On 4 June, the Securities and Exchange Board of India (Sebi) banned 26 entities and individuals from trading in the Indian stock markets. What the media highlighted was Sebi’s observation that these firms were “acting as conduits for re-routing Ketan Parekh’s funds”. Parekh, as some of you may remember, was arrested for market fraud in December 2002. However, there are more relevant and important lessons for investors in the regulator’s order.
Sebi proved that such ‘connected’ entities can create a false sense of huge volumes in a specific stock by trading among each other. For instance, in the case of Cals Refineries, volumes shot up 170 times after the stock was split 10:1 on 30 May 2008. Over half of these transactions were among the 26 firms and individuals. This, according to the order, “would have induced other genuine investors to deal in securities…. Such decisions… would be prejudicial to the interest of the investing public.” Therefore, don’t get swayed by heightened trading activity in a counter.
Secondly, the regulator found that many of these entities had indulged in off-market transactions which were opaque and not known to either the public or the regulator. In such cases, shares were privately ‘borrowed’ by X from Y and sold in the secondary market. Later, X would purchase similar quantities and ‘lend’ it to Y. And when they publicly sold the shares to each other, the buy-sell transactions were synchronised to happen within 60 seconds of each other. Finally, these firms were closely linked with each other. They had either common directors or shared the same office address, and remained in touch with each other.
This implies that despite the Sebi and stringent laws in the country, Indian markets can still be manipulated. This is especially true in the case of small and mid-sized companies, which have minimal floating stock. Therefore, their prices and volumes can be rigged dramatically. Investors should be wary of such unusual occurrences in smaller firms. This is important because the mid-cap and small-cap indices have risen faster than the benchmark Sensex or Nifty in the past three months. Maybe there are still frauds happening out there that you don’t know anything about.
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