IL&FS Top Management: Planned Enrichment through Employee Trust; Jobs and Contracts for Families
UPDATED on 15 October 2018 at 6.50pm to add more information from REDD Intelligence
While all eyes are on the tottering behemoth Infrastructure Leasing & Financial Services (IL&FS) and its hundreds of hydra-headed subsidiaries, more and more details are coming out of the ingenious and crafty devices by which a handful of senior managers had arranged to give themselves hundreds of crores of rupees in perks and windfall gains and got contracts and employment for their relatives.
One such device is the Employee Welfare Trust (EWT), which holds a 12% stake in IL&FS, making it the fourth largest shareholder of the unlisted entity.
At its peak, this small group of privileged managers running the IL&FS group had lined up a massive pay-off through their holding in the IL&FS EWT. Calculated at its peak reported valuation in 2010, says GD Agarwal of REDD Intelligence, a boutique market intelligence agency, the windfall would have amounted to over Rs1,650 crore.
This valuation would have only increased significantly, given that the group grew exponentially, if recklessly, over the next eight years. But the game is over now and so is this planned bonanza.
On digging through mountains of documents, Mr Agarwal found out that, apart from a 12% stake in the holding company, EWT also had a stake in its power and finance subsidiaries. It held a significant 9% stake in IL&FS Securities. Here are some details:
In 2006, there was a preferential allotment to the EWT of 53 lakh shares at Rs91 each. In June 2006, IL&FS also signed an agreement to sell the shares to ADAI (Abu Dhabi Investment Authority) at Rs275, compounded at 17%pa (per annum). More about this later.
In July 2010, The Mint reported that the EWT’s 12% stake was valued at Rs16.5 billion (or Rs1,650 crore/$222.3 million). The report said, IL&FS “was close to signing a share sale agreement with investors to raise around $400 million (Rs1,892 crore) by selling an 8% stake at Rs1,099 a share.”
It went on to say that “some of the shares to be sold will come from employees, who will get more than a 10-fold return on the investment made in 2000.”Apparently, there were other placements in between and even employees who had bought the shares at Rs100 each were going to be able to offload them at Rs275. The Mint report said, “Money from the sale of shares from the welfare trust, estimated to be around $20 million, will be distributed to employees.”
When asked by The Mint, a company spokesperson was defensive about this potential ‘windfall’ and had argued that, unlike technology company executives, who got stock options, “We sell a portion of the stake in the employee trust to reward employees.” There is very little information in the public domain about this trust.
The red herring prospectus (RHP) of IL&FS Transportation Network Ltd, (ITNL) in March 2010, revealed that the EWT was allotted 15 million shares at Rs10 each on 29 September 2006. In less than three years, it sold 4.13 million shares to Bessemer India Capital Holdings II for Rs242 per share. In effect, just Rs15 crore invested in September 2006 had turned into a massive profit of Rs 363 crore in under three years, Mr Agarwal points out.
What is intriguing here is that the share allotment was not to ITNL’s employees but to the EWT of IL&FS, an unlisted holding company which has just 134 permanent employees. More importantly, data from elsewhere suggest that there are only 10 major beneficiaries of the trust, who could be the cabal close to Ravi Parthasarathy; but the details are not known.
The share sale agreement with ADIA on page 6 of the RHP defines ‘Specified Beneficiaries’ as follows: (It) means the 10 (ten) beneficiaries who will receive the greatest number or numbers of Section 62 shares and/or the additional shares upon distribution of the Section 62 shares and/or the additional shares by the EWT.”
This document also notes that the ‘Strike Price’ for sale of shares by the EWT and or specified beneficiaries shall be the aggregate of (i) Rs275 per share and (ii) a rate of return of 17% on the said Rs275 per share compounded annually on a pro rata basis from the completion date.”
Preferential allotment to IL&FS employee trust
Extraordinarily, a former employee of IL&FS insists that all employees of the group were part of the EWT. However, none of them, including those at senior levels in the company, had any knowledge of about the allocation of shares to each employee or how they were valued. He is also emphatic that the clause about 10 Specified Beneficiaries in the document referred to above was to protect ADIA’s interest.
This is borne out by a paragraph which says: “EWT shall not and it shall ensure that the Specified Beneficiaries shall not, participate in any structuring designed primarily to avoid or in any manner vitiate the rights of ADIA and/or the Affiliate Shareholders as contained in Article 208”.
It goes on to say that EWT “shall not transfer or distribute the legal or Beneficial Ownership of or interest in any equity shares to any Specified Beneficiaries” unless they have “first entered into a direct covenant in favour of ADIA” and agree to be bound by the rights of ADIA contained in the article above.
Since there is no information about how EWT or its trustees and IL&FS has not been answering media queries, we have no way of verifying any of this.
While we, in the media, have been focused on the fat salary of Rs26.3 crore that Mr Parthasarathy snagged in FY17-18, even as his 30-year ship was sinking, this pales into insignificance compared with the potential payoff that management and select employees would have received through the EWT. Now that IL&FS has run out of borrowing options and collapsed due to the massive asset-liability mismatch, the value of these shares would be meagre.
An international investor, who has had some rough dealings with an IL&FS group company, says that the functioning of the EWT and how it is controlled “is a fit case for piercing the corporate veil.” He recalls that IL&FS chairman Ravi Parthasarathy used to “push relentlessly for the EWT to have a stake in the most attractive subsidiaries. While some large shareholders resisted, others gave in.”
