CHANCES are if you’re an investor who’s lost his life savings in the country’s stock markets in recent months, the person you’ll blame for this the most is the stock market regulator, SEBI chief D.R. Mehta. And with the Bombay Stock Exchange’s sensex losing as much as a fifth of its value since the budget, clearly there are a lot of people out there in the hate-Mehta club.

Talk to Finance Minister Yashwant Sinha, apart from Mehta himself, and he will tell you that this attitude is totally wrong. After all, in recent months, even the Nasdaq and the Dow Jones in the US have gone through worse gyrations (and it is true that, for the large part, the sensex has mirrored the Nasdaq, with a 12-hour or so time-lag). But no one out there blames Securities and Exchange Commission chief Arthur Levitt for this – the SEC is the US equivalent of our SEBI.

So why are we blaming D.R. Mehta when no US citizen’s are holding Arthur Levitt accountable for their losses? Simple. It is no one’s case that stock markets in the US are as completely rigged as the one’s in India – hence, investors in India lose out not just because of genuine market fluctuations, but also because the markets are rigged. And since the regulator’s job is to ensure the markets are not rigged, it is only natural the regulator share a large part of the blame. (It should be pointed out here that SEBI is not the only regulator being blamed. Other regulators include various stock exchange authorities, the Department of Company Affairs, and the Reserve Bank of India.)

 

 

Though newspaper reports would have you believe that this is the worst-ever stock market crisis India has faced for a long time, stock market regulars will tell you it’s just one of the many that surface from time to time. Prithvi Haldea, who runs Prime Database (the only database on the primary markets in the country), will tell you that India’s stock markets have had close to one scam every year in the past decade. Sure, these have not followed a neat calendar, in the sense that some scams have overlapped and there were a couple of scam-less years. But since there were 10 big scams in the past decade, it’s one and the same thing (see box). In each case, as in the current stock market scandal, the country’s regulators have been found wanting, even squabbling over whose primary responsibility it was to check the scam.

In the case of the ‘vanishing companies’ scandal that surfaced between 1992 and 1996, around 3,911 companies raised Rs 25,000 crore in the primary capital markets and then simply disappeared. Or just did not set up the projects for which the money was raised – certainly the funds vanished. So, for instance, Asian Consolidated raised Rs 115 crore from investors, promising to set up a project to make 500 million aluminium beverage cans a year, but never set up the unit. Last heard, the company was being wound up. The Asian Group, by the way, also set up a factory to produce beer, and raised funds separately to make the seals for the top of beverage cans; that firm was called Asian Tops.

 

 

But neither SEBI, the Department of Company Affairs (DCA), any of the country’s various stock exchanges, or even the police, bothered to penalise the group for the loss to investors through their fraudulent behaviour. For many years, in fact, SEBI argued that this was not its jurisdiction, as did the DCA. Similarly, when plantation companies raised somewhere in the region of Rs 50,000 crore by promising huge returns to investors who put in funds into their teak plantation schemes, and then failed to deliver, there was a dispute over who was to regulate such schemes – SEBI, the DCA, or, hold your breath, the Ministry of Forests!

 

 

Apart from the sleeping regulators, one of the most fascinating aspects of the current stock market scandal is that it is replete with instances of history repeating itself.

When SEBI accused Bombay Stock Exchange President Anand Rathi of misusing his position at the exchange (and thereby forcing his resignation) in early March, Rathi was the second BSE President to go this way. Rathi’s predecessor J.C. Parekh also quit in 1998 under somewhat similar circumstances. In June 1998, Harshad Mehta (remember him?) ran into serious trouble while rigging up the share prices of BPL, Videocon and Sterlite, and was unable to pay for the shares he had bought. So, one night in June 1998, the then BSE President and other broker-office bearers of the BSE, opened up the main computers of the exchange, and allowed brokers to insert fictitious trades in the computer after trading hours were over to cover up the default by making it appear that Harshad had squared up his transactions.

Equally interesting is the amazing similarity in the modus operandi of Ketan Parekh, the reigning Big Bull currently under arrest for his role in the stock scam, and Harshad Mehta who was the linchpin of the original securities scam of 1992. While Harshad used the public sector banking system to fund his operations (remember the much-abused and ingenious bankers’ receipts?), Ketan used a slightly different technique, but also managed to get public funds for his operations. As The Indian Express first reported, during the month prior to his arrest, Ketan Parekh had close to Rs 2,000 crore to play around with.

