In March 2022, the income tax (I-T) authorities had raised an issue of a possible excess booking of expenses to the tune of Rs800 crore in the case of Hero MotoCorp Ltd.
The audit report issued by the then auditor BSR & Co LLP for the year ended 31 March 2022 carried an emphasis of matter (EoM) about the said tax proceedings and the uncertainty regarding its implications in the financial statements until its conclusion. The company had affirmed in the board note that it was cooperating with the authorities to furnish the requisite information.
The statutory auditors changed due to the rotation required under the law and the new auditor, Deloitte Haskins Sells LLP, was appointed at the annual general meeting (AGM) held on 9 August 2022.
Interestingly, Deloitte issued its report on the unaudited results for the first quarter on 12 August 2022, within three days of its appointment as the auditor.
Since the present article is not for assessing the efficiency of the audit process, this astonishing achievement of completing a 'limited' review of a company, which had a turnover in the year ending (YE) 31 March 2023 of Rs34,158 crore, in less than 72 hours is left for other competent agencies to admire, or investigate if necessary!
The new auditor also followed the footsteps of the predecessor and continued the 'emphasis of matter' on the I-T investigations.
A news item on 16 June 2023 indicated that the department of company affairs (DCA) is considering a probe into the alleged relationship between the company and a third-party vendor involving the potential diversion of money. The company sources have mentioned that they are unaware of the matter.
Possibly the 'speed post' is awaiting delivery at the Gurugram post office.
It is not clear if the DCA investigation is an offshoot of the IT proceedings. The central board of direct taxes (CBDT) has, on 31 March 2022, supposedly shared the following with the media though not in the form of a formal press release.
"The CBDT issued a statement confirming the raids on the group along with a company operating chartered flights and a real estate group of Delhi-National capital region (NCR), covering more than 35 premises. "Incriminating documents and digital evidence have been found and seized indicating that the expenses ostensibly shown to have been claimed towards business purposes are not fully supported by evidence," it says.
Expenditure aggregating over Rs800 crore has been booked in the guise of purchase of services from a specific event management entity, it said, adding that the company has siphoned off the money by way of layering.
Isn't there enough in this to concern the independent directors, the audit committee and possibly the auditors?
A question may arise about why the tax investigation has not been finalised after the lapse of 15 months, as even at the conclusion of the search in March 2022, the authorities seemed to have a good fix on the issues involved.
With the technology at the disposal of the company to provide the data, and information at the command of the government, the complete silence over 15 months is inexplicable.
Why did DCA wait so long if the investigation it has planned is connected to the I-T proceedings?
But, as is well known, the government agencies have no obligation to answer any such question and, most likely, the resources of the departments were turned to other pressing regulatory retaliations that feature daily in the press.
However, in the time that has since lapsed, well over a year, there seems to have been no effort on the part of the board of the company, and especially the independent directors, to investigate these issues independently.
The I-T proceedings are not due to a legal issue of interpretation or a challenge to a known transaction that the authorities were seeking to re-characterise or questioning the admissibility of a claim or an incentive.
The allegations are quite serious and implicate the promoter, who is in the driver's seat and running the operations. Diversion of money by using entities that have business contracts is like siphoning money out for the personal benefit of the promoter.
In a listed company, having a large shareholder base with significant institutional holding, the board has a major fiduciary obligation and is not just the mouthpiece of the promoter. Irrespective of the investigation by the tax authorities, the board has an obligation to find out the facts.
It is quite possible that the tax authorities may do a shoddy investigation and the matter may be won in an appeal proceeding on technical or procedural grounds. That doesn't conclude the matter and an independent board cannot be guided by that outcome.
In the time that has elapsed since last March, the board should have initiated a forensic audit by a competent agency to assess the extent of the problem. Its failure to do so is most glaring.
Similarly, the new auditor has brought no fresh thinking to the matter and has followed the approach which the erstwhile auditor adopted.
The aspect of the diversion of money through related party transactions is a major worry for the conscientious independent director on any board especially where the promoter has an executive role in the business.
SEBI, recognising the scope for abuse, has tightened the disclosure requirements over time. The issues impacting the audit committee which has to approve the related-party transaction (RPT), are twofold.
The first is the situation where the related parties are identified. In this case, the fair market value of the goods and services involved in those transactions would need to be assessed. Reasonable professional expertise is available in this regard as the transfer pricing models used in the case of overseas transactions are a good basis to assess the transactions with domestic related parties as well.
The nightmare is where the parties are not properly identified or—worse—where the identity is camouflaged.
A genuine lapse is not to be ruled out as the definition of the related party is complicated and in large companies both the audit committee and the auditors rely on the confirmation provided by the management.
In cases where the management fails to identify the relationship, this may constitute a bona fide mistake. Nevertheless, the regulator will not spare the offenders when it is found out.
The most troublesome area is where the design is to deliberately suppress the relationship which is masked by keeping the shareholding below the 20% threshold and/ or using multiple layers (layering) as suspected in the Hero MotoCorp case.
These can be found only by a detailed forensic investigation. Under normal circumstances, an audit committee cannot seek a forensic audit as it would be seen as a very offensive step and, since all independent directors are only chosen based on the relationship with the promoter, this is ruled out.
But in a case like Hero MotoCorp, since a credible agency has raised doubts, the board's failure to seek a comprehensive forensic audit is a glaring one. There is really no value in having independent directors on a board if they function in the manner they have in this instance. The board has very eminent persons, including a former chairman and managing director (CMD) of the largest bank in the country.
Similarly, the new auditor sailing along with the management with just an EoM to cover its back is stark negligence.
Incidentally, in a case investigated by SEBI in an analogous matter concerning Bombay Dyeing Ltd, the audit committee members were also fined for the failure to consolidate the results of an entity whose shareholding was manipulated to be below the threshold to avoid consolidation.
In 2019, when Subhash Chandra, the promoter of both ZEE Entertainment and Essel Group, pledged some of the assets of ZEE for a loan taken by Essel with no intimation to the board of ZEE, two of the independent directors of ZEE quit and sent a complaint to SEBI. This represents the right response of independent directors in such situations and contrasts with the approach of the independent directors (IDs) of Hero MotoCorp.
To conclude, the meeting of the board of Hero MotoCorp to approve the audited results on 4 May 2023 took place in an unlikely location.
While they operate a plant in Chittoor, was the temple town of Tirupati chosen to seek divine immunity for all concerned?
(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.