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Corporate Apr 9, 2012

Satyam scam and FIs: Case of the dogs that did not bark

By R Jagannathan

Foreign investors, it seems, are in a mood to sue. A week after The Children's Investment Fund (TCI), a UK-based hedge fund, announced that it would be taking Coal India to court for oppressing minority shareholders through below-par pricing of coal, another UK-based investor, the Scottish Aberdeen Asset Management, is suing Mahindra Satyam.

Aberdeen is seeking damages in excess of $150 million for losses suffered in B Ramalinga Raju 2009 Satyam scam.

While TCI is moving a court in India, Aberdeen is moving the High Court of Justice, Queen's Bench Division, Commercial Court, in the United Kingdom.

According to The Economic Times, Mahindra Satyam has, in its earnings disclosures in the past, "acknowledged the legal action initiated by Aberdeen, but has maintained that it is difficult to calculate the potential liability arising from such claims because of subjectivity involved in arriving at damages caused."

When the Mahindras settle with foreign shareholders, they are effectively damaging the interests of local investors twice over. Reuters

However, the interesting point to note is that it is foreign shareholders who are willing to sue promoters for poor corporate governance, not Indian ones. Satyam shares were owned by a great many Indian institutions, including government-owned insurance companies and some bank-owned mutual funds. Why were (and are) they silent?

The Satyam scam, which came to light on 7 January 2009 when promoter Ramalinga Raju sent a notice to the stock exchanges that the company had overstated profits and cash balances to the tune of over Rs 7,000 crore, actually started unravelling around mid-December the previous year. It was thanks to institutional investors.

The road to destruction of shareholder wealth began when Raju, in a desperate bid to hide the fraud, announced that Satyam, an IT company, would be buying two family-owned firms - Maytas Infra and Maytas Properties, both involved in real estate. This irrational decision - of trying to get an IT firm to buy realty companies - was shouted down by many institutional investors, both foreign and domestic ones.

Among others, the institutional investors who opposed Raju and forced him to call off the purchase included CLSA, Templeton, Reliance Mutual Fund, SBI Mutual Fund, HDFC Mutual Fund, Aberdeen and some more foreign funds.

However, while the foreign funds are continuing to pursue the recovery of losses, the domestic funds have not done so. This is curious, because they were amongst the most vocal when the Maytas purchase deal was announced in mid-December 2008.

The refusal of domestic mutual funds and institutions to sue should raise eyebrows since they were not only direct investors in Satyam before the scam, but also standard bearers for other Indian minority shareholders who were duped by Raju's financial skullduggery.

There could be two explanations for this: one is that they bailed out well before Raju's public confession; or they were simply unwilling to fight for minority shareholders.

There is some evidence that many domestic mutual funds sold off Satyam shares before Raju made his confession. According to a PTI report dated 6 January 2009 - which was a day before Raju made his mea culpa public - the IL&FS Trust sold 2.45 crore Satyam shares in the open market on behalf of funds like DSP Blackrock, DSP Merrill Lynch, and HDFC Mutual Fund, among others.

These sales happened between 23 December 2008 and 5 January 2009, well after the aborted Maytas purchase, and conveniently before Raju's public confession on the fraud. Just coincidence, or did they know what was about to happen?

In fact, by refusing to take the Satyam management to court, they have effectively let down all domestic shareholders since, leaving the field clear for foreign investors to settle with Mahindra Satyam. The Aberdeen lawsuit now underway in the UK means that more foreign investors may claim their pound of flesh at the cost of Indian shareholders.

Their silence works against domestic shareholder interests. When the Mahindras settle with foreign shareholders, they are effectively damaging the interests of local investors twice over. Once by leaving them out of the settlement (even though they too lost money), and, secondly, by paying foreign shareholders with money that belongs to all shareholders.

It is a sad commentary on Indian investor activism that their battles have to be fought by foreign investors - no doubt for their personal benefit, but still a battle fought for minority shareholders.

However, there are people willing to condemn foreign investors for taking action. Writing in The Indian Express, Pavan Ahluwalia, Managing Director of Laburnum Capital, who also happens to be the son of Planning Commission Deputy Chairman Montek Singh Ahluwalia, likens TCI's bid to take Coal India to court to "tilting at windmills." In particular, Ahluwalia takes on "journalists, market gurus and corporate lawyers" for lending TCI's case a receptive ear.

While accepting that "TCI has a right to pursue maximum returns for its investors," Ahluwalia finds it "disturbing" that there is "uncritical acceptance of its argument by so many professing only a concern with the public interest."

Surely, Ahluwalia is on the wrong side of history on this. For three reasons.

First, selling coal at low prices is bad policy when fossil fuels are depleting and carbon emissions are a big concern. Surely, Ahluwalia has also heard of worse things going on in oil - where profits are being transferred from ONGC to the oil marketing companies when all of them are listed entities. If he can justify Coal India's bad practices, he can do this too.

Second, there is no case for a government to both be a commercial player and a policy maker on coal prices. The fact that this was mentioned in the Coal India prospectus does not make this acceptable. This conflict of interest is wrong. If the government wants to do both - make policy and own Coal India - it should buy out minority shareholders completely. It cannot first invite minority players to own shares and then sell their interests down the river. A shareholder is a part-owner invited in by the government, not an unwanted interloper.

Third, rather than blame media for getting too excited by TCI's legal challenge, he should be asking why domestic minority shareholders and institutional investors - whether in Coal India or Satyam - do not seem to care about promoter repression.

TCI and Aberdeen are, in fact, proof that domestic institutions are sleeping on the job. Despite all the yelping on corporate governance, domestic institutions are the dogs that did not bark.

by R Jagannathan

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