Bulls, Bears and Other Beasts

by Santosh Nair

  ‘I never thought of it that way, but I guess it must be true,’ I said, both delighted and embarrassed at the same time.

  ‘Of course it is true, Lala. Tell me something, why are you still working after having made so much money?’ Monk asked with a grin.

  ‘For the same reason that you come to work every day despite having made more money than perhaps Shah Rukh Khan and Aamir Khan put together,’ I said.

  My repartee drew laughter from everybody at the table. I thought I saw a flash of anger briefly flicker in Monk’s eyes before he joined the others in the laughter.

  I knew I had overstepped my boundaries with Monk and had to make amends quickly. Monk could discuss my net worth in public, but I was not to take the same liberty with him.

  ‘. . . for the same reason Ketan Parekh comes to work every day or, for that matter, even Warren Buffet, to make more money,’ I continued.

  Monk smiled. Sipping his drink, he said, ‘What I like about Lala as a trader is that he is good at sensing market trends and will quickly get out of a loss-making trade.’

  Nobody at the table caught what Monk was getting at, but I did.

  Three days before the great US stock market crash of 1929, the economist Irving Fisher famously said, ‘Stock prices have reached what looks like a permanently high plateau.’

  A similar delusion seemed to have gripped most of the market experts in India, given the stupendous rise in technology share prices. Some veterans feared the worst, given the way prices were rocketing. For some time now they had been saying a crash was imminent. But after repeatedly being proved wrong they kept their wisdom to themselves, not wanting to appear ridiculously old-fashioned. Also, it made bad business sense; clients did not like brokers preaching caution when stock prices were shooting through the roof every day.

  The normally adventurous Prakash was among the handful who managed to retain a good chunk of his profits. He reduced his trading positions to near-zero by mid-February, and decided to go on a vacation.

  ‘Honestly, Lala, I don’t think we will see a run like this again in our lifetime,’ he told me when I drove him and his wife to the airport. ‘In fact, I have half a mind to quit this profession altogether. Even when this party ends, we will keep hoping to double or treble our money every two months.’

  The party on Nasdaq ended abruptly on 14 March with a 4 per cent drop, sending the index tumbling to 4,707. And suddenly, investors in technology shares around the world were racing to exit the stocks, as if everybody had simultaneously realized at that magic moment that the business models of most of the technology companies were unsustainable. Overnight, these stocks – ardently pursued by fund managers and individuals until so very recently – became pariahs.

  The scene was no different on Dalal Street. The panic selling over the next one month halved the prices of the technology darlings. Many investors saw their paper wealth diminish considerably, or even vanish. When the slide began, many traders and investors held on to their positions, thinking it was another of those bull market corrections that would reverse quickly. By the time they realized the gravity of the situation, trading volumes had dried up. In many stocks, trading was frozen because there were only sellers.

  Like most of the others in the market, I too saw my paper wealth diminish. But there was plenty still left.

  19

  From Bad to Worse

  It was a bleak Diwali on Dalal Street, with the Sensex having fallen to around 3,700 from its peak of 6,000-plus Even the most diehard of bears would not have expected the fall to be this steep though they had anticipated a downswing.

  The aura of invincibility around Ketan had faded now, though he still called the shots in a few of his favourite stocks. He still had access to funding from friendly promoters, could tap into the coffers of Global Trust Bank and Madhavpura Mercantile Co-operative Bank (MMCB), and had fund managers whom he could count on to buy or sell shares on his instructions. He had also the support of the Indian brokerage arms of global investment banks like Credit Suisse First Boston and Dresdner Klienwort Benson, which entered into synchronized buy and sell trades with him. This arrangement helped create the impression of huge trading interest in a stock to attract other market players. Ketan would later tell the Joint Parliamentary Committee probing the 2001 stock market scam that these arrangements were not aimed at creating artificial volumes, but were pure financing deals where the brokerages were loaning him money at a price.

