Securities and Exchange Board of India

Introduction

“ A stitch in time saves nine”

Indeed the scheme of the Securities and Exchange Board of India is directed in the direction of guiding the players in the securities markets towards securing compliance with the various rules, regulations and guidelines enacted under the aegis of the Securities and Exchange Board of India Act, 1992. It is a known fact that in the interpretation and application of many of such rules, regulations, guidelines, etc., pose a problem in view of either the ambiguities in legal drafting or a view of absence of practical legal precedents in the context.

The Securities and Exchange Board of India established as an administrative body in April 1988 became a statutory body in January 1992. The transformation was formalized by an Act of the Indian Parliament in April 1992. The Act charged the SEBI, the first national regulatory body in India with comprehensive statutory powers over practically all aspects of capital market operations, “to protect the interests of the investors and to promote the development of, and to regulate the securities markets by such measures as it thinks fit.”

To break the circle of subsidized financing, where the government owned and/or controlled financial institutions, like the Industrial Development bank of India (IDBI), Industrial Finance Corporation of India (IFCI), Industrial Credit and Investment Corporation of India (ICICI) and a number of other national and state level agencies, which provide funds to the private sector corporations on concessional terms and they themselves receive in turn considerable concessional finance from the Reserve Bank of India, the new economic policy encourages the corporations to raise resources increasingly from private investors. In this context, the promotion and development of the capital markets as well as facilitation of the public participation in those markets by ensuring orderly disclosure of information about borrowing corporations and other forms of investor protection were naturally recognized as two very important goals for the national regulatory body.

Another important goal of SEBI is to protect small investors, through the take over regulations. The very raison d’etre of take over regulations is to protect the interests of the small investors. But the take over regulations still leave scope for ambiguity in their interpretation and their application.

Section 11(1) of the SEBI Act casts upon the SEBI the duty to protect the interests of the investors in securities and to promote the development of and to regulate the securities market through appropriate measures, like regulating the business in stock exchanges, prohibiting fraudulent and unfair trade practices in securities markets, prohibiting insider trading in securities, etc.

The Bhagwathi Committee on Take Over Regulations was of the view that the regulations for takeovers should operate principally to ensure fair and equal treatment of all shareholders in relation to substantial acquisition of shares and takeovers. The regulations should not impose conditions, which are too onerous to fulfill and hence make substantial acquisitions and takeovers difficult and they should ensure that such processes do not take place in a manner without protecting the interests of the shareholders. A balance must be necessarily struck between the two considerations.

As in banking, insurance and few other sectors, a scheme of Ombudsman had been just put in place by SEBI with a view to regulate the capital markets and safeguard the interests of the investors. The role of an Ombudsman is in the nature of a watchdog on the administration. The SEBI Ombudsman can be understood as an office (person) appointed to redress investors’ complaints against a listed company and/or a capital market intermediary. The Ombudsman is bestowed with varied powers and functions, including the power to receive complaints, consider them and facilitate resolutions by amicable settlement.

Chapter 1

Takeover Regulations

Takeovers perform a desirable disciplinary function by replacing inefficient management, deterring fiduciary abuse and enforcing greater sensitivity on the part of the management to the market’s judgment. [1] However, in a market driven economy, where free competition should thrive without relying on the protective hand of bureaucratic intervention, it is important that such critical processes as substantial acquisition of shares and takeovers, which can significantly influence corporate growth, take place within an orderly framework of regulations and that such a framework should be one which comports with the principles of fairness, transparency and equity, and above all, with the need to protect the rights of the shareholders. [2] The Bhagwathi Committee on takeovers was of the view that the regulations for substantial acquisition of shares and takeovers should operate principally to ensure fair and equal treatment of all shareholders in relation to substantial acquisition of shares and takeovers. While on one hand, the regulations should not impose conditions, which are too onerous to fulfill and hence make substantial acquisitions and takeovers difficult; at the same time, they should ensure that such processes do not take place in a clandestine manner without protecting the interests of the shareholders. A balance must be struck between the two conditions.

