CONTENTS

1. BASIC INVESTMENT MATHEMATICS................................................................................................................2

1.1 CAPITAL STRUCTURE.............................................................................................................................................2
1.2 COST OF CAPITAL..................................................................................................................................................2
1.3 PLANNING THE CAPITAL STRUCTURE....................................................................................................................3
1.4 EBIT & EPS..........................................................................................................................................................3
1.5 CORPORATE BENEFITS...........................................................................................................................................4
1.6 VALUATION OF EQUITIES.......................................................................................................................................5
1.6.1 Dividend Capitalisation Approach................................................................................................................5
1.6.2 Earnings Per Share & Price-Earnings Approach.........................................................................................6
1.6.3 Book Value Approach....................................................................................................................................6
1.6.4 Liquidation Value of the Share Approach......................................................................................................7
1.7 RISK AND RETURN................................................................................................................................................7
1.7.1 Return............................................................................................................................................................7
1.7.2 Risk................................................................................................................................................................8
1.7.3 Beta................................................................................................................................................................8
1.7.4 Relationship between Risk and Return..........................................................................................................9
1.7.5 Unsystematic Risk..........................................................................................................................................9
1.7.6 Portfolio Risk.................................................................................................................................................9
2. MARKET INDICES.................................................................................................................................................11
2.1. METHODS OF COMPUTATION..............................................................................................................................11
2.2 ISSUE SIZE CHANGE IN AN INDEX SECURITY......................................................................................................12
2.3 IMPACT COST.......................................................................................................................................................13
3. TIME VALUE OF MONEY AND CAPITAL BUDGETING................................................................................14
3.1 TIME VALUE OF MONEY.....................................................................................................................................14
3.1.1 Future Value of a Single Cash Flow............................................................................................................14
3.1.2 Future Value of an Annuity..........................................................................................................................15
3.1.3 Present Value of a Single Cash Flow...........................................................................................................15
3.1.4 Present Value of an Annuity.........................................................................................................................16
3.2. CAPITAL BUDGETING..........................................................................................................................................16
3.2.1. Capital Investment Decision.......................................................................................................................16
3.2.2. Average Rate of Return...............................................................................................................................17
3.2.3. Payback Period..........................................................................................................................................17
3.2.4 Internal Rate of Return................................................................................................................................18
3.2.5. Net Present Value........................................................................................................................................18
4. FINANCIAL STATEMENT ANALYSIS.................................................................................................................20
4.1 INTRODUCTION....................................................................................................................................................20
4.2 TYPES OF FINANCIAL RATIOS..............................................................................................................................20
4.2.1 Liquidity Ratios...........................................................................................................................................20
4.2.2 Leverage Ratios...........................................................................................................................................21
4.2.3 Turnover Ratios...........................................................................................................................................21
4.2.4 Profitability Ratios.......................................................................................................................................22
4.2.5 Valuation Ratios...........................................................................................................................................23
4.3 PROBLEMS OF FINANCIAL STATEMENT ANALYSIS...............................................................................................23
5. SECURITIES CONTRACTS (REGULATION) ACT, 1956....................................................................................28

6. SECURITIES CONTRACTS (REGULATION) RULES, 1957..............................................................................34

7. SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992........................................................................37

8. SEBI (STOCK BROKERS AND SUB-BROKERS) REGULATIONS, 1992.........................................................41

9. SEBI (DISCLOSURE & INVESTOR PROTECTION) GUIDELINES, 2000........................................................50

10. SECURITIES AND EXCHANGE BOARD OF INDIA (INSIDER TRADING) REGULATIONS, 1992.........52

11. SEBI (SUBSTANTIAL ACQUISITION OF SHARES AND TAKEOVERS) REGULATIONS, 1997................54

12. SEBI (PROHIBITION OF FRAUDULENT AND UNFAIR TRADE PRACTICES RELATING TO

SECURITIES MARKETS) REGULATIONS, 1995....................................................................................................57

13. SEBI’S STOCK WATCH SYSTEM.......................................................................................................................61

13.1 DATABASES........................................................................................................................................................61
13.1.1. Issuer Database........................................................................................................................................61
13.1.2. Securities Database..................................................................................................................................61
13.1.3.Trading Database......................................................................................................................................62
13.1.4 Member Database.....................................................................................................................................62
13.2 ALERTS..............................................................................................................................................................62
13.2.1 Online Real Time Alerts.............................................................................................................................62
13.2.2 Online Non real Time Alerts......................................................................................................................62
13.3 PARAMETERS FOR ALERT GENERATION............................................................................................................62
13.3.1 Price Bands System...................................................................................................................................62
13.3.2. Auction Market.........................................................................................................................................63
13.3.3 Quantity Freeze Percentage (volume of large order)................................................................................64
13.3.4 Price Variation...........................................................................................................................................64
13.3.5 High-Low Variation...................................................................................................................................64
13.3.6 Open Price Variation.................................................................................................................................64
13.3.7 Consecutive Trade Price Variation............................................................................................................64
13.3.8 Quantity Variation.....................................................................................................................................64
13.3.9 Price movement in relation to the index....................................................................................................65
14. OFF-LINE SURVEILLANCE................................................................................................................................68
14.1 MARGINS...........................................................................................................................................................68
14.1.1 Mark to Market Margin............................................................................................................................68
14.1.2 Volatility Margin.......................................................................................................................................68
14.1.3 Gross Exposure Margin............................................................................................................................69
14.1.4 Daily Margin Payable...............................................................................................................................70
14.2 EXCEPTION HANDLING......................................................................................................................................72
14.2.1 Exception Handling in Regular market.....................................................................................................72
Security shortage..................................................................................................................................................72
Bad delivery..........................................................................................................................................................72
Company Objections............................................................................................................................................73
Auction Settlement................................................................................................................................................73
14.2.2 Exception Handling for account period settlement in Book Entry segment..............................................73
Security shortage..................................................................................................................................................73
14.3 CAPITAL ADEQUACY NORMS FOR BROKERS.....................................................................................................74
14.3.1 Base Minimum Capital..............................................................................................................................74
14.3.2 Additional Base Capital.............................................................................................................................74
New CM Members................................................................................................................................................75
14.3.3 Exposure limits.....................................................................................................................................75
14.4 COMPLIANCE.....................................................................................................................................................77
14.4.1 Inspection..................................................................................................................................................77
14.4.2 Investigation..............................................................................................................................................77
15. SURVEILLANCE IN RISK MANAGEMENT.....................................................................................................78
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DECISIONS OF THE INTER-EXCHANGE SURVEILLANCE GROUP.................................................................82

SYLLABUS FOR THE SURVEILLANCE MODULE.............................................................................................105

FURTHER READINGS:............................................................................................................................................107

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 1. BASIC INVESTMENT MATHEMATICS

1.1 Capital Structure

The two principal sources of long term finance of a firm are equity capital and debt capital. The
term financial leverage indicates the proportion of these two sources of finance employed by a
firm.

A share denotes a unit of owner’s capital of a corporate. It may further be classified as ordinary
or preference. Ordinary shares do not carry any fixed rate of return but carry voting rights. The
equity shareholders are paid an annual dividend depending on the profitability of the firm, which
is proposed by the Board and passed in the Annual General Meeting of the company. Preference
Shareholders are entitled to a fixed percentage of dividend per year and they have preference in
the payment of dividend over the ordinary shares. The preference shares can also be of
Convertible or the non-Convertible types. Sometimes shares issued at the time of the initial
offering (IPOs) or Rights Issue may be accompanied by a warrant which entitles the holder to
subscribe to a fixed number of shares after a mentioned period of time at a fixed price. These
warrants are sometimes listed and traded on the exchange as a security.

Example 1: ‘A limited’ has issued debentures of face value Rs.100/- each which is to be
converted into 5 Equity shares. If the market value of the debenture is Rs.90 what is the
conversion price?

Solution: Conversion price = Face value / Conversion ratio

= 100/5
= 20 i.e. Rs.20/-
Conversion ratio is the number of equity shares being issued per debenture.

Various theories have been evolved to understand the relationship between financial leverage and
cost of capital. One of the most popular approach in this regard was enunciated by Modigliani
and Miller. Some of the terms used in this regard are discussed below.

1.2 Cost of Capital

Cost of Debt capital (Kd) = Annual Interest charges (F) / Market value of Debt (B)

Cost of Equity capital (Ke) = Equity earnings (E) / Market value of Equity (S)

Weighted Average Cost of Capital (Ko) = (We x Ke) + (Wd x Kd)

Where We = Proportion of equity to total capital
Wd = Proportion of debt to total capital

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1.3 Planning the Capital Structure
Various factors that influence the planning of the capital structure of a firm includes: the income
of equity shareholders, risks- business risks and finance risks, ability of the firm to raise capital
and regulatory norms.

The implication of alternative financing plans on Earnings and the shareholders can be anlaysed
by studying EBIT and EPS.

1.4 EBIT & EPS

Net Profit earned before payment of interest and tax is termed as Earnings before Interest and tax
(EBIT). On payment of interest and tax, the firm is left with profit available for distribution of
dividend, also called as Earnings After Tax (EAT).

EAT = EBIT – Interest – Tax

Earnings After Tax are available for dividend to both types of shareholders, equity as well as
preference.

Equity earning is profit left after payment of preference dividend from EAT.

Earning Per Share (EPS) is defined as the earnings available for distribution to equity
shareholders.

EPS = equity earnings / no. of equity shares

The relationship between EBIT and EPS is as follows:

EPS = (EBIT – I) (1-t)/n

Example 2: The capital structure of a firm would be influenced by the following factors
(a) Business and Financial risks
(b) SEBI guidelines for Public Issues
(c) The firms own ability
(d) All of the above
Ans. (d)

Example 3: The Earnings Per Share is defined as

(a) EAT – Preference dividend / No of equity shares
(b) EAT / no. of equity shares
(c) EAT / no. of equity shares plus no. of preference shares
(d) EBIT / no. of equity shares
Ans. (a)

Example 4: The cost of capital of a firm is

(a) cost of Equity capital only
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(b) cost of Debt capital only
(c) cost of Debt plus Equity capital
(d) none of the above
Ans. (c)

Example 5: Which of the firms has a high degree of financial leverage?

(a) A firm with only equity capital
(b) A firm with equal proportion of equity capital and debt
(c) A firm with debt capital which is thrice as much as equity capital
(d) A firm with equity capital which is four times as much as debt capital
Ans. (c)

1.5 Corporate Benefits

Benefits accorded to the equity shareholders in the form of dividend, rights and bonus are termed
collectively as corporate benefits. These are normally given to those investors whose names
appear in the Register of Members of the company before the commencement of the Book
Closure period or before the record date. Dividend is the share of the profit paid out to the
owners of the company. Rights refers to the right to subscribe to a proportionate number of
shares at a specified price. Bonus refers to the method of capitalisation of reserves by offering
free shares to the existing shareholders in proportion to their holding. When bonus shares are
issued, earning per share declines.

Ex-Bonus means without bonus. The buyer of an ex-bonus share is not entitled to the bonus
shares. Bonus shares are allotted on a set date to all those shareholders recorded on the books of
the company as of a previous date of record.

Ex-Dividend is a synonym for "without dividend." The buyer of an ex-dividend share is not
entitled to the next dividend payment. Dividends are paid on a set date to all those shareholders
recorded on the books of the company as of a previous date of record.

Ex-Rights means without rights. Companies raising additional money may do so by offering
their shareholders the right to subscribe to new or additional shares, usually at a discount from
the prevailing market price. The buyer of a share selling ex-rights is not entitled to the rights.

The rights issue involves selling of securities to the existing shareholders in proportion to their
current holding. When a company issues additional equity capital it has to be offered in the first
instance to the existing shareholders on a pro-rata basis as per Section 81 of the Companies Act,
1956. The shareholders may by a special resolution forfeit this right, partially or fully by a
special resolution to enable the company to issue additional capital to the public.

A company making a rights issue sends a letter of offer along with four forms A, B, C, D to the
shareholders, Form A is meant for acceptance of the rights and has a column stating the no. of
shares that the holder is entitled to and also a column for additional shares. Form B is used for
renouncing the rights in favour of someone else. Form C is meant for application by the person
in whose favour the rights have been renounced. Form D is to be used to make a request for split

6
forms. The composite application forms must be mailed to the company within a period of 30
days.

Value of a right share:

The value of a share after the rights issue is calculated as follows:

Ex- rights price of a scrip = NPo + M S
N + M

Where N = No. of existing shares held

M = No. of right shares entitled for a holding of N shares
Po = Cum rights price of the scrip
S = Subscription price for the rights.

1.6 Valuation of Equities

1.6.1 Dividend Capitalisation Approach

The intrinsic value (P0) of the stock paying a dividend ‘D’ and the expected price of ‘P 1’ and the
required rate of return of ‘Rr’ is given by P0 = (D + P1) / (1+Rr)

Therefore from the above formula, we can derive the required rate of return (Rr) as
Rr = (D / P0) + g where (D / P0) is called as Dividend Yield.

The expected price ‘P0’ of the equity share which has a price growth of ‘g’ and the required rate
of return ‘Rr’ is given by P0 = D/(Rr - g)

Example 6: The dividend per share of ABC Ltd is Rs.5.00. It is expected to grow at a rate of 4%
per year. What is the expected rate of return for the investor when the current market rate of the
share is Rs.50.
Rr = (5.00/50.00) + 4% i.e. 10% + 4% = 14%

In case of companies having the Earnings as the only source of income, then the intrinsic value
of share given the dividend pay out ratio, growth rate and the required rate of return is given by

Intrinsic Value = (Earning per share * Dividend payout ratio)*100

(Discount rate - Growth rate)

Example 7: What is the intrinsic value per share of scrip XYZ Ltd. given the following?
Earning per share : Rs. 3.00
Dividend pay out ratio : 0.6
Discount rate : 15%
Growth rate : 6%

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Solution:
Intrinsic Value = (Earning per share * Dividend payout ratio)*100
(Discount rate - Growth rate)
= (3.00 * 0.6)*100 / (15 - 6) = Rs. 20

1.6.2 Earnings Per Share & Price-Earnings Approach

The other approach used in financial analysis is the Price–Earnings (P/E) ratio approach, the
value as per the P/E approach is given by

Value = Earning per share (EPS) * Price Earnings ratio

Where EPS = (Profit after Tax /No. of equity shares outstanding)

P/E = (Market Price of the share / EPS)

Example 8: What is the Price-Earnings ratio of the company if the Profit after Tax is Rs.100
crore. The preference dividend to be paid is Rs.10 crore and the outstanding equity is 90 lakh
shares. The current market rate of the share is Rs.250/-.

EPS = (PAT – Preference Dividend)/Issue Capital

= (Rs.100 cr. – Rs.10 cr.)/ 90 lakh shares
= 100

Therefore, P/E = Market Price / EPS = Rs.250 / 100 i.e. 2.5.

Example 9: The market capitalisation of ABC Ltd. on March 31, 1999 is Rs.250 crore. The
company announces a Profit after Tax of Rs.1000 crore. What is the earning price ratio of ABC
Ltd.?

E/P = EPS / Market Price

= PAT / Market Capitalisation

where, Market Capitalisation = Market Price * Issue Capital

Therefore, E/P = Rs.1000 crore / Rs.250 crore i.e. 4.00

1.6.3 Book Value Approach

Book value per share of a company is

Book Value = (net worth of the company / no. of shares outstanding)

where net worth includes equity capital of the company, reserves and surplus. The intrinsic value
thus arrived may vary due to the accounting policy followed by the company.

8
Example 10: What is the book value of the firm having a net worth of Rs.2500 crore and the
number of shares outstanding is 50 crore?

Intrinsic Book Value = Rs.2500 core/ 50 crore i.e. Rs.50

1.6.4 Liquidation Value of the Share Approach

The value of the shares on liquidation of the company is calculated after deducting the amount to
be paid to the creditors & the preference shareholders. Thus the value of the share is given by
Value = (Liquidation Value of the company–Amount paid to the creditors & preference
shareholders) /No. of equity shares outstanding.

Example 11: The company XYZ Ltd. is liquidated realizing Rs.10 crore from liquidation of it
assets. The company had to pay Rs.1 crore to the creditors. What is the value of the share, if the
total outstanding number of share is 45 lakh.

Value of each share = (Rs.10 crore – Rs.1 crore)/ 45 lakh shares; i.e. Rs.20

1.7 Risk and Return

The value of a firm is affected by two key factors: risk and return. Higher the risks higher the
return, other things being equal and vice versa.

1.7.1 Return

The return from an investment is the profit / loss made by the owner during a given period of
time. It is expressed as a percentage of the beginning-of-period value of the investment.

Example 12: The close price of Infosys Technologies on 31-Mar-98 was Rs.1850.15 and the
close price as on 31-Mar-99 was Rs.2930.00. What is the return earned during the period, if the
dividend income during the period is 0.

Return = (Pt - Pt-1)*100/Pt-1 = 100*(2930 - 1850.15)/1850.15 = 58.37%

If the dividend income is also taken into account then the return can be expressed as Return = (D
+ (Pt - Pt-1))*100/Pt-1
The expected rate of return on a portfolio is the sum of the product of the weightage of individual
securities and their returns.
ERp =  wi * RI where i = (1, 2, 3, …n)

Example 13: Suppose, the portfolio contains three stocks A, B and C which are having
weightages of 25%, 40% and 35% respectively in the portfolio. What would be expected return
of the portfolio if the individual stock returns are 10%, 15% and 20% respectively.

Rp = Wa*Ra + Wb*Rb + Wc*Rc

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 = 25%*10% + 40%*15% + 35%*20% = 15.5%

Therefore return on the portfolio is 15.5%.

1.7.2 Risk

Risk is the measure of deviation from the expected value. Risk is measured by Variance, which
is the square of Standard Deviation.

While holding stocks, there is a certain amount of risk that can be removed and certain amount of
risk that cannot be removed.

The risk that cannot be removed is called as Systematic risk or Un-diversifiable risk. Systematic
risk includes shortage in money supply, economic policy followed by the country etc.

However, a part of risk that can be removed is called as Unsystematic risk or Diversifiable risk.
The diversifiable risk is specific to a company like emergence of a competitor, non-availability
of raw materials etc. An investor can reduce such risk by holding stocks of various industries.

Example 14: Portfolio ‘A’ spreads its money equally over 4 stocks. Portfolio ‘B’ spreads its
money equally over 8 stocks. Portfolio ‘C’ spreads its money equally over 16 stocks. Portfolio
‘D’ spreads its money equally over 32 stocks. All these stocks are picked from various industry
groups. Which of the four portfolios has the lowest risk?

Ans. Portfolio ‘D’ is likely to have the lowest unsystematic risk.

1.7.3 Beta

The investors, in order to eliminate the diversifiable risk, hold portfolios of various stock. Hence
the risk is of the portfolio is measured by its non-diversifiable risk. The non-diversifiable is
measured by beta, . Beta measures the extent to which the returns fluctuate as compared to the
returns of the market, which is represented by a market index. The value of Beta for a market
index (S&P CNX Nifty) is always 1.

Given the standard deviation of the returns of the security and the index, Beta is given by
Bj = Cov (Rj ,Rm) / 2M i.e. = jm j m/ 2M
= jm j/m
where jm is the correlation coefficient between the return on the jth security and the return on
the market portfolio, j is the Std. Dev. of security and m is the Std. Deviation of market index.

Example 15: What is the beta value of the security XYZ which has standard deviation of return
of 10% while the standard deviation of return on the S&P CNX Nifty Index is 5%. The
correlation coefficient between the stock XYZ and the Index is –0.9.

Beta = jm j/m

= -0.90 * 10% / 5% i.e. - 1.80
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Example 16: A portfolio has a beta of 0.5. It is well diversified, and carries little unsystematic
risk. On average, on a day when Nifty rises by 2%, how much does the portfolio value change?

Portfolio value = Beta * Return on index = 0.5*2 = 1%

1.7.4 Relationship between Risk and Return

The Capital Asset Pricing Model, also called as CAPM, explains the relationship between the
risk and return of a security. The relationship between the risk and the return as explained by
CAPM is given be the formula:

RoRj = Rf + j * (RoRm - Rj)

Where RoRj is the required rate of return on the security j; Rf is the risk free rate of return, m is
the beta coefficient of security j and RoR m is the expected rate of return on the market portfolio
(market index)
In the above equation (RoRm - Rj) is also called as the risk premium.

Example 17: The stock XYZ Ltd. has a beta of 0.80 and a standard deviation 4 % per day. S & P
CNX Nifty has a standard deviation of 1.3% per day. How much is the unsystematic risk of the
stock?

1.7.5 Unsystematic Risk

Unsystematic Risk = Total Risk – Systematic Risk

From CAPM,
Unsystematic Risk = [Var(Security Returns) – Var(j*Nifty Returns)]
= [ 4%2 – (0.802 * 1.3%2)]
= (14.65)
= 3.83%

1.7.6 Portfolio Risk

The portfolio risk is measured by the standard deviation of the portfolio rate of return. The
riskiness of a portfolio consisting of 2 securities is given by the formula:

p = [(wi2 * i2) + (wj2 * j2 ) + (2 * wi * wj * i * p * ij) ]

Where
p is the standard deviation of portfolio return
wi is the weightage of security i in the portfolio
wj is the weightage of security j in the portfolio
ij is the corellation coefficient between the returns of securities i and j
i is the standard deviation of return of security i

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 j is the standard deviation of return of security j

Note: If the weightages of the securities i and j are not given, then it should be assumed that the
securities have an equal weightage of 50% each in the portfolio.

Example 18: A portfolio consists of two securities A and B. Considering the values as given in
the table below, what is the standard deviation of the portfolio return consisting of these two
securities in the proportion of 45% and 55% respectively.

Correlation coefficient between the returns of securities i and j (ij) 0.75

Standard deviation of return of security i (i) 0.25
Standard deviation of return of security j (j) 0.20

The standard deviation of return on the portfolio would then be

p = [(wi2 * i2) + (wj2 * j2 ) + (2 * wi * wj * i * p * ij) ]

= [(0.452 * 0.252) +(0.552 * 0.202 ) +(2 * 0.45 * 0.55 * 0.25 * 0.20 * 0.75)]
= [( 0.0127) + (0.0121) + (0.0186)]
= (0.0434)
= 20.83%
The portfolio risk, therefore, would be 20.83%.

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 2. MARKET INDICES

2.1. Methods of Computation

(a) Price Weighted Arithmetic Mean Method.

(b) Capitalisation Weighted Arithmetic Mean Method.
(c) Price Weighted Geometric Mean Method.
(d) Capitalisation Weighted Geometric Mean Method.

Example 1: Index comprises of the following four securities on the base date.

