The Financial Bomb Is Ticking Away
The failure of the credit rating agencies to blow the whistle in the Rs90,000 crore Infrastructure Leasing & Financial Services (IL&FS) scam,  business as usual despite 55 prosecutions filed by the ministry of corporate affairs (MCA)  against Pricewaterhousecoopers (PwC) auditors, the STC/ Ispat scam – all these once again,  not only expose the  rampant corruption and  the blatant complicity of the regulators,  but also deliver a frightening message:  a huge financial bomb can explode any moment. 
Last month, credit rating agency ICRA Ltd, the local affiliate of Moody’s Investors Service, sent its managing director and chief executive Naresh Takkar on leave pending an enquiry into “anonymous" allegations against them by an executive. The complaint had been forwarded to the Securities and Exchange Board of India (SEBI).
The complainant had alleged that ICRA’s top brass had meddled in assigning high ratings to IL&FS and its subsidiaries. As is well known, since last September IL&FS has defaulted on its debt payments, triggering a liquidity crisis in the financial services market.  
Takkar was soon joined by Rajesh Mokashi, managing director and chief executive of credit rating agency CARE. Mokashi was also sent on leave, pending completion of the examination of an anonymous complaint received by the SEBI.
The proponents of ‘Corporate Governance’, perhaps the most misused word in Indian corporate circles, couldn’t have been happier. After all, what more can be expected from professionally managed boards. But can one person in any organization be responsible for the entire mess? A few other insights expose the deep malaise. 
Role and Importance of Credit Rating Agencies
Credit rating agencies are supposed to be manned by professionals who understand the financial position and business plans of a given entity, are tuned in to the industry outlook, market challenges, and state of the economy. Such strengths, insights, due diligence and financial analytics are then put to work to assess the ability of its client, i.e., the borrower to meet its credit obligations on the due dates.
The result so arrived at is expressed as the number of times the cash flows of the concerned entity are expected to cover the repayment obligations. The higher the coverage, the stronger the repayment capacity. The credit ratings are used by various stakeholders like the lenders, investors, suppliers.
Distress Signals Ignored Conveniently
Until July last year, India’s credit rating companies had put out investment grade ratings on billions of dollars of corporate debt raised by the IL&FS group and its subsidiaries. The first signs of trouble came in June 2018, when the special purpose vehicles tied to IL&FS Transportation Networks Ltd., a group subsidiary, defaulted on its debt obligations. More defaults in other parts of the empire followed in August and September. Finally, the rating agencies were forced to downgrade the rating status to default in September 2018.
In October 2018, the government was forced to dismiss the IL&FS board and replace it with six eminent persons of its choice led by the well-known and respected banker, Uday Kotak.
The IL&FS case is a prime example of locking the stable door after the horses had bolted. The credit rating agencies had clearly failed to discharge their prime responsibility. 
Major Gaffes
For ICRA, IL&FS was not the only blunder. The investigative capabilities of a media house which exposed its gross inadequacies should have put it on high alert at least five years earlier.  
In  its edition of January 17,  2012, the Times of India reported that but for “Other Income” of Rs200 crore, Pricewaterhousecoopers Pvt Ltd and two of its network audit firms, Price Waterhouse (PW) and Lovelock and Lewes (LL) would have reported heavy losses for the financial year ended 2010-2011 instead of the “made up” profit reported.  
The glaring impact of the said “Other Income” could not have been missed even by a novice (See table below):
For FY 10-11.  All figures in Rs. crore
ICRA conveniently overlooked what even a blind man could see. Despite a note in the audited accounts of LL, that the other income was on account of funds received from a foreign company apparently in violation of existing statues, ICRA did not deem it worthwhile to probe this either. Not only that. It upgraded both the long term and short term ratings of Lovelock and Lewes for 2011. While upgrading the ratings, its report specifically stated that, “ICRA has taken a comprehensive view of the operations of various network firms of PricewaterhouseCoopers International (PwC), operating in India while assigning the ratings”. 
Clearly, the term:  “professional skepticism” meant little to ICRA. It again chose to turn a blind eye and even put out a notice in FY 11-12 when similar amount of funds were alleged to have been received again. It re-affirmed the ratings assigned earlier. 
How many more undetected IL&FS scams are waiting to explode is anybody’s guess. 
Waste of Precious Judicial Time
The “Other Income”, as was later alleged in a PIL, was nothing but camouflaged investment by Pwc Services BV, Netherlands in Indian audit firms in violation of the Foreign Exchange Management Act (FEMA), foreign direct investment (FDI) guidelines, Chartered Accountants Act etc. The Supreme court, vide its judgement dated 23 February 2018 ordered, amongst other actions, investigation by the Enforcement Directorate and the Institute of Chartered Accountants of  India (ICAI) into the receipt of these  foreign funds by various Pwc entities.
All the time and effort of the Supreme Court spent in this case could have been saved had ICRA done its job properly. Takkar was also at the helm when this gross malfeasance happened in Pwc’s case.  But to be fair to him, should he be the only person to be blamed? 
Credit rating agencies boast of multiple layers of a review.  What about the complicity of other wise men/women?  A junior manager who was handling the Pwc case when the above major blunder was committed, is now allegedly a senior vice president with ICRA !
55 Prosecutions Against Pwc Auditors Filed By MCA
An RTI enquiry by this author revealed in September 2018 that MCA had filed a mind boggling 55 prosecutions against Pwc auditors. The prosecutions were filed under section 227 of the Companies Act, 1956. 
