'Friend or Foe?' Cautions CFA Institute on Related-Party Transactions

"The Satyam fraud case illustrates that where there is little separation of ownership and control, minority shareholders need to voice their opinion or run the risk of having their rights significantly compromised," said Lee Kha Loon, CFA, Asia Pacific head of the CFA Institute Centre for Financial Market Integrity, with the release of its study titled "Related-Party Transactions: Cautionary Tales for Investors in Asia".

The recent Satyam scandal in India, which ended with the resignation of the chairman after admitting to fraud and falsifying accounts, started to unravel after the chairman tried to pass an abusive related-party transaction as a deal that would "deliver greater shareholder value." Satyam did not take the proposal to buy the two related companies in question to shareholders, but rather the deals were unanimously approved by the board of directors which consisted of nine members, six of which were supposedly independent. Investors, not having a say in the deals, punished the stock after the announcement and the company withdrew the deals.

The Related-Party Transactions study highlights the prevalence of related-party transactions in the region and shows how they can affect the interests of minority shareholders. Focusing on Hong Kong, mainland China and South Korea, the study discusses the nature and motivation of these transactions which vary according to different ownership structures. Using cases as examples, the study identifies circumstances where related-party transactions have compromised minority shareholders, and explores the effectiveness of current regulations aimed at protecting shareholders’ interests. The study also proposes ways to better protect shareholders from abusive related-party transactions.

"Related-party transactions can serve legitimate, practical purposes as long as they are done on an 'arms-length' basis. However in Asia, corporate custom and structures can often result in related-party transactions that are significantly conflicted and that negatively impact unwitting investors," said Lee. "Connected transactions in Asia and elsewhere have been known as a common tool by which a controlling shareholder can expropriate wealth from minority investors," added New York-based Kurt Schacht, CFA, managing director of the CFA Institute Centre, which advocates fair and efficient capital markets for investors globally.