Eros backs away from Skadden’s independent review

Eros International Plc’s (NYSE: EROS, US$13.84, the “Company”) stock price had a rough October in 2015. After several press release campaigns, and in a bid to stem the loss of investor confidence, on November 2, 2015, before the market opened, the Company announced that its Audit Committee had engaged Skadden, Arps, Slate, Meagher & Flom LLP (“Skadden”) to “conduct an independent internal review” of certain allegations against the Company. They reported the following:

“We are confident in our business fundamentals and we will be announcing our Q2 FY2016 results in the first half of November. Our credibility and reputation are of paramount importance. Our Audit Committee has engaged the U.S. law firm Skadden, Arps, Slate, Meagher & Flom LLP to conduct an independent Internal Review and also to advise us on related matters.”

On the day of the announcement, EROS closed at US$13.62, up 21.93%. Clearly, investors were reassured by this decision of the Audit Committee and the Board of Directors to have a law firm of  Skadden’s stature conduct its independent review.

Indeed, it was, and still is, in the interest of all non-management-related parties for Skadden to conduct a legitimate independent review of the allegations against the Company, EROS’s auditor, its Audit Committee and the Management.

However, somehow, sometime over the period of its gestation, Skadden’s engagement to “conduct an independent” review of the allegations mysteriously transformed into an internal review by the Audit Committee with the assistance of Skadden. Without prior notice to investors about this material change, in a press release dated February 17, 2016 the Chairman of the Audit Committee announced the following:

“In November 2015, the Audit Committee appointed Skadden, Arps, Slate, Meagher & Flom LLP and affiliates, a reputed New York law firm, to assist it in undertaking an Internal Review on the subject matter of certain anonymous allegations and related matters that caused a sharp decline in the Company’s share price. The internal review is at an advanced stage and we are satisfied with its progress. We expect to conclude our review in March and to make a further statement at the time.”

The shift from Skadden taking the lead and “conducting” the review to it merely “assisting” the Audit Committee in its internal review is no small matter. At some point, having felt comfortable that they had assuaged investor concerns through the initial announcement, EROS decided to change the scope of Skadden’s engagement – its brand value having already had the desired halo effect.

In the same February 17, 2016 release, the Chairman of the Audit Committee surprisingly preannounced the outcome of the review:

“Meanwhile, I would like to assure our shareholders that the Audit Committee has reviewed the accounting procedures and principles followed by the Company and has been fully satisfied that the Company has recorded its financial statements and related disclosures appropriately without any material misstatements.”

The Audit Committee abandoned its previously announced plan to have Skadden conduct an independent review and determined to do it themselves.  Effectively, the Committee decided to investigate itself. The “preannouncement” predictably comes as no surprise.

The U.S. Securities and Exchange Commission’s (“SEC”) definition of the function of an Audit Committee is as follows:

“The audit committee, composed of members of the board of directors, plays a critical role in providing oversight over and serving as a check and balance on a company’s financial reporting system. The audit committee provides independent review and oversight of a company’s financial reporting processes, internal controls and independent auditors.”

Why did the Audit Committee – whose credibility and independence on the audit oversight and procedures was being questioned – move away from the announced independent review, conducted by Skadden, to an internal review conducted by themselves, on themselves, with Skadden relegated to a passive role on the side-lines?

Additionally, the timing of the Audit Committee’s February 17, 2016 preannouncement on their satisfaction with the review appears highly convenient given the Company’s business performance for the quarter and dismal share price performance:

Revenues decreased by 39.8% to $60.5 million.

Adjusted EBITDA decreased by 81.9% to $8.9 million.

Net income decreased by 108.9% to $2.5 million net loss.

Thirty three days after the preannouncement, on March 21, 2016 the Company announced that its Audit Committee completed its internal review of (i) UAE sales and revenue recognition; (ii) amortization policy of intangibles, including film and content costs; (iii) related party transactions; (iv) ErosNow registered users count; and (v) Eros’s film library.

The Company re-emphasized that the “independent” directors on the Audit Committee were “assisted” by Skadden. Not surprisingly, the Company’s CEO stated that:

“We are pleased the Audit Committee, with the assistance of Skadden, Arps, Slate, Meagher & Flom LLP, has completed its thorough internal review, and reinforced its confidence in the Company’s accounting policies, practices and disclosures in the Company’s financial statements and other key metrics. We reiterate that the Company maintains the highest standards of integrity and transparency in financial reporting.”

Notable by their absence are the terms “conduct” and “independent” from the above statement along with the fact that Skadden’s engagement was relegated to providing “assistance” to the accused parties. It is important to note that nowhere in EROS’s announcement to its investors is there any mention of its auditor Grant Thornton assisting with the “internal review.”

EROS’s top-level managers and its Board of Directors are the accused parties.  They control the flow of information to investors as well as Skadden’s retainer. Skadden lending its imprimatur and credibility to this futile whitewash would appear to be the extent of their assistance required by the Company.

In order to better interpret this report, it is highly advisable to read the letter written by to Grant Thornton, on June 7, 2016, concerning the Company’s audit procedures and financial reporting, along with the report on Eros’s ‘Dozen Unknown’.