Taking from shareholders for private gains

It is a natural practice – a company borrows from banks to finance its operation and expansion. They spend a part of their profits to pay interests against these loans.

Any company can also loan its surplus money to another company.

But this common business story turns into a curious case when a large number of listed companies lend money to their sister concerns or associate companies in exchange for poor or even no returns – though these listed companies themselves are counting interests on their borrowed amounts.

It is a way of how some directors and managers of listed companies have been pursuing their own benefits at the expense of public shareholders, says asset manager Shaidul Islam, a past president of the CFA Society Bangladesh.

Resurrection of the 2006 regulations

At least 78 of the locally listed companies either made such loans to or became the guarantors of third-party loans taken out by their private sister concerns or associate companies, of which more than 50 have been grossly ignoring the relevant BSEC regulations of 2006, according to the regulatory officials.

The Bangladesh Securities and Exchange Commission (BSEC), under the new leadership since mid-2020, addressed the issue in August as it observed the emerging trend of announcing poor earnings and dividends among a large number of companies, especially the local ones.

The BSEC asked for updated intercompany loan data, but 109 out of over 320 listed companies are yet to report theirs. They will have to submit that soon.

Of the upcoming submissions, there will be some large local companies, which have lent too much to their associates or their directors' private concerns on no or very low interests.

"To protect investors' interest, the BSEC is asking for explanation on why the listed companies made such loans or guarantees to private ones, depriving their own shareholders," said Md Rezaul Karim, executive director and spokesperson of the BSEC.

The regulator is also instructing companies to bring back all the funds lent illegally, unethically with accrued interests over the past years.

Lending to the associate companies where a listed company holds minority shares, or sister companies where it has no ownership but having common sponsor-directors, or violation of BSEC notification, have their own different faces within companies.

Losing proposition for public

Manufacturer Aramit Cement Limited owes over Tk432 crore to banks. It paid around Tk30 crore in interest over the first nine months of the last fiscal year. Finally, the company posted an annual loss of Tk23 crore at the end of the fiscal year and announced no dividends for its shareholders.

But the company had lent more than Tk77 crore to six associate companies and it has charged no interests against those in the last four or five years.

Observers and regulatory officials believe that had the company charged the sister concerns 10% interest against the loans, Aramit Cement shareholders could have easily got 20% dividends even in the tough pandemic year.

While talking to The Business Standard recently, the company officials acknowledged their non-compliances and expressed their readiness to correct things in immediate board meetings.

Golden Harvest Agro Industries Ltd, a leading food processor, collected Tk89 crore through right offers in 2019. Since 2016, it has been providing interest-free loans to its sister concerns, associates and subsidiaries amounting to Tk28-89 crore each year, while the company is itself bearing interests against Tk185 crore in short-term loans and Tk194 in long-term loans from banks.

It also registered poor earnings and paid no dividend to shareholders and the regulator asked the company to get refunded with rational interest accrued over the last five years.

"Accounting itself has no issue with intercompany loans. All we need to check is how the intercompany transactions are arranged," said AF Nesaruddin, a past president of the Institute of Chartered Accountants Bangladesh.

If a listed company arranges any losing proposition for investors, that is unacceptable. On top of that, if the arrangement is intended for merely benefiting the company insiders, that turns for the worst, opined the reputed chartered accountant.

He observes that well-governed companies are serious about protecting public investors' rights, while malpractices and ill motives are more concentrated among mid-profile companies.

The 2006 notification of the BSEC allowed listed companies to lend to subsidiary companies if shareholders approve the plan. But it restricted the loans to associate companies, directors and managers themselves and other companies owned by the directors, popularly called sister concerns.

A Matin Chowdhury, managing director of Malek Spinning Mills Ltd, said the BSEC is doing the right thing to protect investors' interest despite the fact that the regulator ordered his company to bring back the principal of over Tk12 crore it lent without interest to sister or associate private entities along with interests accrued over the last four to five years.

"The regulation is old enough but has never been enforced before. There was also a lack of knowledge and awareness among companies," he said adding, "We have some receivables to our private companies; it emerged based on some needs and we will explain those to the BSEC."

Saiham Textiles Ltd, another old textile company, has also been asked for bringing back Tk12 crore plus accrued interests and to explain the reasons behind charging no interest.

The debate for a breathing space

Even Square Pharmaceuticals Ltd, a top local blue-chip company, also has been served a BSEC letter in the last week which asked the company to explain why they lent Tk305 crore to associate companies alongside providing bank guarantees worth over Tk1,455 crore in favor of the associate companies.

The BSEC also asked for bringing the loans back in seven days.

Md Jahangir Alam, chief financial officer of the pharmaceutical market leader, told The Business Standard, "We lent from our surplus funds and we are charging at least 100 basis points more in interest if compared to the average market rate for fixed deposits."

"The loans made a win-win proposition for both the listed and non-listed companies," he said.

Law firm The Lawyers and Jurists' Head of Chamber Barrister AM Masum, an expert in securities law, said banking regulation outlined the ways what a bank should do and not during lending. The securities regulator also did the same for listed companies almost one and half decades ago.

A large number of listed companies, mostly the poorly governed ones, however, did not comply with the order and it is a good sign that the regulator addressed it, he said.

Shahidul Islam, a long advocate for investors' rights, believes no listed company other than financial businesses should be allowed to lend their surplus fund to sister concerns, associates or even subsidiaries where it owns less than 100% shares.

"It is a crime against public shareholders to make interest free intercompany loans and borrow from banks for the listed company," he said.

The chartered financial analyst and financial risk manager thinks that to lend or provide a guarantee against loans, it involves a lot of financial risk assessment tasks, and non-financial companies better focus on their own business instead.

The Bangladesh Association of Publicly Listed Companies also welcomes the regulator's drive against unethical intercompany loans, said its Secretary General Md Amzad Hossian.

Chartered Accountant AF Nesaruddin believes that the regulator should look into each of the arrangements separately as companies also need some breathing space in different situations like supporting the growth of young backward linkage associates. Of course, there must be winning deals for public shareholders.

Need for effective general meetings and internal custodians

Earlier this year, the BSEC fined five directors of MI Cement Factory, the manufacturer of Crown Cement for the same noncompliance of providing loans of Tk70 crore to sister concerns without shareholders' approval.

Such loans require majority shareholders' approval in general meetings.  

The company appealed to the BSEC to review that and they claim that these were not funded loans, rather trade balance with the group's backward linkage firms, according to Masud Khan, the company's adviser.

Barrister Masum opines that intercompany loans for good reasons can be an option if the regulator approves those on a case-to-case basis, of course, following shareholders' approval.

To stop the unethical practices within the listed companies, general meetings that seek for shareholders' approval need to be very transparent and participative so that real investors can raise their voices, said Abu Ahmed, an honorary professor of economics in Dhaka University and also a stock market expert.

All the experts agreed that independent directors, as the custodians of general shareholders' rights, should have played a meaningful role to prevent any unethical transaction by the listed companies.