Corporate Case

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This Blog is written by Ridhima Mehrotra from Symbiosis Law School, Noida. Edited by Saumya Tripathi.

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INTRODUCTION

In October, 2019 a class action suit was filed in the United States District Court against Infosys, its CEO Salil Parekh and CFO Nilanjan Roy on behalf of persons and entities who bought company’s traded securities between July 7, 2018 and October 20, 2019 alleging for claims for the violations of the US Federal Securities laws. The firm also said in a statement that the company had violated Section 10(b) and Section 20(a) of The Securities Exchange Act, 1934 as well as the Rule 10b-5 under Security Exchange Board. The U.S – based shareholder rights litigation also alleged that the company prepared financial statements which were misleading and false and also involving in “unethical practices” which includes boosting the company’s revenue after the whistleblower complaints of the company were surfaced.

On October 21, 2019 a whistleblower complaint was filed against the senior executives of the company alleging them for “unethical practices” for boosting the profits as well as short term revenues. The letter stated that the employees were told not to recognize various costs in the financial statements such as VISA expense so as to increase the profits of the company. The complaint also alleged that the company bypassed appropriate review as well as approval processes on many large dealings of the company which had negligible margins. The auditors as well as the Board members were unaware of such deals as the company suppressed the information of the same. Revenue and cost recognition of the large deals did not adhere to the accounting standards to improve the near- term profitability. The whistleblower also alleged that the CEO and CFO had put pressure to boost other income by taking risks to help improve near-time profitability.  The whistleblower also sent a complaint to the US Securities and Exchange Commission exposing the company’s unethical practices. [1]

PROVISIONS VIOLATED BY INFOSYS

Section 10(b) of Securities Exchange Act,1934

This section states that it was unlawful for any person to employ manipulative or deceptive conduct in connection with purchase or sale of any security registered on a national securities exchange or any security not so registered, or any security based swap agreement. [2]

Section 20(c) of Securities Exchange Act, 1934

The section deals with the liability of controlling persons and persons who aid and abet violations. The clause (c) states that it is unlawful to file any report, document or information by any director for any director or officer of, or any owner of any securities to delay, hinder or obstruct the filing and making of any such document, report or information. [3]

Rule 10b-5 under Securities Exchange Act, 1934

Rule 10b-5 promulgated under the Securities and Exchange Act of 1934 prohibits manipulative and deceptive practices such as material misrepresentations, omissions in buying or selling of securities.

The rule states that is unlawful for any person, directly or indirectly to employ a device, scheme or artifice to fraud by use of any means or instrumentality of interstate commerce or of the mails or of any national securities exchange. The rule also states to prepare an untrue statement of material fact or omits to state the material fact which is necessary for the making of the statement. It also prohibits to engage in any act, practice or course of operation to deceit or fraud upon any person in connection with the purchase or sale of security. [4]

INFOSYS SHARES SUFFERED STRONG DRUBBING AS US LAW FIRM FILES CLASS-ACTION SUIT

The whistleblower complaints had a great impact on the share price of Infosys. The Market capitalization of Infosys on Bombay Stock Exchange (BSE) fell to Rs. 2,81,883 crore compared to the previous close of Rs. 3,26,939 crore. Infosys investors lost Rs. 45,056 crore of their wealth due to negative sentiment surrounding the stock. The Infosys stock fall up to 16% on both NIFTY and Sensex. The IT share feel 16% to Rs. 645 on National Stock Exchange (NSE) and it fell 16% intra day to Rs. 649.35 on BSE. The large cap stock only saw sell orders and no buy orders on BSE and NSE making the Infosys shares suffer worst fall in 6 years. Even the American Depository Receipts (ADRs) listed on the New York Stock Exchange (NASDAQ) fell over 15 percent. [5]

The lawsuit which came amidst the whistleblower complaints written by an anonymous group of employees made matters worse for the tech services major. When the law firm’s website about the lawsuit, Infosys stock fell 3.58% intraday to the low of Rs. 695 against the previous closing value of Rs. 720.80.