Section 11(1) of the Companies Act casts upon the SEBI the duty to protect the interests of investors in securities and to promote the development of and regulate the securities market through appropriate measures. The measures include the regulation of substantial acquisition of shares and takeover of companies. An attempt was made by the Securities and Exchange Board of India to suggest corrective measures that may ensure the protection of the small investors. As a result of this, SEBI (Substantial Acquisition of Shares and Takeovers) Regulations was drafted in 1997 and the fundamental objective of the Regulations being the protection of small investors. These regulations are applicable only if the target company is a listed company, which is formed under the Companies Act, 1956. The regulations will not apply to an entity, which is not a company even though its securities may be listed.

Regulations 10, 11 and 12 of the Takeover Regulations provides a framework for prevention of unacceptable takeovers and regulates the mechanism for the exercise of the exit option to existing share holders of the company, who do not want the control of the company changed. Regulation 10 states that if the acquirer acquires shares or voting rights in a manner that it entitles him to exercise 15% or more of the voting rights in that company, then he has to make a public announcement to acquire such shares of such a company in accordance with the regulations, because the acquisition of 15% of shares enables a person to ‘take over’, i.e., to effect a change in control of the management of the company. [3] The basic principle under this regulation is to give an exit opportunity to the shareholders to whom the resulting change in management is unacceptable. [4] Regulation 11 of the Takeover Regulations speaks on creeping acquisition by promoters or controllers to enable them to acquire more shares than 15% of the shares and voting rights in a company. Such an acquirer has to make a public announcement to acquire shares in accordance with the regulations. Regulation 12 lays down that irrespective of whether or not there has been any acquisition of shares and voting rights in a company, no acquirer shall acquire control over the target company, unless such person makes an open offer to the already existing members to acquire shares and acquires such shares in accordance with the takeover regulations. The control is interlinked with the fortunes of the company and any change in control could not be without impact on the company’s policies and business prospects and is thus linked to investors’ interests. Therefore, the SEBI has taken enough measures to ensure that there is a public offer in cases of acquisition as under regulations 10, 11 and 12. Regulation 15 provides that the public offer should be made in a national daily, which is in wide circulation, along with a copy being submitted to the Board and to the stock exchanges on which the shares of the company are listed.

Owing to globalization, the ownership pattern of the MNCs has changed considerably the world over. This has brought into open the perplexing issue of ‘indirect acquisition’ of control at the global level. Whether or not an open offer is triggered in cases of indirect acquisition of control is a legal dilemma. There is a dilemma with respect to the tremendous uncertainty that exists in the application of the takeover regulations to global arrangements. For instance, SEBI has granted exemption from the application of the regulations to cases of ‘change in control’ as a consequence of a global arrangement. This establishes a dubious precedent, because it ignores the interests of the small investors. The only caveat that has been imposed on the acquirer under regulation 12 is that he has to pass a special resolution in an extraordinary general meeting, in which the acquirer and its subsidiaries have no voting rights.

Other than the above caveat imposed on the acquirer, SEBI had various powers under chapter V of the Takeover Regulations. The Board may appoint one or more persons as investigating officers to look into the compliance and breach of the takeover regulations. [5] Also, under regulation 40, the acquirer, the target company or the merchant banker has a duty to produce to the investigating officer such books, securities, accounts, records and other documents as the investigating officer may require. The Board also gives power to the investigating officer to ensure that he has reasonable access to the premises, to the documents and to examine or record the statements of any director, acquirer, the target company and the merchant banker. [6]

The board imposes sanctions on the persons violating the provisions of the Regulations. Regulation 45 provides for penalties to be imposed on the acquirer, if he fails to carry out the obligations under the Regulations. [7] The acquirer, the board of directors and the target company failing to undertake the obligations under the Regulations shall be made liable for action in terms of the Regulations and the Act. [8]

