Adani Affair Shows ‘Collapse’ of Regulatory Structure: PCPSPS

The Adani Group controversy has shown several “deeply worrying facets” of the regulatory regime governing capital markets.

According to the Peoples’ Commission on Public Sector and Public Services (PCPSPS), the Hindenburg Report’s allegation that a web of shell companies located in tax havens are connected to key personnel of the Group and own shares of the companies implies that the extent of “public” ownership of shares of these companies is exaggerated and in violation of Securities and Exchange Board of India (SEBI) regulations.

PCPSPS, which includes eminent academics, jurists, trade unionists and social activists, said in a statement on Friday the “crux” of the Hindenburg allegations “pertain to the ownership structure of the Adani Group companies”.
 
“SEBI regulations stipulate that, at least, 25% of the shares of a listed company be with the “public”—persons or entities not connected or controlled by its promoters. This stipulation is meant to ensure that there is wider dispersal of ownership, which would allow for better price discovery of the true value of the shares of a company, and therefore, of a company’s true worth as determined by the market,” PCPSPS said.
 
The Hindenburg allegations about the use of shell companies are critical because “such structures allow for easier manipulation of the Adani Group companies’ share prices, which in turn would make it possible to not just inflate the companies’ valuation,” PCPSPS said.

It would also “leverage higher valuation to mobilise greater quantities of debt than would have been possible without the use of such opaque ownership vehicles”.
 
Pointing to SEBI’s recent statement asserting that capital markets are “stable” and are “functioning in a transparent and fair manner” begs the real issues at stake, PCPSPS said. “First, Hindenburg’s allegations have nothing to do with the stability of otherwise of the Indian stock markets. Instead, its allegations suggest a dereliction of regulatory duties by SEBI in ensuring that its own regulations are complied with by all market participants. Indeed, if anything, the stability of markets rests on compliance with regulatory norms.”
 
Mentioning the February 9 decision of investment research firm MSCI that several constituents of the Adani Group can no longer be eligible for its indices, the PCPSPS said that it is a “damning indication that SEBI has been in gross dereliction of its key duties as a regulator. “MSCI has determined that the characteristics of certain investors have sufficient uncertainty that they should no
longer be designated ‘free float’ pursuant to our methodology,” the index provider said.

It is significant that the shares of the Adani Group companies, which had recovered after a spectacular collapse, “fell sharply” after the MSCI statement.
 
Following the development, Hindenburg founder Nathan Anderson tweeted: “We view this as validation of our findings on offshore stock parking by Adani.”

SEBI’s conduct is in “sharp contrast to that of MSCI. While the private market research firm thought it fit to immediately address the issues that had a bearing on the credibility and integrity of its own indices, the national watchdog has been revealed as a hapless spectator at worst, or, at worst, one that is indulgent to the point of obliging the whims of a buccaneering corporate czar”, PCPSPS said.
 
Second, it appears that SEBI’s own “investigations” into the use of shell companies has been going on for almost two years without any tangible progress, PCPSPS said. “This is indeed serious because it reflects at best either lethargy, carelessness and dereliction of basic regulatory duties, or, at worst, a permissive regulatory regime that encourages cronyism.”
 
Recalling the issues raised by Trinamool Congress Lok Sabha member Mahua Moitra in Parliament on July 19, 2021, PCPSPS said she had asked a question about the Adani Group’s beneficial interests in Foreign Portfolio Investors (FPIs) who invested in its six listed companies. “In particular, she wanted to know whether the regulators had initiated any investigation.

In reply, the minister of state for finance confirmed that while SEBI and DRI had undertaken investigations against a few such FPIs, no investigation had yet been undertaken by the Enforcement Directorate (ED)”.

Citing “confidentiality”, he “refused to disclose whether the Income Tax Department had conducted any investigation.

Further, he provided a long list of beneficial owners of FPIs who invested in the six Adani companies as on June 30, 2021. Among them were many Mauritius-based FPIs”, PCPSPS added.
 
Placed in this context, this “raises serious questions of SEBI’s role as regulator in ensuring that its own rules are complied with. Why has SEBI taken so long in determining the status of the shell companies and their linkages with the listed companies of the Adani Group? And, what has it done about the grave violations of its listing rules if these allegations are indeed true?”
 
Third, recent media reports “reveal that Mauritian authorities have been in touch with SEBI, indicating that SEBI may well know or may have already been in the know about the true identities of ‘beneficial owners’ in entities that own shares of the Adani companies”.
 
