THE FUDGE REPORT

very night when Saurabh Mukherjea, head of institutional equities at broking firm Ambit Capital, leaves his office in central Mumbai for home, he remembers a chilling phone call he got two years ago. “We know which route you take to go home. Aap ko andaza nahin hain hamari taaqat kitni hai (you

have no idea how powerful we are),” he was told. The warning followed a report his research team had released a few days earlier recommending clients sell a company’s shares, pointing to its weak financial performance.

It is not the only such threat Mukherjea has received– he got one as recently as in October. Nor is he the only one to get them. Nick Paulson-Ellis, India head of Espirito Santo Securities, part of the Portuguese financial services group, recalls an incident three years ago when his firm came out with a report questioning the accounting practices of a Hyderabad-based company. He says the company threatened to get him arrested if he ever travelled to the city of the Charminar. “If your analysts are CAs (chartered accountants), we will get them debarred,” was yet another threat.

Telephonic threats can be scary, but legal confrontation, criminal complaints and the prospect of time in prison can be scarier. Nitin Mangal, a consultant for Canadabased Veritas Investment Research Corporation, faces just that fear every day. Indore-based Mangal had worked with Veritas Executive Vice President Neeraj Monga on a report on three companies of the Indiabulls Group. It raised corporate governance concerns about the group management. The report came out on August 8, and on the same day Indiabulls filed two police complaints in Gurgaon and Mumbai alleging Veritas had tried to extort money by offering to delay the report’s release.

What followed was an ordeal for Mangal. The Haryana police asked him to send his representative to Gurgaon. Thereafter, he was asked to appear in person. Fearing arrest, Mangal applied in a Gurgaon district court for anticipatory bail, which was denied on August 23. He then approached the Punjab and Haryana High Court, but the judge hearing the case, Justice Daya Chaudhary, recused herself on September 24. Finally, another high court judge granted interim anticipatory bail to Mangal on November 6. Speaking to Business Today from Singapore, Mangal said this experience was a first for him. Monga adds, “No one has filed a criminal charge against Veritas in its 12 years (of existence). Everyone at Veritas is surprised.”

Where the mind is not fearless

Intimidating research analysts is par for the course in India. While both Mukherjea of Ambit and Paulson-Ellis of Espirito stress that they did not back down from their work, it worries them. “I do not want to put my family and colleagues at risk,” says Mukherjea. Ambit generally avoids covering companies with doubtful accounting or corporate governance practices. It does not track 10 of 50 companies that comprise the benchmark Nifty index of the National Stock Exchange because, in its view, these do not rank high on cor- porate governance standards. If asked, Ambit provides confidential notes to its clients on the companies it does not cover. It also conducts forensic research on companies. Mukherjea recently wrote a report titled ‘The debasing of the RBI and the negative consequences for Indian banks’ for Ambit’s clients.

Equity research in India is conducted mostly by standalone brokerages, the broking arms of banks and the local units of foreign banks. With more than 1,600 analysts from about 132 research firms churning out 30 to 40 reports daily, adding up to 1,000 a month, listed Indian companies should have been under intense scrutiny. But that is not the case and researchers are often found parroting the same numbers and arguments company managements themselves put out.

“Very few analysts say anything different from what the company is saying,” says Aneesh Srivastava, Chief Investment Officer, IDBI Federal Life insurance, for whom reading research reports is part of the job. “This is why institutional investors like insurance companies or mutual funds have their own research teams.” Sanjay Sinha, a former chief investment officer at SBI Mutual Fund, who now runs his own investment advisory firm, says that though analysts’ reports are exhaustive, the conclusions are not always logical.

“Analysts may also have conflicts of interests,” says Amardeep Lakhtakia, an entrepreneur whose website ranks analysts based on the accuracy of their reports and how often they review their recommendations (See India’s Top Analysts). “These reports and recommendations can move the markets and need to be tracked,” Lakhtakia adds.

R. Balakrishnan, a former head of research at the erstwhile DSP Merrill Lynch, says no investment banker wants a negative report from the brokerage arm on a company he may be trying to sell. “There is no Chinese wall,” he adds, referring to the distinction brokerages and investment banks claim to maintain between their research and other businesses.

Cat among the pigeons

The cosy arrangement of “see-no-evil, speak-no-evil” in India was shaken in July 2011 when Veritas started analysing large Indian companies. Veritas is among a handful of independent research firms (see In Search of Truth on Page 56) which do not have any broking or investment banking operations. Its first report on Reliance Communications (RCom) and how it was created by Reliance Industries shook investors. In June 2012, it brought out a second report on RCom. It has also released reports on Kingfisher Airlines and its parent, UB Holdings, and real estate giant DLF, castigating some of their practices and performance.

All the reports recommended investors sell their stocks in these companies. Shares of Reliance Communication and Kingfisher Airlines fell 2.4 per cent and 2.8 per cent, respectively, during the day when the first reports by Veritas were released. RCom declined more than seven per cent when the second report came. DLF plummeted more than 12 per cent intra-day on March 1 this year, as did the three Indiabulls companies on August 8.

Since the release of the first Veritas report, RCom is down 33 per cent, compared with a one per cent drop in the Bombay Stock Exchange’s benchmark Sensex. Kingfisher is down 44 per cent (Sensex up 12 per cent). DLF is down 2.5 per cent since March(Sensex up five per cent). Indiabulls Real Estate and Indiabulls Financial Services have bounced back – their shares are up 26.5 per cent and 10 per cent, respectively, compared with the Sensex’s five per cent rise.

