Sucheta Dalal :SEBI report on Scam 2001 throws surprising results
Sucheta Dalal

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SEBI report on Scam 2001 throws surprising results  

In 15 days flat the Securities and Exchange Board of India (SEBI) has put together a fairly detailed report on the Scam of 2001 and how Ketan Parekh and other operators manipulated the market in collusion with companies, banks, mutual funds and Foreign Institutional Investors (FII). The report also outlines how SEBI has, over the last few years, tried to put in place several measures to improve market safety and integrity through regulatory measures.

Apart from automation, trade guarantee funds, surveillance systems and stringent margin rules, these measures included formatted periodic reporting and event-driven reporting by stock exchanges and the creation of an inter-exchange surveillance group that was coordinated by SEBI. The regulator had also sent out letters and circulars asking stock exchanges to investigate sharp movements in certain K-10 scrips last August.

Yet, all these measures failed to add up to the sort of comprehensive understanding that has been demonstrated in the preliminary report after the stock market crisis.

SEBI has attempted to shift part of the blame to stock exchanges for their inability to detect concentration of trading positions and other irregularities. But it is surprisingly mind on that den of inequity called the Calcutta Stock Exchange (CSE) where it limits its comments to procedural lapses in March this year. What the SEBI report fails to point out is the systemic problems that were either ignored or were not addressed by the inter-exchange risk management mechanism. For instance, the entire report makes no mention of the inspection reports of the major stock exchanges. Problems such as the CSE’s custom of using capital deposited by members for margin requirements. It’s erroneous method of calculating trading exposure limits or even dangerous practices such as collecting and holding margins in the form of cheques instead of debiting brokers’ accounts are part of SEBI’s report to the finance ministry.

However, the report does no say why all these lapses were not detected by the CSE inspection reports and corrected under regulatory supervision. It was common knowledge that the badla session for unofficial trades took place like clock work on the floor of the CSE every week and unofficial badla charges were routinely reported by the business press. But SEBI is curiously silent on the subject.

It would be of interest to find out what the SEBI inspections over the past two years have had to say about CSE’s risk containment measures, lax supervision and illegal badla sessions. Or, whether broker inspection reports had ever detected the large trades which were done by CSE brokers on behalf of Mumbai brokers.

SEBI’s conclusions about systemic risk misses one important point. The system of differing settlement periods played a big part in masking concentrated trading positions of broker cartels that operated across bourses. Since brokers rolled their large trading positions between the CSE, NSE and BSE and others, it was impossible for stock exchanges to assess systemic risk beyond the trading positions on their own bourses. Also, broker inspection reports were limited to individual bourses. Brokers are extremely savvy about their rights and never allowed inspectors of one stock exchange to follow audit trails, which seemed to lead to their market operations on another exchange.

The tracking of broker operations across stock exchanges was clearly SEBI’s job, and it seems to have discharged it very competently in the fortnight leading up to its report to the finance ministry. SEBI’s report indicates that risk containment measures and trade guarantees may have prevented a systemic collapse. But it has done nothing to contain large-scale defaults by brokerage firms. Scores of firms have already closed shop and millions of investors have lost money because of brokers who have gone bust. May brokers have misused broker-pool accounts and delivered demat shares belonging to their clients against their own personal liability. This aspect of the payment crisis has yet to be investigated by the regulator. The culprit is non-uniform settlement periods.

The issue of introducing uniform settlement periods has been debated since 1992 and forms part of the previous JPC report. SEBI has some explaining to do about why it has not been introduced. Over the last two years, bourses that have worried about un-quantifable trading risk due to inter-exchange arbitrage have also been pressing for the introduction of rolling settlements. SEBI needs to explain its role in this delay too.

It is now clear that the entire system was on the brink of a collapse, despite hefty trade guarantee funds available with the BSE and the NSE, only because of lax supervision of one rogue exchange – the CSE. It is only because of SEBI’s ruthless decision to block the payout of obviously collusive deals in Kolkata that contained the problem. SEBI’s drastic methods have spawned several court cases, but it protected the system from a contagion effect. However, the complete absence of supervision at the CSE leading up to the crisis cannot be brushed away with the mere resignation of broker-directors. SEBI has to initiate disciplinary action in order to send an effective message through the system.

Now that the dust is settling down and the powerful broker lobbies of various stock exchanges have been effectively silenced, the regulator and the finance ministry are moving with some speed to introduce long overdue reform measures. The first decision has been the scrapping of the quasi-badla systems such as the NSE’s ALBM and BSE’s BLESS in anticipation of the introduction of rolling settlements. Next on the list is the much needed introduction of unique client identity numbers which will allow the regulator to create audit trails and track individual trading positions across different broking entities. The government is also toying with the idea of making PAN numbers mandatory and enhancing the fines paid from the current Rs five lakhs to higher minimum sum or twice the money involved- which ever is higher.

Finally, an area that has yet to be debated is the issue of Participatory Notes (PNs) by Foreign Institutional Investors (FIIs) abroad. These allow entities which are otherwise ineligible for trading on the Indian market through the susbcription to PNs. SEBI suggests in its report that it ought to be obligatory for FIIs to provide details about the subscribers to PNs issued overseas when asked by the regulator. Similarly, it has asked SEBI to evolve specific norms for OCB transactions.

But these too will not be a substitute for an alert and active SEBI, they can only be tools to strengthen market safety.
-- Sucheta Dalal