  A typical arrangement would consist of Ketan directly transferring shares held by him into the brokerage’s account and receiving cash for them upfront. This facility was known as delivery-versus-payment (DVP), and the transaction was not routed through the stock exchanges’ clearing house. The clearing house route – the normal procedure – would have meant another ten days before Ketan could receive funds for the shares.

  Having bought the shares from Ketan, the brokerages would immediately put through a sell order for the same block at a slightly higher price, the buyers being Ketan and his associates! This time the deal would be routed through the clearing house, giving Ketan about ten days’ time to settle the trade as the payments had to be made only in the week following the weekly settlement cycle. Whatever Ketan’s claim to the JPC about this web of dealings, the public thought of these large trades as a sign of FII interest in a stock.

  With the market showing no signs of revival, Ketan’s troubles were now mounting by the day. When the market had been on the rise, some politicians and their affiliates had given sizeable sums to Ketan to work his magic and multiply their money. As was to be expected, Ketan invested most of it in the stocks he operated. With the prices headed south, he was now in no position to return the principal, let alone get returns on them. The powerful people who had given him money had not the faintest clue about how the stock market worked, and did not care to know either. All they were bothered about was their money.

  The bears were now striking at will, aware that Ketan would not be able to support prices with the same ease he did during the bull market. Also, Ketan had unwittingly antagonized politically powerful people. His proximity to Amar Singh worried some of the big guns in the BJP. The Samajwadi Party and the BJP were fierce rivals, particularly in Uttar Pradesh, and there was a growing feeling that Ketan had become an important source of funds for the SP.

  Then there were the old-economy industrialists who had to endure the double agony of investors ignoring their stocks and upstart technology companies growing in market capitalization by the day. Thanks to Ketan pumping up their stock prices, many technology companies were now in a position to raise huge sums from the market with minimum equity dilution. This allowed them to expand operations at a much faster pace. The new entrants were not a direct threat to the established brick-and-mortar companies, but the latter found it hard to digest the fact that companies with barely any physical assets were commanding exorbitant valuations. In short, Ketan was seen as arming the challengers and threatening to upend the established order.

  The Union Budget in February 2001 brought brief cheer to the market. However, unlike the previous couple of Budgets, this one had little for the information technology sector. In fact, there was some bad news. Export-oriented units and units located in export processing zones, free trade zones and software technology parks had been granted a tax exemption on 25 per cent of their sales in the domestic market until then. This was removed in the Budget. The ceiling on FII investment in a company was now raised to 49 per cent. But this did not really matter at a time when FIIs were fleeing India.

  The bears intensified their assault soon after the Budget, sensing that the overall sentiment had taken a turn for the worse.

  ‘Ketan is foolishly trying to support the prices of his favourites in the face of relentless selling; the bears will make a meal of him this time,’ Monk told me over the phone after he had placed an order through me.

  I had observed that Monk had been a heavy seller in the Ketan favourites like Global Teles
ystems, Himachal Futuristics, Zee and DSQ over the past few weeks. Initially, I thought he was unwinding the long positions Ketan had built in these stocks through him. But his remark about Ketan made me think otherwise.

  Had he switched over to Ketan’s rivals and was now executing trades on their behalf, I wondered. Or was he short-selling the shares in his personal capacity, on the hunch that Ketan’s game was up?

  ‘But Ketan is known for his ability to make a comeback when least expected,’ I said, trying to confirm my suspicion.

  ‘Not this time. He has been done in by overconfidence. He has taken on unmanageable positions, believing he can get prices to obey him irrespective of the market trend. That would have been possible around a year ago. From what I hear, he is now struggling to pay margin money to his brokers,’ Monk said.

  Things were rapidly going downhill for Ketan. In a desperate attempt to prop up the prices, he asked his key brokers in Calcutta to buy on his behalf. Share prices, however, continued to melt away. The authorities saw the market fall as the work of a bear cartel that was unfairly trying to beat down prices for their personal gains. No doubt, heavy short-selling was putting pressure on prices; but when the bulls were ramping up prices a year ago and the bears were losing money, the authorities had seen nothing wrong with that.

