Should Corporate Governance be Applicable to Private Companies?

Filed under Corporate Governance |

By Kumkum Sen

The Adidas Group’s global acquisition of Reebok, which entailed the integration of Reebok’s Indian operations, was achieved in 2011. Reebok has been operating in India since 1991. With over 900 retail outlets in India, Reebok has operated exclusively on franchise models. It is assumed that one of the synergies factored in the acquisition would include the senior management resources. Reportedly in a pre-integration audit, certain financial anomalies and irregularities were suspected, requiring further investigation. Accordingly an external forensic examination was undertaken, availing the services of a globally reputed firm. Media reports suggest that certain glitches were detected, but nothing posing a deal breaker.

Within a year it appeared that Adidas’ initial discomfort was warranted. An internal investigation was initiated, which implicated the top management – notably the Managing Director (MD) and the Chief Operations Officer (COO) of Reebok India. The allegations pertained to fictitious sales involving invoicing without transfers, products being stored in warehouses allegedly belonging to the accused officers (“accused”) and then sold clandestinely. Monies were reportedly collected and misappropriated on the pretext of expansion of franchise outlets. Gross misreporting of inventory values, stock positions are also alleged, indicating a nexus between the franchisees and the accused. Reportedly an internal investigation was made by the Finance Director who found the accused to be the perpetrators of the fraud. They were consequently dismissed from service and on May 21, 2012, a criminal complaint was registered against the former MD and COO for criminal breach of trust and cheating, causing potential loss of around Rs 870 crores to the Company with the Gurgaon Police’s Economic Offences Wing. After an initial enquiry by the Gurgaon Police, an FIR was registered under Sections 406, 408 (Criminal Breach of Trust), 418 (Cheating with Knowledge), 467 (Forgery of Valuable Security) and 477A (Falsifications of Accounts). A Special Investigation Team of the Economic Wing was entrusted with the investigation.

However, within days, the Ministry of Corporate Affairs (MCA) took charge of the matter with the intent of referring the same to the Serious Frauds Investigation Office (SFIO). A preliminary investigation by the Registrar of Companies (RoC) under Section 234 of the Companies Act formed the basis for the MCA to arrive at an opinion that there was prima facie evidence to initiate a further detailed investigation, given the ‘non-cooperation’ by Reebok and Adidas in the investigation process in not providing documents required for the preparation of the ROC report.

The SFIO usually steps in cases of corporate frauds if the investigation involved is complex, multi disciplinary, having international ramifications along with a substantial involvement of public interest. In this case international ramifications are present as the parent company is also reportedly under scanner. The SFIO’s claim to fame is Satyam. But as on date, the SFIO clearly lacks teeth. It also lacks statutory recognition. It has limited resources, though entitled to avail of services of experts from various fields. There is a view that engaging the SFIO in this particular case where the amount is , is probably lesser than Rs 8,700 crore is like using a sledgehammer to crush a nut.

But the Reebok case is not one about SFIO versus local police, but the vacuum in the applicability of corporate governance norms to private companies. Currently, corporate governance in private limited companies is not mandatory by law. Ninety per cent of Indian companies are private or closely held public entities. Investors opt for a private company structure as it has minimal compliances and disclosures. There is a comfort zone which carries with it flexibility of operations. Foreign investors including large listed multinationals prefer to use a private company structure because of the convenience.

It’s a myth that governance issues and frauds occur less where there are smaller number of shareholders. It’s only the volumes involved.

Having said that, most shareholder disputes in private companies can be contained, if not prevented, if the company has some checks and balances in place, not necessarily those provided in Clause 49 of the Listing Agreement, most of which do not work for private companies. What is required is a combination of mechanisms which on one hand prevent frauds and financial irregularities and on the other upholds the independence and flexibility of the private limited company structure.

A key step for any private limited company is careful drafting of its Articles of Association to address its specific cross border requirements – reporting to parent companies, local regulatory reporting and above all senior management accountability ensuring that Board meetings are held on time, not as a paper formality and minutes maintained systematically improve governance.

Normally multinational corporations have their global best practices – but these are locally unregulated. All private companies should have a comprehensive mandate which provides for cross checks, signing and validation responsibilities which would ensure that all transactions, payments are accounted for.

All corporate governance provisions are now to be part of the new Companies Act and Sections 177 and 178, which deal with the audit and other committees is extendable to such other “classes” of companies as maybe prescribed and there are whispers in the corridor that certain provisions would extend to private companies with large operations or turnover, multiple locations and similar criteria.

In the meanwhile, we wait for the Monsoon session and season.

Kumkum Sen is a partner at Bharucha & Partners Delhi Office and can be reached at kumkum.sen@bharucha.in 

(Sourced from Business Standard)

1 Star2 Stars3 Stars4 Stars5 Stars (No Ratings Yet)
Loading ... Loading ...
Posted by on Jun 19 2012. Filed under Corporate Governance. You can follow any responses to this entry through the RSS 2.0. Both comments and pings are currently closed.

Comments are closed

Comments