Broker-run exchanges, main cause for the imbroglio

By Oommen A. Ninan

MUMBAI, MARCH 9. The recent developments in the capital market bring into sharp focus the urgency of preventing brokers from running the stock markets. The Government and the Securities and Exchange Board of India (SEBI) should speed up the demutualisation or corporatisation of the broker-driven stock exchanges, according to knowledgeable market observers.

``We have moved the Government for the demutualisation of exchanges which will involve some legal issues and the Government is examining them,'' said Mr. D. R. Mehta, Chairman, SEBI. He feels the brokers should not be allowed to run the stock exchanges as there is a moral conflict of interest. He said the Bombay Stock Exchange could adopt one of several models - at the New York Stock Exchange the president is a non-broker, in some exchanges 50 per cent of the governing body are non-brokers and there is the National Stock Exchange pattern where professionals run the exchange.

One of the major issues that the market regulator is inquiring into at present is whether the BSE followed the norm that the surveillance of market operations was handled only by the Executive Director. Earlier SEBI had issued detailed guidelines on this matter and emphasised that surveillance should be handled only by executive directors.

The latest crisis shows how the markets can be manipulated with brokers conducting the stock exchange's day-to-day affairs. They are both participants and regulators and this is the crux of the issue. This is not a situation that has emerged all of a sudden, it has been there for several years. One Executive Director of BSE who controlled all aspects of the exchange effectively was Mr. M.R. Mayya. After his retirement none of his successors was able to take control of the exchange as the presidents always overshadowed them.

Till 1994, equity markets in the country were dominated by the BSE. A major policy initiative by SEBI in 1993 that all exchanges should move over to screen-based trading - a decision motivated by considerations of transparency - was first reflected in the establishment of the National Stock Exchange in 1994 which is run by professionals. Later the nation-wide response received for NSE forced the BSE, Asia's oldest stock exchange, to adopt the screen based trading system from March 1995.

Numerous payment crises have occurred in recent years on Indian stock exchanges. Since the reform process began, the BSE was plagued with malpractices which involved member brokers. First, it witnessed the securities scam and then followed a series of payment crises. In April 1995, immediately after introducing screen based trading, the market witnessed in the context of M. S. Shoes, a default involving a total exposure of Rs. 18 crores which led to a payment crisis on the BSE. The issue brought the functioning of the premier exchange to a halt for three days. The late Nineties saw the same Harshad Mehta of the 1992 securities scam moving share prices indirectly. This culminated in the price rigging of shares of BPL, Sterlite and Videocon in June 1998.

Mr. J. C. Parekh, the then president of BSE, along with its vice- president and executive director Mr. R. C. Mathur, had to resign after SEBI initiated an enquiry into the price rigging episode. Even though SEBI debarred several brokers from market operations for varying periods for their involvement in the price rigging case, the issue has remained inconclusive and no action has been taken against the entities involved even after three years.

Mr. Anand Rathi's resignation from the presidentship of BSE on Thursday comes in the wake of allegations of his involvement in the unnatural rise and fall of the benchmark Sensex, specially two days after the Budget. He was under fire from several quarters following the March 2 crash of the index by 176 points after a rise of 177 points on budget day. Now there are reports that several governing board members of the BSE also were involved in the episode.

Those closely watching the stock markets, especially the BSE, point out that the members' interests always clash with the regulation and administration of the exchange. The need of the hour is to separate the ownership rights and trading rights.

The BSE apparently has some legal problems. An Act of Parliament can facilitate the demutualisation process. The BSE is an association of persons and it should be converted into a company. In case of conversion there may be issues related to capital gains, stamp duty and Companies Act. So the BSE is saying that it should have a Demutualisation Act which would address all these issues.

``Our view has been that demutualisation is desirable and we recommended to the Government that the legal impediments should be removed,'' said Prof. J.R. Varma, full time member of SEBI Board. In other countries also, demutualisation took place under separate statutes or an Act of Parliament. ``Our view is clear that we are in favour of demutualisation at the earliest as it gives greater flexibility for the exchanges,'' he added.

In the current set up, brokers own the exchange and elect the governing board that runs the affairs of the exchange. Once the ownership rights and trading rights get separated a broker will be able to sell his ownership right while retaining his trading right. Once this happens it will be the owners who will elect the board and the owners need not be the same brokers.

However, demutualisation alone may not solve all the problems that broker-driven exchanges are facing, but it will definitely bring in the much needed transparency, Prof. Verma said.

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