HISTORY & DEVELOPMENT OF SECURITIES LAW: INDIAN PERSPECTIVE
Author: Aryan Sinha, IV year of B.B.A.,LL.B.(Hons.) from Galgotias University
It is essential for a country’s economy that its stock exchange market has robust health. The more well developed a country’s stock exchange market, the higher are the probabilities of economic development.
History & Development
In April 1601 the English Malay Archipelago Company sent its first expedition to the East Indies and second expedition by the same ships in March 1604. The shareholders in these two voyages made a profit of more than 90% on their investment. After the initial 12 voyages were financed separately, the corporate(s) sifted to a structure of finance that spread risks over several voyages and then became a fully-fledged joint-stock company, with, after 1657, continuous investment unrelated to voyages. In 1688 trading in its stocks began on the London Stock Exchange Market.[i] But the origins of the premium global stock exchange market dwell medieval Italy were within the city-states of Venice, Genoa and Florence new financial arrangements emerged out of growing trade between East and West and advances included such development as deposit banking, marine insurance, bill of exchange, joint-stock companies and transferable securities.[ii] The century between the enactment of the Bubble Act, 1720 and its repeal in 1825 was a particularly a fertile phase for the later development of English company law. Many legal contrivances, generally related to modern company law were developed during this apparent ‘dark age’ for technical innovation. New means and sorts of shareholding and capital raising were developed during this era. Preference shares, debentures and deferred shares were all first introduced during this era of apparent inaction. This was also a period during which considerable refinement occurred in respect of how the liability of shareholders could be limited.[iii]
Amsterdam became the payments centre for the 17th-century European economy. Increasingly it had been only in Amsterdam that merchants and bankers could obtain the bills of exchange they required to settle transactions across Europe.[iv] Though Paris and London were the primary centres of speculation in 1720 they were joined by Amsterdam, Geneva, Hamburg, Lisbon and Vienna.[v]
Amsterdam emerged as the centre of a worldwide marketplace for government debt employed by both borrowers and investors from across Europe and later the United States of America. In contrast, the 18th century wasn’t a period when joint-stock companies flourished once the surplus of the speculative bubble of 1719 – 1720 was over. Only a little nucleus of companies existed whose shares were actively traded and these were more proxies for state debt, as the Bank of England and therefore the English Malay Archipelago.[vi]
Beginning of Securities Market
The earliest stock exchange market was found in Amsterdam in 1602 and it had been involved in buying and selling of shares for Dutch Company. Before this, brokers existed in France handling government securities. It must be noted that the very first real stock exchange market started in Philadelphia within the United States of America during the late 18th century. Later, the New York Stock Exchange Market became popular and Wall Street became the hotspot of brokerage activities. Earlier stockbrokers were largely unorganised, but later most of them joined hands to make institutions and organisations. Security Trading in India goes back to the 18th century when the Malay Archipelago Company began trading in loan securities.
The derivatives market is functioning in India in some form or the opposite for an extended time. Corporate shares with the stock of Bank and Cotton presses started being traded within the 1830s in Mumbai with Bombay Cotton Trade Association being the very first to start the future trading in 1875 within the arena of commodities trading and by the starting of 1900s, India had one among the world’s largest futures industry. Going back to the 1850s the roots of stock exchanges in India sprouted when 22 stockbrokers began trading opposite the Town Hall (Government Building) of Bombay under a banyan tree. The tree remains present within the area and is recognised as Horniman Circle.
This trading continued till a shift to banyan trees at the Meadows Street Junction, which is now referred to as Mahatma Gandhi Road, a decade later. The shift was an ongoing one and the number of brokers gradually increased, finally settling in 1874 at what’s referred to as Dalal Street. The group of 318 people came together to make “Native Shares and Stock Brokers Association” and therefore the membership fee was Rs 1. This association is now recognised as Bombay Stock Exchange (BSE) and in 1965 it had been given permanent recognition by the Government of India under the “Securities Contracts (Regulation) Act, 1956”[vii]. BSE is additionally the oldest stock exchange Market in Asia and it’s been 144 years since it has been formed. Following its formation, the Ahmedabad stock exchange market came into operation in 1894 trading in shares of textile mills. Another development within the history of stock exchanges began with the Calcutta stock exchange opening up in 1908 and commenced trading shares of plantations and fibre mills. It was followed by the Madras Stock Exchange Market starting in 1920.
