KPMG India in a Million Dollar Settlement with PCAOB without any Fallout in India

 #suprioghatak #suchetadalal #kpmg #pcaob #pwc #deloitte #icai #nfra #sebi #ey

KPMG India in a Million Dollar Settlement with PCAOB without any Fallout in India

Inspired by Sucheta Dalal

Introduction - Since I have started writing a couple of decades back the one person who has influenced me the most and still does is Sucheta Dalal. I have written about what KPMG has done in the article PCAOB Sanctions KPMG Firms and Audit Professionals. It has been published on LinkedIn and on Compliance Calendar blog on 12th December.

After that she has written on the same subject. There are some very important things she has touched upon which needs to be emphasised and discussed with our community defined as CAs and CA students.

The PCAOB (The Public Company Accounting Oversight Board) regulates the audits of public companies and SEC-registered brokers and dealers in the US in order to protect investors in the public interest in preparation of informative, accurate, and independent audit reports.

KPMG India settled before the PCAOB on 6 December 2022. But surprise surprise. There is no coverage in India.

PCAOB condemned KPMG Assurance and Consulting Services LLP (KPMG India) and the engagement partner (EP) Sagar P Lakhani for quality control failures, supervisory failures and documentation failures while working with a public company in 2017.

It led to a monetary penalty of $1 M on KPMG India and $75,000 on Mr Lakhani, who has been suspended from associating with a registered public accounting firm for one year and requires KPMG India to undertake and certify the completion of certain improvements to its system of quality control systems.

This is the second time such sanction has happened which relates to an Indian listed entity. The last time was when Satyam Computers collapsed. In May 2011, PCAOB settled an investigation imposing a penalty of $1.5 M plus $6 M by the Securities Exchange Commission (SEC) of the US on five firms of PricewaterhouseCoopers International (PWC) in India. The five PWC entities who participated in the settlement were: Price Waterhouse and Price Waterhouse & Co in Bengaluru, Lovelock & Lewes, Price Waterhouse and Price Waterhouse & Co, Kolkata.

Then, PCAOB’s order correctly said that the reliability of global capital markets depends on auditors fulfilling their obligation to investors to perform robust audits, resulting in well-founded audit reports.

That is why it is surprising that the latest order against KPMG has had no impact in India, and there's nothing in India’s market regulator or audit regulators – The Institute of Chartered Accountants of India (ICAI) or National Financial Reporting Authority (NFRA).

We had expected follow-up on the KPMG India matter. And there are several good reasons for this. First, since it is a settlement, the order does not identify the listed company in which these lapses occurred in 2017. All it says is that the issuer is into wholesale and retail banking and treasury services, headquartered in Mumbai.

The detailed order documents how eAudIT, a proprietary software of KPMG, was misused— they were aware of it but did not stop the misuse. Did the sign-off on blank documents only happen with the bank referred to in the PCAOB order? Was Mr Lakhani the only engagement partner who did this, or was he just unfortunate to be caught?

ICAI, NFRA and the Securities & Exchange Board of India (SEBI) ought to investigate how extensive the practice was and what impact it had on the final audit reports.

Sucheta Dalal emailed KPMG India’s communications department for comments on the PCAOB order. Her article will be updated if they respond. The PCAOB order says that KPMG India has disciplined some personnel and has established and implemented changes to its quality control policies and procedures.

Who Is the Unnamed Bank?

PCAOB’s order details the impact of these lapses on the accounts of the bank, whose identity means a lot to Indian investors and regulators. Since KPMG India and Mr Lakhani are together paying $1,075,000 the lapses are so serious to demand further investigation and Indian investors have the right to know the bitter truth .

The central character is the Mumbai-based private bank with US listing. Sucheta Dalal reached out to some senior people with KPMG links, but they chose to remain silent.

But we are not surprised. Our profession has got away with very relaxed oversight over decades by ICAI. When NFRA chose to act tough we tried to take away the new regulator through the Ministry of Corporate Affairs (MCA) in September 2021.

Let's explore what had happened. In January 2020, when NFRA issued its first set of show-cause notices to auditors of IL&FS Financial Services (IFIN), the two chartered accountants (CAs) rushed to the Delhi High Court with a writ petition, instead of responding to the new regulator. Deloitte Haskins and Sells and BSR & Associates (KPMG India) were the two auditors.

Senior CAs wrote how the profession and industry leaders were upset at NFRA’s action since the firm was superior to most others in the field and suggested that only individual partners should be held responsible and the audit firm let off as debarring a firm causes a lot of disruption.

This view is ironic, as compromise and conspiracy are usually institutionalised as the rewards and incentives of partners are tied to the business generated by them. While partners guilty of professional misconduct who permit the fabrication of accounts must be penalised, sparing the firm will allow large audit firms to make scapegoats out of partners who get caught.

Fortunately, NFRA wasn’t intimidated by the commotion created by the accounting industry. In July 2020, NFRA issued three orders against the engagement partners for IFIN. CA Rukshan Daruvala of Deloitte Haskins and Sells LLP was debarred for five years and slapped a Rs 5 lakh penalty; CA Shrenik Baid was also debarred for five years but was penalised Rs 15 lakh, while CA Udayan Sen, CEO, Deloitte India, was penalised Rs 25 lakh and debarred for seven years.

The findings in all cases were similar—professional misconduct, collusive behaviour in going along with management in agreeing to misstatements/omissions leading to fraud on the users of the financial statements.

NFRA also indicted SRBC & Co, of the Ernst & Young (EY) group for deficiencies in auditing Infrastructure Leasing & Financial Services (IL&FS) for FY 17-18.

