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Expression of feelings by words makes them less significant when it comes to make statement of gratitude. We would hereby like to take the opportunity to express our gratefulness towards Mr. Kumar Bijoy, subject teacher for Merchant Banking for sharing his invaluable knowledge and experience with us. We are indebted to him for providing us with this wonderful opportunity of expanding our horizon in the field of Demat Scams. We express our sincere thanks to him for his constant support and guidance throughout the project which helped us to complete the project successfully. Thanking You Shilpa Babanagare (15602) Tuhina Tandon (15635) Baanee Luthra (15636) Siddharth Das (15638)

Introduction The Significance and History of Capital Market

4 Primary Market Secondary Market Background

Depositories in India

5 7 8

9 Dematerialisation Rematerialisation Demat Accounts

Demat Scam An overview

11 12 13

16 Case Study IDFC 20 Case Study Yes Bank Loopholes in the system Guidelines Introduced 38 29 36

Post demat scam- stricter norms for banks


40 Recommendations 43



Conclusion Bibliography

Annexure INTRODUCTION In terms of reform and development, the Indian capital market and financial sector have been the fastest to grab every opportunity presented by the paradigm shift in Indias economic policy. Their furious developmental activities have put the two top Indian bourses almost on par with the best in the world, in terms of their structure, systems and regulation. But for all the development efforts, the capital market remains seriously flawed because three key ingredients are still missing. They are adequate supervision, strict accountability, and appropriate punishment. As a result, the markets have remained shallow and stunted and have lurched from one financial scandal to another over the last decade. Every policy change in the liberalisation process was pounced upon by unscrupulous companies, who aided by a retinue of investment bankers and consultants diverted thousands of crores of rupees to themselves. In the process, retail investors have been the biggest losers and the effect of their disenchantment is visible in the slow growth of Indias investor population. China has over 25 million investors, while India, with all its rapid development and its 130- year old stock exchange culture has only 19 million investors. It is just over a decade since the setting up of the automated National Stock Exchange (NSE) led to a paradigm shift in the Indian capital market; and eight years since we opted for dematerialisation of shares. Together, they ensured the switch to paper-less trading and propelled a dramatic increase in trading volumes and growth. The conversion of the Bombay Stock Exchange (BSE) into a modern, national bourse completed the change in profile of Indias capital market. Ten years later, the strongest message emanating from the Securities and Exchange Board of Indias (Sebi) sweeping 252-page report on the demat scam is the need to take stock again. Our frontline capital market intermediaries have done a commendable job in leading the reform process and transforming our markets, but 3


Sebis investigation points to the need for another round of action and a reexamination of systems, processes, accountability, statutory provisions and dependence on IT vendors. We need to look beyond the cornering of allotment in 23 Initial Public Offerings (IPOs) through tens of thousand fictitious demat accounts. Although these details occupy over 210 pages of the Sebi report, the more frightening systemic issues are raised by a special investigation of the National Securities Depository Ltd (NSDL). India has adopted a separate depositories legislation that is obviously aimed at providing a measure of independence to depositories. While share depositories are the only market intermediary to have their own statute, NSDL has always claimed that supervision of DPs is entirely the responsibility of Sebi and it has no selfregulatory function either. At the same time, NSDL apparently considers itself free and independent enough to enter other businesses without permission from the market regulator and now it seems, without adequate internal preparedness. THE SIGNIFICANCE & HISTORY OF CAPITAL MARKET The capital market is a place where the suppliers and users of capital meet to share one anothers views, and where a balance is sought to be achieved among diverse market participants. The securities decouple individual acts of saving and investment over time, space and entities and thus allow savings to occur without concomitant investment. Moreover, yield- bearing securities makes present consumption more expensive relative to future consumption, inducing people to save. The composition of savings changes with less of it being held in the form of idle money or unproductive assets, primarily because more divisible and liquid assets are available. The capital market acts as a brake on channeling savings to lowyielding enterprises and impels enterprises to focus on performance. It continuously monitors performance through movements of share prices in the market and the threats of takeover. This improves efficiency of resource mutilation and thereby significantly increases returns on investment. As a result, savers and investors are not constrained by their individual abilities, but facilated by the economys capability to invest and save, which inevitably enhances savings and investment in the economy. Thus, the capital market converts a given stock of investible resources into a larger flow of goods and services and augments economic growth. In fact, the literature is full of theoretical and empirical studies that have established causal robust (statistically significant) two-way relation between the developments in the securities market and economic growth. The Indian capital markets dates back to the 18th century when the securities of the East India Company were traded in Mumbai and Kolkata. However, the

orderly growth of the capital market began with the setting up of The Stock Exchange, Bombay in July 1875 and Ahmedabad Stock Exchange in 1894. Eventually, 22 other Exchanges in various cities sprang up. Given the significance of capital market and the need for the economy to grow at the projected over 8 percent per annum, the managers of the Indian economy have been assiduously promoting the capital market as an engine of growth to provide an alternative yet efficient means of resource mobilization and allocation. Further, the global financial environment is undergoing unremitting transformation. Geographical boundaries have disappeared. The days of insulated and isolated financial markets are history. The success of any capital market largely depends on its ability to align itself with the global order. To realize national aspirations and keep pace with the changing times, the capital markets in India have gone through various stages of liberalization, bringing about fundamental and structural changes in the market design and operation, resulting in broader investment choices, drastic reduction in transaction costs, and efficiency, transparency and safety as also increased integration with the global markets. The opening up of the economy for investment and trade, the dismantling of administered interest and exchange rates regimes and setting up of sound regulatory institutions have enabled this. PRIMARY MARKET The primary is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers. The process of selling new issues to investors is called underwriting. In the case of a new stock issue, this sale is an initial public offering (IPO). Dealers earn a commission that is built into the price of the security offering, though it can be found in the prospectus. Features of Primary Market are:1. This is the market for new long term capital. The primary market is the market where the securities are sold for the first time. Therefore it is also called New Issue Market (NIM). 2. In a primary issue, the securities are issued by the company directly to investors. 3. The company receives the money and issue new security certificates to the investors. 4. Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business. 5. The primary market performs the crucial function of facilitating capital formation in the economy.

6. The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in the new issue market may be raising capital for converting private capital into public capital; this is known as going public. The primary market, which at one time was flooded with a number of issues floated by dubious promoters, depriving gullible investors of their life-time savings has since been transformed. The changes in this area have been epoch-making and include detailing of complete profile of promoters, comprehensive disclosures, the existence of tangible assets and a track record of profit as also reporting end uses of funds to the Company Board as a part of corporate governance, etc. A number of Indian firms have raised money through American Depository Receipts (ADR), Global Depository Receipts (GDR) and External Commercial Borrowings (ECB). Two way fungibility has been permitted to enhance liquidity. During 2005-06, a sum of Rs. 273 billion, as against Rs. 232.71 billion in 2003-04, and the amount raised was next only Hong Kong and way ahead of Japan, Korea & Singapore through primary market. In fact, the corporate sector and governments (Centre and States) together raised a total of Rs. 3.75 trillion from the securities market during 2005. Year 2004 was a very good year for Corporate India. There were nearly 20 initial public offerings including public offers of existing companies. This time the IPOs were backed by good fundamentals and better regulations. The investor got a better buck for his investment. India has come a long way in a decade's time. There have been advancements in technology and there is easy access to the financial markets at lower costs. Such activities have tempted the middle class investor to try out his luck at the markets. The Securities and Exchange Board of India (Sebi), after the unpleasant episodes in the Nineties, decided to have tighter and better norms for IPOs. This has paid off well for the investing community. The result of such norms - only good quality companies line up for IPOs, investors are confident about their investment. Another major initiative is the importance given to the retail investor. Retail investing means reaching out to a wider investor base. This helps in price discovery and real appreciation of the stock prices. Now, this will tempt foreign institutional investors (FIIs) to pump in more funds into India. IPOs that performed well in 2004 were GAIL, ONGC, Biocon, PTC, TCS and NTPC. The Gail offer was oversubscribed 2.5 times the issue size and proved sceptics wrong. The NTPC issues received overwhelming responses and were oversubscribed. IPOs that did not fare well were IBP, IPCL.

The mopping up operations Company Issue (Rs crores) 718.5 39.76 57.58 56.00 10,000 sizeSubscription (times) 3.16 11.3 3.00 13.00 2.80*

IPCL CMC IBP Dredging Corporation ONGC * On the first day of its issue

SECONDARY MARKET The secondary market is the financial market for trading of securities that have already been issued in an initial private or public offering. Alternatively, secondary market can refer to the market for any kind of used goods. The market that exists in a new security just after the new issue, is often referred to as the aftermarket. Once a newly issued stock is listed on a stock exchange, investors and speculators can easily trade on the exchange, as market makers provide bids and offers in the new stock. The institution of central counter party (CCP), which provides full novation and guarantees settlement, has eliminated counter party risk entirely. Over 99 percent of the dematerialization of market capitalization and Straight-Through Processing (STP), mandatory for all institutional trades, have enabled Indian settlement system to function seamlessly, notwithstanding the size and spread.

