How government and captains weaken institutions - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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27 JANUARY 2011

Sometimes it is the little snippet of news reported by the largely compromised media that should make the real headline in our minds. That should trigger an alarm and be a call to action.

So, a few months ago there was a little item that appeared in the media about the search for a new Chairman of the Securities and Exchange Board of India. Apparently, the government was looking for a successor to Mr.Chandrasekhar (Chandu) Bhaskar Bhave, the incumbent Chairman of SEBI. And of course there was no town hall on the television channels or no focused discussion on what had SEBI achieved - or failed to achieve - during the leadership of Mr. Bhave.

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But while there is no town hall, there seems to be a heated debate in the corridors of power on whether the SEBI Chairman should continue or be replaced. Business Standard on December 8, 2010 reported that Prime Minister Manmohan Singh wants Mr. Bhave to stay on for another two years. But that has not changed the fact that there is a search committee seeking a replacement. And we have not heard from the captains of industry on what their views are - at least publicly. But I can guess what many of the moral holders of false beacons are thinking.

The Ministry of Finance is keen to set up a super-regulator, Financial Stability and Development Council. The FSDC is being presented as a co-ordinating body but some see it as a way for the mandarins in the Ministry of Finance to control the independence of the RBI, the IRDA, and SEBI. With all the powers of oversight and regulation now in Bombay (RBI, SEBI) and Hyderabad (IRDA), the captains of industry seeking favours - and funds - may be frustrated in their search for funds to finance their growth. An independent SEBI or RBI is not in their interest. Better to have a one-stop shop where you get all that you want. Just like the modern day malls, you can shop for the favours you want in air-conditioned comfort in one location. Just like they want a one-stop shop for the PR lobbying power. Even after the exposure of the Radia tapes, the call from the captains of industry have not been to ban lobbying but to legalise it!

The reward for men who are honest and competent.
Like Dr. Y. V. Reddy, the ex-Governor of the Reserve Bank of India, who deflected the continuous pressures from the financial geniuses of Wall Street and Dalal Street to yank open the Indian banking to toxic financial products, Mr. Bhave has focused on what is good for investors - and for the steady evolution of the Indian capital markets. That has been the theme of his tenure as Chairman of SEBI.

The mutual fund and investments industry - which I am familiar with - has been forced to start focusing on what is good for its investors. After years of creating mostly irrelevant products to be pumped and dumped via an opaque distribution system, SEBI has forced the industry to clean up. On August 1, 2009 SEBI banned the payment of front end commissions to distributors who went about their usual business of making investors jump from fund to fund in short periods of time. Each "churn" by the investor meant more money for the distributors and the ability to retain "bought assets" for the mutual fund industry. The industry was playing the size sizzles and "mine is a large one" game. A game best left to bachelors on a wild night out rather than to responsible fund managers who have to look after your savings.

Not that SEBI wanted to deprive the distribution industry of its legitimate income. It asked the distributors to collect the fees directly from their clients, so the clients would know what they were paying and whether the advice they got was worth the money they paid. And whether the funds they were made to invest in were really worthy of their life savings. This new and transparent system hit the entire banking industry (about 20% of many banks' revenues was from these fee-based incomes) and the powerful distribution channels. The fact that many in the industry wish to get back to their "old ways" is another story.

The ban on opaque payments by mutual funds to distributors ensured that distributors stopped selling mutual funds and began selling Unit Linked Insurance Plans (ULIPs). In April 2010, SEBI fired a salvo across the insurance companies who were selling ULIPs saying that these were securities markets' products and came under the oversight of SEBI. It took a change in law and the intervention of the Ministry of Finance to protect the insurers' from the oversight of SEBI, suggesting that SEBI had made the correct interpretation and that - based on the then laws - the rules for selling ULIPs were not being followed. But a Bhave-run SEBI forced the issue on the table.

In October 2008, the largest mutual fund houses appealed to SEBI to bail them out from the impact of the Lehman crisis on their bad judgement. The SEBI Chairman refused. His refusal made sense to me, as I sat in the audience and saw the ashen faces of the mutual fund honchos. The rationale supporting the SEBI decision was that the mutual funds had sold a bad product (FMP), not assessed the risk (lending to the real estate developers offering high returns), and now must take the hit from their profits and bonuses paid to all the CEOs who were rewarded for their reckless growth in assets!. The powerful owners of the mutual funds presumably went over Mr. Bhave's head to New Delhi and were bailed out by the RBI. They got their Rs 20,000 crore loan. I am sure the loan has been paid back, with interest. I am also sure that the mutual funds have not learnt a lesson. Risks will stay in the business and another bail out will be there, as long as the phone lines to connected people are not disconnected. That's how financial companies work these days, whether on Wall Street or on Dalal Street.

