India’s stock market regulator is exploring options to make it mandatory for promoters of all listed companies to disclose if they have raised any money by pledging shares they hold in a company.
The move by the Securities and Exchange Board of India (Sebi) is one of a number of measures being explored by regulators in India in light of last week’s disclosure of a $1 billion fraud by Satyam Computer Services, the country’s fourth largest software company.
India’s “Enron”, as it has been described, led to a 5% drop in the country’s main stock index. This followed the revelation by Satyam chairman and chief executive Ramalinga Raju that he had manipulated his company’s accounts for years to show hugely inflated profits and fictitious assets.
The fraud is India’s largest corporate scandal since the early 1990s and its first high-profile casualty since the start of the global financial crisis. India’s entire financial system will now be scrutinised, with the roles played by promoters, company directors, independent directors and auditors all falling under the microscope.
“This episode has taken everyone by surprise,” said Mumbai-based Khaitan & Co partner Rabindra Jhunjhunwala. “There are lots of questions in the minds of people regarding corporate governance.”
Sebi issued a statement on January 7 in response to Raju’s revelation, ordering an investigation into any violations under securities laws. India’s Serious Fraud Investigation Office (SFIO) launched a similar investigation into any corporate law violations. Any legal action will only be initiated once these investigations are complete.
Jhunjhunwala told Asialaw it was “absolutely critical” for the credibility of India’s financial system that regulators send a strong message to those who would commit fraud. “Unless this happens investors will not be reassured,” he said.
The regulator has the power to impose penalties and initiate criminal proceedings in cases where there have been violations of the provisions of the Sebi Act and the various regulations issued there-under, including insider trading regulations and corporate governance norms.
In addition to the investigations launched by the regulators, and as well as the police investigation, the Government of India has also initiated action by superseding Satyam’s board of directors and appointing its nominees, including three independent directors.
On January 11, HDFC chairman Deepak Parekh, ex-Sebi member C Achutan, and former president of global trade body the National Association of Software and Services Companies (NASSCOM) Kiran Karnik were appointed to the board of the Hyderabad-based IT company as independent directors to chart its future course.
Pratap Amin, head of India at Freshfields Bruckhaus Deringer, said: “The fact that the Government has acted so fast shows that it is in a hurry and is sensitive to the fact that this could damage Corporate India.”
The role of independent directors is being heavily scrutinised. Companies appoint such directors at their discretion though it is a requirement that at least one third of a company’s board be independent.
One idea being mooted post-Satyam is that certain professional qualifications may be prescribed for a person to be eligible for appointment as an independent director – though difficulty in finding suitable independent directors may make this impractical.
Listed companies in India are governed by the provisions of the Companies Act and the Listing Agreement. Clause 49 of the latter sets out a requirement for each listed company to set up an audit committee which is responsible for the proper preparation of accounts and for overseeing corporate governance.
It is the duty of the auditors to highlight any non-compliance or discrepancies in the accounts and accordingly qualify their audit report. As auditors to Satyam, PricewaterhouseCoopers has received unwanted press in the last few days though it is adamant it carried out its audit in accordance with the accounting standards issued by the Institute of Chartered Accountants of India.
“There has been some knee-jerk reporting on who is to blame but it’s premature to start apportioning blame,” said Amin. “The issue here is how a listed company that had an audit committee and an international auditor managed to hide the fraud for so long.”
He added: “When the dust settles, people will have to be very practical.”
What seems certain is that the level of due diligence, especially financial due diligence, will go up for all companies in India. And Sebi has mandated that the financial statements of all companies included in the BSE sensex and Nifty 50 be reviewed by another auditor after they are audited by their respective statutory auditors.
New Delhi-based FoxMandal Little partner Manish Kumar Sharma said: “We can expect stricter implementation of the various statutory and regulatory provisions and monitoring by regulatory agencies. Higher penalties may also be provided as a deterrent.”
With Satyam listed on three international exchanges – Mumbai, New York and Amsterdam – the multi-year fraud is already proving something of a bonanza for law firms.
In addition to publicity raising stints on various TV channels and publications, Indian firms have been asked to check for conflicts with many already engaged on the fraud in some capacity.
In the US Connecticut class action law firm Izard Nobel LLP has already filed a suit against Satyam on behalf of those who purchased the Indian company’s American Depository Receipts (ADRs) over the last five years.
“We expect that this episode will generate a good amount of legal work due to fact that there are a number of parties involved – like the company, its shareholders, directors, auditors and clients,” said Sharma. “We are also expecting that other companies will now be more cautious and will avail more services of professionals in their day-to-day working.”
But whether this placates investors remains to be seen, with many concerned that such fraudulent activity may not be restricted to Satyam. Amin told Asialaw that his firm had a number of ongoing deals in India at the moment but that at least three clients had expressed reservations in light of the scandal.
Lawyers say that any regulatory amendments are likely to follow the UK model, which was further refined on January 9 when the Financial Services Authority (FSA) clarified its disclosure requirements for directors who grant security over their shareholdings. But with India due to hold general elections by May 2009, such amendments could prove short-lived.
Look out for a full analysis of the Satyam scandal and its implications in the February edition of Asialaw.