FROM RAJ TO RAFALE 10 Halal Street

Ever since the birth of the Indian stock market–the Bombay Stock Exchange (BSE), the oldest in Asia, has its roots in the 19th century when a few brokers traded under a banyan tree near Horniman Circle–it was rocked by scandals. Earlier in this series, we introduced the readers to the ‘Thug of Bombay’, RoychandPremchand, and his controversial exploits in the 1860s. As the biggest trader in those days, he combined commodities, banks, real estate, and stock market to scam investors, before he was undone by his own acts.

Since then, over the past 160 years, there were several claimants to the title of the ‘Big Bull’, who could brazenly and unscrupulously sway shares, and make them dance to his tune, like the quintessential Indian snake charmer. Remember Harshad Mehta of the early 1990s, and his role in the Securities Scam. Think of Ketan Parekh and his manipulations of the technology stocks in the early 2000s. In recent times, one of the most shameless stage-managers of exchanges was Jignesh Shah, who served 100 days in jail.

But there were two others, who can claim to be the fathers of the modern equity cult in the country. One of them was Manohar J Pherwani, who was the chairman of the Unit Trust of India (UTI) through the 1980s. The other was Dhirubhai Ambani, the late patriarch of the Reliance Industries Group. Together, and many a times independently, they successfully wooed the small investors to invest in stocks. These efforts led to a modern equity cult in the country, and several scandals. For the duo, the market was their fiefdom, and the investors didn’t matter.

Publicly, however, both Pherwani and Ambani said that they were on the side of the investors. By pumping money to push up the shares of his own flagship, Ambani maintained that he wanted his shareholders to become millionaires. Investors latched on to Reliance Industries–within a decade of its going public, Reliance Industries Ltd (RIL) had a million investors by 1985. By 2005, after Ambani died, one of his two sons claimed that the group, which was now divided among the siblings, had 3.5 million shareholders.

By contrast, Pherwani, who managed the huge corpus of UTI, controlled the market in the 1980s. He decided how the stocks behaved on a daily basis, and in the long run. UTI helped in the making of the stock market boom in the second half of the 1980s, which attracted the middle and lower classes. From clerks to senior managers, rich farmers to blue-collar workers, there was a horde to buy shares, which offered unbelievable returns. A herd mentality, as is invariably the case when the market goes up, gripped Indians.

In fact, both Ambani and Pherwani allegedly used unethical means, which were not necessarily illegal in those days, to shore up the shares. Experts would dub their operations as possible cases of insider trading today. More importantly, they created an environment, where the ‘big boys’–industrialists, brokers, wealthy investors, and influential politicians and bureaucrats–openly flouted rules and norms to make a killing on the exchange. Dalal Street, where the BSE was headquartered, quickly and infamously became Halal Street.

Scandals became the norm, rather than exception, over the next few decades, as millions of investors lost their life savings. They shied away from shares for a while, but came back like ants are attracted to honey when the next boom happened. The intensity, expanse, and enormity of the scams became larger since the 1980s. What was unique about the post-1980s was the emergence of three trends–irregularities became regular (a major crisis every 3-7 years), their sizes became huge, and they involved the common man.

Ambani’s strategy to power growth and expansion lay in his ability to regularly raise money from the investors. That’s how he financed his mega projects. For that, it was imperative that the stock price remained high, or went up. Indeed, the route to such success was through the CDs, which offered a cheaper source of finance, if handled in the right manner

Aseemingly innocuous policy to attract NRI (non-resident Indians) investments, and an equally seemingly bland financial instrument, convertible debentures (CDs), helped Ambani. In the 1982 Budget, Finance Minister Pranab Mukherjee allowed NRIs to buy shares in Indian companies. It had two major repercussions–first, as we saw in the previous part of this series, it led to the takeover of politics by business and, second, it resulted in allegedly blatant insider trading by RIL to push up the prices of its stock.
Ambani’s strategy to power growth and expansion lay in his ability to regularly raise money from the investors. That’s how he financed his mega projects. For that, it was imperative that the stock price remained high, or went up. Indeed, the route to such success was through the CDs, which offered a cheaper source of finance, if handled in the right manner. In a paradoxical manner, the overuse of the CDs depended on the high value of the stock price. CDs required a high stock price; a high stock price led to more use of CDs.

A CD is essentially a debenture with a fixed interest rate instrument until it is converted into a share. No one is sure who popularised it in the 1980s. Nitish Sen Gupta, the Controller of Capital Issues (CCI), a now-defunct government department that decided everything related to public issues, took credit for it. In an interview with India Today, Ambani claimed that he convinced Sen Gupta, and had a “devil of a time” doing so. Both had exaggerated, for CD was an old instrument; it wasn’t invented or discovered by either.

