The skeletons from the scam

Print edition : March 02, 2002

The JPC report on the stock market scandal of 2001 would constitute the basis for a comprehensive clean-up of the financial system to shore up public confidence in it.

AFTER many months of low-key progress, the inquiries of the Joint Parliamentary Committee into last year's stock market scandal have begun to gain momentum. There are now realistic expectations that a report may be ready before the Budget session of Parliament runs its course, allowing a discussion to be scheduled along with the wider debate on economic policy and regulation that will follow the presentation of the Union Budget.

The JPC's main deliberations are centred around a series of voluminous reports that have been submitted by the statutory regulatory authority for the stock markets, the Securities and Exchange Board of India (SEBI). Though SEBI was itself found wanting in the enforcement of its authority over the years in which scam was brewing, it is keen now to retrieve credibility with both the investing public and Parliament. Its reports constitute a microscopic examination of the many dubious transactions that culminated in the short-lived bull run in the markets after last year's Union Budget was presented.

Though the Budget in itself provided a rather scant basis for a broad-based investment fervour, a small cartel of operators sought to utilise the momentary euphoria it had engendered to drive up prices and liquidate the long exposures they had taken. It was a self-defeating exercise since a rival cartel of bear operators knew from prolonged observation of the markets just where the vulnerabilities of the bulls lay. Shrewd short-selling in the expectation of profits to be made on the downside of the markets rapidly pushed prices down.

But the bulls had by then gone too far out on a limb. In a climactic contest between bulls and bears, stock markets nationwide plunged into an acute payments crisis, necessitating their closure for an extended period. They have remained subdued since reopening, manifesting a gradual and long-term drift downwards as bad news has piled up, not least from the financial results of companies whose infinite prospects seemed until last year to be the pivot around which the promise of the "New Economy" would be built.

The reigning narrative on the scam is that the bear operators were the villains of the piece. An assiduous effort to foster this public impression is evident in the sequence of official actions and the targeting of Shankar Sharma, chief of First Global Stock Broking and a key figure in the bear cartel. There is a certain symmetry here, as also a contrast, with the 1992 episode, when the bull operations spearheaded by Harshad Mehta, since deceased, were identified as the source of the evil and all the ignominy of rigging the markets was heaped on him. Now, as then, this remains an incomplete picture, and not just for the reason that the victimisation of Shankar Sharma has been read, with some accuracy, as payback for his shareholding in tehelka.com, the Internet news magazine that exposed in March 2000 certain scandalous trends in the matter of defence procurement.

The official narrative fails to carry credibility for the simple reason that there were two parties playing the price-rigging game. And the bear cartel came into the game rather late, when it became evident that the bulls had exposed themselves rather indiscreetly by a sequence of long investments that could not possibly earn them the speculative rewards sought.

The bull operation evidently served an ideological function. Since 1998, the information technology (IT) sector has been designated as the advance guard of a new phase of growth in the Indian economy that would reduce the old fundamentals to irrelevance, propelling the country into the frontier regions of the "New Economy". Aggressive buying by bull operators in certain scrips was expected to pay back through the sheer power of the self-fulfilling prophecy. But the limits of speculative excess had clearly been reached by March last year. Desperate for a bailout, the bull operators contacted the Unit Trust of India (UTI), the country's largest mutual fund. Seeming since long to have forgotten the burdens and obligations of its trusteeship function for public savings, the UTI was easily drafted into this role.

The crisis that has beset the UTI since the stock market crash last year is also part of the JPC's terms of reference. And in pursuing this inquiry, the JPC has the findings of the three-member committee that was set up last year by the Finance Ministry (the S.S. Tarapore Committee) to serve as preliminary guide-posts. The evidence gathered by the Tarapore Committee, though incomplete, offers a telling commentary on the manner in which the stock markets were manipulated in the service of the pecuniary advantage of a few and the larger ideological agenda of an economic reforms process that was running rapidly aground.

In March 2001, the top management of the UTI received from a broker cartel in the Calcutta Stock Exchange (CSE) an offer of a number of shares in two "New Economy" firms - Himachal Futuristic Communications Ltd (HFCL) and DSQ Software Ltd - at specified prices. Both the offers were discounted against the prevalent prices then and the UTI seemingly did not pause to examine the fundamentals of the companies involved. A little deliberation would have served it well.

Since a brief spell of public notoriety after being implicated in a collusive bid for telecom licences in the mid-1990s, when the tainted Himachal Pradesh politician Sukh Ram held the Communications portfolio, HFCL had sunk into obscurity. It re-emerged rather mysteriously in 1999 as a star performer on the bourses. DSQ Software had similarly ridden the euphoria for IT scrips into a wholly inflated valuation of its share price on the market.

In March 2000, the DSQ share was trading at over Rs.2,600 in the Bombay Stock Exchange (BSE). By October that year, it had fallen to Rs.307. HFCL, according to the SEBI report, showed a roughly similar share price trajectory. Both scrips registered a minor recovery subsequently, but when the UTI picked up large volumes of these shares in March last year, on the basis of a telephonic understanding with CSE operators, they were rapidly plunging in value. A 10 per cent discount was offered by the CSE operators, but the UTI's sense of accomplishment in obtaining this bargain must surely have been short-lived, since the following day values fell by 16 per cent and more. Today, the scrips of both HFCL and DSQ are worth next to nothing. And it would strain credulity to argue that the UTI could have gone through these transactions without collusive intent.

