Who will oversee OCBs?

The Securities and Exchange Board of India's report to the Finance Ministry on the scam of 2001 hit the headlines last month and read more like a narration of Houdini acts. The report centres on the nexus between foreign institutional investors (FIIs), share-brokers (read, Mr. Ketan Parekh) and overseas corporate bodies (OCBs). It is alleged that the FIIs opened sub- accounts or issued participatory notes (PNs) and thereby facilitated foreign individuals who were otherwise ineligible to make investments in stocks through the stock markets. Links with tax havens like Mauritius have also been hinted.

Though the atmosphere continues to be grim and a Joint Parliamentary Committee has commenced examination of all related issues, legal battles would follow in due course implicating the FIIs, SEBI and the Reserve Bank of India. The SEBI is right in highlighting the nexus between the brokers, OCBs and FIIs. Unfortunately, this nexus is not a new factor as the porosity of the system has been known for a long time.

Systemic `hole' exploited

During the months when the epidemic raged, it was sad that neither the SEBI nor the RBI woke up to the threat or took timely steps in spite of the abnormal volumes of shares handled through the network. Nor was there anyone to blame it all on "systemic" failures. This time around, it was indeed a systemic "hole" which was exploited by brokers and their collaborators. The gaping hole referred to is the treatment given to NRIs, especially the OCBs.

What is this animal called an OCB? It is an interesting story and deserves narration. When the Government decided to attract remittances from non-resident Indians (NRIs) way back in the 1960s, several incentives such as tax concessions, higher interest rates and exchange protection for deposits were given. The argument was that, unless special concessions or incentives are given, the NRIs might rather prefer to keep their funds in safer havens such as Switzerland or Bahamas than in India. The whole approach was to attract remittances from individuals and the idea of granting similar treatment to companies or corporate bodies did not occur.

Trends in NRI remittances to India in the 1960s and the 1970s revealed a close correlation with the interest differentials between Indian and LIBOR rates. Thus, in the late 1970s when the global rates went up vis-a-vis Indian rates, there was a steep decline in remittances.

A committee was appointed under the chairmanship of Mr. R. N. Malhotra to study the issues. The committee made several suggestions to liberalise NRI facilities and recommended that the facilities could also be extended to companies owned by NRIs since ordinarily large volume funds are held by corporate bodies and not by individuals.

The idea of opening up facilities to corporate bodies owned by NRIs did not find favour with Mr. R. Venkataraman who was then the Finance Minister. He was apprehensive that the facilities could be misused by non-Indians taking cover behind NRIs. He also doubted whether sufficient safeguards could be in place to rein in NRI capital inflows and prevent adverse consequences to the economy.

The Escorts, DCM episodes

Mr. Pranab Mukherjee, who succeeded him, had no hesitation in clearing the entire package recommended by the Malhotra Committee. These were included in his budget for 1982-83 with fanfare. It was in this package that NRIs were allowed to make portfolio investments, that is, investments through stock exchanges within limits.

Within months after the creation of the new facilities, there was the drama of Mr. Swraj Paul attempting to take over DCM and Escorts through the new portfolio route. Mr. Nanda's refusal to transfer the shares stopped Mr. Paul in his tracks. A long court battle followed and it was evident that Mr. Paul had the backing of the PMO (read, Indira Gandhi). Dr. Manmohan Singh who was then the Governor of the RBI had serious reservations over the role of NRIs in take-over bids and threatened to resign on policy differences.

It was during this period that the Ministry of Finance issued a press note clarifying that its intention from the beginning was that the NRI facilities open to individuals were open to OBCs also. Mr. Paul had won round one.

What saved DCM and Escorts ultimately was not the battle in the courts or changes in NRI policies, but their personal equation with Rajiv Gandhi who had taken over as the PM after the assassination of Indira Gandhi. Mr. Paul decided to pack up and accepted compensation from DCM and Escorts for the shares he had acquired through brokers in Delhi. The upshot of DCM/Escorts controversy was that OCBs had become legitimate players in the stock markets.

