Why Subhiksha Trading Services collapsed
(A must read for all the finance, accounting & auditing professionals)
In January 2009, around the time that Satyam Computer Services was collapsing in a heap, Subhiksha too was falling to pieces. In all the noise generated by Satyam's crash, India's biggest discount retailer's downfall was muffled , heard merely as a whisper.
But for Mukand, one of Subhiksha's 15,000 employees and a purchase manager for Karnataka, the noise was deafening. "We had no money, no work, nothing ," he says, recalling the fear and despondency among the staff of Subhiksha, which was regarded as a company that had found the magic formula to make organised retailing a success in India.
Rumours that Subhiksha was in a precarious position started in September 2008 itself. That month, Mukand and his colleagues didn't get their salaries. A month later, the shops, there were 2,000 of them across India--started shutting, one by one. In early 2009, Mukand was given a salary cheque for 14,000. A few days later, he learnt that it was dishonoured.
There was no money in the HSBC and Standard Chartered accounts of Subhiksha, a company which had just the previous year claimed sales of Rs 2,300 crore. When Subhiksha toppled over and sought restructuring of its loans, the world was in the middle of its biggest economic downturn since the 1930s.
The company claimed that its entire inventory was looted by miscreants and spiteful employees, and projected itself as a victim of circumstances. In those tough times, the story was not difficult to believe but what surprised many was the sudden outbreak of animosity between ICICI Venture, India's largest domestic private equity firm, and Premji Invest.
Premji purchased 10% in Subhiksha from ICICI Venture in March 2008 for Rs 230 crore in hopes of selling the shares for a handsome profit when the promised listing happened. He was left holding dud stock. To Premji and his team, handpicked from places like Hindustan Unilever and Bank of America, it was a humiliation. In January 2009, Renuka Ramnath, the chief executive of ICICI Venture, resigned.
But for Mukand, one of Subhiksha's 15,000 employees and a purchase manager for Karnataka, the noise was deafening. "We had no money, no work, nothing ," he says, recalling the fear and despondency among the staff of Subhiksha, which was regarded as a company that had found the magic formula to make organised retailing a success in India.
Rumours that Subhiksha was in a precarious position started in September 2008 itself. That month, Mukand and his colleagues didn't get their salaries. A month later, the shops, there were 2,000 of them across India--started shutting, one by one. In early 2009, Mukand was given a salary cheque for 14,000. A few days later, he learnt that it was dishonoured.
There was no money in the HSBC and Standard Chartered accounts of Subhiksha, a company which had just the previous year claimed sales of Rs 2,300 crore. When Subhiksha toppled over and sought restructuring of its loans, the world was in the middle of its biggest economic downturn since the 1930s.
The company claimed that its entire inventory was looted by miscreants and spiteful employees, and projected itself as a victim of circumstances. In those tough times, the story was not difficult to believe but what surprised many was the sudden outbreak of animosity between ICICI Venture, India's largest domestic private equity firm, and Premji Invest.
Premji purchased 10% in Subhiksha from ICICI Venture in March 2008 for Rs 230 crore in hopes of selling the shares for a handsome profit when the promised listing happened. He was left holding dud stock. To Premji and his team, handpicked from places like Hindustan Unilever and Bank of America, it was a humiliation. In January 2009, Renuka Ramnath, the chief executive of ICICI Venture, resigned.
Subramaniam Speak vs reality
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So did Bala Deshpande who, along with Ramnath, was on the board of Subhiksha. Visakha Mulye, CFO of ICICI Bank, took over and set about repairing the damage to the firm's image . Ramnath moved on to set up another private equity firm called Multiples Asset Management. In Bangalore at Premji Invest, it was not easy to move on. The sudden collapse of a well-known retailer and the disappearance of bank money worth Rs 800 crore was extremely suspicious.
