A bull run in the Indian stock market is usually cut short by a scam, and then a collapse. Yet, this time the market regulator seemed determined to check market abuse even as the Bombay Stock Exchange Sensex index climbed close to the 4000 mark.
Last month the Securities and Exchange Board of India (Sebi) barred Samir Arora, ex-head of Asian emerging markets equity at Alliance Capital, from the stock market alleging breach of fiduciary trust and violation of takeover rules.
Sebi has also tightened surveillance of foreign portfolio investment, which has fuelled the current upswing. Sebi directed foreign institutional investors (FIIs) registered in India to make detailed fortnightly disclosures on offshore derivative contracts such as participatory notes (P notes) that are written on underlying Indian securities. The regulator suspects the notes are used by some Indian firms to launder money, as well as by hedge funds that are not allowed to invest in India.
Soaring Sensex The Sensex scarcely missed a step, crossing 4000 on August 19, up over 20% this year. Foreign investors have invested $2.9 billion into the Indian equity and debt markets this year. According to Emerging Portfolio Fund Research, global emerging market equity funds are overweighting India, Brazil and Thailand to outperform the benchmark MSCI-Emerging Market Funds (MSCI-EMF).
Sebi’s order against Arora details events in January when Alliance invited bids for its stake in Indian subsidiary Alliance Capital Asset Management. Arora, along with Henderson Global Investors, offered to pay $36 million for the company. Arora was to receive 6% of the shares of the new company and another 13% over five years.
Sebi alleges Arora attempted to thwart the bid process by making public his intention to quit the fund unless Henderson’s bid went through. The tussle resulted in redemptions from Alliance funds that cut the assets under management by a third to Rs24 billion ($523 million). In February Alliance said it had put off the sale, and that it was retaining Arora as chief investment officer of Alliance’s Indian operations as well as head of Asian emerging-market equities for Alliance globally.
Sebi also cites violations under India’s takeover rules. Arora is accused of failure to disclose five companies, more than 5% of whose stock his funds owned. The regulator also charges him with having inside information on the swap ratio for the demerger between the Indian subsidiaries of Hewlett-Packard and Digital Globalsoft. It says Arora sold the fund’s entire holding of 146 million DG shares soon after an independent valuer submitted its report and before the terms of the swap were made public. The market later adversely perceived the ratio for DG, causing its share price to fall.
Arora says in response: “I have done nothing against Alliance, against Alliance mutual fund holders or any other capital market entity.” Just days before Sebi’s order, he quit Alliance to join Sabre Capital, headed by former Standard Chartered CEO Rana Talwar.
Ajai Kaul, who heads Alliance’s Indian operations, says: “Alliance has no reason to believe that [Arora] is guilty of insider trading” and that there was no breach of fiduciary trust. Yet, some believe that Alliance could come under scrutiny. JR Varma, a former Sebi board member, says that if, as Sebi says, Arora’s role as a fund manager was in conflict with his role as a possible acquirer of Alliance Capital, why did its board of directors fail to act.
The case will be followed closely because of Arora’s star status. It also raises important issues for privately managed companies that manage 75% of the $22 billion Indian asset management industry.
Some fund managers privately applaud Sebi and say it will force funds to put in place tighter compliance. The head of one fund management house who was a member of a Sebi-sponsored panel that reviewed risk-management systems says: “Internal controls on the investment process in many funds are far from what they should be.”
Sebi’s move to seek disclosures from foreign investors on offshore derivative contracts has its roots in a parliamentary probe into the market crash two years back. The panel’s report criticized the government and Sebi for failing to regulate fictitious Indian companies registered in tax havens such as Mauritius that were being used to launder money into India and pump up their share prices in Indian stock markets.
The report said the anonymous P notes issued by sub-accounts of FIIs registered in India were being used to route such investments. The regulator’s probe resulted in the suspension of the broking licence of CSFB.
Early attempts to probe the offshore market were restrained for fear they would put off foreign investors altogether. Now, backed by foreign currency reserves of $80 billion and a growing economy, the government seems bolder.
Under a new Sebi chairman, Gyanendra Nath Bajpai, Sebi asked FIIs last October to start reporting to the regulator the offshore derivative contracts issued by them. Sebi sources say the identity of the offshore investor was not being disclosed by FIIs. The new format specifically asks FIIs to identify whether the offshore investor is a hedge fund, a corporate investor or a pension fund – as well as the type of contract, such as P notes, equity-linked notes, capped-return notes and investment notes.
As one fund manager says, Sebi can exercise only moral control over contracts written outside India. By removing the anonymity of offshore investment, it hopes only genuine foreign investors that do not want the hassle of registering in India would use that route.
