Sucheta Dalal :Who Are The Regulators Accountable To? (15 April 2002)
Sucheta Dalal

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Who Are The Regulators Accountable To? (15 April 2002)  

Lou Dobbs of CNN’s Moneyline programme and one of the best known personalities in broadcast financial journalism has stirred up a quite a controversy by defending Arthur Andersen and criticising the US Justice department’s action. In several recent broadcasts, Dobbs spoke out for Arthur Andersen’s employees and said, “the effect of the indictment will be to destroy the firm and the livelihoods of most of those 85,000 innocent people”.

In one commentary he said, “Just as I don’t blame the firm of Andersen for the misdeeds of a few, I don’t blame the many fine men and women who serve our country at the Justice Department. But I do blame those few people at Justice who made this horrible decision to punish the many at Andersen for the acts of a few.”

Dobbs has been criticised by leading American papers who accuse him of being motivated by his close links to Andersen; Dobbs in turn has strongly defended his stand against the “wrong-headedness” of the indictment and says that it is one of the strongest positions he has taken on his show.

Dobbs’s stand certainly merits discussion. Does one punish an organisation or just the individuals responsible for fraud? The answer is obvious. You cannot knock down an organisation on account of a few corrupt individuals, even if they happen to be part of its top management.

But such a stand is also flawed. It is top management that sets the ethical tone of an organisation. It signals what is acceptable behaviour and what is not through its system of rewards, incentives and promotions. For instance, an audit firm can signal that wrangling lucrative consultancy assignments is the road to hefty bonuses and partnerships and it is okay to ignore accounting jugglery in the quest of such contracts. Is it fair then to punish employees who follow company policy when they are caught?

Many US companies, especially those on Wall Street, have developed a well-tested strategy for dealing with investigations into financial fraud. As a rule, any action that improves the firms’ profit is welcome until it leads to regulatory action. However, things change dramatically when the regulators step in. The problem is then isolated and pinned to a few individuals and the issue is turned into an employee fraud. The firm turns into the biggest ally of the regulators, promises full cooperation with the investigation and summarily sacks the employees concerned. It then negotiates a settlement with the regulator, pays up a hefty fine without admitting any wrongdoing and its business as usual.

Sometimes the employees are also given a neat exit package to make it less painful to carry the can for their employer.

Clearly, indicting a few individuals is not always the answer. When a fraud is of the magnitude of an Enron and the influence of the organisation as pervasive as that of the bankrupt energy giant, it calls for unusual action. The auditor’s role in helping Enron mislead investors, regulators and policy makers around the world demands that the action against it should send out a much stronger deterrent signal. The punishment cannot be restricted to a few individuals. But then again, such drastic action cannot be the rule; it must be reserved for exceptional cases.

The debate over Dobbs’s stand raises some interesting questions about how we deal with financial transgressions in India. Ever since 1991, we have had large or small financial frauds every year. Very few of these have resulted in a quick trial or punishment of the guilty. But that does not mean that we have not seen plenty of regulatory action; the difference is that our regulatory actions — whether against individuals or institutions — depend on the extent of public outrage and the people or institutions that are involved.

This is indeed true. For instance, when it involves the Reliance group, we always shut down institutions connected with the issue. The first time was in the 1980s when BoB Fiscal Services, the infamous merchant banking arm of Bank of Baroda was closed down. BoB Fiscal was wound up because it was instrumental in routing Larsen & Toubro shares from Unit Trust of India to the Ambanis.

The second time it was another Reliance company — Reliance Consultancy Services, a share registry company for the Reliance group that was ordered to be shut down by the Securities and Exchange Board of India. This followed a massive share-switching controversy in the 1990s when it was accused of suppressing benami shares belonging to the securities scam accused.

In 1992, when the Reserve Bank of India’s supervision itself came into question, the central bank quickly went into a regulatory overdrive. Its actions can be divided into three neat compartments.

* Small private banks without clout (Bank of Karad and Metropolitan Cooperative Bank) were liquidated without bothering about the individual/institution issue.

* Nationalised banks, institutions and their subsidiaries had to be saved at any cost. So National Housing Bank and Canfina Financial Services were protected despite huge losses and their dubious role in the scam. Their financial viability was ensured through some shameless arm-twisting of other institutions. The same rule applied to Indian Bank and UTI, which have been repeatedly bailed out. Powerful foreign banks were simply told to remove their CEOs, treasury chiefs and key employees. Most of them were given golden handshakes. The banks themselves paid tiny fines, which were not even a slap on the wrist. None of their employees suffered the indignity of an arrest.

The treatment of other scams follows a similar pattern. If there is high public outrage, there are a few arrests in order to create photo opportunities for the media. The charges are framed or dropped afterwards.

If those involved are recognisable faces — a Pawan Sachdeva, a C R Bhansali, a P S Subramanyam or a Ketan Parekh, they are more likely to be arrested, it makes people happy. Faceless brokers and bank employees are good props in the photos and suggest stricter action by the regulators.

Big industrialists who fund political parties are never arrested — at best they are raided for income tax evasion or violation of foreign exchange regulations. If the numbers involved are much too large — as in case of the vanishing companies, finance companies or plantation companies, then the regulators wring their hands and do nothing. If this arbitrariness and inaction on the part of the regulators has killed investor confidence then it is just too bad — because the regulators themselves are accountable to nobody.

-- Sucheta Dalal