Keeping company with phantoms

FICCI’s recommendation to provide photographs of subscribers (initial promoters) and witnesses to bye-laws of the company has found place in the concept paper. The question is: Is that sufficient? Are subscribers or witnesses parties to mismanagement?

The answer in most cases is ‘no’.

As per the current SEBI guidelines, typically public issue is after five years of registration of the company.

An attempt should be made to differentiate between companies whose disappearance affects financial institutions and where public interest is involved. In genuine cases, projects are non-starters and don’t move beyond the drawing board. Such companies, until they go through a time-consuming voluntary liquidation process and are struck off the registrar’s list, feature as defunct companies.

But the market regulator must get its act together!

SEBI, the financial markets regulator, received several complaints from investors’ association and individuals. Basic information to classify companies as ‘vanishing’ was becoming a difficult task. However, SEBI has initiated criminal prosecution against 14 fraudulent plantation companies and its directors. Of 642 companies that raised Rs 2,700 crore from the public, over half have vanished. Since most of these companies were not registered with SEBI, the market regulators’ attempt to prosecute has been frustrated due to lack of statutory powers. Only a long-drawn court process can now provide justice to investors.

Similarly, the Reserve Bank of India in 1998 introduced a host of measures prescribing a strict framework for acceptance of public deposits by Non-Banking Financial Companies (NBFCs). These include minimum investment grade credit rating, interest rate on deposits, brokerage and minimum capital adequacy ratio.

What meaningful action has been taken against vanishing companies?

Many companies expected to have raised above Rs 10,000 crore in the 1990s have disappeared. The MCA’s website lists just over 100 companies. In the last few months, several companies have disappeared from the list of ‘vanishing companies’ and no valid explanation has been given by the MCA for the same. Finance Minister P Chidambaram recently agreed at the SEBI-CNBC investor camp that no action has been taken regarding vanishing companies. It is interesting to note that no company has even been prosecuted by the Joint Monitoring Committee formed by SEBI and the MCA.

Do current regulations have enough teeth to deal with vanishing companies?

An impression is sought to be given that the current provisions of the Companies Act are inadequate to deal with erring directors and promoters. However, an examination of the provisions makes it abundantly clear that the law has enough teeth to deal with not just fly-by-night operators but also established companies. The law prescribes strict penal provisions, including imprisonment up to two years, for issuing false statements in company prospectus. The law also provides for imprisonment up to five years for failure to repay depositors. It will be interesting to note how many prosecutions has the MCA launched against deposit and prospectus defaulters.

Another interesting provision in the law deals with two years of imprisonment (non-compoundable offence) for false financial statements, prospectus etc. Courts have held that this provision equally applies to auditors who make false statements. However, prosecution for larger economic offences, which impact public interest, is a rare phenomenon. The Indian court process for permission of action to prosecute under the Indian Penal Code tends to be a long-drawn-out process.

INTERNATIONAL EXPERIENCE

The UK’s Financial Services Authority (FSA), besides aiming to maintain an efficient and orderly and a clean financial market, helps retail customers achieve a fair deal. Following a three-year investigation early this year, the Bradford Crown Court jailed John Rourke (aged 64), who persuaded people to deposit money by lying that investments would be made in risk-free, high-return property schemes. In sentencing him, Judge Scott described him as a ‘‘silver-tongued rogue’’. The FSA directors of enforcement observed that ‘‘while we have successfully brought Mr Rourke to justice, this is of little comfort to those who have fallen to this fraud’’.

The US Securities Exchange Commission (SEC), the watchdog for the world’s most-significant market, has its mission clearly laid down—to protect investors and maintain the integrity of the securities market. The formation of the SEC was the result of the Great Crash of 1929, when 20 million large and small shareholders took advantage of the post-World War I prosperity and set out to make their fortunes in the stock market. It is estimated that of the $50 billion in new securities offered during this period, half became worthless. The SEC organisation comprises five presidentially appointed commissioners (one being the chairman), four divisions and 18 offices. It is staffed by over 3,000 people.

Aside from various laws that govern the US securities industry, the recent most important legislation is the Sarbanes-Oxley Act of 2002. It was characterised by President Bush as ‘‘the most far-reaching reform of America’s business practices since the time of Franklin Roosevelt’’. Besides mandating reforms to enhance corporate governance and financial disclosures in the post-Enron era, the law prescribes for CEOs and responsible officials to take personal responsibility for accuracy of all financial statements, and for companies to demonstrate a strong system of ethical procedures. It has altered the expectations and operations of many private companies, and targeted public companies.

In conclusion, the desire for enforcement, coupled with legislative-backed corporate governance, will send a strong message to defaulters. Investors in listed companies are encouraged to visit SEBI’s website that separately deals with the Securities Markets Awareness Campaign (SMAC) and the various forms of complaints dealing with non-receipt of refunds and dividends. Its mission is to be ‘‘the most dynamic and respected regulator globally’’.

The writer is a chartered accountant and former National Tax Director of Ernst & Young