in the same year thatsubmitting documents to list Once again, the role of external audit company is to recheckthe authenticity of the regulated capitals If the collusion happened between the controlling

shareholders and this audit company, the interests of minority shareholders would beexpropriated.

3.4 The undemanding capital contribution

The capital contribution is common investing activities of fraudulent companies Toreduce the risk and the cost of buying the invoices in operating activities, these firms oftensigns contracts with other companies to invest The total value of these investments oftenaccounts for high percentage of the regulated capital In the China context, author C.Feisuggested that one kind of the fraudulent firms is a company with frequent capitaloperations and related-party transactions and most of these operations were fabricated(C.Fei, 2001) As the result, only the controlling shareholders know the authenticity ofthese investing activities Without supports from the external and internal audit committee,minority shareholders cannot have the truth except the fabricated information in thefinancial statements

3.4.1 The capital contribution through investment

Investing to the other projects of partners is one of activities to gain profits for bothcontrolling and minority shareholders However, the controlling shareholders and thesepartners work as business groups A business group is " a collection of legally independentfirms that are bound by economic (such as ownership, financial and commercial) and social(such as family, kinship, and friendship) ties" (Yiu, Bruton, & Lu, 2005) In addition, thereare cross-holding, board interlocks, and coordinated actions in informal ties of businessgroups (Chung, 2006; Dieleman & Sachs, 2006) When the controlling rights of majorityshareholders overcome ownership (cash-flow) rights, minority shareholders are more likely

to experience expropriations, which cause the principal-principal conflicts In extremecase, "the controlling shareholders can extract high returns from projects that [actual yield]negative returns to the corporation" (Faccio, Lang, & Young, 2001)

The problems in coordinating and allocating resources between affiliated members

of business groups lead to the poor performance of this business groups Minorityshareholders are hard to identify the unfair intra-group transactions due to the lowtransparency of sprawling, loosely-affiliated business groups This kind of network createssignificant opportunities for collusion and unethical transactions However, the regulation

in the frontier stock market like Vietnam is lacking of efficient policies to prevent the

collusion between business groups The lone Circular 90/2015/MoF that required alltransactions of capital contribution by banking activities is a good technical barrier.However, it is not enough to avoid the collusion of business groups because they cantransacts by cheque, or payment order and withdraw all of money later

3.4.2 The capital contribution though invoices

Buying purchase invoices and sale invoices to legalize the fabricated operatingactivities is common method of fraudulent companies in Vietnam One company oftenchooses the member in business groups as a way to reduce the cost as well as to increasethe regulated capital of the company that sold invoices Because the more sale invoice theysell, the more undistributed earning they get Therefore, they can increase the regulatedcapitals and issues more stocks to sell to minority shareholders

3.5 The legal responsibilities of former majority shareholders

In the fraudulent cases, the majority shareholders and leaders often find a safe way

to avoid the legal responsibilities They will resign their managerial roles or sell all theirshares In the managerial aspect, new members will be elected in BoD and seniormanagers In the ownership aspect, all their stocks would sell to new shareholders, but theystill control the trading activities of these accounts After listing, they will sell all stocksfrom these new accounts at high prices When the market price go down at a certain price,they will buy again 75% the number of this company stocks and announce the bankruptcy.The former member would have no legal responsibilities and the minority shareholderswould suffer the substantial losses, which caused by the principal-principal conflicts

To reduce the likelihood of expropriation of minority shareholders due to theseconflicts, on 06/06/2017, the State announced Decree 71/2017/Dec-Gov contains someimportant contents that reduces the possibility of fraudulent activities (Government, 2017),especially in the tone at the top by the addition of external members There are severalhighlighted points that strengthen investor protection:

Table 5 Some highlighted contents in Decree 71/2017/Dec-Gov

Chief audit executive must be a full- efficient

time job and has a degree in auditing oraccounting

Article 24 Responsibilities of the transparency Reducing a consequence of

and to avoid conflicts of interest of information asymmetryCEO

Source: Decree 71/2017/Dec-Gov, Ministry of Finance