by Santosh Nair
Companies would enter into arrangements with their vendors for fake bills to show higher expenses. The excess money would later be paid back to the promoter in cash. If the vendor was an international entity, the promoter could take the money out of the company’s books and divert it to his accounts in tax havens.
There were hawala operators who controlled the dummy entities, be they proprietorship firms, partnership firms, companies or trusts, in India or overseas. Promoters looking to suck out cash from their companies would make cheque payments to the hawala operator for phony expenses, and get the cash back, minus a commission, for the arrangement.
Inflating costs of plant and machinery also helped divert company money to the promoter’s coffers. The inflated payment would be made by the company and the promoter would later collect the money in cash from the supplier. The higher the cost of the machinery, the higher would be the depreciation, and the lower the profits. Depreciation money was set aside for replacing the equipment when their useful life was over. The promoter would then find some way or the other to take this money out.
The ‘other expenses’ head – under which several miscellaneous operating expenses were aggregated in the profit and loss statement – made for a rich conduit for leakage. A sharp rise in ‘other expenses’ in a depressed market or slowing economy could point to money being drained from the company.
There were quite a few instances of acquisition of foreign companies that were nothing but contrivances by promoters to take money out of the company. In some instances, the promoters had raised capital specifically for overseas acquisitions and then bought out little-known companies at exaggerated valuations. These ‘arrangements’ ensured a chunk of the payment would find its way back to the promoter.
One of the unintended consequences of dematerialization was the encouragement of speculative tendencies in promoters. In the days of physical shares, promoters would learn the identity of the buyer or seller only when the shares came to them for transfer. But with dematerialization, they could know within a couple of days which fund manager was buying or selling their stock. The promoters would then use this information to take up positions using shares in their benami accounts. Or, they would approach fixers who would negotiate a deal with the fund managers. If a fund manager was buying a big chunk of the company’s shares, the promoter would offer him shares from the benami account at a slight discount to the market price. Or, if the fund manager was selling, he would offer to buy the entire block of shares so that the price did not weaken.
In 2005, SEBI had tried to make large deals more transparent by naming the buyers and sellers. For all trades in a stock where the total quantity of shares bought or sold was more than 0.5 per cent of the equity base of the company, brokers had to disclose to the stock exchanges the name of the client and the traded price. But operators and promoters managed to find a way around this too.
If a promoter or market operator was transacting a deal of this size, the trade would be routed through a clutch of privately owned finance companies in such a way that no one entity violated the 0.5 per cent threshold. The information on the stock exchange website would only show the name of the fund house and not the details of the counterparty.
With the market once again in the grip of a bull run, Ketan Parekh was back in action. Since he had been banned by SEBI till 2017, he had to operate through fronts. Interestingly, he still had friends among fund managers, and his services were sought by promoters of many mid-cap companies, eager for lofty valuations for their shares.
But there remained the problem of finding brokers to trade through. Following the stock market crash in 2001, brokers who had dealt for Ketan had suffered huge losses. And since his bank accounts were frozen and investigative agencies were closely watching his every move, Ketan could not repay them legally, even if he wanted to.
So he made them a proposal. He would trade through them using fronts. If he profited on the trade, a chunk of that money would go towards repaying his debt. The only way his erstwhile brokers could hope to recoup the money Ketan owed them was to execute his trades. If he lost money on the trade, the broker got nothing, and what was more, he could not complain to the regulator either. After all, Ketan should not have been allowed to trade in the first place.
Still, many brokers took up the offer.
To my surprise, Monk refused to do business with Ketan until his previous dues were cleared.
I asked Monk why.
‘Ketan had planned his game very well,’ Monk told me. ‘Having been in the business of trading for so long, he knew that no trader, however skilled or lucky, could escape the law of averages. In his case, he knew that the losses would be huge enough to wipe out his net worth, given the outsized bets he was taking. While agreeing to manipulate the stocks of a few promoters, he prevailed on them to allot him a good chunk of shares from their benami accounts at throwaway prices. Of those, he transferred a sizeable portion to his accounts abroad masquerading as OCBs.
‘He used the rest of the shares to generate artificial volumes in the stock through circular trading. Finally, when the technology bubble burst globally, Ketan knew he would no longer be able to support the inflated prices of his favourite stocks. He then played his final card. He placed orders with his brokers, including me, to buy shares of the companies he had been manipulating. We bought the shares, unaware that the sellers of those shares were overseas entities controlled by Ketan.’ I could sense the bitterness in Monk’s tone.
He did not have to complete the story for me; I could see how the story would have played out. On the day of settlement, the money was debited from the brokers’ accounts by the stock exchange towards the payment for the shares. Unknown to the brokers, the money flowed into the ‘foreign investors’ accounts and out of the country. When the brokers approached Ketan for payment for the buy orders he had placed with them, he must have bluntly told them that he did not have the money to honour their commitments. There was nothing they could do.
23
A Booming Primary Market
The IPO boom continued in 2005 too. While more companies were listed than a year ago (fifty-five versus twenty-six in 2004), the amount raised was lower by around 20 per cent (Rs 9,918 crore against Rs 12,402 crore).
