UNIT V

A depository is an entity which helps an investor to buy or sell securities such as stocks and bonds
in a paper-less manner. Securities in depository accounts are similar to funds in bank accounts.

What are its main functions?

A depository works as a link between the listed companies which issue shares and shareholders. It
issues these shares through agents associated with it called depository participants or DPs. A DP
can be a bank, financial institution, a broker, or any entity eligible as per SEBI norms and is
responsible for the final transfer of shares from the depository to investors. The investor, at the
end of a transaction receives a confirmation from the depository.

What is the need for a depository?

A depository eliminates the risk associated with holding physical securities. Earlier, the buyer
would have to keep checking if the shares have been transferred safely to his account, and ensure
that theft, damage or loss has not happened. After the depository system came about, such risks
have been greatly reduced since the shares are held in and transferred in an electronic manner.
They also reduce the paper work involved in trading and involved in trading and fasten the
transfer of shares.In 1998, demat or electronic trading was made compulsory for institutional
investors, which led to a spike in the overall trading volumes in the Indian market. Foreign
investors felt more confident about trading in the Indian market due to the depository system as
there were far fewer incidents of forgery, delay and unscrupulous transfer of shares.

What are the names of some depository organizations?

The Depository Act of 1996 paved the way for the establishment of the two depositories in India,
namely National Securities Depository Limited (NSDL) which is promoted by the National Stock
Exchange, Industrial Development Bank of India and Unit Trust of India among others. The other
depository is the Central Depository Services Limited (CDSL) which is promoted by the Bombay
Stock Exchange Bombay Stock Exchange, State Bank of India, Bank of India among others.

Who regulates depositories and depository participants?

The Securities and Exchange Board of India is responsible for the registration, regulation and
inspection of the depository. A depository participant is also answerable to the SEBI. It can be
operational only after registration with SEBI post recommendation by NSDL or CDSL.

ROLE OF NSDL AND CDSL IN INDIAN CAPITAL MARKET

A. NSDL

NSDL carries out its activities through service providers such as depository participants (DPs),
issuing companies and their registrars and share transfer agents and clearing corporations/ clearing
houses of stock exchanges. These entities are NSDL's business partners and are integrated in to
the NSDL depository system to provide various services to investors and clearing members. The
investor can get depository services through NSDL's depository participants. NSDL was
registered by the SEBI on June 7, 1996 as India’s first depository to facilitate trading and
settlement of securities in the dematerialized form. The NSDL is promoted by IDBI, UTI and
NSE to provide electronic depository facilities for securities traded in the equity and debt markets
in the country. NSDL has been set up to cater to the demanding needs of the Indian capital
markets. In the first phase of operations, NSDL will dematerialize scrips and replace them with
electronic entries. This depository promoted by institutions of national stature responsible for
economic development of the country has since established a national infrastructure of
international standard that handles most of the trading and settlement in dematerialised form in
Indian capital market. The Depositories Act also provides for multiple depository system. Using
innovative and flexible technology systems, NSDL works to support the investors and brokers in
the capital market of the country. NSDL provides numerous direct and indirect benefits like:

• Elimination of bad deliveries

• Elimination of all risks associated with physical certificates

• No stamp duty

• Immediate transfer and registration of securities

• Faster settlement cycle

• Faster disbursement of non cash corporate benefits like rights, bonus, etc.

• Reduction in brokerage by many brokers for trading in dematerialized securities

• Reduction in handling of huge volumes of paper

• Periodic status reports

 Elimination of problems related to change of address of investor

 Elimination of problems related to transmission of demat shares
 Elimination of problems related to selling securities on behalf of a minor
 Ease in portfolio monitoring

B. CDSL

CDSL was promoted by BSE Ltd. jointly with leading banks such as State Bank of India, Bank of
India, Bank of Baroda, HDFC Bank, Standard Chartered Bank and Union Bank of India. CDSL
was set up with the objective of providing convenient, dependable and secure depository services
at affordable cost to all market participants. The balances in the investors account recorded and
maintained with CDSL can be obtained through the DP. The DP is required to provide the
investor, at regular intervals, a statement of account which gives the details of the securities
holdings and transactions. The depository system has effectively eliminated paper-based
certificates which were prone to be fake, forged, counterfeit resulting in bad deliveries. CDSL
offers an efficient and instantaneous transfer of securities. CDSL was promoted by BSE Ltd. in
association with Bank of India, Bank of Baroda, State Bank of India and HDFC Bank. BSE Ltd.
has been involved with this venture right from the inception and has contributed overwhelmingly
to the fruition of the project. The initial capital of the company is 104.50 crores (INR). The list of
shareholders with effect from 5th July, 2010 is as under. Role of CDSL in Indian Depository
System are as follows:

• Maintenance of individual investors’ beneficial holdings in an electronic form

• Dematerialization and re-materialization of securities

• Account transfer for settlement of trades in electronic shares

• Allotments in the electronic form in case of initial public offerings

• Distribution of non-cash corporate actions

• Facility for freezing/locking of investor accounts

• Facility for pledge and hypothecation of securities

KEY FEATURES OF THE DEPOSITORY SYSTEM IN INDIA

1. Multi-Depository System: The depository model adopted in India provides for a competitive
multi-depository system. There can be various entities providing depository services. A depository
should be a company formed under the Company Act, 1956 and should have been granted a
certificate of registration under the Securities and Exchange Board of India Act, 1992. Presently,
there are two depositories registered with SEBI, namely:

• National Securities Depository Limited (NSDL), and

• Central Depository Service Limited (CDSL)

2. Depository services through depository participants: The depositories can provide their
services to investors through their agents called depository participants. These agents are
appointed subject to the conditions prescribed under Securities and Exchange Board of India
(Depositories and Participants) Regulations, 1996 and other applicable conditions.

3. Dematerialisation: The model adopted in India provides for dematerialization of securities.

This is a significant step in the direction of achieving a completely paper-free securities market.
Dematerialization is a process by which physical certificates of an investor are converted into
electronic form and credited to the account of the depository participant.

4. Fungibility: The securities held in dematerialized form do not bear any notable feature like
distinctive number, folio number or certificate number. Once shares get dematerialized, they lose
their identity in terms of share certificate, distinctive numbers and folio numbers. Thus all
securities in the same class are identical and interchangeable. For example, all equity shares in the
class of fully paid up shares are interchangeable.

5. Registered Owner/ Beneficial Owner: In the depository system, the ownership of securities
dematerialized is bifurcated between Registered Owner and Beneficial Owner. According to the
Depositories Act, ‘Registered Owner’ means a depository whose name is entered as such in the
register of the issuer. A ‘Beneficial Owner’ means a person whose name is recorded as such with
the depository. Though the securities are registered in the name of the depository actually holding
them, the rights, benefits and liabilities in respect of the securities held by the depository remain
with the beneficial owner. For the securities dematerialized, NSDL/CDSL is the Registered
Owner in the books of the issuer; but ownership rights and liabilities rest with Beneficial Owner.
All the rights, duties and liabilities underlying the security are on the beneficial owner of the
security.

6. Free Transferability of shares: Transfer of shares held in dematerialized form takes place freely
through electronic book-entry system.
 DEMATERIALISATION

SEBI GUIDELINES

Understanding Depository System

1. What is a Depository?

A depository is an organisation which holds securities (like shares, debentures,

bonds, government securities, mutual fund units etc.) of investors in electronic
form at the request of the investors through a registered Depository Participant. It
also provides services related to transactions in securities.

2. How is a depository similar to a bank?

It can be compared with a bank, which holds the funds for depositors. A Bank –
Depository analogy is given in the following table:

BANK-DEPOSITORY – AN ANALOGY

BANK DEPOSITORY

Holds funds in an account Holds securities in an account

Transfers funds between accounts Transfers securities between

on the instruction of the account accounts on the instruction of the
holder BO account holder

Facilitates transfer without having to Facilitates transfer of ownership

handle money without having to handle securities

Facilitates safekeeping of money Facilitates safekeeping of securities

3. How many Depositories are registered with SEBI?

At present two Depositories viz. National Securities Depository Limited (NSDL)

and Central Depository Services (India) Limited (CDSL) are registered with SEBI.

4. Who is a Depository Participant?

A Depository Participant (DP) is an agent of the depository through which it

interfaces with the investor and provides depository services. Public
financial institutions, scheduled commercial banks, foreign banks operating in India
with the approval of the Reserve Bank of India, state financial
corporations, custodians, stock-brokers, clearing corporations /clearing houses,
NBFCs and Registrar to an Issue or Share Transfer Agent complying with the
requirements prescribed by SEBI can be registered as DP. Banking services can
 be availed through a branch whereas depository services can be availed through a
DP.

5. What is the minimum networth required for a depository?

The minimum networth stipulated by SEBI for a depository is Rs.100 crore.

6. How many Depository Participants are registered with SEBI?

As on September 30, 2008, a total of 711 DPs (266 NSDL, 445 CDSL) are
registered with SEBI.

7. Is it compulsory for every investor to open a beneficial owner (BO) account

to trade in the capital market?

