Investors Protection: Legally dishonest
R Balakrishnan | 27 February 2014

The government wants to restore investors’ confidence in the stock markets. How can I have confidence when the government breaks the rules to give undue advantage to the powerful? In the past, the government forced promoters to steal by restricting directors’ salary to ridiculous amounts like Rs3,000 a month. Now, they have legalised robbery by giving promoters the shelter of legal enactments, to rob a company in many ways.

The Companies Act, in its wisdom, had originally provided that when a public limited company wished to issue new shares, it was mandatory to offer it first to the existing shareholders. The original Act was drafted with a view to ensuring that promoters did not cheat the other shareholders. This stopped promoters from issuing shares to themselves when the prices were low or issue shares to others. This section (original Section 81-1) virtually embodied the spirit of true joint stock companies and the principle that every shareholder is an owner and should be treated equally.

Alas, honesty had to give way. The government, at the behest of the industrialists, amended the law to give freedom to the promoters to issue shares to whoever they chose, without bothering about the other shareholders. All it needed was a ‘special resolution’. A three-fourths majority is required, but when promoters own a large chunk, this becomes a formality. It would have been ideal if the law said that it needed the approval of three-fourths of the shareholders who are not promoters.

This one amendment to Section 81 has ensured enormous amount of wrongdoing. Fairness demands that the first offer be made to the existing shareholders and then be passed to the others if they say no. Here, the promoter cuts off the other shareholders without offering even normal courtesies, forget what is fair. The irony can be seen from the sequencing of the legislation itself. Section 81 (1) says that you have to be fair. Section 81(1A) says that you can rob the rest of the world. It is possible to argue that most placements under Section 81(1A) happen at prices above the market price.
Maybe, but that is no excuse to not offer it to the existing shareholders. All it needs is a simple rights issue that is open for 15 to 30 days and then, at the end, offer the unaccepted shares to the intended person. And if you want to offer it to a ‘strategic’ investor, then put it to vote and surely no rational shareholder will have any reason to stall it.

The other vexing area where shareholders get the short-shrift is when the promoter increases his shareholding. First, he does it through preferential issue of ‘warrants’ to himself. This is totally unfair. It is like buying shares on credit! I am sure every other shareholder would also like to have the same privilege of paying 25% today and the rest after a year. If the promoter wants to up his holdings, he is free to buy from the secondary markets. Why should he get anything preferentially? As it is, he takes a few crores in salaries irrespective of the returns to the shareholders. And uses company property as his personal. This is another legally sponsored abuse of the minority shareholder.

The ultimate abuse is when the owner ‘decides’ to do a ‘buy-back’ of the shares. Here, the promoter is cleverly using company money to reduce non-promoter shareholding and thereby increase his own shareholding. I see companies sitting on mountains of debt resorting to this route. What the promoters do is to sell part of their shares when prices rise and then resort to one of these legally permitted abusive routes to restore their shareholdings.

The government and the regulators are paying lip service to the so-called ‘minority’ shareholders. Instead of indulging in foolish legislation to encourage ‘corporate social responsibility’ (abdicating its own responsibility and robbing a shareholder without his permission), if they focused on setting right the wrongs that have been sponsored by them, investors may come back.

Then there is the other vexing issue of disclosure. While everyone talks of transparency, company balance sheets are hiding more than they ever used to, legally. The changes in accounting (sub)standards with the active connivance of the Institute of Chartered Accountants of India (ICAI) has been the single most damaging factor, when it comes to corporate governance. In the name of ‘green’ movement, companies are getting away with murder. This ‘green’ movement is really a red movement. As a shareholder, you get an email saying that the company will ‘presume’ that you do not require a physical copy of the annual report. I can barely read the full page of a digital report on my screen. I need magnifying glasses. I cannot refer to two different pages at the same time as I could do when I held a physical annual report. As it is, the annual report has been ‘abridged’ and subsidiary companies’ accounts are not available either in print or on the company’s website. The Securities and Exchange Board of India and the ministry of company affairs (MCA) have been willing accomplices in this. They should have ensured that digital reports should have been an option instead of a default practice. Surely, the cost of sending out so many annual reports is far less than the amount of perquisites promoters and the top management enjoy. In the name of saving the environment, companies are skimping on giving out information to their owners.

The playing field is tilted against minority shareholders in another way. It has become a common practice of companies to have ‘analyst meets’ with brokers with whom they share more information than with their own shareholders. They give ‘guidance’ on the profits to brokers, but not to the shareholders. How come analysts have more information than a shareholder can ever hope to have? If a company cannot even disclose to its shareholders what it sells and how much of each product to its shareholders, how is it that the analysts are able to provide all of that information in their ‘research’ report? We have imported this from Wall Street; SEBI and MCA should stop this.

SEBI has also actively contributed to hiding information. They had started a system called ‘EDIFAR’, modelled along the lines of EDGAR system of the US, which provides all corporate information in the public domain, in a standard format. In a criminal waste of money and complete abdication of responsibility, successive SEBI chairmen have allowed this to become defunct. The mutual fun(d) industry, instead of providing oversight, is washing its hands off by trying to make a trade body like the Association of Mutual Funds of India into a self-regulatory organisation (SRO). Which SRO, that is a trade body, will ever care for the small investor?

So, the investor is not only being taken for a ride by companies and market intermediaries all the time; they are damned by the regulators and the lawmakers too. But investors have learnt all this the hard way. This is precisely why they stay out of the market and all the efforts of the various government agencies to promote financial literacy and education will come to naught. People just don’t trust the system. In fact, the more financially literate they become, the less they will engage with risk products.

Unless you are so savvy that you can understand corporate India, do not venture into investing in stocks. They are not for the common man.