Open Access Research Article
DEFRAUDING SHAREHOLDERS LIMITATIONS OF CORPORATE GOVERNANCE IN INDIA (By-Muskan Kuchhal, Ranvita Rao Juvvadi, Rishika Pandey & Sivani Lakshmi Madugula)
Published Paper
Article Details
DEFRAUDING
SHAREHOLDERS
LIMITATIONS
OF CORPORATE GOVERNANCE IN INDIA
WITH SPECIAL FOCUS ON THE SAHARA JUDGEMENT
Authored
by-1. Muskan Kuchhal
(18010245)
2. Ranvita Rao Juvvadi (18010303)
3. Rishika Pandey (18010315)
4. Sivani
Lakshmi Madugula (18010393)
Abstract
In
the day and age where corporate investment is highly sought after, instances of
malpractices and frauds are being witnessed at a rate higher than ever before. Over the past few decades,
several examples of outright failure of corporate governance have earned
headlines. The
most common reasons for such scandals are often the lack of transparency,
existence of multiple possible political nexuses of perpetrators, weak
legislation provisions, and the ignorance of general investors. In this background, this
paper aims at critically analyzing one such incident, that is, the Sahara
judgement, and using it to highlight the limitations of corporate governance in
India, while also providing suggestions to deal with the same.
Introduction
In 1978, Subrata Roy founded one of
India's largest conglomerates, the Sahara India Parivar. Within forty years,
it's net worth amounted to a whopping 68,174 crores and boasted a depositor
base of over five crore people. Naturally, when the news of investor fraud
broke out, it was a revelation that shocked the entire country. After four
years of a long drawn public battle with SEBI, Subrata Roy finally surrendered
in May 2014.[1]
This case is pertinent to discuss
because it changed the face of corporate governance in India. It brought
attention to the lack of strong mechanisms in the country that would ensure
good corporate governance along with the need for stringent laws for investor
protection. This paper aims to bring light to the failure of corporate
governance in this case and how changes were made subsequently. Further, it
also emphasizes the importance of regulation bodies such as the Securities and
Exchange Board of India (SEBI), though granted wide discretionary powers, to
not overregulate so as to cause a grave miscarriage of justice.[2] The role
of public opinion and the media in shaping corporate regulations and practices
is also discussed to shed light on another aspect of the focus of this paper.
Towards the end, keeping in mind the adverse effect of cases pertaining to
corporate frauds, a few measures which must be taken to prevent and reduce such
occurrences are also suggested.
A Failure
Of Corporate Governance
Sahara started an investment program
whose schemes were along the lines of an Indian bank's recurring or fixed
deposits. Small investors were reached out to by the company's agents. These
investors were promised higher returns than what banks would generate on
amounts as small as 50 rupees per day. Optional Fully Convertible Debenture
(OFCDs) were issued in the name of Sahara India Real Estate Corporation
(SIRECL) and Sahara Housing Investment Corporation (SHICL). However, it was
claimed that the money raised through these OFCDs
was through private placements.[3] This was
the start of the long legal battle between Sahara and SEBI which highlighted
the failure of corporate governance in India.
Corporate governance is the system or
set of principles based on which a company runs. Its three main pillars are
transparency, accountability and fairness with its main aim being to ensure the
long-term benefit of the stakeholders.[4]
There was definitely a systematic failure of corporate governance in the Sahara
case. One might even suggest that no concrete steps were taken to ensure that
there was any system of principles in the first place. For starters, even
though the OFCDs were issued in the name of SIRECL and SHICL, they were sold to
investors under the name of the “Sahara Pariwar”,[5]
the significance of which will be explored later on in this paper.
The very fact that the name of these
two companies was not actively shared breaks down the pillar of transparency.
What makes it worse is that one of these firms had a net worth of merely Rs. 11
lakhs while the other was making losses. This means that neither of the companies
had the financial backing to collect crores worth of money from its investors.
