A Clean Chit?

CHAPTER XIII: THE MINISTRY OF FINANCE

The Ministry of Finance (MoF) is vested with the overall responsibility for the entire formulation,presentation to the Cabinet, adoption and subsequent implementation of the fiscal, economicand monetary policies of the Government. As part of its implementational responsibility, it overseesthe working of the country's financial systems, including the financial institutions, all NBFCcompanies, capital market and its health. The policy for taxation (direct and indirect), taxcollection and distribution, international negotiations, exchange rates, management of balancepayments are also amongst the diverse responsibilities of this Ministry. It has the followingdepartments:

1. Department of Economic Affairs 
2. Department of Revenue 
3. Department of Expenditure

Lately, the Department of Company Affairs, earlier part of Ministry of Law and Justice, hasbeen attached to the Ministry of Finance.

13.2 Different aspects relating to overall responsibility of Ministry of Finance have been dealtwith under relevant chapters of this Report. This Chapter relates to the overall responsibilities ofthe Ministry of Finance towards stock market scam. The role of Ministry of Finance towards theproblems of the Unit Trust of India has been separately dealt with in Part II of this report. Theearlier JPC of 1992 which enquired into irregularities in securities and banking transactions, inpara 16.62 and 16.63 of their report regarding the responsibilities of the Ministry of Finance hadobserved as under:--

"16.62 The FM has raised a point to which the Committee feel it should react. In hiswritten submission the Minister has stated:

"As regards the functions of the FM, he oversees the work of the Ministry and providesoverall policy guidance to the officials. Revenue and Expenditure decisions are the directresponsibility of the Finance Ministry. As such FM has more direct responsibility in theseareas. He is also responsible for broad policy decisions affecting the financial systemwhere the Finance Ministry is involved. However, FM cannot be held responsible foradministrative failures or management deficiencies in the case of individual banks andother financial institutions."

The Committee feel that such a distinction cannot be sustained by the constitutionaljurisprudence under which the parliamentary system works.

16.63 The principle of constructive ministerial responsibility is equally applicable to otherDepartments and Ministries where acts of omission and commission have taken place inthe discharge of function and duties at different levels." 

13.3 The Committee are agreed that ministerial responsibility in regard to this Report flows from theseprinciples. 

I. CAPITAL MARKET DIVISION OF THE MINISTRY OF FINANCE --  FUNCTIONS AND RESPONSIBILITIES

13.4 In pursuance of the recommendation of the earlier JPC of 1992 and with SEBI comingin as the major regulator of the stock market, the Stock Exchange Division of the Ministry wasdone away with. The total workload was given to the Capital Market Division which formed partof the Department of Economic Affairs.

13.5 Speaking on the role of CM Division in the Ministry of Finance, Shri Ajit Kumar, the thenFinance Secretary stated as under:--

"I just wanted to mention very broadly that in 1947, the Controller of Capital Issues Acthad been promulgated and under that, we used to have an officer called the Controllerof Capital Issues, and it was his job and that of his office to allow all the capital issues -- how many are to be allowed, at what price and so on and so forth. Till 1992, this wasthe position. In between, before that, the Securities Contracts Regulation Act was inposition in 1956. Then, when SEBI came into existence, this office of Controller of CapitalIssues was abolished and all the functions, which this office used to perform, were givenover to the SEBI as the regulator."

13.6 The Capital Market Division deals with broad policy matters, legislative business relatingto any amendment required in Securities Contract Regulation Act or other connected Acts,answering parliamentary questions, coordinating various aspects, servicing the High LevelCoordination Committee on Financial & Capital Markets (HLCCFCM) which has been set upunder the chairmanship of the Governor of the RBI. This Division deals with organizational mattersrelating to UTI and SEBI and Securities Appellate Tribunal (SAT) including appointment of Chairmanand Members of the SEBI Board.

II. BANKING DIVISION -- FUNCTIONS AND RESPONSIBILITIES 

13.7 Within the broad framework explained above prominent functions of the Banking Divisionof direct relevance to the subjects under examination of the JPC include, inter-alia:

--  Processing of appointments of Chief Executives of banks and financial institutions andother official and non-official directors on their boards;

--  Supervision and appraisal of the overall performance of all public sector banks; --  Policy relating to private banks, foreign banks andNBFCs; --  Policy matters relating to credit; --  Resolving disputes between various departments of Government, PSUs and the banks; --  Nominations of CVOs in public sector banks in consultation with theCVC; --  Vigilance Surveillance over Chief Executives of public sector banks and financialinstitutions; and

--  Studies in Preventive intelligence.

III. SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI) 

13.8 SEBI is governed by SEBI Act, 1992 and is accountable to the Parliament through theMinistry of Finance. The SEBI is required to furnish an annual report and annual statement of accounts giving a true and full account of its activities, policies, programmes and finances tothe Central Government which are laid before each House of Parliament. It is through thismethod that Parliament becomes aware of the functioning of SEBI every year. SEBI is entrustedwith the task of protecting the interests of investors in securities and to promote the developmentand regulation of the securities market through appropriate measures. Under Section 4 of theSEBI Act, the Board of members of SEBI consists of a Chairman, two members from amongst theofficials of the Ministries of the Central Government dealing with Finance and Law, one memberfrom the Reserve Bank of India, two other members appointed by the Central Government, whoare professionals and interalia have experience or special knowledge relating to securities market.In practice, however, the senior level positions in SEBI have been held predominantly fromIncome Tax Department/ Indian Administrative Service on deputation basis.

