CHAPTER FIVE ROLE OF SEBI IN CAPITAL MARKET

CHAPTER FIVE ROLE OF SEBI IN CAPITAL MARKET l i

ill CHAPTER FIVE ROLE OF SEBI IN CAPITAL MARKET This chapter deals with role of SEBI in primary market and secondary market. Mutual Funds and Fils have emerged as important players in the capital market during this decade so steps taken by SEBI regarding MFs and Fils is also included in this chapter. Background behind establishment of SEBI, its objectives and overall organisation is also discussed in the early part of this Chapter. 5.1 INTRODUCTION : It was the crash of 1929 which drove millions of American investors to an unexpected encounter with total collapse. The US government was literally benumbed with shock, the new US President Mr. Fraklin Roosevelt set up Securities Exchange Commission (SEC) to regulate the stock markets. Mr.Joseph Kennedy Sr, John F. Kennedy's father was the first President of SEC as he made lot of money on stock exchange. SEC has since grown from the trim and humble organisation of its founding fathers into a powerful and large regulatory machine, which holds global investors and even government in thrall.sebi was established on 1 the lines of SEC. Securities markets in India have grown exponentially since 1980, as judged by the number of issues, amounts raised, market capitalisation, trading volumes as well as price indices. The 1. Indian Securities Market - Agenda for Development and Reforms - a Discussion paper published by SEBI,1994 i 1

112 n.mber of investors, intermediaries, and stock exchanges have also seen significant increase. As the economy grows, securities markets are being increasingly relied upon by the private corporate sector, by public sector units and by banks for raising funds, (/bile the investor profile continues to be dominated by middle class individuals, trends towards institutionalisation in the securities markets is becoming evident. With the opening of the Mutual Fund industry to the private sector, and the advent of foreign portfolio investment, Indian securities markets are set to continue their rapid growth. The healthy development of securities markets with the appropriate degree and manner of regulation will be of immense importance in the developing economy like India on account of their role in meeting the need for greater investment especially in infrastructure sectors^such as power, telecommunication and transportation, that is expected to arise with the progress of economic reform. The need for reforms in the capital market has been evident for some time. The functioning of the stock exchanges shows many shortcoming with long delays, lack of transparency ' and vulnerability to price rigging and insider trading. To counter these deficiencies it had been announced in Budget speech of 1987-88 that the Government would establish a Securities and Exchange Board of India(SEBI) to regulate the capital markets. i

113 1 The SEBI was set up as a non statutory body in 1988. The Securities and Exchange Board of India was set up as an administrative body in April 1988 with the objective of monitoring and regulating the capital market and protecting the investors. Due to the lack of statutory status and power gains of bureaucrats in investment division of the finance ministry including the Office of the Controller of Capital Issues, SEBI 2 could not perform effectively. The securities markets in India was being regulated and controlled by the stock exchanges division of the Ministry of Finance and the Department of Company Affairs but activities were not properly regulated by these divisions. The promulgation of the Securities and Exchange Board of India Ordinance on January 30,1992, SEBI was established as a staututory body on Feb.21,1992. Subsequently, the Ordinance was replaced by the Securities and Exchange Board of India Act on April 4,1992 and further strengthening of its powers through the Securities Laws (Amendment) Act, 1995, mark the process of installation of a regulatory edifice for the Indian securities markets." 1. Dr.Mathur B L, Indian Capital Market - Challenges and responses, RBSA Publishers, Jaipur, 1995, P-2 2 Shaha N.V. & Anil Rao Paila, Role of SEBI in Capital Market, Readings in Indian Financial Services, 1993, P-15

114 5.2 OBJECTIVES. MANAGEMENT AND FUNCTIONS OF SEBI : The objectives and functions of the Securities and Exchange Board of India are specified as under - 5.2.1 OBJECTIVES : The Preamble of the SEBI Act, 1992 enshrines the objectives as follows - "... to protect the interest of the investors in securities and to promote development of, and to regulate the securities market and for matters connected therewith or incidental thereto". 5.2.2 MANAGEMENT OF SEBI : Section 4 of the Act lays down the constitution of the management of SEBI. The board of members of SEBI shall consist of a Chairman, two members from amongst the official of the ministries of Central Government dealings with Finance and Law, one member from amongst the official of Reserve Bank of India constituted under Section 3 of the Reserve Bank of India Act, 193b, two other members to be appointed by Central Government who shall be professionals and interalia have experience or special knowledge relating to securities market. While the superintendence, direction and management of the affairs of SEBI, vests in the Board of Members, the Chairman also has these powers and is empowered to exercise them and to do all acts and things which may be exercised or done by the Board.

115 5.2.3 FUNCTIONS AND POWERS OF SEBI : Section 11(1) of Act cast upon SEBI the duty to protect the interest of investors In securities and to promote the development of and to regulate the securities market, through appropriate measures. The SEBI Act interalia provides SEBI with power to a) Regulate the business transactions in Stock Exchanges. b) Register and regulate the working of collective investment schemes including Mutual funds. c) Register and regulate the working of stock brokers, subbrokers, bankers to the issue, registrar to the issue, merchant bankers, underwriters, portfolio managers, investment advisers and such other intermediaries who., may be associated with the securities market in any manner. d) Promote and regulate SRO's (Self-Regulatory Organisations) e) Prohibit unfair and fraudulent trade practices relating to securities markets. f) Promote investors education and training of financial intermediaries of Securities Market. g) Prohibit insider trading in securities. h) Regulate substantial requisition of shares & takeover of companies. i) Call from information from, undertake inspection, conduct inquiries and audits of SE's and intermediaries and SRO's in the Securities Market. j) Carry out research work. tj!

