Regulation of Intermediaries
Participants in the Indian capital market are required to register with SEBI to perform their businesses, these include, stockbrokers, sub brokers, share transfer agents, bankers to an issue, trustees of a trust deed, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers, and other such intermediaries who may be associated with the securities market in any way;
Stockbrokers are not permitted to buy, sell, or deal in securities, unless they hold a certificate granted by SEBI. At the end of March 1997, they numbered 8,867; each stockbroker is subject to capital adequacy requirements consisting of two components that are, basic minimum capital and supplementary or optional capital related to volume of business. The basic lowest capital requirements vary from one exchange to another. A SEBI regulation requires stockbrokers of BSE or NSE to maintain a least amount of Rs500, 000 (about $14,000), which is the major requirement among the stock exchanges.
However, BSE and NSE want their respective members to deposit with them larger amounts. The additional or optional capital and the basic minimum capital united have to be maintained at 8 percent or more of the gross outstanding business in the exchange (the gross outstanding business means the cumulative amount of sales and purchases by a stockbroker in all securities at any point during the settlement period). Sales and purchases on behalf of customers may not be netted but may be included to those of the broker, there is no compulsory qualification test for stockbrokers and other market participants in India, unlike other countries such as Japan, United Kingdom, and United States.
a. Sub brokers
Most stockbrokers in India are still comparatively small. They cannot afford to directly cover every retail investor in a geographically vast country and in such a complex society; so, they are allowed to transact with sub brokers as the latter play an indispensable role in intermediating between investors and the stock market.
An applicant for a sub broker certificate must be associated with a stockbroker of a recognized stock exchange. A sub broker application may take the form of sole proprietorship, partnership, or corporation. There are two major issues concerning sub brokers in the Indian capital market: majority of sub brokers are not registered with SEBI; and the function of the sub broker is not clearly defined.
No sub broker is supposed to purchase, sell, or deal in securities, without a certificate granted by SEBI. However, there were only about 2,593 sub brokers registered with SEBI as of end-June 1997, while the number of stock sub brokers in India was estimated in the range of 50,000 to 200,000.
The Indian law defines a sub broker as any person, not being a member of a stock exchange, who acts on behalf of a stockbroker as an agent, or otherwise, to assist the investors in buying, selling, or dealing securities through such a stockbroker, based on this definition, the sub broker is either a stockbroker’s agent or an planner for the investor. So, legally speaking, the stockbroker as a principal will be answerable to the investor for a sub broker’s conduct if a sub broker acts as his or her agent. However, the market practice is different from this legally defined relationship. In reality, the stockbroker, in general, issues a contract note of a transaction even to a registered sub broker, thus treating the latter as counterparty; this implicitly denies the stockbroker’s privities with the investor.
NSE does not officially allow its members to transact with end-investors through a sub broker, this is probably because NSE has liberal membership criteria and its computerized trading network can easily provide geographically scattered stockbrokers with direct access to trading on NSE. However, many trading members of NSE have been using registered and unregistered sub brokers.
To sort out this confusion, SEBI enforced the following measures in March 1997: initiation of criminal actions on complaints received against unregistered sub-brokers in suitable cases; revival of the institution of “remisier” under rules and bylaws of the stock exchanges; and prohibition of stockbrokers in dealing with unregistered sub brokers or unregistered remisiers after 1 June 1997 .
In spite of these actions, the confusion has remained; there is a need to address the basic issue of clarifying the responsibility of the sub broker and to operationally define its relationship with the stockbrokers.
b. Merchant Bankers
Under the old system, there were four categories of registered merchant bankers with different minimum net worth requirements. Under the new policy, the categories were abolished. Among other provisions, a merchant banker applicant is required to have a least net value of Rs50 million. The new policy has drawn a clear-cut line between the merchant banker and the nonbanking finance company (NBFC). Under the old policy, a merchant banker is permitted to carry out fund based activities such as deposit-taking, leasing, bill discounting and hire-purchasing. The new policy no longer permit a merchant banker to engage in these fund-based activities apart from for those related exclusively to the capital market such as underwriting. The merchant banker is required to stop such activities within two years.
Likewise, an existing NBFC (nonbanking finance company) performing merchant banking activities is required to relinquish such activities after a certain period of time. The merchant banking industry in India has numerous problems, the major ones being that there are too many merchant bankers, and that they are considered to be relatively incompetent. Only 20 merchant bankers account for 60-85 percent of the merchant banking business, while 148 of them are in business only on paper, in May 1997, a substantial number of merchant bankers were found to be professionally irresponsible or negligent. SEBI listed 134 merchant bankers of Categories I, II, and III who broke their underwriting commitments for possible disciplinary actions, of this number, 95 were in Category I. Moreover, there have been records of listing delay or rejection of initial public offerings (IPOs) in the recent past.