August 2003

Sebi takes first steps against illegal trading

Disguising poorly explained concepts as innovations

top         Sebi takes first steps against illegal trading

August 2003

After complaints of highly-active illegal trading in shares in recent months reached a crescendo the Securities and Exchange Board of India (Sebi) and the National Stock Exchange (NSE) recently conducted a joint investigation into one of the suspected large player in it.

On July 23, Sebi issued an order prohibiting Bansal Sharevest Services (a stockbroking firm having membership on NSE's cash and derivatives segment) and Pradeep Kumar Bansal (a broker on UP, Calcutta and Inter-Connected stock exchange) from dealing in securities in the market or outside till Sebi completed its investigation into their affairs.

According to Sebi, its preliminary findings of its nationwide inspection of Bansal's dealing offices in Bombay, Calcutta, Bangalore, Bhuj and Mathura suggested on the face of it that it was indulging in illegal trading in shares. Non-Sebi media reports suggest that the broker was indulging in heavy trades outside the official stock market. Such illegal trades is referred to by those who indulge in it is as "dabba" trades.

The mechanics. From what little is known about the modus operandi of the illegal market a broker takes a off-market order from a trader of, say, 100 shares in a stock, executes a trade of just one share on his stock exchange's trading terminal (where he has a formal membership) and records the balance 99 shares as a purchase in his unofficial trade book at the same price as the official trade of one share. Neither the 99 unofficially-recorded shares nor the one officially traded share are paid for by the trader and delivered by the broker.

The trader can keep his position of 100 share open upto a week. Within this time he has to compulsorily square it up. When he does that the broker executes a sale trade of one share on the stock exchange trading terminal and the balance 99 shares are recorded as a sale in the unofficial trade book at the official sale price of that one share. If this sale price is more than the earlier purchase price then the broker pays the difference to the trader; in the reverse scenario the trader pays the broker.

Potentially detrimental. The Sebi-NSE team reportedly discovered that Bansal's broking firm had automated the unofficial trade book. By using a sophisticated software he used to keep a log of all the illegal trades done across his dealing offices all over the country.

While the effect is not proven beyond doubt illegal trading can tend to distort the official prices on the stock exchanges. Sebi has not revealed the stocks in which Bansal traded illegally. If these were otherwise illiquid or fundamentally weak stocks then Sebi-NSE's prompt serve investor interests well. And more so when the illegal market also becomes a highly sophisticated one driven by automated systems. One can now only wait for Sebi to finish the investigation and make public its findings.

top   Disguising poorly explained concepts as innovations

August 2003

An inside unknown team at Securities and Exchange Board of India have come up with suggestions for the introduction of six new products that it refers to as "innovations in the securities market". Sebi has posted their discussion paper on its website www.sebi.gov.in and invited public comments on it.

The first new product that the team would like Sebi board to clear is the trading of rights entitlement (in cases where the companies are issue rights shares) in demat form by investors on the stock exchange as against the current practice of physical rights renunciation form being traded directly between interested investors. The other five products discussed are put options on fixed price buybacks and takeovers, buyback of shares for other than cash, issuance and trading of third party covered warrants, put options on bonds and professional rating of intermediaries.

These new products are complex in nature yet have the potential of significantly affecting investors and corporates. Each of them could have a positive or negative effect. Given the significance and complexities involved the discussion paper falls much short of spelling out extensively, efficiently and convincingly the rationale and nature for the new concepts.

This is particularly noticeable in the case of the one on allowing institutional investors issuing third party covered warrants through the stock exchanges. The covered warrants are warrants issued by a holder and not the company to whom the warrants belong. A covered warrant is like a covered call option except that the Sebi team wants it to be traded on the stock exchange like options on stocks currently are but without many of the its standardisation features like well-defined contract specifications and a maximum expiry period of three months.

In order to justify relaxation of such features in options trading that serve investor interest's well the Sebi team puts a spin around it and portrays the options market as it exists in a poor light. In two other instances—while making a case for put options on fixed price buybacks and takeovers and allowing buyback of shares by companies without having to pay cash against it—the justifications are poorly explained.

What raises doubts is also the short three week time frame that Sebi has put for allowing the public to comment on the discussion paper. Understanding the complexities involved and their impact on the markets by an investor wanting to comment would ideally require about three months and not just three weeks.

Further, the Sebi team wants a clearance from the Sebi board before spelling out the modalities of the new concepts. That again is fraught with dangers because to clear the concepts one needs to understand how exactly it works. But such a system of working is not new for Sebi. Investors' interests would only be served if there is competent evaluation of the poorly justified concepts by the Sebi board. Thats not asking for much.

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