Capital is a sine qua non for economic development. Without capital, land will be barren, labour idle and organisation rudderless. Capital enables the entrepreneur to bring together the other factors of production. It is necessary to build and develop infrastructure, buy and put in place plant and machinery, for use as working capital, and for setting up markets and so on. Capital grows out of savings of the community. Capital investment would lead to economic development only if channelised into productive activities. The securities market is the channel through which investible resources are routed to companies. The securities market converts a given stock of investible resources to a larger flow of goods and services. A well-organised and efficiently functioning securities market is conducive to sustained economic growth.
Capital is an essential input for economic development. Capital investment leads to economic growth, only if channelised into productive activities. The securities market is the channel through which investible resources are routed to companies, and enable them to produce goods and services. A well organised and efficient securities market is conducive to sustained economic growth.
Industry raises finance from the capital market with the help of a number of instruments. Broadly speaking, corporates have a choice of (i) equity finance and (ii) debt finance. Experience in different countries varies. Generally, equity-based capital is cheap and less cumbersome to manage and service. Substituting equity finance for debt finance makes domestic firms less vulnerable to fluctuations in earnings or increases in interest rates. During the last decade, more than a third of the increase in net assets of large firms in developing countries across the world, has been secured through equity issuance. This pattern contrasts sharply with that of the industrial countries, in which equity financing during the same period has accounted for less than 5% of the growth in net assets.
In the liberalised economic environment, the capital market plays a crucial role in the process of economic development. The capital market has to arrange funds to meet the financial needs of both public and private sector units, from domestic as well as foreign sources. What is more critical is that the changed environment is characterised by cut-throat competition. Ability of enterprises to mobilise funds at cheap cost will determine their competitiveness vis-à-vis their competitors in order to perform well in a highly competitive environment.
At the time of independence, there were very few corporations in India. Notwithstanding the absence of a corporate culture in the post-independence era, there was an appreciable growth in the capital market especially after 1985. The Indian capital market by 1990 was one of the fastest growing markets in the world. The number of companies listed on the stock exchange, close to 6000, was the second highest after the US and by 1995 the number rose to 8593. Presently, there are more than 10,000 listed companies in the country’s 25 stock exchanges. Shareholding public is estimated at 20 million. Value of securities traded increased from $5 billion in 1985 to $21.9 billion in 1990, which was the fourth largest amongst the emerging markets of the world. Market capitalisation increased from $14.4 billion in 1985 to $38.6 billion in 1990, $65.1 billion in 1992, $80 billion in 1993 and exceeded $120 billion in 1998–99. Turnover ratio (total value traded as percentage of average market capitalisation) rose to 65.9. Resources raised from the capital market by the non-government public limited companies increased from Rs. 7,063.4 million (US $731 million) to Rs 52,668.0 million in 1982–83.
There was an appreciable growth in the capital market in the post-independence era, especially after 1985.The Indian capital market by 1990 was one of the fastest growing markets in the world. Indian corporations raised domestic debt and equity totalling $ 6.4 billion equivalent in 1994–95, $ 8.5 billion in 1996–97. Indian companies have also been raising substantial sums in the international capital markets-$ 4.7 billion in 1994–95, $ 2.3 billion in 1995–96 and $ 4.7 billion in 1996–97.
Indian corporations raised domestic debt and equity totalling $6.4 billion equivalent in 1994–95 and $8.5 billion in 1996–97. Indian companies have also been raising substantial sums in the international capital markets—$4.7 billion in 1994–95, $2.3 billion in 1995–96 and $4.7 billion in 1996–97. There has been a recent dramatic shift toward increased issuance of debt instruments. The equity-debt split was 97% 3% in 1994–95 by 1996–97, it was 23% to 77%.
Figure 16.1 Growth Pattern of the Indian stock market
Note: Presently, there are 25 stock exchanges in the country.
Source: Various issues of Bombay stock exchange’s official directory.
Figure 16.1 portrays the overall growth pattern of Indian stock markets since independence. It is quite evident from the table that Indian stock markets have not only grown in number of exchanges, but also in number of listed companies and in capital of listed companies. The remarkable growth after 1985 can be clearly seen from the table, and this was due to the favourable government policies towards securities market.
However, the functioning of the stock exchanges in India suffered from many weaknesses such as long delays in transfer of shares, issue of allotment letters, and refund, lack of transparency in procedures and vulnerability to price rigging and insider trading. To counter these shortcomings and deficiencies and to regulate the capital market, the government of India set up the Securities and Exchange Board of India (SEBI) in 1988. Initially, SEBI was set up as a non-statutory body, but in January 1992 it was made a statutory body. SEBI was authorised to regulate all merchant banks on issue activity, lay guidelines, supervise and regulate the working of mutual funds and oversee the working of stock exchanges in India. SEBI, in consultation with the government, has taken a number of steps to introduce improved practices and greater transparency in the capital market in the interest of the investing public and the healthy development of the capital market.
