On Friday, M Damodaran, chairman of the Securities and Exchange Board of India (Sebi), boosted investor confidence with tough action to clean the primary capital market. In fact, apart from scrapping Mapin, the investor database, this is the first major systemic issue tackled during his tenure.
Mr Damodaran has often talked tough with market intermediaries and is well plugged into market developments. But six months into his term, people were beginning to wonder when he would walk the talk. Last week’s moves end that speculation, especially since it hurts powerful foreign investment institutions and investment bankers, and also sets a global regulatory precedent. He now needs to guard against foreign investors using the timing of the decision to attack his action.
Sebi’s announcement comes when the market looks vulnerable and seems set for a serious correction. A couple of international investment houses have signalled that Indian stocks are starting to look expensive and that the growth in corporate profits is slowing. The government, too, is openly admitting the uncertainty of continued economic reforms and liberalisation. The ruling Congress party has repeatedly succumbed to the hypocritical anti-reform dictates of the Left parties, while West Bengal aggressively pursues foreign and corporate investment and infrastructure and development. At the same time, it is preening over the introduction of a ridiculously expensive employment guarantee scheme, while politicians and babus are smugly waiting to exploit its gaping loopholes.
Prime Minister Manmohan Singh, in an interview to Rajat Gupta for Mckinsey, also sounds defensive about the slow progress in infrastructure building, labour reform, privatisation and the delay in opening sectors such as retail trade to foreign direct investment. If the market dips or remains volatile in the coming weeks due to these factors, chances are that Sebi’s tough action to check the mischief by institutional investors and investment bankers will be blamed. The government needs to anticipate this and defend the regulator against unwarranted criticism.
Having said that, there are several internal issues that Sebi also needs to resolve. It is acknowledged, within and outside Sebi, that chairman Damodaran has brought leadership and clarity to its functioning. Unfortunately, this was badly marred by its whole-time member, Madhukar, who chose to shock the market by predicting that the Sensex would touch 16,000 by the end of the financial year. In one stroke, he managed to undo much of Mr Damodaran’s tough talk. It is safe to bet that the statement will keep coming back to haunt the regulator at every significant dip in stock prices, despite Mr Damodaran’s attempt to separate Sebi from the personal view of a board director. The blame lies with the finance ministry, which has repeatedly failed to understand that top regulatory assignments require knowledge and experience and cannot be a sinecure for retired bankers and bureaucrats.
• Sebi’s action was needed and comes when the market looks vulnerable
• Shutting defunct regional bourses is another pressing need
• Sebi also needs to do much more to encourage two-way communication
The Magadh Stock Exchange episode last week is another warning signal. Although Sebi slapped down the problem with speed and agility, the sheer brazenness of the scam and the involvement of a stock exchange executive director (whose appointment has to be ratified by the regulator) is worrying. In this case, the ED illegally restarted a defunct stock ex-change, permitting a single scrip to be traded (Bhoruka Finance) for 10 days from August 1 to 10, accounting for over 99% of the turnover, to facilitate a takeover of the company. The rogue ED’s audacity is highlighted by the fact that Bhoruka Finance is not even listed on the Magadh exchange. It is listed on the Bangalore Stock Exchange, permitted to be traded at Magadh at the request of one broker.
The Magadh episode warns of the need to shut down many regional bourses, as it is unfair to spread Sebi’s regulatory resources so thin when most of these are almost defunct. A few months before, finance minister P Chidambaram had warned stock brokers during a Mumbai visit that the government would not hesitate to close these exchanges if they did not clean up their act. It is probably time for him to show he meant what he said. The closure of a dozen defunct bourses (out of 23 exchanges, where only two are genuinely viable) ought not to antagonise either the Congress party or its communist masters and allies.
Finally, the regulator needs to be more receptive to market intelligence and encourage two-way communication. Information provided to Sebi usually vanishes into a black hole, without any acknowledgement. This applies not only to e-mails sent by investors around the country, but also to information provided by investor activists and the media. Even when Sebi initiates investigation based on such feedback, the informants have no clue whether their letters have even been read. This is bad public relations and discouraging to those who want to help the regulator’s effort. In contrast, complaints to the US Securities & Exchange Commission (SEC) are at least acknowledged, with an automated e-mail response.
Meandering investigations are the biggest investor concern today and Sebi needs to address this. Mr Damodaran has revamped the investigation department, but he needs to make it effective by glancing at the fourth Action Taken Report presented to Parliament last month. The lethargy in dealing with brokerage firms directly linked with Ketan Parekh and his cronies almost leaps out of the pages. Some investors and market intermediaries are studying the Right to Information Act to find how much information can be legitimately demanded from the regulator. In a disclosure-based system, much of this should be freely available to investors without needing to extract it under the RTI Act.