The laws relating to membership is contained in rule 8 of the Securities Contracts (Regulations) Rules, 1957 (SCRR) and rules of the stock exchanges.
A look at the evolution of the requirements for membership is useful for better appreciation of legal position. Till 1985, the SCRR [Rule 8 (1), (2) and (3)] required that in order to be a member, a person shall (i) be above the age of 21 years, (ii) be a citizen of India, (iii) have certain experience, and (iv) not suffer from any of the prescribed disqualifications. Disqualification prescribed were that the candidate for membership must not (a) be bankrupt / insolvent, (b) have compounded with creditors, (c) be convicted of an offence involving fraud or dishonesty, (d) be expelled or declared a defaulter by any other exchange, (e) have been refused admission to membership during the preceding year, (f) be 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 (This requirement can be relaxed by government for a specified period on the condition that he does not get associated with any organisation where forward business of any kind whether in goods or commodities or otherwise is carried on), and (g) be a member of any other association which deals in securities, or be a director, partner or employee of a company whose principal business is dealing in securities (He can not associate directly or indirectly with any other exchange). Rule (8) (4), then in vogue, prohibited a company to become a member of a stock exchange.
Thus, the above framework envisaged broking as a profession dependent on individual skills and emphasized on individual attributes. It permitted only individuals to become members and explicitly prohibited companies to become members. The individuals could form partnerships between or among them. It restricted liability of members by prohibiting them from associating with any organisation carrying on forward trading and from becoming member of more than one exchange. It did not allow a broker to carry on non-securities business except as a broker not involving any financial liability. It also did not allow a broker to become members on more than one exchange. A broker was not allowed to advertise for business purpose or issue circulars or other business communications to persons other than his clients. All these indicate that that broking was considered as a profession, not a business.
The High Powered Committee on Stock Exchange Reforms constituted in 1984 realised the limitations of individual brokers and recommended in 1985 that limited companies should also be admitted as members. It also recommended that the Rules, Regulations and Byelaws of stock exchanges may be amended so as to permit members to issue advertisements for business purposes in newspapers or any other media. Implicit in the recommendation was that the broking houses need to be converted from profession to a business entity.
By a notification in June, 1986 Government replaced clause (4) to Rule 8 to remove prohibition on companies to become members. The revised clause permitted companies to become members of the stock exchanges subject to the condition that (i) the company is formed in compliance with section 322 of the Companies Act, 1956; (ii) all the directors of the company have unlimited liability; and (iii) a majority of the directors are members of the exchange and also shareholders of the company. In order to encourage companies to become members, clause (4) was amended in July 1987 to provide that the directors of company who are members of the exchange (not all directors) would have unlimited liability. Government could relax clause (4) requirements to admit IFCI, IDBI, LIC, GIC, UTI, ICICI, subsidiaries of these organisations or of SBI or nationalised banks. The requirements of clauses (1), (2) and (3), which are applicable for individual members, were not made applicable to the corporate members. Further, the entities such as IFCI etc. were allowed to become members without fulfilling any of the requirements applicable to individual members under clauses (1), (2), (3) or the requirements applicable to corporate members under clause (4). This means that the restrictions such as association with any organisation dealing with any forward business or with any other stock exchange are not applicable to these members. The non application of these restrictions was apparently to avoid unreasonable restriction on the freedom of trade of a business entity. Similarly, the requirement of experience was not applicable to corporate members who, as a business entity, could hire the services of professionals.
Rule 8 (1) g was repealed in November 1988 to permit a person to become member of more than one exchange. The circulars issued in December 1988 and August 1991 specified the norms relating to multiple membership in stock exchanges. These circulars require: (i) The original stock exchange should give to the other stock exchange, whose membership is sought by the applicant member, a confidential report regarding the conduct and behaviour of the member. (ii) The multiple membership should be acquired at the same price as is available to public. (iii) The rates of admission fee, security deposit and annual subscription in respect of multiple membership should be same as are applicable to other members. (iv) Disciplinary action such as reprimand, warning, fines and suspension may be confined only to the stock exchange where it is taken with intimation to other stock exchanges. If a member is expelled from one exchange, he would automatically stand expelled from all other stock exchanges where he is a member. (v) Default by a member at one stock exchange should automatically lead to his being declared a defaulter at other stock exchanges. However, apportionment of the assets of defaulter members against the claims must be done strictly exchange wise. If there is, however, a surplus of the assets at any particular stock exchange, the same may be distributed against the claims at other exchanges.
Despite these initiatives, the corporate membership did not take off. The legal changes were effected to open up the membership of stock exchanges to corporates with limited liability, so that brokerage firms may be able to raise capital and retain earnings. Rule 8 (4A) was inserted by a notification in November 1992 to facilitate entry of companies with limited liability as members of stock exchanges subject to the condition that (i) the company should be formed under section 12 of the companies Act, 1956, (ii) such company complies with such financial requirements and norms as may be prescribed by SEBI, (iii) majority of the directors of the company are shareholders of the company and not less than 40% of the paid up capital is held by these directors, (iv) the directors are not disqualified for being members of stock exchange under clause (1) [except sub clause (f)] or clause (3) [except sub clause (f)] and the directors of the company had not held office of directors of any company which had been member of a exchange and declared defaulter or expelled by the stock exchange and (v) not less than two directors of the company possess minimum two years' experience. Thus a self contained provision was made for corporate membership and it was clearly specified that which of the requirements applicable to individual members under clauses (1) and (3) would be applicable for corporate members. Since the working of the clause (4A) was found restrictive, the provisions were liberalised by a notification in October 1994. Sub clause (iii) of Clause (4A) relating to minimum shareholding by directors was deleted. Sub clause (iv) of Clause (4A) was amended to exempt the directors also from the requirement of sub clause (b) of clause (1) and sub clause (a) of clause (3) relating to citizenship of India. Thus the director need to qualify all the requirements applicable to individual members under clauses (1) and (3) except sub clauses relating to association with non-securities business and citizenship of India. In pursuance to sub clause (ii) of clause (4A), SEBI specified in May 1994 the financial requirements and norms for admission of a company as a corporate member. It prescribed minimum paid up capital, maintenance of net worth, and such other additional financial requirement as may be specified by the exchanges. It was also clarified that if a corporate member seeks membership on more than one exchange, these requirements shall be fulfilled in respect of each of the exchanges.
Clause (5) of the Rule 8 provides that the provisions of clause (1), (3) and (4) shall, so far as they can, apply to admission or continuation of any partner in a firm, which is a member of the stock exchange. Though clause (4) was replaced in 1986, reference to clause (4) in clause (5) was, probably inadvertently, not deleted.
In order to encourage existing members to corporatise themselves, which was considered desirable for development of the securities market, the Income Tax Act, 1961 was amended to exempt capital gains tax payable on the difference between the cost of the individual's initial acquisition of membership and the market value of that membership on the date of transfer to the corporate entity. In response, many brokerage firms reorganised themselves into corporate entities. At the end of March 2002 3,862 brokers out of 9,687 were corporate bodies.
