 "The scam that changed India's primary market")
Last month, the Supreme Court passed a judgment quashing a tribunal order against the Securities and Exchange Board of India (Sebi) in the matter of Opee Stock Link, an Ahmedabad-based operator. Over the next few weeks, the regulator would take steps to recover the disgorged illegal gains of about Rs 14 lakh from Opee and its director, Ashok Bagreecha.
The order was a small step forward for the capital market regulator in its endeavour to compensate retail investors hit by what has come to be known as the 'IPO scam' or the 'demat scam'.
In its first-ever disgorgement effort, that stretched over several years, the regulator has reallocated unlawful gains of about Rs 41.34 crore to some 1.27 million investors.
"All the 1.27 million investors are benefitted in the said IPO refund exercise and 80 per cent of the said investors have been fully paid by Sebi," he added.
The regulator still has to distribute a little over Rs 50 crore. "Even though Sebi has passed orders, directing the violators to disgorge the illegal gains, recovery of money from them involves a tedious and time-consuming process and Sebi shall continue to take best efforts in the interest of investors," the regulator added.
M S Sahoo, former whole-time member of Sebi, who now holds the same position at Competition Commission of India, said, "This was the first-ever disgorgement order in India, first-ever compensation to investors from disgorgement. Sebi and every economic regulator should make all-out efforts to seek disgorgement of unlawful gains from the miscreants, in addition to other permissible penal action, and endeavour to identify victims of the misdemeanour and disburse the disgorged amount to them."
Sahoo, who was with Sebi between 2008 and 2011, said the cases could be broadly classified into four. First, through settlement, wherein the entities which made unlawful gains came forward and paid the amount. Sebi passed settlement orders on these. About Rs 30 crore was realised in this manner. Second, disgorgement orders passed against entities which did not come forward for settlement, which were upheld by the Securities Appellate Tribunal (SAT).
Almost in all cases, the parties went for appeal and each one of them was upheld by the Supreme Court. However, in many of these cases, the disgorged sums remained unrealised as the Sebi could not do recovery. After getting new powers in 2014, it started recovering some of these sums.
Third, there were orders set aside by SAT. Sebi appealed against such orders and these are being quashed by the Supreme Court. Opee Stock Link was one such case. Fourth are those cases sent back to the Sebi by the SAT for reconsideration. In the parallel, the adjudicating officer was passing orders on the monetary penalty.
The scam exposed weak links in the system but also led to sweeping changes, effects of which are felt till date.
B Narasimhan, former member of council, Institute of Company Secretaries of India, said, "The infirmities in the system were exploited to the maximum by the operators. Whatever was not proper (in the system) these people took advantage of it. Subsequently, Sebi has taken several steps to improve the system. Permanent Account Number (PAN) was (made) mandatory for all applications and compulsory ASBA (Applications Supported by Blocked Amount) for all bidders was introduced."
The time between allotment and listing has also come down and there has not been a scam of that size since, added Narasimhan, who has worked with the Karvy group in the past.
How the scam surfaced
In 2005, Sebi's surveillance system started picking up unusual off-market transfers of shares in huge quantities. These were shares of companies about to be listed on the stock exchanges.
This evoked the curiosity of the sleuths in Sebi. Usually, an initial public offering (IPO) of equity provides an opportunity for allottees to make a decent profit and exit. Therefore, someone who gets an allotment in an IPO either exits on the listing day itself or holds on for the long term.
But, why were these shares changing hands before the price could be discovered? When investigated, a pattern emerged wherein shares from several hundred demat accounts moved to a handful of accounts, from where these were offloaded on listing day.
Some market sources said the tip-off actually came from the income tax department, which had randomly picked up the income tax returns of one of the operators. "Once a return is picked up for scrutiny, it is almost compulsory for the tax official to find something wrong with it. In this case, it was not very difficult," said a person familiar with the scam.
The tax official allegedly found capital gains tax being paid on a huge amount of shares. When he looked into the allotment details of IPOs, the official found that the entity had applied in the retail (individual) category and had not received any shares in the allotment or received much less than what it paid the capital gains taxes for. Then, he wrote to Sebi about something fishy he smelt, triggering detailed investigations.
In all, Sebi had investigated and found irregularities in 21 IPOs between 2003 and 2005.
