AMITY UNIVERSITY

AMITY LAW SCHOOL

Semester VIIBBA LL.B. (Hons.) Course

ARTICLE ON POOR TRACK RECORD OF SHAREHOLDERS

In the Course of

Corporate Governance

As a part of continuous evaluation scheme

Submitted By: Submitted To:Mr. Rahul MishraPrerna GuptaBBA LLB(H)

ABSTRACT

The shareholders rights as stressed by the Companies Act, other statues and various committees give any investor or the reader the impression that there are enough provisions in the laws of the land, there has hardly been any conviction under them all these years. The liberalization of the Indian economy since 1991 seems to have opened the floodgates of scams and provided vast opportunities to fly-by-night operators. These have destroyed shareholder values. This paper mainly focuses on the various laws enacted for the investor protection in India, committees on investor protection and the lacuna in it which resulted in poor track record of shareholders. Also the paper focuses on SEBI for safeguarding the interest of shareholders through various regulations and guidelines.

INTRODUCTIONThe shareholders rights as stressed by the Companies Act, other statues and various committees give any investor or the reader the impression that there are enough provisions in the laws of the land, there has hardly been any conviction under them all these years. Since 1990, more than INR 600,000 million was collected from prospective shareholders by several companies that did the vanishing trick. Though their names are posted on the World Wide Web, none of the directors or promoters has been prosecuted either by the Registrar of Companies or the SEBI who can file criminal complaints against them under Section 621 of the Companies Act. Directors and promoters can be made personally liable for false statements found in the prospectus. Apart from civil liability, Section 63 of the Companies Act stipulates that persons issuing false or untrue statements will be punishable with imprisonment for two years. Section 68 stipulates that any person who dishonestly induces other persons to subscribe for shares or debentures can be imprisoned for five years. But neither the government nor SEBI has thought it fit to prosecute these scammers for more than a decade[footnoteRef:1]. However, it is heartening to note that recently, after a decade of inactivity the ministry has cracked the whip on vanishing companies. [1: R. Nandagopal, V. Srividya 2007 Emerging Financial Markets]

Prioritizing investor protection, particularly small investors, the Ministry of Company Affairs (MCA) has initiated prosecutions against vanishing companies under the Companies Act as well as other legislations. Besides, launching prosecutions under the Companies Act, action has been taken against such entities by way of registering first information report (FIR) under Indian Penal Code, and vigorously pursuing the prosecutions already launched. In fact, in the case of Maa Leafin & Capital Ltd, the accused has been convicted for non-filing of statutory return,[footnoteRef:2] a Ministry official said. Further, FIRs have been launched against 40 companies, of which 28 have been registered. In the case of Trith Plastic Ltd of Gujarat[footnoteRef:3], charge-sheet has been filed in the court and directors of the company have been arrested. [2: http://www.thehindubusinessline.com/2004/12/13/stories/2004121302390100.htm] [3: http://www.thehindubusinessline.com/2004/12/13/stories/2004121302390100.htm]

INVESTOR PROTECTION IN INDIAInvestors by virtue of their investments in securities of corporations obtain certain rights and powers that are expected to be protected by the State, which gave the charter or legal entity to the corporate bodies or the regulators designated by the State to do so. In many countries, laws and legal regulations are enforced in part by market regulators such as SEBI, in part by courts or government agencies such as the Department of Company Affairs in India and in part by markets themselves. If the investors rights are effectively enforced by one or all of these agencies, It would force insiders to repay creditors and distribute profits to shareholders and thereby protect external financing mechanism form breaking down[footnoteRef:4]. Thus, investor protection can be defined by both (i) the extent of the laws that protect investors rights; and (ii) the strength of the legal institutions that facilitate law enforcement. [4: www.israeli-corporate-governance.org/files/.../Investor_Protection.pdf]

