India’s stock market regulator, Securities and Exchange Board of India (Sebi), has issued another thoroughly investigated and well-drafted order. According to sources, investigation work on this order, related to the manipulation of stock prices using the relatively less regulated GDR (global depository receipts) market, began around a year ago.

Also Read | Mobis Philipose’s earlier columns

It’s heartening to note that some of the triggers for the investigation were alerts from Sebi’s Integrated Market Surveillance System (IMSS), which noticed unusually large orders as well as large-scale off-market transactions in a few stocks between January 2009 and May 2010. It sends a vital message to market participants that the regulator is watching. And when this is followed up by thorough investigations, such as in the above-mentioned GDR case and the one related to insider trading in HDFC Mutual Fund, it is sure to cause market participants to think twice before breaking the law.

Photo Shyamal banerjee/Mint

One of the distinguishing factors of each of the GDR issuances investigated by Sebi was that each was very large in relation to the size of the company. The number of GDRs issued was almost always higher than the existing paid-up capital of these companies. In one case, Asahi Infrastructure and Projects Ltd, the GDR issue was eight times the total equity of the company prior to the GDR issue. Its paid-up equity went up from 37 million shares to 336 million shares after the GDR issue.

Another common feature was that the initial subscribers to these GDR issues almost always the same set of investors. One large investor among them, India Focus Cardinal Fund, is a sub-account of Euram bank AG, which has already been linked to Panchariya. Besides, India Focus and another FII (foreign institutional investor) sub-accounts who initially bought the GDRs, were found to be following a similar pattern with their investments. Not very long after the GDR issuance, they would cancel their GDRs, convert them into Indian shares, and then sell them in the Indian market. Sebi found 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 Panchariya and his family.

Thus, entities related to Panchariya and Pan Asia formed a whole chain— facilitating the GDR issue, arranging for investors, and then providing an exit for these investors in the Indian markets through a chain of known stock brokers. These brokers would eventually exit their positions by selling the shares in the open market to hapless investors, who would be lured in by the sudden surge in volumes and activity in the stock and on the false impression that the stock must be a decent bet given its large GDR issuance and FII investments. According to one market expert, it’s possible that Euram funded the investments of the GDR subscribers, with a lien on the GDR securities.

The outcome of all this from the GDR issuing company’s perspective is that they can completely avoid the regulatory process and due diligence that is required while raising funds in the Indian market. Issuing GDRs are a much simpler process, especially when they are listed in exchanges such as London Stock Exchange’s Alternative Investment Market. Indian regulators have allowed this since it pertains to securities that are listed in markets outside their jurisdiction and are bought by investors who are not regulated by them.

But as the recent investigations show, some market participants are using this as a loophole. And ironically, it’s Indian investors who end up with the short end of the stick, when these GDRs are quickly converted into Indian shares. In sum, while it’s made to look like an issue of GDRs, in essence it’s an issuance of Indian stock, given the fact that most GDRs are cancelled and converted into shares.

Sebi’s investigations also showed that Pan Asia and allies weren’t the only ones following this modus operandi. Another company it investigated, Cals Refineries Ltd, had a similar GDR issue which wasn’t managed by Pan Asia.

Needless to say, Sebi and the central bank will need to look at plugging these loopholes. As a Mint report in July pointed out, regulators are looking at imposing stringent conditions on Indian companies issuing GDRs. But while doing so, policymakers should be careful that genuine users of overseas equity and equity-linked instruments aren’t turned away. Some of the above-mentioned loopholes can be fixed with just better reporting standards, rather than having to get involved in extensive screening.

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