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Acceptance of Fixed Deposits

A company cannot accept deposits in excess of 35% of the paid up capital and free reserves. Of this, 25% deposits can be accepted from the public and the rest 10% from shareholders of the company. The minimum period of acceptance of deposits is one year and the maximum period is limited to 3 years. The company is under an obligation to maintain an amount not less than 15% of the company's deposit liability maturing during the course of the year, in liquid investments such as Government securities, units, deposits with banks etc.

The maximum rate of interest that can be offered on deposits is fixed at 15% (1998). A ceiling on brokerage payable on deposits has been fixed at 1%. The interest earned on fixed deposits of companies does not enjoy any exemption from income tax. Neither does the amount of deposit qualify for any exemption under wealth tax. Under the existing provisions of the Income Tax Act, tax on interest paid/payable is deducted at source if the interest payment exceeds Rs. 2,500 in a financial year unless suitable declaration is furnished by the depositor in regard to the total income of the depositor not exceeding the minimum liable to tax in a financial year.

The acceptance of deposits by non-bank non-financial companies is governed by the Companies (acceptance of deposits) Rules 1975 as amended from time to time. Along with the prescribed application form the terms and conditions of acceptance of deposits are required to be furnished by companies, to the RBI in the case of non-bank finance companies and a copy in case of non-bank non-finance companies.

A careful study of either the financial data in the advertisement or the prescribed particulars as available within the application form would generally reveal the working results and the financial position of the company.

Companies Act

The Companies Act which regulates the activities of the companies from birth to.death has provided for the sources of finance for companies and the methods of marketing the public issues which are marketable. These are in the form of Ownership category, namely, Equities and Preference shares and Debt capital in the form of convertible and non-convertible debentures, fixed deposits etc. Under the Companies Act, Sections 55 to 68 provided for issue of prospectus, its contents, Regis¬tration of Prospectus, civil and criminal liabilities of the Directors for any mis-statements in prospectus etc.

The Act has laid down the methods of raising new issues, namely, through prospectus, letter of offer or statement in lieu of prospectus, Rights and Bonus. Section 58 A and B deal with the conditions for acceptance of deposits, repayments of deposits, etc. while companies (acceptance of deposits) Rules of 1975 laid down the period of maturity, interest rates and other conditions. As company deposits are an avenue of investment, the details regarding them are dealt with briefly later.

Sections 69 to 73 deal with the allotment of new issues to applicants, delivery of certificates and their listing on Stock Exchanges. The allotment is also governed by the guidelines given by the Stock Exchanges as per the listing agreement in the case of listed companies.

The basic framework for trading is provided by the Companies Act in the form of

(1) Marketing the shares as movable property under Section 82.

(2) Ensuring transferability of shares in respect of public limited companies under sections 108 - 112.

(3) The transfer deed through which share certificates are to be transferred is provided for under Section 108.

(4) The validity of the transfer deed under Section 111 is 12 months in the case of listed companies and 24 months in the case of non-listed compa¬nies.

(5) Section 114 provides for issue of share warrants.

So far as investors are concerned, it is desirable that they know the main provisions of the Companies Act, because the issue of prospectus, the contents of it, allotment of new issues, despatch of certificates, transferability etc., are all laid down in it. The rights of shareholders and debentureholders, and different categories of creditors and debtors of companies are set out. The book closure for accounts, presentation of Balance Sheet and Income-Expenditure accounts, payments of dividends etc., are all provided for in this Act. In Particular, Section 82 provides for transferability of shares and Section 73 lays down the conditions for listing of Public Limited Companies. While these sections ensure the marketability of shares of listed public limited companies, trading in them is made possible by the Securities Contracts Regulation Act and the Rules made thereunder.

In view of the fact that purchase and sale of shares through recognised Stock Exchanges and through licensed Stock Brokers are only legal, and those are governed by the SC (R) Act, the investors have to be familiar with this Act and the Rules made thereunder. The relation between the Brokers and Investors and in particular, the disputes if any, between them are governed by the Rules and Bye-laws of the Stock Exchanges which are formulated under this Act.

LEGAL FRAMEWORK FOR SECURITIES MARKETS

New Issues Market and Stock Exchange are a part of the Capital Market where the shares, debentures, bonds and other securities of companies and Government are traded. The Stock Exchange provides facilities for exchange of shares into money and vice versa. New Issues Market ;e the Primary market where the issuers can sell securities, but cannot buy. Stock Exchange is defined as an Association of Member Brokers who assist, facilitate and regulate trading in securities. One can buy and sell in the Stock Exchange or Secondary market.

These securities are issued by the Companies under the Companies Act and by the Government under the *****n Public Debt Act. Since the public are not interested in Government Securities due to lower level of interest rates on them, the public awareness of this market is little or negligible. This market is mainly confined to banks, financial institutions etc.