Small investors are the backbone of the Indian capital market and yet a systematic study of their concerns and attempts to protect them has been relatively of recent origin. Due to lack of proper investor protection, the capital market in the country has experienced a stream of market irregularities and scandals in the 1990s. SEBI itself, though formed with the primary objective of investor protection, took notice of the issue seriously only after the Ketan Parikh Scam (2001) and the UTI crisis (1998 and 2001) and has developed sophisticated institutional mechanism and harnessed computer technology to serve the purpose. Yet, there are still continuing concerns about the speed and effectiveness with which fraudulent activities are detected and punished, which after all, should be the major focus of the capital market reforms in the country.The SEBINCAER study[footnoteRef:5] estimated that the investor population in India was 12.8 million or nearly 8 per cent of all Indian households. The Household Investors Survey of SCMRD (1997)[footnoteRef:6] revealed the following: (i) a majority of investors reported unsatisfactory experience of equity-investing; (ii) 80 per cent of the investors said that they had little or no confidence in company managements; (iii) 55 per cent respondents showed little or no confidence on the market regulator, SEBI; and (iv) most preferred saving instruments and government saving schemes and banks fixed depositors. This reflected a considerable erosion of investor confidence in securities and corporations. [5: www.ncaer.org/publication_details.php?pID=165] [6: www.scmrd.org/Published%20Studies.htm]

All these surveys underlined the need for restoring the investors confidence in private corporations, which enjoy little credibility with investors who have badly burnt their fingers in a series of scams. This calls for a credible programme of corporate governance reform, focusing on outside minority shareholder protection. The situation does not seem to have changed much today notwithstanding the CIIs code and SEBIs guidelines and is the reason why investors prefer government securities rather than corporate securities. The sooner this trend is reversed, the better it will be for the development of the capital market in the country.

N.K. MITRA COMMITTEE ON INVESTOR PROTECTIONThe committee chaired by N. K. Mitra[footnoteRef:7] submitted its report on investor protection in April 2001, with the following recommendations: [7: https://www.safaribooksonline.com/library/view/business.../c8s10.xhtm]

There is a need for a specific Act to protect investor interest. The Act should codify, amend and consolidate laws and practices for the purpose of protecting investors interest in corporate investment;Establishment of a judicial forum and award of compensation for aggrieved investors;Investor Education and Protection Fund which is under the Companies Act should be shifted to the SEBI Act and be administered by SEBI;SEBI should be the only capital market regulator, clothed with the powers of investigation;The regulator, SEBI should require all IPOs to be insured under third party insurance with differential premium based on the risk study by the insurance company;SEBI Act, 1992, should be amended to provide for statutory standing committees on investors protection, market operation and standard setting; andThe Securities Contracts (Regulation) Act, 1956, should be amended to provide for corporatization and good governance of stock exchanges.

LAW ENFORCEMENT FOR INVESTOR PROTECTIONThere are several agencies in India that are expected to protect investors. In fact, there are so many with overlapping functions that they cause confusion to the investors as to whom they should go to for redressal of their grievances. The stated primary objective of the countrys sole capital market regulator, the Securities and Exchange Board of India, popularly known as SEBI, is protection of investors interests. SEBI has provided guidelines for an efficient redressal process in its reference guide for investors. It is pertinent to note that already law courts have started imposing exemplary punishments to directors who violated codes and guidelines on corporate governance provided by competent authorities. In May 2004, Citigroup agreed for a US$ 2.0 billion settlement, and more than a dozen other banks including JP Morgan Chase and Deutsche Bank are likely to fall in line. In January 2005, at the insistence of a US Court, former directors of WorldCom (now known as MCI) have agreed to pay US$ 18 million out of their pockets as part of a shareholder law suit. Likewise, 18 former directors of the collapsed energy conglomerate Enron, agreed to pay US$ 13 million as part of a settlement in another shareholder lawsuit[footnoteRef:8]. Though these settlements are subject to confirmation by the concerned US District Court, corporate governance experts had hailed these settlements for setting a new standard in accountability of directors when companies they oversee go astray. In India too, as per the dictates of a lower court, recently the directors of a non-banking finance company have agreed to pay back to the company a large sum of money it lost, due to their indiscretion in an investment decision. [8: A. C. Fernando 2009, Business Ethics: An Indian Perspective]

LACUNAE IN INVESTOR PROTECTIONThough there is a redressal mechanism in place in the country, investors could not get their complaints adequately addressed to, much less solved to their satisfaction by these public authorities. Multiplicity of authorities, overlapping functions, lack of knowledge and understanding of the common investor about these agencies and lack of enforcement have all acted against investor protection. Notwithstanding the existence of this seemingly comprehensive network of public institutions established for investor protection in India, a series of scams has taken place that has shaken the confidence of investors since 1991, the year of economic liberalization.

