Poor quality of disclosures in India

Prof. Jayanth R Varma has written an article in yesterday's Financial Express on the infrequency of disclosure of the balance sheets in India even though the profit and loss statement is updated every quarter. In fact he understates the problem. Not only the balance sheet, but hundreds of other disclosures are not made once in a quarter, many not even once in a year.

Before I joined SEBI, when I was a part of the Disclosure Committee of SEBI (headed by Mr. Y H Malegam), I had written a working paper at IIM, Ahmedabad which is available here. The basic point of the paper is that the quality of disclosures at the time of public raising of equity is very high (maximum at IPO), while that on a continuous basis by a company is relatively very poor. Because of this a) continuous disclosures are of poor quality - thus a shareholder buying from the secondary market faces poor information flow compared to one buying from the company. b) it takes a very long time to raise capital.

Based on the working paper, Mr. Malegam appointed a sub-committee on 'integrated disclosures' to work on the minute details of improving continuous disclosures. This was of course a herculean task as it required looking into dozens of sources from the Companies Act schedules to regulations and circulars of SEBI. After I joined SEBI, the sub-committee continued the work and came out with the final report in January this year along with exhaustive annexures which would capture disclosures on a frequent if not continuous basis.

Here is a summary from the conclusion of the Report:

"Relying on a regulatory framework based on the requirements of a different era

may be a costly error which we might already be making. We can improve

disclosure by strengthening continuous disclosures and reducing duplication for

which there is substantial cost and no benefit. If we could do that with today’s

technology and thus improve the quality of information while reducing the quantity,

information would become more readable, access to investors will be wider and an

empty formality of registration could be translated into true ‘on tap’ disclosure

available to all continuously. Data concerning business, property, management,

financial condition, and results would be available at all times and updated in a

single document whether there is an issue of capital or not. On the other hand a

much lighter version of memorandum of transactional details could be made with

each issue. Thus, making raising of capital cheaper and easier, information more

accurate and more widely available - benefiting both issuer and investor. The

intermediaries like investment bankers would have a leaner role in capital raising

but a much more substantial role on a continuous basis."

As three years of work has already been done and both the large exchanges were part of the work, implementation of the same would not take much effort given the will to implement it by SEBI.

See my main blog for the full post.

Obituary and Homage

Obituary: Mr. Anand S Bhatt, Anandbhai to all those who have known him, a senior partner at Wadia Ghandy & Co., a leading law firm, passed away at the Trident Hotel, Mumbai. Celebrating his life, extra-ordinary achievements as a lawyer, deep rooted professional ethics and warm humour - by an alumnus of Wadia Ghandy.

Homage: My respects and homage to all those brave people who died trying to save the lives of innocent citizens in Mumbai. Wish more of us could be like you.

PS: It angers me that the Indian media has been telecasting all the moves of the Indian commandos complete with live footage of their positions and movements. Livecast over country?

Long pain ahead in the world

The similarities of the present crisis with the 1929 era are looking eerie (more on that later). While any comparision with the past may be misleading, this surely is not a self correcting 1987 style crash. It's here to stay. Even if one were to concede that we have only a quarter of the problem of the 1929-1934 era, we are still looking at a very deep and a long painful world economy ahead. Here is one gloomy statistic - if you had invested in the Dow at its peak in 1929, you would have had to wait 25 years to get your money back - and that is not counting inflation (the Dow reached its 1929 high only in 1954). Here is another statistic, the markets fell from 1929 till 1934 very gradually with lots of false starts of double digit increases in short bursts - but the market was to fall 89% from its peak.

With the financial markets in a complete mess, a freeze in the money markets (thankfully not yet reflected in the Indian financial markets), a complete flight from risk, expectations of large defaults in the corporate sector, starvation of all forms of equity and debt capital (Indian and overseas), the tendency to deleverage where leveraged and hoarding as much cash as possible by all, the world market doesn't look like it will turn positive for at least a few years from today. While we in India have been living in delusion for a long time about the impending crisis, I think that we do have the chance to come out of it sooner than others - provided we do lots of things right and that too within a few months if not weeks from now. A big expectation of course given our past record of reforms.

