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Come one and come all, including crooks and swindlers
April 2006
There is
something about bull markets, even when it prolongs to a point when you start
wondering whether it is all bull, that anasthetises our capital market regulator,
Securities and Exchange Board of India, into deep slumber. You could call it
pandering to a central government's desire to attribute a bull market purely to
its economic policies. Its futile to expect any one in the regulator's office
or the government to let on that they are doing this and secondly knowing that
what goes up too fast must come down fast as well the powers-that-be attempt to
push back any collapse of the markets until after they are kicked out of power.
Martin Mayer,
author of the 1993 book 'Nightmare On Wall Street – Salomon Brothers and the
Corruption of the Marketplace', wrote in 1999: "The one lesson history
teaches in the financial markets is that there will come a day unlike any other
day. At this point the participants would
like to say, 'all bets are off', but in fact, the bets have been placed and
cannot be changed." Sebi chairman M. Damodaran does not seem to be heeding
such lessons from history.
A good
regulatory system is what guarantees the quality of your investing experience.
You have a right to invest in shares at prices that are not distorted nor
manipulated. The stock market regulator has to ensure this. Regardless of what
it perceives the fundamentals to be it has to convincingly demonstrate that it
is continuously tracking the source of funds driving trades in the market. That,
unfortunately, does not seem to be happening. Instead, all indications are
there of subtle and deliberate lack of regulatory investigation of the sources
of funds behind the unprecedented sustained and frenzied buying of stocks—at
present, particularly, in index stocks. Not that Sebi does not have the power
to order all brokers and their clients to disclose their source of funds. Except
for the power to disgorge illegally acquired gains, Sebi has all the powers
under the SEBI Act, Securities Contracts Regulation Act and its numerous
regulations.
New elephant
– the FIIs. Its a no-brainer that the Indian equity market, like many of its
peer markets in Asia, South
America and Africa, is being swamped with a
never-seen-before influx of global equity inflows. Foreign institutional
investors (FIIs) are dominating the equity markets. But the question that has
been raised but not taken up adequately by Sebi is whether all of it from clean
and legal global equity investors. For instance, global equity data collated by
a professional data company, Emerging Portfolio Funds Research (EPFR),
indicates that the global equity funds tracked by it had, as of January 31 this
year, invested $15 billion in India funds directly and an unspecified figure
through other category of global funds (see table 'India and Peer Markets'). As
per Sebi figures, total FII net equity inflows stood at about $30 billion at
the end of January. If the EPFR-tracked data would not include the remaining
$15 billion one would have to wonder whether there are funds coming into Indian
equities via FII sub-accounts and participatory notes that EPFR would not
consider as global equity investors.
The
unprecedented and sustained nature of huge FII inflows (see table/chart 'FII
investments measured in dollars) should have been enough for Sebi to initiate
in-depth enquiry into the investors. But it was not to be. Its not that Sebi is
in the dark about the onerous nature of some FII inflows. Look at what an
expert group on 'Encouraging FII flows and Checking the Vulnerability of
Capital Markets to Speculative Flows' constituted by the finance ministry in
November 2004 and comprising of the chief economic advisor, three finance
ministry representatives, a Sebi official and a RBI official had to say in a
separate sub-head titled 'PNs and Sub-accounts: Areas of Concern':
"...with PNs issued to various types of entities abroad, the identity of
the actual investor need not necessarily be known to the regulatory bodies...
The investor could be individual or corporate investors who are not subject to
Indian laws. This has given rise to concerns that some of the money coming into
the market via PNs could be the unaccounted wealth of some rich Indians camouflaged
under the guise of FII investment. The money might even be tainted and linked
with such illegal activities as smuggling and drug-running."
PNs and
sub-accounts are two routes for suspect funds to enter. Sub-accounts are
generally foreign private companies and individuals on whose behalf a FII is
permitted (under Sebi rules) to invest and who would otherwise not be eligible
to register as FIIs. Participatory notes are contract notes through which an
FII invests in, say, Indian equities, on its proprietary account but the
purchase is funded by an overseas investor on whose behalf the investment is
made. The expert group report admitted that "this helps keeping the
investor's name anonymous" and that such investors "prefer to avoid
making disclosures required by various regulators." From data that Sebi
shared with the group (but not with you, the investing public) the ominous
signs are there for all to see (see table: 'Almost Half of All FII Net Equity
Inflows is Through PNs').
Yet the
expert group, with the exception of RBI's representative, chickened out and did
not ban the use of PNs or sub-accounts by FIIs. RBI's stance was that issue of
PNs should not be permitted. Its official's dissent note stated that
"Trading of these PNs will lead to multi-layering which will make it
difficult to identify the ultimate holder of PNs. Both conceptually and in
practice, restriction on suspicious flows enhance the reputation of markets and
lead to healthy flows." RBI was also of the view that sub-accounts should
not exist as a separate class of investors. But the two finance ministry representatives
and one of Sebi in the expert group did not show gumption to endorse such views
and so you will continue to see a status quo where PNs and FII sub-accounts
dominate the Indian equity market.
Price
manipulation. A hawk eye on the biggest players would also reveal which stocks
in particular are the most targeted. Even otherwise it is not hard to see. Says
Aunali Rupani, sub-broker with Motilal Oswal Securities: “FII and speculator
money is chasing only about 150 stocks where derivatives trading is available
including index stocks.” Figures on derivatives trading volumes bring out the
enormity more succinctly (see table/chart 'Sky-rocketing Trading Volumes:
Regulatory Attention Still Grounded'). Three years ago, in March 2003 the
average trading volumes per day in cash and derivatives segments of NSE were just
Rs 2,500 crore each. Since then, while cash market trading volumes has grown by
only 3.8 times to Rs 9,500 crore per day in March this year the derivatives
trading volume has sky-rocketed to Rs 33,400 crore or 13.4 times more.
