The Supreme Court-appointed expert committee on May 6 submitted its report on the Adani-Hindenburg issue. The report was released to the lawyers on May 19.
The panel is headed by retired Supreme Court judge Justice A.M. Sapre and consists of experts on financial markets.
Perhaps the Supreme Court had hoped that these experts would help unravel the complex financial dealings flagged by US-based short seller Hindenburg Research. The Adani Group had denied all the allegations of stock manipulation and accounting fraud.
These dealings are not only not understood by the lay persons but even by the informed public.
In a nutshell, the top court panel report implies that the Securities and Exchange Board of India (SEBI) is doing a competent job within the bounds of the regulatory framework and has not discovered wrongdoing. The inference is that the Adani Group has not committed any wrong.
Following the release of the report, it was claimed that the Adani Group has been given a clean chit by the apex court and the share prices of their companies rose sharply. So, was the Hindenburg report, which set off the sharp decline in the Adani stocks, misconceived and mischievous? Was it ‘anti-India’?
The public concern
Why has the issue become a matter of national concern? The Adani Group has grown exponentially, making Gautam Adani the third richest person in 2022. He has been able to get whatever business caught his fancy – airports, ports, energy, and other infrastructure projects. And, apart from the projects in India, he has also managed to acquire businesses abroad.
Though his companies are public, the Indian public shareholding in his companies has been small. So, the Indian public has hardly benefitted from the rapidly growing pie. Even Indian mutual funds’ investment in his companies is small. The debt compared to equity was quite large and has been flagged by financial experts. A high ratio of debt to equity increases the riskiness of the shares. If profits earned are taken as a yardstick of performance, they were low compared to the price of the shares. This is referred to as the price-earning ratio (P/E).
In some of the Adani Group companies, because of the high prices of the shares, the P/E ratio was in the hundreds – an astounding number since most companies have it in the range of 15 to 25. The return on capital for most of the Adani companies was 1% or less. Yet, investment poured into the Adani firms.
In brief, the high prices of the company’s shares led to low returns and a high degree of risk. Why did suave investors invest in such companies thereby inordinately raising the price of the shares of these companies?
Hindenburg Research, therefore, sensed an opportunity to make money. Short sellers make money on stocks which are overpriced by selling the shares. Hindenburg Research released a report on the Adani companies on January 24, 2023, pointing to manipulation of the share prices through irregularities. They claimed that the shares were overpriced by 85% and this gave them the opportunity to short sell. It was done abroad and that led to a steep fall in the price of the Adani companies’ shares.
By February-end, the Adani companies’ market capitalisation had dropped by $134 billion to $98 billion. Adani’s net worth dropped from around $120 billion to $46 billion. It became clear that Adani personally owns 55.2% of the Adani Group. Along with other associates, the promoters holding was close to 75%. This has been one of the concerns.
Three important questions arise: first, how did Adani get hold of so many businesses so quickly? Second, how did the valuation of the shares of the Adani Group rise so rapidly? Third, why did the undue rise in the share prices not raise suspicions among the regulatory agencies – SEBI, the Enforcement Directorate, income tax department, etc.? Did political connections coupled with a lack of action, or investigation by the regulators help Adani acquire assets, possibly at low prices?
The remit of the Supreme Court-appointed committee was only to look into the regulatory failure, especially of SEBI, the stock market regulator. The other basic questions have not been looked into. Further, SEBI was expected to submit its report to the panel, but it has asked the apex court for more time to investigate the complex financial dealings. It has been given time till August.
So, is the expert panel report premature? While at present SEBI may not have been able to come to definitive conclusions on the stock holdings and related party transactions of Adani Group, it may be able to unearth something through deeper investigations. Then what would happen to the conclusions of the expert committee.
The expert committee’s conclusions
The expert panel concluded, ‘The Indian market was not unduly volatile. There was certainly high volatility in the Adani stocks after publication of the Hindenburg Report. The mitigating measures from the Adani Group built confidence in the stocks.’
