DHFL and Reliance Capital Used the ‘Box System’ to Avoid Disclosure, says REDD Report
Moneylife Digital Team 08 June 2019
Over the past one year, the corporate world has been rocked by bankruptcies and huge liquidity crisis. This includes one of the country’s largest airline suspending operations, Rs10 lakh crore of bad loans, the disintegration of the Infrastructure Leasing & Financial Services (IL&FS) group and the Anil Ambani group and rapid demise of Dewan Housing and Finance Corp Ltd (DHFL). This had badly shaken the confidence in non-banking finance companies (NBFCs). How bad is the situation? A just released report by Risk Event-Driven and Distressed Intelligence (REDD) throws some light on the shenanigans of few very large NBFCs have been up to.
NBFCs & housing finance companies (HFCs) together constitute 19.20% of total credit extended by the Indian financial system. Typically, the NBFC sector services borrowers deemed too risky for commercial banks. However, there is an inherent flaw in the system; the NBFC sector gets majority of its funding from commercial banks and mutual funds. So something that was not doable directly by the banks, the same is being done through NBFCs as a vehicle.
(Source: REDD Report)
To add to inherent instability, what is of greater concern is the malpractices as highlighted in the case DHFL, wherein the company was accused of being a vehicle to divert funds. The company used a new structure called as ‘box companies’, says REDD, to evade reporting of funds given to related entities. Using, the box system these companies have found an alternative way to rollover or ever-greening of loans. This is how the Box system works-
1. Say X owns an NBFC XYZ and wants to source funds from it. But the NBFC cannot give funds to X without disclosing the same as a related party transaction.
2. So X promotes three other companies- A, B and C, each with a capital of Rs1 crore. Company A, B and C have Rs1 crore in capital and Rs1 crore in cash each and are owned by X; thus are the related party for the NBFC XYZ.
3. Now, Company A buys 50% of company B and 50% of company C from X. The same is repeated by company B and company C. The end result of this is that, all the 3 companies A, B and C are now owned by each other and X has no ownership of any of these companies and has received back his initial Rs3 crore invested.
4. The company A, B and C now have Rs1 crore of capital and Rs1 crore in investments each.
5.  Now company A, B and C approach the NBFC XYZ for a loan. XYZ does not have to report these loans as related party transactions, as none of these companies is owned by X. But, in reality the real beneficiary of these companies is still X.
6. This way X has extracted money from the NBFC XYZ without having the NBFC to report the same. 
7. Next time, when these loans falls due, another box of companies will be created to fund the companies A, B and C loan repayment; thus effectively rolling over the loans.
Take the case of DHFL, on which a report by Cobrapost highlighted how the company using the box system avoided reporting to the exchanges on the sale of a 9.97% stake in the company. The companies forming the box in this case were Hemisphere, Galaxy and Silicon. The three box companies owned 31.1 million shares in DHFL as of March 2018.
All through the year, they sold the stock, disposing four million shares by the end of June and by September; their holdings had come down by another 7.65 million shares and did not appear in the register by March 2019.
REDD points out that Reliance Capital and its two affiliates, Reliance Home Finance and Reliance Commercial Finance, have engaged in similar kind of funding through box companies. The report indicates that the amount of loan outstanding to these box companies totals around Rs137 billion. REDD also provides details of three box structures of the Reliance ADAG.
The report further points out that, apart from using the box structure for pulling out funds for themselves by the promoters, some NBFCs may be using the same structure to ever-green the loans of each other.
7 months ago
2 years ago
Can Anyone Please Explain the DHFL box structure(Graphic)?

Simply I understand that 3 companies collectively owned 9.97% of DHFL and had owned stakes in each other and then offloaded their investments to outsiders without DHFL having to report it as a stake sale.

What do the curved legend entries signify in the graphic?
(35.7% in Hemisphere,13.1% in galaxy and 28.7% in silicon)

Why don't the inter company stakes of the 3 companies along with their stakes in DHFL not add up to 100% as per the graphic?

