Among the first statements that Meleveetil Damodaran made when he took over as chairman of the Securities and Exchange Board of India (Sebi) in February, 2005, was that punishments for mischief makers would be 'swift and heavy.' There haven't been too many cases to speak of errant participants being brought to book, but Damodaran claims Sebi is winning its fair share of cases.

In a conversation with Shobhana Subramanian and Reena Zachariah, the Sebi chief discusses several of Sebi's new initiatives and those in the pipeline. Excerpts:

Many of the new F&O stocks are very illiquid and some have virtually no track record as listed companies.

We have a set of qualifying standards and if we apply those, many more stocks would qualify for F&O. If you're questioning the criteria for selection to the F&O segment, the board revisited the criteria in February and felt they were all right. But we do take note of media reports on this.

What do you feel about promoters who issue warrants themselves and then cancel them when the market price of the stock falls? Shouldn't the 10 per cent penalty be revisited?

This has come to our notice and we will talk to the exchanges and take a collective view. Even if there is one company that has done this, the issue is important enough -- we will look at this. Clearly, anything that is against the interest of the average investor is not something that we want. If somebody is doing something that might cause unjust enrichment to the promoter, that's something we frown upon.

If the mutual fund industry lobbies against a free entry for direct investors when they buy schemes, as Sebi has proposed, will Sebi change its view?

We have been saying for two years that mutual fund distributors need to be regulated. It looks like this is an industry that is run for distributors, not for investors, not even for the AMCs. Why were people being asked to switch to the NFOs from existing funds which were doing well? And the existing funds are not even advertised. We're not disputing that distributors do a good job but we're saying if they give value, investors will go to them. So, don't take money upfront.

Isn't there a danger of IPO grading misleading investors because it doesn't take into account valuations?

It is true that past performance can never fully determine future performance. But we don't have a country-wide system that gives you comprehensive professional advice, except for few columns in newspapers. You are frightening people away from the market by making them read big documents.

The comfort that a professional agency brings is that it discloses the rationale for what it says and assesses the firm on a simple numerical scale; however, it is not giving a buy or sell recommendation. Some companies are having to make more disclosures as a result of this. It's early days, so let's see how it goes.

What's your view on having a circuit for IPOs on the day of listing?

There is a view that Sebi should not interfere and that there should be price discovery. But the other view is why should price be discovered on day one alone? I personally think that this business of price discovery on the first day is something we set too much importance on, there's no great harm if the price is discovered over a few days. We are in the business to protect investors, not day-traders.

Are many hedge funds registering as FIIs?

Some hedge funds have applied to us but large numbers of them haven't been cleared; they haven't been rejected either. The problem is really what is a hedge fund?

We might be uncomfortable with one category of funds that might, on the basis of their investing style, be causing additional volatility in the market, but I know some institutions that call themselves hedge funds have a lock-in period for investments. So why keep them out?

Since the policy on hedge funds was evolving, anyone calling themselves a hedge fund was kept out, but not rejected. Most foreign institutions want to be in India, if not in their own names, then through offshore derivatives. And there will always be those who want to play the market through derivatives, regardless of whether they comply with the FII rules or not.

What percentage of foreign investment is coming in through participatory notes?

The number keeps moving back and forth and is somewhere between 25-30 per cent. Recent indications are that it has gone up a little but again after the sub-prime crisis, there have been some exits. But it's a fairly significant percentage, it's not something you can ignore.

So are you comfortable with about a fourth of the market being held by PNs when the source of the money is unknown?

I'm not entirely uncomfortable with this. If you consider the source of money, there are anti-money laundering provisions in many jurisdictions of the world and read together with ours, it would be difficult for someone whose source of money is tainted to get into a market. And what the instruments?

They are issued outside of India to people outside of India, so what really is the control that you can have, except a reporting control through the FIIs? The FIIs sign off saying they're not issuing PNs to NRIs, OCBs and PIOs.

Also, it's an oversimplification to say that a destabilising effect happens only when PN holders sell. After all, FIIs too can sell. So, I think, there isn't enough evidence to argue that the PN holder brings more volatility to the market. And if you say that hedge funds are largely here through PNs and therefore bring volatility, they also bring in liquidity. Ours is a reasonably big market, at every dip there will be buyers.

We don't hear of too many instances of Sebi bringing to book errant players. Even the UBS case has not been upheld by SAT.

In the UBS case, SAT felt there was not enough clarity and therefore overruled us. We have appealed in the Supreme Court, so we haven't lost yet. Let's assume the worst case scenario, where SAT's case is upheld, we will then look to see what additional powers we need. I don't look at these as setbacks. A number of SEBI orders have not been challenged and among those that have gone on appeal, SAT has upheld our order on several occasions but then that doesn't make news. There are cases where SAT has said our conclusion is right but the penalty has been reduced and that, I think, is fair.

There are very few cases where SAT has overruled us and we are not as badly off as many people think we are, just because some high profile cases get decided against us.