As per the available statistics at BSE and NSE, 99.9% transactions take place in
dematerialised mode only. Therefore, in view of the convenience of trading in
dematerialised mode, it is advisable to have a beneficial owner (BO) account for
trading at the exchanges.

However to facilitate trading by small investors (Maximum 500 shares, irrespective of

their value) in physical mode the stock exchanges provide an additional trading
window, which gives one time facility for small investors to sell physical shares which
are in compulsory demat list. The buyer of these shares has to demat such shares
before further selling.

8. What are the benefits of availing depository services?

The benefits are enumerated below:-

 A safe and convenient way to hold securities;

 Immediate transfer of securities;

 No stamp duty on transfer of securities;

 Elimination of risks associated with physical certificates such as bad delivery,

fake securities, delays, thefts etc.

 Reduction in paperwork involved in transfer of securities;

 Reduction in transaction cost;

 No odd lot problem, even one share can be traded;

 Nomination facility;

 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;

 Transmission of securities is done by DP eliminating correspondence with

companies;

 Automatic credit into demat account of shares, arising out of

bonus/split/consolidation/merger etc.

 Holding investments in equity and debt instruments in a single account.

Account Opening

9. How can services of a depository be availed?

To avail the services of a depository an investor is required to open a Beneficial

Owner (BO) account with a Depository Participant (DP) of any depository.

10. How can one open an account?

First an investor has to approach a DP and fill up an account opening form. The
account opening form must be supported by copies of any one of the approved
documents which serve as proof of identity (POI) and proof of address (POA) as
specified by SEBI. Apart from these PAN card has to be shown in original at the
time of account opening from April 01, 2006.

All applicants should carry original documents for verification by an authorized

official of the DP, under his signature.

Investor has to sign an agreement with DP in a depository prescribed standard format, which gives details of rights and duties of investor
and DP. DP should provide the investor with a copy of the agreement and schedule of charges for their future reference. The DP will
open the account in the system and give a unique account number, which is also called BO ID (Beneficial Owner Identification
number) and used for all future transactions.

11. What are all charges an investor has to pay for opening and maintenance of a BO account?

SEBI has rationalised the cost structure for dematerialisation by removing account
opening charges, transaction charges (for credit or buy transactions of securities),
custody charges and account closing charges. Custody charges are now paid by
the issuer companies. Broadly, investors are required to pay the charges towards:-

 Dematerialisation and Rematerialisation of their securities

 Annual account maintenance charges
 Transactions fees (only for sell transactions)

The DP may revise the charges by giving 30 days notice in advance.

 Further, SEBI has also advised the DPs to submit to their Depository their
tariff/charge structure every yearlatest by 30th April and changes made therein,
along with the date of effect to enable the investors to have a comparative analysis
of the tariff/charge structure of various DP’s. The information received by the
depositories is put up on their websites.

12. Why should an investor give his bank account details at the time of BO
account opening?

Bank account details are necessary for the protection of interest of investors. When any cash or non cash corporate benefits such as
rights or bonus or dividend is announced for a particular scrip, depositories provide to the concerned issuer /it’s RTA, the details of
the investors, their electronic holdings as on record / book closure date for reckoning the entitlement of corporate benefit.

The disbursement of cash benefits such as dividend is credited directly by the Issuer/it’s RTA to the beneficiary owner through the
ECS (Electronic Clearing Service wherever available) facility or by issuing warrants on which bank account details are printed for
places where ECS facility is not available. The bank account number is mentioned on the dividend and warrant to avoid any
fraudulent misuse. The bank account details will be those which are mentioned in account opening form or modified details that had
been intimated subsequently by the investor to the DP.

13. Can an investor change the details of his bank account?

Yes. However, the investor must inform the DP regarding change in the bank account and corresponding change in MICR
/ IFSC code while updating their bank account details with DP. In the depository system monetary benefits on the security balances
are paid as per the bank account details provided by the investor at the time of account opening. The investor must ensure that any
subsequent changes in bank account details are informed to the DP.

15.14. What should be done if the address of the investor changes?

Investor should immediately inform his DP along with necessary documents, who in
turn will update the records. This will obviate the need of informing different
companies.

14.15. What would be the charges for account closure and securities transfer due to account closing?

SEBI has advised that from January 09, 2006, no charges shall be levied by a
depository on DP and consequently, by a DP on a BO, when a BO transfers all the
securities lying in his account to another branch of the same DP or to another DP
of the same depository or another depository, provided the BO Account/s at
transferee DP and at transferor DP are identical in all respects. In case the BO
Account at transferor DP is a joint account, the BO account at transferee DP
should also be a joint account in the same sequence of ownership.

All other transfer of securities consequent to closure of account, not fulfilling the
above-stated criteria, would be treated like any other transaction and charged as
per the schedule of charges agreed upon between the BO and the DP.

16. Can multiple accounts be opened?

Yes. An investor can open more than one account in the same name with the
same DP and also with different DPs. For all the accounts, investor has to strictly
comply with KYC norms including Proof of Identity, Proof of Address requirements
as stipulated by SEBI and also provide PAN number. The investor has to show the
original PAN card at the time of opening of demat account.
17. Does the investor have to keep any minimum balance of securities in his
account?

No.

18. Is it necessary to have account with the same DP as broker has?

No. Depository / DP can be chosen by investor as per convenience irrespective of

the DP of the broker.

19. Can an investor open a single account for securities owned in different
ownership patterns such as securities owned individually and securities
owned jointly with others?

No. The Demat account must be opened in the same ownership pattern in which
the securities are held in the physical form. e. g. if one share certificate is in the
individual name and another certificate is jointly with somebody, two different
accounts would have to be opened.

20. What is required to be done if one has physical certificates with the same
combination of names, but the sequence of names is different i.e. some
certificates with ‘A’ as first holder and ‘B’ as second holder and other set of
certificates with ‘B’ as first holder and ‘A’ as the second holder?

In this case the investor may open only one account with ‘A’ & ‘B’ as the account
holders and lodge the security certificates with different order of names for
dematerialisation in the same account. An additional form called "Transposition
cum Demat" form will have to be filled in. This would help you to effect change in
the order of names as well as dematerialise the securities.

21. Can an investor operate a joint account on "either or survivor" basis just like
a bank account?

No. The demat account cannot be operated on "either or survivor" basis like the bank
account.

22. Can someone else operate the account on behalf of the BO on the basis of a
power of attorney?

Yes. If the BO authorises any person to operate the account by executing a power
of attorney and submit it to the DP, that person can operate the account on behalf
of the BO.

23. Can addition or deletion of names of accountholders is permitted after

opening the account?

No. The names of the account holders of a BO account cannot be changed. If any
change has to be effected by addition or deletion, a new account has to be opened
in the desired holding pattern (names) and then transfer the securities to the newly
opened account. The old account may be closed.
24. Can an investor close his demat account with one DP and transfer all
securities to another account with another DP?

Yes. The investor can submit account closure request to his DP in the prescribed
form. The DP will transfer all the securities lying in the account, as per the
instruction, and close the demat account.

25. What if there are any discrepancies in the statement of holdings?

In case of any discrepancy in the statement of holdings, investor can contact his
DP and in case of discrepancies in corporate benefits, one can approach the
company / its Registrar and Transfer Agent. If the discrepancy is not resolved,
the investor may approach concerned Depository (NSDL or CDSL).

26. Whether investor can freeze his account(s)?

Investor can freeze his account and/or ISIN and/or specific number of securities under
an ISIN for any given period of time as per applicable Regulations of SEBI and Bye
Laws of the respective depository.

Dematerialisation

27. What is dematerialisation?

Dematerialisation is the process by which physical certificates of an investor are

converted to an equivalent number of securities in electronic form and credited
into the BO’s account with his DP.

28. How can one convert physical holding into electronic holding i.e. how can
one dematerialise securities?

In order to dematerialise physical securities one has to fill in a DRF (Demat

Request Form) which is available with the DP and submit the same along with
physical certificates that are to be dematerialised. Separate DRF has to be filled
for each ISIN. The complete process of dematerialisation is outlined below:

 Surrender certificates for dematerialisation to your DP.

 DP intimates to the Depository regarding the request through the system.

 DP submits the certificates to the registrar of the Issuer Company.

 Registrar confirms the dematerialisation request from depository.

 After dematerialising the certificates, Registrar updates accounts and informs

depository regarding completion of dematerialisation.

 Depository updates its accounts and informs the DP.

 DP updates the demat account of the investor.

30. Can odd lot shares be dematerialised?

Yes, odd lot share certificates can also be dematerialised.

32. Can electronic holdings be converted back into physical certificates?

Yes. The process is called rematerialisation. If one wishes to get back his
securities in the physical form he has to fill in the RRF (Remat Request Form) and
request his DP for rematerialisation of the balances in his securities account. The
process of rematerialisation is outlined below:

• Make a request for rematerialisation.

• Depository participant intimates depository regarding the request through the

system.

• Depository confirms rematerialisation request to the registrar.

• Registrar updates accounts and prints certificates.

