Hall of scam

Why this deadening loss of investor confidence? Why have scamsters managed to push genuine investors out of the market? Why has government failed to revive investor confidence?

A study by Dr L.C. Gupta based on an all-India survey of household investors has some answers. In an article published by NSE News this year, Gupta says that efforts to revive investor confidence have ‘‘flopped’’ because ‘‘government measures have failed to match the investor’s own perceptions about the main cause of his woes.’’

His study reveals that nearly two-third of all investors polled reported three major worries — ‘‘fraudulent company management’’, ‘‘too much volatility’’ and ‘‘too much price manipulation’’. The Society of Capital Market Research & Development and Vivek Financial Focus Ltd. conducted this study during September-October 2002.

Gupta writes, ‘‘investor confidence in the stock market is low primarily because of corporate malfeasance and mismanagement’’, but not only has the regulatory system ‘‘hardly touched even the fringe of this problem’’, but it is in fact ‘‘aggravating it…’’

Yet, look at the number of steps taken in the last decade alone to improve regulation and supervision.

• The SEBI first got its teeth after the 1992 scam. Has been given considerably more powers since then.•
The Reserve Bank of India (RBI) set up the Department of Supervision.•
The Central Bureau of Investigation (CBI) set up an Advisory Board on Banking, Commercial and Financial Frauds (ABBCFF) that is headed by a retired Deputy Governor of the RBI to help it crack corporate crime more efficiently.•
A high level committee comprising the RBI Governor, SEBI Chairman, Finance Secretary was created. This has been expanded to include the Chairman of the insurance regulator and there are reports that its role may be enhanced.•
A Serious Frauds Office will be set up under the Department of Company Affairs (DCA) soon on the lines of a similar office in the United Kingdom.

Will these new proposals work when past efforts have failed? Events of the last decade provide a few answers.

Despite the lessons that should have been learnt in 1992, every serious scam thereafter has caught the regulators napping.

The RBI and SEBI were so clueless about Bhansali’s shaky financial conglomerate that he was allowed to set up a mutual fund and had a provisional license to set up a bank.

The RBI was caught napping when some unknown promoters launched an advertising blitzkrieg using the three biggest celebrity icons of our time for a company called Home Trade. Only when Home Trade went bust that the RBI realised that it had its tentacles deep inside scores of under-regulated and under-supervised cooperative banks and had begun to make inroads into siphoning off pension fund money as well. In fact, but for NSE’s refusal to list Home Trade the company would have continued to march ahead.

The worst examples of regulatory failure are vanishing companies and plantation companies. In the former, the lack of clarity about the specific responsibilities between DCA and SEBI have left investors in the lurch and inflicted the worst damage to investor psyche. The latter saw plantation companies raise tens of thousands of crore of rupees entirely unchecked because the RBI, SEBI and the DCA couldn’t decide who was responsible for their regulation. When the companies began to renege on repayments, each regulator shirked responsibility until the finance ministry had to assign the task of regulation to SEBI.

Is regulatory failure alone to blame? Or, is it the lack of co-ordination between regulators and investigative agencies that allows scamsters to delay investigation by manipulating the system?

Lack of co-ordination is indeed a problem. Anybody investigating or reporting on the various scams would confirm that regulators and investigative agencies are notorious for not sharing information with one another or stone walling even routine queries from other regulators. Investigation reports of regulators that were freely available to the media were not provided to investigative agencies by creating bureaucratic hurdles. To outside observers, constant one-upmanship between the regulators and their attempts to grab credit for every new detail unearthed by their investigation were the obvious problems.

Journalists who have investigated scams have found that better co-ordination and data sharing by the regulators would have accelerated investigation or at least nailed many scamsters.

But surprisingly, those in supervisory positions seem to think that lack of co-ordination is the lesser evil. A reluctance to use existing powers is the bigger problem.

Dr S.S. Tarapore, former Deputy Governor of the RBI and former head of the ABBCFF says that the bigger problem is our reluctance to punish people for wrongdoing. ‘‘Unless we have exemplary punishment, more committees and regulators will not help’’, he says.

The problem, says Tarapore, starts with the willingness of regulators to condone minor misdemeanours. He says: ‘‘If you have to cut a man’s finger nails as punishment and if you don’t cut them deep enough to hurt, then when it is time to cut off his hand you are unable to do it. The reluctance to punish minor offences leads to bigger ones’’. We have to create a culture of making people pay for their sins; ‘‘punish a wrong doing, but don’t kill a fellow’’, says the former central banker. He believes that systemic improvement can come about if regulation is light but comprehensible and supervision is merciless.

C.B. Bhave, MD of the National Share Depository Ltd. (NSDL) also says, ‘‘I am not convinced that lack of co-ordination is a problem. It is a facade’’. If each regulatory body exercised its powers effectively, it would lead to a big clean up of the system.

