How big really was the IPO scam?

by khalid on 04/01/2010 · 0 comments

It has been a strange week for the Securities and Exchange Board of India (SEBI”) and the “IPO scam”. Last week, SEBI published a report produced by a committee headed by Justice D P Wadhwa on how alleged victims of the “IPO scam” ought to be compensated. However, an unexceptionable and lucid order passed last week by the Securities Appellate Tribunal (SAT) poses a much bigger question about the so-called scam.

It is important to take a step back and consider what the so-called scam was about. In 2005, SEBI had a system of proportionate allotment for every applicant in the retail investor category in initial public offerings. A retail investor was defined by the threshould of an investor’s subscription value (a subscription worth Rs 100,000 or less in any IPO) and not on the basis of whether the investor was small or large.

SEBI alleged that large investors with high networth had abused the system by getting small investors to make applications in IPOs. The small investors (variously called “benamis”, “men of straw” and the like in various SEBI orders) were accused of having sold their shares immediately upon allotment and before listing, to large investors. In some cases, it was alleged that the large investors had financed the applications by such small investors.

In a reaction akin to riot police shooting at sight, any person who had received shares from any allottee of shares in an IPO before the shares were listed, was picked up and debarred from dealing in securities. Even the pool accounts of brokers who had received shares from clients desirous of selling on the first day of trading were frozen by SEBI.

It was always SEBI’s position that so long as allotment received in a demat account had been sold to a large investor before listed trading on stock exchanges started, all the allottees were “fictitious”, their demat accounts were “afferent” (a term now an integral part of Indian securities law terminology) and the persons who acquired shares from such allottees were “key operators”. In a nutshell, SEBI’s case was that since the retail investor category entailed proportionate allotment to every applicant, the other subscribers had to leave the party with a smaller allotment and were therefore victims of a scam.

Proceedings relating to the IPO scam ran on a basic fundamental postulate – an assumption that a scam had indeed taken place. The then Finance Minister told Parliament that scam victims would be compensated. SEBI passed an order (later set aside and not appealed by SEBI) providing a new meaning to the term “disgorgement” – asking intermediaries within its regulatory reach to pay what SEBI believed was the value of loss caused to the victims, leaving such regulated intermediaries to chase the real wrong-doers for re-compense through civil proceedings, if, as, and when such alleged scamsters were held to be guilty. The Wadhwa Committee was then formed to determine how victims ought to be compensated.

The SAT has now ruled that there would be nothing illegal about small investors (if they exist, they cannot be “fictitious”) applying for shares using their own means (therefore, not “benami”), and transferring their shares to a large investor before the shares are listed. It would not matter that numerous small investors collectively sell their shares to the large investor before listing, and it would not matter who approached whom for such sale.

A significant component of the so-called IPO scam just got ruled as being no scam at all. A fundamental premise of the Wadhwa Report was that SEBI’s orders relating to the IPO scam were “well documented, comprehensive, lucid and analytical” and “very useful.” In reality, almost every material order most advertised by SEBI in the proceedings has failed to withstand judicial scrutiny. The Wadhwa Committee indeed hedged its risks by stating: “The Committee has made… recommendations… aware that the facts… are disputed… ultimate facts could be different. The committee… hopes… the final facts will not… negate these recommendations.”

The recommendations just got materially negated. It is time to take a deep breath and re-think whether there was at all an IPO scam in India of the scale and magnitude as the world was told.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)


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