116 At its founding, SEBI was charged with the twin responsibilities of regulation and development of Indian securities markets. The twin mission of SEBI being investor 4 protection and market development,the fundamental logic driving SEBI's regulatory approach has been that sustained growth of securities markets could be assured when the markets are able to attract issuers and investors. SEBI has formed rules and regulations covering several areas of the securities markets and various market intermediaries for the first time. It has taken measures to help the development of the market and has been taking action under its powers to enforce its rules and regulations. Every Rule and every Regulation made under the SEBI Act must be laid, as soon as may be after it is made, before each House of Parliament. In accompalishing these objectives, SEBI would be responsible to the needs of the three groups which basically constitute the market. 1) Investors 2) Issuer of Securities 3) Market Intermediaries SEBI has emerged into an effective regulatory body for the securities markets so as to fulfil its mandate of investor protection and market development, enshrined in the SEBI Act. 5.3 AMENDMENTS TO THE SEBI ACT AND ADDITIONAL POWERS TO SEBI : After March 1995, the following additional powers have been granted to SEBI, through an amendment to the SEBI Act.

117 1. Registration and regulation of the working of depositories, custodians. Foreign Institutional Investors, Credit rating agencies. Venture capital funds. 2. Power to frame regulations relating to the issue of capital and other incidental matters. While conducting inquiries, investigations and audits, SEBI has been vested with powers of the Civil Court under Code of Civil Procedure in respect of discovery and production of books, documents, records, and accounts, summoning and enforcing the attendance of persons and examining them on oath. Section 15 of the SEBI Act empowers SEBI to levy monetary fines for violations specified in Section 15A to 15H. These violations relate to failure to submit information to SEBI, failure to enter into agreements with clients, failure to redress investor grievances, violations by mutual funds, violations by stock brokers, violations of insider trading regulations and violations of takeover regulations. SEBI AND PRIMARY MARKET : With the progress of economic reform, the primary markets have become an important source of mobilising funds for Indian corporates. With the removal of restrictions on pricing.and frequency of issues, which were a part of the erstwhile regime imposed by the Capital Issues (Control)Act, and the primary markets have shown indifferent picture since 1992-93.

118 The steps taken by SEBI in the primary market can be broadly divided in to four parts - a) Registration of intermediaries b) Issue of Securities c) Improving disclosure standards d) Other Investor Protection measures 5.4 REGISTRATION OF INTERMEDIARIES : Intermediaries in the primary market such as merchant bankers, underwriters, registrar's to the issue, bankers to the issue are required to be register with SEBI and for the first time regulations have been issued by SEBI to govern these intermedaries. A code of conduct for each intermediary has also been prescribed in the regulations. Capital'adequacy and other norms have been specified for intermediaries, and a system of monitoring and inspecting their operations has been instituted to enforce compliance. 5.4.1 MERCHANT BANKERS : The regulations governing merchant bankers which were notified in Dec.92, prescribe the conditions for the granting or renewals of registration certificates, capital adequacy requirements, the right of SEBI to inspect the accounts etc. SEBI (Merchant Bankers) Rules and Regulations were introduced on 22nd Dec.92 and same were amended on 7th Sept. 95 and 6th June 1996. Apart from issuers, SEBI also laid down a code of conduct for the merchant bankers, to ensure that they carried out their t i

119 activities with the highest standards of integrity and fairness. Lead Managers were also issued guidelines "for interse allocation of responsibilities" in respect of pre and post issue activities. This was done to ensure their responsibility an accountability for their role in the issue of capital. They were instructed to exercise '\iue diligence in independently verifying the contents of the offer^docvments. To encourage merchant bankers to participate in certain types of issue manangement activities and allow more lead managers in issues, SEBI classified merchant bankers into three categories and laid minimum net worth threshold levels for each. And to enable professionals to take part in certian issue management activities, SEBI has introduced a fourth category of merchant bankers who would not require any minimum net worth levels. SEBI has also tried to infuse an element of competition among merchant bankers to make them more attuned to the realities of the market place. SEBI has freed merchant bankers from any ceiling on fees. This is a very significant step towards professinalising merchant banking. As a stick aganist errant merchant bankers, SEBI has introduced a system of punitive action, whereby they would be awarded penalty points for any defaults committed in respect of issues managed by them. A merchant banker is liable for suspension or de-authorisation after a maximum of eight such points.

