Sucheta Dalal :Will Anyone Question the Regulators?
Sucheta Dalal

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Will Anyone Question the Regulators?  

July 15, 2009



Bill Bonner, an editor of The Daily Reckoning, a popular e-zine on financial markets, has an interesting take on the 150-year sentence to Bernie Madoff in June. Madoff was one of the most respectable names in the US financial world for over 20 years while he was faking high returns by running a Ponzi scheme that had ballooned to a stupendous $65 billion before it went bust. In those two decades, Madoff was chairman of the prestigious NASDAQ Stock Exchange and neither the Securities Exchange Commission (SEC) nor the US Treasury Department bothered to investigate his activities properly. In fact, an SEC official had begun to ask uncomfortable questions in 2004, but her investigation was quietly deflected by her boss, who later went on to marry Madoff’s niece.

Bonner thinks that the extraordinary length of Madoff’s sentence reflects public sentiment; after such an enormous financial scandal, the public was baying for his blood. However, in Bonner’s view, “When you balance Bernie’s sins against his virtues, we’re not sure that the man doesn’t come out at least as well as many of his accusers. While Bernie was pretending to make his investors rich, the SEC (Securities Exchange Commission) was pretending to protect them from Bernie. In fact, neither were really doing what they claimed. Which is to say, both are guilty of ordinary evil. While Bernie is behind bars, the SEC and Federal Reserve officials are still at large. Both are clearly guilty of dereliction and negligence.”

Isn’t this true of all scams all over the world? The very same regulators, who do nothing in the face of the most brazen market excesses and allow scamsters to thrive and grow, suddenly turn avenging angels and guardians of ordinary investors after a bubble has burst or a scam has been unearthed. Yet, they are never held accountable for gross dereliction of duty or collusion through inaction. A good example is the entire stock market bubble built by Ketan Parekh (KP) between 1999-2000 right under the benign eye of the Securities and Exchange Board of India (SEBI). Ketan Parekh was a crony of the late Harshad Mehta and a co-accused with him in the 1992 scam case. Yet, the regulator did not think it necessary to investigate the dizzy rise in the K-10 stocks or the source of his stupendous wealth. The Reserve Bank of India (RBI) was just as culpable for failing to investigate KP’s close nexus with Global Trust Bank. Finally, when KP’s speculative excesses did him in, he took down with him two banks and created panic in the financial markets. The regulators immediately went on an investigation overdrive, but nobody asked why they themselves should not be held responsible.

India’s financial regulatory system, including the dangerous multiplicity of ‘independent’ regulators, is unfortunately modelled on the US system and has all its weaknesses. The multiplicity of regulators and the inevitable turf wars are blamed for the lax supervision of several market segments and there is a proposal to ‘reform’ the SEC, shut down some regulators and prod others to be more alert. Moreover, the regulatory capture of policy-making by the Wall Street leaders and their megabucks had kept large segments of the financial market outside the ambit of regulation. Isn’t it stunning that it required hundreds of thousands of Americans to lose their homes or have their credit cancelled before the government felt the need to set up a Consumer Financial Protection Agency? The US regulators, while fully empowered, have been reluctant to act. Indian regulators often make an excuse of inadequate powers. But GV Ramakrishna, SEBI’s first chairman after it became a statutory body, has effectively demonstrated that there is plenty that the regulator can do even without powers.

In SEBI’s case, the excellence of the Pyramid Saimira investigation report exposed how much better its other investigations could have been. Worse, SEBI had to issue a second order on the Pyramid Saimira case on discovering that neither the stock exchange (which is the first line of regulation) nor the broker had bothered to disable the trading account of the barred entity. This exposed for the first time that the regulator has no mechanism to check whether its orders are actually implemented.

Reacting to my article on this lapse, a savvy reader says, all the client details are uploaded on the NSE/BSE systems along with PAN details. Apart from this, depositories also know the details. So, why are only stock-brokers blamed when the NSE and BSE can notify and bar a particular client from trading at the entry level itself, he asks. The regulator certainly knows this obvious detail, but it is easier to target brokers rather than question first-line regulators like exchanges who are now the favoured talent pool for senior postings at SEBI. As for the brokers, they may complain; but, today, the consent order system allows them a fairly easy exit route.

Consider this: a year ago, despite its deep involvement in the Ketan Parekh scam and Global Trust Bank, the Zee group was let off with a mere warning. After a gap of a year, other firms investigated at that time have also walked free. One of these is Mangal Keshav Securities, a firm once closely associated with Ketan Parekh, which was asked to pay Rs3.5 lakh as part of the settlement. Pratik Stock Vision and Nirmal Bang Securities were also investigated for unfair trading practices in that period. They have been let off after they paid Rs1.25 lakh and Rs 4 lakh, respectively. In fact, few investors have even noticed the consent orders. We also have no way of knowing if scores of others who were investigated in the scam period have lined up for similarly favourable treatment under the consent order system.

Another factor that is hampering regulators’ efficiency and skewing the playing field, especially for large, institutional investors, is the turf battle and lack of coordination between various regulators. A recent example is SEBI’s pro-investor decision to scrap mutual fund loads which has skewed the level playing field in favour of insurance companies offering unit linked insurance instruments. But they are supervised by the insurance regulator which has now been stirred into examining the issue. Supervision of debt instruments and currency derivatives is divided between SEBI and the RBI. And there has long been a strong view that the Forward Markets Commission must be merged with SEBI; it was only kept separate at the insistence of Sharad Pawar, the union minister for agriculture. Now, The Economic Survey 2008-09 has once again suggested that all financial market regulation must be brought under SEBI to ‘encourage integrated development’.

In my view, there is no reason why integrated development cannot happen if deliberations of the High Level Coordination Committee on Financial Markets are more structured, transparent and backed by a dedicated secretariat. Integrated development is relatively easy. The more difficult task would be to ensure integrated investigation and supervision to keep markets safe.

While regulators operate in separate silos, market-players, especially scamsters, are geared to dodge regulatory oversight by operating across markets through a maze of similar sounding entities or subsidiaries. The bottom line: do not expect the government or the regulator to act as a watchdog and safeguard your money – they usually wake up when it is too late and this is true all over the world.

-Sucheta Dalal

-- Sucheta Dalal