13.9 The Government representatives on the SEBI Board were expected to maintain flow ofinformation between the Ministry of Finance and SEBI as also to project the Government policyon the SEBI Board. However, as the functioning of SEBI reached a level of maturity, theGovernment expected to give more and more autonomy to that institution. The Board of SEBIwas meant to be autonomous regulatory body and this fact has always been recognized. Finaldecision on any issue within the ambit of the SEBI Act vests with the Board.

13.10 Speaking on the issue of importance of autonomy and distancing politics from economicdecision making, Dr. E. A. S. Sarma, former Secretary, Department of Economic Affairs during hisdeposition before the Committee submitted that the procedures regarding appointment to thetop positions in organizations like SEBI, UTI and Banks are not very transparent. He suggested fora Search Committee or a Professional Group which should search professionals for appointmentto top level positions. He further suggested that such Search Committeeís composition must bedefined and the recommendations of the Search Committee should be binding on thegovernment. Constitution of such a committee should be provided in the relevant statute of anorganization. On being asked by the Committee what could be the composition of such SearchCommittee, he suggested that it may comprise Prime Minister, the Leader of the Opposition andthe Chief Justice of India so that nobody could question the integrity of the Committee.

IV. VOLATILITY IN THE STOCK MARKET 

13.11 In 1999, the Capital Market witnessed an increase in the Sensex which continued inearly 2000. The BSE Sensex which was 3740 on 31.3.1999 rose to 5001 in 31.3.2000 and declinedto 3604 on 30.3.2001. From mid-2000 the stock prices showed a declining trend which wasgradual but steady. From March 2001 the Sensex fell sharply and can be construed as a crashin the stock market.

13.12 The rise in the Sensex over a period of more than nine months from July 1999 toMarch 2000 was unprecedented by Indian standards. The graph generally matched the rise ofstock market prices in the international markets. The pattern of rise and fall in the internationalstock market gets generally reflected with minor variations in the Indian stock market also.However, the rise in Indian markets was associated with a massive increase in the daily turn overin stock markets from a few hundred crore to Rs. 12000 crore and more. It is normal for stockmarket to rise and fall. By themselves, such fluctuations do not constitute a scam. However, ifthe volatility is unusual, the need for enquiring into such market behaviour is imperative. In thatcontext, a question arises as to whether the unusual rise in the prices of shares of certainInformation, Communication and Entertainment (ICE) companies was not fueled by irregular flowof money into the stock market. If this was so, then is it not a failure of SEBI and was not theMinistry of Finance duty-bound to ask serious questions about this trend? 

13.13 In this regard the Ministry of Finance has stated that while fluctuations are normal instock markets and should not be a matter of undue concern, the market regulator and stockexchanges concerned need to be vigilant with regard to the systemic risk or movements drivenby any form of manipulation. The objective of the Government and the market regulator is toensure efficiency and integrity in the functioning of the capital markets. As per statutory provisions,surveillance functions over the capital market operations have been assigned to SEBI and thestatute does not envisage direct interference by the Government in operations of the capitalmarkets and stock exchanges. However, regular periodic reports are received from SEBI andsuitable enquiries are made regarding the functioning of the markets. Successive Ministers ofFinance since the commencement of liberalization have testified before the Committee thatthey kept themselves informed of market developments and enquired, or caused enquiries tobe made about reasons for unusual volatility when this occurred. The Hon'ble Shri YashwantSinha, vouchsafed the Committee that when the Sensex crossed the 6000 mark in February,2000, the SEBI chairman even interrupted a Budget meeting to telephonically inform FinanceMinister of his concern and Finance Minister asked him to take steps to cool the market. Keysteps taken by SEBI in this regard have been elaborated in the chapter on SEBI.

13.14 As per the documents received from the Ministry, taking note of the high degree ofvolatility in the capital market, the Secretary, Department of Economic Affairs in his letteraddressed to SEBI on 26.4.2000 expressed concern about the scope for market manipulation byunscrupulous players in the market. A note was also forwarded containing the following suggestionsfor bringing improvements in the equity market:--

(i) Moving all scrips to the rolling settlement mode as soon as possible.(ii) Simplification of the margin system and strict implementation of margin requirementsthat can be verified through an electronic surveillance system so that requirementsdo not have to be changed frequently.

(iii) Reviewing the 8% share specific, circuit breaker system already under considerationof SEBI be expedited.

(iv) The index futures market may be started as soon as possible. This will give marketparticipants access to an additional hedging instrument. This could be followed up,after completing due diligence with the stock exchanges, by initiating a stock optionsmarket.

(v) It is understood that some brokers continue to trade on the telephone well after thestock exchanges have shut for the day. It is also heard that there is substantial "kerb"badla market in Calcutta outside the stock exchange. SEBI may like to take a closelook at the market manipulation ramifications, if any.

