Corporate Fraud/Misdemeanor - Public Domain - India lessons

Lessons from Mr Market
43

On accounts, I think if things do not seem to add up then it is better to be away from it. Interestingly none of the evidence you have provided have come from IndAS.

I think it may help to not think of it like fraud, but to think of it like ‘by owning shares I have a right to the earnings of the business and its well being. Do I see anything the manager/promoter is doing that is depriving me of my fair share while benefiting him’. Thinking this has helped me quite a bit even as I have been a victim often.

When in doubt, commit the error of omission than the error of commission.

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44

Is there a way to guage this before hand. What is the process/strategy you use? Any insight you can share of this would be helpful.

45

@Chetanpinto I don’t think one set of rules will work in every case as each one is different from the other. I think in general, being skeptical helps. If a company is reporting numbers that don’t match empirical evidence, it’s time to be cautious. It helps to be cautious even about established names, because it’s hard to say which emperor of the day is going to be sans clothes tomorrow. For eg., Are PEL’s numbers sync with how RE sector is doing? Are Bajaj Finance’s numbers in sync with growth in consumer discretionary? Are margins reported in sync with credit costs or RM costs or price realisations of end products? It helps to see how peers are doing to check for divergence and see if it qualifies as deviance. If a sector is suffering and one player doesn’t seem unaffected, again, it’s time to question and understand why and not assume a stellar make-up and business know-how.

It’s good to look at SHP and see how holding of major players have moved. If a business is selling a large chunk of itself, it’s time to be cautious. If a business is set to receive large sum of money, it’s healthy to wonder how much will end up in your hands.

For businesses that allow themselves to put their hand in the till (financials), its important to worry about what sorts of siphoning is possible. If there are fee-based incentives where numbers are front-loaded, we must be cautious to see if bad incentives are responsible for the numbers reported. It might help to see past behaviour of promoters (or even the company he keeps) to see if there are misdemeanours. Absence of evidence doesn’t imply evidence of absence, so even if there is nothing to be found, it’s better to be watchful.

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46

No I don’t use any process / strategy…just think that if you were running the business, does it all make sense.

47

Please don’t use a heavy word like fraud for all except LEEL which has been established.

They are yet to play out like Prabhat which has claimed in filings that they will return “substantial” portion of the returns back to the investor. I am invested from before and company claims that the buyer wanted this kind of transaction.

48

I chose this word for the lack of a better word. My intention isn’t to offend. In Prabhat’s case because it looks like the holding structure is complicated the shareholder wouldn’t be entitled to the full share of the sale proceeds. The shareholder has no choice but hope that the promotor would be ‘generous’ towards minority shareholders. They cannot assume that the sale proceeds would be automatically shared.

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To answer your original question on how to protect against such moves -

Zee and Dewan promoters did not score high on corporate governance and this was well known in investing circles. Even RJ claimed in one interview that he invested in Dewan even though markets had doubt about the company. So Avoid such promoter groups. Avoid concentrated portfolio. Avoid companies where promoters have high pledges.

Checklist does not allow me to invest in media and education stocks so Zee companies would be out. Plus they figure along with Dewan in the list of promoter groups to avoid.

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50

@Chetanpinto

Here’s one instance of no ostensible fraud but being unfair to minority shareholders:

Now if I have followed him and I know this, I would avoid anything that requires me to share my spoils with him. Practically forever. Even if it is very very tempting, because in my world view they (along with his entourage of bankers, brokers, and other players) make it tempting to attract you… then they will trap you.

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51

Frauds /manipulation’s are not perpetuated by pvt companies alone Recently oil India ltd declared a buy back through tender offer record dt was 3rd dec 2018. Govt was to be major benifitiary but as per law 15% of buy back is to be reserved for small investors. But guardians of small investors SEBI has unilaterally waived off buy back from public depriving investors of 40 / 45 Rs profit from buy back If this misadventure is allowed to go unchalleged investors can loose special situation opportunities. Please correct me if I m wrong

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52

Very true. Even in case of PFC/REC merger, open offer clause has been waived.

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This is not correct. Waiver was not for buyback from small shareholders. Waiver was for the fact that Govt. Divested some shares as part of CPSE after buyback was approved but was not yet completed.

I agree though that Govt is not a minority shareholders friendly promoter.

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54

Livemint has well summarised how promoters use their holding entities to raise debentures that gets the best rating from rating agencies. These debentures are rated based on the value of the shares backing them, in effect making them pledges without declaring them such. Investors are misled to believe that the promoter has no pledges when they actually do. The IL&FS bust up has exposed these cosy situations to investors on both sides; in the equity of such shares and investors in debt fund schemes invested in such debentures that have top notch ratings.

If you think about it, such MF schemes are to some degree equity oriented schemes and not debt schemes.

The other very pertinent issue raised by Prof Bakshi is the relaxed ratings to financial firms that has exacerbated the situation.

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Essentially what was happening was debt funds, overflowing with inflows and hard pressed to get yields were trying to get them by investing in quasi equity very well disguised as debt, helped by rating agencies.