RCom dismissed the reports. After the second Veritas report, the company said in a statement that the report was full of “factual inaccuracies and baseless allegations.” It also said Veritas was “systematically working to destroy confidence in Indian capital markets through sensationalist reports”.

Monga defends the reports: “Veritas and I stand by the language we use.”

When contacted for this article, a DLF spokesperson told Business Today the Veritas report was “presumptive and mischievous”. Indiabulls said on August 8 that Veritas released its“false and incorrect reports on different dates for different sets of people for the sole purpose of profiteering in more ways than one”.

Indiabulls went a step further. Its management had come to know of the report Veritas was preparing. It asked Prashant Periwal of Altima Partners, a London–based fund, to contact Monga for subscription details for Veritas’s India reports, according to the police complaint, dated August 8, 2012, filed at Udyog Vihar police station in Gurgaon. Monga apparently emailed Periwal offering to hold back wider release of the Indiabulls report by a day and let Periwal look at it, if he confirmed his subscription for $40,000 (about`21.6 lakh) for the rest of the year. This email formed the basis of Indiabulls’s complaint of extortion.

Michael Palmer, founder and President of Veritas, rejects the allegations. “We sincerely hope that the investigative agencies will see through the charade employed by Indiabulls, and will apprise the courts of the malicious character of the allegations against us,” he told Business Today in an email interview (see the full interview on Page 60). “We believe that our endeavour to highlight corporate governance infractions will be looked upon favourably and, therefore, such arm twisting will be thwarted in the Indian courts.”

Critics argue Veritas’s method of releasing reports is akin to market manipulation. It sometimes first releases its reports to paying clients, who can thus build up their positions. It then provides a summary of the reports to a wider audience a few days later. The wider release often moves the stock price. The clients can take advantage of this share movement to make money. For a retail investor, the situation may seem unfair as the price of a share he holds would have moved before the full paid report trickles down to him – perhaps after months.

Veritas’s practice of not talking to company managements before finalising its reports is also being questioned. Gagan Banga, CEO of Indiabulls Financial Services, who refuses to discuss the Veritas issues, picks his words carefully when he says he welcomes discussions with analysts. “Knowledgeable analysts can be extremely helpful and can provide a wider perspective,” he says. Ambit’s Mukherjea feels this breaks an “unwritten rule” that brokerages should seek a company’s view before releas- ing a “punchy” report with a sell recommendation.

But Veritas has a different opinion. “Financial statements are approved by the board. Managements conduct four quarterly calls or meetings with analysts. They provide information at annual general meetings and during road shows, so there is no real need to approach a company,” says Monga. Mukherjea disagrees.“There are different prisms through which you could view a set of financial data and there could be many interpretations of it,” he says.

Others join in

The year 2012 has seen other analysts get pugnacious as well. Australia’s Macquarie Capital questioned what it called the “aggressive” accounting practices of home loans company Housing Development Finance Corporation (HDFC) while Zurich-based Credit Suisse’s Indian arm raised concerns about JSW Steel’s debt. Espirito Santo questioned the independence of the auditors of education services provider Educomp Solutions and the accounting policies of biotech giant Biocon.

All these companies have rebutted the allegations. HDFC said Macquarie had not verified facts with the company. Biocon said its accounting practices complied with global standards. Educomp called Espirito’s views “sensational” and said compliance with the highest standards of corporate governance was its“utmost priority”.

Though all these questions were raised by India brokerage arms of foreign financial institutions, analysts are not always consistent. On July 6 this year, for instance, Credit Suisse said JSW Steel’s debt was “understated by `119 billion”. Three days later it said in another report that it had not implied there was any“deliberate understatement”, but that it only felt the debt was “effectively higher”.

Neither Credit Suisse nor JSW responded to queries on whether there was any contact between the two after the first report was released.

Raamdeo Agrawal, Joint Managing Director at Motilal Oswal Financial Services and one of the earliest movers in equity research in India, notes that global brokerages can hardly put out reports far better than Indian ones, considering many of the analysts at the foreign firms were earlier with local brokerages.

Espirito’s Paulson-Ellis, a Briton who has worked in Mexico and Brazil, says analysts in India are too deferential in analyst meetings. Monga says they“accept things are not kosher but are not doing enough to change it.”

IN SEARCH OF TRUTH Independent research fi rms are slowly gaining prominence

Veritas Investment Research – Veritas means truth in Latin – says on its website that it has “no underwriting biases and no trading constraints”. That, in essence, defi nes an independent equity research (IER) fi rm. As opposed to a brokerage or an investment bank, an IER fi rm earns revenue only by selling its research reports to institutional clients.

These fi rms have gained prominence only in the last couple of decades, though they have been around for quite a while. The New York-based Argus Research, for instance, was founded in 1934. The London-based Arete was founded in 2000. Stock exchanges have helped in the development of IER fi rms. In 2008, the London Stock Exchange launched an initiative with Argus and two other IERs, Pipal Research Corporation and International Investment Research Plc, to encourage research on companies listed on the LSE and its Alternative Investment Market, a trading platform for smaller companies.

In India, the National Stock Exchange has a similar initiative with Crisil IER, launched in 2009, to track certain companies not widely covered. The Mumbai-based IRIS Business Services started an IER fi rm in 1995. Equity Master was started in 1996. Another fi rm CNI Research is listed on the Indian bourses. But these fi rms have not become very prominent. “Independent research in India is not very scalable,”says IRIS co-founder K. Balachandran.