ONE of the positive spin-offs of the billion-dollar scam involving the promoters of Satyam Computers, India’s fourth-largest information technology company, is the introduction of new rules by the stock market regulator, making it compulsory for promoters of companies to disclose the percentage of shares pledged by them to lenders.

Satyam’s promoters, led by chairman Ramalinga Raju, had quietly pledged almost all their holdings in the company to lenders. The Rajus had promoted Satyam, but over the years they began diluting their share-holding in the company. However, other investors – both institutional and retail – were not aware about the dilution of their equity.

Simultaneously, share prices were rigged as the management continued projecting rapid growth of the company, despite the absence of adequate profits or even new business.

By the time Raju confessed, last month, to having fudged the figures for years, and revealed a scam adding up to over a billion dollars, his (and his family’s) holdings in the company had come down to less than two per cent. Raju and his younger brother Rama are currently lodged in a Hyderabad jail, being interrogated by sleuths from the local police and officials of the Securities and Exchange Board of India (SEBI), the country’s capital market watchdog.

The Satyam scam unravelled after the Rajus rammed through a resolution in a board meeting, directing it to acquire real estate and infrastructure firms – the Maytas group –promoted by Raju’s sons and in which they had substantially more control. However, angry shareholders in the US (Satyam is also listed on the New York Stock Exchange) and India hammered the scrip, forcing the management to back off.

But when nasty details of the scam surfaced, Satyam’s share prices plunged, resulting in investors losing millions of dollars. The Rajus, however, had washed their hands off their holdings earlier, pledging their shares to banks and other lenders. The money that they had raised by pledging the shares had been used to acquire land in and around their infrastructure projects in Hyderabad and other parts of the south Indian state of Andhra Pradesh.

However, the US sub-prime mortgage crisis and last year’s global financial meltdown had a devastating impact on the real estate sector in India, leading to a sharp fall in prices. The Rajus were left holding hundreds of acres of land worth a fraction of what they had invested.

Prices on the Indian stock markets too had plunged and there was little scope for further price-rigging of Satyam shares. Raju’s political backers in Andhra Pradesh – who allegedly include both the ruling Congress and the opposition Telugu Desam Party (TDP) – were also in no position to bail him out, especially with general and state assembly elections due to be held by April or May.

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SEBI did not lose much time in formulating new guidelines relating to the pledging of shares by promoters, after witnessing the sordid Satyam saga. Earlier this month, new rules came into force, with the capital market regulator directing all listed firms to disclose pledging of shares by promoters.

“Promoters who pledge shares have to disclose it to the company and the company has to disclose it to the stock exchanges,” says C.B. Bhave, the no-nonsense chairman of SEBI. “In case of complaints that people are not complying with the regulation, we will investigate them,” he warns.

The companies have to disclose the pledging of shares in their quarterly shareholding pattern and the financial results that they announce every quarter. Many promoters of companies in India routinely pledge their shares to banks, taking loans against the shares.

The banks extend loans adding up to about 50 per cent of the value of the shares that are pledged. They constantly keep monitoring the share prices, and whenever prices decline, they demand additional margin money from the promoters, or sell part of the shares.

Promoters now have to disclose the pledging of shares within seven days of doing so in case they pledge over 25,000 shares or one per cent of the total shareholding or voting rights, whichever is lower. Besides this, quarterly disclosures have also to be made.

The objective is to ensure transparency so that ordinary shareholders will know the extent of the promoters’ shareholding. During bull-runs, investors are not bothered about the extent of a promoter’s holding, but in a bearish market, they would like to know whether the promoters – or their lenders – are dumping their shares and making a quiet exit.

According to Manas S. Ray, executive director, SEBI, “our intention is to see that if the pledged shares had been cashed out, whether the risk management is in place and the investors’ interest is protected.”

But analysts believe that SEBI should insist on further disclosure, allowing investors to know the ‘trigger price’ (the price at which the lender decides to sell off the pledged shares). If a large chunk of shares have been pledged by the promoter, ordinary investors have a right to know at what price the lender will start dumping scrips in the market. This would enable them to take necessary steps to prevent losses in their holdings.

Similarly, it is felt that promoters should also disclose how they have spent the money raised by pledging their shares. In the case of the Rajus of Satyam, the money was primarily diverted to the high-risk real estate business. Other promoters tend to siphon of the funds for personal use.

Says Prithvi Haldea, managing director, Prime Database, which monitors the capital markets: “It is not enough for a promoter to only disclose the number of shares pledged. To make the information more meaningful, we need to know the end use of funds and do subsequent mapping of fund utilisation.”

SEBI now plans to make it compulsory for promoters to disclose the end use of funds raised by pledging shares to lenders.

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ABOUT 300 companies have so far disclosed the extent of shares pledged by their promoters, following the SEBI directives earlier this month. The Tata group, India’s leading business house – which has acquired a clutch of international firms in recent years – has disclosed that the promoters have pledged shares worth almost Rs100 billion.

The Tatas have spent an estimated $18 billion in recent years in acquiring international companies including Corus Steel, NatSteel, Jaguar and Land Rover auto brands, Eight O’Clock Coffee and General Chemicals. The group paid $12 billion to acquire Anglo-Dutch steelmaker Corus, and also bought the two British luxury brands from Ford Motors for $3 billon.

It has also been investing in new businesses, including direct-to-home television service, Tata Sky, and an electronics retail chain, Croma. Tata Sons is the main promoter of the group.

While the group went in for short-term borrowings internationally to fund these acquisitions, the financial crisis in the West has brought pressure on it. Both Tata Steel and Tata Motors are also facing a major crisis, with the sudden decline in demand.

According to Ishaat Hussain, finance director, Tata Sons, it has enough stock of various group firms and would continue pledging shares to raise funds whenever they are needed. He says the practice of pledging shares is quite old.

Hussain notes that whenever there have been margin calls, “we have topped it up. If the need arises, we would pledge further, as there are plenty of Tata stocks to pledge.”

Tata Sons, which is the promoter company for 27 listed entities, has pledged shares in all the leading group companies including Tata Steel, Tata Motors, Tata Power, Indian Hotels Company, Tata Communications, Tata Teleservices (Maharashtra) and Tata Coffee.

Promoters of several other Indian groups and companies have started disclosing the percentage of shares pledged by them with lenders. This is giving a fair idea to both ordinary and institutional (both domestic and international) investors about the promoters’ exposure in their firms. The new disclosure norms would indeed go a long way in bringing about more transparency in the Indian capital markets.