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When lucre lures the best

One of the disturbing aspects of the Tata Finance affair is that even as reputed a group as the Tatas succumbed to the temptations that the speculation promoted by financial liberalisation holds out. This is how liberalisation is refashioning capital.

THE Tata Finance Limited controversy, which is now more than a year old, is turning murkier by the day. In the most recent round of the battle between the current top management of the Tata group and a small bunch of erstwhile trustworthy directors, Dilip R. Pendse, former managing director of TFL, has gone on record to say that Ratan Tata, executive chairman of Tata Sons, was aware of the violations for which he is being made the scapegoat.

Tata Finance Ltd (TFL) is a non-banking finance company (NBFC) that belongs to the Tata stable. Even as recently as March 2000, TFL was predominantly involved in the hire-purchase business, with financing of purchases of commercial vehicles and cars accounting for more than 85 per cent of its business. This was a natural outgrowth of the presence of the group in the automobile sector, and close to a third of Telco's sales was reportedly being financed by TFL.

By this time, however, the lure of quick profits that the financial sector seemed to offer, had resulted in plans to convert TFL into a financial supermarket with interests in housing finance, foreign exchange transactions, merchant banking, credit card issuance and retail banking. To that end it had tied up with TD Waterhouse Inc, a securities firm, and American Express, and created or acquired a number of subsidiaries. These moves, under the leadership of Pendse were seen as the beginning of the refashioning of what was already one of the largest NBFCs in the country into a universal bank in keeping with worldwide trends.

Unfortunately, TFL's newfound aggression put it on a path where it chose to violate regulatory norms in search of size and quick profits. The path involved, among other initiatives, the transfer of large sums of capital to subsidiary or related companies such as Niskalp Investment and Trading Company Ltd and Inshaallah Investments Ltd (IIL). Of these the link with Niskalp proved the most damaging. Using funds borrowed from Tata Finance, Niskalp made investments in the stock markets. This strategy seemed to have worked in the financial year 1999-2000, when Niskalp made a profit because the secondary markets were doing well. But that profit turned into a large loss in 2000-01, when most of Niskalp's trade proved to be loss-making.

While the exact nature of Niskalp's investments is not known since it is a private limited company, its impact on TFL became clear when the latter's accounts for 2000-01 (financial year ending June) showed a loss of Rs.395.6 crores as compared with a profit of Rs.56.8 crores during 1999-2000. According to reports, the net loss was on account of a one-time extraordinary provision of Rs.315 crores against transactions in the form of loans or investments in affiliates. This was in addition to a provision of Rs.72 crores made towards non-performing assets and diminution in the value of investments. The extraordinary items and contingencies included provision for exposure to Niskalp of Rs.266.67 crores, provision for exposure in associate companies of Rs.44.04 crores and provision for estimated permanent diminution in the value of long-term investments of Rs.24.97 crores.

The problem is not just that TFL had burnt its fingers by engaging in immature transactions that were in part violative of regulatory norms. The image of the Tata group has also been tarnished by the fact that it tried to: (i) use the company IIL, in which TFL held a 48 per cent stake and its internal auditors were directors, to trade in TFL shares with funds provided by TFL and other Tata companies, in gross violation of the guidelines of the Securities and Exchange Board of India (SEBI); (ii) hold a couple of individuals from within its top management stable individually responsible for the actions of TFL, despite the firm's direct connection with Tata Sons, the apex holding company of the group; and (iii) de-subsidiarise Niskalp in order to cover up the consequences of these actions from the regulatory authorities and ordinary investors.

At the end of March 2000, IIL had TFL internal auditors Dinesh Bahl and Anu Bahl as its directors. It held 23.57 lakh TFL shares valued at over Rs.24 crores, and was undertaking share investment activity with a paid-up capital of Rs.200 crores plus funds obtained from various Tata companies. Despite this, TFL did not disclose, as required, its links with IIL or the latter's financial position in the public documents relating to the rights issue made at the end of March 2001. Clearly, Tatas as a group was withholding information.