The Indian capital market, like the money market, is known for its dichotomy. It consists of an organised sector and an unorganised sector. In the organised sector of the market, the demand for capital comes mostly from corporates, government and semi-government organisations. The supply comes from household savings, institutional investors such as banks, investment trusts, insurance companies, finance corporations, government and international financing agencies.
The unorganised sector of the capital market on the supply side consists mostly of indigenous bankers and moneylenders. While in the organised sector the demand for funds is mostly for productive investment, a large part of the demand for funds in the unorganised market is for consumption purpose. In fact, many purposes, for which funds are very difficult to get from the organised market, are financed by the unorganised sector. The unorganised capital market in India, like the unorganised money market, is characterised by the existence of multiplicity and exorbitant rates of interest, as well as lack of uniformity in their business transactions. On the other hand, the activities of the organised market are subject to a number of government controls, and of the market regulator, SEBI. Though efforts were initiated to bring the unorganised sector under some sort of regulatory framework or at least to bring in some discipline such as registration, these were not successful and this segment is by and large outside the effective government control.
The organised sector has been subjected to increasing insitutionalisation. The public sector financial institutions account for a large chunk of the business of this sector.
Figure 16.2 Capital market structure
Source: Figure adopted from V.A. Avadhani, Indian Capital Market, Himalaya Publishing House, Mumbai, 1997.
The Indian capital market, as pointed out earlier, has undergone many significant changes since independence. The important factors that have contributed to the development of the Indian capital market are given below:
The expansion of the public sector in the money and capital markets has been accelerated by the nationalisation of the insurance business and the major part of the banking business. The Life Insurance was nationalised in 1956 and the General Insurance in 1972. The Reserve Bank in India was nationalised as early as 1949. The Imperial Bank, the then largest commercial bank in India, was nationalised and established as the State Bank of India in 1955. Fourteen major private commercial banks were nationalised in 1969. With the nationalisation of six more leading private banks in 1980, over 90% of the commercial banking business came to be concentrated in the government sector.
Thus, an important aspect of the Indian capital market is that a large part of the investible funds available in the organised sector is owned by the government. However, the new economic policy has changed the trend, and brought in the private sector in a large measure.
The Indian capital market suffers from the following deficiencies:
The Indian capital market suffers from deficiencies like, lack of diversity in the financial instruments lack, of control over the fair disclosure of financial information, poor growth in the secondary market, prevalence of insider trading and front running.
In a planned economy, like the one we had prior to liberalisation, when the stock exchanges performed a residual role, these deficiencies did not matter much. On the other hand, in a market-driven economy towards which we are moving, capital market is expected to perform multifarious and facilitative functions, such as:
In view of its importance, the continuing shortcomings point to the inability of the market to function at a level that is expected.
With the gradual opening up of the Indian economy, increasing importance of foreign portfolio investment in the market and drastic reduction in import tariffs that has exposed Indian companies to foreign competition, Indian capital market is acquiring a global image. Till recently, participants in the Indian capital market could, to a large extent, afford to ignore what happened in other parts of the world. Share prices largely behaved as if the rest of the world just did not exist. However, now the that Indian capital market responds to all types of external developments, such as US bond yields, the value of the Euro or for that matter of any other currency, the political situation in the Gulf or new petrochem capacity in China.
In short, the Indian capital market is on the threshold of a new era. Gradual globalisation of the market will mean the following changes:
The Indian capital market is on the threshold of a new era. Gradual globalisation of the market will mean the market will be more sensitive to developments that take place abroad; there will be a power shift as domestic institutions are forced to compete with the Foreign Institutional Investors (FIIs) who control the floating stock and are also in control of the Global Depository Receipts (GDR) market.
In the words of G.N. Bajpai, former SEBI Chairman: “It is the securities market which reflects the level of corporate governance of different companies and accordingly allocates resources to best governed companies. If the securities market is efficient, it can penalise the badly governed companies and reward the better-governed companies. Hence, not only the corporate governance standards need to improve, but also efficiency and efficacy of securities market need to improve so that the resources are directed to the deserving companies, which can really boost economic performance. The securities market cannot make best allocation of resources if the standards of corporate governance are not followed in letter and spirit.”