How did they get into this mess? Did IVen mislead them or were they done in by circumstances beyond their control ? Who exactly was R Subramanian, the founder of Subhikhsa, and how did he manage to win and lose everybody's trust so quickly? By then, they had discovered that one of Subramanian's firms, Vishwapriya, was banned twice by Sebi from accessing the capital markets after being found guilty of irregularities in share allotments of two public issues. In Chennai, Tamil Nadu's capital, somebody else was working on the same issue. Help was to come from an unexpected quarter.
ROC INVESTIGATES
Deep within the labyrinth of the Shastri Bhawan complex in Chennai are the headquarters of the southern region of the ministry of corporate affairs . As reports emerged about Subhiksha not paying PF dues and salaries, the registrar of companies (Roc) started probing. Very soon, investigators S Meenakshi and BAMP Rathnaswami uncovered some startling details.
How did they get into this mess? Did IVen mislead them or were they done in by circumstances beyond their control ? Who exactly was R Subramanian, the founder of Subhikhsa, and how did he manage to win and lose everybody's trust so quickly? By then, they had discovered that one of Subramanian's firms, Vishwapriya, was banned twice by Sebi from accessing the capital markets after being found guilty of irregularities in share allotments of two public issues. In Chennai, Tamil Nadu's capital, somebody else was working on the same issue. Help was to come from an unexpected quarter.
ROC INVESTIGATES
Deep within the labyrinth of the Shastri Bhawan complex in Chennai are the headquarters of the southern region of the ministry of corporate affairs . As reports emerged about Subhiksha not paying PF dues and salaries, the registrar of companies (Roc) started probing. Very soon, investigators S Meenakshi and BAMP Rathnaswami uncovered some startling details.
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Subhiksha, they found, was breaking rules regularly. There were numerous violations, some so serious that they felt that Serious Frauds Investigative Office had to be involved. In their April 2010 report, of which ET has a copy, the investigators make a litany of charges against Subhiksha: paper companies were set up to manipulate accounts and siphon money, transactions with related parties were not disclosed , and the board just did not do its job.
The report also raises questions about the role played by Deloitte Haskins & Sells, the auditor, and calls for an SFIO investigation. Subhiksha appeared to be a case of gigantic , systematic fraud with the board turning a blind eye or being simply ignorant, the report says. Private equity greed and reckless behaviour by banks, which lent money without proper checks and balances, completed the mess.
The case of Deloitte almost beggars belief. It stopped auditing the accounts after April-June 2007 for some unfathomable reason. The annual 2007/08 audit was undertaken by another Chennaibased firm, but in the latter half of 2008, Deloitte was reappointed by Subhiksha shareholders . But it did not get an appointment letter , leaving the matter in a limbo.
The report also raises questions about the role played by Deloitte Haskins & Sells, the auditor, and calls for an SFIO investigation. Subhiksha appeared to be a case of gigantic , systematic fraud with the board turning a blind eye or being simply ignorant, the report says. Private equity greed and reckless behaviour by banks, which lent money without proper checks and balances, completed the mess.
The case of Deloitte almost beggars belief. It stopped auditing the accounts after April-June 2007 for some unfathomable reason. The annual 2007/08 audit was undertaken by another Chennaibased firm, but in the latter half of 2008, Deloitte was reappointed by Subhiksha shareholders . But it did not get an appointment letter , leaving the matter in a limbo.
A Deloitte spokesperson said the firm was bound by confidentiality rules and that they had not done any audit as they had not received any financial statements after March 2007. Did Deloitte wash its hands off the crisis after realising that it could not explain the murky accounting? Or was it sidelined by Subramanian, who found its questions on the issue uncomfortable ?
Subramanian set a number of conditions for answering questions, including that he should be given access to the statements and reports that ET has in its possession. The paper declined to accept his conditions. Subhiksha was linked by the investigators to at least 42 shell companies which it suspects were used to route bank money.
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Another eight companies also appear to have been floated by Subramanian. All the companies are linked to each other by common shareholders and all of them hold shares in other companies, forming a complex matrix making it difficult to unravel who is ultimately controlling the company .
