By Ashley Coutinho
The Securities and Exchange Board of India (Sebi) is believed to be examining instances of manipulation of financial positions by more than a dozen listed companies, that includes transactions pertaining to related parties.
The issues that have come to the fore include accounting treatment of debt and interest not applied in accordance with GAAP and fraudulent manipulation of financial position; provisioning of doubtful debts and sale of the same in succeeding year; concealment of audit qualifications during quarterly disclosures; non-disclosure or incorrect disclosure in annual reports and misrepresentation of the receivables, and corresponding provisioning in order to mislead the shareholders about the financial health of the companies, according to a person in the know.
Companies are entering into transactions with related parties in the form of sale of goods or loans. The same money is transferred from one entity to another and subsequently routed back to the listed company or its promoters through those companies. In the process, all of the related party companies get their capital or net worth increased and are able to procure more financing from banks.
“The money ultimately comes back to the promoter. In the listed companies’ books it is shown as provisioning of loans or the loans and transactions are written off as impairment of trade receivables. The impairment is then disclosed through the help of audit firms in the notes to accounts in the financials of the company. So, effectively the company will say everything is in the ordinary course of business and attribute it to adverse economic and business factors,” said the person.
The person added that companies are going to the extent of impairing the selling of an entire subsidiary for a paltry amount.
“There has generally been a concern among investors and regulators on the use of related party transactions to transfer economic resources and benefits to one group of shareholders and their related entities to the detriment of other minority or non-promoter shareholders,” said Sai Venkateshwaran, partner, KPMG in India.
According to him, this has led to periodic review of the regulatory requirements around approval and disclosure of related party transactions, such that there is greater transparency and oversight on such transactions. “The tighter regulations also serve as a deterrent to companies undertaking any abusive related party transactions,” he said.
The recently introduced amendments to the Sebi Listing Regulations, which are partly effective now and become fully effective from April 1, 2023, moves away from a rules-based definition of related parties and covered transactions to a principle-based approach and moves from the legal form of arrangements to looking at their substance, said experts. Under these new rules, transactions undertaken with unrelated parties, where the ultimate beneficiary is a related party, would get covered.
“Greater oversight and approval requirements by the listed parent company’s audit committee and the increasing regulatory reviews of corporate filings, both by Sebi and NFRA will also bring greater rigour to compliance in this area and deter any undesirable practices,” said Venkateshwaran.
“In a bullish market, when valuations are based on revenues or multiples of revenues these kind of shenanigans are bound to happen, be it private or listed markets. This will be especially common in mid and small-cap companies which are typically under-researched,” said Shriram Subramanian, founder and MD, InGovern Research Services.
According to him, investors are often guilty of just looking at the headline numbers and not doing adequate research. “Financial influencers have also been guilty of bidding up stock prices by focussing only on metrics such as PE multiples, RoE and RoCE without digging deeper or doing channel checks. It’s only in the bear markets that most of this manipulation comes out in the open,” he said.
An email sent to Sebi late evening did not immediately get a response.
Sebi had recently settled a case with realty firm Sobha and four individuals in a case related to fraudulent trading and disclosure lapses for Rs 2.92 crore. Sebi had conducted an investigation into certain transactions by Sobha with D K Shivakumar and his family for fiscal years FY17 to FY19. It was alleged that Sobha fraudulently misrepresented the receivables with respect to the construction of residence of DKS in these years and the corresponding provisioning for the same during this time. This allegedly led to publication of manipulated financial results for the three years, which painted a false picture about the financial health of the company.