• Depository updates accounts and downloads details to depository participant.

• Registrar dispatches certificates to investor.

Trading / Settlement

33. What is the procedure for selling dematerialised securities?

The procedure for buying and selling dematerialised securities is similar to the
procedure for buying and selling physical securities. The difference lies in the
process of delivery (in case of sale) and receipt (in case of purchase) of securities.

In case of purchase:-

 The broker will receive the securities in his account on the payout day.

 The broker will give instruction to its DP to debit his account and credit BO's
account.

 BO will give ‘Receipt Instruction’ to DP for receiving credit by filling appropriate

form. However BO can give standing instruction for credit to his account that
will obviate the need of giving Receipt Instruction every time.

In case of sale:-

BO will give delivery instruction through Delivery Instruction Slip (DIS) to DP to debit
his account and credit the broker’s account. Such instruction should reach the
DP’s office at least 24 hours before the pay-in, failing which, DP will accept the
instruction only at the BO’s risk.
34. What 'Standing Instruction' is given in the account opening form?

In a bank account, credit to the account is given only when a 'pay in' slip is
submitted together with cash/cheque. Similarly, in a depository account 'Receipt in'
form has to be submitted to receive securities in the account. However, for the
convenience of BOs, facility of 'standing instruction' is given. If you say 'Yes' for
standing instruction, you need not submit 'Receipt in' slip everytime you buy
securities. If you are particular that securities can be credited to your account only
with your consent, then do not say 'yes' [or tick ] to standing instruction in the
application form.

35. What is delivery instruction slip (DIS)? What precautions do one need to
observe with respect to Delivery Instruction Slips?

To give the delivery one has to fill a form called Delivery Instruction Slip (DIS). DIS
may be compared to cheque book of a bank account. The following precautions
are to be taken in respect of DIS:-

 Ensure and insist with DP to issue DIS book.

 Ensure that DIS numbers are pre-printed and DP takes acknowledgment for the
DIS booklet issued to investor.

 Ensure that your account number [client id] is pre-stamped.

 If the account is a joint account, all the joint holders have to sign the instruction
slips. Instruction cannot be executed if all joint holders have not signed.

 Avoid using loose slips.

 Do not leave signed blank DIS with anyone viz., broker/sub-broker, DPs or any
other person/entity.

 Keep the DIS book under lock and key when not in use.

 If only one entry is made in the DIS book, strike out remaining space to prevent
misuse by any one.

 BO should personally fill in target account-id and all details in the DIS.

 If the DIS booklet is lost / stolen / not traceable, the same must be intimated to
the DP immediately in writing. On receipt of such intimation, the DP will cancel
the unused DIS of the said booklet.

36. Is it possible to give delivery instructions to the DP over Internet and if yes,
how?

Yes. Both NSDL and CDSL have launched this facility for delivering instructions to
your DP over Internet, called SPEED-e and EASI respectively. The facility can be
 used by all registered BOs after paying the applicable charges.

37. Is it possible to get securities allotted in public offering directly in the

electronic form?

Yes, it is possible to get securities allotted to in Public Offerings directly in the

electronic form. In the public issue application form, there is a provision to indicate
the manner in which an investor wants the securities to be allotted. He has to
mention the BO ID, name and DP ID on the application form. Any allotment made
will be credited into the BO account.

Transaction Statement

43. How does one know that the DP has updated the account after each
transaction?

The DP provides a Transaction Statement periodically, which gives details of

current balances and various transactions made through the depository account. If
desired, DP may provide the Transaction Statement at intervals shorter than the
stipulated ones, probably at a cost.

Depositories also provide SMS Alert facility for demat account holders whereby
investors can receive alerts for debits (transfers) to their demat accounts and for
credits in respect of corporate actions for IPO and offer for sale. Under this facility,
investors can receive alerts, a day after such debits (transfers)/credits take place.
These alerts are sent to those account holders who have provided their mobile
numbers to their Depository Participants (DPs).

44. At what frequency will the investor receive his Transaction Statement from
his DP?

DPs have to provide transaction statements to their clients once in a month, if

there is any transaction and if there is no transaction, then once in a quarter.

DPs also provide transaction statement in electronic form under digital signature
subject to their entering into a legally enforceable arrangement with the BOs to this
effect.

45. What is to be done if there are any discrepancies in transaction statement?

In case of any discrepancy in the transaction statement, BO can contact his DP. If the
discrepancy cannot be resolved at the DP level, BO should approach the
Depository.

46. Whom should BO contact in case of any investor complaint / problem /

query?

In case of any investor complaint / problem / query one may first contact his DP. If
DP is unable to solve the complaint / problem / query one should approach
concerned depository. If one is not satisfied one may approach SEBI. One may
 also approach SEBI directly.

Transmission of dematerialised securities

50. What is transmission of dematerialised securities?

Transmission is the process by which securities of a deceased account holder are

transferred to the account of his legal heirs / nominee. Process of transmission in
case of dematerialised holdings is more convenient as the transmission formalities
for all securities held in a demat account can be completed by submitting
documents to the DP, whereas in case of physical securities the legal
heirs/nominee/surviving joint holder has to independently correspond with each
company in which securities are held.

51. In the event of death of the sole holder, how the successors should claim the
securities lying in the demat account?

The claimant should submit to the concerned DP an application Transmission

Request Form (TRF) along with the following supporting documents

1. In case of death of sole holder; where the sole holder has appointed a nominee

 Notarised copy of the death certificate

2. In case of death of the sole holder; where the sole holder has not appointed a
nominee

 Notarised copy of the death certificate

And anyone of the below mentioned documents -

 Succession certificate

 Copy of probated will

 Letter of Administration

The DP, after ensuring that the application is genuine, will transfer securities to the
account of the claimant.

The major advantage in case of dematerialised holdings is that the transmission

formalities for all securities held with a DP can be completed by interaction with the
DP alone, unlike in the case of physical share certificates, where the claimant will
have to interact with each Issuing company or its Registrar separately.

********************
 UNIT IV

SEBI REGULATION FOR THE FUNCTIONING OF STOCK EXCHANGES

Introduction
Stock Exchange is a platform where the trading of securities happens in an organized manner. The
securities may be shares or debts. The stock exchange has not been defined under any Act, but the
commercial definition is generally accepted. Securities and Exchange Board of India, established
in 1992, is the principal regulator of stock exchanges in India.

Securities are financial assets that are tradable and can be divided into three categories- Equity
securities (stocks), Debt securities (bonds) and Derivative securities. The trading of securities can
be done on an exchange or over the counter. So, basically stocks are a subset of securities.
Securities are freely transferable, i.e., they can be transferred from one person to another without
notifying the company whose stocks are being traded.

Some Terms clarified/explained

A stock exchange is a market where securities are bought and sold.

Designated stock exchange has been defined under Section 2(1)(d) of the Securities and
Exchange Board of India (Issue and Listing Debt Securities) Regulations, 2008, as, “a stock
exchange in which securities of the issuer are listed or proposed to be listed and which is chosen
by the issuer for purposes of a particular issue under these regulations”. In case a stock exchange
has trading terminals at more than one place in the country, one of them shall be chosen by the
issuer as the designated stock exchange.

An issuer is a legal entity, i.e., the government, corporation or investment trust, which sells
securities to the public, to fund its operations. The Investor is the person who invests or finances
a company, by purchasing a part of the company, through the medium of stocks and becomes a
part-owner of that company.

A company may raise funds by offering securities to the public when it is done it is called initial
public offering. This kind of market is called Primary market. When these shares are further
traded by the investors, the market is called secondary market.

The person or company which does the buying and selling of stock on behalf of another person or
company is called stockbroker and the charge which he levies for the buying and selling of the
stock is called brokerage charge.

The process of transition of an exchange from mutually-owned association to a shareholder held

company.
History
In its initial days, the securities market was in the form of a co-operative society, where trading
was conducted by members on a mutual basis. Then the Securities Contracts (Regulation) Act,
1956 was passed which corporatized and demutualised the stock exchanges. The trading
continued according to the old system for a long time. By1991, the volume of stocks being traded
reached to unprecedented levels. The Securities and Exchange Board of India (SEBI) was
established as the apex body for regulation of stock exchanges in India in 1988. In 1992 another
Act was introduced, which conferred the extensive range of powers on SEBI. SEBI set up in 1988,
was made a statutory body in 1992.

Securities and Exchange Board of India

Share market is the one of the major pillars for the economy of a country. It is very important to
control the share market in order to strengthen the economic condition of the country and thereby
protect the rights of the investors. Keeping this thing in view, the Capital Issue (Control) Act,
1947 was enforced. But the Act failed to fully control the Share Market. In order to remove its
drawbacks, Securities and Exchange Board of India (SEBI) was established in 1992.

The SEBI Act enumerates the powers with respect to regulating the stock exchange. The act has
conferred a wide variety of powers to SEBI.

