Role of a regulatory authority in a particular market depends on the stage of development that particular securities market is in. In an emerging market like India, the role of a regulatory body is not confined to regulation of the market but it extends to creation of condition that will nurture development of the market through effective discharge of its function of regulation. [2] It is a paradox with both ends tied up. Effective regulation has to be the primary objective, but regulation must pave the way for development of the market. The success of a regulatory authority has to be scaled in terms of these parameters. This dual role will ensure market development along with discipline and fairness in the market along with high degree of market integrity. In 1992, the Securities and Exchange Board of India (SEBI) Act was enacted giving statutory status as an apex regulatory body. Thus, in India SEBI is the apex regulating body, with the twin objects of regulating and developing the capital market. In spite of a multitude of reforms brought into force by it, it has been criticised for its repeated failure to apprehend and prevent major capital market scams time and again. From Ketan Parekh to recent IPO scams, time and again SEBI has failed to prevent major capital market scams, in spite of bringing security reforms each time. Surveillance by SEBI it seems has failed one too many times. It is about time the fundamental gaps in regulation by SEBI, that have plagued SEBI from Ketan Parekh to Chain Roop Bhanshali (CRB), and IPO scams, are fixed.
1. The Event.
The 176-point Sensex crash on March 1, 2001 came as a major shock for the Government of India, the stock markets and the investors alike. More so, as the Union budget tabled a day earlier had been acclaimed for its growth initiatives and had prompted a 177-point increase in the Sensex. This sudden crash in the stock markets prompted the Securities Exchange Board of India (SEBI) to launch immediate investigations into the volatility of stock markets. SEBI also decided to inspect the books of several brokers who were suspected of triggering the crash. [3] Over the subsequent period the Sensex further declined due to various connected events such as Bombay Stock Exchange President (BSE) Anand Rathi's resignation following allegations that he had used certain privileged information which contributed to the crash. [4] By the end of March 2001, at least eight people were reported to have committed suicide and hundreds of investors were driven to the brink of bankruptcy. [5] The first arrest in the scam was of the noted bull [6] , Ketan Parekh (hereinafter KP), on March 30, 2001, by the Central Bureau of Investigation (CBI). Soon, reports abounded as to how KP had single handedly caused one of the biggest scams in the history of Indian financial markets. He was charged with defrauding Bank of India (BoI) of about $30 million among other charges. KP's arrest was followed by yet another panic run on the bourses and the Sensex fell by 147 points. By this time, the scam had become the 'talk of the nation,' with intensive media coverage and unprecedented public outcry. [7] With this background, the researcher shall try to analyse the possible reason of the crash and the possible role of SEBI in the crash.
2. Understanding the crash
The rise of ICE (Information, Communications, and Entertainment) stocks all over the world in early 1999 led to a rise of the Indian stock markets as well. The dotcom boom [8] contributed to the Bull Run [9] led by an upward trend in the NASDAQ [10] .The companies in which KP held stakes included Amitabh Bachchan Corporation Limited (ABCL), Mukta Arts, Tips and Pritish Nandy Communications. He also had stakes in HFCL, Global Telesystems (Global), Zee Telefilms, Crest Communications, and PentaMedia Graphics. KP selected these companies for investment with help from his research team, which listed high growth companies with a small capital base. According to media reports, KP took advantage of low liquidity in these stocks, which eventually came to be known as the 'K-10' stocks. The shares were held through KP's company, Triumph International. In July 1999, he held around 1.2 million shares in Global. KP controlled around 16% of Global's floating stock, 25% of Aftek Infosys, and 15% each in Zee and HFCL. The buoyant stock markets from January to July 1999 helped the K-10 stocks increase in value. HFCL soared by 57% while Global increased by 200%. As a result, brokers and fund managers started investing heavily in K-10 stocks. Mutual funds like Alliance Capital, ICICI Prudential Fund and UTI also invested in K-10 stocks, and saw their net asset value soaring. By January 2000, K-10 stocks regularly featured in the top five traded stocks in the exchanges. HFCL's traded volumes shot up from 80,000 to 1,047,000 shares. Global's total traded value in the Sensex was Rs 51.8 billion. As such huge amounts of money were being pumped into the markets, it became tough for KP to control the movements of the scrips. [11]
KP was assisted financially by specific Ahmadabad based bank. KP's modus operandi of raising funds by offering shares as collateral security was deceptively simple and it worked well during the period of the boom. Probably the manipulation and acquiring of bulk shares in the various companies would never have been detected had there not been a fall in NASDAQ. But the fall in NASDAQ triggered a chain reaction by reducing the volatility of the shares and ultimately culminated in the historic crash of the Sensex.