Modus operandi
Roopalben Panchal, who along with her associates operated thousands of bank and demat accounts and cornered shares meant for retail investors in several IPOs, became the name by which the entire scam came to be identified. In those days, a photograph was needed to open a savings account, pre-requisite for a demat account. The Ahmedabad-based operator, who some officials said was the wife of a sub-broker, ran a photo studio and advertised in local dailies, saying people who got their photographs clicked would get two copies free of cost. Unsuspecting subjects queued in. Investigators later found that copies of these photographs were used for opening fictitious bank and demat accounts.
Another mode of sourcing photographs was found in the Parag Jhaveri case, where the photographs were lifted from a matrimonial site. "It is noted that the font and style of the impression as contained in the photos attached to the letter and as appearing on Shaadi.com appear to be the same. This indicates the possible source of the photographs attached to Parag Jhaveri's letter and shows the dubious design of the Jhaveri group in opening bank accounts in fictitious/benami names, probably without even the knowledge of the persons whose photographs were abused in such manner," a 2007 order by Sebi's whole-time member G Anantharaman said.
The first interim order against Panchal and others was passed in the case of YES Bank IPO, which hit the Street in December 2005. As many as 6,315 fictitious demat accounts were opened for subscribing to YES Bank shares, of which 6,221 had the same address - "402-403, Shashwat Building, Opposite Gujarat College, Ahmedabad". Subsequently, the investigation expanded to 21 IPOs. In 18 cases, Panchal and associates were involved.
This is how they did it: Panchal and her relatives opened bank accounts in their own names with Bharat Overseas Bank (BhOB). Using these bank accounts, they manufactured bank introduction letters for thousands of fictitious names and based on such introduction letters as proof of identity and address, thousands of demat accounts were opened.
For example, Arjav (Panchal) opened a bank account number 9550 with BhOB in December 2004. They prepared a list of 1,000 fictitious names, starting with Kunal and ending with Ritu, each having surname 'Zala'. They created 15 such lists with the same set of first names but with a different surname and thereby created 15,000 fictitious identities. They manufactured bank introduction letters, purportedly issued by BhOB, in favour of each of the 15,000 fictitious names by assigning the bank account number 9550 as a suffix to every name.
Thus, they opened thousands of accounts with the same address, known as afferent accounts. They paid to each Depositary Participant (DP) the account maintenance charges (AMC) and transaction charges for many of these accounts. Separately, they prepared several lists, each with 50 fictitious identities with same surname in the same order as were in the lists used for opening afferent accounts. Many such lists of 50 persons were purportedly certified by Karvy DP. They opened several bank accounts, each jointly with 50 fictitious persons in a list.
These bank accounts enabled the Panchals to avail finance for IPOs from banks. They also obtained finance from many other financiers. With the funds procured from various sources, the Panchals engineered thousands of applications in the retail category over 18 IPOs, according to Sebi orders.
For example, the scamsters were able to corner an allotment of 7.3 million retail category shares through applications from 27,444 afferent accounts in the IDFC IPO.
In those days, applications up to Rs 50,000 did not require a PAN. "Beyond Rs 50,000, a PAN was required. But, no registrar would refuse an application for want of PAN. Sometimes, applications would just have the stapler pins, with no attachment, to give the impression that the PAN copy was originally attached and was missed in transit," said a registrar employee. This meant there was no way of cross-checking duplicate applications by frontline staff at the intermediaries.
After the allotment, they also received the consolidated refunds from issuers through the bank and returned the same to the financiers. They repeated this modus operandi over 18 IPOs.
In the process, they cornered the shares meant for retail in 18 IPOs and made unlawful gains, Sebi found. The operators did not do it all by themselves. Multiple entities of the Hyderabad-based Karvy group, including Karvy Stock Broking (broking and depositary participant), Karvy Consultants (financiers) and Karvy Computershare (registrar and transfer agents) were found to have played a key role in the scam.
"It was also prima facie found that the Karvy group had linkages with the key operators such as Roopal Panchal, Purushottam Budhwani, Dharmesh Mehta, etc. They have admitted in their written submissions that certain of them were their IPO sub-brokers. It was prima facie found that KSBL had introduced the bank accounts of these groups, and facilitated the entire process, starting from making IPO applications for them after collecting pay orders from the bank, arranging finance for them till collecting and distributing their refund orders," a Sebi order of 2006 had said.
"Subsequent investigations which covered 21 IPOs that Karvy seemed to be involved in manipulations of most of them. The subsequent findings, even though they related to transactions which took place prior in time to the two IPOs covered by earlier orders, showed that Karvy's involvement seemed to be much more serious than it was originally known," the Sebi order added. An e-mail sent to Karvy through its public relations agency did not elicit any response.