Share Price Total Shares

A 20.00 4000
B 60.00 5000
C 145.00 2000
D 15.00 10000

(a) Price Weighted Arithmetic Mean Method.

Base and Share Weightages.

Share Price Weightage

A 20.00 20.00 / 240.00 0.0830
B 60.00 60.00 / 240.00 0.2500
C 145.00 145.00 / 240.00 0.6042
D 15.00 15.00 / 240.00 0.0625
Base 240.00 Total = 1.0000

Index = 1.0000  1000 = 1000

Prices Today:

Share Price Issue Size

A 45.00 4000
B 50.00 5000
C 150.00 2000
D 15.00 10000

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Share Weightages

Share Price Weightage over Base

A 45.00 45.00 / 240.00 0.1875
B 50.00 50.00 / 240.00 0.2083
C 150.00 150.00 / 240.00 0.6250
D 15.00 15.00 / 240.00 0.0625
PriceTotal 260.00 Total = 1.0833
Base 240.00

Index = 1.0833  1000 = 1083.30 or 260.00/240.00  1083.30

(b) Capitalisation Weighted Arithmetic Mean Method.

Base Capitalisation and Weightages on base day:

Share Price Issue Size Capitalisation Weightage
A 20.00 4000 80,000 80,000/8,20,000 0.098
B 60.00 5000 3,00,000 3,00,000/8,20,000 0.366
C 145.00 2000 2,90,000 2,90,000/8,20,000 0.354
D 15.00 10000 1,50,000 1,50,000/8,20,000 0.183
Base Capitalisation 8,20,000 Total 1.000

Index = 1.000  1000 = 1000

Prices Today:

Share Price Issue Size Capitalisation Weightage over Base Cap

A 45.00 4000 1,80,000 1,80,000/8,20,000 0.219
B 50.00 5000 2,50,000 2,50,000/8,20,000 0.305
C 150.00 2000 3,00,000 3,00,000/8,20,000 0.366
D 15.00 10000 1,50,000 1,50,000/8,20,000 0.183
Total Market Capitalisation 8,80,000 Total 1.073
Base Capitalisation 8,20,000

Index = 1.073  1000 = 1073.00 or 8,80,000/8,20,000  1073.00

2.2 Issue Size Change in an Index Security

Index value should remain constant even if the issue size and issue price changes on account of
corporate action/change in composition.

Index Value (I) = {Market Capitalisation (M)/ Base Capitalisation (B)}  Initial Index Value
(IIV)
14
Change in Market Capitalisation (M) = *Change in Issue Size  Issue Price
Index should not move with change in issue size.
Therefore
I = {(M + M)/(B +B)}  IIV
 B +B = (M + M)  (IIV/ I)
 B +B = M  IIV/ I + M  IIV/ I
 B +B = B + M  IIV/ I
New Base Capitalisation = Old Base Capitalisation + M  IIV/ I
or
Change in Base Capitalisation (B) = M  IIV/ I

Example 2: On April 5, the total market capitalisation of S&P CNX Nifty is Rs. 197500 crore
and base capitalisation is Rs. 195000 crore. It is decided to replace Scrip A, a constituent of S&P
CNX Nifty having a market capitalisation of Rs. 1000 crore with scrip B that has a market
capitalisation of Rs. 900 crore with effect from April 6. What is the revised base capitalisation of
the S&P CNX Nifty on April 6?

IIV = 1000
M= 197500
B =195000
I = 197500/195000 = 1012.8205
M = 1000-900= -100
New Base Capitalisation = 195000 + (-100  1000)/1012.8205
New Base Capitalisation = 194901
Hence Index Value = 197400/194901 = 1012.8205

2.3 Impact Cost

Example 3: Given the order book for a security, compute the impact cost to buy 1500 shares of
the security.

Order Book
Buy Quantity Buy Price Sell Price Sell Quantity
1000 98.00 99.00 1000
2000 97.00 100.00 1500
1000 96.00 101.00 1000

Impact cost to buy 1500 shares

Ideal Price: (98.00 +99.00)/2 = 98.50

Actual Buy Price = (1000  99.00 + 500  100.00) / 1500 = 99.33
Impact Cost ={(Actual Price - Ideal Price)/ Ideal Price}  100
Impact cost to buy 1500 shares = {(99.33 - 98.50) / 98.50}  100 = 0.84%.

15
 3. TIME VALUE OF MONEY AND CAPITAL BUDGETING

3.1 Time Value of Money

Money has time value. A rupee is less valuable in the future than it is today. Time value of
money could be studied under the following heads:

1. Future value of a single cash flow

2. Future value of an annuity
3. Present value of a single cash flow
4. Present value of an annuity

3.1.1 Future Value of a Single Cash Flow

Future value of money (FV) after a period ‘t’ for which compounding is done at an interest rate
of ‘r’, where the present value (PV) is given by the equation

FV = PV (1+r)t

This assumes that compounding is done at discrete intervals. However, in case of continuous
compounding, the future value is determined using the formula

FV = PV * ert
where the compounding factor is calculated by taking natural logarithm (log to base e).

Example 1: Calculate the value 5 years hence of a deposit of Rs.1,000 made today if the interest
rate is 10%. By discrete compounding

FV = 1000 * (1+0.10)5 = 1000 * (1.1)5 = 1000 * 1.61051 = Rs.1,610.51

By continuous compounding:
FV = 1000 * e (0.10 * 5) = 1000 * 1.648721 = Rs.1,648.72

Example 2: Find the value of Rs. 50,000 deposited for a period of 3 years at the end of the period
when the interest is 10% and continuous compounding is done.

Future Value = 50000* e^(0.01*10*3) = Rs. 67493

The future value (FV) of the present sum (PV) after a period ‘t’ for which compounding is done
‘m’ times a year at an interest rate of ‘r’, is given by the equation
FV = PV (1+(r/m))t
The equation used to convert the nominal rate of interest ‘rm’ where compounding is done ‘m’
times a year to a continuously compounded rate ‘rc’ is given by
rc = m ln (1+rm/m)
16
The effective rate of interest ‘Re’, if compounding is done for a shorter period of ‘m’ times a year,
is more than the nominal rate of interest ‘Rn‘ specified. The difference in the effective and
nominal rate of interest can be found using the formula
Re = (1 + (Rn/m))m - 1

Example 3: How much does a deposit of Rs. 5,000 grow to at the end of 3 years, if the nominal
rate of interest is 10 % and compounding is done quarterly?

Future value = 5000 * ((1 + 0.10/4)^(4*3)) = Rs.6724.45

3.1.2 Future Value of an Annuity

The future value (FV) of a uniform cash flow (CF) made at the end of each period till the time of
maturity ‘t’ for which compounding is done at the rate ‘r’ is given by
FV = CF*(1+r)t-1 + CF*(1+r)t-2 + ... + CF*(1+r)1+CF
= CF [{(1+r)t - 1} / r]

Example 4: Suppose, you deposit Rs. 1,000 annually in a bank for 5 years and your deposits earn
a compound interest rate of 10 per cent, what will be value of this series of deposits (an annuity)
at the end of 5 years? Assuming that each deposit occurs at the end of the year, the future value
of this annuity will be:

=Rs. 1,000 (1.10)4 + Rs. 1,000 (1.10)3 + Rs. 1,000 (1.10)2 + Rs. 1,000 (1.10) + Rs. 1,000 = Rs.
1,000 (1.4641) + Rs. 1,000 (1.3310) + Rs. 1,000 (1.2100) + Rs. 1,000 (1.10) + Rs. 1,000
= Rs. 6,105

Example 5: Two equal annual payments of Rs.2000 are made into a deposit account that pays 8%
interest per year. What is the future value of this annuity at the end of 2 years?

FV = 2000((1+0.01*8)^2-1)/0.01*8 = Rs. 4160

In case of continuous compounding, the future value of annuity is determined using the formula
FV = CF * (ert -1)/r
3.1.3 Present Value of a Single Cash Flow

Present value of (PV) of the future sum (FV) to be received after a period ‘t’ for which
compounding is done at an interest rate of ‘r’, is given by the equation

Present value in case of discrete compounding: PV = FV / (1+r)t

Example 6: What is the present value of Rs.1,000 payable 3 years hence, if the interest rate is 12
% p.a.

PV = 1000 / (1.12)3 i.e. = Rs.711.78

17
Present value in case of continuous compounding PV = FV * e-rt

Example 7: What is the present value of Rs. 50,000 receivable after 3 years at a discount rate of
10% under continuous discounting?

Present Value = 50,000/(exp^(0.01*10*3)) = Rs. 37041

3.1.4 Present Value of an Annuity

The present value of annuity is the sum of the present values of all the cash inflows/outflows.

Present value of an annuity (in case of discrete compounding)

PV = FV [{(1+r)t - 1 }/ {r * (1+r)t}]

Present value of an annuity (in case of continuous compounding)

PVa = FVa * (1-e-rt)/r
Example 8: Future Value of Rs.1000 deposited at the end of each year for 3 years at an interest
rate of 10% compounded annually is
= Rs. 1,000 (1+0.10)2 + Rs. 1,000 (1+0.10)1 + Rs. 1,000 i.e. Rs. 3310.

Example 9: What is the value at maturity of an annuity of Rs. 50,000, continuously compounded
at an interest of 8% for a period of 3 years?

Value of Annuity = 50,000 *(exp^(0.01*8*3)-1)/0.01*8) = Rs. 169530.72

3.2. Capital Budgeting

3.2.1. Capital Investment Decision

A capital investment decision may be required for a new project or a replacement project or for
modernisation. Capital investments decisions:
- have long-term consequences
- are difficult to reverse and
- involve substantial outlays on a firm

These decisions involve a study of cost and benefits associated with such projects. The methods
used to evaluate are:
(1) Average rate of return
(2) Payback period
(3) Internal rate of return
(4) Net present value

3.2.2. Average Rate of Return

18
This measure represents the ratio of the average annual profit after tax to the investments made
in the project.

Avg. Rate of Return = Profit after tax

Book value of Investments
If the income and investment is variable and spread over a time period, then the average is taken
to compute the ratio. This is expressed in percentage terms. The higher the return, the more
attractive the project.
The shortcomings of this measure are:
that it is based on accounting income and not on the timing of cash inflows or outflows,
and it does not consider time value of money.

Example 10: What is the average rate of return for the investment proposal, details of which are
given below?
Investment Profit after tax Investment
Period (yr.) (Rs. Lakh) (Rs. Lakh)
1 1500 8,000
2 1450 7,000
3 1400 5,000

Avg. rate of return = (1500+1450+1400)/3 = 21.75%

(8000+7000+5000)/3

3.2.3. Payback Period

The payback period of an investment project is the time required to recover the initial
investment.
Initial cash outlay
Payback period = _____________________
Annual cash inflow

Thus a shorter payback period for an investment is favoured.

The shortcomings of this evaluation criterion are that it does not consider the dispersion,
magnitude and time value of cash inflows.

Example 11: The firm is considering an investment proposal. The initial cash outlay is Rs. 100
Crore and the annual cash inflows are expected to be Rs. 30 Cr. What is the payback period of
this proposal?

The payback period = 100/30 = 3.33 yrs

Example 12: What is the payback period for a project whose cash flows are given below?

Time Annual Investment

Period (yr.) Inflows (Rs. (Rs. Lakh)
Lakh)
19
 0 - 1,000
1 350 -
2 350 -
3 200 -
4 200 -
5 250 -

In 3 years we recover Rs.900 lakh. Thus the time required to recover Rs. 100 lakh is = (100 /
200) = .5 year
Thus the Payback period = 3.5 yrs (i.e. 3yrs 6 months)

3.2.4 Internal Rate of Return

It is the discounting rate ‘r’, which equates the present value of the cash outflows with the
expected cash inflows for an investment proposal.
CF1 CF2 CF3 CFn
CF0 = ____ + ____ + ____ +……+_____
(1+r) (1+r) 2 (1+r) 3 (1+r) n
Where,
CFn is the cash flow at time intervals,
‘n’ is the investment period duration,

For a proposal the IRR may be calculated manually by trial and error and the approximate value
can be interpolated from the closest answers or a financial calculator may be used.

3.2.5. Net Present Value

For an investment proposal, the NPV is the summation of the present value of all cash flows,
where the discounting is done at a required rate of return ‘k’. A positive NPV will give an accept
signal and negative a reject signal.
CF1 CF2 CF3 CFn
NPV = -(CF0 ) + ____ + ____ + ____ +…+ _____
(1+r) 1 (1+r) 2 (1+r) 3 (1+r) n
Where,
CF0 is the initial cash outflow,
CFn is the cash inflow at time intervals,
‘n’ is the investment period duration,

Example 13: An investment proposal has the following cash flows. If discounting rate is 12%,
then what is the Net present value of the proposal?

Time Initial Investment Expected Annual

Period (yr.) (Rs. Lakh) Inflows (Rs. Lakh)
0 1,000 -
1 - 350
2 - 350
20
 3 - 200
4 - 200
5 - 250

350 350 200 200 250

NPV = -(1000) + ____ + ____ + ____ + _____ + _____
(1+.12) (1+.12) 2 (1+.12) 3 (1+.12) 4 (1+.12) 5

NPV = -1000 + 1002.84 = Rs. 2.84 lakh

21
 4. Financial Statement Analysis

4.1 Introduction

Financial statements need to be properly analysed and interpreted for measuring the performance
and position of a firm. This is of immense help to lenders (short-term as well as long term),
investors, security analysts, managers’ etc.

A study of the financial ratios is the most common tool of financial statement analysis. Financial
ratio analysis is a study of ratios between various items in financial statements.

4.2 Types of Financial Ratios

4.2.1 Liquidity Ratios

Liquidity is the ability of a firm to meet its short-term (usually up to 1 year) obligations.

4.2.1.1 Current Ratio

Current Ratio = Current Assets / Current Liabilities

Current Assets include cash, debtors, marketable securities, inventories, loans and advances,
prepaid expenses.
Current Liabilities include loans and advances (taken), creditors, accrued expenses and
provisions.

This ratio measures the ability of the firm to meet its current liabilities. Usually, higher the
current ratio, the greater the short term solvency of the firm. The break up of the current assets is
very important to assess the liquidity of a firm. A firm with a large proportion of current assets in
the form of cash and accounts receivable is more liquid than a firm with a high proportion of
inventories even though two firms might have the same ratio.

4.2.1.2 Quick Ratio

Quick Ratio = Quick Assets / Current Liabilities

Quick Assets imply Current assets less inventories.

This ratio is based on very highly liquid assets and inventories are deemed to be the least liquid
of the current assets.

22
4.2.2 Leverage Ratios

Financial leverage refers to the use of debt finance. Debt finance is thought to be a cheaper
source of finance and at the same time a riskier source. Leverage ratios help in assessing the risk
arising from the use of debt finance.

4.2.2.1 Debt Equity Ratio

Debt Equity Ratio = Debt / Equity

Debt - Long term as well as short term.

Equity – Share Capital plus Reserves and Surplus (Networth)

It is generally felt that lower the ratio, the greater the degree of protection enjoyed by the
creditors. Generally, incase of capital intensive industries a higher debt-equity ratio is observed.

4.2.2.2 Debt Assets Ratio

Debt Assets Ratio = Debt / Assets

Debt includes Long term as well as short term debt and Assets include total of all assets

4.2.2.3 Interest Coverage Ratio

Interest coverage ratio = Earnings before interest & tax/Interest charges

This ratio measures the margin of safety a firm enjoys with respect to its interest burden. The
higher the ratio, the greater the margin of safety.

4.2.3 Turnover Ratios

4.2.3.1 Inventory Turnover Ratio

Inventory Turnover Ratio = Cost of goods sold / Inventory

Inventory implies balance of the stock of goods at the end of the year.

This ratio reflects the efficiency of inventory management. The higher the ratio, the more
efficient the inventory management.

4.2.3.2 Average Collection Period

Average Collection Period = Receivables / Average Sales per day

4.2.3.4 Receivables Turnover Ratio

23
Receivables Turnover Ratio = Net Sales / Receivables

4.2.3.5 Fixed Assets Turnover Ratio

Fixed Assets Turnover Ratio = Net Sales / Fixed Assets

This ratio is used to measure the efficiency with which fixed assets are employed. A high ratio
indicates an efficient use of fixed assets. Generally this ratio is high when the fixed assets are old
and substantially depreciated.

4.2.4 Profitability Ratios

4.2.4.1 Gross Profit Ratio

Gross Profit Ratio = Gross Profit/Net Sales

Gross Profit implies net sales less cost of goods sold.

This ratio shows the margin left after meeting manufacturing costs and measures the production
efficiency.

4.2.4.2 Net Profit Ratio

Net Profit Margin ratio = Net Profit / Net Sales

This ratio shows the profits left for shareholders as a percentage of net sales. It measures the
overall efficiency of production, administration, selling, financing, pricing and tax management.

4.2.4.3 Net Income to Total Assets Ratio

Net Income to Total Assets ratio = Net income (profit) / Total Assets

This measures how efficiently capital is employed.

4.2.4.4 Return on Investment

Return on Investment = Earnings before Interest and taxes / Total Assets

This measures the performance of the firm without the effect of interest and tax burden.

4.2.4.5 Return on Equity

Return on Equity = Equity earnings / Net Worth

Equity earnings = Profit after tax less preference dividends.

24
Net Worth = Share capital plus reserves and surplus.

This ratio measures the profitability of equity funds invested in the firm. This reflects the
productivity of the ownership capital employed in the firm.

4.2.5 Valuation Ratios

Valuation ratios indicate how the equity stock of the company is assessed in the capital market.
Market value of equity reflects the influence of risk and return.

4.2.5.1 Price Earnings Ratio

Price Earnings Ratio = Marker Price per share / Earnings per share

Market price per share may the price prevailing on a certain day or the average price over a
period of time.
Earning per share is profit after tax divided by the number of outstanding equity shares.

The P/E ratio reflects the growth prospects, corporate image, risks involved and degree of
liquidity of a firm.

4.2.5.2 Yield

Dividend/Initial Price + Price Change/Initial Price

(Dividend Yield) (Capital gains/losses yield)

Companies with low growth prospects offer a high dividend yield and a low capital gains yield.
Companies with high growth prospects offer a low dividend yield and a high capital gains yield.

4.3 Problems of Financial Statement Analysis

Development of benchmarks
Window Dressing
Price Level changes
Variations in accounting policies
Interpretation of Results
Correlation among ratios

25
Illustration:

Balance Sheet of XYZ Co. Ltd as on March 31, 1999 (Rupees in Crore)

Liabilities 1999 1998 Assets 1999 1998

Share Capital Fixed Assets (Net) 33.00 32.20
- Equity 15.00 15.00 Gross Block 59.00
- Preference Less: Depreciation 26.00
Reserves & 11.20 10.60 Investments 1.00 1.00
Surplus
Secured Loans 14.30 13.10 Current Assets, 23.40 15.60
Loans & Advances
- Term Loans 8.30 Cash & Bank 0.20
- Debentures 6.00 Debtors 11.80
Unsecured Loans 6.90 2.50 Inventories 10.60
Current Liabilities 10.50 8.10 Pre-paid expenses 0.80
& Provisions
Miscellaneous 0.50 0.50
Exps & Losses

Total 57.90 49.30 Total 57.90 49.30

26
Income statement for the year ending March 31, 1999 (Rupees in Crore)

1999 1998
Net Sales 70.10 62.30
Less: Cost of goods sold 55.20 47.50
- Stocks 42.10
- Wages and Salaries 6.80
- Other Mfg. Expenses 6.30

Gross Profit 14.90 14.80

Operating expenses 5.60 4.90
- Depreciation 3.00
- General Administration 1.20
- Selling 1.40

Operating Profit 9.30 9.90

Non-operating surplus/deficit (0.40) 0.60
Earnings before interest and tax 8.90 10.50
Interest 2.10 2.20

Profit before tax 6.80 8.30

Tax 3.50 4.10
Profit after tax 3.30 4.20
Dividends 2.70 2.70
Retained earnings 0.60 1.50
1999 1998
Per share data (in Rupees)
Earnings per share 2.20 2.80
Dividend per share 1.80 1.80
Market price per share 21.00 20.00
Book value per share 17.46 17.07

Ratios of XYZ Limited

Liquidity

Current Ratio = Current Assets / Current Liabilities = 23.40/17.40 = 1.34

Quick Ratio = Quick Assets / Current Liablities = 12.80/17.40 = 0.74

Leverage

Debt-Equity Ratio = Debt/Equity = 31.70/26.20 = 1.21

Debt-Assets Ratio = Debt/Assets = 31.70/57.90 = 0.55
Interest Coverage Ratio = EBIT / Debt Interest = 8.90/2.10 = 4.23

27
Turnover

Inventory Turnover = Cost of goods sold/Inventory = 55.20/10.60 = 5.20

Average Collection period = Receivables / Average Sales per day = 11.80/70.1*1/360 = 61 days
Receivables Turnover ratio = Net Sales / Receivables = 70.10/11.80 = 5.94
Fixed Assets Turnover ratio = Net Sales / Fixed Assets = 70.10/33 = 2.12

Profitability Ratios

Gross Profit Margin Ratio = Gross Profit/Net Sales = 14.90/70.10 = 0.21

Net Profit Margin ratio = Net Profit / Net Sales = 3.30/70.10 = 0.047
Net Income to Total Assets ratio = Net income (profit)/Total Assets = 3.30/57.90 = 0.057
Return on Investment = Earnings before Interest and taxes / Total Assets = 8.90/57.90 = 0.154
Return on Equity = Equity earnings / Net Worth = 3.30/26.20 = 0.126

Valuation Ratios

Price Earnings Ratio = Marker Price per share / Earnings per share = 21.0/2.20 = 9.55
Yield = Dividend/Initial Price + Price Change/Initial Price
(Dividend Yield) (Capital gains/losses yield)
= 1.80/20.0 + 1.0/20.0 = 0.14 or 14%

Example 1: A firms’ current assets and current liabilities are 1600 and 1000 respectively. How
much can it borrow on a short-term basis without reducing the current ratio below 1.25?

Let the maximum short-term borrowings be x. The current ratio with this borrowing should be
1.25
1600 + x / 1000 + x = 1.25
x = 1400. Hence the maximum permissible short-term borrowing is 1400.

Example 2: Determine the sales of a firm, given the following information

Current Ratio = 1.4

Quick Ratio = 1.2
Current Liabilities = 1600
Inventory turnover ratio = 8

Current Assets = Current liabilities * Current Ratio = 1600*1.4 = 2240

Current Assets – Inventories = Current Liabilities * Quick ratio = 1600*1.2 = 1920

Inventories = 2240 – 1920 = 320
Sales = Inventories * Inventory ratio = 320*8 = 2560

Example 3: Mohan Inc. has profit before tax of 40 lakh. If the company’s interest coverage ratio
is 6, what is the total interest charge?

