Why are investors of DLF and FT asked to pay the price for their promoters’ behaviour?

On 10th October, the Securities & Exchange Board of India (SEBI) closed a very reluctant, seven-year investigation into dubious disclosures by DLF Limited by barring the company, its chairman KP Singh and key directors from the capital market for three years.

When the news hit the market, the stock crashed 28%. It was the biggest fall since its second listing in 2007. Some Rs7,500 crore of market-capitalisation vanished in a day as the shares, which were offered at Rs525, in a highly controversial and hyped up initial public offering (IPO), dropped to just over Rs100.

But, in contrast to its action against the Sahara group, SEBI has not covered itself in glory this time. If anything, the buck for DLF’s dubious disclosures should stop at the regulator and not the small investor.

The action against DLF, and similar such actions, highlights a basic flaw about SEBI’s penal action: Why is the retail investor constantly punished when regulators, investment bankers, auditors and companies fail to act? But SEBI is not alone in this. The ministry of corporate affairs (MCA), on 22nd October, in a similarly bizarre order, has hit the investors of Financial Technologies (FT) by ordering a forced merger of the National Spot Exchange Limited (NSEL).

This, again, is a regulatory failure. There is no investigation into why the ministry of consumer affairs granted an investigation to permit NSEL and another spot exchange promoted by the NCDEX to be set up in the first place. The FT stock crashed over 20% after the draft order was issued.

Would someone explain how FT’s retail investors are any less the victims than NSEL’s investors? Equity investment is about informed risk-taking, not a gamble. But why are minority shareholders in India being made the victims of lack of clarity on the part of regulators? Punish the promoters of DLF and FT by all means; but why destroy companies and their minority investors for regulatory failure, or promoters’ mischief and regulators’ laxity?

SEBI’s action against DLF seems more like a headline grabbing antic aimed at pleasing a new government that may not be so cordially disposed towards the company. In the process, it has also hit bankers who need to recover nearly Rs20,000 crore from DLF.

Predictably, DLF has appealed the order and the huge expenses incurred on exhausting all its legal remedies will also be borne by the company’s shareholders.

Let’s take a quick look at the DLF case:

€ SEBI permitted DLF to re-list through an IPO, in 2007, without going into the details of a complaint filed by one KK Sinha who had land dealings with the company.

€ SEBI, probably, thought DLF would be smart enough to take care of Mr Sinha’s issues.

But remember, the same DLF, which had previously de-listed its shares in a hurry in 2003, had gone to great lengths to ditch minority shareholders who had held on to their stocks (there were only 1,100 investors and DLF eventually had to provide benefits to 25O-odd). Despite their stupendous personal wealth, DLF’s promoters showed the same arrogance and callousness in dealing with Mr Sinha whose dogged fight has ultimately forced SEBI to act.

€ A similar attitude probably led to the Competition Commission of India imposing a fine of Rs630 crore on DLF for abusing its dominant position to hurt a set of apartment owners at Gurgaon. If anything, DLF’s attitude to its minority investors of 2003, its Gurgaon flat-owners and Mr Sinha raises serious questions about the quality of independent directors and legal advisors that this company has appointed.

€ KK Sinha had a claim of Rs31.09 crore against Sudipti Estates (over development of land), a subsidiary of DLF, in May 2006, when its first red herring prospectus was filed.

Immediately thereafter, a series of legal contortions and transfers of ownership of shares occurred and, when DLF filed a fresh prospectus in 2007, Sudipti Estates was no longer shown as a subsidiary. But Mr Sinha refused to be brushed off. He conducted his own investigation, filed a first information report and, eventually, moved court to show that the de-subsidiarisation was a sham and the shares were transferred to the wives of key management personnel.

€ Were investment bankers involved in the scheme? Kotak Mahindra was one of the lead managers. Its associate, Kotak Bank, provided loans to the three housewives (married to DLF’s managers) to buy the shares of Sudipti Estates to create the fiction of an independent company.

€ Given that DLF’s splashy re-listing at the peak of the global financial market mania was touted to create the most valuable company in India, wouldn’t you expect its legal advisors and investment bankers to advise the company to settle Mr Sinha’s dispute? Such was DLF’s arrogance that the same petty games that it played to shake off 1,100 retail investors who had clung to their shares after the 2003 delisting, was in evidence in the Sinha case.

€ But Mr Sinha wasn’t going away. He moved court against SEBI’s ‘deliberate inaction’. The regulator still did not act. It dragged its feet, obfuscated and argued that Mr Sinha, who was not an investor, had no locus standi on the matter. SEBI’s excuses for not investigating the details provided by Mr Sinha were that Sudipta Estates was an unlisted company and that DLF’s promoters had denied his allegations.

€ Embarrassingly, the Delhi High Court had to point out to SEBI that its stand on action against unlisted companies was exactly opposed to the Sahara twin companies’ case. It ordered the regulator to investigate and also pulled it up for dragging its feet. None of this made much of a difference as long as a Congress-led government was in power and reports about Robert Vadra’s land deals made headlines.

€ After a BJP-led government came to power, SEBI’s actions picked up speed and we have a half-baked order in less than four months. Several other complaints against companies perceived to be very close to the previous government are similarly being dusted down.

SEBI can get away with this, because, as Moneylife has repeatedly pointed out, the rules of disclosure and transparency that it mandates on companies do not apply to its own actions.

Why did SEBI not act against the investment bankers, Kotak Mahindra, who certify that the disclosures in the prospectus are true, fair and adequate? In this case, the involvement of the investment bankers is evident. Is it because SEBI officials know that the pressure to delay action against the realty giant had nothing to do with the investment banking community and was entirely about the promoter’s clout?

We know that too; but, by ignoring the statutory role of investment bankers, it encourages them to collude with dubious management and makes a mockery of the checks & balances built into the regulatory processes. Only if they are forced to pay a price, will investment bankers take their job seriously, instead of bleating about being guided by lawyers and audit firms.

Our capital market operates in a system where the regulator is not accountable for its acts and omissions, but has managed to convince policy-makers to empower it with draconian powers without a reciprocal obligation to issue fair orders, in a reasonable time.

In a DLF-like situation, the corrective action would be a monetary penalty against the promoters and ring-fencing the company from their actions. Even in the Financial Technologies case, retail investors will be punished for the actions of its promoters. This allows the losses to be distributed and the legal fees paid by the corporate entities while the management continues to enjoy unlimited power and perks accrued through listing.

Far from instilling confidence in the regulatory system, such flawed, delayed and capricious actions will only keep investors away from the capital market.

(Sucheta Dalal is the managing editor of Moneylife. She was awarded the Padma Shri in 2006 for her outstanding contribution to journalism. She can be reached at [email protected])