Somasekhar Sundaresan: Good law could mean bad economics

WITHOUT CONTEMPT

One of my favourite columns authored by the current Finance Minister was one on how good law need not mean good economics. He was writing about a market leader in private ports being banned from bidding for a new port, on a charge that it was a monopoly. In money terms, the ban cost the exchequer enormously, but in law, the ban was held to be constitutionally valid, right up to the Supreme Court.

The capital market, over which the finance ministry presides, now faces a similar situation. In 1992, stock brokers, being the most visible market intermediary, were got singled out for payment of registration fees to the Securities and Exchange Board of India (Sebi) as a percentage of the value of business done through their offices.

The registration fees were not linked to brokers' brokerage earnings but to the total value of trading.

Other intermediaries did not suffer the same fate. For instance, merchant bankers, who charge their clients as a percentage of the initial public offer/takeover size, merely have to pay a sum of Rs 2.5 lakh for every three years of operations.

An underwriter, who earns income as a percentage of the commitment made in an IPO, pays Sebi only Rs 2 lakh for every three years.

Mutual funds, which manage large amounts of monies, pay a one-time registration fee of Rs 25 lakh and an annual service charge linked to value of assets managed. The largest mutual fund in India, if it has assets of over Rs 10,000 crore, only pays an annual service charge Rs 7.5 lakh a year.

In contrast, during the first five years since initial registration, a stock broker has to pay a turnover-linked registration fee of Rs 5,000 for the first Rs 1 crore of traded turnover, but on the rest, he has to pay a sum of Rs 1 lakh for every additional Rs 1 crore of turnover.

Only from the sixth year, the stock broker is required to pay a sum of Rs 5,000 for every block of five financial years. Delayed payment attracts a penal interest of 1.25 per cent for delay of every month or part of a month.

A virulent and pugnacious campaign against the turnover-linked fees initiated in 1992, challenging the constitutional validity of the fee, came to an end in 2001. The Supreme Court ruled that the turnover-linked registration fees were constitutionally valid.

But before the Supreme Court could rule on the subject, in parallel, an important policy direction was pushed by the lawmakers. The turnover-linked registration fees had ensured that unless a broker had a substantial scale of operations, there was no charm in being a stock broker.

Further, to encourage the broking community to evolve from being mom-and-pop proprietorships and partnerships, into becoming strong robust corporate players, such consolidation was made exempt from capital gains tax.

Several brokers followed the flow of policy. Some shut shop and sold out to larger players, content with an equity stake in the companies formed out of consolidation. Others converted family shops into corporates.

Yet others merged broking companies controlled by them and having memberships in different exchanges, into single consolidated companies. When broking businesses merge, Sebi has to register the new consolidated avatar.

Each such new avatar was treated by Sebi as a new broking house, and for them, the five-year turnover-linked registration fee clock once again started ticking. It did not matter that there was no change in the ultimate beneficial ownership of the business.

Meanwhile, Sebi issued a curious circular""consolidation of broking companies would not result in a fresh obligation to pay turnover-linked registration fees, provided such consolidation was due to "compulsion of law". The term was left to the stock exchanges to define.

It remains undefined. No one cared to point out that there is no compulsion in any law making broker consolidation compulsory. That government policy was leading brokers to an economic compulsion to consolidate, too was lost.

In January 1998, Sebi amended the law to provide that conversion of a non-corporate brokerage into a corporate brokerage would not attract fresh registration fee liability subject to certain conditions.

But those who had already consolidated prior to 1998, those who responded more quickly to the nudge of government policy are not being spared. An amnesty scheme to waive 80 per cent of the accrued penal interest has been notified. It takes effect on October 15, and brokers have started receiving notices for payment of full dues.

However, this is relevant only for brokers who have defaulted entirely on their dues, brokers who did not consolidate until January 1998, and of course, brokers who have not had to approach Sebi for any routine approval in the interim ""no approval on any aspect of operations was granted without extracting pending fees.

The registration fee may be constitutional and valid. But courts can only rule if policy and law are constitutional. It is for the executive authorities to draft policy that also make economic and commercial sense, apart from being constitutionally valid.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed are personal.)