(vi) In some equity markets of the developed countries short selling is not permitted whenthere is excessive volatility on the "downtick". SEBI may like to look into the possibilityof introducing a similar restriction in our markets. There is a feeling amongst marketfunctionaries in India that such a restriction would reduce the possibility of panicselling.

13.15 The copies of correspondence held by the Ministry of Finance with SEBI on the systemicreforms from April 2000 were made available to the Committee. It is observed therefrom thatthe Ministry has been repeatedly emphasizing the need for expeditious corrective measures foreffective regulation and controlling high degree of volatility in the stock market.

13.16 During deposition before the Committee, the representative of the Capital MarketDivision submitted that the Government was aware of the sharp rise in the stock market indices and that prices of specific stocks had gone up. He informed the Committee that the Governmentwas in touch with SEBI suggesting them to watch out issues like rolling settlement, badla andinvestor education. A number of questions on this subject were asked in the both Houses ofParliament. The Capital Market Division of the Ministry of Finance was in touch with SEBI "at thatpoint of time." They were also watching NASDAQ and while "that was not necessarily the fullexplanation of what was going on in this market but we saw that the Information, Communicationand Entertainment (ICE) companies, their share prices were relatively going even higher." Therepresentative of the Capital Market Division further stated that "SEBI has got back to us sayingthat they have repeatedly issued signals through a variety of ways to the investors to be carefulgiven the fact that stock valuations are very high."

13.17 In the statement by Shri D. R. Mehta, the then Chairman, SEBI submitted to the Committeeduring his deposition on 13.9.2001, it was stated that:

"On three different occasions, SEBI issued press releases cautioning small investors toexercise utmost caution and diligence including verification of fundamentals whiletransacting in securities."

13.18 The Capital Market Division representative also mentioned that they were informed bySEBI that the SEBI has repeatedly issued signals through a variety of ways to investors to becareful to invest in the companies which have low floating stocks and in which there might bealready some issues under investigation by SEBI.

13.19 However, there was inadequate monitoring by SEBI as to whether its directives forinvestor protection were being assiduously implemented. Moreover, there was tardy reporting ofcompliance by Stock Exchanges, and neither SEBI's nominees directors nor SEBI itself cross-checkedthe reassuring reports received from Stock Exchanges against the concerns of the SEBIand the Ministry of Finance which led to the SEBI's circulars. Nor there were any concertedefforts by the regulators or the Ministry to monitor or investigate the exponential rise in the flowof money into the stock market from domestic and international sources. Therefore, there wasinadequacy in action taken to identify issues relating to the integrity of markets and the protectionof investor interests calling for corrective action through the strengthening of regulatory framework.The regulatory framework has now been considerably strengthened but only after the crash ofMarch-April, 2001.

13.20 It is thus observed that the Ministry of Finance have been repeatedly emphasizing the need forexpeditious corrective measures for effective regulation and controlling the high degreeof volatility in stock market. Actions taken by Ministry of Finance and SEBI to warn investors during the riseof stock prices have been noted by the Committee. It has also been noted bythe Committee that there was a feel good factor and feeling that India had arrived on the IT scene. Althoughactions have been taken by the Ministry of Finance and SEBI during the periodwhen the stock market was rising unusually, the Committee are of the considered view that both these shouldhave been more proactive and vigilant.

13.21 The Finance Minister while giving his statement in the Parliament on the extreme volatilityin the stock market on 13.3.2001 stated that SEBI had already started its investigation as far asprice manipulation was concerned and he announced following measures to improve institutionalmechanisms and trading practices in the stock market:

(a) Corporatisation of stock exchanges by which ownership, management, and tradingmembership would be segregated from each other. This would help towardsprofessionalisation of the management of exchanges, enhancing the ability of stockexchanges to raise funds from the market to modernise exchanges and providingbetter investor service;

(b) Extension of rolling settlement to 200 category "A" stocks in Modified Carry ForwardScheme, Automated Lending and Borrowing Mechanism and Borrowing and LendingSecurities Scheme by July, 2001;

(c) Legislative changes to further strengthen provisions in the SEBI Act, 1992 to promoteinvestor protection.

13.22 Regarding the implementation of the aforesaid measures so announced by the FinanceMinister, it has been mentioned in the annual report for the year 2001-2002 of the Ministry ofFinance that:

"As regards coporatisation/ demutualisation of stock exchanges, there have beenconsultations between Ministry of Finance, SEBI, Ministry of Law, Department of CompanyAffairs and stock exchanges. SEBI Board, in its meeting dated 28.12.2001 decided that nobroker member of the stock exchanges shall be an office bearer of an exchange i. e.hold the position of President, Vice President, Treasurer etc. and that no SEBI officialwould be nominated on the Board of stock exchanges. Following this, SEBI has issued anorder dated January 10, 2002, under Section 8 of the Securities Contracts (Regulation)Act, 1956, directing all the recognised stock exchanges to suitably amend its Rules,Articles etc. within a period of two months to give effect to SEBI Board's decision. Theother administrative and legal modalities for demutualisation of stock exchanges arebeing worked out. In case of 11 stock exchanges, which failed to amend Articles orRules to comply with the above referred SEBI Directive, the Articles or Rules of theseexchanges were amended by SEBI through a notification. The other complex administrativeand legal modalities for demutualisation of stock exchanges are being worked out. ACommittee, under the Chairmanship of Justice Kania was constituted by SEBI to providea definite road map for the early completion of the process of demutulisation.

