Sucheta Dalal :The curious investigation into Manic Monday
Sucheta Dalal

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The curious investigation into Manic Monday  

Aug 23, 2004

Any good investigation into market manipulation, price rigging or insider trading usually follows a simple path — it tracks the money. The logic is simple. Find out who made big money and you usually have the culprit. But the Securities and Exchange Board of India’s (SEBI) investigation into the manic crash of May 17 when the National Stock Exchange (NSE) recorded its highest single-day fall (12.24 per cent), seems to do everything but that. Of course, Manic Monday wasn’t only about heavy selling. Traders say that even those who triggered the selling hysteria hadn’t bargained for such an irrational fall and they quickly used the last session to square short positions, cover their tracks and make more money. This happened after the second circuit break, when Indian institutions stepped in to lend stability to prices.

SEBI’s investigation thus needed to focus on who sold heavily in the first few minutes and whether they deliberately set about creating panic in the market. Officially, SEBI says that its investigation is not yet complete, but we find that a preliminary report has been submitted to the government, leading to the conclusion (by government) that a bunch of Non-Resident Indians, sold heavily through Foreign Institutional Investors (FIIs) to destabilise the market and embarrass the new government.  

The Indian Express now has details of SEBI’s initial submissions to the government, which suggests that the preliminary conclusions probably need to be entirely re-evaluated. The report is packed with names and details of those who traded heavily on May 17. It identifies Indian and foreign brokers, traces their FII clients and the underlying investors. Finally, it comes up with a few ‘‘Indian sounding names’’ among hedge funds and Participatory Note (PN) holders, but not enough evidence to stick a theory that Manic Monday was caused by the Congress’s political opponents.

On the other hand, the inquiry into the heavy selling by Indian brokers seems cursory and draws questionable conclusions. More importantly, the report indicates a confused and unfocussed investigation that mixes up issues and seems to draw erroneous inferences. SEBI has collected trade data in three segments — the initial selling, after the break and the closing session. But its findings are strangely based on the net trading position at the end of the day instead of the rapid selling in the very beginning.

Let’s look at what SEBI has found. Its analysis shows that Goldman Sachs & Co. was the biggest seller that day (Rs 198.5 crore), but it also bought Rs 72.8 crore worth of stocks. UBS Securities Asia was thus the biggest net seller, having sold a massive Rs 190 crore of stocks and bought only Rs 2.65 crore. Three Fidelity group funds together sold Rs 126 crore worth of stocks and made no purchases at all. Other large net sellers included Sloane Robinson Investment, ABN Amro Asia Ltd., American Century Investment Management and Emerging Markets Growth Fund Inc. SEBI says that UBS Warburg, Morgan Stanley & Co. International and Merrill Lynch Espana had bought and sold a certain amount of the same stocks, but did it for different clients. Goldman Sachs however bought and sold a ‘‘large number’’ of GAIL shares ‘‘on its own account’’, so did the JP Morgan Trading Desk while acting as a client through its associate Fledgling Nominees International.

Another significant seller was a hedge fund called QVT Financial LP, which sold a large chunk of BPCL shares; it has one Indian name among its many investors. SEBI has also investigated allegations by market participants that FIIs built up huge naked short sales in the derivatives segment prior to May 14 and booked large profits. It also checked if those who had short positions had underlying cash positions and found that Morgan Stanley (Rs 280 crore) and USB Warburg (Rs 157 crore) had indulged in naked short sales and Merrill Lynch was yet to furnish details. SEBI is still investigating details of the underlying clients of all these entities. SEBI has listed several top foreign brokers as issuers of Participatory Notes (PNs) and has called for the names of their underlying clients as well as a list of their directors. It has found ‘‘suspicious’’, ‘‘Indian resembling’’ names among clients of Morgan Stanley, UBS and Merrill Lynch. More pertinently, these clients themselves seem to have been dealing with multiple foreign brokers in India.

SEBI has also been receiving mixed and incorrect information from UBS Warburg on simple details such as whether its trades were proprietary or on behalf of clients. SEBI’s investigation report says that hedge funds were often the ‘‘ultimate underlying clients’’ of many foreign brokers and their details are not yet available. It suggests that some ‘regulatory regimes’ may not even require such disclosures and claims that in some cases FIIs are unaware of the directors and investors of these hedge funds. Doesn’t that create a potentially dangerous situation for the Indian market by allowing unknown investors to run amuck? The issue must be discussed openly rather than at hush-hush meetings of the authorities with FIIs; but that will happen if the findings of the investigation are made public.

Finally, SEBI has identified several Indian brokerage firms as having impacted prices; but makes ridiculous conclusions about the trades. For instance it lists Salasar Stock Broker Ltd, UBS Warburg and Globe Capital Market (they accounted for around 5 per cent of net sales each in the first few minutes), but SEBI says that they didn’t impact prices because they covered the entire short position towards the end of trading.

Other entities that are listed as substantial sellers who impacted stock prices are — RLP Securities (4.12 per cent of net market sales), Goldman Sachs (through Kotak Securities accounted for nearly 4 per cent of derivatives trades in the opening minutes), Fledging Nominees, and Quantum Securities. Did they all trade on their own account?

A reading of SEBI’s initial report to the government leads to the conclusion that its investigators need to understand market mechanics. Also, they clearly have enough data to wind up the investigation and begin action before it turns meaningless. But SEBI investigators clearly need training to understand how speculators operate so that they come to the right conclusions.

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-- Sucheta Dalal