TERM PAPER ON “Study and analyse the impact of major stock markets scams on Indian stockmarket: causes, effects, Regulations made, suggestions: Scam: Enron”SUBMITTED BY- SUBMITTED TO-MRIDULA SHARMA Mr VIKAS ANANDR-1902 B31 LPU10901806
WHAT IS STOCK MARKETA stock market or equity market is a public market (a loose network of economictransactions, not a physical facility or discrete entity) for the trading ofcompany stock (shares) and derivatives at an agreed price; these are securities listed ona stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion USD at thebeginning of October 2008. The total world derivatives market has been estimated at about$791 trillion face or nominal value, 11 times the size of the entire world economy. The valueof the derivatives market, because it is stated in terms of notional values, cannot be directlycompared to a stock or a fixed income security, which traditionally refers to an actual value.Moreover, the vast majority of derivatives cancel each other out. Many such relativelyilliquid securities are valued as marked to model, rather than an actual market price. IMPORTANCE OF STOCK MARKETFunction and purposeThe stock market is one of the most important sources for companies to raise money. Thisallows businesses to be publicly traded, or raise additional capital for expansion by sellingshares of ownership of the company in a public market. The liquidity that an exchangeprovides affords investors the ability to quickly and easily sell securities. This is an attractivefeature of investing in stocks, compared to other less liquid investments such as real estate.History has shown that the price of shares and other assets is an important part of thedynamics of economic activity, and can influence or be an indicator of social mood. Aneconomy where the stock market is on the rise is considered to be an up-and-comingeconomy. In fact, the stock market is often considered the primary indicator of a countryseconomic strength and development.TYPES OF STOCK MARKETThere are two types of stock markets:- 1. Primary market 2. Secondary market
Basically the primary market is the place where the shares are issued for the first time. Sowhen a company is getting listed for the first time at the stock exchange and issuing shares –this process is undertaken at the primary market. That means the process of the Initial PublicOffering or IPO and the debentures are controlled at the primary stock market.On the other hand the secondary market is the stock market where existing stocks are boughtand sold by the retail investors through the brokers. It is the secondary market that controlsthe price of the stocks. Generally when we speak about investing or trading at the stockmarket we mean trading at the secondary stock market. It is the secondary market where wecan invest and trade in the stocks to get the profit from our stock market investment.The classification is made on the type of instrument that is being traded at the market. Boththe Bombay Stock Exchange and the National Stock Exchange have these types of stockmarkets.Equity marketThe first type of market is the equity market or the cash segment where stocks are traded. Inthis type of trading the buyers of the stocks book a buying order with a bid price and theorder are executed through the broker at a negotiated ask price offered by the sellers at themarket. In most cases the deal is closed or the stocks are brought at the best available askprice. In this type of trading the buyer pays the entire amount of the value of the stocks that isdetermined by multiplying the number stocks with the current price of the stock. Once thebuyer pays the entire amount along with the brokerage and taxes of the transaction the stocksare deposited to the DP account of the buyer.Derivative MarketIn the derivative market trading is done mainly through two instruments – the Future contractand the Option contract. In both these types of contracts the stocks are bought and sold in lot.The number of stocks for each lot depends on the valuation of the stock and the valuation ofthe lot is determined by the number of the stocks in a lot multiplied with the current marketprice of the stock. For trading in derivative market you have to buy either the future contractor the option contract.
WHAT ARE STOCK MARKET SCAMS Audit is the most pressing area for change; it is not the only one. The Enron fiasco hasshown that all is not well with the governance of many big American companies. Over theyears all sorts of checks and balances have been created to ensure that company bosses, whosupposedly act as agents for shareholders, their principals, actually do so.Yet the cult of the all-powerful chief executive, armed with sackfulls of stock options, has toooften pushed such checks aside. Companies need stronger non-executive directors, paidenough to devote proper attention to the job; genuinely independent audit and remunerationcommittees; more powerful internal auditors; and a separation of the jobs of chairman andchief executive.The above is an assessment and warning by The Economist in the context of the collapse ofEnron, placed 5th in the latest Fortune 500 rankings of American companies. A number ofother disclosures including that of Tyco International, Adelphia Communications, ComputerAssociates, Qwest Communications, Global Crossing and now WorldCom further deepenedthe scepticism about the state of affairs in corporate America. These are stock market scams.
