SECURITIES MARKET – WHAT CHANGED IN 1992?


Guest Post Author: TRISHA SHREYASHI

1992 is a germane year in the history of the Indian securities market but why? That’s something we’ll get to know further in this article paper. From the situation before SEBI Act was legislated to the infamous Harshad Mehta case that led to this legislation to the era post that; all of it has been briefly discussed to give the reader an overview of SEBI Act with regard to (hereafter “w.r.t.”) securities market. Before letting the readers into the details, let’s first get an overview of securities market:-

A security market is a place that deals with buying and selling securities in an efficient and effective manner which in return helps the economy in the creation of capital and smooth flow of money. These markets play a significant role in the economy’s growth and enlargement. The Secondary market provides a platform to trade in already-issued securities of corporate and government organizations. The developed and well-organized securities market represents the economic condition of the financial sector of the country.

The concept of “Money creating money” represents the capital market wherein the development in the field of the financial sector of the economy will in return require sufficient amount of capital which can be further used for investment purpose and help in capital creation and breaking down of the vicious circle of poverty in developing countries. The Securities market fosters the investment by potential investors and helps in generating returns in terms of interest, dividend, capital appreciation, etc., which involves the element of risk. Security analysis is one step forward when it comes to managing the risk of uncertainty like the market price fluctuations that are indecisive in nature.

The Securities Contracts (Regulation) Act, 1956, has defined Stock Exchange as an “association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling the business of buying, selling and dealing in Securities”. The securities include shares, scrip, stocks, bonds, debentures stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; Government securities & Rights or interest in securities. The cash flow in the economy is possible only through institutes like stock exchanges that provide opportunities for the conversion of scattered savings into profitable investments with minimal risk involved. It is a combination of the savings getting channelized and the free movement of capital in the economy. The stock exchange benefits the community at large by enabling the producers to raise capital which provides employment to millions of people on one hand and on the other hand it provides opportunities to the savers to store the value either as the temporary abode of purchasing power or as a permanent abode of purchasing power in the form of financial assets. There are two major stock exchanges in India, namely NSE and BSE, which are the barometer of security markets in India. Stock market helps in meeting the financial requirement of industries and also providing a market for stock trading to the investors. It also helps in creating financial liquidity in the financial market and provides safety and protection against default risk, as it is primarily regulated by SEBI and various other authorities.

The securities market in India has witnessed tremendous growth in the last twenty years in terms of a number of companies, capitalization, increase in a number of investors, stock exchanges, turn over, and mutual funds etc. The economic liberalization and various reforms in the county have also acted as a catalyst in the development of the securities market. The liberalization measures taken by the government have also facilitated the globalization of the Indian securities market. This has brought notable changes in the securities market and has changed the investment scenario in the country. On the other hand, ever-expanding investors population and market capitalization have also led to a variety of malpractices on the part of the companies, brokers, merchant bankers and many other market participants in new shares and stocks in India. Thus, the government felt a strong need for a regulatory body which could monitor and supervise securities market. SEBI was constituted in 1988 and it obtained its statutory character in 1992 after the enactment of SEBI Act, 1992. SEBI is primarily constituted to regulate and promote the securities market. Concurrently, it is also the duty of SEBI to protect the interest of investors.

Scenario before 1992:

The two legislations that governed the securities market till early 1992 before the enactment of SEBI Act were the Capital Issues (Control) Act, 1947 (CICA) and the Securities Contracts (Regulation) Act, 1956 (SCRA). The war of 1943 introduced CICA to channel resources to support the war effort. After the war, the control was retained with some modifications to regulate the raising of capital companies and to ensure that national resources were channelled into proper lines, i.e., for desirable purposes to serve goals and priorities of the government, and to protect the interests of investors. The stock exchanges operating lacked intact legislation for their regulation until the Bombay Securities Contracts Control Act, 1925. This was, however, found to be deficient in many aspects. After the Constitution coming into force on January 26, 1950, stock exchanges and markets came under the exclusive authority of the Central Government. A.D. Gorwala Committee was appointed in 1951 by the Government to formulate legislation for regulating the stock exchanges and contracts in securities. It gives Central Government regulatory jurisdiction over

  • stock exchanges through a process of recognition and continued supervision,
  • contracts in securities, and
  • listing of securities on stock exchanges.

