In this article, Prakarsh Seth, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses on stock exchanges.
“How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” – Robert G. Allen
Although the above-mentioned quote has nothing much to do with the regulation of stock exchange in India, it highlights the importance of investment and risk-taking. While we are highlighting the importance of risky investment it is pertinent to talk about financial markets. Financial markets not only help investors take risks and get rewards for the same, it also has an important relationship with the economic development of the country. Since financial markets play such an important role, their regulations for enabling orderly functioning should also be given highest priority.
Securities Exchange Board of India
The responsibility for the orderly functioning of the security market has been delegated to Securities Exchange Board of India which is entrusted to protect the interest of investors and ensure the development of securities market.
The responsibility entrusted with SEBI is to create an environment in which the various participants such as the investors, government, intermediaries and the stock exchanges are satisfied.
SEBI derives its validity from Securities and Exchange Board of India Act, 1992 (the SEBI Act, hereafter). The main purpose of the Act is the protection of investors in the securities market and thereby making it a reliable place. The provisions of the SEBI Act define its role in more specific terms. These broadly relate to
- Regulating stock exchanges as well as other security markets
- Regulating trade markets
- Prohibiting practices that are considered to be unhealthy for development of the securities market such as insider trading and fraudulent and unfair trade practices for promoting and regulating self-regulatory organizations.
SEBI performs several of its functions which are based on its powers which have been given to it under Securities Contract Regulation Act, 1956 and the Securities Contract Regulation Rules, 1956. The object of the SCR Act is to provide for the regulation of stock exchanges and of securities dealt in on them. It also indulges in regulating the securities outside the stock market.
Stock market facilitates mobilisation of funds from small investors and channelizes these resources into various development needs. In order to avoid undesirable transactions in securities by regulation of the business of dealing, the Securities Contract Regulation Act, 1956 was enacted by parliament.
Listing of Securities – The Process
According to Section 9 (1) (m) of the SCR Act, any stock exchange is free to make rules for listing of securities as part of the bye laws which govern their working. A company applying to get their securities listed on a particular stock exchange have to apply and comply with the necessary rules specified in the bye laws and SCR rules.
Securities Contract Regulation Rules, 1956 have defined the documents that a company has to provide to the stock exchange while seeking the list of its securities.
The Listing Agreement
All securities exchanges presently have a listing agreement that has several common, standard provisions. It is a contract that securities exchanges enter into with issuers which effectively governs the relationship between the issuer and the investor.
Recognition of stock exchange
Section 3 of the Securities Contract (Regulation) Act lays down that for recognition, every stock exchange for the purpose of being recognised has to make an application in a prescribed manner to the Central Government. If the central government is satisfied, then it may grant recognition subject to further inquiry and condition imposed as laid down in the Act.
Every grant of recognition shall be published in the Official Gazette. The opportunity has to be given to the applicant to present their matter in case their application is refused. Any amendment shall not be made without the involvement of central government.
Corporatisation and Demutualisation of Stock Exchanges
Historically stock exchanges were formed as mutual organisations. Ownership and trading rights were clubbed together. The disadvantage in this is that the organization would work towards the benefit of the members and not the investors. In view of these shortcomings, a step was taken by the Government of India for the demutualisation and Corporatisation of the stock exchanges.
Withdrawal of recognition
If, in the interest of the public, the central government feels that the recognition given to the stock exchange be withdrawn, then it has the power to do so under section 5 of the SCR Act.
Powers vested in Stock Exchanges
Power to call for returns and make direct enquiries
According to Section 6 of the SCR Act, every stock exchange shall preserve books of accounts for a period of minimum 5 years and it may be subject to inspection at times by SEBI.
Power of stock exchanges for management and regulation purposes to make bye-laws
Section 9 of the SCR Act gives the power to the various stock exchanges to make bye-laws for the regulation and control of contracts.
Establish trading floor
A stock exchange may establish additional trading floor with the prior approval of SEBI in accordance with the terms and conditions stipulated by SEBI.
Penalties and procedures
Under Section 23 of the SCR Act, various penalties have been listed and any person who indulges in them be subjected to a penalty decided by the adjudicating officer or imprisonment which may extend to 10 years or fine which may extend to twenty five crore Rupees.
The penalties have been explained as follows –
Penalty for failure to furnish information, return, etc
Any person, who is required under this act, fails to furnish any information, document, books, returns or report to a recognised stock exchange or fails to maintain books of accounts
Penalty for failure by any person to enter into any agreement with clients
Any person who is required under this act or any bye laws of a recognised stock exchange, fails to enter into an agreement with his clients.
Penalty for failure to redress investor’s grievances
If any stock broker, after being called by SEBI, fails to redress the grievances within time.