For example, CD was tried several times by the Tata Group in the 1970s. However, the idea never caught the fancy of either India Inc or the investors for a simple reason. The CCI never allowed it to flourish. Only when Sen Gupta gave his blessings to Ambani to issue CDs did the retail market boom. Only when the regulator (CCI) and issuer (the company) got together did new opportunities open up to use the CDs to woo the investors.

Thanks to the RIL-CCI partnership, RIL largely used CDs to raise, according to India Today, an “unprecedented Rs. 94 billion from the public” between end-1977 and end-1986. Sen Gupta felt that this was “a new experiment in running a big business… without taking term loans… on a significant scale.” Both RIL and CCI energised the equity market. Between 1949 and 1979, the average money mopped up every year was Rs. 580 million, the highest being Rs. 920 million. In 1983 alone, Rs. 10 billion was raised by Indian companies.

To understand what happened, one has to know the intricacies of CDs. A share is risky instrument, which can yield huge returns if the stock price zooms. By contrast, a non-convertible debenture (NCD) is a safe instrument; like a fixed deposit, it yields a fixed interest every year, and the principal amount is repaid after a specified period. A CD is a mix between the two, between risk and safety. To begin with, it behaves like a NCD. Only later, when the project takes off, does the CD get converted into shares.

For companies, it makes immense sense to issue CDs, rather than NCDs or shares. It reduces the owner’s dependence on bank loans and other debt. And it reduces the risks for the investors, as the conversion into shares happens only when the project takes off. The best thing about a CD was that companies can demand premiums from shareholders, who are unwilling to do so for shares due to the attached risks. Thus, a CD acts a bridge between safety and risk, both for the companies and investors. Despite such advantages, CDs never became fashionable until the 1980s.

Obviously, there was a catch, Catch CCI. Everything depended on the period of conversion–the companies wanted it to be longer, the investor shorter–and the price of conversion–the companies wanted it higher, the investor lower. However, until the 1980s, the CCI allowed lower periods and low premiums. This made the CDs unattractive for the issuers. Only when the CCI changed these, which it did for Ambani, that CDs took off. Clearly, Ambani enjoyed the largesse of the CCI, which was carefully choreographed by Sen Gupta.

According to an India Today article, “This seemingly simple gimmick (CD) killed several birds with one stone.” It reduced the debt-equity ratio since the debt raised through CDs was converted into equity. The cost of raising money came down, as interest was paid on CDs for a brief period till its conversion. Given the premium on conversion – Rs. 100 CD was exchanged for 1-2 shares of Rs. 10 each, or a premium of Rs. 40-90 per share–the company kept a check on its equity base, and funnelled this excess amount into its reserves.

There were two others, who can claim to be the fathers of the modern equity cult in the country. One of them was Manohar J Pherwani, who was the chairman of the Unit Trust of India (UTI) through the 1980s. The other was Dhirubhai Ambani, the late patriarch of the Reliance Industries Group. Together, and many a times independently, they successfully wooed the small investors to invest in stocks

In addition, there were huge gains for the investors, but only if the stock price remained high. In the case of one of RIL’s debentures (face value of Rs. 100), it was quoted at Rs. 84, and the share sold for Rs. 115. Once the debenture was exchanged for 1.2 shares, said India Today, “the investor handed in an asset worth Rs. 84 and got back another asset worth Rs. 138 (115 x 1.2) on the market.” It meant an instant profit of Rs. 38 on an investment of Rs. 100! The higher the stock price, the higher the gains.

Not only did the CCI encourage the conversion of RIL’s CDs at attractive premiums, it did the unthinkable, a theoretical impossibility. Ambani, like others, also issued partially convertible debentures (PCDs), in which a fixed component continued to behave like a NCD till its maturity (10 years or so) and the remaining was converted into share(s). The non-convertible could not be exchanged for shares. However, in its wisdom, the CCI allowed this for RIL. It destroyed the sanctity of the rules. But it was hailed by the experts.

All these shenanigans, as we mentioned earlier, could continue only if the share price remained high and attractive. Therefore, it was imperative for Ambani to stall, even defeat, all attacks on the stock. Unfortunately, there was a section of brokers, which felt that since Ambani had possibly deliberately pushed up the stock price, it would come down once he ran out money, which was inevitable. So, the brokers decided to take on RIL.

In March 1982, a bear cartel, possibly led by Manu Manek, who was dubbed “Black Cobra” by Ambani because of the colour of his skin and venomous short-selling strategies, initiated a selling pressure on the RIL stock. As was the tried-and-tested tactics, the cartel short-sold the shares in huge quantities. The objective was that when the price crashed, as it would inevitably would, the cartel would square off the deals. In effect, it would sell the shares at the high price, and buy them at the lower one, and pocket the difference.

Shockingly, large buyers appeared on the scene. The more the cartel short-sold, the more was the buying. Later, the buyers called for the “opponents’ cards”–they asked the sellers to deliver the shares. The cartel was caught in a quandary. Given the baffling buying pressure, RIL had zoomed from Rs. 121 to Rs. 201 a share. If the sellers chose to square off the deals, they would incur a huge loss of Rs. 80 a share, i.e. the difference between the two prices. If they carried on, and if RIL went up further, the losses would be higher.