There was manipulation by brokers during 1918 – 1919. Out of heavy public hue & cry, the Bombay Legislative Council established a Committee to analyse the functions of the Bombay Stock Exchanges and eventually, the Bombay Securities Contracts Control Act, 1925, the very first law to regulate the stock exchanges, was regulated. This law first defined ‘stock exchanges’ which were required to be recognized by the Governor-in-Council and stock exchanges had to submit rules and regulations for handling the securities.
Again during 1928 – 1938, there was an enormous loss in share markets suffered by investors and the Bombay State Government appointed Morrison Committee though the Government didn’t accommodate their suggestions. Immediately after independence, Parliament passed the Capital Issues (Control) Act, 1947 to regulate the issue of securities strictly within the territory of India.
Post-independence Era and Reforms within the Market
There were a series of reforms within the stock exchange market between 1993 and 1996 which further caused the event of exchange-traded equity derivatives markets in India.
There was a particular element of the trading system called “Badla” involving some elements of forwards trading which had been alive for many years. This practice led to the expansion of undesirable market practices and to certify this development it had been prohibited off and on till it had been banned in 2001. Within the 1980s stockbroking services were restricted only to the rich class who could afford them. With the spread of Web Development, stockbroking became accessible.
In the 1990s the stock exchange market witnessed a gentle increase in stock market crises. A facet of those crises was market manipulation on the secondary market. Following are the incidents which prompted the development of the stock market:-
1. Harshad Mehta 1992: The very first “stock market scam” involved both the GOI bond and equity markets. Thereafter, manipulation was supported on inefficiencies within the settlement system in GOI bond market transactions. Inflation happened within the equity markets and therefore the market index went up by 143% between September 1991 and April 1992 and the amount involved within the crises was approx. Rs 54 billion.
2. MS Shoes 1994: Here the dominant shareholder of the firm, took large leveraged positions through brokers at both Delhi and Bombay stock exchanges, to control share prices before the rights were offered. After the share prices crashed, the broker defaulted and BSE was shut down for three days as a consequence.
3. Sesa Goa 1995: Another episode of market crises for the BSE was the case of price manipulation of the shares of Sesa Goa. This was perpetrated by two brokers, who later failed on their margin payments on leveraged positions within the shares and therefore the exposure was about 4.5 million.
4. Bad Deliveries of Physical Certificates 1995: When anonymous trading and therefore the nationwide settlement became the norm by the end of 1995, there was an increased incidence of fraudulent shares being delivered into the stock exchange market. The expected cost of encountering fake certificates in equity settlement in India at the time was as high as 1%.
5. CRB Group 1997: C.R. Bhansali created a gaggle of companies, called the CRB group, which was a conglomerate of finance and non-finance companies. Market manipulation was a crucial focus of group activities. The non-finance companies routed funds to finance companies for price control. The non-finance companies were tasked with sourcing funds from external sources, using corrupted performance numbers. The CRB episode was particularly important in the way it exposed extreme failures of supervision on a part of RBI and SEBI. The aggregate amount involved within the episode was Rs 7 billion.
6. BPL, Videocon, Sterlite 1998: This was an episode of market manipulation involving the broker that engineered the stock exchange market bubble of 1992, Harshad Mehta. He seems to have worked on manipulating the share prices of those three companies, in collusion.
