26 Years Later, the 1992 Scam Trials Linger, Show No Signs of Ending
At the beginning of 2018, all 17 offices of the insurance ombudsman were headless; even today, nine posts remain vacant. The Securities Appellate Tribunal (SAT) has over 400 cases pending because the government has not bothered to make appointments; left with only one out of three members and no presiding officer, SAT can only issue temporary orders that too on urgent matters. Many public sector banks (PSBs) continue be headless. Although we have two finance ministers, of whom one is busy with blog posts and tweets, the finance ministry hasn’t found time to make these crucial appointments.
 
Now, contrast this with two statutory bodies created in 1992 in the wake of the Harshad Mehta scam. They were supposed to be wound up after taking charge of the assets of all scam-accused and distributing the proceeds after the expeditious hearing of cases was complete. But our judicial system is so broken that both, the special court and the custodian, have almost become permanent establishments funded by the Central government. They have been around for a quarter century and may survive another 25 years, going by the pace at which the cases are being tried with over 120 civil cases still pending. 
 
After the Rs5,000-crore securities scam of 1992 engulfed the entire financial system, the government first passed the Special Court (Trial of Offences Relating to Transaction in Securities) Ordinance in 1992 for speedy trial of cases. It was amended in 1994 to include civil cases. A special court was set up in Mumbai to ensure faster trial of cases, with an appeal only to the Supreme Court. Importantly, these cases were limited to securities transactions in a small period—from 1 April 1991 to 6 June 1992. The office of a custodian was set up under the Act, to take charge of scam-related assets and to ‘notify’ the scam-accused. It seized all assets of the notified persons without any distinction between income from legitimate business or income of the persons notified and the scam. 
 
Every year, the Union Budget allocates Rs13 crore for running this office; it is strangely located in Delhi and not Mumbai which is the scene of action. It also has an office in Bengaluru, probably because Canara Bank, one of the two biggest litigants, is located there. Over 26 years, the government has spent Rs338 crore on the custodian’s existence. The way scam cases have dragged would have been a national embarrassment, but for the fact that most people have long forgotten it and/or are uninterested.
 
On 14 May 2017, the Times of India reported that the custodian had “disbursed more than Rs6,000 crore to banks and the income-tax (I-T) department by selling assets of the Harshad Mehta’s family alone and identified another Rs200 crore to be auctioned.” The Harshad Mehta group’s involvement in the scam was probably under Rs2,000 crore; but assets of over Rs6,000 crore have reportedly been recovered from them. The main assets with the custodian belong to stockbrokers whose businesses were shut down and tiny amounts from some individuals. There is, obviously, little to be recovered from other equally complicit institutions such as State Bank of India, Canara Bank and its associates, UCO Bank, Standard Chartered Bank (SCB), Citi Bank, HSBC, Fairgrowth Financial Services, ANZ Grindlays, Andhra Bank as well as several private and public sector companies. 
 
The case for winding up the 1992 scam investigation becomes even more compelling when you compare it with the spate of recent scams and the loot of PSBs by large industrial houses. Nirav Modi (Rs11,400 crore plus), Mehul Choksi (Gitanjali Gems over Rs6,000 crore) and Jatin Mehta (Winsome Diamonds over Rs7,000 crore) had fled the country after dumping huge losses on banks. Vikram Kothari of Rotomac could defraud banks of Rs3,700 crore in a ballpoint pen company. And the humungous bad debts—of Essar, Videocon, Bhushan Steel, Electrosteel and many others—are going to inflict damages running into several lakh crore of rupees, mainly on PSBs even if bankruptcy proceedings lead to a change in ownership. 
 
Isn’t there a clear case for a pragmatic decision to wind up and settle cases against some of the 1992 scam and stop it clogging up our courts? But who has the political courage to do it?
 
Let us look at why the securities scam investigation had been so messed up. The 1992 scam was sensibly handled initially through a multi-disciplinary committee headed by R Janakiraman (former deputy governor of the Reserve Bank of India). The committee included the central bureau of investigation (CBI) and the I-T department, which ought to have ensured that they worked as a team to recover the money and punish the guilty as well. 
 
The committee published six detailed reports that laid bare what had gone wrong and who was accountable. It also formed the basis of the Joint Parliamentary Committee (JPC) report, although that, by its very composition, ensured that it had a political spin. Unfortunately, the Supreme Court decided that the Janakiraman report and the JPC report had no evidentiary value and could not be used in Court.  
 