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55

To Prof. Bakshi’s point on Indian FIs getting better credit rating, it has something to do with the way the banking system is organised and owned in India.

Majority of the banks are owned by the government with an accompanying implicit guarantee on their debt. Even for apparently private sector banks, past actions of the govt/ RBI with regards to insolvent banks such as GTB, or shady players such as Bank of Rajasthan provides comfort that depositors and debt holders will be protected. So there was no real risk to the AAA ratings liberally handed out by the rating agencies.

Even in the case of NBFCs, many people (including yours truly) believed that the govt would step in to bail out debt-holders as the government was either the promoter or quasi owner e.g. IL&FS. It has only now become clear that the govt is in no mood or position to indefinitely keep bailing out such companies. So unfortunately for rating agencies, this merry game came to a not so nice end.

I think the lesson which I have learned at a fairly high cost is that while NBFCs might optically look like banks in terms of size and capabilities, the lack of a RBI backstop is a real risk, and hence it is better to invest in the ones with conservative management and impeccable reputation over ones which have lucrative margins and stellar growth.

As a side note, I was quite surprised when Mr. Vaidhyanathan of Capital First was so eager to trade a top performing NBFC for a mediocre bank just to acquire a ‘banking license’. I think in hindsight, this move looks to be a masterstroke.

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56

Quite an illuminating post. I should add that even State Govt backed Bonds have reneged on their commitments.

In this case the Gujarat Govt enacted a law to squeeze investors from whom money was raised at 19% IRR via deep discount bonds. It was struck down in HC, but the fight continues in SC.

So when someone says I am at ease because a bond is ‘quasi’ Govt guaranteed (whatever that is supposed to mean) as the argument goes for say NHAI bonds, they are deluding themselves.

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Interesting thoughts from Prof. Altman of Altman z-score fame

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BoB initiates a forensic audit of loans to DHFL after Cobrapost revelations.

BoB had outstanding loans of Rs 4,400 crores. The article also says Union Bank of India is seeking consultancy for bids to investigate its loans of Rs 11,650 crores to DHFL.

Separately the CEO has resigned today, while taking a lower designation of an Executive President an Independent Director resigned yesterday..

Also DHFL has confirmed that Income Tax has sent notices under 131. This was disclosed after moneycontrol broke the news.

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59

Bloomberg Quint reports that the Independent Director Ms Vijaya Sampath did not resign for personal reasons as cited by DHFL. This is based on the letter filed with RoC.

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CRISIL downgrades DHFL CPs following ICRA.

https://www.crisil.com/mnt/winshare/Ratings/RatingList/RatingDocs/Dewan%20Housing%20Finance%20Corporation%20Limited_February_27_2019_RR.html

Some added information for January 2019 below (clipped from the above)

At the company’s request, CRISIL has reduced the quantum of rated commercial paper (CP) to Rs 1,525 crore from Rs 8,000 crore, being equal to the outstanding CP quantum. So at 8,000 theoriginal rated amount and about 5 times the ratings would have been worse. Downgrade in CP is like a downgrade in repo/reverse repo…you are just shut out.

DHFL has publicly stated its intention to buy back outstanding CP of Rs 1525 crore within the next month. Effectively if it buysback the CP, it will have no CP outstanding, and a downgrade in CP will also allowit to buyback at a lower price.

The rating action is driven by the limited progress in the last one month in raising funds (including securitisation), its cascading impact on business operations (reflected in negligible disbursements) and slower-than-envisaged build-up of on-balance sheet liquidity. CRISIL has noted the recent spate of events and news regarding DHFL and believes that, in a confidence-sensitive market, the company’s financial flexibility and resource raising ability have been further impacted.

During the month of January 2019, DHFL raised aggregate funds of Rs 1375 crore through sell-down of a project loan. CRISIL understands that DHFL is in the final stages of raising a significant amount through securitisation route. The company has indicated that their securitisable pool of assets remains high. However, CRISIL believes that continued reliance on this route will not help sustain resource profile for a longer period, especially in the context of muted disbursements. In order to conserve liquidity, DHFL has significantly curtailed its disbursements.

CRISIL notes that DHFL has maintained liquidity at ~Rs 4,800 crores currently. DHFL estimates that collections from loan assets will be around Rs 2200 crore per month over the next three months. Against this, they have scheduled average monthly outflows (including debt / loan repayments and securitisation payouts) of around Rs 3450 crore over the next three months.

CRISIL has noted an increase in the premature fixed deposit withdrawals during the first three weeks of February 2019 and any higher than anticipated redemption will be a key rating sensitivity factor.

61

A very well analyzed BQ report confirms that the money lent by DHFL for slum rehabilitation, found its way back to the promoter entity.

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62

Hi,

I request to the senior VP member to share their views on Manpasand Beverages. The concerns that were raised have never been proved against them. My question is should we trust the integrity of the promoters or not after all these events?

For reference I am sharing a 4 months old but informative view on the quality concern of the business.