Behind the whole ignominious episode in the stock markets looms the figure of the Mumbai-based broker Ketan Parekh and an operation that was under way for at least two years prior to the final reckoning. Parekh controlled no fewer than 23 "entities" which operated in the markets, buying and selling shares in a bewildering maze of transactions. This conscious design of complexity succeeded for long in hiding the nexus between the sources from where Parekh was obtaining his funds - corporate houses and banks - and their ultimate destination in speculative ramping up of share prices.

SEBI has laid out a catalogue of the corporate entities that transferred large sums of money to Parekh to play the markets. Apart from DSQ and HFCL, the list includes all the entities whose shares attracted Parekh's speculative attention - the Essel group which controls the television broadcaster Zee, the software group Satyam, drug manufacturers Cadilla and Ranbaxy, and a few others. Parekh of course also tapped a rich vein of finance by inducing Global Trust Bank to sanction overdrafts well in excess of both its and his means. And the trail of fraudulent paper generated by the Madhavpura Mercantile Cooperative Bank (MMCB), with the intent of lubricating Parekh's speculative forays, ended in the collapse of the bank and the financial ruin of its numerous depositors.

The Essel group began transferring large volumes of funds to Parekh when the scrips of its companies, notably its flagship enterprise Zee Telefilms Ltd (ZTL), began gently to subside from the stratospheric heights they had touched in early 2000. According to the testimony received from the Essel group management, a specific undertaking was obtained from Parekh that the funds would not be used for investments in the listed companies belonging to the group. But SEBI has also been informed that the Essel management is aware that Parekh used funds provided him for certain "unauthorised" investments.

Between October 1999 and March 2001, when the ZTL share went through the cycle of boom and bust, Triumph Securities, a company owned by Parekh, accounted for over 18 per cent of the purchases of this scrip on the BSE. On the CSE, Parekh was a significant contributor to the purchases of ZTL shares by two big brokerage houses - the Singhania and Poddar groups. Both the big Kolkata brokers have now been declared defaulters, in part because they made extravagant purchases of these scrips at prices that the market could not be driven up to, even with all their access to corporate funds and bank deposits.

SEBI has made the observation that the large-scale transfer of funds to Parekh began when the shares of the corporate entities concerned were generally on a downward trend. But the derivative argument that the funds were not directly used to prime share values for the companies concerned may not quite stand scrutiny. It may be more credible in the estimation of some JPC members to believe that the funds were transferred with the intent of bolstering prices on the stock markets, so that the companies concerned could complete an ambitious sequence of planned mergers and acquisitions.

SEBI's findings on Cyberspace Infosys, which managed to ride the rollercoaster of a bull run without Parekh's benediction, constitute a telling narrative. Begun in obscure circumstances as a leasing and finance company, Cyberspace acquired its current identity in 1998 with a shrewd eye on the main chance that the hyperbole over IT offered. It claimed to have technical arrangements and tie-ups with Microsoft, Oracle and Lotus, leaving few enterprises from the global high-technology pantheon outside its gaze. It began 1999 with a modest quotation of Rs.38 on the BSE and showed little promise as the year wore on. In September, however, it began a dizzying ascent, touching by mid-March 2000 a quotation of Rs.1,300 on the BSE. The rapid descent began shortly afterwards. Cyberspace closed the year 2000 quoting at just over Rs.140. After the bull run of March 2001 had ended, it was down to the rather pathetic level of Rs.11.

The rise and fall of Cyberspace is a saga that directly implicates the UTI, which began large purchases of the share in September 1999 and continued doing so until March the following year. SEBI has seemingly sought to exculpate the UTI management by arguing that purchases of Cyberspace rarely triggered the circuit breakers that serve to stop trading in a share when prices ascend or descend too sharply on a given day. But this overlooks the simple fact that the circuit-breaker is a short-term remedy used to check speculative excesses on particular days. It has little efficacy in curbing a sustained speculative run on a scrip, as with the UTI's purchases of Cyberspace. And rather revealingly the SEBI report has observed that of the UTI's purchases of this scrip, over 34 per cent were transacted with entities directly associated with some members of the Johri family, the promoters of Cyberspace who are now fugitives from justice.

THE government is today engaged in a desperate holding operation to stem the rapid depletion of public trust in the UTI. Apart from the substantial financial outlays that will be required, which could run to over Rs.6,000 crores, the government also faces a yawning credibility gap.

In July last year, the UTI suspended repurchases in its pivotal US-64 scheme. Over the preceding May, the fund had faced redemptions of an unprecedented magnitude in this scheme, five times higher than in April. This was considered unusual and suggestive of a breach of confidentiality that benefited chosen corporate investors and individuals.

The Tarapore Committee has glossed over this matter with an anodyne argument: since the BSE indices were also falling, it is more than likely that a well-informed investor would have known that US-64 would also run into choppy waters, prompting a flight out of the scheme. Far from suggesting any breach of confidentiality, the committee has argued that this only points to the inherent advantage that nimble-footed investors have over others. But given the current state of knowledge about the UTI's dubious dealings, the burden of proof clearly stands reversed. A more convincing explanation would have to be found for the large-scale redemptions that occurred in May last year, to discharge which the UTI had to contract large commercial loans.

The stakes involved in the US-64 clean-up were aptly summed up by the Deepak Parekh Committee which went into the UTI's travails in a less turbulent time. "With over two crore unit holders," it observed, "public confidence in US-64 is a virtual proxy of public confidence in the Indian financial system." The Tarapore Committee has chosen to reiterate this finding, while refusing to venture into contentious terrain which could lead directly to evidence of malfeasance. The JPC presumably cannot afford that luxury, since its findings would constitute the basis for a comprehensive clean-up on which the financial security of those crores of investors depends.

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