That, in itself, was not such a setback; because the basic work of joining the dots and understanding banking and financial issues and violations was already done. Here’s why things didn't work out that way. Nobody put CBI on the clock or ensured that with the basic groundwork already done, it would have to show some speed as well. CBI took three years to file charge-sheets, some even later. 
 
As many as 45 cases criminal cases were filed including some in cases where banks were unwilling to complain and said they had not lost any money. The cases continue to drag on and one, involving Fairgrowth Financial Services, was decided last week. 
 
The Special Courts Act gave the first preference to I-T dues which set the stage for a huge problem. The I-T department came up with demands totalling over Rs30,000 crore (including interest and penalty) which was a ridiculously large multiple of the scam itself. Unless the tax authorities put a stop to such exaggerated claims, no dispute or recovery will ever be complete or closed in India. 
 
The custodian’s office acts as a sort of recovery agent for the tax department and is managed by government employees on ‘deputation’ from other departments. It has neither the mandate nor the capability of managing assets that it has seized after ‘notifying’ scam accused, although ensuring this was imperative. It took decades for the custodian to get shares held by various scam-accused transferred in its own name and ensure that benefits such as dividends, bonuses, etc, were correctly received. As recently as last year, it was harassing ordinary, innocent investors unconnected with the scam. It sent out demand notices, asking investors to submit dividends and bonuses earned with interest, going back to 1992 on the grounds that they belonged to Harshad Mehta. 
 
This mis-management is especially unfair because the liability of the scam-accused is constantly increasing, since they are held responsible for interest payments. And, yet, their assets are seized; their stock portfolio is not properly managed. Many of the shares held by the Mehta group have seen a dramatic increase in value over the years. Some others with the custodian would have fetched a good return if sold at the right time. Similarly, the value of properties and physical assets has also gone up considerably; but the tax demands with interest compounded will continue to run ahead of this valuation creating an impossible situation.
 
The NDA (National Democratic Alliance) government has been quick to adopt Americanisms such as ‘grandfathering’ and ‘sunset clauses’ for tax laws. Wouldn’t it be in line with its promise of maximum governance and minimum government to set up a ‘credible’ structure to wind up the special court after winding down the cases, de-notify the accused and get the tax department to come with a sane assessment which will actually bring some revenue to the exchequer? Instead, what we have is a meandering litigation that is a drain on PSBs’ resources, pain for those who have got dragged into it and enriches only the legal community.
 
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    COMMENTS

    B. Yerram Raju

    2 years ago

    Piysh Goel had the audacity to say that Governance in PSBs has improved!! When will these bluffs end and sanity begin?

    R JAYAKUMAR

    2 years ago

    While I like lot of reports which come in MoneyLife, somehow the genes is for only negative reporting. We are already burdened with too much negative reporting by the media in all formats.

    Hence my suggestion is please do report positive articles also.
    Why not highlight major achievements by Indians in various fields and so on. It will make the readership more interested in Money Life.

    REPLY

    Sumitha Manivel

    In Reply to R JAYAKUMAR 2 years ago

    Most Moneylife readers are more interested in articles that analyse issues facing investors than in achievements of Indians,there are other magazines for that.

    Avinash Venkata

    In Reply to R JAYAKUMAR 2 years ago

    Empowering small investors with critical information is not negative reporting.

    K S Jegannathan

    2 years ago

    The owners of this publication know all the facts relating to this scam. However, to my knowledge, I feel the bear cartel is responsible. In those days BSE was acting like a club with all the benefits loaded to the bears with badla, undha badla etc. and acting under one man known by the nickname, Cobra which itself is indicative of how things were. As Mehta was a bull, the bear cartel started feeling the heat not to know what to do and resorted to somehow fixing Mehta which they finally succeeded.

    REPLY

    Sachin Purohit

    In Reply to K S Jegannathan 2 years ago

    Based on your level of interest in this security scam, let me recommend a book by this same writer, The Scam (unless you have already read it). This is the most detailed work I have read on this topic.

    B. KRISHNAN

    2 years ago

    If my memory is correct, Harshad Mehta owed the banks less than 1000 crores, but the custodian has recovered 6000 crores. So Harshad Mehta was right in the claim he had made at that time that he was capable of clearing all his debt, if only he could be allowed to act freely. It made good print for newspapers at that time, but now it is more than likely that there would have been no "scam" at all, if the regulators had acted prudently!
    I was one of the small investors caught in the stock market burn-out caused by the "scam", and scared away many a small investor from the market.

