If you think that the Satyam saga is an aberration, you are wrong. If you think that Indian promoters, at least the known ones, generally adhere to corporate ethics, you are incorrect again. Time and again, the interests of the small and minority shareholders, people like you and us, have been badly compromised. Although these moves aren't illegal, many of them are definitely against the spirit and essence of corporate governance. "By and large, we had been kidding ourselves that these things (Satyam-like frauds) don't happen in India," says Dolphy D'Souza, partner, Ernst & Young.
Adds Anil Singhvi, MD, ICAN Advisors: "The concerns of the minority shareholders are hardly respected. Most companies pay little thought to shareholder equality." The chances of more Satyams tumbling out of India Inc's cupboard have only increased now. "The reason there's an increased risk of fraud in a down economy is due to, what's called, the ‘fraud triangle'. You have the pressure (on managements), opportunity, and rationalisation," says Donna Epps, a partner with Deloitte Financial Advisory's anti-fraud practice. Since enforcement is lax in India, despite stringent paper laws, one is likely to witness a huge increase in such promoter-related scandals.
Today, after B. Ramalinga Raju's sensational confession, be sure that you can't believe anyone. Not the promoters for sure. Not even the independent directors and board members with impeccable records, who mostly act like rubber stamps. The less said about the auditors and bankers, the better. Even the regulators, who are meant to protect us, wake up only after the fraud has been perpetrated, just like in the movies. Therefore, it's time to brush up your skills so that you can spot management manipulations.
The Most Vulnerable | |
|---|---|
The sectors that are more commonly affected by scams and frauds | |
| Real estate/infrastructure | 18% |
| Energy & natural gas | 7% |
| Auto/auto ancillary | 7% |
| Pharmaceuticals | 8% |
| Retail/consumer products | 16% |
| Media & entertainment | 7% |
| IT/software/ITeS | 8% |
| Telecom | 9% |
| Financial services/private equity | 19% |
| Other | 1% |
Unfortunately, corporate shenanigans are not easy to detect. Satyam's financials hid more than they revealed. All investors, including FIIs, failed to notice any wrongs in Raju's case. We present eight routes used commonly by promoters to take you for a ride and tell you how you can pinpoint them before it is too late.
THE M&A SNARE
Most mergers are good. But many can be bad for investors. This is true when promoters merge privately held unlisted entities with a profitable publicly listed firm. The idea is to either hike their stake in the listed company, or increase the valuations of the private firms. HIRCO, an investment vehicle of the Mumbai-based Hiranandani group, has postponed its plan to acquire two companies owned by the promoters due to shareholders' backlash. Similarly, when the Delhibased JP Associates decided to allot a huge stake in JP Infratech, a subsidiary, to the promoters, the stock got hammered—and the decision withdrawn. Shareholders were angry since the subsidiary was implementing the prestigious Taj Expressway project.
Anil Agarwal had tried to demerge the Vedanta Group in 2008. The group was to be split into three, a move that would have reduced the stake of Sterlite investors in core Indian assets. When the shareholders objected, the plan was shelved. "Most corporate restructuring, especially demergers, are at the cost of the minority shareholders. It is ironical that while acquisitions come under the purview of Sebi, mergers and demergers continue to fall in the domain of the courts, which have little time to appreciate minority interests," says Singhvi.
Tip: Read the agenda for the board meetings that is intimated to bourses in advance. Also, see analysts' presentations - they usually point out such instances.
THE CASH MAZE
Since most promoters control dozens of firms, both listed and unlisted, they have multiple options to rotate excess cash between these companies. At times, they use the cash generated by profitable companies, mostly listed ones, to support those that are bleeding, which are generally privately held. Promoters may also extend themselves interest-free loans. The south-based Murugappa group recently announced that its four companies would pump in a cumulative Rs 150 crore into the Cholamandalam DBS Finance in the form of convertible preference shares to shore up the latter's capital base. The shareholders of the four firms cried foul. A decision is pending.
Tip: If you have invested in one company of a group, keep an eye on what's happening with the others, especially the financial performance of the ailing ones.
BOARDROOM BATTLES
The founders take control of the board through allotment of preference shares, appointment of ‘dummy' directors and alteration of the structure of holding companies. In 2006, Nalwa Sons Investments, the holding firm of the O.P. Jindal group, decided to allot 15% stake to 19 new recruits through Esops. The investors saw it as a move by the promoters to enhance their voting rights. A stay was obtained from the Company Law Board as a group of shareholders alleged that five of the 19 employees were ‘close' to the promoters. They were directors in other group firms.
Tip: Additional shares issued to individuals or firms should come under your scanner. Find out who they are and what is the real purpose of this move.
CASH COW OR CASH CALF
Before Reliance Power's IPO, the promoters transferred most of the power generation projects from Reliance Energy, the then listed group firm, to the 100% subsidiary. Although none of the shareholders reacted openly, the move was seen as a bid to transfer profitable assets to a company, where the stake of the Reliance Energy shareholders would come down to 45% after the IPO. Thus, the full benefits of the power projects wouldn't accrue to Reliance Energy.
Tip: Always go through the fine print of the draft prospectus in such cases. Promoters have to mention such moves in it. Be wary if a promoter is starting two or more companies in the same sector.
