IPO: DEMAT SCAM. How does the DEMAT scam work?

Knowledge PARTNERS IPO: DEMAT SCAM How does the DEMAT scam work? In the stock market boom of 2004-05, capital of more than Rs 24,000 crores was mobi...
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IPO: DEMAT SCAM

How does the DEMAT scam work? In the stock market boom of 2004-05, capital of more than Rs 24,000 crores was mobilized from the primary markets through IPOs and other public issues. During a bull run, most IPOs are listed at a price higher than the issue price. Financiers with an intention to defraud, lent money to agents who created thousands of fictitious individual bank and demat accounts with the same address. The agent then applied for a company’s IPO in the quota earmarked for small investors through multiple applications from these fictitious account holders. Once the shares were allotted to the fictitious investors, the agent transferred them into the financier’s account, after deducting commission valued in the form of the allotted shares. Factors leading to the scam  

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With the revival of primary market, investors made a beeline for quality IPOs. The allotment to application ratios was low. In such cases multiple applications were rampant. Technology has shortened the gap between closure of subscription and allotment and transfer of shares to demat accounts. The scamsters used the demat system to manipulate the process and moved faster than the market regulator could sense the on-going scam. Banks colluded by opening the benami accounts and funding the unscrupulous agents. It was a failure of the banking system- they failed to follow RBI’s Know Your Customer guidelines (KYC) before opening accounts. Larger subscriptions for issues ensured a better price for the shares of companies in the book building process.

Regulatory Safeguards The Companies Act 1956 has a provision for punishment related to the issue under Sub-section (1) of Section-68A, which states that: “Any person who: a) Makes in a fictitious name an application to a Company for acquiring or subscribing for any shares therein, or b) Otherwise induces a Company to allot, or register any transfer of, shares therein to him, or any other person in a fictitious name, shall be punishable with imprisonment for a term which may extend to five years.” National Conference on “Capital Market Frauds and Malpractices Genesis, Resolution and Prevention” 10 October 2013

The Companies Act 2013, Clause-38: “Punishment for impersonation for acquisition, etc. of shares” (1) Any person who— (a) makes or abets making of an application in a fictitious name to a company for acquiring, or subscribing for, its securities; or (b) makes or abets making of multiple applications to a company in different names or in different combinations of his name or surname for acquiring or subscribing for its securities; or (c) otherwise induces directly or indirectly a company to allot, or register any transfer of, securities to him, or to any other person in a fictitious name, shall be liable for action under section 447. (2) The provisions of sub-section (1) shall be prominently reproduced in every prospectus issued by a company and in every form of application for securities. PHDCCI National Conference on Capital Market Frauds and Malpractices

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(3) Where a person has been convicted under this section, the Court may also order disgorgement of gain, if any, made by, and seizure and disposal of the securities in possession of, such person. The amount thus received through disgorgement or disposal of securities shall be credited to the Investor Education and Protection Fund.

CASE STUDIES

IDFC IPO Scam, the story of greed and related system failure (15 -22 July, 2005): In July 2005, IDFC came out with its public issue of 403.6 mn equity shares of Rs. 10 each at a price of Rs. 34 per equity share. Out of the total shares, 141.3 mn were reserved for small individual investors (defined as individual bidders who bid for equity shares for an amount less than or equal to Rs. 1 lakh). The stock was listed at Rs. 60, a 76% premium to its issue price. Roopalben Panchal and associates, Ahmedabad, opened thousands of fictitious benami demat and bank accounts bearing the same address with Karvy Stock Broking Ltd. This syndicate had as many as 43,982 applicants representing 17.3% of the total applications of the retail portion of the IDFC IPO. These fictitious accounts received IPO allotment of about 11.7 mn shares or ~8.3% of total retail portion of shares. Once they obtained the allotted shares, the fictitious investors transferred these shares to financiers, who then sold these shares on the first day of listing. Bharat Overseas Bank and Citibank allowed IPO finance to the extent of hundreds of crores for fictitious applications. Karvy, the Depository, processed these applications. The scam involved a syndicate of brokers, Depository Participants, Banks, Karvy Stock Broking, agents, other entities and individuals.. The syndicate was formed between Roopalben Panchal, her family, Sugandh Investments, Zaveri, Budhwanis, Sakserias, and Bharat Overseas Bank. YES Bank IPO Scam (15 June -12 July, 2005) Yes Bank issued a total of 70 mn shares, at an issue price of Rs.45, under its IPO on 15 June 2005. These shares were listed at Rs. 65 on BSE & at Rs.65.9 on NSE on 12 July 2005. The total issue was worth Rs. 315 crores, Out of the total of 70 mn shares, 17.5 mn (25%) shares were reserved for small investors. Roopalben Panchal, Sugandh Estates and Investments Pvt Ltd. together with a few others were the major players in the scam. Roopalben received funds from eight entities prior to the IPO. These funds were transferred to 6315 bogus bank and Demat accounts for making applications in the IPO of Yes Bank. The same or similar address in Ahmedabad was provided for all demat accounts and address of Bharat Overseas Bank, Worli, Mumbai were used for all applications. In the IPO process, these accounts were allotted 1.04 mn shares in aggregate- 6% of the shares reserved for small investors. SEBI Action- Roopalben and five other members of the Panchal family were found guilty of cornering shares meant for retail individual investors in 18 IPOs during the period 2003-2006 using multiple and fictitious demat accounts. They were barred from accessing the securities market for a period PHDCCI National Conference on Capital Market Frauds and Malpractices