On a T+2 cycles, all scrips are electronically cleared fully through a central counter party (CCP) on a rolling settlement. The CCP of the exchanges, which operates a tight risk management system and maintains short (T+2) and consistent settlement cycle, is now financially potent to meet the obligations for 4-5 consecutive settlements even if all the trading members default in their obligations. The dynamic risk management system comprises capital adequacy norms, trading and exposure limits, index-based market-wide circuit breakers, margin (mark to market) requirements. The encashability of the underlying of the margins, comprising cash, bank guarantees and securities is evaluated periodically. The real time monitoring of broker positions and margins and automatic disablement of terminals with Value-added Risk (VaR) margining, built on much higher sigma deviation than the best of the markets in the world, has reduced the operational risk to the lowest ebb. In an unfortunate very sharp (over 25 percent in two days) fall of the market in May 2004 the strength of the risk management of the system got tested to the hilt. There was not a single broker failure or default and on the third day (after the two consecutive days of fall) the market functioned as if nothing unusual had happened. Even the CCP was not required to fund any broker- dealers obligations. Secondary marketing is vital to an efficient and modern capital market. Fundamentally, secondary markets mesh the investor's preference for liquidity (i.e., the investor's desire not to tie up his or her money for a long period of time, in case the investor needs it to deal with unforeseen circumstances) with the capital user's preference to be able to use the capital for an extended period of time. For example, a traditional loan allows the borrower to pay back the loan, with interest, over a certain period. For the length of that period of time, the bulk of the lender's investment is inaccessible to the lender, even in cases of emergencies.

BACKGROUND Scrip Based System: It is a traditional and long prevalent system in our country that involves an enormous paper work involving share certificates in paper form and transfer deeds (physical form). The process beginning from buying shares through stock exchanges till getting the certificates duly endorsed in the buyers name in indeed quite complex and time consuming and is riddled with as variety of problems like bad deliveries, for several reasons, e.g., signature differences of transferors, mistake in completing the details in transfer deeds, litigation/disputes in respect of shares purchased, fake certificates, tearing/mutilation of certificates, loss/fraudulent interception of certificates in transit, delays in postal transit to and from the

company, processing time taken by companies in effecting the transfers, cost towards stamp duty @ 0.5 per cent of the market value of shares, and postal/courier charges etc. The system is not an investor friendly and therefore, a revised system is to be implemented. The Need for Establishing Depository Service The Indian Capital market has witnessed unprecedented growth in use of information technology in the past few years. This has made it possible to carry out modernization in trading and settlement systems. Automation of the trading mechanism has given us a trading system comparable with the best in the world. Establishment of a settlement guarantees mechanism removed the counter party risk in stock exchanges. Though the advent of automated trading brought with it several associated benefits such as transparency in trading and equal opportunity for market players all over the country; the problems related to the settlement of trades such as high instances of bad deliveries and long settlement cycles have continued. A transaction covering sale/purchase of securities is completed only after the buyer becomes the rightful owner of the securities and the seller gets the sale consideration. Traditional settlement system involving handling of physical securities gave rise to several settlement risks due to the time that lapsed before trades were settled. After once settled at the stock exchange the transfer of securities involved sending the same along with seller's transfer deeds for registration to the issuer. In many cases the process took more than two months and significant portion of the transactions ended up in bad delivery due to faulty compliance of paper work. Theft forgery, mutilation of certificates and other irregularities were rampant. These are in addition to the issuer's right to refuse the transfer of security. A way out to solve these myriad settlement problems, the Government passed The Depositories Act, 1996 giving retrospective effect to the provisions of the Act from 20th day of September, 1995. The National Securities Depository Limited (NSDL) was inaugurated in Nov 1996 as the first depository in the country. The latest major development, which helped hasten the awakening of the capital market, was that from Jan 4th, 1999, all category of investor can deliver only in dematerialized form with respect to a select list of securities. Concept of a Depository System Depository system essentially aims at eliminating voluminous and cumbersome paper work involved in the script-based system and offers scope for paperless trading through state of-the-art technology. Depository system enables conversion of physical securities in the electronic form through a process of dematerialization (also known as demat) of share certificates and facilitates share transactions and transfers electronically without involving any share certificate or transfer deed. Depository system offers option for converting the shares from electronic form to 9

physical or paper from through a process of rematerialization (also known as remat). DEPOSITORIES IN INDIA National Securities Depository Limited (NSDL) It is an organization promoted by lOBI, UTI and National Stock Exchange of India Ltd. The aim is to provide facilities for holding and handling securities in electronic form. Subsequently; SBI (acquired a 4.76 per cent in NSDL), HDFC bank, Deusche bank, Dena Bank, Canara Bank, Global Trust Bank, Standard Chartered bank, Citibank NA and HSBC have acquired stake in NSDL. It commenced its operations in November 1996. Its headquarter is situated at Mumbai. It is holding and handling securities in electronic form. It facilitates faster settlement cycles. It provides services related to transactions in securities. It interfaces with the investors through its agents called depository participant (DPs). As a depository, NSDL (i) acts as a custodian as well as legally transfer beneficial ownership, (ii) Reduces settlement risk by minimizing the paper work involved in trading, and settling and transferring securities. NSDL offers the following benefits: (a) Dematerialization, (b) Rematerialization, (c) Electronic settlement trades in stock exchanges connected to NSDL, (d) Pledging/ hypothecation of dematerialized securities against bank loan, (e) Electronic credit of securities, (f) Receipt of non-cash corporate benefits such as bonus in electronic form, (g)Other services viz, holding debt instruments in the same account, availing stock lending/ borrowing facility etc. Central Depository Services (India) Ltd. (CDSL). It is the second depository in the country, after NSDL. It is promoted by the Bombay Stock Exchange (BSE), Bank of India, Bank of Baroda, HDFC Bank, State bank of India. The functions rendered by this depository is almost similar that of the NSDL.

Role of Depository Depository is an organization where the securities of an investor are held in electronic form through the medium of Depository Participants (DPs). It enables surrender and withdrawal of securities to and from the depository through the process of demats and remats. It maintains investors holdings in electronic form.


Effect settlement of securities traded in depository made on the stock exchanges. Carries out settlement of traders not done on the stock exchanges (off-market trades) Role of Depository participants A depository participant is a representative in the depository system of an investor. As per the SEBI guidelines, financial institutions/banks/custodians/stock brokers etc. can become depository participants provided they meet the necessary requirements prescribed by SEBI. A depository participant is a first point of contact with the investor. The depository participant serves a link between the investor and the company through the depository in dematerialization of shares and other electronic transactions. Procedure for Opening an Account with a Depository Participant An investor can open more than one account in the same name with the same DP and also with different DPs. To open an account first an investor has to approach a DP and fill up an account opening form. The account opening form must be supported by

Proof of Identity: Signature and photograph of investor must be authenticated by an existing demat account holder or by investor's bank. Alternatively, one can submit a copy of a valid Passport, Voters Id Card, Driving License or PAN card with photograph.

Proof of Address: A copy of ration card / passport / voter ID / PAN card / driving license / bank passbook as proof of address. (Investor should carry original documents for verification by an authorized official of the depository participant, under his signature.)

Execution of Agreement with DP: Further investor has to sign an agreement with DP in a depository prescribed standard format, which details investor's and DPs rights and duties. DP should provide investor with a copy of the agreement and schedule of charges for his future reference.

The DP will open investors' account in the system and give an account number, which is also called BO ID (Beneficiary owner Identification number). The demat account must be opened in the same ownership pattern in which the securities are held in the physical form e.g. if one share certificate is in your individual name and another certificate is jointly with some other, two different 11

accounts would have to be opened. In case of change of his address an Investor should immediately inform his/her DP, who in turn will update the records. This will obviate the need of informing different companies. Benefits of Depository Services

A safe, convenient way to hold securities; Immediate transfer of securities; No stamp duty on transfer of securities; Elimination of risks associated with physical certificates such as bad delivery , fake securities, Delays, thefts etc.; Reduction in paperwork involved in transfer of securities; Reduction in transaction cost; No odd lot problem, even one share can be sold; Nomination facility; Change in address recorded with DP gets registered with all companies in which investor holds securities electronically eliminating the need to correspond with each of them separately; Transmission of securities is done by DP eliminating correspondence with companies; Automatic credit into demat account of shares, arising out-of bonus/split/consolidation/merger etc.

DEMATERIALISATION: Definition: Dematerialization is a process by which the physical share certificates of an investor are taken back by the Company and an equivalent number of securities are credited in electronic form at the request of the investor. An investor will have to first open an account with a Depository Participant and then request for the dematerialization of his share certificates through the Depository Participant so that the dematerialized holdings can be credited into that account. This is very similar to opening a Bank Account. In order to dematerialise physical securities held by an investor, he has to fill in a DRF (Demat Request Form) which is available with the DP and submit the same along with physical share certificates one wishes to dematerialise. Separate DRF has to be filled for each ISIN Number.


Procedure: Surrender certificates for dematerialisation to your depository participant. Depository participant intimates Depository (NSDL or CDSL) of the request through the system. Depository participant submits the certificates to the registrar of the Issuer Company. Registrar confirms the dematerialisation request from depository. After dematerialising the certificates, Registrar updates accounts and informs depository of the completion of dematerialisation. Depository updates its accounts and informs the depository participant. Depository participant updates the demat account of the investor.

