Smoke-Rings Unlimited

THINGS are not going right for ITC chairman Y.C. Deveshwar. Just when he appeared to have won the battle of attrition against its British parent BAT, with the latter reportedly agreeing to have its brands in India manufactured by ITC, comes the showcause notice from the Enforcement Directorate (ED) for the alleged FERA violation of $110 million (Rs 400 crore). This is the newest development in the largest FERA case in Indian business history, which began last October with the ED making a series of raids and arrests, including of two former ITC chairmen and several past and present directors.

While the notice was not unexpected—it was bound to be issued at some point of time—what has come as a bombshell is that for the first time in Indian corporate history, non-executive directors, including nominees of financial institutions (FIs) and BAT, have also been served notices along with Deveshwar and the executive directors as well as three former directors. The ED claims that, under Section 68(1) and (2) of FERA, it has the right to prosecute any person who connived or consented to a FERA violation, and also if his negligence caused or assisted in the violation by others.

So Who Wins? The showcause notices suddenly make it appear as if there can be no winners in this sordid affair. When the scam broke, there had been considerable suspicion that BAT had pressured the government into the ITC raids as part of its strategy to take control of the company. If that is true, BAT now finds two of its nominees on the ITC board—Norman Davis and Richard Pilbeam—also named in the ED notice.

Deveshwar was the one ITC top executive who had apparently come out of the scam without being accused of any misdeeds. Over the last eight months, he had raised morale, put the company back on track and established peace with BAT. But the notice drags him back into murky waters.

When the scam broke, fingers were pointed at the FI nominees on the ITC board: if the violations had been on for nearly a decade, shouldn't they have got wind of it? But never before in Indian corporate history have non-executive directors been charged by enforcement authorities for a company's wrongdoings. The ITC show-cause notice now sets a clear precedent.

And while the chargesheeted FI directors and some non-executive directors of other companies are indignant at the ED's unprecedented decision, others laud it as a bold step. There is investor suspicion that most non-executive directors in India are mere appendages happy to sign unquestioningly on the dotted line approving the way the company is being run and thereafter collecting their fees and annual gifts after enjoying the company's hospitality. What bothers business circles is that while the ED shows such zeal in pursuing ITC, Manu Chhabria of Shaw Wallace continues to cock a snook at the department from Dubai.

The Financial Implications:The ED is empowered to impose a fine up to five times the FERA violation, thus ITC's liability could be as much as $550 million (Rs 2,000 crore). This is on top of the excise claim of Rs 804 crore, of which the company has already deposited Rs 350 crore pending the hearing of its appeal.

Deveshwar is tight-lipped about the showcause notice. But company insiders say these claims will by no means break the Rs 5,960-crore company or erode future profitability. They say the ED chargesheet will be time-consuming and difficult to prove. However, the dredging up of the slime of its dealings with its erstwhile foreign partners, the Chitalias, is bound to smear ITC's image just when it was acquiring a new sheen. Also, if the New Jersey court currently hearing the Chitalia petition against ITC rules in the latter's favour, the ED showcause will lose some of its sting. This judgment is expected any time now. Also, even if the ED adjudicator eventually finds ITC guilty, it is unlikely to impose the maximum fine and the company will probably be allowed to pay up in a phased manner. Asking ITC to pay up the full amount in one go will be an act of stupidity: it'll kill off the highest private sector excise duty payer in the country.

What About BAT? It has agreed to allow ITC to manufacture its brands under licence against a royalty of 5 per cent of net sales per annum. While the agreement awaits government approval, sources say ITC is bargaining to reduce the royalty to 3 per cent. This may mark a new detente between ITC and BAT, for BAT's original plan was to launch its brands through a new joint venture company. BAT's back -ing off on this is partly a fallout of the recent $368 billion US tobacco settlement. This has saddled BAT's US subsidiary Brown & Williamson, which has a 16.5 per cent share of the US market, with sharply reduced profits. BAT is thus keen to start operating as soon as possible in the lucrative Indian market. Indeed, the US settlement could force BAT's global rivals Philip Morris and R.J. Reynolds to look for new markets (read India). BAT wants to be off and running before that happens.

But observers are still not convinced that BAT has given up its attempts to get management control of ITC, although the company denies any such intentions. Over the last couple of years, FIs have acquired around 10 per cent of ITC stocks and, according to stockmarket grapevine, they have been buying on behalf of BAT. So BAT could effectively be holding 44 per cent of ITC equity. Cynics also don't discount the possibility of BAT launching some brands through the Hyderabad-based VST in which BAT has management control. Until the licensing arrangement between BAT and ITC is sealed, BAT could always steer a different course.

Meanwhile, ITC is going ahead with its gameplan of concentrating on core competencies of cigarettes, tobacco, hotels and paper, and either closing or hiving off the rest of its businesses. It has decided not to pour in funds to resurrect its Singapore-based subsidiary, ITC Global, and is hiving off 51.4 per cent of ITC Agro-Tech to US food major Conagra. ITC Agro-Tech will seek shareholders' approval of the proposal at its annual general meeting on August 8.

So, after a six-month lull, Virginia House could again be moving towards a good deal of action.