Further the rolling settlement was extended to 251 category "A" stocks in Modified CarryForward Scheme, Automated Lending and Borrowing Mechanism and Borrowing andLending Securities Scheme on 2.7.2001. From 31.11.2001 rolling settlement has beenextended to all scrips on all stock exchanges. All deferral products have been discontinuedfrom 2/ 7/ 2001. Legislative changes for amending the SEBI Act 1992 to make SEBI a moreeffective body for regulation and development of capital market and for protection ofinvestors are being proposed by the Government."

13.23 The Committee underline the necessity for early implementation of corporatisation/ demutualisation ofStock Exchanges process.

13.24 Commenting on the accountability of the regulatory authorities and the accountabilityof the Ministry of Finance to Parliament on the lapses on the part of regulators, the Secretary,Department of Economic Affairs, submitted:

" ... The general approach of the Government has been to try to instil into the regulatorsprofessionalism. The general approach is also to have systems, to have people who areknowledgeable in their respective sectors, who can run these regulatory bodies asprofessionals and frame regulations which are in line with the best practices insofar asregulation of their respective financial sector instruments are concerned. The Government,I think, does want to give maximum managerial, functional autonomy to the regulatorsso that they can perform their functions in a professional manner without any back-seattype of driving in its day to day operations by the Government. ÉBut obviously autonomycannot be divorced from accountability. The dividing line of accountability, in a verymicro sense, is the day to day reporting or monthly reporting, weekly reporting; howmany cases they have done etc. The other thing is a macro type of an accountability,getting annuals reports, half-yearly reports and overall performance. ÉBut certainly Iwould not say that the solution would be more micro type of interference or accountabilityto Government on a day to day basis."

13.25 With respect to giving more powers to SEBI to enable it to have a better regulatorycontrol over the Capital Market, the Secretary, Department of Economic Affairs stated :

"We have done a fairly detailed study of the powers of SEBI and the powers which arethere with regulators of capital market in other countries, and we have also come to thisconclusion that we do need to vest SEBI with certain more powers for doing betterinvestigation. Today, it cannot have easy access to various documents and other thingswhich are needed for doing effective investigation. Its powers to impose penalties arealso not deterrent enough. So, regarding the investigative powers of SEBI and powers toimpose penalties, on the basis of study of powers which are there with other regulatoryentities which are doing similar jobs in other countries, we have formulated proposals forvesting SEBI with more powers, which are currently under consideration in the Governmentand which the Cabinet would be discussing soon. If they are cleared then, we would beplacing the Bill for consideration of Parliament also. But we have also agreed with SEBIthat it does need to be given some more teeth in that sense."

13.26 The Ministry of Finance had submitted that the Government has initiated examinationof possible legislative changes aimed at further strengthening the SEBI Act, 1992 for investorprotection and to make SEBI a more effective body for regulation and development of capitalmarkets. The Ministry of Law and Justice (Legislative Department) notified Ordinance (No. 6 of2002) on 29.10.2002 to further amend the SEBI Act, 1992. According to this Ordinance, thenumber of members on the SEBI Board has been increased from the existing 6 members to9 members including the Chairman. In addition to this, additional powers as detailed in thechapter "Powers of SEBI" have now been conferred on SEBI to give it more teeth. These enhancedpowers would enable SEBI for carrying out effective investigation by having easy access tovarious documents, impose enhanced penalties and also conferring on it the power of search& seizure etc. Further, under the Ordinance the Securities Appellate Tribunal has now beenmade a multi-member body.

V. ISSUES RELATING TO BANKING SECTOR 

13.27 The functions and responsibilities of the Banking Division in the Department of EconomicAffairs of the Ministry of Finance is given at Para 13.7 ante. Thus, the Banking Division monitorsthe overall functioning of public sector banks, UCBs and rural cooperative banks in the country.It also reviews all circulars/ directions issued by RBI to cover banks/ cooperative banks and non-bankingfinancial companies and gives necessary advice to RBI in this regard. The BankingDivision is not concerned with operation of individual banks for loaning and investment includingcapital market operations. This function is carried out according to the decisions and policieslaid down by the Board of the respective banks under the guidance of the RBI.

13.28 As per the provisions of RBI Act 1938, the general superintendence and directions ofthe affairs and business of the banks has been entrusted to the Central Board of Directors ofRBI. While the Central Government has powers to give such directions to the banks as it considersnecessary, after consultation with the Governor of RBI, it has been the endeavour of the FinanceMinistry not to interfere in the day to day affairs of the banks. The Government has a nomineeon the Board of RBI. Government of India also does not directly monitor the performance of thebanks. This function has been entrusted to the Reserve Bank of India who is regulator of thebanking sector. If any adverse feature about the working of any bank is brought to the noticeof the Government by the Reserve Bank of India, the Government takes necessary remedialmeasures as are necessary.

