By Jayant M. Thakur
Chartered Accountant
Background
and summary of SEBI order
SEBI
has passed an interim order in case of Fortis Healthcare Limited (Order number
WTM/GM/IVD/68/2018-19 dated 17th October, 2018). It has recorded
preliminary findings of accounting and financial frauds whereby, inter alia,
about Rs. 400 crore of company funds that were lent to related parties and
which are now lost.
The manner of carrying out
such alleged fraud as described in the SEBI order makes an interesting reading.
It makes allegations of false accounting entries, use of allegedly intermediary
entities to make related party transactions without necessary approvals or
disclosures, etc. This raises obvious and grave implications of role and
liability of the Board, the Audit Committee, the auditors, the Chief Financial
Officer, the independent directors, etc.
SEBI has passed interim
directions against specified promoter entities ordering, inter alia,
return of monies with interest. It has given them a post-order opportunity of
hearing and also initiated detailed investigation.
While there have been other
transactions over which concerns have been raised in the order, the loans of
about Rs. 400 crore to promoters or promoter owned entities could be focussed
on here. There is a complex background to these loans but, essentially, it
appears that Fortis granted loans aggregating to about Rs. 400 crore (final
balance) eventually to three companies through its wholly owned subsidiary.
These three companies were not ‘related parties’ when such loans were first
granted but later on, the SEBI order says, became promoter owned entities.
However, the interesting aspect was that an attempt was made not to show the
amount of such loans as receivable at the end of every quarter. Instead,
circular bank transactions were made for repayment and giving back of such
loans. Thus, on the last day of each quarter, such loans were shown to have
repaid and then paid back on the next day. Thus, as at the end of each quarter,
for several consecutive quarters, the loans did not appear as outstanding.
Even this, the SEBI order
alleges, was false/fake. It was not even as if the loans were first repaid and
then lent again. There was back-dating of entries. The borrowers were first
paid the monies which were then used that money to repay the original loans.
Even these transactions really took place after the end of the quarter. But the
accounting records were made to show as if the repayment of loans happened on
the last day of the quarter.
This continued for nearly
two long years – repeated over several quarters – till it so happened that even
this token repayment/relending could not be made. The auditors of the company
apparently refused to sign off on the accounts for that quarter. This matter
was reported in media and SEBI promptly initiated action. It called the
auditors for discussion and carried out a preliminary examination of the
details. The preliminary finding was that the amount of about Rs. 400 crore had
actually reached the promoters/promoter controlled entities through the three
companies. These amounts were partly used to repay borrowings of the promoters
and partly retained by a promoter controlled entity. It also appears that this
amount has been lost and provided for as a loss.
Based on these preliminary
findings, SEBI has passed an ad interim order issuing several
directions. It has asked the company to recover these monies. It has asked the
specified promoters and certain entities controlled by them not to transfer any
assets till such amounts are repaid. It has also asked specified persons not to
be associated with the company.
It has also initiated a
much more detailed investigation into the affairs of the company in this
matter. It has also given a post-order opportunity of hearing to the parties.
In particular, SEBI has also stated that it will be looking into the role of all
parties including the auditors in this matter. I would also expect that,
considering the preliminary findings, questions may also be raised on the role
of the Audit Committee, Chief Financial Officer, etc.
Other questions have also
arisen. While, apparently, the three companies to whom loans were given were
not ‘related parties’ as on the date of grant of such loans, such companies
served merely as a conduit to pass on the amounts to the promoter entities.
Further, even these three companies, owing to some restructuring, became
related parties. The compliance of requirements of approval of related party
transactions for such loans or for the disclosure of such transactions and
balances were allegedly not made.
SEBI thus made preliminary
findings of violations of multiple provisions of law. And accordingly, has
passed interim directions and will investigate the matter further and pass
final orders, if any.
Let us discuss in more
detail what could be the implications.
Analysis
of the case in terms of implications assuming the facts stated are true
Let us assume that the
facts stated in the Order are true. It is also to be noted that this is a
preliminary ex-parte order. The parties accused of the violations have yet to
present their case. Even SEBI is yet to make a detailed investigation. But yet,
it would be worth examining what are the implications at least on the
hypothetical basis that all these facts and findings as stated therein are
true. What then would be the specific violations of law, who can be held liable
and what would be the punishment? The following paragraphs make an attempt to
do this.
Nature
of transactions and implications under various laws
Essentially, the
transactions related to loans given and, apparently, that too on interest rates
that sound to be reasonable. On the face of it, such transactions would not be
irregular or illegal. However, as seen earlier, there are some unique features
of the present case. The loans were given to certain parties who promptly
handed over the monies to certain related parties. SEBI alleges that the
intermediary entities were used only to hand over the funds to the related
parties and thus the transactions were related party transactions.
