Belated response

The Central government moves to counter criticism against it over the US-64 crisis.

THE arrest of former Unit Trust of India (UTI) Chairman P.S. Subramanyam and two of the public sector organisation's Executive Directors on July 21 and two other persons on July 25 may well be the first step towards bringing to book people involved in the Unit-Scheme 1964 (US-64) crisis. Ahead of the arrests, as part of attempts to restore investor confidence in the UTI, the Central government announced on July 20 the constitution of a three-member panel, headed by former RBI Deputy Governor S.S. Tarapore, to investigate investment decisions taken by the UTI during the last 10 years. The panel will submit its report in three months.

In announcing on July 2 the UTI's decision to suspend the sale and repurchase of US-64 units for six months, Subramanyam opened a can of worms. It is now known that some investment decisions made by the UTI during the period that led up to the crisis were arbitrary and sometimes even made against evaluations made by its own Economic Research Cell (ERC). Although there is no conclusive evidence of political interference or insider-trading, UTI officials who stand accused in the matter say that instructions came from above. Moreover, it has still not been explained why Rs.4,151 crores came to be withdrawn, primarily by corporates, in May just before the suspension of US-64 was announced. Although the Central government had evidently seen the crisis coming, it did not take any precautions. Instead it chose to feign ignorance.

Subramanyam "resigned" as UTI Chairman a day after he announced the decision on US-64. Apparently, a senior Finance Ministry official called him on the day of the announcement and expressed the government's "lack of confidence" in him. On July 20, Central Bureau of Investigation (CBI) officials in Mumbai raided the residences and offices of Subramanyam, Executive Directors M.M. Kapoor and S.K. Basu, and General Manager Prema Madhu Prasad.

According to the CBI, the raids took place following a tip-off that the UTI, with Subramanyam's approval, had in 2000 invested Rs.32 crores in private placement of shares in a little-known software company, Cyberspace Limited. The CBI said that the investment caused "wrongful loss" to the trust. Moreover, the decision to invest was taken in spite of the ERC recommendation against subscribing to the offer. CBI officials also raided the residence of Cyberspace chairman Arvind Johari and a Mumbai stock broker, Rakesh Mehta. The raids, which began at 6 a.m., continued until late in the evening. On July 21, CBI officials arrested Subramanyam, Kapoor and Basu, charging them with cheating, conspiracy, misuse of office and misappropriation of public funds. Mehta was also taken into custody. Johari was arrested on July 25.

According to the case registered by the Economic Offences Wing of the CBI in Mumbai, the UTI officials conspired under pressure of "extraneous consideration" to enter into a private placement deal in July 2000. They purchased 3,45,000 shares of Cyberspace Ltd at Rs.930 a share, although the price of the company's scrip never crossed Rs.2 on the stock exchanges. The investments were allegedly channelled into the defunct Raja Lakshmi Scheme to avoid scrutiny by regulatory authorities.

Investigations by the CBI revealed that in June 2000, the UTI had received an offer to subscribe to a private placement of equity from Cyberspace. According to the First Information Report (FIR), the UTI's ERC concluded that "operations of the company did not deserve these valuations" and that the "fundamentals of the company may not be able to support a price, even half the offer price". Subramanyam and others endorsed the ERC's recommendation and the offer was rejected. However, four days later the proposal was suddenly revived and it was decided to subscribe to 3.45 lakh shares. The CBI says that share broker Rakesh Mehta acted as the conduit between UTI officials and the Johari brothers. In fact, the CBI claims that Mehta admitted during interrogations that he accepted Rs.50 lakhs to get the job done. Mehta also told the CBI that part of the proceeds were shared with the UTI "high-ups". CBI officials claimed that they recovered Rs.7 lakhs from Mehta's home.

The FIR states that there are reasons to suspect that Arvind Johari brought "undue and extraneous" influence on the executives of the UTI and "offered some consideration" to induce them to change their decision and subscribe to the shares. There is evidence, the FIR states, that SBI Caps and UTI Securities had recommendations to buy Cyberspace Infosys scrips even at prices of over Rs.1,000 apiece. The FIR claims that the funds raised through private placement were not utilised by Cyberspace for the stated purposes - to acquire companies based in the United States and the United Kingdom - but were diverted. The FIR says: "It is alleged that the said funds were ultimately utilised by the directors of Cyberspace for trading in the shares of their company." Moreover, UTI paid Rs.32.8 crores by cheque even before taking delivery of 2.42 lakh shares. The FIR said that Subramanyam was not only aware of but approved these transactions. Soon after the UTI issued the cheque, share prices of Cyberspace Ltd plummeted on the Bombay Stock Exchange. The FIR said that this clearly indicated that the share prices were rigged.

The Johari brothers are no strangers to the CBI. Two months ago they were arrested by the agency on charges of defrauding public sector banks and others to the tune of Rs.200 crores.