120 In the year 1997-98 Amendments to SEBI (Merchant Bankers) Regulations 1992 were made. Only body corporates were allowed to function as merchant bankers. Multiple category of merchant bankers viz Category II, III and IV were abolished and henceforth there will be only one category of merchant bankers. The merchant bankers would now be required to seek separate registration if they wish to act as underwriter or portfolio manager. Merchant bankers were prohibited from carrying on fund based activities other than those related exclusively to the capital market. In effect, the activities undertaken by NBFCs such as accepting deposits, leasing, bill discounting etc. would not be allowed to be undertaken by a merchant banker. In order to monitor the movement of employees of merchant bankers category I, the SEBI directed all category I merchant bankers to submit specified information on their employees engaged in merchant banking activity. Thus, a database of persons engaged in merchant banking industry has been created by the SEBI. 5.4.2 REGISTARS TO THE ISSUE AND SHARE TRANSFER AGENTS The Registrar to the issue(rti) and Share Transfer Agent(STA) play a significant role in the securities market. These two intermediaries are regulated by the SEBI (Registrars to an Issue and Share Transfer Agents) Rules and Regulations notified in 1993. These intermediaries have been classified into 2 categories, Category I who can carry on the activities both as Registars and

121 Transfer Agents and Category II who can carry any one of these activities. The SEBI (Registar to an Issue and Share Transfer Agents) Regulations 1993 were amended to provide for an arms length relationship between the issuer and the Registrars to the Issue. It fcas Jbeen stipulated that no registrar can act as registrar to any issue of securities made by any body corporate, if the Registrar to the Issue and the Issuer are the associates. Registrars to an issue and share transfer agents are required to submit quarterly reports in prescribed formats to SEBI, containing details of their activities. On the basis of quarterly reports as well as the inspection reports, the SEBI takes up issues such as delays on part of the registrars to an issue and share transfer agents. 5.4.3 PORTFOLIO MANAGERS : The Portfolio Managers are now regulated by the Securities and Exchange of India (Portfolio Managers) Rules and Regulations, 1993 notified on January 7, 1993.No person can act as a Portfolio Manager without registration with SEBI. The Rules and Regulations also prescribe the capital adequacy, the contents of contracts between Portfolio Managers and clients, the general responsibilities, the management and investment of client's money, reporting requirements etc. The Regulations also lay down a Code of Conduct for the Portfolio Managers to ensure that the Portfolio Managers conducts

122 :- the business observing high standard of integrity and fairness in their dealings with clients and other Portfolio Managers. 5.4.4 BANKERS TO AN ISSUE : Bankers to an Issue are registered and regulated by the SEBI (Bankers to an Issue) Rules and Regulations 1994. Under these regulations, registration commenced in 1994-95. The various actions were taken against bankers to issue as on March 31,1988 are as follows - - 72 Bankers to an Issue were registered with the SEBI ~ 5 warning letters were issued for delay in submission of final certificate to registrar. - 2 show-cause notices were sent for non compliance of the SEBI directives. - 10 bankers who had not entered into agreements with the issue/client companies as per Regulation were referred to adjudication in Feb.1998 5.4.5 UNDERWRITERS : The number of underwriters registered with the SEBI in terms of SEBI (Underwriters) Rules and Regulations, 1993 was 43 at the end of 1997-98 and was 38 for 1996-97. 6 underwriters were granted registration/renewal during the year 1997-98 and one was cancelled. No person is allowed to act as an underwriter unless he or she holds a certificate granted by SEBI. The registration is valid for three years and has to be renewed thereafter, The

123 underwriters status may be a public or private limited company, an association of persons, a body of individuals, a partnership, a proprietory or others. Every registered stockbroker or registered category I, II and III merchant banker is entitled to act as an underwriter. After stipulating a minimum net worth of Rs.20 lac for issue underwriters, SEBI warned them that any one found indulging in "manipulation or price rigging or cornering activities" would face suspension and possibly even cancellation of their registration. It has also instructed all the stock exchanges not to clear any fresh underwriting commitments of any underwriter who failed to fulfill his commitments in the past. 5.4.6 DEBENTURES TRUSTEES : Debenture Trustees are registered and regulated by the SEBI (Debenture Trustees) Rules and Regulations, 1993. Under these regulations, registration commenced in 1993-94. As on March 31, 1998, 32 Debenture Trustees were registered with SEBI. 5.5 ISSUE OF SECURITIES : In response to market needs and to curb various undersirable practices which came to SEBI's notice, SEBI issued several directives and guidelines regarding the issue of securities, which were aimed at improving disclosure and streamlining the issue process, and which provided increased flexibility to issuers. The details are as follows-

124. 5.5.1 VETTING OF PUBLIC ISSUE DOCUMENTS : SEBI dispensed with the requirement of vetting of public issues of listed companies offering pure debt instruments having atleast an adequately safe credit rating in 1995-96. SEBI also dispensed with the requirement of vetting of right issues (not accompanied by public issue three months prior or subsequent to the right issue). Merchant bankers are required to ensure compliance with SEBI rules, regulations, guidelines and requirements of other laws in this respect. From 1996-97, the requirement of vetting of offer documents by SEBI prior to a public offer discontinued and replaced by filing of draft prospectus with SEBI prior to the public issue. SEBI to convey its observations, if any, within the specified period of 21 days. SEBI stopped waiting of offer documents for types of issue's since 1996. It has increased the responsibility of the Merchant Bankers. It is the duty of the Merchant Bankers to ensure the full disclosures in the offer document. ': 5.5.2 ELIGIBILITY NORMS ; The eligibility norms for companies accessing the primary market have been strengthened to improve the quality of issues. The elibility norms are different for Initial Public Offering and the existing company's public issue.

