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Fraudulent Activities in the Financial Markets and The Role of SEBI

Updated: Mar 11, 2020

by Yash Bhatia

Finding certain loopholes in any system and taking undue advantage of the same for personal benefit is extremely prevalent and pervasive. Wait, isn’t that really corruption?

Well, here is yet another case of unscrupulous activities happening in the Financial Market (the market which is regulated by the Securities and Exchange Board of India – SEBI). Let’s first learn what SEBI is and what role it plays in the financial market (a market in which financial securities like shares, debentures etc., and commodities are traded), since learning it is imperative to understand this article. For simplicity, I’ll be using the term ‘market’ for ‘financial market’ from now on.

The Securities and Exchange Board of India (SEBI) was established in 1988 and received statutory powers in 1992 through the SEBI Act, 1992. It performs the major function of regulating the securities market in India with the main aim being to check that the market functions in a manner, while ensuring the well-being of all the three parties involved – the issuers, the investors and the market intermediaries (who act as a link between the former two and are the string through which all the financial market activities, including buying and selling of securities occur). The SEBI has three major functions to perform– Regulatory, Development and Protective Functions. Focusing on the protective functions, among others, SEBI helps in 1. Checking Price Rigging (the activity wherein the issuers (say, companies) artificially inflate the prices of the securities in order to gain profits at the expense of the investors); 2. Prohibiting Insider Trading (when security trading takes place by someone with material non-public information about the security, for her/his own benefit); 3. Preventing other unfair and fraudulent trade practices.

Following these, SEBI has successfully performed these functions over time and also solved many cases of fraudulent activities being indulged into by the investors and/or the issuers. Recently, various  cases involving the market intermediaries have sprung up. As reported by the Times of India, SEBI launched a probe into a scam which involves  agents who make a killing by fraudulently transferring share certificates from the account of a deceased holder, which are in physical form and have not been claimed by the nominee or the legal heir, into illegal accounts.

This is how the market intermediaries (like brokers) take undue advantage of their position (the gateway of all transactions between the issuers and investors). These agents use unlawful means to get hold of physical shares unclaimed by the legal heir of the deceased. Then, they convert these physical shares into Demat (dematerialised i.e.- securities in electronic mode) form to sell in the market, transfer the funds into bank accounts set up for the purpose and finally make cash withdrawals (they ensure that transactions take place only through cash so as to leave no trail). According to a few sources, the fraud is suspected to be carried out by agents in conspiracy with employees of share transfer agencies, companies, banks and some government offices. It is estimated that the scam runs into crores of rupees. Sources also say that in quite a few cases, such fraudsters have targeted dematerialised shares too, apart from unclaimed dividends of the deceased.

The investigation by the regulator started after a top finance professional complained to SEBI that shares of two companies worth about Rs 23 lakh, which were in the name of two of his relatives (a couple who died decades ago in the US) were fraudulently transferred into an illegal account and sold, and money was taken out through cash withdrawals using fake accounts and forged signatures.

What are some of the steps which can be taken to resolve such issues? Firstly, SEBI needs to become more vigilant towards activities involving such sudden conversion of shares, followed by immediate withdrawal. SEBI can also prevent such activities from occurring by keeping a track record of the deaths of the security holders (investors). But the above two mentioned solutions are really cumbersome, and might not turn out to be that concrete in action. Thus, keeping practicality, applicability and effectiveness in mind, as recommended by depositories and brokerages, a much better solution is to make it mandatory for the holders to hold the shares (securities) only in Demat form, and not as physical shares. However, this major step requires an amendment in the law since the Depositories Act, 1996 allows the holders to hold securities in physical form. The government will have to take this bold step of law amendment to ensure that such activities do not take place in the future.

Also, since most of these acts take place under the trail of forged documents, another probable solution is to develop a mechanism to check such forged documents. Moving on to individual issuers, it is worth noting that since these fraudsters usually get information about the accounts with unclaimed dividends when companies publish this, it is required that access to such information is kept restricted to the holders and not made public.

Further, it is recommended that the entire responsibility of checking unscrupulous activities in the financial markets is not just left to SEBI, but the responsibility be decentralised and companies themselves too take the necessary steps to contribute in making the Indian Financial Market free of fraudulent activities. This can be done by scrutinizing the accounts of the holders on a regular basis, with a special surveillance of those of holders who are old, or who have not been claiming dividends for the past few years.

All these steps can hence prove to be useful in ensuring that the stability as well as the reliability of the Financial Markets in India remains intact.

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