Recent Developments in Indian Stock Exchanges

Insider Trading:

Insider trading had become an extremely sensitive and controversial subject in the stock market in India.

Any person in power whether an officer or director who had access to information of private matters of the company relating to expansion programs of the company, changes in policies, amalgamations, joint contracts, collaboration or any information about its financial results was making full use of his position to give an advantage to relatives, friends or known persons by leaking out information leading to frauds and rigging of price relating to securities.

SEBI has laid down guidelines by prescribing norms handling information which may be considered sensitive. Price forecasts, changes in investment plans, knowledge of mergers and acquisitions, information about contracts are not to be disclosed. The staff and officers who have such sensitive information are to be identified in each company. Controls are to be made on the handling of sensitive information.

Insider Trading Regulations in 1992 notified by SEBI prohibited insider trading, as it is unfair upon investors. Persons who possess price sensitive information because they have connections with a company take advantage of the situation to ‘peg up’ or ‘down’ prices of securities to their advantage.

Depository or Paperless Trading:

The Depository Act was passed in 1996 allowing dematerializing of securities and transfer of security through electronic book entry to help in reducing settlement risks and infrastructure bottlenecks. The dematerialized securities will not have any identification numbers or distinctive numbers.

The National Securities Depository Ltd., was set up in Nov. 1996. Trading of new Initial (NSDC) public offers was to be in dematerialized form upon listing. An exclusive feature of the Indian Capital Market is that multiple depository system has been encouraged.

Hence, there are two Depository Services. The other depository system is also registered. It is called Central Depository Service Ltd. (CDSL). Debt instruments however, are not transferable by endorsement delivery.

Dematerialization of securities is one of the major steps for improving and modernizing market and enhancing the level of investor protection through elimination of bad deliveries and forgery of shares and expediting the transfer of shares. Long-term benefits were expected to accrue to the market through the removal of physical securities.

Usefulness of a Depository System:

A depository system was required in India to eliminate physical certificates.

A depository system has the following advantages:

• Paperless:

It eliminates risks, as this system does not have physical certificates. There are no problems regarding bad deliveries or fake certificates.

• Electronic:

It is an electronic form and provides transfer of securities immediately without any delay.

• Demat Account:

A depository provides a demat account with a client identification number and a depository identification number. Therefore, there is a special identity of a member. He also has a trading account, which enables him with identity and immediate transfer.

• Electronic Transfer:

There is no stamp duty on transfer of securities because there is no physical transfer. It is transfer through a pass book similar to a bank.

• Expenses:

The DP charges a yearly charge for maintaining the member account, hence there is a reduction of paper work and transaction cost of a frequent transfers of securities.

• Eliminates Problems:

Investors had the problem of selling shares in Odd Lots but with the depository system even one share can be sold.

• Nomination:

Since a depository allows a nomination facility, hence shares can be easily transferred at the time of death of a participant.

• Address Changed:

Change in address recorded with DP gets registered with all companies in which investor holds securities electronically, eliminating the need to correspond with each of them separately.

• Elimination of Correspondence:

Transmission of securities is done by DP eliminating correspondence with companies.

• Automatic Credit:

There is an automatic credit into demat account of shares, arising out of bonus, split, consolidation, merger etc.

Conversion of Shares into Dematerialized Form:

In order to dematerialize physical securities, an investor has to fill in a Demat Request Form (DRF) which is available with the DP and submit the same along with physical certificates DRF has to be filled for each ISIN no. The investor has to surrender certificates for dematerialization to the DP (depository participant). Depository participant intimates Depository of the request through the system.

He then submits the certificates to the registrar. The Registrar confirms the dematerialization request from depository. After dematerializing certificates, Registrar updates accounts and informs depository of the completion of dematerializations. Depository updates its accounts and informs the depository participant. Depository participant updates the account and informs the investor.

Re-materialization:

If an investor is interested in getting back his securities in the physical form he has to fill in the Remat Request Form (RRF) and request his DP for re-materialization of the balances in his securities account. He has to make a request for re-materialization.

Then the DP intimates the depository of the request through the system. The Depository confirms re-materialization request to the registrar. Registrar updates accounts and prints certificates. Depository updates accounts and downloads details to depository participant. Registrar dispatches certificates to the investor.

Surveillance on Price Manipulation:

SEBI introduced surveillance and enforcement measures against intermediaries’ violation of laws especially in price manipulations. All exchanges have surveillance departments which co-ordinate with SEBI. SEBI has enforced information to be submitted by exchanges on daily settlement and monitoring reports. SEBI has also created a database for trading on National and Bombay Stock Exchanges.

If price manipulation is detected, auction proceeds may be impounded or frozen so that the manipulator cannot use it. SEBI has introduced ‘Stock Watch’ an advances software for surveillance of market activities programmed to show movements from historical patterns through follow ups by analyst and trained investigators to act as a deterrent to trading and price rigging.

Regulation of Stock Brokers:

Stock Broker and Sub-brokers Regulation Act, was passed in 1992. Brokers had to have a dual registration both with SEBI and with Stock Exchange. Penal action would be taken against any broker for violation of laws. Capital adequacy norms were introduced and they were 3% for individual brokers and 6% for corporate brokers.

For investor protection measures, brokers have been disciplined by introducing the system of maintaining accounts for clients and brokers own account and disclosure of transaction price and brokerage separately in contract note.

Audit has been made compulsory of the brokers’ books and filing of auditor’s report with the SEBI has been made mandatory. SEBI has also extended regulations to sub-brokers. Sub-brokers have to be registered by entering into an agreement with the stock brokers from whom he seeks affiliation.