“A well functioning securities market is conducive to sustained economic growth. A number of studies, starting from World Bank and IMF to various scholars, have pronounced robust relationship not only one way, but also both the ways, between the development in the securities market and the economic growth. This happens, as market gets disciplined, developed, efficient and it avoids the allocation of scarce savings to low-yielding enterprises and forces the enterprises to focus on their performance which is being continuously evaluated through share prices in the market and which faces the threat of take over.”2
Though the classical economists led by Adam Smith believed that over time savings would be equal to investment, it does not seem to happen in actual practice. The reason is not far to seek. The savers are different from investors and their motives are also different. The result is disequilibrium between the two. To quote G.N. Bajpai again: “The unequal distribution of entrepreneurial talents and risk taking proclivities in any economy means that at one extreme end, there are some, whose investment plans may be frustrated for want of enough savings, while at the other end, there are those who do not need to consume all their incomes but who are too inert to save or too cautious to invest the surplus productively. For the economy as a whole, productive investment may thus fall short of its potential level. In these circumstances, the securities market provides a bridge between ultimate savers and ultimate investors and creates the opportunity to put the savings of the cautious at the disposal of the enterprising, thus promising to raise the total level of investment and hence growth. The indivisibility or lumpiness of many potentially profitable but large investments reinforces this argument. These are commonly beyond the financing capacity of any single economic unit but may be supported if the investor can gather and combine the savings of many.3 Moreover, the availability of yield bearing securities, makes present consumption more expensive relative to future consumption and, therefore, people might be induced to consume less today. The composition of savings may also change with fewer savings being held in the form of idle money or unproductive durable assets, simply because more divisible and liquid assets are available.”
The securities market facilitates the globalisation of an economy by providing connectivity to the rest of the world. This linkage helps the inflow of capital into the country’s economy in the form of portfolio investment. Besides, a strong domestic stock market performance will also enable well-run local companies to raise capital abroad. Some of the Indian companies like Reliance, Infosys, L & T, Tata Steel and many others have, for instance, successfully tapped markets abroad and secured huge amounts, a prospect unthinkable hardly a decade back or even now in the domestic market. This practice will, in turn, help raise the efficiency of domestic corporates once they are exposed to international competitive pressures and the necessity of not only surviving amidst competition but also to perform well for their continued survival.
The existence of a domestic securities market will deter capital flight from the domestic economy by providing attractive investment opportunities locally. Economists also point out that a developed securities market successfully monitors the efficiency with which the existing capital stock is deployed and thereby significantly increases the average rate of return on investment. Having established the importance of the securities market for promoting corporate governance standards, and equally important economic development of a country, let us turn to India and its securities market.
Earlier, prior to the setting up of SEBI, the Capital Issues (Control) Act, 1947 governed capital issues in India. The main objectives of this Act were: (i) to ensure that investment in the private corporate sector does not violate priorities and objectives laid down in the Five Year Plans or flow into unproductive sectors; (ii) to promote the expansion of private corporate sector on sound lines in general, and further the growth of particular corporate enterprises having sound capital structure and (iii) to distribute capital issues time-wise in such a manner that there is no overcrowding in a particular period. The Act was enacted to ensure sound capital structure for corporate enterprises, to promote rational and healthy expansion of joint stock companies in India and to protect the interests of the investing public from the fraudulent practices of fly-by-night operators. The authority for control of capital issues was vested with the Controller of Capital Issues (CCI), according to the principles and policies laid down by the central government. However, the office of the Controller of Capital Issues which was functioning more like an extended arm of the government controlled, rather than guided the orderly development of the capital market and became an anachronism in the new era of a liberalised economy.
The Narasimham Committee on the reform of the financial system in India recommended the abolition of the CCI. The committee in its report submitted in 1991 on the financial system argued that the capital market was tightly controlled by the government and there were a number of restrictions placed by the CCI on the operations of this market. This restrictive environment was “neither in tune with the new economic reforms nor conducive to the growth of the capital market”. The committee strongly favoured substantial and speedy liberalisation of the capital market by closing down the office of the CCI. It suggested that SEBI set up in 1988 should be entrusted with the “task of a market regulator to see that the market is operated on the basis of well laid principles and conventions”. It was also recommended that SEBI should not become a controlling authority substituting the CCI. The government of India accepted this recommendation, repealed the Capital Issues (Control) Act, 1947 and abolished the post of the Controller of Capital Issues.
The significance of this step lies in the removal of bureaucratic hurdles in the way of capital issues. In order to raise capital from the market, the companies were required earlier to obtain consent from the CCI who decided the terms and conditions, the amount of capital to be raised and the pricing of public issues. With the abolition of the CCI, companies became free to issue capital and determine the issue prices based on market conditions. For this, however, they are expected to abide by guidelines prescribed by SEBI. In other words, SEBI has been empowered to control and regulate the new issue and old issues market, namely, the Stock Exchange. The following pages provide details of the objectives, powers, responsibilities, success and failures of SEBI—India’s capital market regulator.
The Securities and Exchange Board of India Act, 1992 was enacted by the Indian Parliament “to provide for the establishment of a Board to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto”.
The SEBI Act, 1992 was enacted “to provide for the establishment of a board to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto.”
Section 11(1) of the Securities and Exchange Board of India Act, 1992 explains the powers and functions of SEBI. As per the Act, it shall be the duty of the board to protect interests of the investors in securities and to promote the development of, and to regulate the securities market by such measures as it thinks fit.
