Regulation must target market cynicism

Unscrupulous practices dampen genuine retail investor interest in IPOs One only hopes the market participants and investors — even the most hardened cynics among them — see the true meaning of the regulatory action. THE ORDER of the capital market regulator, the Securities and Exchange Board of India, penalising market intermediaries which participated in the so called demat (IPO) scam is notable for its sweep and, by existing standards, its stringency. By an order dated April 27, about 24 firms and individuals including some high profile brokerages such as Indiabulls and the Karvy group have been barred from participating in the securities market, including the primary market (new issues). (The order against Indiabulls has been stayed.)As many as 85 financiers have also been similarly barred. Twelve depository participants have been told not to open new accounts. The indicted intermediaries can appeal against the order within two weeks.The order has serious implications as even genuine investors dealing with these intermediaries are bound to be affected. Most of those indicted are major players in one or all activities that go under the broad banner of merchant banking/investment banking. Therefore, the SEBI did well to clarify the next day (April 28) that the ban (on dealings in the securities market) would apply only in respect of transactions in the proprietary account of brokers and that transactions on behalf of clients would remain unaffected.The SEBI investigated some 105 IPOs between 2003 and 2005. But the order of April 27 is focussed as it recapitulates the key ingredients of the irregular practices in two initial public offers — those of Yes Bank (YBL) and the Infrastructure Development Finance Company (IDFC). The demat scam As already reported, in these two IPOs, certain entities had cornered shares reserved for retail investors by opening000 of fictitious/benami demat accounts, with active collusion of the depository participants. The idea was to increase their chances of allotment.After allotment these fictitious holders transferred their shares to their financiers. Most of these shares were sold immediately and as some recent IPOs including the two under review listed at a premium, the manipulators must have realised quick and sizable profits. Inevitably it is the category of genuine investors who have suffered as their chances of getting allotments were considerably reduced because of the manipulation. Beyond doubt, such unscrupulous practices, even if not so well documented as now, would have dampened new investor interest in IPOs. Regulatory rules providing for reservation for retail investors are meant to encourage their participation. But if market malfeasance still keeps them out (or gets them a smaller allotment), it is a matter of serious concern.Multiple applications are expressly forbidden. In fact, in an earlier period, prospectus and other issue literature carried an appropriate warning that was displayed prominently.No one says that in the past such practices did not prevail. Whenever a new public issue was perceived to succeed, there was bound to be rampant abuse by way of multiple applications. However, such practices went undetected or possibly ignored.The difference now is this since the early 1990s there is a regulator increasingly willing to take on such manipulators. Investigating these practices is a complex process, calling for painstaking efforts but, as this case shows, well worth it. Protecting market integrity is one of the basic objectives of market regulation.The IPO scam raises questions over technology vis-a-vis the capital market. No one doubts that technology application has been beneficial, even indispensable. Electronic holding of shares (through dematting) and online trading are today routine. Technology should help None of these as also the complex regulatory tasks connected with surveillance would be possible without technology. But a technology— based environment should also be able to prevent frauds — at least frauds that look elementary.To give one specific instance, the SEBI has found that demat accounts running into000 have been opened with the same postal address. Surely, even a more basic technology than what the capital market has now would have spotted it. Perhaps at the branch level (one or two offices of the indicted institutions have opened a very large number of these demat accounts) there was collusion. But surely at the higher level, these could have been easily detected. Both NSDL and CSDL have plenty of explaining to do.Banks and other depository participants flouted the most elementary rules. Most of them are well known names with a reputation to protect. It is incomprehensible how they allowed such practices as encouraging opening of multiple accounts, often benami /fictitious accounts. Surely it will be naïve to categorise these branch level acts as arising from individual weaknesses.Unfortunately, the demat scam is one more instance proving the point that for capital market intermediaries defying regulation is a way to profit, a kind of arbitrage opportunity that their more rule abiding competitor foregoes. Wrong perception Certainly that would seem to be the perception of clients, who value "flexibility" above all, including professional and ethical behaviour on the part of their chosen intermediary.Earlier, when regulation was either non-existent or weak, such practices would escape even the basic opprobrium that they deserved. But the demat scam has occurred in a different era .It is wholly appropriate that the regulator has come down hard on these.The unprecedented volatility that greeted the SEBI order on Friday — a sharp intra day movement in the Sensex of some 500 points only to close above Thursday's levels — is perhaps indicative of the shape of things to come this week. Stock markets have already been unpredictable for some time.However, it is unclear as to how far the SEBI order has been responsible for the market swings. One only hopes the market participants and investors — even the most hardened cynics among them — see the true meaning of the regulatory action.C. R. L. NARASIMHAN