How did a relationship manager with less than five years experience deceive a set of hard-nosed, practical money managers of companies and, in the process, expose the soft underbelly of portfolio management business in one of the top-notch banks? To this one can add, how did this man do all of this in the National Capital Region and get away for so long, where people in finance spend a lifetime to work out getting rich formulae?
Shivraj Puri was either extraordinarily sharp or else, one has to accept, his counterparties were equally dumb. If one says both of these are not true then the explanation for the heist Puri executed was simply one of playing on systemic gullibility, which, in turn, means another such con job could be just round the corner.
These concerns make the arrest of Puri just an aside. One is willing to acknowledge that the Gurgaon police have more or less got their hands on all elements of the story and would move to the prosecution stage soon. But the environment for a fraud stays intact.
The enabling environment is the continued reluctance of India?s small- and mid-sized companies to move on to a more transparent system of managing their finance. Most would have forgotten that many of these companies are now fighting a strange court case against banks for apparently having taken them for a ride, selling them currency derivatives, which they understood little about. At first sight, these cases seem like chalk and cheese, but actually they are not. A large number of Indian companies, including a number of exporters, took counterparty derivative positions on their foreign currency earnings. These products, too, were sold by banks through their marketing executives. But when the global markets spun out of control in 2008, their open positions backfired and they lost out.
The companies have told courts and a sympathetic ministry of corporate affairs that the banks mis-sold the products to them and CBI should chase the banks to recover the same. The courts and the government have swallowed the story hook, line and sinker though RBI had opposed it. Essentially, both the incidents tell us something about the smaller Indian companies. It tells us they are generally cash rich but reluctant to invest in processes or people to avoid a repetition of incidents like the Citibank episode.
A rule of thumb used by treasury managers at large Indian and foreign banks advises clients to set up their own investment outfits if the amounts they have to invest is Rs 500 crore or more, instead of depending solely on banks? wealth managers to handle the business. Such outfits, staffed with two fund managers or so, would cost a company about Rs 10-12 crore a year. In the case of the HNIs and companies that had exposure to Citibank, none were working at this scale. This is the tribe that needs the services of portfolio managers from banks on an extensive scale.
As the Indian economy has expanded hugely in the past 10 years, the numbers of companies that need these services have ballooned. To meet this demand, the banks have also resorted to short cuts, fast-tracking promotions for Puri and their ilk. Many of them are barely out of their colleges. But soon, each of them, by the very nature of their jobs, becomes the confidant of these companies, who are often pretty na?ve in financial engineering.
How na?ve? In the Citibank episode, none of them, who now complain about signing away huge amounts, took the elementary precaution roughly known as ?maker-checker?. Translated as a simple logic, it says the guy who has taken a payment from a company on behalf of a finance company should not be the same person who signs the final receipt. There should be a firewall between the two, with usually a back office with no connection to the client, which should make out the receipt. Did any one of the clients in this case ever check this out? Apparently, never!
Again, the fundamental rule that drives corporate treasuries of large companies is maintaining liquidity and safety. The extension of this principle means the funds are parked in debt instruments that rarely, if ever, exceed the returns from gilts by more than 200 basis points. The Citibank investors had instead chased chit fund-like returns of as high as 36%.
The reason for this too has a lot to do with the multi-tasking nature of the CFOs of these small and medium companies. Without fail, the CFOs of all medium-sized companies double up as fund managers of the promoters, irrespective of whether the company from which they draw their salary is listed or not. Treasury managers and mutual fund bosses are all agreed on this.
In the absence of a well-organised office to deploy funds, it is these gentlemen who carry out the task. Naturally, they find the portfolio and wealth managers from the banks a very useful ally. While Citibank has protested its innocence in this case, the attraction for a bank to dip into the mess, with the sort of boys like Puri, is formidable.
The derivative cases, too, were quite similar, where the CFOs just depended on the ingenuity of the bank officer to pull them through. In the new derivative guidelines, RBI has banned companies with a turnover of less than Rs 100 crore from investing in such products.
Perhaps, every major economy manufactures its own version of a financial Achilles? heel. It is possible, thus, that we might not go the US way of a real estate-fed boom-bust fraud cycle. Instead, it will be the fatal attraction of small companies to chase higher returns, which could remain our trouble spot.
subhomoy.bhattacharjee@expressindia.com