Failure to segregate securities or moneys of clients or client
A registered stock broker if fails to segregate securities or moneys of clients or client or uses the money of a client for himself or for any other client.
Penalty for failure to comply with provisions of listing conditions or delisting conditions
If a company fails to comply with provisions of listing conditions or delisting conditions or commits a breach thereof.
Penalty for excess dematerialisation or delivery of unlisted securities
If any company dematerialises securities more than the issue securities of a company or delivers in the stock exchanges the securities which are not listed or delivers securities where no trading permission has been given by the recognised stock exchange, he shall be liable to a penalty which shall not be less than 5 lakh rupees and which may extend to 5 crore rupees.
Penalty for failure to furnish periodical returns, etc
if a recognised stock exchange fails or neglects to furnish periodical returns to SEBI or fails or neglects to make or amend its rules or bye-laws s directed by SEBI or fails to comply with directions issued by SEBI, such recognised stock exchange shall be liable to a penalty which shall not be less than 5 lakhs rupees and which may extend to 25 crore rupees.
Penalty for contravention where no separate penalty has been prescribed
If anyone contravenes of any provision of this Act, the rules or bye laws or the regulation of the recognised stock exchange or directions issued by SEBI for which no separate penalty has been provided, shall be liable to a penalty which shall not be less than 1 lakh rupees and which may extend to 1 crore rupees.
Under Section 23- I, SEBI shall appoint any officer not below the rank of a division chief of SEBI to be an adjudicating officer for holding an inquiry in the prescribed manner after giving any person concerned a reasonable opportunity to be heard.
Any person aggrieved by the decision of the recognized stock exchange or adjudicating officer or any order of SEBI may appeal to Securities Appellate Tribunal (SAT). SAT shall dispose of the matter in 6 months.
Other functions discharged by SEBI pertaining to regulation of the stock market
A serious concern has been around manipulative practices in the Indian securities markets. Manipulative practices are usually resorted to by traders and brokers in the market. Often they involve the owner managers or promoters of companies who may stand to gain from these practices. These have typically been meant to create a false market in the securities or to push the price of the securities down to unwarrantedly low levels through circular trading and other means. Such practices have not been limited to the so-called “penny stocks” alone but have often been practiced in the shares of larger and well established companies as well. Thus manipulative practices can harm the interests of small and large investors alike as well as that of companies whose shares are subject to such practices. SEBI has addressed these through the SEBI (Fraudulent and Unfair Trade Practices) Regulation, 2003.
SEBI (Amendment) Bill 2002 gave more powers to SEBI to cover all transactions associated with the securities market and in the next year ie 2003, it got the power to impose enhanced monetary penalties.
Transparency is one of the key elements on which SEBI has its focus. Lack of transparency would result in unfair practices. To tackle this problem, SEBI has introduced stricter norms pertaining disclosure of information and has made it mandatory for companies to disclose the risk associated with their projects. The fact that Cash transactions were prohibited by NSE in 2003 and asking the brokers to reveal transactions of more than 0.5 percent of listed shares of company thereby, banning them from trading with each other on the same stock exchange, indicate that SEBI has been going in a positive direction with respect to transparency.
Corporate governance is being extended to all the companies. In 2000, SEBI introduced a new clause calling for one third of the directors of the stock exchange to be independent directors.
Outsourcing the responsibility of surveillance
In the year 2003, SEBI made few changes in the bye-laws for the governance of stock exchanges and allowed a separate entity to manage the surveillance and investigation of stock exchanges. This was done to ensure self-regulation of stock exchanges, define responsibility more clearly etc.
Another Act which is relevant for protection of security market is the Depository Act,1996. This Act provides for regulation of depositories in the matters of securities and matters related to it. It introduces the scripless trading system and settlement, which is important for the effective functioning of the securities markets.
 S 11(2) of SEBI Act
 Rule 19 and Rule 20 of Securities Contract Regulation Rules, 1956
 Section 23A to Section 23H, SCR Act,1956
 Sabarinathan, G., Securities and Exchange Board of India and the Regulation of the Indian Securities Market (June 30, 2010). IIM Bangalore Research Paper No. 309
 NSE (National Stock Exchange), 2003, Indian Security Markets: A Review, and earlier issues,
 Sebi (Securities and Exchange Board of India), 2003, Annual Report2002-03
 Goyal, Ashima. (2006). Regulation and deregulation of the stock market in India. Deregulation and its Discontents: Rewriting the Rules in Asia. 168-192.
 ‘Business Portal Of India : Corporate Governance : Legal Framework : SEBI Laws’ (Archive.india.gov.in, 2018) <https://archive.india.gov.in/business/corporate_governance/sebi_laws.php>