Author name: CBCL

[By Anushka Aggarwal] The author is a student of National Law School of India University (NLSIU).   Introduction Recently, the Securities and Exchange Board of India (SEBI) sent a 31-point advisory to investment bankers via the Association of Investment Bankers of India, the investment banking industry’s representative to SEBI (IPO advisories), which increases the Initial Public Offering (IPO) disclosure requirements and due diligence requirements. This was a part of regulatory advisories that SEBI frequently issues to intermediaries like the AIBI. These advisories operate along with the existing legal framework including the Companies Act, 2013 and Part A of Schedule VI of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. I argue that SEBI’s authority to issue such advisories without a well-defined legal framework opens the door to potential regulatory substitution, i.e., using advisories to perform functions that would typically require a more formal legal framework, such as an amendment. This is concerning given the judiciary’s usual deferential stance toward SEBI which can fail to keep a check on SEBI’s advisory powers, and the implications of this on the securities market: First, the article describes the absence of a clear legal framework governing advisories, and second, addresses the broader implications of this, including how it fails to keep a check on regulatory substitution and contributes to increased transaction costs and inefficiencies within the securities’ market.  The Issue: (Lack of) Legal Framework The Securities and Exchange Board of India Act, 1992 (SEBI Act) which establishes SEBI and lays down its powers and functions does not use the term ‘advisory.’ Under S. 11A and 11B, SEBI has the power to issue ‘regulations,’ ‘orders’ and ‘directions’ to the securities market. I argue that none of these can encompass advisories. All rules and regulations made by the SEBI have to be tabled before the Parliament under S. 31. The Parliament can modify such regulations or invalidate these. However, none of the advisories issued have been tabled before the Parliament, or their validity subject to such tabling. Under S. 11B, a direction by a statutory authority is like an order requiring positive compliance. However, advisories are typically supposed to be clarificatory, offering guidance to help interpret existing law and align market practices. Whether advisories require positive compliance is unclear. Additionally, ‘directions’ is synonymous with ‘orders.’ Since ‘advisories’ cannot be considered ‘directions,’ they cannot be considered ‘orders’ either.    Thus, the SEBI Act not only lacks a clear framework authorizing the issuance of ‘advisories,’ but also the aforementioned ways of regulation cannot encompass ‘advisories.’ Arguendo, the SEBI Act gives SEBI overarching powers to protect the interests of investors and regulate the securities market, and advisories fall under this general regulatory function. However, the lack of a structured legal framework governing advisories leads to concerns about potential regulatory substitution: The content of the IPO advisories is not limited to guidance but effectively amends a regulation as elaborated upon subsequently, but due to its status as an ‘advisory,’ the SEBI circumvented the need for parliamentary tabling. Further, these advisories may blur the line between informal guidance and enforceable regulation, creating uncertainty. For example, the IPO advisories necessitate that the offer document not in conformity with the advisories shall be returned to the company.  The Relevance: Why is This An Issue? This section first examines how issuing advisories bypasses the formal processes required for making regulatory changes, such as passing amendments or issuing new regulations, thereby amounting to regulatory substitution. Instead of following the more rigorous procedures that ensure accountability and transparency, advisories are used to introduce changes informally. This may remain unchecked due to the judiciary’s deferential. Second, it analyzes how the advisories increase transaction costs and lead to inefficiencies in the securities market.  1. Regulatory Substitution Under the IPO advisories, SEBI notified that “any entity or person having any special right under articles of association or shareholders’ agreement should be cancelled before filing the updated draft red herring prospectus.” Before these advisories, such rights were cancelled after the listing of a company as per Regulation 31B of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. These special rights, like veto powers, Right of First Offer/Right of First Refusal, etc., are important for private equity (PE) investors. Retention of special rights, during the critical phase of the company’s transition to a public entity, provides them with a safety net and the ability to influence major decision that could impact their rights vis-à-vis the company. PE investors usually have limited day-to-day control over the company. Their special rights compensate for this by providing mechanisms to protect their investment.  