28
Let interest charge be x
PBIT = 40+x
Interest Coverage ratio = PBIT / Interest
6 = (40+x) / x
x = 8. Hence, the total interest charge is 8 lakh.

29
 5. SECURITIES CONTRACTS (REGULATION) ACT, 1956

The Securities Contracts (Regulation) Act, 1956 [SC(R)A] was enacted to prevent undesirable
transactions in securities by regulating the business of dealing therein and by providing for
certain other matters connected therewith. This is the principal Act, which governs the trading of
securities in India.

According to Section 2(f) of the SC(R)A, a "recognised stock exchange" means a stock
exchange, which is for the time being recognised by the Central Government under Section 4 of
the Act.

The term "Securities" has been defined in the SC(R)A. As per Section 2(h), the 'Securities'
include-
(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities
of a like nature in or of any incorporated company or other body corporate;
(ii) derivative
(iii) units or any other instrument issued by any collective investment scheme to the investors
in such schemes;
(iv) Government securities;
(v) such other instruments as may be declared by the Central Government to be securities;
and
(vi) rights or interests in securities.

"Derivative" includes-

i. a security derived from a debt instrument, share, loan whether secured or unsecured, risk
instrument or contract for differences or any other form of security;
ii. a contract which derives its value from the prices, or index of prices, of underlying
securities;

Section 18(a) of the SC(R)A has been enacted to protect the contracts in derivative from being
invalidated by any other law in existence.

Section 18(a) provides that notwithstanding anything contained in any other law for the time
being in force, contracts in derivative shall be legal and valid if such contracts are-

i. traded on a recognised stock exchange;

ii. settled on the clearing house of the recognised stock exchange, in accordance with the rules
and byelaws of such stock exchanges.

"Spot delivery contract" has been defined in Section 2(i), which means a contract which provides
for-

30
 (a) actual delivery of securities and the payment of a price therefor either on the same day as
the date of the contract or on the next day, the actual period taken for the despatch of the
securities or the remittance of money therefor through the post being excluded from the
computation of the period aforesaid if the parties to the contract do not reside in the same
town or locality;
(b) transfer of the securities by the depository from the account of a beneficial owner to the
account of another beneficial owner when such securities are dealt with by a depository

The SC(R)A gives Central Government regulatory jurisdiction over -

1. stock exchanges, through a process of recognition and continued supervision,
2. contracts in securities, and
3. listing of securities on stock exchanges.

As a condition of recognition, a stock exchange complies with conditions prescribed by Central

Government. Organised trading activity in securities in any area takes place on a recognised
stock exchange. The stock exchanges determine their own listing requirements which have to
confirm with the minimum listing criteria set out in the Rules.

Some of the Powers under the SCRA are exercisable by SEBI. Some other powers exercisable by
Central Government have been made exercisable by SEBI in terms of notification issued under
Section 29 of the SC(R)A.

Powers exercisable by SEBI

Section Powers

6 Call for periodical returns or direct inquiries to be made

9 Approval of Bye-Laws of recognised stock exchanges
10 Make or amend bye-laws of recognised stock exchanges
17 Licensing of dealers in securities

Powers of Central Government delegated to SEBI under section 29 of the SC(R)A

Section Powers

3 Application for recognition of stock exchanges

4 Grant of recognition to stock exchanges
7 Submission of Annual Report
7A Rules restricting voting rights
8 Direct rules to be made or to make rules
11 Supersede governing body of a recognised stock exchanges
12 Suspend business of recognised stock exchanges
13 Contracts in notified areas illegal in certain circumstances
16 Prohibition of contracts
18 Exclusion of spot delivery contracts
28 Inapplicability of the SC(R)A

31
Recognition of stock exchanges

Any stock exchange, which is desirous of being recognised for the purposes of this Act may
make an application in the prescribed manner to SEBI (Section 3). The application shall be filed
in the prescribed format along with copies of the bye- laws and rules of the stock exchange

If the SEBI is satisfied, after making such inquiry as may be necessary in this behalf and after
obtaining such further information, if any, as it may require, it may grant recognition to the stock
exchange subject to the conditions imposed by the SEBI. These conditions may relate to -

(i) the qualifications for membership of stock exchanges,

(ii) the manner in which contracts shall be entered into and enforced as between members,
(iii) the representation of the SEBI on each of the stock exchanges by such number of
persons not exceeding three as the SEBI may nominate in this behalf; and
(iv) the maintenance of accounts of members and their audit by chartered accountants
whenever such audit is required by the SEBI.

The SEBI may withdraw recognition if it is in the interest of the trade or in the public interest by
serving a written notice on the governing body of the stock exchange in this regard and after
giving an opportunity to the governing body to be heard in the matter.

A person without the permission of the SEBI shall not organise or assist in organising or be a
member of any stock exchange (other than a recognised stock exchange) for the purpose of
assisting in, entering into or performing any contracts in securities, according to section 19.

Periodical returns and books of accounts

Every recognised stock exchange shall furnish prescribed periodical returns to the Securities and
Exchange Board of India.

Every recognised stock exchange and every member thereof shall maintain and preserve for such
periods not exceeding five years such books of account, and other documents as the Central
Government, after consultation with the stock exchange concerned, may prescribe in the interest
of the trade or in the public interest, and such books of account, and other documents shall be
subject to inspection at all reasonable times by the Securities and Exchange Board of India
[Section 6(2)].

Annual reports to be furnished by stock exchanges

Every recognised stock exchange shall furnish the SEBI with a copy of the annual report, and
such annual report shall contain such particulars as may be prescribed (Section 7).

32
Bye-laws of the Stock Exchange

A recognised stock exchange may, subject to the previous approval of the Securities and
Exchange Board of India, make bye-laws for the regulation and control of contracts (Section 9).
Such bye-laws may provide for:
(a) the opening and closing of markets and the regulation of the hours of trade,
(b) a clearing house for the periodical settlement of contracts and differences thereunder, the
delivery of and payment for securities, the passing on of delivery orders and the regulation
and maintenance of such clearing house,
(c) the submission to the Securities and Exchange Board of India by the clearing house as
soon as may be after each periodical settlement of all or any of the following particulars as
the Securities and Exchange Board of India may, from time to time require, namely:
(i) the total number of each category of security carried over from one settlement
period to another.
(ii) the total number of each category of security, contracts in respect of which have
been squared up during the course of each settlement period.
(iii) the total number of each category of security actually delivered at each clearing;

(d) the publication by the clearing house of all or any of the particulars submitted to the
Securities and Exchange Board of India under clause (c) subject to the directions, if any,
issued by the Securities and Exchange Board of India] in this behalf,
(e) the regulation or prohibition of blank transfers,
(f) the number and classes of contracts in respect of which settlements shall be made or
differences paid through the clearing house,
(g) the regulation, or prohibition of badlas or carry-over facilities,
(h) the fixing, altering or postponing of days for settlements,
(i) the determination and declaration of market rates, including the opening, closing, highest
and lowest rates for securities,
(j) the terms, conditions and incidents of contracts, including the prescription of margin
requirements, if any, and conditions relating thereto, and the forms of contracts in writing,
(k) the regulation of the entering into, making, performance, rescission and termination, of
contracts, including contracts between members or between a member and his constituent
or between a member and a person who is not a member, and the consequences of default or
insolvency on the part of a seller or buyer or intermediary, the consequences of a breach or
omission by a seller or buyer, and the responsibility of members who are not parties to such
contracts,
(l) the regulation of taravani business including the placing of limitations thereon,
(m) the listing of securities on the stock exchange, the inclusion of any security for the
purpose of dealings and the suspension or withdrawal of any such securities, and the
suspension or prohibition of trading in any specified securities,
(n) the method and procedure for the settlement of claims or disputes, including settlement by
arbitration,
33
(o) the levy and recovery of fees, fines and penalties,
(p) the regulation of the course of business between parties to contracts in any capacity,
(q) the fixing of a scale of brokerage and other charges,
(r) the emergencies in trade which may arise, whether as a result of pool or syndicated
operations or cornering or otherwise, and the exercise of powers in such emergencies
including the power to fix maximum and minimum prices for securities,
(s) the regulation of dealings by members for their own account,
(t) the separation of the functions of jobbers and brokers,
(u) the limitations on the volume of trade done by any individual member in exceptional
circumstances,
(v) the obligation of members to supply such information or explanation and to produce such
documents relating to the business as the governing body may require.

The bye-laws made under this section may specify the bye-laws, the contravention of which shall
make a contract entered into otherwise than in accordance with the bye- laws void under sub-
section (1) of section 14 and provide that the contravention of any of the bye-laws shall render
the member concerned liable to fine, expulsion from membership, suspension from membership
for a specified period, or any other penalty of a like nature not involving the payment of money.

The Securities and Exchange Board of India may under section 10, either on a request in writing
received by it in this behalf from the governing body of a recognised stock exchange or on its
own motion, if it is satisfied after consultation with the governing body of the stock exchange
that it is necessary or expedient so to do and after recording its reasons for so doing, make bye-
laws, for all or any of the matters specified in section 9 or amend any bye-laws made by such
stock exchange under that section.

Supersession of the governing body of a recognised stock exchange

If SEBI is of the opinion that the governing body of any recognised stock exchange should be
superseded, then the SEBI may serve on the governing body a written notice in this regard
specifying the reasons. The SEBI after giving an opportunity to the governing body to be heard
in the matter, it may, by notification in the Official Gazette declare the governing body of such
stock exchange to be superseded. It may appoint any person or persons to exercise and perform
all the powers and duties of the governing body, and, and where more persons than one are
appointed, may appoint one of such persons to be the chairman and another to be the vice-
chairman thereof.

Suspension of business of recognised stock exchanges

SEBI may direct a recognised stock exchange to suspend such of its business for such period not
exceeding seven days and subject to such conditions as may be specified in the notification. If
the SEBI is of the opinion of the Central Government that the interest of the trade or the public
interest requires that the period should be extended may, by like notification extend the said
period from time to time, according to Section 12.

Contracts in notified areas illegal or void in certain circumstances

34
As per section 13, if the SEBI is satisfied, having regard to the nature or the volume of
transactions in securities in any State or area, that it is necessary so to do, it may, by notification
in the Official Gazette, declare this section to apply to such State or area, and thereupon every
contract in such State or area which is entered into after date of the notification otherwise than
between members of a recognised stock exchange in such State or area or through or with such
member shall be illegal.

As per section 14, any contract entered into in any State or area specified in the notification
under section 13 which is in contravention of any of the bye- laws specified in that behalf under
clause (a) of sub-section (3) of section 9 shall be void with regard to the rights of any member of
the recognised stock exchange who has entered into such contract in contravention of any such
bye-laws, and the rights of any other person who has knowingly participated in the transaction
entailing such contravention.

Members may not act as principals in certain circumstances

A member of a recognised stock exchange shall not in respect of any securities enter into any
contract as a principal with any person other than a member of a recognised stock exchange,
unless he has secured the consent or authority of such person and discloses in the note,
memorandum or agreement of sale or purchase that he is acting as a principal, section 15.

Power to prohibit contracts in certain cases

If the SEBI is of opinion that it is necessary to prevent undesirable speculation in specified

securities in any State or area, it may, by notification in the Official Gazette, declare that no
person in the State or area specified in the notification shall, save with the permission of the
Central Government, enter into any contract for the sale or purchase of any security specified in
the notification except to the extent and in the manner, if any, specified therein, according to
section 16.

Section 22(a) provides for a right of appeal to Securities Appellate Tribunal against refusal of
stock exchange to list securities of public companies, if the said companies feel aggrieved with
such refusal. Securities Appellate Tribunal has been given power to vary or set side the decision
of the stock exchange.

Section 29(a) deals with the power of Central Government to delegate the powers (except the
power under Section 30), exercisable by it under the provisions of SCRA to SEBI or RBI subject
to such conditions it may specify.

Section 30 of the SCRA provides power for Central Government to make rules for the purpose of
carrying out into effect the object of this Act.

35
 6. SECURITIES CONTRACTS (REGULATION) RULES, 1957

The Central Government has made Securities Contracts (Regulation) Rules, 1957, as required by
sub-section (3) of the Section 30 of the Securities Contracts (Regulation) Act, 1956 for carrying
the purposes of that Act. The powers under the SCRR, 1957 are exercisable by SEBI only.

Qualifications for membership of recognised stock exchanges (Rule 8)

A person is eligible to be elected as a member of a recognised stock exchange if he has worked

for not less than two years as a partner with, or as an authorised assistant or authorised clerk or
remisier or apprentice to, a member; or he agrees to work for a minimum period of two years as a
partner or representative member with another member and to enter into bargains on the floor of
the stock exchange and not in his own name but in the name of such other member; or he
succeeds to the established business of a deceased or retiring member who is his father, uncle,
brother or any other person who is, in the opinion of the governing body, a close relative, and if :

(i) he is of twenty-one years of age or more,

(ii) he is a citizen of India,
(iii) he has not been adjudged bankrupt or he has not been proved to be insolvent,
(iv) he has not compounded with his creditors,
(v) he has not been convicted of an offence involving fraud or dishonesty;
(vi) he is not engaged as principal or employee in any business other than that of securities
except as a broker or agent not involving any personal financial liability,
(vii) he has not been at any time expelled or declared a defaulter by any other stock exchange,
(viii) he has not been previously refused admission to membership unless a period of one year
has elapsed since the date of such rejection.

A person who is a member at the time of application for recognition or subsequently admitted as
a member shall continue as such if -
(a) he ceases to be a citizen of India,
(b) he is adjudged bankrupt or a receiving order in bankruptcy is made against him or he is
proved to be insolvent;
(c) he is convicted of an offence involving fraud or dishonesty;
(d) he engages either as principal or employee in any business other than that of securities except
as a broker or agent not involving any personal financial liability.

Contracts between members of recognised stock exchange

All contracts between the members of a recognised stock exchange shall be confirmed in writing
and shall be enforced in accordance with the rules and bye-laws of the stock exchange of which
they are members (Rule 9).

Books of account and other documents by every recognised stock exchange

36
Rule 14 of the SCRR requires every recognised stock exchange shall maintain and preserve the
following books of account and documents for a period of five years:
(1) Minute books of the meetings of-
(a) members;
(b) governing body;
(c) any standing committee or committees of the governing body or of the general body of
members.
(2) Register of members showing their full names and addresses. Where any member of the stock
exchange is a firm, full names and addresses of all partners shall be shown.
(3) Register of authorised clerks.
(4) Register of remisiers of authorised assistants.
(5) Record of security deposits.
(6) Margin deposits book.
(7) Ledgers.
(8) Journals.
(9) Cash book.
(10) Bank pass-book.

Books of account and other documents to be maintained and preserved by every member of
a recognised stock exchange

Rule 15 of the SCRR requires every member of a recognised stock exchange to maintain and
preserve the following books of account and documents for a period of five years:

(a) Register of transactions (Sauda book).

(b) Clients' ledger.
(c) General ledger.
(d) Journals.
(e) Cash book.
(f) Bank pass-book.
(g) Documents register showing full particulars of shares and securities received and delivered.

Every member of a recognised stock exchange shall maintain and preserve the following
documents for a period of two years:

(a) Members' contract books showing details of all contracts entered into by him with other
members of the same exchange or counter-foils or duplicates of memos of confirmation issued to
such other members.
(b) Counter-foils or duplicates of contract notes issued to clients.
(c) Written consent of clients in respect of contracts entered into as principals.

Submission of annual report

According Rule 17, every recognised stock exchange shall within the specified time furnish the
SEBI annually with a report about its activities during the preceding calendar year, which shall
interalia contain detailed information about the following matters:
37
(a) changes in rules and bye-laws, if any;
(b) changes in the composition of the governing body;
(c) any new sub-committees set up and changes in the composition of existing ones;
(d) admissions, re-admissions, deaths or resignations of members;
(e) disciplinary action against members;
(f) arbitration of disputes (nature and number) between members and non-members;
(g) defaults;
(h) action taken to combat any emergency in trade;
(i) securities listed and de-listed; and
(j) securities brought on or removed from the forward list.

Every recognised stock exchange shall within one month of the date of the holding of its annual
general meeting, furnish the SEBI with a copy of its audited balance sheet and profit and loss
account for its preceding financial year.

Submission of periodical returns

Every recognised stock exchange as per Rule 17 A shall furnish the SEBI periodical returns
relating to-
(i) the official rates for the securities enlisted thereon;
(ii) the number of shares delivered through the clearing house;
(iii) the making-up prices;
(iv) the clearing house programmes;
(v) the number of securities listed and de-listed during the previous three months;
(vi) the number of securities brought on or removed from the forward list during the previous
three months; and
(vii) any other matter as may be specified by the SEBI

38
 7. SECURITIES AND EXCHANGE BOARD OF INDIA ACT,

1992

The Securities and Exchange Board of India Act, 1992 has been enacted to provide for the
establishment of a Board to protect the interest of investors in securities and to promote the
development of, and to regulate, the securities market and for matters connected therewith or
incidental thereto. It came into force on the 30th day of January, 1992.

Establishment and incorporation of Board

Major part of the liberalisation process was the repeal of the Capital Issues (Control) Act, 1947
in May 1992. With this, Government’s control over issues of capital, pricing of the issues, fixing
of premia and rates of interest on debentures etc. ceased, and the office which administered the
Act was abolished: the market was allowed to allocate resources to competing uses. However to
ensure effective regulation of the market, SEBI Act, 1992 was enacted to empower SEBI with
statutory powers for (a) protecting the interests of investors in securities (b) promoting the
development of the securities market and (c) regulating the securities market. Its regulatory
jurisdiction extends over corporates in the issuance of capital and transfer of securities, in
addition to all intermediaries and persons associated with securities market. SEBI can specify the
matters to be disclosed and the standards of disclosure required for the protection of investors in
respect of issues; can issue directions to all intermediaries and other persons associated with the
securities market in the interest of investors or of orderly development of the securities market;
and can conduct enquiries, audits and inspection of all concerned and adjudicate offences under
the Act. In short, it has been given necessary autonomy and authority to regulate and develop an
orderly securities market. All the intermediaries in the market, such as brokers and sub-brokers,
underwriters, merchant bankers, bankers to the issue, share transfer agents and registrars to the
issue, are now required to register with SEBI and are governed by its regulations. A code of
conduct for each intermediary has been prescribed in the regulations; capital adequacy and other
norms have been specified; a system of monitoring and inspecting their operations has been
instituted to enforce compliance; and disciplinary actions are being taken against the
intermediaries violating any regulation.

The Central Government may, by notification, appoint, for the purposes of this Act, a Board by
the name of the Securities and Exchange Board of India under Section 3 of the SEBI Act. The
Board shall be a body corporate by the name aforesaid having perpetual succession and a
common seal, with power subject to the provisions of this Act, to acquire, hold and dispose of
property, both movable and immovable, and to contract, and shall, by the said name, sue or be
sued. The head office of the Board shall be at Bombay. The Board may establish offices at other
places in India.
39
The SEBI has offices in Mumbai, Calcutta, New Delhi and Chennai.

The Board shall consist of the following members, namely:-

(a) a Chairman;
(b) two members from amongst the officials of the Ministries of the Central Government dealing
with Finance and Law;
(c) one member from amongst the officials of the Reserve Bank of India constituted under
section 3 of the Reserve Bank of India Act, 1934;
(d) two other members, to be appointed by the Central Government.

The general superintendence, direction and management of the affairs of the Board shall vest in a
Board of members, which may exercise all powers and do all acts and things which may be
exercised or done by the Board.

Save as otherwise determined by regulations, the Chairman shall also have powers of general
superintendence and direction of the affairs of the Board and may also exercise all powers and do
all acts and things which may be exercised or done by the Board.

The Chairman and members referred to in clauses (a) and (d) of sub-section (1) shall be
appointed by the Central Government and the members referred to in clauses (b) and (c) of that
sub-section shall be nominated by the Central Government and the Reserve Bank of India
respectively.

The Chairman and the other members referred to in clauses (a) and (d) of sub-section (1) shall be
from amongst the persons of ability, integrity and standing who have shown capacity in dealing
with problems relating to securities market or have special knowledge or experience of law,
finance, economics, accountancy, administration or in any other discipline which, in the opinion
of the Central Government, shall be useful to the Board.

The Board may appoint officers and employees for the efficient discharge of its functions under
this Act.

Functions of the Board

The SEBI shall protect the interests of the investors in securities and to promote and
development of, and to regulate the securities market by such measures as it thinks fit. The
measures referred to therein may provide for -
(a) regulating the business in stock exchanges and any other securities markets;
(b) registering and regulating the working of stock brokers, sub-brokers, share transfer agents,
bankers to an issue, trustees of trust deeds, registrars to an issue, merchant bankers,
underwriters, portfolio managers, investment advisers and such other intermediaries who
may be associated with securities markets in any manner.
(c) registering and regulating the working of the depositories, participants, custodians of
securities, foreign institutional investors, credit rating agencies and such other intermediaries
as the Board may, by notification, specify in this behalf.
40
(d) registering and regulating the working of venture capital funds and collective investment
schemes including mutual funds;
(e) promoting and regulating self-regulatory organisations;
(f) prohibiting fraudulent and unfair trade practices relating to securities markets;
(g) promoting investors' education and training of intermediaries of securities markets;
(h) prohibiting insider trading in securities;
(i) regulating substantial acquisition of shares and take-over of companies;
(j) calling for information from, undertaking inspection, conducting inquiries and audits of the
stock exchanges, mutual funds and other persons associated with the securities market and
intermediaries and self- regulatory organisations in the securities market;
(k) performing such functions and exercising according to Securities Contracts (Regulation) Act,
1956, as may be delegated to it by the Central Government;
(l) levying fees or other charges for carrying out the purpose of this section;
(m)conducting research for the above purposes;
(n) calling from or furnishing to any such agencies, as may be specified by the Board, such
information as may be considered necessary by it for the efficient discharge of its functions;
(o) performing such other functions as may be prescribed.

Registration of stock broker, sub-broker, share transfer agents etc.

A person in the following capacity shall buy, sell or deal in securities after obtaining a certificate
of registration from SEBI, as required by Section 12:
1) Stock-broker,
2) Sub- broker,
3) Share transfer agent,
4) Banker to an issue,
5) Trustee of trust deed,
6) Registrar to an issue,
7) Merchant banker,
8) Underwriter,
9) Portfolio manager,
10) Investment adviser
11) Depository,
12) Depository Participant
13) Custodian of securities,
14) Foreign institutional investor,
15) Credit rating agency or
16) Collective investment schemes,
17) Venture capital funds,
18) Mutual fund, and
19) Any other intermediary associated with the securities market

An application shall be made for registration in the prescribed manner with the prescribed fee.
But the SEBI may, by order, suspend or cancel a certificate of registration.

