After the horses bolted

Print edition : April 28, 2001

SEBI has stepped in, and action has been taken against many of those involved in the recent stock market fraud, but it all amounts to too little, too late.

A LITTLE like the police as pictured in many of the movies that are churned out by the Mumbai-based film industry, the Securities and Exchange Board of India (SEBI) arrived at the scene of India's largest stock market fraud after all the action was over. A fortnight after stockbroker Ketan V. Parekh's arrest on March 30, SEBI finally acted to break the nexus among banks, corporate houses and brokers. On April 15, SEBI submitted its interim investigative report on the scam to the Finance Minister following bitter criticism that the regulatory body had failed to do its job. The interim report lays bare the collusive practices that bound together banks, brokers, fund managers and market regulators, all working together to rig share prices. Action has now been taken against companies and individuals involved in the fraud, but hundreds of thousands of small investors who lost their savings believe it is just too little, too late.

SEBI's investigations, in a sense, only affirm much of what is already known about the scam. The report has confirmed that Parekh, who led the bull cartel, was instrumental in pushing up share prices to spectacular levels, paving the way for their eventual, and equally spectacular, collapse. The Banks' exposure to the broker, SEBI's report says, is "huge". In essence, Parekh borrowed funds from banks against shares of dubious real value, and used the money to jack up the value of the stocks he held. This circle was broken by the bear cartel, alarmed at the apparently endless boom in the markets. The main players of the bear cartel, including former president of the Bombay Stock Exchange (BSE) Anand Rathi and brokers Nirmal Bang and R.S. Damani, also used dubious practices to precipitate the crash. All three have been suspended from trading, and SEBI has promised that they will face punishment.

Ketan Parekh being taken to the court.-VIVEK BENDRE

Parekh's arrest seems to have had something of a ripple effect in the markets. For the first time, SEBI barred a foreign brokerage from trading. On April 18, the brokerage arm of Credit Suisse First Boston (CSFB) was asked to stop its operations. In addition, SEBI named Shankar Sharma, chief of the First Global, a brokerage as one that played a role in pummelling stock prices. The naming of Sharma assumes significance as he is a large stock holder in Tehelka.com. Although there is no allegation that he had any role in the arms deal investigation, some believe that Sharma had inside information on when Tehelka would begin its expose of corruption in defence and arms deals. SEBI has also sacked the entire broker director governing board of the BSE. However, even while SEBI is attempting to clean the mess, its own house remains to be set in order. Its director D.R. Mehta could be held accountable for much of the crisis. Among the victims of the scam it is becoming increasingly clear that one could well be him.

Enterprises such as Global Trust Bank (GTB) and the UTI Bank, believed to have been key collaborators of Parekh, have also suffered casualties. The proposed merger between GTB and UTI Bank had to be called off when it became clear that Parekh had helped ramp up GTB stock prices just before the deal went through. GTB chairman Ramesh Gelli has resigned following charges that he aided and schemed with Parekh. Although he vehemently denies Parekh's involvement with UTI investment, the fate of UTI chairman P.S. Subramaniam remains uncertain. SEBI investigators believe that Parekh regularly used UTI to dump ramped up shares, and that its fund managers often backed stocks he had purchased in violation of prudent investment norms. UTI has already suffered the consequences of recent events, and has been forced to put on hold its plans to enter the insurance sector.

Interestingly, Parekh's long-time mentor, Harshad Mehta, has been one among SEBI's recent victims. Mehta, the architect of the 1992 securities scandal, has been barred for life from trading for having worked with his protege to engineer an abortive bull run in 1998. Three high-profile corporations, BPL, Videocon and Sterlite Industries, have been barred from accessing the capital markets for a period of four, three and two years respectively. All the three companies were under investigation for a long period as they were suspected of manipulating their share prices with Mehta's assistance. Interestingly, critics of the sale of the public sector Bharat Aluminium Company (Balco) had pointed out that Sterlite had been blacklisted for share-price rigging in the past. The fate of the Balco sale, in the wake of Sterlite's recent problems, is still unclear. All the three companies have filed legal appeals against SEBI's ban. Mehta, already battling trial court convictions related to the 1992 scam in the Supreme Court, also intends to fight the sanction against him in court.

Parekh's manipulation of the market, like that of Mehta, was in essence simple, even crude. His research companies would identify fledgling technology companies, and other ICE (Information, Communication and Entertainment) stocks. Some of these companies had good business models, at least on paper, but little stock market presence. After talking to the company's promoters, Parekh's associates would start propping up the share prices by enhancing its market activity. This is where UTI's role became crucial. UTI's mutual fund division, allegedly under Parekh's influence, invested heavily in the stocks he favoured. Other mutual fund investors followed suit believing that the market activity indicated that these companies had a good future. Pentafour, Global Telesystems, Zee Telefilms and Himachal Futuristic Communications Limited (HFCL) were among the favoured shares.