125 :- ELIGIBILITY NORMS FOR INITIAL PUBLIC OFFERING are - a) the company has a track record of dividend payment for 1 the immediate preceding three years. b) a public financial institution or scheduled commercial bank has appraised the project to be financed through the proposed offer to the public, and the appraising agency participates in financing the project by way of i loan or equity to the extent of at least 10 % of the 2 project cost. ELIGIBILITY FOR PUBLIC ISSUE : An issue of equity share or convertible securities to the public by a listed company seeking to raise fresh capital faces typically fewer restriction than an IPO. Only if a listed company which intends to issue new securities to the public such that its post-issue net worth would grow to move than five times its preissue net worth, does the company have to satisfy the eligibility 3 criteria for an IPO before it makes the proposed issue. 1. The guideline was modified to " the immediately preceding three years" from "atleast three years out of the immediately preceding five years".( SEBI Press Release Ref.PR 91/97, August 12, 1997. 2 Part A of SEBI clarification Nos.XV and Part A of SEBI Clarification Nos. XVI of SEBI Guidelines. 3. The guideline was modified to"will have a post-issue net worth of more five times its pre-issue net worth"from"has been listed for less than 3 years or does not have a three year track record of dividend payment out of the preceding five years" SEBI Press Release Ref.No.PR 91/97 dated August 12, 1997

126 5.5.3 PRICING OF THE ISSUE : A listed company making a public offer may freely price its equity shares or convertible securities, provided that the 1 company has a three year track record of consistent 2 profitability and makes a disclosure of the relevant information 3 on the offer document. Earlier, there used to be detailed pricing norms imposed on an IPO, depending on whether the issue was priced at par, at a premium or otherwise, such price norms not longer exist. 5.5.4 PROMOTER S MINIMUM CONTRIBUTION : SEBI has prescribed separate norms for IPO and the public issue of existing companies. PROMOTERS MINIMUM CONTRIBUTION IN IPO The promoter group of an issuing company, including its promoters, directors, friends, relatives, associates etc., is reguired to make at least a certain amount of contribution, known as "Promoter's Contribution", to company s IPO. [1] The promoter and/or his or her followers are required to invest their money as a kind of commitment. The requirements of the promoter's contribution is given on the next page. 1. 2 years in the case of public sector banks (Part B of SEBI clarification No.XVI dated July 17, 1996 2. Section B (I) of SEBI Guidelines, dated June 11, 1992 3. SEBI Press Release i2ef.no. PR 91/97 dated August 12, 1997 ) t

127 Promoter's Minimum Contribution in IPO Class of companies An unlisted company with a capital three-year track record of consistent profitability An unlisted company which capital does not have a three-year track record of consistent profitability but has set up by existing company(ies) with a five-year track record of of consistent profitability Promoter's Minimum Contribution 20% of the post issue 50% of the post-issue if the issue size is Rs.l billion or less Slab rates are given in table( ) if the issue size exceeds Rs.l billion An unlisted company of which shares are offered for sale not be issue The promoters' shareholding after offer for sale shall less than 20% of the post capital Source : SEBI Clarifications and Guidelines 1. Section L of SEBI Clarification No.l dated June 17, 1992 Slab rates for PMC in case issue exceeds Rs.l billion Size of Capital Issue Percentage of Contribution On first Rs.l billion 50 Next Rs.2 billion 40 Next Rs.3 billion 30 Balance of issue amount 15 Source :Section 2.3, SEBI Clarification No.VII

128 :- PROMOTERS' MINIMUM CONTRIBUTION - LISTED COMPANY In a public issue by a listed company, the promoters are either required to contribute at least 20 % of the proposed issue, or to ensure that their shareholding be kept at 20% or 1 more of the company's expanded capital. However, there are exemptions to this rule. 55.5 LOCK-IN PERIOD : Minimum Promoters contribution and lock in period in IPOs. In an IPO, the promoters' minimum contribution will be locked 2 in for a period of three years from the date of allotment in the issue or the date of commencement of commercial production, whichever is later. During this period, all members of the promoter group are prohibited from disposing of shares acquired as a result of the promoters' contribution. In addition, if the promoters contribution in.an IPO exceeds the promoters' minimum contribution, the excess will also 3 be locked in for a period of three years. 1. Section L (a) of SEBI Clarification No.II dated July 16, 1992 2. Part B of SEBI Clarification No.XIX, RMB (DIP Series) Circular No.5 (96-97) 3. SEBI Press Release dated October 26, 1994

129 Minimum Promoters contribution & lock in period in public issues by listed company is given below - Class of Companies A company which has been listed on a stock exchange for at least 3 years and has a track record of dividend payment for at least 3 immediate preceding years Minimum Promoters' Contribution Not required Lock-in period Not applicable A listed company which does not satisfy the condition in (1) above The contribution to be at least 20% of the proposed issue or the shareholding to be at least 20% of the expanded capital 3 years Source : SEBI Guidelines & Clarification 5.5.6 PREFERENTIAL ALLOTMENT : An issue of securities to selected persons, at a price which may or may not be related to the prevailing market price of the securities, is conventionlly called preferential allotment. The selected persons need not be existing shareholders of the company. A preferential allotment is not linked to a public issue and should not be mixed up with reservation on preferential basis in a public issue. A preferential allotment earlier had some undersirable features. Firstly allotments tended to be made to the promoters or existing management. Secondly, the issue prices of securities tended to be unrelated to the prevailing market price. The minority shareholder's interest were thus likely to be