REMATERIALISATION: Rematerialisation is the process by which a client can get his electronic holdings converted into physical certificates. The client has to submit the rematerialisation request to the DP with whom he has an account. The DP enters the request in its system which blocks the client's holdings to that extent automatically. The DP releases the request to NSDL and sends the request form to the Issuer/ R&T agent. The Issuer/ R&T agent then prints the certificates, dispatches the same to the client and simultaneously electronically confirms the acceptance of the request to NSDL. Thereafter, the client's blocked balances are debited. Features:

A client can rematerialise his dematerialised holdings at any point of time. The rematerialisation process is completed within 30 days. The securities sent for rematerialisation cannot be traded.


The client will submit a request to the DP for rematerialisation of holdings in its account. On receipt of the request form, the DP will verify that the form is duly filled in and issue to the client, an acknowledgement slip, signed and stamped. The DP will verify the signature of the client as on the form with the specimen available in its records. If the signatures are different the DP will ensure the identity of the client. If the form is in order the DP will enter the request details in its DPM (software provided by NSDL to the DP). While entering the details, if it is found that the client's account does not have enough balance, the DP will not entertain the request. The DP will intimate the client that the request cannot be entertained since the client does not have sufficient balance. 13

If there is sufficient balance in the client's account, the DP will enter the request in the DPM and the DPM will generate a Rematerialisation Request Number (RRN). The RRN so generated is entered in the space provided for the purpose in the rematerialisation request form. Details recorded for the RRN should be verified by a person other than the person who entered the data. The request is then released to the DM by the DP. The DM forwards the request to the Issuer/ R&T agent electronically. The DP will fill the authorisation portion of the request form. The DP will then despatch the request form to the Issuer/ R&T agent. While processing the request, the Issuer/ R&T agent may report some objections. Depending on the nature of objection, the Issuer/ R&T agent may reject the request or process it partially, seeking rectification for the remaining, and send an objection memo to the DP. The Issuer/ R&T agent accepts the request for rematerialisation prints and despatches the certificates to the client and sends electronic confirmation to the DM. The DM downloads this information to the DPM and the status of the rematerialisation request is updated in the DPM. The DP must inform the client about the changes in the client account following the acceptance of the request.


The client has to mention the lot type in the rematerialisation request form. Securities sent for rematerialisation cannot be traded. Before initiating a rematerialisation request in a security the client must ensure that he has sufficient free balances in that security in his depository account.

DEMAT ACCOUNTS A demat account, the abbreviation for dematerialized account, is a type of banking account which dematerializes paper-based physical stock shares. Dematerialization signifies conversion of a share certificate from its physical form to electronic form for the same number of holding which is credited to your demat account which you open with a Depository Participant (DP). Demat has resulted in the elimination of possible mutilated certificates, lost certificates, postal delays and counterfeit shares. Now it is safe, secure and convenient buying, selling and transacting stocks without suffering endless paperwork and delays. You can convert your securities to electronic format with Demat Account. Securities registered in your name are surrendered to depository 14

participant (DP) and these are sent to the respective companies who will cancel them after "Dematerialization" and credit your depository account with the DP. The securities on Dematerialization appear as balances in your depository account. These balances are transferable like physical shares. If at a later date, you wish to have these "demat" securities converted back into paper certificates; the Depository helps you to do this. Advantages of a demat account Reduces brokerage charges. Makes pledging/hypothecation of shares easier. Shares bought or sold are transferred in your name on the very next day of pay out. In case of physical shares, transfer of ownership takes 30 days or sometimes even more. Avoids confusion in the ownership title of securities. Provides easy receipt of public issue allotments. It also helps you avoid bad deliveries caused by signature mismatch, postal delays and loss of certificates in transit. It eliminates risks associated with forgery, counterfeiting and loss due to fire, theft or mutilation. Demat account holders can also avoid stamp duty (as against 0.5 per cent payable on physical shares), avoid filling up of transfer deeds, and obtain quick receipt of such benefits as stock splits and bonuses. The concept of an odd lot in respect of dematerialized shares stands abolished, i.e. in the demat mode, market lot becomes one share. Facility for freezing / locking of investor accounts, which enables you to make your account non-operational, for instance if you are abroad. Investors prefer to buy shares which are already in dematerialized form. Trading in the demat form eliminates the cumbersome use of paper There is no stamp duty applicable on the value of transferred shares compared to the physical mode. This means a saving of nearly 0.5% in stamp costs. Normally brokerage for demat shares is lower. Procedure 1. Fill demat request form (DRF) (obtained from a depository participant or DP with whom your depository account is opened) 2. Deface the share certificate(s) you want to dematerialise by writing across Surrendered for dematerialisation. 3. Submit the DRF & share certificate(s) to DP. DP would forward them to the issuer / their R&T Agent. 4. After dematerialisation, your depository account with your DP, would be credited with the dematerialised securities.


Important facts: If your shares are held in joint names, be sure to open the account in the same order of names. If X, Y and Z jointly hold 100 shares in a company and have three share certificates all listing X, Y and Z as the first, second and third holders respectively, one account will suffice. For different combinations of names, open separate accounts for each combination. If the three certificates are held as XYZ, YXZ and ZYX, three accounts are necessary. There is no limit to the number of accounts you can open. There is no limit to the number of DPs you can have accounts with. You can even open a multiple-sign demat account, which can be operated by multiple holders, like a joint savings bank account. You can open a demat account even before you acquire your first security. Documents required: The extent of documentation required to open a demat account may vary according to your relationship with the institution. If you plan to open a demat account with a bank, a savings account holder has an edge over the non-account holder. In fact, banks usually offer additional incentives to customers who open a demat account with them. Along with the application form, your photographs (with co-applicants) and proof of identity/residence/date of birth have to be submitted. The DPs also ask for a DP-client agreement to be executed on non-judicial stamp paper.


DEMAT SCAM AN OVERVIEW A unique modus operandi was used in the IPO scam in IDFC and YES bank in which an accused came out with an advertisement in local dailies asking public to click a photograph and also get two copies free of cost. The Ads put out by Roopalben Nareshbhai Panchal, one of the main accused in IPO scam in IDFC and YES bank, saw a large number of people gathering to avail this free service, but least did they know what the photographs would be used for. According to the CBI, the accused used to click photographs and keep one copy for opening fictitious bank and Dematerialised (D-MAT) accounts. There were 6,315 fictitious D-MAT accounts opened for procurement of YES bank shares out of which 6,221 had the same address of "402-403 Shashwat Building, Opposite Gujarat College, Ahmedabad". In the IDFC bank, there were 27,064 fake bank accounts out of which 4,990 had the address of "406 Shashwat Building", 4,971 had common address of "403-Shashwat Building" and 4,946 had an address of "307-Shashwat Building". The modus operandi of Panchal was to obtain photographs of large number of people and once they were available, fictitious names along with these snaps were used to open fictitious bank and D-MAT accounts. Then an application was made for allotment of these shares to the account holders. Once the allotment was made, the shares were transferred to Panchal's account, who in turn passed them to financers. These financers offloaded the shares on the opening day of the listing of shares in the stock market and made illegal gains as list price was higher then allotment price. The IPO scam came to light in 2005 when the private 'Yes Bank' launched its initial public offering. Roopalben Panchal, a resident of Ahmedabad, had allegedly opened several fake demat accounts and subsequently raised finances on the shares allotted to her through Bharat Overseas Bank branches. The Sebi started a broad investigation into IPO allotments after it detected irregularities in the buying of shares of YES Banks IPO in 2005. Major scams:


IDFC Issue YES bank IPO Suzlon Energy Ltd. Sasken Communication Technology Ltd. IL&FS ICICI Bank

Major parties involved: Ms Roopalben Nareshbhai Panchal Dhiren Vora Sugandh Estate and Investments Pvt. Ltd. Karvy DP Financers

Purushottam Ghanshyam Budhwani Shri Manojdev Seksaria Role played by each party Ms. Roopalben Nareshbhai Panchal: Deepak Panchal, his wife Devangi and her sister Roopalben has been in the business of arranging multiple/bogus applications for investing in stock markets since 1983. They had been persuading their relatives and friends to open a bank account through them, and later on the demat accounts also, when paperless trading was introduced in the late 1990s. To increase the scale of his business, Panchal needed more demat and bank accounts. While he could create fictitious names, for photographs he persuaded a photo shop to run a free photo campaign for the public. Mr. Dhiren Vora:


He is known to be a big operator in Ahmedabad and runs several investment firms like H. Nyalchand Financial Services (HNFS). Large corporates, including a large media house based in Ahmedabad, are said to be his clients. In February 2000, Sebi had warned HNFS for non-compliance of norms. Again, in January 2004, Sebi had banned Vora and his two firms, HNFS and Park Light Rolling, on charges of price manipulation. An appeal in the Securities Appellate Tribunal (SAT) revoked his ban, and Vora was back in business within five months. Vora had easy access to big funds and persuaded Panchal to change the scale of what was essentially a small-scale operation till then. Fortuitously for the players concerned, the primary market had started showing signs of revival after several years in the dumps. And, thus, began the game of cornering shares in the retail quota of IPOs.

