India has positioned itself amidst the top global economies and is growing in leap and bounds. Stock markets have hit record highs this month after victories in key state elections by BJP boosted investor sentiment, raising hopes of a continuation in the government’s reform agenda. Completing 2017, the Sensex closed above 34,000 and Nifty crossing the 10,500 mark, with a phenomenal 28% gain. According to Bloomberg, India is now home to the world’s eighth-biggest stock market, overtaking Canada for the first time in almost a decade. The score: India $2.29 trillion, Canada $2.28 trillion. So how does this translate to those investors in Dalal Street or the BSE; Investors had became richer by Rs 45.50 lakh crore this year, over 45 lakh crore rupees gain in a single year. With investors and stock markets beginning to play at unprecedented levels, the situation calls for a bigger vigil to ensure a fair play.
The stock market prices and GDP have been observed to go hand in hand. Countries doing well in terms of GDP performance tend to experience gains in domestic stock exchanges. The growing theoretical literature argues that stock markets are crucially linked to economic growth. When stock market begins to bloom to record levels, there is a greater need to ensure shareholder interests, which calls for greater internal controls to check insider trading.
Even before the sensational gains in August, the Hindu Business Line put forth an article, “Spike in Insider trading, Manipulation.” The first sentence reads: Insider trading, manipulation, and stock price rigging are at their peak in India’s equity markets. According to it, in 2016-17, there were nearly 185 fresh cases of market manipulation and price rigging and 34 new cases of insider trading under investigation by market regulator SEBI. This is more than double the number of such cases in the previous year, data gathered by Hindu Business Line from SEBI revealed. However, the rise in numbers is mainly on the back of tip-offs from the Income-Tax Department, which has been closely studying tax evasion via stock markets post demonetization in November 2016, according to a SEBI official.
Last month, Reuters had documented at least 12 cases of prescient messages about major Indian companies, including Dr. Reddy‘s, being posted in private WhatsApp groups. The report identifies a dozen messages that accurately predicted Q2 earnings patterns (and even a bonus announcement in one case) for specific listed stocks. The messages were being passed around, just before the results were officially announced. These messages were being circulated in private Whatsapp groups frequented by equity traders. These were all big companies – in fact, more than half of the stock concerned were members of the Nifty-50.
The existing scenario has been wrapped up by Bloomberg as “Insiders Do More Than Trade in India – The country’s financial markets aren’t set up to protect ordinary investors.” Bloomberg on its opinion on India further says, “This is just another reminder of the fact that, while nominally India’s financial markets are set up to protect ordinary investors and market participants, in actual fact they work to protect insiders. This isn’t generally understood, given that India’s laws against insider trading and protecting minority shareholders are strict on paper.” The WhatsApp story seems to confirm something of an open secret in Mumbai stock market circles: There are closed networks that tend to get information about companies well before the general public. Sebi struggles to get insider-trading prosecutions off the ground.
Exploiting loopholes in laws and regulations is an area of expertise for many among us as recent money laundering and scam investigations point out. We have seen hawala transactions, benami transactions, willful defaults, and the likes of many such financial crimes. However compared to all these crimes, insider trading should be a cakewalk for many, where unfair gains have no trails left, much to the loss of the genuine investors. The earlier imprisonment of executives Raj Rajaratnam of Galleon Group LLC and Rajat Gupta of McKinsey for insider trading in the US is proof enough of what we could be capable of.
It is on records that the Supreme Court had also noted that rules on insider trading simply weren’t clear enough. Although Sebi has been empowered to handle this, the situation is far from necessary. Sebi has only 780 employees, one for every six companies listed on an Indian stock exchange. (Fifteen times as many people work at the U.S. Securities and Exchange Commission, one for every company listed on an American exchange.) Nor does the training or background of Sebi’s employees necessarily inspire confidence. It is high time that we have in place our own Sarbanes Oxley Act. The US Sarbanes Oxley Act not only covers wrong doing but also covers unintentional acts, the reporting people, the reporting procedures, protects whistle blowers, protects federal employees. The regulators are also provided with normal authorized secrecy procedures, when dealing with confidential information.
The US has a market capitalization of over 25 trillions followed by a very distant China at over 8 trillions. The American NYSE and NASDAQ are the world’s two largest stock markets. The American Securities and Exchange Commission (SEC) could serve as a reference point and role model for most nations aspiring to control stock market trading activity. The functioning of the American public corporations was fundamentally changed by the Sarbanes Oxley Act of 2002, which was developed subsequent to the corporate scandals of Enron, WorldCom etc. The Act specifies the regulations that need to be in place with regard to the Internal Controls for their financial disclosures. Section 302 of the Act makes the signing authority responsible for the internal controls and requires the signing authority to list the shortcomings with regard to internal control. Also any important changes in internal control that could possibly have a negative effect on it, should also be specified. Section 808 imposes fines or imprisonment of up to 20 years for concealing, destroying or falsifying records. An accountant who knowingly violates the reporting guidelines can be imprisoned up to 10 years.
In the US, the trading patterns of all stocks are generally monitored by regulating agencies looking for any suspicious transactions. There have been several instances where top company officials have been charged for insider reporting. Apart from punishments, the government has also placed regulations on the trading activity of the company’s senior management staff, with regard to their own stocks. Their trading of their stock is controlled and regulated by several criteria like the volume of stocks they can trade and time. All top management staff and people with access to reporting information would have to declare their holdings and interests in the company. They would also have to report on the stocks held by their friends and relatives in the company.
The American Sarbanes-Oxley Act calls on the CEOs and CFOs to certify that appropriate measures were adopted in the processing and reporting of their financial data, to uphold the integrity of the data. To ensure compliance with the best practices as required by the US regulations, financial firms assess their service providers and evaluate their security procedures. The financial firms verify the physical security process, password regulations, and employee background verification procedures of the service provider, as part of their evaluation.
Given the fact that the market is bulging to the seams and coupled to the fact that there is more happening than what meets the eye, we need to bring a major changeover at the earliest time. The fact that the US and India are already cooperating in the domain of finance and taxes, it should be very feasible to import the US Securities and Exchange Commission’s activities into India’s Sebi. Irrespective of the fact whether controls are to be developed on our own or imported and activated, there is a very urgent need to reign in insider activity, with a fully prepared and confident Sebi, always leading from the front. Sebi executives must realize that the shady insider activity is relatively an unknown concept among most investing public in our country today. However, it cannot take a long time for that to change. This could probably mean Sebi has a very little time left to act.