Scheme of penalties under the SEBI Act

41
The SEBI Act, 1992 provides for two alternative types of punishment for violation of the
provisions of the Act. They are :
a) suspension or cancellation of certificate of registration to be imposed by SEBI only as on
regulation framed by SEBI,
b) monetary penalty to be imposed by an adjudicating officer appointed by SEBI, as per rules
framed by Central Government.

SEBI has been empowered to adjudicate a wide range of violations and impose monetary
penalties on any intermediary or other participants in the securities market. Chapter VI-A has
listed out a wide range of violations along with maximum penalties leviable. It provides for a
highest penalty of Rs.10 lakh and the violations listed are failure to submit any document,
information or furnish any return, failure to maintain required books of accounts or records
carrying on any collective investment scheme without registration, failure to enter into
agreement with clients, insider trading, failure to redress the grievances of investors, failure to
issue contract notes, charging excessive brokerage by brokers, failure to disclose substantial
acquisition of shares and takeovers etc. The amendment Act provides for three types of monetary
penalties, viz, (a) a lump sum penalty for a specific violation of the Act, (b) a penalty for
everyday during which the violation continues, and (c) a multiple of the amount involved in the
violation. The amount of penalty is determined subject to the ceiling, by the adjudicating officer
who will be guided by the factors including amount of disproportionate gain or unfair advantage
wherever quantifiable made as a result of the amount of loss caused to an investor or any group
of investors as a result of default, and the repetitive nature of the default.

The adjudicating officer is required to be appointed by the SEBI. He shall not be an officer
below the rank of a division chief of SEBI. He will hold an enquiry after giving a person
reasonable opportunity of being heard for the purpose of determining if any violation has taken
place and imposing penalty. To ensure fair enquiry and penalty, it has been provided that appeal
against the orders of adjudicating officers would lie to the securities appellate tribunal.

42
8. SEBI (STOCK BROKERS & SUB-BROKERS) REGULATIONS, 1992

SEBI (Stock Brokers and Sub-brokers) Regulations, 1992 came into force on 22 nd October, 1992,
which was published in the Official Gazette.

The term small investor has been defined by the Regulation 1(g). Small investor means any
investor buying or selling securities on a cash transaction for a market value not exceeding
rupees fifty thousand in aggregate on any day as shown in a contract note issued by the stock-
broker.

Registration of Stock Broker

A stock broker shall apply in the prescribed format for grant of a certificate through the stock
exchange or stock exchanges, as the case may be, of which he is admitted as a member
(Regulation 3). The stock exchange shall forward the application form to the Board as early as
possible but not later than thirty days from the date of its receipt.

The SEBI shall take into account for considering the grant of a certificate all matters relating to
buying, selling, or dealing in securities and in particular the following, namely, whether the stock
broker -
(a) is eligible to be admitted as a member of a stock exchange;
(b) has the necessary infrastructure like adequate office space, equipment and man power to
effectively discharge his activities;
(c) has any past experience in the business of buying, selling or dealing in securities;
(d) is subjected to disciplinary proceedings under the rules, regulations and bye-laws of a stock
exchange with respect to his business as a stock-broker involving either himself or any of his
partners, directors or employees.

The SEBI on being satisfied that the stock-broker is eligible, shall grant a certificate to the
stock-broker and send an intimation to that effect to the stock exchange or stock exchanges as the
case may be.

The stock-broker holding a certificate shall at all times abide by the Code of Conduct as
specified at Schedule II of the Regulations.

Where an application for grant of a certificate does not fulfil the requirements, the Board may
reject the application after giving a reasonable opportunity of being heard.

Registration of Sub-Broker

An application by a sub- broker for the grant of a certificate shall be made in the prescribed
format accompanied by a recommendation letter from a stock-broker of a recognised stock
exchange with whom he is to be affiliated along with two references including one from his
banker (according to Regulation 11). The application form shall be submitted to the stock
43
exchange of which the stock- broker with whom he is to be affiliated is a member. The stock
exchange on receipt of an application shall verify the information contained therein and shall
also certify that the applicant is eligible for registration. The stock exchange shall forward the
application form of such applicants who comply with all the requirements specified in the
Regulations to the Board as early as possible, but not later than thirty days from the date of its
receipt.

The eligibility criteria for registration as a sub-broker are as follows:

In case of company, partnership firm and sole proprietorship firm, the directors, the partners and
the individual, shall comply with the following requirements :

(a) the applicant is not less than 21 years of age;

(b) the applicant has not been convicted of any offence involving fraud or dishonesty;
(c) the applicant has atleast passed 12th standard equivalent examination from an institution
recognised by the Government:

Maintenance of proper books of accounts, records etc

Every stock-broker shall keep and maintain the following books of accounts, records and
documents for a period of five years, as required by Regulation 17:

(a) Register of transactions (Sauda Book);

(b) Clients ledger;
(c) General ledger;
(d) Journals;
(e) Cash book;
(f) Bank pass book;
(g) Documents register should include particulars of shares and securities received and
delivered;
(h) Members' contract books showing details of all contracts entered into by him with other
members of the an exchange or counterfoils or duplicates of memos of confirmation issued to
such other member;
(i) Counterfoils or duplicates of contract notes issued to clients;
(j) Written consent of clients in respect of contracts entered into as principals;
(k) Margin deposit book;
(l) Registers of accounts of sub- brokers;
(m)An agreement with a sub- broker specifying the scope of authority and responsibilities of the
Stock-Broker and such sub- broker.

Every stock broker shall intimate to the Board the place where the books of accounts, records
and documents are maintained. These books of account and other records shall be maintained for
a minimum period of five years.

44
Every stock broker shall, after the close of each accounting period furnish to the Board if so
required as soon as possible but not later than six months from the close of the said period a copy
of the audited balance sheet and profit and loss account, as at the end of the said accounting
period:

Procedure for inspection

The SEBI may appoint one or more persons as inspecting authority to undertake inspection of
the books of accounts, other records and documents of the stock- brokers under Regulation 19
for the following purposes:
(a) to ensure that the books of accounts and other books are being maintained in the manner
required;
(b) that the provisions of the Act, rules, regulations and the provisions of the Securities Contracts
(Regulation) Act and the rules made thereunder are being complied with;
(c) to investigate into the complaints received from investors, other stock brokers, sub-brokers or
any other person on any matter having a bearing on the activities of the stock- brokers; and
(d) to investigate suo-moto, in the interest of securities business or investors' interest, into the
affairs of the stock-broker.

It shall be the duty of broker on inspection to produce to the inspecting authority such books,
accounts and other documents in his custody or control and furnish him with the statements and
information relating to the transactions in securities market within such time as the said officer
may require. The stock-broker shall allow the inspecting authority to have reasonable access to
the premises occupied by such stock- broker or by any other person on his behalf and also extend
reasonable facility for examining any books, records, documents and computer data in the
possession of the stock- broker or any other person and also provide copies of documents or
other materials which, in the opinion of the inspecting authority are relevant.

The inspecting authority, in the course of inspection, shall be entitled to examine or record
statements of any member, director, partner, proprietor and employee of the stock- broker. It shall
be the duty of every director proprietor, partner, officer and employee of the stock broker to give
to the inspecting authority all assistance in connection with the inspection, which the stock
broker may be reasonably expected to give.

The inspecting authority shall, as soon as may be possible submit an inspection report to the
SEBI. The SEBI shall after consideration of the inspection report communicate the findings to
the stock-broker to give him an opportunity of being heard before any action is taken by the
Board on the findings of the inspecting authority. On receipt of the explanation, if any, from the
stock-broker, the Board may call upon the stock-broker to take such measures as the Board may
deem fit in the interest of the securities market and for due compliance with the provisions of the
Act, rules and regulations.

Procedure in case of default

45
A stock-broker who

(a) fails to comply with any conditions subject to which registration has been granted;
(b) contravenes any of the provisions of the Act, rules or regulations;
(c) contravenes the provisions of the Securities Contracts (Regulation) Act or the rules
made thereunder;
(d) contravenes the rules, regulations or bye-laws of the stock exchange;

shall be liable to suspension of registration, after the inquiry, for a specified period; or
cancellation of registration (Regulation 25).

A penalty of suspension of registration of a stock- broker may be imposed if:-

(i) the stock-broker violates the provisions of the Act, rules and regulations;
(ii) the stock-broker does not follow the code of conduct
(iii) the stock-broker -
(a) fails to furnish any information related to his transactions in securities as required by
the Board;
(b) furnishes wrong or false information,
(c) does not submit periodical returns as required by the Board;
(d) does not co-operate in any enquiry conducted by the Board;
(iv) the stock-broker fails to resolve the complaints of the investors or fails to give a
satisfactory reply to the Board in this behalf;
(v) the stock-broker indulges in manipulating or price rigging or cornering activities in the
market;
(vi) the stock-broker is guilty of misconduct or improper or unbusinesslike or unprofessional
conduct;
(vii) the financial position of the stock broker deteriorates to such an extent that the Board is
of the opinion that his continuance in securities business is not in the interest of investors
and other stock- brokers;
(viii) the stock-broker fails to pay the fees;
(ix) the stock-broker violates the conditions of registration;
(x) the membership of the stock- broker is suspended by the stock exchange:

A penalty of cancellation of registration of a stock-broker may be imposed if:-

(i) the stock-broker violates any provisions of insider trading regulations or take-over
regulations;
(ii) the stock-broker is guilty of fraud, or is convicted of a criminal offence; and
(iii) cancellation of membership of the stock-broker by the stock exchange.

46
Relations between clients and Brokers/Sub-brokers

(1) Clients and brokers

1. Broker
A Broker/Trading Member is a person (agency) who arranges the purchase
and sale of an asset by acting as an intermediary between the purchaser and
the seller at an exchange.

2 Agreements with Clients

The Trading Member shall enter into an agreement in the specified format
provided by NSE with the client before accepting orders on latter’s behalf.
The said agreement shall be executed on Non-Judicial Stamp Paper, duly
signed by both the parties on all the pages. In Maharashtra, Non-Judicial
Stamp Paper of Rs. 20 is required for the said agreement. Copy of the said
agreement is to be kept permanently.

In addition to the Agreement, the Trading Member shall seek information

from the client in the 'Client Registration Application Form' obtaining
information like: investor risk profile, financial profile, social profile, investor
identification details, family, income, employment, age, investments, other
assets, financial liabilities, other responsibilities, social standing, investments
horizon, risk taking ability etc. The Trading Member shall obtain recent
passport size photographs (three copies) of each of their clients in case
of individual clients and of all partners in case of partnership firms
and of the dominant promoter in case of corporate clients. The Trading
Member shall also take proof of identification of the client.

A stock-broker shall not deal knowingly, directly or indirectly, with a client

who defaults to another stock-broker.

There is no limit on maximum number of clients for a trading member.

3. Margins From the Clients

It shall be mandatory for the Trading Member to collect margins from clients
in all cases where the margin in respect of the client in the settlement, would
work out to be more than Rs.50,000/-. The margin so collected shall be kept
separately in the client bank account and utilised for making payment to the
clearing house for margin and settlement with respect to that client.

4. Execution of Orders

47
The Trading Member shall ensure that appropriate confirmed order
instructions are obtained from the clients before placement of an order on
the system. In order to execute a trade for a client, a broker must have
specific customer instructions as to name of the company, the precise
number of shares and limit/market price condition.

He shall keep relevant records or documents of the same and of the

completion or otherwise of these orders thereof.

Where the client requires an order to be placed or any of his order to be

modified after the order has been entered in the system but has not been
traded, the Trading Member shall ensure that he obtains order
placement/modification details in writing from the client.

The Trading Member shall make available to his client the order number and
copies of the order confirmation slip / modification slip / cancellation slip and
a copy of the trade confirmation slip as generated on the Trading System,
forthwith on execution of the trade.

The Trading Member shall maintain copies of all instructions in writing from
clients including Participants for an order placement, order modification,
order cancellation, trade cancellation etc.

5. Accumulation of orders

The Trading Member shall not accumulate client’s order / unexecuted

balances of order where such aggregate orders / aggregate of unexecuted
balance is greater than the Regular lot size, specified for that security by the
Exchange. The Trading Member shall place forthwith all the accumulated
orders where they exceed the Regular lot size.

Where the Trading Member has accumulated the orders of several clients to
meet the requirement of the Regular lot quantity, he may give his own order
number referred to as the Reference Number, together with a reference
number to the NEAT Order Number, to the client.

Example 1: If a client is interested to buy shares from a broker, what should

he inform his brokers?

Ans. The client shall specify clearly in writing to his broker:

(i) the name of the scrip,
(ii) The precise number of shares,
(iii) buy price range, and
(iv) limit/market price condition.

48
6. Contract Notes

A Stock-broker shall issue a contract note to his clients for trades

(purchase/sale of securities) executed with all relevant details as required
therein to be filled in. A contract note shall be issued to a client within 24
hours of the execution of the contract duly signed by the Trading Member or
his Authorized Signatory or Client Attorney. A contract note should contain name,
registered address and dealing office address of the issuing broker and SEBI registration number
of the issuing broker. The contract note should have all trade related information viz., trade date,
scrip name, quantity, rate at which trade has taken place, brokerage charged by broker, service
tax etc. The contract note should be signed by the authorised signatory. The Trading Member
shall maintain details in the counterfoils of contract notes.

No member of a recognised stock exchange shall in respect of any securities

enter into any contract as a principal with any person other than a member
of a recognised stock exchange, unless he has secured the consent or
authority of such person and discloses in the note, memorandum or
agreement of sale or purchase that he is acting as a principal.

The contract note attracts stamp duty at the rates prescribed by concerned
state

7. Payments/Delivery of Securities to The Clients

Every Trading Member shall make payments to his clients or deliver the
securities purchased within 48 hours of pay-out unless the client has
requested otherwise.

Trading Members are advised to exercise extreme caution in accepting

deliveries of securities obtained by clients. This is to avoid introduction of
any fake/forged/stolen shares into the market.

8. Brokerage

The Trading Member shall charge brokerage at rates not exceeding the rate
prescribed by SEBI i.e., 2.5%. The brokerage shall be charged separately
from the clients and shall be indicated separately from the price, in the
contract note. The Trading Member may not share brokerage with a person
who is a Trading Member or in employment of another Trading Member.

The Trading Member can charge the following levies/fee from the clients in
addition to the brokerage:

1. Service Tax (Service Tax is 5 % of the brokerage).

2. Stamp duty
49
Example 2: If a client has sold 10000 shares of a scrip @ Rs. 50, what is the
maximum brokerage that the client can be charged?

Ans. The client can be charged a maximum brokerage of 2.5%

Maximum brokerage = 2.50 % Rs. 5,00,000
= Rs. 12,500.

9. Segregation of Bank Accounts

The Trading Member should maintain separate bank accounts for clients
funds and own funds. It shall be compulsory for all trading members to keep
the money of the clients in a separate account and their own money in a
separate account. Funds shall be transferred from the client account to the
clearing account for the purpose of funds pay-in obligations on behalf of the
clients and vice-versa in case of funds pay-out. No payment for transaction in
which the Trading Member is taking position as a principal will be allowed to
be made from the client’s account.

10. Interest, Dividends, Rights and Call

The buyer shall be entitled to receive all vouchers, coupons, dividends, cash
bonus, bonus issues, rights and other privileges which may pertain to
securities bought cum voucher, cum coupons, cum dividend, cum cash
bonus, cum bonus issues, cum rights, etc. and the seller shall be entitled to
receive all vouchers, coupons, dividends, cash bonus, bonus issues, rights
and other privileges which may pertain to securities sold ex vouchers, ex
coupons, ex dividends, ex cash bonus, ex bonus, ex rights, etc.

(2) Clients and Sub-brokers relations

1. Agreement

The Sub-broker shall enter into an agreement with the client, before placing
orders. Such agreement shall include provisions specified by the Exchange in
this behalf. The said agreement to be executed on Non-Judicial Stamp Paper.

The client should provide information to the Sub-broker in the ‘Client

registration Application Form’.

2. Orders

50
The sub-broker shall ensure that appropriate confirmed order instructions are
obtained from the clients before placement of an order on the system and
shall keep relevant records or documents of the same and of the completion
or otherwise of these orders thereof.

3. Purchase/Sale Note

The Sub-broker shall provide a purchase/sale note for all transactions made
within 24 hours of the execution of the contract.

The sub-broker shall ensure that -

1. Stamp duty is paid by the Sub-broker.

2. The service tax charged in the bill is shown in the contract note.
3. Purchase/sale note is signed by the authorised signatory.
4. Purchase/sale note is subject to jurisdiction of the courts of Mumbai.

4. Payments/Delivery Of Securities

The Sub-broker shall make payments to his clients or deliver the securities
purchased within 48 hours of pay-out unless the client has requested
otherwise.

5. Brokerage

The Sub-broker shall charge his brokerage at rates not exceeding the rate
prescribed by SEBI i.e., 1.5%.

The brokerage charged by the Trading Member and the Sub-broker shall be
indicated separately from the clients and shall be indicated separately from
the price, in the purchase/sale note.

The total brokerage that can be charged to a client is (max of 1.5 by sub-
broker of the traded value + 1.0 % or more by the Trading member) subject
to an over all % of 2.5.

Example 3: What is the maximum brokerage that can be charged by a sub-

broker, to his client who has purchased shares worth Rs. 3,00,000?

Max brokerage = (3,00,000*1.5)/100

= Rs. 4500.

51
 9. SEBI (DISCLOSURE & INVESTOR PROTECTION)

GUIDELINES, 2000

These Guidelines have been issued by SEBI under section 11 of the SEBI Act, 1992. These
guidelines have come into effect from 27.01.2000.

These Guidelines prescribe the norms applicable to all public issues by listed and unlisted
companies, all offers of sale and rights issues by listed companies, whose share capital is listed,
except in case of rights issues where the aggregate value of securities offered does not exceed
Rs.50 lakh.

Eligibility norms for companies issuing securities;

Some of the important conditions for issue of securities;

1(a) No company shall make any issue of public issue of securities, unless a draft prospectus has
been filed with the SEBI, through an eligible Merchant Banker, at least 21 days prior to the filing
of Prospectus with the Registrar of Companies.

(b) No company shall make any issue of securities through a rights issue where the aggregate
value of securities, including premium, if any, exceeds Rs.50 lakh, unless the letter of offer is
filed with the SEBI, through an eligible Merchant Banker, at least 21 days prior to the filing of
letter of offer with the Regional Stock Exchange.

2. The company should not have been debarred from issuing security by any order or direction of
SEBI.

3. The company shall not make an issue of securities unless it had made an application for listing
of those securities in the stock exchange(s).

4. Thc Company shall not make public or rights issue or an offer for sale of securities unless the
company enters into an agreement with a depository for dematerialization of securities already
issued or proposed to be issued to the public or existing shareholders and also gives an option to
subscribers/shareholders/investors to receive security certificates or hold securities in
dematerialized form.

5. Any unlisted company shall not make any public issue of equity shares unless the company
has
a) a track record of distributable profits in terms of section 205 of the Companies Act for atleast
three out of immediately preceding five years; and
b) a pre-issue networth of not less than Rupees One crore in three out of preceding five years,
with the minimum networth to be met during immediately preceding two years.

Public issue by Listed Companies:

52
1. A listed company shall be eligible to make a public issue of equity shares or any security
convertible at later date into equity share.
2. Public issue by listed companies which has changed its name to indicate as if it was engaged
in the business / activities in information technology sector during a period of three years prior to
filing of offer document with the Board, shall be eligible to make a public issue of equity share
or securities convertible at a later date into equity share, if;

(a) (i) it has a track record of distributable profits in terms of Section 205 of Companies Act,
for at least three (3) out of immediately preceding five (5) years from the information
technology business / activities, and
(ii) it has a pre-issue networth of not less than Rs. one crore in three (3) out of preceding
five (5) years, with the minimum networth to be met during immediately preceding two
(2) years
(b) if the company does not satisfy the requirements specified in clause (a) above, it can make
a public issue provided that it satisfies the requirements laid down for unlisted companies.

Exemptions from Eligibility norms

There are certain exemptions from some of the above provisions in case of ;

i) a banking company including a Local Area Bank (hereinafter referred to as Private Sector
Banks) set up under sub-section (c) of Section 5 of the Banking Regulation Act, 1949 and which
has received license from the Reserve Bank of India, or

ii) a corresponding new bank set up under the Banking Companies (Acquisition and Transfer of
Undertaking) Act, 1970 Banking Companies (Acquisition and Transfer of Undertaking) Act,
1980, State Bank of India Act 1955 and State Bank of India (Subsidiary Banks) Act, 1959
(hereinafter referred to as “public sector banks”).

iii) an infrastructure company

a) whose project has been appraised by a Public Financial Institution or Infrastructure

Development Finance Corporation (IDFC) or Infrastructure Leasing and Financing Services Ltd.
(IL&FS) and

b) not less than 5% of the project cost is financed by any of the institutions referred to in sub-
clause (a), jointly or severally, irrespective of whether they appraise the project or not, by way of
loan or subscription to equity or a combination of both.

iv) rights issue by a listed company

53
 10. Securities and Exchange Board of India (Insider Trading)

Regulations, 1992

The Securities and Exchange Board of India (Insider Trading) Regulations, 1992 deals with
prohibition on dealing communication or counseling on matters relating to inside trading, SEBI's
right to investigate, Procedure for investigation and Obligations of insider on investigation by the
Board.

According to Securities and Exchange Board of India (Insider Trading) Regulations, 1992,
insider means any person who, is or was connected with the company or is deemed to have been
connected with the company, and who is reasonably expected to have access, by virtue of such
connection, to unpublished price sensitive information in respect of securities of the company, or
who has received or has had access to such unpublished price sensitive information.

A connected person means any person who-

(i) is a director, as defined in clause (13) of section 2 of the Companies Act, 1956 (1 of
1956) of a company, or is deemed to be a director of that company by virtue of sub-clause
(10) of section 307 of that Act, or
(ii) occupies the position as an officer or an employee of the company or holds a position
involving a professional or business relationship between himself and the company and
who may reasonably be expected to have an access to unpublished price sensitive
information in relation to that company.

