Did Sebi miss any tricks in Ambani consent order?

On 14 January 2011, the Securities and Exchange Board of India (Sebi) issued a consent order to Anil Ambani and four of his senior Reliance ADA Group (R-ADAG) executives for alleged violations of the Sebi (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations 2003 and the Sebi (FII) Regulations 1995.

Ambani and his executives offered to pay Rs 50 crore, agreed to abstain from investing in the stock market till December 2011 in their individual capacities, and committed that their companies - Reliance Infrastructure and Reliance Natural Resources Ltd (RNRL) - would also stay out of the secondary markets till December 2012. They also agreed to pay the fines from their own pockets and not burden their companies with it, but without admitting or denying guilt.

The consent order related to what Sebi initially thought were merely misrepresentations by Reliance Infrastructure and RNRL on "the nature of investments in yield management certificates/deposits and profits and losses thereof" in their annual reports for 2006-07, 2007-08 and 2008-09. Sebi also investigated the group's bid to use money raised abroad through external commercial borrowings (ECBs) and foreign currency convertible bonds (FCCBs) in Reliance Communications (RCom) through the illegal FII route.

On 15 May 2012, the Upper Tribunal - which hears appeals against orders of the regulator, the Financial Services Authority (FSA) - confirmed a fine 1.25 million (around Rs 10.08 crore at current exchange rates) on Sachin Karpe (See Firstpost story). A former UBS Wealth Management (Asia II Desk) Managing Director, Karpe was the key intermediary enabling the channelisation of $250 million (about Rs 1,000 crore at Rs 40 to the dollar) of Anil Ambani's (or R-ADAG's) funds into a Mauritius Protected Cell Company (Pluri Cell E) for ultimate investment into RCom shares.

Among other things, the UK Tribunal observed that Karpe helped open an account with the Swiss bank (i.e. UBS) in Zurich for Cell E, and "RCom shares and derivatives (and other assets) were held on this account. At certain times, the value of these assets exceeded US$ 400 million."

So, at some point, $250 million (Rs 1,000 crore) of investment became $400 million (Rs 1,600 crore or more) - a paper gain of Rs 600 crore.

But Sebi, and the high-powered advisory committee (HPAC) which scrutinises requests for consent orders, saw it fit to levy only Rs 50 crore in what could have been a Rs 600 crore gain if the actions of Karpe and Anil Ambani's Mauritius front had gone undetected.

Was Sebi aware of the scale of the operation before it agreed to the consent order? Did it quiz Karpe on his role and links with the Reliance ADA Group accounts he was handling? Did it close the investigations too soon when a consent deal was offered?

Details put out by the UK Upper Tribunal show that two kinds of financial shenanigans were going on: one involving Karpe, who was seen using clients' money for loans and transactions that they knew nothing about; and the other involving exertions on behalf of Ambani to set up a Mauritius vehicle which could not be traced back to him.

 Did Sebi miss any tricks in Ambani consent order?

Was Sebi aware of the scale of the operation before it agreed to the consent order? Reuters

The Upper Tribunal upheld FSA's decision on Karpe which, among other things, said that he moved funds from one customer account to another to disguise losses which had arisen as a result of unauthorised trading. He did this by (a) establishing loans between customer accounts without the knowledge of the recipient customers, and (b) making unauthorised transfers between customer accounts.

Karpe seems to have had a free run moving money and executing loan deals across accounts with impunity. These are the examples the Tribunal cites:

"On 31 October 2005, a loan of $5 million was made for the duration of 12 months from Customer M to Customer C (of UBS wealth management). The interest rate was said to have been 8 percent. This loan was rolled over repeatedly ...at increased interest rates from 9.5 to 9.625 percent. The Customer C account was closed in February 2007, and the liability to repay the loan was transferred to the Customer A account. The loan was not repaid."

" On 3 March 2006, a loan of $3 million was made for the duration of six months from Customer M to Customer C. The interest rate was said to have been 9 percent. This loan was repeatedly rolled over and was also transferred to Customer A. $2 million of the loan capital was repaid from the Customer A account."

"On 22 September 2006, a loan of $3 million was made for the duration of six months from Customer M to Customer C. The interest rate was said to have been 8.75 percent at the outset. This loan was repaid in full using monies from the Customer A account on 19 November 2007."

"On 20 February 2006, a loan of $1.5 million was made for the duration of 12 months from Customer N to Customer C. On 19 April 2007, Customer N sought repayment of the loan which should have matured on 19 February 2007. On 21 April 2007, Karpe informed Customer N that he had rolled over the loan for three months. Karpe had not been given instructions from Customer N to do so. On 24 May 2007, the loan was repaid by Customer A. Customer A also paid $152,373 to Customer N on that date in respect of interest on the loan."

Then again, "on 15 November 2005, a loan of $1 million was made for the duration of one year from Customer O to Customer C. On 15 November 2006, the loan was rolled over for 12 months and interest of $85,000 was paid from Customer C to Customer O. On 19 November 2007, the loan was repaid by Customer A, including interest of $95,000."

And it goes on and on about many such deals. The Tribunal observes: "Between 4 December 2006 and 21 January 2008, 67 transfers were carried out between Customer A and the accounts of other UBS customers...The aggregate value of the transfers between the various accounts was USD 29,507,690 and 5,141,220. All of these transfers were unauthorised."