As the impasse continued, the Bombay Stock Exchange was closed for a few days. Finally, a settlement was reached; the cartel paid, and went back home licking its wounds. Only in May 1983 did one get an idea on how the buying was financed. Mukherjee, the FM who allowed NRIs to buy shares on the Indian exchanges, told the Parliament that 11 NRI-owned firms invested Rs. 225.2 million in the Indian market between April 1982 and April 1983.

In July 1983, he revealed the names of the UK-based buyers, which included bizarre names such as Fiasco Investments, and Crocodile Investments, and they had invested 98 per cent of the total amount in RIL shares. In November 1983, the FM admitted that before these 11 firms were registered in the UK, they were headquartered in the Isle of Man, a tax haven. Most of the owners of the entities were Gujaratis, and one of them was Krishna Kant Shah.

In the early 1990s, Harshad Mehta, a Bombay-based cavalier broker, was the new uncrowned king of stocks. A mere whiff that he was interested in a company would cause its share price to soar. Mehta invented a new theory, replacement theory, to justify high prices. This said that the valuation of a company must be based on the replacement value of its “plant and machinery”, and not merely on its future earnings

Media reports claimed that Shah was born in Kenya, shifted to Britain in 1959, and owned a small business. Shah denied any connection with Isle of Man. Years later, a link was established between Shah and Ambani. According to author Hamish MacDonald, they studied together in Junagadh, then a princely state that is now a part of Gujarat. As a child, Shah was arrested in 1947 during the agitation for the accession of the princely state to India. He was only released because of Ambani’s mysterious intervention.

Over the next few decades, the Reliance Industries group was regularly involved in tussles with bear cartels, accused of insider trading, charged with fooling the investors, and alleged to have resorted to irregularities to manage the stock market. But the significance of Ambani’s tryst with the retail investors was the confidence, brazenness, and arrogance that it gave to the subsequent manipulators. Every ambitious entrepreneur across the country thought that he or she could replicate this strategy.
Pherwani did the same, but a larger level. During the second half of the 1980s, as he fuelled a market boom through UTI, he willy-nilly participated in, and encouraged, scores of scams that bloodied the small investors. For example, companies routinely fixed their stock prices, helped by favourable media reports by corrupt journalists, circular buying by brokers (one sold to the second at a higher price, who sold to the third at a still higher price, and so on), and UTI’s huge corpus. Then they dumped the stocks.

Another known racket was rights renunciation. The promoters would issue shares to themselves, and their favourites (including brokers, journalists, and financial institutions), at face value of Rs. 10. They would collectively take the prices higher. Then, they would announce a rights issue, i.e. fresh stock to be sold to the existing shareholders, at premiums. Those who got the shares earlier at low prices would then renounce their rights’ entitlements, and the additional shares would be sold to the retail investors.

Burnt by such experiences, the small investor walked away. From those ashes rose a new ‘Big Bull’. In the early 1990s, Harshad Mehta, a Bombay-based cavalier broker, was the new uncrowned king of stocks. A mere whiff that he was interested in a company would cause its share price to soar. Mehta invented a new theory, replacement theory, to justify high prices. This said that the valuation of a company must be based on the replacement value of its “plant and machinery”, and not merely on its future earnings.

It was a sham. In 1992, he was embroiled in Rs. 4,000-crore Securities Scam, which was investigated by a Joint Parliamentary Committee (JPC). The JPC’s 1993 report said, “The scam is basically a deliberate and criminal use of Public funds through various types of securities transactions with the aim of illegally siphoning of funds of banks and PSUs (public sector undertakings) to select brokers for speculative returns.” Mehta and others basically channelised huge sums from the banking sector to buy stocks.

The JPC added that this signified a larger systemic failure and “chronic disorder” since it involved a gamut of the stakeholders in the country’s financial sector, including the various stock market players and regulators, financial institutions, the central bank of the country (Reserve Bank of India), and the finance ministry and other economic ministries. It seemed that everyone was involved–entrepreneurs, bankers, brokers, high net-worth individuals, regulators, and policy makers.

Retail investors were also sucked into other mala-fide schemes. They were cheated by the non-banking finance companies (NBFCs), like Nidhi funds, and chit funds, through the 1990s and 2000s. Nidhis, chit funds, and other NBFCs promised a higher monthly interest rate, way over the existing market ones. In essence, they ran Ponzi schemes, i.e. collect money from new depositors, and use it to pay the high interest to the previous ones. If the cycle broke, the depositors lost their money as the NBFCs would vanish.

Other stock scandals continued. Regularly, the investors were hurt. But after some time, they would re-enter the market, or the market would woo new younger ones. Long live the small investor!