Astronomical gains in penny stocks under Sebi lens

Astronomical share price rises could signal speculative trading, posing risks to retail investors, particularly those new to the stock market, the official said on the condition of anonymity. The Securities and Exchange Board of India (Sebi), the official said, aims to protect investors through targeted enforcement.

But as the regulator cannot monitor every small company or suspicious activity, it also aims to protect investors through education, the official said. “The regulator is doing its best to ensure investors are protected. The orders of the regulator carry a message for investors, but they should check these orders."

Sebi is looking to ringfence investors at a time the ongoing volatility has wiped out ₹60 trillion from investor wealth in the past three-and-a-half months. Millions of new retail investors drawn by the pandemic-driven stock frenzy--demat accounts surged about fourfold since March 2020 to 185.30 million--would be among the worst hit. 

Also read | Sebi to enhance risk metrics in F&O to curb manipulation fears in cash, derivative markets: Ananth Narayan G

The regulator’s concerns stem from the surge in the prices of penny stocks and micro-caps even though their earnings have not kept pace. The Nifty Microcap Index surged 21.7% over the past year through 10 January. But its price-to-equity ratio, a measure of share price relative to profit, fell from 32.27 to 29.75. Some penny stocks and micro-caps have seen gains of more than 1000% during the period.

Last year, Sebi imposed curbs to prevent speculative trading in derivatives and social media tips. It also cracked down in individual cases for strict action. It recently suspended trading in Bharat Global Developers Ltd within a week of discovering financial misrepresentation to prevent further manipulation and send a message to the broader market.

The official quoted earlier said much like a police force cannot catch all petty criminals, it is impossible for the regulator to issue orders for every company engaged in manipulative practices. “However, the focus remains on educating investors, especially first-time ones, about the risks of investing in speculative stocks or following unverified advice from social media influencers."

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Sonam Srivastava, founder and fund manager at Wright Research PMS, cautioned that blanket punitive measures might stifle growth, particularly for micro-cap companies recovering after restructuring. “Transparency in investigations and strict monitoring of unusual trading patterns are essential," she said, advocating a balance between investor education and prompt action against proven manipulation.

Regulatory vigilance

To be sure, the regulator's vigilance extends beyond micro-caps. It recently introduced curbs to prevent retail investors from speculating in futures and options after a study showed that most individual investors lose money on such products. It also tightened rules for funding of initial public offerings (IPO).

The regulator and market institutions are "watchful" for any signs of manipulation that might occur in one market to profit from another, Sebi whole-time member Ananth Narayan G said during a symposium. “Often, on social media, we hear rumors claiming that manipulation in the cash market is driving activity in the derivatives market, which leads to either extreme volatility or a complete lack of it, benefiting certain manipulators."

Sebi has repeatedly warned investors against blindly following stock tips on social media, particularly those promoting obscure small-cap stocks. It encourages thorough research before investing, especially in IPOs or heavily advertised stocks.

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In August, the flagged the risk of companies listed on the Small and Medium Enterprises platform making exaggerated claims, misleading investors into buying overpriced securities. In October, Sebi cancelled Trafiksol ITS Technologies' SME IPO and ordered a refund after uncovering irregularities.

In 2023, Sebi barred 55 entities for allegedly manipulating stock prices via YouTube.

Subhash Chandra Garg, former finance secretary and a former whole-time member of Sebi, compared the current situation to the period between 2012 and 2016, with manipulators inflated prices of penny stocks or low-cap companies by trading within a closed group to convert black money, ultimately trapping retail investors. The government and Sebi addressed this through measures like shifting penny stocks to delivery-based trade and modifying the Income Tax Act.

Garg called for accountability regarding how small-cap stocks were issued at premiums. “While Sebi may argue that it is a free market and investors should make informed decisions, this issue should have been tackled more professionally," he said. He also raised concerns over the surge in demat accounts, suspecting that some may be used to secure IPO allotments, which warrants investigation.

And read | Sebi’s meds do the trick in slowing retail options frenzy. Next dose in January.

However, according to Ashish Padiyar, co-founder of Bellwether Associates, the resilience of smaller stocks amid broader market corrections may also indicate a structural change in investor sentiment, favouring higher growth potential in smaller companies.

Moreover, Sebi’s current actions may not sufficiently curb manipulative practices, he said, suggesting to also educate investors to differentiate between companies with genuine growth potential and those driven by speculation. “By taking a more proactive action, Sebi can better protect investors and contribute to the overall health of the Indian stock market."