The statutory objectives of the SEBI as per the Act are given below:
To realise the above core objectives and to carry out its tasks, the Act spells out the functions of SEBI in greater details, as under:4
The act spells out the functions of SEBI regulating the business in stock exchanges and any other securities markets, registering and regulating the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, invesment advisers and such other intermediaries who may be associated with securities markets in any manner; prohibiting insider trading in securities.
To carry out its responsibilities under the Act, the board is entrusted with the same powers as are vested in a civil court in respect of the following matters, namely:
The board may, for the protection of investors, specify the following by regulations:
The board is empowered under the SEBI Act to issue directions to the following intermediaries: Stock-brokers, sub-brokers, share transfer agent, banker to an issue, trustee of trust deed, registrar to an issue, merchant banker, underwriter, portfolio manager, depository, depository participant, custodian of securities, foreign institutional investor, credit rating agency or any other intermediary associated with the securities market.
Under Section 11 B of the SEBI Act, the board is empowered to issue directions to the following intermediaries:
Different intermediaries mentioned above can commence functioning in their respective activities only after registration with the SEBI and complying with requirements as stated under specific regulations intended for each.
SEBI has issued detailed rules and regulations to be adhered to by each of the intermediaries above specified.
The SEBI Act also contained a provision for the establishment of an appellate authority to arbiter and exercise power in matters of disputes over SEBI’s decisions as a regulator.
The central government shall by notification, establish one or more Appellate Tribunals to be known as the Securities Appellate Tribunal to function as Appellate Authority and hear appeals.
It is stipulated in the SEBI Act that under Section 15(Y) that no civil court shall have jurisdiction to entertain any suit or proceeding in respect of any matter which an adjudicating officer appointed under this Act or a Securities Appellate Tribunal constituted under this Act is empowered by or under this Act to determine and no injunction taken or to be taken in pursuance of any power conferred by or under this Act. However, appeals against the decision of the Securities Appellate Tribunal can be preferred before a High Court.
In January 1995, the Government of India promulgated an Ordinance to amend SEBI Act, 1992, so as to arm the regulator with additional powers for ensuring the orderly development of the capital market and to enhance its ability to protect the interests of investors. The important features of this Ordinance are the following:
In January 1995, the Government of India promulgated an ordinance to amend SEBI Act, 1992 to arm the regulator with additional powers. Among other power it has been empowered to file complaints in courts and to notify its regulations without prior approval of the government, provided with regulatory powers over companies in the issuance of capital, the transfer of securities and other related matters, and to impose monetary penalties on capital market intermediaries and other participants for a listed range of violations.
Notwithstanding the regulator’s best efforts, the stock market was plagued by price manipulations and insider trading. SEBI known for its low indictment rate of violators of its rules hardly penalised insider traders and was dubbed a toothless tiger. Unscrupulous players and fly-by-night operators abounded, manipulated the system and share prices with impunity, while the regulator watched helplessly from the sidelines. In its defence, SEBI has been pointing out that the law did not give it adequate powers and that the existing penalties (Rs. 5,000 to 5 lakh) were too meagre to deter violators. Taking cognisance of this constraint, the government introduced the Securities and Exchange Board of India (Amendment) Bill, 2002 in the Lok Sobha in November 2002. The Bill was passed by the Parliament on 2 December 2002. It replaced the Ordinance issued by the government on 29 October 2002. The Bill made four key changes that gave SEBI extensive powers to regulate the market. The changes made under the amended Act were as under:
G.N. Bajpai, former Chairman, Securities and Exchance Board of India, claimed in an international conference in 2003: “With the objective of improving market efficiency, enhancing transparency, preventing unfair trade practices and bringing the Indian market up to international standards, a package of reforms consisting of measures to liberalise, regulate and develop the securities market was introduced in the 1990s. The practice of allocation of resources among different competing entities as well as its terms by a central authority was discontinued. The issuers complying with the eligibility criteria now have freedom to issue the securities at market-determined rates. The secondary market overcame the geographical barriers by moving to screen-based trading, which made trading system accessible to everybody anywhere in the Indian sub-continent. Trades enjoy counter-party guarantee. The trading cycle has been shortened to a day and trades are settled within two working days while all deferral products are banned. Physical security certificates have almost disappeared. A variety of derivatives are available. In fact, some reforms such as straight through processing in securities, T+2 rolling settlement, clearing corporation being the central counter party to all the trades on the exchanges, real time monitoring of brokers positions and margins, and automatic disabling of brokers’ terminals are singular to the Indian securities market. Indian disclosure and accounting standards are as modern, updated, potent and versatile as those of any other market. Today, the Indian securities market stands shoulder to shoulder with most developed markets in North America, Western Europe and Far East.”5
According to SEBI’s former chairman, The Securities and Exchange Board of India has been focussing on the following areas to improve corporate governance:
The erstwhile SEBI chairman, G.N. Bajpai, claims quoting academicians and researchers that disclosure standard in the Indian regulatory jurisdiction are at par with the best in the world. According to him this is a feedback from several global organisations, both regulatory and market participants.
