[Part I is available at https://www.thesecuritiesblawg.in/post/historical-underpinnings-to-indian-securities-market-regulation-part-i-pre-independence]
By the time of India’s independence, several new stock exchanges had sprung up across the country. In fact, there were multiple stock exchanges in some cities. The state of the securities market was glum as there were several undesirable activities happening across the medley of stock exchanges, street markets and even independent dealers. The stock exchanges also were very divergent in their functioning. While some were unincorporated private registered associations like Bombay Stock Exchange (“BSE”) and Ahmedabad Stock Exchange (“ASE”), others were joint stock companies like Chennai Stock Exchange (“CSE”).
Complicated problems had arisen in management of company stock exchanges due to their directorate playing dual roles as also the managing board of the exchange.[1] Further, only BSE and ASE had well defined and written rules approved by the government, while some exchanges had partly written and partly unwritten rules and some even worked entirely under convention and usages.[2] Other than BSE and ASE, exchanges did not even have adequate listing regulations and memos or notes continued to be substituted for formal contracts leading to evasion of contract stamps. Further, though clearing had started to exist in BSE and ASE, it was limited to only few securities and blank transfers continued to hold foot.[3]
PJ Thomas Committee Report
In his report in 1948, P J Thomas observed that the sustained ruinous speculation in Indian markets was a result of several defects including differencing and postponement of settlements, easy credit facilities in form of margin trading, blank transfers, indiscriminate advances of money by moneylenders and certain banks, laxity in enforcing the rules of exchanges and the generally unwieldy and ineffective governing bodies of the exchanges. He also observed that street markets and fraudulent practices in them had lowered the commercial morality in the stock market. Some of the brokers of street markets were collecting vast funds and roping large numbers of persons into stock market speculation. Some of them also worked as agents of the stock exchange members and often carried out manipulations in the stock market.
During this time, there were also manipulations by company directors and promoters. There were instances of staging, price manipulations to suit their nefarious designs and employment of various devices to keep voting powers in their hands by undermining the powers of shareholders. Further, there were instances of officers of the companies using inside information for speculating profitability in their companies’ shares to the detriment of investing public. Thomas recommended a central law regulating the entire market, stock exchanges, street markets and private dealers. He also suggested that dealings in shares of a company by its own directors and agents as well as share pushing activities by promoters at the floatation stage should be checked. Further, he recommended setting up an independent competent authority to administer the law. He also recommended that the central government should impose restrictions on badla, blank transfers and other objectionable practices.
Gorwala Committee Report
The Committee on Proposed Legislation for the Regulation of Stock Exchanges and Contracts in Securities under the leadership of A D Gorwala (“Gorwala Committee”) also noted the lack of laws governing most exchanges and the inefficiency of the the Bombay Securities Contracts Control Act, 1925 ("BSCC Act") for its failure to check speculative activities in markets. It noted that failure of BSCC Act was on account of it failing to distinguish between ready delivery contracts and forwards and by making transactions outside stock exchange merely void and not illegal. This Committee felt that the only way to check speculation outside the stock exchanges was to eliminate it altogether. It also felt that the business in the stock exchange should be conducted in conformity with bye-laws which must be so framed to only permit healthy speculation.
Accordingly, the Gorwala Committee recommended that for effective control, the government should have the power to amend the rules and bye-laws of the stock exchange, and the power to nominate its representatives on the exchange. It also recommended that the government should have the power to suspend business, supersede the governing body, institute enquiries and withdraw recognition of the stock exchange in extraordinary situations. It also recommended setting up a regulatory authority to regulate the stock market. Further, it recommended that all dealings in securities must be regulated, except spot transactions. It also attempted to discourage blank transfers by recommending provision (a) mandating maintenance of clearing houses by stock exchanges and (b) payment of dividends only to registered holders.
The Securities Contracts (Regulation) Act, 1956: The Bill
The aforementioned recommendations of Gorwala Committee formed sort of a foundation for the draft of the Securities Contracts (Regulation) Act, 1956 (“SCRA”). The bill was referred to a joint committee which presented its report to the Lok Sabha in February of 1956 and the Lok Sabha passed the bill on July 16, 1956 after elaborate discussions on the same day. The Rajya Sabha discussed the bill over the course of two days during August of 1956 and passed the same with certain amendments.
