Why are shareholders voting against dividends at AGMs?

Recently, I noticed an interesting trend in two AGMs of Sep 2013. In the AGM of  listed jewellery retail firm Shree Ganesh held on 6th Sep 2013, 99.61% of the votes(52823544 shares) were cast against the Board of Directors proposed final dividend of 10%. Promoters own 73.46% of 7,19,06,485 shares so they seem to have voted en-bloc against the dividend, and since no one else attended, that become a 100% vote against the dividend. Maybe this was an unwritten clause in the preferential allotment done earlier that month.

In the case of Gitanjali Gems AGM held on 30 Sep 2013 http://www.bseindia.com/xml-data/corpfiling/AttachHis/Gitanjali_Gems_Ltd_011013.pdf 100% promoter votes and 99,75% 'public shareholder' votes were cast against dividend declaration, while 100% institutional shareholders voted for dividends, but ended up on the losing side. A very interesting case of maybe financial distress or trying to push the share price down.

In the previous year, infrastructure firm Atlanta Ltd saw shareholders voting against its 10% dividend(20 paise per share) but there were no other examples I noticed. 

While Indian company law permits shareholders to reduce/avoid declaration of dividend proposed by the Board, this is the FIRST time I've seen two instances of companies doing so, both financially stressed firms in the jewellery sector. But then, this was a month of several firsts with the withdrawal of audit reports in FirstLeasing, MCX etc.

Warren Buffet's investment partnerships cannot be born in India as LLP even now

Warren Buffet built his initial reputation and winnings through an investment partnership, where friends/relatives/acquaintances invested their capital in partnership with his acumen! It was a win-win for both parties in the end. However, in India, thanks to the legal and regulatory issues, this is next to impossible. Recently, a friend was thinking of setting up his own investment partnership in which he wanted auditable returns, favourable tax treatment, ease of entry/exit of investors, and least administrative cost. But after reading this excellent article http://capitalmind.in/2011/06/creating-a-hedge-fund-in-india/ I realized that that would be next to impossible. Since that article did not cover LLPs in depth, I decided to do so. This would cover questions like structuring investment partnership as LLP etc

1. What do I mean by investment partnership? As commonly understood, investment partnership happens where investor funds are pooled in a common strategy, without any investor specific customization within the fund. For example, 10 friends entrust Rs 5 lakhs each to their common friend Mr X to invest in special situations. This would be an investment partnership, as funds are pooled. 
2. Which regulations govern this? The securities regulator SEBI governs portfolio managers(discretionary and otherwise), mandating minimum investment limit(Rs 25 lakhs), restrictions on fee methodology(water mark etc). Even for those who feel they are not covered by that restriction due to 'not being companies etc', the SEBI Alternate Investment Regulations 2012 cover this  ―Alternative Investment Fund‖ means any fund established or incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate which,-(i) is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors; and (ii) is not covered under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, Securities and  Exchange Board of India (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities: Since the partnership will be an investments company by its very nature(http://india-financing.com/Question_of_Definition-What_Exactly_is_an_NBFC.pdf), RBI regulations of registration etc will apply http://www.rbi.org.in/scripts/FAQView.aspx?Id=71
3.  RBI regulations apply to NBFCs(non banking financial COMPANIES) and not to firms, why should the LLP be subject to this? Section 14 of the LLP Act 2008 states that On registration, a limited liability partnership shall, by its name, be capable of.....(d)  doing and suffering such other acts and things as bodies corporate may lawfully do and suffer. Section 2(d) of the LLP Act2008 defines body corporate.... “body corporate” means a company as defined in section 3 of the Companies Act, 1956 (1 of 1956) and includes..Therefore, since LLP is a body corporate under the Act and subject to other acts applicable to body corporates, the RBI NBFC norms will apply to it to the same extent that they would apply to companies. 
4. Are any minimum qualifications needed? After reading the SEBI AIF Regulations at the link below, I realized that this would be a difficult http://www.sebi.gov.in/cms/sebi_data/attachdocs/1337601524196.pdf the key investment team of the Manager of Alternative Investment Fund has adequate experience, with at least one key personnel having not less than five years experience in advising or managing pools of capital or in fund or asset or wealth or portfolio management or in the business of buying, selling and dealing of securities or other financial assets and has relevant professional qualification; 
5.   The requirement of three regulators? Renowned lawyer Mr Sandeep Parekh opines that both RBI and SEBI will need to give approval, apart from the administrative approval from Companies/LLP regulator.  "It's a three-stage process for RBI-regulated entities like non-banking finance companies (NBFCs). The first step would be to incorporate; this is done by the Registrar of Companies. Second, they have to obtain a licence to operate as NBFC and for which it must apply to RBI; and thirdly, if an NBFC intends to provide investment advisory services it will likely need permission first from RBI and then from Sebi," said Sandeep Parekh, founder of Finsec Law Advisors. "This would obviate turf wars between financial regulators," he said. http://articles.economictimes.indiatimes.com/2012-10-02/news/34218105_1_sebi-board-capital-market-regulator-corporates In practice, some friends inform me that the LLP/companies registrars seek NOC from RBI even before first step! 