Some of the most important powers of SEBI with respect to regulating the Indian
stock market are listed below:

Specifying rules and regulations

SEBI has the authority to specify rules and regulations to control the stock exchange. For
example, the timings i.e. opening (9.15 am) and closing (3.30 pm) time of the market has been set
by SEBI, and it retains the right to change the timing if required.

Providing licenses to dealers and brokers

Every dealer or broker requires a prior approval and license from SEBI to start distributing
securities to investors. It also reserves the right to withhold or cancel the license of brokers and
dealers not adhering to guidelines.

Reviewing the performance of various stock exchanges

The regulating body is also responsible for the performances of various stock exchanges and
bringing transparency in their functioning.

Controlling mergers, acquisitions and take-overs of the companies

Some companies try to manipulate stocks and buy a majority stake in other companies with an
intention of a take-over. SEBI controls and prohibits such movements if it is not in the interest of
the company.

Prohibiting unfair trade practices in the market

While SEBI has laid down specific guidelines that promote fair trade practices, many companies
occasionally undertake activities that are not healthy for the market. SEBI has the power to
prohibit such activities and take action against the parties involved in such a trade. Penalties may
range from Rs 25 crores or 3 times the profits made out of such failure, whichever is higher.

Imposition of Penalties in case of violation

A number of acts / activities have been identified and declared to be punishable by SEBI. The
same has been mentioned under various sections of the Act.

Stock broker activities

A penalty can be imposed in case a stockbroker defaults or fails in –

1. Issuing in Contract Note, or

2. Delivering any security or making payment of an amount due to an investor , or
3. charges an amount of brokerage which is in excess of brokerage specified in the
regulations.

The penalty may range from Rs 1 lac per day to Rs 1 crore depending on the type of default or
failure.

Insider Trading
A person becomes liable of insider trading if –

1. Deals of self or others on basis of unpublished / confidential price sensitive information,

or
2. Communicates any unpublished price sensitive information, or
3. Counsels any person to deal in securities of any corporate on basis of unpublished price
sensitive information.

The penalty can be very heavy is such cases going upto Rs 25 crores or thrice the profit made out
of such insider trading activity, whichever is higher.

Non Disclosure of acquisition of shares and takeovers

Non Disclosure penalty is applicable if a person fails to –

1. Disclose his total shareholding in a corporate body before acquiring further shares of the
corporate body, or
2. Makes a public announcement so are to acquire shares at a certain price, or
3. Makes a public offer by sending an offer letter to the shareholder of the concerned
corporate, or
4. Makes payment of consideration to shareholders who sold their shares pursuant to the
offer letter as mentioned earlier.

Here again, the penalty can be very heavy ranging from Rs 25 crores or thrice the profit made out
of such Non Disclosure activity, whichever is higher .

Contravention of rules where no separate penalty has been provided

The Act has also specified the penalty for such instances wherein no specific or separate penalty
has been provided. The penalty in such cases may go upto Rs 1 crore.
Broadly, for the purpose of clarity on regulatory aspects and other functions of the SEBI, one can
divide the functions of SEBI into three parts:

Protective Functions:

 To check unfair trade practices in respect to share / security market.

 To check insiders trading in shares / securities.
 To provide education relating to dealing in securities to the investors.
 To provide a code of conduct relating to the security market.

Regulatory Functions (already enumerated earlier in detail):

 To regulate the business doing done in the share / securities market.

 To register and regulate the various venture capital funds.
 To carry out an audit of the share markets.
 To register and regulate the credit rating agency.

Developmental Functions:

 To impart training to the various Intermediaries.

 To encourage self regulating organizations.
 To carry on research work.
 To publish various kinds of information for the education & convenience of all the parties
operating in the capital markets.

Conclusion
The stock market as mentioned earlier is a barometer of the state of the economy for a country. It
indicates the direction, the growth and overall health of the economy. All this is reflected on a real
time basis, in the most transparent & non partisan manner, strictly on the basis of merits.
Therefore regulating the performance and activities of the stock market, so that same may be
conducted in an orderly manner, is of critical importance. The SEBI Act and the provisions
incorporated in the Act are all a measure of the importance that has been placed on the orderly
conduct of the stock market. Any violations are to be dealt with in a strict manner along with the
provision of large and stringent penalties.
 Role of Intermediaries in a Securities Market
INTRODUCTION

Financial intermediaries and financial markets can in many cases act as substitute sources of
financial services. Lenders/savers in particular have a choice between the risk, return and liquidity
offered by both segments of the financial system. Each segment is able to offer a different range
of investments and offers services to firms that are not complete substitutes. Broadly speaking,
financial markets provide lower cost arms length debt or equity finance to a smaller group of
firms able to obtain such finance, while financial intermediaries offer finance with a higher cost
reflecting the expense of uncovering information and ongoing monitoring. Financial
intermediaries and markets may also provide complementary financial services to many firms.

We identify the challenges confronted in the intermediaries-driven market regime, especially in

preventing intermediaries’ conflicts of interests vis-à-vis investors and issuer companies.
Moreover, in the paper we attempt to ascertain if the existing regulatory framework is cognisant
of such challenges and if it encompasses measures to fix intermediaries’ accountability and
liability in conflict of interests situations. Currently, a rule-based avoidance regime of conflicts of
interest is predominant in India, in contrast to the principle- based compliance seen in more
mature capital markets. Given that regulations and rules alone cannot remedy such situations of
conflict, the rules need to be supplemented with enduring principles and an ethical business
culture. Creating robust internal control systems and self- regulation would be the two primary
and predominant mechanisms to establish this culture. We conclude that conflicts of interests of
intermediaries are inevitable, and we make recommendations to combat the conflict of interest
crisis and mitigate risks while scrutinising India’s regulatory approach towards this menace from a
practical standpoint. The establishment of SEBI-registered Self-Regulatory Organisations for
market intermediaries is expected to bring the Indian market at par with international markets.
EVOLUTION: HOW INTERMEDIARIES CAME INTO OPERATION

In the era of closed markets, intermediaries were not common because buyers and sellers
transacted in close proximity to one another and a “middleman” was not required. However, as
financial markets expanded and matured, it was no longer possible for buyers and sellers to have
direct dealing; thus, contemporary capital markets are substantially dependent on market
intermediaries. To understand this dependence, to comprehend how market intermediaries are
driving the market today, and to ascertain the regulatory contours of India’s securities market
regulator— the Securities and Exchange Board of India (SEBI)—in respect of intermediary
governance, it is imperative to understand who these market intermediaries are.

In simple terms, market intermediaries operate as the bridge between capital providers and capital
seekers. According to this understanding, any person operating in the capital markets other than
the issuer and the investor may be considered a market intermediary. Does the regulatory
understanding of “market intermediaries” conform to this interpretation? Interestingly, the SEBI
does not offer any conceptual or exhaustive definition of “market intermediaries.”
“Market intermediaries” under SEBI regulations,2008[i]

It is worthwhile to refer to the definition of intermediaries provided in the SEBI (Intermediaries)

Regulations, 2008 (henceforward, the Intermediaries Regulations), which in turn makes reference
to Sections 11(2)(b), (ba), and Section 12(1), (1A) of the SEBI Act, 1992[ii]. According to these
provisions, intermediaries comprise the following:

(a) stock brokers and sub-brokers

(b) share transfer agents

(c) bankers to an issue

(d) trustees of trust deeds

(e) registrars to an issue

(f) merchant bankers

(g) underwriters

(h) portfolio managers

(i) investment advisers

(j) depositories and depository participants

(k) custodians of securities

(l) credit rating agencies

(m) asset management companies

(n) clearing members

(o) trading members

(p) any other intermediary who may be associated with securities markets in any manner

The Intermediaries Regulations specifically excludes foreign institutional investors, foreign

venture capital investors, mutual funds, collective investment schemes, and venture capital funds
from the definition of intermediaries[iii]. Further, it is imperative to note that since only Chapters
V and VI of the Intermediary Regulations are effective, the clause containing the definition is not
yet operative. Nevertheless, it may be referred to in order to understand the concept from a
regulatory perspective.
Interpreting the term “associated with securities market” under SEBI regulations,2008[iv]

Ambiguity arises while interpreting the residual category, i.e., (p), much of which depends on how
the SEBI interprets “associated with securities market.” Although not in the context of
intermediaries, courts have held that “persons associated with market” would include everyone
who has something to do with the securities market.[v] For instance, audit firms without any
direct association with share market activities are reckoned to be “associated with securities
market,” since the auditing accounts of a company has a direct impact on the investor’s interest
and market stability.[vi] While this issue is currently pending in appeal before the Supreme Court
of India, a study of decided cases indicates that the SEBI interprets “associated with market”
to include all persons having any direct or indirect link with the securities market.
ROLE OF SECURITIES MARKET INTERMEDIARIES
A necessary evil

The primary need for market intermediaries in the securities market is to match its demand and
supply forces. In other words, intermediaries facilitate economies in confronting the critical
challenge of the allocation of savings to investment opportunities, as shown in Figure 1.
Figure 1 :Flow of Funds in the Capital Market

Economies that are able to match their available resources/savings to appropriate investment
opportunities are successful in the creation of novel business avenues and the generation of more
wealth and progress. Thus, to say that intermediaries are capable of making or breaking
economies would not be an overstatement. Further, investors and issuers are no longer
homogenous; issuers and investors today are diverse and depict heterogeneous characteristics. To
connect and manage such diverse groups, a mature market with sophisticated middlemen is
essential.

