Cheques and balances by Sucheta Dalal

Cheques & Balances by Sucheta Dalal

November 12, 2000

Investor protection: is it too much or too little?

SEBI’s insider trading regulations were creating a police state which would only end up with the regulator chasing the big guys and let away scores of insider traders get away

They are still whispering about it in Mumbai. A couple of weeks ago, the Securities and Exchange Board of India (SEBI) held a meeting of its committee on insider trading to discuss ways to eliminate loopholes and tighten regulation.
In the middle of a fairly animated discussion the members became conscious about the open friction between SEBI’s Sr Executive Director and its board member. Prof J R Varma, the member SEBI was not all happy at the trend of the discussion.

Suddenly, to everybody’s surprise he simply exploded and voiced serious objection to the trend of the debate. Among other things, he is supposed to have said that SEBI’s insider trading regulations were creating a police state which would only end up with the regulator chasing the big guys and let away scores of insider traders get away. He also said that he did not believe in the Securities and Exchange Commission (SEC) type of regulations, which need innumerable declarations from companies and their employees before buying shares. Finally, he declared that if SEBI insists on the tightening of insider trading rules he would like to voice his dissent. The committee was nonplussed and the deliberations inconclusive. But Prof Varma’s opinions are extremely worrying to investors.

To be fair to Prof Varma, he has always been very open about his views on regulation. He is no admirer of the powerful US watchdog — the Securities Exchange Commission (SEC), and makes no bones about his opposition to its style of regulation which he says is stifling and excessive.

The problem is that Prof Varma is no longer a senior academic at India’s premier management school. He is the second most important person at SEBI and his views are bound to have a huge influence on the already inadequate protection available to Indian investors.

But let us first compare the US situation with India. It is indeed a fact that even in the US market, intermediaries love to hate the SEC. Secondly, there is as much confusion in that country about the over-lapping roles of multiple regulators but various other factors ensure that investors are not left hapless and unprotected. Thirdly, the SEC generates as much gossip when senior officials working with it move to lucrative private sector jobs.

Yet, nobody would argue that the SEC is not a powerful and effective watchdog which instills fear among intermediaries and enforces broad compliance with its regulations. Also, the SEC’s track record shows that it does not react to market developments after unregulated schemes and businesses collapse but is more proactive. For instance, these days Chairman Arthur Levitt and the Commissioners are constantly campaigning against internet fraud, better accounting practices and the selective leak of information by companies to research analysts.

The SEC clamped down on US plantation company schemes the first time that one surfaced (the Orange Grove Securities case), by filing a suit against it on the grounds that it was a mutual fund and hence subject to SEC norms and disclosures. It won after a long and hard fought battle. In India, plantation companies were allowed to rip off over Rs 15,000 crore without a shred of regulation or accountability until they collapsed. Even after, it led to a tussle between government departments to avoid responsibility for regulating the sector. Investors who have lost their money have no hope of redressal.

Funnily enough, even the aggressive and proactive SEC does not consider its rules adequate to protect investors. It expects investors to file individual litigation. The average US investor has powerful support from their judicial system — individuals can afford the cost of litigation, the judicial process is usually swift and the damages huge and exemplary. Also the fear of an individual triumph snowballing into a class action suit is so enormous that it forces companies to treat their shareholders with respect pay attention to the quality of their disclosures.

Yet, the system is by no means perfect. Fraudsters and scamsters are always a jump ahead of the regulator and coming up with new ways to beat the system. The difference is that the process of tightening regulation is dynamic and continuous. More importantly, the alleged excessive regulation has not killed the US market, nor even stifled it. Though market intermediaries may crib, they fall in line and live with the bureaucracy and the market continues to thrive and expand and become safer. On the other hand, the Indian experience has repeatedly proved that inadequate regulation and absence of protection leads to large-scale fraud against investors and ends up killing different segments of the financial market.

Over the last 15 years, the first to collapse was the market for corporate debentures — investors are still running from SEBI to DCA for redressal. With liberalisation came the IPO boom. Again the market is not yet fully recovered from its three-year collapse. The one-line repeal of the Controller of Capital Issues Act allowed a free-for-all which led to several thousand crores of losses and hundreds of vanished companies. Then came the collapse of the plantation companies and non-banking financial companies — again, investors have not recovered a single rupee and the promoters have made away with the loot.

The mutual fund industry remains a problem area. Investors were forced to wage a long battle with nationalised bank promoted mutual funds merely to force them to keep their promises. The government controlled UTI is the bigger problem. When UTI nearly went bankrupt in 1998, the government bailed it out with a Rs 4800 crore-fund infusion and created the SUS-98 — a special scheme in which to transfer public sector shares held by it. Those share prices have slumped substantially the last two years. Newspaper reports say that the value of UTI’s investments has eroded substantially again. Funnily, the government continues to keep UTI outside the regulatory supervision of SEBI in spite such a recommendation by the Vaghul Committee as well as the Deepak Parekh committee.

All these experiences only establish that far from creating a police state, or an over regulated market, we need to work a lot harder at protecting investors. We need to sensitise the judiciary to understand the concept of exemplary damages, we need to look at expeditious disposal of investor litigation; we need to consider whether better equipped consumer courts would be the appropriate forum for trying individual investor complaints. It will be a sad day for investors if SEBI begins to lose focus and starts relaxing existing regulation, instead of pushing for disgorgement of unlawful earnings, fighting for higher compensation and working at empowering investor associations.