A person is deemed to be a connected person if such person-

(i) is a company under the same management or group or any subsidiary company thereof
within the meaning of section (1B) of section 370, or sub-section (11) of section 372, of
the Companies Act, 1956 (1 of 1956) or sub-clause (g) of section 2 of the Monopolies
and Restrictive Trade Practices Act, 1969 (54 of 1969) as the case may be; or
(ii) is an official or a member of a stock exchange or of a clearing house of that stock
exchange, or a dealer in securities within the meaning of clause (c) of section 2, and
section 17 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) respectively or
any employee of such member or dealer of a stock- exchange;
(iii) is a merchant banker, share transfer agent, registrar to an issue, debenture trustee, broker,
portfolio manager, Investment Advisor, sub- broker, Investment Company or an
employee thereof, or, is a member of the Board of Trustees of a mutual fund or a
member of the Board of Directors of the Asset Management Company of a mutual fund
or is an employee thereof who have a fiduciary relationship with the company;
(iv) is a member of the Board of Directors, or an employee, of a public financial institution as
defined in Section 4A of the Companies Act, 1956; or
(v) is an official or an employee of a self Regulatory Organisation recognised or authorised
by the Board of a regulatory body; or
(vi) is a relative of any of the aforementioned persons;
(vii) is a banker of the company.
54
Unpublished price sensitive information" means any information which relates to the following
matters or is of concern, directly or indirectly, to a company, and is not generally known or
published by such company for general information, but which if published or known, is likely to
materially affect the price of securities of that company in the market -

(i) financial results (both half-yearly and annual) of the company:

(ii) intended declaration of dividends (both interim and final);
(iii) issue of shares by way of public rights, bonus, etc.;
(iv) any major expansion plans or execution of new projects;
(v) amalgamation, mergers and take-overs;
(vi) disposal of the whole or substantially the whole of the undertaking;
(vii) such other information as may affect the earnings of the company.
(viii) any changes in policies, plans or operations of the company.

55
11. SEBI (Substantial Acquisition of Shares and Takeovers) Regulations,

1997

In exercise of the powers conferred by Section 30 of the SEBI Act, the SEBI notified the SEBI
(Substantial Acquisition of Shares and Take Over) Regulations, 1994 on 4 th November, 1994.
These Regulations were amended and published in the official Gazette on February 20, 1997.

Definitions
The terms used in the SEBI (Substantial Acquisition of Shares and Take Over) Amendment
Regulations, 1997 are defined in Regulation 2.

(1) Acquirer means any person who, directly or indirectly, acquires or agrees to acquire shares
or voting rights in the target company, or acquires or agrees to acquire control over the target
company, either by himself or with any person acting in concert with the acquirer.

(2) Control shall include the right to appoint majority of the directors or to control the
management or policy decisions exercisable by a person or persons acting individually or in
concert, directly or indirectly, including by virtue of their shareholding or management rights
or shareholders agreements or voting agreements or in any other manner.

(3) Person acting in concert comprises,

(a) persons who, for a common objective or purpose of substantial acquisition of shares or
voting rights or gaining control over the target company, pursuant to an agreement or
understanding (formal or informal), directly or indirectly co-operate by acquiring or
agreeing to acquire shares or voting rights in the target company or control over the
target company.
(b) Without prejudice to the generality of this definition, the following persons will be
deemed to be persons acting in concert with other persons in the same category, unless
the contrary is established :
i) a company, its holding company, or subsidiary of such company or company
under the same management either individually or together with each other;
ii) a company with any of its directors, or any person entrusted with the
management of the funds of the company;
iii) directors of companies referred to in sub-clause (i) of clause (2) and their
associates;
iv) mutual fund with sponsor or trustee or asset management company;
v) foreign institutional investors with sub account(s);
vi) merchant bankers with their client(s) as acquirer;
vii) portfolio managers with their client(s) as acquirer;
viii) venture capital funds with sponsors;
ix) banks with financial advisers, stock brokers of the acquirer, or any company

56
 which is a holding company, subsidiary or relative of the acquirer. Provided that sub-
clause (ix) shall not apply to a bank whose sole relationship with the acquirer or with
any company, which is a holding company or a subsidiary of the acquirer or with a
relative of the acquirer, is by way of providing normal commercial banking services
or such activities in connection with the offer such as confirming availability of
funds, handling acceptances and other registration work.

x) any investment company with any person who has an interest as director, fund
manager, trustee, or as a shareholder having not less than 2% of the paid-up
capital of that company or with any other investment company in which such
person or his associate holds not less than 2% of the paid up capital of the
latter company.

(4) Offer period means the period between the date of public announcement of the first offer
and the date of closure of that offer.

(5) Promoter means

(a) (i) the person or persons who are in control of the company, or
(ii) person or persons named in any offer document as promoters;
(b) a relative of the promoter within the meaning of section 6 of the Companies Act, 1956
(c) in case of a corporate body:
(i) a subsidiary or holding company of that body, or
(ii) any company in which the `Promoter' holds 10% or more of the equity capital or
which holds 10% or more of the equity capital of the Promoter, or
(iii) any corporate body in which a group of individuals or corporate bodies or
combinations thereof who hold 20% or more of the equity capital in that company
also hold 20% or more of the equity capital of the `Promoter'; and
(d) in case of an individual,
(i) any company in which 10% or more of the share capital is held by the `Promoter' or
a relative of the `Promoter' or a firm or Hindu undivided family in which the
`Promoter' or his relative is a partner or co-parcener or a combination thereof,
(ii) any company in which a company specified in (i) above, holds 10% or more of the
share capital, or
(iii) any HUF or firm in which the aggregate share of the Promoter and his relatives is
equal to or more than 10% of the total.

(6) Shares means shares in the share capital of a company carrying voting rights and includes
any security which would entitle the holder to receive shares with voting rights.

(7) Target company means a listed company whose shares or voting rights or control is directly
or indirectly acquired or is being acquired.

The SEBI (Substantial Acquisition of Shares and Take Over) Regulations, 1994 governs the
following areas:
1) Disclosure of shareholding and control in a listed company

57
2) Substantial acquisition of shares or voting rights in and acquisition of control over a listed
company
3) Bail out takeovers

58
12. SEBI (PROHIBITION OF FRAUDULENT AND UNFAIR TRADE

PRACTICES RELATING TO SECURITIES MARKETS)

REGULATIONS, 1995

The Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade
Practices relating to Securities Markets) Regulations, 1995 was enacted to prevent fraudulent and
unfair trade practices in the securities market..

The Act regulates the prohibition :

(1) of certain dealings in securities,
(2) against Market Manipulation,
(3) of misleading statements to induce sale or purchase of securities, and
(4) on unfair trade practice relating to securities

The term fraud has been defined by Regulation 2.(1) (c). Fraud includes any of the following acts
committed by a party to a contract, or with his connivance, or by his agent, with intent to deceive
another party thereto or his agent, or to induce him to enter into the contract:-
(1) the suggestion, as to a fact, of that which is not true, by one who does not believe it to be
true;
(2) the active concealment of a fact by one having knowledge or belief of the fact;
(3) a promise made without any intention of performing it;
(4) any other act fitted to deceive;
(5) any such act or omission as the law specially declares to be fraudulent.

Explanation: Mere silence as to facts likely to affect the willingness of a person to enter into a
contract is not fraud, unless the circumstances of the case are such that, regard being had to them,
it is the duty of the person keeping silence to speak, or unless his silence is, in itself, equivalent
to speech.

Prohibition of certain dealings in securities

A person shall not buy, sell or otherwise deal in securities in a fraudulent manner (Regulation n
3).

Prohibition against Market Manipulation

For prohibition against market manipulation, Regulation 4 has specified that -

59
(i) A person shall not effect, take part in, or enter into, either directly or indirectly,
transactions in securities, with the intention of artificially raising or depressing the prices
of securities and thereby inducing the sale or purchase of securities by any person,
(ii) A person shall not indulge in any act, which is calculated to create a false or misleading
appearance of trading on the securities market,
(iii) A person shall not indulge in any act which results in reflection of prices of securities
based on transactions that are not genuine trade transactions,
(iv) A person shall not enter into a purchase or sale of any securities, not intended to effect
transfer of beneficial ownership but intended to operate only as a device to inflate,
depress, or cause fluctuations in the market price of securities, and
(v) A person shall not pay, offer or agree to pay or offer, directly or indirectly, to any person
any money or money's worth for inducing another person to purchase or sell any security
with the sole object of inflating, depressing, or causing fluctuations in the market price of
securities

Prohibition of misleading statements to induce sale or purchase of securities

According to Regulation 5(1), a person shall not make any statement, or disseminate any
information which -
(a) is misleading in a material particular; and
(b) is likely to induce the sale or purchase of securities by any other person or is likely to
have the effect of increasing or depressing the market price of securities, if when he makes the
statement or disseminates the information-
(i) he does not care whether the statement or information is true or false; or
(ii) he knows, or ought reasonably to have known that the statement or information is
misleading in any material particular.

The general comments made in good faith whether in public or in private, shall not apply to
(a) the economic policy of the Government,
(b) the economic situation in the country,
(c) trends in the securities markets,
(d) any other matter of a similar nature,
.
Prohibition on unfair trade practice relating to securities (Regulation 6)

A person shall not

(a) in the course of his business, knowingly engage in any act, or practice which would operate
as a fraud upon any person in connection with the purchase or sale of, or any other dealing in,
any securities;
(b) on his own behalf or on behalf of any person, knowingly buy, sell or otherwise deal in
securities, pending the execution of any order of his client relating to the same security for
purchase, sale or other dealings in respect of securities.
(c) intentionally and in contravention of any law for the time being in force delays the transfer of
securities in the name of the transferee or the dispatch of securities or connected documents
to any transferee;
(d) indulge in falsification of the books, accounts and records
60
(e) when acting as an agent, execute a transaction with a client at a price other than the price at
which the transaction was executed by him, whether on a stock exchange or otherwise, or at a
price other than the price at which it was offset against the transaction of another client.

Investigation into alleged contravention

The SEBI has right to conduct investigation under Regulation 7 suo-moto or upon information
received by it through an investigating officer in respect of the conduct and affairs of any person
buying, selling or otherwise dealing in securities. The investigation can be conducted:
(a) to ascertain whether there are any circumstances which would render any person guilty of
having contravened any of these regulations or any directions issued thereunder;
(b) to investigate into any complaint of any contravention of the regulation, received from any
investor, intermediary or any other person;

The SEBI shall give a notice to the person in respect of whom an investigation before causing an
investigation but Board may not give such notice if it is in the interest of the investors or in the
public interest.

Duties of the person in respect of whom an investigation has been ordered [Regulation 9]
(1) He should produce to the Investigating Officer such books, accounts and other documents in
his custody or control and furnish him with such statements and information as the said
officer may reasonably require for the purposes of the investigation

(2) He should -
(a) allow the Investigating Officer to have access to the premises occupied by such person at
all reasonable times for the purpose of investigation,
(b) extend to the Investigating Officer reasonable facilities for examining any books,
accounts and other documents in his custody or control (whether kept manually or in
computer or in any other form) reasonably required for the purposes of the investigation,
(c) provide to such Investigating Officer copies of any such books, accounts and records
which, in the opinion of the Investigating Officer, are relevant to the investigation or, as
the case may be, allow him to take out computer printout thereof.

(3) He should give to the Investigating Officer, all such assistance and otherwise extend all such
co- operation as may reasonably be required in connection with the investigation and to
furnish information relevant to such investigation as may be reasonably sought by such
officer

Investigating Officer
The Investigating Officer shall conduct investigation as directed by the Board. He has power to
examine orally and to record the statement of the person concerned, any director, partner,
member or employee of such person [Regulation 9 (3)]. The Investigating Officer shall, on
completion of the investigation, after taking into account all relevant facts and submissions made
by the person concerned, submit a report to the Board (Regulation 10).

61
The SEBI on receipt of the report from the investigating officer may issue directions under
Regulation 11 for ensuring due compliance with the provisions of the Act, Rules and Regulations
made thereunder The Board may give opportunity of hearing to the person concerned.

Purpose of the direction

The directions may be issued for the following purposes:
(a) directing the person concerned not to deal in securities in any particular manner;
(b) requiring the person concerned to call upon any of its officers, other employees or
representatives to refrain from dealing in securities in any particular manner;
(c) prohibiting the person concerned from disposing of any of the securities acquired in
contravention of these regulations;
(d) directing the person concerned to dispose of any such securities acquired in contravention of
these regulations, in such manner as the Board may deem fit, for restoring the status-quo
ante.

The Board may, in the circumstances specified in Regulation 11, and without prejudice to its
power under Regulation 12, initiate action for suspension or cancellation of registration of an
intermediary holding a certificate of registration under section 12 of the Act.

62
 13. SEBI’S STOCK WATCH SYSTEM

For effective surveillance and monitoring of the securities markets it was felt
that there is a need to have a system with a common framework across all
the stock exchanges. The objectives of this system, termed as the Stock
Watch System, is to give suitable indicators for the detection of potential
illegal or improper activity to protect investor confidence and the integrity of
the securities market and its players.

13.1 Databases

The Stock Watch System has standardized information available with all the
stock exchanges. This standard information is stored in the form of four
databases classified as follows:
a) Issuer Database.
b) Securities Database.
c) Trading Database.
d) Member Database.

In order to access information on a security from any of these databases,

there is a unique identification number which comprises the first seven digits
of the ISIN number issued by SEBI. In order to access information for any
member, a unique identification code is being formulated on lines similar to
the ISIN codes for securities. Final objective of the uniform structure of these
databases is to make these databases accessible on line to other stock
exchanges.

In order to detect any improper activity, the system has standardized alerts,
which are classified as follows:
 Online Real Time Alerts.
 Online Non-real Time Alerts.
These alerts generated are stored in two separate databases, which are
dynamically updated.

Detailed description of these databases and alerts is given below:

13.1.1. Issuer Database

This database is maintained by the regional stock exchange and is updated

every week. The database contains information about the company whose
instruments are traded on the exchange. This information includes the name,
63
address, the line of business, the promoters, share holding pattern, capital
history, balance sheet, profit and loss accounts, corporate actions, subsidiary
companies etc.

13.1.2. Securities Database

This database is maintained by all stock exchanges and updated every week.
The database contains information about the instruments like shares,
preference shares, warrants, debentures etc, which are traded on the
exchange. This information includes the name of the company, the
instrument type, floating stock, trading start date, ex-date, no-delivery
periods, dates and reasons for suspension of trading, details of fake and
forged shares etc.

13.1.3.Trading Database

This database is maintained by all stock exchanges. It is updated on-

line/daily/end of settlement based on the type of information. This
information includes price, volume and value relating to the trades,
obligations, deliveries and auctions, positions, price bands etc.

13.1.4 Member Database

This database is maintained by all stock exchanges. The information in this

database includes the name and the type of membership, name, address
and qualification, details of other exchange’s membership, securities in
which the member is active, short and bad delivery record, suspension
record, investor grievance complains, arbitration cases, sub-brokers with
their names and addresses, the turnover details, net worth etc.

13.2 Alerts

13.2.1 Online Real Time Alerts

These alerts are based on the order and trade related information during the
trading hours. The objective of these alerts is to identify any abnormality as
soon at it happens. These alerts include intra-day price movement related
and abnormal order and trade quantity or value related alerts.

13.2.2 Online Non real Time Alerts

These alerts are based on the traded related information at the end of the
day and the available historical information. The objective of these alerts is
to analyze the price, volume and value variations over a period.

64
13.3 Parameters for Alert Generation

The parameters that are used for alert generation are explained below:

13.3.1 Price Bands System

Daily price bands are applicable on the Previous Day’s Close Price as follows:

Category Price
Band
Less than Rs.10.00 +/-
50.00%
Rs. 10.00 to Rs. +/-
19.95 25.00%
Rs.20.00 and +/- 8.00%
above

In case of 200 securities jointly identified by BSE and NSE the price band are
relaxed by further 4%. Once the scrip touches 8% price band in either
direction, trading in that scrip would be restricted up to the price band for
half an hour. After half an hour of trading, price band would be further
relaxed by 4% in that direction only.

In case of scrip touches the price band of 8% in BSE prior to NSE, on receipt
of such information from BSE, the price band would be relaxed at NSE by 4%
in that direction, after such relaxation is applied at BSE

In cases where the scrip touches the price band on either side, in last half an
hour of trading, then the trading in that scrip would be restricted up to the
price band for fifteen minutes instead of half an hour. After fifteen minutes,
the price band would be further relaxed by 4%in that direction only.

The relaxation in price band would be effected only if the scrip (scrip other
than those in compulsory rolling settlement) touches the price band in any
direction in EQ series in the normal market. Once the price band is flexed in
series EQ for a security then price band shall also be flexed in other relevant
series AE,BE,BT and TT. In case of rolling settlements the price band shall be
flexed in series BE only and price band in series BT for the respective
security shall be flexed only on request from member. Similarly price bands
shall be flexed in market type ‘S’ and ‘O’ for the purpose of ALBM and
Limited Physical Market, only if the price bands have been flexed in the

65
Normal Market as detailed above and on specific request from member in
this regard.

The above provisions are not applicable in case of securities trading below
Rs.20

There is no settlement price band. Maximum/minimum prices calculated on

the basis of the price ranges applicable are rounded (ceiling) to Rs.0.05.

13.3.2. Auction Market

Price bands are applicable over Previous day’s close price and are as follows:

Category Price
Band
Less than Rs.10.00 +/-
50.00%
Rs. 10.00 to Rs. +/-
19.95 25.00%
Rs.20.00 and +/-
above 15.00%

13.3.3 Quantity Freeze Percentage (volume of large order)

Any order, whose value is greater than or equal to around Rs.5.00 crore
subject to a ceiling of 1.00% of the issue size, results in a quantity freeze and
does not go directly into the order books. Such orders go into the books only
after the exchange’s approval. Rejected quantity freeze results in the
cancellation of the order.

13.3.4 Price Variation

It is defined a the variation between the last trade price (LTP t) and the
previous close price (P) of a security expressed as a percentage of the
previous close price (P). i.e.
Price Variation = {(LTPt  P)/ P}  100

13.3.5 High-Low Variation

It is defined as the variation between the high price (H) and the low price (L)
of a security expressed as a percentage of the previous close price (P). i.e.
High-Low Variation = {(H  L)/ P}  100
This parameter can also be expressed as a percentage of the low price i.e.

66
High-Low Variation over low price = {(H  L)/ L}  100.

13.3.6 Open Price Variation

It is defined as the variation between the open price (O) and the previous
close price (P) of a security expressed as a percentage of the previous close
price (P). i.e.
Open Price Variation = {(O  P)/ P}  100

13.3.7 Consecutive Trade Price Variation

It is defined as the variation between the last trade price (LTP t) and the
previous trade price (LTPt-1) of a security expressed as a percentage of the
previous trade price (LTPt-1) i.e. Consecutive Trade Price Variation (LTP) =
{(LTPt  LTPt-1)/ LTPt-1}  100

13.3.8 Quantity Variation

It is defined as the percentage variation between the total traded quantity Q

and the average traded quantity Qavg expressed as a percentage of the
average traded quantity.

Quantity Variation = {(Q  Qavg)/ Qavg}  100

Quantity Variation Ratio = Q/ Qavg

Daily Average Traded Quantity = Total number of shares traded in the last
‘n’ trading days/n

13.3.9 Price movement in relation to the index

This is used to identify securities whose price movement is opposite to the

index movement. The parameter to be calculated when a security moves
opposite to the index is
the difference between the % change in index and the % price variation of
the security.

Example 1: Close price of a security on the last day of a settlement is

Rs.22.00. The next settlement consists of five trading days. The security
witnesses maximum possible price fall during this settlement and closes of
the bandhit price on the lower side on all trading days. What is the close
price of the security on the last day of this settlement? The tick size is Rs.
0.05. (Price band is flexed further by 4% for the security having base price of
Rs.20 and above)
Solution:
P0 = 22.00
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1 day of settlement:
P1 = (1-0.12)  22.00 = 19.36  19.40

2nd day of settlement:

P2 = (1-0.25)  19.40 = 14.55=14.55

3rd day of settlement:

P3 = (1-0.25)  14.55 = 10.91  10.95

4th day of settlement:

P4 = (1-0.25)  10.95 = 8.21  8.25

last day of settlement:

P5 = (1-0.50)  8.25 = 4.13  4.15

Hence the close price of the security on the last day of settlement is Rs 4.15

Example 2: Issue size of a security is 8,00,00,000. Close price of a security

on the last day of a settlement is Rs.25.00. A trading member enters an
order to buy 8,50,000 shares at a price of Rs. 25.25 on the first day of the
next settlement. Will the order directly go into the order books?
Solution:

Step 1:
Order Price = Rs. 25.25
Order Size = 8,50,000 shares.
Value of the order = 25.25  850000 = 2,14,62,500  Rs. 2.15 Cr.
This is less than Rs.5.00 Cr.

Step 2:
Order size as a percentage of issue size = (850000/80000000)  100 =
1.06%
This is greater than 1.00.

Hence the order will not go directly into the order books and will result in a
Quantity Freeze.

Example 3: Following alerts have been configured on the Stock Watch

System of the Exchange.
1) Magnitude of the close price variation percentage as compared to the
previous day's close price is greater than or equal to 4.00%.
2) Magnitude of the high-low variation percentage as compared to the
previous day's close price is greater than or equal to 7.00%.

68
3) Magnitude of the open price variation percentage as compared to the
previous day's close price is greater than or equal to 3.00%.
4) Magnitude of the price variation between last trade and the previous trade
is greater than or equal to 4.00%.
5) Security hits the price band only on the high side.
6) Security hits the price band only on the low side.
7) Security hits the price band on the high and the low side.
8) Traded quantity has exceeded two times the two-month daily average
traded quantity.
9) Security moves opposite to the index and the difference between
percentage index variation and percentage price variation is greater than
5.00.

The previous close price of a security is Rs. 100.00. The security opens at
Rs.99.00, rises to a high of Rs.99.50, touches a low of Rs.92.00 and then
closes at Rs.93.00. The total traded quantity is 1,00,000 shares. The two-
month average traded quantity is 75,050 shares. Index closes at 1031.00
points over its previous close of 996.00. Which of the alerts would be
triggered on the stock watch system?
Solution:
1) Magnitude of close price variation % = abs {(93.00  100.00)/100} 100
= 7.00
(criteria satisfied >4.00%)

2) High low variation % ( wrt Pr cls) = {(99.50  92.00)/100} 100 = 7.50

(satisfied >=7.00%)

3) Magnitude of open price variation % (wrt Pr cls) = abs {(99.00 

100.00)/100} 100 = 1.00
(not satisfied <3.00%)

4) Variation magnitude between last trade and prev trade = abs {(99.00 
100.00)/100} 100 = 1.00
(not satisfied < 4.00%)
For the first trade of the day which is at open price, the previous trade price
is the previous day close price.