All this is good but it is too little, too late. Three other orders were passed since then. Alll in 2022. CA Gulshan Jagdish Jham was debarred for a year and slapped with a penalty of Rs 1 lakh for professional misconduct, failure to report material misstatements, and exercise due diligence in the audit of Prabhu Steel Industries Ltd.

CA Som Prakash Aggarwal (of S Prakash Aggarwal & Co) was debarred for three years and slapped with a penalty of Rs 3 lakh as EP of Vikas WSP Ltd. He was also asked to undertake training on accounting and audit standards and submit proof thereof within 180 days.

CA Rajiv Bengali (of Subramaniam Bengali & Associates) was barred for five years and a penalty of Rs 5 lakh. As EP for Trilogic Digital Media, he was charged with false reporting in the independent auditor's report, failure to comply with auditing standards, etc.

Given the number of forensic audits ordered by SEBI and the falsification of accounts or diversion of funds brought out during the bankruptcy resolution process of corporate defaulters, regulatory action seems too little, too slow.

V Ranganathan, former director and partner at Ernst & Young LLP, says that public banks have written off more than Rs10 T in the last five years and the average recovery has been so poor it is a reflection of the audit at the banks’ and the borrowers’ end.

It is high time the government takes this issue seriously and strengthens the system and makes it robust to monitor the audit firms and create a distinct legal framework for swift and fair trials.

Some favour the US-style settlement process adopted by PCAOB and KPMG India to our slow and agonising process. But we have seen how the settlement provision has been vitiated by arbitrary settlement amounts at SEBI. Often, the penalties are trivial, and there is no information on the wrongdoing or its impact that will help or warn investors.

Last but not the least, there seems to be no shame in ‘settling’ wrongdoing, which defeats its very purpose. Sucheta Dalal's sources told her a whole bunch of ‘consultants’ have set up shop, offering to negotiate quick and low settlements with the regulator.

Even in the KPMG India case, the PCAOB order is not satisfactory as it does not name the bank involved. If PCAOB’s claimed objective is to protect investors and further the public interest in the preparation of informative, accurate, and independent audit reports, the settlement order tells us nothing about whether or not the bank’s audit was compromised and to what extent. How does that protect investors?

Compromised, conniving or negligent auditors are a big worry for any lender or investment professional. Apart from a few good orders from NFRA, some in our profession, especially after the IL&FS debacle, have tried to separate audit and non-audit business. Others are sticking to the claim that there is no conflict of interest.

In Sucheta Dalal's view, it is too early to introduce a ‘settlement’ system in India. It would be far better to strengthen NFRA and give it more teeth and manpower to effect a serious clean-up first.

To be continued

Why Deloitte has not Signed Byju's Financials for 2020-21 Even After 15 Months

 #suprioghatak #byjus #deloitte #revenuerecogntion #accountingstandards 

Deloitte has not signed Byju's financial statements for 2020-21. They have not submitted the financial reports for 2021-22 also.

While Byju's dismissed concerns, if it fails the acid test, it could horrify the entire $3.5 B Indian edtech industry, seasoned investors, upcoming founders included.

What is the problem with Byju’s finances? Are they inaccurate?

Byju’s is late in filing. Next, its books may reveal several discrepancies. Let's have a look.

Accounting issues, troublesome lending arrangements and a constant need for cash are playing simultaneously.  

The reported numbers seem to be distorted for more reasons than one. Bundling hardware like memory cards and tablets in its revenue calculations may have been done to inflate them. They accounted for 63% of its revenue in 2020 with an annual increase of 55%.

Byju’s and its controversial subsidiary WhiteHat Jr draw loans to keep prices affordable and offer a 100% default guarantee to lending partners. This risky practice is disliked.

Byju's says securitization and First Loss Deposit Guarantee (FLDG) are accepted industry practices. If not for FLDG, the majority of consumer parents would not be able to raise personal loans from banks and financial institutions at affordable rates.

Byju’s says that the late filings are not a cause for concern.

Valued at a colossal $22 B, Byju’s has raised over $6 B in its 12-year existence. It has expanded to new countries including the UK, Australia, Brazil, Indonesia, and Mexico. Revenues are not even $1 B. Ideally, the revenue multiples in the edtech space, 19x for larger companies, should be at least $1 B.

It has been on an acquisition splurge since the pandemic, embracing not just e-learning companies but professional skilling and augmented reality start-ups. It is eyeing a public market debut at a massive $48 B valuation soon.

The delay is not a red flag, it said. These numerous acquisitions are being examined thoroughly and the lack of audit bandwidth for the company has scaled up rapidly. Within a few days we can actually see that report.

Byju's made at least 10 acquisitions for a cumulative transaction value of around $2.5 B in 2021.

It has completed the consolidation of businesses and will be filing its pending financial results in June.

This response comes after The Ken reported that Byju's has not filed its financial statements for 2020-21 and 2021-22 as auditor Deloitte is hesitant to put its signature due to problems in refunds, loan guarantees and unusual revenue recognition practices.

Byju's says that they follow the highest standards in all business practices from student success to governance and accounting standards. These practices have been in operation for the last six years, have been audited by Deloitte, and records are submitted to all relevant authorities over these years.

Attributing the delay to a series of acquisitions made by Byju's in 2020 and 2021, they reiterate that multiple acquisitions were made in 2020-21 and each had a different accounting style and year. They have completed the consolidation of businesses and will be filing their financial results this month.

