MCC judgment -- regulatory lapses are the real culprit

On September 7, Justice R Jayasimha Babu of the Madras High Court dictated a path-breaking judgment with regard to MCC Finance Ltd (an MA Chidambaram group company). It should give sleepless nights to financial regulators and the corporate sector.

The path-breaking judgment ought to have investors and depositors in all corporate financial instruments dancing in the streets. It is by far the biggest blow to the steady and criminal diversion of funds by Indian industrialists and the failure of regulators to act decisively to protect investor interests. In this case the court has repeatedly castigated the RBI for its abject failure as the regulator of the non-banking finance companies. The judge says it failed to "act with vigour, range, depth and speed that the law required of it for protecting the public interest". The court is categorical that it is the "inefficiency and ineffectiveness of the regulatory" authorities which is to blame for the hundreds of crores lost by depositors in the crash of NBFCs over the last five years. Regulators entrusted with protecting public interest, says the judge, cannot "shrink and snivel into their chairs" to "screen away things unpleasant" and leave public interest unguarded. While Justice Jayasimha Babu notes the"criminal conduct" of MCC's management, he blames lax regulators for allowing them to get away with it.

Hearing a slew of winding up petitions against MCC Finance Ltd which is part of the Rs 3,500 crore MA Chidambaram group headed by AC Muthiah, the judge says that the RBI treated the interests of 50,000 depositors who had invested over Rs 200 crore in the company with callousness. In MCC's case it allowed asset stripping and financial irregularities to continue unchecked even after a special audit commissioned by it had revealed negative new owned funds of Rs 68.5 crore, failure to comply with prudential norms and falsification of information regarding the SLR (statutory liquidity ratio), way back in 1997. It says that the RBI was "gullible enough to think that the MAC group will set things right" and allowed it to remain in charge.

The MCC Finance story is a staggering account of how the most renowned of industrial groups will fool investors and divert funds. MCC had set up 10 investment companies and three firms without disclosing this to shareholders who were falsely told that it had no subsidiaries. A massive Rs 171 crore was lent to these companies which the court says is "practically irrecoverable" today. The money was used to buy shares of the Chidambaram group companies. The 10 investment companies and three firms which were lent the money have no assets; MCC itself was allowed by the RBI to sell valuable fixed assets worth Rs 22.7 crore to group companies SPIC and SICAL so that creditors got nothing when the company has been ordered into liquidation. The RBI, says the court, "bestirred itself" only after a second audit by Venkatesh & Co which revealed further damage, and a criminal attempt by MCC to tamper with the records to make it appear that the SPIC group does not owe any money at all to MCC. Apart from divertingdepositor's money MCC hd also borrowed Rs 30 crore from banks. Strangely, these banks lent the money without any enquiries about MCC's fixed assets or to secure their loans with a charge on the assets.

A special officer appointed in 1999 did precious little other than to preside over a preferential disbursement of Rs 8 crore to some investors. The court notes that this too is wrong. It considers it unfortunate that the Company Law Board did not consider the fact that MCC's meagre assets as its losses had to be equally shared by all depositors and cannot be selectively disbursed. The MCC story is repeated across the corporate sector, as is the RBI's failure to act on time.

While allowing the winding up of the company, the court notes that its liabilities are an enormous Rs 300 crore while the value of realisable assets is negligible and doubtful. The court has expressed open doubts about the veracity of almost all the claims made by the company about its assets and operations: it has ordered a further probe. S Srinivasan, former chairman of Bharat Overseas Bank, has been appointed administrator and the central government has been asked to tone up the office of the official liquidator to make investigations and winding up of companies more efficient. The MCC case is more shocking because it shows that even renowned and seemingly conservative industrial groups will not balk at lining their pockets by defrauding small investors. The judgment has now empowered the small man to fight regulatory lapses and lethargy which let this happen. For the first time the heat is squarely on the RBI, which is among the most opaque of financial regulators. Over the years it has repeatedlymothballed its own inspection reports which have pointed to financial irregularities. While the present judgment has only indicted the RBI as an institution, it may not be long before individuals in charge are specifically identified for collusion with industry or ensuring regulatory inaction.

Author's e-mail: suchetadalal@yahoo.com

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