As the market watchdog gets ready for its 10th chairman (assuming the incumbent is not given another extension), we seem to be back to the scourge of stock brokers defaulting regularly and misappropriating investors’ money. The regulator, Securities and Exchange Board of India (SEBI), seems clueless about how to deal with it.
We have been led to believe that these problems were buried in the previous century. But when supervision is replaced by committees, we get procedural solutions and new disclosure and reporting requirements that fail to address the problem. Enforcement and penalties cannot be replaced with a morass of red-tape that is easy to dodge or exploit.
Ideally, the SEBI chairman, as an independent regulator, ought to be judged by his ability to keep markets safe and ought to make a televised presentation of his performance to the parliamentary standing committee on finance every year.
Unfortunately, parliamentary committees in India, although headed by an Opposition member, have turned into junkets and very few parliamentarians have interest in, or domain knowledge of, the committees they represent.
The immediate consequence is that each SEBI chairman is a transitory bird, focused on appearing busy with development work, ‘managing’ the finance ministry and working for an extension. A reading of former chairman UK Sinha’s book on his years at SEBI provides the best possible insight into what the regulator considers his achievements after the second longest tenure of six years as SEBI chief.
Regulatory capture by the National Stock Exchange (NSE) started under CB Bhave, and the saga of slow, pointless and unending investigation (while constantly tinkering with reporting requirements), has continued under Ajay Tyagi as well.
SEBI is essentially a chairman-led organisation and, barring one or two, all the top appointees in the past decade have parachuted from other cadres with the responsibility to pass key orders, while also learning on the job. Many whole-time members come to SEBI in post-retirement jobs and have little interest in effecting systemic changes or tightening investigation, supervision and adjudication.
It is not as though SEBI officials are unaware of the problems or have not raised them internally. Here is something that was explained to me by a SEBI insider, in response to my charge about meandering investigations killing investor confidence which has been forcefully raised inside SEBI with no effect.
Let me present just two orders by an adjudicating officer that cover 75 cases filed on SCORES
(SEBI Complaints Redress System). In the first instance, SEBI’s Ahmedabad office closed 35 cases through a single order (Adjudication order No.AKD /AO-41-75 /2018-19) and 40 cases in the second order (Adjudication order No. AKD IAO-1-40/2018-19). They do not reflect the competence of the adjudicating officer, but the meaninglessness of the exercise itself. In both cases, the orders document the seemingly impressive and painstaking effort by SEBI officials in response to complaints on SCORES.
They start by writing to each company against which there is an investor complaint, asking it to get registered on SEBI’s SCORES system to enable online complaint redressal. In effect, these are companies which didn't even meet the first requirement in the redress process.
When the 35 companies failed to respond, each company was issued a carefully drafted show-cause notice (SCN). Remember, there is an official drafting and sending out a letter for each individual company. There is still no response.
In the interest of natural justice, SEBI then spends money on publishing advertisements in two newspapers with ‘nationwide circulation’ to call them for personal hearings. One is in an English daily and another in a regional newspaper where the person/ entity complained against was ‘last known to have resided’. This point is important because it suggests some effort to locate the address.
It is at this stage that an adjudication officer is appointed to examine the matter and pass orders for failure to register with SCORES and he makes a monumental finding. The “status of the companies on SEBI SCORES website is either ‘Compulsory Delisted’ or ‘Suspended’ from BSE and/or shown as listed on derecognized regional exchanges.”
It turns out that these companies were listed on the regional stock exchanges at Jaipur, Chennai, Madhya Pradesh, Vadodara, Delhi and Ahmedabad, which were all officially granted an exit by SEBI sometime between 2015 and 2018.
Consequently, the adjudicating officer says, “looking at the entire gamut of evidence present and taking into account facts of the case” he has no choice but to ‘dispose’ the complaints.
This happened in December 2018; but there would be dozens of such orders, or variations of this silly waste of time, money and human resources. Since both orders are under Section 15-1 of the SEBI Act, read with rule 5 of SEBI (procedure for holding inquiry and imposing penalties by adjudicating officer) rules, 1995, one presumes that this foolishness has been going on for over 15 years.
SEBI claims to have cutting-edge software for market surveillance and real-time price manipulation (it is another matter that we only ever see evidence of this being used for post-facto investigations). But its officers cannot find information that would be easily available through a Google search if not from its own internal records. Did they not notice that the companies were suspended while looking for the address to decide on the regional newspaper for the advertisement?
At this rate, we will not have effective grievance redress even if thousands of officers are engaged in pointless and wasteful work, while their salaries are recovered from fees collected through intermediaries and, eventually, the investor.
With SEBI officials so busy with such meaningless work, is it any wonder that complaints are piling up, or being quietly closed by converting them into investigations and designating the complainant a ‘whistleblower’?
The consequence of an enforcement system that is clogged with senseless procedural work is the large number of broker defaults and the failure of SEBI as well as stock exchanges to anticipate issues and initiate preventive action. What is worse, every post-mortem only leads to more regulation and paperwork, as we have seen with corporate governance disclosures.
SEBI has claimed, in a letter to the finance ministry seen by Moneylife, that it discovered “serious instances of misappropriation/ misuse of huge amounts of client’s securities by stock brokers such as Karvy Stock Broking Ltd., BMA Wealth Creators Ltd., Vrise Securities Pvt. Ltd., etc, during its own inspections.”
In fact, investors of BMA Wealth even blocked
the entrance of SEBI in December 2019 to get the regulator to pay attention to their grievances.
Under SEBI rules, investors can be paid from the investor protection fund of stock exchanges only when the brokerage firm is declared a defaulter. In February 2020, SEBI declared Vrise Securities, Kaynet Finance and BMA Wealth Creators as defaulters, but not Karvy Stock Broking, where the misappropriation is massive (over Rs2,000 crore) and chairman C Parthasarathy has repeatedly bought time by promising to bring in money.
As Moneylife has reported earlier, investors have also lost money in Amrapali Aadya Trading and Investments, KassaFinvest, Unicorn, Vasanti Securities, Royal International, Click2Trade, Allied Financial Services, Ficus Securities and Fairwealth. Some of the brokers, such as Modex, are also said to have diverted clients’ funds.
These broker defaults appear to have depleted the investor protection fund of India’s largest stock exchange and here we hit upon another mystery.
The NSE, which has a near monopoly over the Indian capital market and accounts for over 90% of trading, has only Rs549 crore
in its Investor Protection Fund Trust, as opposed to Rs725 crore with the Bombay Stock Exchange (BSE). Since contributions to the fund are based on turnover, the NSE’s fund ought to be at least 15 to 20 times bigger than that of the BSE. But no data is available on NSE’s website. We have asked the NSE for details and will update this article if we receive a response.
Given that there are thousands of complaints against some of the big defaulting brokers, will the NSE’s investor protection fund be able to cover all claims even with the cap of Rs25 lakh per investor?
What happens if it does not? Where is the transparency? The promise of trade and settlement guarantees and a fall back on investor protection fund, were the key planks of India’s big leap to modern, automated, paperless trading. Thanks to mechanical and confused processes and lack of regulatory accountability, we seem to be regressing to the 1990s in some ways. These are points for the government to ponder, when it chooses a new SEBI chairman—a safe and efficient capital market is key to India’s economic revival.