Price manipulation and insider trading - that was the first reaction of many market watchers when Reliance suddenly announced its decision to sell its 10.05 per cent stake in Larsen & Toubro on November 18, 2001.
Until a few weeks leading to the sale by Reliance, the L&T scrip price was languishing so badly on the bourses that an investor called Ravindra Mehta complained to the Securities and Exchange Board of India. His letter (dated October 22, 2001), said shareholder value had eroded because L&T's management was 'dilly-dallying' over the demerger of its cement division.
Within a matter of days, the share price was electrified. The stock rose from under Rs 150 and was at Rs 208.50 when Reliance announced it sale on November 18. Yet, Grasim paid Reliance a hefty Rs 306 for its 10.05 per cent stake or 2.5 crore shares. Was there insider trading? Who knew about the deal? Who profited from the information and who was buying the shares before the sale?
The answer is -- Reliance Industries. As this column will show, the SEBI investigation (documents relating to which is available with this columnist) so far seems to establish a clear case of insider trading based on information collated from the bourses, from Reliance and Grasim.
This investigation followed a complaint by Kirit Somaiya, a member of Parliament who wrote to SEBI on January 7, 2002 alleging that Reliance had first increased its holding in L&T from 6.62 per cent to 10.05 per cent and then sold the shares to Grasim at Rs 306 and accused the group of fraudulent practices and insider trading.
SEBI's investigators confirm all that and worse. They now need to wrap it up with specific questions and corroborating information such as telephone records to prove their case. Although Reliance Industries claims it has done no wrong, let us examine the facts.
The stock exchanges:
In response to SEBI's queries the National Stock Exchange told SEBI that at book closure on July 5, 2001 Reliance group has declared its holding as follows: Reliance Industrial Investment Holdings Ltd 3.71 per cent of L&T equity, Reliance Industries 2.15 per cent and Reliance Capital 6,692 shares.
The Bombay Stock Exchange is more interesting. It says that during the period October 8, 2001 to November 9, 2001 Reliance bought 1.95 per cent of L&T's equity, then again between November 12 to November 15 it bought another 0.17 per cent of the capital. This means that just three days before the sale announcement and a couple of weeks before it, Reliance was furiously buying L&T shares in the stock market.
Obviously, the big increase in L&T's scrip would be due to its purchases.
Now let us look at Reliance's submission to SEBI. Reliance says it used to 'manage equity investments in L&T with the objective of maximising returns from time to time.' On March 31, 2001 it held 6.62 per cent of L&T equity. However, after September 11, 2001 when the BSE Sensex had touched a 10-year low of around 2,600, Reliance says it had 'used the opportunity of the then prevailing low and attractive prices to consolidate our equity share holding in L&T, thereby strengthening our position to make an open offer for L&T, if and when considered appropriate at any point of time in the future.'
It points out that speculation about a possible open offer from Reliance for L&T shares was also 'widely reported in the media at that time.' Anybody in the market knows it is easy to plant speculative reports in the media as a cover for buying shares and unless such reports can be attributed to a company spokesperson these are meaningless. But Reliance's response is interesting for another reason.
Forget about buying L&T, its sales in earlier months were equally interesting.
Who sold the shares?
Reliance's response to SEBI contains an interesting little table, which lists its sale and purchase of L&T shares since April 1, 2001 when it had held 6.62 per cent of the equity. Then in May, June and July 2001 it sold large quantities of the scrip (0.04 per cent, 1.81 per cent and 0.78 per cent of its stake, respectively, in those months) again in October 2001 it sold another 0.08 per cent of its stake. Its holding had thus dropped to just 3.92 per cent by October 1, 2001.
This large-scale selling would certainly have had a negative impact on the price leading to Ravindra Mehta's complaint to SEBI about erosion in shareholder value.
Then, all of a sudden in October 2001 Reliance turned an aggressive buyer. It picked up a hefty 6.17 per cent stake in L&T in under a month and took its total holding to 10.09 per cent. The entire lot was off-loaded on to Grasim at a huge premium on November 18, making a fantastic profit for Reliance. In other words, Reliance is a clear beneficiary of the upward and downward movement of L&T's share price.
This raises another issue. If Reliance's share had fallen below 5 per cent and later increased to 10 per cent, did it inform SEBI, as required under the takeover regulations? No. Both the stock exchanges have confirmed that Reliance has not intimated them of the fluctuation in its shareholding. I also learn that SEBI's legal department has stated that the takeover regulations require RIL to have informed SEBI about its stake crossing 5 per cent on November 1, 2001.
