This should rank as the foremost financial fraud in free India!
It required no circumlocution of the globe, to traverse Bermuda and like destinations. At best, it happened within a single PIN (postal index number) code!
It was a company not promoted by any entrepreneur with a fake goods and services tax (GST) registration traceable with difficulty to Chandni Chowk, but by a few of the most exalted financial institutions in the country, initially, like HDFC, UTI and Central Bank of India with a leading Japanese corporation in tow; later, Life Insurance Corporation of India (LIC) and State Bank of India (SBI) took a larger stake.
Its board of directors boasted the who’s who of corporate India, like RC Bhargava, Keki Mistry, Sunil B Mathur, Michael Pinto and Jaithirth Rao, just for a sample!
It was helmed by a high-decibel trio of professional experts with roots in IIM(A) and premier institutions!
And to top it all, it had the Indian affiliate of the top global audit firms to check its accounts and carried as a badge a triple-A rating by all the rating agencies in the country!
It is important to keep alive the memory of this grand scandal in the mind of the general public even should the likes of Hindenburg conspire to intrude that space!
Ideally, the case study of Infrastructure Leasing & Financial Services Limited (IL&FS) should form part of the NCERT high school syllabus for accounts and commerce!
The overall texture of the IL&FS fraud is generally well understood.
Artful manipulation of the financial statements. Window dressing the numbers to impress the credit rating agencies and the banks. Managerial misdemeanor of fattening their pockets. A possible collusion of the auditors, a credit rating system which was on auction, together with a complete regulatory failure to monitor.
The current status of the actions initiated by the different agencies against the perpetrators of this scandal is not clear. Nor the fact if any worthwhile headway has been made to convict some or all of them.
However, the taxonomy of the scale of the scandal has emerged more clearly since the completion of the restatement of the financial statements of the entities involved.
It is a massive but necessary exercise to get a professional agency to rework the accounts and have a qualified audit firm to audit the numbers afresh and highlight the extent of misstatement in the financial statements.
This exercise also exposes the serious laches and lacuna in the original audit carried out by the firms engaged in the past.
The discrepancy in the numbers unearthed in the process of the restatement reveals a more clinical picture of the extent of the financial misstatement in the original accounts.
The restatement has been carried out for five financial years; year ended March 2014 onwards up to the year ended March 2018.
The scandal surfaced sometime in September 2018.
The gamut of the work done and the information gathered in the restatement exercise is enormous and deep and no less than a seasoned accounting or auditing expert is required to fully unveil the details.
The attempt here is merely to encapsulate a few patent issues for the benefit of common readers.
The data is tabulated for two entities, IL&FS, the ultimate parent, and one of its key subsidiaries IL&FS Financial Services Ltd (IFIN).
The profit before tax (PBT) in the original audited accounts and the one reworked post the recent exercise is reproduced as it is. The difference between the two represents the extent of the misstatement in the originally audited numbers.
The table below pertains to the stand-alone IL&FS, parent entity, and shows the discrepancy year-wise of the pre-tax profits, as originally reported and after the restatement.
While the restatement has many components due to adjustment for provisions not made for bad loans, income recognition issues and a fictitious asset sale, an item that needs to be specifically highlighted is with regard to the recognition of income from consultancy in FY13-14.
FY13-14 is the first year of restatement and one of the findings in the fresh audit is the overstatement of the consultancy income. The original accounts showed an amount of Rs328 crore and this was revised to Rs12 crore in the restatement.
This aspect is perhaps the essence of what had gone wrong in the original audit of the entity.
It is reasonable to infer that the management was under pressure to show profits and had cooked up this figure.
The income from consultancy in the year preceding (FY12-13) was negligible. This in itself should have been a red flag to dig deep.
Secondly, the income as recognised was not from any of the subsidiaries or associates. IL&FS mainly survives on income from its cluster, like brand fees, service fees, interest on loans, etc.
A third-party income of a substantial quantum and, all of a sudden, where historically none such existed, is something that even a greenhorn CA article clerk is told to investigate!
Another such fake amount for consultancy fee was set up in year ending (YE) March 2015 for a sum of Rs199.86 crore which, on restatement, was revised to Rs7.6 crore.
There is enough reason to believe that the standard audit procedures were not done.
In FY17-18, SRBC & Co LLP, a member of EY took over the audit. It appears that no correction was made to the past issue of cooked-up income.
It is not clear if the amount was shown as recovered from the party concerned by any dubious way, or even that was not done and the debtor balance was living large!
However, if the concerned audit firms believe that the above interpretation is incorrect, they may clarify the correct position. Based on the evidence available, the current takeaway of fraud on this score is inescapable.
There could be some curiosity among accounting professionals reading this article as to what the restatement reconciliation actually is. It is not convenient to put out the details for all the years.
As a sample, the summary for 2017-18 is extracted below.
The summary for IFIN on the restatement is as below.
Another interesting fact emerging from the restated accounts is the way the two companies were lending to defaulting parties to clear the over-dues so that both the income recognition issue and the provisioning for bad loans, as per RBI norms, are bypassed.
The table below gives the year-wise lending in violation of the norms by both IL&FS and IFIN.
This, again, reflects directly on the audit quality. The most elementary issue in auditing a non-banking financial company (NBFC) is to check this fact as this is a fundamental requirement of Reserve Bank of India (RBI).
It is a different matter that RBI itself failed to identify this in its inspections!
In all of this cooking the books, the direct beneficiaries were the top management in getting an outsized remuneration.
The figures for the three musketeers—the twins who were the mastermind behind the show and the circus, Ravi Parthasarathy (1952-2022) and Hari Sankaran, together with the abetting accomplice, Arun Saha—are shown in the table below.
In FY13-14, when it appears the accounts were doctored for the first time (or detected so), as already discussed in detail, IL&FS issued three tranches of preference shares, mopping up Rs769 crore initially and another about Rs230 crore subsequently.
The instrument was structured with a face value of Rs7,500 and a premium of Rs5,000, each. Preference shares at a premium was a clever innovation to boost the net worth with securities premium being credited which raised the book value of the equity shares!
Losing little time, a rights issue for the equity shares was made, with Rs10 par value, being issued at a premium of Rs740 each!
The preference shares commanded a coupon of 16.38% and 16.06% which, at that time, entitled the holders to a tax-free dividend!
The small catch was that the coupon was applicable on the face value of Rs7,500 and not on the premium paid of Rs5,000!
It was an issue that was lapped up like hot cakes given the excellent yield for a triple-A-rated company, with an MNC auditor to boot!
Based on the data now available in the restated accounts, a large part of the shares was taken up by top corporates like L&T, Shree Cement, Wipro, and HDFC Asset Management and high-networth individuals (HNIs) like Azim Premji.
These preference shares were actively marketed by private banks like HDFC Bank, Deutsche Bank and ICICI Bank to their clients.
The redemption dates of these preference shares are long gone. The IL&FS group in the best-case scenario may only repay a part of its secured loans to banks.
It is obvious that many investors are still stuck with the shares (they were little traded once the scam erupted) with uncertainty on how and when to claim a capital loss!
They can certainly consider a class action suit on the auditors and the directors for the loss occasioned to them due to the financial shenanigans. The case becomes stronger with the restated accounts showing the extent of conscious manipulation.
Just as the directors were amply paid as shown earlier, the auditors too were, as given in the tables below. They should have enough wherewithal to meet any liability!
Perish the thought, if the audit fees increased in tandem with the level of misstatement!
(
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.)