Where Lies Become Facts | |
|---|---|
The most common areas where fraudulent manipulation is done | |
| Revenue | 54.6% |
| Assets | 26.9% |
| Other expenses/shareholder accounts | 24.9% |
| Accounts receivables | 19.6% |
| Inventory | 13.2% |
| Cost of goods sold | 11.5% |
| Other liabilities | 7.4% |
| Reserves | 5.9% |
| Allowance for bad debt | 4.3% |
| Marketable securities | 3.5% |
| Payables | 1.6% |
Source: KPMG | |
THE DELISTING DILEMMA
As per law, in case of delisting, the managements have to ‘discover' the real delisting price through the reverse book building (RBB) process. But promoters have found ways to wriggle around this clause. A common tactic is to announce a buyback scheme, with a cap on repurchase price, while the RBB is on. Some investors can be misled by it and bid at the buyback price. At times, companies delist in a bear market, and relist at a premium when the market improves.
Tip: Watch out if the promoters' holding rises above 75%. In case of small companies, a steep fall in trading volumes or extreme volatility are danger signals.
BUYBACK BROUHAHA
Although it is the investor's discretion to agree to a buyback offer, promoters can sometimes force it down his throat. In 2001, Sterlite Industries pressured the shareholders when it mailed them cheques for the specified amounts. In addition, in the letter to shareholders, it said that if they didn't say ‘no' officially, it would be deemed a ‘yes'. The company obtained court permission to ‘sweep' the shares from the depository accounts if the investors encashed the cheques or didn't say no.
Tip: Read all communication that you receive from the company. Don't encash any cheque that you receive. Find out why it has been issued to you.
UNFAVOURABLE OFFER
Sometimes, takeover tycoons can avoid making an open offer even when it is clear that they are acquiring a company. Sebi rules state that if someone buys 15%, it triggers the takeover code and the buyer has to give an open offer to all the existing shareholders of the target company. But there's a loophole. In 2000, Gujarat Ambuja initially purchased an 11% stake from the Tatas in ACC. Sebi ruled that it didn't need to give an open offer. Then Gujarat Ambuja acquired another big chunk, but kept the overall stake just below 15%.
Tip: Although it's difficult to notice such creeping acquisitions, keep your antennae up when you hear of one. Read media reports and analysts' comments to be on top of what's happening.
Related Party Transactions | ||
|---|---|---|
Promoters' private dealings with the company affect the interests of the shareholders, but sometimes these are not disclosed | ||
| Characteristic | Firms | |
| RPTs disclosed to shareholders | 94% | |
| Firm requires RPTs to be on an arm's length terms | 78% | |
| RPTs are more than 1% of revenues | 67% | |
| RPTs are more than 5% of revenues | 20% | |
| Nature of RPT approval | From inside director | From shareholders |
| No specific requirement | 27% | 34% |
| Approval by board of directors | 70% | 60% |
| Approval by independent directors | 9% | 7% |
| Figures are percentage of respondents in a survey of CEOs, CFOs & company secretaries of 301 private firms in six major metros in India. Source: V. Khanna, University of Michigan Law School. | ||
GRANDMA'S RECIPE
As the Satyam fraud has proved, cooking up financial figures is a favourite activity for promoters. During the current global recession and faltering growth in India, there will be additional pressure to show spectacular performance to keep the valuations high. Owners will be forced to meet the investors' expectations, and signs of weak financials will be punished severely. Balance sheets can be doctored through the following means:
Tip: Read the firm's balance sheet carefully. Pore through the figures and look for the above-mentioned discrepancies.
Cases of Corporate Accounting Frauds
Famous Indian cases:
Anil Agarwal, Sterlite:
Abandoned a restructuring plan after institutional investors threatened legal action. Minority shareholders' stake in core Indian assets would have come down, in exchange for a piece in Vedanta’s copper mine in Zambia, whose assets were unproven.
Niranjan Hiranandani, Hiranandani Constructions:
Has had to postpone the proposed merger of two group companies, Hirco Developments and Hiranandani Investment, with Hirco, its Londonlisted investment vehicle, after mounting pressure from shareholders.
Naveen Jindal, O.P. Jindal Group:
Abandoned plans to allot 15% stake in Nalwa Sons to 19 new employees through Esops after a few investors obtained a stay order from the Company Law Board, alleging that these staffers were in fact 'persons acting in concert' with the promoters.
J.P. Gaur, JP Associates:
The company called off its plan to transfer stake in JP Infratech, a 100% subsidiary that houses the multi-billion dollar Taj Expressway project, after the stock was hammered when the proposal was announced.
N.S. Sekhsaria, Gujarat Ambuja Cements:
The company used the loophole in the law to avoid making an open offer by maintaining its stake at just below 15%, despite taking over the company from the majority shareholders.
Rajiv Singh, DLF:
The company was forced to compensate shareholders whose debentures were forfeited when the firm was delisted in September 2003 even before it could come out with an IPO in 2007..
- Narayan Krishnamurthy, Rakesh Rai, Priya Kapoor, Tanvi Varma, Shruti Kohli, Sameer Bhardwaj and Alam Srinivas