In cases where preferential allotment results in change of control of the management of the company, the entire transaction remains exempted from the application of regulations 10, 11 and 12. Clearly, there is scope for the promoters to enter into a private arrangement with the prospective party wishing to take over the company. That way, the promoters could ensure that they get a good price for their stake, at the cost of the interests of the retail investors. The preferential allotment route can easily enable the promoters to increase their stake in the company, instead of buying the shares in the open market. But in the current scenario, the SEBI has removed the clause in the Takeover Code that hitherto exempted the preferential allotment issues relating to mandatory public announcement and consolidation of holdings under the Code. The Bhagwathi Committee, which was appointed by SEBI to review the takeover code, had recommended the exclusion of the preferential issue of capital from the applicability of the takeover regulations. The committee had recommended that the acquisition of shares covered under Section 81(1A) of the Companies Act be exempt from the applicability of regulations so long as there is a full disclosure about the proposal in the notice to the extraordinary general meeting called for consideration of the preferential issue. Preferential allotment of shares by companies will now attract the provisions of the Takeover Code, with the SEBI rejecting the recommendation of the Bhagwathi Committee to exempt such issues from the Code. [9] Capital market observers view the latest decision of SEBI as a measure aimed at correcting the increasing trend among the companies in the country to adopt the “preferential allotment exemption route” to circumvent the regulatory provisions for public offer. [10]

Chapter 2

Ombudsman Regulations

The term “Ombudsman” is ahm bedz man, which means a public official appointed to investigate the complaints filed by citizens, against government agencies or officials, who may be infringing on the rights of the individuals. [11] The concept of Ombudsman traces its roots to administrative law. It is a measure of imposing checks and balances on the functioning of public authorities. It is an attorney or representative, who investigates a complaint against the administration. It is a watchdog of the administration, and it has long proven to be a most effective means of bringing back people’s faith in the administration.

The SEBI has realized its twin objectives of regulating the capital market and safeguarding the interests of the investors. [12] In order to solve the problems of the investors, the Securities and Exchange Board of India has suggested the setting up of an Ombudsman for the securities market. Ombudsman is a regulator, which is an alternate mechanism that is cheap, fast, informal and efficient. In the year 2003, a legal advisory committee headed by Justice Venkatachaliah was set up to prepare a draft of the SEBI (Ombudsman) Regulations. The committee suggested that the SEBI (Ombudsman) Regulations be framed by the SEBI pursuant to its functions under section 11 of the Securities and Exchange Board of India Act, 1992. The Joint Parliamentary Committee on the stock market scam suggested that the concept of Ombudsman be extended to the capital market also. The committee said that the aim of setting up such a system is to solve various complaints of the investors as the SEBI has been receiving complaints against listed companies, particularly with respect to non-receipt of refund orders, share and unit certificates and dividends and many other matters. [13] The only available action against intermediaries was suspension and cancellation of registration or imposition of monetary penalty. But this did not fully redress the grievances of the investors. So, the setting up of Ombudsman was necessary to overcome this problem.

Therefore on August 21st 2003, the SEBI announced the new Ombudsman Regulations to address the grievances of the investors. The Regulations authorize SEBI to appoint the Ombudsman on the recommendation of a Selection Committee chaired by a representative of SEBI, who must at least be an executive director. To be appointed an Ombudsman, the person has to be a citizen of India, between the age of 45 and 65, and:

a retired district judge or qualified to be appointed as a district judge

or have 10 years of experience in any regulatory body

or have 10 years of special knowledge and experience in law, finance, corporate matters, economics, management or administration

or have been an office bearer of an investors’ association recognized by the SEBI, with not less than 10 years experience in matters relating to investor protection

The Ombudsman is appointed for a period of three years and is eligible for reappointment for another two years. A person will be disqualified if convicted of any offences of moral turpitude, is declared bankrupt or of unsound mind, has been charge sheeted for economic offences, or was a full time director in the office of an intermediary or a listed company and a period of three years has not elapsed from the date of leaving such a position. [14]

The regulations also permit SEBI to appoint an additional Ombudsman for an array of specific matters in a specific territorial jurisdiction. The regulations also require every additional Ombudsman to fulfill the above criteria. In addition, the regulations require every listed company and intermediary to make full disclosure in its offer document and client agreements about the mechanism for redressal of grievances through the office of the Ombudsman. [15] Regulation 9 states that notwithstanding the appointment of Ombudsman under regulation 3, SEBI may appoint a person as a stipendiary Ombudsman out of the panel prepared under sub-regulation 4 of regulation 3, for the purpose of acting as an Ombudsman in respect of a specific matter or matters. [16]

