Spot A Corporate Scam

FOR some it’s clearly winter, for those spoiling for a fight with neighbouring countries it’s a time for bellicosity and for many it’s a period of abstinence and renouncement. But, for Corporate India, this is, undeniably, a season for corporate governance. The nice-sounding, and sanctimonious, phrase moves from conference halls to board rooms this month as Satyam occupies business mindspace, boggles the popular imagination and becomes the new “shock-and-awe” item of the season.

The term ‘corporate governance’ tends to make an appearance and leave a strong impression mostly during times of market crashes and slow economic activity. During go-go times, no one cares. Even the Satyam skeletons would have stayed firmly locked up, rattling some consciences occasionally.

But, this time, long faces are discussing the issue seriously on television channels, equity analysts are saying they knew all along that India Inc was seriously in deficit and many company promoters are looking over their shoulders every so often.

Does this end here? Hopefully. But, if one is to hear all the doomsday artists and professional corporate watchers, this could just be the beginning of a long procession of companies waiting to be outed. So, here’s a favourite parlour game: how to spot and detect the next wrong ones. Look out for these traits:

* This one is a sure give-away. Be suspicious of companies suddenly launching on unrelated diversifications with great gusto. For instance, a chemicals processing company starting a floriculture project is a sure sign that it is planning some land-related scam or is using up shareholder’s money for a hare-brained project to be launched by the promoter’s son.

* Beware of companies which have huge related-party transactions. This is one old (and successful) model of siphoning off cash from the company. It is also a not-sosubtle way of ‘inflating’ sales. About 50% of one large, and listed, real estate company’s sales are to a group company (which stays resolutely private), but the money to be received from the same company somehow does not jive with the sales number. In this way, the listed company uses public money to build projects, sells them to the private company, shows pumped-up sales, but the buyer (the private company) is over time shown as incapable of paying up, the receivable is written off from the listed company and when the sales eventually happens, the shareholders of the private company gain the most. Cost is borne by the public, but profits stay with only the promoters.

* Keep your antennae up for companies which suddenly change their accounting policies. Many companies suddenly change either their depreciation policy or even their revenue recognition policy. A change in the depreciation policy allows many companies to either reduce their actual losses or helps balloon profits. Many corporates also suddenly change how they acknowledge revenue accretion. In many cases, this helps show a sudden increase in sales, resulting in better valuation on the stock markets.

* Another red flag: Companies that suddenly show a dramatic jump in sales, when nothing extraordinary has happened in the economic environment to justify the spurt in growth. One media company which went public a few years ago, showed a spectacular jump in its total revenue a couple of months before filing its prospectus. Recently, another technology company showed a 900% jump in sales over just six quarters ended September 2008! People should be beating a path to this company’s door for some clues on how to locate undiscovered multitudes of buyers.

* Many companies, during good times, entered into some exotic foreign exchange derivative contracts, hoping to punt on the movement of currencies they had no clue about, such as the Swiss franc. In good times, all’s acceptable. But, come crunch time and all these derivative contracts have now shrunk in value. But, the companies that bought these fancy products are yet to recognise the forex losses on their profit and loss accounts. It’s a bit like a time bomb ticking away in the accounts. Some companies have disclosed their exposure, but are refusing to provide for it, hoping it will go away one day like a bad dream.

* Ditto is the case with many companies which had loaded up on forex debt, like a famished urchin landing up at a free, five-star buffet. Today, they are shying away from showing the losses on these debts, especially since the rupee-dollar has moved adversely from the time they had contracted the debt. Expect to hear more about a fancy term called Accounting Standard 30 in the coming days.

So, what’s the lesson from this time? Sorry to sound cynical, but as long as the system stays what it is, there might be just a few more revelations, and then it’s back to business as usual. C’mon, we’re all forgetting the basics. Can you ask people to keep a tight rein on greed in a market that’s asking everybody to buy that fancy yacht, or that bejewelled watch, in the space of a heart-beat? Perhaps, it’s better for all of us if we were to accept this silver-tongued beast as an irrefutable part of our lives.