India's fundamental flaw has been, while the real economy is still burdened with red tape, it is very easy to make portfolio investments in equity (and even real estate) - and that too with no tax burden for overseas investors because of abusive tax treaties. This makes it easy to bring in and take away 'hot money' in a matter of a few minutes. While I support free flow of capital, I find the pain in productive employement of capital - combined with the ease of portfolio capital flows, perverse. We are below most parts of sub-saharan Africa in our competitive index on ease of doing business at 109th position out of 134 countries (WEF's Global Competitiveness Index 2008-09). We also have the distinction of being 127th out of the same 134 countries in terms of our fiscal deficit percentage to GDP. By the way contrary to government figures our deficit exceeds 9% rather than the 3.5% as claimed in official figures - the lower number is arrived at by excluding big ticket subsidies from the deficit numbers. This of course means that we have a very limited access to fiscal stimuli, unless the government decides to print notes and aggravate inflation.

While it would be suicidal to restrain capital outflows, like we tried some tricks with overseas borrowing and lending of stocks, we only have two tools left. One is monetary and the other is productivity enhancements. With still high levels of CRR, SLR and interest rates, there is still enough ammunition to reduce these and inject liquidity into the system. While liquidity enhancements have not worked in the past few months as corporates and financial institutions are sucking up all the extra liquidity, such enhancements will only work with bringing confidence back into the markets. And that can work only with improving productivity gains. That would result in a virtual dismantling of the large remnants of the license raj, introducing labour law reforms which are unpopular, repeal any law which requires going to more than one agency for governmental approval. Let the government deal with government bureaucracy and give a single window clearance for any project within a period of 30 days, so long as it is not hazardous etc. This is not an impossible goal, SEBI/RBI already give a single window clearance for a range of intermediaries including registration of Foreign Institutional Investors.

Whatever few fiscal tools we have left should be employed to partner with the private sector to enhance education and infrastructure. I don't see all this happening, and believe me, I really don't want to sound like Cassandra, but things are more grim ahead than we are prepared to accept.

PS: Argentina is better than us in fudging numbers. They remove from the index (for consumer price inflation) anything which moves up in double digits. The reason? If it becomes so pricey, people will find a substitute!

Please see my main blog here for the full post.

My blog has moved from the current site at blogspot to blogs.livemint.com

I am happy to announce that my blog will now be hosted by the Mint newspaper at:
http://blogs.livemint.com/blogs/initial_private_opinion - this would give my blog a much wider readership. Nothing changes except for the site address and the fact that email subscriptions are no longer available. Those on the mailing list should move to a Google Reader, Bloglines or such other blog reader where they need to add the following 'feed':
http://blogs.livemint.com/blogs/initial_private_opinion/privaterss.aspx


I apologize for the inconvenience to the email subscribers - though I believe the next version of the hosting site would enable email subscriptions (coming within a few weeks at most).


I will be updating this site for the next few weeks so that any subscribers to this site will receive a summary of the future blogs along with a link to that posting - I hope this minimizes the inconvenience for the transition.

Somali pirates to acquire Citigroup

You have to be living on the moon if you haven't read a single piece on Somali pirate and the financial sector humour. Here is a fake Bloomberg piece.

"Somali Pirates in Discussions to Acquire Citigroup

By Andreas Hippin

November 20 (Bloomberg) -- The Somali pirates, renegade Somalis known for hijacking ships for ransom in the Gulf of Aden, are negotiating a purchase of Citigroup.The pirates would buy Citigroup with new debt and their existing cash stockpiles, earned most recently from hijacking numerous ships, including most recently a $200 million Saudi Arabian oil tanker. The Somali pirates are offering up to $0.10 per share for Citigroup, pirate spokesman Sugule Ali said earlier today. The negotiations have entered the final stage, Ali said. 

