Scamsters, SEBI and the stock markets

Three months after it first unearthed the IPO scam in the Yes Bank and IDFC public issues, SEBI has finally passed a sweeping 252 page against a host of market operators, brokerages, financiers and depository participants. The order literally this morning, sending the indices to a free fall not seen in the last two years.

Apart from private financiers and shady operators, the order has also passed restrictions on some of the largest and well-known commercial banks, including foreign banks, and stock brokerages. Two depository participants — Karvy Stock Broking and IndiaBulls — have been told to shut shop and investors have been asked to shift their demat accounts within the next 15 days.

As SEBI has promised a final order shortly, the entities mentioned in the order have already started making representations before the regulatory body. All of them have denied any wrongdoing and early signs are that it would be some time before the issue is finally buried.

Modus Operandi
The method of operation of all the operators was similar. They opened thousands of bank accounts in fictitious names using false identity proofs, but with the same address. These banks accounts were used to open demat accounts through which they applied for IPO's in the retail category. (See: Thousands of accounts, same investor - the art of manipulating IPOs).

As IPO's started attracting huge interest from retail investors, getting allotment became increasingly more difficult. Submitting a large number of applications through thousands of demat accounts ensured large allotments to these operators. Large portions of the shares reserved for the retail category were cornered in this fashion.

As soon as the allotment process was completed, shares were consolidated in the demat accounts of the operators by transferring small lots from a large number of demat accounts.

The operators were funded by financiers, who received shares from the operators through off-market transactions before listing. Most of them sold the shares immediately after listing, making phenomenal profits.

Roopalben Panchal — the queen bee
The most active among the scam operators was Roopalben Nareshbhai Panchal, who was named by SEBI last year in the cases of Yes Bank and IDFC. She had many financiers had opened thousands of demat accounts through Karvy DP.

It is still not clear if Roopalben was directly involved in the scam as she is reportedly a lady who is well into her '50s. It is likely that someone used her name and identity, possibly close family members, to carry out the fraud.

The numbers in some cases are mind-boggling. She was allotted 72.04 lakh shares during the IDFC IPO through 12,258 different demat accounts. She had also cornered 15.8 lakh NTPC shares through 7,386 demat accounts and 9.47 lakh shares of Yes Bank though 6,315 accounts. She has been active in 13 other IPO's during the last couple of years.

Since these are only the number of successful accounts, the actual number of demat accounts through which she submitted IPO bids would be substantially higher. It is an incredible feat to have opened so many different accounts and managed the administrative details of submitting IPO bids for all these accounts. Business schools should consider inviting her to impart their students practical 'operations management' skills!

Of course, she had some resourceful financiers to back her. Among the prominent financiers of Roopalben are private companies like Seer Finlease which gave her Rs9.5 crore, Taurus Infosys with Rs3.3 crore, Excell Multitech with Rs4.6 crore and Zenet Software which provided her with Rs2.65 crore.

SEBI has worked out the possible profits made by the financiers of Roopalben if they had sold out on the listing day at Rs45.8 crore. The gains would have been much more if they had held on to their holdings as stocks like TCS, NTPC, Suzlon and FCS Software have subsequently appreciated much more.

Reports quoting finance ministry sources indicate that a penal ruling against Roopalben would be passed within two weeks. These reports indicate that she may be slapped with a heavy financial penalty.

Brokerages and their role
IndiaBulls is the most prominent brokerage mentioned in the SEBI order. The company has been a high flier in the last few years and has surprised many by the tremendous growth in business. Not content with stock broking, the company diversified into the real estate space and stunned the markets with some major deals worth hundreds of crores in Mumbai and New Delhi. Recently it has also ventured into retail financing.

SEBI has classified IndiaBulls as a key operator who received 13,939 shares of TCS from 559 different demat accounts. The company says these are genuine client accounts and the shares were transferred to the account of the brokerage as trading margins. The management argues that 13,939 shares of TCS are very insignificant for a large company like IndiaBulls to risk its reputation and invite regulatory wrath.

