30 September 2016

Corporate Governance in India

Delighted to announce the publication of book 'Corporate Governance in India' of which I authored one chapter - on Related Party Transactions.

Link to OUP site.

01 September 2016

Class action suits - Potent, yet problematic?

I have a short piece on class actions under the new Companies Act and its dysfunctionality linked here and copied below:

After the Satyam fraud, India, as a country, realized that shareholders, of Indian companies, who have faced fraud, could not be made whole. In contrast, the international shareholders could obtain US $125 million by filing a class action suit at a US court. The Irani Committee proposed the inclusion of class action law suits in the then proposed Companies Act.

Section 245 of the Companies Act provides a right to members and depositors to bring an action against the company, its directors, auditors, experts, or consultants, for any fraudulent act or omission committed or likely to be committed by them. This has so far remained a dead letter since we have not yet seen a single class action law suit since 2014. This is primarily because of what economists call the tragedy of the commons. An investor must fight alone bearing the costs of, and delays in, litigation, but the benefits are enjoyed by all investors. In addition, the provision is clumsily drafted, complete with a glaring typo, provides barely any benefit, puts an onus of collecting a sufficient number of investors or depositors, and even has a provision for imposing costs in some cases.

For class actions to be effective, the right place to introduce a beneficial provision is in the Civil Procedure Code and the provisions should have clear benefits, deal with the tragedy of commons, reduce the burden on the litigating investor/depositor and finally, for this to really succeed, there will need to be an introduction of contingent fees payable to lawyers.

23 August 2016

Sebi’s move to curb distributors may hurt MF investors - ET

I have a piece in today's Economic Times analysing SEBI's circular seeking to impose particular disclosure norms which are intended to dis-intermediate distributors. While disclosures and expense caps both have existed, the new development will hurt investors rather than help them. Please read the full piece below to see why or click here for the original piece on ET's website:

"A person with surplus money is likely to invest it in four broad classes of assets and investments: Real estate, gold, fixed deposits and other investments.
The last decade has been brutal to nearly all investors. Gold hasn’t performed well except in spurts, real estate has been disappointing.
Ulips and other toxic products which were hard-sold with up to 45% commission would take a decade just to reach the par value. Fixed deposits provided an optical illusion, with high inflation, they mainly yielded negative real returns.
The only real investment which has consistently delivered, over any 3-year or longer period after all expenses, has been equity mutual funds.

An investor is free to invest directly in the stock market, or free to pay a fee to a mutual fund for managing his money. Similarly, an investor is free to directly invest in a mutual fund or invest through a distributor.
Market regulator Sebi provides a cap on the total fees chargeable by mutual funds to the investor. This has prevented creation and sale of toxic mutual funds.
Sebi’s circular effective October mandates disclosure of absolute amounts, instead of percentage, of commissions paid by funds to distributors. It also obligates the disclosure of the expense ratio of the fund where a distributor is involved and where it is a direct sale. These appear at flush blush to improve transparency, but will push investors away from mutual fund investments.
Firstly, the disclosure of commission in absolute number for investments is likely to overstate the commission in later years.
For a distributor, investment advice, fulfilling suitability, KYC norms, cost of travelling and selling to the investor and other costs are incurred in the first year and the benefits are usually paid by way of trail commissions over many years.
Sebi has encouraged this underpayment initially with emphasis on the ‘trail’ as being useful for the cause of longterm investment. Clearly, the investor will be unhappy seeing a commission paid in year 5 when little service is provided.
Secondly, showing the expense of a direct plan versus showing the expense of a distributed plan every six months will goad the investor into believing the two products are identical and he is wasting money on the distributed plan. A distributor is no longer merely an agent of the fund as Sebi has imposed specific KYC and suitability norms on the distributor.
Thus pushing an investor away from the distributor is likely to push the investor away from the most suitable products. The average small retail investor in the absence of proper advice may buy over-risky products because they seem to produce better returns or buy under-risky product resulting in low income.
Of course, a sophisticated investor does not need a distributor, but the number of sophisticated retail investors is quite limited. Sebi has already made sufficient disclosures mandatory showing the different expense ratios between direct and distributed plans.
Thirdly, many costs are attached with creating a mutual fund product including asset management fees, trustee fees, registrar and transfer agent fees, legal and audit fees, advertisement and Sebi fees. It is unclear why only one of them is deemed important from a disclosure perspective, except to push a dis-intermediated model.

Finally, the real danger of a dis-intermediated model is this. Only 11% of equity funds are sold directly, the balance nearly 90% is sold through distributors. These distributors travel through smaller cities, or spread the message through bank branches and are spreading the word of the relatively safe, high-return investment with a small and capped expense ratio.
If these distributors are dis-intermediated, what will happen will be not sale of lower cost mutual funds as Sebi is aiming. But rather investors will move away to other push products like Ulips, which are toxic, fixed deposits, which post inflation reduce wealth, or non-productive assets like land and gold.
If India wants to build its equity markets, build its infrastructure, build a productive industry which requires capital, it must seek full disclosure and cap on fees as Sebi has rightly done till now, but it should not physically seek to dis-intermediate distributors. That will hurt most the investors, the regulator seeks to protect."