"You may not like our price, but we are not in the business of paying for things. Be happy we are in the mood to offer the shareholders anything," said Ali.The pirates will finance part of the purchase by selling new Pirate Ransom Backed Securities.  The PRBS's are backed by the cash flows from future ransom payments from hijackings in the Gulf of Aden.  Moody's and S&P have already issued their top investment grade ratings for the PRBS's.

Head pirate, Ubu Kalid Shandu, said: "We need a bank so that we have a place to keep all of our ransom money. Thankfully, the dislocations in the capital markets has allowed us to purchase Citigroup at an attractive valuation and to take advantage of TARP capital to grow the business even faster."

Shandu added, "We don't call ourselves pirates. We are coastguards and this will just allow us to guard our coasts better."

*CITI IN TALKS WITH SOMALI PIRATES FOR POSSIBLE CAPITAL INFUSION

*WILL REQUIRE ALL CITI EMPLOYEES TO WEAR PATCH OVER ONE EYE

*SOMALIAN PIRATES APPLY TO BECOME BANK TO ACCESS TARP

*PAULSON: TARP PIRATE EQUITY IS AN `INVESTMENT,' WILL PAY OFF

*KASHKARI SAYS `SOMALI PIRATES ARE 'FUNDAMENTALLY SOUND' '

*Moody's upgrade Somali Pirates to AAA

*HUD SAYS SOMALI DHOW FORECLOSURE PROGRAM HAD `VERY LOW'  PARTICPATION                                                 

*SOMALI PIRATES IN DISCUSSION TO ACQUIRE CITIBANK              

*FED OFFICIALS: AGGRESSIVE EASING WOULD CUT SOMALI PIRATE RISK 

* FED AGREED OCT. 29 TO TAKE `WHATEVER STEPS' NEEDED FOR SOMALI PIRATES"

 Courtesy: Streetwise Blog. 

Lectures from the other world

Here is some interesting lecturing we Indians received a year back, as I look into my diary. On 29th Oct 2007, the US Treasury Secretary had come to the SEBI office.

Guess what he spoke about for half an hour to senior SEBI officials. The benefits of non intervention by the government and regulators with market forces. I smile everytime I think about that day and Freddie Mac, Fannie Mae, Bear Sterns, AIG, Wachovia, and now the strategically important General Motors. I think I missed half a dozen entities, but you get the idea...

After Secretary Paulson, we met with Neel Kashkari among many others in government to government talks, Neel is now famous as the person who heads the bailout team managing the 750 billion dollar fund which alarmingly sounds like TRAP. 

If I rewind my diary even more by some ten years, I worked with Robert Hoyt at the law firm Wilmer Cutler and Pickering (now Wilmer Hale) and we worked on a case on markups on Mortgage Backed Securities. Robert is now General Counsel at the treasury and is responsible on the legal side for managing the TARP amongst other things.

PS: We won that case in court.

The group of 20's prescription to the world problems

The G-20 or the group of 20 is an association of 20 advanced and emerging countries who have agreed to come together to tackle the financial crisis. (Some trivia: the G20 only has 19 countries). The G20 was convened rather than the traditional G7 or the group of rich countries, both to give legitimacy to tackle the international problem at a broader level, given the increased importance of emerging countries. Besides, as the origin of the problem was in the first world, it might be a good idea to have a broader dialogue. Lastly, some of the emerging countries, particularly some with huge foreign reserves and surpluses and capacity for growth, could not possibly be ignored to tackle the ever deepening problem.

 At the end of the meeting of the heads of the government and finance ministers of the 19 countries plus EU, they came out with a statement based on common agreement towards solving the problems of the world economy. Here is a summary:

Page 1: Alan Greenspan made the mess

Page 2-end: Let's do the obvious in stimulating the economy and bring new regulations and promise to withhold erecting protectionist trade barriers - all without making any commitments on any of these.

 

Here is an even shorter summary:

Let's meet again.

India has of course within a few hours of the statement increased tariffs on steel and several other goods. So much for commitment. Of course almost every country will break all these nice promises, particularly the one promising to work towards implementing the Doha round successfully. All sound and fury signifying nothing.

