CONTROVERSY

L'affaire Tata Finance

The questions surrounding the affairs of Tata Finance Limited that have come up in the context of the withdrawal of a report prepared by the auditing firm A.F. Ferguson, pitch the house of Tatas into a scandal unprecedented in its history. Issues that concern the role of the auditing profession in corporate governance and the use of corporate subsidiaries to obfuscate accounts also come to the fore.

V. SRIDHAR
ANUPAMA KATAKAM

"It takes a lot of trust to be
appointed a leader. I see
greatness of character in this
admission that once in a while
things will and do go wrong.
Don't push it under the carpet;
deal with it. Very few large
corporations in India do
this in practice."

- R. Gopalakrishnan,
executive director, Tata Sons.

THE stench of scandal is emanating from the house of Tatas, one of the biggest and oldest industrial conglomerates in India. Barely months after its actions in the wake of its takeover of Videsh Sanchar Nigam Ltd (VSNL) raised a controversy, the role of its non-banking finance company (NBFC), Tata Finance Ltd. (TFL), has pitched the group in a scandal unprecedented in its history. The controversy is not confined to the group. The auditing profession, already under a cloud in the wake of the Enron saga, has been dragged into the scandal when one of the oldest audit firms in India, A.F. Ferguson (AFF), withdrew a special report prepared for the Tatas by one of its senior partners in early August.

Multiple regulatory and professional bodies are now investigating the affairs at TFL, and there are people who doubt whether anything that will give confidence to investors and public opinion at large will emerge from their efforts. The Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), the Department of Company Affairs (DCA), and the apex body of the auditing profession, the Institute of Chartered Accountants of India (ICAI), are all investigating TFL within their regulatory frameworks.

PAUL NORONHA
Bombay House, the head office of Tata Sons in Mumbai.

Two elements of the TFL controversy are reminiscent of l'affaire Enron: the role of the auditing profession in corporate governance, and the role of corporate subsidiaries in obfuscating accounts. Although there were sporadic media reports last year about the goings-on at TFL, the controversy peaked when AFF withdrew its 904-page report on August 2, prepared by its partner in charge of the special assignment, Y.M. Kale. AFF also announced that it was sacking Kale, an auditor who serves on the committees of several regulatory agencies and government bodies.

Kale was asked to inquire into the affairs at TFL and its subsidiaries between 1999 and 2001. He commenced his work in June 2001 and submitted an interim report to the Tatas within a month. The final version was submitted in April 2002. By July, extracts of the report appeared in the media but the controversy exploded when AFF announced that it was withdrawing the report and returning Rs.95 lakhs that it had earned in fees from the Tatas. It said that the chairman of TFL had "lost confidence" in Kale. In its press release issued on August 8, AFF also expressed reservations about Kale's "past conduct" and stated that its partners had "lost faith" in Kale, who joined AFF three decades ago.

In a dramatic development on August 19, officials of the Registrar of Companies (RoC) in Mumbai, acting on behalf of the Department of Company Affairs (DCA) in Delhi, commenced search and seizure operations at six premises of not only A.F. Ferguson but also of AF Ferguson & Associates, which deals with the consulting business of Ferguson. The DCA operation, spread over three days, was conducted after invoking rarely used provisions under Section 234-A of the Companies Act. The legal clause is specifically meant to enable the RoC to act if, in his perception, there is a fear that documents may be "destroyed, mutilated, altered, falsified or secreted".

VIVEK BENDRE
Dilip R. Pendse, former managing director of TFL.

In a press release issued on August 20, the DCA said that it filed a petition in the Mumbai High Court because it received reports that important documents pertaining to TFL were being shredded. Although the seized documents have to be returned in 30 days, the RoC is at liberty to make copies of the documents. The DCA also said that the TFL premises would be searched if the documents revealed any "connection" between the auditing firm and the Tata company. ICAI functionaries have termed the DCA action "unprecedented". The ICAI is in the process of examining a case of professional misconduct against AFF. According to ICAI president Ashok Chandak, a case of gross negligence can be considered after a copy of the withdrawn report is received by the ICAI. Incidentally, Kale was president of the ICAI during 1995-96 and was elected to its central council for five terms.