The regulations also provide for the dispute settlement mechanism. A complaint against a listed company or an intermediary can be filed with the office of the Ombudsman within whose jurisdiction the registered or corporate office of such listed company or intermediary is located. Legal practitioners are not permitted to represent the listed company or the intermediary at the proceedings before the Ombudsman, except where specifically permitted. [17] The Ombudsman will not entertain complaints that have been previously decided by SEBI, the Ombudsman himself, or by any court, tribunal or arbitrator. Before filing the complaint, the aggrieved investor should have made a written representation of his grievance to the listed company or the intermediary. The Ombudsman is required to make an award within three months from the date of filing of the complaint after first giving the parties one month to amicably resolve the matter. [18] SEBI has the power to review the award passed by the Ombudsman. Both SEBI and the Ombudsman are entitled to award reasonable compensation with interest, and the non-implementation of such awards by any person without reasonable cause will render the person liable to a monetary penalty as well as stringent disciplinary action. The Ombudsman is empowered to facilitate amicable resolution of the complaints received against any listed company or a market intermediary and also adjudicate such complaints in the event of failure of a friendly or amicable settlement. [19]

Other than the above powers granted to the Ombudsman, there are also some duties, which are cast upon the Ombudsman. For instance, the Ombudsman shall submit an annual report to the Board within three months of the close of each financial year containing general review of activities of his office of Ombudsman. The Ombudsman also has to furnish from time to time such information to the Board as may be required by the Board. [20]

The SEBI has also specified the grounds on which the Ombudsman can entertain complaints from the investors. The grounds include non-receipt of dividend, non-receipt of allotment letters, share certificates, unit certificates, debenture certificates, non-receipt of refund orders, rights and bonus entitlements, non-receipt of interest, redemption amount, non-transfer of securities within the stipulated time, any grievances against any intermediary or listed company, etc.

Owing to the importance of the Ombudsman, SEBI through its regulations made it mandatory that every intermediary and listed company have to display the full name and address of the Ombudsman in its office premises, to bring to knowledge about the same to the shareholders or investors. Further, disclosure also is required to be made in the offer documents and other agreements with clients.

In case of any difficulties while implementing the provisions of the Ombudsman Regulations, SEBI may issue such directions and clarifications as it may think necessary or expedient to remove such difficulties.

Chapter 3

SEBI and Insider Trading

Insider trading is not new to India. Insider trading has become a corporate method to dupe shareholders. In simple terms insider trading occurs when a person uses privileged information available to him because of his association with a company to buy or sell shares. [21] What boosted the morale of the ‘insider’ traders was the fact there was no clear-cut guidelines governing insider trading. But now, regulations relating to insider trading are framed under the Securities and Exchange Board of India (Insider Trading) Regulations, 1992. The SEBI regulations define insider trader as “any person who is or was connected with the company or is deemed to have been connected with the company and who is reasonably expected to have access, by virtue of such connection, to unpublished price-sensitive information in respect of securities of the company…” [22] These regulations impose an express prohibition on dealing, communicating or counseling on matters relating to insider trading and restrict any dealing in securities of a company listed on any stock exchange on the basis of any unpublished price sensitive information. There are several instances in India, where directors and promoters have used price sensitive information to buy and sell shares.

The regulations impose several restrictions on the buying and selling of securities of the company. The regulations state that the employees including the directors of the company, when in possession of any unpublished price sensitive information pertaining to the company shall not buy or sell securities either on their own behalf or on behalf of any other person. [23] They also cannot communicate, counsel or disclose any unpublished price sensitive information to any person, except in a manner permitted by law.

One of the most important instances of insider trading in India is the Rakesh Agarwal case. The Securities Appellate Tribunal’s verdict in this case has serious implications. In this case, the accused was held not guilty of insider trading. The plain reading of the SEBI (Insider Trading) Regulations appears to indicate that two conditions needs to be fulfilled to hold a person to be guilty of insider trading:

the “insider” must be a connected person by virtue of his position in the company such as director, officer or employee with a professional or business relationship with access to the unpublished price sensitive information.

the person must have traded in those securities on the basis of the unpublished price sensitive information

But in the instant case, along the above two conditions being satisfied, the presiding officer of the tribunal added another condition to be fulfilled. He stated that it has to be proved that the insider had derived an unfair advantage over the other parties or had a profit motive while trading on the basis of the unpublished price sensitive information.

