Sucheta Dalal :Investor activism: Indian capital markets' missing li<x>nk
Sucheta Dalal

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Investor activism: Indian capital markets' missing link  

December 4, 2001

Last week the government attempted to push through an amendment to the Companies Bill 2001 to allow companies to buy back 10 per cent of their capital with a simple board resolution instead of the special resolution.

As against this companies could only buy back 5 per cent of their equity in a given year that too after investor approval through a special resolution.

The bill was attempting to convert an ordinance, which was hastily promulgated a few weeks ago into an act. And the Ministry of Law, Justice and Company Affairs, justified it as "a suggestion from the finance ministry" aimed at boosting "market sentiment".

The idea was that companies would buy up increasing quantities of their shares (using shareholders money which forms part of corporate reserves) and this would mop up floating stock and push up stock prices. And voila! Market sentiment would get a great boost.

The reality, however, is vastly different. Firstly, a few Indian business groups and many multinational companies have made share buyback offers. The MNCs, in fact, have made repeated buyback offers in an attempt to take their companies private, which is against the interests of retail investors because it reduced the number of good companies available for investment.

The Indian companies on the other hand are attempting to shore up the promoter groups' share holding due to fears of a hostile takeover.

Either way, the retail investor and their 'sentiment' is nowhere on the list of priorities or either category of companies.

Yet, this blatantly anti-investor move was pushed through the Securities and Exchange Board of India with record speed and little discussion, apparently at the finance ministry's insistence. Nobody bothered to notice that it wasn't investors who were demanding increased share buyback but the corporate sector.

Also, investor associations were not even consulted.

Now that the third amendment to the Companies Bill 2001 is in Parliament, company law experts have suddenly noticed that that it provides scope for insider trading by the board of directors of companies (even the best Indian boards are notorious for insider trading) because it does not mandate immediate disclosure to stock exchanges of the buyback plans.

According to the Economic Times, the bill will face rough weather in parliament, because parliamentarian are agitated at the "discrimination against small shareholders" and that they plan to take government to task for not protecting minority investors.

That parliamentarians are concerned about the small shareholders is indeed a joke. Had they really been concerned, we would have seen at least a couple of scam investigations reach their logical conclusion over the last ten years.

Moreover, if parliamentarians are really concerned about minority shareholders, there is a simply was to protect their interests. They should simply force government to drop the amendment. Remember that the increased buyback was aimed at "boosting market sentiment" - well, market sentiment is already boosted and a variety of experts and brokers on CNBC have confidently and unhesitatingly proclaimed a new bull run. So why bother to amend the Companies Act?

The best solution would be to let the ordinance lapse and restore status quo.

Since that is unlikely to happen, the next few weeks would probably expose the real reason behind the sudden concern for retail investors.

However, what is really worrisome is the silence of the retail investors.

Why were there no protests when Sebi mooted increased share buyback by companies in order to boost sentiment? Where were the investor associations? Why isn't there effective intervention by investor groups? The answer is simple.

The absence of strong investor organisations is a major lacuna in the Indian capital market.

All over the world, powerful investor groups supplement the efforts of regulators by tracking corporate decisions and filing class action suits against anti-investor activities. Their actions compel companies to follow good business practices.

In India investor associations are the weakest segment of the capital market. In a country that has 23 recognised stock exchanges and a 125-year history of organised trading, only 12 investor associations qualified for recognition by Sebi.

Most of these are tiny, under financed and usually unable to drum up a large enough membership. They also have very few members who are serious activists and able to understand capital market related issues. The reasons for this are not far to seek.

Despite so many scandals that have rocked the financial market and caused losses of the order of millions to investors, there isn't a single instance when investors have been able to get their money back or be awarded damages.

Most often, the investigation itself is not completed for decades. Naturally, no investor wants more of his money spent chasing a lost cause by joining investor groups.

The system is so badly loaded against investors, that even in the few instances where Sebi is able levy penalties, the maximum fine leviable is a paltry Rs 500,000 - and that too is not payable to the investors. As against this the cost of litigation would be a large multiple of the maximum penalty.

The lack of awareness or sensitivity about investor issues also extends to the judiciary. All over the world, stringent monetary penalties are seen as the best deterrent to corporate fraud. In India there are almost no monetary costs attached to any corporate crime.

Whether it is diversion of funds, mismanagement or fraud, Indian courts have almost never awarded significant exemplary damages. In fact, the combination of a slow and expensive judicial trial without any hope of exemplary damages being awarded at the end of successful litigation is itself a deterrent to investor activism.

Hence, there are no class action lawsuits. Without the fear of investor action, or public embarrassment, even professional bodies such as the Merchant bankers association, the mutual funds association or even the Institute of Chartered Accountants have abandoned all pretense of being self-regulatory organizations and have simply turned into lobby groups.

Until Indian investors turn mature enough to understand the need to form strong associations without the single, short-term focus of having only their specific individual grievances redressed anti-investor actions such as the proposed buy-back amendment will be the norm rather than an exception.

-- Sucheta Dalal