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

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Stock Markets: IPO Plot Thickens

IPO Plot Thickens The Securities Exchange Board of India


IPO Plot Thickens

he Securities Exchange Board of India’s (SEBI) sweeping order against a range of market participants in relation to the initial public offer (IPO) scam on April 27 leaves no doubt about the regulator’s intentions: to clean up the mess and send out a clear message to market participants about its willingness and ability to take strident penal action against wrongdoers. Events since have demonstrated why mere good intentions might not be enough. The regulator clearly did not anticipate the confusion its order would create in the minds of investors, who believed they would have to discontinue trading through the brokerage firms that had been penalised and/or suspend their transactions with the 12 indicted depository participants (DPs). Even though a clarification the following day specified that client transactions would remain unaffected, as the order applied only to the proprietary accounts of brokers, it gave investors 15 days to shift their accounts from Karvy and Pratik DP (the most serious offenders). The market tanked by nearly 500 points and two of the named players, Karvy and broker Saumil Bhavnagiri, managed to get stays on portions of SEBI’s order by moving the Andhra Pradesh and Gujarat High Courts respectively. The result is that the regulator looks like it has been a victim of rash judgment, or worse, it has not done its homework even though it conducted a difficult and meticulous investigation into the demat scam that broke in December 2005. Unlike the past, the regulator has demonstrated its resolve to clamp down on mischief makers, though it has shown itself in a poor light by its lack of attention to the operational and legal issues arising out of its order.

It came to light in the IPO allotment process of Yes Bank and IDFC that thousands of benami bank and depository accounts had been used by a few operators to file multiple applications to get allotment under the retail category. The shares were transferred to the financiers through off-market transactions prior to listing and then sold upon listing at a hefty profit. A wider investigation at SEBI’s behest revealed that between 2003 and 2005, cases of manipulation by 24 key operators were found in the instance of 21 IPOs. In all, 58,938 benami accounts were used to apply for allocations in the primary market under the retail category; 84 per cent of these were opened with Karvy DP. What stands out here is the degree of coordination or even collusion between a range of market participants that facilitated the exploitation of “fortuitous” loopholes in the system and the generous oversight of norm violations. Demat accounts were opened prior to the opening of bank accounts or on the basis of fraudulent bank letters, DPs accepted consolidated cheques for payment towards transactions in multiple accounts, while the ruse of allowing a separate “address for correspondence” in the depository system simplified matters a great deal for the scam operators. Inspection of DP activities by the depositories has been found by SEBI to be glaringly inadequate; a systems audit conducted at NSDL found that the client data uploaded by a DP is never actually checked. In fact, NSDL does not even check if a DP physically exists before it recommends registration with SEBI! NSDL’s data management software has been found wanting in many respects, while the depository itself has not maintained account creation dates prior to 1999. These are serious lapses to say the least, considering that the depositories are like safe vaults that hold the country’s capital market assets. In view of this, it is surprising that the market regulator has let off the depositories so lightly, by simply directing them to “take all appropriate actions including revamping of management….”

Twenty-four of the key operators as well as 85 other individuals and firms who acted as their financiers have nevertheless been barred from the market until further notice. Twelve depository participants have been directed not to open new demat accounts, in addition to the two (including Karvy) that were prevented from doing so in January. The stay obtained by Karvy even allows it to open fresh demat accounts, though the other affected DPs have not moved the court, possibly because this section of the business is either

Economic and Political Weekly May 13, 2006

not very significant or profitable. Penal action might still be the easy part, ensuring that due diligence is exercised by key market participants every step of the way and that surveillance and monitoring systems are sensitive and responsive to irregularities is the harder task. The regulator must now focus on ways to overturn the lethargy that has set into the system and come up with solutions to ensure that violations show up faster on the radar of key market participants.


Economic and Political Weekly May 13, 2006

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