Penal action and settlement
Action was taken by Sebi against several intermediaries such as the depositories, depositary participants, registrars and brokers. "The systems of NSDL and CDSL were strengthened to eliminate multiple demat accounts. The proper Know Your Customer (KYC) framework was put in place. The scam also helped regulator equip itself better internally in terms of surveillance and investigation capacities," said a former Sebi official. Some Karvy entities were debarred from operating in the market.
In addition, the Reserve Bank of India passed orders against errant banks. Fines of Rs 5 lakh to Rs 20 lakh were imposed on BhOB, Citibank, HDFC Bank, ICICI Bank, Indian Overseas Bank, Standard Chartered Bank and Vijaya Bank for violation of anti-money laundering norms. BhOB was eventually merged with Indian Overseas Bank.
After deciding on the disgorgement, the next big question for Sebi was who would get the compensation. It was not easy. A formula was worked out by a committee under the chairmanship of ex-judge D P Wadhwa. It recommended the procedure of identification of persons who were deprived in the said IPOs and the manner in which reallocation of shares to such persons should take place.
An administrator was appointed to look into the refund process to the eligible investors. The administrator identified 1,275,000 lakh investors as eligible ones for distribution of a total amount of Rs 92 crore, the regulator said.
After initial rounds of recovery of amounts from some of the persons directed to be disgorged, in April 2010, Sebi distributed Rs 23.3 crore. Of these, 799,000 investors were paid the full eligible amount and 476,000 investors who were eligible for a reallocation amount of more than Rs 300 were paid a sum of Rs 300 each, according to Sebi.
The regulator added the newly conferred recovery powers under the Securities Laws (Amendment) Act, 2014 helped in recovery from more operators. The sums so recovered went into the Tranche-II distribution initiated by Sebi in December 2015. About Rs 18.06 crore was distributed to 463,000 investors in this phase.
"Keeping in view the cost involved, no distribution was made to 12,000 investors eligible for a reallocation amount of Rs 30 or less. Of 463,000 investors, 203,000 investors were paid the full eligible amounts and remaining 260,000 investors, who are eligible for a reallocation amount of more than Rs 500, were paid a sum of Rs 500 each," the Sebi spokesperson added.
The order was a small step forward for the capital market regulator in its endeavour to compensate retail investors hit by what has come to be known as the 'IPO scam' or the 'demat scam'.
In its first-ever disgorgement effort, that stretched over several years, the regulator has reallocated unlawful gains of about Rs 41.34 crore to some 1.27 million investors.
More From This Section
"The remaining amount to be recoverable from the persons directed to be disgorged is either pending in litigation or in the process of recovery. As and when further disgorgement amount is recovered by Sebi, reallocation will be made in future to the remaining 260,000 investors who have already been paid up to Rs 800 (each) in the above distribution," the Sebi spokesperson said in a detailed response to queries by Business Standard. (THE DEMATS THE MERRIER)
"All the 1.27 million investors are benefitted in the said IPO refund exercise and 80 per cent of the said investors have been fully paid by Sebi," he added.
The regulator still has to distribute a little over Rs 50 crore. "Even though Sebi has passed orders, directing the violators to disgorge the illegal gains, recovery of money from them involves a tedious and time-consuming process and Sebi shall continue to take best efforts in the interest of investors," the regulator added.
M S Sahoo, former whole-time member of Sebi, who now holds the same position at Competition Commission of India, said, "This was the first-ever disgorgement order in India, first-ever compensation to investors from disgorgement. Sebi and every economic regulator should make all-out efforts to seek disgorgement of unlawful gains from the miscreants, in addition to other permissible penal action, and endeavour to identify victims of the misdemeanour and disburse the disgorged amount to them."
Sahoo, who was with Sebi between 2008 and 2011, said the cases could be broadly classified into four. First, through settlement, wherein the entities which made unlawful gains came forward and paid the amount. Sebi passed settlement orders on these. About Rs 30 crore was realised in this manner. Second, disgorgement orders passed against entities which did not come forward for settlement, which were upheld by the Securities Appellate Tribunal (SAT).
Almost in all cases, the parties went for appeal and each one of them was upheld by the Supreme Court. However, in many of these cases, the disgorged sums remained unrealised as the Sebi could not do recovery. After getting new powers in 2014, it started recovering some of these sums.
