Sucheta Dalal :Desi regulations for local conditions
Sucheta Dalal

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Desi regulations for local conditions  

February 14, 2000

These days when SEBI contemplates measures to globalise the Indian capital market or to introduce new regulation, it immediately looks to the US markets for parallels. A curious sidelight of such comparisons is that whenever one protests what seems like sharp practices which hurt Indian investors, our now globalised market intermediaries turnaround and say that it is an accepted market practice in the US.

Lets look at a few examples:

Industrial Credit and Investment Corporation of India (ICICI) responded to the National Stock Exchange's (NSE) saying that it would "neither confirm or deny" rumors about whether it was negotiating the takeover of Centurion Bank. The rumor-based price turbulence was allowed to continue and it was argued by various people that such an answer to a regulator was acceptable in the US.

When book-building was introduced in India, the enormous discretionary powers arrogated to themselves by the lead managers were unfair to investors. In the first book building issue, one of the lead managers even tried to charge a non-refundable service fee which was equal to the application amount. Application processing fees continue to be high and investors are not told that only applications on the forms of the main lead manager are likely to lead to allotment.

A further distortion is that large investors are allowed to apply without any application money - this leads to artificial oversubscription numbers sometimes large enough to bridge the national fiscal deficit. This usually leads to a manic rush to invest in these issues. Announcement of fund quotas by finance companies which are nearly ten times the size of the issue also sends out certain questionable price signals. Again, we are told that such tricks are perfectly legitimate in the US.

The Securities and Exchange Board of India (SEBI) recently warned companies that brokers cannot hold exclusive briefings for large investors. Not only is this ignored, but some brokers have even issued advertisements announcing the fact that their seminars will be held at luxury resorts for their exclusive institutional clients and fund managers. Again, I am told, that this is a common practice abroad.

I claim no detailed knowledge about US systems. What one does know is that the structure of the US market is different from that in India. It is dominated by large institutional investors who do not shy away from reporting irregularities by the competition to the regulator or the press. Investors can also protect their rights by filing litigation individually and it is quickly turned into class action if they win. The damages awarded by courts and the regulators are also huge and punishing.

The bigger difference though is the sort of penalties levied by developed markets such as the US, not only by the powerful Securities Exchange Commission (SEC) but also self-regulatory bodies such as the NASDAQ. The NASDAQ has an independent company handling enforcement and investigation. A cursory look at its website would shock investors at the heavy penalties imposed by it for what would seem like minor misdemeanors in India such as delay in filing accounts or 'inadequate' co-operation with the regulator. Brokers are routinely asked to re-appear for their qualifying exams and the penalties are so high that the market intermediary is never again tempted to break rules.

The SEC is also swift in catching new ways of duping investors. The first time a plantation company type operation surfaced in the US (Orange Grove Securities), SEC filed litigation against it charging that the scheme amounted to nothing but a mutual fund and disclosures and regulations required for the purpose had not been sought. It lost the case in the lower courts but pursued it all the way to the Supreme Court where it led to being a part of the famous Blue Skies Regulations of the US to combat various unusual frauds.

It's the same with Internet-based trading. Way back in October 1998, the SEC announced charges against 44 stock promoters caught in a nationwide enforcement sweep to combat Internet fraud. These promoters failed to tell investors that more than 235 companies paid them millions of dollars in cash and shares in exchange for touting their stock on the Internet. The traders were also dumping shares in the market for easy profits.

SEC also puts out regular information on its site about new ways of duping investors through online bulletin boards.

Look at the sort of fines that have already been imposed by the SEC for Internet fraud where the online newsletters failed to say that they had been paid by companies to tout their stock.

Francis A Tribble and Sloane Fitzgerald, Inc. were sued by the SEC and slapped with a $15,000 penalty.

Charles O. Huttoe and twelve other defendants ran a classic "pump and dump" scheme in a company called Systems of Excellence. They were fined $12.5 million, but he spent most of his ill-gotten gains, and investors did not get their money back. Huttoe and the author of the online newsletter were also sentenced to federal prison and they pleaded guilty to other criminal charges.

Matthew Bowin recruited investors for his company, Interactive Products and Services, raised $190,000 from 150 investors and pocketed the money. He was convicted of 54 felony counts and sentenced to ten years in jail.

These are just a few examples on SEC's website.

Contrast this with India. Indian investors are at the receiving end of companies with low corporate ethics and poor disclosures. Insider trading remains rampant and law enforcement is not only poor, but is compounded by the problem of overlapping jurisdiction of the various regulators and their refusal to co-operate with each to tighten the enforcement machinery. Compensations are niggardly and courts nearly inaccessible and pointless. Here is more:

A 1998 case drags into the year 2000 even when there is fairly substantial proof available that three companies and a score of brokers colluded with a broker who was previously accused in a multi-billion dollar financial scandal to rig up their share prices. Less than half-a-dozen of those involved in the most brazen price rigging from 1993-95 have been punished, either because the regulators is not equipped/empowered to continue the investigation.

The rampant rigging killed the Initial public offerings (IPO) for nearly four years. Investors continue to fight cases hoping that the courts may force regulators to act against "vanishing companies". Unlike in the US, shady finance companies and plantation companies were allowed to proliferate, advertise and fool the public until they had collected tens of thousand crores of rupees through Ponzi-like schemes and finally collapsed. Even later the regulators keep squabbling to shirk regulation of these companies.

Even today, while the BSE Sensitive Index has soared past the 6000 mark and it is abundantly clear that a few stocks are driving up prices, SEBI has started no detailed investigation about where the money is coming from. On the contrary SEBI has quietly relaxed the entry norms for Foreign Institutional Investors (FIIs) opening the doors for hot money to enter the market.

The list could go on. But it is abundantly clear that comparisons with the US are a ridiculous way of permitting malpractice to proliferate. Indian regulations have to be tailored to Indian conditions - until we learn to punish wrong doings swiftly and adequately we need to go slow on introducing foreign practices and systems. This one-sided globalisation will just have to be stop.

-- Sucheta Dalal