To show it's seriousness about wanting to keep the capital markets safe, SEBI has recently taken on the mighty Sahara group (and the RBI has followed); has fined one Reliance group Rs 50 crore and banned key individuals including Anil Ambani from investing in the Indian stock markets for one year; and is still to announce its decision on a case of alleged insider trading on another Reliance group company controlled by Mukesh Ambani. The last person to take on alleged wrongdoings at such a scale - even if they happened to be mighty - was Bhure Lal, the missile of once Prime Minister and once Finance Minister V. P. Singh in his war against corruption over 25 years ago.

These are big steps. Contrast this with the whimpers and the excuses that come out of most ministries and ministers (probably with the exception of Ministry of Environment these days) on any issue. Where is India's fight against black money? Where is India's fight against corruption in awarding land contracts and telecom licenses? Who is looking after the interests of the aam aadmi?

And don't look to USA or Wall Street for advice. The crimes on Wall Street and the financial institutions have gone unpunished. In fact tax payers in the western world have been left a bill. The recent US Republican Party leader of the financial services committee said that regulators are there to serve the financial institutions and that the financial institutions are not there to be subservient to regulators! So much for any long term recovery of the US economy! The next blow up will be even bigger!

There have been smaller battles, too, that SEBI has fought - and is still fighting - as it balances the creation of a capital market which matches the needs of savers and investors with the desire to have more competition from the financial intermediaries, while ensuring that the rot does not creep into the system.

  1. the big guns in the mutual fund industry wanted AMCs to have a minimum net worth of Rs 50 crore, SEBI shot that down;

  2. the international and large local brokers wanted P-Notes to remain opaque vehicles for money finding its way to India. SEBI has insisted on transparency and full disclosure of who the ultimate owners are. P-Notes subverted the government's original policies of facilitating long term institutional investors into India by allowing unknown pools of money to play around the Indian stock markets, including allegations that much of this P-Note money is from bank accounts held by Indians illegally outside India. A practice known as "round-tripping";

  3. the recent report submitted by the Bimal Jalan committee on the issue of listing for stock exchanges and depositories was another tough call between the balance of having competition, having transparency, making sure that investors are not short-changed by the financial geniuses, and ensuring the evolution and progress of the Indian capital markets. SEBI took on the big and the powerful - and many of you helped by sharing your views with SEBI - and has to make a final decision on these issues shortly.
There should be little doubt from a retail investor's perspective that SEBI is trying to clean up the system and make it safe for investors. If SEBI version 1.0 was writing the laws and creating the framework of the stock markets, SEBI version 2.0 (as this is called) is to clean up the system and clear the murky waters and eliminate the sharks.

But what was the reward for Dr Reddy when he stepped down as RBI Governor? No committees to head because he was working for policies that saved India and refused to work for the bankers who wanted to sell new age toxic derivatives to make India a more open capital market. Open, in their definition of crony capitalism, means that the financial geniuses will maximise their profits and - if they fail - they will send the bill to tax payers. Just like they did in America.

And what is the reward for Goldman, Sachs and others who lobby so hard to crack open India's relatively sane policies? They get appointed on committees to head the financing of India's infrastructure needs. Unbelievable!

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Oh, captain, my captain!
So where are the captains of industry when institutions created to safeguard India and Indian investors are being perverted?

Where were all the captains when, in 2004, the CEO of IDFC was affectively cornered into resigning when he reportedly refused to play ball with the government's views? IDFC was meant to be the cornerstone to finance India's infrastructure sector - today it is just another wanna-be-all finance company supposedly aiming to be a bank!

Where are FICCI, CII, and all the bodies that represent these captains who happily shoot out letters on corruption?
Guess who bribes the politicians and the bureaucrats?
Guess which folks went squealing for help each time SEBI came down on them?

If you have any doubts hear the Radia tapes again.

People like Dr. Reddy of the RBI and C. B. Bhave of SEBI are inconvenient truths for the captains as they ride their ships into the murky waters where the currents of corruptions take them to the high tide of astronomical market caps.

There are many other solid, straight forward bureaucrats in PSUs, in RBI, in SEBI, the police, the judiciary, the ministries and in many other institutions who need to know that they have the support of the people. That their political masters and the captains cannot hijack the Indian economy forever for their private gain.

Just to clarify, the people who take the bribes - or subvert the institutional processes - are across the political spectrum. This is not a Congress or BJP problem.

The SEBI Chairman and 3 whole time director were appointed by the government. Initially, the job was for 3 years. Now they have made it a 5-year position. But not for Mr. Bhave. He will be sent out in 3 years. The reasons are obvious.

I have no idea whether Mr. Bhave wants an extension or not. But have they even offered it to him?