 

Here is the text of the statement of G-20. 

See my main blog posting here. 

Getting India back on the growth path

Yesterday I moderated a panel at the India Economic Summit organised by the World Economic Forum and CII. It was titled "Securing India’s Future Growth in a World@Risk".

Here is the official Press Release of the discussion at the panel:
• Neeraj Bharadwaj • Pramod Bhasin • Ghanshyam Dass • Habil F. Khorakiwala • Sunil Mehta Moderated by • Sandeep Parekh Monday 17 November
With the long-term consequences of the global economic crisis unclear, the panel considered its impact on India and the priorities for business and government. They differed as to whether this should be seen as a time for pessimism or opportunity.

Declaring himself a pessimist, Sandeep Parekh, Visiting Associate Faculty, Indian Institute of Management Ahmedabad, India; a Young Global Leader, opened the session by describing India as a slowed-down economy with worse still to come. He said a “vicious cycle” has been created with banks and financial institutions clinging to their assets, not giving loans and inhibiting spending. “The key element is people don’t trust one another, don’t want to lend … and people don’t know whether the bank is going to be solvent 48 hours from now.”

Sunil Mehta, Country Head and Chief Executive Officer, India, American International Group, India, said India should use this time of “slowdown” to go back to basics and to focus on “soft infrastructure – the institutional framework on which our growth is anchored”. He pointed out that while, now, people are looking to government to resolve the crisis, in times of economic prosperity, they demand space to grow. He called for an input from the private sector into government and for the creation of a “a pool of talent”.

Habil F. Khorakiwala, Chairman, Wockhardt, India, said: “When we say Indian growth is at risk, we mean Indian high growth is at risk.” He said there has been a crisis of confidence and swift action is needed to address it. He added: “When your house is on fire, what do you do? You need to act fast!” He called for increased liberalization of the economy and the lowering of interest rates. “It’s not a time to worry about fiscal deficit and inflation. What we’ve got to think about is growth,” he said. “We have do everything possible to get growth going and everything will fall back in place.” He added that India sits on a fairly large Forex reserve and questioned whether it would be better to invest that money in India.

Pramod Bhasin, President and Chief Executive Officer, Genpact, India, declared himself a huge pessimist: “I strongly believe that we are in the midst of a huge crisis. If you go around and talk to people in small scale enterprises or medium scale enterprises, the story is dismal.” However, he also said it presents a unique opportunity for India to develop new cost and operational models because India will be operating in a market where former competitors will/may not be operating.

Ghanshyam Dass, Managing Director, NASDAQ, India, agreed that “in every adversity there is an opportunity” and it is a time to rethink market structures and regulatory controls. “We need to ensure markets are efficient, inclusive, transparent and well regulated,” he said.
Neeraj Bharadwaj, Managing Director and Country Head, Apax Partners India Advisers, India; Young Global Leader, said he is an optimist. He said India is not at risk but simply experiencing a slower growth rate. “Is India at risk? Definitely not! Are we going to choke? Definitely not!” He conceded that there has been a stock market correction and the real estate bubble has burst. However, he pointed out that exports in India account for less than 20% of GDP. The economy is underpinned by a young demographic and growing middle class. He added that there are also opportunities to be had: “The best deals are done when valuations are cheap.”
One participant suggested that the current pessimism in India has followed a time of “irrational hubris” and added that it is wrong to draw too many parallels with the West. Parekh replied that it is impossible to deny that the global downturn has resulted in a material impact for India.

You can find the Press Release and profile of the participants at the WEF's site on the IES.

SEBI Annual Report 2008 - big fees and big pendency

The SEBI Annual Report 2007-08 is out today. Two notable things which stand out are a) steep increase in fees collected and b) large pendency in quasi judicial proceedings. Of course neither issue is new.