Sugandh Estate and Investments Ltd.: Parag Jhaveri of Sugandh Estate. Sugandh allegedly collected money from financiers and investors and applied for allotment in the IPOs through a host of friends and relatives. On allotment or refund, these friends passed back the shares or money to Sugandh, who then passed it on to the financiers and investors.

Karvy DP: Panchal couldnt have carried on the business on such a scale without some help. Had the banks and the depository participants (DPs) carried out even a cursory check, the scam would have been caught early on. Banks like Bharat Overseas, Vijaya and HDFC facilitated account opening and funding. And the DPs were reckless in opening demat accounts. In the Yes Bank IPO, Panchal applied through 6,315 demat accounts for 1,050 shares each. In the IDFC issue, he used 27,000 demat accounts to apply for 1,400 shares each. All these demat accounts were opened through Karvy DP. The banking and depository regulations are silent on the number of accounts that can be opened by an individual. But if a bank gets applications for opening 14,000 accounts or a DP gets 1,500 applications in a single day, and most of them coming from a common address, it is hard to believe that this would have gone through without a hitch without some help at least. As per the Sebi order, the Panchals opened 14,000 demat accounts with Karvy DP over two days. Karvy-DP has opened the accounts of the investors by obtaining the supporting documents mechanically and has not taken proper precautions to ascertain the identity or genuineness of the persons and execution of the DP-BO agreements. It entirely relied upon the documents issued by the Scheduled Commercial Bank 19

submitted by the investors as documents in support of "Proof of Identity" and "Proof of Address", even though the same persons opened BO accounts in different names. Karvy-DP did not exercised proper care and precautions while processing of the debit instruction slips for transfer of securities. Financers: Assuming that applications through these huge number of demat accounts in yes bank IPO and IDFC issue were made at the cut-off prices, a back-of-theenvelope calculation shows that an amount of Rs 30 crore in Yes Bank and Rs 129 crore in IDFC was made available to Deepak Panchal. Where did he get this money from? According to market sources, almost 40-50 per cent came from broker financiers, including an Ahmedabad-based media house that has routed the money as a short-term advance to one of the brokers involved in the scam. The rest of it was arranged through IPO financing from banks like Bharat Overseas Bank, Indian Overseas Bank, Vijaya Bank, City Bank, HDFC Bank, ICICI Bank and Standard Chartered Bank. Should it be called the connivance or negligence on the part of bank that IPO finance extended to numerous fictitious individuals? These banks clearly didnt adhere to the know your customer (KYC) rules while opening these accounts and extending loans for the IPO. Purushottam Ghanshyam Budhwani In IDFC, one Purshottham Budhwani got 12.63 lakh shares (8 per cent of the IDFC allotment) from 4,748 demat accounts held with Karvy-DP and Pratik DP. Here again, the addresses and bank accounts of majority of these accounts were the same. Budhwani sold a major chunk of his holding at Rs 61-64 on listing. MECHANISM USED: In any IPO, 35 per cent of the issuing companys shares are reserved for the retail investor. One qualifies as a retail investor if the application amount is not more than Rs 1 lakh (this limit was Rs 50,000 during the Yes Bank IPO). Thats why, an individual, who doesnt qualify as an institutional investor but wants to apply for a large chunk of the IPO shares, has every incentive to try and get around the regulation limit of Rs 1 lakh per retail investor. Panchals and Budhwani applied to the issue through the medium of thousands of fictitious / benami IPO applicants with each of the application being for small value so as to be eligible for allotment under the retail category. These applications were made in fictitious or benami names. The IPO applicants were merely name lenders or non existent. These bogus allotees transferred shares to Panchals or Budhwanis, the syndicate before lising. These shares were sold on the first day of listing and made a windfall gain.


It found that certain entities had cornered IPO shares reserved for retail applicants by making applications in the retail category through the medium of thousands of fictitious/ benami IPO applicants with each application being for small value so as to be eligible for allotment under the retail category. It was also discovered that subsequent to the receipt of IPO allotment, fictitious/benami allottees transferred the shares to those who controlled those accounts who in turn transferred the shares to the persons financing the transactions i.e. those who made available the funds for executing the game plan. The financiers in turn sold the shares on the first day of listing thereby making a windfall gain since the price of allotment was less than the listing price in view of the booming market. In nutshell, a handful of persons virtually monopolized the retail allotment by elbowing out the genuine investors. The Board found that large number of multiple dematerialized accounts with common addresses had been opened by a few entities.

CASE STUDY IDFC (Industrial Development Finance Corporation) IPO Infrastructure Development Finance Company Ltd. (IDFC) came out with an IPO in the recent past. The Initial Public Offer (IPO) of IDFC opened on July 15, 2005 and closed on July 22, 2005. The shares of IDFC were listed on the Stock Exchanges, namely Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) on August 12, 2005. IDFC came out with a public issue of 403,600,000 equity shares of Rs. 10 each for cash at a price of Rs. 34 per equity share aggregating to Rs. 13,72,24,00,000 constituting 35.96 % of the fully diluted post issue paid up capital of IDFC. 403,600,000 EQUITY SHARES

141,260,000 equity shares Offered to retail investors

60,540,000 equity shares offered to non institutional investors

201,800,000 equity shares offered to QIB investors


Pre issue capital of IDFC

1,002,453,512 equity shares.

Post issue capital of IDFC

1,122,453,512 equity shares.

Retail portion

oversubscribed by 5.27 times. oversubscribed by 56.53 times.

Non institutional portion

Central Depository Services Limited (CDSL) and National Securities Depository Limited (NSDL) were advised by the surveillance department of SEBI to furnish the details of large off-market transactions in IDFC shares during the period from July 22, 2005 to August 15, 2005. Information furnished by CDSL: Ms. Roopalben Nareshbhai Panchal had received 39, 43,184 shares from 14,807 dematerialized accounts through off-market transactions on August 11, 2005 and Mr. Purshottam Ghanshyam Budhwani had received 2, 98,412 shares from 1122 dematerialized accounts through off-market transactions on August 08, 2005 i.e. prior to the listing and commencement of trading on the Stock Exchanges. Information furnished by NSDL: Ms Roopalben Panchal had received 32,61,426 shares from 12,257 dematerialized accounts through off-market transactions on August 08, 2005 and Sugandh Estates and Investments Pvt. Ltd. had received 27,08,944 shares from 10181 dematerialized accounts through off market transactions on August 08,2005. Transactions in IDFC Shares by Ms. Roopalben Panchal and her Associates The dematerialized account transaction statement of Roopalben Panchal (DP: Karvy Stockbroking Ltd. Client Id 11920868), as obtained from NSDL, shows that on August 08, 2005 she had received, 12253 Demat accounts * 266 shares each = 32, 59,298 shares


532 Demat accounts *

4 shares each = 2,128 shares

Thus she had received a total of 32, 61,426 shares in off market transactions from 12257 dematerialized accounts. Sr.No. 1 2 3 4 5 6 7 Demat A/c Opening Upto 15.08.04 16.08.04 17.08.04 18.08.04 19.07.05 20.07.05 21.07.05 Total No. of Accounts 5990 2729 195 59 1001 1525 758 12257

Out of the above IDFC shares received by her, she in turn, transferred 32, 61,400 shares to the dematerialized account of 10 entities, the details of which is as below:


As per the information furnished by CDSL, the transaction statement of Roopalben Panchal (DP: Karvy Stock broking Ltd. Client Id 1301440000307503) shows that on August 11, 2005 she had received, 14790 demat accounts * 266 shares each = 39, 34,140 shares 17 demat accounts * 532 shares each = 9,044 shares Thus she had received a total of 39, 43,184 shares through off market transactions from 14,807 dematerialized accounts prior to listing on the stock exchanges. Out of these shares she had received she transferred 38, 91,654 equity shares to the demat accounts of 8 entities listed below:


Roopalben Nareshbhai Panchal. KSBL/1301440000307503 received 266 shares each from 14790 dematerialized accounts aggregating to 3934140 shares and 532 shares each from 17 dematerialized accounts aggregating to 9044 shares aggregating to a total of 39,43,184 shares on 11.08.05. Transferred out 38, 91,654 shares on 11.08.05, 12.08.05 and 13.08.05.

Transferred 10,00,000 shares to Devangiben Dipakbhai Panchal.

Transferred 8,290 shares to Bhargav R. Panchal

Transferred 11,990 shares to Jayantilal Jitmal

Transferred 11,00,000 Shares to Bhanuprasad Dipakkumar Trivedi

Transferred 50,000 shares to Shilpa Rajan Dapki

Transferred 17,00,000 to Dipak Jashvantlal Panchal

Transferred 11,000 shares to Hina Bhargav Panchal Transferred 10,374 shares to Dipak Jashvantlal Panchal

It was further observed that of these 14,807 demat accounts, the number of demat account holders with similar names were as follows: Name Vania Patil Ranka Pandya Desai Rathi Verma Gandhi Trivedi Number of account holders 976 976 936 1000 1000 999 1000 991 995 Name Barot Vala Pathak Bhatt Number of account holders 1000 999 975 977


Transactions in IDFC Shares by Sugandh Estates and Investments Pvt. Ltd. and its Associates As per the information furnished by NSDL, the transaction statement of Sugandh Estates and Investments Pvt. Ltd. (DP: Karvy Stockbroking Ltd. Client Id 14405199) shows that on August 08, 2005 i.e. prior to the date of listing on the stock exchanges, it had received, 10,178 demat accounts * 266 shares each = 27, 07,348 shares 3 demat accounts * 532 shares each = 1,596 shares Thus it had received a total of 27, 08,944 shares in off market transactions from 10,181 dematerialized account-holders.