Though
fuelled by FIIs delivery-based purchases in cash market as well as their
trading positions in derivatives, the game of leverage is in full flow. An Rs
30,000 crore daily volume was unimaginable earlier. Who are behind these
trading volumes? Is NSE keeping a watch on the biggest brokers and is Sebi
asking these brokers to reveal their biggest trading customers? Of its 915 cash
market members, NSE's last available monthly newsletter, reveals that the
highest 10 brokers in terms of cash market trading volumes accounted for 24 per
cent of total volumes in January this year as against 20 per cent during
2004-05.
Lower number
of brokers are making up for more and more trading volume. NSE does not
disclose the break-up of broker concentration for its derivatives segment. In
derivatives trading, our equity market has revealed itself to be a stock-loving
leveraged one because nowhere else on our Earth does one sees 54 per cent of
all derivatives trading volume concentrated in stock futures contracts as it
does here. What the speculators and operators did with badla trading during
Harshad Mehta and Ketan Parekh times is now being carried out through stock
futures – albeit with tighter ropewalking since NSE's margining system is quite
stringent. But where is the intensive scrutiny of big-ticket investors,
including FII sub-accounts and PNs, in the derivatives stocks? Why is there not
a single public statement by Sebi about the nature and findings of an enquiry,
if any, given the unstoppable boom in price and volumes?
Sebi's
intervention is necessary to cool down frenzied market participants. This was
clearly evident in mid-last year when circular trading that was reaching
dangerous proportions in mid-cap and small-cap stocks. Sebi passed interim
orders in about just 8-10 stocks in September and October last year. Even
though these interim orders lacked teeth in the sense that they only banned
further dealings in the shares of those stocks by involved promoters, directors
and connected investors and brokers, they had a salutary effect of deterrence.
Prices in
mid-cap and small-cap stocks stabilised. Says Rupani: “Since September last
year we have seen two-third of all traded stocks touching new lows." Since
Sebi has chosen to go soft on FII sub-accounts and PNs and since their
investments are primarily in index and derivative stocks there has been an
unprecedented shift in the trends. Main indices have continued to shoot up
leaving behind second line of indices. Numbers reveal this. As on March 30, on
a year-to-date basis, while Sensex gave 78 per cent appreciation other indices (even
the other mainline index Nifty have returned less) – 50-stock Nifty (68%),
Junior Nifty comprising of next large 50 stocks (47%) and CNX Midcap (61%).
Returns are negative with almost all non-index stocks.
Yet, much needed
to be done that has not been done. Leave aside initiating fresh investigations
in more stocks where circular trading had occurred, six months have elapsed and
Sebi has not passed any final orders in even the 8-10 cases. What was
particularly noticeable about the circular trading cases was the role of
brokers. In IFSL stock, for instance, 13 connected individuals and corporate
bodies executed their manipulative market trades through eight brokers of which
at least two—Fortis Securities and Indiabulls Securities —were big shareholders
in IFSL with respective stakes of 3.5 per cent and 2.4 per cent. This, market
sources, say would have emanated from large margin trading accounts of these
brokers. So far Sebi has not come out in the open about any fresh findings in
the matter. And thats a cause for worry.
Other
worrying signs. We have extensively covered the benami multiple application IPO
scam since it came out in the open on December 15 through Sebi's interim order
in Yes Bank IPO case. The latest development was that Sebi had handed over the case
to CBI leaving a large question mark on the potential end result. When
will final orders be passed on the corporate and individual investors behind
the scam is uncertain? Also, says Virendra Jain, head of Midas Touch Investors
Association, "Under Sebi rules it is the lead manager's job to weed out
multiple application bids and we would like to know whether Sebi is going to
take any action against them."
Another
worrying aspect of your dealings in the market is the security of your demat
account. We had reported on one mind-numbing example of how some investors of
Edelweiss Securities (a CDSL DP) saw shares vanish from their demat accounts. This pernicious problem does not seem to abate.
We now have
another case with us. About 20 investors (based in Guntur, Andhra
Pradesh) having their demat accounts with UTI Securities (a NSDL DP) have
experienced the same. Outlook Money has carefully looked at the documents of
the case of two investors and we clearly sense fraud having been committed.
Says M. Dipak, son of Mittapalli Rangarao and Mittapalli Sobha – two affected
investors who are senior citizens: "In January this year we came to know
that Tilak Associates, franchisee of UTI Securities, fraudulently transferred
our shares to his or associate account and went absconding." The value of
Mittapallis' vanished shares is about Rs 60 lakh and together with other
affected investors the value could be about Rs 5 crore.
In both the
above cases the DPs haven't restored the shares to the investors and so far the
two depositories haven't taken any penal action against their DPs involved. Such
systemic deficiencies and regulatory inaction threatens the very core of your
investing experience.
Another
critical threat is the agreement you sign with your broker and DP. Here too, no concrete action has been taken by the stock
exchanges or Sebi against brokers like Indiabulls Securities, Kotak Securities
and HDFC Securities whose examples we gave in our story.
With regulators
refusing to act tough against offenders the stock market has become a haven for
all kinds of exploitations and abuses. Be aware and beware.
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