Karvy DP is one of the main culprits according to SEBI as more than 80 per cent of the fraudulent demat accounts were opened through it. An inspection by SEBI and an independent auditor on Karvy revealed many regulatory violations which are listed in the order. As expected, the company management has denied all allegations.

Interestingly, thousands of demat accounts were simultaneously opened with Karvy DP on the same day by some of the operators. Most of these accounts have been closed down subsequently, presumably on completion of IPO's.

Such large churn in demat accounts should have alerted the management, even if one were to accept the argument that they have not done anything wrong. SEBI also found out that Karvy DP failed to cross-verify the identity and address proof of demat account holders.

Karvy Stock Broking is listed as a financier in the SEBI order. The company management asserts that they have not financed even a single IPO applicant so far.

The role of SEBI
While market participants are lauding the SEBI action, analysts and the media, the fact remains that the regulatory body was slow in reacting to the problem.

These operators have been abusing the IPO process for more than two years now. By SEBI's own findings, these operators were indulging in fraudulent practices right from the follow-on issue from Maruti Udyog in June 2003. The fact that the scam came to light only last December points to the severe shortcomings of the market surveillance mechanism of the exchanges.

Even after the scam came to light following SEBI's preliminary investigations into the IPO's of Yes Bank and IDFC, the regulator did not take any proactive steps to plug the loopholes in system. It is believed that some of these operators and financiers were active in several subsequent issues. Some reports suggested that these financiers pumped in a total of over Rs6,000 crore in the recently concluded IPO from Reliance Petroleum.

The language of the order issued yesterday restraining some of the leading broking companies from trading was ambiguous. The order said stock brokerages like IndiaBulls and Karvy are barred from dealing in the securities market including IPO's.

Anyone reading the order would have interpreted that these brokerages are prevented from all trading, including trading on behalf of their clients. Television anchors and the pundits appearing on these channels supported this view and the lakhs of retail investors who invest through these brokerages must have had a sleepless night yesterday.

An order of such significance should not have left its operative part ambiguous and open to interpretation. To assuage investor fears, SEBI had to issue a clarification today morning that retail investors can transact through these brokerages.

The order that has been passed is an interim, ex-parte order and the persons and entities mentioned have 15 days to file their objections. Thereafter the final order would be issued and the defendants can approach the Securities Appellate Authority (SAT) with appeals.

If history is anything to go by, nothing much may eventually come out of SEBI's action. SEBI has had a very poor track record in defending its orders at the Securities Appellate Tribunal (SAT) and in most cases, the SAT has overturned SEBI orders.

Impact on markets
The media frenzy ever since the SEBI order was issued yesterday has created the impression that something catastrophic has happened to the stock markets. The panic selling witnessed in opening trades this was mainly a result of media hype.

The SEBI order would definitely have an impact on short-term sentiments. Most of this sentimental impact on individual traders and retail investors has already been played out this morning. The remaining uncertainty can now be expected to be erased when the next wave of liquidity lifts the indices.

The scam and its impact have not affected foreign investors and institutional investors in any way. No FII's or large domestic institutions are involved or were defrauded like in earlier scams. The confidence of overseas investors in Indian markets may in fact improve as the regulator has acted, even though it was a bit late.

The brokerages mentioned in the report like IndiaBulls would be severely affected in the short to medium term. They would lose the confidence of customers and would see significant erosion in their customer base. This would not have any impact on volumes as we are talking about just two brokerages who cater to online trading by retail investors. Most of these investors will move over to other brokerages and without let or hinderance.

Some analysts are worried about the action against some of the leading banks. However, these banks have been allowed to retain their existing depository customers. Besides, depository business contributes only a small portion to the revenues of these banks and hence would not have much of an impact.

There are unconfirmed reports that RBI may take stringent action against these banks, including a freeze on permission to open new branches and ATM's.

The fact that this development is not very significant for the overall long- term health of the markets was made clear from the sharp recovery of indices once the initial panic had settled down.

In fact, one would not be particularly surprised if this development leaves no impact on retail participation in future IPO's.