13.29 The Ministry of Finance in their reply to a question regarding comparison between the1992 scam and the present scam regarding the role of the banks, submitted that the irregularitiesin securities transactions uncovered in 1992 involved complex and interconnected transactionsbetween public sector banks, private sector banks, foreign banks, co-operative banks and financialinstitutions. The major contributing factor of these irregularities was that transactions in Governmentsecurities were undertaken in physical form and not in dematerialized form. Based on therecommendations of the earlier JPC (1992), a number of measures have been taken by theGovernment of India and the Reserve Bank of India (RBI) to address the systemic deficiencies,which contributed to the irregularities. The measures so taken had insulated to a large extentthe Government Securities market from the irregularities observed earlier. The irregularities observedin 2001 are mainly of a fraudulent nature undertaken by a few small private sector banks andco-operative banks in collusion with the stockbrokers. The irregularities noticed now have not sofar revealed any systemic deficiencies but are basically violations of RBI instructions.

13.30 The SEBI informed the Committee that it has been concerned with the need for havinga centralized monitoring mechanism for the flow of funds from the banking sector into stockmarkets. This matter was discussed as agenda item No. 3 in the High Level CoordinationCommittee on Financial & Capital Markets (HLCCFCM) on 16.8.2001. The specific suggestionmade by SEBI was that there is a need for a central authority to monitor the flow of funds intothe stock markets, brokers should be required to disclose the source of their funds to a centralizedauthority for trading in excess of a certain limit and these requirements should be made applicableto clients also. After considering this agenda point, the High Level Coordination Committeeobserved that as per the SEBI's preliminary investigation into the current market crisis an observationwas made on the procurement of large funds from the banks by some broker entities involvedin market manipulation. It was found that apart from funding by promoter groups to the brokers,substantial funds were given by certain banks to the broking entities associated with KetanParekh. The pattern of acquiring substantial funds from the banking system leading to the arrestof Ketan Parekh by CBI in connection with Pay-order fraud suggests misuse of the bankingsystem.

13.31 A number of legislative proposals have been initiated by RBI and have been discussed in detail underthe chapter "Reserve Bank of India" of this report. The Committee are constrained to observe that there have been serious delays at both the regulators' end and in the Ministry of Financeand other Ministries concerned in processing legislative proposals for strengtheningthe regulators and endowing them with more punitive powers. The Committee deplore the delays in Government inprocessing the legislative changes proposed by the RBI with the dispatch thatthey deserve. 

13.32 Regarding the implementation of recommendation of the earlier JPC of 1992 securitiesscam that statutory provision be made with regard to bouncing of SGL transfer forms as penaloffence as in the case of cheques, the Ministry have informed that the same has been acceptedand accordingly, the Public Debt Act, 1944 is being repealed and enabling provisions havebeen proposed in the Government Securities Bill. Further, a new section has been inserted forlevy of penalties. According to the Ministry, the enactment of the proposed new legislation canbe done after passing of the requisite Resolutions by the State Legislatures. In this regard, the Ministry has informed that the concurrence of all State Legislatures has since been obtainedand accordingly, a Draft Cabinet Note alongwith draft of the proposed Government SecuritiesBill approved by Finance Minister has been sent to Department of Legal Affairs for comments/concurrence on 11.2.2002. The matter was further discussed with that Department by concernedofficers of the Ministry of Finance and RBI in a meeting held on 21.5.2002. In order to expediteconcurrence of the Department of Legal Affairs, a reminder was issued vide D. O. letter dated21.6.2002. The file was received back on 29.7.2002 from Department of Legal Affairs, for someclarifications. It is expected that the Bill will be introduced in the winter session (2002) of theParliament.

VII. HIGH LEVEL COORDINATION COMMITTEE ON FINANCIAL AND CAPITAL MARKETS (HLCC) 

13.33 This Committee was constituted for ensuring greater coordination among the regulatoryagencies in the financial and capital markets and to meet regularly to review the positionregarding financial/ capital markets. The functions of HLCC as reported by the Ministry of Financeto Parliament in its ATRs of 1994 are as follows:

"In May 1992 the Finance Ministry set up a High Level Coordination Committee on Financialand Capital Markets under the Chairmanship of Governor, Reserve Bank of India andincluding Chairman, SEBI and Secretary, Department of Economic Affairs as members.This Committee has been set up for ensuring greater coordination among regulatoryagencies in the Financial and Capital Markets and meet regularly to review the positionregarding financial/ capital markets."

13.34 The Committee has been meeting at regular intervals since May, 1992 under theChairmanship of Governor, RBI with Secretary, Economic Affairs and Chairman, SEBI as members.In October 2000, Chairman, Insurance Regulatory Development Agency was included as memberof the Committee. The Capital Market Division in the Ministry of Finance functions as the Secretariatof this Committee. A Standing Committee on Capital Market has been constituted by the HLCCto examine capital market policy issues as required, put up the agenda for HLCC meetings andfollow up on its decisions. The members of the Committee are an Executive Director each fromSEBI and RBI.

