Shankar Sharma, Nirmal Bang and CSFB may have been given a raw deal

I went to Bombay. There everyone who is anyone seems to have it. Shankar Sharma accuses Sebi of selectively leaking its reports to favourite reporters. It has a precedent: one previous chairman of Sebi achieved greatness by strategic cultivation of half a dozen journalists. But this nurturing of an image is imprudent; as I shall show, it would have been wiser for Sebi to keep the report really secret.

The report is motivated by “unusual market behaviour in spite of a well received Union budget.” How was it unusual? The report cites “excessive volatility”; but the figures it cites are of a fall in prices between February 28 and March 2. And by chapter 3, the “volatility” becomes a “downtrend”.

It is atributed to short sales, unwinding of long positions, spot sales, and market sentiments. By market sentiments are meant “unfavourable projections” in the Economic Survey, a meltdown in Nasdaq, and the Tehelka exposure. But the exposure on March 13 cannot have caused prices to fall 11 days earlier; and after the exposure, prices actually rose.

The three other reasons are sales of different kinds. Can sales cause a fall in prices? The simple answer is that sales are identically equal to purchases; they no more reduce prices than purchases raise them. Short sales are sales promised at a future date by someone who just now does not have the shares.

Normally at that date he will just receive or pay the difference between the forward price at which he short-sold and the spot price; such squaring up will have no effect on the price. But if the corresponding buyers think the shares on sale in the market would not cover the short sales, they may ask for delivery.

Then the short sellers will have to buy the shares in the market, and the price will rise. Contrarily, if the short sellers suspect the buyers do not have the money, they may force the buyers to take delivery. The buyers may sell other shares, or borrow money; the rate of interest may rise, and some other investors who have borrowed money may sell their shares to reduce their debt.

In both cases, prices of shares — not necessarily the one that was originally short sold — may fall. To summarise, there is absolutely no presumption that sales, short or spot, naked or clothed, cause prices to fall. All Sebi’s figures of sales by sundry suspects and coincident price declines are so much dross.

All players want to make a profit — even wrongdoers. Sebi must show either that they made a profit — that they sold shares at a higher price than they bought at, or that the prices fell more or rose less than those at which they short-sold or unwound their long positions. It never does. This disconnection between the required and offered evidence is written all over the report. Take Sebi’s various charges.

Nexus or interconnection: The evidence must refer to either ownership or control. Sebi thinks that the fact that KP introduced a party to a bank, or that it dealt with a KP firm or in KP scrips — itself a tendentious misnomer — is evidence of nexus. Sebi repeatedly alleges nexus without offering any credible evidence.

“Hammering” prices: Causing a price to decline is not profitable in itself; but it can be used as a part of a money-making strategy. An entity may make sustained enough sales to reduce prices and create a general expectation of a further fall, and buy back when the prices fall. The indispensable pieces of evidence would be that the entity was a compulsive and dominant seller during a long period, and that it bought later. Sebi gives many figures of such sales.

To illustrate, Nirmal Bang's short sales accounted for 15 per cent of Wipro shares sold in selected 8 minutes, 3 per cent of SSI shares sold in 20 minutes, or less than 1 per cent of Zee Telecommunications shares sold in 10 minutes. These figures are ridiculously small, even after the deliberate selection of short time intervals. And there is no evidence of later purchases.

Circular trading: Circular trading, to be profitable, must be substantial and sustained enough to influence the price trend, and the responsible trader must eventually use the trend to make a profit. Sebi gives a table to show circular trading between First Global and Bang Equity. First Global bought shares of SSI, Wipro, SBI and Reliance Capital from Bang on and February 27 and 28, and sold them back to him on March 1. On Wipro it made a small loss; on all others it made a profit — which meant that the prices rose — despite First Global being a merciless hammerer. Bang made a loss, but we would not know his final results until he sold the shares. And the quantities were so small relatively to market turnover that even Sebi dared not give the proportions. A pair of a sale and a buyback does not make circular trading.

Structured transactions: This mysterious term means transferring shares from one of KP’s affiliates to another through the market. For instance, KP sold Rs 15.6 billion’s worth of shares through CSFB, a foreign broker, in January-March. (Though Sebi will not tell you, KP must have bought more or less the same amount’s worth.) Of the shares sold, 3 per cent of Adani Exports shares, 40 per cent of Shonkh Technology shares, 80 per cent of Global Trust Bank shares and 37 per cent of Zee Telefilm shares were picked up by a KP affiliate in synchronised trasactions.

This is like me transferring shares to my wife, which is quite legal. Why did KP do it through the market? Maybe he had a client for whom he had to buy at the market price, but wanted to unload some of his own holdings. That too is legal. Sebi could not find anything wrong, so it invented the term, “structured transactions”.

It also found that CSFB paid KP entities proceeds on the day of sale, and recovered interest on delayed collections in the broker’s commission it charged. Sebi never asked CSFB if it did this only for KP or for all customers. My guess is that CSFB is a merchant bank, and extends credit from the time of purchase to the time of settlement to all customers. Sebi calls this providing short-term working capital to KP; it was really offering immediate liquidity to all its customers — normal business of a merchant bank. For it, Sebi banned CSFB from trading.

After reading this report, I was doubtful about Ketan Parekh’s dealings, but convinced that Shankar Sharma, Nirmal Bang and CSFB were innocent on the evidence presented. If that is true, it follows that they have been given a raw deal by Sebi.