The Enron scandal in the US was facilitated by off-balance sheet items — transactions and entities that were not disclosed to shareholders. The build-up to the US financial collapse of 2008 also saw banks taking large transactions and risks off the publicly reported books, and tucking them away in unreported corners where regulators and shareholders could not get a peep. Many similar scams have been possible only because companies created entities and accounts that were used to indulge in unreported transactions, and to create hidden assets and liabilities. The question is whether the same thing has been happening in India.
Consider the disclosures now tumbling out, about how some of Mr Raja’s favoured telecom companies (Swan, Loop, Datacom, etc) were indulging in transactions that were hidden from view because they used or were used by unlisted intermediaries, subsidiaries and associate firms — and also related parties. Shares in the companies that got Mr Raja’s licences were held by even existing telecom firms through intermediaries of different kinds. The money trail has led to strange places (including the inevitable Mauritius) and obscure firms about whom little or nothing is known.
While some or all of these may not technically come under the banner of “off-balance sheet” items, they are all hidden from scrutiny and therefore, from the point of view of public disclosure to the shareholders, boards and auditors of listed firms, completely opaque. Ramalinga Raju at Satyam has provided an object lesson in how this was done; money from the listed entity went into firms controlled by family members. Anil Ambani’s campaign against his brother Mukesh’s activities in the undivided Reliance group was that large transactions were taken off the books of the listed company and routed through unlisted investment companies and dummy firms — a practice that, he contended at the time, militated against corporate transparency and accountability.
There are legitimate reasons why such investment firms exist. Businessmen hold shares through them in order to limit personal liability. Corporate intermediaries are also used for reasons of tax efficiency, bringing in partners for individual businesses, raising finances for specific projects and so on. Policy itself sometimes encourages the formation of dummy firms; nationwide telecom licences worth thousands of crores of rupees were available to companies with share capital of no more than Rs 10 crore!
It should be obvious that the proliferation of such corporate intermediaries means reduced transparency. In a well-known case in the 1980s, the income tax people alleged tax evasion by Sarabhai enterprises through some 1,300 investment subsidiaries and trusts. In a share-switching case involving Reliance in the 1990s, investigations revealed the use of scores of intermediary companies that were used for share transactions. While the use of such intermediaries and investment firms cannot and need not be done away with, is there any way by which the law can prevent a parallel set of shadow activities going on through such companies, activities that should be reported and transparent?
One method would be to extend disclosure of such transactions to the boards, auditors and shareholders of the ultimate parent company that is listed, in cases where transactions are above a certain size, or which exceed a stipulated percentage of share capital or net worth. Such approvals are required already, but stop short. A second hole to plug would be the use of related party transactions (as in loop); the solution might be to prevent interested parties from voting when the subject goes to shareholders for approval. In the absence of proper corporate governance norms, such stipulations can never be foolproof. Still, it is clear that today’s rules are hopelessly inadequate, and need to be tightened.