Further, all the above 10,181 dematerialized account-holders have their bank accounts with Vijaya Bank Ambavadi Branch, Ahmedabad - 380015 and the bank account numbers appear to run in continuous serial numbers of different batches. Transactions in IDFC Shares by Pushottam Ghanshyam Budhwani and his Associates The transaction statement in the dematerialized account of Pushottam Ghanshyam Budhwani (Client Id: 1202020000006413) held with DP Pratik Stock Vision Pvt Limited and client ID: 130144000247208 held with Karvy-DP, was obtained from CDSL. It is seen that on August 8, 2005 Purshottam Budhwani received, 27

1,121 demat accounts * 266 shares each = 2, 98,412 shares 2,821 demat accounts * 266 shares each = 7, 50,386 shares 532 demat accounts * 1 share each = 532 shares 172 demat accounts * 266 shares each = 45, 752 shares


Thus Purshottam Budhwani had received 10, 95,082 IDFC shares from 4116 dematerialized accounts in his CDSL dematerialized account held with Karvy-DP and Pratik-DP. It was found that out of the above 4116 dematerialized account-holders that had made off-market transfers to Purshottam Budhwani, 1294 holders have their dematerialized accounts with Pratik- DP and 2822 holders have their dematerialized accounts with Karvy-DP. All the 2822 dematerialized accounts held with Karvy-DP have been opened on the same date i.e. July 22, 2005. Based on information obtained from NSDL, it is seen that during August 10-13, 2005, Purshottam Budhwani had received 266 shares each from 632 dematerialized account-holders aggregating to 1,68,112 shares in his NSDL dematerialized account held with the DP Anagram Stock Broking Ltd. (Anagram- DP) (DP Id: IN302201 Client Id: 10093022). It is seen that out of these 632 dematerialized account-holders 239 have their dematerialized accounts with ING Vysya Bank Ltd. (DP Id:IN300610) and the balance 393 have their dematerialized accounts with HDFC Bank Ltd. (DP Id: IN301549).


From the above discussions, it is seen that Purshottam Budhwani had received IDFC shares in his CDSL (Karvy-DP and Pratik-DP) and NSDL (Anagram- DP) dematerialized accounts through off-market transactions from as many as 4748 dematerialized account-holders. It was found that Purshottam Budhwani has adopted a similar modus operandi as in the IDFC IPO in respect of various other IPOs during the year 2005 such as Suzlon Energy Ltd. SPL Industries Ltd. Shoppers Stop, Provogue India Ltd. Nectar Life sciences Ltd. IL&FS Invest smart Ltd. Gokuldas Exports Ltd. Gateway Distriparks Ltd. etc. Transactions in IDFC Shares by Manojdev Seksaria and his Associates Manojdev Seksaria, had his dematerialized account with Karvy-DP (client ID: 1301440000051951) has received, 1,989 demat accounts * 266 shares each = 5, 29, 074 shares 36 demat accounts * 266 shares each = 9,576 shares


All the above Seksarias including Manojdev Seksaria having a common address and a common surname / part-name have together received a total of 538650 shares in off-market transactions on August 12, 2005. A summary of the details of dematerialized accounts that apparently served as conduits for cornering IDFC IPO shares for Roopalben Panchal, Sugandh, Purshottam Budhwani and Manojdev Seksaria is as below:


These shares were transferred to the following entities: Zenet software Ltd. Taurus infosys Ltd. Rajan V Dapki Bhargav R Panchal Jayantilal Jitmal Seer Finlease Pvt. Ltd. Excel Multitech Ltd. Devangi Deepakbhai Panchal Hasmukhlal N Vora Welvet Financial Advisors Pvt. Ltd. Jayesh P Khandwala (HUF) Hina Bhargav Panchal Gautam N Jhaveri Bhanuprasad Dipakkumar Trivedi Deepak Jashwantlal Panchal


CASE STUDY YES BANK LTD. The IPO scam came to light in 2005 when the private 'Yes Bank' launched its initial public offer, which saw one Roopalben Panchal of Ahmedabad opening multiple fake demat accounts and subsequently raising finances on the shares allotted to her through the Bharat Overseas Bank branches. The country's premier depository National Securities Depository Ltd (NSDL) has said SEBI has not followed the "principles of natural justice" while blaming NSDL on the YES Bank IPO scam. "In this case (YES Bank IPO case), NSDL has not been heard at all before passing any orders. Nor has SEBI given any documents or evidence to NSDL which form the basis of SEBI's conclusion regarding NSDL," it said in a letter addressed to Mr G Anantharaman, Whole-Time Member, SEBI, who passed the order on the IPO scam. In a detailed "objections" to the SEBI's order, NSDL has put the ball back in the regulator's court by saying that the matter concerning the "important regulation" on market manipulation was entirely "within the jurisdiction of SEBI". The letter notes, `As far as market manipulation is concerned, the SEBI has very rightly not assigned any supervisory role or cast any obligation on NSDL for administering the provisions of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003. Therefore, NSDL is not concerned with this very important regulation. It is entirely within the jurisdiction of SEBI.' "As the order has been passed against NSDL without following the principles of natural justice, without giving NSDL the material and documents which SEBI seeks to rely on, the order suffers from grave legal defects," the NSDL letter said. "You have given an opportunity to those persons against whom you have issued directions to file objections within 15 days from the date of this order and avail of an opportunity of personal hearing at SEBI, if so desirous," the letter said further. In its order on YES Bank IPO, the SEBI had said: "It is matter of concern that NSDL, which is a self-regulatory organisation and within whose regulatory domain Karvy-DP falls, could not detect in advance the apparently systemic deficiencies in Karvy-DP".


When the Securities Exchange Board of India (Sebi) started scanning an entire spectrum of IPOs launched over 2003, 2004 and 2005, it ended digging up more dirt and probably prevented a larger conspiracy to hijack the market.

Here is a lowdown on the IPO scam: >What is the scam? It involved manipulation of the primary marketread initial public offers (IPOs) by financiers and market players by using fictitious or benaami demat accounts. While investigating the Yes Bank scam, Sebi found that certain entities had illegally obtained IPO shares reserved for retail applicants through thousands of benaami demat accounts. They then transferred the shares to financiers, who sold on the first day of listing, making windfall gains from the price difference between the IPO price and the listing price. > What is an IPO? An IPO is the first sale of an entity's common shares to public investors. When an entity wants to enter the market, it makes its share available to common investors in form of an auction sale. Each application for an IPO has to be within a cut-off figure, which is eligible for allotment in the retail investors category. But in this case, financiers and market players illegally cornered these retail investors' shares. > When was the scam detected? The IPO scam came to light in 2005 when the private 'Yes Bank' launched its initial public offering. Roopalben Panchal, a resident of Ahmedabad, had allegedly opened several fake demat accounts and subsequently raised finances on the shares allotted to her through Bharat Overseas Bank branches. The Sebi started a broad investigation into IPO allotments after it detected irregularities in the buying of shares of YES Banks IPO in 2005. > What triggered the Sebi probe? 33

On October 10 last year, an Income Tax raid on businessman Purushottam Budhwani accidentally found he was controlling over 5,000 demat accounts. Sebi finds this suspicious. On December 15, Sebi declared results of its probe, how a few people cornered a large chunk of YES Bank IPO shares. On January 11 this year, Sebi discovered huge rigging in the IDFC IPO. Roopalben Panchal was found to be controlling nearly 15,000 demat accounts. It was found that once they obtained these shares, the fictitious investors transferred them to financiers. The financiers then sold these shares on the first day of listing, reaping huge profits between the IPO price and the listing price. The Sebi report covered 105 IPOs from 2003-2005. The Sebi probe covered several IPOs dating back to 2005, 2004 and 2003 to detect misuse. These included the offerings of Jet Airways, Sasken Communications, Suzlon Energy, Punj Lloyds, JP Hydro Power, NTPC, PVR Cinema, Shringar Cinema and others. A lot more dubious accounts across several IPOs are expected to tumble out in the next few days. It also detected similar irregularities in the IDFC IPO, in which over 8 per cent of the allotment in the retail segment was cornered by fictitious applicants through multiple demat accounts. > Who is Roopalben Panchal? Roopalben Panchal of IndiaBulls Securities is allegedly the mastermind of the scam. Finance Ministry officials are expected to act against her soon. > How is this different from Harshad Mehtas scam? The securities scam involved price manipulation in the secondary market, read stocks. Whereas in this case, the manipulation happened in the primary market even before the shares (IPOs) entered the stocks market. This time, fraudsters targeted the primary market to make a quick buck at the expense of the gullible small investors. Direct Participants (DPs) used retail applicants shares for reaping benefits in the stock market. > How big is the scam?