The common thread in all this is that Customer A seems to be the ultimate guarantor for all of Karpe's deals. Was Customer A in the loop? Why was Customer A's account the backstop for Karpe's unauthorised transactions? And, of course, who was Customer A?

We know now that Customer A is probably an Indian national. The FSA, in the course of its investigations, had called one Mr X to ask him if Customer Account A was his. Mr X, in the presence of a Sebi official (which is why one presumes Mr X is an Indian), apparently said no, the account wasn't his. So how did FSA think it could be him?

Says the Tribunal: "We base no conclusions on Mr X's denial that he was beneficial owner of Customer A. We, in common with the FSA, conclude as a fact that no instructions had been given by Mr X as regards the many Customer A transactions."

So did Karpe do it all on his own? Is Customer A an unknown sucker who allowed his account to be used like a rescue account for all of Karpe's client investments that failed to pay off? Why didn't Customer A object?

The Tribunal throws no further light on Customer A, but since the presumption is that it is an Indian account, maybe the Reserve Bank of India and Sebi should jointly investigate.

But after the UK Tribunal's order, there can be no doubt about Karpe's links with the Ambani accounts.

Reason: not only did Karpe help him set up his Mauritius investment structure, he did so by subverting UBS's compliance and internal control procedures. He made two attempts to help Ambani route money into RCom shares, and the second one (involving the creation of Pluri Cell E) succeeded.

The Tribunal, in its indictment of Karpe, says he "knew that the use of Cell E...was not the first attempt to use an investment structure for Reliance ADAG for the purpose of breaching Indian law. The first, unsuccessful, attempt was a proposed investment for Mr Ambani and/or his family to invest in Indian securities using an insurance vehicle. To conceal the true nature of that investment, Mr (Jaspreet) Ahuja ( a client adviser) deliberately, and over a prolonged period, provided UBS' Legal and Compliance Department in Zurich ("Compliance Zurich") with false and/or misleading information. Mr Karpe was copied into all of the correspondence but did not correct the false information provided by Mr Ahuja. Mr Karpe also made misleading statements regarding the ownership of the proposed investment directly to Compliance in Zurich.

After the attempt to help Ambani through an insurance vehicle failed, Karpe decided to use the Mauritius Cell E route. To do this, he and Ahuja, had to hoodwink UBS's compliance officers, lie and cheat. Among other things, Kapre and/or Ahuja did the following:

* Told the Singapore compliance department that Cell E's real beneficial owners were not Ambani and Co but two French nationals.

* Arranged for $250 million to be invested in Cell E between December 2006 and October 2007, not as direct equity investment, but as "structured notes". That is, a third bank would issue the notes to Ambani & Co and the funds would flow to Cell E as though they were the bank's investments. The banks were merely issuing notes to Ambani and routed the money received to Cell E, as requested. The "notes conveyed all of the risk and reward of the shares in Cell E to the Reliance investors." This is, perhaps, the aspect that Sebi probed and found objectionable (those "yield management certificates/deposits" of 2006-07, 2007-08 and 2008-09)

* To further disguise the routing of money to Cell E, "in January 2007, $68 million was transferred from Reliance Natural Resources Ltd (RNRL), one of the Reliance Investors, to Cell E's account with a third party bank....In order to conceal the link between RNRL and Cell E, Mr Karpe caused the payment to be routed via the account of another UBS WM customer, Customer Q, which was not connected to Reliance ADAG in any way, and was unaware of the transactions made through its account.

What the Tribunal establishes is that Karpe was willing to subvert any compliance rule or law, including Indian laws that Ambani breached, to help the latter. But, in the end, Karpe didn't turn up to offer any defence before the Tribunal.

On the other hand, as Firstpost noted in an earlier story, between September 2007 and January 2008, Karpe ordered three redemptions from Ambani's Pluri Cell E account amounting to $8 million (around Rs 32 crore then), but the proceeds were not credited to the beneficial holder (Ambani & Co) but to Customer A.

The Tribunal noted that "There was...no connection between Cell E or its beneficial owner, Reliance ADAG, and the Customer A account; Customer A did not invest in Cell E. Reliance ADAG was not aware of the payments that were made to Customer A."

After his indictment, Karpe put out this statement: "I have not gained any personal benefit directly from any of the transactions and this has been acknowledged by the Upper Tribunal. My actions were largely to assist clients and as a result of the nature of business at UBS, as well as the then prevalent compliance culture at UBS for which it has already accepted censure by the FSA.I am very disappointed that the Upper Tribunal did not consider all the evidence and arguments put forward by me and on my behalf, though I am happy that the Tribunal did at least acknowledge that some of the clients may have made excessive claims. While I do not agree with some of the conclusions, and in particular with the Tribunal's approach to the important legal issue, I have decided not to take the case further on appeal. I would like to settle the matter with the FSA and put this old matter behind me."

Karpe is the missing link that connects Ambani's Cell E to Customer A. No one, though, knows whether it was just Karpe's caper or something more at work. He surely knows more than he is letting on (read more here). The UK Tribunal couldn't care less. But shouldn't our regulators be looking closer at when happened?

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Updated Date: Dec 20, 2014 08:47:58 IST