SEBI has ensured that a company is required to make specified disclosures at the time of issue and make continuous disclosures as long as its securities are listed on exchanges. The standards for these disclosures including the content, medium and time of disclosures have been specified in the Companies Act, Disclosure and Investor Protection Guidelines, Listing Agreement Regulations relating to insider trading and takeover etc. These disclosures are made through various documents such as prospectus, quarterly statements, annual reports etc. and are disseminated through media, web sites of the company and the exchanges, and through EDIFAR (Electronic Data Information Filing and Retrieval) system maintained by the regulator. These disclosures relate to financial performance, sharehoding pattern, trading by insiders, substantial acquisitions, related party disclosures, audit qualifications, buyback details, corporate governance, actions taken against company, risk management, utilisation of issue proceeds, remuneration of directors etc. All listed companies and organisations associated with securities markets including the intermediaries, asset management companies, trustees of mutual funds, SROs, stock exchanges, clearing house/corporations, public financial institutions, professional firms such as auditors, accountancy firms, law firms, consultants, etc. assisting or advising listed companies are required to abide by the Code of Corporate Disclosure Practices specified in SEBI (Insider Trading) regulations.
SEBI has ensured that a company is required to make specified disclosures at the time of issue and make continuous disclosures as long as its securities are listed on exchanges. The standards for these disclosures including the content, medium and time of disclosures have been specified in the Companies Act, Disclosure and Investor Protection Guidelines, Listing Agreement Regulations relating to insider trading and takeover etc. These disclosures are made through various documents such as prospectus, quarterly statements, annual reports etc.
In the opinion of the chairman of SEBI, the Indian securities market has a large infrastructure to meet the demands of a sub-continental market. Presently, there are 25 stock exchanges and about 10,000 brokers, 15,000 sub-brokers, more than 10,000 listed companies, 500 foreign institutional investors, 400 depository participants, 150 merchant bankers, 40 mutual funds offering over 450 schemes, and 20 million investors. Yet, there is only one regulator. Not only the numbers are gigantic but also the systems and infrastructure are equally atlantean and sophisticated. All stock exchanges in India offer on line, fully automated, nation-wide anonymous, order-driven screen based trading system. It has a comprehensive risk management system. The depositories legislation ensures free transferability of securities with speed, accuracy and security. The securities are transferred electronically in demat form. Further, Indian accounting standards follow international accounting standards (principle based) and are by and large aligned. In addition to creating an efficient trading platform and settlement mechanism, SEBI’s focus is substantially directed towards the following:
SEBI aims at ensuring that no misconduct goes unnoticed or unpunished. It keeps an eye on the happenings in the market and identifies anything unusual or undesirable which may adversely affect the efficacy of the market. Every market participant, irrespective of his size and influence in the market or in the policy, is held accountable for his misdeeds. The proactive approach of the regulator in enforcement can be gauged from the fact that during the financial year 2002–2003, SEBI passed 561 orders, out of which over 350 were punitive.
SEBI has avowed that its regulation and guidance of the country’s securities market would spell success in the area of corporate governance. The Kumar Mangalam Birla Committee of the Indian jurisdiction outlined a code of good corporate governance, which compared very well with the recommendations of the Cadbury Committee and the OECD codes. The code was operationalised by inserting a new clause (Clause 49) to the Listing Agreement (LA) and have been made applicable to all the listed companies in India in a phased manner. Following the implementation of the Birla committee recommendations, substantial developments took place in the corporate world and securities market, which required revisit of the issue. The Narayana Murthy Committee has refined the corporate governance norms, which are proposed to be implemented through modification in the listing agreement. The government also appointed few committees to suggest ways and means of realising good corporate governance. Based on their recommendations, government is trying to provide statutory back-up to corporate governance standards.
SEBI has avowed that its regulation and guidance of the country’s securities market would spell success in the area of corporate governance. The Birla committee outlined a code of good corporate governance. The code was operationalised by inserting a new clause (clause 49) to the Listing Agreement (LA) and have been made applicable to all this listed companies in India in a phased manner.
The initiatives for improvement in corporate governance, according to G.N. Bajpai, come mainly from three sources, namely, the market, regulator and the legislature. While the legislative initiative is directed towards bringing about amendments to the basic law-India’s Companies Act to include certain fundamental provisions related to corporate governance, dynamic aspects of corporate governance such as disclosures, accounting standards etc. are being pursued through the regulatory initiatives by bringing about amendments to the Listing Agreement. Such an approach is aimed at because a comparatively more complicated and protracted process is involved in the amendments to legislation in a truly democratic society like India’s. The most important initiative comes from market forces and mechanisms, which encourage and insist on the management’s improving the quality of corporate governance. Indian market has formalised such forces in the form of a rating called “Corporate Governance and Value Creation Rating”, which according to SEBI chairman is quite unique in the world and is sought after voluntarily by companies.
