Gautam Shah, chartered accountant and expert working with charitable institutions, asks non-government organisations to be scrupulous about the rules, if they want to avoid harassment at the hands of the authorities
Click here for more pictures of the workshop
Civil society organisations have come to play an increasingly important role in our lives. While the government struggles to implement laws and schemes, non-government organisations (NGOs) have, in many cases, effectively filled in the gaps. From reviving neighbourhoods to educating slum children, providing relief during calamities or even taking care of stray dogs, they are visibly active in several areas. This increasing responsibility is putting pressure on the management of their activities. Unfortunately, there have been allegations of poor management against quite a few of these organisations.
The zeal for charity is not enough. Institutions should be equally diligent with their financial accounts and they must comply with the laws if they are to be more effective and inspire trust in the public. This was the advice of Gautam Shah, managing partner of Gautam Shah & Associates, Chartered Accountants, to NGO workers at a workshop hosted by Moneylife Foundation on Saturday, 18 December 2010.
"We feel very good when we donate something for a noble cause, but is it enough," Mr Shah asked the participants attending the programme. "We have to see that the money is utilised properly, and to ensure that the support continues even when the donor is no more. Moreover, not some family member, but the public at large should be the beneficiary. That defines the purpose of a charitable institution. And for a good NGO to continue you have to stick to every norm, notify the authorities of every single development and most importantly, maintain detailed verifiable financial records. "
At the outset, Mr Shah described the process of setting up a charitable institution. While elaborating the mechanism for formation and registration, he explained why a Section 25 company was an ideal format over a charitable trust and society. He said, "People think that setting up an NGO is an easy thing. It is not. Several clauses are to be included in the constitution and many documents and certificates are required. If these are not in place at the registration, the institution will be unable to make any amendments in the future and could face many problems."
He gave an example of a charitable trust which had two persons as trustees. It did not mention what was to happen if one of the two quit or died. As a result, the trust suffered much difficulty. Many institutions face similar difficulties because of a lack of technical knowledge.
NGOs should not only get registered under Section 12(a) and get an 80G certificate, but they should also know how to channelise funds properly. NGOs, who accept contributions from abroad, should source the money from an NRE account (non-resident external) and get registered under the Foreign Contribution Regulation Act 1976 (FCRA). "Just think", said Mr Shah, "if the Tirupati temple does not have an FCRA registration, it cannot do anything with the huge amount of donations it gets from NRIs and foreigners. Then, the only other way is to convert this money to 'white money', which is definitely not preferable."
Also, it is very important to have proper accounting in a fixed format. Mr Shah recommended that accounting should be intensive and done by professionals. He said that it is a must to have at least four meetings annually, as well as maintain a minute book recording the proceedings, to present to the supervisors.
Mr Shah warned that the proposed Direct Tax Code (DTC) "is going to be very bad for NGOs". Earlier, NGOs could accumulate 15% of their funds for some future big project, for five years. But that feature is to be changed considerably under the DTC. The new rule will only allow for 15% of surplus or 10% of gross earnings (whichever is greater) to be accumulated for five years. Also, exemptions will be more basic in nature, like that of individual tax exemptions.
While sticking to the rules is good in itself, it also helps to avoid many legal hassles and interferences from the authorities. In Maharashtra, NGOs are set up under the Bombay Public Trust Act, 1950, and are under the scrutiny of the charity commissioner. "The charity commissioner is the Supreme Court," Mr Shah said. He mentioned the elaborate red-tape process and an astonishing amount of paperwork that an NGO has to undertake before, during and after the registration. Every financial and administrative detail is to be notified, otherwise, the NGO could be threatened with de-registration and may even be closed down.
Mr Shah gave the example of an exclusive high-end association which had to undergo a lot of trouble because it had not notified the charity commissioner of some changes. To their horror, they were told that they had conducted "illegal activities" for a decade, and their work was suspended. They were unable to get relief even after many phone calls to higher-ups. After meek submission and several apologies (and some payments), the association was allowed to operate again.
