Sunil Jain: India's SocGen problem

RATIONAL EXPECTATIONS

Given the charges and counter-charges being levelled between Societe Generale (SocGen) and its 31-year-old trader Jerome Kerviel, who is accused of blowing a $7.2 bn hole in its books by carrying out unauthorised trades, it is going to take some time to figure out who's really to blame. Kerviel and his lawyers, for instance, say his supervisors were well aware of what he was doing since, with his position limits as a junior trader, it was not possible to generate the profits he was. It doesn't help that the Eurex derivatives exchange raised an alarm over Kerviel's trading a year ago or that SocGen sought to unwind Kerviel's trades before letting the market know of the problem for three whole days "" in most countries, this would be construed as insider trading, a very serious offence.

While the SocGen affair is likely to result in its takeover by another bank and the possible removal of its top brass, the bank's foray into India hasn't been without its own share of controversy "" except in this case, the authorities have simply washed their hands of the matter.

Towards the end of 2003, SocGen, along with UTI International, began marketing, to overseas investors, the India Equity Plus Series, a financial paper linked to the UTI Masterplus and a JP Morgan dollar fund (a "safe" fund) "" a volatility formula was given in the "Terms and Conditions" booklet to indicate at what conditions of the Indian market SocGen would invest its funds; a "Key Features Document" was also circulated "" the CEO of UTI International wrote to brokers saying around 60-70 per cent of the fund's balances would be invested in Masterplus on Day 1 itself. It was that simple "" two possible investments only and all exchange rates risks were to be borne by the investors.

Problem is, when the single-largest investor in the fund sought to get out a year later, during which time the Sensex had climbed handsomely, he was offered a return of just 2-3 per cent instead of the 24 per cent or so his calculations showed he'd earned. This is when things got messy as SocGen then sought refuge in clauses in documents like a "Pricing Supplement" which were not given to investors at the time their money was taken "" this "Pricing Supplement" is dated February 24, 2004, more than a month after investors paid up and reached investors even later. It allowed, among other things, SocGen to buy a six-year option on the Sensex, presumably (since this was not publicly traded, it's not clear who this was bought from or at what price) and to issue Zero Coupon Bonds which heavily penalised pre-maturity exits.

But that dispute is something investors and SocGen will sort out, the purpose of this piece is to highlight how UTI and the Securities and Exchange Board of India (Sebi) behaved on the matter. When the angry investor wrote to SocGen citing the Key Features Document (exit with a small penalty/load), he was told it had not been prepared by SocGen but by UTI Dubai and that it was, in any case, "only marketing material"! When this was pointed out to UTI International, it wrote to SocGen stating that both UTI International and SocGen had drafted the documents jointly that that SocGen had better not go around disowning them.

This is where UTI's role comes under a cloud. After repeating that the Key Features Document had been jointly prepared by UTI and SocGen, UTI Asset Management Company's Executive Director wrote to this reporter in December 2005 saying the "Term Sheet, and Pricing Supplement which were prepared by Soc Gen were also given to the investors at the time of Initial Offer". This is curious since the Pricing Supplement is clearly dated more than a month after investors paid up; in any case, how does UTI explain the Key Features being dramatically different from the Pricing Supplement? Here is a clear case of UTI co-marketing paper, and of its partner disowning its promises as publicity material, and it took no action, including reporting the matter to Sebi, which regulates FIIs such as SocGen.

You'd have thought the Sebi chief, himself the head of UTI when all of this happened, would have investigated the matter when it was brought to his attention nearly two years ago, particularly since his job is to ensure FIIs investing into India are "fit and proper". Sebi has, however, washed its hand of the case arguing the events took place overseas and that UTI International was just "an agent of the investor for purchase of the notes" (whatever that might mean in legalese, in English that means UTI International's job was to protect the investors!). With SocGen now owning 37 per cent of SBI Mutual Fund and planning to branch out into other sectors, it's time Sebi decided to get a bit more pro-active.