Related party transactions
require disclosure that they are so, disclosure of the related parties, etc.,
who are source of such relation and, importantly, certain approvals by the
Audit Committee, shareholders, etc.
According to SEBI, these
‘repayment’ and ‘relending’ transactions at the end of each quarter were effectively
sham. In view of this, then, these were accounting irregularities, false
disclosures and even fraud. These too would result in serious implications
under the Act and Regulations. The consequences, as we will see later, can be
in several forms ranging from debarment to prosecution.
However, let us see who can
be said to be liable if such frauds, wrongful disclosures, non-compliances,
etc., have taken place.
Liability
of the Executive Directors
Transactions of such size
and nature can be expected to have been initiated by Executive Directors (i.e.
the Managing/Wholetime Directors). Unless this presumption can be rebutted,
primary blame may fall on them. It would be also their duty to inform the
various other persons involved such as Audit Committee, Board, etc., of the
real nature of the transactions. Thus, the primary liability and action for
non-compliance may fall on them first.
Liability
of CFO
The Chief Financial Officer
(“CFO”), being in charge of accounts and finance, is the other person who too
could be expected to know – or at least inquire into – the real nature of such
large transactions. This is more so considering that there were entries of
repayment on last day of each quarter and relending on the next day that SEBI
found as sham transactions.
Here again, unless the CFO
rebuts and shows he was not at all aware or involved, he would again be the
first group of persons against whom proceedings could be initiated.
Liability
of internal/statutory auditors
The nature of transactions
and the manner in which they are carried out could validly raise a concern that
the auditors should have been able to detect that there is something seriously
irregular here. Here, again, unless they are able to rebut this presumption,
they could face action.
Liability
of Audit Committee
The Audit Committee can be
expected to go into matters of accounts and audit in more detail than the Board
but less than the executive directors, internal/statutory auditors and the CFO.
They are expected to examine the accounts and matters of compliance more
critically. However, they are to an extent, also subject to what is presented
to them by such executives and auditors. Unless they can show that they had
critically examined the accounts and also they were not informed of anything
irregular in the transactions, they may be subject to action.
Liability of Board and independent directors
Primarily, it can be argued
that the Board and independent directors would examine what is placed before
it. If the accounts, on the face of it, do not show anything irregular, that no
information is passed to them about irregularity in the transactions and that
they have been otherwise diligent, they may not be liable for such defaults.
Liability
of others including Company Secretary
The authorities may examine
the facts and critically examine the role of the Company Secretary and other
executives to ascertain whether they could have been aware of the transactions
and even be involved in the violations. If there is a positive finding, they
too may be subject to various adverse actions.
Implications
of the violations
The findings, as presented
and if assumed to be found to be finally true, indicate violation of multiple
provisions of the Act/Regulations. The accounts are not truly/fairly stated.
There are false statements made in accounts. The provisions relating to related
party transactions including obtaining of approvals, making of disclosures,
etc., have not been complied with. The transactions are in the nature of fraud
and thus may result in serious action under the Act/Regulations.
The authorities including
the Ministry of Corporate Affairs and SEBI would have several powers to take various
adverse actions against the guilty persons. They can debar the auditors,
directors, CFO, etc., from acting as such to listed companies and other persons
associated with capital markets. They can pass orders of penalty and even
disgorgement of fees earned. They can initiate prosecution. The parties may be
required to ensure that the monies are repaid (or they pay the monies
themselves) with interest.
New
powers proposed by SEBI
As has been discussed
earlier in this column, SEBI has recently proposed amendments of several of the
Regulations whereby it has sought powers directly on Chartered
Accountants/auditors, valuers, Company Secretaries, etc. The amendments
provided for specific role of care and other duties by such persons and empower
SEBI to take action directly on such persons if they are found wanting in
performance of such duties. Representations have been made against these
amendments for various reasons including for encroachment powers of other
authorities, making such powers too wide, etc.
However, cases such as
these could make the argument of SEBI even stronger that it needs such powers
to be able to punish errant persons involved so as to restore the credibility
of capital markets.
Conclusion
Such cases are rightly
cause of worry whether the system is strong enough to prevent such things from
happening or at least catch such violations well in time. Further, the
detection and punishment too has to be swift and strong so as to act as
deterrent to others from doing such things.
In the present case, if the
findings are indeed finally held to be true, there has been no prevention and
no timely detection. It appears that the monies may have been lost at least for
now. It will have to be seen whether the action of SEBI is swift and effective
to recover the monies and also punish the perpetrators so as also to act as
deterrent for others.
