Reform SEBI

Dr Bharat Jhunjhunwala
Bernie Madoff is an American former non-executive Chairman of the NASDAQ stock market. He founded Bernard L. Madoff Investment Securities LLC in 1960. He contributed hugely to the Democratic Party. He offered double-digit returns on deposits-more than double the prevailing bank rates-and met his payment obligations successfully. He would deposit the borrowed money with banks at rates much lower than paid by him leading to huge losses. But he would put up a brave face, attract new depositors and use that money to repay the earlier depositors wanting to exit.
Financial Analyst Harry Markopolos smelt that something was wrong. How could Madoff garner returns double of those prevailing on the Wall Street? He informed the U. S. Securities and Exchange Commission it was impossible to achieve the gains Madoff claimed to deliver. His complaint was ignored by Commission for eight long years till the bubble burst in 2008 when Madoff was not able to meet his payment obligations and was arrested.
The story has three lessons for us. One, there is no such thing as a free lunch. It is simply not possible to pay returns much higher than those prevailing in the market. Any such promise is likely to be by based on some fraud. Two, such frauds are perpetrated by influential persons often with high political connections. Crux of their success is building of image so that new depositors continue to be lured. Negative publicity is the last thing they want. Hence it is necessary for these operators to be on the right side of the politicians. Three, these frauds happen because the regulators look the other way.
Such frauds have been recurrent in our country. The Sanchaita Investments collapsed in 1979. It promoter Bihari Prasad Murarka has been on the run since then. Large numbers of schemes relating to teak forestry were floated in the nineties. I know of one successful business group that has never recovered from the fallout of one such scheme promoted by it.
The last decade has seen investment schemes relating to goats, sheep and Emu Birds suggesting that returns in excess of two percent per month could be obtained.
Recent events relating to Sahara and Saradha are only continuation of these troubles. It is not surprise then that both groups have got endorsements from high-flyers like Mahendra Dhoni and Sachin Tendulkar. They also have close connections with various political parties.
The letter written by Saradha’s Sudipto Sen to the CBI eloquently details how he was blackmailed by politicians. It cannot be otherwise. The politicians smell the vulnerability of the schemes to negative publicity and extract their pound of flesh to keep their mouths shut.
The problem is compounded by passing the buck between regulators. The Reserve Bank of India has the mandate to regulate deposits-meaning monies loaned at specified rates of interest. Thus Non Banking Finance Companies come under its regulatory domain. The second regulator is SEBI. Its mandate is to regulate ‘investments’.
Here investments may be understood as monies received for investment in some specified product such as a teak tree or a goat. The returns here would be commensurate with the price of the product such as a teak tree upon maturity. Thus share markets come under the ambit of SEBI. The third regulator is the Registrar of Chit Funds of the State Governments. Chit funds are like a kitty. A group of persons, less than 49 in numbers, comes together to save and borrow from their collective savings.
One in greatest need pays a higher premium which is shared between other members of the group. Any group exceeding 49 goes out of the ambit of the Chit Fund and has to be regulated by the Reserve Bank.
It seems to me that most of these schemes fall in the regulatory domain of SEBI since these are investment oriented. SEBI, however, does not seem to have the will or the resources to regulate these entities. Corporate Affairs Minister Sachin Pilot recently informed the Lok Sabha about the large number of such cases identified by SEBI. 87 companies across the country have vanished after raising funds totaling Rs 342 crore through public issues.
Another 87 other companies are being probed for duping the general public. 669 companies have duped the investors of Rs 7,435 crore through illegal collective investment schemes. Many companies have ‘vanished’ with whereabouts of their offices or directors having become untraceable.
These figures are an admission that the responsibility of regulating these companies falls squarely on the shoulders of SEBI. It is surprising, therefore, that Pilot said that Chief Ministers of various states have been requested to issue directions to their respective police authorities to take action against the erring companies; and that he has written to Finance Minister to facilitate increased surveillance by RBI over Non Banking Finance Companies. This sounds like passing the buck to me. The State Governments have no regulatory authority over these companies.
They can only intervene only after a fraud is detected and take action under the Indian Penal Code. Need is to provide adequate resources to SEBI to regulate the sector effectively. Ministry of Corporate Affairs should own the responsibility for these troubles and set its house in order.
Another problem is the grey area between ‘deposit’ and ‘investment’. Many companies are promoting both deposit and investment activities. This leads to dual surveillance both by RBI and SEBI-or none at all. Both can shift the responsibility on the other. It is necessary for the two regulators to coordinate their surveillance activities. Perhaps powers of RBI may be delegated to SEBI where the primary activity of a company is investment; and powers of SEBI may be delegated to RBI where the primary activity of a company is deposit. It is time that the Finance and Corporate Affairs Ministries clear up the ‘no man’s land’ between the two regulators.

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