How Byju's records its revenue from sales of hardware (memory cards, tablets etc.) and software (apps and online classes) could have caused a discrepancy in the edtech firm’s financial statements.

Loan guarantees are the second issue highlighted. Byju's offers a 100 percent default guarantee to some lending partners that make loans to its customers. Such guarantees are called First Loss Default Guarantees (FLDG). If the customer fails to repay, Byju’s foots the bill, out of its own books or by raising cash from private investors.

It said that working with lenders that help consumers finance a course lies at the heart of what allows Byju’s to book revenues in advance.

So far, Byju's has raised over $6 B in funding, with the founder Byju Raveendran pumping $400 M in its leading the latest $800 M funding round at a valuation of $22 B in March 2022.

The refund guarantees offered by Byju's and its subsidiaries could create pain points if the actual refunds far exceed the budgeted amount.

Byju's is looking to go for an IPO in the US through the SPAC route. Hence, Deloitte could be taking a cautious stand.

Now the Indian edtech space is reeling under the bad weather of the funding winter, causing at least two start-ups to shut operations - Udayy and Lido Learning.

Edtech unicorns Vedantu and Unacademy have laid off over 600 employees each. At least 800 employees have resigned at Byju's owned White Hat Jr. The total edtech layoffs have crossed 3,500 over the last two months.

Conclusion

With these practices, Byju Ravindran's own standing as a founder is at stake as recently founders like Ankiti Bose and Ashneer Grover were shown the door for false revenue reporting and accounting.

A few million dollar questions remain to be answered

Why has Deloitte signed the previous financial statements and held off this time?

Why have the investors been investing so much money in a start-up like Byju's?

Please read Part-2 and Part-3 

About Author

CA Suprio Ghatak

Qualification: The Institute Of Chartered Accountants Of India

Company: J K V S & CO, Chartered Accountants

Location: Kolkata

About Author :

I am a Partner at J K V S & CO. I look after Recruitment, Training and Development. I am working here since May 2017.I also look into all ICAI related matters of the firm.

PwC UK ordered to pay fine of £ 5M over audits of London-listed construction groups

#pwc #pwcuk #frc #penalties #auditfailure #regulatoryaction #bigfour

PwC UK ordered to pay fine of £ 5M over audits of London-listed construction groups

Financial Reporting Council (FRC), the UK regulator has ordered penalties to be paid by PwC UK for their failures on accounts of Kier and Galliford Try. PwC’s work was not of the required standard.

PwC UK has been fined twice in a day by Financial Reporting Council (FRC) over audit failures of the two London-listed construction groups.

It was ordered to pay £5 M after Financial Reporting Council (FRC) found problems in both the audits. The companies have been hit by accounting errors in the recent past.

Financial Reporting Council (FRC) found severe problems with PwC’s audit of long-term contracts in these two companies, including recognition of revenue and costs on large contracts at Galliford Try.

The fines are the latest regulatory action over audits in the construction and outsourcing sectors, where accounting treatment of multiyear contracts and validity of assumptions made by company management in preparing the accounts are key issues.

Meticulous audit of long-term contract accounting is very important in construction companies, where many contracts are spread over a number of years. That’s what Claudia Mortimore, Financial Reporting Council (FRC) deputy executive council said.

Auditors must ensure they obtain sufficient appropriate audit evidence to support accounting of the contracts as well as apply sufficient professional scepticism. This is indispensable to allow investors to have confidence in the financial statements.

PwC UK was ordered to pay £ 3M for failing to meet the regulatory requirements in its audit of Galliford Try’s accounts for 2018 and 2019. The penalty was reduced from £ 5.5M in recognition of its co-operation. 

Financial Reporting Council (FRC) said PwC had not done enough to challenge declarations made by Galliford Try’s management, which was found in 2020 to have overstated its assets by £ 94.3M.

A further penalty of almost £ 2M was ordered, reduced from £ 3.35M, for its audit of Kier’s accounts for the year ended June 2017, when it failed to find errors in the company’s income and cash flow statements.

In both the companies - Galliford Try and Kier, PwC had not shown suitable professional scepticism and failed to gather sufficient audit evidence in its audits.

PwC UK agreed to pay more than £ 756,000 to cover the cost of the two FRC investigations.

Jonathan Hook, the partner who led the audits of both companies, was given two fines totalling more than £ 135,000. He retired from PwC UK in 2021. Both Hook and PwC UK were given severe admonishment by FRC.

PwC UK  had invested a lot in improving audit quality, including long-term contracts, since the audits of Kier and Galliford Try.

Financial Reporting Council (FRC) instructed PwC UK to review its audits of listed companies, where long-term contracts are widespread and to report to FRC on the results. PwC received the best score out of the Big Four accounting firms in FRC’s most recent quality inspections.

Financial Reporting Council (FRC) investigations into PwC UK’s audits of Kier and Galliford Try are the latest regulatory actions against auditors of UK-listed contractors.

Deloitte was ordered in April 2022 to pay a fine and costs of more than £ 2M for audit failures at Mitie, while Grant Thornton LLP (US) was fined £ 700,000 in November 2021 for problems with its review of the accounts of Interserve, which became insolvent in 2019 and entered the legal process.

Financial Reporting Council (FRC) is also investigating KPMG UK for signing off the accounts of outsourcer Carillion before it went into liquidation, and mid-tier (read medium sized) firm BDO UK LLP over its auditing of NMCN, a London-listed construction company that went into liquidation in October 2021.

Financial Reporting Council (FRC) in January 2022 was probing PwC’s work at defence contractor Babcock, which has also disclosed accounting errors in recent years.