Fees Collected (see Page 94 of the report)
SEBI mainly operates out of the fees collected by it from transactions and intermediaries in the securities market and also interest from a corpus which it has accumulated from past fees and some interest free loans from public sector institutions. Around three years back SEBI increased its fees, and in light of the boom in the markets, the amount collected dramatically increased. This in fact reached unnecessary levels as operating costs of SEBI have hovered well below Rs. 50 crores (Rs. 500 million). The bloating corpus resulted in caps being introduced in the fees. Since, fees still continued to gallop, they were revised comprehensively around the middle of this year (by 50 to 90%) based on a VK Chopra committee report (see page 34) of which I was a part. This is reflected in the Annual Report - fees increased by nearly 100 percent year on year. With expenses being a quarter of annual fee and a bloated corpus to boot, it may be time SEBI wrote a one time cheque to the government of India.

Pendency of quasi judicial orders (see page 108)
While this is a long standing problem i.e. of a very large number of cases pending adjudication/enquiry/other orders, the introduction of consent orders last year only made a small dent in the large number of outstanding cases. While an aggressive attempt is being made to reduce the backlog, the problem is far too great to be tackled by just putting in some extra effort. See page 108 - there are 1500 cases pending with the Board and another two thousand plus pending with officers, not counting those in the court. With a disposal of only 200 odd cases by the officers with some two thousand plus still outstanding and a disposal of 600 plus by the Board with over 1500 oustanding, there is a need to approach the problem from a different perspective. My perspective has always been that people should take a call and the institution should not pursue all violations which come to its attention. The American SEC goes after only a few cases which come to its attention. Similarly, it would be useful to go after the big fish as also a sample of the smaller violations rather than every case which comes to its attention. Trivial cases must immediately be dropped. Unfortunately, in the government no one really wants to take the call of dropping an action which creates this huge inflow of new cases. Unless a brave attempt is made to rationalise the number of cases seriously taken up, getting a zero backlog will be a difficult if not impossible target to achieve.

On a happy note, the consent process and efficiency have virtually eliminated the backlog of cases pending before the appellate tribunal (SAT). Witness that 203 appeals were filed in the year while the year end pendency is only 138.

See the full posting on my main blog.

New SEBI member appointment - a dark pool

US India Business Council conference call

Day before evening I had a conference call with members of the US-India Business Council organized by their financial services executive committee.

I spoke about the following issues:
Overview of Financial Climate in India:
Short-selling: Modification to the Securities Lending and Borrowing System
Pricing Formulas in private placement are restricting capital formation
Developing the Corporate Debt Market:

See my main blog for a summary of the same.

Unfairness of takeover amendments

I have written in today's Economic Times about the unfairness arising from the recent SEBI amendments to takeover regulations, a subject I have blogged about over the past 3 days.

An exchange for Small and Medium Enterprises

SEBI has come out with a "Framework for recognition and supervision of stock exchanges/platforms of stock exchanges for small and medium enterprises". Though small and medium enterprise (SME) specific exchange platform has been talked about for years if not decades, for various reasons, the concept has never reached fruition.

Several of the then 'regional stock exchanges' were set up to cater to listing of the SME sector. Because of a geographical fiat, these exchanges survived for several years, till NSE and then BSE grew nationally and the geographical fiat was repealed, making them defunct (some are doing well, though not in their function as an exchange but as brokers of BSE/NSE). The next round of SME exchange came with the Indo-next platform, which was given as a concession to the BSE - while the history of Indo-next is somewhat complex, BSE never really wanted it to succeed as an SME platform. The Indo-next platform thus met with a still born transfer from BSE's own junk yard and a few companies from regional exchanges on transfer. To get a fuller history of these, please see the "Report of the Committee to Study The Future of Regional Stock Exchanges (RSEs) – Post Demutualisation" of which I was a part. The report, though focused on the Regional Stock Exchanges, examined various possibilities of one or more regional exchanges becoming SME oriented. But even then, it looked like a serious management challenge unlikely to succeed.

Now SEBI has put out a framework to take forward the incomplete task. While the framework ought to give relaxations to existing rules for the exchange and its companies to become viable, it doesn't give any indication of such relaxations e.g. half yearly disclosures instead of quarterly disclosures. The framework only repeats the requirements of the existing legal framework for recognising exchanges.