Conclusion:-Given the capital, annual fees and experience requirements, such a venture would be stillborn in India if intended to be run legally. 

For AS-29,can legislation ever be 'virtually certain to be enacted'?

Suppose a new law/regulation is proposed which adversely impacts an industry/stock. If listed, the stock markets give instant feedback by driving the stock down atleast in the short term. But the financials rarely reflect this possible impact until the law is formally passed. Does this mean investors are conservative, or that accountants are aggressive? The truth is neither-it is just that markets can assign their own subjective estimate of the impact of the bill, while accountants are bound by accounting standards like AS-29, which I proceed to dissect below. 

Under AS-29 on measuring provisions, it mandates that the effect of possible new legislation should be considered while measuring a liability, when sufficient objective evidence exists that the legislation is virtually certain to be enacted. However, recognizing the inherent uncertainty in the whole process, the standard itself admits that in many cases, sufficient evidence will not exist until the new legislation is notified. Even while perusing through infrastructure companies annual reports/public filings(an industry with multiple laws relating to land reform/coal pricing/gas allocations etc), I did not notice any such provision anticipating pending laws, with companies instead preferring to recognize it as a liability. The reason for this is

1. Proposals/news leaks often remain 'in the air' without concrete action. Sometimes, I feel that bureaucrats merely leak proposals to get a riskless preview of public reaction, and then modify the final proposals to please their political masters.
2. Long time to pass any legislation especially sensitive ones. Opposition holding up the House for trivial issues, does not make things easier. 
3. Executive has powers to notify the effective date of the law, and as examples of the Competition Act 2002/Benami Property Act etc would show, many 'hot potatoes' may make it through Parliament and the President's sanction, but not beyond that
4. Devil in the details-delegated legislation-many laws especially economic/securities laws rely heavily on delegated legislation, which do at times, vary from the popular meaning/understanding.

Therefore, even well minded companies would find it difficult to find any objective evidence for what the draft bill may materialize to at the end of the whole process. For that reason, even conservative accountants may decide to let this slide and instead face the final law when it comes. And so because of the above uncertainties, one would be hardpressed to find a law which is 'virtually certain to be enacted' in its present form, especially in this coalition era.

Assessing legal risk-an investor guide

Open any annual report, and chances are that you would see a plethora of legal risks(here, legal merely means a violation of any contract/law, which is under dispute). An IIM-A Prof famously said 'law changes at the stroke of the pen'. That pen stroke can cost billion-just ask Vodafone, SKS Microfinance, Reliance Communiations, RNRL, Reliance Industries, HCC, JSW Steel etc-all victims of recent legal related issues.They may be

1. Tax related-that table you see attached to the audit report, listing the forum/subject matter/tax amount and period of the dispute. This may be related to direct or indirect taxes. While the company/its legal expert would ordinarily have evaluated the chances of winning before deciding to litigate, remember that companies starved  of cash flow may have little option, but to contest perfectly valid tax claims. While Vodafone TDS dispute hogged the headlines, there are many other disputes below the surface such as service tax on real estate, license fee for telecom, TDS issues for telcos/airlines etc
2.  Litigation related:- Companies typically wriggle out of disclosures when they are on the losing side by claiming the protection of 'sub judice' disputes. Still, where amounts at stake are signifc
3. Proposed legislation/Draft Reports:- It is sad that most investors/analysts may not bother to read the detailed draft/bill, but prefer to rely on the press release/some summary out there. Whether it be the Lokayukta reportwhere Sesa Goa crashed till it released clarifications), AP MFI Bill/Central MFI Bill(which lead to SKS microfinance stock see-sawing), mining bill(where mining stocks fell); market did overreact before sanity prevailed. For the recent bills(on ports, land acquisition) etc, this knee jerk reaction has decreased, maybe because noone expects these bills to be passed during the current log jam of Parliament. 
4. C&AG Reports:- Thanks to an activist C&AG, and a media hungry for that next soundbyte/breaking news, C&AG reports are the next source of fear for companies. Even a mighty giant like Reliance lost 10% due to a C&AG accusation of goldplating. Given this, what hope do others have? This, although actual legal action and enforcement would take years, due to which NPV would be lesser
5. Political:- The Mayawati Govt threw hurdles into RPower's projects in UP, thanks to his links with her rivals the SP. Mamta Bannerjee's Govt's first act was to confiscate the Singur properties of Tata Motors, which she perceived as siding with the Left.  When the DMK fell out of favour with the UPA at the centre, the AIDMK state Govt leapt on Sun TV like a hungry vulture. To keep Sharad Pawar's NCP toeing the party line at the state level, HCC's premier project Lavasa(where his shadow ownership is whispered about) was held up for months on environment grounds,  till court intervention. As infrastructure analysts would concur, projects(especially irrigation, roads) are doled out as rewards for electoral support-though the PPP framework is reducing this. 
6. Raids by income tax/labour inspectors/receipt of notices:- Satyam is fighting a case where the IT Dept has demanded thousands of crores of additional liability on (as per Satyam) non existent income. This would impact the valuation till the matter is resolved. People with legal flair can analyze and benefit. Also, at times, there are news announcement of 'search and seizures','surveys','raids' etc. One should note that unless the company is formally charge sheeted/arrests made/fines recovered, this news is as good as noise. 