All these companies have either common directors, common shareholder or share addresses. Investigators have reason to believe that Subramanian diverted bank funds to many of these shell companies and hid the fact by inflating Subhiksha revenue, profits and inventory in order to give the impression of growth. Three more companies, linked to Subramanian, are linked together by common directors and common investments, the report says.
For instance , Stone N Sand Builders, Sun N Sand Tours and Shevaroy Holiday Resorts all have a share capital of 5 lakh, share premium of 5 lakh and investments of 5 lakh in each other. "It seems that no amount was received by any of these three companies towards share capital and share premium and no amount was paid by any of these three companies towards investments in these companies and possibly there may be only book entries, which is a very serious matter," the report says. "It is felt that these examples are only tip of the iceberg.
There is heavy manipulation in the accounts of the company." In another instance, the investigators found that for a few months beginning October 2006, City Capital Foundation, a company in which Subramanian has declared interest, was retaining all credit card sales collections of Subhiksha and depositing it with the company only towards the end of the month. "....
There is diversion of huge funds of the company each month from the month of October 2006 to March 2007 to City Capital Foundation.... Hence directors are working in a manner prejudicial to the interest of the company," the investigators wrote. While most of the diversion seems to have happened through circular banking transactions, other cases are more blatant. City Capital, for instance, was asked in April 2005 to set up all shops outside the state of Tamil Nadu.
All capital expenditure was undertaken by it but there is no record of any board resolution or approval given by the board. A director told ET that this matter was never discussed or brought to the notice of the board. The investigators also said Subramanian has declared interest in 13 companies but has maintained that they are not related parties.
All these companies have either common directors, common shareholder or share addresses. Investigators have reason to believe that Subramanian diverted bank funds to many of these shell companies and hid the fact by inflating Subhiksha revenue, profits and inventory in order to give the impression of growth. Three more companies, linked to Subramanian, are linked together by common directors and common investments, the report says.
For instance , Stone N Sand Builders, Sun N Sand Tours and Shevaroy Holiday Resorts all have a share capital of 5 lakh, share premium of 5 lakh and investments of 5 lakh in each other. "It seems that no amount was received by any of these three companies towards share capital and share premium and no amount was paid by any of these three companies towards investments in these companies and possibly there may be only book entries, which is a very serious matter," the report says. "It is felt that these examples are only tip of the iceberg.
There is heavy manipulation in the accounts of the company." In another instance, the investigators found that for a few months beginning October 2006, City Capital Foundation, a company in which Subramanian has declared interest, was retaining all credit card sales collections of Subhiksha and depositing it with the company only towards the end of the month. "....
There is diversion of huge funds of the company each month from the month of October 2006 to March 2007 to City Capital Foundation.... Hence directors are working in a manner prejudicial to the interest of the company," the investigators wrote. While most of the diversion seems to have happened through circular banking transactions, other cases are more blatant. City Capital, for instance, was asked in April 2005 to set up all shops outside the state of Tamil Nadu.
All capital expenditure was undertaken by it but there is no record of any board resolution or approval given by the board. A director told ET that this matter was never discussed or brought to the notice of the board. The investigators also said Subramanian has declared interest in 13 companies but has maintained that they are not related parties.
Subhiksha buys most of its grocery items from these companies and Subramanian has claimed he has secured an opinion from justice VN Khare, former chief justice, that they are not related parties . A copy of the legal opinion has not been shared with the investigators. Loans for more than Rs 600 crore were taken without a full discussion or approval from the board, raising the question how banks allowed this to happen.
"It is astonishing as to how all these banks sanctioned such huge loans when the company had fixed assets of Rs 188.38 crore and inventories of Rs 363.92 crore only as per the audited balance sheet as of March 31, 2007 which was only available from September 2007." On November 22, 2008, the directors of Subhiksha gathered for a crucial board meeting.. A few weeks before, IVen's Ramnath had discovered something alarming in the accounts. The inventory position in July-September was Rs 660 crore, a huge figure for any retail company.
