Thursday, December 10, 2015

SEBI PREPARES GROUND FOR FRAUD

FROM BUSINESS WORLD OF 26 DECEMBER 2006


FM should think for himself


It appals me to see how little P. Chidambaram has thought about the so called IPO scam and how easily he has allowed himself to be misled by Sebi. If a company issues new shares at a price that is lower than the market price, then those whom it allots those shares will make a profit. It does not explicitly have to underprice the shares. If it excludes some people from those qualified to buy the shares, that by itself will have reduced demand for the shares and hence the issue price. Even if it rations shares between defined classes of shareholders, then shares will not go to the highest bidder and will again be underpriced. The beneficiary of underpricing is the favoured new shareholder; the victim is the incumbent shareholder, for underpricing means that the company subsidizes new allottees. It will get less money from the issue than it would have if the issue had been sold to the highest bidder. This is why a company which the directors run in the interests of shareholders will not underprice shares.

But our government used to force companies to underprice new issues. It had an official called Controller of Capital Issues. He fixed the price on the basis of past profitability; that ensured that the shares of every company whom investors expected to do better in the future were underpriced. Demand for their issues would exceed supply, so the issues had to be rationed. The government told companies how. It made them allot some shares to ‘small’ shareholders. They were small only in name; no one checked how rich or poor they were. The definition of a small shareholder was one who was allotted only a small number of shares. The government aimed to give shares to a large number of shareholders. It claimed thereby that being a socialist government it was spreading wealth. But all it was doing was to force companies to subsidize an undefinable set of shareholders.

Since the shares could be sold at a profit as soon as they were traded on stock markets, ‘small’ shareholders made automatic profit on allotment. So, too many ‘small’ shareholders applied, and shares had to be rationed amongst them. To increase their chance of getting shares, ‘small’ shareholders would make multiple applications. That was considered unfair and banned, but since shareholders applied in different variants of their and their relatives’ names, it was impossible to identify the real allottees. So, a racket of multiple applications and allotments went on for decades.

It was a scandal, and when I was in the finance ministry in the early 1990s, we decided to end it. We transferred all powers of the Controller of Capital Issues to Sebi, but not the power of controlling issue price, thinking that thereby we would make Sebi incapable of underpricing shares.

But we were wrong. Sebi brought back rationing of shares; it ordained that half of the share issues would go to those whom it called Qualified Institutional Investors, 35 per cent to ‘small’ investors whom it renamed ‘retail’ investors, and 15 per cent to others, whom it has named high net-worth Individuals. The last, who have the most money, have the smallest share. So they pose as retail investors and make money. Sebi caught one group of them, and on their account, has engorged crores out of their depository participants and brokers. It has imposed stringent ‘know-your-customer’ stipulations on DPs and brokers. And the finance minister has repeatedly assured Parliament that the guilty will be punished. But what is their guilt? They are guilty of a crime invented by the government and perpetuated by Sebi, a crime that is difficult to detect, and a crime that has terrible effects on the development of our corporate sector.

Identity is easy to invent, hide or forge, so issue rationing will inevitably lead to fraud. It will  contract India’s narrow investor base, reduce demand for shares, slow down corporate expansion and force companies to raise money abroad. Mr Chidambaram should put an end to Sebi’s malign game.