Simply stated, section 227 is most critical to the interests of the shareholders and various stakeholders. It puts the onus on the auditors to report to the members of the company whether the balance sheet and the profit and loss account give a true and fair view of the affairs of the company. Violation of this section amounts to gross dereliction of duty by an auditor and can be highly detrimental to the interests of the stakeholders. 
As per the RTI disclosure, one Pwc partner was involved in 33 prosecutions, another one in 19 !! That the regulator for the audit profession, i.e., the Institute of Chartered Accountants turned a blind eye to this, should be hardly surprising given my earlier article.
A director level person from another rating agency, Fitch’s Singapore’s Office, left the firm after he was found to have violated Fitch’s Code of conduct in the IL&FS. At least some organisations walk the talk.
Praful Patel/Air India scam
The Enforcement Directorate and the Central Bureau of Investigation (CBI) have only now  started questioning former civil aviation minister Praful Patel in connection with an aviation scandal dating back to 2008-09. Patel is being investigated for alleged corruption and causing humungous loss to Air India by giving up its profitable routes and timings in favour of national and international airlines. 
STC/Ispat scam
Pramod Mittal, the younger brother of global steel tycoon, Lakshmi Mittal was the promoter of Ispat Industries Limited (IIL) and also the chairman of his overseas empire by the name of Global Steel Holding (GSHL).  He had made London his base almost two decades back. 
IIL’s debts soared past Rs8,500 crore in 2002 after two restructurings by its lenders  under the corporate debt restructuring scheme and generous write-offs. At a time when IIL could not service even its interest payments, its board meetings, attended by senior bankers, were held in 7 star hotels! 
Grapevine has it that thousands of crores of rupees were siphoned off including money for  the setting up of Global Steel Holdings Ltd (GSHL), headquartered in the Isle of Man and for other personal interests. The overseas business was largely funded by the State Trading Corporation (STC), a public enterprise, for procuring raw material for its Philippines operations between 2005 and 2010. Despite frequent defaults, GSHL continued to draw additional amounts solely because of its political patronage and connivance of STC officials and other lenders.  
At the last count, Pramod Mittal owed more than Rs2200 crore to STC. Chances of even partial recovery were extremely slim.  Various criminal cases and even a look out notice for him and his family had been issued by ED. No one from STC/any other lender was however touched. 
By a quirk of fate, STC recovered the whole amount! Pramod’s defaults were coming in the way of Lakshmi Mittal’s acquisition of Essar Steel and it is said that he cleared the entire dues of his younger brother so that his larger plans for India were not stifled. 
While this pretense of cat and mouse continued in India, something striking happened in Bosnia. Pramod Mittal was arrested in Bosnia on 24 July 2019 and released only after paying a hefty €12.5 million ( appx. Rs100 crore). Mittal was held for suspicious transfer of nearly €11 million from Lukavac (Bosnia)-based GIKIL (Global Ispat Koksna Industrija) which is a joint venture between GSHL and Coke and Chemical Conglomerate owned by the government of Bosnia. 
Different tales, same story
The above cases expose only the tip of the dirty underbelly of corporate India which continues to flourish, thanks to rampant corruption and pliable regulators.  Even these cases have come to light decades later but only after irreparable damage has already been inflicted. 
One has to be extremely unlucky to get caught in India. The size of undetected corporate scams is anybody’s guess. Non-performing assets (NPA) of banks of Rs10 lakh crore can be safely taken to be understated. A huge financial bomb is waiting to explode any time. 
There is however a silver lining to all this:  India can learn a lot from Bosnia if it wants to be a $5 trillion economy by 2025.
(Sarvesh Mathur is a senior financial professional, who has earlier worked as CFO of Tata Telecom Ltd and PricewaterhouseCoopers.)
Satish Mathew
5 years ago
These regulater entities are waste and needed to be restructured.
5 years ago
Seems like we are heading towards tough times..!
pravin banker
5 years ago
Excellent article and point well made. I know first hand since I was advisor to PM for three years 2004-2007 , al be it for his Bulgaria operation, not Bosnia. I was also negotiating with IL&FS Parthasarathy and his executives to buy out a loan they made to Stemcor - about USD 110 million - around 2015. Even though the loan was shaky, Stemcor having defaulted I was advisor to Stemcor late former Chairman Ralph Oppenheimer. Not only did IL&FS refused to sell but they increased the line and capitalized interest.
Around 2001 I marched into Robert Wolf's office with a revelation. RW was the Chairman of UBS Americas and UBS had underwitten some $5 billion in loans - the Osprey bonds- for Enron. The debt was supposed to be collateralized . What I discovered was that the then CFO Fastow had shifted the collateral, pledging it for some bank loans. Wolf was livid and soon not only ditched their remaining exposure but shorted the shares which cratered quickly from over $30 per share to under $1. Alliance - a big shareholder - finally dumped at 27 cents.

I recall Ken Lays lament. Senators could be bought cheap, a mere $100,000. Investment Bankers could be bought for a million .. BUT those damn auditors. They want 25mm plus. Enron's auditors were Arthur Anderson who looked the other way when the collaterals were shifted. The government forced Anderson into bankruptcy.
Replied to pravin banker comment 5 years ago
Thumbs up to you too....!
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