What is even more shocking, according to SEBI’s preliminary report, Ketan got around Rs 670 crore of this from corporates such as Zee and HFCL, whose shares he was ramping up. Both Zee and HFCL had raised this money for business purposes but diverted it to Parekh illegally. Though it has been over a month, the government has taken no action against either Zee or HFCL. Zee has, for the record, said that it gave funds to Ketan to buy a stake in entertainment firm ABCL and television channel B4U, though both firms have denied that they were selling out to Zee.

 

 

Ketan also had large borrowings from Global Trust Bank, whose shares he was ramping up (so that it could get a good deal at the time of its merger with UTI Bank) – he got Rs 250 crore loan from here, though Global Trust’s chairman Ramesh Gelli (who was later asked to quit) repeatedly said that lending to Ketan was less than Rs 100 crore in keeping with Reserve Bank of India norms. Ketan and his associates got another Rs 1,000 crore from the Madhavpura Mercantile Co-operative Bank despite the fact that RBI regulations ruled that the maximum a broker could have got as a loan was Rs 15 crore.

Thus, Ketan’s modus operandi was clearly to ramp up shares of select firms in collusion with the promoters – ironically, during the Ketan clean up, SEBI concluded a 3-year old case where Harshad Mehta colluded with the managements of BPL, Sterlite and Videocon to ramp up their shares with money provided by these managements – and to get funding from them to do this. In the current Ketan case, SEBI has found prima facie evidence of price rigging in the scrips of Global Trust Bank, Zee Telefilms, HFCL, Lupin Laboratories, Aftek Infosys and Padmini Polymer.

Now with the prices of select shares constantly going up thanks largely to this rigging, can you blame innocent investors who bought into such scrips thinking the market was genuine? I know of at least one college lecturer who withdrew her provident fund to buy a few shares of Infosys when they cost Rs 10,000; today, they are worth a fraction of that.

Sadly, the sordid saga of blatant rigging did not stop here. Though UTI chief P. Subramanyam has denied any collusion with Ketan, it is interesting that UTI’s purchases closely mirror Ketan’s buying in what are called the K-10 stocks, or stocks that Ketan bought aggressively into. What is equally difficult to rationalise, and lends credence to the theory that there was something fishy in the market, is UTI’s purchases of completely unknown stocks like Arvind Johri’s Cyberspace Infosys – Cyberspace, interestingly, was earlier known as Century Finance, and changed its name to take advantage of the boom in infotech stocks. (Cyberspace, by the way, was just one such firm. There were scores of others, and no meaningful action was taken to stop investors from getting duped).

An even more alarming facet of how the market was rigged is brought out by the fact that when the Bombay Stock Exchange began investigating the sudden rise in prices of Cyberspace, which sky-rocketed to Rs 1,450 within a few weeks, SEBI’s divisional chief (surveillance), Deepak Sancheti, cautioned BSE’s officials about Johri’s powerful connections and asked them to go slow on the investigations.

 

 

The most frightening aspect of the entire scam, of course, is how long it had been going on for, and how it was finally discovered. While various analysts and journalists had been asking for investigations into the sudden runaway behaviour of select stocks for well over a year, between the country’s stock exchanges and SEBI everything was found to be all right. It was only when the sensex fell dramatically the day after it welcomed Yashwant Sinha’s budget that serious action began. The FM was visibly angry that his party had been brought to a halt, and so insisted that SEBI conduct a full-fledged investigation. Simultaneously, teams from the CBI, the Income Tax and the Enforcement Directorate were pressed into service to probe the nexus between brokers and corporates, and various stock market cartels.

 

 

In other words, if the markets had not crashed after the budget, Yashwant Sinha would not have insisted on a thorough probe, and chances are that life would have continued the way it has!

And then, within a matter of six weeks, SEBI found everything that it was unable to all this time. They even found that FII Credit Suisse First Boston was funding Ketan Parekh and disguising these loans by creating false records of transactions. It then charged Ketan ‘brokerage’ fees which was actually nothing but the interest on the loans it gave him. It even found evidence of how brokers acting for Ketan placed dubious sell-orders to complete the paperwork to cover the dubious financing.

SEBI also found, its preliminary report says, evidence that there was a big bear cartel in the market and that one of them, Shankar Sharma, was closely linked with Tehelka.com – he owned a large part of the dotcom. The allegation is that Sharma was short-selling shares since he knew there was going to be a major expose that would shake the government and hence the country’s stock markets.

