Scams happen with high regularity because the price of getting caught is insignificant.
Aggrieved investors run from the police to already clogged courts to find redress for issues for which financial regulators have been specifically set up.
For over 3,750 years we have known what to do, but we don’t do it, observes Debashis Basu.
Scams, mis-selling, and wrongdoing, which are pervasive in the financial markets, hurt retail investors the most, destroying large chunks of their hard-earned savings.
Every such episode sees regulators tighten the rules without reducing the number of offences.
In fact, a spate of recent broker defaults or shenanigans by mutual funds are reminiscent of the 1990s and have blown off the hard-won improvements in marketplace safety.
One view is to accept this as an inevitable fact, saying: ‘What more can regulators do, beyond learning from each case and plugging loopholes?’ Or that ‘There will be crooks everywhere, you can’t stop them; it happens all over the world’.
Another is to blame investors, by calling them greedy and gullible.
There is a simple solution to drastically reduce the cases of misconduct, drawn from an idea that goes back 3,750 years. But before I come to it, let’s examine our current regulatory approach.
When YES Bank collapsed in March this year, the Reserve Bank of India allowed the bank to write off the entire value (Rs 8,415 crore) of what are called the AT1 bonds.
Those who lost money included depositors who parked a sizeable chunk of their life savings in these bonds at the behest of YES Bank’s relationship managers.
The relationship managers mis-sold these bonds with a five-year tenure and 9.5 per cent per annum interest, claiming they were ‘as safe as bank fixed deposits, having no linkage to the riskier equity market’.
Relationship managers pushed retail investors to pick up these bonds from the secondary market (these bonds are not meant for retail investors and, hence, primary issuance is not available for them).
When investors lost all money and dragged the lender to court, demanding compensation, the RBI said that risks to these bonds were well known. And yet, AT1 bonds continued to be sold as safe FDs, which we exposed in Moneylife on October 1.
On October 5, the Securities and Exchange Board of India finally acted to ensure that AT1 bonds are less accessible to retail investors.
Banks can issue them only on an electronic platform and only to institutional investors with the minimum allotment size and trading lot size fixed at Rs 1 crore.
By this, Sebi acknowledged that YES Bank’s AT1 bonds were mis-sold, but the perpetrators of the mis-selling scam have got away.
On October 1, Sebi finally acted against the National Stock Exchange for buying stakes in unrelated businesses without its approval.
The NSE invested in six entities that are not germane to the stock exchange’s business. The order says, ‘The NSE, being the leading stock exchange, should have set higher standards of compliance… the violation is repetitive in nature and has continued for a long period’.
Let’s look one of the six violations which relates to its investment in Computer Age Management Systems (CAMS), which just went public.
Some time in 2010, the BSE was interested in buying a 51 per cent stake in CAMS. Sebi stopped the BSE, saying it amounted to a conflict of interest.
But in December 2013, it allowed the NSE to strike a deal with two shareholders of CAMS to buy a 45 per cent stake at Rs 187.86.
The NSE’s previous management, in its supreme arrogance, did not bother to seek permission from Sebi or even inform the regulator.
Sebi started investigating the case in early 2017. The NSE continued to hold a 37.5 per cent stake, having sold 7.5 per cent to a Warburg Pincus fund.
The NSE’s stake of 18.285 million shares, acquired with the regulator’s tacit acquiescence, was valued at approximately Rs 2,444 crore, giving the NSE a profit of Rs 2,102 crore.
This is in addition to the profit of Rs 125 crore it had already booked. Remember, Sebi’s October 1 order says that buying this stake was illegal in the first place.
Guess the fine Sebi imposed on the NSE for a series of six violations quoted in the order? Rs 6 crore.
This makes the fine about Rs 1 crore for buying the CAMS stake without permission, while the NSE is richer by about Rs 2,300 crore.
Who says violation doesn’t pay?
Credit rating agencies
The Infrastructure Leasing and Financial Services group, a behemoth with Rs 91,000 crore of borrowing, had issued non-convertible debentures.
Credit rating agencies had given it the highest rating, until they were dramatically downgraded to default grade in a matter of 25 to 40 days in September 2018.
When Sebi finally acted against the credit rating agencies, it said, ‘The role of a CRA is that of a financial ‘gatekeeper’ and any inaccuracy in the rating processes adopted by the CRA has a significant negative impact on the securities market.’
The fine for this astonishing dereliction, which inflicted ‘severe financial losses’ on investors: An insignificant Rs 25 lakh on each credit rating agencies (ICRA, CARE, and India Ratings), which was later raised to Rs 1 crore.
In 2019, CARE Ratings made a profit of Rs 200 crore, while ICRA made a profit of Rs 150 crore. Remember, these huge profits are possible only because Sebi has made ratings mandatory.
You can see the pattern. Scams, misconduct, and misdemeanours happen with high regularity not because these are inevitable, but because the price of getting caught is insignificant.
Meanwhile, aggrieved investors, let down by regulators, run from the police to already clogged courts to find redress for issues for which financial regulators have been specifically set up.
Sadly, for over 3,750 years we have known what to do, but we don’t do it.
One of the earliest and most complete written legal codes came from the Babylonian king Hammurabi (1792 to 1750 BC).
The Hammurabi Code established standards for commercial interactions and set fines and punishments for breaches.
Hammurabi understood that edicts and rules would not make people accountable; we need to make them pay for violation, forcing them to have their ‘skin in the game’.
The skin has to be literal, he declared.
If we were to apply the Hammurabi Code to above three cases even lightly, there should have been personal fines on the relationship managers of YES Bank, a year’s profit as fine on the credit rating agencies, and disgorgement of the entire NSE’s profit in the CAMS deal — apart from personal fines on senior officials of the CRAs and the NSE.
If these seem egregious, so are the transgressions.
Until we impose exemplary personal and institutional costs for such acts, we are signalling that it pays to commit financial offences, which is why they would keep recurring.
Debashis Basu is the editor of www.moneylife.in.
Feature Presentation: Rajesh Alva/Rediff.com