The capital market comprises of two components, namely, New Issues Market where companies issue directly securities to the public and the Stock Market or the Secondary Market where the existing securities are bought and sold.

Trading in old securities is governed by the Securities Contract (Regulation) Act of 1956 and the Securities Contract (Regulation) Rules of 1957. The Act has provided for recognition to the Stock Exchanges and gave wide ranging powers to the Government to control and regulate the Stock Exchanges. It has laid down the types of contracts in securities which can be traded or purchased and sold and for listing of securities of public limited companies, whose shares are being traded. The Act and the Rules made thereunder have provided for qualifications for members, contracts to be traded, trading period, permitted deals, settlement periods, clearance and delivery of shares etc. The actual Rules and Bye-laws of each Stock Exchange have enshrined these rules. The Act is applicable to Public Limited Companies, which are listed on Stock Exchanges and ensure transferability of shares and laid down the conditions under which transferability can be denied to investors.

Schematic Presentation of Emergence of Market

A schematic presentation of the emergence of markets through the flow of cash, credit and savings of the public is made in Charts 1.1 to 1.5. It will be seenfrom Chart 1.1 that money flows lead to claims on financial assets and physical assets and financial assets in turn when issued as securities result in trading in markets.

The money and capital markets are shown separately as short-term and long-term wings of the markets. The components of capital market are shown as primary and secondary markets whose details are explained in terms of instruments traded, institutions involved and operations undertaken in Charts 1.3 and 1.4 respectively. Chart 1.2 explains the savings flows of the household sector into financial assets invested by the household sector, namely, currency, deposits of banks, etc. Chart 1.5 presents the inter-relations of the various institutions and markets, namely, the stock exchange, brokers, banks, financial institutions, etc.

Finally, the investor clients and corporate clients and the various services rendered to them by these markets are briefly depicted in this chart as constituting the totality of the markets. The further details of these charts are explained in later chapters.

Primary Issues and Derivative Securities

Primary issues are those issued by the companies, Governments and financial institutions. Derivative issues are those which are based on the original primary issues.

There are a number of derivative instruments which are used to generate a market for the primary issues. Thus in many developed markets abroad, there are warrants, options, futures, index linked instruments etc. which have well-established markets and they are based on some primary instruments.

In *****, options are now permitted and some form of futures trading exists in Group A securities on the stock exchanges as they are permitted to be carried forward from settlement to settlement without taking delivery of shares. Since January 1995, options and futures have been permitted.

More recently, new instruments have been developed in *****, namely, warrants, Zero coupon bonds, conversion options, rights options etc. But in many cases these are riot well developed and secondary markets for these instruments do not exist and trading does not take place as in the case of listed shares and particularly those on the specified group (Group A) of stock exchanges.

Reference is made in the subsequent chapters to many new instruments which are introduced both in the capital market and the money market in *****. Besides, the RBI has also recently permitted the securitisation of bank debts in the sense that the debit balances on companies' accounts can be transferred to other banks and financial institutions which are willing to discount them or purchase them at a price but the market in many new instruments is yet to be developed in *****.

Characteristics of Securities

The major characteristics of securities are their transferability and marketability. These help the process of trading and investment in them.

Under the *****n Companies Act, Sections 82 and 111 deal with the transfer of shares.

In the case of public limited companies, the objective of the Companies Act as also of the Listing Agreement with the Stock Exchanges is to ensure free and unfettered transfer of shares. Under Section 82 of the Companies Act, shares are treated as any movable property. As any right to property, these are freely transferable. By one amendment in 1985, Section 22(A) of the Securities Contracts (Regulation) Act has denied the right to refuse to transfer shares by a public limited company except on technical grounds.

The other grounds on which the transfer can be refused are specifically laid down under the Act and the company has to specify the reasons for such refusal to transfer and reference has to be made to the Company Law Board whose decision to refuse or not to refuse the transfer of shares will be final. Thus the essential characteristic of transferability of shares is well preserved which gives them the market which in turn extends liquidity to these shares. This has led to the emergence of securities markets in *****.

Mobilisation of Savings for Investment

The issue of securities can be looked at from various angles. These may be set out as follows:

(1) From the point of view of issuers, these are the sources of finance for long¬term capital investment and for working capital. They can thus invest more than their resources;

(ii) From the point of view of investors, these are IOUs or promissory notes, giving an income or a return to their investment. They provide a channel to their savings and cater to the asset preferences of the public with varying characteristics of risk, income, maturity, etc.;

(iii) From the point of view of the nation, these issues mobilise the savings for investment and capital formation in the country. They promote the growth of output and income by a multiplier leading to a rise in the output by a multiple of the original investment over a period of time;

(iv) From the point of view of the financial intermediaries like banks, financial institutions, etc., these issues are a source of income to them for the management of these issues placing them with the public, providing liquidity and marketability to them.

