Take care of the pennies

The Securities and Exchange Board of India has finally swung into action to check the irrational exuberance in penny stocks, and the move has already started yielding results""in spite of the rise in the Sensex in the last few sessions, penny stocks have come down from their absurd levels.

Importantly, the stock exchanges and the market regulator have successfully deflated these stocks through purely market measures. For example, the BSE has shifted more than 900 scrips to the trade-to-trade segment in order to contain excessive speculation. Circuit filters across the T, TS and Z group stocks were reduced to 5 per cent, which has clearly contributed to cooling off these scrips.

Moreover, 100 per cent VaR margins had been imposed in the trade-to-trade and Z category from early August. The effect of all these measures has been a choking off of liquidity in penny stocks, on the one hand, and increasing the cost of transacting in them, on the other.

The BSE has also pointed out that it has suspended a large number of companies in the Z category, i.e. those companies that have not complied with the listing regulations.

Additionally, together with tightening the margin requirements and imposing circuit filters, Sebi has started taking action against promoters who have allegedly ramped up their scrips in cahoots with brokers.

A few promoters had also been feeding false and misleading information about their companies' prospects and plans, and these people have now been barred from the capital markets, while trading in the scrips of their companies has been suspended.

All this has had a salutary effect not only on the stocks targeted by the regulator and the stock exchanges, but on other small and illiquid stocks as well, as speculators dumped these stocks in panic.

There is little doubt, however, that both the market regulator and the stock exchanges seem to have been blind to what was happening in penny stocks for quite some time. To take an example, why did it take so long to check the rise in the scrip of a home finance company whose business licence had been cancelled months ago?

Or why should the exchange have to wait for three months, during which a penny stock rose 900 per cent, before clamping down on it? There are also instances when the exchange took action very late in spite of a suspiciously sharp rise in trading volumes.

All this had led to a situation where penny stocks had been allowed to run up too far too fast, and there was no alternative to injecting a sharp correction to cool the market. The stock exchanges will no doubt point out that it is better late than never, but there are several issues that are highlighted by the delayed action.

First, it's clear that their surveillance mechanism leaves something to be desired. Second, and more important, there have been accusations that many "small investors" have been lured into these stocks simply because the manipulation was not nipped in the bud. But while that is undoubtedly true, it's also a fact that the main motivating factor for many so-called "small investors" has been unmitigated greed.

These small speculators""it would be a mistake to call them investors""were out to make a quick buck and were well aware of the risks that they took. As for the genuine small investors, their interests are best served by routing their money through mutual funds.