Dyed in black

Bombay Dyeing's shareholders have been defrauded due to its management's deceitful attempt to exploit a legal loophole

- Arul Selvan

SEBI's recent penalty on Bombay Dyeing is an eye-opener for investors on how companies can take advantage of seemingly legal routes to distort financial results and inflate sales figures blatantly.

On March 29, 2012, Bombay Dyeing sold around 30 per cent stake in its unlisted associate company Scal Services and this resulted in the former's stake coming down to 19 per cent. While this appears to be a very normal business activity, things started taking an interesting turn when the very next day the real-estate segment of Bombay Dyeing started selling flats and other real-estate rights to Scal for the purpose of business development.

So far so good. Or at least that's what shareholders thought. But as revealed by SEBI's investigation, these transactions were actually a part of a deliberate scheme that was designed to fool investors. What was actually transpiring behind the scenes was that the management was seeking to find a way around certain accounting rules which required the elimination of intra-group sales in the consolidated financial statements of an entity having significant shareholdings in other companies.

Modus operandi

According to the provisions of the Companies Act, 2013, a parent company needs to consolidate the financial results of its subsidiary company only if it has a shareholding of more than 20 per cent. Thus, by reducing its stake to just below this threshold, Bombay Dyeing was able to recognise ₹2,492 crore of revenue and ₹1,302 crore of operating profits out of sales to Scal over a period of seven years.