  By now, bad news was pouring in from every corner. Just two days after the Budget, BSE president Anand Rathi called up the surveillance department of the exchange and asked for confidential information on broker positions in certain stocks. Rathi would later claim that he had sought the information to see if the crash in the Sensex that day was caused by institutional investor selling or speculative selling, and direct risk management measures accordingly. Whatever his justification, this was in violation of the code of conduct for BSE governing board members. The taped conversation between Rathi and the surveillance official was leaked to the press by a BSE official, and Rathi was accused of seeking the information for his personal gains and of passing it on to the bear cartel. Subsequent probes could not prove the charge against Rathi that he personally gained from the information. But the damage was already done. Less than a week after the revelation, SEBI dismissed the entire board of directors of BSE.

  The already beaten-down technology shares were hit by another thunderbolt when NIIT Technologies – among the darlings of the market – announced a profit warning. That soured the mood for a host of second-line IT services stocks such as VisualSoft, Polaris and KPIT Infosystems.

  Amid a growing perception that bears were to blame for the chaos in the market, SEBI tried to arrest the slide by banning naked short sales. This ban meant a trader could only sell shares that he owned. He could not short-sell and then square up his position by buying an equivalent quantity of that stock later. On paper, this measure was expected to boost stock prices as rattled bears rushed to cover up their positions by buying the quantity of shares they had sold. Instead, the ban had the opposite effect, and the Sensex shed another 500-odd points over the next three sessions following the ban.

  ‘The bears may have stopped short-selling, but those with delivery are still selling. To support the market you need buying, which is simply not there,’ GB told me when I asked him for his view.

  There was more bad news for the country coming. Only a couple of days after the BSE board was fired, a sting operation by the investigative website Tehelka.com showed senior defence officials and politicians from the ruling NDA coalition taking bribes in return for favouring a fictitious arms company. This was a big blow to the credibility of the government, which had always claimed it would not tolerate corruption. The government alleged that the exposé was deliberately timed to further dampen stock market sentiment. That was because Shankar Sharma of First Global Stockbroking was a key shareholder in Buffalo Networks, the holding company that owned Tehelka.com.

  Shankar Sharma, Radhakishan Damani, and Nirmal Bang were accused of acting in concert to hammer prices, and were the target of raids by the Income Tax Department and Enforcement Directorate. There were others who were raided too, but they were not so high profile. A SEBI probe found that entities related to Nirmal Bang and First Global had entered into synchronized trades to give an impression of heavy selling to beat down share prices. On appeal, Bang and Damani were able to prove that their trades were not large enough to depress prices and that they had not violated any rules. Sharma’s ordeal continued for much longer.

  All through March, Ketan’s situation was getting worse by the day. The raids by investigating agencies and the consequent freezing of his bank accounts cut off his access to funds. Ketan asked brokers in Mumbai and Kolkata to buy stocks on his behalf and promised to pay them interest for holding the shares on his behalf. He also placed some of his stocks as collateral with these brokers for margin obligations.

  Many in the market now felt he had become emotionally attached to the stocks whose prices he was going all out to support. Some claimed the promoters of the companies had beseeched Ketan to save their stocks, and he had agreed to oblige them, overestimating his own ability. The truth was simpler. Ketan tried to support the prices in an attempt to save himself. It was a desperate gamble, but he had little choice. When prices move up or down sharply, they tend to create self-reinforcing loops. Ketan was hoping that if he managed to stabilize the prices through small purchases, the selling pressure would ease and the prices would rebound, giving him some breathing space. The alternative was to dump his existing positions, but that would have caused prices to fall even more steeply, and he would still not be able to exit his positions fully. Sitting still and waiting for the selling fury to abate would not have helped either. With prices in a free fall, he would have to pay marked-to-market margins to the stock exchanges, which called for funds. In the marked-to-market margin system, an increase in the value of your outstanding positions gets you a credit in your account, while a decrease in the same requires you to deposit the difference as margin to the stock exchange.

