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Improving transparency in related party transactions Companies enter into related party transactions mainly for two reasons--they cannot be avoided in an economy such as ours, and they are extremely convenient. Family-run businesses are common in India, and it is natural that there will transactions between the parties. For a private limited company that does not need to have an audit committee, related party transactions are very convenient since no approvals are required, and financial emergencies can be resolved in a matter of minutes. Even companies that need to run their related party transactions through an audit committee for their approval, find it convenient to get an omnibus approval for the financial year. Yet, the sheer convenience of related party transactions is also its major shortcoming. Wikipedia lists about 100-odd companies under the category accounting scandals a majority of them would have had transactions with related parties that resulted in the accounting scandal. From Enron toSatyam and Luckin Coffee to Gensol Engineering, related party transactions were the main cause of accounting scandals. Luckin Coffee, once hailed as China s answer to Starbucks, became infamous for a major accounting scandal in 2020 involving fabricated sales and questionable related party transactions. Many of these fake transactions were routed through related parties, including suppliers and business affiliates with ties to company executives. Investigations revealed that Luckin used these entities to create the illusion of a booming business, overstating revenues and inflating operating metrics. Payments were allegedly recycled through related companies, making them appear as legitimate third-party sales. Surge in valuation This manipulation misled investors and regulators, leading to a dramatic surge in the company s valuation prior to the scandal. The consequences were swift: the company s shares plummeted, it was de-listed from the NASDAQ, and multiple executives were fired. Chinese regulators fined Luckin over $8.98 million, while the US SEC imposed a $180 million penalty for securities fraud. The Luckin Coffee case highlights the severe risks associated with inadequate disclosure and governance of related party transactions, especially in high-growth companies under pressure to meet aggressive financial targets. Since it would be foolhardy to ban related party transactions, regulators have mandated proper identification, adequate disclosure and transactions at arm s length. For listed companies, the Securities and Exchange Board of India (SEBI) has been updating its disclosure requirements for related party transactions at frequent intervals. For listed entities, a new set of requirements kick in from September 1. The framework categorises related party transactions by size and type, triggering varied disclosure levels. Material transactions have been defined to be those exceeding Rs.1,000 crore or 10 per cent of consolidated turnover (whichever is lower), or 5 per cent of turnover in royalty/brand deals. These require audit committee and shareholder approval, with comprehensive disclosures. Promoter-related transactions (non-material but promoter-linked) have been defined to be those exceeding lower of 2 per cent of turnover, 2 per cent of net worth, or 5 per cent of average PAT. These transactions require audit committee approval, comprehensive disclosures. Residual transactions are those that are less than Rs.1 crore per year-- these require limited and minimum disclosures. The disclosures vary-- minimum, limited, or comprehensive-- reflecting the transaction s quantum, nature and stakeholder involvement. Shareholder notices for material RPTs must include the commentary of the audit committee, valuations, bid comparisons (especially royalty), and QR-code access. By anchoring disclosure tiers to clear monetary cut-offs, SEBI ensures transparency, yet without imposing a one-size-fits-all burden. The disclosure norms may encourage companies to comply and not connive. However, if another big incident takes place involving RPTs, regulators will be forced to act differently, which could include surprise audits of RPTs. www.thehindubusinessline.com, dt. 04-07-2025

Improving transparency in related party transactions

Companies enter into related party transactions mainly for two reasons--they cannot be avoided in an economy such as ours, and they are extremely convenient. Family-run businesses are common in India, and it is natural that there will transactions between the parties. For a private limited company that does not need to have an audit committee, related party transactions are very convenient since no approvals are required, and financial emergencies can be resolved in a matter of minutes. Even companies that need to run their related party transactions through an audit committee for their approval, find it convenient to get an omnibus approval for the financial year.

Yet, the sheer convenience of related party transactions is also its major shortcoming. Wikipedia lists about 100-odd companies under the category accounting scandals a majority of them would have had transactions with related parties that resulted in the accounting scandal. From Enron toSatyam and Luckin Coffee to Gensol Engineering, related party transactions were the main cause of accounting scandals.

Luckin Coffee, once hailed as China s answer to Starbucks, became infamous for a major accounting scandal in 2020 involving fabricated sales and questionable related party transactions. Many of these fake transactions were routed through related parties, including suppliers and business affiliates with ties to company executives. Investigations revealed that Luckin used these entities to create the illusion of a booming business, overstating revenues and inflating operating metrics. Payments were allegedly recycled through related companies, making them appear as legitimate third-party sales.

Surge in valuation

This manipulation misled investors and regulators, leading to a dramatic surge in the company s valuation prior to the scandal. The consequences were swift: the company s shares plummeted, it was de-listed from the NASDAQ, and multiple executives were fired. Chinese regulators fined Luckin over $8.98 million, while the US SEC imposed a $180 million penalty for securities fraud. The Luckin Coffee case highlights the severe risks associated with inadequate disclosure and governance of related party transactions, especially in high-growth companies under pressure to meet aggressive financial targets.

Since it would be foolhardy to ban related party transactions, regulators have mandated proper identification, adequate disclosure and transactions at arm s length. For listed companies, the Securities and Exchange Board of India (SEBI) has been updating its disclosure requirements for related party transactions at frequent intervals. For listed entities, a new set of requirements kick in from September 1. The framework categorises related party transactions by size and type, triggering varied disclosure levels.

Material transactions have been defined to be those exceeding Rs.1,000 crore or 10 per cent of consolidated turnover (whichever is lower), or 5 per cent of turnover in royalty/brand deals. These require audit committee and shareholder approval, with comprehensive disclosures. Promoter-related transactions (non-material but promoter-linked) have been defined to be those exceeding lower of 2 per cent of turnover, 2 per cent of net worth, or 5 per cent of average PAT. These transactions require audit committee approval, comprehensive disclosures.

Residual transactions are those that are less than Rs.1 crore per year-- these require limited and minimum disclosures. The disclosures vary-- minimum, limited, or comprehensive-- reflecting the transaction s quantum, nature and stakeholder involvement. Shareholder notices for material RPTs must include the commentary of the audit committee, valuations, bid comparisons (especially royalty), and QR-code access. By anchoring disclosure tiers to clear monetary cut-offs, SEBI ensures transparency, yet without imposing a one-size-fits-all burden.

The disclosure norms may encourage companies to comply and not connive. However, if another big incident takes place involving RPTs, regulators will be forced to act differently, which could include surprise audits of RPTs.

www.thehindubusinessline.com, dt. 04-07-2025