Financial Reporting Council (FRC) is also reviewing PwC UK's audits in other sectors, with investigations under way into its audits of BT, Eddie Stobart Logistics, collapsed minibond company London Capital and Finance and Wyelands Bank, owned by steel tycoon Sanjeev Gupta. 

To be continued

KPMG fined £3.4M over Big Failures in the 2010 Rolls-Royce audit in UK

#kpmg #frc #rollsroyce #bigfour #noncompliance #criminalinvestigation 

KPMG fined £3.4M over Big Failures in the 2010 Rolls-Royce audit in UK 

The Financial Reporting Council (FRC), independent regulator in the UK and Ireland, responsible for regulating auditors, accountants and actuaries, and setting the UK's Corporate Governance and Stewardship Codes, says KPMG’s audit of Rolls-Royce PLC, major British manufacturer of aircraft engines, marine propulsion systems, and power-generation systems, failed to report payments to Indian intermediaries. 

KPMG will pay a fine of £3.4M to FRC after accepting failures in its audit of Rolls-Royce, Britain’s most prominent aerospace and defence manufacturer, that paid a £500M settlement after bribery allegations. 

KPMG received a severe rap over the knuckles from FRC, and will have to assign an independent review into the efficacy of its policies.

KPMG has been fined £3.4M by FRC for serious failures in its audit of Rolls-Royce’s 2010 accounts, five years after the engine-maker reached a settlement with authorities over corruption allegations. 

It is the fourth significant fine KPMG has paid this year.

Anthony Sykes, the KPMG partner who led the audit, will also pay a £112,500 fine and received a severe rap over his knuckles ahead of his retirement from KPMG in September. The fines for KPMG and Sykes were reduced from £4.5M and £150,000 respectively as they cooperated with FRC. KPMG will also pay FRC’s costs for the investigation.

The series of scandals of the Big Four continue and this is the latest. All have been fined millions of pounds for audits that had significant inadequacies.

Poor quality audits have been blamed from collapsed construction firm Carillion – for which KPMG was this month fined £14M – to retailer BHS, for which PwC was fined £6.5M. KPMG has also been fined this year in the alcohol distributor Conviviality and Revolution Bars.

Rolls-Royce agreed to pay £671M in penalties in 2017 after prolonged investigations into bribes it paid for export contracts, including £500M in UK and other payments in US and Brazil. The charges in the deferred prosecution agreement included false accounting and conspiracy to corrupt.

FRC says, bribery and malpractice through intermediaries and advisers in the defence field were prominent at the time of audit, and KPMG should have known it as it was auditing another defence company which paid a large fine to settle a criminal investigation.

FRC said KPMG had failed to deal properly with Rolls-Royce which was not complying with legal requirements in relation to payments of agents in India.

The serious failures highlighted by the FRC related to two payments – £3.3M and £1.9M – made to Indian intermediaries.

KPMG was aware in July 2010, but did not include them in the audit report. Sykes also instructed a manager to remove a paragraph referring to them from minutes.

FRC says that KPMG failed to exercise professional scepticism and did not obtain sufficient audit evidence and document this on the Rolls-Royce audit file. Its quality control was substandard.

Claudia Mortimore, the deputy executive counsel to the FRC, highlighted the need for accountants to question their clients’ assertions. 

“It is essential that auditors are alive to the risks of companies’ non-compliance with laws and regulations, and conduct work in this area with care and sufficient professional scepticism,” she said. “This is particularly so when the audited entity is in a sector where such risks are known to be prevalent.”

To be continued

The Dark Side of the Indian Capital Market - Inspired by Sucheta Dalal

After reading Sucheta Dalal's article I feel like having viewed a good crime thriller in a lavish multiplex. It's a fact and not a story where the guilty always escape undetected and every time his employer (read - brokerage firm) goes all the way to protect him. And what does the regulator Securities and Exchange Board of India (SEBI) do? Nothing.

Since 2016, SEBI has issued multiple circulars to strengthen compliance and reporting requirements for brokers. In 2018, rules were framed to prevent unauthorised trading by stockbrokers and set up an early warning system. Yet, we have 32 broker failures over 2.5 years at the National Stock Exchange (NSE) and an unending list of unreported stories. Two have been discussed by the author.

Brokers have used the lock-down period to loot people with well-laid traps backed by the semblance of all regulatory compliances. They ensured technical compliance with all SEBI regulations pertaining to margin and ledger statements, emails and SMS messages.

A brokerage firm is not even a bank; yet, it has the audacity to wrest the extraordinary power to illegally freeze the demat accounts of family members and lock up their lifetime investments. All because the grievance redressal in India is poor and as good as non-existent and our courts and regulators have failed to ever award punitive damages to victims.

In another case the broker after violating SEBI’s guidelines began a criminal cover-up to avoid the loss of nearly Rs 7 cr that the firm would need to write off. The firm was mopping up huge brokerage income from these trades. More importantly, SEBI has no concept of a family account; the broker’s action was illegal and as good as highway robbery. The broker had no consent to even use the son’s shares as collateral for the loan to their mother or liquidate them to recoup losses.

To cut a long story short, the brokerage firm, instead of sacking the guilty employee, defended his action. In all, the broker got the 82-year-old mother to execute over 2,000 derivatives trades worth a mind-boggling Rs 340 cr between April 2020 and March 2021, leading to a loss of Rs 2 cr. The story shows that the employee’s actions were fully backed by the organisation which defended fraud, forgery and theft.

