SEBI has within itself facets of the executive, legislature and judiciary. The article traces important cases tackled by the SEBI in the last quarter of a century and attempts to answer the question whether the Bureau has been able to make full use of the wide-ranging powers vested in it SEBI, per se, is one of the most empowered regulatory authorities. It has within...
SEBI has within itself facets of the executive, legislature and judiciary. The article traces important cases tackled by the SEBI in the last quarter of a century and attempts to answer the question whether the Bureau has been able to make full use of the wide-ranging powers vested in it
SEBI, per se, is one of the most empowered regulatory authorities. It has within itself facets of the trias politica as espoused by Baron de Montesquieu: the executive, the legislature and the judiciary. In its executive role, SEBI regulates a host of market intermediaries, conducts investigations of fraudulent and manipulative activities and monitors and conducts surveillance of the market systems. In its role as a legislative entity, SEBI frames rules, regulations, guidelines and circulars to govern and regulate the Indian securities markets. The quasi-judicial arm is responsible for passing of various types of orders against market participants in the Indian markets. The orders that SEBI is empowered to pass range from debarment from accessing the securities markets, disgorgement of ill-gotten gains, huge monetary penalties, cancellation of registration of market intermediaries, cease and desist orders and so on.
The natural question that arises is whether SEBI has been able to use and implement these wide ranging powers that it has been vested with in an effective manner? Has SEBI had a deterring effect on market manipulators or have market manipulators always been a step ahead of SEBI in this eternal game of cat and mouse?
The Harshad Mehta Saga
To reach a definitive answer to this question, one has to examine some of the serious market manipulations which have been investigated by SEBI in the last 25 years. The SEBI Act was notified in January 1992 and in April, it was faced with the Harshad Mehta Scam. Harshad Mehta, a stock broker at BSE, along with his associates, was accused of manipulating the BSE Sensex. Though broadly the Harshad Mehta scam was a banking fraud, (as loopholes in the banking system were exploited and huge funds were drained off from inter-bank transactions), the money which the banks were defrauded of was ploughed back into the stock exchanges resulting in a phenomenal rise in the BSE Sensex. When the fraud was discovered, almost by accident, the tables turned on Harshad Mehta and the banks started demanding the monies from him.
This resulted in the popping of the bubble and the Sensex, which had risen so dramatically, fell by almost 570 points, sending jitters through the system. Investigative agencies sprang into action and Harshad Mehta and his gang of operatives were charged with several criminal violations. Investigations and enforcement action followed but Harshad Mehta was out of jail on bail after some 100-odd days in custody. He subsequently set up a maze of companies which functioned as the Damayanti Group. He again managed to fuel investor imagination through one of India's first tip dispensing website. Also, it was alleged that he managed to get hand in glove with several reputable Indian corporates and build up another bubble. Unfortunately for Harshad Mehta, this time around too, the bubble burst and the SEBI investigation that followed resulted in him being debarred for life from accessing the Indian securities markets. Sadly, the famed "Big Bull" and the "Pied Piper" of the Indian securities markets perished while in jail on the last day of 2001, after living for 9 years with the #hashtag of a scamster!
It may be argued that the Harshad Mehta scam came as a blessing in disguise as the Indian authorities took note of the serious systemic lapses which triggered the entire scam. It took a genius to exploit the loophole and Harshad Mehta perhaps conducted his operations with the flair of the master conductor of an orchestra. SEBI took note of the developments and formulated several rules and regulations to ensure that the Indian securities markets were properly regulated and monitored. The year 1992 witnessed the introduction of regulations prohibiting insider trading, regulating brokers and for merchant bankers. The years that followed saw the framing of regulations governing intermediaries to a large extent and coupled with the powers guaranteed by the SEBI Act, SEBI started grandfathering a modern, secure and regulated securities market. However, this was not to be and became apparent when the Ketan Parekh scam again shook the very foundations of the Indian securities markets.
The Ketan Parekh Jolt
Ketan Parekh is reputed to have had Harshad Mehta as a mentor in his formative years. In 1999-2000 when Indian technology scrips were showing an upward trend, Ketan Parekh was instrumental in driving up plain vanilla technology scrips to record highs through fictitious, circular and synchronised transactions to name a few. He associated with several other stock brokers across exchanges, secured large loans from several commercial banks as well as cooperative banks, and invested heavily in his favoured basket of stocks, famously called the K-10 scrips.
Allegedly, Ketan Parekh obtained loans from Global Trust Bank to the tune of approximately '250 crores and from Madhavpura Mercantile Co-operative Bank to the tune of '1000 crores. However, the alleged bear cartel comprising entities like the Nirmal Bang group, the Anand Rathi group and the Shankar Sharma group placed huge sell orders on the K-10 scrips and the Sensex crashed by 176 points. Investigations revealed that Ketan Parekh had secured the loans from various banks using inflated K-10s scrips as collateral and the banks with exposure to these securities were the worst hit.