So, it appears that the expert panel thinks that things are okay. It also gave some good suggestions about investor awareness but these are not germane to the issue at hand.
The really important aspect is the regulatory failure which has three components.
First, let’s look at the issue of minimum public shareholding. The expert committee said, “SEBI has been investigating the ownership of the 13 overseas entities since October 2020. SEBI has found 42 contributories to the assets under management of the 13 overseas entities. SEBI has drawn a blank’ because ‘in 2018, the very provision dealing with “opaque structure” was done away with’.
This ‘led to SEBI drawing a blank worldwide, despite its best efforts’. ‘The securities market regulator suspects wrongdoing, but also finds compliance with various stipulations in attendant regulations. Therefore, the record reveals a chicken-and-egg situation.’
It further concluded that ‘it would not be possible to return a finding of a regulatory failure’. The implication is that there is suspicion of wrongdoing but it cannot be proved since the rules were changed in 2018, which a) prevents investigation and b) SEBI is acting within the new rules so there is no regulatory failure on its part.
Second is the issue of related party transactions. Again, the definition of the terms “related party” and “related party transaction” were amended by SEBI substantially in November 2021. They were given deferred effect to enable companies to re-arrange their affairs to become compliant with the law.
Thus, it was concluded that ‘the feasibility of testing the principles underlying the regulations governing related party transactions has been eroded.’ Again due to changes in the definitions, this aspect cannot be proved even if it happened. Further, without settling the issue of minimum public shareholding, this aspect also cannot be resolved. Violation of the minimum public shareholding rules would be by the related parties.
So should the expert committee have waited for greater clarity rather than submitting its report, just in case SEBI comes up with some crucial new findings?
Finally, the issue of price manipulation was also mentioned in the report. The committee said, ‘In a nutshell, no pattern of artificial trading or “wash trades” among the same parties’ multiple times was found. However, this is qualified by saying, cases are still under investigation and the committee therefore does not express any opinion on merits. It would not be possible to return a finding of regulatory failure on this count.’
This conclusion is bound to follow if the issue of ‘related party transactions’ is not sorted out since it is precisely these transactions that were allegedly used for price manipulation.
So, the expert panel is saying that SEBI is following the changed rules and therefore there is no regulatory failure. This is a conditional exoneration of the Adani Group. Further, key issues have not been addressed like the high price to earnings ratio or the rapid acquisition of assets in India or abroad.
Opacity of financial transactions
So, the expert committee could not get to the bottom of the entire matter. This is surprising since the corporates in the committee are fully aware of the opacity of the financial transactions, or the hidden layers behind the transactions. They know it privately. But this knowledge is not shared with the public.
Businessmen and policymakers are aware how hawala transactions work and who are the operators. They know how under and over invoicing is done to generate black incomes, a part of which is transferred abroad. They know how insider trading and round tripping is carried out. They also know how shell companies use ‘layering’ to hide the trail of funds and shield the actual owner of the funds.
They are also aware of the loopholes in the laws that enable crooked transactions to occur. Whenever businesses experience difficulties, pressure is mounted on the government to modify the rules as happened with SEBI rules as pointed out by the expert committee.
Rules or laws can never be perfect. Chartered accountants and corporate and income tax lawyers are tasked with helping businesses find loopholes. Failing all this, bribery enables tweaking of the rules.
The corporate members of the expert committee could have exposed much more of the wrongdoings but they have chosen to be formalistic.
An opportunity to expose and clean up corporate manipulations, misuse of the financial structures and international financial architecture underlying the manipulations has been missed. Perhaps they did not wish to expose the systems that are used by the corporates. They could have performed a national duty by doing so, as it would have made the Indian economy more competitive and efficient, curbed black income generation and checked growing inequalities. All this would have helped the Indian economy achieve its potential.
Arun Kumar is the author of Indian Economy’s Greatest Crisis: Impact of the Coronavirus and the Road Ahead.