The pillar of accountability collapsed when the companies did not handle the
public's money with any of the safeguards prescribed by SEBI. There was no
clear accounting of funds, its audit and the supervision of its end use. [6]
The pillar of fairness ceased to exist
when the board of directors let the red herring prospectuses contain
misstatements and untrue statements. SIRECL passed a special resolution to
raise funds by the way of private placement through unsecured OFCDs to
associates, friends, employees and other individuals who were associated with
Sahara. This was done
without giving any sort of
advertisement to the general public.[7]Promoters,
directors and auditors play a key role in ensuring that corporate governance is
carried out smoothly. However, in the pursuit of certain incentives, they can
be distracted from doing so. The promoter in this case, Mr. Subrata Roy had his
own image to maintain which would have been tarnished if he stopped the
operations of the two companies on the grounds of it being illegal. He was on
the path of becoming a brand in himself. In all likelihood, the directors of
the company did not speak out and in fact, encouraged the breach of corporate
governance probably to ensure the continuance of their tenure. As far as the
auditors are concerned, they must have wanted to continue receiving their
auditing fees even if it meant being a part of a scam of this magnitude.[8] It is
interesting to note that the RBI forced Sahara to leave its auditing firm of
twenty-five years leaving the intentions of the auditors, questionable.[9]
Sahara might have made profits in the
short run by overlooking corporate governance, however, it eventually became
liable to pay an extraneous amount. Thus, opting for unethical routes will only
result in debt for the company and it is always wise to ensure corporate
governance for long term benefits; especially in a country like India, which
rewards the companies it trusts in the long run. Cases like this one which
showcase the failure of corporate governance do not only harm the stakeholders
of that company but also have a ripple effect in the rest of that country's
market. It repels foreign investment in the Indian market. However, the
government has certainly encouraged several new provisions to ensure corporate governance.
We will discuss a few more suggestions that can be adopted to further
strengthen the application of good corporate governance in the country's
companies towards the end of the paper.
Role Of SEBI - A Guardian Of The
Indian Stock Markets
The Securities and Exchange Board of
India (SEBI) is an appointed authority in provisions within the SEBI Act of
1992, and regulates the financial markets of India. Although SEBI was initially
established as a non-statutory body, the SEBI Act of 1992 declared the same as
an autonomous body with statutory powers.[10]
The late 1970s posed great problems to the stock exchanges in India, where
numerous issues of malpractices and violation of the then Companies Act[11] had
arisen. To remedy this, the role of SEBI was modified to ensure that the
interests of both issuers and investors are adequately protected, by preventing
insider trading and fraudulent practices, regulating companies, conducting
inquiries to name a few. Further, SEBI is also competent to administer hearings
and pass judgements on any issues of breach of ethics detected on the stock
exchanges.
The Sahara case[12]
led to crucial conclusions on the nature and jurisdiction of SEBI, while
particularly considering what constitutes “Securities” within the Companies Act[13], SCRA[14], and SEBI
Act[15]. During
the pendency of the proceedings, the Supreme Court directed SEBI as an expert
body to examine the nature of an OFCD[16]
and whether it would come under ‘Hybrid Securities’ under the Companies Act. In
the current case, both firms under Sahara were unlisted and issued OFCDs to
collect money from investors for around two years and received a collection of
over Rs.17,656 crores. There was an issuance of shares to 30 million investors
while the requirements necessary for public issuance of securities were
circumvented. Sahara contended that such issuance was only given to members
associated with the companies, that is, members part of the parivar, and
therefore, must be considered as a private issuance of shares, and thus, the
matter must be dealt with by the Ministry of Corporate Affairs (MCA) and not
SEBI. Both SEBI and the Supreme Court refuted this claim and referred to
section 67(3) of the Act[17],
declaring the current offer as deemed to be a public offer. Further, the Court
held
that the company invited a public
demand for OFCDs through its issuance of Information Memorandum under Section
60B[18], which is
available with public companies only, which was also not complied with by
Sahara as they did not publish a final prospectus. While deciding upon the
same, the Court looked into the powers of SEBI to adjudicate under sections 55A
of the Companies act[19] and 11A,
11B of SEBI Act[20],
concluding that SEBI Act confers SEBI with certain unique powers to protect the
interests of investors. Since such powers do not contravene any existing law
and there exists no conflict of jurisdiction between both, and therefore, SEBI
has the power to administer any listed public companies and also those public
companies which plan to get their securities listed. Additionally, the
ambiguity surrounding these sections was addressed in the Companies Bill of
2012[21], where
the undisputed jurisdiction of investment schemes involving more than 50 people
was granted.
This judgement highlighted the
unalloyed powers of SEBI with regard to both public listed and unlisted
companies. Additionally, by way of Securities Laws Amendment Act[22] and as
stated expressly under section 24 of the new Act[23],
SEBI could now investigate and raid any entity and sign agreements with
financial regulators for information. Although this bill could not be passed,
the new provisions of the Act and the judgement of the Sahara case granted
adequate powers on SEBI to regulate Indian markets, some of which broadly
influenced the current market systems. While the intention behind such grant of
power is to ensure the stock markets are not ridiculed with instances of
fraudulent practices, a question might arise as to the scope for misuse or
misinterpretation of such powers granted.
