Sucheta Dalal :The great demat rush: Truth or dare?
Sucheta Dalal

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The great demat rush: Truth or dare?  

Jan 23, 2006

What is new about multiple applications? It has been going on for years. In fact some nationalised bank branches in Gujarat are notorious for accepting thousands of multiple application even after the issue has closed for subscription,’’ says an senior investment banker.


That is indeed true. The difference is that we were told that a paperless system with electronic transfers would make it easy to detect such fraud and create a clean, transparent and efficient system.


While the system has become marvellously efficient, investors were clearly misled about the ‘clean and transparent’ bit. This becomes more worrying if stock exchanges and depositories come up with technical arguments about whether or not they are ‘‘Self Regulatory Organisations’’ (SROs) and split hair about the extent of their regulatory and supervisory responsibility over brokers after having failed to detect what should have been evident to any alert intermediary, let alone SROs. The depositories found nothing strange about tens of thousands of accounts transferring shares to an under-a-dozen accounts, without waiting to check the listing price.


It is common knowledge that IPOs auctions are priced in a manner as to leave ‘‘something on the table’’ for a post-listing surge. Sure enough, most IPOs, especially those under the regulatory scanner, debuted on the bourse at a sharp premium to issue price. Even though one IPO after another saw the scrip rallying smartly after listing, depository officials seem to have found nothing unusual about thousands of investors apparently willing to forgo this profit opportunity and flipping the shares even before they were listed.


Did the depositories feel that it was not their business to keep any eye on such developments because they are not SROs? If that is the case, then Sebi will have to choose one of two regulatory options. It can post its officials inside the depositories to scan data or depend on the integrated real time market surveillance system that was supposed to include depositories in later phases.


But surveillance from the outside is bound to have its limitations so Sebi must change its rules to ensure that depositories and bourses have some clear-cut and specified responsibility for surveillance and supervision.


In fact, Sebi has been forced to remind market intermediaries that the Money Laundering Act casts a responsibility on them to look out for and report suspicious transactions, not necessarily in cash. Stock exchanges too are equally guilty of not paying attention to suspicious trading patterns. For instance, ever since the IPO market has revived, some alert stock brokers have been pointing out to the incidence of a large number of bulk deals that are reported on stock exchange websites on the very day of listing.


Since stock exchanges publish the names of bulk buyers and sellers, it is also clear that a large number of sellers are not qualified institutional buyers (QIB), who are capable of having received bulk allotments.


Consider just one example that is the subject of much discussion in the market. Educomp Solutions is a company whose recent IPO was placed at Rs 125 per share. The issue opened for trading on January 13 at around Rs 185 per share, a Rs 65 premium to the offer price. The scrip immediately sizzled up to Rs 250, and the trading price band was expanded by the bourses to allow a further rise. It finally closed the day at Rs 314.


A look at the bulk deal segment of the NSE shows a large number of buy-sell transactions by the same entity for a price differential of a few paise. Each block comprises a few lakh shares, but always in odd number. Do these qualify as abnormal trades that merit investigation? Is it Sebi’s job to notice and investigate these trades or does the primary responsibility lie with stock exchanges? Clearly, we need both answers and an investigation, because the pattern repeats itself over scores of recent IPOs.


Instead of addressing issues of supervision and responsibility, many experts have been underplaying the IPO swindle and even questioning whether there is any criminality involved in making multiple applications by the thousands. Many attribute the problem to the existence of a ‘‘retail’’ quota. Their solution is to knock off the special bucket for retail investors in the IPO subscriptions and level the playing field between large and small investors.


If such a move shuts out retail investors, the argument is that small investors must, in any case, invest through mutual funds, since retail investors have not demonstrated the ability to value shares correctly in the book-building auction process.


Such arguments however ignore several vital facts. First, that retail investor have applied at the upper end of the indicative price band in all good issues, but they have shown far more prudence in their subscription quotas. Genuine investors have not chased after high-priced issues, and even the ICICI Bank issue barely managed a one-time retail subscription because investors found the pricing too aggressive although the bank offered them a small discount.


In contrast, mutual funds, FIIs and other qualified institutional buyers have rushed to pick up aggressively-priced issues within minutes after the subscription lists opened, leading to a massive over-subscription. The mischief in such applications has become evident after Sebi introduced pro-rata allotment and a 10 per cent margin for institutional applications. Immediately the phenomenon of over-subscription dropped significantly. In fact, the IDFC issue was the last issue under the discretionary allotment regime.


It must also be remembered that the revival of the IPO market is barely two years old. Although they are willing to trust mutual funds again and forget past grievances, the industry’s track record does not justify sweeping changes just because we are currently in the midst of a raging bull market and there is a rush to subscribe to IPOs.


Also, levelling the playing field alone is no guarantee of fair play. Unless there is a large number of institutional players, there is always the danger that they will form a cartel to drive up issue prices. In the circumstance, it would be foolish to believe that tinkering with policies is a substitute for powerful supervision and alert regulatory intermediaries.


-- Sucheta Dalal