Thus, the SEBI effectively amended a Regulation that secures important rights for PE investors through the use of advisories, which are part of an informal framework. This constitutes regulatory substitution because by issuing advisories, SEBI was able to introduce a significant change without going through the formal process that would normally require parliamentary approval. This not only undermines the transparency and accountability checks required for rule-making but also impacts the regulatory landscape. Although SEBI later withdrew the advisory, this action did not fully resolve the issues created by the initial substitution. The next section will explore how these negative impacts cannot be undone by the withdrawal.  The potential for SEBI to engage in regulatory substitution through advisories could remain insufficiently addressed due to the judiciary’s deferential stance towards SEBI. In Prakash Gupta, the court defers to SEBI remarking that SEBI’s actions are guided by public interest and its role in maintaining market integrity and investor protection. The courts have avoided substituting their judgment for that of SEBI, acknowledging the latter’s extensive regulatory and adjudicatory powers, and specialized knowledge. A stronger form of deference is displayed here since the statute was clear that the offences could be compounded (only) by the SAT or a court. The court concludes that SEBI’s consent cannot be made mandatory owing to the language of the statute, but held that the views of SEBI must necessarily be considered by the SAT and the court, and

[By Debangana Nag] The author is a student of the West Bengal National University of Juridical Sciences.   Introduction In its recent board meeting on 30th September, SEBI outlined maintaining pari-passu rights of the investors in Alternate Investment funds to maintain a level playing field among them. The Board approved proposals to amend the AIF Regulations to state that, in all other respects (barring specified exemptions), investors’ rights in an AIF scheme shall be pro-rata and pari-passu, meaning investors must have equal rights (pari passu) in all investments within the scheme, thereby stating that no investor will be prioritised over another. Additionally, any returns or distributions from the scheme will be allocated proportionally (pro rata) based on the amount each investor had contributed, ensuring that their share of returns is directly in line with their investment. However, to prevent existing investments from being disrupted, the SEBI has allowed them to continue.  In May 2023, a consultation paper was released by SEBI seeking comments from the public. This paper emphasised that the pro-rata principle should be regarded as of utmost importance in AIFs, highlighting it as crucial for maintaining fairness. In contrast, the pari-passu principle was highlighted as a means to guarantee equality in economic rights among all investors. SEBI identified key issues concerning the use of the Priority Distribution Model by AIFs, which classifies investors into distinct groups, raising concerns about its implications for equitable treatment.  By examining this decision in light of SEBI’s consultation paper on pro-rata and pari-passu rights, this article shall critically analyse how the decision fails to balance investor protection and flexibility required by managers for creating innovative investment products along with emphasising the need to prevent regulatory arbitrage.  Understanding SEBI’s Decision on Pro-Rata and Pari-Passu Rights Although the pro-rata is not explicitly stated in the AIF Regulations, ensuring proportional rights for investors particularly in the distribution of investment proceeds is a fundamental feature of the AIF framework. However in a PD Model in the event of a loss, money from the residual capital of junior-class investors could be utilised to reimburse the senior-class investors. A hurdle rate is a performance-based benchmark for a fund that guarantees minimum returns. Senior class investors have lower hurdle rates which are prioritised during the payment. In the event of a profit, the senior class investors receive distributions until their hurdle rate is satisfied, after which the junior class investors get any residual funds.   As discussed in the Introduction, this decision by SEBI aims to uphold equitable distribution of profit and loss to ensure fairness and investor protection while emphasising that the principle of fairness that must be secured in a pooled investment like AIF.  