Additionally, in contemporary securities markets, investors and issuers rely heavily on

intermediaries to operate on well-informed decisions. Investors, especially retail investors, do not
have adequate information, knowledge, or expertise, and issuers do not have adequate resources to
reach out to individual investors spread across the country and the globe. Therefore,
intermediaries have a very crucial and sensitive role to play in making the market matrix—
especially anonymous order-driven trading platforms—work smoothly.

The role of the following financial intermediaries is discussed here[vii]:

  Investment Banks
 Security Analysts
 Market Makers

Stock markets provide a platform for trading to occur between buyers and sellers. A security’s
price is determined based on the market process. Market makers can provide many different
services and facilitate trading. The service provided by market makers depends on the structure of
the market. A market maker sometimes acts as a broker in which case her role is to bring buyers
and sellers together. Another important role of a market maker is to provide liquidity to the market
particularly in situations when the market for a stock does not clear automatically at one price.
The market maker steps in and supplies securities out of her inventory or buys the stock with her
capital in case there is excess supply. Most stocks in emerging markets tend to be thinly traded
and lack liquidity, therefore this role of the market maker becomes even more crucial. Market
makers do not themselves determine the trading price.

Market makers need to be compensated for this “dealer” role. When acting as a dealer, the market
maker posts a bid and a ask price for each security that she wants to trade in. She earns the spread
as compensation for providing immediacy and price continuity. This price continuity should result
in smaller price swings from transaction to transaction and hence lower price volatility. Dealers
face three types of costs:

 Order-Processing Costs: These include the cost of space, communication, and labor.
 Risk-Bearing Costs: By stepping in the market maker they hold an inventory position.
 Adverse-Information Costs: Market Makers can be victimized by information traders

Market makers should be required to post continuous two-sided quotes that are firm for the size
posted. They should be bound only for the posted size but within this posted size they should not
be able to back away. Stock exchanges should make it fairly easy to allow somebody to become a
market maker. For example, on Nasdaq any member can become a market maker as long as they
satisfy minimum net capital requirements. A market maker can also withdraw its registration
fairly easily. If he withdraws voluntarily then he cannot make a market in that security for 2
business days.
Investment Banks

Investment banks perform a number of different functions. A typical investment bank’s services
will include:

 Financing Services: They help companies and governments raise capital by issuing
different types of securities such as, equity, debt, private placements, commercial paper,
medium-term notes.
 Investment Services: They trade and make a market in major equity and fixed income
products. Many of them specialize in block trading.
 Research: Maintenance of large databases that allows them to produce research reports on
economies, markets, companies, stocks, and bonds.
 Mergers and Acquisitions: Advise on mergers, acquisitions, and divestitures to help
companies become more competitive.

Some of these critical financial intermediary services need further development in emerging
markets. If financial intermediaries start performing these functions the markets will become more
efficient and information flow will increase making the markets less volatile in the long- run.
Next, the specific role of investment banks is discussed in capital raising in the primary markets.
Security Analysts

Security analysis examines and evaluates individual securities to estimate the results of investing
in them. In making judgment about valuation of securities the analyst must seek out reliable
information. This information can come from financial statements, discussions with company
executives, clients, and suppliers. The discipline requires detailed analysis and diligence.

There are several barriers to the development of the security analysis profession in emerging
markets. Lack of timely and reliable information is of utmost importance. If The pumping of
funds into these companies by venture capitalists raised the market expectations, and the share
prices of these Internet companies inflated tremendously. However, these valuations proved to be
unsustainable as the share prices of these companies dropped sharply in April 2000. Eventually,
these led to the “bubble burst”,having far- reaching implications on the U.S. economy as a whole,
which economists refer to as the “lemons problem.”

information is available late or has been manipulated then the security analyst cannot do the
valuation. If it is too costly to obtain the information then that becomes another hurdle. There is
also a lack of expertise available to do this research and analysis.

Security analysts can play an important role in advising potential investors on a wide range of
corporate governance issues that include shareholder rights, independent directors, and hostile
takeovers.
INDIAN LAWS GOVERNING SECURITIES MARKET INTERMEDIARIES

The SEBI crafted a comprehensive regulatory framework encompassing all intermediary

categories—the Intermediary Regulations. However, most of the provisions are yet to be notified,
except those dealing with enforcement orders and procedures.

Today, intermediaries continue to be governed by the specific regulations governing each

category of intermediaries, which inter alia include:

 The SEBI (Stock Brokers and Sub- brokers) Regulations, 1992;

 The SEBI (Depositories and Participants) Regulations, 1996;
 The SEBI (Bankers to an Issue) Regulations, 1994; the SEBI (Merchant Bankers)
Regulations, 1992;
 The SEBI (Portfolio Managers) Regulations, 1993;
 The SEBI (Registrar to an Issue and Share Transfer Agents) Regulations, 1993;
 The SEBI (Underwriters) Regulations, 1993.

The basic structure of all these regulations includes the registration requirements, eligibility
conditions, continuous compliance requirements, perpetuity or renewal of registrations (as the
case may be), code of conduct, disclosures, maintenance of books/records, inspection and
disciplinary proceedings, investigation, enquiry, adjudication, enforcement orders, and appeal
powers.

Despite the basic structural commonalities, the specific regulations pertaining to the various
categories of intermediaries are not uniform in terms of continual disclosures, display of
registration certificate at intermediary offices, prohibition of irresponsible investment advice and
disclosure of interests involved, permanency of registration, redressal of investor grievances, and
specific conflict of interests and corporate governance provisions found in Regulations 4, 12(2),
15, 11, 13 and the Code of Conduct of the Intermediary Regulations, inter alia. A consolidated
intermediary regulatory framework based on consistent objective standards—which would be able
to account for the common requirements of intermediaries while preventing conflicts in
interpretation with the specific regulations for each category—is essential today. From an
administrative perspective, a consolidated framework would be convenient, especially while
legally amending the common intermediary requirements/mandates. Hence, effectuating the
Intermediary Regulations is critical to disciplining the market.
CONFLICT OF INTEREST
Defrauding by intermediaries

The term “conflict of interests” is widely used to identify situations where pecuniary or other
competing interests prevent a party from acting in a certain manner, which would otherwise be
legally or ethically appropriate; however, there is no universally accepted definition for the same.
A conflict of interests situation can generally be understood as a situation where the multifaceted
interests of an individual are in inter se conflict. In the context of market intermediaries, such
conflicts are augmented by the vast and diversified client base, endless product innovations,
undisclosed and complex market mechanics, and simultaneous operations in multiple intermediary
services.

(i) Client financing by intermediary: Where the intermediary has extended finance facility
(loans/credit) to any of its clients, it will tend to invest the client’s funds in a manner that
facilitates the expeditious recovery of the loan/credit, regardless of the investment objectives of
the client.

(ii) Churning: Churning refers to a situation where a broker, for the sole purpose of generating
commissions and maximising its income, is involved in excessive trading on a client’s account,
even when such trading involves unprofitable investments or unnecessary transaction costs for the
client.

(iii) Use of clients’ funds for proprietary trades: Intermediaries may give advice to their
clients that is contrary to what the real circumstances demand, and then use the funds earned by
commission to trade as per the real market conditions on the proprietary account. This conflict is
more prevalent when the intermediary is operating in different capacities; for instance, as a market
analyst and investment advisor for the client and also as a stock broker undertaking proprietary
trades.

(iv) Aggregation of orders: Aggregation of orders placed by clients with proprietary accounts,
undertaken primarily for reducing administrative costs and enhanced convenience, may benefit
the intermediary at a client’s cost.

(v) Competitive actions: Intermediaries may indulge in unfair competitive practices, such as
soliciting and inducing other intermediaries’ clients, which is detrimental to investors and market
functions.

(vi) Circular trading: Circular trading involves the buying/selling of certain scrips inter se the
intermediary and its group entities or other intermediaries to create artificial volume in the scrip,
thus causing an increase in the price of the scrip

(vii) Laddering: Laddering involves favourable share allotment to investors (mostly institutional
investors) who promise to purchase further shares from the secondary market through the same
intermediary. Such practices not only result in discriminatory market practices but also create
artificial stock prices to lure retail investors.
(viii) Stuffing {Underwriting v. investor interest}: When an intermediary underwrites an issue
and simultaneously represents investors in the same issue, the investors might end up paying a
higher issue price. Moreover, the intermediary may make false and fraudulent statements to sell
the issue. Further, underwriters often shift their potential loss from unsuccessful underwritings to
a client account that is not well monitored by the client and is subject to the underwriter’s
discretion and decisions. This is known as stuffing.

