Paytm Payments Bank fallout: What regulatory and corporate governance red flags should investors watch for?

Paytm | CMP Rs 405 | Paytm stock fell 3.16 percent as 58.2 lakh shares or 0.92 percent of equity changed hands. According to CNBCTV18 report, 0.92 percent of equity worth Rs 241 crore changed hands at an average of Rs 414 per share.

On January 31, the Reserve Bank of India delivered a body blow to Vijay Shekhar Sharma’s Paytm Payments Bank, virtually halting the bank’s operations by imposing significant business restrictions. The immediate fallout was a sharp correction in the stock price of One97 Communications Ltd, which holds a 49% stake in the payments bank.

While the RBI’s major regulatory action against Paytm Payments Bank may have come as a bolt out of the blue for the over 1.1 million retail shareholders of the company, legal and markets experts cautioned that investors need to be mindful of such regulatory risks, especially when it comes to new-age technology companies, which operate in businesses where the regulators and regulations themselves are evolving to keep pace with changes in technology.

Do Not Miss | Paytm woes continue as stock falls 6%, a day after Rs 103 crore block deal

“As far as regulatory risk is concerned, investors should recognise that new-age tech companies operate in areas where regulations, too, are still evolving. For any new-age business, the risk of evolving regulations will always be a sword hanging over their heads,” said Pranav Haldea, Managing Director, Prime Database Group.

Investors should be fully cognisant of this risk while looking to invest in companies from new-age sectors, said Haldea.

Also Read | Tough times ahead for Paytm Payments Bank as RBI refuses to offer any concessions

Experts added that investors need to carefully screen a company’s corporate governance practices as a history of past violations and non-compliance with regulations can eventually lead to major regulatory action against it.

“Any pending investigation, notice of violation or failure to comply with statutory obligations and regulations would be a red flag for investors. As a pending investigation might affect the investor’s interest, it is important to ascertain the company’s compliance with statutory regulations from a corporate governance and regulatory risk perspective,” said Manmeet Kaur, partner at law firm Karanjawala & Co.

While the Paytm saga may appear sudden and shocking, experts feel that neither may be true.

“As an investor there were multiple signs and not just restricted to Paytm. Take what has unravelled at BharatPe, and Byjus and many others—it matters little that some of these are unlisted names. The hubris is similar. The pressure of the relentless quest to grow (and not just to justify ever-increasing valuations) does manifest itself in various ways. Systems not keeping pace, compliance mindset not being inculcated, cosy deals and revenue leakages (read Related Party Transactions) galore are some of these symptoms,” said Jayesh H, Co-founder, Juris Corp Advocates and Solicitors.

Must Read | Vijay Shekhar Sharma meets FM Sitharaman amid Paytm Payments Bank crisis: Sources

He highlighted that in the current case, the RBI had imposed sanctions on the company on more than one occasion previously.

“And in this country, you take KYC lightly at your peril. And if you add to that a not-too-serious attitude on AML (anti-money laundering), then you are marked, and when the action comes, it will be swift and sudden, and, as in the current case, it can be fatal,” he added.

Corporate governance red flags

Experts recommend that investors look for corporate governance red flags before they invest their hard-earned money in any stock. There are several standard governance checks that investors can start with in their due diligence, including looking at the promoter background, profile of the board of directors, auditors and related-party transactions.

“When it comes to corporate governance, the foremost thing investors should look at is the promoter of the company and his or her track record, what other companies he/she runs or has run in the past and if any economic offences have been committed in the past,” said Prime Database’s Haldea.

He added that investors should also look at the board’s composition, and the profile of the directors, especially the independent directors. “Who are the auditors of the company? That's another area investors should look at,” said Haldea.

To be sure, while experts say that having a good board and a top auditor is good, it is not a fail-safe, as has been seen in many high-profile cases in the past.

“Ultimately, good corporate governance is a function of the DNA of the promoter,” declared Haldea.