If TCS was the blockbuster IPO of 2004, then Jet Airways and Suzlon Energy were the most sought-after offerings of 2005. Investor enthusiasm was natural, considering both Jet Airways and Suzlon were the market leaders in their respective sectors – aviation and wind turbines. Jet raised close to Rs 1,900 crore and Suzlon around Rs 1,350 crore.
Long-term investors in both stocks would lose heavily in the coming years, as the companies’ financial performance kept worsening steadily.
To be fair to Suzlon, the stock delivered handsome returns through the bull market. Offered at Rs 510 to the public, the stock peaked at Rs 2,300 in the second week of January 2008 before its downhill journey. But investors who had bought the stock during the IPO still had a chance to make some profits, as it was only towards the end of October that the share price fell below the issue price. But Jet Airways turned out to be a disappointment for IPO investors in less than a year after its listing. In fact, many investors started to regret their decision within a month’s time of their purchase. It must have caused all the more heartburn considering Jet was tipped to be a sure winner because of its dominant market share.
There was some heartburn in store for merchant bankers too.
Till August 2005, merchant bankers to a public issue could decide which institutional investors to allot shares to, and how much, whenever the issue was oversubscribed. This arrangement helped the merchant bankers favour their important clients by allotting them a higher number of shares than they did to the smaller institutional players. Domestic mutual funds, in particular, got a raw deal as merchant bankers gave priority to FIIs. Peeved at this discrimination, many of the marginalized institutional players complained to SEBI.
The regulator scrapped
the discretionary powers and ruled that all institutional investors should be allotted shares proportionately if the issue was oversubscribed. Merchant bankers protested, saying the power to decide allotments helped weed out the short-term players among institutional investors looking to make a fast buck on listing. Encouraging short-term players would increase fluctuations in the stock price and scare away retail investors, they argued.
I found the argument hollow. The main reason for their opposing the removal of discretionary powers was the fear that it would diminish their importance among institutional clients. Also, there was no way to prove that the so-called ‘long-term investors’ actually stayed invested for the long term. I have seen plenty of flippers (investors who buy shares in IPOs to sell them on listing day) among long-term investors too.
Try as hard as they would, their arguments did not wash with SEBI.
Another good thing the regulator did was to ask institutional players to deposit 10 per cent of the value of the shares at the time they applied for them. Until then only retail investors had to pay up for shares – that too, the entire amount – at the time of application. This inequity allowed institutional players to bid for any number of shares since their money was not getting locked in.
Often, merchant bankers and even promoters would ask some of the reputed institutional investors to bid for a large number of shares in their issue. This would help create the impression that the issue was in demand with fund managers. Since merchant bankers had discretionary powers of allotment, the fund managers would not have to buy all the shares they had bid for either. In effect, these investors were lending their names to ensure the success of the issue.
In book-built issues, the friendly fund managers would bid for a large quantity of shares at the upper end of the price band. The other investors too were now persuaded to bid high or risk not being allotted shares if the final price was at the top end of the band. Having to put 10 per cent of the money on the table at the time of application did help curb some of the exaggerated bids by institutional investors.
The IPO boom nearly got derailed by a SEBI probe, which revealed that shares reserved for retail investors in the Yes Bank and IDFC IPOs were cornered by a group of racketeers who opened fictitious demat accounts. The matter first came to light sometime in July when, during an income tax raid on businessman Purshottam Budhwani, it was found that he controlled 6,000-odd demat accounts. The Income Tax department then tipped off SEBI, which began its probe by examining the allotments in the IDFC and Yes Bank IPOs.
The findings enraged retail investors who were either not allotted shares or got fewer shares than they might have because of the scam. Yes Bank shares had risen more than 50 per cent in less than three months since their listing in October. Shares of IDFC had more than doubled since their listing in August.
SEBI widened the probe to IPOs dating back to June 2003. It brought out a detailed report in April 2006. The investigators found that in 21 IPOs, shares meant for retail investors had been cornered by a group of 85 financiers working through 24 players fronting for them. Based on the listing-day gains, SEBI concluded that the financiers and their fronts had together made a profit of Rs 72 crore through this theft of shares.
In all, around 59,000 benami demat accounts were opened, and applications for shares in IPOs were made by these fictitious entities. Nearly 84 per cent of the accounts were opened by the depository participant (DP) Karvy. A DP is an agent of a depository, an intermediary between the depository and the investor. A large number of such benami accounts were opened at other DPs too, the notable ones being HDFC Bank, Centurion Bank of Punjab (which was later acquired by HDFC Bank) and ILFS.
In every case, the DP had not diligently checked for proof of identity and proof of address of the entities opening demat accounts. They were required to do so under the Know Your Customer (KYC) norms. Strangely, none of the DPs found anything suspicious about accounts with common postal addresses being opened in bulk on the same day. No red flag was raised either when the IPO shares allotted to the benami accounts were consolidated in a select few demat accounts to which they were transferred just before listing day.
