On 17 July 2009, a Mumbai tabloid, MiD DAY, reported that the police had arrested one R Venkatraman, a promoter and executive director of India Infoline, a leading brokerage firm, after Aarti Gunjikar, an investor, complained about having been duped of Rs13 lakh. His was the third arrest in the case on charges of cheating and conspiracy. Immediately after the arrest, the case was settled with the firm paying the investor, by demand draft,
Rs18 lakh which included Rs5 lakh of interest. This is not the first time India Infoline has been accused of carrying out unauthorised trades and causing losses to investors.
There are similar complaints of unauthorised trading against almost every leading broker. More shocking than the loss is the fact that investors are given the run-around by all those who are mandated to protect them. Stock exchanges, as the first line of regulation, rarely help investors;they simply push them into an unequal, usually losing arbitration with the brokerage firm.
Often, only when readying for a battle, do investors discover that they have signed a comprehensive power of attorney (PoA) that allows the brokerage to transact on their behalf and move funds and shares in and out of their accounts. Moneylife was one of the earliest to point out the evils of PoA and the gross misuse of the arbitration route; but, for years, SEBI has done nothing to change the situation.
Thousands of investors have knocked on SEBI’s doors for protection against crimes like the ones committed by India Infoline, but it is only recently that the regulator has at least acknowledged that there are holes that need fixing. Such acknowledgement of systemic holes and attempts at plugging them is a typical bear-market thought process and should have seized the regulators months ago.
By many accounts, we are on the threshold of a global economic recovery. Corporate results for the June quarter are turning out to be good including those of software companies, which mainly depend on contracts from the US, a country racked by recession. We may or may not be into a new bull market but it appears that the bear market is over—and with it the chances of making the investment infrastructure conducive for wider investor participation.
The fact is that the equity ecosystem makes it very difficult for investors to come into the market and invest safely and confidently. The paraphernalia of opening a broking and a demat account, the often unpleasant treatment at the hands of market intermediaries, the casual handling of investor grievances by regulators, the skewed policymaking process where institutional interests dominate and investors’ voice is rarely heard, the onerous and capricious income-tax rules—all combine to deter new investors and irritate existing ones. If you are even slightly unlucky, you will join the ranks of harassed investors.
That is why, when at a post-Budget meeting the finance minister Pranab Mukherjee said, “SEBI needs to focus on protecting the interest of investors,” which was its basic objective, he had hit the bull’s eye. At least it showed right thinking within the powers-that-be. Indeed, this early emphasis on investors is a sharp departure and a welcome relief from the obsessive tracking of the Sensex that marked his predecessor’s tenure.Pranabbabu has made the right beginning, by emphasising investor protection, but he must ideally step back and decide what the role of the retail investor in the Indian capital market is. Only when this is clear can other policies and investor protection issues be correctly framed. Surprising as it may seem, this clarity is lacking and I know this from personal experience.
In the run up to the Budget of 2007, prime minister Manmohan Singh had called several senior editors for a discussion with finance minister P Chidambaram where
Dr C Rangarajan was also present. It was the fifth year of a ferocious bull market and retail investors were rushing into mutual funds, unaware that they were the fall guys getting in at the peak.
I pointed out that the government needed to decide on the role of retail investors in the market and frame policy accordingly. If the government did not want retail investors investing directly, that was fine; but it must then ensure that mutual funds’ procedures & practices and benefits were clearly targeted at retail investors and adequate measures were put in place to ensure their protection. The then finance minister all but sneered at the idea and said that mutual fund trustees ought to take care of retail investors’ issues. Such was the arrogance and euphoria of the bull market that the government did not want to waste even a minute to consider that the mutual fund industry had grown to be entirely skewed in favour of corporate investors. In fact, the finance minister seemed to believe that the market had orbited into a perpetual bull phase, with a few minor corrections to let off steam.
Pranabbabu is faced with the grim reality of how excessive financial speculation can destroy entire economies, not merely individual or corporate wealth. So he must step back and examine the current market ecosystem first. Is policymaking driven by a clear understanding of where retail investors stand in the whole equity culture?
