How guilty is Samir Arora?

The reason it is hard to answer that question definitively is that the arguments that the Securities and Exchange Board have set out in its order banning Arora -- the former star Asia-Pacific fund manager of Alliance Capital Management -- from trading in August are far from convincing.

Sebi's order is in the public domain and can be accessed on the Sebi Web site. What does it say?

There are three main charges. One, that Arora played a pivotal role in thwarting Alliance Capital's efforts to sell its India operations by resorting to unethical means.

Two, he did not make disclosures or sometimes made wrongful disclosures when some of Alliance's holdings in certain stocks breached limits that required informing the respective companies.

Third, he sold his entire holding in Digital GlobalSoft based on unpublished, price-sensitive information.

Let's consider Sebi's charges one by one. At the outset, we would like to clarify that a questionnaire sent early last week to Sebi chairman G N Bajpai's office as well to whole-time director T M Nagarajan did not elicit any response, despite several reminders.

The first charge makes one wonder whose interest Sebi is serving -- Alliance Capital, which is stuck with its Indian operations because it could not get the desired valuation after its corpus shrank, HDFC, which had to pull out of a deal that was almost signed, or the unit-holders of Alliance Capital?

If the Alliance Capital management could not push through the sale of its Indian subsidiary because one of its key employees allegedly sabotaged the deal by adopting unethical practices why should Sebi get involved at all?

Sebi's contention is that the Rs 1,300-odd crore (Rs 13 billion) redemption between November 2002 and January 2003 in Alliance funds triggered "forced selling" of equities, which resulted in a sharp fall in the net asset value of Alliance's equity funds which hurt the remaining investors in the schemes.

Numbers sourced from Delhi-based mutual fund research company Value Research, however, do not support this argument.

During December 2002 and January 2003 Alliance funds performed pretty much in sync with the rest of the mutual fund industry.

It is also noteworthy that the total corpus of equity funds that Arora was managing fell from Rs 817 crore (Rs 8.17 billion) (in November 30, 2002) to Rs 609 crore (Rs 6.09 billion) (in January 31, 2003), a net outflow of Rs 177 crore (Rs 1.77 billion), according to Value Research data.

In any case, it is normal to see redemptions when a fund company is put up for sale or a star fund manager quits. There are several examples.

When Zurich India Mutual Fund was taken over by HDFC Mutual Fund, Zurich India faced redemptions of Rs 1,500 crore (Rs 15 billion) between December 31, 2002 and March 31, 2003 when the merger agreement was signed.

Similarly, when ITI Pioneer was negotiating the sale, the assets of the mutual fund fell by Rs 1,400 crore (Rs 14 billion). Redemptions take place for several reasons.

Distributors don't like to push for higher sales, new investors don't invest and existing investors may pull out due to uncertainties. Also, the more famous the fund manager the more money finds its way out.

Sebi says Arora did not care to deny rumours about his exit (he was headed for Sabre Capital) and let uncertainty prevail and redemptions continue.

What could Arora have done to arrest redemptions? If he confirmed that he was quitting, redemptions would have happened anyway. If he denied his exit, it would have been unfair to Alliance unitholders.

The second charge against Arora is that of non-disclosure of shareholdings when they crossed certain limits.

According to Sebi, Arora was the only person who was aware of the combined shareholding of ACMF (Alliance Capital Mutual Fund, India) and ACM (Alliance Capital Management, USA) in various companies, like Balaji Telefilms and Mastek, and he failed to make proper disclosures.

This raises the question of what precisely a fund manager is to do and what is the role of a compliance manager. Normally, all mutual funds companies are mandated to have a compliance officers to look after such issues.

Domestic fund managers who manage much smaller corpuses affirm that it is not possible for fund managers to keep track of disclosures. Arora was managing more than a billion dollars across Asia Pacific, by no means a small amount. Besides, Alliance did have a compliance officer called Piyush Surana. What was his role?

Also, was the board of directors not aware that there is a Sebi regulation regarding disclosure of total holdings by all funds of Alliance taken together?

Wasn't it the board's duty, as much as the fund manager's, to ensure that there were proper systems to avoid wrongful disclosure or non-disclosures?

It may be recalled that in November 2001 when Reliance Industries was pulled up by Sebi for not disclosing to L&T that its holding has crossed 5 per cent, the company got away with fine of Rs 5 lakh (Rs 500,000).

Why is it that in Arora's case it is considered such a serious offence that he has to be debarred from the markets?

Sebi accuses Arora of investing in mid-cap stocks with low floating stock. Sebi also alleges that Arora and his team maintained close rapport with such companies for extracting crucial un-published, price sensitive information and used such information for making investment decisions.

According Value Research, there were some 24 equity funds with mid-cap orientation as on March 31, 2002. So investing in mid-caps is no crime.

But how does one justify using insider information? Here, fund managers unanimously say that there is a thin divide between what can be considered access to insider information and sheer interpretation of information that is not private.

Discussions with various fund managers and brokers suggest that they often take calls based on company managers' body language and reading between the lines. This enables them to take calls ahead of the market.

So if a fund manager walks out of a management meeting and decides to sell the shares of the company, does it mean that the management whispered something in the fund manager's ears?

Or it could be just that the fund manager was intelligent enough to gauge the managers' body language correctly? It could be either.

This is why the third charge against Arora is the most crucial. Sebi alleges specifically that Arora was privy to information on the merger ratio of Digital GlobalSoft and a division of Hewlett-Packard India much before the announcement was made by the company.

Arora sold the entire holdings of 14.66 lakh (Rs 1.466 million) shares of DGL, on behalf of ACMF and ACM, immediately after an independent valuer submitted his report but before the ratio was announced for the de-merger of the HP division which was to be merged with DGL.

Here again, Sebi's arguments are not sound.

According to Sebi, Arora based his decision to exit Digital on the valuation report submitted by Bansi Mehta & Co, which was appointed by the Digital management 'informally.' The valuation report was submitted on May 7.

Sebi has also said that it is only much later (on May 30) that Digital appointed Deloitte Haskins Sells for a fairness opinion. The de-merger ratio was finally announced by Digital on June 7 after DHS gave its approval.

If Sebi's propositions are correct, Arora may well be on a weak wicket on this count. But then, Sebi ought to ask many more questions.

How can independent valuers be appointed by just one company concerned in the deal, and that too informally? Was fairness opinion sought from DHS just a formality?

The trail of grey areas suggests that with Arora, Sebi has adopted a hit-and-trial method. Either Sebi recognises that insider trading is notoriously difficult to prove, so building up many accusations against Arora may strengthen its case. But can many weak cases equal one strong case?

Even more curiously, Sebi issued its disbarring order a day after Arora announced his plans to quit Alliance to join Sabre. Clearly, there seems to be more to the Arora case than meets the eye.