Buyers (be) aware! - Views on News from Equitymaster

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Buyers (be) aware!

Jun 18, 2003

Every now and then, we read about stock market regulators ordering a probe into the rise in prices of securities listed on the exchanges. Sometimes, an enquiry is set up for finding out the reasons as to why the stocks of a particular sector have risen rapidly within a short span of time. It is important for the regulatory bodies to keep a close watch on various securities so as to protect investor interests. But then isnt it strange? How could stock market gains hurt investors? The answer here would be - they can! Assume, one Mr. A has good sources in a company X and through them, this Mr. A has got access to some relevant information regarding the company which could affect the share price of the company on the bourses, positively or negatively. Now, he acts in the market on the basis of the news that is acquired from company sources, thus making the stock price of the company behave quite irrationally.

If the stock price rises, it is advantageous for the retail investor as he reaps windfall gains due to some reason about which he is almost certainly unaware. But sometimes, the greed factor creeps in, which many a times controls human rationale and prevents him from booking profits. At the same time, the opposite could also have happened wherein the stock price could turn for the worse and put investors in the lurch, not knowing a thing about the reason behind the strange movement in the stock. According to a poll conducted by Equitymaster.com in mid-May last month, over 1/3rd of the people voted for the greed factor. However, the key reason for stock market scams according to them was regulatory loopholes (48%).

This whole scenario of acting on unpublished company information, which is relevant to the value of the company and consequently its stock price, is called insider trading. This is precisely what the regulators aim at curtailing while ordering probes into the strange behaviour of stock prices. This close watch by the regulators is necessary in a scam-marred country like India. Insider trading leads to increased stock market volatility and hence greater risks for retail investors. This ultimately leads to investors losing confidence in capital markets.

The Ketan Parekh related scam caused a lot of heads to roll in the BSE. It also brought considerable embarrassment to the stock markets regulatory authority, Securities and Exchange Board of India (SEBI). Since then, the government has shown the inclination to improve systems so as to safeguard small investors. Some of them being laws on corporate governance, higher disclosure norms for companies, severe penalties for insider trading, rolling settlement and shifting the trading cycle from T+5 to the T+2 settlement system. Rolling settlements and a shorter settlement cycle effectively leaves very little time for speculators to affect valuation. Moreover, with the SEBI already making plans to introduce the T+1 settlement system, it is only going to reduce the risk in the market for retail investors. This step by SEBI is praiseworthy considering the fact that the US and UK markets are still following the T+3 system. Thus, going forward, one can expect market efficiencies to improve and the investors will be the sole beneficiaries. But in the end, buyers (be) aware.

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