R. Rajagopalan in his book Directors and Corporate Governance makes the following observation on the role of SEBI: “The Securities and Exchange Board of India and its various committees should be complimented for many things happening in the capital market in India. Be it in the area of protection of small investors’ interests, or technology upgradation or development of securities market, SEBI has indeed been working with commensurate speed and efficiency in the last couple of years. There has, however, been a common perception that SEBI has not developed a cadre of regulatory personnel to effectively track violations. After the Harshad Mehta’s securities scam in 90s which was blamed on a systemic failure, the system needed a thorough overhauling. However, nothing really happened. Later another scamster, Ketan Parikh made use of the loopholes in the system to his advantage. He was instrumental in rigging the prices of shares resulting in heavy losses to the investing public, which led to erosion of faith in the capital market. Over the years, quite a few companies raised money through IPOs and disappeared without a trace. It is not seen that the perpetrators of these frauds are promptly brought to book.”
In the changed environment of the Indian economy, when after more than four decades of heavy regulation and anemic growth, with the government slowly opening the economy to market forces, and promoting modification of financial institutions, SEBI has to play a proactive role as a capital market regulator. SEBI’s performance has to be judged in the context of its efficiency in this dynamic environment. The SEBI has made progress in a number of areas:
The record of the SEBI, over the period, has indeed been encouraging. SEBI has sought to check and control unfair practices on the stock exchanges, acted against transgressing companies, brokers accused of rigging prices, and scrips showing large price movements. At the same time, SEBI has sought to reduce regulation, and instead to leave it largely to the players in the market.
The capital market is composed of two constituents: the primary market and the secondary market. While the primary market deals with the issue of new stocks and shares, the secondary market deals with the buying and selling of existing stocks and shares. SEBI, as a regulator of capital market, has to play a regulatory role in both these markets. With a view to improving practices and ensuring greater transparency in capital markets so as to have a healthy capital market development and promote corporate governance among companies, SEBI has taken several steps as given below:
The primary capital market plays an important role in the overall functioning of securities market. Vibrancy of primary market, among other things, is a function of macro economic factors, industrial output and demand. Over the years, the Securities and Exchange Board of India, the market regulator, has taken several initiatives to improve the operational efficiency and transparency of the primary market, which provides investors with issues of high quality and for firms a market where they can raise resources in a cost-effective manner. However, despite these measures the primary market remained lackluster in recent years.
Bonds have been the primary instruments for the resource mobilisation in the primary market followed by equity. Equity with premium compared to the previous year, more than doubled in 2002–2003, while issues in the public sector were dominant during the year, compared to the issues in the private sector, which raised about 87 per cent in the previous year.
With regard to the primary market, the part of the capital market that concerns with the issues of new stocks and shares, the following major changes have been effected by SEBI:
With regard to the primary market, the following major changes have been effected by SEBI: Relating to new issues new norms were introduced; freedom to fix par value of shares; guidelines for tightening the entry norms issued; relating to IPOs measures were spelt out; investor protection measures were taken; cost reduction measures.
The government of India has also liberalised investment norms for Non-Resident Indians (NRIs) so that they and overseas corporate bodies can buy shares and debentures without prior permission of the Reserve Bank of India which has been the practice followed hitherto.
In the matter of reform of the secondary market, a market that is engaged in the buying and selling of old stocks and shares, SEBI has initiated the following measures:
In the secondary market, SEBI has initiated measures: registration of intermediaries, reconstitution of stock exchange governing bodies and regulation of collective investment schemes.
Beginning July 2002, SEBI has been posting all orders passed by its chairman against errant companies and market intermediaries on its website. This provides useful information to investors.
Interest Rate Derivatives trading was formalised on the stock exchanges with the launch of futures on 10-year zero yield coupon bond and zero-coupon notional T-Bill in June 2003.
Further, SEBI has introduced measures in the secondary market, delisting guidelines, central listing authority, derivative trading, and demutualisation and corporatisation of regional stock exchanges.
Traditionally, the Regional Stock Exchanges (RSEs) functioned as mutual societies owned and operated by member brokers. A few of them have already switched to the corporate form. The new action plan now requires them to segregate ownership rights from trading rights. Professionals rather than broker representatives will conduct the affairs of the exchanges. Can the RSEs come together as has been proposed many times and transform themselves into the country’s third exchange along with the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE)? That is a moot question, though few will question the need for increased competition that will give greater choice to investors.
However, in practice, it has always been difficult to form a third all India exchange. Despite the current moves to restructure the RSEs, there is no guarantee that a demutualised and corporate exchange by itself will be the recipe for survival and eventual success. On the contrary, in the opinion of experts, there are valid reasons to be skeptical. The RSEs, in their new form will require a large number of stock market professionals who are scarce. Besides, an exchange operating for profit may sacrifice regulatory concerns for commercial gains.