TFL, by the Tatas' own admission, is believed to have run up losses amounting to nearly Rs.500 crores by June 30, 2001. That in itself is not something shady. However, the manner in which the company ran losses in order to protect its other group entities is what lies at the centre of the controversy. At the heart of the matter is the functioning of a till recently unknown TFL subsidiary, Niskalp Investment & Trading Company Ltd. TFL financed its subsidiaries through inter-corporate deposits (ICD), which measure, according to critics, was aimed at protecting the business interests of other companies in the Tata stable.

Niskalp was also an active player in the share market and made substantial profits in the stock market boom, until its collapse in 2000. Between March 2000 and March 2001, TFL's exposure to Niskalp increased sharply from about Rs.220 crores to nearly Rs.500 crores. By the Tatas' own admission in mid-2001, the capital adequacy ratio (CAR) of TFL was way below the RBI-prescribed 12 per cent during the entire period between September 1999 and March 2001. The device of ICDs was adopted by the TFL management to get around the statutory requirement, although the RBI norms specify that ICDs are to be netted out while computing CAR requirements. While these are the key elements of the happenings at TFL, the controversy centres on who takes the blame for the scandal at TFL. In 2001, TFL decided to "desubsidiarise" Niskalp, allegedly in order to protect its own balance sheet by not having to disclose the losses of its subsidiary any more.

The Tatas have sought to pin the blame on TFL's former managing director Dilip R. Pendse. Since last year, the group has filed a series of complaints and cases against Pendse. These include insider trading and other stock market-related complaints filed before SEBI, complaints of criminal conduct filed before the Mumbai police, and a civil suit in the Mumbai High Court alleging that Pendse caused losses to the tune of Rs.424.50 crores. The Tatas have also filed a complaint to the RBI, alleging violations of RBI regulations by Pendse.

In a full-page advertisement issued in leading dailies (particularly the business press) soon after Kale was dismissed, the Tatas claimed that the Kale report did not constitute a statutory audit and denied that it had "arm-twisted" AFF into withdrawing the report. The Tatas also denied that they had dismissed the report because it was "inconvenient". They claimed, instead, that Kale had adopted a "biased/partial approach" by selectively scrutinising evidence. The Tatas said that the group was pumping Rs.500 crores into TFL to "revitalise" it and that this was "an unprecedented step in Indian corporate history". The Tatas produced their own reasons for dismissing the report. In particular, the advertisement stressed that Kale had chosen to disregard "a vital statement of an ex-employee alleging that the former managing director of TFL (Pendse) and others asked him to undertake certain fictitious transactions which amounted to offences of falsification of accounts, use of false documents and cheating." The Tatas claimed that AFF produced this "crucial piece of evidence" after Kale was dismissed.

However, a few days later, this claim about the "evidence" was discredited when a financial daily published a letter purportedly written by the "ex-employee", Prakash B. Karyekar. It turns out that Karyekar was a former company secretary and chief accountant at Niskalp. In his letter to Kale, dated August 14, 2001, Karyekar retracted his earlier statement, issued five days earlier, claiming that it was "factually incorrect". He is also believed to have stated that this was because "it was prepared under tremendous tension, with a disturbed frame of mind due to shock and also under threat of an arrest." Karyekar's subsequent statement takes the sting out of the Tatas' main objection to the Kale report - that it was biased and based on selective summoning of evidence.

More drama was in store as Pendse went to the Mumbai High Court to file his counter-affidavit, in response to the civil suit filed by TFL on May 17, 2002 claiming damages from Pendse to the extent of Rs.424.50 crores. In his nearly 90-page response filed on August 16, Pendse countered that all the illegal transactions attributed to him were "in fact collective business decisions of the entire Board" of TFL. In addition, he claimed that most of the decisions attributed to him were implemented with the knowledge of several other persons, including Ratan Tata (executive chairman of Tata Sons) and N.A. Soonawala (director of Tata Industries, and financial adviser to the Tata Group). Tata Sons and Tata Industries are the two main holding companies of the Tata Group. Pendse also pointed out that Freddie Mehta, the then TFL chairman, J.E. Talaulicar, chairman of Niskalp and a board member of Tata Sons and Kishore Chaukar, TFL vice-chairman, were all part of the decision-making process at TFL. In saying this he was implying that they not only knew about the happenings but also approved the decisions that he took as managing director.