What happens next? The broker can continue to fight and seek arbitration. Since the amount is large, it will be examined by NSE and escalated to SEBI. On paper, the regulator has the power to search, seize, interrogate, raid and punish the broker. Will it act? So far, in the past 20 years, no SEBI chairman has woken up on behalf of investors.

To be continued

The Axis Mutual Fund Story

 

#suprioghatak #frontrunning #insidertrading #axismutualfund #sebi

The Axis Mutual Fund Story 

What is the difference between front-running and insider trading?

Both affect mutual fund unit holders and stock market investors.

Our seventh-largest fund house, Axis Mutual Fund, has suspended two fund managers including its chief dealer and is investigating improprieties in the funds they have handled. While it is yet unknown what is the exact nature of these violations, domestic mutual funds have come under investigation for front-running.

Front-running is not insider trading, though the culprits make money in both by trading in shares. In front-running, a dealer within an institutional money manager like a mutual fund or a share broker abuses knowledge of orders that the mutual fund has for the day and tries to profit from them.

What are the differences between the two?

How to make a cheat sheet in a front-running fraud

The fund manager decides what to buy or sell. Informs his dealer who executes the trade on behalf of the fund house. It has a dealing room in an isolated area where these trades happen all day long. Only dealers and fund managers are allowed entry. And the crime takes place here.

The dealer to make profit enters the market minutes before punching the fund house order. Mutual funds place large orders which sharply move the stock price.

The dealer buys or sells the stock minutes before a mutual fund places its trades, buying or selling the stock.

The idea is to profit from the big investor’s moves, either by buying or selling shares.

What is insider trading?

It is when a company insider, official, employee or senior executive, takes advantage of unpublished price-sensitive information (UPSI) to trade in the company’s stock and make profits from such transactions.

It is done by a company’s employee to make profit by dealing in the company’s shares.

Front running can be done in just about any stocks or sectors by unrelated people, having knowledge of large investors’ plans to trade in the markets.

What is the Impact on investors?

Insider trading gives an unfair advantage on the basis of non-public information.

SEBI (Prohibition of Insider Trading) Regulations clearly define the insider and what constitutes unpublished price-sensitive information.

Public shareholders like mutual funds are at a disadvantage as company insiders have access to UPSI, take undue advantage and use accounts of their associates to execute such trades.

SEBI has put in place certain checks and balances to prevent insider trading. For example, SEBI’s code of conduct for listed companies states that trading restrictions on insiders can come into force from the end of every quarter till 48 hours after the declaration of the company’s financial results.

In front-running, if the dealer benefits, how does it harm the unit holders of the fund house?

Knowing that the mutual fund is going to buy a certain stock, he can build a position immediately in another account. And as the price rises with the mutual fund buying it in large quantities, he can sell the stock and make a quick profit.

Similar is the case when the dealer knows that the mutual fund is going to sell a stock. Then, the mutual fund scheme is deprived of a market-driven price, as the presence of more participants who have taken positions in the market, the stock price gets impacted.

When the fund house finally enters, the stock price is already manipulated.

A one-off incident does not materially impact a stock’s price. But a dealer repeatedly front-running a large investor can make lots of money.

Worse still, if the buying is large enough, it can create a large jump in the stock price. So, when the mutual fund is buying, it is buying at a higher price than it would have otherwise.

The dealer will not execute such fraudulent trades in his own account, but through his associates and their accounts, to avoid getting caught. These accounts are mule accounts in stock market vocab.

Front-running also impacts other stock market investors, as the latter trade at prices manipulated by the dealer for his own gain.

Most mutual funds have strong control measures to check front-running. Access to dealing room is strictly controlled. Surveillance cameras keep an eye on the dealing room. No mobile phones are allowed inside the dealing room.

All conversations are on recorded lines. Declarations need to be made of personal holdings as well as those defined as relatives. Pre-clearance is required when trading in shares in personal account or in those of relatives.

However, all such controls are possible within the premises of the fund house. Work from home has made it difficult to ensure these controls in letter and spirit. Calls still get recorded, but who is interacting within his own premises cannot be controlled.

How has SEBI dealt with front running?

When SEBI has found violations, it has imposed monetary penalties. Dealers, fund managers and the outside brokers with whom they have worked in collusion get penalised. Rarely the CEO of the fund house pays a monetary penalty. Unlike US SEC, it is rarer in India to penalise or debar a CEO of an Asset Management Company. On the gravity of the securities fraud, SEBI pulls up the fund house’s trustees and the Board of Directors.

Sometimes, proceedings get settled through consent mechanism of SEBI, also known as settlement process, where the institution under investigation, settles the case with SEBI in lieu of payment of monetary penalty and voluntary restrictions. In one of the first cases of insider trading that came to light in public domain, a large fund house’s head had to pay Rs 15 lakh fine, as part of SEBI’s consent proceedings. The fund house and its trustee board had to pay Rs 20 lakh each.

A consent mechanism is usually of two types; one where the fund house neither admits nor denies the findings of fact or conclusion of law, and the second category where there is admission. In the first the penalty amount is higher in comparison to the cases where fund house admits the charges.

And how is the consent fine decided? SEBI relies on the formula prescribed in the Regulations where it takes into account the size and nature of the offence, impact on the market, the company and conduct of the culprit.

