Sucheta Dalal :Competition Among Regulators? (24 Nov 2003)
Sucheta Dalal

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Competition Among Regulators? (24 Nov 2003)  

The US corporate scandals of 2002 led to legislations that forced more transparency on American companies with special attention to whistle- blowers. In fact, it is well acknowledged that if the voices of whistle-blowers had not been suppressed, things might have been different at Enron, WorldCom and even the Federal Bureau of Investigation.

TimeMagazine recognised this by naming three women whistle-blowers — Cynthia Cooper, Coleen Rowley and Sherron Watkins, as its Person of the Year, 2002.

But Indian businessmen obviously have short memories. Or they think we have nothing to learn from these scandals. That’s why, many have objected vehemently to the Securities and Exchange Board of India’s giving a voice to whistle-blowers through its amendment to clause 49 of the listing agreement between stock exchanges.

Many industrialists are objecting to the very concept of a mandatory voice for whistle-blowers on the grounds that it would lead to frivolous complaints against the management. Such fears are clearly baseless. Complaints by whistle-blowers are never anonymous; they are expected to back up charges with concrete evidence of wrongdoing. The possibility is that family managed Indian companies are worried that their employees would blow the whistle when they deliberately debilitate publicly held companies by siphoning funds to their private coffers. In that case, it is all the more imperative that the regulator backs a strong whistle-blower protection policy.

India Inc has been equally vociferous against a nine-year term for independent directors. That’s because they would have to find new persons every nine years who would fit the definition of ‘independent’ and yet be non-intrusive enough to safely invite on to their boards.

Corporate India scored an important victory for itself, when it forced the government to withdraw the Companies Act Amendment Bill 2002, but there is bad news for businessmen. The trend towards more independent directors, better governance and increased accountability is only gaining ground in America and is bound to extend to our part of the world. The wave of scandals that have hit the mutual fund industry and the latest revelations about mischief by currency traders will have its impact on regulation. The damage caused by fund managers colluding with large investors to prey on the fund corpus is far worse than companies cheating retail investors.

At least equity investors are expected to operate on the principle of caveat emptor and keep tabs on their investment. In a mutual fund, the investor puts a greater fiduciary responsibility on the fund manager pays a hefty fund management fee to the Asset Management Company.

American policy makers have recognised this when they opted for a drastic tightening of mutual fund regulation last week. On November 19, the House of Representatives overwhelmingly approved a legislation to deter mismanagement of funds, improve disclosure of information regarding fund management fees and staunch trading abuse. The extent of support for the legislation is clear from its 418 to 2 approval. In fact, many legislators are still not satisfied with the present bill and want it further tightened. But what has been done so far is enough to cause disquiet among Indian industrialists and mutual fund companies.

The US legislation requires each fund company to write a code of ethics and to appoint a chief compliance officer who would report to the independent directors. It also increases the minimum number of independent directors on mutual funds from the present 50 per cent of the board to 66 per cent, while simultaneously tightening the definition of independent director.

Let’s compare this with the protests over the Companies Act Amendment Bill and the amendment to clause 49 of the listing agreement. The biggest objection was to the proposed increase in independent directors to over half the board strength. In America, the Securities Exchange Commission, which has been caught napping on the mutual fund scandals, was embarrassed enough to recommend that 75 per cent of the mutual fund board should be independent. But that proposal seems to have been watered down in the recent legislation.

Once the mutual fund scandal dies down, one can expect some relaxation in the legislation as has happened with the Sarbannes Oxley legislation. But there is no escaping the fact that US companies and mutual funds will have to get used to tighter scrutiny, more independent directors and a clearly enunciated code of conduct that they must live by. And that will be the shape of things to come in countries that believe in shareholder democracy and investor protection.

Another significant aspect of the American mutual fund scandal, from our point of view, is the failure of the powerful SEC to detect what was happening under its benign supervision. SEC chairman Donaldson acknowledged in his testimony before the Senate Committee on Banking, Housing and Urban Affairs that the commission failed to spot the problems early enough. In fact, he said, “the extent of this has come as a surprise to us”. Almost every one of the cases against a dozen odd large mutual funds was initiated by Eliot Spitzer, the maverick New York Attorney State Attorney General and not through SEC inspections. The market watchdog is now putting in place a team to catch the possibility of similar fraud elsewhere in the market.

The lesson here is that regulators are not infallible. And, that multiple regulators, if they are alert and effective, can compete and work better at protecting investor interest. In the US, competition and turf battles between the SEC and Spitzer have led to a war of words between the regulators. Spitzer has wondered aloud at the SEC’s failure to detect the mutual fund fraud and even criticised its quick settlement of charges with funds such as Putnam. SEC in turn has accused Spitzer of trying to muscle into its turf of framing new regulation.

But like all open competition, that between powerful regulators would also work in favour of investors. We in India have quiet turf battles between the regulators, where each works at scuttling the others initiatives without admitting to any lapses or failure on its own part. Just as we borrow regulatory practices from the US, there is a need to look at changes in the regulatory structures to increase competition and make the system work for investors.

-- Sucheta Dalal