The Financial Markets Tribunal (FMT), an independent tribunal of the Dubai Financial Services Authority (DFSA), today made orders in respect of Arqaam Capital Limited (Arqaam) and its auditor, Ernst & Young (E&Y). The orders were made with the consent of both Arqaam and E&Y.

In essence:

(i) Arqaam failed to comply with International Financial Reporting Standards (IFRS) when it accounted for transactions involving artworks in its financial statements for the year ended 30 June 2009 (the 2009 Accounts);

(ii) E&Y failed to comply with International Standards of Auditing (ISA) when carrying out the audit of the 2009 Accounts;

(iii) Arqaam will restate the 2009 Accounts and its 2010 financial statements, and  adjust its 2010 and 2011 financial statements for any flow on implications, within 28 days;

(iv) Arqaam and E&Y will each pay a fine of AED 183,500 (USD $50,000) to the DFSA within 28 days; and

(v) Arqaam and E&Y will pay the DFSA’s costs of the investigation and the FMT proceedings within 28 days.

The Chief Executive of the DFSA, Mr Ian Johnston said: “Where Authorised Firms and Auditors are in breach of DFSA legislation, in this case by not meeting accounting or audit standards, the DFSA will hold such firms to account.

It is important that the financial statements of financial services firms are clear and do not have the potential to mislead.

The action taken by the DFSA and the FMT’s orders confirm the DFSA’s commitment to maintaining international standards within the Dubai International Financial Centre (DIFC).

The DFSA will, therefore, take all necessary measures to protect the integrity of the financial markets it regulates”.

Background

1. E&Y was registered by the DFSA as an auditor in the DIFC on 3 January 2006, and has been Arqaam’s auditor since March 2007.

2. Arqaam was registered as a company in the DIFC on 29 March 2007, and licensed to carry on financial services by the DFSA as a Category 2 Firm on 23 May 2007.

3. Arqaam is required to lodge audited financial statements with the DFSA at the end of each financial year.

4. In July 2007, Arqaam commissioned eight (8) pieces of artwork (the Artworks) as an investment and for display at its offices and agreed a purchase price for them (the Original Purchase Price). The Artworks were completed and delivered to Arqaam in October 2008. 

5. In August 2009, Arqaam obtained a valuation of the Artworks (the Valuation) from an art gallery revaluing the Artworks at an increased price to the Original Purchase Price (the Valuation Price). The difference between the Valuation Price and the Original Purchase Price is hereafter referred to as the Valuation Gain.

6. Arqaam approached E&Y to agree the accounting treatment for the Artworks.   

7. Following discussion with E&Y, in September 2009, Arqaam arranged for and executed sale and buy-back agreements with a company (the Buyer) on the following terms:

(a) A sale agreement dated 29 June 2009, in which Arqaam sold the Artworks to the Buyer at the Valuation Price; and

(b) A purchase agreement dated 30 June 2009, in which the Buyer sold the Artworks to Arqaam at the Valuation Price (together, the Artworks Transaction).

8. The Artworks Transaction was an accounting trade which lacked economic substance as there was no real intention to sell or repurchase the Artworks.   The Artworks Transaction was not an arm’s length transaction.

9. The DFSA did not allege dishonesty or intention to deceive or mislead, or that the Valuation was not genuine, or that anyone suffered loss.

10. On 31 October 2009, Arqaam lodged the 2009 Accounts with the DFSA. The 2009 Accounts were audited by E&Y.

Accounting Treatment

11. The 2009 Accounts were prepared on the basis that the Artworks had been sold and repurchased at the Valuation Price in the financial year ending 30 June 2009, when in fact the sale and repurchase transaction was executed in September 2009. Since the sale and repurchase was of no economic substance, the 2009 Accounts should not have reflected it.

12. On the DFSA’s case, the accounting treatment adopted by Arqaam had the following effect on the 2009 Accounts:

a. It decreased losses in 2009 by 21% in the Statement of Income by the Valuation Gain on the Artworks;

b. It increased stated assets in the Balance Sheet (namely Plant and Equipment) by the amount of the Valuation Gain.  Further, Arqaam failed to make disclosures, as required under IFRS as to the nature of the increase that such a treatment would require; and

c. It resulted in the Statement of Cash Flow recording that Arqaam made both a gain and a disposal in respect of the Artworks, when in fact there were no cash flows resulting from the transactions. 

13. On E&Y’s and Arqaam's case, Arqaam was entitled to account for the Artworks in the manner in which they did, arguing that the balance sheet and income statement numbers should have been as presented in the 2009 Accounts. 

14. E&Y gave an unqualified audit opinion that the 2009 Accounts present fairly, in all material respects, the financial position of Arqaam as of 30 June 2009 and its financial performance and its cash flows for the period then ended in accordance with IFRS.

DFSA Regulatory Action

15. The DFSA commenced its investigation into Arqaam and E&Y’s failures to comply with IFRS and ISA respectively on 23 June 2010 and issued Notices of Fines to both Arqaam and E&Y on 20 March 2011.

16. E&Y and Arqaam lodged Notices of Objections to the fines on 16 May 2011 and 29 May 2011 respectively.

17. The DFSA commenced proceedings in the FMT against Arqaam and E&Y on 3 August 2011.  The DFSA sought declarations of contraventions of DFSA administered rules that required Arqaam and E&Y to comply with IFRS and ISA respectively, the imposition of financial penalties and orders for Arqaam to restate the 2009 Accounts.  

18. Arqaam and E&Y filed proceedings in the FMT to hold the proceedings in private and to prevent any publication of the FMT proceedings and its orders.  The DFSA objected to the restriction on the publicity. The FMT heard the arguments at an FMT hearing in London on 12 December 2011 and, on 11 January 2012, issued its decision to make public both the proceedings and its decisions.  The FMT’s decision can be accessed at:

Documents/FMT/DECISION%20ON%20APPLICATION%20FOR%20DIRECTIONS-%20revised.pdf

19. Arqaam appealed the FMT’s decision to the DIFC Courts.  The DFSA opposed the application, and there was a hearing of the appeal on 23 May 2012.

20. The DIFC Courts delivered its judgment on 4 September 2012 in favour of the DFSA.  The judgment can be accessed at:

https://difccourts.visionhall.eu/?Start=search#:3

The DFSA’s media release in respect of the judgment can be accessed at:

DFSA-Action-in-the-Financial-Markets-Tribunal

21. The hearing of the substantive matters was to commence in the FMT on 17 September 2012.  However, the parties settled the proceedings with consent orders as summarised in this media release.