Cheques and balances by Sucheta Dalal

Cheques & Balances by Sucheta Dalal

September 24, 2000

How unsafe are so-called ‘secured’ debentures?

SEBI recently amended the rules governing debenture trustees after discovering debenture defaults to the tune of Rs 373 cr. But these are neither adequate nor comprehensive

Over the past decades investors have subscribed to several thousand crores of so-called ‘secured debentures’, assuming that they are ‘secured’ against the issuing company’s physical assets and that their interests are adequately protected by responsible ‘Debenture Trustees’.

Chasing the case of Urmila Agashe, revealed how false these assumptions were. In fact, the law governing the fiduciary role of Debenture Trustees (DT) is porous enough to be redundant. DTs can walk away from their responsibilities at any time without informing investors or the regulator. They do not even have to return the fees pocketed by them. Here is a look at how bad things are.

Urmila Agashe, a senior citizen, owns 54 debentures (Folio No 150136) of Montari Industries which had ICICI as its Debenture Trustee (DT). Mrs. Agashe began to correspond with Montari in 1994 when it stopped paying interest. In 1997 she was informed that the company was sick and had approached the BIFR for rehabilitation. She then wrote to ICICI asking what it had done to protect her interests. ICICI calmly told her that it had resigned as DT. She wrote to the Department of Company Affairs (DCA) and drew a blank.

However, SEBI in a carefully worded reply to this newspaper reveal how bleak the situation is for investors. SEBI says, yes - a DT can simply walk away from its obligations by resigning. It relies on the provisions of the Indian Trusts Act, which provides for the appointment of new trustees and removal of trustees but not for investors rights in case a Trustee resigns. According to SEBI, “there is no specific provision in the regulations providing for DT to inform the investors if he resigns. However, DT is required to fulfill his obligations in ethical manner as per the Code of Conduct”. This is utterly meaningless. ICICI which has acted as a Debenture Trustee (along with leading nationalised banks) in this and other issues is clearly aware of the huge loopholes and is brazenly using it, untroubled by fiduciary responsibilities and ethical issues involved in ditching investors. After all it is more concerned with its own mountain of bad debts.

Another astonishing revelation emanating from SEBI’s candid answers is that the Indian Trusts Act does not oblige the existing Trustee to remain in place and fulfill its fiduciary duties until a new one is appointed. The Trust deed is expected to provide for the appointment of new trustees when the old one resigns, but finding a new DT for a sick company seems almost impossible. On August 8, SEBI amended the rules governing debenture trustees after discovering debenture defaults to the tune of Rs 373 crore. But these are neither adequate nor comprehensive. One of these rules eliminates the conflict between the role of institutions/banks as DTs and as lenders to companies. SEBI has dictated that no DT shall act as such for debentures issues of its associate companies or those were it is a lender or proposes to be a lender.

In cases where lending banks/institutions are already DTs they have to resign within two years from August 8. This probably makes many existing debenture issues even more unsafe. It allows DTs to walk away claiming compliance with SEBI rules. A minor blessing for investors is the amendment which ensures that a Trust deed is executed and security created against the assets of the company. Compliance is extracted by forcing issue proceeds to be kept in an escrow account until the creation of security. But it still means that if a DT resigns, there will be nobody responsible for liquidating the security and paying investors.

The disenchantment of investors with debentures is documented by SEBI’s own investor survey in collaboration with NCAER. The survey says that contrary to the theory that “debentures should find favour with risk averse investors”, Indian investors rate them as risky as equities. On indication of how dead the debenture market is for retail investors is from the scores of investment and broker websites that spew out detailed information on equities and companies.

A search of a dozen odd top sites drew a complete blank with regard to debentures - not even the Crisil site provides a listing of outstanding debentures or their rating. Yet, almost every week Crisil puts out reports on downgrades and new ratings which suggest that there is an active market for debentures. The question then is who subscribes to these debentures? Apparently, it is usually large institutional investors, trusts, mutual funds and even pension schemes.

Are these expert investors unaware of the risks or are they persuaded to invest in debenture issues? Investor needs to ask what steps have been taken by such institutional investors to protect their investment in the event of corporate failure.
Since banks and financial institutions usually act as DTs, it is worth finding out how many subscribe to such issues knowing how unsafe they are. Investors have the right to information about - the total number of outstanding debenture issues, the financial health of the issuers, the existence or otherwise of debenture trustees, the number of debenture defaulters and steps taken by their DTs to liquidate the security and pay investors.

Only SEBI has the authority to collate this information and it needs to be urgently displayed on its website. The debenture rules also need to be amended again. In fact, the SEBI investor survey itself prescribes a course of action. It says that the negative investor perception “puts an onus on the regulatory apparatus to punish defaulting companies and errant debenture trustees who have not carried out their responsibilities”. It is now up to the SEBI to follow its own prescription, but for investors who have already lost their money, litigation seems to be the only redressal option. Though the legal position may be tenuous, they can at least hope for judicial activism to note how the ‘safety’ enshrined in the issue of debentures is made redundant by the brazen use of loopholes by the biggest financial institutions in the country.