These are usual requirements for recognising any stock exchange. However, instead of granting relaxation, it provides for a minimum trading lot of Rs. 100,000. And it also provides that the exchange have a networth of Rs. 100 crores (Rs. 1,000,000,000). The first requirement is counter-intuitive, but appropriate. Small cap companies are extremely high risk i.e. most of them will naturally fail as most entrepreneurial ventures do. Thus investors in small cap companies must be large sophisticated investors. By putting a minimum trading lot limit of 100,000 rupees it will protect the smaller investors from burning their fingers.

The other requirement of a billion rupees of networth is inappropriate and anti-competitive. Even the current massive exchanges (BSE, NSE and MCX) are not obliged to have such numbers. The networth would depend on the size of trading and risk management requirements of the exchange. Further, if the clearance and settlement is outsourced (as is envisaged in the framework), the entire risk management no longer resides in the exchange and the exchange in fact does not rationally need a substantial networth. IOSCO principles clearly recognise this (IOSCO is a body comprising of all securities regulators). Besides being bad policy, this will also make such an exchange unviable - a capital of a billion rupees at a 20% expectation of returns just doesn't make economic sense unless it is being run as a cost centre by an existing exchange.

SEBI thus needs to drop the requirement of networth, which needs to be applied rationally according to size and risk management principles. Even clearing corporations cannot be mandated to have a one size fit all networth requirement which would only entrench the existing players and kill competition. Also the framework must flesh out the specific relaxations which are envisaged for the companies and the exchange. Without these, the concept is not likely to take off at all.

To see the full post please see my main blog here.

The new investment adviser on the block

Today's Economic Times reports (I of course assume the reporting is accurate) - "The finance ministry has deferred its plan to allow only those companies with 25% minimum public ownership to stay listed, till the stock market comes out of the bearish phase." and "It is understood the government does not want to force promoters to offload in a bearish market as that would further erode investor confidence."

Thank goodness for small (and temporary) mercies...even if it is only to help the promoters rather than the investors.

Another interesting tid bit about the latest investment adviser on the block from the same report:

"A finance ministry study has recently revealed that Q1 and Q2 corporate profits had no relationship with the sharply-lower valuations of blue-chip scrips."

Whoa this is rich, new method of valuation I guess (adjusted discounted cash flow) - note absence of Q3 not to mention expectations. Here is some better advice: Haresh Soneji, Prof. JR Varma and Rahul Bhasin.

And here is the one I've been blogging about for the past two days i.e. the creeping limit generosity for the promoters:

"Implementing this would become difficult without rolling back SEBI’s October 27 decision to allow promoters to buy up to 75% in listed companies through the creeping acquisition route — 5% a year without SEBI approval. When promoters own 75% and institutions maintain their holding at the previous levels, the public would have to be satisfied with less than 25%. The ministry and the regulator would modify the provision, which was introduced only as a temporary crisis management measure, it is learnt. Today, public holds an average of 13% capital in a company although 35% is reserved for them at the public issue stage."

Creeping capitulation - takeover regulation amendments

If you had any doubts about my views of the perversity of the SEBI action on relaxing the creeping acquisition limits (blogged yesterday), take a look at what the Hong Kong regulator has said about similar lobbying efforts by promoters, it is probably more hard hitting than what I said yesterday:

"The Takeovers Panel by a substantial majority was opposed to any relaxation of the
provisions of the relevant rules for the following reasons:

1. the proposals ran counter to General Principle 1 of the Takeovers Code which requires
equality of treatment for all shareholders; this is an absolutely fundamental principle
underpinning the regulation of takeovers and mergers in Hong Kong;

2. no jurisdiction that had a similar regulatory framework as Hong Kong had proposed
temporary waivers of important provisions of their takeovers regulations in response to
recent market conditions;

3. the proposals, were they to be implemented, would likely reflect poorly on Hong Kong
as an international financial centre. In this regard, it is noted that the temporary waiver
of the 35% trigger and 5% creeper in 1987 was subject to criticism;

4. while the stock market had experienced substantial declines in prices, there was no
suggestion that it was not functioning properly;

5. the proposals were opportunistic in that they appeared to be motivated more by the
interests of major or controlling shareholders than the market as a whole;

6. they would be seen as favouring big business interests at the expense of other stock
market participants and, in fact, may work against their interests; and

7. there was no evidence to indicate that support for the proposals was widespread or
that the proposals would boost confidence in the market for the shares of particular
companies or the market as a whole."