At present stock exchanges in India are “mutual” and non- profit organisations enjoying tax exemption. The trading members are stockbrokers who also own, control and manage such exchanges for their mutual benefit. The ownership rights and trading rights are combined together in a membership card, which is not freely transferable.
At present stock exchanges in India are “mutual” and non-profit organisations enjoying tax exemption. The trading members are stockbrokers who also own, control and manage such exchanges for their mutual benefit. The ownership rights and trading rights are combined together in a membership card, which is not freely transferable. A publicly held organisation is in a position to ensure greater transparency in dealings, accountability and market discipline and is amenable to changes.
On the other hand, a “demutual” exchange is one in which three distinct sets of people own the exchange, manage it and use its services. The three stakeholders are shareholders, brokers and investing public. The management is vested in a board of directors, assisted by a professional team. A demutualised exchange is generally a profit organisation and a tax paying entity. The ownership rights are freely transferable and there is no membership card.
A typical mutual exchange managed by broker’s representatives is not an ideal model for an enlightened self-regulatory organisation. In this regard, a demutualised framework is expected to have a balanced approach without the inherent conflict of interest. It can generate a greater management accountability. In a competitive environment stock exchanges require funds and to raise funds, mutualised organisations suffer from their own limitations, whereas a demutualised set-up can tap capital markets. A publicly held organisation is in a position to ensure greater transparency in dealings, accountability and market discipline and is amenable to changes. However, a demutualised and corporate form of stock exchange is not an unmixed blessing either. According to C.R.L. Narasimhan, an authority on the subject, they have the following disadvantages:6
It is also likely that the government will push for a speedy transition to the new mode of governance. However, even if the board objectives are achieved, it is likely that the perception of the exchange may not improve dramatically over the short term.
Though SEBI has come a long way in acquiring more powers and wielding great authority in regulating the Indian capital market, it also suffers from a number of shortcomings. These are as follows:
SEBI suffers from a number of shortcomings like lack of adequate required power.
Likewise, another mandatory requirement for the corporates was to have the whistle blower policy. SEBI’s earlier circular had provided for a whistle blower policy through which a company should establish a mechanism for employees to report to the management concerns about unethical behaviours, actual or suspected fraud, or violation of the company’s code of conduct or ethics policy. This mechanism could also provide for direct access to the chairman of the audit committee in exceptional cases. Once established, the existence of the mechanism may be appropriately communicated within the organisation. The provision of having a whistle-blower policy too has now been made a non-mandatory requirement. In this context, SEBI watchers argue: “It is sad that SEBI buckled under pressure from the intense lobbying by corporates. Some of the promoters are against the whistle-blower policy. This does not suit their working style.” Such fickle-minded approach on the part of the regulator not only brings to the fore its inability to enforce well-intentioned regulations evolved out of considerable experience, thought, and deliberation, but also SEBI could not be believed to promote corporate governance practices with any degree of commitment to the cause.
SEBI suffers from other shortcomings such as mammoth size of the market and inefficient handling, inefficient standard regulatory model.
As a result, SEBI’s initiatives to regulate stock exchanges too have been ineffectual; they were involved in considerable wrangles without significantly improving the working of the stock exchange. This is because SEBI’s approach is as bureaucratic as its predecessor. Both are of the same type; they involve rule making without much thought of rationale or consequences.
Critics of SEBI’s role and the way it has been functioning point out that India’s capital markets so far are not sufficiently mature, nor do they guarantee sufficient levels of investor protection to constitute an effective governance mechanism as they do in Anglo-American countries. Besides, unlike the US Securities and Exchange Commission (SEC), SEBI does not have direct oversight over the auditing and accounting profession. SEBI has left it to the Institute of Chartered Accountants of India to set and monitor standards closer to international norms. This dichotomy in authority in enforcing auditing and accounting standards so essential for promoting corporate governance also make SEBI as a less powerful market regulator vis-à-vis the SEC of United States.
The Dhanuka Committee was appointed to examine all current capital market regulations and to suggest amendments to them. In its report the committee recommended that SEBI’s powers be enlarged to enable it to be an effective market regulator. It has recommended the following:
Dhanuka Committee recommended that all provisions related to listed companies referring to capital market and insurance or dealing in securities wherever found in Companies Act are administered by SEBI; SEBI should be the sole authority for framing regulations for all matters related to such issues; SEBI should be authorised to frame regulations relating to transfer of securities and must be vested with powers of investigation and enforcement; and the scope of powers and functions of the SEBI board be enlarged and a new definition of issues is drafted because the definition under the Companies Act is far too limited as all issuers are not companies but other form of legal entities which currently do not come under its purview.
In the light of recommendations of various committees and criticisms of analysts of capital market, a number of suggestions can be made to improve SEBI’s performance in future.
