How to spot another Gensol? Zerodha’s step-by-step guide on red flags in corporate governance
SEBI’s latest crackdown against Gensol Engineering has sparked a debate on red flags in corporate governance. Discount brokerage Zerodha’s Varsity, in its latest post, has analysed ways by which retail investors can spot the red flags in corporate governance and potentially another ‘Gensol’, to avoid any unnecessary losses in equities.
The Securities and Exchange Board of India (SEBI) in its crackdown against Gensol Engineering, barred promoter brothers Anmol Singh Jaggi and Puneet Singh Jaggi from directorships in listed companies, stopped the company’s planned stock split, and named a forensic auditor to investigate the matter further.
Zerodha’s Varsity said, “SEBI’s debarment of Gensol and its promoters from the securities market has resurfaced the discussion on corporate governance.”
SEBI’s order, after it investigated a complaint received in June 2024, pointed to serious governance lapses, fund diversion and submission of falsified documents. The complaint alleged share price manipulation and misappropriation of company funds. The probe unearthed what it described as a “complete breakdown” of internal controls and corporate governance.
Zerodha’s step-by-step guide on how to spot red flags in corporate governance:
1.’Opinion’ in Auditor’s Report
When studying a listed firm, check for the “Independent Auditor’s Report” in its annual report. The first section of the Auditor’s Report is titled “Opinion” or “Unqualified Opinion.” It is a red flag if titled anything else.” According to Varsity, a few other ways to spot red flags in corporate governance are:
-Qualified Opinion: lack of complete info
-Disclaimer of Opinion: Lack of info and unreliable financials
-Adverse Opinion: The auditor outright disagrees with the financials provided by the firm.
A company with Opinion or Unqualified Opinion is not necessarily clean in its corporate governance. It only means that the auditor has not found any issue with the financials. Gensol’s financials seem clear. But corporate governance runs beyond just financials.
2.Annual corporate governance report
All listed companies submit a comprehensive corporate governance report annually. It details the board members’ age, experience, and remuneration and outlines the board’s procedures. The more details a corporate governance report has, the better it is.
3.Reservation of profit, board seats
All companies are also required to:
– Reserve a portion of their board seats for female and independent members.
– Spend a portion of their profits on CSR
– Report the percentage of male-female employees
– Report the remuneration of board members and key managerial personnel
4.High pledge by promoters
Gensol’s promoters, Anmol Jaggi and Puneet Jaggi, were not drawing any salary. However, ~75 per cent of their stake in Gensol was pledged. It is a common tax-saving practice not to draw a salary and borrow against shares. Such a high pledge on promoter shares is also a red flag.
5.Unclear corporate Actions
Some firms might operate within the law, but their actions might show some red flags.
1⃣Announcing buybacks when the share price is well below its peak.
2⃣Paying dividends despite reporting losses or paying dividends by adding debt because a parent entity needs funds.
3⃣Convoluted holding structure – Parent A holds 50 per cent in B. A and B together own 50 per cent of C. C has used some funds to buy shares in B.
Such a structure is legitimate but confusing. It can also be used to manipulate the stock price or funnel funds. Gensol is a case in point.
4⃣Related-party transactions are commonly used to embezzle funds. Loans given to related parties are an easy red flag. Loan guarantees given for related parties are liabilities, but not reported on the balance sheet. ~13 per cemt of Gensol’s revenues came from related parties.
“Despite the checks, if you miss spotting red flags, perhaps the firm has forged documents, issued misstatements, falsified sales/profit numbers, evaded taxes, and/or used company funds for personal or family affairs – issues usually detected only in an investigation,” said Zerodha’s Varsity