01 August 2016

Courts might hold guaranteed return of capital clause invalid - Business Standard

I have a piece in today's Business Standard on the Tata-Docomo dispute. Here is the link and below is the full piece:

The Tata Docomo deal poses one of the most interesting conundrums from a legal perspective. This piece is based on the broad contours of the arguments in public domain. And as a lawyer, I may disclaim my views on seeing the definitive agreement between the two. Broadly the issue is that Tata and Docomo entered into an agreement where Docomo invested in Tata’s telecom business. The agreement was signed with a clause guaranteeing at least 50% return of (rather than on) capital in case the company did not do well. While ordinarily, contracts are enforceable, this one had two legal issues.

The first was that for a foreign investor, RBI permits investment in Indian companies through equity or debt route. The debt route is quite restrictive and the equity rather liberal. The foreign exchange Act, FEMA, and RBI’s position on FEMA is that if you make an equity investment, you cannot get a guaranteed return on or of capital. In fact, if you so choose, the equity investment must come as debt and relevant regulations with respect to lending by a foreign entity would kick in. Tata and Docomo did not term it a debt issuance and therefore the investment was valid, but the condition guaranteeing return of capital was not.

The second issue is an old circular under the Securities Contracts (Regulations) Act which prohibits puts and calls in contracts in public companies. The rigour of the circular is now diluted, but it was a broader prohibition then.

While the Supreme Court has in case after case reduced the possibility of court intervention where an arbitral tribunal has passed an order, this may well be a case where courts may hold the clause in the agreement as being invalid. The twist in the tale is that Tata seems to support the payment while RBI is opposing the same. Ultimately, the case will likely take many twists and turns before finally getting decided in the Supreme Court. 

02 June 2016

Reforms at SEBI - my interview for cover story of Dalal Street Investment Journal

I was interviewed by the Dalal Street Investment Journal on the performance of SEBI till now and the future of the regulatory framework of the securities markets.

Below is the full interview:

01 June 2016

Fraud, Manipulation and Insider Trading in the Indian Securities Markets - 2nd Edition

Really excited to see (I don't have a copy with me yet) the 2nd Edition of my book "Fraud, Manipulation and Insider Trading in the Indian Securities Markets". It is now in hardcover and available online.

Thanks due to Mr. Damodaran for his foreward and kind words of praise for the 1st Edition from Mr. Fali Nariman, Senior Counsel, Mr. Ashish Chauhan, CEO of BSE, Mr. Janak Dwarkadas, Senior Counsel and Prof. Umakanth, National University of Singapore. Special thanks also to Monika Halan and PR Ramesh for reviewing the previous book in magazines.

You can buy a copy or review the contents by clicking here.

26 May 2016

Financial sector reforms: Move faster, sooner - Economic Times

I have a piece in today's Economic Times on the financial sector reforms in the two years of Modi rule and the way forward for the balance three years. Posted below is the full piece and here is the link to the original.

Financial sector reforms: Move faster, sooner

India’s financial sector and its regulators have much to be pleased about, though not enough to be complacent about. To start with, the RBI has always had a formidable reputation as a central banker. On the Sebi front, a World Bank ease of doing business study placed India at the 8th rank on investor protection. Incidentally, that was the only metric on which India performed in the top ten.
Archimedes said “give me a lever long enough and a fulcrum on which to place it, and I shall move the world”. The financial sector can be India’s lever and the regulators the fulcrum to improve the Indian economy by providing easier capital resulting in a Cambrian explosion of productivity and growth. The past two years have seen some significant changes in the financial regulatory structure.
The most dramatic of the changes, which will cast long shadows was the merger of the forward commodities futures regulator, with the securities regulator, Sebi. The merger has brought about significant improvements in the quality of regulation. The government should push for a more unified regulator with insurance, pension and even banking, falling under Sebi’s domain. This will prevent Sahara like problems arising out of regulatory gaps or turf fights like those seen between Sebi and the insurance regulator.
Significant reforms have been carried out in liberalising limits of foreign investments in areas such as insurance, defence, and railways. The FIPB is sought to be abolished.
The move would reduce pointless bureaucratic hurdles in foreign investments and unnecessary movement of files between three ministries and one or more financial regulators. More liberalisation in sectors would be key to further investments and draining the swamp of unnecessary procedure and multiple bodies should be the next important step.
The Jan Dhan Yojana has been a significant and impactful first step in financial inclusion. The objective to bank more people can be furthered with a removal of the requirement of ‘address proof’ which unnecessarily bars mobile citizens from opening bank accounts even though they have identity proofs. When I first moved to Ahmedabad to teach at IIM, I was unable to open a bank account for this reason. Imagine the plight of the uneducated and the poor.
The recent efforts to do away with tax havens and double nontax treaties is a tough step, which was long overdue and will end the apartheid against domestic investors. This should be carried to its logical conclusion and all investors, foreign or domestic should be treated fairly.
We need to improve the markets of corporate debt, securitisation, real estate trusts, infrastructure trusts for the development of India’s infrastructure. Similarly, developing the alternative investment fund market, currently pygmy-sized, would develop domestic investment of money which will go into productive use. Nearly 99% of the problems in all these areas relate to direct taxes or stamp duty.
The recent Narayana Murthy report constituted by Sebi hardly had any reform suggestions for the regulator — they were nearly all tax issues.
Finally, being able to raise capital is no good unless that capital is well deployed and the ease of doing business is improved with fewer permissions, forms and bureaucracy. That includes the modern ‘right to die’ for companies sought to be introduced by the new bankruptcy code.