Do stock market investors need more protection?

While a rotten stock market makes investors run away out of fear, ad hoc fire-fighting measures make fundraisers run away because of high costs of compliance and high liabilities. (Representative image)

The Supreme Court has recently directed SEBI to initiate steps for enhancing investor protection, in the light of the Adani-Hindenburg saga, where it is said that investors lost lakhs of crores in just a few days. While the Supreme Court has not directed specific changes to the law, it has raised broad areas of concern. And rightly so, since SEBI has domain expertise.

Indeed, the SC has suggested appointment of an expert committee to oversee, maybe on an ongoing basis. The top court particularly emphasised that nowadays, not just knowledgeable large investors, but countless mid-size and small investors also invest in shares.

Protecting Small Investors

And the last part is particularly noteworthy. The number of small investors, as particularly evidenced by the huge rise in the number of demat accounts, have skyrocketed. That said, the role of SEBI in respect to investor protection has consciously evolved over the years. Before SEBI, we had the Controller of Capital Issues which was one extreme where there was micromanagement of public issues.

In later reforms towards freer markets, the lawmakers rightly did not shift from being a Controller to the other extreme of laissez faire or ‘caveat emptor’ (let the buyer beware). Instead, a wiser approach of greater disclosure was taken. Indeed, the new regulations were aptly named Issue of Capital and Disclosure Regulations.

The regulations did specify certain minimum entry requirements to restrict fly-by-night companies. But the core focus was on copious disclosure requirements in the offer document to help make an informed decision. These were to be reviewed by registered merchant bankers with a high level of diligence (several merchant bankers have been penalised for alleged lapses).

How Trust Erodes

The offer document easily runs into hundreds of pages. However, there is also provision for a shorter abridged prospectus. The overall approach still is that SEBI will generally not judge the merits of public offers nor will it screen them in any major way except where there are any specific non-compliances.

However, stock markets have continued to show sporadic or even widespread cases of abuse by savvy scamsters. Even where the companies/promoters are not fraudsters, there have been concerns that smart marketing has led to issues at high prices that helped exit to certain groups, but the prices then fell soon leading to loss to investors.

Then, on an ongoing basis too, there are endless malpractices. Insider trading and front running cases are being detected very regularly and this shows some offenders are being caught. But the dominant perception is that these are merely the tip of the iceberg, that only amateurs are being caught while smart, tech-savvy scamsters, using also the unorganised cash economy and fronts, do not leave even a trace of evidence leading back to them.

Small And Vulnerable

While front running cases are easier to catch since the easily gathered data is self-demonstrative of the guilt, catching insider dealers is more difficult. Even where some prima facie evidence is available, it often does not stand up in law, partly also due to half-baked proceedings initiated. For example in the recent WhatsApp case, proceedings against all the parties had to be unceremoniously dropped.

Then there are endless cases of so-called tipsters who, through SMS, social media, websites, etc. collect a huge number of followers (with many actually paying for these fraudulent tips!) and then carry out either blatant pump-and-dump operations or squeeze a huge amount of fees. SEBI releases an order almost every day against such alleged operators. As SEBI itself demonstrated recently by a detailed study, most of the small traders in options actually lose monies.

So it will not be too cynical to say that snakes continue to lurk in every corner of the stock markets. The question then is whether more regulations, more committees, more teeth to SEBI, etc. is the solution. Regulations are already in threadbare detail – just the ICDR Regulations run into 400+ pages. There are committees too. SEBI already has a mouthful of sharp teeth to bite, rip and tear. SEBI can penalise, it can debar, it can disgorge illicit profits, it can cancel/suspend registration of intermediaries and it can prosecute wrong doers.

Lure Of Quick Profits

The larger question is whether wisdom of the risks of investing in stock markets, particularly in pursuit of quick profits, can ever be imbibed by more regulatory measures? As the recent telegram channel case showed, the alleged scamsters used smart psychological tactics to invoke greed and the fear of missing out (FOMO), making small investors rush into making the foolish decision of investing without verifying.

And that brings us to the question of how well are these culprits punished to set an example to strongly disincentivise others. There is far more to do to improve investigation, to strengthen the evidence gathering and adjudicating process such that it stands up to independent scrutiny, and to levy such stiff penalties that it makes the wrongdoer suffer for committing the harm as well as to set an example for others.

While a rotten stock market makes investors run away out of fear, ad hoc fire-fighting measures make fundraisers run away because of high costs of compliance and high liabilities. Each of these scenarios results in a loss to the financial pillar that is the stock markets, which is instrumental in raising risk money.

More regulations, more disclosures, more committees, etc are merely ad hoc measures which are more dil ko bahlane ke liye khayal acchha hai (a good thought to amuse the heart) and do not yield long-term solutions. A nuanced approach is needed rather than mere palliatives that assuage the investors.

Jayant Thakur is a chartered accountant. Views are personal, and do not represent the stand of this publication.