This was precisely discussed in the
case of DLF v. SEBI[24], where
the purpose for granting such discretionary powers was looked into. Under this
case, the untimely delay by SEBI in writing the order violated the principles
of fair hearing and the reliance on FAQs as an interpretation of law or as a
binding statement must not be valid. While the matter is yet to be decided
finally by the Supreme Court, the case highlighted the need for SEBI to adhere
to rules and rely on relevant materials. While instances of the potential
misuse of powers is not a reason enough to limit the powers of SEBI in the
domain of stock markets, there is an active need to ensure that the granted
powers are not exploited or dealt with in a hasty manner.
Role Of Public Opinion And Media
It is crucial to study the social
implications that arose as a result of the Sahara fraud based on the investor’s
point of view and the regulatory framework at the time. Mr. Subrata Roy understood
his clientele, that is, small investors who had no access to banks, at a time
when no one else was willing to and fulfilled their needs through his money
schemes. He also was fully cognizant of the Indian culture and the
incorporation of the marketing strategy of Sahara – ‘The World’s Biggest
Family’ had a consequential influence over the Indian public who valued family.
Over the years, he was photographed with top politicians, actors and corporate
leaders – influencers who were respected by the public. The media, of course,
played a big role in spreading this information. It is because of all these
reasons, that he was able to garner a reputation and trust among the public who
believed that he could do no wrong.
After he had established his position,
he began to purposely engage himself in various business portfolios which had
poor corporate governance direction and regulatory frameworks. The lack of
transparency in Sahara’s business transactions and dealings is one of the
elements that contributed to its success over a brief period of time. It
certainly worked in Sahara’s favour that a substantial chunk of its investors
were villagers who were unclear of the fraud associated with this model of
business.[25]
To further expand upon the briefly
mentioned role of the media, it is first important to understand its role in
corporate governance. As the media discloses evaluations of firms and their
leaders and can broadcast this information to a huge and far-reaching audience,
it has the ability to impact the prestige of firms and firm leaders in a
positive and negative manner, both. Additionally, playing its governance role,
merely by reporting about firms’ actions and thus giving the investors a louder
voice, the media can influence firm outcomes.[26]
In the beginning, the media worked in favour of Mr. Subrata Roy and took a turn
in the opposite direction when a case was made against Sahara.
Since people in society are more
likely to not take the pain to gather the information themselves but rather
listen when it becomes available for free, the role of the media becomes even
more paramount. However, in the hunt for headline worthy news, there comes a
tussle when confidential information is involved and whether or not the source
should be revealed. This is one of the aspects that the Court dealt with in the
Sahara Judgement and observed that “the media should follow a self-imposed
restriction and should by itself know where to draw the line.”[27]
However, the Court, on discussing the
doctrine of postponement, made it clear that when, in some cases, the matter at
hand is too sensitive for the media to report on and if reported would have an
unpropitious effect on court proceedings, the court may order the postponement
of reporting by the media.
It appears that the Supreme Court has
acted with honorable intentions whilst pronouncing the judgement but over time,
the landmark judgement which vindicates the fundamental right of freedom of
speech and expression, seems to be far away from the original goal it set out
to achieve. Instead of laying down regulations to be followed by the media, the
court relied upon self-regulation which has left the field wide open and
resulted in substantial discretionary powers of the court to decide sub judice matters of postponement in
reporting.[28] This will
most likely result in confusion and excess litigation thus emphasizing the need
for incorporation of the suggestions we propose in the paper, keeping in mind
the influential role of the media.
Measures To Prevent Corporate
Frauds In India
Corporate frauds are detrimental to
the economic well-being of a country as well as its image in the international
scenario as a country with high cases of corporate frauds loses national as
well as international investors owing to the risk factor and bad reputation. As
we have already seen in this paper by virtue of the Sahara case[29],
corporate frauds not only affect the public at large but also other
stakeholders like shareholders, employees and so on.
With regards to the culprits of
corporate fraud in India, the institutions in place responsible for
punishing them are investigating and
regulation bodies such as RBI, CBI, SEBI and so on.[30]
Unfortunately, such bodies do not have specialists in the sphere of
investigation which is why most culprits are able to find their way out with
ease. This paper aims to offer a solution to this problem, while relying on the
principles of Forensic Accounting.
Under Forensic Accounting, matters of
business related with financial transactions are investigated. This helps
predict and in turn prevent possible situations of fraud.[31]
In the Indian scenario, this will be especially helpful because these days a
large number of corporate frauds involve complicated issues of Information
Technology (IT) which is an area of expertise for forensic accountants.
