Best to exit stocks stuck in regulatory mess

These could fall sharply, eroding your wealth; also, as recovery might take long, booking losses might be sensible at times

Regulatory woes are as big a problem for investors as for companies because it is difficult to decide on investments in these firms. On the one hand is the risk of investors losing their hard-earned money if they stay put and on the other, there is a risk of not being able to benefit from a recovery if such stocks see a turnaround.

Investment experts are unanimous that individual investors shouldn't enter stocks of companies stuck in regulatory mess. But, sometimes, regulatory concerns come up later and a judgment on this comes with additional delay. A case in point is the Securities and Exchange Board of India (Sebi) announcing a final order in the DLF case six years after it took up the issue.

As all stocks run the risk of facing regulatory issues, Piyush Garg, chief investment officer of ICICI Securities, says individuals should get out of scrips at the first hint of regulatory concern. "The bigger disadvantage with stocks stuck in regulatory issues is these might not be able to give you positive returns, even if they don't give negative returns. The DLF stock has lost a lot (73 per cent since October 22, 2009, when it stood at Rs 448.75) in the past six years. And, if it isn't able to give you positive returns for the next five years, your money and time will be wasted," he says.

The DLF stock fell 28 per cent through the week following the Sebi order.

Similarly, Jindal Steel and Power, embroiled in a mining case, has fallen 50 per cent since April 2013 and 25 per cent since September this year. Financial Technologies India Ltd (FTIL) has fallen 67 per cent since July 31, 2013, when a payment crisis broke out at National Spot Exchange Ltd, promoted by it.

Before taking a decision on her/his investment, one needs to consider how much of the bad news has been factored into the stock price and whether or not the stock can give quick returns. If one looks at the stocks stuck in regulatory issues between 2013 and 2014, it is seen most haven't recorded much change in the price.

Sudhakar Ramasubramanian, managing director of Aditya Birla Money, agrees with Garg. "Individual investors should always invest in quality stocks, not those facing issues. This is because such stocks could fall sharply on any negative news and retail investors can't handle that. While one could take some risk at times, one should also ensure she/he is invested in a diversified basket of 20-30 stocks and the impact of a controversial stock is one-two per cent of the overall equity portfolio. At best, a high risk-taker could have 5-10 per cent exposure of the overall equity portfolio in stocks embroiled in hassles."

HOSE WHO GOT PULLED UP

• Recently, DLF and its promoters were barred from accessing the capital markets for three years, as the company failed to provide key information on subsidiaries and pending legal cases during its initial public offering (IPO) in 2007.
• In August, founders of technology firm Bharatiya Global Infomedia were barred from the markets for five years for failure to disclose key information about preferential loans and use of IPO proceeds in 2011.
• In July, Gammon India promoter Abhijit Rajan was barred from accessing the securities market for seeming to have breached insider trading rules, while dealing in shares of Gammon Infrastructure Projects.
• In March, PG Electroplast and its promoters — Promod Gupta, Anurag Gupta, Vishal Gupta and Vikas Gupta — were prohibited from raising money and barred from the securities market for 10 years.
• In October 2013, DSQ Software and its promoter Dinesh Dalmia were barred from capital markets for seven years, following fraudulent trading in 1998, which led to a sharp rise in the stock price.
• In May 2013, six Zenith Infotech promoters — Rajkumar Saraf, Akash Kumar Saraf, Devita Saraf, Vijayrani Saraf, VU Technologies and Zenith Technologies — faced a ban from trading in securities.
• In October this year, the regulator fined GlaxoSmithKline Plc and a group company that had stake in GlaxoSmithKline Pharmaceuticals Rs 25 lakh for delay in disclosing changes in the shareholding structure of the India-listed unit.
• On July 5, 2013, when Gillette did not comply with the minimum shareholding norms of 75:25, Sebi froze voting rights and corporate benefits such as dividend, rights, bonus and share splits on the excess portion held by the promoters. The promoters were also barred from holding any new position as a director in any listed entity.

Only savvy individual investors (those who understand stock markets and the associated risks) should consider volatile stocks. On a good day, it could give them 15-20 per cent upside. That's why some recommend avoiding stocks in whose case promoter integrity has been questioned or any other type of regulatory issue(s) have even been hinted at. This should be one of the filters during stock selection.

  Vikram Dhawan, director of Equentis Capital, says in the US or Europe, when companies face regulatory issues, they largely pay the penalty levied and put their act together to clean the mess. Some also go to the level of restructuring the top or mid-management to regain investor confidence. India, too, has laws through which the managing director of a company could be asked to step down if the company gets into trouble. However, these aren't enforced often, though Sebi is making efforts in this regard.

Dhawan says individual investors should get out of stocks of companies pulled up by regulatory bodies. If they decide to remain put, it should only be because the company is seeing some movement towards a clean-up act.

Another way to decide is to consider the severity of the case slapped on an entity, says Shriram Subramanian, founder of InGovern Research. This is because there are risks for companies such as Infosys Technologies in case of an issue pertaining to the US' immigration department, or a risk to UB Group chief Vijay Mallya's businesses if he is declared a wilful defaulter.

One has to evaluate the impact of a case on a company's reputation and operations, Subramanian says. For instance, in GSK Plc's case, the regulator acknowledged the company didn't receive any "quantifiable gain or unfair advantage" due to the delay in disclosing changes in the shareholding structure of its India-listed unit, though it imposed a penalty. There could be similar technical issues, pertaining to taxation or tax returns, in which case investors need not panic.

In DLF's case, the company won't be able to raise funds for retiring debt. Also, it might not be able to participate in real estate trusts. But there won't be any impact on its operations.

At the same time, as there are better stocks in the market, one might want to exit DLF. Also, the company's projects are concentrated in a particular region.

Similarly, the US immigration concern won't be much of a concern for Infosys, as the company is sitting on cash piles. But if the immigration department puts a restriction on the number of employees to be allowed into that country, the company's operations will be impacted, says Subramanian.