Sudhir Mulji: Fixing responsibilities

Those of us who have failed to understand the finance minister's sleight of hand in improving public finance would be wise to leave commentary on the Budget to others, and in the plethora of budgetary comments it would be a mistake to fail to compliment the new chairman of SEBI on his swift action in delaying the introduction of MAPIN for the ordinary investors.

The decision to form a committee to examine the grievances of investors will hopefully lead to the rejection of this superfluous and irrelevant piece of bureaucracy; the composition of the committee should include not just those committed to introducing the legislation but also those who might oppose it.

Committees of this kind should reflect the variety of views and not simply provide the authorities with an excuse to introduce legislation that they have already committed themselves to.

But it is to be hoped that the new chairman of SEBI will apply a new broom to many of the conceptual anachronisms that accumulated in SEBI laws over the years.

To give a simple example, consider the notion of "promoters" in Indian legislation. In English legislation the classic definition of a promoter was provided by Chief Justice Cockburn in 1877 in the following words:

"A promoter is one who undertakes to form a company with reference to a given project, and to set it going, and who takes the necessary steps to accomplish the purpose, ... and so long as the work of formation continues those who carry out the work must I think retain the character of promoters. Of course if a governing body, in the shape of Directors has once been formed, ... the functions of the promoters are at an end."

In other words the underlying concept in English legislation is that a promoter initiates an enterprise but as soon as the formation is complete and directors have taken over to run the enterprise, the role of the promoter is complete and brought to an end.

In contrast, under Indian law it would seem that the role of the promoter is never brought to an end. The promoter is deemed to be there in perpetuity, listed as such with no clear responsibility even when the governance of a company has been handed over to directors.

Indian listing agreements require that every year a list of promoters be stated and this list never diminishes but is added to by all who are deemed to be associates of the promoter. Since associates include wives and descendants of promoters, there is never an end to promoters. It would seem that under Indian law the promoter like God never dies.

Such a conceptual framework has simply no purpose to it. The confusion of the legislation weakens its purpose and thereby negates the obligations of those who build and run enterprises.

Undoubtedly, a promoter of a company has fiduciary obligations, for, he acts as an agent to a principal (the investor), for whom he must act in good faith.

It is, therefore, necessary that such an agent does not cheat or arrange to make secret and undisclosed profits in the formation of a company; but having formed the company his role ceases; the obligation passes on to the directors who take over; the promoter never escapes his liabilities during the formation just as a murderer cannot escape a crime he has committed, but his role as a promoter ends when directors take over.

By requiring promoters to be listed on a perpetual basis, Indian legislation may claim to be comprehensive but it actually weakens responsibility because it could enable a board of directors to divide responsibility between the persons who promoted an enterprise and the group that took over to run it.

Much of the justification for the MAPIN legislation has been that it will enable the authorities to catch and trace those who have promoted bad companies and subsequently disappeared.

But that evades the question of how these promoters were able to list these companies on the stock exchanges. Those who promote these organisations have a fiduciary responsibility but there is also a fiduciary responsibility to those who allowed these organisations to be listed and perpetuated.

In economics, there is now increasing interest in what is broadly described as a principal-agent problem as to the means and incentives required to ensure that those who have a fiduciary duty to others, like directors to their shareholders or promoters to their directors, should be encouraged to perform their obligations with diligence and responsibility.

In considering these matters, Indian economic legislation has adopted a broad-brush approach by putting obligations collectively on any person who can remotely be identified.

I have cited as an example the obligations put on promoters and their associates who may have long completed their task of promoting an enterprise, or as in the case of associates, have no active role in the promotion but still continue to have irrelevant legal obligations.

What is the purpose of listing promoters year in and year out? It is simply a catch-all type of legislation""a characteristic reaction of a bureaucracy that fails to understand the role and the duties of the relevant agents to their principal.

It is this unnecessary superfluity that MAPIN has introduced.

Bureaucratic administrators generally conclude that if there are more persons capable of being obliged, the obligation will be fulfilled; but it is a grave error to believe that adding to collective responsibility ensures a good performance of individual obligations.

Since it is not possible to legislate for every individual, it is necessary to be precise in the formulation of obligations of corporate office-bearers. The way to do that is to introduce identifiable principles that precisely address the purpose of the legislation.

Too general a rule only adds to confusion and endless redefinitions.

In the second generation of reforms, for better or worse, we have chosen the general path of globalisation. We should endeavour to follow global practices and stop innovating on known conventions unless they are adopted in enough countries.

In no other country is there a notion of promoters continuing beyond the limited period of forming a company, or of the identification of investors by a Unique Identification Number, or, for that matter, a tax on the withdrawal of cash.

That should not necessarily prevent us from introducing such good new ideas, but it is a concomitant of globalisation to consider why such good ideas have not been introduced elsewhere.

This suggestion will be dismissed as following the herd policy; yet there is good reason to do so. For, sadly the level of experience of our administrators in the workings of business is so superficial that we would be wise to restrict our initiatives to those that have been well adopted in other countries.

The finance minister has expressed the hope that Mumbai, which physically lies midway between Tokyo and London, will develop as a commercial centre that reflects the international standing of its two rivals.

Much of this will depend upon the rules that its markets reflect, compared with those of its powerful contenders. In part at least that should involve pursuing the same regulations that they normally apply, not such that defeat both logic and common sense.

(The views expressed here are solely those of the author and not of his organisation.)

smulji@aol.com