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How to spot corporate cons

Company owners occasionally use loopholes in the law to serve their own interests, leaving small investors in the lurch. Here's how to identify them.

Print Edition: February 5, 2009

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/infrastructure18%
Energy & natural gas7%
Auto/auto ancillary7%
Pharmaceuticals8%
Retail/consumer products16%
Media & entertainment7%
IT/software/ITeS8%
Telecom9%
Financial services/private equity19%
Other1%

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.

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