ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Spectre of Benami Accounts

ECONOMIC AND POLITICAL WEEKLY Spectre of Benami Accounts Further investigation into the demat racket first unearthed by the Securities and Exchange Board of India (SEBI) on December 15 last year has yielded some startling revelations about the extent to which market infrastructure is being abused for illicit gains in the primary share market. Not only do the investigations implicate market participants across the board (banks, depository participants or DPs, brokers, registrars and investors), in what might well be the proverbial tip of the iceberg, it also raises questions about the efficacy of the book-building processitself, through which the price of a security is discovered prior to its listing on the exchange. In a little over a month, more than 43,000

January 28, 2006

WEEKLYECONOMIC AND POLITICAL

Spectre of Benami Accounts

F
urther investigation into the demat racket first illegal. It is pertinent to note here that SEBI clearly states unearthed by the Securities and Exchange Board on its website that a retail investor can open more than of India (SEBI) on December 15 last year has yielded one demat account, in the same name and with the same some startling revelations about the extent to which DP! Nevertheless, the opening of thousands of demat market infrastructure is being abused for illicit gains accounts with the same name and address on consecutive in the primary share market. Not only do the investi-days by the same DP should have acted as a signal to both gations implicate market participants across the board the concerned depository and regulator. There is a strong (banks, depository participants or DPs, brokers, regis-case now to curb this facility, especially with regard to trars and investors), in what might well be the proverbial the same DP, whose purpose, apart from making multiple tip of the iceberg, it also raises questions about the applications for primary issues, is not clear. SEBI is also efficacy of the book-building processitself,through which considering barring share transfer before listing, for the price of a security is discovered prior to its listing there is a gap of seven days between share allotment on the exchange. In a little over a month, more than 43,000 and listing and this should help in plugging one conduit. ‘benami’ or bogus demat accounts in the initial public The failure on the part of concerned banks to impleoffering (IPO) of IDFC and 7,600 accounts in that of ment know your customer guidelines is just as glaring. YES Bank were found to have been operated by a clutch Though the Reserve Bank of India might have penalised of investors to obtain share allocation under the retail the banks with a paltry sum, the pattern of transactions category. The open use of benami bank accounts to fund suggests a level of connivance that demands investithese transactions also reveals the ease with which gation into the actions of bank officials and severe action money can be laundered in the system. The scam worked against them if need be. So far the regulator has not like this: the shares obtained by applying for an issue initiated any such process with the bank boards. Though through these thousands of accounts were transferred to the central bank is right in saying that it cannot microthe principal actors through off market transactions prior manage the activities of every bank branch, this unto listing and then sold at a hefty profit on the day of wittingly confirms that there has been a failure of proper listing. In the IDFC issue, the “investors” were able to surveillance and governance of the banking system. The get allotment of a stunning 8 per cent of the shares in irregularities remained undetected even through the retail category in this way. several layers of audit across seven large well estab-The practice of multiple applications is certainly not lished banks and it is likely that more damning evidence new to the Indian stock market – prior to the capital will emerge from the scrutiny of other IPOs. There is market reforms initiated in 1991, formula-based issue clearly a need for close coordination between the RBI pricing by the Controller of Capital Issues ensured and banks’ internal audit systems for improved methods abnormal profits to applicants in the secondary market of surveillance as well as supervision. after listing. In spite of moving to market determined Lastly, there is the question of whether the bookpricing, the incentives for mischief have reappeared, building process itself is more amenable to abuse. The with most new issues gaining in price upon listing in price discovery that takes place through bidding by the current bullish phase. But what distinguishes the institutional buyers, high net worth individuals and retail present events is the regulatory grey area that not only investors is less than perfect and, in fact, issues are often offers loopholes to manipulators, but also raises doubts structured so as to leave “something on the table” for

about which of their actions could strictly be termed investors. In other words, the issue price is pegged in

a way that it might list at a premium and thus attract more investors. The other problem is that the retail category is rarely as heavily oversubscribed as the others and the greater chance of getting an allocation might provide an inadvertent incentive for filing multiple applications. One option might be to adopt a proportionate allotment method, in which all applicants would get a fraction of the shares they applied for, depending on the degree of oversubscription. A more extreme proposal would be to adopt a pure auction method to arrive at the issue price of a security in which institutional investors and high net worth individuals would tend to have a larger role in price formation. Retail investors could then pick up shares in the secondary market as the difference between the issue and listing price would be minimal if the former truly reflected demand. There is a need now to come down heavily on those involved to set a precedent of low tolerance for fraudulent activity in capital markets, but the opportunity to ask some hard questions about systemic chinks should not be lost. EPW

Economic and Political Weekly January 28, 2006

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