Ig­no­rance and ap­a­thy be­hind the NPA prob­lem

Mint Asia ST - - Views Theirview - Deep Narayan

Since 2011, the au­thor es­ti­mates that close to Rs4 tril­lion of share­holder value was eroded when the stock price of non-per­form­ing as­sets (NPA) and stressed com­pa­nies fell by 95% to 99% from their pre-de­fault days. This mas­sive ero­sion of share­holder value is a di­rect out­come of a sys­tem-wide cor­po­rate gover­nance fail­ure. Specif­i­cally, it refers to the fail­ure of the de­faulted com­pany’s man­age­ment and board to promptly dis­close the com­pany’s de­fault to the ex­change.

To the ex­tent that a debt-ser­vic­ing de­fault can po­ten­tially erode equity value, in terms of share­holder im­pact it ranks in the same cat­e­gory as merg­ers/ ac­qui­si­tions.

The ab­sence of prompt dis­clo­sure is a dis­ser­vice to in­vestors.

Mi­nor­ity share­hold­ers’ morale was boosted when on 4 Au­gust, the Se­cu­ri­ties and Ex­change Board of In­dia (Sebi) man­dated that from 1 Oc­to­ber, listed com­pa­nies are to re­port “de­fault” in ser­vic­ing a bank loan within 24 hours of the de­fault. How­ever, share­hold­ers’ eu­pho­ria was short-lived, as on 29 Septem­ber the reg­u­la­tor an­nounced an in­def­i­nite de­fer­ment in im­ple­men­ta­tion of the move. This piece ar­gues that even with­out this man­date, the board of di­rec­tors (BOD) of listed and de­faulted com­pa­nies still re­main an­swer­able to the mi­nor­ity share­hold­ers for non-dis­clo­sure of crit­i­cal in­for­ma­tion about their com­pany’s de­fault. In fact it may be ar­gued that even un­der the ex­ist­ing rules of Sebi and com­pany law, at least some BOD of de­faulted com­pa­nies may be found neg­li­gent and it is a sur­prise that till date no class-ac­tion suits have been ini­ti­ated against some of them.

‘Ma­te­ri­al­ity’ of de­fault im­plicit in LODR

The orig­i­nal List­ing Obli­ga­tion and Dis­clo­sure Re­quire­ment (LODR), does have clauses such as “The com­pany should en­sure timely and ac­cu­rate dis­clo­sure on all ma­te­rial mat­ters in­clud­ing the fi­nan­cial sit­u­a­tion, per­for­mance, own­er­ship, and gover­nance of the com­pany.” Fur­ther, when Sebi en­hanced the LODR in Septem­ber 2015, it pro­vided an over­ar­ch­ing def­i­ni­tion of “ma­te­ri­al­ity” by stat­ing “Ev­ery listed en­tity shall make dis­clo­sures of any events or in­for­ma­tion which, in the opin­ion of the board of di­rec­tors of the listed com­pany, is ma­te­rial”.

Fur­ther it pro­vided guid­ance on what may con­sti­tute a ma­te­rial event: (a) “the omis­sion of an event or in­for­ma­tion, which is likely to re­sult in dis­con­ti­nu­ity or al­ter­ation of event or in­for­ma­tion al­ready avail­able pub­licly;”(b) “the omis­sion of an event or in­for­ma­tion is likely to re­sult in sig­nif­i­cant mar­ket re­ac­tion if the said omis- sion came to light at a later date”.

The BOD of de­faulted com­pa­nies should have known, if not from cor­po­rate fi­nance 101 text books, by ob­serv­ing global and In­dian mar­kets that stock prices crash by 95% to 99% when in­for­ma­tion of debt/loan de­fault reaches the mar­ket. Given the LODR’S guid­ance of ma­te­ri­al­ity and the an­tic­i­pated com­pe­tence level of re­puted BOD, it’s a sur­prise that they failed to promptly share de­tails of the de­fault with share­hold­ers.

Of course one may ar­gue that a BOD may not have ac­cess to in­for­ma­tion on whether the com­pany was de­fault­ing on any fi­nan­cial obli­ga­tion. How­ever, as per LODR, the manda­tory list of min­i­mum in­for­ma­tion that is sup­posed to be placed be­fore the BOD is sup­posed to in­clude “any ma­te­rial de­fault in fi­nan­cial obli­ga­tions to and by the listed en­tity, or sub­stan­tial non-pay­ment for goods sold by the listed en­tity.” If the man­age­ment has been hid­ing this in­for­ma­tion from the board, it’s an­other gover­nance lapse. BOD neg­li­gent or in­com­pe­tent If the BOD failed to iden­tify de­fault as a ma­te­rial event then ques­tions may be raised on their com­pe­tence. How­ever, if they failed to en­sure that the in­for­ma­tion promptly reached the ex­change then it may be an is­sue of neg­li­gence. The Septem­ber 2015 LODR en­hance­ment ar­tic­u­lated the re­spon­si­bil­i­ties of the board as:

The board of di­rec­tors and se­nior man­age­ment shall con­duct them­selves so as to meet the ex­pec­ta­tions of op­er­a­tional trans­parency to stake­hold­ers.

En­sur­ing the in­tegrity of the listed en­tity’s ac­count­ing and fi­nan­cial re­port­ing sys­tems, in­clud­ing the in­de­pen­dent audit, and that ap­pro­pri­ate sys­tems of con­trol are in place, in par­tic­u­lar, sys­tems for risk man­age­ment, fi­nan­cial and op­er­a­tional con­trol.

Over­see­ing the process of dis­clo­sure and com­mu­ni­ca­tions.

It may be ar­gued that non-dis­clo­sure of the event of de­fault re­flects poorly on op­er­a­tional trans­parency and in­tegrity of a re­port­ing sys­tem with re­spect to risk man­age­ment and fi­nan­cial con­trol. This shows that the BOD may not be act­ing on the lines ex­pected un­der LODR. Ap­a­thy and ig­no­rance of mar­ket While much con­jec­ture had been made of why Sebi re­versed its 4 Au­gust cir­cu­lar, lit­tle has been pub­licly dis­cussed on whether the reg­u­la­tor can take ac­tion against de­faulted com­pa­nies for non-dis­clo­sure of de­fault in­for­ma­tion even un­der ex­ist­ing LODR with re­spect to non-dis­clo­sure of ma­te­rial in­for­ma­tion about de­fault.

De­spite the fact that the Com­pa­nies Act 2013 al­lows share­hold­ers to file class-ac­tion suits, none of the com­pa­nies with bad loans has been sued for neg­li­gence in duty for non-dis­clo­sure of ma­te­rial in­for­ma­tion de­spite share­hold­ers ex­pe­ri­enc­ing mas­sive losses. It ap­pears that in­com­pe­tent boards thrive un­der ig­no­rant, ap­a­thetic in­vestors.

Re­spond to this col­umn at views@livemint.com

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