Incidentally, just a day earlier, the Sensex had risen by 177 points. SEBI initiated action against Ketan Parekh and ultimately after investigations and enforcement proceedings, debarred Ketan Parekh from accessing the securities markets till 2017. Understanding the severity of the scam, SEBI introduced measures which were to change the face of the Indian securities markets forever. The settlement cycle was reduced and the present T+2 cycle was introduced, stock exchanges were demutualised, Badla trading was banned, and exchange traded derivatives were introduced, to name a few.
The IPO Tale
The Ketan Parekh fiasco did change the face of the Indian securities markets. But it did not stop fraudsters and scamsters from coming out with innovative and manipulative schemes. The IPO irregularities scam is another case in point. The stock exchanges noticed severe irregularities in the Yes Bank IPO which hinted at the possibility of large scale off-market transactions immediately following the date of allotment and prior to the listing of shares on the stock exchanges. SEBI regulations prescribed a quota for "small investors" wishing to invest in the market. Typically, oversubscription in the retail segment of an IPO is substantially less than over-subscription in the non-retail segment for sought-after IPOs.
Certain entities had cornered IPO shares reserved for retail applicants by making applications in the retail category through the medium of thousands of fictitious / benami applicants, with each application being for small value so as to be eligible for allotment under the retail category. Subsequent to the receipt of IPO allotment, these fictitious / benami allottees had transferred shares to their principals who in turn transferred the shares to the financiers, directly or through a web of transactions that had originally made available the funds for executing the game-plan.
The financiers in turn sold most of these shares on the first day of listing thereby realising the windfall gain of the price difference between IPO allotment price and the listing price. SEBI investigations also found out that the photographs attached to the benami / fictitious applications were downloaded from popular matrimonial websites. Subsequently, all IPOs which had hit the markets between 2003 and 2005 were taken up for investigations by SEBI and similar modus operandi was discovered.
Proceedings were initiated against the key operators and the financiers, and inter alia, they were debarred from participating in the securities markets and called upon to disgorge ill-gotten gains. Incidentally, the role of market intermediaries was called into focus and their role was examined in detail. SEBI had prescribed Know Your Client (KYC) norms which each market intermediary was to adhere to.
The entire scheme for cornering the retail portion of IPOs could not have succeeded but for the active role played by Depositories and Depository Participants facilitating the opening of numerous demat accounts in fictitious / benami names which accounts were subsequently used for making applications in various IPOs, receiving allotment and thereafter pooling the same in the demat accounts of the key operators through offmarket transfers prior to or immediately after the listing and commencement of trading on the stock exchanges.
This resulted in the rescinding of the then prevailing SEBI (Disclosure and Investor Protection) Guidelines, 2000 and the notification of the SEBI (Issue of Capital and Disclosure Requirement) Regulations, 2009, through which the processes of raising funds from the public was codified and given the force of law.
The Sahara Scheme
The law enforcement mechanisms of SEBI were once again put to the test in the landmark case against the Sahara companies and Subroto Roy Sahara himself. Two Sahara group companies which were privately held had taken advantage of a loophole in the Indian legal system and issued instruments to more than 50 people disregarding the fact that issue made to more than 50 people will be considered as a public issue, an activity which a private company is not permitted to indulge in.
Investigations were initiated and Sahara famously claimed that since the issuing companies were private limited companies, they fell within the regulatory purview of the Registrar of Companies and were not restricted by the norms governing issues to the public, which fell within SEBI's regulatory purview. Though SEBI had passed several orders, interim and final, Sahara moved from pillar to post, indulged in forum hopping, appealed to several High Courts, the Securities Appellate Tribunal and the Supreme Court. Subsequently, the Supreme Court took a stern view of the matter, as a consequence of which, Sahara Shree found himself behind bars. The Sahara matter, especially the way SEBI proactively and decisively took on the challenge, is laudable.
The Ponzi Emerges
The Sahara matter assumes even greater significance in the light of the outbreak of several Ponzi scheme frauds in India's eastern states. Several companies had mushroomed and were raising monies in a similar fashion from the public at large and seeking shelter under the general defence that they had been raised by Sahara. Schemes were being floated by these companies akin to collective investment schemes but they were not submitting to the regulatory purview of SEBI by registering under the Collective Investment Scheme Regulations.
The severity of this issue was highlighted with the collapse of the Sharda Group in West Bengal and the seriousness, severity and intensity of the possible implications are mind-boggling. SEBI is currently investigating the matter and hopefully the investigations will be concluded soon.
Investigations Begin
The various scams when they break always cast a shadow of doubt on the competency of SEBI to regulate the markets effectively. One of the instances which is highlighted not only by the media but also by the Securities Appellate Tribunal is the time taken by SEBI to complete its investigations in the matters and pass final orders. SEBI had taken years and years to complete its investigations into the scams perpetrated by Harshad Mehta, Ketan Parekh and associated entities, the IPO irregularities matter, the Sahara irregularities as well as the ongoing Ponzi scheme investigations.
Comparisons were drawn with similar regulators like the Securities Exchange Commission of the US and the Financial Services Authority of the UK to demonstrate the speed with which their investigation and enforcement actions were concluded. Thus, we need to briefly examine in broad strokes the process and procedure followed by SEBI in conducting its investigations and enforcement actions.
