Why Promoters Cheat?

As the capital markets flourish there will always be new businesses entering to tap the vast pools of capital available. As the middle class grows & technology makes it easier to transact on the exchanges, a lot of retail capital will flow through. But with all these innovations one thing cannot be said for certain, the honesty of many of these business promoters to look after shareholder’s interest rather than just their own.

The market regulator has a difficult time to keep track of all these known & future offendors. But should we as investors rely solely on the regulator’s ability to track these offendors down or should we question the intentions of business owners before we invest with them?

To start with, I believe we need to understand what makes these promoters want to cheat their partners (shareholders). Perhaps that may open a window into their personality to figure out if they will be prone to cheat or not. In Hindu philosophy there are these objectives that we ought to live by throughout our life. They are, Kama, Artha, Dharma & Moksha. The first one deals with Desire (Kama), the second deals with Wealth (Artha), the third deals with Moral well-being (Dharma) & finally retirement (Moksha) or spiritual liberation. Continue reading

Mr. Modi as prime minister? Heavens no …….

Recently we had ‘leading’ businessmen praising Mr. Narendra Modi and telling us how he would make a great prime minister for the country. One of the biggest positivesof Mr. Modi which is pointed out is his business friendly nature. How he encourages businesses to create employment and economic growth and how Gujarat has prospered under his government.

Leaving aside the politics of it and purely focusing on Mr. Modi as a business friendly chief minister let us look at some of the actions of the Gujarat Government. First we had the spectacle of the state government directing state PSU to give a huge portion of their profits for charitable purposes. Here at least shareholder approval was sought and in some cases the motion was defeated (though it does not justify the proposal to give large amounts to charity in the first place).

Next we had a situation where the Gujarat assembly at the behest of the state government passed a law forcing redemption of Sardar Sarovar Narmada Nigam Ltd. bonds even though as an issuer it had no call provisions for early redemption. This was done without anybody’s consent. Neither were bond holders consulted nor SEBI. The validity of the ‘law’ itself is doubtful to my mind. How can a state law override the provisions of the Companies Act which has been passed by the country’s parliament?

To return to the broader issue of Mr. Modi as a business friendly chief minister, one of the pre-requisites for being business friendly is to follow contractual terms, laws and business ethics. In the absence of this, no amount of speed in giving clearances can make one business friendly. One wonders whether Mr. Tata, Mr. Ambani and Mr. Mittal would be so gung-ho if the terms of their contracts (the price of Nano factory land for example) were to be changed unilaterally by Mr. Modi in the times to come. 

To paraphrase Warren Buffett – If you are dealing with a person, deal with some one who has integrity, intelligence and energy. If the person does not have integrity, it is better that the person is dumb and lazy. Otherwise he will use all his intelligence and energy in trying to cheat you.

Crisis of faith

Last week was like the pope being told that Jesus never existed or a scientist being told that the big bang never happened and it was all a fake or a biologist being told that Darwin’s theory is irrelevant.

Over the years we have learnt to be sceptical about unaudited quarterly numbers. We take management guidance with a pinch of salt. We are even used to mergers, de-mergers, spin offs etc which are unfriendly to minority shareholders. We even go through the notes to accounts with a fine tooth comb to check the accounting policies and other games that are played upon us. Look at the FCCB and foreign exchange related accounting of large Indian companies (RCOM) for example.

However as Investors, the Annual Report published by companies and the financial statements signed by (supposedly good quality) auditors are sacrosanct. They are almost like the bible to a pope. We never stopped to wonder if the cash and bank balances stated in the audit report or the borrowing amounts could be incorrect. There could be some inflating of sales and debtor numbers in one year which would affect the subsequent year. However a fraud of this magnitude over a period of many years is unimaginable.

The Satyam episode struck at the very root of our faith. If such a large company with one of the big four as auditors, with a NYSE listing and being subject to Sarbanes Oxley regulations can have such a big hole in its financials, what hope does one have in analysing financials of other companies.

The only path forward for investors is to be ruthless in demanding standards of integrity from the management and promoters of the companies they invest in. There have always been question marks on the promoters of Satyam and the way they ran the company. Look at this link for a past controversy on their acquisition way back in 1998 http://www.internetnews.com/bus-news/article.php/264581. ‘Consistent growth’ and ‘attractive valuations’ always lured investors like the sirens lured the sailors passing by and got them to ignore red flags raised in the past.

To give due ‘credit’ to the Satyam promoters, they also seemingly cleaned up their act and got marquee independent directors, contributed to philanthropy and had one of the big four as auditors. The Maytas episode showed that old habits die hard.

After the failed attempt at taking over Maytas, it was all the more tempting. There was a real prospect of Rajus being thrown out and a L&T or HP or Tech Mahindra or some other company taking over /merging with Satyam. Further there was a huge amount of cash on the books. How could one go wrong buying Satyam at say Rs. 180? The price paid was only a little more than the cash per share. There was a good business that they were running after all. I was also tempted to ‘Ride the tiger’ (after all margin of safety seemed to be there), thankfully I resisted the temptation. The following from Buffett weighed in the decision.

  • There never is just one cockroach in a kitchen cabinet. If one has appeared, there will be many more inside. (Maytas / Upaid etc.)
  • The way a person will treat shareholders can be predicted from how they treat clients, employees, the government and society at large. An entity which uses bribes to get business (eg. World Bank) will not hesitate to fudge number in shareholder reports.
  • Rule number one ‘Don’t lose money’ Rule number two ‘Don’t forget Rule one’. The Upaid case was simply too scary.

I have mixed feelings about fate (you could call me agnostic about fate). However after the news of the fraud came out, I thanked my lucky stars that I resisted the temptation. Amen.

Punishment @ speed of thought !!!

Punishment @ speed of thoughtwould be the headline were Bill Gates to write on the affairs at Satyam. It seems that the ‘Promoters’ of Satyam would have lost 5% of their holding out of the 8% that they used to hold after the failed takeover bid for MAYTAS. This would have happened in a matter of days and maybe in as short a time span as 24 hours. Never before have promoters been punished so severely and so swiftly. The punishment came despite the fact that the MAYTAS deal was called off before the markets opened the next day.

I hope this serves as a deterrent to would be corporate defrauders.

(If only markets could devise a mechanism to punish perpetrators of terror as swiftly and effectively ……)