(ix) Internal Conflicts

This category involves intra-intermediary conflicts, such as in the case of an intermediary having
group operations. What is in the best interests of the group may not be in the best interests of a
specific branch or subsidiary. In such a situation, decisions are usually taken factoring the overall
interest of the group, resulting in losses to the branch/subsidiary concerned and its related clients.
This conflict has become more rampant with the increasing percentage of corporate
intermediaries.

Similarly, when intermediaries under common ownership deal in diverse categories of

intermediary services, what is profitable for one service may be detrimental to another.

Multiple Services Conflicts

This category includes the conflicts inherent in the practice of multiple intermediary services by
the same intermediary (or intermediaries under common ownership). For instance, when two
intermediaries are owned by the same proprietor, with one providing analyst and advisory services
and the other underwriting an issue, the analyst’s report and investment advice is likely to be
prejudiced and biased in favour of the underwritten issue. Similarly, the common owner may use
the insider information procured during the underwriting process by one of its concerns for
subsequent trading in those shares, either on its own account or on behalf of clients through
another concern.

Another example of this conflict category is where a merchant banker rolls out a public issue and
recommends investor subscription to this issue in the capacity of an investment advisor, regardless
of the actual health of the issue. The variety of services rendered by an intermediary is directly
correlated with the situations involving conflicts of interest; i.e., with the increase in such
services, the probability and likelihood of conflicts of interests also rise.
REGULATING THE ACTIVITIES OF INTERMEDIARIES

Conflicts of interests involving securities market intermediaries are inevitable and can be expected
to increase with further progression and maturity of the market. While this issue cannot be
eliminated, it can certainly be regulated to check any exorbitant abuse and to mitigate losses.
Some regulatory efforts to this end are discussed below.

 Regulatory efforts of RBI.

 Regulatory efforts of SEBI

Regulatory efforts of RBI

Reserve Bank of India (RBI)

The RBI, vide the Master Circular on Prudential Norms for Classification, Valuation, and
Operation of Investment Portfolio by Financial Institutions (RBI, 2012), prescribed an internal
control system for investments made by specified financial institutions:

 Clear functional separation of trading, accounting, and settlement, with monitoring and
control.Clear separation of proprietary account, portfolio management client account, and
other constituents’ (such as brokers) account. Further, any transactions between the
financial institution’s proprietary account and portfolio account are required to be strictly
at arm’s length rates.
 Portfolio management client’s account must be subjected to a separate audit by an external
auditor.
 In the case of placement of funds for portfolio management by the same client on more
than one occasion, on a continuous basis, each such placement should be treated as a
separate account.
 Portfolio management client services are required to be in the nature of investment
consultancy/management for a fee, entirely at the client’s risk without any guarantee of
investment returns.
 A client having a portfolio account is entitled to get periodic statements of its portfolio
account.[xix]

Regulatory efforts of SEBI

The SEBI is cognisant of the menace of conflicts of interests at the intermediary level, as reflected
in several of its regulatory provisions.

 Regulation 15 of the Intermediary Regulations: This requires an intermediary as well as

its directors, officers, employees, and key management personnel (henceforward, “related
persons”) to disclose any direct or indirect interest of itself or its dependents in any
security of which it renders any investment advice. Further, it forbids them from rendering
any investment advice unless they have reasonable grounds to believe that the
recommendation is suitable. However, the SEBI does not explain what grounds will
qualify as reasonable to make an advice appropriate, and much is left for the
intermediaries to interpret.
 Regulation 16 of the Intermediary Regulations read with the Code of Conduct
(Schedule III)[xx]: An intermediary, along with its related persons, are required to
conform at all times to the Code of Conduct (henceforward, the Code), which includes the
following provisions for conflicts of interests:

 Specific provisions for conflict of interests, requiring intermediaries to avoid situations

involving conflicts of interests, to make adequate disclosures of its interests (including
potential sources and areas of conflict) to the public, and to resolve any such conflicts in
an equitable manner. (Article 4 of the Code)
 Best efforts to protect investors having considered the client’s needs, environment, and its
own professional skills. (Article 1.1 of the Code)
 High standards of integrity, fairness, dignity, ethics, and professionalism in conduct of
business. (Article 1.2 of the Code)
 Exercise of due diligence, independent professional judgment, and no collusion with other
intermediaries. (Article 1.3 of the Code)
 No misrepresentation, misleading, or exaggerated statements to clients. (Articles 3.2 and
3.3 of the Code)
 Quality disclosures to enable clients to make well-informed and balanced decisions.
(Article 3.1 of the Code)
  No indulgence in any unfair competition practices that are prejudicial to investors. (Article
5.1 of the Code)
 No indulgence in corrupt practices such as price rigging, creation of false market, passing
of price sensitive information, or activities distorting the market equilibrium, for personal
gain. (Article 5.3 of the Code)
 Arm’s length relationship with respect to activities undertaken in different intermediary
categories or market positions.

(iii) Regulation (17)(2)(b) of the Intermediary Regulations read with Article 6.1 of the
Code: An intermediary is required to implement adequate internal control systems and safeguards.

(iv) Regulation 12(4) of the Intermediary Regulations read with Article 5.2 of the Code: An
intermediary is required to maintain records, data, and back-up at all times, which can facilitate
tracing any defaults and manipulations.

(v) Regulation 3 of the Intermediary Regulations read with Form A (Schedule I): An
intermediary is required to disclose its ownership structure and the details of its promoters at
the time of registration, which could potentially help the regulator to manage conflicts of interests
arising from the same proprietors undertaking multiple intermediary services or from the owners
having any conflicting engagements.

As was stated earlier, since most of the Intermediary Regulations are not yet operative, these
provisions are only persuasive in nature. Nevertheless, most of these provisions are mirrored in
the specific intermediary regulations and their respective codes of conduct as well, and
intermediaries are mandatorily bound by similar provisions for conflicts of interests (discussed
later in more detail).

(vi) SEBI (Investment Advisors) Regulations, 2012[xxi]: While the SEBI approved this
regulation in August 2012, it is yet to be notified. This regulation requires an investment adviser
to act in a fiduciary capacity towards its clients, segregate other activities undertaken—such as
distribution, referral, or execution business—from advisory services, and disclose all conflicts of
interests, including any commission remuneration or compensation received from such other
services.

While direct commercial exploitation of investors from irresponsible and ignorant investment
advice may be curtailed by regulating the entities providing investment advice to investors for a
commission, the advice rendered without any fee attributable to it is excluded from the ambit of
this regulation, as suggested by the Investment Advisory Board of the SEBI in the 3–4 November,
2012 meeting (SEBI, 2012c). Thus, it is yet to be seen how these regulations are implemented
with regard to the otherwise specifically exempted intermediary categories in practice (SEBI,
2012b).

Further, these regulations encompass the class of investment advisers providing investment
advisory services to private investment trusts, family offices, private equity funds, venture capital
funds, and hedge funds. The regulations do not exempt from certification this class of advisers,
although their services are directed towards sophisticated institutional investors, who are expected
to be aware of investment risks.

It is pertinent to note that the U.S. Investment Advisers Act, 1940 provides exemptions from
registration with the SEC to investment advisers in certain circumstances; e.g., if the investment
adviser has less than fifteen clients, it does not hold itself out generally to the public as an
investment adviser, and it does not advise investment companies. Likewise, under the Financial
Advisers Regulations, 2002 of Singapore, a financial adviser is exempt from holding a financial
adviser’s license if it provides advice to only thirty accredited investors.

Therefore, an exemption along these lines in the Regulations would be very beneficial, as this
would enable the regulator to focus on and commit its resources to monitoring the investment
advisers that cater to the more vulnerable investor category of retail investors, and would greatly
reduce the administrative burden.
PROHIBITION OF INSIDER TRADING

The SEBI (Prohibition of Insider Trading) Regulations, 1992 (henceforward, the Insider
Trading Regulations): Any dealing in securities by an insider while in possession of unpublished
price-sensitive information is prohibited.

Thus, although the Insider Trading Regulations is not specific to intermediaries, it condemns
dealing in securities by intermediaries based on or while in possession of insider information, e.g.,
information procured while underwriting an issue, whether as an agent for its clients or as the
principal on its proprietary account.16

 The Insider Trading Regulations also mandate the creation of a “Chinese wall” for the
segregation of the departments/undertakings with access to unpublished price-
 sensitive information from the public areas.17 Following this, the intermediaries are
required to put in place “Chinese walls” to check abuse of confidential information, more
so when the same entity operates as intermediary in different capacities, such as
underwriter as well as investment advisor.
 Further, analysts preparing the research reports of a company are forbidden from trading in
its securities for thirty days from the preparation of such report, and are required to
disclose their interest, if any, in the company.

Specific intermediary regulations: The SEBI has issued several circulars under the SEBI (Stock
Broker & Sub-broker) Regulations, 1992, mandating the segregation of broker proprietary monies
from client monies,19 the disclosure of proprietary trading undertaken to its clients,20 and so on.
Similar preventive provisions are also found in the SEBI (Portfolio Managers) Regulations,
1993,21 the SEBI (Merchant Bankers) Regulations, 1992,22 and the SEBI (Underwriters)
Regulations, 1993.

