A news item in all the major
financial news papers on 27th November 2007 stated that the
Mumbai-based IT firm Hexaware Technologies’ earnings
for the current fiscal may take a dent, as it is expected to suffer a loss of
about $20-25 million (Rs 80-Rs100 crore) owing to “potentially fraudulent”
foreign exchange transactions conducted by a senior company official.
The ordinary reader may
be excused if he thinks that Hexagon must be engaged in investment banking
activities. On the other hand a risk officer in one of the investment banks would
be tempted to compare the episode to that of Barings Plc also known as ‘Queens Bank’. In fact the modus operandi appears to be the same,
even though on a smaller scale, in view of the fact that the official was
working for a technology company and the scope was limited.
The following is a brief account of
the incident as revealed by the company:
Ø
The unnamed official had committed the company to several forex
contracts involving ‘options’ during the last few months without proper
authority and had actively concealed these transactions from the company board.
The official was in the treasury department reporting to Chief Financial
Officer.
Ø
The
company also said it was suspending the official in this connection for
actively concealing these transactions and exercising unauthorized fiduciary
powers.
Ø
The company has discovered about 11 unauthorized forex deals
entered on the company’s behalf pertaining to currencies such as the dollar,
Euro, Pound Sterling, Yen and Swiss Francs. However, the company did not give
the total value of the contracts. Options contracts grant their buyers the
right to buy or sell a security at a set price by a given date.
Ø
The company now wants to soak up the losses in the current fiscal
year itself and hence it is looking at unwinding most of these options in the
current quarter. The company has set aside about $25 million to cover potential
losses.
Ø
The company has constituted a special committee to conduct an
internal investigation and suggest changes to the company’s foreign exchange
management practices. The committee is expected to come out with its findings
within 30 days.
Ø
The company has also placed an embargo on all options deals.
Further, it has decided that future forex deals will necessarily have to be
transacted jointly by two signatories out of the designated four from the top
management.
Ø
The company
has roped in consultant Jamal Mecklai to work with it on minimizing the negative
impact of these transactions. The company said as of now, no criminal
proceedings had been initiated against the employee who had conducted the
option transactions and actively concealed them.
Ø
As
per the chairman of the company, there is no need to get in to these structured
option deals. There is only need for a simple forward cover. In addition to the
special committee appointed to conduct an investigation into the transactions;
an internal task force dedicated to mitigating the impact of the forex option
transactions had also been constituted. One of the executive directors has been
relocated from the firm’s Chennai facility to its office in Mumbai to oversee
the matter on a full-time basis
Ø
According
to sources, a small private bank, at least two large foreign banks with
significant presence in India
This episode is an eye opener for all the technology companies as they are also equally vulnerable
to such acts by their officials unless suitable controls and reporting systems
are in place.
In this background it is necessary to
understand the present position regarding handling of foreign exchange
transactions by these technology companies.
·
There
was a time when dollar was at its peak as against Indian rupee. The going was
too good and even the exchange cover by way of swap was felt not necessary.
·
The
situation is totally reversed now. The companies have to not only hedge their
currency realizations; they have to look in to some innovations to cover the
exchange risk. With the rupee's unrelenting march against dollar continuing,
smart hedging has increasingly been taking the mindshare of finance heads of
Indian enterprises that service US customers.
·
According
to currency market sources, several companies, taking bets that euro and yen
will slip against dollar, have struck derivatives deals to cut cost and prop up
revenue without assessing the hidden exchange risks. They said more such hits
from option deals are feared in the coming days. Some of the companies will,
however, find a way to absorb the losses and keep the development out of public
domain.
·
In
addition to traditional options, enterprises are increasingly strategizing
innovative and smart ways and means to offset the risk of forex conversion on
profitability. Multi-currency options, insisting customers to pay in euro or
even including a forex eventuality clause in contracts are some of the
innovative options that are thought about.
·
One
particular company has stated that forward contracts accounts for 75% of their
hedge while more riskier option contract is only 25%. Another option is to
create a dollar payable loan thereby creating a reverse exposure. Even an
attempt is said to be being made to enter in to rupee denomination contracts.
But many customers may not oblige as it is about moving the currency risk to
their side.
The
Issues:
Role of Banks:
§
The
company has not revealed the names of the bankers involved. Obviously the
intention is to retain their good will. But definitely the company has a good
case against them.
§
Whether
the company is aware or not the banks are liable for their actions if they have
not taken due care to ensure that the necessary legal formalities are completed
before any facility is made available.
§
The
facilities like forward exchange cover and options are contracts entered into
between the banks and the customer companies undertaking delivery of foreign
currencies on a future date at the agreed rates. In case of options there is
the provision to either complete or reject the transaction on due dates; but at
a cost already fixed.
§
Bankers
treat all such contracts as contingent liabilities. The facilities are made
available within certain limits assessed basing on the needs, the soundness and
past dealings of the companies.
§
Bankers
always insist on the company to pass a suitable resolution by the board of
directors authorizing specified directors to avail the facility and to execute
the necessary documents. It should be noted here that such powers cannot be
delegated down the line by the concerned directors. Such action would be ultra vires the company.
§
Even
though there are specific sanctioned limits bankers are not expected to make
available these facilities as a routine. It is incumbent upon them to ensure
that the facility is not used for speculative purposes. They should also ensure
that the requisite documents and applications are signed by the authorized
signatories only. Any attempt to avail the facilities without following the
usual formalities should be immediately brought to the notice of the top
management. Wherever joint signatories are involved it is essential to ensure
both the signatures.
§
Any
transaction which appears to be beyond the normal business of the company
should be brought to the notice of the top management.
Viewed in the above
back ground the company’s situation can be analyzed as follows:
v
The
company’s internal controls and reporting systems were not in place.
v
The
company’s policy does not permit these kinds of deals at all. Only a simple
forward cover is permitted. The CFO should have ensured that the official
concerned was working within this policy.
v
The
official in charge of banking transactions could act independently.
v
The
Chief Financial Officer to whom the above official was reporting was not aware
of the goings on in the major functions of his portfolio. He should have
ensured that the official concerned was working within the company policy only.
v
The
news reports mention the transactions as “potentially fraudulent”. It is not
clear as to what motivated the official to commit such fraud. On the face of
it, unlike in banks and other financial institutions, such fraudulent
transactions cannot result in any monetary benefit to the officer concerned in
a technology company.
v
It
is very much possible that entering into such contracts in the past might have
benefited the company substantially. As a result the official might have been
given a free hand by the CFO to continue with such practice. Now that the
transactions have resulted in losses he may be feigning ignorance! However he
is accountable on both the counts!
The
following preventive actions are suggested (For Technology companies in
general):
The company should have a foreign
exchange policy in place. It is advisable to permit only simple forward cover.
There is no necessity to permit exotic forex structured options deals. A
technology company is not expected to have expertise in this area; neither is
it desirable. The official in charge should take
prior consent from the CFO for each individual deals. A simple office note system followed by banks may
be put in place. A periodical report may be placed
before the Managing Director covering all such transactions for his perusal. The board resolution covering the
banking transactions should provide that the deal application to banks should
invariably signed by two officials, one being the Chief financial Officer
himself. Bankers should be given clear
instructions that all important documents will have joint signatures and no
deviation is to be allowed. Internal auditors may be advised to
verify and confirm that all the banking transactions are strictly as per
company policy. Also that no transactions are taking place without the due
concurrence of the CFO.
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