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SEBI’s new regulation on illiquid stocks will have an adverse impact on equity markets in India and could alienate current and future investors
Illiquidity in many micro- and small-cap stocks has always been of a serious concern to the small Indian investor and is one of the reasons why manipulation is so rampant. The Bombay Stock Exchange (BSE) houses a lot of such companies but both SEBI (Securities and Exchange Board of India) and BSE do nearly nothing about it. SEBI has finally come up with a harebrained idea to combat manipulation by taking action on illiquid stocks which will take effect from 1 April 2013.
SEBI, India’s securities market watchdog, may have shot itself in the foot yet again, when it plans to regulate illiquid stocks. Its earnest effort to curb manipulation, while laudable, may have damaging effects on the long term future of Indian equities market. Vide the circular CIR/MRD/DP/6/2013, issued on 14 February 2013, it plans to introduce trading through periodic call auction for illiquid scrips.
SEBI’s has taken the term illiquidity to a whole new level. According to the watchdog, an illiquid stock is a stock that satisfied one or more of the following criteria:
1. The average daily trading volume of a scrip in a quarter is less than 10,000;
2. The average daily number of trades is less than 50 in a quarter;
3. The scrip is classified at illiquid at all exchanges where it is traded.
Let us assume that a stock XYZ is quoting at Rs500. So, in order for it to be a ‘liquid’ stock, it ought to have an average trading value of Rs50 lakh (Rs500 x 10,000; assuming share price does not move). However, on the other hand, if the share price of another stock, say PQR, is valued 50 paise, then the average value is Rs5,000 (0.50 x 10,000). It must be noted that majority of the manipulation happens in the micro-cap segment (and are often called “penny stocks”). This means a stock valued at 50 paise has a higher probability of being rigged than a stock valued at Rs500. After all, a promoter or market player needs just Rs5,000 to influence the price in the normal market and make it ‘liquid’. Remember, sometimes even great and well-run companies can be illiquid. So, if well-run companies are put into a separate trading bracket, there will be a stigma or label attached to them.
For a long time, Moneylife has been covering stocks on manipulation, especially those stocks which tend to be ‘illiquid’ under SEBI’s current criteria. You can check out the Unquoted section in our Moneylife magazine every fortnight. You can also check it on our website over here. We even carried an exclusive cover story last year devoted to stock price manipulation and how ineffectual our market regulators have been. We had found out that regulators and exchanges had not even taken action on errant companies, even those who have committed blunders in the past. Sometimes, all it requires is basic monitoring skills to nab such companies. SEBI has, instead of tackling the problem on manipulation head-on and investigating each situation on a case-by-case basis by using its expensive (funded by taxpayers’ money) so called IMSS surveillance system, targeted ‘illiquid’ stocks.
More pertinently is what could possibly happen during the call auction. According to the circular, it states: “The call auction duration shall be one hour, of which 45 minutes shall be allowed for order entry, order modification and order cancellation, eight minutes shall be for order matching and trade confirmation and remaining seven minutes shall be a buffer period for closing the current session and facilitating the transition to next session. The session shall close randomly during the last one minute of the order entry between the 44th and 45th minute. Such random closure shall be system driven.”
What happens during the eight minutes is crucial. There is bound to be frenetic trading coupled with quick order modification and such. It is very difficult to skillfully place an order within a short frame of time let alone modify it. Some brokers may even refuse to trade in such scrips fearing that market regulators will be onto them for rigging. Some may even decline their customers’ orders on similar grounds. A combination of all this will exacerbate the liquidity scenario. This is also antithesis of free market capitalism where brokers and customers are free to place an order at their time of liking instead of the stipulated eight minute window.
According to the circular, it was SEBI’s Secondary Market Advisory Committee (SMAC) who came upon the call auction idea. The circular states: “SMAC also made recommendation on the introduction of trading through periodic call auction mechanism for illiquid scrips in the equity market.” Once this regulation is put into force, the most affected party will be BSE where majority of the thinly traded stock takes place.
Ashishkumar Chauhan, managing director and chief executive officer of BSE, sits on the SMAC committee. According to SEBI website, the SMAC committee consists of the following ‘experts’ who advocated this scheme:
• Ms Maninder Cheema, deputy general manager, Market Regulation Department, Division of Policy, SEBI
The market regulator is seeking clarificatory directions for implementing orders of the apex court. In a five point plea, SEBI has also asked for civil detention of Subrata Roy and three other Sahara directors and also wants them to deposit their passports with its whole-time member
Market regulator Securities and Exchange Board of India (SEBI) has moved five pleas before the Supreme Court for directions.
We learn that SEBI's move was triggered by the fact that Sahara has approached the Securities Appellate Tribunal (SAT). Sahara India, a partnership firm of Sahara group, has also filed another case in the Allahabad High Court for de-freezing its accounts. Both these things made it difficult for the regulator to go ahead with implementing the SC order of 31 August 2012 without some clarifying directions from the apex court.
SEBI has made five points in its application…
Last month, close on the heels of ordering attachment of bank accounts, investments and all other assets of Sahara India Real Estate Corp, Sahara Housing Investment Corp and directors and their promoters, including group chief Subrata Roy, the market regulator had cautioned investors and general public against transacting with these companies and persons.
SEBI had said that in furtherance to a Supreme Court order directing refund of investors’ money collected by these Sahara firms, it has ordered “attachment of all moveable and immoveable properties, bank accounts and demat accounts of these two companies and that of its promoters and directors namely Subrata Roy Sahara, Vandana Bhargava, Ashok Roy Choudhary and Ravi Shankar Dubey”.
On 13th February, SEBI passed two separate orders, together running into 160 pages, directing attachment of properties and freezing of accounts.
It was after the Supreme Court said that the regulator was free to freeze the accounts and attach properties if Sahara firms were not complying with the apex court’s earlier orders of August 2012 towards refund of investors’ money totalling over Rs24,000 crore.
The assets ordered to be attached included those related to the group’s Aamby Valley resort town near Pune, other real estate assets in Delhi, Mumbai and at other places across the country, shares, mutual funds and various other investments.
Passing the attachment orders, SEBI said that the two companies had raised Rs6,380 crore and Rs19,400 crore, respectively from bondholders and ‘various illegalities’ were committed in raising of these funds.
With regard to Subrata Roy and three other directors, namely Vandana Bhargava, Ravi Shanker Dubey and Ashok Roy Choudhary, SEBI ordered freezing of all bank and demat accounts of these four persons, as also attachment of all moveable and immoveable properties in their name with immediate effect.
Sahara said that it had already deposited Rs5,120 crore with SEBI that was in excess of its total liability towards refund to investors.
The market regulator has slapped a fine of Rs10 lakh each on ISF Securities and Vishwas Securities for executing trades amongst themselves in large quantities and creating artificial volume and price increase in the scrip of EIL