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The inside story of Sebi crackdown on dabba trading

G.N. Bajpai
A new book chronicles how in 2003 Sebi broke the back of powerful lobbies that perpetuated the black economy around hoax trading of shares

Byculla, a south Mumbai neighbourhood, is known for its crowded and narrow lanes filled with honking cars fighting for space, its rows and rows of vegetable sellers, delicious streetside non-vegetarian food and its non-descript, medium-sized residential and commercial buildings.

One morning in July 2003, a group of four or five men struggled their way through the Byculla chaos to reach an old, worn-out, shabbily painted, medium-sized building. They forced themselves inside the building and entered the door bearing the name plate Bansal Sharevest Securities Pvt. Ltd.

Once these men revealed their identities as Securities and Exchange Board of India (Sebi) officers, there was commotion inside the office. Some people tried to escape through the back door, some threw documents outside the window, some simply sat at their desks in fear, and some rushed to making distress calls. The Sebi officers managed to calm them down and began their work of search and seizure of the premises.

The interior of the office, with its sophisticated equipment and gadgets, was an antithesis of the dilapidated exterior of the building that housed the office. The other offices of Bansal Sharevest in Bhuj, Kolkata, Mathura and Bengaluru were also simultaneously raided by Sebi officers. This was the first-ever raid conducted by Sebi. It was only a few months back, in December 2002, that Sebi had been given the authority to conduct search and seizure. What prompted Sebi to use this power within six months itself was the growing menace of ‘dabba traders'.

This is how a usual share purchase in the share market looked like: An investor wanting to buy shares for, say ₹100, would instruct his broker to execute the purchase on his behalf. The broker would either take the amount of ₹100 upfront from the investor or, if he has sufficient margin money from the investor with him, would purchase shares for ₹100 on the investor's behalf from the exchange by paying that amount himself. Each trade involved some cost to the investor; a percentage of the transaction amount had to be paid as broker fee, exchange fee, Sebi turnover fee, stamp duty and, from October 2004 onwards, a percentage of the transaction amount would go to the income tax department as Securities Transaction Tax too.

As it stood then, for a transaction amount of ₹100, the total cost would amount to about ₹101, the fees and other payments amounting to about 1 per cent of the transaction amount. This would be paid by the investor to his broker (even if the amount of ₹100 was not paid upfront, some amount had to be kept by the investor with the broker as margin money).

A similar cost would be incurred when the investor decided to sell his shares. The sale/purchase transactions would be recorded on a system, with proper trails and paper documentation. Obviously, settlement of a trade in the stock market is guaranteed, and even if one of the parties defaults, the buyer would invariably get his shares and the seller his money.

The dabba trader's way

But there were certain brokers and investors with misplaced adventurism who preferred to trade the dabba trading way. As the name suggests, dabba trading is nothing but hoax trading or fake transactions. Continuing from the above example, if an investor wanted to bet on shares for ₹100, in dabba trading the trades would not be formally executed at all! The broker would, on behalf of his customer, execute the trade off the market.

This meant the investor would simply bet on that scrip at a particular price point. If the price point rose, the customer would gain and get the difference between quoted price and the price point, and if the price fell, he would lose and shell out the difference.

In our example, if the price of the scrip fell to ₹90 (on a pre-decided date, the reference price being ₹100), the broker or investor would settle the position by paying or receiving ₹10. All these transactions were done in cash. There was no actual share purchase or sale and no actual payment to the exchanges (either of the transaction amount or the margin money). In fact, the broker/investor did not even need ₹100 with them to bet on trades. An investor could very well have ₹10 or nothing in his pocket, and still bet on shares for ₹100.

Dabba trading was simply betting on stock movements. If the anticipated movement went in your favour, you gained money, and if it did not you lost money. Since it was not a transaction, there was absolutely no transaction cost.

To avoid confusion between the betting parties, a price point would be officially fixed by trading a small amount of shares in the formal market at that price (say, 1 share would be purchased through the formal route at ₹100 to fix that as the reference price, while the total bet could involve ten shares, 1,000 shares or more). Thus there would be many small, single transactions made by the dabba brokers and investors.

There could be many buyers and sellers, and the trades would square off on a mutually agreed date. Whatever deals happened were on the basis of mere trust. Most of the time, the investors were willing participants in the dabba trade. Sometimes the broker did the dabba trading without the knowledge of the investor and even on his own behalf. At times brokers would speculate on a stock themselves by creating false client accounts to show that some genuine work was happening at their terminals.

The impact of dabba trading

This dabba trading was akin to a full-fledged parallel black economy of the stock market. Lakhs of crores of rupees were being betted, but hardly any of it was happening through the exchanges, and many authorities (the exchanges, Sebi, the revenue department etc.) were being deprived of thousands of crores of rupees in revenue. Also, exchanges were deprived of the share purchase prices or margin safety. In addition, if the brokers/investors made any gains, they would not be paying capital gains tax on their dabba trades, causing a further loss of revenue to the country's exchequer.

Second, this dabba trading was akin to pure gambling, which is prohibited in India. Brokers and investors often make trade bets, risking crores of rupees without having the adequate amount with them for backing their bets, as anyway the bets were off market and there were no margins in reserve. So even if a bet was won, the losing broker or investor from whom the money was to be collected would vanish. In the end, investors' money would be at big risk, and there was no exchange guarantee and margin safety to protect them.

