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Historical Underpinnings of Indian Securities Market Regulation - Part I: Pre Independence




The Native Share & Stock Brokers’ Association of Bombay (now the Bombay Stock Exchange (“BSE”) became the first organized stock exchange of India by formally constituting in 1887. Though, the association had been functioning for years before that and even had basic rules, regulations and customs in place to facilitate members in carrying out trading. The small market for few companies flourished in Bombay bringing vast wealth to the companies, as also great influence, authority and wealth to its members (brokers).[1] The market saw booms and busts until the American Civil War which brought some disillusionment and failures and reduced its popularity and scale. Until 1914, dealings on the exchange (apart from government securities) were limited to a few textile shares.[2] BSE however, continued to play a significant role in organized share transactions. Eventually, the Ahmedabad Stock Exchange (“ASE”) and Calcutta Stock Exchange (“CSE”) started in 1894 and 1908.


World War I

BSE caught national interest when World War I led to Europe ceasing production of manufactured articles other than those necessary for war and the stoppage of import of several articles to India. This led to a massive boom with various new company flotations (which were several times oversubscribed) and rise in share prices of existing companies.[3] Large number of new investors with modest backgrounds poured money into the stock exchange until the bubble burst leading to significant public discontent.[4]


In 1992, a resolution was moved in the Bombay Legislative Council on account of heavy speculation that had taken place on BSE in 1919-22. This led to the setting up of the Bombay Stock Exchange Enquiry Commission under Wilfred Atlay (“Atlay Commission”). The Atlay Commission’s enquiry uncovered two critical issues plaguing the exchange, i.e., corners and blank transfers, as well as various other inefficiencies.


A corner arose when someone controls shares with the sole object of inflating their price. It can arise when more shares than are available for delivery on the day of settlement have been sold and the buyer holds the seller up to ransom, of sorts.
Blank Transfers were transfers wherein only the transferor’s name was specified and the transferee’s name as well as the date of signing were absent. During this time, owing to the lack of technology, the process of getting a transferee’s name registered in the books of the company issuing security could take approximately a months’ time and was expensive as one had to pay the stamp duty to the government and transfer fee to the company. Thus, blank transfers facilitated negotiability and made for swift movement of securities from party to party to enable the holder to sell the security without wasting time. Their negotiability made it easy for holders to obtain credit but it also encouraged speculation, evasion of income tax and rendered registers of companies incomplete and inaccurate with real holders’ identity unrevealed. The issue of blank transfers remained unsolved, as we will see, for decades to come.

During this time, by virtue of Rule 26 of BSE, the exchange could intervene at the instance of evident and significant corners and ‘fix’ prices to dissipate the corners. These prices were to an extent a compromise of the price differences.


The Atlay Commission recommended the abolition of this rule on the principle that contracts freely entered into for sale or purchase of shares must be fulfilled by delivery of shares or payment of the purchase price and the failure to deliver should trigger the ordinary procedure of the exchange whereby shares are brought against him in the open market. Though BSE agreed to delete this rule, it preferred modified rules proposed in the Minority Report by Mr. Bhulabhai Desai, which empowered the committee to declare a corner in any share when it was convinced that there was to be a corner and to suspend all future dealings in it for the then ensuing and subsequent settlement cycle.


The Atlay Commission also found many deficiencies in the functioning of BSE such as undue leniency for grave misconduct. The rules and regulations of the exchange were found hard to ascertain with some printed on loose sheets of paper or unprinted. The brokers were found to act as dealers by acting as principals to transactions with their clients and making gala/secret profits. They were also found to be issuing pencil memoranda of contracts instead of contract notes. Further, it was also found that the exchange had been closed in deference to the rules at times by brokers at their pleasure. The Atlay Commission recommended the obvious need for strengthening the disciplinary rules of BSE and enforcement of the same. It also recommended the rules be printed and made available to the public and for brokers to use stamped uniform contracts. BSE agreed to publish and introduce the new rules recommended in this regard.[5] 


Before government action to regulate the exchange could be formalized, speculation again rose to unhealthy heights leading to a crash in June 1925 and created panic in BSE. An offer made by the government to grant BSE with monopoly in organized trading in securities in exchange for control in the rule-making power of the exchange was declined.[6] This led to the enactment of the Bombay Securities Contracts Control Act, 1925 (“BSCC Act”) for safeguarding public interest. However, BSCC Act also failed to suppress the unhealthy speculation and crisis despite the suspension of forward trading.


Several crisis in 1928 brought noisy public criticism against BSE and its governing body leading to commissioning a second enquiry in 1936 by a Committee presided over by Mr. W B Morison (“Morison Committee”). It noted that though cornering had subsided, ruinous speculation had wreaked havoc in BSE, while finding that 80-90% of total transacted business on BSE was speculative in nature and a substantial portion of this was causing degeneration of the market towards a mere gambling in differences. The Morison Committee recommended compulsory margins, abolition of blank transfers, vesting powers with the government to impose rules on the exchange’s governing body and extending control over ready delivery contracts. These interventions however, did not materialize on account of the outbreak of World War II.



World War II

During the war, the Government prohibited forward trade in 1943 in commodity markets, cotton, oil seeds and bullion. This had the result of diverting speculators’ attention to the share market. Despite being a ready delivery basis market, forward dealings were ongoing in some way or the other at BSE under the guise of budla.[7]


During this time, settlements used to happen fortnightly/monthly on pre-specified dates of the exchange. Budla is carry forward of a position till the next settlement. It involved parties such as vyaj budlawala and teji budlawala who would lend money and shares respectively for a price plus contango or backwardation charges respectively as and when required by parties wishing to carry forward their trades. The interest rates of such borrowings were dependent on the price of the shares.


When both the parties to the trade wished to postpone the settlement, the bear took the role of vyaj budliwala and carried forward the transaction and both agreed to mark the contract at settlement and pay up the differences.[8] If the bull did not want delivery, he paid up badla or contango to the bear. Sometimes during overselling, when the bull had reason to believe that the bear would not deliver, he insisted on delivery, and this would be resisted by the bear seeking postponement by payment of backwardation.[9] The badla or backwardation charges being relatively determined and these transactions dependent more on information about brokers' positions and the power play rather than on the company fundamentals,[10] If left uncontrolled, could lead to market degeneration.


To tackle this, the government promulgated Defence of India Rule 94C in September of 1943 prohibiting stock exchanges to permit anything but ready delivery dealings and limiting the period of even such contracts to seven days. As options and budla were now banned on stock exchanges, speculators moved to unorganized share bazars, e.g., grey markets in Bombay and Ahmedabad and Katni in Calcutta.


More on the grey markets and beyond in the next post. Stay tuned.


[1] Minority Report of Mr. Bhulabhai J Desai, Esq., Report of the Bombay Stock Exchange Enquiry Committee under the chairmanship of Wilfred Atlay, 1925 (“Atlay Committee Report”).

[2] Report on the Regulation of the Stock Market in India by P J Thomas, 1948 (“PJ Thomas Report”).

[3] Atlay Committee Report.

[4] PJ Thomas Report.

[5] Supra, at 2.

[6] Ibid.

[7] Supra, at 2.

[8] 'Badla': The Mumbai Derivative, Vivek Kulkarni, EPW, Vol. 32, No. 42 (Oct. 18-24, 1997), pp. 2747-2749+2751-2752

[9] Ibid.

[10] Ibid.

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