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THEIR FAILINGS, OUR LEARNINGS

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THE FABRIC OF GOVERNANCE

Context: When a large listed textiles Company produces and sells material that does not conform to the description of the product, there will almost certainly be an adverse impact on the financials and the reputation. The importance of quality control cannot be overstated.

  • A listed textiles Company had certification for their bedsheets being made with 100% Egyptian cotton. In August 2016, an investigation by the second large retailer, by value, in the US, revealed that the bedsheets did not contain Egyptian cotton, as mentioned, but was an amalgamation of lower quality fibres. The retailer wrote to its customers blaming the Company, and offering refund for their purchases. It also terminated business ties with the Company, which amounted to approx. 10% of the Company’s overall business.
  • The Company’s other big accounts in the US also initiated a similar probe, and threatened to stop selling its products.
  • 0n August 20, 2016, the Company filed a statement with the Stock Exchanges calling the issue a “product specification issue”. It stated that it was appointing an external auditor, one of the big 4 firms, to audit the supply systems and processes. It was reported by media that the firm was to give its report in 6-8 weeks.
  • On August 22, 2016, the Company held a conference call with analysts, wherein the Managing Director stated that he took responsibility for what happened, without stating what went wrong. He also mentioned that it was an issue of fibre, and not quality, and that the Company would continue to ship its other products to its customers. He also mentioned the appointment of the audit firm. He however refused to comment on what led to the retailer initiating an enquiry in the first place.
  • In September, 2016, the Company informed the Stock Exchanges that the affected product represented 6% of its annual business.
  • In September, 2016, through a Stock Exchange filing, the Company informed that 2 putative class-action complaints had been filed in the US against the Company, and its US subsidiary. The central allegation in both the complaints was that the product was not 100% Egyptian cotton, as was claimed. They did not challenge the safety or fitness of the product. Both complaints allege that the amount in controversy exceeded $5 million. However, neither complaints sought a specified amount of damage or provided a methodology for determining damages.
  • It further stated that none of the action had been certified for class treatment by the relevant courts, which is required under US law before an action can proceed on a class basis, and no motion to obtain such certifications had been initiated.
  • The Company mentioned that since these cases were only in the preliminary stages, they did not know whether they would be permitted as class actions, and so could not determine whether they were material. The Company engaged 2 law firms, one in the US, to defend the matter, and one in India, as its legal adviser.
  • The big 4 audit firm suggested several remedial measures covering structural, procedural, people and technological measures, on which the Company began action. It increased third party assurances, vendor audit etc. The Company also started producing all Egyptian cotton products in-house.
  • In the Annual Report for FY 2016-17, the statutory auditors, one of the big 4 audit firms, in the auditor’s report, under “Emphasis of Matter” mentioned that “four putative class action suits were filed in USA against the Company and its subsidiary by some consumers who purchased the products manufactured by the Company. In December 2016, these putative class actions suits were consolidated in one of the courts in USA and it is proceeding as a single putative class action. A consolidated amended complaint was filed for the action during the quarter ended March 31, 2017 and, pursuant to stipulation of the parties and the court’s scheduling order, the parties have agreed to conduct mediation in a time-bound manner.”
  • The Board did not respond to this in its report, and stated that the auditor’s report was self-explanatory and therefore do not call for any comment.
  • In the Annual Report for FY 2017-18, the statutory auditor, another big 4 audit firm, since the earlier one had been mandatorily rotated out, stated under “Emphasis of Matter” that “four putative class action suits filed in USA against the Company and its subsidiary by certain consumers were consolidated in one of the courts during the quarter ended December 31, 2016 and are proceeding as a single putative class action. The court proceedings are in a preliminary stage and it cannot be determined at present whether the consolidated putative class action suit will be permitted to proceed as a class action and therefore the monetary impact, if any, of the final outcome of the law suit is currently un-ascertainable.”
  • On May 24, 2019, the Company informed the Stock Exchanges about the consolidated putative class action suits (consolidated during the quarter that ended December 31, 2016). To avoid the burden, cost and uncertainty of continued litigation in US, the Board had approved entering into a settlement agreement, which provides monetary payments to settlement not to exceed $36 million. This was subject to approval by appropriate courts and Regulators in the US.
  • In the Annual Report for FY 2018-19, the statutory auditor, in addition to mentioning what was stated by the Company on May 24, 2019, said that “The Exceptional Item, aggregating to INR 2,080.24 million and INR Nil for the year ended March 31, 2019 and March 31, 2018 respectively, represents a provision for the settlement costs that have been estimated by the management based on expert advice which includes monetary payments or vouchers for all class members in the US who submit claims subject to validation by an independent third party, fees payable to legal counsel, and costs related to the administration of the settlement. The settlement agreement is subject to approval by the appropriate courts in the United States and regulators, and is intended to resolve legal claims”.
  • The Board did not comment on this in its report, stating that the auditor’s comments were self-explanatory.
  • On July 3, 2019, the Company informed the Stock Exchanges that it had received preliminary court approval for its settlement agreement. The plaintiffs in other pending litigations involving these issues had also agreed not to object to the settlement agreement and suspend litigation pending the settlement agreement’s final approval. The Company had agreed to increase payouts to individual settlement class members without increasing the aggregate $36 million settlement cap. The provision already made by the Company during quarter ended March 31, 2019 remained unchanged and adequate.
  • On October 29, 2019, the Company informed the Stock Exchanges that it had received a final approval for its settlement agreement. The provision made by the Company based on expert advice during the quarter ended March 31, 2019 remained unchanged and was adequate.
  • In the annual report for FY 2019-20, in the Management Discussion and Analysis (MDA), the Company stated that “The Company has settled the class action claims during the year which came to a closure now”.

Points to ponder –

  • When this matter first came to notice, could the Board have done anything more to contain reputational risk?
  • How does one satisfy oneself regarding the adequacy of checks and balances?