When the markets are moribund, Indian policymakers pull out all stops to convince small investors that they should be putting their savings into the stock market.

But these investors are in for a rude shock the moment a scam hits a listed firm. Then, regulators quickly scramble to bail out lenders, employees, consumers and other stakeholders whose interests they feel impelled to protect. Public shareholders are usually left in the lurch.

The latest instance is the Government’s decision to invoke special company law provisions to propose a merger of the National Spot Exchange Limited (NSEL) with its parent company, Financial Technologies. Basically, the NSEL was found to be offering illegal forward contracts to traders on its platform. When the Forward Markets Commission (FMC) asked it to stop these trades, exchange members defaulted on their dues valued at ₹5,600 crore.

With NSEL failing to enforce these obligations, the Centre, egged on by the FMC, has come up with the idea of a merger. The reasoning is that, though NSEL itself may be broke, once it is merged with its parent company, cash flows from FTIL can be used to meet the dues of investors. This merger, the Government contends, is essential in the ‘public interest’.

But there is a serious flaw to this reasoning. The concept of limited liability is fundamental to equity investing. Going by it, FTIL, as the parent company for NSEL, may deserve to lose its entire investment in its subsidiary because of the latter’s mismanagement. But to saddle it with the liabilities of NSEL beyond this, is an injustice to the firm’s public shareholders.

Over 54 per cent of FTIL’s shares are today held by its public shareholders. With the FTIL stock already falling by over 80 per cent from Rs 1700 to sub-Rs 200 in the last four years, FTIL investors have already paid a stiff price for the misdoings of its promoters. So, if the regulators are convinced that the investors who traded on NSEL’s forward contracts deserve protection, why not retail shareholders in FTIL?

Saving Satyam’s investors

But then, this isn’t the first instance when public shareholders of a scam-hit company have got a raw deal from the regulators. Take Satyam Computers, where the company’s top managers conspired to systematically inflate its revenues, profits and cash balances over a period of four years.

When the founder-chairman Ramalinga Raju decided to confess to his crimes in January 2009, shareholders lost 80 per cent of their wealth in the stock on a single day.

So, was the Government worried about the losses to these shareholders?

Not really. More concerned that the accounting fraud would damage the country’s image, and under pressure to save Satyam’s employees, the Centre hastily cobbled together a deal for Tech Mahindra to acquire Satyam. Even as a forensic audit of Satyam’s books was still on, the firm was hastily ‘valued’ and sold to Tech Mahindra at a distress price of ₹58 per share.

Thanks to the promoter’s shenanigans, retail investors were forced to take an 85 per cent haircut on their Satyam shares, compared to its pre-scam highs.

No swap

Public shareholders have been treated pretty shabbily in other cases too. Remember Global Trust Bank (GTB), one of the earliest private sector banks?

When the bank was found to be nursing large non-performing loans and a negative net worth in 2009, it took a mere 48 hours for the Reserve Bank of India to order GTB’s merger with the Oriental Bank of Commerce.

With GTB boasting lakhs of depositors, the RBI was keen to protect them. But the disturbing fact is that this merger was done without offering GTB shareholders any exit route.

It is usual in mergers between two listed firms for shareholders to receive shares in the new entity at a fair swap ratio. But in Global Trust Bank’s case, its assets and liabilities were simply transferred, rendering it a shell company.

Both in the Satyam and GTB cases, company insiders offloaded a chunk of their own shares before the scams came to light. It is public investors who were left holding the baby.

These instances make it clear that the interests of the equity shareholders often come last with regulators when corporate scandals come to light. The explanation usually offered is that this is the ‘equity risk’ that investors sign up for, when they dabble in the stock market.

But this is an absolutely wrong interpretation of equity risks. When an investor buys shares, he is fully prepared to deal with business cycles, fluctuating company profits or even risks relating to the success or failure of the business itself.

But he is certainly not signing up for the possibility that the company’s promoters or top management will rob him blind, and that ineffectual regulators will passively allow such mis-governance. The equity shareholder is as much a victim of fraud and mis-governance perpetrated by dubious promoters, as other stakeholders who deal with a listed firm.

If equity investors were expected to take on this risk too, hardly anyone would be foolish enough to take on the travails of stock market investing.