This decision has been much criticized because proving insider trading according to the present regulations is already difficult, and in addition to these, if the tribunal’s conditions are imposed, it becomes virtually impossible to enforce the insider trading regulations.

After the Hindustan Lever insider trading case fiasco, the Securities and Exchange Board of India (SEBI) has made a plea to the Union government to grant it more powers to tackle the growing menace of white-collar crimes. The regulatory body is lobbying for more monetary penalties to punish erring companies for insider trading.

Accordingly, in the year 2002, SEBI notified amendments to the insider trading regulations based on the recommendations of the Kumara Mangalam Birla Committee. After the amendments, the regulations cover almost the entire gamut of insider trading. Under the new amendments to the insider trading regulations, subscription to the primary issues has also been covered in addition to dealing in securities based on inside information. Another important amendment in the regulation includes dealing in securities based on unpublished price sensitive information is sought to be prohibited while communication of price-sensitive information per se is not an offence. [24] The new regulation has also clarified that companies dealing in securities of another company based on inside information has been specifically prohibited. However, as per the new norms, the communication of price sensitive information per se is not an offence, but only dealing in securities based on unpublished price sensitive information has been prohibited. But even after the amendments, interestingly, according to SEBI’s own data, none of the SEBI’s measures have helped to curb insider trading in the stock exchanges. According to SEBI, till date none of the Indian stock exchanges have reported any case of insider trading.

Conclusion

The decision to amend the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 has facilitated the merger and acquisition activities in India’s market. The amendments are aimed at undoing the complications caused by the earlier amendments of 2004. Amongst other modifications, the 2006 amendments have broadened the definition of a promoter. The 2006 amendments also seek to align the Takeover Regulations with recent changes to the listing agreement relating to minimum public shareholding. The amendments propose that no acquirer, including people acting in concert, holding 55 per cent or more, but less than 75 per cent of the shares or voting rights in a target company, shall acquire any additional shares or voting rights, unless he makes a public announcement concerning such acquisition of shares in accordance with the Takeover Regulations. [25] The provisions that prohibit preferential allotments or market purchases of more than 55 per cent now stand deleted by virtue of the 2006 amendment. However, creeping acquisitions continue to be permitted at up to 5 per cent in a financial year up to a maximum limit of 55 per cent. As per the Takeover Regulations, any offer higher than such prescribed limit would require an open offer. With the Takeover Regulations prohibiting acquisition of more than 55 per cent through market purchase or preferential allotment and the listing agreement prescribing different levels of public share holding for different companies, lack of transparency in law led to a number of transactions having to be tortuously structured. [26]

The SEBI Ombudsman, although, has been successful to an extent, it is not without flaws. For instance, the objective of the Ombudsman mechanism of SEBI is the speedy redressal of investor grievances on various matters, as more specifically mentioned in clause 13 of the said regulation. However, the proposed mechanism is bound to delay the dispensation of justice, thereby defeating the very objective. Another drawback is that the Ombudsman shall be nominated by the SEBI chairman on the basis of the recommendation made by a selection committee. But SEBI, the appointing authority, is headed by a person who has no judicial background. Further, the said regulation shall not mandate that the recommendation of the selection committee shall be final and binding. [27] This is sham of justice. Also, legal representation is expressly disallowed unless the Ombudsman permits it and that too it is restricted only to complainants. This sounds laudable but is unjustified because if there are any issues of law or even facts then legal representation is a must and further it should not be forgotten that the Ombudsman may not always be a lawyer or a person having any knowledge of law.

The Stock Watch system of insider trading is also being developed which would provide for detection of possible insider trading cases, as the system would generate alerts on abnormal trades prior to important events. The SEBI says besides the investigation of insider trading cases being strengthened, compliance officers are being designated by companies under the advice of SEBI who could be contacted by the exchanges to verify any rumours. This would also help to prevent misuse of information. Interestingly, according to SEBI’s own data, none of the SEBI’s measures have helped to curb insider trading in the stock exchanges. According to SEBI, till date none of the Indian stock exchanges have reported any case of insider trading.