To be continued

The Fall of The House of Cards. How Founders Burnt Millions and Razed Zilingo to the Ground

The Fall of The House of Cards. How Founders Burnt Millions and Razed Zilingo to the Ground

#suprioghatak #zilingo #startups #sequoia

Introduction

Zilingo, a play on the word "zillion," was established in 2015 by CEO Ankiti Bose and cofounder Dhruv Kapoor. The idea came when Bose, holidaying in Bangkok, noticed many small and medium-sized shops without online presence.

In 2015 Bose left Sequoia Capital where she was an investment analyst and launched her own company, Zilingo. At twenty-three she founded Zilingo, an e-commerce platform that offers B2B focused services. She moved to Singapore in 2016, where she developed Zilingo software and supply chain solutions.

From building solar panels and games to an e-commerce unicorn, that’s the journey of Zilingo’s Dhruv Kapoor. An IIT-Guwahati alumni, now heading a 100-odd team, he structures work for engineering, UX design, product management, data analytics, data science, and multiple other teams regularly. He worked at Yahoo for a couple of years till 2013. As co-founder and Chief Technology and Product Officer at Zilingo, Dhruv is excited by the possibility of shaping the future of supply chains.

Zilingo has developed a proprietary suite of applications which allows fashion merchants to access manufacturers around Asia.

Businesses include a business-to-consumer (B2C) and business-to-business (B2B) marketplace, private label as a service, an e-pos and inventory management service, trend forecasting and fintech services.

Why a VC like Sequoia bought in

Sequoia Capital is an American venture capital (VC) firm owned by Doug Leone and Michael Moritz headquartered in Menlo Park, California which mainly focuses on the technology industry. It was the most active VC fund company in India in 2019. 

Zilingo said it has raised $226 M in its latest funding round from existing backers such as VC Sequoia Capital, with Singapore’s Temasek Holdings joining as a new investor in 2019.

Sequoia Capital is among the top VC firms globally, investing in startups at the growth stage and above. In 2018, they launched Surge for early-stage startups based on–or building for–India and Southeast Asia. It has funded 11 SEA startups in 2019, making it the 4th most active VC in Southeast Asia.

What’s Happening Now

A bitter clash of vision between founders Ankiti Bose and Dhruv Kapoor is threatening to swallow Zilingo.

The capital-intensive B2C vertical and lack of a tech platform for B2B operations initially led to overspending on marketing, employees emptying cash and much more.

Ankiti Bose is suspended and has initiated legal action and exploring a lawsuit against Dhruv Kapoor and likes to buy back Sequoia’s 26% stake in Zilingo.

How did the circumstances turn so threatening for Zilingo?

Ankiti Bose and Zilingo’s life has taken a turn since inception. It searched for growth in 2018.

The idea that came out would change the trajectory of Zilingo forever. It solved the challenge with scaling up and signing vendors and suppliers very fast.

But involved operations and deep discounting that would straighten out the startup, one of the biggest success stories from Southeast Asia and Singapore.

In 2021, another massive shift — more significant than planned. It was a clash between Bose and Sequoia, the company’s earliest and most consistent institutional investor.

It was not professional fallout, but something personal between the two over the direction of the company, the cash burn and no road to profitability, all dating back to the focus on rampant growth from 2018. This happened even as tensions between Bose and Dhruv Kapoor continued to escalate.

Kapoor and other senior employees at the company buried complaints of sexual harassment.

How did things get so bad?

A house of cards, riddled with ideas missing in the initial years, and overspending to market and promote the B2C fashion vertical meant Zilingo burnt millions. The founders clashed over ideas and alleged patterns of sexual harassment in the company.

Was there Willful Fraud

There was willful fraud. We don’t know what it was, how it happened and how it evaded notice of the board and investors.

This escalated from mismanagement, millions of dollars burnt to a massive controversy threatening to swallow the entire company. What will happen to the 500+ employees? Why the VCs are neglecting corporate governance processes and not pushing for transparency are all million-dollar questions. 

The operations initially were in a complete mess owing to a lack of a working tech platform to onboard clients. Processes and sales reporting were manually done like traditional supply chain businesses. Sales and procurement teams worked without any direction or targets.

Valuation Built On GMV

The only focus to maximize GMV led to a no-holds-barred approach to sales and unethical behaviour from the sales team.

Sales personnel striking cash-based deals with vendors, overbilling purchases and under-invoicing sales. And the buyer and seller were the same or related entities.

Emails sent from fake email IDs to Zilingo’s auditors in Singapore containing documents confirming outstanding amounts owed by some vendors.

It is still unclear if the dues were recovered or they were actually outstanding.

Zilingo has not filed its financials in Singapore since FY2019.

Its latest audited financial performance shows losses of $236.5 M in FY2019. Net cash flow from operating activities was a negative $95 M, with a high debt-to-equity ratio of -1.60.

Zilingo has completely shut its B2C operations — it only contributed 0.5% to the net revenue in FY2021, and is not accounted for in FY2022 projections.

Over the past three financial years (2019-2021), the cumulative loss for the company was over $430 M, while the total net income over these years is just $285 M. However, the company is claiming positive contribution margins in FY2021 of $4.1 M.

Zilingo Mismanaged Millions

Its expansion did not stop with zero planning. It issued $14 M in loans from books to suppliers in India and Indonesia. No risk assessment was conducted and the entire amount written off as bad.

Zilingo paid more than 2X just seven months later after Bose showed desperation to acquire nCinga.

Bose expensed personal spending to the company’s accounts.

The current scenario and suspension of Ankiti Bose is not about cash burn or GMV boosting, which Zilingo did, but willful misconduct and fraud, the nature and the perpetrator of which are still a mystery.

Ankiti Bose Vs Dhruv Kapoor

Kapoor had been at odds with Bose on a number of matters.