M C Shah during the discussions on July 16, 1956 in Lok Sabha while deliberating on the Select Committee’s suggestions, highlighted that “The Bill is the first all-India legislation on this subject and attempts to standardize stock exchange practice all over India”. It was also seen as an essential complementary measure to the then newly enforced Companies Act, 1956. Shah, during the course of summarizing the bill, highlighted how it did not provide granular regulation of the daily activities of the exchanges, but provided for a general skeletal while vesting substantial powers with the Central Government, to be exercised generally, in consultation with the governing bodies of the exchanges, when the government considers the use of such powers “necessary either in the interest of legitimate business or in public interest”.
The following paragraphs highlight some discussions on key provisions of the SCRA to aid in understanding the rationale and the prevailing background that led to the design of the said provisions, most of which stand till date.
Spot Delivery Contracts
In Rajya Sabha on August 2, 1956, M C Shah succinctly summarized the considerations for provisions on spot delivery contracts. He explained how in terms of the original bill, spot delivery contracts were to be exempt from licensing provisions in areas notified under Cl. 13, i.e., areas where Central Government had declared by official gazette notification that no dealings in securities should take place otherwise than between members of recognized exchange or through or with such members. However, it subjected all contracts, including spot delivery contracts to licensing in non-notified areas. Later, basis the Select Committee recommendation which found this discriminatory, this was revised to provide that ordinarily spot delivery contracts everywhere would be exempt from the provisions of the bill, irrespective of area.
Further, in this regard, the Central Government was to be empowered to require licensing for such contracts in any area, should it consider it necessary to do so in the interest of trade or in public interest. Thus, it was envisaged that spot delivery contracts would be free from regulation, “unless the Central Government considers it expedient to regulate such contracts in the interests of trade or in public interest.” This power was given to the Central Government with a view to ensure that forward transactions are not done under the guise of spot delivery contracts by misusing the erstwhile three-day period allowed for completion of the spot delivery contracts.
This explains the design of Section 18 of the SCRA, which excludes spot delivery contracts from sections 13, 14, 15 and 17.
Blank Transfers
One of the most debated issues in the parliament when discussing the bill, led to the retention of Section 9(2)(e) which provides that the bye-laws of exchanges to provide for “the regulation or prohibition of blank transfers”. The debates on this issue in both the houses were quite polarized with one group advocating for allowing blank transfers and vocalizing the negotiability, liquidity and ease of doing business that blank transfers afforded whereas the other segment highlighted the need to ban them altogether on account of ills perpetuated by them, such as avoidance of tax and speculation. The blank transfer conundrum can be noted from record of proceedings of Lok Sabha as follows:
“…it is a very knotty problem. There are two sides to the question. Some say there ought not to be blank transfers. Some say it is necessary. There was sharp difference of opinion even in the Gorwala Committee which reported on this matter, and therefore we have thought it advisable not to have any provisions in the Act itself, but to take powers to frame rules and regulations wherein we will consider this question very carefully. We will discuss this question with the authorities…and try to find out a way which will not hamper the development of the stock exchanges and at the same time serve the purpose while doing away with the mischief that blank transfers are said to create…we cannot immediately take any action which may create difficulties in the healthy development of the business in stocks, shares and securities.”
It becomes important to understand this along with rationale of the scheme of the present Section 27 dealing with 'Title to Dividends'. During the discussions on the bill in the Rajya Sabha in this regard, it was noted that the original draft of the bill was intended to act as a severe deterrent to holding shares on blank transfers for indefinite period. However, it noted that
“If the prohibition embodied in this clause were to extend beyond dividends to bonuses and other rights attaching to the shares, it might in some cases involve the holders of such shares in heavy capital loss. In view of the positive recommendations which it has made elsewhere in his report that the life of blank transfers should be limited to a period of six months, the committee felt it was not necessary to impose such a disproportionately heavy penalty on the holders of such shares. Accordingly, the committee has amended clause 27 so as to confine its application only to the receiving and retaining the dividends on such shares.”