    Three Brokers Identified in Deloitte’s Audit as Having Allegedly Misused NSE’s Co-location Facility
    The Securities and Exchange Board of India (SEBI) has issued show cause notices to National Stock Exchange (NSE) officials and brokers who allegedly misused the co-location (colo) facility. Deloitte Touche Tohmatsu India LLP conducted forensic investigations into three brokers including OPG Securities, SMC Global and Barclays Securities, according to a report in Moneycontrol.com, which claims to have seen the Deloitte report. SEBI is said to have issued a show cause notice to the three brokers.
     
    In 2015, an anonymous whistleblower had written to SEBI and to Sucheta Dalal of managing editor of Moneylife alleging that some trading members on the NSE who had subscribed to the exchange’s co-location server facility were getting an unfair advantage by way of faster access to the exchange’s. The whistleblower also alleged the collusion of NSE officials.
     
    It may be recalled that Moneylife was the first to expose this scam in mid-2015, for which NSE had filed a defamation case against us.  A single-judge had penalised NSE for Rs50 lakhs for having filed a case against us. After filing an appeal against the order, NSE paid up the penalty. Meanwhile, in the wake of the scam, the top brass of NSE had to resign and a new management team took charge.
     
    According to Deloitte report, tn the Futures and Options segment, OPG appeared to be the first to connect to the tick-by-tick server on a significant number of trading days between 2012 (233 days) and 2013 (248 days). OPG had connected to the secondary server even after receiving multiple communications from the exchange to disconnect from it, says the report, as reported in Moneycontrol.
     
    In its submission on May 28, 2018, OPG in turn apparently said that it was facing various issues while connecting with the server. The Delhi-based company claimed that there were around 35,000 disconnections to the primary server over 365 days between 2012 and May 2014 (approximately 98 disconnections per day). They connected to the secondary server as a contingency measure to minimize the risks faced due to unforeseen disruptions in the Tick by Tick (TBT).
     
    OPG appears to have used the algorithm provided by “Omnesys” and “Greeksoft” to perform trading through their NSE co-location. 
     
    In its forensic audit Deloitte found that SMC global had connected to the secondary server even after several reminders from the exchange to avoid doing so. As per the NSE circular, secondary server was to be used only when a primary server is not available. In the audit, Deloitte found that between 2010 and 2015, SMC had connected to the secondary server on 389 days in the Future and Options segment.
     
    The report said, “Out of the above 389 days that SMC connected to the secondary server, we observed that it had made complaints to COLO support on 210 days. However, for the remaining 179 days, on which SMC was connected to the secondary server we did not observe any complaint made to the COLO support or the exchange. For 210 days that SMC had connected to the secondary server, it made complaints only on 64 days to COLO support about connectivity or network issues.”
     
    On September 8, 2017, SEBI had ordered a forensic audit of the brokers that used the co-location facility.
     
    In the Colo issue, there are two detailed reports. One by SEBI’s Technical Advisory Committee (TAC) and a forensic audit report from Deloitte. The detailed investigation by TAC and forensic audit by Deloitte pointed out how brokers could get advantage in connecting to the NSE’s servers because the Exchange had no ‘load balancers’ and ‘randomisers’ in its systems architecture. Both report also said, Delhi-based OPG Securities was consistently able to connect to NSE’s trading system ahead of other trading members, as alleged by the whistleblower’s letter. The TAC also found that the architecture of NSE with respect to dissemination of Tick-by-Tick (TBT) through TCP/IP was prone to manipulation/abuse. (Read: TAC Report Proves Systemic Lapses at the NSE)
     
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    Will SEBI Succeed in Trying to Create a Much-needed Vibrant Bond Market ?
    On the Budget day, India sought to expand its bond market beyond the traditional ambit of sovereign debt. Pursuant to this objective, market regulator Securities and Exchange Board of India (SEBI) initiated diversification of borrowings of Indian corporates by mandating to raise at least a quarter of their incremental funds from the bond market. The regulator came out with a consultation paper in order to address the liquidity problem persisting in the bond market, with an intention to create a robust secondary market for the debt securities in India.
     
    SEBI’s proposal and corresponding inferences
     
    The regulator proposed that listed companies with outstanding long-term borrowings of Rs100 crore and a credit rating of AA and above will have to compulsorily raise 25% of their debt from the bond market from the next financial year. Lower rated corporates have been exempted from the framework for the time being due to the limited demand for such securities.
     
    It is believed that if the 25% norm is followed religiously, it would tantamount to increased bond floatation as more companies would be able to access the debt market. Ideally, the move should provide insurance companies, provident funds and pension funds an opportunity to invest in high yielding instruments and open up a new funding avenue for lower-rated companies. Besides, the government might limit corporates' dependence on banks and the risk associated with it. However, there is a need for an expansion in the investor base for implementation of these rules.
     
