If anyone has forgotten the way the game ‘passing the parcel’ is played, easy guidance can be obtained from the recent order of Ashwani Bhatia, whole-time member (WTM) of the Securities and Exchange Board of India (SEBI) in the matter of one of the major corporate scandals of recent years, when a promoter confessed to serious wrongdoing and sadly committed suicide.
SEBI’s credibility has come under much scrutiny recently when the highest court set up a committee to look into matters relating to the securities market which silently sidelined the regulator from its premier role. The order referred to the above, where the agency, instead of making a full investigation of how the money was swindled and identifying the end use, passed the buck to the very company under investigation to use the office of a law firm to recover it, and directed National Stock Exchange (NSE) to oversee the exercise!
Café Coffee Day lost its much-touted aroma and acquired a great deal of stink when its promoter and chief executive officer (CEO), VG Siddharth’s suicide note surfaced sometime in the last week of July 2019. The subsequent investigations undertaken by the company exposed significant diversion of funds by the promoter from a web of subsidiaries to the promoter’s family members and entities controlled by them.
As per the said note, the promoter took the entire responsibility for all the misdemeanours—though with no other detail spelt out.
Coffee Day Enterprises Ltd (CDEL), the listed parent, had nearly 50 subsidiaries and was involved in an array of activities, though its coffee outlets were the popular face to the lady on the street.
SEBI has recently concluded its proceedings initiated to penalise the company for the non-compliance with the applicable legal provisions and for inflicting huge losses on the investors due to the precipitous drop in the share price post the discovery of the fraud.
The facts fall in a narrow compass as the diversion of the funds by the promoter is quite stark and has happened apparently within a short time frame. The forensic audit report was the basis to appreciate the modus operandi, which was quite straightforward.
The deceased promoter had, unknown to anyone within or outside the company, transferred the funds to a privately-owned related party which was almost entirely held by the family members. The amount so diverted, which was ultimately siphoned out by the promoters in multifarious modes, totalled Rs3,535 crore.
The method was sans any complexity that typically surrounds fraud. A fraud is where the perpetrator creates subterfuges and a sophisticated cover to steal. This case is like a child dipping its hands into a cookie jar to empty its contents!
It is not clear what held up the SEBI investigation in this matter for almost two years as its show-cause notice was issued in early 2021; the fraud had taken place and was known another two years earlier.
A perusal of the information available on the company website (the latest being the 2018 full annual report) discloses that the auditor of the holding company audited a very small part of the overall consolidated assets and the revenue, and significantly relied on the work done by the other auditors.
The names of the other auditors who audited the subsidiaries seem relatively less known.
Even as of the close of the financial year 2018, there were tell-tale signs of questionable transactions. The company (along with the subsidiaries) had significant borrowings and yet showed a large amount of cash in the bank (and cash equivalents). This should give room for doubts about why a company borrowed money at high interest rates and kept huge balances that secured little return.
There were major amounts outstanding as advances paid to related parties with whom there existed few normal business transactions. If not these, at least the significant advances to some related parties for the purchase of land should have set the alarm bells ringing in the audit committee. It is not evident whether the auditor of the holding company at that time, BSR & Co, which is one of the four big firms, asked probing questions on these.
Apparently, nobody suspected the purity of the coffee and that of the financial statements till the promoter left behind the confessional note!
Though the entire fraud and diversion of funds was caused by an individual in authority, the company and the rest of the apparatus become liable for the illegal transactions carried out and rightly penalised by SEBI, though how the penalty amounts would be recovered from a sunken ship is anybody’s guess.
But the strange part of the SEBI order is the direction as contained in the portion extracted below to help due appreciation of the same
“a) The noticee shall take all necessary steps for recovery of entire dues from Mysore Amalgamated Coffee Estates Ltd (MACEL) and its related entities, along with due interest, that are outstanding to the subsidiaries of the noticee.
(b) The noticee, in consultation with the NSE, shall appoint an independent law firm, of standing and repute, to take effective steps for recovery of the outstanding dues, as directed in sub-para (a) above, within 60 days of this order. The law firm, so appointed, shall act independent of the Board of CDEL for this matter, under the oversight of the NSE, on behalf of the noticee and its subsidiaries.
(c) The noticee, its board and its subsidiaries shall extend all necessary assistance and authorization to the law firm, appointed in terms of direction at sub-para (b), as directed above. The valid expenses incurred by the law firm in discharge of its obligations shall be borne by the noticee.
(d) The law firm so appointed under sub-para (b) above shall file a quarterly report with NSE/ CDEL Board, detailing the progress in the recovery process.
(e) The noticee shall place in every annual general meeting an updated detailed report on the recovery process undertaken by the noticee and its subsidiaries, as submitted by the law firm appointed in terms of direction at sub-para (b) above, for the information of its shareholders.
(f) The tenure of the law firm appointed in terms of sub-para (b) above shall be until the lapse of three months from the date of conclusion of three annual general meetings of CDEL, held after passing of this order or till the dues are recovered, whichever is earlier. If the dues still remain to be recovered at the time of conclusion of three annual general meetings, the shareholders of CDEL shall decide the appropriate way forward, including whether the management should continue to run the company.”
For the sake of clarity, the term notice/CDEL above refers to the holding company against which the proceedings were initiated; and MACEL is the promoter company that was used to siphon out the funds.
The role of SEBI in investigating frauds that result in loss to investors is beyond question and equally, its remit to ban such perpetrators from the capital markets and to levy a fine.
The most baffling part of the order is the above directions for monitoring the recovery of the money siphoned out. SEBI, with all its powers and with the time it had to investigate, did not find out who finally took the money away and what use it was put to. That would have been the most important leg of this investigation as all the rest was anyway obvious. Much firepower of SEBI was expended in analysing whether a particular subsidiary was a material one or not.
SEBI’s exercise is one of utter futility and has obfuscated the real crime. The issue of why a particular party was not categorised as a related party and how such transactions were incorrectly represented is the least of the issue that a high-power regulator should spend years on. The primary question is how the Rs3,515 crore siphoned was deployed finally, and why the auditors and the directors failed to ask the right questions.
The group, through various entities, had borrowed heavily from some of the top institutions like banks and mutual funds, who strangely lent the money to the subsidiaries and not to the main listed company. The holding company board seems to have been completely oblivious to what went on in the subsidiaries.
The overall debt in the 2018 books was about Rs6,000 crore. The company sold its holding in Mindtree during March-April 2019 and must have received about Rs3,000 crore as sale proceeds. Since all the shares were under pledge, the lenders would have taken out the entire cash. The Rs3,515 crore that was siphoned out between April and March 2019 must have possibly come out of borrowings.
The strangest component of the SEBI direction is the burden placed on NSE to monitor the recovery of the money siphoned out. What has a stock exchange, which is an independent entity with little expertise in investigative and policing roles, to involve itself in this type of fraud?
NSE, which prima facie has no role beyond operating an efficient stock exchange and making sure its own governance is good, is not an extended arm of SEBI to be foisted with such responsibilities. Will the next such case be allotted to the BSE?
How many such cases can be monitored by NSE? Should SEBI believe it is the best option to trace fraudulently done transactions? Why weren’t the dozens of illustrious predecessors in mega frauds, like DHFL, tested earlier in this experiment?
What would a law firm, however elite its status, be able to contribute to recovering diverted funds? How many have such proven credentials? Looks like a pie-in-the-sky idea which has been invented to fake SEBI’s concern for the investors!
Looks like SEBI, by its own actions, will diminish its role and relevance and lend justification to the salience of court-appointed committees to monitor its performance in investor protection!
(Ranganathan V is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies.)