Moral:- One can crystal out certain lessons from these sorry tales

1. Avoid a knee jerk reaction, and read the full bill/draft/details, and assess the probability of loss. This would need more than passing legal knowledge, so using an expert may help for important issues
2. Assess political leanings of corporates, as change of governments(more common in this coalition era) may turn corporate fortunes topsy turvy
3. Where a landmark tax verdict has been rendered, chances are that the next Budget will contain an amendment to reverse that favourable(to taxpayer) verdict with retrospective effect. This has happened for the offshore oils services income tax, cigarettes excise duty, lottery tickets service tax, realty service tax etc; and is likely to happen again. So hesitate before factoring in tax wins in the valuations.

Selectively picking court orders to inflate profits-some examples

Indian litigation is final only when it reaches the apex court, and is either turned down or dismissed. But till that stage, people can interpret judgements to their convenience, or the assessment whether it will be upheld or dismissed at further courts. Unless the judgement is perverse(evidently wrong on facts/law), it would be apt to pass accounting entries at status quo. But companies often pass entries as per their favoured outcome, thus boosting profits/non cash assets. Below are some examples.

1. Music royalties from FM radio stations to composers/lyricists:- Indian Performing Right Society (IPRS)  collected royalties on behalf of music composers and lyricists.  But between June-July 2011, the Delhi & Mumbai High courts held that the collection had no legal basis. Both HCs stayed the judgement till September 30, to permit IPRS to appeal for a stay in the Supreme Court. That means the judgement has no legal effect till that date, and may not continue if the Supreme Court agrees with IPRS and grants a stay. Naturally, FM radio channels who had paid the royalties till date were pleased. One of them, Reliance Broadcast Network promptly obtained a legal opinion and decided not only to avoid paying future dues, but also claim refund of the Rs 8.79 crores paid till date. They credited that amount to the accounts, assuming that they would get back those proceeds.  That is indeed jumping the gun, and premature, because even if IPRS loses in the SC, it would be difficult to recover payments made under a mistake of law. 
2. State Advisory Prices(SAP) for sugar procurement in UP:- An annual charade is played out where the UP Govt fixes SAP much above the Centrally advised MSP(minimum support price). Sugar mills do not want to pay that SAP, and thus approach the HC for stays, which is granted if the mills pay farmers at the SAP pending resolution of the case. Cash outflows happen at higher level, but sugar mills account it at the lower MSP, assuming they would win the case, which is doubtful.
3. Stayed cess/state taxes:- States periodically impose water cess, electricity duty etc which the user industries naturally dislike. They then waste 3-4yrs at the HC/SC level and end up paying the cess with interest, but till then avoid booking those expenses in their books. Of late, to sanctify this practice, an industry association is roped in to file the suit, so that companies can claim to be following an industry practice. 

Takeaway:- As an investor, be aware of such legal risk, especially if the amounts at stake are high. An example of RNRL should warn even the casual investor, how legal risk can destroy the economics of a company. Even if orders do not destroy the company, adverse outcomes may still erode the share price, with no advance warning(orders usually are not leaked in India!). 

The essential legal distinction between CDS and 'credit insurance'.

During the subprime crisis, some investment banks who purchased CDS from 'professional counterparties', were accused of using insider information on the underlying security's credit risk(from the commercial/investment banking side). The implication was that by not disclosing the conflict of interest/insider information, the banks were able to purchase CDS at lower prices, which they then profitably exited around the time of the subprime crisis.

Now, CDS is essentially a bet that the security will default. And credit insurance is pretty much the same thing(economically). The crucial difference between insurance and put option is that

1. Insurance, in most cases, covers only actual loss and also known as 'contract of indemnity'. But in case of CDS/put options, the person purchasing protection need not physically own the security.
2. To solve the perennial information asymmetry problem, insurance laws deem insurance to be a 'contract of utmost good faith' and mandate full disclosure of all risks.  But in financial products, unless the bank is deemed to owe a fiduiciary duty to its client/counterparty(which all banks invariably disclaim to the fullest extent allowed), they are not subject to such fair dealing norms. And regulators consider these players to be 'big boys' not in need of such protection
3. In CDS, one can hedge partially without penalty but in insurance, there are penalties for under-insurance where the average clause is applied. 

Hence, before accusing the CDS buyers of sparking moral hazard etc, it would be good to know that different structures have varying obligations despite having the same economic consequences. Another example of regulatory arbitrage maybe.