Taken aback, she asked a team of IVen investigators to inspect all Subhiksha warehouses for an independent survey. Subramanian protested loudly but was overruled. The survey team returned a few days later. The inventory, according to them, was not even worth Rs 50 crore. The board meet itself was stormy. Subramanian refused to consider it a formal one and Rama Bijapurkar chaired it. It lasted one full day and Subramanian was questioned in detail about the discrepancies in the company's accounts, the amount of money due and the loans.
Auditors from Deloitte were called in and they made the startling disclosure that no appointment letter had been issued by Subhiksha. In the end, the board decided to take control: appoint KPMG to do a detailed audit, appoint a CFO and ask the company to finalise the accounts for the period to June 2008 before December. According to Bijapurkar (a detailed account given by her on behalf of all the directors was submitted to the RoC by advocates Manilal Kher Ahmed & Co), the company did not comply.
Audited accounts for 2008 were not finalised and no CFO was appointed. KPMG, she adds, was not allowed to do the audit. One by one, the IVen nominees resigned. For Ramnath, it was a bitter end to what promised to be a great investment . Subhiksha should have done an IPO by early 2008 and her company could have exited, making a cool profit. Its failure had as much to do with her and IVen's lack of oversight as with Subramanian's financial manoeuvring.
WAS PREMJI HANDED A LEMON ?
Between July and September 2008, her firm sent out numerous missives to overseas and domestic funds about a possible investment in Subhiksha . A list of funds who were contacted and their response is a part of a judgement given by Justice V Ramasubramanian J of the Madras High Court in one of the many cases relating to Subhiksha. Replying to a mail by IVen's Sanjay Mehrotra on September 4, 2008, Navroz Udwadia of Eton Park International , London said that while they were excited about a business model they were not willing to throw "stupid money around" . "Therefore, it is clear that even upto September 2008, IVen was looking for foreign investors to bail the company (Subhiksha) out of the woods....
They cannot really feign ignorance of what was happening in the company in the transferor company except by coming up with a confession that such nominee directors failed to perform their duties and obligations," the judge said, dismissing the firm's pleas that they were misled and kept in the dark by Subhiksha. Renuka Ramnath did not reply officially to an email on the issue but she has defended herself within ICICI saying that she was a non-executive director and therefore did not about everything that was happening in the company. One of her jobs as an investor was to put some trust in the management , which she did, until she discovered that too many things were going wrong. While all this was happening, Premji Invest officials were on pins and needles. Having invested Rs 230 crore for a minority stake without a board seat, they could only watch helplessly as their plans unravelled. First they were told in May 2008 that the IPO was off.
Then they were asked to sign off a dubious reverse merger scheme to get the company listed. Third, they were asked to lend some money in December 2008. A furious Bobby Mustafa confronted Ramnath but was told that IVen had given a similar loan in September of that year to bail the company out of a cash crunch. The seemingly fast-growing and high-performing Subhiksha appeared to be in full meltdown mode before their eyes. Premji Invest officials were blunt about where the blame lay. "ICICI Venture approached us directly in late 2007 for a pre-IPO investment in Subhiksha.
We were constantly told that the transaction needed to be completed urgently as an IPO was imminent ..... However, what was not known to us then, was that, prior to our investment , Amarchand Mangaldas had not signed off on the DRHP in the form that it was made available to us. We also learnt that in 2007, a whistleblower made disclosures of serious issues to ICICI Venture and Deloitte, which were not communicated to us," it said. Their suspicion stemmed from two different but related developments. One was a three-way conversation on December 31, 2007 between Subramanian, Ramnath and Cyril Shroff, the managing partner of law firm Amarchand Mangaldas. That meeting decided the fate of the IPO.
The other was the discovery of a dossier on Subramanian and Subhiksha, compiled by V Rajendran. Rajendran runs a packaging company on the outskirts of Chennai. In the late 1990s, he approached R Subramanian for a loan. The loan was granted in return for which Rajendran pledged his land and shares in his company Citrex Products. A couple of years later, Rajendran, according to the petition filed in the Madras high court, repaid the loan and asked for the papers.
