Ultimately, the market regulator needed less than a week of hard work to bring some sanity to the brazenly manipulated penny stock market, comprising over 1,000 regularly traded companies. This initial probe into a handful of scrips was adequate to expose several dubious practices, all known to trading circles, but having escaped regulatory attention.
The first of these is the role of large brokers in aiding and funding manipulation. A successful circular trading operation leading to an upward price spiral often needs the support of a large brokerage firm to lend credibility to the stock tip, offices around the country to hide the trail and the ability to lure small speculators by providing funds against shares to create a pyramid. A few brokers who were caught have quickly distanced themselves from the regulatory action. The Securities and Exchange Board of India (Sebi) needs to probe deeper.
Earlier, banks, finance companies and brokers had a list of quality shares against which they financed investors. But leading stockbrokers say this bull run has seen financiers colluding with brokers to lend money against the most dubious scrips. Worse, the original capital invested by market operators is also in the form of a clean loan availed from foreign and private banks.
Another official myth blown by the probe is that foreign institutional investors (FIIs) operate in the blue-chip segment, make researched decisions and are not involved in scummy penny stock manipulation. We say official myth, as market circles reel off examples of shady dealings by a dozen FIIs, including big and venerable international names. It is only the government, especially the finance ministry, that ignores anecdotal evidence and makes no attempt to probe beneficial ownership of these investments. Is Sebi probing why an FII called Copthall was buying SBI Home Finance shares in bulk deals even after its business licence had been cancelled? Has it at least questioned stock exchanges which made no move to suspend trading in the shares, but blindly reported the bulk deals on their websites?
Sebi has even netted big FII fish in its probe. We need to watch if these investigations will be tracked back to the ultimate investors in these questionable stocks. At least two blue-chip FIIs are notorious as the happy parking spot for all Indians who need to hide other income. Sebi now has enough reason to demand that various layers obscuring their real beneficiaries be peeled off.
• Sebi must at least probe investor complaints of absurd valuations
• The penny stock probe has once again exposed the complicity of auditors
Also exposed was the role of company promoters/ management. Again, it is common knowledge in the trading community that a successful ramping operation can rarely be run without active involvement of management. Sebi’s probe showed how firms issued fake statements to stock exchanges, announcing upbeat plans and profit projections not backed by performance. This exposes the hollowness of the disclosure-based system, where stock exchanges and the regulator accept company statements without even random verification. At the least, one expects Sebi to verify at least those cases where investors have complained about absurd valuations or false claims. In fact, this effort has to be initiated by stock exchanges, using the various fees they are allowed to retain for investor protection. This process should also apply to initial public offerings (IPOs) and rights issues, where companies have been getting away with untenable claims in their prospectus.
The penny stock action again exposes the role of auditors. It has referred two firms to the Institute of Chartered Accountants of
India for further action. Every big scam in India has exposed the complicity of auditors, but their self-regulation structure remains weak and ineffectual.
Then, the lack of co-ordination between Sebi, the ministry of company affairs (MCA) and the Reserve Bank of India (RBI). Large brokers are accessing bank funds to finance speculators, but the RBI has merely issued vague warnings and circulars. Simi-larly, swift and effective action by the MCA is vital to nailing company managements that dupe investors by making false or exaggerated claims or siphon off money raised from the market.
Finally, so long as we have a Dinesh Dalmia happily running multiple businesses in India and the US despite an Interpol alert and a stack of pending regulatory actions and court cases, it is foolish to imagine the government is consistently serious about market regulation.