Apart from the YES Bank fraud, Sebi reportedly has definite data about two IPOs where retail allotments were rigged, but market observers believe the scam is far bigger. The Yes Bank and IDFC cases are only a tip of an iceberg, say analysts. The Sebi probe has identified more operators and some market intermediaries involved in the misuse of the initial allotment process in public offerings dating back to 04-05. The Income-Tax Department in Ahmedabad has found that two major accused, Panchal and Sugandh Investments, have together made Rs 60.62 crore in 18 months.

Role of Depository Participants > Suzlon Energy IPO: Rs 1,496.34 cr (September 23-29, 2005)

Key operators used 21,692 fictitious accounts to corner 3,23,023 shares which is equal to 3.74 per cent of the total number of shares allotted to retail individual investors. > Jet Airways IPO: Rs 1899.3 crore (Feb 18-24, 2005)

Key operators used 1,186 fake accounts for cornering 20,901 shares which is equal to 0.52 per cent of the total number of shares allotted to retail investors. > National Thermal Power Corporation IPO Rs 5,368.14 crore (Oct 7-14, 2004). 12,853 afferent accounts were used for cornering 27, 50,730 shares representing 1.3 per cent of the total number of shares allotted to retail investors. > Tata Consultancy Services IPO: Rs 4,713.47 crore and 14,619 'benami' accounts were used to corner 2, 61,294 shares representing 2.09 per cent of the total shares allotted to retail individual investors. On the IPO applications in fictitious names, the letter said "NSDL is not concerned in any manner with this activity as applications of investors to an IPO are forwarded to the Registrar to an Issue. Scrutiny of applications is done by the Registrar to an issue...NSDL has no role to play when applications for an IPO are made," the letter said. Lessons from Yes Bank IPO scam


NO SYSTEM is foolproof from someone determined to undermine it. That is perhaps what the manipulation of the allotment process in Yes Bank's Initial Public Offering proves. A combination of factors appear to have led to the scam. It was a subversion of the system by one individual who applied to the IPO in 6,315 different names, from the same address, to get a large number of shares allotted. It was also a systemic failure as the depository participant (Karvy Stock Broking, in this case) failed to notice the abnormal fact of the same address supporting more than 6,000 different names. Then, there is the possibility of collusion at the bank branch that extended a loan to so many `applicants' with the same address. This can be ascertained only by an investigation by the bank or the Reserve Bank of India. One cannot help asking the question though: Whatever happened to prudent lending practices that would have required the bank to verify the address of each borrower as also his personal identity? To be sure, the Yes Bank IPO may not be the only one where the allotment process was manipulated. There are probably others out there who are attempting or have attempted the same though the full picture may never be known. How do we prevent such acts that are obviously wrong but also patently unfair to investors who stick to the rulebook and are not allotted any shares? There is a suggestion to review the entire system of quotas for retail, high-net-worth individuals and institutional investors. It would be wrong to do away with a system that is desirable, just because one individual has manipulated it. The quota system was, after all, instituted to ensure that the small retail investor is not discriminated against in the allotment process. There is also talk that all depository accounts with the same address will now come under the scanner. While this will, no doubt, help identify benami accounts and those opened with fictitious names, care ought to be taken because there could also be genuine cases of more than one account having the same address. This will typically happen where more than one member of a family has an account or where an individual has an account in his name and also in that of his HUF. There could also be cases of an investor who already has one demat account with one participant opening a new one with another just to take advantage of lower transaction charges. Just as there is nothing wrong having multiple savings bank accounts so also with depository accounts. The problem arises only when such multiple accounts are misused. Any filtering exercise to identify fictitious accounts ought to, therefore, be done at the depository level and not at the depository participant level. There also needs to be coordinated action by the two depositories NSDL and CDSL, in this respect.


One suggestion by Mr C. B. Bhave, CMD, NSDL, is to allot a unique identification number to every investor who will have to quote it in his IPO application. This is a workable suggestion that deserves serious thought. If allotting a unique identification number is a cumbersome process, the regulator can consider using the income-tax permanent account number (PAN) itself as a unique identification tag. It is now mandatory to quote the PAN for all applications exceeding Rs 50,000 in value; the regulator can consider making it mandatory for all investors regardless of the value of shares applied for. The only problem is that not all investors are income-tax assessees and, therefore, may not have a PAN number. For instance, housewives and retired senior citizens may be investing in the stock market but may not be assessees. However, even a unique identification number cannot help where there is a systemic failure, as in the Yes Bank IPO case. Finding an answer to the following questions that arise from the episode may help. First, how did the depository participant fail to notice so many accounts with the same address even assuming that they were opened over several months? The sheer number ought to have caught the eyes of the depository participant. Crucial is a periodic scan of all accounts with a depository participant not just to weed out benami and fictitious accounts but also to prevent other malpractices. Second, how did the registrar to the issue fail to notice thousands of applications with the same address? The mere fact that an IPO generates tens of thousands of applications cannot be an excuse, given that the entire process of allotment is computerised. Does the registrar scan the list of successful allottees at all? Finally, how did the applicant manage to secure loans under fictitious names to invest in the IPO? This is the most important question of all and deserves to be investigated fully. ACTIONS TAKEN: SEBI has issued suitable directions against the above mentioned key operators prohibiting them from dealings in securities. The financiers and other related entities have been directed not buy, sell or deal in IDFC / YBL shares and in other ensuing IPOs. As regards, opening of dematerialized accounts in the names of fictitious / benami entities, SEBI has directed the major DPs involved, namely, Karvy-DP and Pratik-DP not to open new dematerialized accounts till further directions. References have been made to RBI and Income Tax department communicating the findings of SEBI. In addition, the following actions have been taken: 1. Karvy Stockbroking Ltd. and Pratik Stock Vision P Ltd., the Depository Participants involved in the said two IPOs have been inspected by SEBI. The 37

2. 3. 4. 5.


7. 8.


inspection has revealed numerous violations by these DPs. Besides the detailed verification relating to the dematerialized accounts opened by Karvy-DP has revealed that Karvy-DP has violated the various norms prescribed by SEBI with regard to the operations of a DP including failure to follow the know your client norms laid down by SEBI. Karvy Computershare Ltd., the Registrar to the Issue in the two IPOs has been inspected. References have been made to RBI, Income Tax department and CBI communicating the findings of SEBI in this matter. SEBI has also filed complaints with CBI. SEBI is initiating prosecution proceedings against the concerned entities. As directed by SEBI, the depositories i.e. NSDL and CDSL have advised their respective DPs to verify the genuineness of the dematerialized accountholders where 20 or more dematerialized account-holders have a common address and to close those dematerialized accounts where the DPs are unable to do the above verification. During the course of the above verification it was noticed that certain DPs had large number of dematerialized account-holders sharing a few common addresses. Some of these DPs have been inspected by the depositories as well as an independent Chartered Account Firm engaged by SEBI. The above inspections of the DPs disclosed various irregularities and appropriate actions will be taken against the concerned DPs. The depositories have been directed to form a co-ordination committee to co-ordinate with the surveillance department of SEBI for monitoring abnormal transactions in dematerialized accounts. As an interim measure to check misuse through off- market transfer prior to listing, SEBI, vide circular dated January 19, 2006, has advised the depositories that in case of IPOs they should activate the ISINs only on the date of commencement of trading on the stock exchanges. Since some of the demat accounts that were used in the IPOs of Yes Bank and IDFC were opened during the year 2003, the depositories were advised to identify all the other IPOs during 2003, 2004 and 2005 wherein the same modus operandi has been adopted by the identified entities and to identify other entities besides those already identified by SEBI who were suspected to be indulging in the same modus operandi.


LOOPHOLES IN THE SYSTEM: Karvy Stock Broking ltd.: As a participant it had opened accounts of investors by obtaining the supporting documents mechanically and had not taken proper precautions to ascertain the identity and genuineness of the persons. The depositories also observed in their reports that the karvy had entirely relied upon the documents issued by the scheduled commercial banks submitted by the investors as documents in support of proof of identity and proof of address even though the same persons opened their beneficial owner accounts in different names. The reports also mentioned that it had not exercised proper care and precautions while processing the debit instruction slips for transfer of securities and that such slackness and deficiencies in procedures and manner of conducting the depository participant operations were not in conformity with the procedures prescribed by the Board and the two depositories. SEBI: The primary function and duty of the Board is to protect the interests of the investors in securities and to regulate the securities market. The preamble to the Act which declares the dominant purpose also makes it clear that the Board has been established for this purpose. This duty is performed under sections 11 and 11B of the Act which are the very soul and heart of it. Under section 11, as it then stood, the Board could regulate the securities market by taking such measures as it thought fit but it felt handicapped when it came to issuing 39

