IPO scam

The action by the Securities and Exchange Board of India (Sebi) in unearthing the scam involving multiple benami applications for shares offered to the public is welcome and in fact was long overdue. Multiple applications for shares have been known to exist from perhaps as far back as the 1970s, when underpriced issues by the Indian subsidiaries of global corporations (who were Indianising their shareholding as mandated by the Foreign Exchange Regulations Act) became a passport to easy money""so long as you could get a share allotment. Since the rules on such allotment favoured retail investors, people began making applications for small numbers of shares in multiple names, rather than asking for many shares in one name. The practice may have begun by using the names of real people (family members, other relatives, friends and acquaintances), but at some stage the "professionals" took over and began using benami applications.

Two regulatory issues arose. Once it became mandatory that you had to submit your permanent account number (PAN) issued by the income tax department, along with each application, it became incumbent on the market intermediaries handling the issue to make sure that applicants had in fact given their PANs""and to reject all those who did not. The professionals circumvented this requirement by stating that the PAN had been applied for""and the intermediaries accepted this, even when they could see that hundreds if not thousands of applications were being made from the same address (how many people can reasonably be expected to be staying at one postal address?).

The equally serious regulatory issue concerned the banks. For, unsuccessful applicants get their share application money refunded by cheque and this has to be deposited in a bank account. Since there cannot be bank accounts in benami names (bank managers are supposed to know their customers), there was a grand bank scam going on. This apparently began with poorly administered cooperative banks, who would be happy to credit cheques in multiple names to one account (shades of Harshad Mehta here) but, if the latest Sebi action is to be believed, has spread to the regular scheduled commercial banks as well.

In other words, the Sebi action shows up defective market practice (favourable allotment ratios for small investors, in comparison with other individuals) as well as collusion by market intermediaries and banks. Whether the companies issuing shares were also in the game is not clear, and the answer may vary from case to case. Such scams may also not have been going on at all times during the past 30 years, and may have peaked only when the market has been hot (when IPOs are guaranteed to list at a premium to the issue price, as in recent months). But the general picture is clear, as also the corrective action that should be taken.

For a start, Sebi should review the share allotment rules. It may be feasible to have one rate of allotment for institutional investors and another for individual investors, but clearly you are inviting a problem if individuals themselves are dealt with differently, based on the number of shares they have applied for. Second, strict action should be taken against all the market and financial intermediaries who have facilitated this scam by winking at benami applications in the thousands. No system can be reformed if culprits, when caught, are not brought to book. Both Sebi and the Reserve Bank of India, as well as state governments, who oversee the co-operative banks, have their work cut out for them. What the investing public needs to be assured about is that this scam will not be repeated.