Today, corporate and institutional interests dominate policymaking and skew the decision-making process. They also influence legal rulings and public opinion, by manipulating a pliant media. Every decision-making committee of the regulator is packed with market intermediaries. Investor representation is token. In the past few years, SEBI has accredited 17 investor associations, half of whom are clueless about market regulation and have virtually no public membership. Also, SEBI itself is intolerant of criticism with the result that investor protection remains an overused slogan and a hurried band-aid when the bear strikes. That is why so many problems, highlighted several years ago, continue to remain unaddressed.
Investors Unwelcome: Even at the height of the bull run, when the combined trading volumes of the two main exchanges had soared to around Rs1 lakh crore a day, the retail investor population was stagnant at the mythical two crore, while the number of active demat accounts suggest that it was half the number. There has been no official attempt to establish the size of the retail investor population for more than a decade because it may embarrass the regulator. The market remains dominated by Indian and foreign institutional investors and corporate treasury funds.
While we boast of two electronic national bourses, in over a decade after we moved to dematerialised trading, SEBI has not ensured a wide penetration of depository and brokerage services even in larger towns and cities. In many places, investors have no choice but to deal with a single DP or a single well-resourced broker, since the wide network expansion of the boom years has been cut back sharply. Internet trading is not an option because most parts of India reel under power cuts. So investors sign the PoAs as demanded by intermediaries and risk their money or stay out of the market.
False Trading Volumes: Fake volumes, created by market manipulators, were seen as a sign of investor participation. Ever since the Ketan Parekh scam, we have been hammering away at various SEBI chairmen, and most certainly the National Stock Exchange (NSE) managing director Ravi Narain, that building of false trading volumes is the first indicator of market manipulation and must be investigated. It is only in its recent orders that SEBI has begun to look at the ‘creation of fake volumes’ more seriously. Until then, it was influenced by a market-economist who argued that market manipulation is impossible when trading volumes are large.
Power of Attorney: Brokers slip in PoA documents with the application forms without informing the investors of its true implications. PoAs allow brokerage firms to operate investors’ depository accounts for purchase and delivery of shares, withhold funds or square off trading positions as they deem fit. Some even specify that an investor cannot operate his/her own account. This is patently illegal. Moneylife took this up with SEBI in March 2006. But the regulator allowed the abuse to continue. Recently, media reports have suggested that SEBI may finally be looking at PoAs. But, in 2006, here is what the then SEBI chief, M Damodaran, told us: “If we standardise it, it will be seen as a SEBI document and on the strength of that if somebody still manages some kind of mischief, then we will end up defending the PoA rather than supporting the investor. That is not a position I want to be in.” He also said that those who sign up for Internet trading are supposed to be savvy investors who are aware of what they are signing. Is there really a change of heart at SEBI now? Only time will tell.
Know Your Customer (KYC): The mindlessness of KYC regulation has been thoroughly exposed. SEBI’s own investigation into the Pyramid Saimira case showed the ease with which shady brokers, such as Nirmal Kotecha, are able to create scores of front-persons who open broker and DP accounts which are used to manipulate the market. On the other hand, our prize-winning letter from Gopinath Prabhu in this issue reveals how genuine investors are so intimidated by the KYC process that it keeps them away from the market.
Portfolio Management Services (PMS): In a recent move, SEBI tightened the norms for PMS, making it mandatory for portfolio managers to keep separate accounts of clients rather than in a pool account. However, investors say this is not good enough. They want brokers to report each transaction made on their behalf.
Regulating the Regulators: Frankly, the stock market could do with some improvement in the reporting systems of the regulator as well. The finance minister must ask SEBI to conduct a credible investor survey which should be posted on its website and updated at least annually. Similarly, SEBI must put up on its website the distribution of brokerage and DP services with their contact details. That will tell us the geographical spread of these intermediaries and reveal whether investors have access and choice. Thirdly, SEBI must develop an easily accessible database that lists the names of all intermediaries who have opted for the consent process, the charges against them and the amount paid. It is not enough that this information is on the SEBI website; it must be made easy to search in a tabular form, with details available at the click of a mouse. Maybe SEBI can take the help of Prime Database to create such databases.
Finally, even corporate reporting is not available on a statutory website. Pranabbabu needs to give SEBI a deadline to revive EDIFAR (electronic data information filing and retrieval system) or an equivalent website within the next 12 months. Only when the FM insists that these basics should be in place, would ‘investor protection’ seem to be seriously on the government’s agenda.