Sub-brokers can transact business only through stock broker with whom he is registered. If he wants to do business through more than one stock broker, he has to be registered separately with each one of them.

Options and Derivatives:

Options can be classified as call options or put options. The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) have launched derivatives. They will offer derivatives for three tenures one in the first instance each for subsequent three months.

So, in July, Nifty call and put options can be purchased for July end, August end and September end. The last day of the contract would be the expiration date. In an options contract, a premium has to be paid to enter a contract.

Buyer’s losses are limited to the extent of premium paid but his gains are unlimited. Seller’s profits are limited to premiums received but losses are unlimited.

These derivatives have been started by SEBI to bring about investor confidence to establish the market and to reduce risk. Initially, options trading will be allowed only in 14 stocks. Option will not allow a person to defer settlement of sale/purchase but they will enable placing of bets on Stock Markets.

Regulation of Mutual Funds:

SEBI regulates the Mutual Funds to provide portfolio disclosure and standardization of accounting procedures. It is a requirement of SEBI that Mutual Funds should have a trustee company which is separate from the asset Management Company and the securities of the various schemes should be kept with a custodian independent of the Mutual Fund.

All Mutual Funds should be regulated with the SEBI. All schemes of UTI after 1994 have also been brought under the control of SEBI. SEBI created certain procedures of valuation norms and asset value and pricing for the Mutual Funds. The primary interest of SEBI to control Mutual Fund schemes was to protect investors from fraudulent deals.

To bring transparency in operations, SEBI directed mutual fund investors to mention their permanent account number (PAN) for investments over Rs. 50000. In case where neither the PAN nor the GIR number has been allotted, the fact of non-allotment is to be mentioned in the application form. Mutual fund was prohibited from accepting any application without these details.

All mutual funds were also told to obtain a unique client code from the Bombay Stock Exchange or the National Stock Exchange for each of their existing schemes and plans.

Following the collapse of Global Trust Bank (GTB), SEBI asked all mutual funds to provide details of their investments in fixed deposits of banks. In particular, SEBI called for specifying FD investments exceeding 25% of the total portfolio of a scheme.

To prevent mutual fund schemes from turning into portfolio management schemes, each has directed mutual funds scheme and individual plan under the schemes should have a minimum of 20 investors and no single investor should account for more than 25% of the corpus of such scheme/plan. In case of non-compliance, the schemes/plans will be wound up and investor’s money redeemed at applicable Net Asset Value.

SEBI issued a new format for Mutual Funds to file information details of investment objective of the scheme, asset allocation pattern of the scheme, risk profile of the scheme, plans and options, name of the fund manager, name of the trustee company, performance of the scheme, expenses of the scheme, i.e.,

(i) Load structure

(ii) Recurring expenses, tax treatment for the investors/unit holders and daily net asset value (NAV).

Regulation of Foreign Institutional Investors (FIIs):

FIIs had a large volume of funds. By the nature of their trading volumes, FIIs can retain Control over the stock market. SEBI had to keep these FIIs under its control for protecting the investors. Hence, all FIIs had to be registered with SEBI.

FIIs having a capital of 100 crores could register themselves as depositories and their procedures were to be evaluated by an independent agency. FIIs are also allowed to invest in debt securities but investment in equity and debt securities should be in the ratio of 70:30. The FIIs under SEBI include Pension Funds, Mutual Funds, Asset Management Companies, Investment Trust and Charitable Institutions.

Buy back of Shares:

Buy Back of shares is another development of Indian Corporate practice. It was permitted by SEBI in 1998, following the companies (amendment) ordinance by the Central Government. Buy back of shares is a method whereby a company is allowed to purchase its own shares out of its free reserves, securities premium account, or the proceeds of other specified securities like preference shares.

However, it cannot be made out of earlier issue of equity shares. Buy back of shares may be done from existing shareholders on a proportionate basis, through open market purchases and through company employees where securities are issued under stock option or sweat equity.

It is a strategy used for restructuring a company’s share capital and increasing the value of its shares. It can also have the effect of a greater control of the company by the management and promoters through the use of excess funds available with the company.

Buy back its shares as per SEBI’s regulations only when the following conditions are fulfilled:

1. The Articles of Association of a company authorize buy back of shares.
2. A special resolution is passed by the general body to authorize the repurchase of shares. The resolution should have an attached document giving details of all material facts like: need for buy back, amount to be invested, type of securities intended for repurchase and time limit for completion of buy back.
3. The debt equity ratio after buy back should not be more than 2:1 of secured and unsecured debt except with prior permission of Central Government.
4. The other specified securities of the company are fully paid up and (both listed and unlisted securities) are in accordance with SEBI regulations.
5. The buyback of shares is less than 25% of paid up capital and free reserves of the company as shown in the latest balance sheet of the company.
6. The buyback should be completed within twelve months from the date of passing the special resolution.
7. The shares/other specified securities would be extinguished within seven days of completion of buy back procedure of the company.
8. The company will not be permitted to issue the same type of shares/securities which have been bought back for a period of twenty-four months. The exception to such an issue would be the issue of bonus shares of stock-option schemes, conversion of preference shares/debentures into equity issues.
9. In addition, a company has to file a declaration of solvency verified by an affidavit in a prescribed form with the Registrar of companies within 30 days after completion of buy back. This has been amended in October 2001 to bring in relaxation to companies to buy back shares. The amendments are:
10. There can be only one buy back in 365 days.
11. Companies can buy back less than 10% of equity with the approval of the Board of directors meeting.
12. If a company issues less than 10% equity it does not require shareholders’ approval.