Furthermore, SEBI granted exemptions from these regulations to certain entities like those owned by the Government, multilateral development financial institutions, State Industrial Development Corporations and other specified entities as designated by SEBI. Importantly, only these entities will be allowed to give less than pro-rata rights to persons who subscribe to junior-class units of the AIF scheme. This exemption has also been granted to Large Value Funds (LVF) but only if each investor explicitly agrees to waive off their Pari-passu rights. According to SEBI regulations, Section 2(1)pa, an LVF is an AIF where each investor commits a minimum of ₹70 crore.  It is pertinent to mention here that the SEBI Board has authorised that only in the above-mentioned AIFs, certain differential rights can be granted to some investors while the rights of other investors remain unaffected. The permitted terms for offering differentiated rights will be determined by the Standard Setting Forum for AIFs in collaboration with and certain principles outlined by SEBI.  Critical analysis of SEBI’s stance on the Priority Distribution modelSEBI has categorically banned AIFs following the Priority Distribution model (PD Model) from raising fresh commitments or making investments in a new investee company. In its consultation paper, SEBI identified that in a PD Model, investors are categorised into senior and junior groups. Senior investors are accorded priority in the distribution of returns, typically enjoying reduced risk and assured repayment before any allocation is made to junior investors. Junior investors, by contrast, assume a higher level of risk as they are compensated only after the senior class has been fully satisfied. This often results in the junior class disproportionately bearing losses in adverse scenarios. However, in exchange for this elevated risk, junior investors may realise greater returns contingent upon the overall performance of the fund. This hierarchical structure prioritises the protection of senior investors while exposing junior investors to greater risk for potentially higher rewards.  In addition, SEBI noted that this model led to a regulatory arbitrage which is prone to misuse for unethical financing like evergreening of loans.  A Working Group had recommended allowing the PD Model in limited scenarios; however, SEBI decided against this, stressing that the model’s risks outweigh its benefits.  Balancing flexibility and investor protection: Differential Rights and Operational Flexibility for AIFs To balance investor protection with operational flexibility, SEBI has allowed AIFs to offer certain differential rights to certain investors provided that they do not affect the rights of other investors to prevent conflict of interests. The rationale for this decision, highlighted earlier, was to prevent scenarios similar to those that led to the 2008 financial crisis, where investors were disproportionately impacted by differential tranches in collateralized debt obligations (CDOs), causing widespread financial instability. In such cases, investors, particularly those holding junior tranches often did not fully understand the associated risks. Junior tranche holders were typically the last to receive payments and the first to absorb any losses, making these tranches riskier.   However, it is important to underscore the trade-off between providing investors with choice and regulating AIFs, especially for those seeking opportunities through differential tranches that offer higher risk and potentially greater rewards. AIFs are investment products specifically designed for people who are considered experienced enough to negotiate their own terms. The move to prohibit fresh investments into AIFs following these structures signals SEBI’s low tolerance for financial innovation in a move towards strict regulations over risk-laden flexibility. Units with

[By Ojas Singh & Tanuj Goyal] The authors are students of Symbiosis Law School, Pune.   INTRODUCTION On 27 June 2024, SEBI in its board meeting, paved the way for public companies to be delisted through the Fixed Price Offer (FPO), as an alternative mechanism to Reverse Book Building (RBB). The move comes following the release of the consultation paper on 14th August 2023, which included crucial modifications to the SEBI (Delisting of Equity Shares) Regulations 2021 ( Delisting Regulations).   While the RBB model was detected with some irregularities, such as inflated share prices driven by speculative trading and manipulation by some shareholders, a new mechanism is being proposed. The market regulator intends to protect the interests of promoters as well as the shareholders by bringing in a fixed premium and adjusted book value calculations that would reduce market volatility and increase efficiency. However, notwithstanding these intentions, the new framework is not without its share of criticisms and possible pitfalls. This article would consist of a primer on the RBB and the new FPO process, and would then proceed to analyse the benefits and pitfalls of the proposed mechanism.   