| The efficacy of surveillance and follow-up legal action needs to be reviewed by the regulators.
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| Indian equity markets have outperformed most developed country equity markets in the last six years. Further, it is a reflection of confidence in the administration of regulatory safeguards in Indian stock markets that there are no rumblings about market malpractices. However, it is at times of relative calm when there has been a manifold rise in equity market levels that the market regulator and the stock exchanges need to review the effectiveness of controls against market malfeasance.
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| The last so-called Indian stock market and banking "scam" took place in 2001-02. The attached table provides the Sensex, Nifty, Nasdaq and Dow highs and lows between 1997 and 2003 and the current values in December 2007.
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The table shows that the Sensex nose-dived by more than 60% from a high in 2000 to its low in 2001. By December 2007 Indian equity indices have risen to record levels and the Sensex is up by about 700% since its low in 2001. In sharp contrast, the Dow is less than 20% up since 2000 and the Nasdaq is still 45% below its peak in 2000.
| MARKET PLAY | | | High | Low | Current | | Sensex | 5,935
(8/2/2000) | 2,620
(21/9/2001) | 19,092
(19/12/2007) | | Nifty | 1,756
(10/2/2000) | 815
(26/10/1998) | 5,751
(19/12/2007) | | Dow | 11,726
(13/1/2000) | 6,441
(10/4/1997) | 13,345
(19/12/2007) | | Nasdaq | 5,051
(8/4/2000) | 1,125
(9/10/2002) | 2,606
(19/12/2007) |
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| Sebi's efforts at maintaining market integrity are rooted in sound principles. Market surveillance is entrusted to stock exchanges and stock watch systems are used to detect unusual price movements. In addition, the regulator, in coordination with stock exchanges, has instituted a range of risk-mitigation measures including margining, price bands and inspections of intermediaries. In the past, some manipulation went undetected due to inadequate coordination across financial sector regulators. In the 1992, 1996 and 2001 episodes, the wrong-doing was spread across banks, NBFCs, mutual funds and brokerages.
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| Coordination across Indian financial regulators is effected through the High-Level Committee for Financial Markets (HLCFM). It would help if a Sub-Committee of representatives from surveillance departments in each regulator were to meet at regular intervals. This Surveillance Sub-Committee could be obliged to report two weeks before each HLCFM meeting so that unusual trends would be focused upon and investigative efforts initiated, if necessary.
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| Large cap stocks are now free of the egregious manipulation which was common in the "badla" years of the past. For instance, when there is persistent misalignment between the value of a stock and its traded price, speculators take opposing futures or options positions, for shares in which exchange-traded derivatives is permitted. Consequently, there is less room for stock price manipulation. The challenge in the next few years is to make all listed mid- and small-cap stocks eligible for derivatives trading. At the margin, this should make it easier for smaller firms to access much-needed capital.
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| It is important to view FII investments in Indian equity markets in perspective. The global stock of financial assets, according to a December 2007 McKinsey Global Institute study, was $167 trillion at the end of 2006 and the market value of FII investments in Indian equity markets is about $240 billion. The opportunity cost of market disruption due to FIIs scrambling to exit after a perceived scam obliges us to upgrade market integrity practices.
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| It has been some time since the Government of India submitted its Action Taken Reports on the recommendations of the Joint Parliamentary Committees (JPC) post the 1992 and 2001 scams. However, it is not clear to the investor community that the wrong-doers who were named post the 1992 and 2001 JPCs and the 1996 CR Bhansali episode have been successfully prosecuted. It appears that although financial sector regulators' orders in surveillance cases are available on their web-sites there is not much information on follow-up legal action.
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| There were many instances of wrong-doing in the US securities markets during the boom years of 2000-02. For example, there were several cases in which the SEC penalised major investment banks for their role as IPO lead managers in discriminating against retail investors by making preferred stock assignments to institutional and high net-worth individuals. However, the SEC in the United States and the FSA in the UK provide current information on the legal status of financial crime cases. Given the complexity and high volumes of spot and derivatives transactions, it is recognised that electronic surveillance needs to be complemented with information from individuals. Hence the SEC and FSA emphasis on eliciting inputs from market participants and whistle-blowers. Additionally, US firms have made it mandatory for their employees to comply with "Personal Trading Standards", i.e. company personnel have to disclose or obtain pre-clearance for stock market purchases/sales by them or their close relatives. It would help reduce front-running among other market malpractices if comprehensive disclosure standards were to be made compulsory for all Indian corporate sector employees.
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| A continuous review of illegitimate practices is necessary to protect market integrity. For example, in 2007 the FSA defined Politically Exposed Persons (PEPs) as "individuals whose prominent position in public life gives them opportunities for profiting from corruption". This definition extends to immediate family members and close associates. The FSA has drafted "good practice guidance for firms to deal with PEPs". The FSA's work on PEPs is worth examining for its implications for Indian regulatory standards.
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| As many of us have found to our cost, obtaining rulings from Indian courts can be very time-consuming. In this context, a comparison between the staff strengths of our financial regulators' legal departments and those in other jurisdictions shows that our institutions are understaffed. It is clear from a cursory glance at Sebi's orders that legal battles can be prolonged and Sebi needs additional resources for it to maintain its deterrent credibility.
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| The media is universally under competitive pressure to get the attention of its target audience and it also has inflexible deadlines. Even with the best of intentions this can result in incorrect reporting, which could mislead the market. Indian financial sector regulators need to agree with media managers on norms for accuracy of reporting.
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| To summarise, Indian equity and exchange-traded derivatives markets are closer to international best practices as compared to debt markets. Consequently, to maintain the market credibility of these star performers in Indian capital markets the efficacy of surveillance and follow-up legal action needs to be jointly reviewed by the regulators.
j.bhagwati@gmail.com |
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