Sebi's clampdown on DLF exposes India Inc's dirty secret about subsidiaries

Cases disposed off by Company Law Board have almost invariably a common thread running through them - the use of subsidiaries for dubious purposes. In fact, in the Indian context subsidiaries present a classic example of wheels within a wheel. There are companies with hundreds of subsidiaries as the Sebiorder on DLF vividly brings out. Though in effect they are all subsidiaries, the multi-layering confers a sort of anonymity on some of the distant subsidiaries, so much so that the ultimate holding company glibly washes its hands off them and contends that it has nothing to do with them.

This is precisely what the saga of DLF all about as fas as its murky deals in the run up to the IPO in 2008 is concerned. Some of the companies, which were admittedly subsidiaries, morphed into independent entities having nothing to do with DLF with housewives of key managerial personnel of DLF becoming their shareholders. ( Read more about that here )

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Sebi’smeticulous investigation showed that the housewives were just fronts for DLF—the money with which the housewives purchased the shares of these subsidiaries were in the final analysis provided by DLF. And these subsidiaries owneda sizeable part of the land bank, the major asset of DLF. The reason why DLF was coy about admitting that these companies indeed continued to be its subsidiaries was that many of the land owned by them were bedeviled by title disputes, a trade hazard of any realty company.

Subsidiaries lend themselves to misuse on two counts. First, plum assets are owned by them primarily for the promoters of the holding company and their associates. In other words, the non-promoter shareholders have no claim on such prime assets. Second, subsidiaries can be used to hide some of the disagreeable assets and liabilities of the holding company.

Since the IPO norms of the SEBI requires disclosure of material facts relating to both the issuing company and its subsidiaries, DLF had hastily de-subsidiarized these companies by roping in innocent housewives of its key managerial personnel. In fact, the SEBI verdict points out that around that time as many as 288 companies were banished so that they did not legally have anything to do with DLF, though de facto they were all DLF babies. The idea of such wholesale banishment was these companies holding dubious titles should not spoil the IPO party of DLF.

Incidentally, DLF succeeded in its mission—it pulled wool over everyone’s eyes, and walked away with more than Rs 9,000 crore with shares with a face value of Rs 2 issued at Rs 525. The merchant bankers to the issue happily went along with whatever DLF said or did not say in its prospectus. The Qualified Institutional Buyers who play the pied piper role in the Indian IPO market also did not think anything amiss in the feverish de-subsidiarization activity in the run up to the IPO. The biggest loser of course was the public which is now holding the can.

The Companies Act 2013 has done well to stop the wheel within the wheel within the wheel arrangement by prohibiting a subsidiary to bethe holding company of another subsidiary. It has also done well to mandate presentation of consolidated accounts for holding companies which willbring out the true impact of financial transactions with their subsidiaries. However, neither the company law nor Sebi can stop companies that are not legally subsidiaries but effectively are, say by having stooges like housewives of key managerial personnel as the dominant shareholders. In other words, inconvenient subsidiaries could be dropped like hot potatoes at crucial times.

The SEBI order while making DLF and its promoters persona non grata in the securities market has not delisted the shares of DLF because it knew such a step would hurt the small investors more than anybody else. In a way this is poetic justice – banishment from the securities market of those who tried to banish inconvenient subsidiaries!