Why related party transactions may need more regulatory attention

The practice picked up during the pandemic, come into focus as Adani controversy unfolds

The way the Adani Group conducts related party transactions is part of a US short-seller’s scathing report on the conglomerate.

The value of these potentially problematic transactions have gone up for listed companies as a whole after Covid-19, shows a 'Business Standard' analysis of 221 firms on the S&P BSE 500 index with available data.

Hindenburg Research last month published a report alleging improprieties by the Adani Group, highlighting related party transactions. Adani has denied the allegations as "a lie".

These are transactions that a company enters into with entities related to the owner or majority shareholder, also called the promoter. They are necessary when group companies are sources for business necessities like raw materials or technology, but there is a risk that the transactions can be skewed in favour of the promoters' interests at the cost of other shareholders.

The total value of such transactions—recorded in companies' profit and loss statements—was the equivalent of 19.83 per cent of net sales in 2021-22, compared to 18.86 per cent in 2018-19. The value of such transactions was at its highest in at least five years. The value of such transactions recorded in balance sheets has tapered from pandemic highs, but it is still more than before Covid-19 (9.1 per cent in 2021-22 against 8.86 per cent in 2018-19) as seen in chart 1.

Key sectors that stood out for their post-pandemic rise in related party transactions include construction, steel, chemicals, retail and cement (chart 2). The profit-and-loss statement data is shown here as it is more substantial than balance sheet numbers, but the latter also shows a similar trend.

The stock market regulator investigates irregularities in related party transactions, but priorities depend on the chairperson. Under GN Bajpai, the Securities and Exchange Board of India (Sebi) was focused on market manipulation cases early this century. Data for present Sebi chairperson Madhabi Puri Buch is not available. The previous chairperson, Ajay Tyagi, widened the scope: ‘miscellaneous’ cases accounted for nearly 30.24 per cent of investigations during his tenure. Miscellaneous cases can include financial statement fraud as well as others that do not fall under market manipulation, insider trading, takeover or issue-related investigations (chart 3).

Sebi has sought to tighten norms for related party transactions, but the challenge is perhaps in creating the deterrence that successful probes can bring. There are nearly 5,000 listed companies. The regulator is able to take up fewer than 200 investigations a year.