As mandated by the Companies Act,
2013 the corporate sector must audit accountants; the CAs, CS and CWA that are
in charge of managing accounts. These professionals are neither equipped with
the skills and knowledge expected in the workings of forensic accountants, nor
are the subjects for the same present in the curriculum In India.[32] In the
Sahara case[33] too, RBI
had to undergo as many as eleven quarterly meetings in order to allow a
forensic audit by KPMG.[34] This
delay can be remedied by having forensic accountants and viewing Forensic
Accounting as a separate profession in India. A curriculum must be put in place
for the same.
Further, other measures which can
effectively reduce corporate frauds in India are also suggested. The first
among these is the need to amend the laws which criminalize corporate crimes.
This is because when we see laws such as the Indian Telegraph Act, 1885 (ITA)
we can see how these are outdated and need to have stricter punishments. For
instance,
the maximum penalty under ITA is jail
for three years and a meagre fine of rupees one thousand only. What one must
keep in mind while looking at this is that culprits of frauds in the Telecom
sectors are booked under this act, which means that people committing frauds
worth crores are facing this almost negligent penalty.[35]
The second measure is to make
stricter provisions for bail. Culprits of high-level corporate frauds hire top
tier lawyers who obtain bail for them. In this regard the courts should follow
the judgement of Narendrjeet Singh Sahni
v/s Union of India[36],
in which the Supreme Court held that the court should not provide bail to
culprits who misplace the faith of people who have invested their entire life’s
savings with them.[37] In the
Sahara case[38] too,
despite committing fraud worth tens of crores, Subrata Roy was granted parole
within two years after which he permanently stayed out of jail by making
regular payments and fines.[39]
We could also consider the approach
followed by the United Kingdom to deal with the range of financial scandals in
the 1980s such as the collapse of the Bank of Credit and Commerce International
and the Maxwell Group. There, a body that was controlled by private players was
established and it defined corporate governance regulations and created
measures to force companies to divulge performance in accordance with
standards. It also allowed the force of the public and the media to change
practices (crucial, having discussed the significance of the role of the media
in our country).
The advantage of this body was that
it was self-regulatory and up to the body to impose penalties and thus, it sped
up the process of justice[40].
If a similar route is followed in India, there would therefore be a reduction
in the huge backlog of cases and assurance of timely investigation and trial.
Lastly, offenders in corporate fraud
cases should not be allowed to enjoy the proceeds they keep receiving even
after having committed fraud.[41] This is
why, even after paying a heavy compensation, most of these offenders continue
to live in luxury.
India has received the status of one
of the fastest growing economies in the world. Due to many regulations and
provisions mandated by law being backward and insufficient, especially in high
profile cases there is a frequent occurrence of cases involving corporate fraud
as the culprits think they can easily get away with them contrary to the view
in criminal cases. To prevent and reduce the occurrence of corporate fraud and
to instill a more serious attitude in people towards such offences, this paper
offers the aforementioned measures to be implemented in India. Though companies
may not always be recognized for being socially responsible, they must remember
that irresponsibility does not go unseen and is not without price.
Conclusion
Investors are an important part of
any company's growth and success. In a country like India where a good
percentage of the population is uneducated, they become easy targets of manipulation.
Frauds like these may limit the low-income citizen from investing in the market
as in this case too, it was the poor who bore the brunt. The government owes
its citizens strong mechanisms to ensure financial regulation. Despite Sahara's
size and the scale at which it was operating its schemes, it took SEBI two
years to get acquainted with the irregularities. This highlights the lack of
interaction between the different financial sector regulators. The Financial
Stability and Development Council is a regular forum for such interactions;
however, it concentrates only on macro matters. More interaction on the
grass-root level has to be encouraged.[42]
The reliance of the Indian economy on
the corporate sector is only going to increase. Foreign investment too can only
be attracted if ironclad financial regulations are set in place. The need to
hold the big players of the corporate sector accountable and ensure that they
can't bypass regulators is the need of the hour.
Article Information
DEFRAUDING SHAREHOLDERS LIMITATIONS OF CORPORATE GOVERNANCE IN INDIA (By-Muskan Kuchhal, Ranvita Rao Juvvadi, Rishika Pandey & Sivani Lakshmi Madugula)
Authors: Muskan Kuchhal, Ranvita Rao Juvvadi, Rishika Pandey, Sivani Lakshmi Madugula
- Journal IJLRA
- ISSN 2582-6433
- Published 2022/07/16
- Volume 2
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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