How a $2.6 trillion fund was taken for a ride

The “Big Client,” which is how the SEBI identified the victim of the scheme in its interim order last week, is none other than Capital Group. The Los Angeles-based fund manager with $2.6 trillion worth of equity stakes in companies worldwide confirmed Tuesday that it has indeed been taken for a ride.

By Andy Mukherjee

India’s market regulator has unearthed a plot to allegedly generate millions of dollars in illegal gains through the legitimate trades of a large overseas investor. The “Big Client,” which is how the Securities and Exchange Board of India (SEBI) identified the victim of the scheme in its interim order last week, is none other than Capital Group. The Los Angeles-based fund manager with $2.6 trillion worth of equity stakes in companies worldwide confirmed Tuesday that it has indeed been taken for a ride.

The alleged organizer is Ketan Parekh, a former stockbroker the regulator has chased out of the market once before. He was banned for 14 years for his role in one of the worst financial scams to hit India at the turn of the millennium. This time, too, the SEBI has restricted Parekh from trading. It has also directed him — and others it says were part of the plan to enrich themselves from nonpublic information — to return 658 million rupees ($7.8 million) of their allegedly illegal profits and commissions.

The SEBI has issued an ex parte order to stop the “siphoning off of the unlawful gains,” it says. Parekh and others can request the regulator for a personal hearing in 21 days to seek changes in the final order. Or they can challenge the regulator in courts. So far none of the affected parties have made a statement, either by themselves or through their lawyers, on whether they intend to contest the order.

The Parekh order, which comes close on the heels of another front-running scandal, makes it the right time to ask if India can do more to allay global investors’ perennial concerns about tipping their hand when they go into the market.

The two Indian brokerages named in the SEBI order as handling a sizable chunk of Capital’s trades have no links with Parekh. A former sales trader at one of them told me about how eyes used to light up when a deal ticket from Capital came along. While the folks on the desk were thinking about the commission, for a punter in India or a hedge fund in Singapore or Hong Kong, knowing about the order — and profiting from that nonpublic knowledge — could be their information edge.

The SEBI’s investigation shows how this edge was exploited unbeknownst to the investor.

Capital used the services of Rohit Salgaocar, a Singapore-based intermediary, because he could find liquidity for some of the US fund’s trades in India. But how did he do it exactly? Salgaocar told the regulator that 90% of Capital’s orders routed via him were filled by Parekh, according to the SEBI order.

The former Mumbai stockbroker — who previously was found guilty of price manipulation — would take the quantity and price information, and put it out in WhatsApp chat groups. Parekh’s alleged associates, who had saved his contact on their devices as “Jack,” “John,” “Boss,” or “Well-wisher,” would scoop up the shares minutes before Capital’s buy order went to its broker. They would then sell them to the US fund at a profit. (Or, if Capital was selling any shares, they would short them in advance and buy at a lower price from Capital’s brokers.)

The SEBI says it has evidence of a money trail between Parekh and his associates, those who allegedly profited from knowledge that was supposed to be available only to Salgaocar, and not Parekh. The regulator also says it has statements under oath from Salgaocar and Parekh that they used to communicate over WhatsApp. From these, it has drawn the inference that time-sensitive nonpublic information flowed from Salgaocar to Parekh, neither of whom have yet said publicly if they agree with this characterization of their interaction.

The regulator has also barred Salgaocar from the markets, and made him liable, along with Parekh and his alleged associates, for the return of the gains. The two brokers filling Capital’s orders are not under the SEBI’s scanner. They had commission-sharing agreements to return most of their net income on Capital’s trades to Salgaocar, who wasn’t paid by the fund. Meanwhile, Capital “had no knowledge of the unauthorized use of our order information,” a spokesperson told me in an email. Neither the fund nor its traders are under investigation for any wrongdoing.

The market structure for equities in India has some well-known shortcomings. Most bulky orders that would get negotiated in a quiet corner in other jurisdictions have to be punched into the main market screen, where other participants are waiting to pounce because the term sheet of the bilateral deal has leaked beforehand.

And it’s a very leaky market, as any regular viewer of dealing room chatter on Indian business TV will attest. Even newspaper reports routinely ascribe surging prices to buying by mutual funds of Kala Pathar, which means “black rock” in Hindi, a not-so-veiled reference to BlackRock Inc.; the code phrase for Life Insurance Corporation of India is “Big Daddy.” With their trading intentions already public knowledge, large investors’ orders are prone to slippages. One way to mitigate them would be to allow the matching of blocks in so-called dark pools.

The evidence that the SEBI has managed to put together in its 188-page report is daunting, complete with screenshots and testimonies. But that’s perhaps because of the alleged involvement of Parekh. An investigation of this scale can’t possibly be repeated in every case. What’s needed is a more systemic approach to fixing information leaks. Front-running is a bug in every market. India has to work doubly hard to stop it from being thought of as a feature.