(x) SEBI on churning in the context of mutual funds: While condemning conflicting
practices like churning in the context of mutual funds, the SEBI recommended the inclusion of
misselling as a “fraudulent and unfair trade practice” under the SEBI (Prohibition of Fraudulent
and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (henceforward, the
FUTP Regulations) (SEBI, 2012b).

(xi) Regulation 4(2) of the FUTP Regulations: In addition to general fraudulent and unfair
trade practices such as false statements or concealment of truth, promises made without intending
to perform, and so on, the FUTP prohibits certain practices specific to intermediaries, such as an
intermediary reporting transactions in an inflated manner to its client so as to increase its
commission/brokerage; circular transactions with respect to a security entered into between
intermediaries to provide a false and inflated impression of trading; an intermediary
buying/selling securities in advance of a substantial client order, or where a futures or option
position is taken about an impending transaction in the same or related futures or options contract,
and so on.
Despite these FUTP provisions, it appears that fixing the liability of intermediaries under these
regulations is qualified by the onerous “knowledge” test; i.e., unless it can be proved that the
broker had the knowledge of the circular nature of trades directed by its client, the broker cannot
be held liable.

Further, the FUTP Regulations need clearer interpretations, more so in view of the recent
Securities Appellate Tribunal (SAT) order26 stating that the FUTP Regulations do not clearly
define “front-running”[xxiv] and therefore, setting aside the SEBI order penalising certain
intermediaries for front-running.

Having said that, there have been several instances recently where the SEBI took proactive
measures against intermediaries under the FUTP Regulations.

Considering that most of these regulatory provisions prefix the conflicts of interests aspect with
the word “shall,” it appears that the SEBI intends to create mandatory obligations of
intermediaries in this regard. However, there are a few exceptions to this rule-based regime, such
as the requirement of arm’s length relationship (mentioned earlier in this section), which is a
“shall endeavour to” provision, and thus, is only recommendatory in nature. Therefore, it may be
stated that the law relating to conflicts of interests of intermediaries in India is a blend of rule-
based and principle-based regulations. While it is well acknowledged that most of the conflicts of
interests are dependent on internal controls, the Indian capital market is still not mature enough to
rely completely on self-regulation and culture rectification. Thus, despite containing several
lacunae and loopholes, the current combination of rule- based and principle-based regulatory
framework in India is appreciable in today’s context. The onus now lies on the effective
implementation of this framework, which continues to be a challenge.
CHALLENGES
In fixing accountability of intermediaries

Managing conflicts of interests of intermediaries and fixing their accountability is an onerous

challenge, which further intensifies with the increasing complexities and diversities of the market.
Some of the emerging aspects that can potentially increase the abuse of conflict of interests by
intermediaries are discussed below.

(i) Outsourcing of intermediary services: Intermediary services are no exception to the surge of
inbound and outbound outsourcing witnessed by India. Taking cognizance of this, the SEBI issued
certain guidelines on outsourcing by intermediaries in 2011,[xxv]similar to the 2011 Guidelines
on Outsourcing for Capital Market Intermediaries issued by the Securities Commission
(Malaysia).

While the SEBI (through this circular) retains accountability and liability of the registered
intermediaries with respect to all outsourced services, it does not require the third-party
outsourced entities to procure any regulatory approval or registration prior to undertaking such
outsourced assignments. Further, unlike the 2011 Malaysia Guidelines, it does not make any
distinction between domestic and offshore/outsourced entities in terms of due diligence,
regulation, and governance. Considering that this circular is still in a nascent stage, it is yet to be
seen how the intermediaries implement and conform to these outsourcing principles.

(ii) Market analysts and researchers: While analysts/researchers associated with mainstream
intermediaries such as broking houses, merchant bankers, and so on are regulated, those operating
on an independent and standalone basis, especially those providing services other than for a fee
(SEBI, 2012c), remain outside any registration requirements of the regulator, which necessitates a
comprehensive regulatory regime for them, similar the U.S. rules .

(iii) Rapid growth of intermediaries: With the rapid increase in the number of intermediaries
in the Indian market, it becomes difficult to identify the genuine and authorised intermediaries
from the disguised, fraudulent ones. In this context, it is essential that the SEBI publishes a
comprehensive updated database of all registered intermediaries, similar to what the Monetary
Authority of Singapore publishes.[xxvi] While the SEBI website provides lists of recognised
intermediaries,[xxvii] these lists are not updated; some of the lists date back to 2009.

To combat the menace of abuse of market mechanics caused by the faceless market interface of
the anonymous technology-driven trading platforms, a comprehensive institutionalised definition
of “intermediaries” is urgently needed to determine the regulatory contours and eliminate the
unrecognised entities floating in the market without any streamlined accountability. Moreover,
standardised benchmarks regulating intermediaries’ conduct, on similar lines as the Intermediary
Regulations, must be made operational at the earliest to facilitate the fixation of accountability.

(iv) Lack of expertise and advent of hybrid products: The risks linked to market dealings
aggravate manifold owing to the complex and hybrid products floating in the market today. The
dearth of expert intermediary services increases the market apprehensions. It is high time that the
dealings in complex products were restricted to only intermediaries having
expertise/qualifications, ascertained through certification programs, minimum experience
conditions, and so on[xxviii].

(v) Irresponsible and unauthenticated news/rumours: Despite the SEBI’s directions to control
the circulation of unauthenticated news/rumours having serious market implications, this problem
persists, more so in smaller towns and remote areas lacking sophisticated corporate
intermediaries. The “stock guru” scam involving crores of investors’ monies duped by certain
individuals through fake offices, celebrity promotion, and ambitious promises of returns equalling
double the invested amount within six months, which was unravelled recently is a glaring example
of the abuse of naive investors. To this end, the SEBI must take proactive steps towards investor
education and awareness, with a focus on retail investors, such that investors are able to exercise
prudence and judgement to filter information prior to making investments based on such
information. This becomes all the more critical considering that the SEBI is an active player at the
IOSCO, and heads the Asia-Pacific Regional Committee of the IOSCO.

(vi) Extensive anti-corruption laws: Factoring the impact of the U.S. Foreign Corrupt Practices
Act, 1977, along with the U.K.’s Bribery Act, 2010, Indian companies and individuals all over the
world with foreign exposure, including market intermediaries, must put in place anti-corruption
compliance policies and procedures. Failing to do so may trigger strict enforcement actions and
prosecutions by the U.S. Department of Justice and the SEC. Further, anti- corruption compliance
must be factored by intermediaries while selecting their outsourcing/business partners, as any
direct or indirect U.S./U.K. exposure can trigger anti-corruption enforcement actions.

Companies and commercial ventures are now significant interested parties to corruption matters
pursuant to extensive corruption laws at the international level. Therefore, the SEBI must take
cognisance of this less explored but critical area in the context of actions of market intermediaries
and market participants as a whole.
CONCLUSION

Since the reliance on principle-based compliance demands a more mature capital market and since
the Indian capital market has still not matured, a rule-based avoidance regime of conflicts of
interest is predominant in India, which is evidenced in various SEBI Regulations and the Code of
Conduct, the SEBI enforcement actions, and the RBI Guidelines.

While a shift from a rule-based towards a principle-based compliance regime should not be hasty,
and must be aligned with India’s market conditions, regulations and rules35 alone cannot remedy
such situations of conflict, which need to be supplemented with enduring principles and an ethical
business culture.

Creating robust internal control systems and self-regulation are the two primary and predominant
mechanisms to establish this culture. Although India has been debating over the establishment of
SEBI-registered Self-Regulatory Organisations (SROs) for market intermediaries for a long time,
and despite the SEBI having promulgated the SEBI (Self- Regulatory Organisations) Regulations,
2004 (the “SRO Regulations”) for the recognition and constitution of SROs, this concept
continues to remain theoretical. While the SEBI has advocated the formation of a registered SRO
for intermediaries36 and has more recently proposed the formation of a self-regulatory board for
investment advisors,37 the proposition to this end is yet to materialise. Most jurisdictions like the
U.S., Japan, Korea, and Turkey have established SROs—the National Association of Securities
Dealers for brokers, Japan Stock Dealers Association, Korean Stock Dealers Association, and the
Association of Capital Market Intermediary Institutions for all capital market intermediaries,
respectively. Although India has a few functional industry associations like the Association of
Mutual Funds of India for the mutual funds industry, they are not yet registered with the SEBI as
SROs under the SRO Regulations.38 To work at par with international markets and to cope with
intermediary challenges, the Indian market eagerly awaits the launch of its first SEBI-registered
intermediary SRO.

Intermediaries Associated with

the Securities Markets

Primary market intermediaries

 Merchant bankers Merchant bankers play an important role in issue management

process. Lead managers (category I merchant bankers) have to ensure correctness of the
information furnished in the offer document. They have to ensure compliance with SEBI
rules and regulations as also Guidelines for Disclosures and Investor Protection. To this
effect, they are required to submit to SEBI a due diligence certificate confirming that the
disclosures made in the draft prospectus or letter of offer are true, fair and adequate to
enable the prospective investors to make a well informed investment decision. The role of
merchant bankers in performing their due diligence functions has become even more
important with the strengthening of disclosure requirements and with SEBI giving up the
vetting of prospectuses. SEBI's various operational guidelines issued during the year to
merchant bankers primarily addressed the need to enhance the standard of disclosures.

