The events unfolding in Hyderabad over the past week or so bring to fore the blatant violations of risk management procedures by intermediaries and even more brazen circumventing of disclosure norms laid down by the Securities and Exchange Board of India (Sebi) by promoters and listed lenders. The fact that there has not been any strong response from Sebi shows the helplessness of the regulator in situations where both parties decide to have such unprotected transactions by mutual consent and later get into public mudslinging.
After several Andhra-based firms got into trouble with pledging of shares a couple of years ago, Sebi made it compulsory for such pledges to be reported on a continuous basis through stock exchange disclosures. Sebi also required companies to make quarterly disclosures of these pledges alongwith shareholding declarations.
A complaint by Karvy Stock Broking to the Hyderabad police has shown how promoters may have used their shares to raise money without disclosing it to the stock exchanges. According to the complaint, promoters of Deccan Chronicle and Future Capital and their lenders got into an agreement called non-disposal undertaking-power of attorney (NDU-POA). While this arrangement gives the lenders most of the benefits of a pledge, it protects the downside of a potential erosion of value if the arrangement is disclosed to the public.
Under a regular pledge, the pledgor will submit an instruction to its depository participant to initiate a pledge/hypothecation request in the software provided by NSDL/CDSL, indicating the option ‘create a pledge/hypothecation’ in the pledge/hypothecation form. The pledgor will indicate therein, the agreement number, closure date of the pledge/hypothecation (this date is indicative of the duration of pledge/hypothecation), pledgee’s details, and the details of securities to be pledged. A pledge is then created electronically and will reflect in both pledgor and pledgee’s DP accounts. But under the NDU-POA, the entire depository mechanism is being circumvented.
The Karvy complaint also shows how the intermediary was able to break the NDU-POA just on the basis of instructions from the promoters alone. It did not wait for any confirmation from the other party to the contract with Future Capital Holdings (FCH). Karvy claims “based on the track record of the account holder, their reputation and status as also the fact that they are promoters of a reputed company, had in good faith and in belief that the agreement with FCH was terminated,” the transactions were executed.
Why should there be an investor protection framework, market infrastructure institutions such as exchanges and clearing corporations if all transactions can be conducted in such good faith and based on reputation?
“The account holders have made several oral assurances and stated that as fresh documentation for a fresh loan against property was under process with FCH, there has been a delay in obtaining the satisfaction letter from FCH,” the complaint says. Oral assurances? Are we still living in the 19th century? If this is the real world, then are all these state-of-the-art electronic systems and gadgets just for the regulators to show off and media to wax eloquent about, while the real world is still oral and physical?
In fact, one of the promoters allegedly made Karvy believe that “this termination letter was a mere formality.” If somebody can make somebody ‘believe’ something, why should these companies invest shareholders’ money in some ominously named creature called risk management system. Time has come for Sebi to take a second look at the definition of pledge and expand it to bring in all these off-market arrangements. It is also a good time to crack down on the tendency to bend rules based on “track records and reputation”.