Now, what is an OCB? The RBI's book says, "Overseas corporate bodies (OCBs) are bodies predominantly owned by individuals of Indian nationality or origin resident outside India and include overseas companies, partnership firms, societies and other corporate bodies which are owned, directly or indirectly, to the extent of at least 60 per cent by individuals of Indian nationality or origin resident outside India as also overseas trusts in which at least 60 per cent of the beneficial interest is irrevocably held by such persons." Such ownership or interest should be actually held by them and not as nominees. This definition is so broad and nebulous that one would expect clear guidelines from the RBI for proper verification of OCBs and their status.

While there are no guidelines, the RBI has tried to skirt the issue by reliance on certificates by auditors. All that an OCB has to do is to get a certificate from an auditor in two forms (one for direct ownership and another for indirect ownership - like Newton's for two cats, separately!) affirming that not less than 60 per cent of ownership/interest is held by NRIs. No other questions are asked.

Safest route for arbitrage operations

There is no way a scheduled bank or even an officer of the RBI can verify facts of ownership or interest in OCBs. Each year a certificate is given about the continuing NRI interest and it is accepted in good faith. There is also no way other regulatory agencies (RBI or SEBI or the Ministry of Finance) can ascertain the funding sources of OCBs. As long as the OCBs have cozy relations with foreign banks and fund managers, they can access funds for all their transactions.

Loans given by foreign banks are covered by back-to-back guarantees. For major foreign banks, the OCB route proved to be the safest way of arbitrage in a volatile international market. Other funds and agencies of murky standing such as those engaged in hawala or money laundering would not have missed the attractions of the OCB route to park their funds in India. It is not accidental that most of them are located in tax havens such as Mauritius.

The linkage of OCBs with some of our industrial houses has come to light often. The Reliance group is known to have formed companies abroad - Crocodile and Scorpion - and their funds were deployed to maintain their share quotations or to push them up.

From a link with industrial houses to regular links with FIIs is but a short hop. But then, the returns begin to leap as the range of share portfolio gets widened. With luck, and if they could join hands with a leader in the stock market, say Mr. Ketan Parekh, they get richer. Combined with global hype on "new economy" stocks (so-called KP-10 in the stock markets), their business reaches astronomical levels.

These agents knew when to withdraw since they had links with global exchanges and advance intelligence about the coming collapse of the 'new economy' stocks. Many banks, mutual funds (including the UTI) and a large mass of small investors ended up holding "dud" stocks. The country wakes up to another scandal and a JPC is formed.

Stringent norms required

What conclusions do we draw from this brief analysis? First, there is too much porosity over NRI schemes. In particular, there is need to define clearly the concept and role of OCBs and lay down stringent requirements to monitor their transactions regularly.

Reliance on certificates given by non-resident auditors who are not subject to the professional discipline and control of national bodies such as the Institute of Chartered Accountants of India should be replaced by a more reliable system. The other, in parallel, is that there is need to tighten the supervision of FIIs by special report requirements and onsite inspections on a regular basis.

The report of the U.K. Department of Trade and Industry released in March this year on the financial irregularities of Mr. Robert Maxwell in the early 1990s bears many similarities to our stock scam. Mr. Maxwell diverted pension funds of 400 companies controlled by him and manipulated inter-company transfers for share purchases and realised, at a rather late stage, that the chain had irretrievably snapped a la Parekh.

The DTI implicates squarely respectable names such as Coopers & Lybrand, Goldman Sachs and Samuel Montague which had lent their names or services to Maxwell. Can auditors in tax havens be worthier in their role in certifying the status of OCBs?

Though the whole episode is disturbing, given the loose manner in which NRI facilities are being operated, the legal case against the broker-FII-OCBs nexus per se is rather weak. They can however be faulted for specific acts of violation of banking or SEBI norms and regulations.

K. Subramanian

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