Do you think that SEBI’s decision of banning the badla system was right? Discuss it.

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Discuss the SEBI decisions after the scam was revealed.

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Discuss in detail the modus operandi of Ketan Parekh.

 


The sudden crash in the stock markets in March 1, 2001, by 176 points prompted the Securities Exchange Board of India (SEBI) to investigate into the volatility of stock markets. Anand Rathi, the President of Bombay Stock Exchange (BSE), resigned because of the allegations that he used some privileged information, which led to crash. At least eight people committed suicide and many investors went bankrupt due to crash.

CBI arrested Mr Ketan Parekh, famously known as ‘Bombay Bull’, in March, 2001. He was basically a chartered accountant. He came into limelight during 1992 scam. Over the years, Ketan Parekh built a network of companies, mainly in Mumbai, involved in stock market operations. The companies in which Ketan Parekh held stakes included Amitabh Bachchan Corporation Limited (ABCL), Mukta Arts, Tips and Pritish Nandy Communications. He also had stakes in HFCL, Global Telesystems (Global), Zee Telefilms, Crest Communications, and PentaMedia Graphics. Ketan Parekh selected those companies for investment which listed high growth with a small capital base.

The stocks in which Ketan Parekh invested became famous as K-10 Stocks in the market. The shares were held through Ketan Parekh’s company, Triumph International. In July 1999, he held around 1.2 million shares in Global. Ketan Parekh controlled around 16% of Global’s floating stock, 25% of Aftek Infosys, and 15% each in Zee and HFCL. The buoyant stock markets from January to July 1999 helped the K-10 stocks increase in value substantially. HFCL soared by 57%, while Global increased by 200%. As a result, brokers and fund managers started investing heavily in K-10 stocks.

Mutual funds like Alliance Capital, ICICI Prudential Fund and UTI also invested in K-10 stocks, and saw their net asset value soaring. By January 2000, K-10 stocks regularly featured in the top five traded stocks in the exchanges. It is said that Ketan Parekh doesn’t have the financial muscle to buy such large number of stocks. Financing methods of Ketan Parekh were very simple. He bought shares when they were trading at low prices and when the price was high; he pledged the shares with banks as collateral for funds. He also borrowed from companies like HFCL. All this is not possible without the help of bank.

Ketan Parekh’s main ally in this was Ahmedabad-based Madhavapura Mercantile Cooperative Bank (MMCB). Ketan Parekh and his associates started tapping the MMCB for funds in early 2000. In December 2000, when Ketan Parekh faced liquidity problems in settlements, he used MMCB in two different ways. First was the pay order route, wherein Ketan Parekh issued cheques drawn on BoI to MMCB, against which MMCB issued pay orders. The pay orders were discounted at BoI. It was alleged that MMCB issued funds to Ketan Parekh without proper collateral security and even crossed its capital market exposure limits. As per an RBI inspection report, MMCB’s loans to stock markets were around Rs. 10 billion of which over Rs. 8 billion were lent to Ketan Parekh and his firms.

The second route was borrowing from an MMCB branch at Mandvi (Mumbai), where different companies owned by Ketan Parekh and his associates had accounts. Ketan Parekh used around 16 such accounts, either directly or through other broker firms, to obtain funds. Apart from direct borrowings by Ketan Parekh-owned finance companies, a few brokers were also believed to have taken loans on his behalf.

The MMCB pay order issue hit several public sector banks very hard. These included State Bank of India, Bank of India and the Punjab National Bank, all of whom lost huge amounts in the scam. Ketan Parekh’s modus operandi of raising funds is doing well when share prices were high but as the value of K-10 stocks started declining, Banks asked Ketan Parekh to pledge more share or return some amount. Mutual funds also reduced their exposure in K-10 stocks. To his relief, in May 2000, K-10 stocks began picking up. HFCL nearly doubled from Rs. 790 to Rs. 1,353 by July 2000, while Global shot up to Rs. 1,153. Aftek Infosys was also trading at above Rs. 1000.

In December 2000, the NASDAQ crashed again and technology stocks took the hardest beating ever in the US. In India too, people start questioning the future of technology stocks. Mutual funds and other investors started reducing their investment in K-10 stocks. Ketan Parekh began to have liquidity problems and lost a lot of money during that period.

The payment crises at Calcutta Stock Exchange (CSE) gave the biggest setback to Ketan Parekh. Brokers at CSE used to buy shares at Ketan Parekh’s behest. Though, officially the scrips were in the brokers’ names, unofficially Ketan Parekh held them. Ketan Parekh used to cover any losses that occurred due to price shortfall of the scrips and paid a 2.5% weekly interest to the brokers. By February 2001, the scrips held by Ketan Parekh’s brokers at CSE were reduced to an estimated Rs. 6-7 billion amount from their initial worth of Rs. 12 billion. The situation worsened as Ketan Parekh’s badla payments of Rs. 5-6 billion were not honoured on time for the settlement and about 70 CSE brokers, including the top three brokers of the CSE (Dinesh Singhania, Sanjay Khemani and Ashok Podar) defaulted on their payments. The CSE brokers started pressurizing Ketan Parekh for payments. Ketan Parekh again turned to MMCB to get loans.

By now, SEBI was implementing several measures to control the damage. An additional 10% deposit margin was imposed on outstanding net sales in the stock markets. Also, the limit for application of the additional volatility margins was lowered from 80% to 60%. To revive the markets, SEBI imposed restriction on short sales and ordered that the sale of shares had to be followed by deliveries. It suspended all the broker member directors of BSE’s governing board. SEBI also banned trading by all stock exchange presidents, vice-presidents and treasurers. A historical decision to ban the badla system in the country was taken, effective from July 2001, and a rolling settlement system for 200 Group A shares was introduced on the BSE.

The small investor was feeling deceived as he believed that all the parties working in the stock exchange are responsible for the Scam. SEBI’s measures were widely criticized as being reactive rather than proactive. The market regulator was blamed for being lax in handling the issue of unusual price movement and tremendous volatility in certain shares over an 18-month period prior to February 2001.

Many exchanges were not happy with the decision of banning the badla system as they felt it would rig the liquidity in the market. Analysts who opposed the ban argued that the ban on badla without a suitable alternative for all the scrips, which were being moved to rolling settlement, would rig the volatility in the markets. They argued that the lack of finances for all players in the market would enable the few persons who were able to get funds from the banking system – including co-operative banks or promoters – to have an undue influence on the markets.

Ketan Parekh was released on bail in May 2001. The scam had set back the Indian economy by at least a year. It is not Ketan Parekh rather it is the system which gave the room to persons like Ketan Parekh to do such thing which cost India around Rs. 2000 billion not a small amount for a developing nation.

Mayank Rai

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