If you are stuck in stocks that have lost over half their value so far in 2018, then it may be hard to exit as liquidity shrinks.

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Stocks like Vakrangee and Manpasand Beverages saw their market value erode by more than half in 2018 as concerns over the resignation of auditors just ahead of the quarterly results weighed on sentiment. The recent stock to be hit by the resignation of auditors was Atlanta.

Vakrangee, which was trading above Rs 400 per share in January, lost over 90 percent by June when it hit a fresh 52-week low of Rs 31. Manpasand Beverages, which was trading above Rs 440 per share in January, more than halved in the last 5 months. It closed at Rs 203.05 on June 1. Shares of Atlanta have plunged over 60 percent since the beginning of this year.

There is one thing common in all three stocks. The decline in all three stocks is related to the resignation of auditors. On April 27, Price Waterhouse & Co resigned as auditor of Vakrangee while Deloitte Haskins & Sells choose not to continue as auditors of Manpasand Beverages on May 26.

On May 29, Price Waterhouse Chartered Accountants, statutory auditors of Atlanta, resigned with immediate effect. Their exit led to a massive 31 percent fall in its shares.

Shareholders of Manapasand Beverages lost as much as 53 percent after the news hit D-Street. Vakrangee has plunged 67 percent in a matter of 25 trading sessions.

Stuck in these stocks, here what you can do now?

Auditors can resign for a whole host of reasons. If the company is fundamentally strong and the resignation is not related to any ethical misconduct, then the impact on shares will remain only for the short-term.

However, if the auditors resigned because of non-availability of some material information pertaining to the company, then its best to exit the stock, but it is not a ground to initiate legal action.

“While per se there is no legal recourse available to investors just because an auditor has resigned, it raises apprehensions on the quality and transparency of the financial information reported by the company,” Kalpana Unadkat, Partner, Khaitan & Co, said.

However, she was quick to add that if there are indeed corporate governance breaches or an attempt to defraud the shareholders, investors can institute class action claims and seek compensation from the company and its directors. “The management and the company will also be subject to further penal consequences in case of such breaches.”

For an investor, one thing is clear that everything is not fine. At present, except for the reasons communicated by the company to stock exchanges, there is no other information publicly available.

Auditors seldom make their reasons known to the public on account of various factors such as liability. Unless there are changes in listing guidelines, shareholders will have to wait until the regulator investigates and comes out with its factual position, experts suggest.

“There cannot be smoke without fire and one cannot clap with one hand are two sayings which aptly fit the present situation. Most times this is the last resort with auditors. Investors have no option but to wait for clarification from the company (to the stock exchange or otherwise) and observe/track subsequent actions which may clear the doubts casted by such events,” Milan Mody, Partner, NA Shah Associates, said.

Mody added that the window under insider trading regulations may have to be closed till the casual vacancy is filled up (this has happened in the case of Atlanta) as the appointment of the new auditor would have to be ratified by shareholders.

As per the revised SEBI (Listing Obligations and Disclosure Requirements) guidelines which came into effect from April 1, 2018, in case of resignation by an auditor before their tenure ends, stock exchanges need to be informed about the reason for resignation within 24 hours. The incoming auditor would also have to seek a no objection certificate (NOC) from the outgoing auditor.

Are there any red flags that investors should pay attention to?

It may be difficult to pick-up early signs of any wrongdoing by the company but investors should keep an eye on these factors as highlighted by experts:

Study audit notes carefully

Unadkat of Khaitan & Co feels one starting point would be to read carefully the notes to accounts made by the auditors in the financial statements. “Also, the resignation of key officers (such as CFO or independent directors, audit committee members) in a short span of time may be a good reason for investors to probe further. The other obvious ones would be to watch out for any regulatory notices by SEBI or tax authorities,” she explained.

Follow the rationale why the auditor resigned

Resignation of an auditor is a very serious concern for the company as well as the investor. The latter must see whether the resignation is due to a breach of corporate governance. “For instance, a person or partner of a firm will not be eligible for conducting an audit if such persons or partner at the date of appointment or reappointment holds an appointment as auditor of more than 20 companies,” Ritesh Ashar, Chief Strategy Officer at KIFS Trade Capital, said.

He stated that private companies are also included in the maximum limit of 20 companies. If the resignation is not due to the breach of corporate governance, he feels the investors should not be worried about the resignation. “But if it is related to a breach, then investors should go into the details of the matter.”

Quality of the auditing firm

Nikhil Kamath, Co-founder, Zerodha, said quality of the auditing firm is something people should pay heed to. “An auditor who resigns at the last minute, especially without reason, should definitely be penalised.”

Frequent change in auditors

Sudden resignation is mainly on account of differences with regards to an audit issue between the auditor and the company’s management. It could also be on account of non-sharing of significant information by the management with auditors.

“Some of the early warning signals which investors can look at are adverse comments in previous audit reports, frequent changes in auditors, large related party transactions, default in payment of loan instalments, non-payment of undisputed statutory dues, cash flow contains, continued losses, overleverage, financial statements not prepared on time and action by other regulators and tax departments are few of the early warning signs which one can look for,” Mody stated.

Disclaimer: The views and investment tips expressed by investment experts are their own and not that of the website or its management. Users are advised to check with certified experts before taking any investment decisions.

Source: Moneycontrol.com