Third, there were orders set aside by SAT. Sebi appealed against such orders and these are being quashed by the Supreme Court. Opee Stock Link was one such case. Fourth are those cases sent back to the Sebi by the SAT for reconsideration. In the parallel, the adjudicating officer was passing orders on the monetary penalty.
The scam exposed weak links in the system but also led to sweeping changes, effects of which are felt till date.
B Narasimhan, former member of council, Institute of Company Secretaries of India, said, "The infirmities in the system were exploited to the maximum by the operators. Whatever was not proper (in the system) these people took advantage of it. Subsequently, Sebi has taken several steps to improve the system. Permanent Account Number (PAN) was (made) mandatory for all applications and compulsory ASBA (Applications Supported by Blocked Amount) for all bidders was introduced."
The time between allotment and listing has also come down and there has not been a scam of that size since, added Narasimhan, who has worked with the Karvy group in the past.
How the scam surfaced
In 2005, Sebi's surveillance system started picking up unusual off-market transfers of shares in huge quantities. These were shares of companies about to be listed on the stock exchanges.
This evoked the curiosity of the sleuths in Sebi. Usually, an initial public offering (IPO) of equity provides an opportunity for allottees to make a decent profit and exit. Therefore, someone who gets an allotment in an IPO either exits on the listing day itself or holds on for the long term.
But, why were these shares changing hands before the price could be discovered? When investigated, a pattern emerged wherein shares from several hundred demat accounts moved to a handful of accounts, from where these were offloaded on listing day.
Some market sources said the tip-off actually came from the income tax department, which had randomly picked up the income tax returns of one of the operators. "Once a return is picked up for scrutiny, it is almost compulsory for the tax official to find something wrong with it. In this case, it was not very difficult," said a person familiar with the scam.
The tax official allegedly found capital gains tax being paid on a huge amount of shares. When he looked into the allotment details of IPOs, the official found that the entity had applied in the retail (individual) category and had not received any shares in the allotment or received much less than what it paid the capital gains taxes for. Then, he wrote to Sebi about something fishy he smelt, triggering detailed investigations.
In all, Sebi had investigated and found irregularities in 21 IPOs between 2003 and 2005.
Modus operandi
Roopalben Panchal, who along with her associates operated thousands of bank and demat accounts and cornered shares meant for retail investors in several IPOs, became the name by which the entire scam came to be identified. In those days, a photograph was needed to open a savings account, pre-requisite for a demat account. The Ahmedabad-based operator, who some officials said was the wife of a sub-broker, ran a photo studio and advertised in local dailies, saying people who got their photographs clicked would get two copies free of cost. Unsuspecting subjects queued in. Investigators later found that copies of these photographs were used for opening fictitious bank and demat accounts.
Another mode of sourcing photographs was found in the Parag Jhaveri case, where the photographs were lifted from a matrimonial site. "It is noted that the font and style of the impression as contained in the photos attached to the letter and as appearing on Shaadi.com appear to be the same. This indicates the possible source of the photographs attached to Parag Jhaveri's letter and shows the dubious design of the Jhaveri group in opening bank accounts in fictitious/benami names, probably without even the knowledge of the persons whose photographs were abused in such manner," a 2007 order by Sebi's whole-time member G Anantharaman said.
The first interim order against Panchal and others was passed in the case of YES Bank IPO, which hit the Street in December 2005. As many as 6,315 fictitious demat accounts were opened for subscribing to YES Bank shares, of which 6,221 had the same address - "402-403, Shashwat Building, Opposite Gujarat College, Ahmedabad". Subsequently, the investigation expanded to 21 IPOs. In 18 cases, Panchal and associates were involved.
This is how they did it: Panchal and her relatives opened bank accounts in their own names with Bharat Overseas Bank (BhOB). Using these bank accounts, they manufactured bank introduction letters for thousands of fictitious names and based on such introduction letters as proof of identity and address, thousands of demat accounts were opened.
For example, Arjav (Panchal) opened a bank account number 9550 with BhOB in December 2004. They prepared a list of 1,000 fictitious names, starting with Kunal and ending with Ritu, each having surname 'Zala'. They created 15 such lists with the same set of first names but with a different surname and thereby created 15,000 fictitious identities. They manufactured bank introduction letters, purportedly issued by BhOB, in favour of each of the 15,000 fictitious names by assigning the bank account number 9550 as a suffix to every name.
Thus, they opened thousands of accounts with the same address, known as afferent accounts. They paid to each Depositary Participant (DP) the account maintenance charges (AMC) and transaction charges for many of these accounts. Separately, they prepared several lists, each with 50 fictitious identities with same surname in the same order as were in the lists used for opening afferent accounts. Many such lists of 50 persons were purportedly certified by Karvy DP. They opened several bank accounts, each jointly with 50 fictitious persons in a list.