At many DPs, hundreds of demat account holders had identical postal addresses. It was common for many retail investors to have multiple demat accounts. This was a throwback to the days when retail investors would make multiple applications in a public issue to increase their chances of share allotment. Since there was nothing such as a Permanent Account Number (PAN) at the time, these investors got away. A household of four – the husband, wife and two children – could apply under at least half a dozen combinations of names.
When dematerialization was introduced, investors who jointly held shares in various combinations had to open as many demat accounts under those exact combinations to get their shares dematerialized. As a result, many households had multiple demat accounts. So multiple demat accounts with identical postal addresses were not uncommon. But when hundreds of accounts had the same address, it should have set the alarm bells ringing.
The SEBI probe found that the depositories imposed fairly steep penalties – up to Rs 3 lakh in some cases – if employees at the DPs did not have NSE’s Certification in Financial Markets (NCFM). And in bizarre disproportion, the penalty for violation of account opening rules was between Rs 500 and Rs 1,000. Despite DPs repeatedly violating account opening rules, the depositories did not take any action beyond imposing paltry monetary fines. This showed the casualness with which the depositories inspected the DPs.
Market players thought the SEBI report would dampen retail investor interest in public issues. But the IPO juggernaut continued to roll on, with 75 companies raising Rs 24,779 crore in 2006 – more than twice the sum raised in 2005.
24
No Stopping the Bulls
The Sensex hit the historic 10,000-mark in February 2006. By now, a sense of euphoria was again suffusing the market. Emerging markets were the flavour of the season across the globe, and India was no exception to the trend. FIIs were buying everything in sight, and the retail money flow into mutual funds too was steadily on the rise. By the last week of April, the Sensex had rocketed to 12,000, and was not showing any signs of fatigue.
Reliance Petroleum was the blockbuster IPO of the year, with the company raising Rs 2,700 crore. The 45 crore share issue, priced at Rs 60 apiece, was subscribed a whopping 51 times, reflecting the frenzied mood in the primary as well as the secondary markets.
As stock market history shows, steep climbs are often followed by equally steep declines. A combination of rising commodity prices, firming up of interest rates globally, and concerns about expensive valuations of emerging market stocks triggered a worldwide fall in equity markets.
The Sensex fell below 9,000 by June, its 30 per cent fall the steepest since the bull market had started in May 2003. Many felt the bull market was as good as over.
GB was among those who had a contrarian view of the situation, thanks to his proximity to top market operators.
‘The economy still appears to be in good health. Companies are still in expansion mode, earnings are growing and jobs are being created. I would not be too worried,’ he told me. I knew he was echoing the views of either Radhakishan Damani or Rakesh. Damani had still not returned to the market, so in all likelihood it would have to be Rakesh’s views.
The crash affected investor appetite for the IPOs that hit the market between June and August. GMR Infrastructure’s issue had to be priced at the lower end of the bidding band of Rs 210-250. The issue was subscribed close to seven times. The institutional portion was subscribed eleven times, but retail investor response was poor. The shares got a lukewarm response on listing day, and could barely manage a 2 per cent premium before ending the day at the issue price of Rs 210.
I wondered where all the institutional investors who had enthusiastically bid for the issue had vanished. If the institutional portion was subscribed eleven times, it meant those who applied had got only on
e share for every eleven they had bid for. When the share was available close to its issue price on listing, these investors could have bought the remaining shares they had wanted. That there was hardly any demand on listing day suggested that some strings had been pulled to ensure that the issue got a decent response. Still, investors who subscribed to the issue and held on for a year had no cause for regret, as the stock appreciated nearly fivefold over the next eighteen months.
By the end of August that year the global markets had settled down, and in the following month had resumed their climb. The Sensex was crossing 1,000-point milestones at the strike rate of Sanath Jayasuriya in top form. In October, it reclaimed the 12,000 mark, on the first day of November, hit 13,000 and in the first week of December, it topped 14,000.
The mania in the secondary market notwithstanding, one of the high-profile public issues of the year turned out to be an anticlimax for the company as well as its merchant bankers.
Cairn India, the Indian arm of UK-based Cairn Plc, was looking to raise over Rs 6,000 crore through an IPO. Until then, only ONGC had raised a bigger amount – Rs 10,500 crore – through a public issue. But everything seemed to go wrong for the IPO, right from the moment the issue opened for subscription in December.
The issue, with its price fixed at Rs 160-190, was fully subscribed on the first day of bidding itself. But many institutional investors reduced the size of their bids and revised downward their bid price, with quite a few withdrawing their bids altogether. This had a cascading effect, as many retail investors too chose to withdraw their bids sensing institutional investor apathy. By the last day, it appeared that the issue may not be fully subscribed.
The pedigreed merchant bankers to the issue then had to fill the shortfall by paying from their pockets. Had the issue not attracted enough bids in the first place, the merchant bankers would only have had their reputation to worry about and not their pockets. But with investors withdrawing their bids, the merchant bankers were obliged under their agreement with the company to bridge the shortfall.