BACKGROUND The RBB mechanism was introduced in 2003 through the SEBI (Delisting of Securities) Guidelines 2003. In the RBB process, a delisting company is required to ascertain a minimum floor price for the shares of the company. The calculation of the floor price is very similar to the floor price for an open offer under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Takeover Code). The price was determined based on many aspects including book value, average market price, and future growth potential. Investors would discover the price through bidding, stating the minimum price at which they were willing to sell their shares. A minimum of 90% of the shareholding had to be acquired by the acquirer through this method to ensure successful delisting.   The delisting, when accepted, leads to the purchase of all shares at a price at or below the Delisting Price, at the Delisting Price. This Delisting Price can be further negotiated by the acquirer through the process of ‘counter-offer’.   Because promoters have to agree for the price discovered through RBB to delist, getting enough public shareholders interested in a delisting proposal and the price at which most shares are offered by public shareholders heavily affects the success of a delisting.  A successful delisting can be elusive, as the discovered price through RBB would find itself having an inordinate premium, maybe even above 100% of the Floor Price. For instance as seen in delisting’s such as Brady and Morris Engineering Company Ltd (1128.70%), Universus Photo Imagings Ltd. (164.34%), Shreyas Shipping & Logistics Ltd. (138.35%) and Linde India (517%).  In all these cases, delisting attempts were found unsuccessful as the acquirers were not ready to pay the excessively high discovered prices. For example, in the delisting of Universus Photo Imagings Ltd., it could be noted that the discovered price of ₹ 1,500 (Rupees One Thousand Five Hundred) per share was not consented upon by the acquirers, as it was way above the price offered by them (₹ 568 or Rupees five hundred sixty eight per share). Additionally, in some delisting cases, even having an excessive premium over the indicative price offered by the acquirers may not result it in being successful. As seen in the delisting of Elcid Investments Limited, whose market price per share was ₹ 15 (Rupees Fifteen), but the floor price per share was computed to ₹1,61,023 (Rupees One Lakh Sixty-One Thousand Twenty Three) per share. Despite the premium of around 9,50,000%, the delisting price was rejected initially by the shareholders. This delisting underscores the flaws in the RBB process, where even a huge premium over the market price can fail to secure an approval from the shareholders. This trend of inflated pricing under the RBB process, not only thwarted several delisting attempts but also led to a misalignment between the acquirers and shareholders. Additionally, shareholders who would often hold out to higher prices, would further stall the delisting process. SEBI found that most firms that voluntarily delisted through the RBB process paid premiums with a median value of 125% from 2015 to 2018. This shows the unsustainable financial burden faced by the companies, meanwhile the speculative shareholders were allowed to manipulate the process. This manipulation was further aggravated by the rule that promoters could submit counter-offers only if their post-offer shareholding exceeded 90% of the company’s total issued shares. These concerns were reiterated by the SEBI chairperson, who stated that the companies looking to acquire more than 90%, would find the prices heavily inflated due to certain shareholders who would acquire shares to cross the 10%. Subsequently, counter-offers under the RBB could only be made, if the acquirers post-offer shareholding turned out to be above 90% of the company’s total issued shares. These rules give the shareholders the ability to manipulate and exert control over the discovered price.  SEBI acknowledged these concerns in its consultation paper released on August 14, 2023. Accordingly, the regulatory authority introduced the FPO with an aim to reduce speculative trading and provide a balance between the interests of the investors and the acquirers.   DECODING THE CHANGES Delisting through fixed price offer: As per the modifications under the Delisting Regulations, the delisting price must be at least 15% over the market price of a share. Public shareholders now only need to decide if they want to tender their shares at a fixed price. A delisting is successful, only when an acquirer’s post-offer shareholding exceeds 90% of a company’s total share capital.  Insertion of Adjusted Book Value for the computation of Floor price: Before, the ‘floor price’ was computed based on several factors such as Volume Weighted Average Price (VWAP) of acquired shares during 52 weeks prior to the reference date, VWAP of 60 days preceding the reference date etc. as per Regulation 8 of the Takeover Code. Now, adjusted book value will be used as an additional parameter to