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Unit Trust of India: The messy change-over

Earlier in the day, Finance Minister Yashwant Sinha had announced that the government would inquire into what was happening at UTI, but that was clearly not enough. There was pressure for heads to roll. Finally, North Block demanded Subramanyam's immediate resignation late in the night. It was faxed by him and was instantly accepted somewhere close to midnight.

Thus ended a chapter which began turbulently with the Rs 33 billion bailout of US-64 in 1999, missed an opportunity to turn the tide during the tech mania and incredible bull run of 1999-2000, and ended in another crisis exactly two years later. Subramanyam's ouster had seemed imminent immediately after the market crashed on March 2, just after the Union Budget. However, he weathered that storm, only to run into an avalanche of criticism over the moratorium of US 64's open-ended structure.

Ultimately Subramanyam is understood to have carried the can, not only for US-64's bad performance (UTI had argued that 19 of its equity schemes had outperformed their respective benchmarks but nobody wants to listen to it. Investors are furious at the slashed dividend and the moratorium on redemptions), but for several dubious decisions such as its heavy purchase of Ketan Parekh scrips; the bailout of companies known as the K-10 stocks after the crash; the purchase of debentures with low credit ratings and finally the huge purchases of unlisted companies at steep premia. It is reliably learnt that the finance ministry has information and evidence that made Subramanyam's continuance at UTI difficult -- he had to go.

However, that still does not address the immediate problem. Having sacked the UTI chairman, what happens next?

Getting a competent new chairman is next on the agenda and though a UTI executive director has temporarily been put in charge, it is learnt that a quick replacement for Subramanyam is definitely on the cards. It is reliably learnt that Dr P J Nayak, a former Trustee of UTI and present chief of UTI Bank may be the main contender for the post. However, Nayak, a former IAS officer may require some persuasion before he accepts the hot seat at a time like this.

For investors, a reconsideration of the six-month moratorium is also high on the agenda. It is a widely held opinion that UTI's action in shutting down its sale-purchase window tantamounts to breach of trust - it was almost like a bank refusing to accept deposits or to permit withdrawals from savings accounts. The government may have to address the issue immediately.

(Incidentally, the US-64 actually registered a single trade on NSE's equity segment at Rs 11 for the first time on Tuesday as opposed to the wholesale debt market segment that the former chairman mentioned. But the trade was in the demat segment and nobody knows how it would be settled.)

Various bankers have suggested that UTI should open a window for repurchase of units from small investors with an upper limit. But that too is easier said than done. If UTI permits just the repurchase of units from small investors and it leads to a huge pressure for redemption, then the fund will have to be a continuous seller in the market to meet redemption demands. This is probably why UTI board decided on the moratorium.

The more important question is: what would be the repurchase price? It would be preposterous if UTI is again allowed to fix an artificial repurchase price which is not based on its net asset value. Will UTI then be forced to make its NAV public?

To my mind, there is no alternative to UTI biting the bullet today. US-64 has to be made NAV-based no matter what the consequences. Also, the government has to initiate steps to bring UTI on par with other mutual funds.

In fact, UTI's problems today have their genesis in the soft-approach adopted by the Deepak Parekh Committee. While the committee was forthcoming about the true state of UTI's finances in 1999, its recommendations were too soft and incomplete.

Parekh recommended a huge bailout of Rs 48 billion and tax exemptions for all mutual funds to muzzle their protests and those of investors. This led to a boom in the market and stock prices shot up. Ultimately the government infused only Rs 33 billion into the Special Unit Scheme 1999 to which public sector shares were transferred at book value.

But having recommended such a huge bailout at the exchequer's expense, the Parekh committee itself set the stage for the second bailout. It gave UTI three years to make the US-64 NAV-based, although that was clearly the time to do so. Even more shocking was that UTI was allowed to resume July sales/repurchases at high prices that were completely out of line with NAV.

If that were not enough, the Parekh Committee allowed US-64 to remain outside Sebi regulation and simply made no effort to fix responsibility or make the scheme more accountable, other than to demand restructuring of the board and setting up of audit committees.

The Parekh Committee also did not touch US 64's hybrid structure as a mutual fund and development institution, which allows its management to invest in real estate or set up a bank or lend to the corporate sector. In fact, it is this strange structure and absence of accountability, which has made UTI a virtual handmaiden of the successive governments and politicians.

The result is there for all to see. UTI again stands accused of collusion with speculators and has betrayed the trust of investors. Moreover, with another massive scam on its hands and a Joint Parliamentary Commission investigating it, the government can no longer cover up the mess or avoid a drastic restructuring of UTI.

Whatever the decisions in the next few days, or the outcome of public interest litigations filed by unit holders, it seems clear that UTI's days as an investment behemoth with a disproportionate influence over the Indian capital market are fast coming to an end.

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