This ensured the stock exchanges complied with conditions prescribed by Central Government, allowing organised trading activity in securities is permitted on recognised stock exchanges.

Scenario post-1992:

SEBI Act, 1992 was enacted with the statutory responsibilities to

  • safeguard the interest of investors in securities,
  • promote the development and growth of the securities market, and
  • regulate the exchange in securities market.

This was followed by the repeal of the Capital Issues (Control) Act, 1947 which paved the way for market-determined allocation of resources. Later, the Securities Laws (Amendment) Act in 1995 was enacted, which extended SEBI’s power over corporate in the issuance of capital and transfer of securities, in addition to all intermediaries and persons associated with securities market. It authorized SEBI to appoint adjudicating officers to adjudicate a wide range of violations and impose monetary penalties and provided for establishment of Securities Appellate Tribunals (SATs) to hear appeals against the orders of the adjudicating officers. This was followed by the Depositories Act in 1996, to provide for the establishment of depositories in securities with the objective of ensuring free transferability of securities with speed, accuracy and security. It made securities of public limited companies freely transferable subject to certain exceptions; dematerialised the securities in the depository mode, and provided for maintenance of ownership records in a book-entry form.

Factors of SEBI legislation that played a key role in determining stock market regulation & boost

  • Dematerialization
  • Unique client ID
  • Establishment of a Central Listing Authority
  • Demutualization
  • Liquidity
  • Corporate Accountability & Corporate Governance
  • Dynamic Environment for Market Intermediaries
  • Public Issues

However, the securities scam of 1992 and 2000-02 highlighted the ambiguities in the legislation which had been exploited by manipulating brokers. With the objective of improving the market many measures and reforms were undertaken. The market today uses state-of-the-art information technology to provide efficient and transparent trading, clearing and settlement mechanisms and has witnessed several innovations in products and services via demutualization of stock exchange governance, screen-based trading, compression of settlement cycles, dematerialization and electronic transfer of securities, security lending and borrowing, professionalization of trading members, fine-tuned risk management systems, emergence of clearing corporations to assume counterparty risks, market of debt and derivative instruments and intensive use of information technology.

CASE STUDIES

Harshad Mehta Case:

In the early 1990s, the banks in India had to maintain a particular amount of their deposits in government bonds. This ratio was called SLR (Statutory Liquidity Ratio). Each bank had to submit a detailed sheet of its balance on a day to day basis and also show that there was a sufficient amount invested in government bonds. In such cases, the brokers knew which bank had more or less bonds than the required amount. Harshad Mehta was one such broker dealing with many banks at the same time. He very cleverly scammed some capital out of the banking system and invested in the stock market. In this settlement process, deliveries of securities and payments were made through the broker. The seller handed over the securities to the broker, who passed them to the buyer, while the buyer gave the cheque to the broker, who then made the payment to the seller. The broker here imitated the transaction to be one to have happened with the bank. He arranged fake bank receipts to be issued. This went on as long as the stock prices kept going up, and no one had a clue about Mehta’s operations. Once the fraud was exposed, though, a lot of banks were left holding BRs which did not have any value. The entire scam cost Rs 40 billion to the market. He was arrested and banished from the stock market. Harshad Mehta fraud has affected the whole of the nation. The Market had collapsed. Several investors have lost their money.

This scam initiated that a watchdog in the form of regulatory body be introduced, after which the SEBI Act, 1992 was enacted. A need was therefore felt to remove these shortcomings so that it is better equipped to investigate and enforce against the market, unfair trade and malpractice. In furtherance, the object of the Act is to keep a check on such manipulative or fraudulent transaction which is not bonafide and has genuine transaction of sale and purchase but a part of the manipulative mechanism.

Ketan Parekh Scam:

An infamous case of ‘price rigging’ history. According to RBI regulation, a broker is allowed a loan of only Rs. 15cr. Mr Parekh borrowed Rs 250cr from Global Trust Bank and Rs. 1000cr from Madhavpura Merchantile Cooperative along with his. The method of price rigging in the scripts of Global Trust Bank, ZEE Telefilms, HFCL, Lupin Laboratories, Aftech Infosys and Padmini Polymer was being used. Ketan Parekh took advantage of low liquidity in these stocks which later on became popular as K-10 stock.

