Sucheta Dalal :Muscle-flexing
Sucheta Dalal

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May 3, 2010

 The Securities and Exchange Board of India (SEBI) issued a strange scolding to the Bombay Stock Exchange (BSE) in April that has gone almost unnoticed, despite its wider implications. The order was strange because of the admission that there wasn’t any substance to the show-cause notice that it issued to the BSE. But, instead of simply dismissing the issue without any directions, SEBI’s whole-time member offers a piece of gratuitous advice that has significantly larger implications. The issue in question is at least six years old, when a different chairman and CEO headed the BSE management; both left under a cloud in 2008. SEBI woke up to the possibility of initiating action against the bourse for their actions only in 2009.


The story begins in July 2004, when the BSE sought permission to introduce a market-making scheme to kick-start its dormant derivatives segment by injecting liquidity through active buy-sell quotes. SEBI, correctly, disallowed this scheme, because the BSE proposed to reimburse losses incurred by designated market-makers. The regulator said this would expose the bourse to “commercial risk as an insurance agency.” Instead, it asked BSE to re-submit a proposal with internationally accepted incentive payments to market-makers; but the BSE dropped the plan.


In November 2006, BSE introduced another ‘market development scheme’ (never publicly announced) through two entities called Apollo Sindhoori Capital Investments and Sam Global Securities without any open reimbursement of losses. This scheme operated between December 2006 and May 2008, only for derivatives contracts of the BSE Sensex and Reliance Industries. Although there was no improvement in BSE’s derivatives segment, it cost the Exchange a hefty Rs90 crore. SEBI initiated no direct action against the bourse; instead, the BSE CEO and chairman, during whose tenure the scheme was implemented, suddenly resigned. According to the grapevine, losses on the secret market-making contract and a hurriedly sealed $60 million systems maintenance contract to OMX AB of Sweden ( were the reason for their exit. Almost a year later, in May 2009, BSE appointed Madhu Kannan, formerly from the New York Stock Exchange, as its CEO. When BSE’s brand new management team under Mr Kannan was just getting into gear to take on the dominant NSE, SEBI suddenly decided to slap it with a show-cause notice (in October 2009) for the old case. What induced this action? And why would SEBI want to dishearten BSE’s new management when it was about to challenge the NSE’s monopoly in the equity derivatives segment?

Well, nobody questions SEBI’s actions, however strange, least of all the finance ministry.

But the order reveals the funny goings-on at the bourse between 2004 and 2008. In response to the notice, the BSE team, led by Madhu Kannan, pointed out that it had run three market-making schemes starting from 2002 and the regulator was informed of them through its ‘Monthly Development Reports’. It also argued that SEBI regulations did not mandate either a prior or post-facto approval for launching market-making schemes and that a committee of the regulator had, in fact, encouraged such activity. BSE said that it had only sought SEBI’s permission in 2004, out of ‘abundant caution’ and as a matter of ‘good governance’ because it intended to reimburse the losses of market-makers. That scheme was dropped after SEBI objected to it; even the Rs90-crore expense incurred on the 2006 scheme was claimed to be for advertising and promotion. 


Left without much of a case against the BSE, the regulator admits that “this is not a fit case for issuing directions or take action” under the show-cause notice. But it wouldn’t let go of its position either, so it ‘advised’ the BSE and “reminded it of its duty” to bring to SEBI, “such schemes which have wide and far-reaching market implications for the securities market.” However, SEBI’s whole-time member, KM Abraham, who issued this order, says, “I would stop short of prescribing what (such) a scheme would be or laying down yardsticks that would set apart (such) scheme” with market-wide implications. He preferred to leave this “to the better judgement” of the Exchange.


Why would SEBI issue such a weak show-cause notice when it had already ensured the exit of the previous top management? Why was a new management forced to defend those actions? Was there some ulterior motive for someone to time the show-cause notice? Will that person be identified and held accountable? After all, the SEBI order admits it has no case against the BSE. But it has still twisted the situation to suggest that it would be free to issue more such notices, as and when its officers want to render a slap or two to the bourse by claiming that an issue, which does not legally require SEBI approval, was not brought to its attention!


Meanwhile, even in this order, SEBI does not think it fit to mention that the investing public has a right to know about any market-making scheme introduced by any of the bourses and the terms of any arrangement with brokerage firms to provide such services must be put in the public domain. The BSE’s deal of 2006 wasn’t known until after the exit of Rajnikant Patel, its former CEO. And we still don’t know if any other bourse is running similar schemes.


Instead of dashing off show-cause notices to bourses and intermediaries, it is probably time that senior management at SEBI is given a crash course on the merits of prescribing disclosure and transparency as a tool for protecting investor interest and as an aid to market development. One more question still remains. Isn’t the regulator obliged to initiate timely and time-bound action? How does one ensure that SEBI does not go the way of other government investigating agencies that are completely unaccountable and easy hand-maidens of the government of the day? — Sucheta Dalal


-- Sucheta Dalal