Here is the link to the two page rejection of the request by such lobbies.

The full post of this is available here.

The new amendments to the takeover regulations - misguided or sloppy? Yes.

SEBI has once again played around with the numbers in the takeover regulations. In light of the recent downward movement of prices, it seems that SEBI is attempting to make it easier for promoters to acquire shares from the market without making an open offer to the public shareholders.

To give a brief background, the securities market regulator has prescribed by regulation (takeover regulations) that if a person exceeds certain threshold acquisition of shares or voting rights, he or she must make a tender offer for at least 20% of the capital of the company. The philosophy of the regulation is that if there is any shift in control, non-control shareholders must be given an option to sell out of the company. The three key thresholds have been a) on crossing 15% b) on crossing acquisition of over 5% if the person (along with those acting in concert with him/her) already hold between 15 and 55% c) on acquisition of even a single share beyond 55% upto 75%. There are some minor complications which are not relevant here. The amendment of 30th October 08 creates another layer of creeping acquisition of 5% between 55% and 75% levels, thus enabling promoters to shift control for an additional 20% without making a tender offer.

There are two major problems with this decision. First, these numbers should not be played around with on a routine basis - they have been previously amended on 10/1998, 10/2001, 9/2002, 1/2005, 5/2006. The fact that SEBI has broad power to create its own law book should not be seen as a license to amend the law on a regular basis. All laws should have certainty and even specialized people cannot keep track of changes in these delegated legislation. There are also problems related to keeping track with the transition time e.g. will the new law apply or the old one where public announcement is not yet made but acquisition has already been made?

The more serious issue with this amendment is whether, it is SEBI’s role to manipulate the market merely because it is going down by making it easier for promoters to purchase shares giving short shrift to the exit rights of the public shareholders? If the regulator were allowed to manipulate the market, would it have the moral authority to prosecute other ordinary manipulators?

Also, the amendments seem to be carried out at an incredible speed. I have never before seen amendments being carried out within three days of the board meeting/Press Release. Not only from a time perspective, but also from the sloppiness of the amendment, this hurry becomes very apparent.

Does it remind you of certain wooden arrows with a diameter of 5/16th of an inch or less?

See the full post here.

Buy back of securities by companies resulting in compulsory takeover offer - new SEBI amendment to hurt ordinary shareholders

When a company does a buy back of its equity shares, its promoters may choose to tender in their shares into the buy back proposal, or not. If the promoters choose not to put their shares into the offer pot, their percentage shareholding will clearly go up even though they have not bought any shares. SEBI’s takeover regulations prescribe that when a person acquires shares or voting rights beyond a particular threshold, he or she must make a tender offer for a minimum of 20% of shares of the company to the other shareholders. In other words, if the promoters were not to tender their shares, their ownership in terms of number of shares would remain constant, while the proportion of their shareholding in the company's capital would increase (as the other shareholders' equity has been bought back) - thus triggering a compulsory tender offer requirement – where the tender offer limits have been crossed.

In law, the buy-back where the promoter does not participate does indeed trigger the tender offer as the regulations provide for acquisition of shares or voting rights. By electing not to participate in the buy back program, the promoters are exercising their will to increase their shareholding. By so doing, they are acquiring voting rights, thus triggering the tender offer.