In Whose Interest?
Is the structure and objective of mutual funds in sync with investors' interests?
When financial reforms started in 1993, policymakers declared that retail investors should invest in mutual funds. ‘Investing is too complex’, the individual investor was told; hence, ‘please turn over your money to the experts. They will get you better returns’. This was the received wisdom from the United States where the existence of thousands of fund companies and millions of fund investors prove how robust the idea is. Unfortunately, this experiment was off to a terrible start in India. If mutual funds were seen as the high priests of investing, that was not the Indian experience for almost a decade.
Before 1994, mutual funds were run by government-owned banks and financial institutions, like Canara Bank, Indian Bank, Punjab National Bank, General Insurance Corporation, etc. And towering over the market was the Unit Trust of India (UTI), a strange animal, combining corporate lending with equity investment. In 1994, the first crop of private mutual funds came in. They were supposed to deliver great returns with their specialised knowledge and skills. By 1998, all of them were on the verge of collapse and needed bailouts. The most scandalous manifestation of this, of course, was UTI itself which needed two successive bailouts—one in 1998 and another in 2000—to keep the markets from panicking and to ‘restore investors’ confidence’ in the system.
Fund managers are supposed to be experts, unlike millions of uninformed and emotional individual investors, who, reacting to greed, buy high and, then, reacting to fear, sell low. But in the words of the Deepak Parekh Committee, set up to deal with the financial crisis of UTI in late 1998: “After making a promising start in the early 1990s, the mutual fund industry in India failed to take off. The performance of mutual funds has been so poor as to cause the investor to lose confidence in the entire industry, as is reflected in listed schemes trading at discounts ranging from 40% to 60% of their NAVs. Within the mutual fund industry, equity related schemes have been the worst performers due to prolonged bear market. Given this state of affairs, the Committee is of the strong opinion that there is an imperative need to tackle the situation on a war footing.”
The reason for the poor performance of fund companies until 2003 was twofold. One was corruption. They often acted in collusion with unscrupulous companies and market intermediaries, instead of acting independently on behalf of investors. The other was due to the fact that the performance of the overwhelming majority of mutual funds is fully correlated with broad market trends. Most of them outperform only in sudden bursts, as a matter of luck. Fund performance has nothing to do with the size of the firm, its pedigree, asset size, past record or any other factor.
But there is a bigger issue with the structure of fund management business itself—accountability and purpose. The aim, process and structure of the fund management are designed to accumulate assets because they make a fixed fee on the assets they hold. Since asset accumulation is the objective, fund companies make a beeline with new fund offerings (NFOs) when there is a bull market and investor optimism is running high. They neither gain nor lose irrespective of whether or not the investors make money. Therefore, identifying a bear phase and focusing on preservation of investors’ capital during a downturn is not a priority. Neither are the schemes designed to substantially outperform the market. They merely bob up and down with the market. That is why performance is conveniently benchmarked to an index—the mass-market indicator. To be wrong when everyone else is wrong is not so bad. Hence everyone focuses on the same numbers, similar stocks, surfing the latest fad.
The Morgan Example
All these observations are best exemplified by the record of Morgan Stanley’s Growth Fund. When the fund launched its close-ended growth fund in January 1994, investors braved freezing temperatures and rain at many places to put in Rs1,000 crore into the fund. Investor frenzy ran so high that an illegal future market of Morgan’s yet-to-be-issued units developed. With the money, Morgan set about investing indiscriminately, spreading itself thin over too many stocks in too many sectors. Over the next few years, it changed several fund managers amid whispers of their arrogance, wrongdoing and nexus with brokers. This was fine except that many of the stocks in Morgan’s portfolio were part of the scum that comes to surface in a frothy market—medium-sized companies with bloated balance sheets, inflated promise of earnings, small market capitalisation and illiquid shares. That made Morgan’s fund look exactly like a retail investor’s portfolio, six months after a boom.Over eight years of investing, the Fund had delivered only a 3% return. Such examples underline why fund schemes have performed no better than many ordinary investors.
Is all this old history irrelevant, now that India is a different growth story altogether? Well, over 15 years, Morgan Stanley Growth Fund has offered a return of just 10.8%—if you were mad enough to wait after nine consecutive years of poor performance. - D.B.