130 compromised. SEBI introduced pricing rules and a lock-in period in August 1994. The SEBI guidelines for Preferential Allotment issues on August 4, 1994 address the concern regarding the lack of transparency and market unrelated pricing which accompanied several preferential issues which were made in the past. In addition to imposing a requirement for pricing of these allotments at market related levels, the guidelines also imposed a condition of lock-in period. The interest of shareholders could be adequately protected by the requirement of pricing preferential allotments in line with market prices, besides approval at a General Meeting of shareholders was required for making preferential issues. Pricing of shares to be issued upon the exercise of warrants or conversion of convertible bonds that are issued by a preferential allotment is also regulated so that the allottees may not be unreasonably favoured at the expense of minority shareholders. Securities issued to the promoters or his or her group by 1 way of preferential allotment have a lock-in period of 3 years and are not transferable for that period. The lock-in period for securities issued to other categories of investors by way of a 2 preferential allotment was removed in March 1996. 1. Additional guidelines - Preferential Allotments of Shares, SEBI Press Release, dated August 4, 1994, amended by SEBI Press Release dated August 8, 1994 SEBI RMB (DIP Series) Circular No.3 (95-95) dated August 5,1994 and "Meeting of the Advisory Committee on Primary Market held on Thursday, February 6,1997",SEBI Press Release Ref.No.33/97, Mar.6, 1997. 2 Part B SEBI Clarification No.XIV, dated March 1, 1996.

131 5.5.7 ALLOTMENT : Securities issued and alloted in public issue are divided into three groups according mode of allotment a) net offer to the public b) firm allotments c) reservation a) Net offer to the public : Net offer to the public is the portion of a public issue that is offered to the public for subscription at the offer price. This has to be at least 25% of the total number of securities offered in the issue to qualify for listing. An important objective of a public issue is the widening of the shareholders base, therefore a minimum of 50% of net offer to the public out of the public issue amount has to be reserved for individual investors applying for securities not exceeding 1,000 securities in each case. b) Firm allotment : Firm allotments are the portion of a public issue that is reserved for, and placed with selected investors. A firm allotment to permanent/regular employees of the issuer is subject to a ceiling of 10% of the issue amount. Previously, there were individual ceilings to firm allotmentss that could be made to (i) Indian and multilateral development financial institutions, (ii) Indian mutual funds, (Hi) Fils, including Non-Resident Indians and Overseas Corporate Bodies. These ceilings have been removed. As a result, the first

132 two categories of investors may be freely alloted securities up to 75% of the issue amount. However, an allotment to the category of Fils and NRIs/OCBs is still constrained by 24% or 30% ceilings for the aggregate foreign ownership by Fils and 1 NRIs/OCBs under the RBI regulation. The provision of making reservations or firm allotments as part of the public issue was also extended to scheduled banks in addition to financial institutions in 1997-98. c) Reservations : Reservations are the portion of a public issue that is reserved for & alloted to investors of selected categories at the issue price on competitive basis, e.g. reservation for employees The limit of 200 shares per employee to be allotted on firm basis to a permanent/regular employee of the issuer in a public issue has been removed. However, as earlier, reservation to employees in a public issue may not exceed 10% of the size of the issi Listed companies are permitted to issue securities to employees under Employee Stock Option Scheme (ESOPS) subject to two main conditions. a) issue of securities to employees under ESOPS should not exceed 5% of the paid up capital of the company in any one year b) pricing of securities should be in accordance with formula contained in SEBI preferential offer guidelines dated August 4, 1994. The companies were free to devise further details of the ESOPS including the terms of payment. 1.Section 3 of SEBI Clarification No.XII, Dated Sept. 29, 1995

133 5.5.8 APPLICATION MONEY : To prevent fraudulent encashment of refund orders, it was decided that application forms for subscription to the public issue must necessarily indicate savings bank/current account number and name of the bank with which such account is held. The minimum application size reduced to Rs.2000 from Rs.5000 to encourage small investors. Permanent Account Number (PAN) or General Index Register (GIR) should be necessarily be given in the application for public or rights issues only when the monetary value of the proposed investment exceeds to Rs.50000. The previous limit was Rs.20000. 5.5.9 ALLOTMENT OF SHARES : The proprotionate basis of allotment was brought in to overcome the problem of multiple applications in smaller lots which increased costs and processing delays. The minimum application size was raised ( minimum 500 shares) and number of mandatory collection centres decreased to reduce the cost of raising funds. 5.5.10 PUBLIC REPRESENTATIVE AT THE TIME OF ALLOTMENT : To ensure that no malpractices take place during the allotment process in oversubscribed public issues, SEBI has stipulated that its representatives would oversee the allotment process of such issues.

