Detecting rampant abuses in public issues

IPO BOOM: With the boom in initial public offers (IPO), sellers of application forms are more visible in Dalal Street in Mumbai. — File photo

IPO BOOM: With the boom in initial public offers (IPO), sellers of application forms are more visible in Dalal Street in Mumbai. — File photo  

The menace of multiple applications is prompted by enhanced chances of allotment and quick profit from quality issues

The SEBI order points out that there has been a failure on the part of the bankers to the issues, the registrars and the depository participants.

REPORTS OF serious malpractices in two recent public issues — those of Yes Bank and IDFC — may look depressingly familiar. After all, manipulation of applicants list in an Initial Public Offer by submitting multiple applications is not something new. Ever since new issues were seen to promise immediate returns to successful allottees, malfeasant acts involving benami/outright fictitious applications have been frequent. However, very little detection took place in a lax, mostly non-existent, regulatory regime through the 1970s and 1980s.The practice of submitting multiple applications by the same party is expressly forbidden for two elementary reasons. Invariably the perpetrators resort to benami transactions or apply under fictitious names. Money laundering including unaccounted money transactions obviously take place under the guise of applying for new issues. Second, it directly affects the interests of genuine investors. The intention behind the fraud is to corner shares: multiple applications improve their chances of a large allotment at the cost of genuine investors.Nowadays almost all new public offers are made through the book-building route. Shares can be allotted only in the electronic mode through demat accounts opened with one or other of the depository participants. The applicant, now called the bidder, can submit only one bid for the required number of equity shares. Offer documents routinely define multiple bids as follows: "Two or more bids will be deemed to be multiple bids if the sole or first bidder is one and the same.'' Such (multiple) bids will automatically be rejected.

Common practice in'80s

If the illegal, irregular practice was so widespread (and so much in common knowledge) why was it not put down vigorously? One has to look at the still evolving regulatory environment and stock market practices over the years for possible answers.There was very little that anyone could do in the late 1970s and early 1980s when the great wave of FERA divestment took place and made investing in new issues a highly attractive option. Thanks to the Controller of Capital Issues norms that deliberately encouraged underpricing of these blue chips, investors who were lucky to be allotted reaped a bonanza. The allotment procedure has been something akin to conducting a lottery. Successful outcomes in both depend on chance.In a hugely oversubscribed public issue of those days, the success ratio was sometimes one in 100 or so. Evidently applying for more in the same category through multiple applications shortens the odds. There was no single capital market regulator until 1992 when SEBI, constituted a little earlier then, was given a legal status. The stock exchanges, which determined the allotment ratios, had very little data to pin down the culprits, even if they could be identified.One of the major capital market reforms of the early Nineties was the abolition of the institution of the Controller of Capital Issues. Consequently share- issuing companies were allowed to price their issues in line with their (anticipated) market prices. Free market pricing was supposed to align market demand for the new issues with the intrinsic worth and do away with the pre-issue premium. However, for a number of reasons — paucity of quality issues, increasing tendency to raise capital abroad, reduction in public issue requirements — have all contributed to a mismatch between demand and supply.With the revival in the primary market, investors have been making a beeline for quality issues. As the SEBI order in the case of the IDFC IPO says, multiple applications would have been rampant in many recent issues although only in one other case — the Yes Bank IPO — has the regulator identified the rampant malpractice and its perpetrators. The other major development since the 1990s has been the rapid adoption of technology by the capital market and its participants. As far as the IPO segment is concerned, technology has played a major role in streamlining procedures andshortening the period between closure of the subscription list and allotment. Demat procedures — a major capital market reform measure by itself — would not have been possible without the use of technology. In fact the post-issue work involving the registrars has been the weak link in the issue process. Notwithstanding a liberal application of technology the post-issue work has frequently failed. The ONGC fiasco is still fresh in every investor's mind. As the well-documented manipulations in the IDFC and Yes Bank cases show, it is possible for fraudsters to beat even a technology-upgraded system.SEBI's order (in the IDFC case) has found Karvy, the depository participant (DP), guilty of having aided and abetted the scam. "It is matter of serious concern that Karvy-DP has opened such apparently benami/fictitious accounts working out to over 95 per cent (42,056 nos) of the multiple dematerialised accounts in relation to the IDFC IPO.''Multiple demats require multiple bank accounts. SEBI has found rampant misuse of multiple bank accounts by `name-lenders'/'non-genuine persons' sharing common addresses. Banks have also colluded by funding a majority of those accounts. The banks named are Bharat Overseas Bank, HDFC Bank, Indian Overseas Bank, ING Vysya Bank and Vijay Bank. These banks that opened the benami accounts and apparently funded their accounts have been referred to the RBI.Collusion by banks here goes beyond enabling unscrupulous operators to make quick money at the expense of genuine investors. If the allegations are true, these banks may also be guilty of deliberately violating, even ignoring, KYC (Know Your Customer) norms. If proved, this will be a gross dereliction of duty for which they will have to face the music.The two principal depositories, NSDL and CDSL, though escaping direct blame, have been asked to assume greater responsibility in the interest of investors and integrity of the markets. Although the DP (Karvy) has been the first point of contact with the fraud perpetrators, the depositories cannot plead ignorance of "thousands of dematerialised accounts being opened on the same day with the same branch and being introduced by the same bank.'' Depositories with their self-professed technological prowess have been the pivot on which the system of dematting shares has revolved. Are the issuers and managers to the issue free from blame? It has always been in the issuing company's interest to garner a large oversubscription, even though unlike before there are no special monetary incentives for such action. Some managers to the issue might have assiduously cultivated their clients by promising record subscriptions. Besides, the managers have the responsibility of vetting other intermediaries. As the SEBI order points out, there has been a failure on the part of the bankers to the issues, the registrars and the DP.SEBI's action in identifying the malfeasant acts is commendable. If it succeeds in fixing accountability — a much maligned word incidentally — it will help in checking the rampant cynicism that has come to cloud perceptions of the financial markets.C. R. L. NARASIMHAN

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