He was disappointed with the nCinga acquisition. Promises made by Bose were not kept. And then there was more tension to follow in 2020.

After laying off employees in 2020, Zilingo entered the personal protective equipment (PPEs) space. Kapoor opposed this as it was not Zilingo’s strength. Despite Bose’s assurances it signed contracts with German and Indian governments and brought on suppliers.

The Indian government is in a legal battle for failure to deliver 10 M KN95 masks. The contract value was $22.5 M. Zilingo claims the Indian government did not give the mandatory 30% of total invoice value as bank guarantee. This is pending in the Delhi High Court.

Despite being cofounders and having substantial stake, Kapoor and Bose seemed to lead different companies. Kapoor was into tech and product development, while Bose led the sales, marketing and administrative responsibilities. Such a split is common, but what is not is one not knowing what the other’s doing. This is a serious lapse in judgement and leadership apathy for critical areas of the business. Kapoor is equally responsible for upholding best practices, and calling out problems or issues. But alas these were two different Zilingos, culturally and organisationally. And this is what completely derailed Zilingo after years of burning cash became a problem.

Sequoia’s Shailendra Singh Vs Ankiti Bose 

There was a change in dynamics between Bose, key investor Sequoia Capital India and Shailendra Singh, a managing director at the VC firm. The fallout began in January 2021.

These two objectives — profitability and fundraising — seemed diametrically opposite and the CEO was uncertain on whether this slow-burn strategy would pay off.

Bose believed Zilingo had enough to push for growth and raise a new round, but this line of thinking was clashing with Sequoia’s goals.

At one point, Sequoia had suggested former Myntra CEO Ananth Narayanan, as a successor. But constant decline from Ankiti’s side as she thought Sequoia has never pushed other founders from its portfolio in this way.

Who Watches The Celebrity Founder? 

Investors asking for profitability is nothing new, but the duo’s relationship is said to have deteriorated when Bose accused Sequoia of selectively targetting her.

In the aftermath of CEO Bose’s suspension and the stepping down of Sequoia’s Shailendra Singh from Zilingo’s board, the VC firm released a post on its blog talking about corporate governance, willful fraud and misconduct by its founders. The suspension comes after a whistleblower allegation against fraud in Zilingo.

Can investors claim ignorance for all practices at Zilingo? How has the board, which includes Sequoia, other prominent investors, not looked into the books or financials for two years, having had a full-time CFO?

And if they were examined, how did wilful fraud escape notice?

What Next for Zilingo?

A parallel lie in BharatPe and Zilingo — one of the cofounders has been suspended for irregularities, while the focus is on mudslinging and digging up old accusations.

Sexual harassment complaints were raised against a senior employee, who is there since 2019 and now heading the company’s primary revenue source. These were buried by the management.

From 900 employees in early 2020, workforce has reduced to 500 after many rounds of layoffs.

Even if it raises funds at a less than satisfactory valuation, the pressure to grow and show profits will remain. The other option is distress sale at a lower valuation, impacting employees, as transformation of people post acquisitions is a big challenge. Zilingo will be having a new CEO in the near future.

Ankiti Bose is a huge part of the company — a brand in her own right and the face of Zilingo — but her days might be numbered, unless her legal steps yield results. But with a new leader or with Bose as CEO, will it matter? Can Zilingo and its founders climb out of the hole they have dug?

What will happen in the near future?

Ankiti Bose is exploring buyback option ahead of board meeting and has begun talks with new investors to buy out a majority stake, including the 25% equity owned by Sequoia Capital.

Zilingo is one of Sequoia Capital India’s key investments in the South East Asia region, and the start-up entered the unicorn club when it raised a $226 M Series D round in April 2019. Bose who is at the helm of the company since its inception in 2015 is facing allegations of financial irregularities, with the board accusing her of inflating revenues.

The allegations against Bose emerged after the start-up began the internal process to raise $200 M in funding led by Goldman Sachs Group which has now been discontinued. Zilingo submitted all key financial statements for a due diligence process for the $200 M funding. The company currently has enough cash in the bank for the next 15-18 months. The $200 M talks for funding were paused without her consent, accounting practices and financial investigation was launched on March 31 and she was immediately suspended from her role as CEO. The investigation was prompted by Zilingo’s auditor raising questions about its accounting during the due diligence process

Zilingo has appointed Deloitte to probe the harassment charges filed by cofounder Ankiti Bose against the company after her suspension as confirmed by the board on 2^nd May. The decision to suspend her was a joint decision by the board and the relevant shareholders.

After the suspension, Sequoia India MD Shailendra Singh vacated his seat on Zilingo's board, in an ongoing exodus that has seen representatives from Temasek and Burda Principal quit.

The startup has raised more than $308 M to date, with Germany’s Burda and Sofina Capital being its other major investors. The entire situation at Zilingo unfolded while it was in talks for raising a funding round worth $150-200 M.

To be continued

(Inspired by Nikhil Subramaniam)

How Reliance got the Keys. What Mukesh Ambani did at Future Retail can be a B-School Case Study

How Reliance got the Keys. What Mukesh Ambani did at Future Retail can be a B-School Case Study

#suprioghatak #amazon #relianceretail #futureretail

Amazon’s claim to ownership rests primarily on paper. Reliance has legal arguments of its own too, based on another set of contracts. But with one key difference—Reliance also owns the keys to the building.

In terms of legal brilliance it would be hard to top what Amazon had done. But that was before we understood what Reliance did. Because that is just something else altogether. And it makes for an even better story. Let's find out what happened on the night of February 25.