134 In 1994-95 keeping in view the new requirement of minimum application money being Rs.5000 and allotment to be made on proporationate basis, it was decided that a SEBI nominated public representative was required to be associated in public issues only in cases where a par issue is oversubscribed by more than five times and premium issue by more the two times. 5.5.11 BOOKJJUILDING : For the first time, guidelines to introduce the book building procedure have been issued, which can be adopted for issues of over Rs.100 crore. Book building, which is widely used in other markets, has been found to be a fair transparent and market driven way of pricing and allocation of issues. In 1996-97, to further encourage book building, the book building option available for the portion of the issue sold as firm allotment and allowed for public issues of over Rs.100 crore relaxed & debt issues not accompanied by an equity component & equity issues of less than Rs.100 crore, subject to the compliance with the Securities Contracts (Regulation) Rules allowed. The existing SEBI Guidelines restricted the facility of bookbuilding to 75% of the issue size. However, this constrained the l benefits arising out of demand and price discovery. The facility of making an issue through book building has now been extended to entire issue size and shall be available to issuer companies which propose to make an issue of capital of and above Rs.100 crore from 1997-98.

135 5.6 IMPROVING DISCLOSURE STANDARDS : One of the first steps taken by SEBI was to issue guidelines for disclousure and investor protection with regard to capital issues. Disclousure norms for things like the company's track e record, details of previous issues, promises vs performance, justification for pricing etc. were prescribed and prospectus and other offer documents had to go through a vetting process. A new format of prospectus for capital issues, disclosing among other things, risk factors in the perception of the management was introduced at SEBI's instance. During 1994-95, SEBI continued to take measures for improving investor protection in the primary markets through better disclosure of relevant information about the issuer and the nature of the securities to be issued. In addition to ensuring investor protection, SEBI has also been making efforts to streamline the process of issuing securities so as to reduce the cost of raising funds from Indian securities markets. 5.6.1 OFFER DOCUMENT : Issuing companies were allowed to indicate the issue price in consultation with the lead manager within a price band of 20% of the floor price at the time of submission of the offer document to SEBI. The actual time could be determined only at the time of filing the offer documents with the Registrar of Companies or with the concerned stock exchange. This has allowed

136 a greater flexibility to issuers in pricing of the issue by taking market conditions into account. Due diligence certificate given by the lead manager to SEBI was made a part of the offer document, in order to make merchant bankers more accountable. In order to enhance the transparency in public issues, the offer document is now a public document even at draft stage, as soon as it is filed with or submitted to SEBI so that prospective investors and market participants have sufficient time to bring any adverse feature to the notice of SEBI before the issue opens for subscription. Lead managers and stock exchanges have instructed to make copies of the draft prospectus available to the public. Such copies can also be obtained from SEBI. The validity period of letters issued by SEBI giving observations on offer documents filed with SEBI was decided to be extended to 365 days from the date of observation letter. 5.6.2 PROSPECTUS : The front.page of the prospectus modified to bring it in line with international practice. The colour of the front page required to be white and no patterns or pictures allowed to be used. Risk factors and'other necessary information about the issue such as the registered offices of the issuer and the lead manager are to be published on front page. 5.63 RECOMMENDATION OF MALEGAM COMMITTEE : With the rapid expansion in the primary market, there were

137 concerns raised about the quality of the some issuers who were able to raise funds from the market in the period after the repeal of the Capital Issues (Control)Act 1947. In response to these concerns, SEBI had strengthened norms for public issues, raised the standards of disclosure in public issues to enhance the level of investor protection without seeking to control the freedom of eligible issuers to enter the market and freely price their issues. This was done in 1995-96, through the implementation of the recommendations of the expert committee appointed in 1994-95 under the chairmanship of Shri Y.H.Malegam, to examine the issues related to disclosure and eligibility norms for issuers in the primary market. The committee submitted its report during the year 1995-96 and in keeping with its established practice. SEBI published the report and widely circulated it among market participantss, to encourage debate on the report and elicit views of the market participants. SEBI accepted almost all of the recommendations made by the Committee and implemented them during the year. The main recommendations implemented by SEBI are given below - 1) Unlisted companies which have been in commercial operation for more than 2 years and whose post issue paid up capital is Es.3 crore or more, but less than Rs.5 crore, are eligible for listing only on those stock exchanges where trading of securities is screen jbasedtj Besides, such issuers are required to put in place market making arrangements to

138 ensure liquidity to investors. Greater disclosure in the offer document regarding expenditure incurred on the project before filing the offer document with SEBI for vetting and proposed to be incurred at later stages is required to be madej^the means and sources of financing such expenditure are required to be stated. Zlt^Issuers are required to disclose details of "bridge loans" which were to be repaid from the proceeds of the issue. 4) A more detail break up of the activities of the issuer is expected. Issuers are required to specify further details of 'turnover' reported in their profit and loss statements, to clearly bring the contribution to the stated turnover figures from the products manufactured by the issuer, products traded in by the issuer and from products not normally dealt in by the issuer. 5) In the asset and liability statement, issuers are required to deduct "revaluation reserves" from 'fixed assets' and from 'reserves' and net worth is required to be arrived at after such deduction. 6) Issuers are required to give details of the shareholding in the issuer company of promoters, and directors of the promoter, where the promoter is a body corporate, as well as details of the transactions by promoters and directors of the promoters in the six months preceeding the date of filling of the offer document with SEBI. Issuers are required to

139 provide details of the prices at which the transactions took place and the relevant dates. 7) Issuers are required to give details, inter alia, of technical or financial collaborators, buy back arrangements,largest shareholders, group companies, the basis for issue price, financial information, accounting ratios and other income. 8) Additional disclosures are required to be made in abridged prospectus as is required in full prospectus to improve disclosure standards in the abridged prospectus. 9) Only prospectus for issues made by new companies and existing companies setting up new projects, or undertaking a major expansion programme, could incorporate future projections, provided the projections were based on the appraisal done by a financial institution or a scheduled commercial bank which is either financing the project or is committed to finance the project. 10) The advertisement code for issues has been strengthened to prevent issuers and intermediaries from misleading investors. No corporate advertisement can now be issued between the date of issue of acknowledgement card by SEBI and closure of the issue and the annoucement of the closure of issue can only be made after getting a certificate from the registrar to the issue that atleast 90% of the issue has been subscribed to. 11) The lead manager to the isssue is required to furnish due diligence certificates at five different stages of the issue process.

