People's Democracy

IN the era of liberalised financial markets in India, it appears that even before the dust settles on one financial "scam" there is a new one in the making. We need only recall the engineered boom in stock markets in the early 1990s which involved all major Indian and foreign banks and the "big bull" Harshad Mehta, the subsequent periodic instances of alleged insider trading and price rigging by corporations and broking firms, and, more recently, the infamous Ketan Parekh episode involving among others the Madhavpura Mercantile Cooperative Bank. In all cases, investigations, while focusing attention on the ease with which one or more high profile brokers or firms could access huge sums of money to play the market, have not yielded adequate "regulatory measures" to prevent another scam.

Not surprisingly, therefore, the media is agog with another financial scam, involving a set of cooperative banks and a high profile broker, Home Trade, which has once again seen a few hundred crores of rupees disappear into thin air. What is surprising was that this was a scam which was obviously in the making before the very eyes of the regulators. Home Trade was an unusual venture inasmuch as, at the time of its launch around two years back, it combined activity in two areas which were both at a low, if not in a state of collapse. The first was an internet venture, in the form of a portal that provided information and entertainment to satisfy visitors interested in its principal activity. And second, its principal activity, which was to encourage internet trading of stocks and shares. This dotcom brokerage, ostensibly aiming to attract small investors who had fled markets after burning their fingers, was launched with a high profile advertising campaign that roped in celebrities like Hrithik Roshan, Sachin Tendulkar and Shah Rukh Khan. The campaign, estimated by one source to have cost as much as Rs 65 crore, was mysterious, since it long remained silent on the product being sold, and was geared at establishing the "Home Trade" brand and win customer confidence in the name. What it did not fail to do was to attract public attention, leading to much media discussion on the campaign itself.

The experience with dotcom failures, abroad and in India, that spent huge sums of money even before earning a single unit of currency, should itself have alerted the authorities into scrutinising the venture. More so because, unlike conventional dotcom firms, this one had a revenue model that made it even more risky and suspect: to earn money through brokerage fees from small investors at a time when the market was by no means booming. The case for suspicion and a modicum of scrutiny would have been strengthened if the regulatory authorities had examined the antecedents of the promoters and its chief executive, Sanjay Agarwal.

Agarwal came to Home Trade with a reputation, built during his days with Lloyd’s Brokerage set up by Lloyd’s Finance, one more Mumbai-based finance company that had picked up the name of an internationally known finance company. Set up in 1994, with a paid-up capital of Rs 2.2 crore, Lloyd’s Brokerage soon acquired the reputation in market circles of being a "dynamic", market-mover. However, when the BSE Sensex fell by 367 points on a single day in mid-January 1997, the Securities and Exchange Board of India (SEBI) launched an investigation that came to the conclusion that there was prima-facie evidence that Lloyds Brokerage, was responsible for the unusual volatility. By then the firm had changed its name to Euro Asian Securities (EAS), consequent to a sale of 75 per cent of its stake to Mauritius-based S N Investments. Speculative transactions, it appeared, were key to the strategy of EAS, as it has been known to be of most financial entities. However, whether for lack of adequate evidence or other reasons, in October 1999, EAS was let of with an admonition by SEBI, which even permitted the promoters to offload 25 per cent of their stake through a public issue valued at Rs 32.94 crore.

Armed with those funds EAS transformed itself into the internet-based brokerage Home Trade, that was soon favoured with venture funding from two new sources, Euro Discover Technology Ventures and Euro Discover, which also established a second company called Ways India Ltd that functioned as part of the Home Trade group.

Given this rather labyrinthine evolution of Home Trade from sources that had been investigated for possible market manipulation and given its seemingly irrational choice of area of operation and timing, the company was seen by many, barring the regulators, as being an operation that was suspect from the point of view of market prudence. Yet investigations into Home Trade’s activities had to wait for a NABARD report filed on April 19 to the RBI, on the Nagpur District Central Cooperative Bank (NDCCB), which had made huge investments in government securities, but was not in possession of the certificates for the same. Home Trade, it transpires, had obtained Rs 124 crore from NDCCB for investment in government securities, but had not delivered the certificates. Caught out by the NABARD team, the chairman of NDCCB, Sunil Kedar, was the first to file a complaint against Home Trade on grounds of cheating.

Once the NDCCB complaint had been filed, the floodgates were opened. Thus far at least eight cooperative banks in Maharashtra, some banks from Gujarat and, in an unusual turn, the Seamen’s Provident Fund, have reported having invested in government securities through Home Trade and another brokerage Gilt Edge but have yet to receive the relevant certificates. The sums involved could be in excess of Rs 300 crore. What is more, some of the banks had reportedly provided Home Trade with loans to pursue its undefined activities, serving virtually as venture capitalists.

The revelations have resulted in investigations into investments in government securities by cooperative banks and provident fund organisations. It has also increased coverage of the Home Trade scam by sections of the media, which normally tend to celebrate high profile financial players and present their views as disinterested assessments of market movements and government policies. But now that Home Trade, which had access to crores, of which a significant chunk was handed over as advertisement revenue to the very same media, is now reportedly left with just Rs 22,000 in its bank account, the tendency is to dismiss the firm as just a scam and a few individuals in Home Trade and the cooperative banks as aberrations.

The route to discovering that Home Trade was a fragile venture that was bound to collapse from losses suffered by investors who, not to legitimately, had handed over large sums of money to the company, is indeed circuitous. After all by March the financial press was reporting that both Home Trade and its sister company Ways India were downsizing operations and retrenching staff, many of whom had not been paid for some time. But neither the regulators nor the media found reason to investigate a company that had burnt up crores in a few months.

Sanjay Agarwal, who has since been arrested, is reportedly himself unapologetic. While admitting to some "mismanagement" in his debt servicing division, Agarwal is reported to have claimed that Home Trade has a "great financial model." At one level he is perhaps right. His was a model of changing form to pursue every option of speculative return that existed. When the project of earning huge commissions through internet broking was found to be not working, he expected to make large sums by trading in government securities in the expectation that their prices would rise since the government was keen on driving down interest rates. To find investors who would make their purchases through him Agarwal offered an extra two per cent return on investments made through him, and targeted cash rich but poorly regulated sectors like the cooperative banks and small provident funds. His gamble did not work, leading to his being unable to deliver on his trades, but in keeping with what is the true business of finance he at least gambled.

The difficulty about dropping Agarwal like a brick when he is already well on the way down is that the exercise only serves to divert attention from larger issues. These are that financial markets, where information available to some is not available to others, are prone to speculation and failure. They therefore need to be tightly controlled or regulated. But India’s economic reform programme has not only liberalised these markets substantially and devalued regulation, it has made the garnering of large profits by financial entities a sign of "efficiency". This legitimises speculation, so long as you are not caught out because of failure.

One result is that when failures do occur it is not the system put in place by reform that is blamed, but the individuals who have been caught out because of failure. Liberalisation is persisted with and financial failure recurs. The problem is that failures affect not just the speculators or those involved in the bank-broker speculative nexus. It also threatens to wipe out a part or the whole of the savings of individuals, which have been invested in entities they do not control, but which they believe the government regulates. It is this trust in government rather than the confidence bought by huge publicity campaigns that finally explain the willingness of small investors to hand money over to entities that are similar to those who have known to have misused them in the past. Given that, it is not enough if the government wakes up each time it is faced with what it dismisses as a scam. It must undo the regime and the structures that render the system fragile.