However, UTI was not the sole ally of Parekh. Other banks, notably the now bankrupt Madhavpura Mercantile Co-operative Bank (MMCB), regularly issued him credit against his overpriced ICE stocks. Investigations have shown that MMCB violated Reserve Bank of India (RBI) regulations to provide about Rs.840 crores to Parekh's companies. Banks such as GTB and Standard Chartered had also given Parekh an over-draft facility which he used to recycle funds in the market. SEBI's investigations reveal that by the end of March, Ketan Parekh had access to almost Rs.2,000 crores of funds, primarily from banks. "Ketan Parekh misused the banking system to channelise banking funds into the stock market," the SEBI reports says.

All this worked well, until the slow-down in the United States markets in February led foreign institutional investors (FIIs) to sell off their holdings in India. Tehelka.com's expose initiated an even sharper downward spiral, enabling the bear cartel to launch a final, full-blown onslaught.

Rumours that Parekh was facing financial problems began making the rounds in the market and this heralded the final act. Desperate to prop up his share values, Parekh took a Rs.140 crore pay order from the Ahmedabad-based MMCB. Bank of India (BoI) discounted that pay order and gave Parekh Rs.137 crores. However, these funds were to disappear into the falling market. BoI, like Parekh, also lost money. When the pay order was sent to the clearing house, it bounced. Parekh's over-valued shares had collapsed and MMCB could not raise the money to meet its obligations. Following this, the 38-year-old Ketan Parekh was arrested in connection with a Rs.137 crore BoI pay order scam (Frontline, April 27). Soon after Parekh's arrest, MMCB chairman Ramesh Parekh surrendered to the police. Central Bureau of Investigation (CBI) officials have opposed Ketan Parekh's bail applications, arguing that the full extent of the conspiracy behind the fraud has yet to be discovered.

While SEBI's action is welcome, it might soon face questions about its somnolence when the fraud was on. The Central government was believed to be unhappy with SEBI's conduct and a complete overhaul of the capital markets regulatory body was announced. CBI officials were to investigate why SEBI chose to turn a blind eye to the conduct of the bull and bear cartels, given that several market analysts were aware something odd was going on. There is a lot of pressure on the government because a large number of small investors have lost their money. With interest rates coming down, many middle and lower middle class people saw the stock market as a suitable investment option. Many people lost their hard-earned savings when the stock market crashed. ICE stocks have been trading at almost half their bull run value. Many people believe that most of these stocks are unlikely to recover any time soon.

Helped by interest rate cuts in the U.S., the BSE Sensex staged a minor recovery in recent days and industry heavyweights were attempting to raise stock prices. The rupee too has shown some short-term stability, helped again by inflows from foreign investors. But while the stock market may slowly be recovering from the March 2 crash, the events that followed have caused enormous structural damage to both stock prices and market confidence. The instability has been compounded by bell-wether stocks like Infosys Technologies announcing profit warnings. Making matters worse is the slowdown in the U.S. economy which has dampened investor sentiment.

On April 12, the financial markets went into a tailspin with the Sensex touching a 28-month low of 3183.77 points. On April 16, the rupee weakened against the dollar to reach an all-time low of Rs.47. Selling pressure led by index heavyweights such as Infosys, Zee Telefilms and Satyam Computers in the wake of the U.S. slowdown and scam-related action were believed to be partly responsible for this.

Meanwhile, Finance Minister Yashwant Sinha announced in the Lok Sabha that the Central government was planning to take some steps in order to put an end to manipulation of the stock market and rigging of share prices. Among the actions planned are amendments to the SEBI Act of 1992 in order to strengthen the market watchdog. Yashwant Sinha said that the stock exchanges will have to develop software and create suitable infrastructure before July 2 in order to make trading more transparent.

The RBI is also expected to take stringent action against those who violate regulations. In the credit policy that was announced on April 19, the RBI had said that cooperative banks must not lend against shares to individuals or organisations. Other rules and guidelines for urban cooperative banks will soon be introduced. As an incentive to honest players, banks will also be allowed to offer loans at rates lower than the market lending rate to creditworthy borrowers.

However, it is worth remembering that each market fraud in the past has provoked promises of reform, none of which has had any evident effect. The current scam and the market crash has wiped out over Rs.2,00,000 crores of market wealth. Ordinary people have paid a heavy price. Hopefully, it will not take a decade to secure justice, as it did with the Harshad Mehta scam of 1992. It remains to be seen whether the government can plug the holes in a system that allowed racketeers such as Parekh and Mehta to thrive.

This article is closed for comments.
Please Email the Editor