The fight over Future Retail’s assets had a surprise finale — when a billionaire just took over the shopping aisles.

In the unexpected climax, Mukesh Ambani decided who gets to own the assets of Future Retail Ltd. not in an arbitration tribunal in Singapore or in a courtroom in New Delhi, but in a shopping aisle.

Future Retail had been subleasing store space from Reliance Industries Ltd. It was operating only on Ambani’s endurance as Future couldn’t come up with the rent. But with Amazon continuing to block Reliance’s $3.4 B purchase of Future’s assets, Ambani decided to make the acquisition a fact of life. He terminated the leases and is taking control of the properties.

It was a dramatic epilogue to a three year old narrative. Amazon initially helped Future by investing $192 M in Future Coupons Private Limited, a gift voucher unit of founder Kishore Biyani for him to use the funds to steady the debt-laden Indian retailer.

The 2019 deal's condition was that assets in the 1,500 stores pan India wouldn’t be sold to Ambani, who owns India’s largest retail empire. Biyani did exactly that after Covid-19 decimated operations. Amazon began proceedings against Future for breach of contract. The Reliance deal was on hold until Ambani decided he has had enough. 

Future Retail was living under a rock. Its bailout by Ambani was a commercial deal and not a humanitarian mission. It was Future’s job to take care of all its stakeholders, most importantly the creditors.

And where’s Amazon in all this? It has learned the hard way that taking on Ambani on his home turf was impossible. So Amazon offered an out-of-court settlement over its funds invested in Future Coupons Pvt. Ltd. which had been its first move in the drama. Amazon couldn’t have rescued Future Retail as India’s draconian foreign direct investment (FDI) rules were a big roadblock. So it did the next best thing. It funded privately held Future Coupons indirectly holding some control over Future Retail.

That control proved to be fragile. After agreeing to Reliance’s deal, Future wanted to come out of the contract with Amazon. Its independent directors complained to Competition Commission of India (CCI) that Amazon had deliberately misled the true nature of the Future Coupons deal, which effectively put Amazon in the driver’s seat at Future Retail, violating India’s 2018 FDI law. CCI promptly suspended its earlier approval of Amazon’s investment, and the Delhi High Court halted the Singapore arbitration panel’s work.

But if Future with a net worth of negative $280 M was betting that Reliance would wait patiently as it sorted out its legal troubles with Amazon, it misjudged the situation. 342 of its large stores and 493 of smaller outlets — constituting 55% to 65% of retail revenue — have so far received termination notices of sub-leases from Reliance entities.

It’s dishonest for Future to now appear shocked, that Amazon is moving in before concluding the formal purchase. Possession is nine-tenths of the law. Amazon had given Future an option in January for a further $914 M bailout, but Future's independent directors found it inadequate, given the astronomical debt. Now it’s for Future’s 2025 dollar bondholders to figure out if they’ll be made whole. Trading around 60 cents to the dollar through the stealth acquisition, it doesn't indicate any creditor confidence.

How does a physical takeover work? There’s inventory, furniture, lighting and point-of-sale equipment, all pledged to creditors.

There’s nothing left at Reliance to discuss. The outcome is this. On the urging of Future Retail, the Indian judiciary put a bullet through the arbitration law, never allowing it to settle a simple commercial dispute. The consequences are for Future — and India — to bear.

When faced with heavyweight opponents, the odds of enforcing a contract in the country are slim. Nobody should complain if foreigners are skeptical of India’s growth in “ease of doing business." But then, it’s a fast-modernizing market of 1.4 B consumers. Amazon can’t give up on it. It alleged that Future was trying to remove the “substratum of the dispute" by transferring its stores to Reliance in a “clandestine manner." It informed the Supreme Court that truce talks had failed. It’s hard to say if Amazon’s continued protests will discourage Future's lenders from blessing the change of control — or if it’s already too late for that.

As for Future, it doesn’t have much. Going defunct is a feature of capitalism. But the humiliating manner in which an Indian pioneer of modern retail got ripped apart store by store for the wrong choices it made should be a case study.

However, before academics get busy, creditors need to find out where the shopping racks and the cash machines are kept. It’s their collateral, after all, and the comprehensive lesson of this contest has been that everyone should grab what they can. While stocks last.

Updates as of Now

State Bank of India has written to Future Retail Ltd. seeking accountability on the company's stores taken over by Mukesh Ambani-controlled Reliance Industries Ltd. SBI reiterated that the lenders have rights over stock, moveable fixed assets in all the outlets of the company, and in the case of its sale, the entire proceeds will need to be used to settle their dues.

Reliance Projects & Property Management Services Ltd. had taken over 835 sub-leased stores of Future Retail after voiding the lease agreements, the company had informed exchanges in March. These included 342 large-format stores including Big Bazaar, Fashion@Big Bazaar, and 493 small outlets such as Easy Day and Heritage. Reliance Group also took over 112 Future Lifestyle Fashions Ltd. stores.

After Reliance took over the stores, Bank of India on behalf of the lenders had issued a public notice warning people against dealing with Future Group's assets. In the notice, the bank had highlighted that lenders have rights over the group's assets owing to the loans they had extended, and any sale without their consent would be subject to legal proceedings.

The lenders are not sure if the value determined nearly two years ago would still hold since significant deterioration has taken place since. Even if the sale were to be concluded now, lenders are unlikely to recover a large part of their Rs 30,000 cr dues against Future.

(Inspired by Andy Mukherjee) 

 

To be continued