13.35 At a recent meeting on 27.5.2002, HLCC recommended to the Government that: 

"HLCC is not a monitoring body but only coordinate issues as and when required. TheCommittee would meet as and when required to resolve policy issues at regulator's level

--  Wherever a specific regulator feels that an issue requires inter-agency consultation. 

--  Any other issue which in the opinion of the Ministry of Finance requires consultationwith the regulators".

Until government takes a view on this recommendation, the terms of reference of HLCCremain as set out in the 1994 ATRs submitted to Parliament.

13.36 In response to the Committee pointing out that HLCC appears to have played almostno role in checking the behaviour of the stock market during the period 1998-2002 and to knowwhether HLCC had functioned as a forum in which the regulatory authorities of different kindsand authorities responsible to Parliament actually coordinated their work, the response of theSecretary, Department of Economic Affairs was:

"Frankly HLCC is as it is presently constituted, my understanding is that it has not beengiven the responsibility of advising Government or looking into macro policy type ofissues. The role of this HLCC is just the coordination amongst the activities of differentregulators in the financial sectors, and to the extent there is an interface with the Ministryof Finance with the regulators. This is more a forum where regulators sit among themselvesand exchange information, where there is an overlapping of the regulating regime ofone regulator and another regulator."

13.37 Since the issue of 1992 scam report, the meetings of the HLCC were held as under:-- 

13.38 A perusal of the working of the HLCC indicates that this Committee concerned itself with theco-ordination aspects only. The Committee did not go into the general situation of the economy or the stock market and did not make any recommendations excepting those that related to actions tocoordinate activities of various regulators like RBI, SEBI, DCA etc.

VIII. ISSUES RELATING TO OCBs AND FIIs 

13.39 The Government of India decided to introduce a package of measures to facilitateremittances of investments by NRIs/ persons of Indian origins which was announced by the FinanceMinister in his Budget Speech on 27.2.1982. The Portfolio Investments Scheme (PIS) for NRIs/ OCBsformed a part of the package measures. In formulating the PIS scheme at that time, theGovernment had three considerations:--

(a) As much flexibility as possible should be available to non-residents for bringing foreignexchange into India and the concern should be the purpose of investments ratherthan legal entity of the non-resident investor of Indian origin,

(b) It was to be ensured that the benefits of the scheme should not be available to non-residentpersons or overseas bodies other than those of Indian nationality/ origin, and

(c) The investment of funds under the scheme should not lead to take over of existingcompanies through operations in the stock market.

13.40 In April, 1982 the PIS was extended to OCBs and in September, 1983, the definition ofOCBs was modified by the Government and extended to cover even indirect ownership to theextent of at least 60% by NRIs. In June, 1998 the scheme was modified by the Government toenhance the individual and aggregate portfolio investment ceiling for NRIs/ OCBs. Individualinvestment limit was raised from 1 per cent to 5 per cent and aggregate limit was raised from5 percent to 10 percent of the paid up equity capital of the Indian company. Further, in orderto provide a greater margin of flexibility for NRIs/ OCBs, the scheme was, simultaneously, modifiedto provide for an exclusive aggregate investment limit for NRIs/ OCBs and a separate aggregateportfolio investment ceiling for FIIs.

13.41 A convention for avoidance of double taxation and prevention of fiscal evasion withrespect to taxes of Income and Capital Gains was entered into between India and Mauritius on6.12.1983. In August 1993, CCIT Mumbai brought it to the notice of the CBDT that some assetmanagement companies were using the treaty with Mauritius for preferential treatment andaccordingly the matter was taken up with Mauritian authorities to ensure that the benefits ofbilateral tax treaty were not allowed to be misused. Then, in March 1994 a clarificatory circularwas issued laying down that any resident of Mauritius deriving income from alienation of sharesof Indian companies would be liable to capital gains tax only in Mauritius and will not have anycapital gains tax liability in India. Then again on 13.4.2000 another circular was issued by CBDTto its assessing officers inter-alia clarifying that a certificate from Mauritian authorities would bea sufficient proof that a taxpayer was resident in Mauritius, which was struck down by the DelhiHigh Court on the ground that an administrative circular could not abridge the rights grantedto an assessing officer under the Income Tax Act to investigate further the true residence of ataxpayer. The SLP filed by the Government has been admitted by the Supreme Court and theorder of Delhi High Court has been stayed.

13.42 As regards FIIs, the Ministry have submitted that FIIs were allowed to invest in IndianCapital Market in terms of Government of India guidelines for Foreign Institutional Investors (FII)dated 14.9.1992, stipulating overall ceiling of 24% on the investment by FIIs together withNRI/ OCB investment in the secondary market, in the total issued and paid up capital of anIndian company. Further, SEBI came out with the SEBI( FII) Regulations in November, 1995 whichcovered exhaustively various aspects such as eligible categories, securities in which FIIs caninvest, ceilings on their investment and procedure for making applications for obtaining permissionunder FERA from RBI and registration with SEBI.