140 12) Issuers are required to furnish a list of the persons consisting the promoters or promoters group to SEBI. 13) The track record of the profitability of a division of a company, spinning off into a separate company, can now be considered for the purpose of a public issue at premium by such a separate company. 14) Issuers are also required to give information regarding unusual or infrequent events or transactions, significant economic changes that materially affected or are likely to affect the income from continuing operations, the distribution of turnover among each segment in which the issuer operates, the status of any publicly announced product or venture, the seasonal variations in the issuers business, the concentration of business with a small number of supplies or customers and issuers perception of competitive conditions, cost and technological conditions in their segment of industry. 15) Management perception and analysis of the financial conditions and results of operations as reflected in the financial statements.is now required to be given. 16) Whenever, statements of assets and liabilities, profits and loss or any other financial information is qualified by the notes of an auditor, all necessary adjustments, wherever qualification is possible shall be made in the statement itself.

141 5.7 OTHER MEASURES RELATED TO PRIMARY MARKET : 5.7.1 NEW INSTRUMENT "5T0CKINVEST" : In March 1992, the SEBI In consultation with RBI has designed this instrument to be issued by banks like the pay order or DD but with a difference that the money kept is now on lien with the Bank until the allotment or non allotment but 'earning interest for the investor during this period. A new instrument, "Stockinvest" was introduced to ensure that investors did not suffer due to delays in the allotment process. It is valid upto six months from the date of its issue and the same can be renewed on expiry. On SEBI's initiative that the instrument of Stockinvest was floated to reduce the headache of investors ( in receiving refund orders etc.) as well as eliminate the medium of "float money", whereby promoters enjoyed interest free funds for two or three months, prior to allotment. The scheme did not work out as smoothly as envisaged. The number of shares which could be bought back from the original allottees upon listing as a 'safety net* has been increased from 500 shares to 1000 shares.

142 5.7.2 USE OF FUNDS BY DFIs : Development Financial Institutions (DFIs) have been allowed to utilise the moneys raised by them through public offerings, espcially of debt instruments even before allotment of the instruments and/or listing of the instruments, enabling more effective use of funds, provided the following conditions are met: a) The DFI would pay interest to the investors from the date not later than the date from which such permission to utilise the funds has been granted. b) The DFI would undertake to refund the entire amount in case its listing application is rejected by any of the stock exchanges where listing of its instruments has been sought, and c) The DFI had complied with the provisions of the Companies Act, 1956 wherever applicable. 5.7.3 ADVERTISEMENT AT THE TIME OF PUBLIC ISSUE : - - - - - - - - Restrictions on display of corporate advertisements also removed and corporates allowed to issue corporate advertisements after 21 days from the date of filing the offer document with SEBI till the issue closure date provided all risk factors are mentioned in the advertisement. 5.7.4 RATING FOR AGRO BONDS AND PLANTATION BONDS : In November 1997, the Central Government decided that entities which issue instruments such as agro bonds, plantation bonds etc. and the schemes throgh which such instruments are issued would be treated as collective investment schemes coming

143 under the provisions of the SEBI Act 1992 and would be regulated by the SEBI. The provisions of the SEBI Act prohibited any new scheme to be sponsored or further fund to be raised. Meanwhile the SEBI also stipulated that all existing schemes could mobilise funds only through the existing schemes after obtaining a rating from any of the recognised credit rating agencies.

144 SECONDARY MARKET In 1994-95, several changes were made by the government and SEPT in regulations relating to the functioning of the secondary markets.these involved in the membership rules of the stock exchanges, amendments to the Listing Agreement and the Securities Contracts (Regulation ) Act 1956 and amendments to the SEBI Act 1992. Some importnat decisions regarding the secondary market are given below. To further empower SEBI in its role as the primary regulator of the securities markets, the government issued a notification in September 1994, enabling SEBI to exercise several powers concurrently with the government. These powers allow SEBI to - a) Grant recognition to stock exchanges and to renew or withdraw such recognition b) Issue notifications regarding the applicability of section 13 to any state, area or otherwise c) Consider the appeals against refusal of stock exchanges to list securities d) Issue notifications regarding the non-applicability of the Securities Contracts (Regulation) Act 1956 to any class of contracts or contract. AMENDMENT TO THE SECURITIES CONTRACT (REGULATION) ACT 1956 In order to allow for the trading of new instruments in the secondary markets, and facilitate the enforcement of continuing

