It probably started with the Income Tax department’s (I-T) discovery that one Purshottam Dudlani owned a whopping 5,000 demat accounts. The IT referred the case to the Securities and Exchange Board of India (Sebi) and the matter is still under investigation. Meanwhile, Sebi hit on two more cases that are similar — they pertain to one Roopalben Panchal and an entity called Sugandh, who seem to be at the centre of a brazen IPO scam.
Automated systems are supposed to increase transparency and provide easy audit trails to investors; together they are expected to deter fraudsters.
However, the Panchal, Sugandh and Dudlani cases are threatening to explode into a scandal that will force the regulator to revisit its systems and those of market intermediaries who are responsible for the safe handling of investors’ funds.
Here is the market regulator’s case in a nutshell: Sebi had asked stock exchanges to look at off-market transactions in shares after the allotment of IPOs but prior to their listing. This was based on intelligence about possible manipulation of IPO processes.
The BSE investigation revealed a flurry of activity in the account of Roopalben Panchal in connection with the YES Bank IPO allotment. This activity took the form of off-market transactions between the time that the Yes Bank IPO was allotted on July 5 and its listing on July 12.
Investigations showed that Panchal’s demat account received 150 shares each from a stunning 6,315 allottees within a day after the allotment. This added up to a massive 9,47,250 shares. Yet, her name did not figure among the top 100 individual allottees of the heavily subscribed issue. This led to the clear suspicion of manipulation through multiple applications. A day before listing, Panchal transferred the shares to seven other entities of which five offloaded their entire holding on the very day the issue was listed. More significantly, it turned out that 6,221 of the 6315 allottees had listed their address as 402-403 Shashwat, Opposite Gujarat College, Ellisbridge, Ahmedabad - 380006. This is also the address of Roopalben’s sister Devangi Panchal with whom she holds a joint account. All the 6,315 entities also have their bank accounts with Bharat Overseas Bank and their demat accounts with the same Depository Participant (DP) — Karvy Consultants.
A random check revealed that 20 applicants showed the Worli branch of Bharat Overseas Bank as their address; there were also several other clusters of 20 to 50 entities with identical addresses. A similar scam, with the same DP, involved the transfer of 150 shares each from 1,315 benami accounts to an entity called Sugandh, which in turn flipped most of the shares on listing. These findings have caused several red faces among capital market intermediaries. Sebi’s swift interim order has cast a wide net that is bound to catch all those who colluded in the scam or inadvertently facilitated it through weak systems or incompetent screening.
First under the spotlight is Karvy Consultants, which has gone on record to insist that it has followed Know-Your-Client (KYC) rules and each of the 6,315 accounts is genuine. Both Sebi and the National Securities Depository Ltd (NSDL) are sceptical about this claim and NSDL has been ordered to conduct a detailed, time-bound inspection of Karvy and report to the regulator.
Incidentally, both depositories have been asked to enhance surveillance and check why their systems are unable to detect multiple applications of such a large order. NSDL too has been pulled up for failing to detect systemic deficiencies. It has in turn called for some action on the introduction of Unique Identification Numbers and promised to report all systemic loopholes to Sebi.
The large sum of money involved in Roopalben’s applications and the fact that the shares were immediately flipped on listing shows that the scam could not have happened without bank collusion. The Reserve Bank of India (RBI) Governor Venugopal Reddy has also reacted quickly. He rules out a systemic lapse and has assured swift investigation and action.
In the past, the RBI and Sebi took a fairly lenient view of bank malpractices connected with the IPO application and allotment process. The Consumer Education and Research Centre has been fighting two cases of IPO-related malpractices since the 1990s where banks were let off with a slap on the wrist. The RBI governor says heavy penalties have been imposed on banks that did not comply with KYC norms. RBI clearly needs to publicise such punishments so that they have a deterrent impact. The central bank may come up with some unpleasant surprises if it expands the investigation to cover the capital market exposure of select banks by way of broker financing, margin funding and lines of credit to finance companies affiliated to brokerage firms.
Anecdotal evidence suggests that the IPO application scam is fairly widespread. However until the Income Tax alert, nobody realised that fake demat accounts ran into the thousands.
Moreover, all such cases may not be easy to detect. For instance, one has heard of a large transport fleet owner boasting that he had opened demat accounts in the name of all his drivers across the country. There are stories from Ahmedabad about people opening accounts in names lifted out of a telephone directory. This provides false identification in case someone makes a cursory verification by calling the phone number.
Sebi already has three cases on hand, with the third relating to Purshottam Dudlani, still under investigation. The DP in that case is HDFC Bank, says NSDL; this suggests that many other DPs need to be closely scrutinised.
A corollary to the detection of large-scale benami accounts is the problem of investors lacking protection against fraudulent transfer of shares from their demat accounts. Investor groups have been agitating the issue for a while; so far, the benefit of doubt in case of fraud first goes to the DP and not the investor. Sebi’s swift and decisive action has set the ball rolling to unravel the scam, but it is clear that the regulator needs to examine all systemic deficiencies very carefully indeed.