13.43 As regards the misuse of Portfolio Investments by NRI/ OCBs, it has been decided by RBInotification dated 29.11.2001 that, henceforth, Overseas Corporate Bodies (OCBs) shall not bepermitted to invest under the Portfolio Investments Scheme (PIS) in India. OCBs will howevercontinue to enjoy the facilities of opening non-resident accounts and making direct investmentas permitted so far. Further, the OCBs that have already made investment under the PIS, maycontinue to hold such shares/ debentures till these are sold on the Stock Exchange.

13.44 The various issues concerning the misuse of PIS by OCBs and regarding investments byFIIs and OCBs in the Indian securities market using the tax free Mauritius Route have beenextensively dealt with in the chapters on "OCBs and FIIs Sub-account" and "CBDT" of thisreport.

13.45 The Ministry of Finance is the nodal authority and co-ordinates the functions of all the departments/organisations working under its administrative control. Regulators are accountable to the Ministry of Finance which, in turn, is responsible to Parliament. All the policy making powers alsovest with the Ministry. SEBI, as the independent statutory Regulator, has been endowedwith powers to autonomously regulate capital markets. According to the Ministry, the general approach of theGovernment has been to instil professionalism by having the people who areknowledgeable in their respective fields. The Committee find that SEBI which was set up as a statutory bodythrough an Act of Parliament in 1992 was hitherto being managed at the seniorlevel not by the professionals but by the persons taken mostly from the Income Tax Department/Indian Administrative Service on deputation basis. Besides, as per the provisions of SEBI Act, 1992, the SEBIBoard consists of 5 members besides the Chairman. The Board is largely dominated bythe Government nominees as the Chairman and 2 members are nominated by the Central Government from amongst theofficials of Ministry of Finance and Ministry of Law, while onemember is nominated by the RBI. The Ministry of Finance have made legislative changes for amending the SEBIAct through an Ordinance in order to give it more teeth for regulating anddevelopment of capital market. The Committee are of the view that in order to give true autonomy to the marketregulator, there should be complete transparency in the appointmentof the Chairman and the members of the Board. In this regard, the Committee agree with the suggestion of theformer Secretary of the Department of Economic Affairs that for appointmentto the top positions in such organizations including the banks, there should be a Search Committee, whoserecommendations should be final and mandatory. In order to give such bodya legal sanctity, it is essential that its constitution is well defined and provided under the relevantstatute. The Committee therefore, recommend that while amending the SEBI Act, this aspectshould also be given serious consideration.

13.46 While accepting that managerial and functional accountability is required to be vested in statutoryindependent Regulators so that they can perform their functions effectively and without undue interference, the Committee stress that accountability must go hand-in-hand with autonomy andthe principles governing the responsibility of the Minister to Parliament in termsof the constitutional jurisprudence under which the parliamentary system works. The Ministry should alsoevolve appropriate checks and balances to overcome the systematic shortcomingsin the present system which has resulted in this scam. The Committee feel that the approach of the Ministry ofFinance should be to progressively make SEBI a very effective and efficientregulator of capital market which can inspire confidence amongst various players. The Committee note thatrecent legislation has now endowed SEBI with the required powers to moderate stockmarket volatility and inspire investor confidence.13.47 The Committee recall that the 1992 JPC had drawn attention in paragraph 2.8 of its Report to the"very damaging approach (which) seems to pervade, that of transferring responsibility downwards. This distressing lack of fibre in the apparatus of governance can only debilitatethe state." Regrettably, notwithstanding the passage of nearly a decade since thatReport, nothing seems to have changed. The culture of governance continues to be pervaded by attempts attransferring responsibility elsewhere. Therefore, the Committee recommend thatthere must be a clear demarcation of responsibilities between the Regulators and the executive so that thereis transparency in the system of accountability.

13.48 The Ministry of Finance, being the financial custodian of the country, is duty bound to protect theinterests of the small investors. SEBI has now been endowed with statutory powersunder the amended SEBI Act to secure redressal of investor grievances and entitle investors to seekcompensation, the award of damages etc. Besides this, Professor L. N. Mitra in his report toSEBI on this issue has also suggested for a separate Act for investors protection, as detailed in Chapter XIVof this Report. The Committee recommend expeditious action on this proposal.Further, in order to deal with vanishing companies and collective investment schemes, SEBI has suggested thatSecurities Appellate Tribunal (SAT) be empowered to attach properties of suchdefaulters. The Government has reconstituted the SAT to be a multi-member body which should help inexpeditious disposal of cases.

13.49 Regarding demutualisation and corporatisation of the stock exchanges, the SEBI constituted aCommittee under the Chairmanship of Justice Kania to provide definite road mapfor the early completion of the process, which has since submitted its Report. The Committee recommend thatthe Government must ensure expeditious implementation of the demutualisationand corporatisation process so as to improve management of the exchanges and enabling smooth conduct ofbusiness in a fair and non-partisan manner. 