Had it done so, SEBI would have been alerted to Reliance's large-scale market activity in the L&T scrip and probably monitored it more closely. Even otherwise, failure to inform SEBI under regulation 15A is punishable with a Rs 500,000 fine. But that is less than an insignificant punishment.
Insider trading and manipulation
The bigger issue here is that Reliance's large trading activity in the market clearly amounts to insider trading and price manipulation. What does it have to say about this?
According to Reliance, Nimesh Kampani of JM Morgan Stanley approached it for the first time on November 16 with a proposal to purchase the entire block of shares held by them in L&T by Grasim. As the BSE's response shows, Reliance was picking up large quantities of L&T until November 15. On the 16th, Reliance claims it got this offer to sell the entire lot to Grasim at a hefty premium of 47 per cent to the already inflated closing price.
SEBI has obtained Reliance and Grasim's submissions with regard to the timing. After all, establishing insider trading would depend on when the negotiations began. Here is what they say:
The Reliance version is it was first approached by Mr Kampani on November 16, it did not do any due diligence (since it knew L&T already), the entire deal was negotiated by one RIL executive - Amitabh Jhunjhunwala. A board committee constituted in April 2001, comprising the two Ambani brothers Anil and Mukesh and their two cousins Nikhil and Hetal Meswani, immediately approved the deal and the sale was through.
The question is, if Mr Kampani approached Reliance only on November 16, what was he negotiating for - a stake of 3.92 per cent which was Reliance's holding on October 1, or the stake of 6.62 per cent, which was the last officially declared holding in April 2001 or the 10.05 per cent stake which it had quickly acquired a few days before the deal? Also, when Grasim decided to acquire the 'entire RIL stake' in L&T, did it know that the stake was a mere 3.92 per cent and the rest would be delivered through market acquisition? SEBI has either not asked these questions or has kept them out of its report; but these are questions that the regulator obviously needs to ask.
Interestingly, telephone records between Reliance and JM Morgan Stanley would not be of much help - because, as Reliance has told SEBI - 'Reliance and JMMS have regularly interacted with each other on a variety of capital market issues.' But even without such evidence of the deal being discussed by Reliance before November 16, it really bends the imagination to believe the shares were not acquired with the clear intention of selling them to Grasim.
Curiously, Grasim's reply is vague about when the deal was proposed. It merely says that JMMS, (admittedly a close business associate of Reliance) proposed the deal 'during November 2001' and acted as Grasim's advisor. No other agency, except a law firm was involved in doing the due diligence and the transaction was concluded on November 18.
The pricing puzzle
Justifying the high premium that it paid, Grasim has made the intriguing claim that 'it was the general consensus between Grasim Industries' team and JMMS that acquiring a stake in L&T through market operations was not workable/feasible.' But if Reliance acquired over 6.17 per cent of L&T shares through market operations, that too within a few weeks, why couldn't Grasim do the same?
Also, since the JM half of JMMS is closely connected with the market, did it not know that Reliance was the biggest buyer in L&T in the market, that its activities were pushing up the price and were making the deal more expensive for its client Grasim? Obviously, neither side has asked too many questions of one another - as least not publicly.
The answer may lie in Grasim's deal with Reliance that the Ambani brothers would step down as non-executive directors of L&T and Reliance would agree not to 'acquire or deal in L&T shares' either directly or through its associates or subsidiaries for a minimum period of five years. Interestingly, the L&T management seems to be a quiet approver of all that went on and quickly took the Birlas on board.
If Grasim had in fact done some due diligence, it would have known that Reliance with 3.92 per cent of the equity was no threat to its acquisition plans. In fact, since Kumar Mangalam Birla wrote SEBI's corporate governance report, he probably owed it to Grasim's shareholders to conduct such due diligence, instead of paying a premium on a ramped up price for shares that had been hurriedly purchased in the market to be dumped on him. But Grasim's shareholders are not asking Birla any questions either.
Whichever way one looks at it, the deal probably for the first time provides ample evidence of price manipulation as well as insider dealing by a large business house. It now remains to be seen how SEBI rules on the issue. In an interview to a business newspaper, SEBI chairman D R Mehta recently lamented that corporate houses have become very powerful and exert a lot of pressure on the regulator. Will that be the case this time too, or will the political clout of Somaiya and the ruling Bharatiya Janata Party he belongs to provide the counter pressure necessary to takes the issue to its logical conclusion?