The risk was even more in cases where brokers indulged in dabba trades without informing their clients. Some dabba traders would, however, hedge their net positions daily through official derivatives trades, but those were exceptions rather than the rule. Since dabba trading was becoming widespread, their volumes were growing and many gullible investors were getting drawn in. It had the propensity to become a contagion, which could eventually spread to the capital market in many ways. Large failures of dabba trades would affect sentiments in the capital market, and if they happened around the dates of derivatives settlement, it was bound to impact the market and become a low-lying possibility of a market-wide failure later.

After all, these transactions were ostensibly done as stock exchange transactions. And how could the regulator permit this illegal activity? Generally, dabba trading happened in centres where the smaller regional stock exchanges (RSEs) were present. RSE governing boards were not strictly monitoring the norms of trading and surveillance. Brokers in their zones often constituted a kind of financial mafia whom the governing boards had to obey. They had to ignore the illegalities committed right in or outside the stock exchange premises.

Shockingly, some brokers had even convinced themselves that they were helping people through these fraudulent dabba trades. When asked questioned about his activities, Sunil Kalyan, a Kolkata-based dabba trader, made the following statement in a leading daily: “Whatever I am doing is a gainful economic activity for a lot of individuals. Investors who come to my office do it willingly. There is no truth in your statement that they have been cheated in the process.”

It was estimated that the average turnover from dabba trades amounted to ₹2,000 crore daily; whereas formal trades were in the range of ₹4,000 crore to ₹8,000 crore in turnover at the time. So dabba trades constituted about a third of overall market trades. That was a huge informal market. Some sections of the media even estimated the turnover from dabba trading at ₹6,000 crore a day-that is, equal to or more than the formal markets. Ahmedabad Stock Exchange was particularly notorious for the dabba trading that happened outside its premises.

Investors seldom complained, as they did not have adequate knowledge about the markets or about their right to complain, and could be easily hoodwinked by the brokers with some fake story of money loss. Some investors wishing to complain were threatened by the brokers. And sometimes, investors themselves were involved in the speculation or gambling. As far as documentation was concerned, some brokers tampered with their software to generate fake trails and paper documents.

Believe it or not, there were special software providers for dabba trading. Using their software a broker could punch an order for ten shares on the exchange, but the actual order that would get executed would only be for one share. The numbers punched would automatically be divided or the zeros just vanished. So on paper one would see ten share purchase orders being executed, whereas in reality only one share was traded through the formal route (this was required to establish the reference price, as mentioned above).

The crackdown

Once instances of dabba trading came to the notice of Sebi, it was decided to crackdown on the traders. A full-fledged search and seizure was planned. Sebi probed further, established proofs, unearthed the names of the brokers indulging in this illegal trading and finally formed a team of four or five officers to start the surprise raids on these brokers, among whom Bansal Sharevest was the first, and probably the most prominent one.

Since these unofficial trades were also an illegal activity, in general, we sought the help of the respective state governments by writing to the concerned chief ministers for their support in curbing them.

Many of these unscrupulous brokers (including Bansal Sharevest), not surprisingly, had political backing, and even had some politicians, amongst other influential persons, as their clients. But concern about the consequences of our action was not on our minds when we raided such brokers. The securities watchdog had a job at hand, so we went ahead and did it, taking some risk of a possible backlash from the affected parties.

Every raid had to be planned with utmost precision and secrecy to avoid any information leakage. Since raids could turn hostile, help was taken from the police to accompany the Sebi officers on the raids and to facilitate forcible entry into the brokers' premises. The local magistrate was taken into confidence for formal judicial permission only the previous night (of the planned raid) as we did not want any third party to know about our plans.

At the end of the raid on Bansal Sharevest, computers and note books were seized and the employees and promoters taken for questioning. One raid led to the names of many other dabba traders, and over time, many illegal traders were nabbed; others shut down overnight on hearing of Sebi's operations against their lot.

Unfortunately, the markets regulator does not have the powers of a criminal court, and it could only do one of three civil actions against the culprits-issue them a warning; impose a monetary penalty; cancel their license and/or debar the traders from the market. In the end, we imposed the highest penalties possible under the Sebi Act 1992, debarring the involved persons from the market and cancelling the licences of the brokers involved in dabba trading.

Human ingenuity is limitless. The temptation to profit in an underhand way by exploiting opportunities is universal. Daredevils and evil minds marshal their ingenuity to translate their temptation into activities like dabba trading. Regulatory alacrity and fast judicial deliverance can certainly curb, if not entirely prevent, such misdemeanours from becoming widespread and posing a risk to the system.

Whereas the regulatory alacrity was adequate, the criminal justice system in the country could not respond with equal urgency. Many criminal cases filed by Sebi have not been heard for years. So where is the question of ultimate action in these matters?

I hope that one day the dynamics of criminal justice systems will get wings and the Indian judicial system a sense of urgency.

Extracted from A Game Changer's Memoir, by G.N. Bajpai, published by Penguin Random House India.

G.N. Bajpai was the chairman of Sebi between 2002 and 2005.