ANALYSIS

When a whistleblower goes to a firm’s board and causes the SEC and other regulatory entities to investigate claims, it is a serious issue. Infosys is responding to this situation seriously, in a principled and transparent way. The CEO and CFO recused themselves. The firm appropriately brought in outside counsel to investigate the accounting claim.

There is no clarification as to what is the validity as well as the seriousness of the whistleblower’s complaint as well as class action lawsuit. It could be that Infosys is inappropriately using accounting treatments, but it’s just as likely that there is just a disagreement as to the accounting treatments of the firm’s large deals. It’s not surprising that there is internal consternation that might lead to the whistleblower’s claim, as hot debates are typical when companies wrestle through the appropriate accounting mechanism for large deals.

Here is my analysis as to what can be the consequences of these complaints and lawsuits on Infosys stakeholders.

IMPACT ON CUSTOMERS– It can be analyzed that the customers of Infosys will have little or no short-run impact of the situation on them. Existing customers have a long history of good service from Infosys. Whatever the results of this inquiry, Infosys’ service won’t change. I don’t see any material change in the posture that customers have toward Infosys in existing accounts, nor do I anticipate change would happen because of any potential outcome of this investigation. If your company is an Infosys customer, basically this whistleblower situation means very little to you. You have had good service from Infosys and will continue to get good service. Under any

conceivable scenario, Infosys will be a well-financed, strong firm with a strong set of offerings and will be a strong partner for digital transformation.

IMPACT ON SHAREHOLDERS– Regarding the Infosys shareholders, it can be analyzed that there might be no change in the position of long-term position of Infosys. Under any circumstances, it will remain a well-positioned, competitive firm driving strong margins and good growth. The big Infosys investors will have no impact of this situation and will not impair or change the fundamental position of Infosys and its competitive strength. The firm likely will continue in its current trajectory but small investors can have a huge loss of this situation.

Secondly, it can be analyzed that the whistleblower group of Infosys thought it fit to send the voice recordings and evidences to the U.S Department of Labor’s Whistleblower Protection Program, rather than to the company itself, claiming that its identity would be revealed.  Therefore, it can be said that the protection of whistleblowers in India is not as effective as that in US where a separate entity takes care of such incidences. The Companies Act., 2013 makes it mandatory for entities listed on the stock exchanges to set up an audit committee to investigate whistleblower complaints. It also provides safeguards against their victimization, but does not provide a mechanism to protect them. The safeguards are entirely dependent on the policies drafted by the companies themselves whereas in US the office of the Whistleblower Protection Program enforces protections for employees who suffer retaliation for engaging in protected activities under more than 20 federal laws.

CONCLUSION

The company Infosys gave clarifications in relation to certain media reports on whistleblower complaints. [6] The class action suit was also dismissed by the plaintiff without any prejudice on May 21,2020 and the same was informed to the public by the company on the BSE site through corporate announcement.[7] After the dismissal of the lawsuit the shares of the Infosys Ltd gained as much as 2.34 percent to Rs. 687.95 The audit committee also found no evidence of financial impropriety or executive misconduct and gave a clean chit to CEO Salil Parekh and CFO Nilanjan Roy who were accused by anonymous whistleblowers. The company also got a clean chit from Security Exchanges Commission (SEC) in the whistleblower case and the company also released a detailed report on the outcome of its audit committee investigation.

REFERENCES

[1] https://www.cnbctv18.com/information-technology/infosys-whistleblower-complaint-read-the-full-text-of-the-letter-to-the-board-and-us-sec-against-ceo-cfo-4569181.htm

[2] Sec 10(b), Securities Exchange Act, 1934.

[3] Sec. 20 (c), Securities Exchange Act, 1934.

[4] Rule 10b-5, Securities and Exchange Act, 1934.

[5] https://www.nasdaq.com/articles/u.s.-sec-investigates-indias-infosys-on-whistleblower-complaints-2019-10-24.

[6] https://www.bseindia.com/xml-data/corpfiling/AttachHis/8f6c497a-273d-4e16-bc1b-97a14dbbab41.pdf.

[7] https://www.bseindia.com/corporates/anndet_new.aspx?newsid=0747b23b-c4b7-4f86-a4ac-30848b00e5dc.