Does SEBI’s Coffee Day order expose fundamental weakness in law?

This is not the first time that such an order has been made by SEBI. The infamous Satyam case, and the allegations against CG Power have similar underpinnings

A recent SEBI order against Coffee Day Enterprises Limited (CDEL) raises fundamental questions about the workability of the elaborate corporate governance and legal framework — primarily on whether they can be bypassed.

In this case, SEBI has alleged that huge transactions in subsidiaries of CDEL were carried out almost single-handedly by the late promoter and chairman/managing director. These transactions, the order states, are in the form of ‘diversion of funds amounting to Rs 3,535 crores’ from seven subsidiaries of CDEL to an entity ‘related to promoters of CDEL’.

Much of this (about Rs 2,694 crore) allegedly happened in the first quarter of Financial Year 2019-20, and followed with the suicide of the promoter.

To put this in perspective, the net worth of CDEL as on March 31, 2019 was about Rs 3,166 crore. Thus, the alleged diversion of funds totalled to ~112 per cent of the net worth. According to SEBI, till September 30, 2022, only about Rs 111 crore (or ~3 per cent) has been recovered.

SEBI’s findings can be summarised as: CDEL was the holding company for 49 subsidiaries, but seven of these were the subject matter of this order. CDEL held a predominant holding in these subsidiaries. For example, in Coffee Day Global Limited (CDGL), which had substantial revenues, CDEL held almost 91 per cent of the share capital.

It was found that between April 2019 and July 2019, seven subsidiaries ‘diverted’ huge funds to MACEL, an entity allegedly related to the promoters. The amount due from MACEL increased from Rs 842 crore on March 31, 2019 to Rs 3,535 crore on July 31, 2019. SEBI is yet to receive a satisfactory explanation for these developments.

For SEBI, the most alarming finding was found in a reply to it by CDEL itself. “I note that the Noticee has itself admitted that VGS, the Promoter and CEO, was running the entire show within CDEL and its subsidiaries. It has further admitted that VGS used to collect the signed blank cheques and all the fund transfers were done by him. I find that this amounts to an admission by the Noticee that the listed company was being run like a personal fiefdom with no checks and balances in place. Nothing, it appears, could have prevented the diversion of funds from the subsidiaries of CDEL”. To reiterate, these transfers of thousands of crores, albeit from the subsidiaries of CDEL to a promoter-related entity, were made allegedly by a single person. One will have to see whether these SEBI findings are upheld in appeals.

We could move beyond the specifics of this case, and consider what are some of the legal safeguards. To state the basics, a limited company, and that too a publicly-listed company, is run by a Board — not by an individual. The managing director is appointed by the Board/shareholders, and reports to the Board.

The corporate governance requirements of the Companies Act and SEBI regulations require appointment of independent directors and setting up of important committees such as the audit committee. Related-party transactions are subject to close regulation and approvals by the audit committee/shareholders.

The Board/audit committee is required to ensure that there are adequate controls, particularly financial controls. Key managerial personnel such as chief financial officer and company secretary, the statutory auditors, and the internal auditors are among the other pillars. The question then is whether this elaborate framework still has gaping holes that could allow a single person (or a group of persons) to divert funds that are more than the total net worth of the company.

SEBI has made allegations of multiple violations against the company. The fact that the funds were paid out of subsidiaries, however, muddles the waters since the subsidiaries are separate legal entities. The allegation that some subsidiaries were ‘material subsidiaries’ requiring closer supervision has failed because the law then provided a higher benchmark. SEBI, of course, insisted that CDEL could have treated such subsidiaries as material applying the ‘spirit’ of the law. Finally, though, the order states that SEBI is “constrained to let off (CDEL) in this respect purely on technicalities”.

Nonetheless, the core allegation that the company/group was run almost single-handed by one person, the promoter, was given emphasis and the highest penalty provided under law, Rs 26 crore, was levied. This is apart from multiple other directions.

The issues to seriously ponder are fundamental, and three of them need to be highlighted. One, whether the laws were lacking and need a serious overhaul? Two, whether this is a one-off case, and the matter can be closed by punishing all who are found guilty? Three, whether the elaborate provisions of law and corporate governance requirements amount to merely a façade in India, one which can be bypassed by promoters?

This is not the first time that such an order has been made by SEBI. The infamous Satyam case, even if more than a decade-old now, is fresh in our minds. The allegations in the CG Power matter have similar underpinnings. There are several other such examples.

The positive aspect here is that these allegations are still the exceptions rather than rule. The negative aspect to it is that well-managed companies adhere to the regulations despite elaborate laws — not because of them.

(Jayant Thakur is a chartered accountant.)

The views expressed are the author's own. They do not necessarily reflect the views of DH.