5) Hits price band on High side = abs {(99.50  100.00)/100} 100 = 0.5
(not satisfied < 8.00%)

6) Hits price band on Low side = abs {(92.00  100.00)/100} = 8.0

(satisfied = 8.00%)

7) Hit price band on both sides

(not satisfied )
69
8) Traded Qty to 2 month daily average. = 1,00,000/75050 =1.33
(not satisfied < 2.00)

9) % Difference in Index and Security price variation

Security falls while the index rises.
Index Variation % = {(1031.00  996.00)/996.00}  100 = +3.51%
Close Price Variation = {(93.00  100.00)/100.00}  100 = 7.00%
Difference = (+3.51)  (7.00) = 10.51
(satisfied >=+5.00)

Thus alerts 1, 2, 6 and 9 would be triggered.

70
 14. OFF-LINE SURVEILLANCE

14.1 Margins
Margin represents a prescribed token amount evidencing commitment made by an client in the
form of cash and/or securities or in any other form to honour the executed
transaction/contract/trade. NSCCL imposes stringent margin requirements on CMs, as explained
below:

14.1.1 Mark to Market Margin

Mark to market margin is the aggregate amount of actual loss incurred on the positions closed
out during the course of the day and the notional loss, which a member would incur, if the net
cumulative outstanding positions in all securities were to be closed out at the closing price of the
relevant trading day. For each security, this is worked out by multiplying the difference between
the close price and the price at which the trade was executed by the cumulative buy and sell open
position (for buy position the close price being lower than actual trade price and for sale position
the close price being higher than actual trade price). The aggregate across all securities is Mark
to Market margin payable by a member. It is calculated as under :

MTM Profit/Loss = [(Total Buy Qty X Close price) – Total Buy Value] + [Total Sale Value -
(Total Sale Qty X Close price)]

Actual profit and notional profit worked out on identical basis are ignored while calculating mark
to market margin. In case of Regular Market segment, after close of a trading cycle, mark to
market margin continues to be computed in respect of transactions of the closed trading cycle till
its funds pay-in day because the positions for the closed settlement are not settled by way of
delivery and payment. The credit for mark to market profit is therefore not taken into account
and all the mark to market losses are taken into consideration. In cases where the outstanding
position in a security is zero, the difference between the buy and sell values is considered for the
mark to market calculation.

Mark to market losses in the Regular Market segment in a security are adjusted against the Mark
to Market profits in other securities. Mark to Market margins are calculated separately for the
two trading cycles. Credit for Mark to Market profits of the closed trading cycle is not given
against Mark to Market losses of the current trading cycle, as per SEBI directive.

14.1.2 Volatility Margin

Volatility Margin is imposed to curb excessive volatility in the market and to act as a deterrent to
building up of excessive outstanding positions. Volatility of a security is determined on the basis
of fluctuations in stock prices over a six-week period. The volatility percentage is defined as :
(6 week high price – 6 week low price)/6 week low price * 100

71
Price variations on account of calls, bonuses, rights, mergers, amalgamations and scheme of
arrangements are adjusted for determining volatile securities and adjustment in prices, when
securities are traded ex-benefits, is made for the purpose of computation of volatility. The margin
rates are as under :

Price Variation Margin Rates (%)

 60% - < 70% 5
 70% - < 90% 10
 90% - < 110% 15
 110%- < 130% 20
 130%- < 150% 25
150% 30

The securities that attract volatility margin and the margin rates applicable are announced on the
last day of the trading cycle and are applicable from the first day of the succeeding trading
cycle. The volatility margin is levied on the net outstanding position of the member in each
security based on the respective margin rates.
Further, if prices have been volatile, say, upwards (or downwards) and are attracting margins on
the buy side (or sell side), and if the price movement reverses and exhibits a decline (or
increases) of 16% or more, then the margins will be applicable on sell side (buy side) as per rates
prescribed.
The volatility margins is not applicable for securities whose prices are less than Rs.40. However,
it attracts volatility margin if the price of a security increases to Rs. 40 or more. If a price of a
security reduces to below Rs. 40 in a trading period, it will still be eligible for consideration
during that trading period.
If a security attracts both the mark-to-market and the volatility margins, the higher of the two is
levied as daily margin.

14.1.3 Gross Exposure Margin

Gross Exposure Margin is computed on the aggregate of the net cumulative outstanding positions
in each security of the CM in the following manner:
Gross Exposure (Rs. Million) Margin Payable
0 – 10 Nil

>10 and upto 30 2.5%

>30 and upto 60 Rs. 5 lac plus 5% in excess of Rs.30 million
>60 and upto 80 Rs.20 lac plus 10% in excess of Rs.60 million

72
 >80 and upto 200 Rs.40 lac plus 15% in excess of Rs.80 million
> 200 Rs. 220 lac plus 20% in excess of Rs. 200 million

14.1.4 Additional margin of 5% will be imposed on net sale position at the end of day on all
securities.

14.1.5 Gross exposure

Example 1: The price movements for the following securities is as given below:

Security Preceding Preceding Settlement

6-week High 6-week Low Close
A 140.00 80.00 100.00
B 205.00 195.00 200.00
C 15.00 5.00 10.00
D 105.00 95.00 100.00
E 130.00 90.00 110.00

Which of the following statements is true for the above securities for the next settlement.
1.Security A will attract an additional volatility margin at a rate of 15.00%.
2. Security B will attract an additional volatility margin at a rate of 5.00 %.
3.Security C will attract an additional volatility margin at the rate of 20.00%.
4. Security D will attract an additional volatility margin at the rate of 10.00 %.
5.Security E will attract an additional volatility margin at the rate of 5.00%.

Answer: Security A and E will attract an additional volatility margin at a rate of 15.00% and
5.00% respectively.

Example 2: A member trades in four securities, A, B, C and D on a trading day. The Gross
Exposure Margin computed for the member is Rs.10.00 Lakh. All the above securities are
identified as volatile at their respective margin rates. The Mark-to-Market Margin and the
Volatility Margin computed for each of these securities is given below:

Security Mark-to-Market Margin Volatility Margin

A Rs.6.00 Lakh Rs. 5.00 Lakh
B Rs.4.00 Lakh Rs.5.00 Lakh
C Rs.2.00 Lakh Rs. 3.00 Lakh
D Rs. 6.00 Lakh Rs. 5.00 Lakh

What is the Total Margin payable by the Member?

Answer:

73
The Member has to pay a sum of Daily margin and Volatility Margin. The daily margin consists
of Mark to market margin and Gross Exposure Margin.

First, we find out the higher of the Mark-to-Market Margin and Volatility Margin for each scrip
Scrip A - Rs. 6 lakh (Mark-to-Market Margin)
Scrip B - Rs. 5 lakh (Volatility Margin)
Scrip C - Rs. 3 lakh (Volatility Margin)
Scrip D - Rs. 6 lakh (Mark-to-Market Margin)

Hence, the Mark-to-Market Margin is Rs. 12 lakh and Volatility Margin is Rs. 8 lakh. And the
Gross Exposure Margin is Rs. 10 lakh.

So, the Daily Margin comes to Rs. 12 lakh (higher of Mark to market margin and Gross
Exposure Margin) and Volatility Margin comes to Rs. 8 lakh.

The Member has to pay a total margin of Rs. 20 lakh.

Example 3: A member has traded in the following five securities on a trading day.
(In Rs. lakh)
Security Buy Position Sell Position
A Rs.60.00 Rs. 0.00
B Rs.40.00 Rs.5.00
C Rs.0.00 Rs. 34.00
D Rs. 6.00 Rs. 19.00
E Rs.29.00 Rs. 4.00

All the above securities are identified as volatile at their respective margin rates. What is the
Gross Exposure Margin payable by the Member?

Answer:
Gross Exposure Margin is computed on the aggregate of the cumulative net outstanding positions
(purchases or sales) in the following manner:

Gross Exposure (Rs. crore) Margin Payable %

0-1 Nil
>1 and upto 3 2.5% in excess of Rs.1 crore
>3 and upto 6 Rs.5 lakh plus 5% in excess of Rs.3 crore
>6 and upto 8 Rs.20 lakh plus 10% in excess of Rs.6 crore
>8 and upto 10 Rs.40 lakh plus 15% in excess of Rs.8 crore
>10 Rs.70 lakh plus 25% in excess of Rs.10 crore

First, calculate net outstanding position for each scrip and the aggregate of the
(In Rs. lakh)
Security Buy Position Sell Position Net outstanding position
A 60.00 Nil 60.00
B 40.00 5.00 35.00
74
 C Nil 34.00 34.00
D 6.00 19.00 13.00
E 29.00 4.00 25.00
Cumulative net outstanding position 167.00

The Gross Exposure Margin for the Cumulative net outstanding position of the member (as per
above table) comes to Rs. 1.675 lakh (167 lakh minus 100 lakh = 67 lakh * 2.5%).

14.2 Exception Handling

14.2.1 Exception Handling in Regular market

Exception conditions may arise because of short delivery of securities by clearing members, bad
deliveries, company objections or non-availability of clear funds into the clearing account on the
pay-out day.

Security shortage
Each clearing member communicates to the NSCCL on the pay-in day the securities it is
delivering and those it is unable to deliver. NSCCL identifies short deliveries on Tuesday and
conducts a buying-in auction for the quantity of securities actually found short-delivered, on the
pay-out day through the NSE trading system.

The clearing member is also debited by an amount equivalent to the securities not delivered and
valued at a valuation price (the closing price as announced by NSE on the Friday previous to the
day of the valuation).

If the buy-in auction price is more than the valuation price, the clearing member is debited the
difference in amount.

Bad delivery
Bad deliveries (deliveries which are prima facie defective such as not containing pre-specified
particulars like the trading member stamp on the transfer deed etc.) are required to be reported to
the NSCCL within two days from the receipt of documents. The delivering member is required to
rectify these within two days.

In a typical settlement cycle bad deliveries are reported by Friday. These are handed over to the
delivering member on Saturday for rectification by Tuesday, failing which NSCCL conducts an
auction buy-in on Wednesday. As in the case of short deliveries there is a valuation debit and a
square up in the event of unsuccessful auctions. All shortages not bought-in are deemed closed
out at the highest price between the first day of the trading period till the day of squaring up or
closing price on the auction day plus 20%, whichever is higher. This amount is credited to the
receiving member’s account on the auction pay-out day.

Company Objections
Company objections arise when, on lodgment of the securities, accompanied with the duly
executed transfer deeds, with the company for transfer by the transferee (last buyer), they are
75
returned by the company due to signature mismatch or for any other reason for which the transfer
of security in the name of the transferee cannot take effect.

The original selling clearing member (referred to as introducing member) of the documents in
NSE is responsible for rectifying/replacing defective documents (‘objection cases’) to the
receiving clearing member. If the clearing member is unable to rectify/replace defective
documents on or before 21 days of lodgment of documents, NSCCL conducts a buying-in
auction for the unrectified part of defective document, on the next auction day (Wednesday)
through the trading system of NSE. All objections which are not bought-in are deemed closed out
on the auction day at the closing price on the auction day plus 20%. This amount is credited to
the receiving member’s account on the auction pay-out day.

Non-availability of clear funds

In case of funds shortage, NSCCL withholds securities which are receivable as pay-out to the
CM. These securities are released only after the shortage amount is cleared. If shortage is not
cleared, the NSCCL disposes off the securities by selling them out and requiring the CM to pay
the difference between the funds shortage and the sale proceeds.

Auction Settlement
The buy-in auctions are settled on trade for trade basis. In a typical settlement cycle, auctions are
usually held on Wednesday. The auction pay-in for both funds and securities is on Friday and
pay-out on Saturday.

14.2.2 Exception Handling for account period settlement in Book Entry segment

Exception conditions may arise because of short delivery of securities by clearing members or
non-availability of clear funds into the clearing account on the pay-out day.

Security shortage
Each clearing member communicates to the NSCCL on the settlement day the securities it is
delivering and those it is unable to deliver and the NSCCL conducts a buying-in auction for the
quantity of securities actually found short-delivered, on the following day through the NSE
trading system.
The clearing member is also debited by an amount equivalent to the securities not delivered and
valued at a valuation price (the closing price as announced by NSE on the Friday previous to the
day of the valuation).

If the buy-in auction price is more than the valuation price, the clearing member is debited the
difference in amount.

All shortages not bought-in are deemed closed out at the highest price between the first day of
the trading period till the day of squaring off or closing price on the auction day plus 20%,
whichever is higher. This amount is credited to the receiving member’s account on the auction
pay-out day.

76
Non-availability of clear funds
In case of funds shortage, NSCCL withholds securities which are receivable as pay-out to the
CM. These securities are released only after the shortage amount is cleared. If shortage is not
cleared, the NSCCL disposes off the securities by selling them out and requiring the CM to pay
the difference between the funds shortage and the sale proceeds.

14.3 Capital Adequacy Norms for Brokers

The capital adequacy requirements stipulated by the NSE are substantially in excess of the
minimum statutory requirements as also in comparison to those stipulated by other stock
exchanges.

14.3.1 Base Minimum Capital

Base minimum capital is a requirement of the Exchange subject to minimum stipulated by SEBI.

14.3.2 Additional Base Capital

Additional Base Capital is required to be deposited with the NSCCL by the Clearing Member for
taking additional exposure. In other words, if the clearing member desires to have higher intra-
day limit and/or gross exposure limit, additional deposit will have to be placed with the
Exchange for a specified period for exceeding the gross exposure and intra-day turnover limit
set, based on the base minimum capital, respectively.

The base minimum capital requirements prescribed by the National Stock Exchange for existing
members are as follows:
(In Rs. lakh)
Deposit Structure WDM Segment Capital Market Segment
Corporates Individuals and
Registered firms
Interest free Deposit 100 50 32.5
Collateral Security Deposit -- 25 17.5
Total 100 75 50.0

In case of WDM Segment, deposits are acceptable in the form of cash only. In case of Capital
Market Segment, Interest free deposit is taken in the form of cash and the security deposit can be
given by the clearing members in the form of cash, FDR, bank guarantee or approved securities.

Bank guarantees issued by the approved banks towards the base capital are accepted in the
prescribed format, approved specifically by the Exchange in this regard. In case the bank
guarantee is invoked, the bank is required to pay the guarantee amount within 24 hours.
Replacement of Fixed deposit receipts by bank guarantees or approved securities towards base
capital involves no payment of money to the Exchange.

Securities, approved by the Exchange, are maintained with approved custodians. Securities
deposited as a part of the base minimum capital are valued with a specified haircut on a weekly
basis.
77
Only corporates are admitted as new members. Only a member on the CM segment can take membership
on the Futures and Options segment. In case of new members, the following deposit structure is
applicable: (in Rs. lakh)
Deposit Structure WDM CM F&O- Index Futures sub-segment
Segment Existing CM Members New CM
Members
TM TM-CM TM TM-CM
Interest Free Security Deposit 150 100 8 25 25 50
Collateral Security Deposit -- 25 -- 25 -- 25

14.3.3 Exposure limits

NSCCL imposes limits on turnover and exposure in relation to the base minimum capital or
additional base capital of a member, which is the amount of funds, and securities that a member
keeps with the Exchange/NSCCL. A member, desiring to have exposure higher than permissible
against base minimum capital, is required to bring in additional base capital upfront.

(a) Intra-day turnover limit

TM clearing members are subject to intra-day trading limits. Gross turnover (buy+sell) intra-day
shall not exceed thirty three and one-third (33 1/3) times the base capital (cash deposit and other
deposits in the form of securities or bank guarantees with the Clearing Corporation and the
NSE). If TM clearing members desire to increase the limit, additional deposits by way of cash,
bank guarantee or Fixed Deposit Receipt (FDR) have to be submitted to the Clearing
Corporation. Additional deposits by way of securities in electronic form (‘demat securities’) may
be deposited. These additional deposits other than deposits in the form of securities will be
considered for the purpose of meeting margin requirements.

The additional deposits of the member shall be used first for adjustment against gross exposure
of the member. After such adjustments, the surplus additional deposits, if any, excluding deposits
in the form of securities, shall be utilised for meeting margin requirements. TM clearing
members violating the intra-day gross turnover limit at any time on any trading day shall not be
permitted to trade forthwith.

TM clearing members may be permitted to trade from the next trading day with a reduced intra-
day turnover limit of 20 times the base capital till margins in the form of additional deposits as
stipulated above are deposited with the Clearing Corporation. TM clearing members will be
given a maximum of 15 days time from the date of the violation to bring in the margins. Upon
TM clearing members failing to deposit the margins within the stipulated time the reduced
turnover limit of 20 times the base capital will be applicable for a period of one month from the
last date for providing the margin deposits.

Upon TM clearing member violating the reduced intra-day turnover limit, the above mentioned
provisions shall apply and the intra-day turnover limit will be further reduced to 15 times. Upon
subsequent violations, the intra-day turnover limit will be further reduced from 15 times to 10
times and then from 10 times to 5 times the base capital. TM clearing members shall not be

78
permitted to trade if any subsequent violation occurs till the required additional deposit is
brought in.

(b) Gross Exposure Limit

TM clearing members are subject to gross exposure limits. Gross exposure, being the aggregate
of the cumulative net outstanding positions (purchases or sales) in each security of TM clearing
member at any time, shall not exceed eight and half (8.5) times the base capital (cash deposit and
other deposits in the form of securities or bank guarantees with the Clearing Corporation and the
NSE) or any such lower limits as applicable to the members.

For TM clearing members who participate in the ALBM scheme of the Securities Lending
Programme (‘Participant’), the gross exposure for ALBM transactions (‘ALBM Gross
Exposure’) for each Participant shall be computed based on transactions executed in the ALBM
session in the same manner as stipulated above. For such TM Clearing Members, the gross
exposure limit as calculated above shall be reduced by the ALBM gross exposure so computed.

If TM clearing members desire to increase the limit, additional deposits by way of cash, bank
guarantee or Fixed Deposit Receipt (FDR) have to be submitted to the Clearing Corporation.
Additional deposits by way of securities in electronic form (‘demat securities’) may be
deposited. These additional deposits other than deposits in the form of securities will be
considered for the purpose of meeting margin requirements.

All ABC given in the form of cash/FDR (cash component) should be atleast 30% of the total
ABC and cash margins in respect of every trading member. In case where non-cash component is
more than 70% of the total additional base capital, the excess non-cash component shall be
ignored for the purpose of exposure limits requirements and/or for margin requirements.

The additional deposits of the member shall be used first for adjustment against gross exposure
of the member. After such adjustments, the surplus additional deposits, if any, excluding deposits
in the form of securities, shall be utilised for meeting margin requirements.

TM clearing members exceeding the gross exposure limit shall not be permitted to trade with
immediate effect and shall not be permitted to do so until the cumulative gross exposure is
reduced to below 8.5 times the base capital or any such lower limits as applicable to the
members. Members who desire to reduce their gross exposure may submit their order entry
requirements to the Clearing Corporation.

A penalty of Rs.5000/- will be levied for each violation of gross exposure limit which shall be
paid by next day. The penalty will be debited to the clearing account of the member. Non-
payment of penalty in time will attract penal interest of 15 basis points per day till the date of
payment. In respect of violation of gross exposure limits on more than one occasion on the same
day, each violation would be treated as a separate instance for purpose of calculation of penalty.
The penalty as indicated above, would be charged to the members irrespective of whether the
member brings in additional base capital subsequently.

79
14.4 Compliance
14.4.1 Inspection

The Ministry of Finance has prescribed that every stock exchange shall inspect the books of
accounts and records of 10% of active Trading Members in a year.

The NSE and NSCCL require the clearing members to maintain several books of accounts and
other documents. They are required to strictly adhere to a code of conduct and standards of
service. NSCCL along with NSEIL conducts periodic inspection of the books and accounts of the
clearing members to ensure compliance with its Bye Laws, Rules and Regulations.

Purpose of inspection:

a) to ensure that the accounts and other books are being maintained in the manner required;
b) to ensure that the provisions of SEBI Act, rules and regulations thereunder are being
complied with;
c) to ensure that provisions of the Securities Contracts(Regulation) Act and the rules made there
under are being complied with;
d) to ensure that various provisions of NSE Bye-laws, Rules and Regulations and any directions
or instructions issued thereunder are being complied with;
e) to investigate into complaints received from investors, other members of the Exchange or any
other person on any matter having a bearing on the activities of the Trading Member,
f) to investigate suo-moto, for any reason where circumstances so warrant an inspection into the
affairs of the Trading Member in public interest;
g) to examine whether any notices, circulars, instructions or orders issued by the
Exchange/Clearing Corporation time to time relating to trading and other activities of
Trading Members are being complied with;
h) to comply with any of the directives issued in this behalf by any regulating authority
including Government of India.

The Exchange may get the inspection conducted by its own officials or by outside professionals.
The Inspecting Authority shall, as soon as possible submit an inspection report to the Exchange.
The Exchange shall after consideration of the inspection report, communicate the findings to the
Trading Member to give him an opportunity of being heard before any action is taken by the
Exchange on the findings of the inspecting authority. On receipt of explanation, if any, from the
Trading Member, the Exchange may call upon Trading member to take such measures as the
Exchange may deem fit in public interest.

14.4.2 Investigation

NSE also conducts investigation of the books of accounts and records of its Members in case of
the fake, forged and stolen shares introduced and/or delivered by the Member, voluminous
trading in illiquid scrips, sudden spurt in the price of a scrip etc.

80
15. SURVEILLANCE IN RISK MANAGEMENT

National Securities Clearing Corporation Limited (NSCCL), a wholly owned subsidiary of the
National Stock Exchange carries out the clearing and settlement of trades executed on the
Exchange. In recognition of the fact that market integrity is the essence of any financial market
and believing in the philosophy that prevention is better than cure, NSCCL has put in place a
comprehensive risk management system which is constantly monitored and upgraded to pre-
empt market failures. The risk management process encompasses various facets including the
track record and performance of members, their net worth, on-line monitoring of exposure, initial
as well as mark-to-market margin, monitoring of positions of high risk securities, etc.

Methods employed

A. Settlement Guarantee Mechanism

The principle of novation is the hallmark of modern clearing institutions. NSCCL has adopted
this principle for settlement of all trades. It is the legal counter-party to the settlement obligations
of every member. NSCCL meets all settlement obligations, regardless of member complying
with his obligations, without any discretion. Once a member fails on any obligations, NSCCL
immediately initiates measures to reduce exposure limits, withhold pay out of securities, square
up open positions, disable trading terminal until member’s obligations are fully discharged.