Mr Shah described how some of these officials abused their position for personal gain. The law, while making many procedures mandatory towards ensuring accountability, is giving NGOs nightmares. "We do good for society, and then we are harassed. The process should be such that the authorities should be accountable and NGOs should be allowed to function freely," Mr Shah said.
Mr Shah had some specific advice: "Do not start an NGO in Maharashtra. Get it done somewhere else. That way, even if your operations and property are in Maharashtra, the charity commissioner cannot interfere with the operations." This brought up the question on the ideal place to start an NGO. "New Delhi," Mr Shah answered promptly. "In union territories, central laws are applicable, which are more simplified and the process is hassle-free. Delhi, being the capital, will provide the best infrastructure and ensure better access to resources."
Questions from NGO representatives attending the workshop ranged from tax exemptions to legal issues and validation certificates. Mr Shah answered most of the questions and promised to answer more on email.
For Mr Shah, social duty comes before private gain. He holds a PhD in business finance for which he submitted a thesis on "Management of Charitable Institutions-a Financial Perspective". His association utilises 80% of the funds to help NGOs with their finances. "For me, charity is not a hobby. I am where I am because of somebody's contribution. And so, I think it is very important to help other people."
The turning point for him came many years ago, when he decided to sponsor the education of his maid's daughter. He decided to establish his association about a decade back, when a school with more than 600 students approached him for help with their accounts. The charity commissioner had threatened to close it down because the accounts showed discrepancies. Mr Shah helped the institution out, and decided to start an association which would help charitable institutions with financial management and legal advice.
This workshop was second such programme for NGOs held by Moneylife Foundation. The first was held in July.Click here for details and registration.
The proposed rules regarding compensation to exchange executives are flawed, as are the rules for listing of exchanges and restricting their profits, and the powers to SEBI to regulate market infrastructure institutions
Compensation for executives: The Bimal Jalan Committee report on ownership and governance of market infrastructure envisages that the key executives will not have any variable component in their remuneration. The report states that the remuneration should be determined after giving due regard to industry standards. If we go by industry standards, most of the corporate world has a fixed as well as a variable component. In fact, all high-paid executives do have a large variable component so that the burden of the salary on the organisation is not very high and some minimum performance and accountability is assured.
The National Stock Exchange (NSE) has a fixed remuneration package, whereas the Bombay Stock Exchange (BSE) has a fixed-cum-variable remuneration package. The reasons are obvious. The BSE top management team was hired at a time when it was necessary to get high-class performance to increase the BSE market share. The top management on the NSE on the other hand has grown with the organisation and though there were challenges, the pressures to revive a sagging exchange were different.
There is no reason given by the committee on why the variable component should not be there. Favouring a particular model indicates a bias, more so when the reasons of such recommendation are contrary to its own views on market salaries.
Listing of exchanges: The Jalan Committee has raised the issue of the conflict arising out of self-listing of shares. Instead of thinking of a solution, such as monitoring by the Securities and Exchange Board of India (SEBI) or a separate cell within the exchange to monitor listing norms, it has recommended that listing is not advisable. In a bizarre comparison, the Jalan Committee states that the share price of the exchange would impact the credibility of the exchange. I am sure that the buyers of Colgate toothpaste are least bothered about share prices of Colgate. Everybody who is connected with the stock market understands that the price of the stock has no connection with the credibility of an organisation, but it has more to do with the demand supply of shares in the short term and financial performance and thereby its credibility in the long term.
The government is pushing very hard to promote financial inclusion and make available the prosperity in the share market to all Indian citizens. A statement of this kind is very saddening. This implies a general impression that most companies in the country are vehicles of speculative investments. The committee does not address the issue of current shareholders of the stock exchanges whose exit route would be sealed by its recommendations, if these proposals are accepted. It was always envisaged that stock exchange shares would be listed and the BSE delayed filing of the prospectus following the setting up of this committee. The modalities of listing are necessary, rather than question the very idea of listing. The question is how and where to list and not whether to list.