SHASHI ASHIWAL
Ishaat Hussain, chairman, Tata Finance Ltd.

However, the effort to 'nail' Pendse, the then managing director, for these and other violations was rendered easy by evidence of insider trading in TFL shares. On March 30, 2001, on the eve of the opening of a Rs.93-crore rights issue by TFL, J.E. Talaulicar, the chairman of Niskalp and a director on the board of TFL, offloaded one lakh shares of TFL owned by him and his family members at a price of Rs.69 a share, when the prevailing market price was Rs.36 a share. Since the subsequent declaration of losses by TFL saw a collapse in its share values, Talaulicar was clearly using inside information to protect and make a large profit on his investments. Talaulicar held that the transaction was arranged for him by Pendse and reported the same to an internal committee of the group set up in August 2001 to investigate the matter when this and other transactions by TFL and its directors were being subjected to public scrutiny and scrutiny by the regulatory authorities.

The involvement of Pendse in this operation, which was reportedly not revealed to the TFL board, provided grounds for the Tata management to argue that whatever happened in TFL was the result of his actions, which were kept secret from the rest of the board. Even if this improbable argument is accepted, the Tatas cannot hide the fact that the group initially tried to suppress the consequences of these actions for TFL's financials, by desubsidiarising Niskalp. While shareholders were suffering losses because of the collapse of TFL share prices as a result of Niskalp's activities, Niskalp ceased to be a subsidiary of TFL on June 30, 2001. The company had been acquired for Rs.40 crores by Ewart Investments. Interestingly, Ewart had been financed by TFL to undertake the acquisition! The point is that once Niskalp ceased to be a subsidiary of TFL, its financial position need not impinge on the accounts of TFL. The action, which could not have occurred without the concurrence of the board of TFL, was clearly aimed at clearing up the balance sheet of the company and conceal the financial position of Niskalp from TFL's shareholders.

Having completed this operation, the top management of the Tata group chose to launch its strategy of holding individuals like Pendse and Talaulicar responsible for all the transactions of TFL. It had already appointed a team from A.F. Ferguson, the reputed auditing and consulting firm, headed by senior partner Y.M. Kale to conduct an investigation into TFL, ostensibly to identify how management systems failed and work out remedial measures. It also sacked Pendse and lodged complaints against him with the police and SEBI, alleging fraudulent transactions.

THE current round of the controversy relates to the response of the Tata management to the Kale report. The report, a serious exercise running into 904 pages, not merely finds TFL's corporate governance practices wanting, but identifies other members of the board, besides Pendse, who could not have been ignorant of the transactions concerned and specifically criticises some, such as then TFL director Kishore Chaukar.

While full details of the now-suppressed report are not available, a leak to the press suggests that it identified several questionable transactions in the form of intra-group investments that helped some companies of the Tata group such as Tata Chemicals and Telco to book profits and declare dividends. According to reports, the study suggested that the nature of a number of transactions "raises doubts as to whether these were conducted to generate book profits or merely facilitate regulatory compliance". In its view there was need to ascertain whether under the erstwhile TFL management there was "a pattern of using circular intra-group transactions, mostly to either book profits for some of the companies in the group as and when required, or merely facilitate regulatory compliance".

A few examples of such transactions are available from the press. The picture that emerges is one where a large number of oddly titled firms, which fall within the Tata group, undertake transactions aimed at allowing a particular firm to record profits and pay out dividends. Thus, a group company IECIL first accepts large inter-corporate deposits from other group companies, for which it pays out interest estimated at Rs.68 lakhs. On March 31, 2000, the money obtained through these deposits is used to buy 13.3 lakh shares of TFL for Rs.12.6 crores from Sheba Properties, a subsidiary of Telco. This allows Sheba Properties to declare a profit, against which a dividend of Rs.6.5 crores is paid out.