SEBI needs to be vested with more powers; among these mention may be made of the following important ones:
To make SEBI perform and act like the Securities and Exchange Commission of the USA, government should provide it more powers to penalise and debar the wrongdoers. Further, government should also consider granting it powers for suo moto action on any matter connected with the capital market. Thus, if SEBI is to be successful in its role as a regulator, it needs to have more powers to prosecute the errant members of the system. If every announcement could be taken to court and eventually get it changed, there is no case for setting up of a separate regulatory body like SEBI. However, the consolation is that things are changing albeit slowly. Critics also have to appreciate the fact that in a developing economy such as ours where almost all economic institutions are nascent or just evolving and in transition, immediate and appropriate responses to fast changing and dynamic economic and commercial situations—good or bad for the overall development of the economy—may not be forthcoming in a measure that is available in mature and developed economies. This is exactly the crux of the problem that developing economies face and that is one of the reasons why they are poor and impoverished. It may take some more time and efforts for them to catch up with more efficient and mature institutions of developed countries. The deficiencies of SEBI as a capital market regulator have to be understood and appreciated in such a context.
(This case is based on print and electronic reports and is meant for class room discussion only. The author has no intention to tarnish the reputations of corporates or individuals).
Ketan Parikh is a notorious name in the annals of India’s securities market. He used an ingenious technique to get public funds for his price-rigging operations. As the Indian Express reported, Ketan Parekh had close to Rs. 2000 crore to play around with during the month prior to his arrest in 2001. Securities and Exchange Board of India’s (SEBI) preliminary enquiry unearthed the fact that Ketan got around Rs. 670 crore from corporations such as Zee and HFCL whose shares he was ramping up. Both Zee and HFCL had raised this money for business purposes but diverted it to Ketan unauthorisedly. Though Zee reported that it gave funds to Ketan to buy a stake in entertainment firm ABCL and television channel B4U, both these firms denied that they were selling their stakes to Zee. Ketan had also borrowed Rs. 250 crore from Global Trust Bank, against the Reserve Bank of India’s (RBI) norms. He was ramping up GTB’s shares too with a view to getting a good deal at the time of its expected merger with UTI Bank. Ketan and his associates got another Rs.1000 crore from the Madhavpura Mercantile Co-operative Bank despite the fact that RBI regulations ruled that a broker could get a maximum loan of Rs.15 crore only.
SEBI also found that the Foreign Institutional Investor Credit Suisse First Boston was funding Ketan Parikh’s operations disguising these loans by creating false records of transactions. It then charged Ketan brokerage fees which was actually nothing but the interest on the loans it gave him. SEBI even found evidence of how brokers acting for Ketan placed dubious sell-orders to complete the paperwork to cover their illegal operations. SEBI also found out evidence that there was a big bear cartel in the market and that one of them, Shankar Sharma, was closely linked with Tehelka.com—he owned a large part of the dotcom. The allegation was that Sharma was short-selling shares since he knew there was going to be a major expose that would shake the government and hence the country’s stock markets.
Ketan’s modus operandi was to ramp up shares of select firms in collusion with their promoters. In the Ketan 2001 Scam case, SEBI found prima facie evidence of price rigging in the scrips of Global Trust Bank, Zee Telefilms, HFCL, Lupin Laboratories, Aftek Infosys and Padmini Polymer. Though UTI denied any link with Ketan, it was found that UTI’s purchases almost aligned with Ketan’s buying in what are called the K-10 stocks, or those stocks that Ketan had been buying. UTI also purchased hitherto unknown stocks such as Arvind Johri’s Cyberspace Infosys—Cyberspace interestingly, was the erstwhile Century Finance, which changed its name like many others, to sound infotech in order to take advantage of the boom in infotech stocks. Market rigging was found to be so obvious that the Bombay Stock Exchange (BSE) began investigating the sudden rise in prices of Cyberspace which sky-rocketed to Rs. 1450 within a few weeks of its launching. However, its value fell below par as the investigation had started.
The most frightening aspect of the entire scam, of course, was how long it had been going on unsuspected and unchecked, and how long it took to discover the fraud. More damaging was the fact that SEBI’s Regional Chief in charge of surveillance cautioned BSE’s officials about Johri’s powerful connections and asked them to go slow on the investigations. If the markets had not crashed after the budget, the then Finance Minister Yashwant Sinha would not have insisted on a thorough probe, and chances were that life would have continued the way it was.
In almost all such scams, the public were told that it was a “system failure”, that it was not just individuals who erred, it was the system that failed. While that sounds like the classic rogue’s defence, it remains sadly true. For every possible system that could fail did so in this particular case, either by design or by default. Moreover, as usual, the cautious investigation and the long legal procedures, even when the entire market was aware of Ketan Parikh’s and his accomplices’ wrongdoings, proved that “delayed justice meant denied justice” to the hapless investors whose confidence in the securities market was rudely shaken once again.
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