An anonymous whistleblower, who claims to be part of the “senior management team at Deloitte, Haskins and Sells LLP (Deloitte)” and has been “privy to several internal irregularities in providing professional services to the IL&FS (Infrastructure Leasing & Financial Services) group” has written to us outlining how the audit firm benefited by helping the failed group fudge its accounts year after year.
In fact, Deloitte ensured a clean chit to IL&FS even when the Reserve Bank of India (RBI) claims to have red flagged a few issues and asked it to reduce its outstanding debt. It is another matter that IL&FS did nothing. The whistleblower says, “The extent of the scam is mind boggling” and hopes that investigation agencies would question members of the audit team, thereby giving him a chance to disclose how the “the senior management at Deloitte is aware of the financial mismanagement and impropriety by the IL&FS group” and actively helped fudge facts.
Deloitte has an internal reporting system; but the whistleblower says, “I have no faith in the current leadership and, hence, am consciously not resorting to our internal whistle-blowing mechanism.” He goes on to provide a few details which need to be understood in the context of what we already know about its relationship with IL&FS.
Deloitte has audited IL&FS Financial Services Ltd (IFIN) for 10 years and remained the auditor until it completed 10 years in 2018. The audit reporthad absolutely no adverse findings even in 2017-18. On 3rd April, the new IL&FS management headed by banker Uday Kotak said that 90% of the loans advanced by IFIN, the lending arm of IL&FS, had turned bad.
1. Deloitte was a beneficiary of IL&FS’s ‘unmitigated growth’ over the decade in multiple ways. It enjoyed a ‘preferred advisor role’ and was awarded several advisory contracts on a ‘single sourced basis’ at ‘substantially high fees’ as compensation.
2. When audit findings would not show IL&FS in a ‘favourable light’ and Deloitte had to take a position, the auditor conveniently relied on “management explanations and comfort letters by compromising on its independent opinion.” At times, IL&FS’s top management would meet and “coerce Deloitte partners for a more favourable position or watered down position.” This was in addition to the ‘watering down of views’ that already happened internally at Deloitte, in the first instance.
3. Over the years, says the whistleblower, this led the entire audit becoming “susceptible to legacy positions and compounded the financial misreporting.” In many cases “the language of the management response was agreed before hand by Deloitte to close its internal reviews.”
4. The whistleblower claims that, in the past three years, Deloitte discovered enough facts that would have qualified the report. However, a specific audit partner (name withheld by Moneylife) would hold close-door meetings with IL&FS’s senior management and find ways to ‘manage’ these by relying on management explanations and opinions.
The whistleblower goes on to outline how Deloitte benefited from these compromises.
“As a compensation,” for accommodating IL&FS in audit “it was agreed that the group will remunerate Deloitte by way of consulting and advisory fees.” Deloitte Consulting, a separate legal entity was paid crores of rupees under the guise of a ‘strategy study for diversification’. He also says, “Deloitte charged a very large sum of fees to recommend creating a more complex financial services business and grow its already stressed books.”
The audit partner allegedly worked with the consulting entity partner to ensure that Deloitte earned a whopping Rs20 crore annually from the IL&FS group as a reward for ‘managing’ its audit. The ‘round-tripping’ of loans, which was disclosed in detail by a forensic audit ordered by the new management at IL&FS, was not only well known to Deloitte’s senior partners, but they also “helped to identify new businesses to cover round-tripping.”
According to the whistleblower, Deloitte employed a senior tax adviser (name withheld by Moneylife) at a very high salary “to ensure that he would continue to earn high revenues for Deloitte.” He helped design complex tax structures that would meet the ‘eye of the law’ while Deloitte would be protect itself through management explanations.
How To Unearth
Worryingly, the whistleblower says that since the collapse of IL&FS, the team at Deloitte has been “involved in a massive cover up and creating paper trail.” He goes on to suggest how investigators can unearth the involvement of Deloitte’s top brass.
Accessing internal mails of select persons and checking their e-calendars for meetings that were not officially minuted.
Confirming internal revenue targets for fees earned from IL&FS group. Checking non-audit and consulting fees billed by Deloitte from IL&FS group, its associates and especially its joint venture partners.
Questioning audit team members dealing with IL&FS.
The question is: Is the government really serious about a clean-up? So far, everybody connected has been treated with kid gloves. The government-appointed board of IL&FS commissioned Grant Thornton to conduct a forensic audit of IFIN (Project Icarus) which came up with a shocking interim report detailing outright fraud, mismanagement of funds, capricious actions and total disregard for regulators and regulation by the previous management. It also narrowed down the responsibility to the committee of directors (CoD) comprising: founder and former chairman Ravi Parthasarathy, former vice-chairman Hari Shankaran, director Arun Saha and IFIN’s former managing director, Ramesh C Bawa. Even this has not led to any decisive action other than issuing a few show-cause notices. What is worse, some very close friends of this cabal have been appointed by the government to head the new management.
The Institute of Chartered Accountants of India is also investigating the role of all auditors and its interim report has already accused them of acting in a ‘fraudulent and negligent’ manner. The Deloitte whistleblower has only confirmed that this was the result of a deliberate nexus with the auditor and for financial benefit.
Moneylife wrote to Deloitte’s India CEO (chief executive officer) Punit Ranjen for his comments. A PR (public relations) agency for the audit firm sent us this reply on behalf of Deloitte.
“Deloitte strongly disagrees with the issues raised in your mail and these seem to be an attempt to malign the reputation of the firm. The statements made are incorrect and misleading. As you are aware, there are ongoing investigations by regulators and agencies. Further, given our responsibility to maintain client confidentiality, we are regrettably constrained from providing you with the information you have sought. However, we wish to emphasise that our work has been conducted in accordance with prescribed standards and regulations.”
