Not long ago, we got endless lectures from foreign investors and fund managers on how corrupt and shady Indian market practices were, and how these had to be transformed if India was to attract any money from abroad.
There is now a discreet silence from that end because of the apparently endless series scandals in American corporations and markets. It started with balance sheet scandals like that of Enron. It extended quickly to the incestuous relations between auditors and the companies they audited, and led to the collapse and extinction of Andersen. This overlapped with the scandal of bogus trades conducted by several energy trading companies to fool shareholders about revenue and regulators about the premium to be paid for energy supplied in times of congestion. Many other tycoons like Kozlowski of Tyco and Rigas of Adelphia Communications were arrested for fraud and malfeasance.
Then Eliot Spitzer, attorney general of New York , trained his guns on the conflicts of interest within investment banks, which often recommended that investors buy totally dud companies in order to profit from commissions. Many of the biggest names on Wall Street paid hefty fines totalling billions of dollars in settlements, and promised to create institutional barriers that would promote better governance. There followed a scandal over initial public offerings: it transpired that a favoured few clients of issue managers has obtained disproportionate allocations of shares.
Now Spitzer has trained his guns on the sector that attracts the maximum number of small investors, and has traditionally been regarded as the safest way to invest in stock markets: mutual funds. Charges of unfair trading have been levelled against gigantic mutual fund managers like Putnam, whose CEO has been forced to resign. Criminal charges have been brought against the chairman of Strong Mutual Funds. Staff have been fired in companies with names as illustrious as Morgan Stanley, Merrill Lynch and Citibank.
US mutual funds have been accused of three types of wrong-doing: late trading, market timing, and inflated fees. It is worth elaborating on each.
The price of shares owned by a mutual fund fluctuates throughout the day, but the mutual fund declares its net asset value (NAV) when markets close every day, at 4 pm . This NAV is the basis on which purchases and sales take place till 4 pm the next day. Allowing favoured investors to trade after 4 pm but at the previous day’s price is late trading, and enables the investor to take advantage of the fluctuation in price of shares held by the mutual fund after 4 pm. Fund managers are allowed to execute orders received before 4 pm after that deadline. In practice, many orders were actually placed after 4 pm .
It was insider trading of the purest sort, with a favoured set of investors using information withheld from others. It had become common practice and was well known to insiders, yet the Securities and Exchange Commission (SEC) , supposedly a fearsome watchdog, seemed completely oblivious to what was going on. This cozy arrangements ended only because of the peculiar legal climate of the US , where some state attorney generals can muscle into a jurisdiction normally reserved for the securities watchdog.
Market timing is a more complex crime, involving the rapid buying and selling of a fund to take advantage of fluctuations in the prices of underlying shares. This is not illegal unless the fund’s own rules prohibit it, which is generally the case.
Finally, there is overcharging of fees. You might say that in a free market, there should be no controls on what fees different fund managers charge. That is not the position Spitzer has taken. He calculates that if mutual fund managers had charged the same fees that pension fund managers do, the benefit to mutual fund holders would be a whopping $10 billion a year. Mutual fund own $7 trillion of assets, so even if managers skim off just 0.1%, that amounts to $7 billion.
Today, there is silent jubilation in the Mumbai headquarters of the Securities and Exchange Board of India (Sebi). This body has often been accused of being asleep while dirty tricks are played on Indian stock markets. Why can’t Sebi be more like SEC, critics have often asked. Today SEC is looking as negligent and incompetent as Sebi at its worst. One Sebi official says gleefully, “This was going on for years and everybody on Wall Street knew it, yet nobody did anything.”
So, can we take heart from this? Were Harshad Mehta and Ketan Parekh no worse than the blue-blooded crooks of Wall Street? Are finance men (and women) crooks the world over, and have we in India been mistaken in believing that our financial managers and markets are any worse than abroad?
The answer, I am afraid, is that crookedness is more widespread and unchecked in India . The proof is that the biggest names in the US have been put in the dock or behind bars, and many have been sacked or fined. Nothing remotely comparable has happened in India . Indian corporates routinely cook their books, but no big company like Enron has been shut down, and no big names have been arrested like Kozlowski of Tyco or Rigas of Adelphia. Sebi’s action against some errant brokers pales in comparison with the fines routinely levied by SEC levies, or the settlements Spitzer has negotiated with erring Wall Street firms.
Out-of-court settlements in the US are viewed by the public and politicians as a way of speeding up justice. By contrast any attempt to settle out of court in India would promptly be decried as corruption. And so cases in India drag on forever, till the accused/accuser dies of old age (remember Harshad Mehta and Lakhubhai Pathak ).
The scandals on Wall Street provide us with schadenfreude (a German word for enjoying the troubles of others) but little more. To aspire to reach US standards of crookedness seems impossibly optimistic.