Chances are you haven't really paid much attention to the Bombay Stock Exchange's decision to suspend trading in Design Auto Systems a couple of years ago.
Trading in the company's shares was suspended, the BSE site tells you, because unlisted shares of the firm were being traded -- essentially, the firm had issued preferential shares and before these were even listed, they were being traded.
While BSE insiders say there are several other such firms, the Web site doesn't make it easy to find out which firms have been suspended for trading in unlisted shares -- unless you know the name of the firm and then go and check the reason for its suspension. So what, you might well say, it's just a technical infringement.
Actually, it's a whole lot more, and the problem is getting a lot more severe with an increasing number of firms over the last few years going in for preferential allotments of shares. In 2001-02, of the 411 firms that applied to the BSE for listing, for instance, 212 were for preferential allotments, and in 2002-03, 287 of the 560 listing applications were for preferential allotments.
Here's how it works: firms allot shares at a huge discount to their promoters, and the promoters then sell these shares in the market -- in the early 1990s, crooked promoters creamed off over Rs 6,000 crore (Rs 60 billion) in this manner.
While matters were tightened somewhat after the blatant rip off of the 1990s -- price formulae were laid down and sales of equity got through preferential allotments was banned for a year after the issue -- the problem still remains quite serious with crooked promoters finding novel ways out.
Several sell the shares they had prior to the preferential-issue at the market price, and then use the preferential issue shares to ensure their shareholdings remain the same as earlier!
In fact, according to data compiled by G Madhan in the Business Line of February 29, in just the first two months of the year, Rs 3,000 crore (Rs 30 billion) was raised through preferential allotments. And this was raised at discounts (to the market price) of between 1.5 per cent and 53 per cent -- the discount was 1.6 per cent in the case of Max India and 53.1 per cent in the case of Nagarjuna Construction. But what's even more interesting is that stock prices of several firms rose dramatically -- 82.5 per cent in the case of Nagarjuna -- in the month prior to the date of announcement of the preferential issue.
In other words, if company promoters wanted to cream off money from the market, this was a wonderful opportunity.
While the Securities and Exchange Board of India keeps coming up with guidelines to curb the abuse, the problem is that Sebi just isn't able to do a good job monitoring pre- and post-listing compliance by companies. It doesn't help that, in the case of preferential allotments, Sebi doesn't even do a perfunctory scrutiny -- it chooses to concentrate on rights and public issues.
The good news, however, is that Sebi has allowed the formation of a Central Listing Authority (CLA) whose only job will be to come up with rules for the listing of firms' securities (whether equity or debt, public/rights or preferential), and to ensure these are complied with -- the United Kingdom has a UKLA for precisely the same function.
While Sebi notified the formation of the CLA in February last year, it took a year to draft its rules and regulations and then find a CEO for it (T V Rangaswamy, the new CEO used to be a general manager at ICICI Infotech and was part of the founding team at the National Stock Exchange), and it is only now that the CLA has got an office -- a temporary space in the offices of the National Securities Depository Limited (NSDL). According to insiders, CLA will be ready to function in another three to four months.
Another significant abuse that will get curtailed once the CLA gets operational is that no stock exchange in the country will be allowed to give listings to securities on its own. Since naive investors feel that a stock exchange's authorities have done due diligence on a company before it gets listed, getting listed is a major area of effort for company managements. But, since the smaller exchanges are desperate for business, the level of diligence is quite poor, though even some of the bigger exchanges don't come out much better.
In May, 2002, for instance, just a fortnight before it was exposed as a fraud, the BSE's governing board actually approved the listing of Home Trade Limited. In fact, despite the fact that the exchange's own research department said the firm was a fraud, BSE's Listing Committee approved Home Trades' listing -- in fact, it was just because one member, the investors' representative, kept protesting, that the matter was pushed up to the board.
The note of the research department, for instance, said the firm's income was generated from selling shares of other group companies -- of the Rs 67.2 crore (Rs 672 million) income of 2000-01, Rs 66.8 crore (Rs 668 million) was from sale of shares of group companies, and even these shares were sold to a related company.
In fact, it later transpired that the BSE itself had rejected the firm's listing application in 1999 itself -- it was after this that Home Trade went to Pune Stock Exchange for listing -- and that the firm had been issued a show cause notice by Sebi in May 1997, and that it had been disabled from trading by the NSE from September 1998 to July 2001.
Apart from the clear problem in BSE's behaviour in this case, what's important is that the full information on the firm's listing history was never available to all the exchanges -- so, for instance, the Pune exchange didn't know BSE had rejected the listing in 1999. With one central listing authority, clearly, such a problem will get minimised.
Of course, what the CLA will really need is a powerful database with all manner of information on different firms. And the intelligence to use it effectively.
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