How abridged accounts help companies commit fraud and why this needs to be stopped
Somesh Arora, August 11,2017
Closing the gate after the horse has bolted is symptomatic of how the government and its regulators react. Toughened ‘procedures’ that are evolved at the bureaucratic levels are generally the outcome of a kneejerk reaction to some frauds or irregularities committed. The game is to shift the blame to system-failures, and try to plug the loopholes which were exploited by the fraudster. The government is attuned to plugging loopholes, quite akin to the little Dutch Boy. But loopholes are holes which will leak from elsewhere. Therefore, making better systems and procedures is considered as the key to fraud-prevention in the future. ‘A few jobs saved from vigilance are worth creating a procedure for all to follow’ is the maxim of bureaucratic red tape.
The courts, therefore, have been appropriately laying emphasis on substantive compliance rather than procedural. This has even led to unnecessary litigation at times, because for babus, procedures are sacrosanct, having made by some of their own clan and the internal vigilance minces no words for those choosing to ignore it, as no more lives of lesser mortals can be saved by the same type of fraud. Nothing sums up judicial approach towards procedures more appropriately than the observations of the Supreme Court in Commissioner of Sales Tax, UP, vs Auriaya Chamber of Commerce, Allahabad reported in 1986 (25) E.L.T. 867 (S.C.), where in the apex court observed that the rules or procedures are hand-maidens of justice, not its mistress. Substantial justice should not get entangled in the cobweb of procedures.
But procedures do serve as a mistress for certain corporate interests, even if not for justice. Whenever such procedures are evolved, they will generally be ornamented with virtues of rationality, austerity, economic well-being, national and larger public interest—so that the façade is not removed to arrive at the interests that may have to be served. The thinking of the lobbyist is simple: If you cannot do it through policy, do it through procedures.
During the early 1990s, ‘liberalisation and globalisation’ were the buzz words, and India was just venturing out of the shackling and back-breaking Companies Act, 1956, which had made survival difficult for those companies who had no access to the sarkari darbar. The Act was made more and more powerful to ensure that corporates remained subservient to political bosses even if it meant lack of growth.
The phase of liberalisation was just the opposite, one when caution was thrown to winds. During the period, certain interests lobbied with the ministry of corporate affairs to amend rules regarding detailed balance-sheets which was required to be circulated to the shareholders. The pretext chosen was that there was a high compliance cost involved specially for the companies with larger shareholder base who had to spend huge amounts on printing and postage. The costs actually in those times were higher than the dividend payouts received by majority of the shareholders. The printing and postage costs to such companies by the standards of that time was a reasonable logic to agitate amendments to the “onerous” requirement. The complicit government department was only too keen to oblige. This made the procedure that permitted abridged final accounts and balance-sheets to be sent to the shareholders in-vogue. Even though the requirement of placing detailed accounts was fulfilled by displaying them at the registered office of the company, the smart companies quickly changed the registered offices to remote areas, thumbing their nose, so to speak, at the shareholders and the regulators. Over a period of time, the abridged balance-sheet gradually started to conceal more than it revealed. What were the chartered accountant’s observations, if there were any? What was the status of bank loans and their re-payments? What were the tax liabilities or any non-compliance or any breach of any law for which authorities were holding such companies liable? All this hardly came to be revealed. And, most important, the details of persons and companies that were benefitting from the largesse of loans, advances and sundry debts remained hidden. The Central Economic Intelligence Bureau had, in the late-1990s, flagged this issue with serious concern, prompting the finance ministry to press RBI for a fiscal leash on recalcitrant promoters. In October 1998, RBI mandated that no company could lend money at a rate of interest lower than which it borrows. But this discipline was short-lived, lasting only for a couple of years. In the subsequent Master Circular, the earlier circular was given a quiet burial. Therein lies the tale of non-performing assets. If the evil had then been nipped, the blooming stressed assets of banks would have been a matter of the past.
Even after the turn of the millennium, when information technology came into use extensively—for meetings, dividend payouts, voting, etc, all communications have become IT-driven—the love for the abridged balance-sheet continues to be there. It is relished by most corporates, who do not want transparency for their shareholders. All this despite the fact that, in governments, e-governance has become the ruling mantra. One would have expected much more transparency in corporate disclosures compared to earlier times, especially after the coming into force of the Right to Information Act. Abridged accounts laid the seeds for corporate frauds and, in few select cases, where the same has come to light, siphoning off of loans and advances and sundry debts has been found to be the norm. This is amply clear from investigations that discovered diversions by the likes of Kingfisher and Mahua channel. The modus operandi is simple: Hiving off funds to offshore companies or transferring the same to a maze of companies created by them to dupe the compliant bankers. The fraud committed by Satyam may not have been possible if all details relating to highly paid employees had been made available to shareholders to view and debate. The abridged balance-sheets have been the reason for lack of accountability of the top management as they were hardly being questioned. RBI, over time, emphasised that banks should ensure a loan review mechanism for larger advances soon after sanction and continuously monitor the weaknesses developing in the accounts for initiating corrective measures in time. Even Sebi mandated that utilisation of funds raised by the companies must be disclosed in annual accounts. But the mandate was followed more in breach than in compliance.
There is no reason why the ministry of corporate affairs cannot now make detailed accounts mandatory—this will include details of salaries, expenditure, loans and advances and sundry creditors/ debtors, etc, that are to be presented to the shareholders in the digital form annually. At present, abridged accounts only are being sent. Since the detailed accounts are presented to the board of directors and auditors, there is no reason to withhold these from the shareholders. Furthermore, every company must carry these detailed accounts on their website, too. This measure alone will allow all non-performing assets to be tracked since there will be accountability and informed shareholders will raise questions if funds are diverted fraudulently. The shareholders, after all, come in to the picture much before sleuths of agencies like SFIO or CBI do.
Sadly, the regulators concerned—RBI, Sebi and MCA—have been complicit in the shenanigans of ruthless promoters. These agencies ought to have acted years ago rather than crying over spilt milk or NPAs. Will they act now? The Prime Minister’s Office must force the decision down the throat of reluctant regulators. Without this check, the asset-stripping will continue unabated, leaving banks and, more importantly, shareholders, holding the baby.
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