PAUL NORONHA
Ratan Tata, Chairman of the Tata group

Soon after Pendse's claim was reported in the media, Ratan Tata said that he learnt about the problems at Niskalp only in April 2001, when Pendse called him in Dubai. Pendse retorted by saying that he used to meet Ratan Tata every Wednesday for 30 to 45 minutes to discuss the affairs of the group. Pendse, who was associated with the Tatas for almost 25 years, maintained that he used to provide Freddie Mehta with daily net asset value (NAV) statements of Niskalp since November 2000 and that Mehta's "hands on" style of functioning meant that he reviewed the investment portfolio of the TFL subsidiary on a regular basis.

Pendse, whose term as managing director ended on May 31, 2001, also made the dramatic assertion that Chaukar tore off page 60 of a folder titled "Review of Operations" at a meeting of the TFL board on April 30, 2001. He claimed that the particular page "clearly reflected" Niskalp's borrowings from TFL at Rs. 433 crores. Pendse stated that Chaukar not only tore off page 60 but directed others at the meeting to do so. He claimed that Chaukar justified his action by claiming that it was aimed at protecting other members of the board.

The Tatas filed a first information report (FIR) against Pendse with the Mumbai police on August 6, 2001, alleging criminal breach of trust. Ironically, Freddie Mehta had lavished praise on Pendse at the 16th annual general meeting on November 22, 2000, for having enabled Niskalp to contribute a hefty dividend to the parent company.

In the entire TFL drama, only Kale appears to have come out unscathed. Extracts of the report leaked to the media indicate that he was unwilling to take sides during his investigations. His insistence on obtaining a holistic picture, without allowing himself to be hustled into putting out a pliable report, probably caused it to be trashed by the Tatas and AFF.

Kale is also reported to have concluded that the ICDs, which rotate moneys in circular deals, were probably conducted to generate book profits or to "merely facilitate regulatory compliance". He is also reported to have made critical remarks about the quality of corporate governance at TFL and its subsidiaries between 1999 and 2001.

The Kale Committee is reported to have found Talaulicar guilty of insider trading. He sold one lakh shares of Tata Finance at Rs. 69 a share on March 30, 2001, just before the company's rights issue opened. When the issue opened the price of the shares went down to Rs. 40 apiece. The report said that Talaulicar being an insider had prior information about Niskalp's financial position and his selling of the shares was tantamount to action based on privileged insider knowledge. SEBI has been investigating the case and is reported to have concurred with the Kale report on this matter. However, Talaulicar remains on the board of Tata Sons.

Speaking to Frontline, a senior auditor working for one of the big audit firms remarked: "Kale is a well-respected professional in the accounting fraternity. The question is whether he was made a scapegoat, whether AFF was pressured into removing him, and what kind of pressure was he under. No one knows. Yet, for someone like him to be removed, it is possible that some pressure was applied in the situation." There have also been scarcely veiled references in the auditing fraternity to the fact that AFF handles the accounts for several Tata companies and that this might have had a bearing on AFF's decision to withdraw the report.

Kale, who is on the International Accounting Standards Board, is a former Chairman of the ICAI's accounting standards board and chairman of the ICAI audit practices committee. He is a member of the National Drug and Pharmaceutical Development Council and the Working Group on drug pricing policy. He serves on RBI and SEBI committees.

A source close to Kale told Frontline that Kale had expected to become managing partner of the AFF in two years. This source said: "The Tatas wanted to peg a few ex-TFL employees... Dilip Pendse being one of them. But Kale pointed out that there were others too who were involved. I do not think AFF thought the report would boomerang on it. But people have been congratulating him on taking a stand against such a big organisation."

Several auditors told Frontline that a report of such significance could not have been submitted to the Tatas without an "in-house peer review".

The Mumbai Police completed its investigations into the charges a few weeks ago and has submitted the report to the court. A senior official of the Mumbai Police's economic offences wing told Frontline in that it was obvious that the "TFL board knew everything that Pendse did. None of these transactions could have taken place without their connivance. All the minutes of the board meetings have been signed. We all know the truth but no one wants to do anything."

Meanwhile, the ICAI is seeking more suo motu powers so that it can summon evidence against audit firms and auditors.