NSCCL assumes the counter party risk of each member and guarantees financial settlement.
Counter party risk is guaranteed through a fine tuned risk management system and an innovative
method of on-line position monitoring and automatic disablement. A large Settlement Guarantee
Fund, which stood at Rs. 1391 crore as on 31st March 2000, provides the cushion for any residual
risk. As a consequence, despite the fact that daily traded volumes have crossed Rs. 8000 crore,
credit risk no longer poses any problem in the market place. The market has now full confidence
that settlements will take place in time and will be completed irrespective of possible default by
isolated trading members. The concept of guaranteed settlements has completely changed the
way market safety is perceived
The Settlement Guarantee Fund is an important element of reservoir facilitating the settlement
process. The Fund operates like a self-insurance mechanism and is funded through the
contributions made by trading members, transaction charges, penalty amounts, fines etc.
recovered by NSCCL.
A part of the cash deposit and the entire security deposit of every clearing member with the
Exchange has been converted into an initial contribution towards the Settlement Guarantee Fund,
as indicated below:
Type of Member Cash Deposit Deposit in the form of bank guarantee or
securities (Rs. Lakh)
(Rs. Lakh)
Individual/ partnership firms 6.00 17.50
Corporates 9.00 25.00

81
There is a provision that as and when volumes of business increase, members may be required to
make additional contributions allowing the fund to grow alongwith the market volumes.

NSCCL guarantees financial settlement of settlement obligations arising out of regular market
deals:

 Up to the normal pay-out in the case of non-depository deals involving physical settlement
of securities

 All Depository deals excluding those in trade-for-trade segment and the negotiated deals.

B. High Capital Adequacy Norms

A CM is required to maintain a networth of Rs. 100 lakh (Rs.75 lakh for individual member). He
is also required to maintain a base minimum capital of
Rs. 75 lakh (Rs. 50 lakh for individual member) comprising of a security deposit of Rs. 25 lakh
(Rs. 17.5 lakh for individual member) with NSCCL in the form of cash, FDR, approved
securities or bank guarantee and a cash deposit of Rs. 50 lakh (Rs. 32.5 lakh in case of individual
member), as indicated below:

Capital Adequacy Norms (In Rs. Lakh)

Net worth 100 75

Cash Deposit 50* 32.5
Security Deposit 25 17.5
Security Deposit
Security Deposit

*100 in case of new corporate members

C. Periodic Inspection of Books

The Bye-laws of NSE and NSCCL require CMs to maintain several books of accounts and other
documents. They are required to strictly adhere to a code of conduct and standards of service.
NSCCL along with NSE conducts periodic inspection of the books and accounts of CMs to
ensure compliance with its Bye-laws, Rules and Regulations, Rules under SCRA, Regulations
relating to stock-brokers and sub-brokers notified by SEBI and various circulars, notices, orders
issued by NSE/NSCCL and various guidelines, directives, circulars etc. issued by SEBI.

D. Efficient Settlement and Post Settlement Systems

82
To provide participants with reliable and risk free trading and settlement system, the Exchange
had adopted the weekly settlement cycles. The settlement cycles are adhered to strictly and there
are well-defined procedures for addressing post settlement issues. For any temporary shortfall
either in funds or securities, NSCCL conducts a compulsory auction or buy-in which reduces
open exposures and uncertainty regarding settlement.

E. Penalty points and penal interest

NSCCL has instituted a penalty points system for non-performance in settlement by way of short
delivery or bad delivery and such defaults attract penalty points and a penal interest charge. The
penalty interest and points are levied for a month. The amount of penalty points that are earned,
and the penalty that would be imposed for different types of violations are made transparent to
the clearing members. The strict implementation of this system acts as a strong deterrent for
settlement lapses. In addition, it also helps in identifying potential problem cases.

F. Margin requirements

NSCCL imposes stringent margin requirements on CMs. It collects from its members the mark
to market margin, which is computed on the basis of mark to market losses of a clearing member,
which is monitored on a real time basis. In addition, NSCCL also levies a volatility margin on
specific securities which witness unusual volatility as also a margin on gross exposure of
members based on pre-specified slabs. All margins levied by Clearing Corporation are collected
on a T+1 basis. (Please refer to the previous chapter for details).

G. Exposure limits
NSCCL imposes limits on turnover and exposure in relation to the base minimum capital or
additional base capital of a member, which is the amount of funds, and securities that a member
keeps with the Exchange/NSCCL. A member, desiring to have exposure higher than permissible
against base minimum capital, is required to bring in additional base capital upfront.

H. On-line Exposure monitoring

NSCCL has in place an on-line position monitoring and surveillance system. Exposure of the
CMs is monitored on a real time basis. A system of alerts has been built in so that both the
member and NSCCL are alerted when the intra-day turnover/gross exposure of a member
approaches pre-set levels (70%, 80% etc.). The system also allows NSCCL to further check the
micro-details of members’ positions, if required. This facilitates NSCCL to take pro-active
action. NSCCL has a discretion to initiate action suo moto for reducing a member position, if
required, more particularly where a member, after NSCCL requiring him to reduce his position
fails to close out positions or make additional margin calls. The system is also capable of
continuously marking positions to market and relate mark to market losses to base capital and
margins available. A portfolio analysis based system is also under development that will further
help in streamlining this process of monitoring and generating alerts.

83
I. Indemnity insurance

The Exchange has arranged a comprehensive insurance scheme to cover risks of trading
members. The Exchange has also taken adequate insurance cover to protect against risks arising
from settlement defaults and transit risk arising from securities movement among its Clearing
Centres located at four Metros, Mumbai, Calcutta, Delhi and Chennai.

J. Pre-delivery verification of securities

To minimise risks associated with bad paper, there is a system of pre-delivery verification of
securities to detect upfront fake, forged or stolen securities in respect of several securities. To
effectively handle this critical activity, NSCCL has put in place a Lost and Stolen Shares -
LASS database. This database is based on information obtained from/made available by various
companies/registrars and share transfer agents in respect of lost/misplaced/stolen/duplicate
certificates

K. Dematerialisation of securities

The Exchange took a major step in promoting the National Securities Depository Ltd. (NSDL),
the first depository in the country so as to enhance the efficiency in settlement systems as also to
reduce the menace of fake/forged and stolen securities. This has ushered in an era of
dematerialised trading which has reduced handling of large volumes of paper and eliminated
risks associated with physical certificates such as loss, theft, mutilation, forgery etc.

All of the above measures are taken with a view to minimize systemic risks. Most importantly,
the above laid down procedures are strictly enforced. As a result, all settlements are going
through smoothly. The proportion of short deliveries for which the Exchange has had to conduct
auctions has averaged 1.3% in 1999-2000. The proportion of bad deliveries unrectified and due
for auction has averaged 0.23%. This is in sharp contrast to the experience of other exchanges in
India. Investors are now able to plan their cash flows reasonably well. Institutions are able to
trade with a higher degree of confidence and a much lower settlement and credit risk.

84
 Decisions of the Inter-Exchange Surveillance Group

ISG DECISIONS FROM DECEMBER, 1998 TO MARCH 31, 2000.

Sr. No. ISG Meeting Details

Date
1 ISG Meeting Implementation of a uniform daily price band of 10%.
dated 17-12-97
Committee set up to decide price bands with respect to
infrequently traded scrips.
Forming a group for framing the price bands for illiquid
scrips.
SEBI directed all the exchanges to display the action
taken by the DAC of the exchange to be displayed on the
board of the exchange to ensure proper dissemination of
information to the investors.
Appointment of compliance officers for the companies
for quick verification of rumours by the exchange
officials.
Appointment of co-ordination officer for each exchange
to facilitate the exchange of information between the
exchanges.
Reconstitution of the ISG bringing in the exchanges with
a comparative higher turnover.
Joint Inspection and Investigations by the stock
exchanges in cases of brokers having multiple
memberships across various exchanges.
Scrips were earlier put on spot delivery at the time of
public/rights issue by existing companies. This was
removed as the surveillance systems were now in place
and there was no need to put the scrips under spot.

2 ISG Meeting The Stock Exchanges were directed to collect margins

dated 21-4- due from members before the close of banking hours next
1998 day. The margins would be collected either by direct
debit to the members bank account or by cheque issued
on the clearing bank branch of the exchange. In the event
of non payment of margins from the members the
exchanges shall ensure that the members are not able to
increase his exposure and towards this end, shall take
suitable measures which may include switching the
trading terminal of the member. The outstanding position
of the member could also be squared off in the presence
of the officer of the exchange in the exchange premises or

85
 as per the instruction of the member by the officer of the
exchange.
A committee of the code of ethics was evolved for the
Directors and other functionaries of the stock exchanges.
It was decided to form a group consisting of Directors
from BSE, CSE, UPSE, DSE and the Managing Director
of NSE and SEBI to formulate such code of ethics.
Simplification of the price bands below Rs. 20 by the
stock exchanges.
SEBI advised the exchanges to levy the special margins
in an objective manner to bring in greater objectivity in
levying special margins.
Committee formed to decide on the relaxation of price
bands due to different holiday schedules at the stock
exchanges.
Committee formed to improve connectivity between
SEBI and the exchanges.

3 ISG Meeting Ban of short sales in view of the huge bear phase
Dated 15-6-98 experienced by the market.
Removal of the weekly price bands and introduction of
additional volatility margins and concentration margins.

4 ISG Meeting Preparing the Training and Certification Program

Dated 15-10-
98
Implementation of the Phase I of the Stock Watch System
by NSE.
Committee formed to discuss the co-ordination and
sharing of information among the exchanges.

5 ISG Meeting Implementation of the Phase I of the Stock Watch System

Dated 10-3-99 by NSE and DSE
Committee formed to rationalise the margin system.
The exchanges were asked to assess their manpower
requirements and recruit quality manpower especially in
the area of surveillance.
Discontinuation of the routine daily report by ASE, BSE,
CSE, DSE and NSE and replacing the same with
exception reports.
Devising an internal system of documentation and actions
taken by the surveillance departments of the exchanges.
BSE and NSE asked to conduct the training and
certification program. BSE and NSE asked to prepare
independently a training module and a question bank for

86
 the purpose of examination on the lines of the syllabus
submitted by the working group. The syllabus and
question bank would be approved by SEBI.
Sharing of information between the exchanges in case a
member fake and forged shares worth Rs. 5 lacs or more
in a quarter.

6 ISG Meeting Tracking companies who had changed names to suggest

Dated 15-12- that they were in the business of software related
99 activities and asking the exchanges to investigate any
abnormal activity in the trading of the scrip. The
exchanges were also advised to suspend scrips, putting
scrips on spot and warning the investors for possible
manipulations etc.
Directing exchanges to Verify rumours for possible
market manipulations like Insider Trading, Market
Manipulations etc.
Imposition of higher special/ad-hoc margins in respect of
low floating stock companies.
Reduction of Gross exposure limit to 10% of the existing
limit for brokers having exposures more than 3 crores.
Increasing carry forward margins to 15% from 10%.
Increasing the additional volatility margins percentages at
various slabs.
7 ISG Meeting Modification of the daily price band for the top 100 scrips
Dated 14-1- from 8% to 12% after half an hour in either direction.
2000
Increasing the slabs of additional volatility margins
The brokers were asked to compulsorily collect margins
from all clients whose margin requirement is more Rs. 1
lac.
Directing exchanges to suspend scrips identified as
vanishing companies.
Indefinite suspension of NBFCs whose registration were
cancelled by RBI.
No need to seek prior approval of SEBI for suspension of
scrips for more than 3 days. However the exchanges
would have to submit an investigation report within one
month of the suspension.

8 ISG Meeting The exchanges were asked to take incremental additional

Dated 11-2- capital and margins from the top 25 brokers in cash or
2000 FDRs only.

87
9 ISG Meeting Additional 5% margin imposed on the net outstanding
Dated 14-2- positions for 10 scrips.
2000

Increase in cash component of additional capital and

margin to 50%.

10 ISG Meeting Prioritisation and Benchmarking of alerts generated under the Stock
Dated 17-5-2000 Watch System to be completed within one month.
The role of Governing Board vis-à-vis surveillance functioning of the
exchanges
Documentation of Surveillance activities to be completed within one
month.
Augmentation of the surveillance staff strength
Training and Certification Program for surveillance staff at the
exchanges to be done immediately.
Institutionalised co-ordination between exchanges in surveillance
activities needed due to multiple memberships and derivatives
trading.
Verification of rumours with companies by the exchanges to be
continued.
Modification in the price band system has worked well and that the
8% + 4% modification is serving its purpose well.

88
 IES/SrED/CIR-/98
January 21, 1998

The Presidents/Executive Directors/managing Directors

All Stock Exchanges

Dear Sir,

The Meeting of the Inter Exchange market Surveillance Group (ISG) along with the meeting of
the Heads of the Stock Exchanges was held on December 17, 1997 at Mumbai. In the meeting of
the ISG after discussion the following decisions were taken which need to be implemented by
the Exchanges and indicated below:

Uniform intra-day price band of 10% : (Action by all stock Exchanges)

In addition to the price cap of 25% which is being implemented uniformly by all stock
exchanges, it was decided that the intra-day price band which is presently flexible in the range of
upto 10% would be implemented uniformly at 10%. This is to be implemented by all exchanges
by January 31, 1998, if not already done.

Price bands on the scrips traded below Rs.20/-- (Action by all Stock Exchanges)

It was decided to retain the flexibility of the price bands by the exchanges themselves in the
scrips trading upto Rs.20/- However, the exchanges are required to send us details of how they
are operating the price bands in the scrips quoted below Rs.20/- for information.

Price bands in respect of infrequently traded scrips : (Action by NSE, BSE and DSE)

Though broadly it was agreed that if the scrip is not traded for six settlement the NSE formula
(sq. root of Number of days not traded on NSE)* (Normal price band of NSE) for fixing the
price bands may be used. If the scrip is not traded for more than 15 settlements then the
exchange would approve the price case by case. However, no uniform view could emerge on
fixing of price bands for infrequently traded scrips. It was therefore, decided to form a small
group comprising of representatives of BSE, NSE and DSE, to frame the guidelines and the basis
on which such price bands could be fixed. NSE would be the co-ordinator and give a report by
January 31, 1998.

Public disclosure of information relating to actions taken against the members : (Action by
all Stock Exchnages)

Presently the action taken against the members including penal actions are not disclosed to other
market participants/investors by all the Exchanges. It was agreed that such actions need to be
disclosed in the larger interest of the investors and market participants. It was therefore decided
that the actions taken by the Disciplinary Action Committee (DAC) against the member brokers
would be made public and would at least be displayed on the notice board of the respective
89
exchanges. Exchanges are also advised to consider issue of press releases when such actions are
of a grave nature.

Dissemination of price sensitive information to public/investors : (Action by all Stock

Exchanges)

It was discussed that there was need to have proper dissemination of price sensitive and other
important information relating to corporates/market, to investors in the quickest possible manner.
For this purpose the service provider like Reuters etc., cold also be used. The exchanges should
also display such information on their terminals in the quickest possible manner.

Dealing with market rumours: (Action by all Stock Exchanges and SEBI)

It was agreed that the rumours in the market can do considerable damage to the normal
functioning and behavior of the market. It is therefore essential to have quick verification of
such rumours from the corporates as well as from other entities whenever it is so necessary.
Therefore it was decided that exchanges would make it possible to verify such rumours in the
quickest possible manner and inform other market participants/investors, if possible through
their terminals. Further to begin with top 100 companies which figure in BSE specified groups
of securities and NSE Nifty would be asked to designate a compliance officer who could be
contacted by exchanges whenever such verification is needed. This would be taken up by SEBI.

Co-ordination between exchanges : (Action by all Stokc Exchanges)

To facilitate better and quicker co-ordination it was decided that all exchanges would designate a
co-ordination officer who cold be contacted by the other exchanges for immediate exchange of
information . A list of such co-ordinating officers would be sent to the Senior Executive
Director, Investigation, Enforcement and Surveillance, SEBI, who would communicate the same
to all exchanges. This should be done by January 31, 1998.

Joint Inspection/investigation in case of brokers having multiple membership :Action taken

by SEBI and all Stock Exchanges)

It was decided that in some suitable cases, the exchanges would co-ordinate and carry out joint
inspection of members having multiple membership. Besides there should be information
sharing also in such cases. Modalities of such inspection and sharing of such information would
be worked out by SEBI with the help of the Exchanges.

Putting scrip on spot delivery : (Action by all Stock Exchanges)

It was agreed that there is no longer a need for putting scrip on spot delivery at the time of a
rights issue/public issue by an existing listed company since surveillance systems which were not
existing earlier when this decision was taken are now in place.

90
Implementation of phase I of the Stoc Watch System : (Action by all Stock Exchanges)

The time limit for implementation of Phase I of the Stock Watch System has been extended to
January 31, 1998.

Reconstitution of Inter Excahnge Market Surveillance Group (ISG: (Action by BSE, SEBI
and members of ISG)

ISG is reconstituted and now it would be consisting of representatives of BSE, NSE, DSE, CSE,
ASE, LASE, and BgSE. Further, it is decided that the convenor for the meetings for the year
1998 would be BSE and at least once a month meeting of this group would be held, which would
be convened by BSE and co-ordinated by SEBI.

The above decisions should be implemented as indicated. However, if there is some problem in
implementation, the same should be brought to our notice in time.

Yours faithfully,

(L.K.SINHHVI)

91
L. K. SINGHVI
SR. EXECUTIVE DIRECTOR
Investigations Enforcement and Surveillance
5 May, 1998
IES/LKS/ /98

The Executive Directors/Managing Director/Presidents

of all the Stock Exchanges

Re: Meeting of the Inter-Exchange Market Surveillance Group (ISG) held on April 21,
1998

Dear Sir,

Please find enclosed the minutes of the meeting of the Inter Exchange Market Surveillance
Group (ISG) held on April 21, 1998.

As was decided at the meeting all the stock exchanges are required to initiate immediate action
on the following points:

1. Price Bands for Scrips trading at less than Rs. 20/-

It was observed that in the cases of scrips trading at less than Rs. 20/- different systems of price
bands were being followed by stock exchanges. The price bands for scrips being traded at less
than Rs. 20/- would have to be simplified by the stock exchanges.

2. Implementation of the first phase of the Stock Watch System

With respect to the implementation of the first phase of the Stock Watch System, all the
exchanges are advised to take up this matter on top priority. NSE and BSE informed that at their
exchanges the same would be operational by June 1998. In the case of DSE it would be
operational by first week of August.

3. Names and other details in respect of co-ordination officers

All the stock exchanges had not sent names and other details in respect of co-ordination officers
to SEBI. The exchanges are to send the details by May 13, 1998.

4. The issue of dealing with market volatility.

Of late the stock markets had seen a lot of volatility coupled with large intra-day and intra-
settlement variations in the indices and/or prices of certain scrips.

The role and importance of the surveillance departments of the stock exchanges in maintaining
the market equilibrium and balance during the period of volatility in the market is felt. Therefore,
92
the surveillance departments of the exchanges are asked to gear up to such situations for ensuring
safety and fairness of the market.

5. Prompt Collection of Margins

In the context of ensuring market safety as discussed in 4 above it was decided that the Stock
Exchanges would collect margins due from members before the close of banking hours on the
following day. The margins would be collected either by direct debit to the members bank
account or by cheque issued on the clearing bank branch of the exchange. In the event of non
payment of margins by the members the exchanges would ensure that the members are not able
to increase their exposure in the market and a member would not have unsupervised access to the
trading terminal.

6. Need to levy special margin in an objective manner.

Exchanges have to frame internal broad parameters for levying special margins so that the
element of subjectivity could be reduced to the extent possible and the procedure is perceived as
transparent and fair. The decisions to levy special margins would have to be specifically recorded
with reasons and approval of the Executive Director of the Exchange.

7. Need for narrowing down price variations on exchanges on the day the scrip is listed.

The existing system of keeping the scrip free of price bands for price discovery on the first day
of trading is to be continued with.

Yours sincerely,

Sd/-

(L.K. SINGHVI)

93
Dated: June 16, 1998
Ref.No.PR 151/98

SUBJECT : .......................................................................................................................................

....................................................................................................................................
SMDRP DEPTT
Issued by: .......................................................................................................................................

TEXT

Yesterday (15th June 1998), certain measures were taken by SEBI in consultation with the
Inter-Exchange Surveillance Group and he stock exchanges regarding the introduction of
concentration margins, and incremental margin on carry forward trades. The market
position was further reviewed today and in consultation with the stock exchanges it was
decided that the stock exchanges should take the following measures. These measures are
temporary and will be reviewed shortly.

1. With effect from June 17, 1998, net outstanding sales position at the end of any
trading in each security must result in delivery.
2. However, in respect of carry forward business, all outstanding short sale positions at
the end of trading of June 16, 1998 will be squared up in the following manner:
i. at least 50% in the current settlement, and
ii. the balance in the succeeding settlement.
3. This measure will not be applicable for securities which are in “No Delivery”.
However, net sales transactions in these securities will attract a daily margin of 50%
of the net outstanding position in the Settlement in which the securities are in “No
Delivery”. All outstanding net sale position at the end of the “No Delivery” period
must result in delivery.
4. Squaring up of net outstanding purchase position is permitted.

All stock exchanges must ensure strict compliance of these stipulations.

It may be noted that these measures would not affect the trades of domestic or foreign
institutions as they are trading in delivery basis only.

The stock exchanges have also been advised to keep a close watch on outstanding
positions and levy appropriate special margins in addition to the normal margins. Besides,
the measures taken yesterday relating to concentration margin and incremental carry
forward margins too would help contain built up of excessive speculative purchase
positions. The measures regarding the excessive buying positions too will be reviewed
shortly.

94
L K SINGHVI
SENIOR EXECUTIVE DIRECTOR
Investigations Enforcement and Surveillance
October 29, 1998
IES/LKS/ /98

The Executive Directors/Managing Director/Presidents

of all the Stock Exchanges

Re: Meeting of the Inter-Exchange Market Surveillance Group (ISG) held on October 15,
1998

Dear Sir,

Please find enclosed the minutes of the meeting of the Inter Exchange Market Surveillance
Group (ISG) held on October 15, 1998. The stock exchanges are advised to go through the
minutes carefully and implement the agreed propositions and the decisions taken. Following
follow-up actions also need to be taken expeditiously:

1. The stock exchanges would inform SEBI about the present staff strength and present
surveillance system, and would also indicate by October 31, 1998 manpower and systems
requirements keeping in view the existing functions and further improvements which are to
be put in place.

2. A working group comprising representatives of NSE, BSE and DSE will work out the
training capsule for the surveillance staff of the stock exchanges. This group will also
indicate how certification is to be done. The three stock exchanges may intimate to SEBI the
names of the senior staff members who would be preparing the training capsule. NSE will
co-ordinate the proceedings of this working group and send the report and the working paper
to SEBI by November 30, 1998.

3. The core group, constituted for the Stock Watch System will suggest new formats of
reporting by the stock exchanges to SEBI latest by November 30, 1998.

