Some Safeguards For Effective Regulation (8 Sep 2003)
Global outrage over New York Stock Exchange (NYSE) chief Richard Grasso’s phenomenal $140 million compensation couldn’t have been better timed. Just as institutions around the world are debating how the NYSE continues to operate like a “club’, India has introduced The Securities Laws (Amendment) Bill, 2003 in the Lok Sabha, which aims to eliminate the last vestiges of clubbiness in the running of stock exchanges.
The Amendment Bill aims to do a lot more than demutualise stock exchanges. In their corporate avatar, the Bill will grant bourses enormous powers over companies and brokers in order to ensure effective market supervision.
The outrage over Mr Grasso’s salary will hopefully draw timely attention to the fact that stock exchanges could easily retain their clubby culture despite their demutualised structure unless the board of directors is chosen with care.
The Financial Times of London says about the NYSE that, “governance is nominally in the hands of the owners of the seats or the right to trade on the floor (in India these would be broker members)”. However, there is also “a silent majority of owners” who are “passive shareholders” and lease their seats to active traders. But the “real power is held by the large firms whose representatives on the board raise their thumbs up or down on questions such as Richard Grasso’s pay”.
It is this board, comprising of the most powerful names on Wall Street and corporate America, such as Martha Stewart (now resigned), Madeleine K Albright, Andrea Jung, Peter Larson, Gerald Levin and James Cayne that approved Mr Grasso’s fat compensation packet without any performance benchmarks, even though he functions in an almost monopolistic environment. The NYSE earned a paltry $ 11.5 million in its latest quarter when Mr Grasso’s compensation details caused so much furore.
How will things work in the emerging Indian scenario? For starters, SEBI has already cleared the path for demutualisation or closure of many bourses. At least three stock exchanges are already under SEBI-appointed administrators and The Stock Exchange, Mumbai (BSE) is headed by a non-broker.
The new Amendment Bill, which aims to separate ownership, voting rights and management from access to trading in stock exchanges, is more or less modelled on the structure of the National Stock Exchange (NSE). But there is a difference; the NSE has no brokers on its board while the newly demutualised bourses will have to cut broker representation to a fourth of the board strength. The rest will comprise SEBI-appointed public representatives or nominees of new shareholders who will hold 51 per cent of the shareholding in the new corporate structure.
The phenomenal success of the NSE has lulled the government into believing that its professional structure alone is key to its success. That is a dangerous fallacy and the government would be well advised to study the NYSE controversy to see how ‘clubby’ relationships can remain intact within a corporate facade.
The BSE itself offers interesting pointers to how this can happen. For instance, although the BSE already has a 50 per cent public representation, the public directors have never distinguished their terms by showing any independence of views or action. In fact, when the BSE whistle blower Atul Tirodkar was being persecuted, the public directors— comprising eminent academics, bureaucrats and nominees of regulatory bodies—were more intemperate and unreasonable in their demand for his ouster than the broker-directors.
Secondly, outside directors remain independent only if they are precluded from taking on other monetary relationships with the bourse. For instance, asking board directors to head arbitration committees etc that are paid hefty daily allowances and sitting fees seems a sure way to kill their independence.
Thirdly, the demutualisation process must be preceded by an independent inquiry by the regulator into the wage structure and spending patterns of various stock exchanges.
Just as Richard Grasso’s pay packet is reportedly over “several hundred times the salary of the Chairman of the Federal Reserve Board”, SEBI would find that salary structures at smaller stock exchanges are significantly higher than those at the NSE and the National Share Depository. Their routine expenditure on advertising, lectures and functions is also much higher. The regulator must encourage more austerity at the bourses in line with their falling market share and profitability.
Fourthly, SEBI must realise that the Securities Laws (Amendment) Bill, 2003 puts vast powers into the hands of stock exchanges and its own officials. Stock Exchanges will be empowered to levy fines going up to Rs 25 crore for many offences. They will also be empowered to delist securities for a variety of reasons such as — “insider trading” or “unfair trade practices” by company directors, failure to redress investor grievances, or even if a company’s net worth falls below paid up capital. Companies can also be delisted if their management indulges in mischief such as dematerialising excess securities or issuing new securities without obtaining listing permission.
While the power to impose crushing fines is necessary and long overdue, it can also breed greater corruption and vindictive action by petty officials. SEBI must ensure that its own officials and those of self-regulatory agencies wield the stick with caution and pragmatism. Otherwise, the enhanced powers will only be a source of harassment by regulators and lead to increased litigation.
There is another issue that merits some consideration. Greater power for the regulator must be accompanied by greater responsibility and accountability. Just as bank borrowers want “lenders liability” rules, regulators must also accept some pressure to deliver results and justify punitive action. In India, the conviction rate of all regulatory and investigative agencies (the CBI, Enforcement Directorate, the police and the Income Tax authorities) is abysmal. Yet, their mammoth powers allow them to harass and humiliate people, with no obligation to file charges within a defined timeframe.
SEBI too has initiated several disciplinary actions that it has failed to justify in subsequent investigations. In a couple of cases, it has refused to initiate punitive action despite possessing clear evidence. It is only fair that new rules that empower the regulator to impose debilitating punishments must be tempered with accountability norms in order to ensure a just and equitable capital market. -- Sucheta Dalal