Vishwapriya declined, claiming that the money had not been paid back. An enraged Rajendran decided to get even and undertook painstaking work to compile a dossier on Subramanian's alleged misdeeds. Subramanian claims that his information was illegally obtained by hacking and has filed an FIR with the Chennai police. But a police investigation failed to corroborate the charges.
This dossier was shared by Rajendran with IVen officials in October 2007 and with Deloitte and a number of other banks. No action was taken. After Subhiksha shut shop, Premji Invest officials looking for evidence of wrong-doing were tipped off and linked up with Rajendran. On December 31, the last date for Subhiksha's draft red herring prospectus to be cleared and filed with Sebi, Shroff declined to give the green signal for the IPO plan. When word about Shroff's refusal reached Premji Invest, they blamed IVen for hiding facts.
According to them, IVen had written emails to Premji Invest in January 2008 saying that the 10% stake sale in Subhiksha was a pre-IPO placement. If the lawyers had not signed off on the IPO, where was the question of pre-IPO placement? The dossier and Rajendran's meeting with ICICI Venture in 2007 is also evidence, according to Premji Invest, of ICICI Venture's duplicity. Today, Subramanian still functions out of the Subhiksha office and the firm has opened a few stores in Chennai. Friends praise his brilliant intellect and his innovative streak that briefly made him a darling of the media and the envy of the retail industry .
"He once told me that he has read all the law there is to read and that there is nothing more to learn," a friend who studied with him at IIT Chennai said. That is why perhaps, he is spending a lot of time preparing for court cases on his own. The ministry of corporate affairs is trying to get the stay on the SFIO probe vacated and another hearing is scheduled soon.
The banks want their money (more than Rs 800 crore of loans were outstanding in 2008) back but so far very little has been achieved legally. If nothing else, the Subhiksha episode exposes the Indian regulatory and banking system's deep vulnerability . Whether it is private equity firms willing to glance the other way in return for a quick buck, accounting firms relying excessively on management-speak or banks desperate for business, promoters accused of violations always manage to stay ahead.
Failed Model: A Timeline
1997: Subhiksha Trading Services is set up as a private limited company. It becomes a public company in 2005
2000: ICICI Venture makes its first investment in Subhikhsa, which has grown to a chain of 50 stores. It buys about a 15% stake for Rs 15 crore
2000: ICICI Ventures' Bala Deshpande joins Subhiksha's board. Renuka Ramnath is nominated to the board 2 years later
DEC '07: IPO plans called off after legal firm Amarchand Mangaldass refuses to sign off
2008: Azim Premji's Zash Investment acquires 10% stake in Subhiksha from ICICI Ventures for 230cr
MARCH '08 : Azim Premji promoted Zash Investments signs deal to buy 10% in Subhiksha for 230 crore
JUNE '08 : Subhiksha proposes a reverse merger with Blue Green Constructions to get listed
MAY-SEP '08: Complaints , reports appear in media about delay in payment of salaries, arrears in PF dues
OCT '08 : Subhiksha shareholders' meet clears proposal for reverse merger, creditors a lso approve proposal
NOV '08 : Story board meet called by shareholders and directors meet to discuss problems. Subramanian is asked to prepare accounts for 2007/08, appoint a CFO in consultation with the board. KPMG is asked to conduct a complete audit
DEC 08 : Premji Invest, lends Rs 50 crore to Subhiksha to tide over acute financial crunch
JAN '09 : ICICI Venture and independent directors resign from Subhiksha board. Most of company's 1,650 shops are shut
JAN-MAR '09 : Kotak Mahindra Bank files winding up petition
MAR '09 : Madras high court appoints provisional liquidator
APR '09 : Decision stayed : but proceedings of winding up can continue
JUN '09 : Registrar of Companies, Chennai, orders a probe into Subhiksha affairs
NOV '09 : Supreme Court asks Madras high court to dispose of reverse merger petitions
OCT '10 : Madras high court rejects Subhiksha-Blue Green merger, paves way for winding up
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