These bank accounts enabled the Panchals to avail finance for IPOs from banks. They also obtained finance from many other financiers. With the funds procured from various sources, the Panchals engineered thousands of applications in the retail category over 18 IPOs, according to Sebi orders.
For example, the scamsters were able to corner an allotment of 7.3 million retail category shares through applications from 27,444 afferent accounts in the IDFC IPO.
In those days, applications up to Rs 50,000 did not require a PAN. "Beyond Rs 50,000, a PAN was required. But, no registrar would refuse an application for want of PAN. Sometimes, applications would just have the stapler pins, with no attachment, to give the impression that the PAN copy was originally attached and was missed in transit," said a registrar employee. This meant there was no way of cross-checking duplicate applications by frontline staff at the intermediaries.
After the allotment, they also received the consolidated refunds from issuers through the bank and returned the same to the financiers. They repeated this modus operandi over 18 IPOs.
In the process, they cornered the shares meant for retail in 18 IPOs and made unlawful gains, Sebi found. The operators did not do it all by themselves. Multiple entities of the Hyderabad-based Karvy group, including Karvy Stock Broking (broking and depositary participant), Karvy Consultants (financiers) and Karvy Computershare (registrar and transfer agents) were found to have played a key role in the scam.
"It was also prima facie found that the Karvy group had linkages with the key operators such as Roopal Panchal, Purushottam Budhwani, Dharmesh Mehta, etc. They have admitted in their written submissions that certain of them were their IPO sub-brokers. It was prima facie found that KSBL had introduced the bank accounts of these groups, and facilitated the entire process, starting from making IPO applications for them after collecting pay orders from the bank, arranging finance for them till collecting and distributing their refund orders," a Sebi order of 2006 had said.
"Subsequent investigations which covered 21 IPOs that Karvy seemed to be involved in manipulations of most of them. The subsequent findings, even though they related to transactions which took place prior in time to the two IPOs covered by earlier orders, showed that Karvy's involvement seemed to be much more serious than it was originally known," the Sebi order added. An e-mail sent to Karvy through its public relations agency did not elicit any response.
Penal action and settlement
Action was taken by Sebi against several intermediaries such as the depositories, depositary participants, registrars and brokers. "The systems of NSDL and CDSL were strengthened to eliminate multiple demat accounts. The proper Know Your Customer (KYC) framework was put in place. The scam also helped regulator equip itself better internally in terms of surveillance and investigation capacities," said a former Sebi official. Some Karvy entities were debarred from operating in the market.
In addition, the Reserve Bank of India passed orders against errant banks. Fines of Rs 5 lakh to Rs 20 lakh were imposed on BhOB, Citibank, HDFC Bank, ICICI Bank, Indian Overseas Bank, Standard Chartered Bank and Vijaya Bank for violation of anti-money laundering norms. BhOB was eventually merged with Indian Overseas Bank.
After deciding on the disgorgement, the next big question for Sebi was who would get the compensation. It was not easy. A formula was worked out by a committee under the chairmanship of ex-judge D P Wadhwa. It recommended the procedure of identification of persons who were deprived in the said IPOs and the manner in which reallocation of shares to such persons should take place.
An administrator was appointed to look into the refund process to the eligible investors. The administrator identified 1,275,000 lakh investors as eligible ones for distribution of a total amount of Rs 92 crore, the regulator said.
After initial rounds of recovery of amounts from some of the persons directed to be disgorged, in April 2010, Sebi distributed Rs 23.3 crore. Of these, 799,000 investors were paid the full eligible amount and 476,000 investors who were eligible for a reallocation amount of more than Rs 300 were paid a sum of Rs 300 each, according to Sebi.
The regulator added the newly conferred recovery powers under the Securities Laws (Amendment) Act, 2014 helped in recovery from more operators. The sums so recovered went into the Tranche-II distribution initiated by Sebi in December 2015. About Rs 18.06 crore was distributed to 463,000 investors in this phase.
"Keeping in view the cost involved, no distribution was made to 12,000 investors eligible for a reallocation amount of Rs 30 or less. Of 463,000 investors, 203,000 investors were paid the full eligible amounts and remaining 260,000 investors, who are eligible for a reallocation amount of more than Rs 500, were paid a sum of Rs 500 each," the Sebi spokesperson added.