MAJOR STOCK MARKET SCAMSRAMALINGA RAJUThe biggest corporate scam in India has come from one of the most respectedbusinessmen. Satyam founder Byrraju Ramalinga Raju resigned as its chairman afteradmitting to cooking up the account books. His efforts to fill the "fictitious assets with realones" through Maytas acquisition failed, after which he decided to confess the crime. Witha fraud involving about Rs 8,000 crore (Rs 80 billion), Satyam is heading for more troublein the days ahead.EFFECT Indias fourth largest IT company lost a staggering Rs 10,000 crore (Rs 100 billion) inmarket capitalisation as investors reacted sharply and dumped shares, pushing down thescrip by 78 per cent to Rs 39.95 on the Bombay Stock Exchange.HARSHAD MEHTA’S SCAM The major scam was perpetrated by Harshad Mehta. The diversion of funds from thebanking system led to zooming of share prices to unprecedented levels within a span ofthree months (Jan-Mar 1992) during which time the BSE Sensitive Index (Sensex) morethan doubled from about 2,000 to 4,400. EFFECT This gave rise to a false impression of the windfall gains that could be had from the stock market and created a `herd’ mentality. During the boom period, shares of even loss-making companies commanded high premium. A Special Court also sentenced Sudhir Mehta, Harshad Mehtas brother, and six others, including four bank officials, to rigorous imprisonment (RI) ranging from 1 year to 10 years on the charge of duping State Bank of India to the tune of Rs 600 crore (Rs 6 billion) in connection with the securities scam that rocked the financial markets in 1992. He died in 2002 with many litigations still pending against him.
Other major scandal of the initial period was the promoters, especially MNCs; issuingthemselves preferential shares at prices far lower than the then prevailing market prices.Apart from the doubtful quality of many of the new issues, an important case which shookthe markets in early 1995 was the Rs. 350 crore Fully Convertible Debentures (FCD)issues of M.S. Shoes. EFFECT- The Company was accused of inadequate disclosures. Taking advantage of free pricing of issues, many companies charged high premium. But the post-listing returns proved to be disappointing. In the post liberalisation period a good number of companies were not only non-manufacturing ones, but the purpose of issue also varied from project finance to working capital. In terms of numbers, about one-third of the issues were by financial companies with a preponderance of non-banking financial companies (NBFCs). A number of public issues were made without any critical scrutiny. The Reliance share switching scandal, gross disappointment with Morgan Stanley’sMutual Fund issue, misdemeanours of the so-called plantation companies and theturbulence in the NBFCs with the CRB group in the vanguard hurt the secondary marketand further eroded investors’ trust in the stock market. Primary market scam of the mid-1990s, an important one in this sequence, whichmeant unscrupulous fly-by-night promoters made good with public money and some ofthem even ‘vanished’ after collecting funds from the public, severely shook the confidenceof the individual investors. In addition, communal disturbances – the latest being theGujarat carnage, war fears, East Asian financial crisis, sanctions following nuclear tests,UTI’s US-64 troubles, etc. further contributed to the difficulties by periodically depressingmarket.THE KETAN PAREKH SCAM It was an example of the inherently weak financial, regulatory and legal set up in India.Ketan Parekh is a Mumbai based share and stock broker. He is from a well to do share-brokerage based family. He was involved in the shares scam of the year 2000/01. CAUSE The study by SEBI found that the flow of funds originating from Ketan Parekh, when paired with securities market transactions of connected clients leads to the possibility
that these trades were executed to confuse the funds trail and to integrate the money originating from the banned stock broker into the system of banking. Ketan’s possible involvement was found by SEBI during its investigation into professed manipulative trading in the scripts of Cals Refineries Limited, Confidence Petroleum India Limited, Bang Overseas Limited, Shree Precoated Steels Limited and Temptation Foods Limited.ENRON CASE Enrons demise was the creation of partnerships with shell companies, these shellcompanies, run by Enron executives who profited richly from them, allowed Enron tokeep hundreds of millions of dollars in debt off its books. But once stock analysts andfinancial journalists heard about these arrangements, investors began to lose confidence inthe companys finances. The results run on the stock, lowered credit ratings andinsolvency. According to claims and counter-claims filed in Delaware court hearings(ofthe Enron Case); many of the most prominent names in world finance - includingCitigroup, JP Morgan Chase, CIBC, Deutsche Bank and Dresdner Bank - were stillinvolved in the partnership, directly or indirectly, when Enron filed for bankruptcy.Originally, it appears that initially Enron was using 15 SPEs (Special Purpose Entities)appropriately by placing non energy-related business into separate legal entities. CAUSE What they did wrong was that they apparently tried to manufacture earnings by manipulating the capital structure of the SPEs, hide their losses, did not have independent outside partners that prevented full disclosure and did not disclose the risks in their financial statements. Enron, in order to circumvent the outside ownership rules funnelled money through a series of partnerships that appeared to be independent businesses, but which were controlled by Enron management. The scope and importance of the off-balance sheet vehicles were not widely known among investors in Enron stock, but they were no secret to many Wall Street firms. By the end of 1999, according to company estimates, it had moved $27bn of its total $60bn in assets off balance sheet.IPO SCAMThe Securities and Exchange Board of India barred 24 key operators, including India bullsand Karvy Stock Broking, from operating in the stock market and banned 12 depositoryparticipants from opening fresh accounts for their involvement in the Initial Public Offerscam. .Suzlon Energy Ltds Rs 1,496.34 crore (Rs 14.963 billion) public issue (September 23-29, 2005). The retail portion was oversubscribed 6.04 times and the non-
institutional portion was oversubscribed 40.27 times. Key operators used 21,692fictitious accounts to corner 323,023 shares representing 3.74 per cent of the totalnumber of shares allotted to retail individual investors.Jet Airwayss Rs 1,899.3 crore (Rs 18.993 billion) public offer (Feb 18-24, 2005). Theretail portion was subscribed 2.99 times and the non-institutional portion by 12.5times. Key operators used 1186 fake accounts for cornering 20,901 shares representing0.52 per cent of the total number of shares allotted to retail investors.Tata Consultancy Services’ Rs 4,713.47 crore (Rs 47.134 billion) public offer (Aug19-23, 2004). The retail portion was oversubscribed 2.86 times and the non-institutional portion by 19.15 times. Key operators used 14,619 benami accounts tocorner 261,294 shares representing 2.09 per cent of the total shares allotted to retailindividual investors.