Even from a fairness standard, apart from the clear law, the tender offer must be triggered. The increase in shareholding is not incidental to the buy back program. The increase is occurring because the promoters are choosing to elect a particular method of buy back and then electing not to tender their shares into the buyback program - had they chosen to tender fully, their shareholding would have in fact fallen. Only because of the exercise of the volition of the promoters is the acquisition occurring rather than as an incidental occurrence. Besides, if the promoters are obligated to make a compulsory tender offer when they are using their own money to acquire shares (in a usual acquisition of shares), it would be wholly perverse to exempt them if they acquire additional capital with company money (using the buy back route).

Please see the full posting here.

Short selling - modification to the borrowing and lending mechanism of securities

Day before yesterday (31 Oct 08), SEBI has come out with some modifications to the borrowing and lending scheme of securities, which as proposed in Dec 2007 has been a non starter. The SLB scheme (Securities Lending and Borrowing) was expected to jump start the market in short selling, as it is not possible to short sell securities unless there is a viable mechanism to borrow securities to complete delivery. The amendment makes the following important change:

“ 1 Tenure
Tenure for SLB may be increased to 30 days from the present 7 days.
…“

However, this is unlikely to revive the market as there are continuing design failures in the short selling mechanism. In addition, in today’s environment, where short sellers are seen as criminals (see my previous posts here, here, here and here) it is highly unlikely that anyone will short sell with such visibility – it’s almost like walking around a shooting range with a bulls-eye painted on your head.

In any case, even if the persecution of short sellers were to abate, the market is unlikely to take off for the following reasons in that order:

A) Restricting the borrowing and lending facility to the exchange is a bad idea. If I want to borrow from my good friend who has securities to lend, the present mechanism doesn’t allow that. This is important because two big institutions who want to enter into a bi-lateral transaction for borrowing and lending are prohibited from doing so. This kills the most obvious and simplest of facility for big players who do not want the whole world to know that they have borrowed securities (which is a dangerous thing to do, when you are short the stock – see point B below).

B) The disclosure of positions by the exchange at the end of the week make the market wholly unattractive. At the time of the creation of the short position, the seller has to declare that it is a short position. While, the short position is not immediately disclosed to the market, they are disclosed weekly. This is again like walking in a shooting range with a bulls-eye painted on your head. A short position disclosure will invite people to hurt the short sellers by ‘squeezing them out’ as everyone knows the approximate date when the short seller will be forced to buy from the market whatever be the price. In fact every rational person would try to squeeze out the short and thus profit from the short seller if this data is in the public domain while the short position is open. This makes a short sale unviable. Even if the current disclosure norm is made monthly in line with the change in the tenure, the problem will persist. It may sound counter-intuitive, but more disclosure in this case is not good.

C) The securities eligible for short selling and thus SLB are only the most liquid of securities (those which are eligible to be traded on the derivatives market). This is wrong – those securities which are most in need of short selling i.e. to control manipulators, are outside of this list.

D) The tenure of 1 month is too artificial. It automatically excludes anyone with a view of over 1 month from short selling. Why should there be a hard tenure for borrowing, this rigidity combined with point A) above will ensure that the market will not take off.

Of course the intra-day or two day short selling will continue amongst day traders, but that is hardly the same as taking a month long or a quarter long position on a stock. In any case, negative views can be expressed through the futures and options markets by creating a synthetic short on a stock or simply dumping existing stock.

Update: See piece by Mobis Philipose in Mint of 4 Nov 08 on the isssue.

The Sentimental laws of India – Vol I

When I attended my first year law, I remember several types of laws including the constitution, statutory laws and various types of delegated legislations and executive orders. But this is clearly the first sentimental law of India passed by SEBI and that too by a Press Release - "SEBI disapproves of the activity of the foreign institutional investors lending shares abroad." and "The custodians are requested to communicate to their FII constituents the disapproval of SEBI as stated above."

Please see my blog at livemint.com here.

The government is above the law - Corporate Governance in public sector

A first of its kind SEBI (Securities and Exchange Board of India) order against GAIL India (a listed government controlled company registered under the Indian Companies Act 1956 as a government company) was passed on the 27th Oct 08. It relates to applicability of corporate governance norms to public sector companies. Please see my blog at livemint.com discussing this issue here.