United Spirits chairman Vijay Mallya. Photo: Mint - Livemint

United Spirits chairman Vijay Mallya. Photo: Mint

Bengaluru/Mumbai: The spat between Diageo Plc-controlled United Spirits Ltd (USL) and the company's chairman Vijay Mallya raises questions about the roles of all the parties involved in the internal probe that found alleged financial irregularities and about the quality of Diageo's due diligence when it bought a controlling stake in United Spirits and later raised it.

The rift, which was made public on Saturday, also highlights a series of missteps by Diageo after it gained control at India's largest liquor maker. Since Diageo completed buying a 25.02% stake in United Spirits in July 2013, the Bengaluru-based company has paid nearly Rs.20 crore in compensation to chief financial officer (CFO) P.A. Murali, a company veteran known to be close to Mallya, and approved several related-party transactions with Mallya's UB Group, at least one of which is now under scrutiny. In 2013, Diageo named Murali as one of its nominees on the board of United Spirits. Last week, Murali resigned from the company ahead of the announcement of the findings of the internal probe. Two other board members appointed by Diageo had resigned when the investigation began in September.

"We do recognize that any due diligence exercise, even when properly carried out has its limitations, as not every issue arising on account of historical transactions can be identified," a Diageo spokesperson said in an emailed response to a query. "The matters which have come to light from the inquiry were not previously disclosed to Diageo—and they pre-date our transactions to invest in USL. These matters were brought to the attention of the United Spirits board as part of the finalization of the FY2014 accounts of United Spirits."

The probe that suggested fraud at United Spirits was conducted by accounting firm PwC, which was the company's auditor in at least one of the years when these activities took shape. PwC was United Spirits' auditor for more than five years until August 2011, and it gave a clean chit to United Spirits' accounts in these years.

While PwC and United Spirits did not respond to Mint's queries about the decision to appoint the auditing firm and whether it was related to PwC's previous auditing role at United Spirits, both companies also failed to respond to queries about how the probe was kept independent despite PwC's previous role.

"The report being referred to has been done by our forensics team for Diageo. We stand by the work done and believe it to be of the highest professional standards," PwC said in an emailed statement through a spokesperson.

The board of United Spirits on Saturday asked chairman Mallya to resign after an internal probe suggested the liquor baron may have been involved in financial irregularities at United Spirits. The probe was led by chief executive officer Anand Kripalu,
who was appointed last year
by Diageo, the majority shareholder in United Spirits. Mallya hit back saying the probe was "severely flawed" and declined to resign.

Soon after United Spirits finally reported its thrice-delayed fourth-quarter earnings in September, the company initiated an inquiry into its accounting practices as several cases of suspected financial impropriety surfaced. Among other issues, the internal inquiry looked at loans by United Spirits to UB Group entities that were used to prop up Kingfisher Airlines Ltd from 2010-2013.

United Spirits said the inquiry revealed the company may have understated the amount it was owed by United Breweries (Holdings) Ltd (UBHL), the parent company of the UB Group. United Spirits and UBHL entered an agreement in July 2013 when the companies agreed to convert all loans by United Spirits into a single loan deal of Rs.1,337 crore. United Spirits got this agreement cleared by shareholders in January, but the company is now suggesting the amount may be higher.

During the duration of the alleged financial irregularities at United Spirits, Mallya was the chairman and Murali CFO.

"It's a bit puzzling that United Spirits has approved this and other related-party transactions even after Diageo came in," said Prabal Basu Roy, ex-group CFO at Polaris and CEO of Diptish Investments and Fund Advisors. "It's hard to understand why they've taken so much time to find out about previous alleged irregularities, especially when the market knew for years that United Spirits was being used to fund Kingfisher."

In response to queries on why the United Spirits board approved some related-party transactions between the company and UBHL earlier this year, a United Spirits spokesperson said there was a legal requirement for the company to report "historical related-party transactions that would reasonably continue post-31 March 2015 for approval by shareholders at the first general meeting of shareholders held after 30 September 2014".

Regulatory troubles?

United Spirits said on Saturday that it would report the transactions covered under the probe to the authorities as required under applicable law. Diageo declined to comment on whether the US stock markets regulator, the Securities and Exchange Commission (SEC), would get involved.

Diageo, which is listed in the UK and the US, has run into regulatory trouble before. In 2011, the UK-based company paid more than $16 million to the SEC to settle charges that its employees paid bribes in India and two other Asian countries. That fine was related to bribery payments, not financial irregularities.

According to the United Spirits internal probe, the transactions involving alleged irregularities that took place between 2010 and July 2013, the month it finished buying a controlling 25.02% stake in United Spirits.

Whether the SEC or regulators in India and the UK will look at the alleged financial irregularities at United Spirits is unclear.

"Diageo is trying to clean up the books and break away from United Spirits' past and Murali's resignation and Mallya's potential removal are the final steps in this," said Shriram Subramanian, managing director of InGovern, a corporate governance research firm. "Diageo was obviously very eager to gain leadership position in India and over the longer-term, they may still see this as a price worth paying."

Battle ahead

United Spirits is now likely to approach shareholders to seek Mallya's removal from the board. The company's board also asked Diageo to review its shareholder agreement with Mallya's UB Group. According to this pact, Diageo agreed to support Mallya as non-executive director and chairman of United Spirits as long as the UB Group or Mallya hold at least 1% in United Spirits. The UB Group currently owns roughly 5% of United Spirits.

"When Diageo got to the skin of things, the company has realized several anomalies. And they asked the responsible people to quit. Mallya is just defending himself like any accused," said Arun Kejriwal, founder of Kejriwal Research and Investment Services Pvt. Ltd.

Mallya, no stranger to corporate battles, said he won't give up his board position. "The board of directors cannot oust me. Only shareholders can," Mallya told Mint on Sunday.

Will he take Diageo and United Spirits to court? "Why should I go to the court? I deal with the situations as they are supposed to be dealt with," Mallya replied.

United Spirits is also initiating "necessary internal proceedings in accordance with the applicable rules and policies of the company" against employees alleged to have been involved in transactions covered by the probe.

"There could be more such forced resignations coming," said a person familiar with the development, referring to the resignation of CFO Murali. This person declined to be named as he wasn't allowed to speak with reporters.

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