Can the captains of industry support this effort to ensure that he is offered another 2 years? I would imagine that the captains of industry - seeing the potential benefit from a milder SEBI - are not in conversation with the government to see that Mr Bhave gets an extension. But they do lament on national TV that Lavasa is such a pretty township and how can it be destroyed!

Retail investors are clueless about the dynamics of the decision making process of the head of an institution that oversees how their savings are looked after. The murky corridors of New Delhi continue with all the whispers and the lobbying. Some say that the PM and the ex-FM Chidambaram probably want Mr. Bhave to continue. Some say that the new FM may be upset that the SEBI chairman took on the IRDA and the large corporates in SEBI's fight to bring investor interest back into the capital markets.
Who knows the truth?
But, the honest truth is that we should care.

In the 1980's over 10% of our annual savings went to the capital markets. Now it is less than 3%. Investors are scared of scams and scamsters.

This was - and is - an opportunity to clean up the system.

So write an email to the Prime Minster. A click on the link below will take you the web site that allows you to share your feelings on this issue.

There is only room for 500 characters, and there are 2 suggested texts that you can cut and paste from here...or feel free to create your own text.

Click here - http://pmindia.nic.in/write.htm

Option A: Mr. Bhave should continue as SEBI Chairman.

Dear Prime Minister: In Mr Bhave we have a Chairman of SEBI who is trying to clean up the system and make it safe for investors. We are concerned that Mr Bhave is leaving. While we have no grudge against any candidate, we do know that the SEBI still has many battles to fight. And you know how important it is for honest and competent people to stay on as long as the job is finished. I wish for Mr Bhave will continue to be SEBI Chairman.

Option B: Mr. Bhave should NOT continue as SEBI Chairman.

Dear PM: I am glad you allowed the SEBI Chairman's appointment to lapse. His continuous fight to clean up the system and his high integrity and competence were really an irritant. The confirmation of Mr Bhave's exit just after Republic Day will be a solid endorsement of the new India being built for enhancing the wealth of the well connected. I support the fact that Mr Bhave will no longer be SEBI Chairman. My hearty congratulations to your team for not giving him an extension!


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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.


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29 Responses to "How government and captains weaken institutions"

Vinod Shetti

Feb 9, 2011

Sir, I have been your follower and tracking your views on the market, this is very good idea to listen to our voice. We need people like Mr.Bhave in these turbulent times when there is war going on between government and Industry.

Like (1)

Vs

Feb 7, 2011

Absoloutely true. Mr Bhaves decision to Ban mighty companies is unparellel and unprecedented. If he stays many such incidents may come to light and the cleanup would obviously help honest investors.

Like (1)

RAGINI SHUKLA

Feb 2, 2011

YOU R SEARCH LIGHT IN TURBUELENT ECONOMICSEA

Like (1)

SRIDHAR

Feb 1, 2011

WOW..the link to the PM webpost says that you have reached your maximum number of posts !!

How, I wonder !

Unless they are running a Dedupe on the message itself.

Like (1)

Ravi

Jan 30, 2011

Well Ajit! Lapse of Mr. Bhave's appointments seems to be at behest of the PM or at least he consents for the matter. Don't you think, as per usual this is another most convenient / non-confrontation way for him to ensure he remains in power for his remaining term.

I tried to post Option I - Mr. Bhave to stay on PMO website and a message flashes that I have reached maximum limit to post messages!! I never posted any message before

No one to blame but we the voters for electing present political regime but as you said it hardly makes difference who assumes the power in New Delhi corridors. Whether India or the US, aam aadmi / aam investor has been at the receiving end

Like (1)

Vijay Raj Singh

Jan 29, 2011

Sir, you are doing an excellent job, my best wishes are always with you, in India we need to increase the participation of retail investors in our capital markets, because that is the only way of getting inflation adjusted real returns and accomplishing their financial goals. The best thing about you is you are probably the greatest value investors in India and die hard followers of Benjamin Graham and Warren Buffett.

Like (1)

K.M.Manohar Kumar

Jan 29, 2011

Well done Mr.Dayal. It is an excellent idea to get the small investors like me to appeal directly to the PM. I hope that more and more retail investors wil join in this endeavour to make it effective and fruitful. Please keep up your good work. The retail investors of the country will be with you all the way. Thanks and Regards.

Like (1)

K

Jan 28, 2011

How about IPO Scam ? WHy have you not covered how three orders were supressed. How NSDL and other players given clean chit

Like (1)

vinay P Valmiki

Jan 28, 2011

Mr.Dayal hats off to you at least you raised your voice but so called Jagruk print & electronic media is keeping mum on such a serious issue

Like (1)

Ramesh

Jan 28, 2011

Ajit, Great article Sir. Appreciate your unique view points and your analysis. Look forward to more good work from you.

Like (1)
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