SEBI trading curbs when promoter fail to dematerialize their holdings
September 20, 2011
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I was interviewed on CNBC TV18 today on the implications of the trading curbs imposed by the Securities and Exchange Board of India (SEBI) on companies whose promoters do not dematerialize all their shares. Even though the deadline is now only 10 days away, many of the largest companies in India including several state owned companies are not in compliance and could therefore face these curbs.
The principal points that I made in the interview were as follows:
- It is necessary to eliminate physical shares completely to deal with the risks of fraud. I argued this point at length in an article that I wrote in January.
- However, the measure introduced by the regulator is highly problematic because it penalizes the company and all its shareholders for a failure on the part of its promoters. The trading curbs reduce the liquidity of shares for innocent shareholders who have already dematerialized their shares.
- The logic of the SEBI measure is presumably that the trading curbs hurt the promoters so much that they would comply with it. I argued that this is incorrect. In a rising market, the trading curbs slow down the rise in the share price of the affected company by slowing down price discovery and making it harder for speculators to buy the stock. This presumably hurts the promoters. But this effect is completely symmetric – in a falling market, the slowing of price discovery supports the stock price. The stock price does not fall as much as it otherwise would because speculators find it difficult to short sell the stock. It is conceivable that some promoters will delay dematerialization precisely to activate the trading curbs.
- It is distressing that the government is not dematerializing its shares in state owned companies. I argue that the Comptroller and Auditor General (CAG) should be worried about the potential for fraud and theft and should insist on dematerialization.
- If neither the regulators nor the promoters blink in this game of chicken, the Indian stock market could be severely affected. Impeding price discovery in a large number of index stocks would create serious problems for the index derivative market as well.
- If the regulator really wants the promoters to fall in line, it is much better to say that physical shares will not be entitled to voting rights or to dividends until they are dematerialized.
The transcript of the interview as well as the video are available at the CNBC web site.