We shared the whistleblower’s letter with Claire Hassett, managing director, Deloitte Global Communications who, in turn, appears to have shared it with senior management in India. There has been no further response from Deloitte.
We have also shared the whistleblower’s letter with Uday Kotak, now the chairman of IL&FS, and with an official of the Serious Frauds Investigation Office (SFIO), which is investigating IL&FS, as well as other Central government agencies.
The independence of rating agencies and statutory auditors is critical to keep a check on malpractices of borrowers. If rating agencies and auditors were not derelict in their duty, the shenanigans of IL&FS would have been discovered much earlier. The loss to lenders could be well in excess of Rs30,000 crore. More importantly, if the checks & balances in a system—provided by ratings, audits and inspections (by the RBI in this case) fail—then all investment decisions become like a lottery. If that is the basis on which we are forced to invest, why has the government spent so much money on creating five giant regulatory organisations for the financial sector alone?
Unless those responsible for allowing the IL&FS mismanagement to continue for years are booked, what kind of message are we sending to investors and the people?
Total outstanding debt of fraud-hit Infrastructure Leasing and Financial Services Ltd (IL&FS) group is Rs99,354 crore and not Rs91,000 crore as being stated. This includes fund based outstanding principal of Rs94,216 crore and non-fund-based outstanding, including bank guarantees and letters of credit of Rs5,139 crore, says IL&FS group in its presentation.
In the fund-based dues, a total of Rs4,570 crore in principal outstanding includes Rs1233 crore towards Gujarat International Finance Tec-City (GIFT City) where IL&FS has 50% stake, and Rs3,337 crore towards ONGC Tripura Power Ltd, where the group has 26% stake.
IL&FS group has creditors across its different layers of subsidiaries. Out of its total outstanding of Rs94,216 crore to creditors, Rs73,359 crore are secured debt while rest Rs20,857 crore is unsecured debt, the company says.
Talking about the highly complex structure across the IL&FS group, its presentation admitted that the board requires time to comprehend, develop and implement resolution plans for these entities. Originally, there were 347 entities in the IL&FS group as identified by the new board. Out of this, 45 entities, including 42 foreign and three domestic units were closed, leaving the IL&FS group with 302 units that include 133 foreign and 169 domestic companies.
IL&FS group has maximum (160) number of subsidiaries in transportation, followed by energy sector with 35 and financial sector with 30 entities.
In addition, the IL&FS group has a complex holding structure with multiple layers. So far the new board has identified four layers in the group. IL&FS group has several wholly owned subsidiaries (WOS), subsidiaries with counterparties, including private and government, associate companies and joint ventures (JVs).
Its JV partners include ORIX Corp of Japan, which owns 23.54% stake in IL&FS, public sector units (PSUs) and several state governments as well as listed companies.
According to IL&FS presentation, the new board headed by Uday Kotak is appointing advisors and securing a moratorium order from third party actions for creating a calm period. "To protect stakeholder interests, we are developing a resolution framework for managing unprecedented group insolvency using the umbrella resolution approach that is built on principles analogous to IBC. This includes resolution plan for international entities, assessment of resolution options, kick starting and monitoring asset monetisation process, subject to approval from NCLT and supervision of Justice (retd) DK Jain," the copmany says.
It now appears that as much as 90% of the loans advanced by IL&FS Financial Services Ltd (IFIN), the lending arm of the infrastructure conglomerate, Infrastructure Leasing and Financial Services Ltd (IL&FS) have turned bad. This again underlines the deep corruption and culpability of the previous management.
Of its loan book of Rs18,805 crore, Rs10,656 crore was lent to third-party borrowers and nearly Rs7,000 crore to group companies, N Sivaraman, chief operating officer at IL&FS group, has revealed.
According to Kaushik Modak, who now heads IFIN, the company has recovered Rs931 crore since the new board led by banker Uday Kotak took over the IL&FS Group.
According to a senior banker, before funding, the lenders are supposed to analyse qualitative and quantitative parameters and sanction the debt only if these are satisfactory. The qualitative parameters are credentials of the management and organisational team plus comprehensive risk identification and mitigation.
Bankers are also supposed to use “quantitative parameters such the borrower's ability to bring the equity - fresh or through operating cash flow, and viability - standalone and overall. The lender cannot forego this due diligence and rely on credit rating. Post-sanction, there has to be intense monitoring of the fund use during project construction and operations, thereafter,” he continued.
“All of this applies to special purpose vehicles (SPVs), setting up project or to infrastructure financing companies, which raises funds for downstream investments in SPVs. If a finance company is funding projects, it has to undertake strenuous due diligence as above,” he added.
According to him if “IFIN has bad loans of 90%, it only proves that it did not do any due diligence, worth talking about. In fact its short-term borrowing to invest in SPVs shows criminal negligence. Obviously, the banks, which financed I-FIN and IL&FS projects did absolutely no due diligence either. They blindly accepted the junk submitted by IL&FS. So the banks also cannot be absolved of the crime.”
Amazingly, mutual funds, which are supposed to channel retail investors’ money into safe debt, have put the corpus of fixed maturity plans into IL&FS related debt paper. “This is a stunning commentary of their complacency and negligence. There should be claw back on hefty packages which find managers draw,” he suggested.
Unfortunately, given the mood of elections and slow process of establishing negligence and criminality, it is unlikely that any banker will be caught in what is turning out to be one of the biggest financial scandals of India.