MUMBAI (Reuters) - Stock market watchdog SEBI, long lambasted as toothless, has more resources than ever before to spot rogue trades. Even though it has singled out a hedge fund as the target of its first major trading probe, detractors remain unconvinced.
What they need to see is a high-profile bust.
The Securities and Exchange Board of India (SEBI) hopes it will achieve just that after accusing Hong Kong-based multi-asset fund Factorial Capital Management Ltd of shorting L&T Finance Holdings Ltd using information allegedly leaked by bankers on a cut-price share offering.
"Nobody takes their investigation seriously, they are a paper tiger," said J.N. Gupta, a former SEBI director who now runs a shareholder advisory firm. "But if they can set a precedent in this case, it will work like magic for their image."
SEBI has a dismal track record on fighting insider trading. Until now, it has never probed a foreign investor for illegally seeking to acquire and profit from market-moving information not yet made public. Almost all of SEBI's cases have been against penny-stock dealers. Many of them were settled by payments of tiny fines.
Lax regulation has deterred long-term investors who would like to bet on India, leaving the market prone to the whims of short-term speculators. Indian stocks hit record highs this month on promises by India's new prime minister, Narendra Modi, of economic reform. But only last year they were roiled by the winding down of U.S. economic stimulus policies.
Under the leadership of U.K. Sinha, appointed in 2011, SEBI has built its capacity to identify suspicious trades, insiders and analysts say.
It has more than trebled its annual spending to 2.81 billion rupees ($47 million) over the past six years. The regulator also recently hiked transaction fees, which Sinha said is to commit greater resources to enforcement and surveillance.
The 62-year-old chief, whose term was recently extended by two years, has a record as an effective administrator. He pushed through banking and capital market reforms at the finance ministry, later running India's oldest mutual fund.
In a seven-page order, SEBI said it had established that Factorial was approached by Credit Suisse to gauge interest in a potential sale of L&T Finance shares, after which Factorial built a big short position in the stock. Short sellers seek to profit from price falls.
The SEBI order said Credit Suisse employees had discussed the expected pricing of the share sale in chatrooms, and that the information could have leaked to outsiders. SEBI did not accuse Credit Suisse of any wrongdoing.
"Factorial was aware of or at least had an indication of the pricing and they blatantly abused that information," said one SEBI official, who has worked on the case, requesting anonymity. "We think this is an open and shut case."
Factorial has said SEBI's allegations, made on June 5, are without merit. It has 21 days to respond.
SEBI could ban Factorial and fine it up to 250 million rupees, or three times its illegal profits, subject to a possible court challenge. It could also seek jail terms, although it has never launched criminal proceedings in an insider trading case.
The regulator has also reserved the right to investigate the local unit of Credit Suisse Group, alleged to be the source of the leak. Credit Suisse has declined to comment.
The SEBI official said the regulator receives about 100-200 alerts related to suspicious trading activity on a busy day, which are then followed up by its officers.
"Our systems have become more sophisticated over the years. We are constantly upgrading algorithms used to track suspicious trading, and learning from past mistakes," the official said.
SEBI has revamped rules to improve transparency in Indian markets over the past year, launching new corporate governance guidelines and disclosure rules for companies.
Sinha has also won greater powers to monitor telephone data records and carry out searches against suspects without a court order.
But new legislation to combat insider trading, to replace a two-decade-old law, is stalled.
"We still find enforcement relatively weak – we don't see huge improvement there," said Jamie Allen, head of the Asian Corporate Governance Association, which has ranked India seventh out of the 11 markets it monitors for quality of oversight.
SEBI's inability to counter securities fraud has driven away retail investors from India's markets in recent years, with over $5.15 billion leaving stock funds in the last four years alone.
Jonathan Schiessl, an India fund manager at Ashburton Asset Management said his firm steers "as far as possible" away from Indian small and mid-cap stocks due to apparent manipulation of their stock prices. ($1=59.60 Indian rupees)
Editing by Douglas Busvine and Ryan Woo