We began our series discussing two transactions where not only is the evidence of fraud is, in our view, clear and convincing; but, the impacts can be quantified. From the outside, fraud is usually difficult to quantify – even analysts who specialize in detecting fraud usually struggle to estimate its impact. Based on feedback, we believe there was some misunderstanding by investors about the impacts of the fraud we detailed in Part I. The fraudulent inflation was not limited to below-the-line (i.e., non-operating) income inflation. Deferred revenue without matching expenses is an above-the-line profit inflation technique, which we illustrate in a reported vs. estimated real margin comparison table on page 3 of the initial report.
We continue our series of reports with a look at another transaction with a quantifiable above-the-line impact, Firstleap. We focus on Firstleap second also because it is a bit of a brainteaser – we invite investors to try to reconcile to the numbers TAL reported. Taken together, Parts I and II show the variety of levers available to TAL to fraudulently inflate profits – all three transactions are obscure transactions to which investors seemed to pay scant attention at the time, and yet they have each made material contributions to profit overstatements.
Our next report in the series will detail our conclusion that TAL commits fraud in the financials for its core Peiyou business. The Peiyou fraud is more difficult to quantify, but our research suggests fraudulent overstatement of Peiyou revenue of approximately 25% to 30%. Future reports will detail fundamental weakness in Peiyou, and other reasons that the real portions of TAL’s profits are not sustainable.
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