It was felt that a further strengthening of the criteria for registration of merchant bankers
was necessary, primarily through an increase in the net worth requirements, so that their
capital would be commensurate with the level of activities undertaken by them. With this
 in view, the net worth requirement for category I merchant bankers was raised in 1995-96
to Rs. 5 crore. In 1996-97, the SEBI (Merchant Bankers) Regulations, 1992 were amended
to require the payment of fees for each letter of offer or draft prospectus that is filed with
SEBI. Part III gives further details of the registration of merchant bankers during 1996-97.

 Underwriters Underwriters are required to register with SEBI in terms of the SEBI
(Underwriters) Rules and Regulations, 1993. In addition to underwriters registered with
SEBI in terms of these regulations, all registered merchant bankers in categories I, II and
III and stockbrokers and mutual funds registered with SEBI can function as underwriters.
Part III gives further details of registration of underwriters. In 1996-97, the SEBI
(Underwriters) Regulations, 1993 were amended mainly pertaining to some procedural
matters.

 Bankers to an Issue Scheduled banks acting as bankers to an issue are required to be

registered with SEBI in terms of the SEBI (Bankers to the Issue) Rules and Regulations,
1994. These regulations lay down eligibility criteria for bankers to an issue and require
registrants to meet periodic reporting requirements. Part III gives further details of
registration of bankers to an issue.

 Portfolio managers Portfolio managers are required to register with SEBI in terms of the
SEBI (Portfolio Managers) Rules and Regulations, 1993. The registered portfolio
managers exclusively carry on portfolio management activities. In addition all merchant
bankers in categories I and II can act as portfolio managers with prior permission from
SEBI. Part III gives further details of the registration of portfolio managers.

 Debenture trustees Debenture trustees are registered with SEBI in terms of the SEBI
(Debenture Trustees) Rules and Regulations, 1993. Since 1995-96, SEBI has been
monitoring the working of debenture trustees by calling for details regarding compliance
by issuers of the terms of the debenture trust deed, creation of security, payment of
interest, redemption of debentures and redressal of complaints of debenture holders
regarding non-receipt of interest/redemption proceeds on due dates. Part III gives further
details of the registration of debenture trustees.

 Registrars to an Issue and Share Transfer Agents Registrars to an issue (RTI) and share
transfer agents (STA) are registered with SEBI in terms of the SEBI (Registrar to the Issue
and Share Transfer Agent) Rules and Regulations, 1993. Under these regulations,
registration commenced in 1993-94 and is granted under two categories: category I - to act
as both registrar to the issue and share transfer agent and category II - to act as either
registrar to an issue or share transfer agent. With the setting up of the depository and the
expansion of the network of depositories, the traditional work of registrars is likely to
undergo a change.

Secondary Market Intermediaries

 Stock brokers All stock brokers dealing in securities are registered with SEBI in terms of
SEBI (Stock Brokers and Sub Brokers) Regulation 1992. During 1996-97, 391 additional
brokers were registered with SEBI making the total registered membership to 8,867 as on
March 31, 1997.

 Sub brokers In many cases, individual investors transact in securities through sub
brokers. It is therefore absolutely imperative to regulate this class of intermediary. As on
March 31, 1997 only 1,798 sub brokers were registered with SEBI. The main reason for
 the limited success in registering large number of sub brokers is that brokers are reluctant
to take responsibility of the acts of the sub-brokers. Measures initiated by SEBI for
bringing sub-brokers more fully under the ambit of regulatory oversight have been
described earlier in this Report.

STOCK MARKET INDICATORS

What Are Stock Indices?

 A stock market index is a statistical measure which shows changes taking place in the
stock market. To create an index, a few similar kinds of stocks are chosen from amongst
the securities already listed on the exchange and grouped together.
The criteria of stock selection could be the type of industry, market capitalisation or the
size of the company. The value of the stock market index is computed using values of the
underlying stocks. Any change taking place in the underlying stock prices impact the
overall value of the index. If the prices of most of the underlying securities rise, then the
index will rise and vice-versa.
In this way, a stock index reflects overall market sentiment and direction of price
movements of products in the financial, commodities or any other markets.

 Some of the notable indices in India are as follows:

 a. Benchmark indices like NSE Nifty and BSE Sensex
 b. Broad-based indices like Nifty 50 and BSE 100
 c. Indices based on market capitalization like the BSE Smallcap and BSE Midcap
 d. Sectoral indices like Nifty FMCG Index and CNX IT

2. Why are stock indices required?

The stock market index acts like a barometer which shows the overall conditions of the market.
They facilitate the investors in identifying the general pattern of the market. Investors take the
stock market as a reference to decide about which stocks to go for investing.
The following lists the importance of stock market index:

a. Aids in Stock-Picking
In a share market, you would thousands of companies listed on the exchange. Broadly, picking the
appropriate stock for investment may seem like a nightmare. Without a benchmark, you may not
be able to differentiate between the stocks. Simultaneously sorting the stocks becomes a
challenge. In this situation, a stock market acts like an instant differentiator. It classifies the
companies and their shares based on key characteristics like the size of company, sector, industry
type and so on.

b. Acts as a Representative
Investing in equities involves risk and you need to take an informed decision. Studying about
stocks individually may seem very impractical. Indices help to fill the knowledge gaps that exist
among the investors. They represent the trend of the whole market or a certain sector of the
market. In India, the NSE Nifty the BSE Sensex act as the benchmark indices. They are believed
to indicate the performance of the entire stock market. In the same manner, an index which is
made up of pharma stocks is assumed to portray the average price of stocks of companies
operating in the pharmaceutical industry.

c. The Parameter for Peer Comparison

Before including a stock in your portfolio, you have to assess whether it’s worth the money. By
comparing with the underlying index, you can easily judge the performance of a stock. If the stock
gives higher returns than the index, it’s said to have outperformed the index. If it gives lower
returns than the index, it’s said to have underperformed the index.
You would definitely want to invest in a multibagger so as to justify the risk assumed. Else you
can be better off investing in low-cost professionally managed index funds. You may also
compare the index with a set of stocks like the Information technology sector. As an investor, you
can know market trends easily.

d. Reflects Investor Sentiment

When you are participating in equity markets, amongst other things, knowing investor sentiment
becomes an important aspect. It is because the sentiment affects the demand for a stock which in
turn impacts the overall price. In order to invest in the right stock, you should know the reason
behind the rise/fall in its prices. At this juncture, indices help to gauge the mood of investors. You
may even recognize investor sentiment for a particular sector and across market capitalizations.

e. Helps in Passive Investment

Passive investment refers to investing in a portfolio of securities which replicates the stocks of an
index. Investors who want to cut down on the cost of research and stock selection prefer to invest
in index portfolio. Consequently, the returns of the portfolio will resemble that of the index. If an
investor’s portfolio resembles the Sensex, then his portfolio is going to deliver returns of around
8% when the Sensex earns 8% returns.

3. How are stock market indices developed?

An index is made up of similar stocks based on market capitalization, industry or company size.
Upon selection of stocks, the index value is computed. Each stock will have a different price and
price change in one stock would not be proportionately equal to the price change in another. So,
the value of the index value cannot be arrived at as a simple sum of the prices of all the stocks.
Here is when the importance of assigning weights to stocks comes into play. Each stock in the
index is assigned a particular weightage based on its market capitalization or price. The weight
represents the extent of the impact that the stock’s price change has on the value of the index.
The two most commonly used stock market indices are as follows:

a. Market-cap weightage
Market capitalization refers to the total market value of the stock of a company. It is calculated by
multiplying the total number of outstanding stocks floated by the company with the share price of
a stock. It, therefore, considers both the price as well as the size of the stock. In an index which
uses market-cap weightage, the stocks are assigned weightage based on their market capitalization
as compared to the total market capitalization of the index.
Suppose a stock has a market capitalization of Rs. 50,000 whereas the underlying index has a total
market-cap of Rs. 1,00,000. Thus, the weightage given to the stock will be 50%.
It is important to note that market capitalization of a stock changes every day with the fluctuation
in its price. Due to this reason, weightage of the stock would change daily. But usually such a
change is marginal in nature. Moreover, the companies with higher market-caps get more
importance in this method.

In India, free-float market capitalization is used by most of the indices. Here, the total number of
shares listed by a company is not used to compute market capitalization. Instead, use only the
amount of shares available for trading publicly. Consequently, it gives a smaller number than the
market capitalization.

b. Price weightage

In this method, the value of an index value is computed based on the stock price of a company
rather than the market capitalization. Thus, the stocks which have higher prices receive greater
weightages in the index as compared to the stocks which have lower prices. This method has been
used in The Dow Jones Industrial Average in the US and the Nikkei 225 in Japan.