4. The Phase I of the Stock Watch System based on the parameters specified by SEBI is to be
implemented by DSE by November 30, 1998, CSE by December 30, 1998. BSE is to
implement the same by January 31, 1999. As informed by NSE, it has largely implemented
the Phase I of the Stock Watch System; however, if any areas need further
implementation/improvement, the same may be done by December 31, 1998. Other stock
exchanges should also endeavour to implement on priority, preferably by March 31, 1999.

5. The core group for Stock Watch System will consider prescribing separate simplified
requirements for stock watch system to be implemented by the smaller stock exchanges. The
meeting should be held on priority.

95
6. A working group comprising of NSE, BSE, DSE, CSE and BgSE has been formed to discuss
co-ordination and sharing of information by the stock exchanges. The working group would
address the issues of identifying common members, nature and type of information to be
shared, situations in which such information sharing is required, timeliness of such
information and possible actions to be initiated at the stock exchanges level. The Group will
have its first meeting in the first week of November 1998. BSE will co-ordinate the meetings
of this working group.

7. A working group comprising of Shri Kamal Parekh, President, CSE, Shri Tapas Datta, ED,
CSE, Smt Dina Mehta, Board Member, BSE, Shri R C Mathur, ED, BSE, Dr. R H Patil, MD,
NSE, Shri Deepak Chowdhary, President, DSE, Shri Sodhi, ED, DSE, Shri Vishwanath
Dhiri, President, LSE, Shri Prem Kumar, President, MSE and D D Sharda, President, UPSE
will deliberate on evolving the code of ethics for elected directors and key functionaries of
the stock exchanges. It should have a meeting in the early part of November 1998. SEBI will
co-ordinate the meetings of this working group.

Yours sincerely,

(L.K. SINGHVI)

Encl: a/a

96
DEEPAK SANCHETY
DIVISION CHIEF

The Executive Directors/Managing Directors

Of all the Stock Exchanges.

March 26, 1999

Dear Sir,

Sub: Meeting of the interchange market Surveillance Group (ISG) held on March 10, 1999

Please find enclosed the minutes of the meeting of the Inter-Exchange Market Surveillance
Group (ISG) held n March 10, 199. The Stock Exchanges are advised to go through the minutes
carefully and implement the agreed prepositions and the decisions taken. The following follow-
up actions need to be taken expeditiously:

1. With a view to streamline, rationalise and refine the margining system, a group comprising of
NSE, BSE, DSE, CSE, UPSE, BgSE, and Shri L.K.Singhvi, Dr. Executive Director, Shri
Pratip Kar, Executive Director and Shri M.D.Patel, Executive Director, from SEBI has been
formed. This group would review the existing margin mechanism and submit their
recommendation within a month. The meeting of the group will be convened by SEBI.

2. The need for strengthening of the surveillance departments of the stock exchanges in terms
of manpower and systems was again emphasied in the meeting. All exchanges had earlier
been asked to submit their existing and proposed manpower requirement to SEBI. Not all
Exchanges had sent their replies. The exchanges are advised to identify their manpower
requirements for surveillance activity and to go their respective boards for additional staff,
keeping SEBI informed of the same.

3. In order to bring about greater responsibility and accountability, the surveillance departments
of the exchanges are advised to devise an internal system of documentation of surveillance
activity and follow up actions.

4. NSE and DSE have implemented the Phase-I of the stock watch system prescribed y SEBI.
BSE would be implementing the same by the end of March 1999, CSE and BgSE would have
their system in place by the end of April, 1999 and ASE by the end of June 1999. Other
exchanges should also endeavor to implement the system on priority.

5. The working group constituted to formulate a training module and to lay down procedure for
certification for the surveillance staff of the exchanges has submitted its report. After
considering the same it has been decide that BSE and NSE shall conduct the training and
97
 certification program. Both BSE and NSE shall be independently prepare the training
module and a question bank for the purpose of examination on the lines of the syllabus
submitted b the working group, and submit the same for SEBI approval. The training and
certification programme should be in place within a month and it shall be mandatory for
surveillance staff of all the exchanges to acquire the certification. They may obtain the
certification either from BSE or NSE.

6. The daily market report, which is being sent by major exchanges to SEBI, stands
discontinued. All exchange will now be required to report daily on exemption basis,
outlining circumstances which have a bearing on the risk management of the exchange and
the safety and integrity of the market, if any. A circular in this regard is issued separately.

7. A working group comprising NSE, BSE, DSE, CSE and BgSE had been formed to detail
norms for coordination and sharing of information among stock exchanges. The working
group is in the process of finalizing their report, which would be put up shortly. However, if
a member has introduced fake and forged shares worth rupees five lakh or more in a quarter
(three month period) the information about it should immediately be shares with all
exchanges.

8. It was once again emphasized that the Executive Directors are directly responsible for
surveillance functioning of the exchanges. The executive Directors of exchanges would also
ensure that surveillance is effective and all surveillance decisions are taken without any
interference.

9. The stock exchanges are once again advised to keep a strict vigil on market movements
especially in the case of some companies which have changes their name or added prefix or
suffix to their names suggesting that these companies are related to software and information
technology areas. Further, such companies will be required to disclose the turnover and
income from software business in their quarterly and annual report. A circular in this regard
shall be issued separately.

Yours sincerely,

Sd/-

DEEPAK SANCHETY

98
L.K.SINGHVI
SENIOR EXECUTIVE DIRECTOR
Investigation, enforcement and Surveillance

December 21, 1999

LKS/203/99

The Executive Directors/ Managing Directors/Presidents

Of all the Stock Exchanges

Dear Sir,

In the meeting of the Inter Exchange Market Surveillance Group (ISG) held on December 15,
1999 at SEBI, recent market trends and the issues related to surveillance and monitoring by the
exchanges were discussed. The exchanges assured us that because of the comprehensive
margining system and other risk containment measures in place, the markets, have achieved
overall safety. However, while taking note of the comfort level in the area of market safety, it
was emphasied by me that apart from safety of the market, the exchanges also have to ensure that
market manipulations are detected and dealt with promptly and effectively. This was very
crucial to protect the investors and preserve the health of the markets.

In the context of recent trends the exchanges need to have a more pro-active approach
particularly with respect to certain sectors which are showing relatively very high .volumes as
well as valuations. The exchanges now also have Stock Watch System in place which provides
them with enhanced surveillance capabilities. Any further steps required for realizing the full
potential of the system should be taken on utmost priority.

If need not be reiterated that the Executive Directors of the exchanges are fully responsible for
the surveillance and monitoring and they have to ensure timely, ongoing, effective and pro-active
surveillance to preserve the safety as well as integrity of the markets.

This letter may please be acknowledged.

Yours sincerely,

Sd/-

(L.K.SINGHVI)

99
L. K. SINGHVI
Sr. Executive Director
Tel : 91-22-2851599 Fax : 91-22-2883296
Email: lks@sebi.gov.in
18 January, 2000
IES/LKS/ /2000
The Executive Directors/Managing Directors
of all the Stock Exchanges

Re: Meeting of the Inter-Exchange Market Surveillance Group (ISG) held on January 14,
2000.

Dear Sir,

With reference to the meeting of the Inter-Exchange Market Surveillance Group held on January
14, 2000 the following decisions were taken. All the stock exchanges are required to initiate
immediate action on the following and send a compliance report latest by January 31, 2000:

1. Daily Price Bands for the top 100 scrips

The system of price bands has evolved well over a period of time and has served its purpose
well. As a measure to increase liquidity in high turnover stocks, it was decided to modify the
daily price band in the following manner for the top 100 scrips:

a) It was decided that once a scrip touched the 8% price band in either direction, the trading
in that scrip would be restricted upto the price band for half an hour. After half an hour,
the price band would be further relaxed by 4% in that direction only.

b) The relaxation of the price bands can only be done at BSE or NSE. The other exchanges
would relax the price bands (by 4%) only after such relaxation is applied at BSE or NSE.

c) This modification of the price bands would initially be applicable on the top 100 scrips.
The 100 scrips would be commonly identified by BSE and NSE. The list of 100 scrips
would be communicated.

d) The exchange (BSE or NSE) where the price band in any of the 100 scrips is hit first,
would communicate such information to the other exchanges including by email so that
the relaxation of price bands could also be undertaken by the other exchanges. The
information would also be communicated through PTI and Reuters.

e) In case the price band is hit on either side in the last half an hour of trading, then the
trading in that scrip would be restricted upto the price band for fifteen minutes instead of
half an hour. After fifteen minutes, the price band would be further relaxed by 4% in that
direction only.

100
 f) The modified price band system would be made applicable from Monday, January 24,
2000.

2. Review of the additional volatility margins

In view of the relaxation in price bands and also with a view to focus on scrips with higher
volatility, the additional volatility margins were reviewed and modified. The additional volatility
margins would be applicable for volatility (six weekly (high – low) / low) above 60% instead of
the earlier 40%. The applicable rates would be as follows:

Sr. No. Volatility % of Additional

Volatility Margins
1 60% - 70% 5%
2 70% - 90% 10%
3 90% - 110% 15%
4 110% - 130% 20%
5 130% - 150% 25%
6 Above 150% 30%

The above rates would be applicable from settlement accounting period commencing
immediately after Monday, January 24, 2000.

3. Indefinite suspension of scrips

Presently, the exchanges have to seek prior approval from SEBI for suspending scrips for more
than three days. The issues related to suspension of trading in scrips were discussed in the
meeting and it was decided that as all the information required for taking such decisions is
available with the exchanges, the decision for suspension of trading of scrips including for more
than 3 days should be taken at the exchange level itself. However, if the trading in a scrip is
suspended for 2 days or more the exchange would have to immediately intimate all the other
exchanges where the scrip is traded for necessary action at their end as per the earlier SEBI
circular no. SMD/SED/ RCG/271/96 dated January 19, 1996. It may again be noted that if the
trading in a scrip is suspended beyond 3 days then it is mandatory for all the exchanges to
investigate the trading in the scrip and submit a preliminary report to SEBI within 15 days which
would be followed by a final report within one month after the date of suspension . It would also
be the responsibility of the exchange to inform SEBI about the suspension in trading of scrips for
more than 3 days.

Yours sincerely,

(L.K. SINGHVI)

101
O.P.GAHROTRA
SR. EXECUTIVE DIRECTOR

OPG/2880/2000
February 11, 2000

Managing Director/Executive Director

BSE/NSE/CSE/DSE/ASE

Dear Sir,

Considering the recent increase in volatility in the stock markets, the market positions was
reviewed in consultation with major exchange. After discussions, it was decided that stock
exchanges should further enhance their vigilance on the market operations and also take the
following measures in addition to measure taken earlier :-

 Brokers-specific measures : where the brokers have built up sizeable positions they should
be asked to either reduce positions or to make advance pay-in. Such brokers could also be
subjected to adhoc margins by the stock exchanges.

 Scrips-specific measures : these would include impositions of special margins on volatile

scrips.

 Exchanges should take incremental additional capital and margins from their top 25 brokers
in the form of cash or FDRs only for the next four weeks, i.e. they should withdraw the
exiting facility of accepting incremental additional capital/margins by way of bank
guarantees or securities. Top 25 brokers are to be selected in terms of marginable gross
exposure at the close of the third day of their trading cycle. The unutilised portion of bank
guarantee and securities deposited by these brokers would not be considered for margin and
capital requirements would be payable in cash/FDR only. The list of top 25 brokers selected
in one trading cycle would continue till the next list of top 25 brokers is selected in the
subsequent trading cycle.

In cases of excessive market volatility or circumstances where risk element is higher, exchanges
are expected to take further action as required.

Further to review the market scenario and measures taken to ensure safety and security in the
market, a meeting will be held on Feb 14, 2000 at 11.30 a.m. in Conference Room, SEBI, Mittal
court, -B Wing, Nariman Point, Mumbai. You are requested to attend the meeting.

Your sincerely,

(O.P.GAHROTRA)

102
L. K. SINGHVI
Sr. Executive Director
Tel : 91-22-2851599 Fax : 91-22-2883296
Email: lks@sebi.gov.in
15 February, 2000
IES/LKS/ /2000
The Executive Directors/Managing Directors
of all the Stock Exchanges

Re:Meeting of the Inter-Exchange Market Surveillance Group (ISG) held on February 14,
2000.

Dear Sir,

With reference to the meeting of the Inter-Exchange Market Surveillance Group held on
February 14, 2000 the following decisions were taken. All the stock exchanges are required to
initiate immediate action on the following and send a compliance report latest by February 29,
2000:

1. Additional 5% margin to be imposed on end of the day net outstanding positions

Following ten scrips in terms of outstanding positions, volume and Volatility have been
identified by the stock exchanges who attended the meeting -:

SCRIP NAME SCRIP NAME

Infosys Technologies Limited
Zee Telefilms Ltd
Satyam Computers Ltd
Global Telesystems Ltd
Himachal Futuristic Communications Ltd.
Pentamedia Graphic Limited
Silverline Technologies Ltd.
Digital Equipment Ltd.
NIIT Ltd.
DSQ Software Ltd

The list above should be reviewed by BSE/NSE periodically till any further decision in this
regard. The additional 5% margin would be imposed on end of the day net outstanding positions
of brokers in these scrips. This margin will be retained till the first day of the next accounts
period . This additional margin should be imposed beginning February 16, 2000.

2.. Increase in Cash component of additional capital and margin to 50%

It was decided that the cash component of additional capital and margin should be increased and
standardised. The cash component should reach the level of 50% by the end of March 2000. The
Stock Exchanges are requested to work out a phased programme to implement the above and
inform SEBI of the same.

3. Collection of Margins from clients

Exchanges should ensure that brokers collect margins from clients wherever the margin liability
for the client exceeds Rs.1 Lakh . The exchanges would carry out inspections to verify that the
brokers are abiding by this requirement.

103
The Exchanges are further advised to strengthen their surveillance and monitoring to detect
market manipulations in a timely and proactive manner.

Yours sincerely,

(L.K. SINGHVI)

104
L. K. SINGHVI
Sr. Executive Director
Tel : 91-22-2851599 Fax : 91-22-2883296
Email: lks@sebi.gov.in

May 25, 2000

LKS/ /2000

The Executive Directors/Managing Directors

of all the Stock Exchanges

Re: Meeting of the Inter-Exchange Market Surveillance Group (ISG) held on May 17,
2000.

Dear Sir,

In the meeting of the Inter-Exchange Market Surveillance Group held on May 17, 2000 the
following decisions were taken. All the stock exchanges are required to initiate immediate action
on the same and send a compliance report by May 31, 2000:

1) Prioritisation and Benchmarking of alerts generated under the Stock Watch

System: The stock watch system was developed and implemented to generate alerts on
abnormal trading and manipulative market activity. However the Stock Watch System can
only be effectively utilised if the there is proper bench marking and prioritization of alerts
to identify and focus on high priority sectors/areas of follow up/investigations. It was
agreed that exchanges will complete the process of proper benchmarking and
prioritisation of alerts and make the system fully functional within one month.

2) The role of Governing Board vis-à-vis surveillance functioning of the exchanges –

The issue of the role of the Governing Board with regard to surveillance functioning of
the exchange was discussed and it was clarified that there is no ambiguity as regards the
overall role of the Governing Boards. In this context reference was drawn to earlier SEBI
circular no. SMD/3953/96 dated August 17, 1996 wherein SEBI had infact directed the
Governing Boards of the exchanges to review the functioning of their surveillance
department at every Board meeting.

As regards the responsibility of the Executive Director, since surveillance is a very important and
sensitive area it was stipulated that this would be under the direct responsibility of the Executive
Director who is the senior most executive of the exchange. It was also advised earlier that there
should be no interference in the functioning of the surveillance department, which should be
done in a very professional and objective manner. The spirit behind such stipulation was that
there should be no interference from individual directors, member brokers or any other vested
interest and there was never any doubt that Board as a whole would oversee and give policy
directive to the surveillance functioning in the exchange.
105
3) Documentation of Surveillance activities : There has to be a proper and systematic
documentation of surveillance procedures to ensure transparency, objectivity and
accountability in the functioning of the surveillance department. It was agreed that the
exchanges would put in place a system of documenting surveillance activities within one
month.

4) Augmentation of the surveillance staff strength: The staff strength in the exchanges
for surveillance and monitoring is generally not adequate. It may be recalled that earlier
also, (letters dated October 29, 1998 and March 26, 1999) the exchanges were asked to
review the staff strength of the surveillance function and appropriately augment the same.
However no significant action has been taken by the exchanges. Hence the exchanges are
advised to review and assess the requirements of surveillance manpower and take steps to
deploy the required manpower within a short and reasonable timeframe.

5) Training and Certification Program for surveillance staff at the exchanges : It may
be recollected that a surveillance training module was prepared earlier by BSE and NSE.
All the exchanges are advised to arrange for training and certification for their
surveillance personnel from either BSE or NSE. This is necessary to bring a more
professional approach in the area of surveillance and monitoring.

6) Institutionalised co-ordination between exchanges in surveillance activities: With

multiple listing and membership, trading aberrations and abnormal trading activity is
sometimes difficult to identify in isolation. Also in the context of the proposed derivatives
trading it would be all the more important that there is greater co-ordination among the
exchanges in the matter of monitoring and investigation. Hence there is a need to build
an institutional mechanism for the purpose of exchanging timely information and co-
ordination in investigations wherever required. BSE, NSE, DSE and CSE may send their
suggestions on how to bring about the same by May 31, 2000.

7) Verification of rumours with companies by the exchanges: It is known that rumours

can create distortions in trading patterns, leading to unrealistic valuations. Presently the
exchanges are verifying the rumors with the companies and disseminating the same to the
investors. However there is a need to effectively and continuously provide correct
information to the market and also take punitive actions wherever instances of deliberate
rumor propagation are noticed. Exchanges may further strengthen this area of their
surveillance activity.

8) Modification in the price band system: The meeting also discussed and reviewed the
functioning of the price band mechanism and the recent relaxation of price band by 4%
beyond 8% after half an hour halt. The feedback given was that the new system of price
relaxation by 4% has been working well and has served the purpose for which it was
introduced. It has been noticed that the scrips after hitting 8% freeze when relaxed to
further 4% in majority of the cases were traded between 8% and 4% and only in a small
number of cases were hitting 12% freeze. This is providing the required opportunity to
the investors to trade in the scrips which would have been denied to them in the earlier
106
 system. It was also agreed that while the system is working well any deliberate attempt
in the market to misuse the system of price band should be examined properly and
whenever such instances are detected, preventive and punitive actions should be
immediately taken and also reported to SEBI.

Yours sincerely,

(L.K. SINGHVI)

107
SYLLABUS FOR THE SURVEILLANCE MODULE
Introduction of importance of surveillance in stock exchanges–certain recent problems–the need
for good surveillance mechanism to tackle those problems–overview of the coverage of the
programme.

 Basic Investment Mathematics

- share price quotation, return on equity, earning per share(EPS), dividend yield, cash earning
per share, price to earning ratio, diluted P/E, adjusted EPS, book value, market price, intrinsic
value, capital gains, value of a right, value of bonus, cost of equity, cum dividend price, ex
dividend price.

- beta concept, calculation and significance; Stock indices.

- time value of money, present value, future value, compound value, annuities, amortization,
discount rate, internal rate of return, equal monthly installments; pay back period, internal
rate of return, net present value, return on investment.

- financial statements, net worth, current assets, current liability, debt to equity ratio, current
ratio, current assets, understanding and interpreting of financial statements, interpretation of
credit ratings.

- analysis of data – use of excel sheets and fox pro–creation, analysis and storing of data bases,
report forms, graphs etc.

 Rules and Regulations

- Securities Contracts Regulation Act, 1956 and Rules, 1957.

- recognition of Stock Exchanges, periodical returns to SEBI, Power of SEBI to make or

amend Exchange Rules and Bye-laws, power to supersede governing board of exchanges,
power to suspend business of recognised stock exchanges (Section 3 to 12) Contracts in
securities contracts in notified areas illegal or void in certain circumstances, members may
not act as principals in certain circumstances, power to prohibit contacts in certain cases.

- qualification for membership of recognised stock exchanges, books of account and other
documents to be preserved by the recognised stock exchanges and their members, listing
requirements, etc.

- Securities and Exchange Board of India Act, 1992

role and functions–General Powers, regulating the business in stock exchanges and any other
securities market, registering and regulating the working of stock brokers, sub-brokers, share
transfer agents and such other intermediaries who may be associated with the securities
markets in any manner.
- SEBI to regulate all intermediaries in securities business, penalties for failure to follow rules
and regulations, power to adjudicate, appellate procedure.
108
- SEBI (Stock Brokers and sub-brokers Regulations, requirements of contract notes,
regulations of transactions between clients and brokers.

- SEBI guidelines on disclosures and investor protection, SEBI (insider trading) Regulations,
the definition of insider, person deemed to be a connected person, Unpublished price
sensitive information, responsibilities of insider. SEBI substantial acquisition of shares and
take over regulations, SEBI Regulation on prohibition of fraudulent and unfair trade practices
relating to securities markets, prohibition against market manipulation, prohibition of
misleading statements to induce sale or purchase of securities, prohibition on unfair trade
practices relating to securities.

- power of the Board to order investigation, procedure for investigation, duty to produce
records, power of the board to issue direction, purpose of direction, suspension or
cancellation of registration of an intermediary holding a certificate of registration.

 Stock Watch Systems

- scrip monitoring using stock watch systems, price, volume, volatility analysis, real time
graphs, queries, alerts – on line analysis, reports.

 Off line surveillance

- margining requirements - SEBI guidelines, procedures in respect of exception handling,
Position monitoring, exposure and turnover limits, basic concepts of base capital – Base
minimum capital, additional capital, forms in which capital required to be maintained,
reporting requirements. Inspection mechanisms, and investigation techniques, disciplinary
action procedures in various exchanges.

 Role of surveillance in risk management

- Types of risks to members, Settlement guarantee mechanism, risk to the Clearing
Corporations / Clearing House, Need for risk containment, Methods employed, Role of scrip
monitoring and position monitoring in risk containment, timely action and risk management.

109
 FURTHER READINGS

1. Indian Securities Market-A Review, NSE’s Publication

2. Please refer to the following Act, Rules and Regulations:

- Securities Contracts (Regulation) Act, 1956
- Securities Contracts (Regulation) Rules, 1957
- Securities and Exchange Board of India Act, 1992
- SEBI (Stock Brokers and Sub-brokers) Regulations, 1992
- SEBI (Disclosures & Investor Protection) Guidelines, 2000
- Securities and Exchange Board of India (Insider Trading) Regulations, 1992
- SEBI (Substantial Acquisition of Shares and Take Over) Regulations, 1997
- Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade
Practices relating to Securities Market) Regulations, 1995

110