Thus, the securities markets comprise all the above players, namely, issuers, savers, investors, intermediaries, etc. and the major activity is the moblisation of funds from saving and their channelisation into investment.

IOUs as Securities

In the securities markets, the securities dealt with are equity shares, preference shares, debentures and bonds. These securities being financial claims are issued as I.O.U.s or Promissory Notes. In the primary market, the issues are made to the primary or original savers. The other forms of holding debt or borrowings such as public deposits or bank owned IOUs are not securitised and hence not tradable. In certain cases like the P.O. Certificates, bank deposits, LIC policy certificates etc., they are not transferable by endorsement, but they have a primary market as these primary issues are I.O.U.s, used to mobilise the savings of the public. The market for such primary securities is limited to one stage and there is no secondary market for them. The UTI units and the instruments of many mutual funds in ***** belong to a hybrid category, as these are not securities according to the strict definition of the term under the *****n Companies Act. But as they can be sold back to the issuing institution or sold in the market if they are quoted on the Stock Exchange, they enjoy liquidity.

Thus UTI units under the 1964 scheme for example can be repurchased by the UTI, which provides liquidity to these instruments. The master shares of UTI and the stocks of some mutual funds can also be traded as they are quoted on the Stock Exchanges and they are close ended Schemes.

The securities markets emerge out of the two characteristics of financial instruments: (a) mobilising primary savings from the public to serve as sources of funds for the issuing authority; and (b) providing liquidity to these instruments through regular quotations in the financial markets and thus traded. The primary markets exist only if the first condition is satisfied. The secondary market also operates if both the conditions are satisfied.

The pattern of corporate financing and the extent of their dependence on the external sources of funds, as opposed to the internally generated cash flows, would thus determine the creation of new securities. The retained earnings are the internally generated funds which have an opportunity cost but whose issue costs are zero. There are, howeiler, issue costs for equity and preference shares, convertible and non-convertible debentures etc. The capital market and stock market do provide the facilities for new issues and conversion of issues into money and vice versa, so that investors are assured of liquidity for their investments so as to induce them to enter these markets.

What are Securities?

Securities are claims on money and are like promissory notes or I.O.U. Securities are a source of funds for companies, Govt. etc.

The external sources of funds of the companies are as follows:

(A) Long-term Funds

(i) Ownership capital — equity and preference capital.

(ii) Debt Capital — debentures and long-term borrowings in the form of deposits from public or credit limits or advances from banks and financial institutions, etc.

(B) Short-term Funds

(i) Borrowings from banks.

(ii) Trade credits and suppliers' credits, etc.

Of the above sources, the most popular are those which are tradable and transferable. They have a market and their liquidity is ensured, as in the case of equity shares, preference shares, debentures and bonds. Of these the ownership instruments, particularly the equity shares, are generally the most liquid as they are not only tradable in the securities markets but also enjoy the prospects of capital appreciation, in addition to dividends. The market for these has thus grown much faster than for others.

What is Securities Market?

Securities markets are markets in financial assets or instruments and these are represented as I.O.Us (I owe you) in financial form. These are issued by business organisations, corporate units and the Governments, Central or State. Public sector undertakings also issue these securities. These securities are used to finance their investment and current expenditure. These are thus sources of funds to the issuers.

There are different types of business organisations in *****, namely, partner¬ship firms, cooperative societies, private and public limited companies and joint sector organisations etc. The more frequently organised method is the company, registered under the *****n Companies Act 1956. Under this Act, there are three types of companies:

(a) companies limited by guarantee;

(b) companies which are private limited companies — limited by shares paid up; and

(c) companies which are public limited companies — limited by shares paid up. Under the Act, the private limited companies can have 50 members and their shares are not transferable freely. These companies reserve the right to refuse any transfer of shares and as such trading in them is restricted.

Due to these inhibitive features, private limited companies do not have easy access to the securities markets. Only public limited companies are largely popular as they can raise funds from the public through the issue of shares. The methods of raising funds used by the corporate sector are to issue securities, either ownership instruments or debt instruments.

SECURITIES AND SECURITIES MARKETS

The issue of securities by corporate units in ***** is as old as the introduction of joint-stock enterprises by the British Government. The 18th and 19th centuries saw the emergence of cotton and jute textiles, tea and plantation industries in *****.

Many companies were set up as joint-stock enterprises with liability limited by shares. A vast number of businessmen in major cities purchased these shares and trading started in them early in the 19th century, thanks to their enterprising spirit. In those days, although many of these companies were financed by the issue of shares to the public, they mainly depended on the joint-stock British banks in ***** and borrowals from abroad. British enterprise and the British Government have thus helped the emergence of the securities markets in *****.

The corporate securities have come to have a market first. So far as the Government securities are concerned, the British ***** Government borrowed mostly in London by issue of Sterling consols. Only later in the 19th century did the Government issue treasury bills and Government securities in rupees. This led to the emergence of the Government securities market also in *****.

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