GDR scam: more needs to be done

Securities and Exchange Board of India’s (Sebi) final order on the GDR (global depository receipts) scam is anything but final. The regulator has barred 13 brokers and individuals from the markets for their role in the scam.

But the big fish are still to be booked, and although Sebi is convinced about its case, there has been no attempt at disgorging wrongful gains.

Of course, one could argue that the regulator’s hands have been tied after the Securities Appellate Tribunal (SAT) ruled that regulation of GDRs is outside the purview of Sebi. While the regulator managed to get a stay on SAT’s order in the Supreme Court, the case is still to be decided. Even so, it’s unfortunate that more hasn’t been done.

The case pertains to GDR issuances by a merchant banking firm, Pan Asia Advisors Ltd, in 2009. In each of these issuances, there were large-scale on-market and off-market transactions in 2009 and 2010. When Sebi investigated these transactions, it found that entities related to Pan Asia formed an entire chain—facilitating the GDR issue for small Indian companies, arranging for investors, and then providing an exit for these investors in the Indian markets through a chain of known stock brokers.

Sebi’s case is that the GDR issuances were a mere sham. The initial subscribers to these GDR issues were almost always the same set of investors, who would, soon enough, cancel their GDRs, convert them into Indian shares, and then sell them in the Indian market. Sebi found that a large portion of these sales were in the form of synchronized trades with the same set of stock brokers based in India. Even the brokers were found to be connected to Pan Asia and its founder.

The current order is against this set of brokers, who allegedly acted in connivance with Pan Asia.

Sebi also found that these brokers would eventually exit their positions by selling the shares in the open market to hapless investors. The lure for retail investors was two-fold: the sudden surge in volume in these stocks and the impression that the stock must be a decent bet given its large GDR issuance and investments by foreign institutional investors (FIIs).

Presumably because of the SAT order, which is being contested in the Supreme Court, Sebi has chosen to be silent on Pan Asia and the others involved in the scam in its final order. But even with the set of Indian brokers who facilitated the sale for the original GDR investors, Sebi should have gone further than merely barring them from the market for five years.

According to the regulator’s investigation, these brokers bought shares from the original set of GDR subscribers and also sold shares in the open market. Whether or not they gained from these transactions, it makes sense to impose a monetary penalty. While it isn’t easy to figure the amount of unlawful gains because of the convoluted nature of these transactions, Sebi could still have attempted to disgorge unlawful gains, given its view that the GDR issuing companies and the merchant banker and its related entities gained at the expense of Indian retail investors. And if it continues to face jurisdictional restrictions owing to the fact that it doesn’t regulate the GDR market, it has little choice but to go after the entities involved in the Indian leg of the transactions.

Hopefully, this isn’t the last we’ve heard about Sebi’s action in the GDR manipulation case.

Gujarat High Court on wilful defaulters

Earlier this month, the Gujarat High Court ruled against a part of the central bank’s circular on wilful defaulters. Reserve Bank of India’s master circular from July 2012 states that banks can declare all directors of a defaulting company as wilful defaulters. The high court ruled that this is arbitrary and unreasonable and that it shatters the concept of the identity of the company being different and distinct from its directors. The court said these observations will not apply to promoters or entrepreneurs.

This is an important judgment and the principle, if embraced by regulators such as Sebi and the government, will go a long way in bringing relief to directors of a company.

In the past, some independent directors have been harassed for the faults of the companies they were associated with. This has led to immense uncertainty and a dearth of people willing to take up such positions. Ironically, there is pressure to increase the number of independent directors on boards of companies as well from regulators. The above mentioned safeguard will help achieve this objective.

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