3. Assessing SEBI's role as a regulating authority in the KP Scam.
The role of SEBI as a regulating authority of the capital market came under tremendous criticism. Measures adopted by SEBI to mitigate the damages were widely alleged as reactive rather than being proactive. The scam was an evidence of the unpardonable laxity on part of the regulating authority in not noticing the unusual price movement and exceptional volatility in certain shares. [12] It was a shameful exhibition of SEBI's poor market intelligence. Perhaps SEBI's failure was a direct consequence of poor vigilance of capital market. It has to be understood that the philosophy behind SEBI's measures in regulation has to be preventive rather than being corrective. A corrective philosophy in capital market will perhaps always result in SEBI being a scam late in preventing scams in the capital market.
B. Analysing CRB scam as evidence of weak governance in the sphere of Corporate Criminal Liability.
Till March 1997 CRB group was one of the leading groups in the finance industry. Investors and bankers were too eager to place their money with the group. The person behind the group was C.R. Bhansali, after whom the group was named. C.R. Bhansali is best remembered for the astonishingly simple methods he employed to hoodwink a large network of institutions and people at the Reserve Bank of India, Securities and Exchange Board of India (SEBI), a number of banks, credit rating agencies, auditors, media and investors. [13] His strategy was straight forward and simple. To raise money from the market, Bhansali used his own money to rig prices.
1. Facts and figures.
In the months leading up to January 1995, when CRB capital markets came to the market with Rs.86.75 crore at a premium of Rs90, the company's share price doubled to Rs.142 and then went to drop dramatically after the issue. CRB Corporation's share price history follows a similar trend peaking at around Rs.65 at the time of the big issue in late 1994. The prices were later quoted at Rs.5 and Rs.3 when the scam broke out. Hence, most of the funds that the company raised by way of equity were by way of premium issues. Bhansali used two methods to rig prices. First, he siphoned money into his private finance companies, which would then buy his stock. And then he used his other public companies to buy into each other as cross-holdings. For e.g., both CRB Mutual Fund and CRB Custodian services featured in the top 10 companies in which CRB Mutual Fund invested in 1994-95. CRB Custodian invested Rs. 15 crore into CRB Capital markets, which in turn invested Rs.17 crore in CRB Mutual fund. The latter holds 24 lakh shares of CRB Corporation, which again has a 16 crore investment in CRB capital markets. [14] Simultaneously, Bhansali was also elaborately dressing up his balance sheet for the benefit of the public shareholders and the banks. In the three years starting March 1994, CRB capital markets income jumped nearly five times to Rs.129 crore, while its net profit jumped three times to Rs.52 crore. This profit growth came when the company was showing negative cash flows from operations -Rs.88 crore in 1995-96 and -Rs. 79 crore in 1994-95. [15] In the last two years of its operation, CRB group raised Rs. 466.2 crore from the capital market. Out of this Rs.320.35 crore went into the purchase of assets and investments Most of the funds that the company raised by way of equity were by way of premium issues. [16] Further, CRB Capital Market issued Rs.200 crore of secured debentures in April 1996. These debentures later stood unsecured as the company did not register the charge on the assets. The company also raised Rs.135.24 crore by way of fixed deposits from the public with outstanding deposits as on March 1996 being Rs.139.83 crore. [17] With more than 80 per cent of the funds raised being in nature of unsecured loans, there were doubts whether the company has adequate asset backing to pay off these loans. The crisis that unfolded had already had direct fallout in post dated cheques of depositors being dishonoured - creating panic amongst deposit holders. [18] Other companies that belonged to the CRB group followed a similar model. For the purpose of the present paper, going into further details as to how other CRB group companies siphoned investor's funds by hoodwinking them by rigging price of the shares is irrelevant. What is relevant is the fact that there was extensive rigging/ manipulation of price which ultimately resulted in debacle in which the small investors were hit the hardest. [19] The important question is when price manipulation and rigging such enormity were taking place on a continuous basis, why was not SEBI able to unearth such malpractice which could have prevented a debacle of such magnitude where hundreds of small investors were driven to the brink of bankruptcy, with all their life's savings vanishing into wilderness? It is indeed a matter of deep introspection.