145 disclosure and investor protection norms, changes were made to the Securities Contracts (Regulation) Act. The changes are given below - a) The Securities Contracts (Regulation) Act 1956 has been suitably amended to allow the issuance and trading of options in securities. b) The Act has also been amended to allow existing stock exchanges to establish additional trading floors outside their area of operation c) Violation of listing agreement have been made an offence under the Act The role of SEBI related to secondary market is discussed under four categories. a) Administration of stock exchanges b) Safety and integrity of secondary market c) Efficiency & Transparency in secondary market d) Checking unfair trade practices e) Investor protection f) Other measures

146 5.8 ADMINISTRATION OF STOCK EXCHANGES : 5.8.1 REGULATION OF BROKERS AND SUB-BROKERS : Prior to these regulations, the stock brokers were required to be registered only with stock exchanges of which they were members & the sub-brokers were not regulated by any authority. The SEBI Regulation introduced the concept of dual registration of stock brokers with SEBI and the stock exchanges & brought the broker and sub-broker within the regulatory fold for the first time. All stock brokers are registered with the SEBI in terms of SEBI (Stock Brokers and Sub-Brokers)Regulation,1992. The total number of registered brokers and sub-brokers as on March 31,1998, stood at 9005 and 3760 respectively. 5.8.2 GOVERNING BOARDS OF EXCHANGES AND VARIOUS COMMITTEES In past, the Governing Boards of the Stock Exchanges were constituted by the members of the Stock Exchanges. Although there were a few Public Represenativess and Nominees appointed' by the Government, the Boards were dominated by the brokers. The Governing Boards of exchanges have been reorganised' and broad based, so that they represent different interests, '& not just the interests of their members. The Governing Boards now consist of 50 per cent representatives of the members & 50 per cent non member representatives.the various committees of stock exchanges have been restructured, for example, 'their disciplinary, default and arbitration committees now have a majority of non-brokers. 7 The exchanges are now required to appoint a non-member

147 professorial in the capacity of an executive director or principal officer, who is empowered and made responsible for the day-to-day management of the exchange. Through a notification issued under the Securities Contract (Regulation) Act 1956 the power to regulate stock exchanges, was delegated to SEBI. This includes recognition, rules, articles, voting rights, delivery contracts, stock exchange, listing and nomination of public representative. 5.8.3 CORPORATE MEMBERSHIP : SEBI has been encouraging corporate membership of stock exchanges, so that stock broking intermediaries would be able to incorporate as limited liability companies, which would allow them to attract capital. Direct investment by foreign stock broking firms through joint ventures has also been allowed by the Government. The rules under the Securities Contracts (Regulation) Rules 1957 enabling the entry of corporate members were further relaxed. Eligibility criteria for the corporate membership of governing bodies of the stock exchange have been prescribed by SEBI, to enable corporate members to be elected to the governing bodies of the stock exchanges. 5.8.4 ARBITRATION MECHANISM : In order to expedite the settlement of disputes, all stock exchanges have been advised to review the position of the pending arbitration cases in every meeting of the governing body and to ensure that cases are disposed of within the stipulated period of 4 months.

148 5.9 SAFETY AND INTEGRITY OF SECONDARY MARKET : 5.9.1 CAPITAL ADEQUACY NORMS FOR BROKERS : For ensuring safety of the, trades in the market and protection of investors, it is essential that the member firms are adequately capitalised in relation to their outstanding positions. SEBI has also been insisting on the imposition of capital adequacy norms for all members of stock exchanges, whether i corporate or not. As part of the mover towards better capital adequacy, the stock exchanges are to double their existing base minimum capital requirement for their individual members. In addition to capital adequacy, insurance of stock brokers has a useful role to play in reducing risks for investors. Accordingly, the stock exchanges are in the process of taking out suitable policies for their members. To ensure adequacy of the capital base of the stock brokers, SEBI required all stock exchanges to double the amounts prescribed for the minimum capital for brokers from January 1996. This amount now stands at Rs.10 lakh for members of the Mumbai and Calcutta stock exchanges. Rs.7 lakh for brokers who are members of the Delhi and Ahmedabad stock exchanges and Rs.A lakh for brokers on the remaining exchanges in the country. 5.9.2 MARKET MARGIN SYSTEM : To ensure integrity and safety of the markets, SEBI advised all the exchanges to introduce daily mark to market margin system

U9 and to collect scrip wise. 100% of marked to market notional loss of a broker on a daily basis. This margin is in addition to any other margin that the exchange may be levying and is collected in cash/bank guarantee without netting gain or loss across scrips. The effectiveness of the measure was. tested out during the periods of volatility witnessed by the securities markets in early 1997. 5.9.3 PRICE BAND : To curb undesirable volatility, all exchanges were required to fix uniformly daily price band at 10% and a weekly overall limit of 25%. However, in case of scrips up to the value of Rs.20, the price bands could be decided by, the stock exchanges. The price band would be calculated on the basis of the closing price of the scrip on the previous day, ~ which will be the weighted average price of the last half'hour of trading in the scrip on that exchange. 5.9.4 SETTING UP OF TRADE/SETTLEMENT GUARANTEE FUND BY STOCK EXCHANGES One of the shortcomings of the clearing and settlement process of the Indian stock markets was the absence of a system to reduce counter-party risk. Managing this risk is an essential need of a safe and efficient market, which can be achieved through setting up of a Trade or Settlement Guarantee Fund. The principal objective of this Fund is to provide the necessary funds and ensure timely completion of settlements in cases of