Sucheta Dalal :Lifting the veil off the great demat rush
Sucheta Dalal

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Lifting the veil off the great demat rush  

Jan 16, 2006

Just a month ago, Dr L.C. Gupta’s survey of Household Investors seemed hopelessly outdated. Commissioned by the Investor Education and Protection Fund under the Ministry of Company Affairs, the survey conducted in June 2005 said: ‘‘The overall effect of the demat system has not been to attract a greater number of domestic retail investors into share-ownership but the opposite. The demat system has been very attractive to speculators and frequent traders.’’


When the survey was released recently, the findings seemed all wrong. Statistics showed that retail investors had apparently forgotten past losses and were apparently rushing to open demat accounts by the tens of thousands. It now turns out that Gupta made no mistake and the return of the retail investor may have been a huge exaggeration.


Look at the numbers: some 47,000 fake demat accounts in the IDFC issue, over 10,000 fake accounts in the Yes Bank issue and at least a dozen other Initial Public Offerings (IPOs) still to be investigated. The infamous Roopalben Panchal, whose link to 6,315 demat accounts seemed scandalous in the Yes Bank IPO, now turns out to be connected to an incredible 14,807 demat holders who obligingly transferred their allotment to her before the issue opened for trading.


And we do not even have an indicative number of others involved in this swindle who received refund orders instead of allotments. Is it any wonder that IDFC and Yes Bank opened for trading at a huge premium to listing price?


I learn that a few more banks and Depository Participants (DPs) may be dragged into the investigation that will cover other over-subscribed IPOs of the recent past. Sebi officials, however, say that the number of banks and entities (Roopalben Panchal, Sugandh, Purshottam Budhwani and Manojdev Seksaria), as well as the demat accounts that they operated, may remain more-or-less the same but for a few additions.


Unlike the hard work required to piece together the first two cases, SEBI expects the rest to tumble out on a detailed examination of those who are already caught. When the perversion of the Yes Bank IPO allotment was unearthed, Reserve Bank of India (RBI) Governor Venugopal Reddy had said that it was not a systemic issue but a localised fraud that would be dealt with severely.


After the IDFC revelations, the Finance Minister cracked the whip but indicated that there were ‘‘systemic deficiencies’’. He also promised ‘‘severe action’’ against those responsible. The question is — where are these systemic deficiencies? Are they in the allotment process?


The SEBI order, asking depositories to step up their surveillance process, says that any system that cannot detect multiple dematerialised accounts with common addresses is unacceptable. But the issue may not be one of surveillance but of system design and Depositories may have to rejig their software using international algorithms to detect multiple applications. In fact, it is surprising that this need was not anticipated and built into the system since IPO abuse through multiple applications has been rampant for decades.


Some overhaul at the systemic level is bound to be mandated in the wake of the Yes Bank and IDFC issues but this needs to be extended to the banking system. At the lowest level of the banking system - that is savings accounts - the vastness of the network and incomplete automation ensures that very little effort is made to verify if KYC norms are followed by bank officials.


In the IPO scam itself, the number of bank involved has increased to six. But punishing a few banks and officials is not enough. In the 1990s, Sebi had introduced the ‘Stock Invest’ scheme to prevent investors’ funds from being locked up for nearly two months until the allotment process was complete. The issue of ‘Stock Invest’ involved proper client identification, but the scheme was destroyed because banks colluded with petty scamsters.


In Pashupati Cables, 80 per cent of the issue was allegedly cornered by 14 individuals; this was possible only because a branch of the State Bank of Indore colluded to issue ‘Stock Invest’ without verification. Similarly Global Trust Bank had been pulled up by the RBI for abuse of the ‘Stock Invest’ scheme while the Navrangpura branch of Punjab National Bank helped a dubious Growmore Solvents claim a 90 per cent subscription (minimum subscription required for companies to retain IPO proceeds) by misusing the ‘Stock Invest’ scheme.


Later, small bank branches used to collude with thieves to encash stolen refund cheques and dividend warrants by allowing the thieves to deposit cheques into temporarily opened accounts. This time again, banks allowed the opening of thousands of demat accounts by the same person on the same day with Karvy, the Depository Participant (DP) that accounted for 95 per cent of the dubious accounts in the IDFC case. The findings indicate that banks clearly knew that a fraud was being perpetrated, especially since many of them had provided loans for IPO applications, which requires a higher degree of scrutiny.


As SEBI says, ‘‘Banks have also played their part by opening bank accounts and providing a pro-tempore loan to these fictitious entities with the objective of earning interest and other charges’’. That is why it has asked for an investigation into the dealings of Bharat Overseas Bank, HDFC Bank, Indian Overseas Bank, ING Vysya Bank and Vijaya Bank.


Since these names include some of the most savvy and profitable Indian banks, it is difficult to identify a common motive for collusion. However, the Finance Minister is well aware that the banking system at the small branch level is extremely vulnerable to collusion by officials in laundering unaccounted money and other mischief. In an interview in May 2005, Chidambaram had said, ‘‘There is a misconception that money put in a bank is white money and is not tainted money. The banking system is, in fact, a well-known instrument of laundering money. I have massive evidence of the banking system used for laundering’’.


This is a gaping systemic flaw that needs to be fixed, but not by imposing a Banking Transaction Tax.


-- Sucheta Dalal