The mystery of capital

SEBI’s order on UBS is a dangerous case of anniversaryitis


The SEBI order against the Swiss FII, UBS, on the grounds that it did not cooperate in the investigation into the events of May 17, 2004 came exactly on the first anniversary of the stockmarket crash. It makes one wonder how much of the punishment was symbolism in that SEBI punished someone exactly a year after the event. A professional agency should push out work as and when it gets completed, and not seek political symbolism.

The punishment itself is a rap on the knuckles of UBS for delaying providing the names of their clients’ clients on grounds of client confidentiality agreements in various jurisdictions. This information, says SEBI, the FII should have had with itself and provided promptly under the “Know Your Client” clause. If the law requires that the FII must hold the names of the final clients with itself, then it should not be telling the regulator that it does not have them. SEBI has, therefore, banned UBS from issuing PNs (participatory notes) for a year, an instrument through which overseas clients invest in India.

The 60-page order itself is an odd mix of innuendo and legal claims, endowed with more of an amateurish literary flavour than the professional competence of a legal department. An enforcement order from a regulator must be a clear legal document, where a specific claim is made about the misdeeds of the accused, and undisputable evidence is offered that the accused is guilty beyond all reasonable doubt. Instead, the SEBI order engages in elaborate innuendo that UBS tried to manipulate the market. SEBI then chickens out and does not actually charge UBS with market manipulation. The actual misdeed with which UBS is charged is delay in giving information.

The order indicates that even after getting the names of the clients, SEBI was not able to prove market manipulation. The order says, “SEBI is not required to prove its case with mathematical precision to a demonstrable degree.” And that “the law does not require SEBI to prove the impossible.” The task was to prove that to make a profit of Rs 42 crore, UBS caused the market to fall by more than Rs 120,000 crore, while holding relatively small positions. But then this information was available to SEBI at the time of beginning the investigation, and SEBI would have known that to prove its case would be impossible.

The movement in the stock markets on May 17 can be seen to be largely a consequence of two factors. First, the global factors. Many markets in East Asia, such as in Indonesia and South Korea, fell even more sharply. Second, domestic political factors. The fall was the consequence of uncertainty about the political composition and consequently economic policies of the new government in New Delhi. If an investor (domestic or foreign) expected markets in India to fall, and took positions accordingly, it is wrong to jump to the conclusion that it had made the market fall. However, instead of indicating that it may be impossible to prove manipulation, SEBI blames UBS, saying that “since the UBS did not give the information in a timely manner, investigations stand virtually thwarted”.

SEBI is treading on very dangerous ground when it questions the right of the FII to sell at a time when the FII felt it should. India has given foreign capital the unquestioned right to leave the country at any point. Only when investors know that they are free to exit do they feel comfortable about entering a market. The SEBI order questions the right of the investor to sell Indian equity at a time when the investor feels it should. The order says, “It was suspected that the steep market fall on May 17, 2004 could have been triggered as a result of UBS playing ducks and drakes in the market, accentuating the selling pressure for no reason linked to the fundamentals of the scrips or their performance.”

It is not for SEBI to say when the owner of an asset can sell the asset or when the owner feels pessimistic about the asset’s future. The owner may be alone in believing that the asset would do badly and may choose to sell. It does not need to justify its belief to anybody.

In this case, however, UBS’s view was not different from the view of many other market participants. SEBI is all alone if it believes that the events in the days before May 17, 2004 were not of profound significance to the Indian economy, and thus “fundamentals” as viewed by an investor. The events of the year that followed have borne out a good deal of the skepticism on May 17 about the ability of the UPA government to deliver good economic policy. SEBI is wrong in jumping to the conclusion — which it is itself unable to prove — that market manipulation is responsible for the sharp fall in stock prices.

Investigations are still on into the behaviour of other entities on May 17, 2004. Names and details are not known. There are two possibilities. Either, all of the others promptly provided names of their clients and their clients’ clients and SEBI found none of them guilty of market manipulation. This may be why UPS, which delayed giving the names, became the only entity to be punished on the first anniversary of May 17, 2004. Or, the others also delayed and will also be found guilty under the “Know Your Client” clause. They will also be blamed for the impossibility of a meaningful investigation and nobody will be found guilty of market manipulation. The real culprit behind the crash — the change in expectations about the economic policies of a communist supported government — will go unmentioned.

UBS is sure to appeal against the order at the Securities Appellate Tribunal (SAT), the specialised fast-track court for hearing securities related cases. The discussion there will presumably centre around the narrow question of whether UBS violated FII regulations, and whether the punishment is commensurate with the crime. SEBI has a history of losing high-profile cases at SAT. SEBI’s reputation will be enhanced if they win this case at SAT. However, SEBI’s reputation has not been accentuated by the release of a politicised and poorly drafted order.


Ila Patnaik