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IPO scam…it’s difficult to pin down the kingpin.

Can the ultimate financiers and movers behind any security-related scam be brought to book? And if so, by whom? Is it SEBI, the income-tax department or, quite simply, the police?

All financial scams have one thing in common: They require someone to advance money upfront for reaping the benefits of some artful scheme that is conceived. Those scams involving publicly listed shares present a slightly different dilemma. One could have a situation where the scheme is conceived and the initial investment made by one or more individuals. But when the scam eventually surfaces, one would see only the hand of some market entities, such as brokers, depository participants or even the depository institution itself.

To see the scam as one involving just these intermediaries would be unfair even though it would not have been possible without the active participation or, at best, utter indifference of these players to the subversion of the market process by someone else.

At the same time, the financiers who conceived the scheme are not regulated by the stock exchanges. For that matter, one could even argue that they are not subject to oversight by the market regulator SEBI.

Although there are conflicting points of view, one thing is certain. For SEBI to claim that the scam had been perpetrated by entities not regulated by it, even as interests of genuine investors in the primary market are blatantly exploited, would be doing an injustice to its legislative mandate in spirit. The question of who will nail the ultimate financiers has been brought up afresh by the Securities Appellate Tribunal’s latest order allowing an appeal by depository participant Karvy against SEBI’s disgorgement order in the IPO scam. The SAT order, which quashed the ‘disgorgement’ order against Karvy, made a rather critical remark of SEBI: It said the regulator had asked two depositories and their participants [intermediaries] to disgorge the entire amount of illegal gains related to the scam, while the financiers — SEBI had identified 82 — had been issued no disgorgement order.

“It would have been premature of SEBI to pass disgorgement orders against the financiers before the proceedings against them are complete,” said Mr J. M. Thakur, a chartered accountant who has appeared in SEBI-related cases. But Mr Thakur also holds that it was premature on the part of SEBI to pass disgorgement orders against the intermediaries when proceedings against them are incomplete too.

“What SEBI did with the disgorgement order was to indiscriminately chase the intermediaries on the wrong premise that it is unable to go after the real wrongdoers, even while recording who the wrongdoers are,” says Mr Somasekhar Sundaresan, Partner, J Sagar Associates, (Advocates & Solicitors).

SEBI did freeze the accounts of the financiers it had identified, but why did it not issue a disgorgement order against them too? (That the disgorgement order against the intermediaries too was quashed by SAT is a separate matter.) What is the extent of the regulator’s power over them?

The disgorgement order signalled a first of its kind. It was passed with the need felt to restore confidence about the market process in the minds of investors who were deprived of their entitlement to shares under the IPO as a result of illegal cornering of shares by some financiers. The Wadhva Committee report of December 2007 recommended making good deprived investors in money terms.

One view holds that SEBI ought to consider such financiers too as “persons associated with the market” along with entities such as depository participants (such as Karvy) or the depositories themselves who are registered and over whom the regulator (SEBI)’s powers are undisputed. This view also holds that SEBI had sufficient prima facie evidence against them in the IPO case. It must be remembered that under law SEBI can only adjudicate and levy a penalty against “persons associated with the market”.

Of course technically SEBI has the powers to proceed against and pass directives against anyone under Section 11B (and this is not in dispute by anyone, even by SAT or the courts, nor even by officials at SEBI).

Why then did it not proceed against the financiers? But against this must be set the fact that the legislative intention behind the use of the term ‘persons associated with the market’ could well have been to bring under SEBI’s ambit, classes of persons who in the normal course of business deal with securities, and not some individuals who come together on a one-off basis to exploit some latent inadequacies in the stock market as came to pass in the by-now famous IPO scam.

Indeed some kind of premeditation on the part of SEBI should be evident, such as in identifying a class of persons and framing rules/regulations for their conduct for any presumption that SEBI’s writ runs against them.

SEBI, in its order of disgorgement, which had imposed a liability on a ‘joint and several’ basis, meaning each one named in the order is responsible individually and collectively for the sum in question that is to be paid up, explained that several entities were involved in the transactions. This implies that the exact apportionment of the liabilities between various parties can be decided between themselves and from all persons, including financiers, master account holders, key operators, and other violators. “It is not in the interest of the public that the regulator should spend its time in deciding private disputes between various perpetrators of the IPO fraud/cornering of shares,” the SEBI order said.

Persons familiar with SEBI’s functioning feel that although the regulator has the powers to proceed against anybody associated with the market, it does not have the wherewithal to do so. It can only proceed as far as its domain expertise takes it, its expertise being within the boundaries of stock market operations.

These persons hold that while it is clearly established who the registered intermediaries are in the IPO scam, it is by no means certain that the financiers identified by SEBI are indeed the ultimate financiers; there could be an entire chain of financiers extending even beyond the borders of the country. And it is not SEBI’s job to go tracking fund flows which the Enforcement Directorate has better expertise in.

SEBI’s idea was probably that the intermediaries brought to book by it will in turn seek justice from the layer of financiers whom they interfaced with, through separate civil suits. This would then have a ripple effect as these financiers in turn would seek remedy from their financiers, and so on. This of course brings fierce criticism: “The key principle is that under Indian law, these are preposterous and unsustainable arguments on first principles,” says Mr Sundaresan.

“Disgorgement presupposes extracting wrongful earnings from the wrongdoer who has such earning with him. If anyone else [here, intermediaries] is found to also have done wrong, you can only penalise him. And that would have to be in a legitimate manner.”

The IPO case was in fact passed on by SEBI to the I-T department and the CBI. The I-T department at Ahmedabad has approached SEBI to release the value of frozen accounts towards the I-T liabilities of the scamsters.

The Enforcement Directorate has also made a move for control over the frozen accounts, having taken its complaint to the Adjudicating Authority under the Prevention of Money Laundering Act. The CBI has already filed a chargesheet in the courts.

But there are legal experts who do not buy this argument. “Every investigative agency in India, and indeed in any country, routinely passes on information to other investigative agencies,” says Mr Sundaresan.

“This does not mean they do not have the powers themselves. The same facts, when they lead to violations of other laws, it is natural that you pass on information to other agencies too. SEBI has even been granted powers to conduct search and seizure. Short of power to arrest, SEBI has all the powers. Even the I-T department does not have the powers to arrest.”

Of course since the proceedings are still going on against the intermediaries and the financiers in the IPO case, it is still a possibility that SEBI may issue disgorgement orders against the intermediaries and, who knows, the financiers too. “Disgorgement has not been tested with finality in any court of law,” said a legal expert. The disgorgement order that was quashed by SAT was anyway pending completion of proceedings against the accused in the IPO scam. SAT has also recognised that.

There is another point of view that feels the public purpose is to some extent served by tackling the intermediaries whether the financiers are brought to book or not. After all, financiers may devise any number of ingenious ways of subverting the system, but the intermediaries as the first level gatekeepers in the system have a responsibility to exercise due diligence.

Going after the ultimate financiers, given the reality of the pressure that can be brought on by the powers that be, looks well-nigh impossible. Some idea of the difficulty of pinning down the ultimate financiers can be had from the fact that the CBI chargesheet itself is understood to have not named any financier in the scam.

Obviously there are difficulties in naming the financiers. What SEBI will do once its proceedings are complete would be interesting to see; as also to what extent the I-T department and ED will succeed in tracking down the ultimate financiers, while the moot point now remains how disgorgement itself will be effective against sovereign claims.

More Stories on : Investor Protection | IPOs | Economic Offences | Regulatory Bodies & Rulings

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