The volume of trading in these stocks kept on increasing and Ketan Parekh started facing difficulty in controlling its modus operandi was to raise funds by offering shares as collateral security to the banks. This worked in favour of him as long as markets were good but problems started when the market crashed in the year 2000, followed by a crash in NASDAQ. Banks pressurized him for pledging more shares as collateral security or refund some money. Fall in KP- stock prices led to payment crisis at Calcutta Stock Exchange. He was arrested by CBI on the charges of defrauding Bank of India for around 30$ million.

Satyam Scam (2009):

A case of Corporate Fraud, Satyam Computers Ltd. (popularly known as Satyam) was leading global business and Information technology (IT) services company delivering consulting, system integration and outsourcing solutions. It was incorporated in 1987, with 20 employees by two brothers B. Rama Raju and B. Ramalinga Raju. It grew to become the fourth-largest software company in India with a market capitalization of $3 billion $2.1 billion revenues in 2008. The problem began when Raju announced in Dec 2008 that in order to de-risk its core business, the company’s Board had approved the acquisition of two Maytas companies i.e. Maytas Infrastructure Ltd. and Maytas Properties Ltd. The acquisition would mean an outflow of $1.6 billion from the company’s books. The negative reactions from both domestic as well as foreign investors forced him to retreat within 12 hours. The fact that Raju’s family held owned 35% in Maytas Properties Ltd. and 36% stake in Maytas Infra made the suspicion stronger. Share prices plunged by 55% on concerns about Satyam’s corporate governance. The World Bank charged Satyam of its involvement in data theft and bribing the Bank staff on its 25 Dec 2008 and banned it from its dealing for the next 8 years. Mangalam Srinivasam the longest-serving independent Director on the Board resigned owning moral responsibility over Satyam scam. This was followed by the resignation from three more directors of the company. On 7th Jan 2009, in a letter to the Board, B. Ramalinga Raju confessed that there were inflated cash and bank of Rs. 5,040cr whereas the amount reflected in the books being Rs. 5,361cr. It also showed receipt of accrued interest of Rs. 376cr which was not in existence. The books also reflected an understated liability of Rs. 1,230cr and overstated debtors of Rs. 2,651cr against the actual debt of Rs. 490cr. Raju also admitted that Satyam’s profit was inflated over several years. It was found out that what started as a marginal gap between the actual operating profit and the reported figure attained unmanageable disproportionate increase as the size of the company grew and every attempt to eliminate that gap had failed.

EPILOGUE

Stock market renders valuable services to the country, corporate sector and investing community. The Stock Exchange helps in rapid economic development and economic growth in the country and severs as an agency of capital formation. It induces the masses to save and invest in industries. SEBI, the first National Regulatory Body in India with comprehensive statutory power over practically all aspects of the capital market operation to Protect the Interest of the Investors and to promote the development and to regulate the securities market by such measures as it thinks fit. It has various committees including, Technical Advisory Committee, and a committee of review of the structure of market infrastructure, member of the advisory board for SEBI Investor Protection and Education Fund, takeover regulation advisory committee, market advisory committee etc.

Securities market regulators in almost all developed and emerging markets have for some time been concerned about the importance of the subject and of the need to raise the standards of corporate governance. The financial crisis in the Asian markets in the recent past have highlighted the need for an improved level of corporate governance and the lack of it in certain countries have been mentioned as one of the causes of the crisis. Formation of a regulatory body like the Securities and Exchange Board of India has helped the market to operate in an orderly fashion and address the corporate frauds rapidly occurring in the country. Therefore, it is a much appraised and permanent legislation in regard of regulation of the capital market. Thus, the stock market is one of the reasons why India is becoming a financially secured and economically stable country. For a developing nation like ours, it is important to establish a proper economy and well-equipped stock market. More than this, investors play a key role in the whole process of stock trading. It is important to adhere to proper ways of investing and not to resort to improper ways.

Suggestions to tackle lacunae in the present legislation:

  • Enhancing operational efficiency w.r.t. availability of information.
  • Striking organizational & structural balance as suggested by Pherwani committee
  • Tackling speculations so as to avoid more Harshad Mehta & Ketan Parekh instances.
  • Tackling volatility and unpredictability of markets

Considering these suggestions, one could promise a well established, well-formulated and a malpractice free market.

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