In almost all such scams, we are told that it was a ‘systemic failure’, that it was not just individuals who erred, it was the system that failed. While that sounds like the classic rogue’s defence, sadly it remains true. For every possible system that could fail did so in this particular case, either by design or by default.

 

 

Let us begin with SEBI, whose primary job is to protect investors by ensuring the market is not rigged. Clearly SEBI did not do its job, but do you know how big its surveillance department is? It has just 20 officers who are supposed to look into the affairs of 7,000-odd listed firms and over 15,000 intermediaries like brokers and merchant bankers. It is equally true, and tragic, that SEBI chief D.R. Mehta had never aggressively campaigned for a larger surveillance staff either.

The fact is that SEBI was set up with no expertise either, and so it was destined to fail, and miserably at that. Till 1992, for instance, prices for new issues were decided by the Controller of Capital Issues – that was an inefficient system. But then one fine day Finance Minister Manmohan Singh said the CCI would be abolished and markets would determine the pricing. Just like that. SEBI was set up with no expertise whatsoever; it did not even know how to regulate merchant bankers, and what constituted good merchant bankers. There was this merchant banker in Baroda who would drive down to industrial estates and persuade small units to float IPOs at huge premia, which was to be split between them! It was only by 1996, by when these companies had raised Rs 25,000 crore, that SEBI was equipped enough to realise there was a problem, and set up the Malegam Committee to recommend norms for new issues.

Nor are things that hot when it comes to the surveillance by the country’s stock exchanges – logically, these are the first rung of surveillance for the markets. In August last year, when SEBI asked the National Stock Exchange to probe the massive hike in prices of select scrips, to see if particular brokers were cornering the shares in an attempt to rig the markets, the NSE actually said there was no unusual activity at all! SEBI asked NSE to probe shares like DSQ Software, Global Telesystems, Himachal Futuristic, Pentamedia Graphics, Silverline Technologies and Zee Telefilms – all shares whose prices were rising stratospherically.

It is equally true that neither the BSE nor the NSE has good enough software to allow them to track unusual movements in various scrips. Even ex-BSE President Anand Rathi admits that while the software is being installed, sufficient training has not been given to staffers to monitor the system effectively.

 

 

And while it is true that broker-run exchanges in themselves do not mean corruption – after all, the same ramping up took place on the NSE as well, and it was the NSE which gave a clean chit in August – the fact is that brokers have had their way all these years. Till today, for instance, the country’s major stock exchanges do not have the same day on which brokers have to square up or settle their accounts. This is done so that, with the same pool of funds, brokers can take huge positions across stock exchanges.

It is equally true that the RBI does not have the powers to regulate co-operative banks like Madhavpura. And the fact is that the legal system is so over-worked that Harshad’s still around, that it has taken SEBI three years to act on the information about Harshad’s collusion to rig up prices of BPL, Videocon and Sterlite. This case, by the way, is far from over, some say it has just begun.

 

 

While there have been many sceptics, primarily finance ministers of various hues, saying the stock markets do not matter (and that they are more worried about INA Market and Khan Market), the fact is that they do. The biggest casualty of the decline in investors’ faith in the markets, of course, is the fact that the amounts raised by companies from the primary markets declined steadily over the years. They fell from Rs 18,341 crore in 1995-96 to Rs 14,372 crore the next year, Rs 4,764 crore in 1997-98, and to Rs 4,127 in the first nine months of 2000-01.

The same sad fate also hit firms that made rights issues – that is, issues made to existing shareholders instead of to the general public. According to Prime Database, the number of firms that made rights issues fell from 488 in 1992-93 to 291 in 1995-96, and finally to just 28 in 1999-00. The amounts raised by these rights fell from Rs 12,630 crore to Rs 6,520 crore, and finally to just Rs 1,560 crore in the relevant periods.

According to an investor perception survey done last year by the NCAER on behalf of SEBI, the outlook seems very gloomy. For one, the proportion of households putting their savings in shares/debentures declined from 10.2 per cent in 1992-93 to 2.4 per cent in 1998-99, and for the next one year it was forecast that just seven per cent of total household savings would be invested in equity. The same survey said that 56 per cent of urban and 72 per cent of rural households said they would not make any fresh investments in the country’s stock markets. That is a direct result of the regulators collective failure to make India’s equity markets a safe place.