Companies have tricked the markets without coming on record over pledged shares

In 2008-09, India Inc had faced some real tough times in the aftermath of global finance crisis that had contagion effect on emerging markets. Several companies declared their financial condition that turned out to be far worse than what they claimed earlier.

Satyam Computers scam perpetuated by Ramalinga Raju and his team came into public domain only after the US-triggered financial turmoil hit the Mumbai shores. Revelations by several companies at that point had led market regulator, Securities and Exchange Board of India (SEBI) to frame fresh rules and regulation making it compulsory for promoters to declare the pledged shares used for mopping up resources.

A decade later, India Inc seems to be faced with similar issues especially after liquidity crunch following crisis at IL&FS. Once again, some skeletons are tumbling out.  In last three months, several instances of promoters pledging shares to raise money have hit headlines. Otherwise, such price sensitive information would have been under wraps. Even bankers, markets regulator and investors may not have known.

What’s stirring the hornet’s nest is that transfer of shares to holding company that in turn issued debt paper. In effect, companies have tricked the markets without coming on record over pledged shares. Promoters and their financial advisors seem to have blatantly skirted rules on pledged shares of promoters but also related party transactions and debt availed by subsidiaries.

On the face of it, companies may not have violated any law. They would have only found ways to bypass the law. In the process, minority shareholders, both retail and institutional have clearly been taken for a ride. In the Essel Group case, after one fourth of shareholders wealth got wiped out, promoters led by Subhash Chandra conceded that he committed mistakes. This will mean very little for minority shareholders.

Making the disclosure on pledging of shares stringent could be a way out. Piecemeal approach may not serve the purpose. Laws should be simple and clear with little scope for subjective interpretation. Even if the shares are being pledge by way of holding company, issuing debt paper through complexly structured transaction may have to be disclosed right away before the stock exchange and SEBI. Some non-bank financial companies have funded promoters that pledged shares with them. Going forward, NBFCs may also have to disclose the extent of financing such deals. That way, every shareholder can evaluate the risks he or she’s exposed to with investments in companies and listed NBFCs.

Reserve bank of India (RBI) and SEBI will have come together as regulators to tame promoters that seek to hoodwink the system and take investors for a ride. Coordinated efforts by the regulators will ensure that promoters and their financial advisors do not advantage of gaps in the law when both RBI and SEBI make changes separately.

SEBI may also have to re-look at insider trading norms given that top rung corporate officials have had price sensitive information relating pledged shares of promoters. There are several instances where such officials have sold out before the pledged shares issue hit the wires. Its not only insiders in the companies but those with banks, financial institutions that have actually take advantage of pledging shares information.

These individuals could have used trading accounts unconnected to them to make the moolah and profiteer in the market by throwing the ethics to winds. Regulators may have to periodically preen through suspected transactions that may he connected to ‘insider norms’ that presently focus on employees and promoters of companies. All those involved in the transaction chain may have to be covered in the insider trading norms.