  In a final throw of the dice, Ketan chose to support the prices of his chosen stocks, hoping to arrest their slide at least temporarily. On CSE, his associates were loading up on DSQ, Himachal Futuristics and other such junk stocks, and then attempting to carry forward the positions. But their prices continued to flag.

  Sensing trouble, many of Ketan’s brokers started offloading his positions. Others dumped the stocks he had placed with them as collateral. These actions set off a vicious cycle, the falling prices triggering off selling, every wave of selling leading to a further fall in prices, and so on. Trading in many stocks was frozen for lack of buyers, and brokers, unable to unwind their positions fully, defaulted on payments to the exchanges.

  Ketan’s situation was made worse by many badla financiers deciding to withdraw funds from the market at the same time that he was badly strapped for cash (too much of a coincidence, I thought). Badla rates shot through the roof as the handful of remaining financiers then asked for a steep premium. Undoubtedly, those Ketan had caused heartburn to on his way up the ladder of fortune were now tightening the screws on him.

  On CSE, there was a major payment crisis as Ketan’s associates who bought on his behalf were unable to make their payments to the exchange. There was a cumulative shortfall of Rs 106 crore across three settlement cycles, even as the exchange somehow tried to complete the settlement by invoking bank guarantees and appropriating the margin money of the defaulting brokers. In addition, the exchange dipped into its trade guarantee fund to bridge the shortfall. But all these measures were still not good enough to tide over the defaults.

  With all exit routes closed, Ketan decided to go for broke. He got MMCB to issue him a pay order for Rs 137 crore and pledged his shares, by now worthless, as collateral. This was not the first time that the bank’s chairman Ramesh Parikh had accommodated Ketan. In fact, the bank had been facing liquidity problems since early March when it became common knowledge that Ketan had a free run of the bank. Parikh was loaning funds to Ketan far in exce
ss of the limits set by RBI, and that too without collecting adequate collateral. Unnerved by rumours that the bank had given a hefty bank guarantee to the latest Big Bull on Dalal Street, wary depositors started taking their money out of the bank, effectively sealing its fate.

  Ketan was a major reason for the bank to go under, but he was not the only reason. Ramesh Parikh’s son Vinit Parikh was an active player in the stock market through his firm Madhur Capital, and was said to be dipping liberally into the bank’s coffers to repay his trading losses. At the time of issue of the pay order to Ketan, MMCB had already been hollowed out. Ketan presented the pay order to Bank of India, which released the money to him. When Bank of India presented the pay order to MMCB for the money, the pay order, naturally, bounced.

  Only too aware of the fate that befell the officials at SBI who allowed Harshad more time to settle his accounts, Bank of India chairman V. Krishnamurthy showed no such leniency to Ketan. He promptly called in the CBI, and on 30 March, a Friday, Ketan was arrested after market hours.

  Interestingly, the market shrugged off the development. The Sensex fell barely 40 points on Monday.

  ‘Looks like people don’t have anything left to sell,’ Prakash remarked, when we discussed the market that evening.

  A major casualty of the stock market crash was UTI’s flagship mutual fund scheme US-64. Just before it went under in July 2001, the scheme had 1.9 crore unitholding accounts – 99 per cent of them belonging to retail investors – and around Rs 16,500 crore of funds under management. A flawed pricing mechanism meant that the price at which investors purchased US-64 units, as well as the price at which they sold the units back to UTI, had no relation to the NAV – or the true value – of the scheme. UTI would increase the sale and repurchase of US-64 by 20 paise every month. To a large extent, these fresh inflows helped pay the unit holders who wanted to exit. Such a pricing mechanism gave certain returns to existing and exiting investors, but also created the perception among investors that US-64 was an ‘assured returns’ scheme without any risk. Till the early 1990s, equity investments accounted for 20 per cent of the US-64 portfolio, and debt instruments for the rest. By June 2001, as the bull run was in its death throes, equities accounted for 75 per cent of US-64’s portfolio, and included a good many dubious stocks purchased for nefarious reasons.