The other set of transactions noted by the report go thus: whenever TFL reached inter-corporate deposit (ICD) limits and could not access further funds from group companies through this route to finance its transactions, it would sell shares to group companies through 'ready-forward transactions', where the company sold shares today to access funds, only to buy back the shares at some later date. Thus it appears that TFL and Niskalp provided finance in the form of ICDs to Inshaallah Investments Ltd., which then bought shares of TFL. TFL (and Niskalp) earned interest income from these ICDs and TFL booked profits on the sale of its shares.

Clearly, since there were a large number of other companies such as Tata Chemicals and Telco which benefited from TFL's activities, it is difficult to sustain the position that the Tata management was unaware of the activities of TFL. Based on its examination of transactions of these kinds, the Ferguson team delivered its indictment: "How could so many questionable transactions even be discussed, let alone actually contracted or recorded, by senior officials of such reputed companies, even on the assumption that someone wielding authority had proposed these transactions? In other words, even if the suggestion to commit irregularities had emanated from a few, how were these acquiesced to by so many? How did these not arouse widespread consternation and why did they not rush to report the goings on to the board of Tata Finance/Niskalp Investments or even higher?" In sum, there was little possibility that the rest of the group's top management was ignorant of the developments in TFL.

Within days of its submission, the report is ''rejected'' by the Tata management and "withdrawn" by the auditing firm, which has commissioned a fresh report based on the information collected. The leak soon makes it clear that the report was not received well because it implicates more than just Pendse with knowledge of the suspect transactions. Soon thereafter, Kale is reported to have resigned his position as senior partner of Ferguson, ostensibly on the grounds that he does not approve of the decision of the firm to withdraw the report and rewrite it. But Ferguson itself declares that he had not resigned but had been "sacked" since the firm had lost faith in him after taking account of the "inaccuracies" in the report as pointed out by TFL chairman Ishaat Hussain. Meanwhile, Pendse himself publicly declares that he has been made a scapegoat by the group to clear itself of involvement in transactions that he claimed the board was aware of and had acquiesced in.

IT is not surprising that the whole episode has set off speculation in the media, which is damaging not just because of the involvement of a Tata firm in the suspect transactions but because the group's management is seen to have extracted a toll from a forthright auditor in order to save its reputation. The fact that the auditing firm involved is one of India's leading ones further undermines confidence in governance of what was considered the best segment of India's corporate sector. The audit firm went to the extent of claiming that, since the Rs.2.5 crores it earned from the Tata group was an "insignificant amount" when compared to its gross annual fees, it cannot be seen as having withdrawn the report and sacked Kale under pressure from the Tatas. In fact, the Tatas took it upon themselves to declare that Kale's "cessation from his partnership" was "the result of a decision that was unanimously taken by the partners following a detailed internal enquiry". If the distance between the client and the auditor was as much as it has been claimed to be, it would have been best to leave such explanations to the auditing firm.

There are three conclusions that emerge from the limited information that is available about this episode, which is to do with the behaviour of even reputed business groups or firms like Tatas and A.F. Ferguson. First, the fact that the business group consists of a large number of companies, straddling different areas of economic activity, implies that a number of ostensibly "arms length" transactions among legally independent firms are actually part of the group as a single entity. This has, to an extent, been always true of the corporate sector in India. But liberalisation that has substantially diluted regulations imposed on the big business groups has possibly increased such transactions substantially.

Secondly, the TFL episode reveals that in the wake of liberalisation, which includes financial liberalisation, these transactions include financial transactions that allow core firms in the group and possibly the central decision-making authority to book profits and earn high returns through dividends. Those dividends may even serve to inflate prices of listed firms in the market. Finally, even the best in the auditing business in India are not independent of the clients they serve, as is indeed true elsewhere in the world as well.

What bothers some is the fact that even the Tata group, with its reputation for good management and its tendency to be in a business for the long run, has succumbed to the lure of lucre that the speculation promoted by financial liberalisation holds out. Clearly, this is the way liberalisation is refashioning Indian capital. Its influence is evidently strong enough to transform even the best. Unfortunately for the Tata group and fortunately for the rest of India, they lost out on their gamble. If not, the illusion that scams are not systemic but the result of bad practices by a few rogue businessmen would have still prevailed.