A Demat scam from the early 2000’s

by | Jul 25, 2019 | Learning Module 3, Topic 4: Primary Markets and Initial Public Offerings | 0 comments

I read about an IPO scams from the early 2000’s. This was a time before KYC norms were in place, requirement for identity proof, address proofs, were all still being formalized. Here is what I can piece together.

Step 1: Create multiple bank accounts.

One enterprising lady, apparently the wife of a sub-broker ran a photo studio, offered two free photos for each one clicked. Another sourced photographs from Shaadi.com, a matrimonial site! All one needed as identity proof was a photograph to open a bank account, without the subject’s knowledge.

Step 2: Create multiple demat accounts.

Using their own legitimate bank accounts, the perpetrators generate letters of introduction to open multiple fictitious demat accounts. The address in the letters served as proof. Detailed alphabetized lists were maintained, a number of these fake demat accounts have the same address. Account maintenance charges and transactions charges were paid to the relevant depository participants (DPs).

Step 3: Subscribe to IPO allotments.

From the demat accounts, the fraudsters then subscribed to IPO allotments. At the time, PAN numbers were not required for amounts below Rs. 50,000 and the registrar didn’t really bother with it anyway. One news story says that over 6000 such demat accounts were opened which then subscribed to the YES bank IPO (will this bank never leave me?).

Step 4: Obtain financing for the IPO.

Also at the time, bank branches that provided demat services were offering loans to retail investors for purchasing shares in IPOs. One offer from TamilNadu Mercantile Bank eagerly says loans can be upto 50% of the issue price, maximum of Rs 10 lakhs, often approved the same day. Loans had to be repaid 7 days after IPO shares were allotted.  So funding is secured.

Step 5: After allotment.

Another news story says that in the IPO for IDFC, over 7.3 million shares were allotted to 27444 accounts controlled by the scam artists. Shares from these and other fake demat accounts are transferred to a specific demat accounts from which they were sold after listing. SEBI surveillance systems first picked up on these off-market transfers and that was one way the scam was identified.

The expectation, around the IPO time was that there would be a pop in the stock price after listing at which point, shares from those few demat accounts controlled by the promoters would be sold, the loan repaid and the difference kept. For fake demat accounts that did not receive an allotment, the refunded amount would be used to settle the loan.

There was (and still is) a period between allotment and listing. If the IPO is not that hot, and not oversubscribed there is a chance that the allotment price would end up below the listing price. However, there are people interested in the IPO but didn’t get the allotment. Perhaps they were willing to buy in the black market at above the allotment price. Apparently, there were multiple instances of shares changing hands after allotment and before listing. This appears to have caught the attention of the income-tax department who saw large capital gains tax payments before the listing date on these off-market trades. This served as another hint that something was afoot.

Post-mortem.

In all, 21 IPOs between 2003-2005 were affected by the above shenanigans. These include household names like Suzlon Energy and Jet Airways, in addition to YES and IDFC mentioned above.  Many entities in the Karvy group, as brokers, DPs, financiers and IPO registrars were implicated as the story unfolded. This scam resulted in the first SEBI disgorgement order, which requires them to pay affected investors from funds received from the scamsters. Curiously, it is not easy to identify who these might even be, its almost a victimless crime.  I would guess these are people who did not receive an allotment but otherwise might have.