directions to any market intermediary or persons associated with the securities market. Negligence of Financiers: The commercial banks did not adhere to Know Your Customer norms facilitating misuse of IPO finance to ineligible borrowers. Banks extended IPO finance to fictitious/benami individuals without appropriate due diligence to establish their identity or existence. Apart from providing intra day funding of margin money to brokers, the bank had extended huge amounts to a group of accounts through these fictitious/benami individuals in violation of RBI directive on limits on funding of IPOs, (which specified, inter-alia, a limit of Rs.10 lakh per individual).The internal control system has failed to arrest the above irregularities. It also did not act upon the alerts emanated from the internal audit. Collection of account payee cheques of various individuals who are not the customers of the bank, besides crediting the proceeds of the refund orders to accounts other than the accounts of the payees. Thus the financiers failed to monitor the unusual and suspicious transactions in the account and failed to verify the end use of funds with respect to the loans granted. No regulation: There is hardly any regulation on demat accounts. There is no limit on the accounts a person can open with a depository participant nor there is limit on the number of depository participants one can have their account with. This makes it difficult for the regulators to keep a track on transactions made by a person. Negligence of NSDL: NSDL never could capture the fact that there were agents being used for opening of demat account by Karvy DP. This is in spite of the six monthly inspections conducted by NSDL at various locations of Karvy. This leads to the impression that Inspections were perfunctory besides facilitating fictitious / benami / multiple accounts. If the DP work related to account opening is not being monitored by NSDL, then this raises a question regarding the purpose of the activity of Inspection or visits by depository. In fact the inspection forms include sub sections for checking account opening. NSDL never physically verifies the DP prior to recommending the registration of DP with SEBI. This is quite serious as it may get a DP recommended without complete knowledge of where it exists. Integrity of Account creation dates, which are essential for maintaining integrity of any financial systems, has not been maintained in NSDL systems. NSDL has never had the application code verified by any third party. While maker and checker is an established process in financial industry, this has not been followed till date by NSDL in its own systems as the DM software never verifies any data except for the fact that it came from a valid DP id. Physical verification has revealed that on the mainframe that hosts the DM and database there is no evident control on creation of users and groups. There is no evidence


of monitoring any of the access logs on the mainframe. There is no documentation to disclose the management intent to monitor or audit the logs created on mainframe. NSDL till date has made no byelaws for any internal monitoring review and control of its processes as required under Section 26 (p) of Depositories Act, 1996 as well as section 34 of SEBI (Depositories and Participants) regulations, 1996. Auditors have pointed this out for IS (Information System) audit at different times but have never been implemented.

GUIDELINES INTRODUCED: 1. Verification By Depositories: SEBI vide circular dated SMDRP/Policy/CIR- 36/2000 dated August 4, 2000, has prescribed detailed procedure to be followed by all depository participants at the time of opening beneficiary account. The said circular prescribed the documents which can be accepted by the DPs for the purpose of proof of identity and proof of address. In respect of proof of identity the documents prescribed are PAN Id, Voter Id, Ration Card, Passport etc and for proof of address the documents prescribed are Telephone Bill, Electricity bill etc. Subsequently, vide circular ref: MRD/DoP/Dep/Cir-29/2004 dated August 24, 2004 SEBI stipulated that an identity card / document issued by Scheduled Commercial Banks containing the applicants photo / address may be accepted as POI and POA. The circular further clarified that the aforesaid documents are the minimum requirement for opening a BO Account. The Depository Participants (DPs) must verify the copy of the document with the 41

original before accepting the same as valid. While opening a BO Account, the DPs are required to exercise due diligence while establishing the identity of the person to ensure the safety and integrity of the depository system. All depository participants are required to comply with procedures prescribed in the said circular while opening any client account to ensure that none of the accounts are opened without obtaining valid proof of identity and proof of address. Thus, the primary documents essential for opening client account with depository participant are proof of identity and proof of address. Therefore, every depository participant should exercise utmost care, due diligence while opening beneficiary accounts in terms of compliance of the circular to ensure that benami accounts are not opened. All the documents submitted by the applicants should be verified with the original documents and only upon satisfaction of the authenticity of the documents submitted that depository participant should proceed with opening clients account. 2. PAN made essential: PAN has been made mandatory for transacting in the Futures and Options market as well as for operating a Beneficiary Owner (BO) Account in the Depository system. Moreover to further strengthen the Know Your Client (KYC) norms in the cash market with a view to facilitate sound audit trail, it has been decided that PAN will be mandatory for all the entities/persons who are desirous of transacting in the cash market with effect from October 1, 2006. In order to strengthen the Know Your Client (KYC) norms and identify every participant in the securities market with their respective PAN thereby ensuring sound audit trail of all the transactions, it has been decided that PAN would be the sole identification number for all participants transacting in the securities market, irrespective of the amount of transaction. The intermediaries are advised in this regard as under: To put in the necessary systems in place so that all the individual databases of their clients and clients transactions are linked to the PAN details of the client with which detailed analysis can be made. To build the necessary infrastructure for enabling accessibility and query based on PAN thereby enabling retrieval of all the details of the clients that is available including the transactions done by them. To collect copies of PAN cards issued to their existing as well as new clients by the Income Tax Department and maintain the same in their record after verifying with the original.

3. Extension of Powers with SEBI


On the basis of the past experience of the Board, a need was felt to amend the Act to enable it to issue directions, whenever necessary, for the purpose of protecting the interests of investors and the securities market. By a parliamentary act board is now enabled to issue directions to any intermediary of the securities market or any other person associated therewith if it thinks it is necessary in the interests of investors or orderly development of securities market or to prevent the affairs of any intermediary from being conducted in a manner detrimental to the interests of investors or securities market or to secure the proper management of any such intermediary. For regulating the securities market and with a view to protect the same, the Board started issuing interim orders/directions under this newly added provision to keep the erring intermediaries or other delinquents associated therewith out of the market. The Board can now regulate the market and send the right signals to others. The Board could impose monetary penalties also in addition to or other than penalties of suspension or cancellation of certificate of registration which may not be appropriate in all cases of defaults.

Post-demat scam, stricter exposure norms for banks

In the wake of the demat scam, the RBI will come out with stricter group exposure norms for banks. Exposure limits for individuals may also be revised, reports The Economic Times. The RBIs action would mean banks may also have to reset their exposure to corporate groups and high net worth individuals, HNI, soon. The RBI is shortly coming out with detailed guidelines on compliance function that is applicable to both individual and group wide basis, the finance ministry has said


in a written reply to the standing committee on finance. The ministrys response follows a detailed analysis being done by the Parliamentary committee about the contours of the demat scam. At present, a banks loan exposure to a single borrower is capped at 15% of capital funds (tier I and tier II capital) while it is 40% for a group. Banks are also allowed an additional allowance of 5-10% of their capital funds for the infrastructure sector. In exceptional circumstances, with the approval of their boards, the banks can consider enhancement of the exposure to a borrower up to a further 5% of capital funds that is 20% for a single borrower and 45% of capital funds for a group borrower. The government feels that the demat scam in which several people created fictitious demat accounts to corner shares meant for retail investors in public issues has shown that funds were cornered, taking advantage of some loopholes in the exposure norms of banks. Accordingly, the government has taken a position that while Sebis initiative of making PAN number mandatory to open a demat account is welcome, there has to be a further tightening of the exposure norms so that corporates or individuals face tighter screening at the time of raising funds from banks. The RBI has, therefore, also decided to make a distinction between the compliance functions from the audit functions to prevent a conflict of interest between the two. A study on this aspect had already been taken up at the seven banks that have been implicated in the scam for detecting loopholes and initiating corrective action, according to the ministrys response to the standing committee. The seven commercial banks fined by the RBI violated its regulations on Know Your Customer norms, breaching prudent banking practices and facilitating misuse of IPO finance to benami individuals. The banks include Bharat Overseas Bank, Citibank, Vijaya Bank, HDFC Bank, ICICI Bank, Indian Overseas Bank and Standard Chartered Bank. The RBI has imposed penalties ranging from Rs 5 lakh to Rs 25 lakh on several financial entities in the wake of some retail investors misusing the IPO route to corner shares. The penalties were imposed taking into account the extent and the enormity of violations. The irregularities were established by the RBI during inspections after a reference was made by the Sebi.

PREVENTIVE MEASURES OUR RECOMMENDATIONS: Strict adherence to Know Your Customer (KYC) norms by banks is essential to curb the evils of black money, money laundering and so on.