    Rationale 
     
    There is no secondary market for corporate bonds in India to speak of. The sorry state of affair could be because of illiquid debt market, bad press in case of default, risk-averse attitude as well as lack of awareness among investors.
     
    On the brighter side, bonds are the ideal way to raise funds for a certain kind of long-gestation infrastructure project, which, typically, are capital-intensive.  It takes years to roll out toll-roads, build flyovers and set up massive power generating plants. The project developer has no cash flow to service debt until the project is running and banks may not be considered a viable source as bank funding is short tenure, which would result in asset-liability mismatch. 
     
    A sound corporate bond market would take a lot of pressure off banks, which are reeling under bad debts. Retail investors will also get a chance to invest in such projects via debt funds. In short, large exposure to risk would be substantiated with huge rewards.
     
    The issuer-issuance conundrum
     
     
    The above chart demonstrates the issuance by different types of entities. It is palpable that almost 60-70% of the total issues are done by financial sector entities while the private sector non-financial entities constitute only around 20% of the total issuances.
     
    Debenture Redemption Reserve (DRR)
     
    Financial sector companies, including NBFCs doing private placement, have been exempted from the maintenance of debenture redemption reserve (DRR), while all issuances by non-financial entities and entities doing public issue are required to set aside a part of their profits (equivalent to 25 % of the value of outstanding debentures) as DRR. Besides, such companies have to invest at least an amount equivalent to 15% of the debentures maturing during the year in bank deposits, government securities, etc. Such an earmarking of funds imposes an opportunity cost on the issuer.
     
    Hence, it can be inferred that if the requirement of DRR is dispensed with, it will naturally facilitate more corporates to access the bond market for their financing needs. Further, in order to safeguard the investors from the default risk of the issuer, execution of Insolvency and Bankruptcy Code 2016 would prove to be a panacea.
     
    DRR maintenance imposes a significant cost on public issue of bonds and on bonds issued on the basis of private placement by non-financial corporates. Given that the issue of protection of bond investors, in cases of default, has been significantly addressed by the enactment and operationalisation of the Insolvency and Bankruptcy Code (IBC), it is felt that if the requirement of DRR is dispensed with, it will naturally facilitate more corporates to access the bond market for their financing needs.
     
    Investment Grade
     
    The need to invest in bonds with lower ratings and deviating from ‘AA’ to ‘A’ grade ratings, would impact pension and provident funds more because they have largely invested in AAA-rated securities. As of today, even the provision to invest in up to AA-rated instruments is hardly explored by most of the larger investors. Corporate bonds rated 'BBB' or equivalent are investment grade. In India, most regulators permit bonds with the 'AA' rating only as eligible for investment. However, this case may not hold true after SEBI’s proposal. 
     
     
    As per SEBI, in 2016-17, 51% of total borrowings came from bonds compared to 37% in 2012-13, a good indication for the deepening of bond market. However, borrowings are still heavily skewed towards high rated borrowers, with 90% of the issuances concentrated in the AA and AAA rated categories. In light of the extant depth of the bond markets, it is hoped that the proposed rules should not be onerous for corporates.
     
    SEBI proposed a “comply or explain” framework for the new rules. This means that companies would need to disclose non-compliance as part of “continuous disclosure requirements,” the regulator said. Further, from the third year of implementation i.e. F.Y. 2021-22, the requirement of bond borrowings shall be tested for a contiguous block of two years i.e. F.Y. 2021-22 and 2022-23 will be treated as one block and the requirement of 25% borrowing through bond market shall need to be complied with for the sum of incremental borrowings made across the period of the block. Further, at the end of the block if there is any deficiency in the requisite bond borrowing, a monetary penalty in the range of 0.2% to 0.3% of the shortfall shall be levied.
     
    Impact on Financier’s Interest
     
    The entry barrier for lower rated corporate bonds would be demolished because the proposal might escalate the pool of investment grade issuers. So far, the loan route was considered the Holy Grail for small borrowers. The bond avenue would serve as an alternative for them to raise funds at a reasonable price keeping in mind investor’s perpetual keenness to diversify their investments as diversification results in risk reduction. It may be useful to classify BBB-rated corporate bonds as investment grade and thus allow pension funds and insurance companies to enter that space.
     
    Whether SEBI’s attempt would prove to be a boon or a bane, will only be seen as the days unfold.
     
    (Rajeev Jhawar is an Executive at Vinod Kothari Consultants P Ltd)
     
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