A fraudulent and manipulative activity is brought to SEBI's notice through various channels. The fraudulent and manipulative activity may be detected by the surveillance mechanisms at SEBI, BSE, NSE or any of the exchanges, brought to the notice of SEBI by any entity or intermediary, by way of a simple investor complaint, sharing of information by other authorities or agencies, direction from any authority, to name a few.
On receipt of this information, investigations are initiated and information is requested from the various identified entities. If the entities from which SEBI has sought information do not co-operate, SEBI issues summons to demand the same after converting the preliminary examination into a formal investigation. Data from the exchanges, market intermediaries and other associated bodies are obtained.
The trade logs and order logs are examined to identify the trades which may be fraudulent or manipulative trades. Once the trades are identified, the role of the participants and the intermediaries is looked into. The identified entities are then examined under oath and in person, firstly by requesting cooperation or otherwise by issuing summons. The entire data generated is analysed and linkages are established between the various actors to the fraud. Data is also obtained regarding the flow of funds between the various parties and the fund flow data is examined in the light of the flow of securities.
Additionally, call records are identified and used to corroborate the findings of the investigation. Once the investigations are complete, proceedings are initiated against the identified parties who allegedly participated in the market fraud, show cause notices are issued, replies received by the parties are reviewed, the parties are granted opportunities of personal hearing before the authority in SEBI hearing the matter and lastly an order is passed in the matter. Often, during the pendency of investigations or when the alleged fraud is noticed, SEBI passes ex-parte ad-interim orders too enforcing interim action against the concerned entities.
SEBI is bound by the principles of natural justice and thus provides several opportunities to entities to either submit information, reply to show cause notices, appear for statement recording exercises or appear for personal hearing before the internal authorities. It is trite to mention, that a lot of the delays associated with the entire investigation process are because of the numerous opportunities which are granted to parties to provide information or because SEBI tries to adhere to the principles of natural justice. There have been several instances when investigations conducted by SEBI or orders passed by SEBI have been struck down by the appellate authority, namely the Securities Appellate Tribunal.
In several cases, the matters are remanded back to SEBI for fresh examination for technicalities connected with the framing of the charge in the show cause notices or on grounds that SEBI has acted in contravention of the principles of natural justice. In such an event, the process recommences from the stage of issuing the show cause notice and the entire cycle is repeated again, ensuring that the proceedings stretch on.
Let's Fast Track It
It must be highlighted that justice delayed is justice denied and as such, it is the duty of the SEBI to ensure that it is in a position to complete its investigations at the earliest. There are certain steps which SEBI may resort to ensure that its investigations process is streamlined further. SEBI must resort to maximum use of technology in identifying the fraudulent activities in the market as well as the manipulative and fraudulent trades. The trade log and order log examination process may also be automated or processed with the help of technology, thereby reducing the timeframes involved.
SEBI already has systems available with it called the Integrated Market Surveillance System (IMSS) and Data Warehousing Business Intelligence System (DWBIS) which are essentially infrastructure and processes for data acquisition and collection, alert generation and tracking, and research and regulatory analysis.
The DWBIS is reported to be a data integration solution using SAS data warehousing and analytics technologies for fraud investigation. The system is also said to be primed to monitor and spot market malpractices, market manipulation patterns and also monitor circular trading, pump and dump scenarios, insider trading and front running practices. It is highly recommended that SEBI proactively deploys these fairly advanced systems to actively curb securities fraud and bring order to the Indian securities markets.
The enforcement proceedings initiated by SEBI after completion of the investigations also suffers from a serious flaw which needs to be addressed at the earliest. SEBI has the power to initiate adjudication proceedings against market participants, inquiry proceedings against SEBI registered intermediaries and proceedings under Section 11 of the SEBI Act.
During the pendency of the proceedings, for various reasons, the officer conducting these proceedings is replaced and new officers appointed, mostly because the officer previously presiding on the proceedings has been transferred to another department. This creates a huge problem as the new officer appointed to conduct the proceedings reexamines the issue and often grants an opportunity of personal hearing to the entity.
Thus, the vicious cycle of delays is again repeated. This not only severely impacts the aggrieved party, it also portrays SEBI in a dubious light to market participants. SEBI may explore ways and means to ensure that the officer presiding over a proceeding, except for retirement or resignation, must conclude those proceedings before he is transferred to another department.
The Jury Is Out
There are so many other prominent investigations and enforcement proceedings which have been conducted by SEBI over the last 25 years which deserves mention like the Pyramid Saimira episode, the Satyam investigations, Parsoli Corporation, the DLF matter. Irrespective of the efforts undertaken by SEBI to fulfil its mandate to protect the interests of the investors, to promote the development of and regulate the securities markets, questions abound whether the Indian markets will be plagued with similar scams in the future? Whether the measures against Ketan Parekh were enough to ensure that he was kept out of the markets? Whether the investments of small investors are really safe from fraudulent and manipulative activities? Only time will tell.
Disclaimer - The views expressed in this article are the personal views of the author and are purely informative in nature.