G.V. Ramakrishna, the formidable former SEBI Chairman agrees, but thinks that the reluctance to punish extends to regulators as well. He points out that despite several major scams in the country, no regulator has ever been asked to go. ‘‘A person who by commission or omission has allowed a scam to occur has to go; the buck has to stop at the top, only then will the system work effectively’’, he says, but that hasn’t happened.

According to the former SEBI chief, ‘‘Unless the regulator’s responsibility is fixed, and he is fair, impartial and effective, the reluctance to regulate and the insouciance trickles down the organisation. And the system is hijacked by the regulated entities.’’

Regulatory failure has serious implications for the investor. Each scam has exposed persistent and widespread regulatory failure, that has never been addressed. For instance, in 1992, it was discovered that inspection reports of the RBI has been buried and the issues raised by them were cursorily dealt with by issuing vague circulars and general warning to all banks.

This time too, the Joint Parliamentary Committee (JPC) investigating the Scam 2000 has scathingly indicted all the regulators — the DCA, SEBI and the RBI. With respect to the DCA it has said that its inspectors do not seem to understand their function. Yet, the JPC too has protected the regulators by refusing to identify any individuals and making them accountable.

Even in dealing with the UTI debacle it has avoided any direct indictments, with the result that its most notorious chairman has not been punished. Ramakrishna, in fact, blames the entire UTI problem on the government. The need to supervise UTI and the problems with its internal handling of funds and inter-scheme transfers were detected in 1992. According to Mr. Ramakrishna, the finance ministry protected it in the most ‘‘unfair, unjust and unlawful manner’’ by setting up innumerable committees to avoid bringing it under SEBI supervision. Investors paid the price.

If investors are staying away from the market today, it is because of the unreasonable risks that they are asked to bear. Industrialists like to believe that investors are a greedy bunch that needs to be pampered while making an IPO and ignored after that. A favourite allegation is that investors want high returns and no risks.

Ramakrishna disagrees. ‘‘Investors should be asked to take genuine market risks, but they cannot be asked to bear systemic risks. To make the market safe for investors by eliminating systemic risk is the job of the regulator. Today, investors are being asked to bear systemic risks as well as market risks and that doubles the jeopardy for investor’’, he says. But it gets worse. When organisations such as UTI fail, then the risk is transferred to taxpayers through a government bailout.

A former regulator identifies another problem. ‘‘Follow the money’’, is an age-old dictum followed by regulators and investigators around the world; but it is consistently ignored in India. Whether it was the incredible bull runs that were manipulated by Harshad Mehta and Ketan Parekh, or Home Trade’s seemingly bottomless source of finance, a simple effort by the RBI to track the movement of money would have nailed the problem before it went out of control.

If the RBI had learnt from the 1992 scam and asked banks to track and report the movement of money behind Ketan Parekh’s trades, it would have led to Madhavpura Mercantile Cooperative Bank, Global Trust Bank and the system of discounting pay orders by these banks much faster. The problem, says an unnamed source is that the RBI doesn’t quite get it even today. It is as identified lending against shares as the reason for excessive manipulation. But whether it was Madhavpura giving Ketan Parekh clean credit of nearly Rs 840 crore rupees or Global Trust Bank’s willingness to advance Rs 354 crore to First Global Finance and to subscribe to debenture of its investment vehicles—a close watch by the RBI would have detected this. The rapid movement of funds to and from companies such as Zee and HFCL through Ketan Parekh’s many accounts in Global Trust Bank also ought to have been detected by an alert central bank.

However, not only have senior RBI officials not been pulled up for their failure, but the central bank in turn has yet to punish a single bank official for their collusion with scamsters. The RBI seems to think that asking bankers to step down from management is all the punishment that the scam merits.

And so it is in every aspect of the capital market. The biggest of our corporate houses have conned investors by raising money at incredibly high premia and not delivered on project completion. They have brazenly found loopholes to avoid giving investors a fair deal and have manipulated policy to raise their family holding in companies by allotting themselves cheap shares on a preferential basis.

Years of such abuse has disgusted genuine investors and caused them to shun the capital market for so long that it ought to worry policy makers. So far, falling interest rates and the easy availability of bank finance has allowed government and the corporate sector to ignore investor sentiment. But no modern economy can afford to ignore investor grievances forever.

The real problem, says Ramakrishna, lies with the government — ‘‘For appointing inefficient regulators, then tolerating inefficient and indolent regulators and finally for preventing regulators from doing their job.’’ Unless that changes, we may continue to have new scams that will surprise regulators and rob investors almost every year.

Profiles by Somnath & Jaidev Majumdar in Kolkata