Sucheta Dalal :IPO Scam: Time to examine systemic issues
Sucheta Dalal

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IPO Scam: Time to examine systemic issues  

Feb 13, 2006

A few weeks ago, the Reserve Bank of India (RBI) levied tiny fines on banks involved in what is known as the IPO Scam, patted itself on the back, and sought to bury the issue. But the good news for investors is that the government and the capital market regulator are inclined to do a lot more than that, even without the BJP seeking to extract political mileage from the scam.


For starters, the Finance Ministry wants the Securities and Exchange Board of India (Sebi) to find a way to reallocate scamsters’ shares frozen in the Yes Bank and IDFC issues. The regulator must take this forward by forcing a disgorgement and re-distribution of profits earned by Rooopalben Panchal and gang in at least 20 other IPOs where they had cornered disproportionate shares while perfecting their mischief.


The BJP wants this investigation to be handed over to the Central Bureau of Investigation (CBI); but this demand has little merit when its former MP, Kirit Somaiya himself admits that Sebi has conducted a competent investigation. Moreover, the CBI must at least prove itself capable of nabbing scamsters who have red-corner notices posted against them but are able to enter and exit the country at will.


Media reports that the Finance Ministry plans to scrap the retail investor quota have correctly agitated the BJP; but these reports also seem to have little substance since the regulator is not inclined to back such a move. It is unlikely that the Ministry will undermine Sebi in an over-heated market when the need of the hour is cooperation and coordination.


Interestingly, some influential people want the retail investor quota enhanced to encourage small investors. But subscription patterns show that retail investors continue to be wary about investing in over-priced IPOs and Follow-on Public Offers (FPOs). In fact, the highly successful ICICI Bank issue already saw an under-subscription in the retail segment even in a raging bull market. This trend of lower retail subscriptions will increase as the quality and pricing of issues turns more outrageous.


If anything, Sebi needs to question the irrational exuberance of institutional investors in connection with over-priced IPOs and FPOs. Market circles insist that institutional investors collude with brokers and company managements to organise a variant of the pump-and-dump scheme by engineering oversubscription of public offers at inflated prices. They aim to dump these shares in the secondary market after orchestrating a flare up in post-listing prices.


Actions of mutual funds also need to be watched to ensure that they don’t provide an exit route to hedge funds and scamsters when this ferocious bull phase goes into an inevitable correction. Investor confidence is still too fragile to withstand another blow from the mutual fund industry.


An important take-away from the IPO scam is the need for better investor identification. The government is toying with the idea of making it mandatory for PAN (Permanent Account Number) to be quoted on all capital market transactions without any exemption limits. This is both fair and overdue.


Logically, only savings and surpluses are invested in the capital market and anyone who has investible funds ought to be filing tax returns, irrespective of whether they have a taxable income. Day traders and operators who live off the market also have no reason to complain; the government’s tax policies have been extremely generous to them (thanks to the need for parity with foreign investors who are encouraged to invest in India by offering an attractive tax regime) and they must reciprocate by filing regular tax returns like the rest of us.


Mandatory PANs will be effective only if Sebi provides R&T Agents access to the Income Tax Department’s PAN database for electronic evidencing. This will allow them to verify if investors are quoting accurate PAN numbers at the Depository Participant (DP) and broker level.


There is also a need to examine a few broader systemic issues. For instance, insiders tell me that investors are sometimes forced to open multiple DP accounts (which are expensive and difficult to maintain) because some scrips are dematerialised only by NSDL and a few exclusively by Central Depository Services Ltd (CDSL). Since depositories operate like utility services they must both offer dematerialisation for all shares, thereby streamlining the system.


The quality and adequacy of capital market intermediaries is another worrying issue. There is a serious shortage of Registrar and Transfer (R&T) Agents as well as Depository Participants (DPs). The number of R&T Agents has slowly dwindled from a high of 250 to less than five. Similarly banks, who are in a position to expand the DP network, say that the business barely makes any money. However, depositories themselves are extremely profitable and constantly diversifying into new businesses.


The number of RTA Agents has dwindled mainly because the primary market was dead for a decade after the excesses of the early 1990s, when hundreds of petty businessmen and traders floated IPOs and decamped with investors’ money. The market has turned buoyant only in the last year.


In March 2004, when the registrar MCS bungled the allotment of ONGC’s IPO, it was already clear that these intermediaries were over-burdened. Two years later, the IPO market has grown exponentially, yet the R&T Agents business is obviously not attractive or profitable enough to attract new entrants.


Sebi needs to examine the fee structure of all market intermediaries to ensure that margins and profit distribution is equitable and enhances market infrastructure without casting an unfair burden on investors. Sebi also needs to take charge of the task of getting companies to share a part of the R&T cost burden, since they are the biggest beneficiaries of dematerialisation.


Finally, the Finance Ministry and Sebi will need to go back to the Sebi Act and the Depositories Act to examine if the regulations and statutory responsibility for inspecting and governing all bodies connected with the process are adequate to ensure a safe and effectively regulated capital market.


-- Sucheta Dalal