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Halls of the Blind

I can see what you see not
Vision milky, then eyes rot.
When you turn, they will be gone,
Whispering their hidden song.
Then you see what cannot be
Shadows move where light should be.
Out of darkness, out of mind,
Cast down into the Halls of the Blind. 

- Diablo

I usually avoid referring to stuff from the 90s as the opening act. It risks giving away my vintage…

But the above words from one of the most successful role-playing games from the 90s – Diablo – (who remembers it?) is apt for this edition.

Auditor Problems.

It’s an opportune moment to dive into the Corporate Halls of the Blind.


Indian markets have been beset by a sudden wave of auditor resignations from listed companies in recent times. Stock prices of the affected companies have taken a beating. Runaway auditors have caused market participants to speculate over the next defection, as alpha monkeys smell quick gains. Auditor issues have surfaced after a period of widespread price correction. Wounded consciences that were assuaged by the Band-Aid of rising stock prices have been violently peeled off as prices have turned down.

Rule of thumb: identification of ‘n’ frauds (real or otherwise) leads to 2^n fraud suspects, as sleuths scour the market for impending pockets of doom.

The problem highlights several aspects of investor behaviour that is worth noting. As always, history is the best place to look.

A throwback to the internet bubble era, with a special focus on a then market darling – Enron Corporation.

An excerpt from its then Annual Report, reprinted word-for-word. Friendly English commentary follows soon after.

Enron entered into a series of transactions involving a third party and the Related Party. The effect of the transactions was (i) Enron and the third party amended certain forward contracts to purchase shares of Enron common stock, resulting in Enron having forward contracts to purchase Enron common shares at the market price on that day, (ii) the Related Party received 6.8 million shares of Enron common stock subject to certain restrictions and (iii) Enron received a note receivable, which was repaid in December 1999, and certain financial instruments hedging an investment held by Enron. Enron recorded the assets received and equity issued at estimated fair value. In connection with the transactions, the Related Party agreed that the senior officer of Enron would have no pecuniary interest in such Enron common shares and would be restricted from voting on matters related to such shares. In 2000, Enron and the Related Party entered into an agreement to terminate certain financial instruments that had been entered into during 1999. In connection with this agreement, Enron received approximately 3.1 million shares of Enron common stock held by the Related Party. A put option, which was originally entered into in the first quarter of 2000 and gave the Related Party the right to sell shares of Enron common stock to Enron at a strike price of $71.31 per share, was terminated under this agreement. In return, Enron paid approximately $26.8 million to the Related Party.

English translation:

Enron transferred 6.8 MM stock to the related party; gets back only 3.1 MM shares. Net-net: Enron transferred 3.7 MM shares valued at $260 MM at that time + $27 MM for a total cash transfer of $300 MM to cancel a contract with the Entity controlled by a very interested party. A fictitious contract is created from thin air, then nullified, with a very real movement of hard cash.

This ‘gifting’ accounted for a quarter of Enron’s operating cash flow in 1999.

These should've been noticed by discerning investors. But not many did. Until it was too late.

In the internet boom as Enron’s stock price levitated, few took notice or reacted to such wondrous nonsense. A precipitous fall in the stock price triggered ‘auditor concerns’, then ‘scandal’.

Rest (in peace) is history.


In bullish times, when a growing mass of believers coalesce around rapidly levitating stock prices, numbers and other such mundanities seldom matter. Until they do.

The recent auditor issues in India has dusted off questions that lurked in the shadows during normal (‘bullish’) times.

How can one be confident that the numbers that really count are being counted correctly?

Of what use is identifying a ‘fraud’ if nothing can be done about it (read: profitable exploitation)?

Faced with such difficulties, the market’s muscle memory kicks in for a rational Pascal’s Wager. ‘It wouldn’t hurt much if I believed in God and God didn’t exist. But I could benefit greatly if God existed. So let me believe in the numbers…until…’

Markets scrub their conscience on dodgy companies and selectively outrage against some when the tide turns.

Yet, many questions continue to be lost in the Halls of the Blind:

What about the Outsourced Diligence Model of investing? ‘A’ relies on an auditor, who relies on other auditors/managements, who rely on fuzzy estimates of unquantifiable aspects of businesses.

Markets do not exist as a torchbearer of collective morality. To the extent that the collective belief that markets discount future earnings potential is true, corporate governance issues shall be relegated to the shadows in the next cycle.


Often get asked as to how investors can keep up with all this. It seems scary to many that such dangers lurk in the shadows.

It helps to remember that in the long timeline of history, failure is the norm, success the exception. A sceptical mind-set that assumes most things are likely to fail is a good place to begin. Since the pool of failures vastly outnumbers successes, a philosophy that rests on elimination is a strong weapon in an investor’s arsenal.



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