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of three months. In February 2011, SEBI directed them to disgorge the unlawful gains they made, amounting to Rs 24 crore and also pay simple interest at 10% for five years from 2005 to 2010 (Rs 12 crores)- a total of Rs 36 crore. If they failed to disgorge the money within 45 days, they would be barred from the securities market for nine years. However the final decision is still pending in the court. This was the first significant order to be issued after Mr U K Sinha became chairman of SEBI. Since then regulatory bodies are more alert on the issue, and there has been significant drops in the number of demat accounts across Gujarat by nearly 25% since the Panchals-led demat scam came to the surface. Suzlon Energy IPO: Rs. 1496.3 crores (September 23-29, 2005) Suzlon Energy fixed a price band of Rs. 425-510 for its initial public offering of 29.3 million shares of Rs 10 each. Of the total issue, 8.6 mn (~30%) shares were reserved for retail investors. The key operators involved in the scam used 21,692 fictitious accounts to corner 323,023 shares which was equal to 3.7% of the total number of shares allotted to retail individual investors. SEBI levied a penalty of Rs. 1 crore on Dhaval Mehta involved in the Suzlon Energy and IDFC issue. SEBI debarred another player in the scam Chandrakant Amratlal Parekh from dealing in the stock market for one year and also imposed a fine of Rs. 30 lakh for his involvement in the in Suzlon IPO case. Jet Airways IPO: Rs. 1899.3 crores (Feb 18-24, 2005) Jet Airways made an IPO issue size of 17.2 mn shares of Rs.10 each. Of the total issue, 25% or ~4.3 mn shares were reserved for retail investors. The key operators involved used 1,186 fictitious accounts to corner 20,901 shares which were equal to 0.5% of the total number of shares allotted to retail investors. SEBI ordered the involved entity linked with the Jet Airways and IDFC issue, Opee Stock Link to disgorge Rs. 1.2 crores and barred it from trading for one year. NTPC IPO: Rs. 5368.1 crores (October 7-14, 2004) Key operators used 12,853 fake accounts to corner 2,750,730 shares representing 1.3% of total number of shares allotted to retail investors.

Regulatory actions related to the above scams     

24 entities including Indiabulls and Karvy banned from primary and secondary market, 12 DPs including HDFC Bank, IDBI Bank, Central Bank, ING Vysya Bank, IL&FS and Motilal Oswal told not to open fresh demat accounts. 85 financiers barred from the market The promoters of CDSL and NSDL were directed to take all appropriate actions including revamping of management of the two entities RBI fined three Banks - HDFC Bank, ING Vysya Bank and IDBI Bank for violation of KYC norms relating to loans against shares and investing in IPOs.

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In an interim order, SEBI imposed a penalty of Rs. 11.81 crores on NSDL, CDSL, and 8 depository participants including Karvy, HDFC Bank, IDBI Bank, ING Vysya Bank for violation of KYC norms SAT upheld SEBI’s power to direct the above errant entities to disgorge the illicit gains, however it maintained SEBI can direct the entities to disgorge only after the guilt is proven on conclusion of the pending proceedings.

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National Conference on “Capital Market Frauds and Malpractices - Genesis, Resolution and Prevention” 10 October 2013

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