Small Cap Stock Promoters Secretly Dumped Shares Keeping Investors In The Dark

On March 14, the world’s most valuable company, Apple, settled a class action lawsuit filed by a bunch of irate investors who alleged that CEO Tim Cook misled them about the company’s performance. It agreed to pay $490 million as a settlement. 

The trigger was a November 2018 earnings call where Cook suggested that while the company was struggling in other countries, sales were not under pressure in China, its biggest market outside the US. A few days later, however, the company told suppliers to cut production and a little over a month later slashed its quarterly revenue forecast due to US-China tensions. It wiped out $74 billion of its market value in one day and many investors suffered heavy losses. 

While Cook’s comments may have been a misreading of the geopolitical situation, it turned out to be presenting wrong information to investors that caused them losses. Although the settlement was just Apple’s two days’ profit, the case highlighted the importance of correct information and speed of disclosures. 

Investors Be Damned

Companies hiding material information is not an uncommon occurrence and frequently causes investors financial loss. Although it is rare among reputed firms, investors in smallcap and midcap stocks regularly fall victim to inadequate information and pump-and-dump schemes. It is one reason why the market regulator Securities and Exchange Board of India (SEBI) and exchanges are wary when valuations in these segments rise suddenly. 

Insiders selling stock in large quantities is a typical warning sign of trouble. Insider trades or purchases and sales of company stock by managers, directors or promoters, have to be reported as soon as they are done. Sometimes, promoters are brazen enough to not even inform the exchanges. 

Here are a few recent examples. 

BGR Energy

The engineering and construction company which builds equipment and installations for industries such as power plants, oil refineries and petrochemical complexes, ran into financial trouble last year. By the middle of 2023, BGR was unable to service its debt. In November, banks classified their loans as bad and demanded immediate repayment. The company, however, kept quiet about the trouble. It disclosed the information to exchanges only in late December.

After a particularly poor FY24 third quarter, BGR’s chief financial officer and company secretary quit on February 8 and 9 respectively. It was not disclosed to shareholders until February 14, 2024, the same day that its auditors wrote adverse remarks in the company’s account statement. They said the company was in deep trouble but the management was cagey about what it intended to do.

The four independent directors on BGR’s board resigned on February 22 but it informed the exchanges five days later.

While other shareholders remained in the dark, promoters quietly offloaded a substantial part of their stake. Between February 21 and 29, they dumped one-third of the shares they owned in the open market. BGR’s stock price crashed from its 52-week high of Rs 119 to Rs 49 apiece in those eight days even as the promoters’ stake fell to 50% from 75%. 

Varanium Cloud

When business process outsourcing company Varanium Cloud disclosed its shareholding structure as on December 31, 2023, its investors were in for a shock. The promoter group’s holding in the company had dropped from 63.19% on September 30, 2023, to 36.38% on the last day of the year. 

The company had raised money from investors in an initial public offer and was listed on the NSE’s SME segment in September 2022. Its stock hit a high of Rs 240 apiece in a year, roughly double its IPO price. So a steep drop in promoter shareholding weeks after it hit its year’s peak sends only one message–the company is in trouble. The disclosure was made around January 20, 2024 when its share traded around Rs 140. As it began its downward slide, the company clarified to the NSE on January 22 that there was an error in the shareholding pattern and the promoters had not sold any shares. It said it will file a correction on January 29. In an earnings call on February 6, it said it will file the correct shareholding pattern next quarter!

Meanwhile, unbeknownst to investors, the company’s promoter Harshawardhan Sabale was entangled in a court case. The company did not disclose the information to shareholders. On March 21, online legal news portal LiveLaw reported that the Bombay High Court had issued a non-bailable warrant against Sabale and ordered his assets frozen, reportedly for not repaying about Rs 50 crore to some creditors. The share price ended below Rs 50 last week.

Insider trading data filed with the NSE, however, reveals that the promoter was lying. Sabale sold around 75 lakhs shares or almost 16% stake in December. It is possible that the disclosure of all sales is still undisclosed.

The Core reached out to BGR Energy and Varanium Cloud, and this article will be updated if and when we receive a response.

Ultracab

When the Gujarat-based electric cable maker filed its quarterly shareholding pattern, investors discovered that the promoter shareholding had fallen to under 28% at the end of December from about 60% in September. However, in a blatant violation of listing norms, the company never disclosed the details to the public, investors or the BSE where it is listed.

At current valuation, the sale of shares would have fetched the promoters about Rs 45 crore. Ultracab investors are still in the dark as to what caused the promoters to sell off such a big chunk of their ownership and controlling interest. The stock has since lost over 50% of its value.

The Law

According to the SEBI (Prohibition of Insider Trading) Regulations, 2015, “every promoter, member of the promoter group, designated person and director of every company shall disclose to the company the number of such securities acquired or disposed of within two trading days of such transaction if the value of the securities traded, whether in one transaction or a series of transactions over any calendar quarter, aggregates to a traded value in excess of ten lakh rupees or such other value as may be specified.”

As per SEBI(SAST) Regulations, disclosure is required if a promoter acquires or sells a stake of more than 5%.

The term promoter is unique to India where it is synonymous with the family or individuals who founded a business. Indian businesses are largely family-owned and controlled. In some cases, promoters have enormous influence over their companies even when they own very little equity. A good example is the Zee Entertainment Enterprises where the Goenkas have less than 4% stake but were able to stall the merger with Culver Max Entertainment, better known as Sony India. 

Often several members of the family occupy key positions in the companies they own. That makes them privy to information that could move their share price, even leading to a popular saying in financial markets: Do as the promoters do. Simply put, following the actions of the most informed insiders could itself, however cynical, be an investing strategy. 

Asset manager Unifi Capital estimates that if an investor had bought the stock promoters disclosed as having purchased and sold them after holding for three years, between 2005 and 2021, the CAGR would have been 23.7%!