13.50 It is imperative that the question of coordination between various Regulators among themselves and withthe Government be seriously addressed to by the Ministry of Finance. TheGovernment in their revised Action Taken Report on the implementation of recommendations of the earlier JPC onSecurities Scam which was tabled in Parliament in December 1994 had interalia submitted that the HLCC constituted by the Ministry of Finance in May 1992 had been set up for ensuringgreater co-ordination among the regulatory agencies in the financial and capitalmarkets and meet regularly to review the position regarding financial/ capital markets. The Committee notethat HLCC has not carried out the latter portion of their mandate viz. "regularlyreview the position regarding financial/ capital market." The Committee consider this an unfortunateomission. The Ministry of Finance on its part and in relation to the assurance given by it to theParliament in its revised ATR has not referred such crucial issues to the HLCC which was supposed to reviewthe position regarding financial/ capital markets. Had these issues been taken up bythe HLCC periodically, it would have definitely helped in minimizing, if not preventing altogether theirregularities which have surfaced in the present scam.

13.51 Although there is need for better and closer coordination amongst the multiple agencies which areactively involved in our financial system, the Committee are of the considered viewthat a super regulator is not the answer to the problem. This task can be handled by HLCC and to this end HLCCshould be serviced by an efficient secretariat. In addition to its present functions,HLCC should also be mandated to ensure the expeditious implementation of ATRs arising out of JPCrecommendations. The Committee also stress the importance of elaborating and detailingthe functions of HLCC with regard to undertaking "regular review of position regarding the financial/capital market."

13.52 The Committee note that while the Banking Division monitors the overall functioning of public sectorbanks and rural cooperative banking system in the country besides reviewingcirculars/ instructions issued by RBI, it is not concerned with individual operations of the banks as the sameare carried out in accordance with the guidelines of the RBI. As per the provisions ofthe RBI Act, the general superintendence and direction of the affairs of the Banks has been entrusted to theCentral Board of Directors of RBI on which the Government has a nominee(generally Finance Secretary). Further, before taking a decision in a matter of larger public interest, RBIconsults the Government. However, the Banking Division is responsible for legislativeframework relating to the Banking Sector which includes RBI Act, 1934, Banking Regulation Act, 1949, SBI Act,1955, Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980, Regional Rural Banks Act, 1976, Public Debt Act, 1944 etc. The Committee however note that a largenumber of legislative proposals with respect to the Commercial and urbanco-operative banks mooted by the RBI are pending consideration in the Ministry. The details of the proposalshave already been mentioned in the Chapter on the Reserve Bank of India of thisreport. The Committee recommend that the Ministry should expeditiously finalise the proposed amendments in theBanking Regulation Act, 1949 and introduce the amended legislation in theParliament at the earliest. 

13.53 The Committee express their concern at the inordinate delay of almost 8 years by the Government inimplementing the recommendations of the earlier JPC of 1992 on Securities Scam regarding the framing of statutory provisions with regard to making the bouncing of SGLtransfer forms as penal offence as in the case of cheques. Although the saidrecommendation was accepted by the Government way back in 1994, but so far the Government Securities Bill, inwhich the statutory provision is proposed to be incorporated is yet to beenacted and the Bill is expected to be introduced in Parliament only during the Winter Session of 2002. As thematter has already been inordinately delayed, the Committee recommend thatthe Government should expeditiously repeal the Public Debt Act, 1944 and enact the new legislation withoutfurther loss of time. 

13.54 To contextualise the period in which the present scam surfaced, resulting ultimately in the crash of thestock market from March 2001 onwards, the Committee reviewed theimplementation of the recommendations of the 1992-93 Joint Parliamentary Committee which had enquired into"irregularities in securities and banking transactions and found a number ofareas in which the recommendations had not been taken seriously. The process of economic liberalizationvis-a-vis banking transactions and innovative portfolio management schemes hadstarted almost concurrently with the proceedings of the earlier JPC. Although through the 1982 Budget speechof the then Finance Minister, OCBs had been given the same status as NRIs andPIOs and allowed to invest in India, and in 1992 through the Budget speech of the then Finance Minister, FIIswere allowed to enter the Indian capital market. Modifications in the regulationsrelating to OCBs since 1982 and FIIs between 1992 and 1999 have not put sufficient risk-hedging regulatorymeasures in place. Therefore, systemic deficiencies caused by insufficient risk-hedgingregulatory measures opened windows of opportunity for brokers, ALMB/ BLESS/ MCFS players, OCBs/ FIIs etc.Therefore, it is these regulatory lapses which were part of the problem and needfocused attention. 

13.55 According to the Banking Division, based on the recommendations of the earlier JPC on Securities Scam, anumber of measures have been taken by the Government and the RBI to address systematic deficiencies which contributed to the irregularities. However, the steps taken thusfar have not forestalled irregularities which have led to large amounts of moneybeing pumped into the stock market and its consequent misuse by certain entities, as detailed in this Report.

13.56 As discussed elsewhere in this report, the Committee are concerned to note that there has been noregulatory framework to monitor the activities of OCBs as these are neither registerednor regulated by SEBI and also are not under the regulatory framework of RBI. The Ministry of Finance beingthe main policy making body, has not applied their mind in this regard. TheCommittee note that this issue has currently been addressed by banning OCBs from making any fresh portfolioinvestment in the securities markets. The Committee are of the view that this maynot be a permanent solution and recommend that the Ministry of Finance needs to lay down clear policyguidelines for monitoring the operations of OCBs. 

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