Market infrastructure institutions (MIIs) to generate only reasonable profit: The Jalan Committee recommends that there should be a cap on profitability of the exchanges and other MIIs. Any profit earned over and above the prescribed return on net worth shall be transferred to the Investor Protection Fund (IPF) or Settlement Guarantee Fund (SGF), as the case may be.
The profitability of exchanges and clearing corporations are essentially from three sources: transaction charge, penalty collected from members, and income earned on treasury operations of the funds deposited by brokers as margins. Hence, pragmatically speaking, the Committee should have recommended payment of interest on the broker's funds and reduction in transaction charges. Transferring funds to IPF or SGF fund serves nobody's purpose since there have been no broker defaults in recent times and investor claims are hardly made to the IPF. In the absence of default, again the SGF fund is hardly used. Hence, there will only be further interest accumulation to these funds.
It would be more advisable to reduce the cost of transaction, which is in the interest of every investor. Our markets are also over-margined and due to general ignorance of the risk associated with the stock markets, exchanges have got away with excessive margining. There is a strong case to rationalise the margin structures. Reduction in transaction charges, payment of interest on margins and rationalisation of margins, will automatically cap the exchange profits.
Powers to SEBI in matters relating to MIIs: The Committee is of the view that SEBI should have the discretion to limit the number of MIIs operating in the market, in the interest of the market and in public interest. Instead of limiting the MIIs, it would be desirable to set up countrywide investor participation benchmarks and permit exchanges once the benchmarks are reached. For example, another depository can come up when the combined beneficial owners of the current depositories are say 5 crore. This would link the infrastructure to the demand in the economy. To sum up, instead of putting discretion with SEBI, it is desirable to have performance benchmarks so that basic principles of equity and democracy are prevailed upon. There should also be a provision to close MIIs by SEBI if they fail to reach minimum benchmarks in terms of membership, turnover, etc. This would ensure that price wars indulged in by new exchanges are not just entry strategies but a long-term strategy for survival is in place. Such a condition will in fact accentuate the price wars as there is a time limit to achieve the benchmarks! There is an opinion that every entity interested in setting up an exchange should be allowed to do so. Let the market forces decide whether the exchange should continue operations. Unfortunately, our markets lack depth in terms of the number of participants who use exchange services. Competing on price only leads to attracting speculators who are extremely cost conscious. Wastages in terms of computer systems, networks, office buildings, and so on, are evident in the regional exchanges. Interconnected Stock Exchange (ISE) was promoted by all regional exchanges to trade on the BSE and the NSE and then they directly became members of the BSE and the NSE through their subsidiaries. The infrastructure was wasted. Now ISE is trying to survive like any other broking house.
To conclude, all issues arising from demutualisation and regulation of MIIs should have been addressed before allowing stock exchanges to demutualise. Unfortunately, the Jalan Committee report is a non-starter and in fact, regressive in its ideas. It appears biased in favour of a particular exchange and does not address the problems. It is not bold in taking a stand that exchanges are utilities. Half-hearted attempts at restricting top management remuneration, a cap on income and not listing the shares is an attempt to give a colour of socialism to the stock exchanges. Socialism per se is not bad.
A bold stand is required to call the exchanges as public utilities and bring down the cost of transaction and spend money on the development and penetration of the capital market throughout the country.
(This is the second and concluding part of a critique by Deena Mehta on the Bimal Jalan Committee Report. In the first part, 'Jalan Report a damp squib - I', published on Monday, Mrs Mehta wrote that the shareholding proposals of the Committee for market infrastructure institutions are biased and not justified and that the report sidetracks corporate governance issues and the developmental role of stock exchanges. Deena Mehta is managing director of Asit C Mehta Investment Intermediates Ltd. She is one of the three trading member directors on the board of the Bombay Stock Exchange. To read the first part click http://www.moneylife.in/article/72/12497.html)
A look at the pros and cons of the Hero Honda split reveals more long-term negatives if at all; in the short term nothing much has changed. Surprisingly, the split does not seem to do much for Bajaj either
Hero Honda clarified yesterday that royalty payments to Honda will be about 3-5% of sales for new models and at the existing level of 2.5-3% for current products. The company believes that these payments (as a percentage of sales) will decrease as volumes increase, so they assume volumes will rise fast over the next three years or so.