A limit on the maximum number of demat accounts a person can have could probably under each pattern with one or more DPs. This can act as a measure to monitor the activities of account holders and eliminate such scams. It is essential to have stringent provisions and a disciplinary mechanism for investors, besides stricter surveillance on all market intermediaries. Currently, depository-level inspections are minimal. This activity should be done on an ongoing basis with the help of professionals. Banks should be asked to indulge in core banking, and other capital market-related activities ought to be separated. The practice of bankers being brokers and depository participants should also be reviewed. Similarly, having the same entity as broker and depository participant should be discouraged. It should be allowed only after utmost care is taken that internal controls are in place. A documentation procedure for opening all types of customer accounts is essential. The customer accounts should be clearly classified on the basis of risk i.e. medium and high risk and due diligence must be given for such accounts. Enhanced due diligence in respect of accounts with beneficial ownership, non-face to face transactions, group companies, high risk businesses and wire transfers etc. is essential. Effective audit machinery needs to be incorporated in banking industry. This would help in detecting suspicious transactions and prompt reporting of the same to principal office branches. Providing finance to apply for IPOs or capital market activities from the bank or branch where broking/demat account is maintained should be prohibited. Bank and demat accounts should not be activated unless KYC norms are adhered to. There is also a need to monitor off-market transactions and money transfers. Providing each market player, including investors, with a unique identification number (like MAPIN) can check many a market evil. The number must be mandated in all primary and secondary market deals, bank accounts, high-value transactions, property registration, vehicle registration, and so on. Only then can regulators check bogus transactions and book fictitious persons. In such a case, even if a person has multiple bank and demat accounts, malpractices cannot happen. It is worthwhile exploring the electronic filing of IPO applications, so that cheques are not required and investors' bank accounts automatically get debited or credited. 45

It is essential to develop Identity Infrastructure in India so that it becomes feasible to enforce rules such as no more that one application per citizen. The price distortion created by SEBI could as well be eliminated. There is no case for special allocations for 'individual investors.' The ultimate aim of a good IPO mechanism is that the price discovered in the IPO auction should be practically the same as the price at first listing. Once this is done, there is no 'special profit' in buying at the IPO, which can be politically allocated to 'individual investors.' Individual investors who didn't obtain shares in the auction would be able to buy them on the secondary market at essentially the same price. Thus it is essential to make our IPO a market on pure auction. Use of technology to stay one step ahead of scamsters is the need of the hour. Technology can be used to tackle fraud at each stage from prevention, detection or investigation. With constant monitoring, it is possible to continually improve detection and accuracy rates. The issue assumes importance since demat accounts are easy to set up. Experian's Hunter solution identifies fictitious/fraudulent applications. This ensures that previously fraudulent, suspect, declined or multiple applications can be identified.


It is just over a decade since the setting up of the automated National Stock Exchange (NSE) led to a paradigm shift in the Indian capital market; and eight years since we opted for dematerialisation of shares. Together, they ensured the switch to paper-less trading and propelled a dramatic increase in trading volumes and growth. The conversion of the Bombay Stock Exchange (BSE) into a modern, national bourse completed the change in profile of Indias capital market. Ten years later, the strongest message emanating from the Securities and Exchange Board of Indias (Sebi) sweeping 252-page report on the demat scam is the need to take stock again. Our frontline capital market intermediaries have done a commendable job in leading the reform process and transforming our markets, but Sebis investigation points to the need for another round of action and a reexamination of systems, processes, accountability, statutory provisions and dependence on IT vendors. We need to look beyond the cornering of allotment in 23 Initial Public Offerings (IPOs) through tens of thousand fictitious demat accounts. Although these details occupy over 210 pages of the Sebi report, the more frightening systemic issues are raised by a special investigation of the National Securities Depository Ltd (NSDL). Probably, for the first time, SEBI has ordered an independent audit of NSDL that was conducted by iSec Services Pvt Ltd, a firm that combines expertise in IT Security and systems audit with investigation skills of the police. The findings reveal that quick-fix solution like reintroducing Unique Identification Numbers (UIN)with or without biometricswill not address the grave systemic deficiencies exposed by the audit. At first reading, Sebis order accusing depositories of contributory negligence and grave management lapses seems rather harsh, but the detailed elaboration of issues is positively alarming. The report exposes in detail the absence of adequate controls, systems and procedures for monitoring and evaluating compliance with statutory requirements and to supervise Depository Participants (DPs) appropriately. Data security lapses highlighted by the audit need discussion at the highest level since the Finance Ministry is pushing all Indians into e-filing of tax returns and they too are to be handled largely by NSDL. iSec has pointed to specific flaws in the data integrity and logical security of the demat system, exposing the fact that perfect audit trails touted by the depository, are killed by deliberation corruption of data.


NSDL officials have packed the database with dummy dates (0001-01-01) for the period prior to 16/4/1999. Account activation dates were added into the depository system only after July 2, 2005, and all dates prior to that are stuffed with numbers such as 9999-12-31. The birth dates of minor nominees have been filed as 0001-0101. There are also other fields where junk data has been entered into the database. Then there is the issue of lax internal procedures. iSec points out that there are no byelaws for internal monitoring and review of processes. And the callous attitude towards statutory compliances led to the creation of multiple demat accounts. Errors in opening demat accounts were noted as far back as 2003 and continued to crop up repeatedly, yet DPs were let off with penalties of Rs 500 to Rs 1000. In contrast, NSDL levied a hefty fine going up to Rs 3.5 lakh for not employing certified employees. The priorities were clearly wrong. This, combined with a cursory and cheery culture of inspections, set the stage for serious mischief. Given the state of affairs we are lucky that the damage and financial losses were not considerably worse. Sebi says that NSDLs DP inspections last for just a day and are called visits, which are followed by a sign off report. This breezy informality does not mention bye laws under which the visit is carried out and make the process of initiating penal action difficult. Inspections are also riddled with errors and hence unreliable. NSDL officials often permitted DP (Depository Participant) registration without even a physical inspection. Further, In NSDL there are no byelaws for internal controls or standard procedures for auditing, reviewing and monitoring DPs. Many of the problems flow from here. The Karvy group of intermediaries, which has come in for a special drubbing in the IPO scam investigation, is a prime example of lax oversight by the depository. The special audit reveals that Karvy employed agents to open depository accounts when there was no sanction for such agents. These were entrusted the job of opening new accounts and often bypassed the tedium of verifying addresses and identities. NSDLs six monthly inspection never detected their existence and allowed tens of thousand accounts to be opened. These findings are so serious that they need to be addressed at a policy level. India has adopted a separate depositories legislation that is obviously aimed at providing a measure of independence to depositories. While share depositories are the only market intermediary to have their own statute, NSDL has always claimed that supervision of DPs is entirely the responsibility of Sebi and it has no self-regulatory function either. At the same time, NSDL apparently considers itself free and independent enough to enter other businesses without permission from the market regulator and now it seems, without adequate internal preparedness.



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SEBI advised the depositories to examine all the IPOs during the period from January 2003 to December 2005 in respect of those dematerialized accounts that had received 20 or more credits reckoning the period from the date of close of respective IPO to the first day of trading on listing (both days including). Since the pay- in / pay-out for shares listed on the stock exchanges commences two days after the date of listing on the stock exchanges, it stands to reason that trades done till one day after listing would necessarily involve dealing in IPO shares. For the purpose of the above examination, SEBI obtained the details of all IPOs during the above period from the stock exchanges i.e. BSE and NSE and forwarded the same to NSDL and CDSL. The details of IPOs during 2003-2005 as obtained from the stock exchanges are as given below:








The data relating to the demat accounts that had acted as conduits (hereinafter referred to as afferent accounts) for the above 23 entities was obtained from NSDL. It is seen that there are 37,240 demat accounts that had acted has afferent accounts for the above 23 entities. NSDL has informed that out of the above 37,240 dematerialized accounts, as many as 31,818 demat accounts have been closed. In respect of the remaining 5422 accounts, NSDL has advised its DPs to confirm whether they have the KYC documents for such accounts. Subsequent information furnished by NSDL relating to 4602 demat accounts, shows that in many of the cases the DPs had obtained KYC documents towards POI and POA. However, in respect of six demat accounts (4 with DP ICICI Bank, 1 with ING Vysya Bank and 1 with Shah Investor's Home Ltd), there were neither POI nor POA. In respect of 820 accounts pertaining to HDFC Bank (684 accounts) and Karvy DP (136 accounts), NSDL informed that the same would be provided in due course.

























The details of the 24 key operators are given below. The figures in bracket indicate the IPO in which each key operator had adopted this modus operandi in a large scale and the number of credits received by the key operators in their demat accounts: 1. Roopalben Nareshbhai Panchal (IDFC-12258) 2. Sugandh Estates And Investments Pvt Ltd (IDFC-10194) 3. Dhaval A. Mehta (Suzlon Energy-3863) 4. Arjav Nareshbhai Panchal (Patni Computers-2541) 5. Parag P Jhaveri (IDFC-2083) 6. Kelan Atulbhai Doshi (IDFC-1970) 7. Ambuja Estate And Holdings Pvt Ltd. (TCS-1665) 8. Purshottam Budhwani (IDFC-1379) 9. Dharmesh Bhupendra M (IDFC-1206) 10. Jhaveri Securities Pvt. Ltd. (Suzlon Energy-1225) 11. Biren Kantilal Shah & Shah Biren Kantilal (Suzlon Energy-1303) 12. Kamal P Jhaveri (IDFC-883) 13. Devangi Dipakbhai Panchal(TV Today Network-862) 14. Chandrakant Amratlal Parekh (Suzlon Energy-803) 15. Dharmesh K Katakia (IDFC-749) 16. D B Mehta (NTPC-710) 17. Pratik Mafatlal Shah (Suzlon Energy-710) 18. Dhaval K Katakia (IDFC-700) 19. Deepakkumar Shantilal Jain (IDFC-686) 20. Himani N Patel (Suzlon Energy-635) 21. Deepak Madhukant Patel (Jet Airways-633) 22. Indiabulls Securities Ltd. (TCS-559) 23. Opee Stock - Link Ltd. (Jet Airways-553) 24. Manojdev Seksaria (IDFC 1989)