Sucheta Dalal :Slices of the market regulator at work
Sucheta Dalal

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Slices of the market regulator at work  

Apr 4, 2005


Winds of change are blowing at Securities and Exchange Board of India. In what is now typical of M. Damodaran’s functioning, the transformation is happening simultaneously at many levels.


On the organisational front, the chairman is working at creating a specialised cadre while also trying to rope in mid-career professionals willing to work with the regulatory body on short contracts. At the same time, there is a clear message to Sebi officials that promotions and increments can no longer be taken for granted and will depend entirely on performance. Also, many mindless pursuits of the previous regime, such as the Central Listing Authority (CLA) and the office of the Ombudsman may go out of the window.


The CLA was created despite misgivings and doubts expressed by the committee that examined its feasibility. SEBI alone is responsible for wasting precious time in trying to and failing to set up the CLA.


Meanwhile, Sebi ignored investor associations’ persistent demand to introduce an independent rating mechanism or advisory that would aid investment decisions in new issues. Finally, faced with the problem of approving a plethora of dubious public offerings (that meet all its disclosure norms), Sebi began to delay approvals, sometimes as long as six months.


Last week, under the new regime, the regulator suddenly cleared a spate of small issues. Has Sebi suddenly turned confident about issue quality? Or will many of these issues end up robbing investors again? Only time will provide the answers.


Scrapping the plan for setting up an Investor Ombudsman has an interesting thought process behind it. The preamble of the Sebi Act puts investor protection ahead of capital market development and regulation. This means that Sebi ought to be able to redress investor complaints without needing an Ombudsman to handle its core function, feels the new chairman. That is a welcome attitude, but the challenge is for the regulator to deliver on this responsibility at least 13 years after the Sebi Act gave it statutory teeth.


Another major change will be in Sebi’s propensity to set up innumerable committees. As Chairman of the Unit Trust of India and IDBI, one of the first things that Damodaran did was to scrap various investment and advisory committees that existed in those institutions. He plans to do the same at Sebi. Barring a re-constituted Primary Market and Secondary Market Committee and a couple more, all others are likely to be wound up.


My worry is that Sebi may also throw out some of positive suggestions made by these committees. At least, three such recommendations ought to have been implemented long before this bull-run gained momentum and it is unclear why these decisions have been delayed interminably.


The first is an automated process suggested by the SMILE committee to make the IPO application process fault free. This committee was set up after the debacle in allotment of PSU issues in March 2004. The SMILE recommendations would have streamlined the application process and made it error free by avoiding multiple entries of investor data by different intermediaries.


However, while the Sebi board found time to revise the definition of ‘small investor’ and increase their allotment quota from 25 per cent to 35 per cent of Initial Public Offerings, it hasn’t found to time to make the allotment process fool proof by implementing the SMILE recommendations.


It is the same with preferential allotment. Investor groups have long complained about promoters taking minority shareholders for a ride by giving themselves cheaper warrants and shares on a preferential basis in every bull market. This allows them to profit from the sale of existing shares without diluting their stake.


Over the years, Sebi made preferential allotments less outrageous by mandating a 20 per cent lock-in of promoters’ shares and one year lock in for others. But this was clearly not adeterrent and needs further improvement. Sebi recently put out a discussion paper to tighten preferential allotment rules. Among other things, the new rules block the unjust enrichment of promoters through restrictions on the conversion of warrants to equity. The new rules prescribe a single relevant date for conversion and pricing of warrants.


Another disincentive is created by locking-in the entire promoter holding for three-years and locking in allotments to collaborators and other investors for a year. The new preferential rules have however been delayed for so long that scores of companies have again enriched their promoters at the cost of other investors. The promoters’ game of profiting from preferential allotment is on full swing.


Sometimes the allotment is to large Indian or foreign investors in the clear expectation of triggering a price increase through their association and raising fresh equity at a higher premium. Once again, Sebi will end up bolting the stable doors when it is too late. Recent preferential allotment plans include those of Nagarjuna Constructions, Thiru Arooran Sugars, Kohinoor Broadcasting, TVS Finance & Services, Sabero Organics, United Western Bank, Steel Exchange India, Bhushan Steel and Bank of Punjab.


In most cases, the companies have given themselves wide ranging powers to allot shares to promoters, friends, NRIs, associates or anyone else they choose to favour with their largesse. In the absence of postal ballots there is little that investors can do to block such resolutions. Like preferential allotments, the rash of Foreign Currency Convertible Bonds (FCCBs) and Global Depository Receipts (GDRs) are another source of worry.


These issues dilute shareholder value but are curiously outside Sebi’s regulatory purview. They have no disclosure requirements even though the shares may eventually be listed on the domestic bourses. Recent FCCB and GDR issuers include some notorious companies, including large defaulters on institutional loans, who came to grief during the manic days of 1993-95 because of their indiscriminate expansion, diversification and fund-raising actions. This time they are bypassing both the domestic investors and the passive regulator. Hopefully the change of guard at Sebi will not delay regulatory action and close the window of opportunity for the unjust enrichment of unscrupulous promoters.


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-- Sucheta Dalal