REGULATIONS MADE The past ten years are witness to many changes in line with this objective. Trading and settlement procedures have been improved.1) New instruments have been introduced.2) Disclosure levels have been enhanced.3) Measures to protect investors’ interest and educate them have been initiated at least on paper.4) A code of corporate governance has been put in place. Steps were initiated to change the organisational structure of the stock exchanges:- a. In appointing nominee directors by financial institutions was to keep a close watch on the managements and make the company boards function effectively. b. Auditors on their part had to disclose the reasonableness of transactions with related parties. c. There were limits on managerial remuneration and inter-corporate investment and loans. Many of these had to be introduced both with a view to improve disclosures as also in response to the misdeeds of certain industrial Houses.
SUGGETSIONSHere are the some of the suggestions that should be taken to reduce and more ever removethese scams:-1. It is desirable to have a diversified and balanced financial system where both financial intermediaries and financial markets play important roles in imparting greater competitiveness and efficiency to the financial system.2. In the present context of financial liberalisation, stock markets and banks emerge as sources of corporate finance and stock Market development actually tends to increase the quantity of bank loans through improved debt equity ratios.3. The coexistence of both systems is socially desirable not only because it encourages competition, but also because it reduces transaction costs within the financial system, and helps improve resource allocation within the economy.4. The regulator should continuously monitor the investment pattern so that any undue change in a particular stream, like the broker position, could be identified and immediate investigation conducted.5. The Government also should strengthen the investment institutions to facilitate long-term investments.6. Flow of money to the capital market from the lending institutions should be more transparent so that undue concentration of lending on particular scrip is avoided.7. Access to the market must be related to the genuine need for the funds rather than to benefits flowing from limited public participation.8. The minimum public offer should be placed considerably higher than the present 10 percent.Thus we can say that the occurrence and reoccurrence of such security scams and financialscandals can be attributed to a failure of corporate governance in finance despite the existenceof a functioning regulatory authority empowered with the legal sanctions but throughimplication of these suggestions we curb these scams to a great extent.
CONCLUSIONThe security scams and financial scandals discussed here involved the manipulation of hugeamounts of money. The purpose of the so called “traders” or “investors” was not genuine.Audit is important not just from the point of protecting shareholders’ interest. It has a muchgreater responsibility of informing the wider body of stakeholders of the fair and true statusof affairs of an entity.Given the fact that one of the world’s top five accounting firms is involved in more than onescam should send shivers down the spine of many. The leading firms are also involved in taxhavens. After all, these are the ones which are engaged to prepare consultancy reports forIndian companies and governments. These are the ones appointed as investment advisors.There is no point in blindly following their models, policies and procedures.The perpetrators had such a comprehensive knowledge of how the system worked that theymanipulated it. It is clearly evident that the occurrence and reoccurrence of such securityScams and financial scandals as some point in time are attributed to a failure of corporategovernance in finance and that of financial regulation.Corporate Governance vs. Financial Regulation is more a personal thing which involves theadherence to rules regulations and ethics by officials. It is more self enforced as a ethicalbehaviour or a matter of pursuing codes of conduct without an outside agent monitoring, butfinancial market regulation in exercised more by an external organization either a regulatorybody authorized to monitor and impose a surveillance mechanism to ensure frauds ormisdemeanours are not perpetuated and so that the market functions efficiently to oversee thefunctions of the market participants and impose fines and other penalty for non-compliance.In India corporate governance revolves around ethical behaviour on part of Management,knowing to make right decisions and also knowing to choose between right and wrong.Management should be made more accountable for their actions in terms of deployment offunds, making decisions and also transmitting information.There is no escape from developing proper checks and balances and enforcing them strictly.For this one need not always have to reinvent the wheel or wait for some upheaval indeveloped countries.