Since the Johari brothers, the promoters of Cyberspace Ltd, had a dubious reputation in business, it was not hard for the CBI to reach a conclusion. Moreover, the CBI alleged that by absconding, Arvind Johari had validated his guilt. The modus operandi of the brothers was quite simple. Companies owned by them would buy shares on behalf of investors. However, they would never transfer them into the name of the investor; instead they would use them as collateral to raise more funds from banks.

An interesting twist in the tale is provided by Cyberspace's alleged connection with the Prime Minister's Office (PMO). Cyberspace is a Lucknow-based company. In January this year, the Bharatiya Janata Party-led government in Uttar Pradesh entered into a joint venture agreement with the Joharis to set up Cybertron Technopolis, a software technology park, in Lucknow. Prime Minister Atal Behari Vajpayee was invited by the Uttar Pradesh government to inaugurate the project.

Miffed at being dragged into the controversy, the PMO issued a statement saying that Vajpayee inaugurated the venture but did not go to Lucknow specifically for this purpose. According to a report, one of the key collaborators of the Johari brothers, Pradeep Narayan Mathur, was a leader of the Vishwa Hindu Parishad (VHP) and a trustee of the Sangh Parivar-linked organisation called the Vishwa Samvad Kendra (VSK) in Lucknow. Informed sources told Frontline that while the Rashtriya Swayamsevak Sangh (RSS) insisted that Mathur was only an employee of the Joharis, in reality his political connections were instrumental in getting the Uttar Pradesh government to agree to the venture. A financial analyst said that not only were the Joharis influential in the State, but their links went up to the Centre. He added that the manner in which Subramanyam sanctioned the share purchase of Cyberspace suggested that political pressure might have been brought on him.

Defending the share purchase, Subramanyam told the Special Court in his bail plea that it was purely a business decision. He said he had taken several decisions in his career spanning 37 years and none of them had become problematic. He questioned the logic of persecuting him on the Cyberspace issue. The CBI said that the three accused did not have a plausible explanation as to why the decision not to invest in Cyberspace was revoked. The CBI said that although the three had not admitted to anything, they kept blaming each other.

After rejecting the bail application, Special Judge S.R. Mehra said that considering the far-reaching effects of the investigation on investors of the UTI, "it was desirable that the state, through the CBI, is given more time to decide on the matter''. The Special Court remanded Subramanyam, Kapoor, Basu and Mehta to police custody until July 27.

THE UTI's decision to suspend the sale and repurchase of US-64 units for six months has affected more than 20 million investors, most of them people who have invested all their savings in them. Every year, at the start of July (the UTI follows a July to June year), the trust announces its sale and repurchase price. Hence, the decision to suspend repurchases was unprecedented. "It is pure mismanagement of investments that has led the UTI to this situation," a financial analyst told Frontline. "They do not have the liquidity to buy back units and therefore give their investors a reasonable return of their investments," he added.

According to information that is available, the UTI manages Rs.57,500 crores in assets, about two-thirds of the total assets of the Indian mutual fund industry. "Any problem at the UTI is bound to have a negative impact on the entire Indian financial system as the UTI is the biggest investor in the market," a financial analyst said. "The fact that the UTI was linked to Ketan Parekh and his K-10 stocks should have made us realise that corrupt and unscrupulous people operated the trust," said Akash Gupta, who owned about 6,000 US-64 units. "They really duped us with the US-64 announcement," he said. He alleged that clearly there was a scam here. "How did many leading corporates pull out funds from US-64 in April and May this year before the ban?" he asked.

Tell-tale signs of deterioration in the scheme were evident for more than a year. Anticipating losses during the recent switch to Net Asset Value (NAV) pricing, many investors may have quit the scheme. Holding on to the poorly priced K-10 stocks to bail Ketan Parekh out was another sign of rot. Perhaps corporates pulled out, having seen the writing on the wall. Gupta said that investors expected the government to protect them should anything go wrong.

Meanwhile, the new UTI chairman, M. Damodaran, has announced a four-pronged strategy to revamp the mutual fund and restore investor confidence. Damodaran said that bank loans would be used to meet the redemption pressure and the government would be asked for an infusion of funds if share prices did not gain significantly. The size of the trust will be cut and there will be no more US-64 sales. Moreover, an asset management company will be set up and the US-64 scheme will be split into two or three schemes. The UTI will also hire professional fund managers paying market-related salaries. The most significant decision is to bring the UTI under the purview of the Securities and Exchange Board of India (SEBI).

The CBI investigations relating to Subramanyam, Kapoor, Basu and Mehta will continue. The CBI hopes to unearth much more on the accused, including facts on the charge by Subramanyam's supporters that he has been made a scapegoat. Meanwhile, Kapoor, Basu and Prema Madhu Prasad have been suspended by the UTI.

In Parliament, the Opposition has demanded the resignation of Finance Minister Yashwant Sinha in connection with the scam. When Parliament met on July 24, Sinha categorically denied allegations that he knew about the Cyberspace deal. Yet, the Centre's belated response to the UTI's troubles points to the Union government's casual approach to important issues. Regardless of Sinha's denials, it is becoming increasingly obvious that the buck stops at the Union Finance Ministry.