A few days ago, the stock price crashed on talk that the royalty outgo would be 8%! The bad news is that Hero Honda (or do we say Hero?) will now have to pay ‘new model fees’ to Honda in addition to royalty. After it buys out Honda’s stake the Munjal family will own 52%, that is double from the current 26%. It seems clear from the nature of the split that while in the near term (2-3 years) it will have no impact on Hero Honda, longer term it is a slight negative. The split does not seem to work in favour of competitor Bajaj Auto either.
Market players are mostly underweight on the stock and they believe that the stupendous 18% rise in the stock price yesterday is a good opportunity to exit the stock.
• Not much change in the near term for Hero Honda since it continues to get technical support from Honda and gets to use the brand name till 2014.
• Zero royalty payments after 2014.
• Royalty payment will start falling sooner than expected (the management says as early as next month) if the company will develop more models itself.
• Higher exports, as the company can now export to locations where Honda has a presence
• Hero Honda has three years to develop its R&D capabilities—not a very long time, but enough to come up with decent models at least in the entry-level segment from where it gets 70% of its sales.
• Even if Honda reserves its good models for Honda Motorcycle & Scooter India (HMSI), its wholly-owned subsidiary, Hero’s old ‘Splendour’ and ‘Passion’ models constitute 70% of its sales; all new bikes in the last few years add up to only 8% of its sales—so this should not be a huge problem.
• Although Honda needs to provide new models to Hero Honda under the new agreement, there is a possibility it will reserve all the good ones for HMSI.
• Hero will have to pay new model fees, which could be hefty.
• R&D spend for Hero Honda will rise—Bajaj spends about 1.5% of sales and TVS about 2% on this. Although it is not impossible that HH may come up with good models, since it is getting three years to develop them, historical evidence shows it has not been easy. Bajaj had many failures after its split with Kawasaki—like Wind, Caliber, Discover 125CC, XCD 125CC. HH has indicated that it will pay about 1.5%.
• Exports may not rise as fast as expected because it takes time to understand local markets and to build supply chains. Additionally, they cannot use the Honda name for exports. Branding will be a challenge.
• Advertising and selling expenses are likely to shoot up after the split.
Implication for Bajaj Auto
• HMSI is likely to turn more aggressive in its plans—its models and network expansion. Its models compete more with Bajaj Auto’s products and this could erode Bajaj’s market share.
• Hero Honda, too, might turn a bit more aggressive in the next 2-3 years to assure its dealers, vendors, and employees and this again could be a negative for Bajaj Auto.
• Hero Honda will turn more aggressive in the exports market, again a business area that was Bajaj Auto’s domain so far.
In a conference call on 20th December, HH said it will have to create new capacities to meet the growing demand, and in addition to de-bottlenecking it may look at setting up a fourth plant which would entail capital expenditure.
The news of the split drove the stock price down to Rs1,560 on 15th December from a high of Rs2,062 on 30th November—a 24% fall in a fortnight. However, yesterday, the stock rose 18% in a single day and is back to around Rs 2,000.
According to CLSA’s valuations, Hero Honda trades at 13.6 times FY12 price-to-earnings, while Bajaj Auto trades at 14 times.
(This article is based on secondary research. The report is for information only. None of the stock information, data and company information presented herein constitutes a recommendation or solicitation of any offer to buy or sell any securities. Investors must do their own research and due diligence before acting on any security. Some of the opinions expressed in this article are the author’s own and may not necessarily represent those of Moneylife.)