He calls it a “Faustian bargain stuck with the shareholders: you give shares as sweat equity to EWT; in return, I’m incentivized to pay dividends (even via borrowings) to all shareholders regardless of whether the company doing well or not.”
Given the personal incentives involved through the EWT, it is no wonder that IL&FS kept paying dividends even when the ship was tilting.
The board, led by Uday Kotak, which is meeting today, and the Serious Frauds Investigation Office (SFIO) need to investigate EWT and its activities.
More Vehicles for Personal Enrichment
Another important finding, through those who have dealt with IL&FS companies, is that the EWT and salaries were not the only vehicle for personal enrichment of top executives and favoured employees. We have details, so far, of at least four of the top 10 executives at IL&FS having employed their children or sons-in-law in lucrative positions within the group with better than normal salaries and benefits.
Ravi Parthasarathy’s daughter, Rhea Parthasarathy, is employed at IL&FS. Her salary is listed in the FY16-17 annual report. There is no disclosure in the latest report, although sources say she continues to work there. But this is the least significant.
The son-in-law of K Ramachand is employed by the group at Dubai. Contracts to handle the interiors of the IL&FS building, running into crores of rupees, were handled by Mr Ramchand’s wife. There is now a lookout notice against him. Similarly, another top executive’s son runs a construction business that works for IL&FS. The extraction of value from cars purchased for the company’s car-pool is another story that is known to all key employees but will have to be examined by the SFIO.
Informed sources also say that the lavish expenses, including luxury holidays for families, were organised and paid through foreign subsidiaries, including the one in Spain.
A letter from an insider speaks of the extravagant salaries and performance benefits paid out to former secretaries, promoted to head administration, but who seem to be rewarded more for the personal work done for senior managers.
What makes the analysis of the sordid state of IL&FS’s finances difficult is that disclosures are poor and, probably, falsified as well—although auditors across the group pocketed large fees.
The newly appointed IL&FS board held its second meeting last week. Hopefully, the board can throw light on how it plans to deal the crisis. IL&FS has a hole of almost Rs30,000 crore in its balance sheet. Will it still attempt a bailout and postpone the problem, or will it manage to find buyers for the many viable subsidiaries, even if it is with a haircut?
Those who are watching the situation would like to see whether Mr Kotak, who headed a corporate governance committee last year appointed by the market regulator, manages to fix any personal accountability. After all, the IL&FS mess was caused by the top management, which ran the group as its personal fief.
In a detailed analysis released on 15th October, REDD Intelligence has put out a more detailed analysis of the operations of IL&FS Employee Welfare Trust.
We are reproducing it in full:
IL&FS has 130 employees as per the FY2018 annual report, and looking at the holdings of IL&FS Employee Welfare Trust (IL&FS EWT), an investment vehicle for employees, each member should be at least a millionaire.
The total value of its holdings in four IL&FS companies was an estimated Rs25.8 billion ($350 million). The latest addition is an unknown stake in Earth Environment Management Services Ltd after an Rs1.88 billion ($25.5 million) loan write off by IL&FS Financial Services Ltd.
IL&FS EWT owned 17.8 million shares (including 2.5 million shares it monetized) in IL&FS, as per company filings. These shares at the last rights offer price in September 2014 of Rs750 per share were worth Rs13.35 billion ($181 million; rights offers are generally at a discount to market value). If one were to use the Rs1,099 per share that Bay Capital paid to buy IL&FS shares as per a July 2010 Mint report, then the value of these holding was Rs19.56 billion ($265.2 million).
It is estimated that IL&FS EWT sold 2.5 million shares between September 2009 and March 2012 according to company filings. HDFC Bank also sold 1.62 million of 14.05 million shares it held in IL&FS in FY2011. These sales may be the last successful monetization of stakes in IL&FS before the company's fall from grace.
IL&FS EWT also entered into a share purchase agreement in June 2006 to sell shares to Abu Dhabi Investment Authority (ADIA) at Rs275 per share. Despite the deal, it is surprising the board approved the issuance of 5.4 million shares to the IL&FS EWT at Rs85 per share, a price that was even lower than the share issuance price of Rs90 per share 18 years ago.
The 5.4 million share issue looks like a sweet deal for IL&FS EWT given that IL&FS issued 19.6 million shares in September 1994 at Rs90 per share and another 18.8 million shares in December 2001 at Rs60 per share. About 10.3 million shares under a rights issue were also issued in September 2014 at Rs750 per share.
Another interesting deal involves IL&FS Transportation (ITNL). IL&FS EWT subscribed 15 million shares of IL&FS Transportation at Rs10 per share on 29 September 2006, the same day it allotted 76 million shares to parent IL&FS at Rs45 per share. Just three months later it issued 4.16 million shares to Trinity Capital at Rs100 per share.
Within three years, IL&FS EWT sold 4.3 million shares in ITNL to Bessemer's India Fund for Rs242 per share, a whopping 24.2 times gain.
With IL&FS EWT the beneficiary of what seem to be favorable deals, the immediate question is how many beneficiaries are there at IL&FS EWT? Are they the 130 employees of IL&FS parent or does it also include employees from subsidiaries?
The share purchase agreement for the June 2006 deal between IL&FS EWT and ADIA referred to 10 specified beneficiaries, as per the share purchase agreement. However, in the absence of other information about IL&FS EWT, it is difficult to come to any solid conclusions, just more questions.
(This article has been updated with additional information)