2. Loopholes in regulation that aided the scam.
The records in various sources regarding SEBI's role as a regulating authority reveals a surprising fact. SEBI first detected the irregularities in CRB's operations as early as in December 1995 during a routine inspection. Analysts say that even a cursory look at CRB Mutual fund's balance sheet would reveal that the trustees and the fund managers did everything but run a proper fund. [20] what is even more baffling is the fact that SEBI informed the RBI that the inquiry conducted by them in respect of CRB was completed and later further confirmed that they were free to launch new schemes from 1July 1996. [21] So, SEBI not only had the knowledge of irregularity at a very early stage, it underestimated such irregularity and condoned such irregularity by allowing them to go ahead with their scheme. This exhibit inexplicable laxity and inertia on part of SEBI to take prompt action, and perhaps a complete lack of understanding of the possible ramification of such irregularity. All SEBI did was to take a decision to conduct a study to find out whether there was any systematic failure that led to the CRB scam. That perhaps can not be termed as proactive market vigilance and intelligence. Another failure on the part of SEBI was the fact that out of the overall liability of Rs. 600 crore, only Rs. 230 crore could be recovered. [22] Majority of the bulk of the investor's money was siphoned away through various channels and was untraceable. In absence of any disgorgement provision in the act, the major bulk of money was never recovered. This is a classic example of extremely weak governance on part of the regulating authority, SEBI.
C. A look at IPO scam: again SEBI hoodwinked by alarmingly simple strategy of price manipulation.
1. The scheme of the scam.
The Economic Times on 27 Apr, 2007, 0130 hrs IST, reported that the capital market regulator, SEBI "has unearthed a new scam in the IPO market." [23] The strategy was surprisingly simple and clichéd. A handful of operators ensured that stock prices shoot up and stay high on the day of listing, as also over the next few trading sessions with an intend to corner a chunk of shares intended for retail investors and sell them when the demand shoots up. [24] After investigating the listing pattern, SEBI found out that the "dramatic upsurges on the day of listing of securities or soon thereafter" are driven by trades meant to be executed. In its investigation, SEBI has observed that certain entities have placed an abnormally large share orders at prices far below the prevailing market rates. The intention of placing such orders was, therefore, not genuine trading but only artificial enhancement of demand, which constitutes a manipulative practice. [25]
2. A welcome move towards proactive regulation by SEBI
It would be unfair not to hail the efforts of SEBI in the present scam towards prevention of the scam. It has to be credited to SEBI that it has taken a few leafs out of the lessons it has received in the experience of the previous scams. But at the same time, the fact that SEBI was duped at least temporarily by such simple clichéd price manipulation strategy does not speak well about SEBI's governance of capital market. It boils down to the old flaw in SEBI's regulation mechanism: poor market vigilance and market intelligence. But there are a few encouraging signs that has been exhibited by SEBI. The preventive approach was much prompter than in the previous capital market scams.
3. A rejoinder: winding up the discussion
The consistent pattern that has emerged regarding defect in SEBI's regulatory framework in all the afore stated capital market scams is inability of SEBI as a regulating authority to monitor events taking place in the capital market. It is submitted that the researcher understands that such monitoring is an extremely difficult task, but acceptance and dependence on regulatory framework would necessitate vigilant monitoring of the capital market. Another parallel argument is about complete deregulation, but since the present paper is dealing regulatory framework, analysis of deregulation as a solution is beyond the scope of the present paper. SEBI needs to come up with solutions for a more vigilant monitoring of the capital market. A more proactive implementation of investigatory powers anticipating irregularity is necessary.
The Commission on the Regulation of U.S. Capital Markets in the 21st century [26] can provide a reliable paradigm towards better market regulation but at the same time the essential complexities of a developing market with that of a much leveller developed capital market should be borne in mind. The principle recommendation for Reform and modernize the federal government's regulatory approach to financial markets and market participants in order to give the Securities and Exchange Commission (SEC) the flexibility to address issues relating to the implementation of the Sarbanes-Oxley Act of 2002 (SOX) by making it part of the Securities Exchange Act of 1934. [27]
In context of application of better regulation principles in capital markets, the UK Financial Services Authority (FSA) Act can provide helpful suggestions. FSA Act requires consultation and cost benefit analysis which can be adopted in Neo Indian capital market scenario. [28] It recognizes a need for move towards extra legal means for better regulation. Market failure analysis is yet another possible solution. [29]
Conclusion
Throughout the whole experience of capital market scams, the pattern of failure of SEBI as a regulating authority has more or less remained constant. Poor market vigilance and lack of market intelligence have been the primary cause of failure of SEBI to prevent capital market scams.
Lack of vision and foresight in vigilance appears to be one of the primary weaknesses in regulation by SEBI. Framing of independent investigating agencies to be headed by professionally trained capital market analysts can be seen as a possible solution. For dealing with market manipulators in real time, the enforcement procedure needs to be eased significantly, providing much needed flexibility in operation. Stricter punitive measures such as large fines seem to be necessary. The inception of disgorgement as a remedial civil action is also necessary for recovering manipulated amount. [30]
In view of this discussion, the hypothesis of the researcher about the need for both substantial and procedural amendments is found to be correct.
