Friday, 19 January 2018

 Hey Siri! Is the management ethical?

There are many questions that Siri cannot answer. This is just one of them. 
Whether the management is ethical and works as a trustee for shareholders can be answered by the shareholders themselves - and only them. Nobody else.

I read up on the business of Intellect Design Arena. I also studied the management of the company, or more specifically the man behind Intellect Design Arena: Arun Jain. While reading about him on some discussion forums- I read that there are doubts about his integrity and him not clearing the Buffett’s newspaper test. 

I decided to look into the concerns. The first concern and the strongest one which I came across was about Arun Jain being banned by SEBI for 2 years on insider trading charges. This has been a serious concern amongst a lot of people. Let’s see what SEBI has written in its order. The order can be found here.

The issues which SEBI has raised are:

1.     Price sensitive information (unpublished) was known to the Promoter Group
2.   On the basis of that information, the promoter group sold 15,080 shares of the company and pocketed gains of INR 27.26 lakh
The replies which the Promoter Group (Arun Jain & Others) gave were:

1.     Out of 15,000,000 shares held by the promoter group, only 15,080 shares were sold
2.     Money was required to buy a plot of land in Gurgaon
3.     Promoters have already paid INR 700,000 to settle case under the consent mechanism of SEBI. SEBI has however re-opened the case.
Consent mechanism is a legal process to settle cases without admission or denial of the alleged irregularity. The intent is to put an end to the litigation and move on in life.

The questions I would ask myself as an investor are:

1.     If the promoters really wanted to benefit from price sensitive information, would they sell only 15,080 shares? Why not more? (Magnitude)

15,080 shares are just 0.1% of the total quantity of 15,000,000 held by the promoters. The charge of dealing in 15,080 shares - to my mind is like a speeding ticket. The speed limit at a highway may be 60 miles/hour and you just happen to accidentally drive at 65 miles/hour. Surely, it’s a mistake. But it’s unlike driving at 100 miles/hour and that too drunk.
So, I consider the magnitude to be quite important in the overall scheme of things. Magnitude helps us to be sure about the intent. If Mr. Jain had a bad intent, he would have sold many more shares that the promoter group held.

2.     Assume for a moment that Arun Jain is not trustworthy. Did I find any other instance where he showed the tendency to behave unethically? (Repeat Behaviour)

Usually- unethical people find it difficult to control their temptation (like everybody else). They do it more than once.
So, if Arun Jain is unethical – is there any other instance of him playing close to the line? I did not find any instance. Hence, my answer is No.
Instead I found quite a few instances which speak highly of him.

3.     What has been the track record of investigations done and orders passed by SEBI? (Credibility of the Source)

Please find here a research paper written by Ms Dharmistha Raval, Ex- ED of SEBI and Ex- Professor (Indira Gandhi Institute of Developmental Research). She did an analysis of the regulatory processes at SEBI. Kindly see page 20 and 21.

A total of 1309 orders pronounced by SEBI and later heard by SAT during 1998-2009 were analysed for the study. Out of 1309 orders, 237 fell under the “Others” category which means that those cases were not heard on the basis of merit. Leaving them out, leaves us with 1072 cases. Out of these, a total of 427 appeals were lost by SEBI. That is in ~40% cases, SEBI lost the appeal when its order was challenged in SAT.

I respect SEBI but it will be incorrect to base my thesis on something which stands scrutiny only 60% of the time.

4.     Opinions of others? (Wisdom of the Crowd)

About others' opinions, I think it is a matter of perception. It’s more like the 'Red Indians- collecting-wood' story. Since, everybody thinks Arun Jain is doubtful, everybody else also, thinks he is doubtful. This is a circular argument and lacks stamina.

Combining the above 4 reasons, in my view the allegations of insider trading against Arun Jain do not hold water.

The second concern was about Arun Jain getting arrested in Indonesia in 2001. Reading about the case- it is found that Polaris Software was executing a project for a client- Bank Artha Graha. There was some commercial dispute and Arun Jain travelled to Indonesia to meet the client and resolve the issue. Dispute could not be resolved and the client ordered the police to arrest him. It is said that Bank Artha Graha was owned by the Indonesian Army Foundation and the generals decided to take matter in their hands- literally.
I don’t think there is much to read in that. It was a commercial dispute and should have been solved in the appropriate way. It was just bad luck for Arun Jain. He happened to be in the wrong place at the wrong time.

I will now put across circumstantial evidence why I think the promoter of Intellect Design Arena is clean.

1.     Arun Jain was earlier the MD of Polaris Software (sold to Virtusa). He did not draw any salary from Polaris Software since August 2010. Now, he does not draw any salary from Intellect Design Arena. In one of the interviews, he mentioned that since he is a promoter shareholder of the company, he doesn’t need any salary. He will create wealth alongside other shareholders.

Excerpts from the respective annual reports :

(Source: Polaris Software Lab. Annual Report 2010-11)

(Source: Intellect Design Arena Limited. Annual Report 2016-17)

His last drawn full year’s salary from Polaris Software during FY 2009-10 was around 1.5 cr.
It’s difficult to accept that somebody will forego 1.5 cr every year (without counting any increase in salary) which rightfully belongs to him and play around with insider trading rules for a meagre gain of 27 lakh.

2.     Intellect has won marquee deals from RBI, LIC and Govt e Marketplace. Given that RBI has stringent checks and balances in place, I would assign high weight to the quality of management which is selected by RBI to implements its core banking system.

Overall, I feel that Arun Jain is clean and quite ethical. I would love to read your views even if they are contradictory to what I have stated. But please substantiate it with data because :

It’s a capital mistake to theorize without data ~ Sherlock Holmes.

This is not a stock recommendation. This post is for discussion purposes only. My clients and me may be holding position in the stock.


yogendra Khare said...

Pretty good research. I like your approach and thought process.

ravi said...

Great Article Ankur, thanks for sharing this, provides lots of insights on how to interpret and deep dive into such situations.

Swapnil Mane said...

I have seen people terminated from their jobs for a fake bill of 300rs. I think the intent is more important than the magnitude.

KAMAL GARG said...

I agree with the thesis that Arun Jain cannot be counted as an offender. His misdeeds were rather casual in nature like breaking the speed limit and that too once only.

Ankur Jain said...

I agree with you, Swapnil. Intent is more important than magnitude. But only when we can judge the intent beyond doubt.

My point is- when we can't establish intent without doubt- we should look at circumstantial evidence of which magnitude is just one of the parameters. And we should not jump at quick conclusions and colour a genuine mistake with that of a fraud.

Hemant Bhatia said...

Thank you for clearing many doubts.

Kinshuk Chandra said...

Hi Ankur,
Thanks for such a wonderful post. It helps me learn how to judge the management in an unbiased way. Can you please tell me what is this story - "Red Indians- collecting-wood"? Is this story the one -

Thanks :)

Ankur Jain said...

Thanks Kinshuk! This is the same story.