The Mauritius minister for financial services and good governance is “reported to have reiterated that Indian regulatory agencies ‘are allowed full information even up to the ultimate beneficiaries’. While insisting that such information has been shared with the Indian agencies on an ongoing basis ‘for quite some time’, he revealed that such information included information pertaining to the Adani Group companies”, the statement read.

“These revelations indicate that SEBI’s fruitless and prolonged ‘investigation’ into the true extent of ‘public’ shareholding in the Adani Group companies facilitates the continued abuse of Indian capital markets by sharp operators.”
 
While SEBI’s role in “preventing the use of shell companies has become obvious, even more shocking has been the role of key ministries in the Union government, particularly the finance ministry and ministry of corporate Affairs. It is shocking that neither ministry has thought it fit to even define a shell company let alone prevent the use of such opaque structures, which are detrimental to the growth of a healthy capital market that is transparent to all stakeholders”. Answering a Rajya Sabha Question on shell companies on February 6, 2018, the corporate affairs minister said, “The Companies Act, 2013, does not define the term ‘shell company. However, the Organization for Economic Cooperation and Development (OECD) defines a shell company as a company which is formally registered or otherwise legally organised in an economy but which does not conduct any operation in that economy other than in a pass through capacity.”
 
In effect, the Centre, “by conceding that it has no laws to check the abuse of shell companies, has accepted that it has no interest in establishing structures that promote transparency in markets that ensure that the identities of the true beneficial owners of companies are visible to all instead of hiding behind opaque walls”, PCPSPS said.
 
Worse was the government’s August 2022 decision to allow Indian corporate entities to invest in foreign locations, which “provides ample scope for Indian entities to use shell companies located in tax havens to indulge in round-tripping, a mechanism that enables the rerouting of black money into the Indian economy”, the statement added.

The decision also “permitted” domestic entities to make overseas investment “even if they were under investigation by any investigative agency or regulatory authority—a provision that “opened the overseas doors for tainted individuals and companies to continue with round-tripping. This raises concerns about the motives underlying the decision”.
 
PCPSPS finds the Reserve Bank of India’s (RBI) recent action in summoning details of loans by Indian banks to entities of the Adani Group “shocking”.

“One would assume that the RBI, as the key regulator of the Indian banking system, would have had this information with it on a real-time basis. Its recent assurance that there is no danger to the banking system because of excessive leverage does not inspire confidence purely because one wonders whether all the relevant information has been factored in.” 
 
In fact, about five months ago, when CreditSights, a research wing of the US-based Fitch rating agency, cautioned Indian regulators about overleveraged operations of the Adani Group, the “People’s Commission had written to the RBI governor asking that the banking sector regulator assess the implications for the health of the financial institutions and for the stability of the financial system. It is obvious that the RBI failed to act on our letter”, PCPSPS said.

The volatility in the stock market “reveals the abject ereliction of duties by multiple actors in the Indian regulatory landscape. At the very top of the governance structure are key ministries and department which have failed to establish checks and balances”, PCPSPS alleged. SEBI, as the market regulator, has “failed to implement” its own rules, which “question the credibility and integrity” of the Indian capital markets. The banking sector regulator has been a “mere bystander allowing a bubble to assume
threatening proportions. In sum, the Adani affair highlights the “wanton neglect of national regulatory systems, mechanisms and structures and signals that India is open for abuse at will by sharp operators”, it further alleged.
 
PCPSPS urged Parliament and the people at large to pressure the government to urgently promulgate laws and regulations that ensure that shell companies established in overseas jurisdictions are in compliance of national laws and regulations.

“This would make it amply clear to foreign entities that there is zero tolerance of violations of Indian regulations.” Laws should also ensure the autonomy of regulatory agencies such as SEBI, RBI and Registrar of Companies so that they function with a degree of transparency.

Besides, the Central Bureau of Investigation, ED, DRI, IT Department, Serious Frauds Investigation Office, etc. should have “functional autonomy”. The “arbitrary and selective conduct of their investigations in recent times is obvious to all.

Their control by the executive is what enables not just their use as tools of harassment but also as a means of serving the needs and demands of cronies. This needs to change.” The government should also “stop forthwith the disinvestment and asset monetisation drives as they are detrimental to national interest”, PCPSPS added.