RELATIONSHIP BETWEEN INVESTOR PROTECTION AND CORPORATE GOVERNANCERecent research confirms that an essential feature of good corporate governance is strong investor protection. According to Rafael La Porta et al (1999)[footnoteRef:9], Corporate Governance is to a large extent a set of mechanisms through which outside investors protect themselves against expropriation by the insiders. Expropriation is possible because of the agency problems that are inherent in the formation and structure of corporations. Shareholders or investors of a firm who are too numerous and scattered cannot manage it, and therefore, entrust the management of the firm to managers who include the Board of Directors and senior executives such as the CEO and the CFO. However, managerial actions depart from those required to maximize shareholder returns. Such mismatch of objectives results in agency problem. Investors do realize and accept a certain level of self-interested behaviours in managers while they delegate responsibility to them. But when such self-indulgence by managers exceeds reasonable limits, principles of corporate governance come in to check such abuses and malpractices. The core substance of corporate governance lies in designing and putting in place mechanisms such as disclosures, monitoring, oversight and corrective systems that we can align the objectives of the two sets of players (investors and managers) as closely as possible. [9: https://ideas.repec.org/f/pla273.html]

CONCLUSIONThe phenomenal growth of modern corporations, have brought about the kind and order of material wealth to the international community that was never possible a few years ago. But this growth was possible, due to the evolution of public limited or joint stock companies, which are most attractive to investors. In such organizations, financial liability of the shareholders is limited to the extent of the shares held by them. However, the investor needs to be protected from insiders as he is not involved in the day-to-day management of the company. To realize such an investor protection, countries have evolved rules, regulations, systems and mechanismsboth internal (to the company) and external.There is a global consensus about the objective of good corporate governance: maximizing long-term shareholder value. The members of a company enjoy various rights in relation to the company. These rights are conferred on them either by the Indian Companies Act of 1956 and 2013 or by the Memorandum and Articles of Association of the company or by the general law, especially those relating to contracts under the Indian Contract Act, 1872.Various committees have been set up both in India and elsewhere to guide the shareholders with regard to good corporate governance, especially their long term interests. The SEBI, as the custodian of investor appointed Narayana Murthy Committee on Corporate Governance focused on investors and shareholders. Though the Companies Act, other statutes and recommendations of various committees give an investor the impression that there are enough provisions in the laws of the land, there has hardly been any conviction under them all these years. Strong investor protection is associated with effective corporate governance. Investors by virtue of their investments in securities of corporations obtain certain rights and powers that are expected to be protected by the State which gave the legal entity to the corporate bodies or the regulators designated by the State to do so. Recent research confirms that an essential feature of good corporate governance is strong investor protection. The insidersboth managers and controlling shareholderscan expropriate the investors in a variety of ways. Investor protection is not attainable without adequate and reliable corporate information. There are rules and regulations that are designed to protect investors. The objective of the corporate is to protect the rights of outside investors, including both shareholders and creditors. Investor protection provides an impetus for the growth of capital markets. Due to lack of proper investor protection, the capital market in India has experienced a stream of market irregularities and scandals in the 1990s. There are several agencies in India that are expected to protect investors. These include the SEBI, Department of Company Affairs, Department of Economic Affairs, Reserve Bank of India, Consumer Courts and Courts of Law.An objective analysis of the problems faced by investors in countries like India, leading to an erosion of their confidence in the capital market with the attendant adverse impact on the economic growth, shows that the major problems arise due to corporate miss governance and not due to minor aberrations in following the procedures set by SEBI. To rectify such a situation, actions that lead to corporate miss governance should be codified and small investors provided with statutory rights to enforce civil liability against the directors whose misdeeds and non-application of minds in investment or other decisions have adversely impacted the company and its shareholders. In last it should be remembered that it has taken more than a decade for the government to initiate legal action against the scammers. Besides, it should be kept in mind that the slow-grinding judicial processes will take its own time and if past experience is any guidance, it will take another decade or more at the fastest, to get the judgement. Even then, there is no guarantee that the guilty will be convicted and the poor investors money returned. This is the state of affairs that has caused untold misery to the poor Indian shareholder/investor.