Badlas
Lok Sabha saw discussions on badla as well, it was discussed as follows:
“About this badla business, if you allow forward trading, it is but legitimate that badlas or carry over facilities should be there. It will be very difficult to regulate that unless you have a provision that except the spot delivery contracts, no other contracts will be allowed in the stock exchanges….it was necessary to regulate these forward transactions in securities, but under the present circumstances, we have to allow bona fide forward transactions to continue. We want to check excessive speculation at times verging on gambling by the bull operators and in such emergencies, we have taken powers to take action in consultation with the governing bodies.”
It can be thus seen that the SCRA prescribes that the regulation, or prohibition of budlas or carry-over facilities has been provided for the exchanges to make bye-laws on, in terms of Section 9(2)(g). Further Section 9(2)(s) also provides that exchanges make bye-laws in relation to “emergencies in trade which may arise, whether as a result of pool or syndicated operations or cornering or otherwise, and exercise such powers in such emergencies, including the power to fix maximum and minimum prices for securities.”
Ban on any stock exchange operating without approval of the Central Government
Rajya Sabha proceedings noted that, as a corollary to other amendments suggested by the Select Committee, Clause 19 was introduced prohibiting the setting up or maintenance of non-recognised stock exchanges in any area, except with Central Government’s approval. It was noted in this regard that in the design of the original bill, there remained a risk of non-recognised stock exchanges springing up in non-notified areas under the guise of licensed dealers or in places where the provisions regarding recognition and/or licensing had not been made applicable, which was not seen desirable.
Further, in relation to bar on Kerb Trading, following was discussed:
“The Select Committee has elaborated the provisions of clause 23 (Penalties) by some important amendments to it, the effect of which is to strengthen considerably, the scheme of regulation envisaged in clauses 13 to 19 of the Bill. These amendments penalise kerb trading and/or touting by persons who are neither members of a recognised stock exchange nor licensed dealers nor their authorised agents. Similarly, the penalties contained in clause 23 have been extended to the owning or keeping of places used for the purpose of entering into contracts in securities in contravention of the provisions of the Act, as also to the managing, controlling or assisting in the keeping of such places. These are useful amendment which as I have already stated, strengthen the operative provisions of the Act relating to the regulation of the dealings in securities. (emphasis supplied)”
Options
In the Lok Sabha, the view with respect to options was quite stern towards banning options, making them illegal and prescribing penalties for engaging in them. Similarly, the Rajya Sabha also saw vocal voices in support of banning options. M C Shah was noted to have stated here that:
“Options should be made illegal and should be penalized, there should be punishment to the extent of one year, though that is a small one…to my mind, the business of options is nothing but gambling and that gambling should be curbed at any cost…There is no question of only regulating options, because it is nothing but gambling, according to what I understand of options. Therefore, I feel there is no case for allowing options even in regulated form. If we allow options in a regulated form, it will be nothing short of allowing gambling…”
Thus, the Act, as originally passed consisted in its object “An Act to prevent undesirable transactions in securities…by prohibiting options…” and Section 20 which prohibited options in securities [The prohibition of options, both from the language in the object of the law as well as Section 20 was omitted later in 1959]
By 1957, five stock exchanges were recognized under Section 4 of the SCRA, which rose to 14 in 1984. Seven of these, i.e., stock exchanges at Bombay, Hyderabad, Ahmedabad, Calcutta, Madras, New Delhi and Bangalore had permanent recognition whereas the others[4] held temporary recognitions typically reviewed for a 5-year time period.
[Sources for Parliamentary Proceedings: eparlib.nic.in (Lok Sabha, 16 July 1956) (Rajya Sabha, 2 August 1956 and 6 August 1956)]
[1] Supra, at 2.
[2] Ibid,
[3] Ibid.
[4] Stock exchanges at Indore, Kanpur, Ludhiana, Cochin, Pune, Gauhati and Mangalore.
[Any/All views expressed here are personal and belong solely to the author]
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