Thanks in advance for any answers
2 years ago
Box System must STOP forthwith..SEBI & RBI must issue Guidelines to NBFC's to plug loopholes in the system..
2 years ago
Box or khoka companies came into their own in the years of huge PPP entities and more. Airport privatisation was just one example. https://www.moneylife.in/article/khoka-companiesempty-corporates-make-no-noise/22300.html
Replied to Veeresh comment 2 years ago
Let somebody google " top tax rates" in different countries. In UK -before Thatcher-it was 83%. In US, it was 94 % in 1944 , India it used to be 97.75% !!!! The thing is bad law devours good law. Honestly , how many individuals will be willing to pay 97.75% of the income ? Why not 100% , by the way ? So tax avoidance is encouraged and then it becomes more and more entrenched. Now US President is suspected of dodging taxes for decades !!! Make-believe laws are framed by some govt servants and then passed be venal politicians. When these absurd and often contradictory laws are enforced , they generate grotesque outcomes( think of narcotic laws). The same politicians spend trillions of dollar for wars in the name of "democracy", "national self interests" -US for example-and kill millions of people all over the world. Chanakya once invited a foreign dignitary to his house. The foreigner was astonished to see the powerful minister was living almost in a hut . When asked why, Chanakya replied when " when rulers live palaces, people become poor". Look at Donald Trump , Africa, yes India, etc. I am no way condoning the loot by people like mama-bhanja but let us not miss the other side of the coin.
Vijay Parekh
2 years ago
Well. This is a systemic failure. These are possible only and only when regularity authorities becomes hand and gloves. Audits etc is just a eyewash. Everyone is interested in giving funny suggestions and get fat fees. Why no action so far far big defaults by adag group. Nothing would change.
A good eye opener article.
Ajeya S
2 years ago
Good article, keep up the good work . . .
Mohan Krishnan
2 years ago
If you have investible surplus then invest in Govt Schemes, Sovereign Bonds or Bond Funds and Nifty or Sensex funds. This way you can cut out incompetent fund managers. But return of Capital with decent return will be assured.
However if you get caught by a broker you will be taken to the cleaners in the guise of higher return. You become your own enemy.
2 years ago
The naked truth that comes out is that with bad or corrupt promoters , investors have little chance. Regulations, regulators,auditors etc are of no use. Mostly, they are hand-in-glove. It is frightening that in IL&FS, DHFL ,..top MF, DII, FII HNIs, ...were involved and not only "rookie retail investors". In this, India is no exception, though the degree may vary in other countries. The losers are millions of sincere investors. Also corporate India . All of them are not bad. We have people like Premji of Wipro. On one hand savers are trying desperately to find return -at least-that can beat inflation . On the other hand ,good promoters are unable to get money from the market by bad sentiment created by companies like IL&FS, DHFL , ADAG group etc. Just think of the euphoria when ADAG floated Reliance Power IPO in Jan,2008. What did the investors get ?
Replied to SURAJIT SOM comment 2 years ago
In adequate control on corporate governance by regulators.
Replied to SURAJIT SOM comment 2 years ago
I have for a long time being saying that mutual funds are a systemic risk. Proved correct now.
Replied to SUDHAKAR OJHA comment 2 years ago
Can you suggest where a saver can put his money ? FD ? Or stop saving altogether ? Thar's what has happened in rich countries.
Replied to SURAJIT SOM comment 2 years ago
Equity funds are safer than debt funds. Equity is safety than equity funds but we need to know how to select and give long time. So nothing is totally Safe.
Replied to SUDHAKAR OJHA comment 2 years ago
Sorry for typos.
I was saved by adhering strictly to MoneyLife Advisories.
Replied to SURAJIT SOM comment 2 years ago
O was saved strictly sticking to Advisory from Monochrome foundation
2 years ago
With aforesight and intent ! No thought on creditworthiness of the new box cos that have no business !
2 years ago
Good explanation. But could not understand the holes in our accounting policies / laws / auditors role. In any case X owns all three box companies even though indirect one which can be easily understood by looking at share holding pattern of these companies so what does auditors varify during internal / statutaory audits? And why does our company law / corporate laws allow such manipulation?

I believe money life should take some initiative to find out the cause for such manipulation and role of involved agencies. You people are voice of minority investors, so please do something for robust financial reporting and audit standard.

Savitha KL
2 years ago
Why SEBI does not unearth this, why market regulators sleep
2 years ago
Excellent Article! Could you clarify whether DHFL lent any money to any promoter entities? That was part of Cobrapost's allegations but was denied vehemently by the company and the independent audit report.
Subhash Chand Garg
2 years ago
This is the actual modus operandi of all private sector companies hailed by media for solutions of all the problems of India
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