Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Open the books

I wrote a piece in the Financial Express today on the
enhancements to corporate disclosure that are required in the
aftermath of the Satyam fraud.

Ramalinga Raju was in jail two days after he confessed to a
$1.5 billion fraud at Satyam and has remained there since then. By
contrast, Bernie Madoff is still ensconced in his home more than a
month after he confessed to a $50 billion fraud in the United
States. Two days after the Raju confession, there was a new board of
directors for Satyam taking charge of its assets and trying to
preserve as much of shareholder value as possible. Meanwhile, Madoff
has spent his time out on bail mailing a million dollars worth of
jewellery as gifts to his friends and relatives, putting them beyond
the reach of the investors whom he has defrauded.

On the whole then, the Indian government has done better than the
low expectations that we have of our rulers, while the US has
conformed to the images of crony capitalism that has characterised its
bailout era.

But complacency would be a mistake on our part. Emerging markets
are held to higher standards than developed markets, and it is
essential to use Satyam as an opportunity to make a series of
much-needed disclosure and governance reforms. The question to ask is
not whether these reforms would have prevented Satyam; the relevant
question is whether these reforms would help bolster investor
confidence in the Indian corporate sector at a time when it has been
badly shaken.

Much as the government might like to portray Satyam as an
unfortunate exception, the fact is that most investors, both in India
and abroad, think of it as symptomatic of the problems that could be
lurking in many other leading Indian companies. Of course, companies
will voluntarily increase their disclosure standards to signal that
they have nothing to hide. But this by itself is not
enough. Disclosure is most effective and useful to investors when it
is carried out in a uniform way by many companies. This is where
regulators have a role to play.

Increasing the quality of quarterly disclosures is very
important. Satyam was, of course, subject to this requirement as a US
listed company and it is conceivable that these disclosure
requirements forced a confession in early January 2009 shortly before
the results of the quarter ended December 2008 were to be
unveiled. Absent the pressure of this disclosure requirement, it is
not beyond the realm of possibility that the deception might have been
kept up for another quarter till the year end in March 2009.

I have written in the past (FE, November 27, 2008) on the need to
force companies to reveal the complete balance sheet and not just the
income statement highlights on a quarterly basis. This needs to be
pushed forward more rapidly. On the same lines, a more rapid move to
international accounting standards is desirable. Certain key standards
like AS 30 on financial instruments could be targeted for accelerated
adoption and implementation.

Greater regulatory scrutiny of corporate disclosures is also
essential. The Raghuram Rajan Committee on financial sector reforms
(of which I was a member) has recommended that India should adopt a
system of reviewing the accounting filings of companies on a selective
or sample basis on the lines of what the SEC does in the US.

Equally important are measures to improve private sector scrutiny
of corporate disclosures. In the US, the Edgar database of regulatory
filings with its full text search capability and its XBRL based
interactivity is a huge boon. It is difficult to see how private
sector scrutiny of the kind carried out by could ever be
done without Edgar. The dissemination of corporate disclosures by the
exchanges and by Sebi on their websites does not come remotely close
to what Edgar achieves in the US. We should make it a top priority to
get our own Edgar style repository functional as quickly as possible.

I am also a proponent of combining regulatory review and private
sector scrutiny in innovative ways. For example, a short seller who
believes that there is something wrong with the accounts of a company
should be able to demand a regulatory review by paying a fee to cover
the regulator’s costs. Needless to say, the results of the review
should be announced only publicly so that the short seller does not
get any advance information. He would of course benefit from the price
impact of the review findings on any pre-existing short positions.

I am invariably told that this scheme would be misused by people to
embarrass their corporate rivals. My flippant response is that there
is nothing wrong in harnessing corporate rivalry in such a
constructive way to improve the credibility of corporate
disclosures. More seriously, if a review leads to a clean chit, the
public announcement of this would benefit the target company. This in
itself would act as a disincentive against frivolous review requests
by people endowed with deep pockets.


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