The main investor, a chartered financial and alternative investment analyst, thought he was onto a sure-fire winner when he was offered a chance to invest in an overseas private healthcare group. He also roped in his cousin, who was a partner in his investment firm.
The fund management company marketing the deal told them that the group had a track record of paying out a 9 per cent dividend based on its stock price, and there was a chance its value would triple when it was eventually listed on the stock exchange.
It was all so tempting that they even visited the group’s head office overseas, met some key officers, and toured its hospitals and dental clinics.
So taken were they that the main investor put in over $560,000, comprising $280,000 of his own savings and loans of $280,000, while the cousin chipped in with $140,000.
Deal not transparent
There were red flags aplenty from the word go: Buying shares from a private company was risky as there was no transparency in how the stock price was determined.
The Singapore investors were sold about 196,000 shares at US$2.80 apiece but early investors had paid only US$1.
As it turned out, what they bought were not newly created shares but came from the personal stash of the company’s chief executive. This begged the question: Why would the CEO sell his shares – albeit at a very decent profit – if a public listing that could substantially increase their value was supposedly just around the corner?
There were no agreements inked between the investors and the company because this was supposedly a straightforward process of acquiring shares. There were no agreed terms that the investors would be guaranteed their 9 per cent dividend that would be based on their stock price since the shares were not publicly traded.
The only discussion on the potential yield was done via e-mail exchanges with the fund management firm, which showed a table detailing dividend payments of 9 per cent from previous years.
As it turned out, the investors realised they had bought into a dud about a year later when the dividend declared was only 7 per cent and this was to be pegged to the original share price of US$1.
Based on the stock they had and length of holding, it meant that they would get a payment of less than $1,000 in total.
To make matters worse, not only was the public listing plan scuttled, but the company also ran into trouble and eventually went bust.
With all of their $700,000 up in smoke, the investors chose to sue the fund manager for misleading them into a bad deal.
High Court Judge Mohamed Faizal noted that when an investment sours, it is natural for aggrieved investors to blame those who advised them and marketed the deal.
“This entirely fathomable and very human reaction stems from a myriad and complex mix of emotions that often come up when such high-risk, high-potential investments fail, ranging from frustration to anger, and betrayal,” he added.
But the reality for many of these cases is that the losses stem from factors such as “luck and risk” that are beyond the control of fund managers.
The judge noted that the fund manager might have engaged in “a bit of puffery and marketing talk” to highlight only the more positive aspects of the investment, while not dwelling excessively on the negatives.
While such puffery might induce the layperson into believing the whole pitch, the judge found that the Singapore investors’ extensive background in investment and finance would enable them to spot the fund manager’s role in optimistically promoting such investments.
So the court ruled that the Singapore investors were not misled and dismissed their claim for compensation.
The case highlights two important investment tips.
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No one can predict the future
This case serves as a cautionary tale that all numbers and projected yields presented during an investment pitch are always just “illustrative” and do not guarantee the eventual outcome.
If you are adamant about getting such returns, insist that such terms are recorded in your investment agreement because information presented in slides or e-mails is not legally binding.
In this case, the fund manager noted that its chart was meant only to show how the dividend scheme worked under various scenarios, assuming a 9 per cent dividend was declared.
Moreover, the information was not false because the chart was based on funds from shareholders then and the company did historically declare dividends at 9 per cent of the invested capital.
That said, a common refrain in the investing community has always been that past profits of any company should never be viewed as an assurance that similar profits will continue to accumulate in the future.
A promise of future conduct, such as a statement that investors would receive dividends, would not support a legal claim for misrepresentation because it referred to a “future event”.
The company in this case did declare a dividend, albeit a lower one that was not to the investors’ expectation.
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Due diligence is paramount
Although the investors in this case were highly qualified, Judge Faizal noted that they did not seek any written confirmation on two important points that mattered to them – the public listing and the “guaranteed” 9 per cent dividend payment.
The most obvious way to obtain some assurance would have been during their site visit, where they had the chance to meet the firm’s senior management and conduct a check of its accounts.
“The fact that these matters conveniently never came up in the due diligence process, or were simply not followed up on, indicates that it is likely that the alleged representations were never made,” Judge Faizal said.
Although the investors wrote to the fund manager to seek confirmation over the 9 per cent dividend, they went ahead with the deal despite not getting a response on this point.
The judge also found it odd that these seasoned Singapore investors expected that the 9 per cent dividend would be paid based on their higher share purchase price.
After all, there was no commercial reason why any company would pay out dividends based on a percentage of the purchase price from the sales between shareholders themselves, given that this had nothing to do with the infusion of actual equity into the company.
What investors should consider
The case highlights the high risks of investing in private companies due to the lack of transparency and the difficulty for average investors to cash out their shares.
After all, why choose to go private when the convenience of online share trading platforms has enabled investors to buy and sell shares of reputable and global companies easily and in a transparent manner?
You can also keep up to date with the news of these companies and then make informed decisions on whether to continue to stay invested or cash out.
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There is also the choice of investing in a stock index fund that contains a basket of well-known firms, instead of banking on just one stock.
Ultimately, if you still choose to invest in private companies, make sure you carry out careful checks so that you don’t end up being short-changed by unclear and murky business practices.
Tan Ooi Boon writes for and oversees the Invest section of The Straits Times.
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