The Hindu Business Line : Lesson from IPO scams

THOUGH India's stock market is at times seen as being on a par with its global counterparts, so far as market systems and procedures are concerned, the recent demat-related IPO (initial public offer) scam has once again opened up a can of worms.

Over the last decade, rapid transformation has taken place in India's capital market. The use of information technology and integration of financial markets have enhanced the risk profile of the market. Perhaps, a code of governance is desirable at the investor's level too.

So far as the primary market is concerned, some major reforms include the ushering in of the tried and trusted (till recently) demat environment, proportional allotment, market discovered price mechanism, enhanced allocation for retail investors (35 per cent), and so on. Issue of new securities only in electronic form is another major development.

Of late, public issues have grown, both in number and value. Besides rights issues and private placements, 73 issues valued at Rs 23,000 crore hit the market till November of this fiscal. According to SEBI, till October 2005, over Rs 13,000 crore was collected through private placements and another Rs 41,000 crore by mutual funds. Thanks to the current bull-run in the secondary market, almost all the IPOs have been oversubscribed.

Looking back, in all the major stock scams — Harshad Mehta (1992), Ketan Parekh (2001), et al — there were two common features: collusion by banks and poor surveillance. Flouting of the `know your customer' (KYC) norms by banks is common. The Government, through regulatory agencies such as the RBI and SEBI, has been advocating strict adherence to these norms in order to curb the evils of black money, money-laundering, and so on.

Though there is no legal bar on the number of bank and demat accounts that can be opened, one is expected to open only that many accounts which one can manage. Opening accounts in benami names is an offence under the Companies Act. Accordingly, any person who makes in a fictitious name an application to a company for acquiring or subscribing to shares, or induces a company to allot, register or transfer shares to him or any other person in a fictitious name, shall be punished with imprisonment extending up to five years.

So, while having more than one account is allowed, one cannot apply for shares under fictitious names. Unlike earlier, when share application forms were punched and checked physically and multiple applications rejected, such an exercise may not be carried out that meticulously now owing to larger volumes, short duration of 10-15 days for allotment and listing of shares, and most investor-related data being captured from the DP-ID number.

As in bank and demat accounts, there is no record of those who hold more than one PAN card, more than one credit card of the same company and even multiple PPF accounts in the same bank, city or in different towns.

As per the KYC norms, for opening a demat account, apart from photo identity proof, it is mandatory to mention details of bank account number, MICR number of bank branch, and so on.

Since photo identity proof is also a must for opening a bank account, it is quite likely that bank accounts might have been opened first, and based on their existence, the depository participant might have taken a lenient view and opened demat accounts. However, if a large number of demat accounts were opened in a short span of, say, 10-15 days, as in the recent scam, due diligence was called for.

Key lessons from the IPO scam are that we need stringent provisions and a disciplinary mechanism for investors, besides stricter surveillance on all market intermediaries. Currently, depository-level inspections are minimal. This activity should be done on an ongoing basis with the help of professionals. Banks should be asked to indulge in core banking, and other capital market-related activities ought to be separated.

The practice of bankers being brokers and depository participants should also be reviewed. And, similarly, having the same entity as broker and depository participant should be discouraged. It should be allowed only after utmost care is taken that internal controls are in place.

Providing finance to apply for IPOs or capital market activities from the bank or branch where broking/demat account is maintained should be prohibited. There is a need to fix a ceiling on the number of demat accounts one can have under each pattern with one or more DPs.

Bank and demat accounts should not be activated unless KYC norms are adhered to. There is also a need to monitor off-market transactions and money transfers. This would happen if the PAN is made mandatory.

Providing each market player, including investors, with a unique identification number (like MAPIN) can check many a market evil. The number must be mandated in all primary and secondary market deals, bank accounts, high-value transactions, property registration, vehicle registration, and so on. Only then can regulators check bogus transactions and book fictitious persons. In such a case, even if a person has multiple bank and demat accounts, malpractices cannot happen. It is worthwhile exploring the electronic filing of IPO applications, so that cheques are not required and investors' bank accounts automatically get debited or credited.

(The author is a Jaipur-based chartered accountant.)

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