7. Ketan Parekh 2001: This was triggered by a fall in the prices of IT stocks globally. Ketan Parekh was seen to be a pacesetter of the episode, with leveraged positions onset of stocks called the “K10 stocks”. There are allegations of fraud during this crisis concerning an illegal “Badla” market at the Calcutta Stock Exchange Market and banking fraud.
The above instances have had a disruptive effect on the market that’s:
Intermediation between households investing in shares and firms financing projects by issuing shares which were resolved by reform methods by the government.
In the post-independence era, the BSE dominated the magnitude of trading. However, the low level of transparency and undependable clearing and settlement systems, aside from other macro factors, increased the necessity for a financial market regulator, and therefore the SEBI was born in 1988 as a non-autonomous body. Later it was made a statutory body in 1992.
Thereafter, in 1952 cash settlement and options trading were prohibited by the government and derivatives trading shifted to informal forward methods in the stock exchange market. At the present, the government allows for market-based pricing mechanisms and shows less scepticism towards derivatives trading. The prohibition on futures trading of the many commodities was lifted starting within the early 2000s and national electronic exchanges were created. Within the 1980s stockbroking services were used only by a wealthy class who could afford them. With the development of the Internet, stockbroking services became accessible to even the commoner. Major organisations and corporations became involved in stockbroking activities.
Although within the wake of the Harshad Mehta scam in 1992, there was a pressing need for an additional stock exchange market large enough to compete with BSE and convey transparency to the stock exchange market. It resulted in the development of the National Stock Exchange Market (NSE). It had been incorporated in 1992, became recognised as a stock exchange market in 1993, and trading began thereon in 1994. It had been the very first stock exchange on which trading was conducted electronically. In response to the present competition, BSE also introduced an electronic trading system referred to as BSE Online Trading (BOLT) in 1995.
Thereafter, BSE launched its sensitivity index, the Sensex, known at the present because the S&P BSE Sensex, in 1986 with 1978-79 as the base year. This is often an index of 30 companies and maybe a benchmark stock market index, measuring the general performance of the exchange. Equity derivative methods were introduced by the exchange in 2000. Index options were launched in June 2001, stock options in July 2001, and stock futures in November 2001. India’s first free-float index, BSE Teck, was launched in July 2001. Its competitor, NSE launched its benchmark exchange, the CNX Nifty, now referred to as Nifty 50, in 1996. It comprises 50 stocks and functions as a performance measure of the stock exchange. In terms of electronic screen-based trading and derivatives, it has left behind its competitor BSE by introducing first of its kind consultancies, products and services.
Current Stock Exchanges
After the establishment of BSE and NSE, 23 stock exchanges were added not including the BSE. At the present, there are 23 approved stock exchanges in India out of which 6 are functional:-
Calcutta Stock Market Exchange
India International Exchange (India INX)
Metropolitan Stock Exchange Market
NSE IFSC Ltd
Thus, from the days when buyers and sellers had to assemble at stock exchanges for trading till these times when the dawn of Information & Technology has made the operations at stock exchanges electronic hence making stock markets available online. Trading facilities are often accessed from home or office on the phone or the Internet. Therefore, with new products and services, rampant growth available in stock trading can be foreseen.
[i] James Fulcher, Capitalism: A very short introduction, Page 1 and 3 Oxford University Press 2004.
[ii] Ranald C. Michie, The Global Securities Market: A History, Page 17, Oxford University Press 2008.
[iii] Rob Mc Queen & Ashgate, A Social History of Company Law: Great Britain and the Australian Colonies 1854 - 1920, Page 17.
[iv] Ranald C. Michie, The Global Securities Market: A History, Page 24, Oxford University Press 2008.
[v] Ranald C. Michie, The Global Securities Market: A History, Page 34, Oxford University Press 2008.
[vi] Ranald C. Michie, The Global Securities Market: A History, Page 38, Oxford University Press 2008.
[vii] Securities Contract (Regulations) Act 1956, IndiaCode https://www.indiacode.nic.in/handle/123456789/1644?view_type=browse&sam_handle=123456789/1362