Author name: CBCL

[By Gagireddy Vyshnavi Reddy] The author is a student of Tamil Nadu National Law University.   Part-1  With the advancement of technology, the incorporation of algorithm strategies into the trading of securities has emerged and has been growing at an exponential rate since then. The provision of algorithm strategies for the purpose of trading securities can be sought in two ways, where one of them is by the provision of such strategies by the stock brokers themselves, however, another way is through the third party algorithm strategy providers, where the stock brokers outsource the services of the third party algorithm strategy providers. SEBI in its Consultation Paper on Algorithm Trading by Retail Investors, 2021 has stated that the services provided by such third party algorithm strategy providers cannot be categorized as either investment advisor or a research analyst and thereby such third party service providers are not recognized. This article focuses on how there is mis-regulation of such third party algorithm strategy providers, and how their services cannot be interpreted as  investment advisors but can be categorized as research analysts henceforth eliminating the unnecessary burden placed on the stock brokers in gaining permission for each and every algorithm strategy employed from the third party algorithm strategy provider by not recognizing the third party algorithm strategy providers under a regulatory framework.   INTRODUCTION Algorithmic Trading has been used very widely in India from the past few years. According to report from the National Institute of Financial Management submitted to the Department of Economic Affairs indicates that over 50% of total orders at both the National Stock Exchange and Bombay Stock Exchange are algorithmic trades on the client side, while over 40% are trades on the prop side. Algorithmic Trading refers to an automated execution of logic that generates a buy or sell order of the securities in the securities market. It enables the investor in trading the securities when there is an appropriate market situation that enables the investor in gaining profits. This would not require the interference by the investor in analyzing and keeping a track on the market conditions in order to trade the securities.  The rise of algorithmic trading in India can be traced back to SEBI’s Circular on Introduction of Direct Market Facility in 2008 (2008 Guidelines) allowing institutional investors to use the direct market access (DMA) facility, which allowed brokers to offer their clients direct access to the exchange trading system without any manual intervention. Later, SEBI released the “The Broad Guidelines on Algorithmic Trading” (2012 Guidelines) and these 2012 Guidelines provide for seeking mandatory approval by the stock brokers from the stock exchanges for providing the service of algorithm trading to the investors. It also provides various other compliance for the stock brokers and the stock exchanges to be followed in order to enable the investors with the facility of algorithm trading by providing algorithm strategies. Further, SEBI has also released the Consultation Paper on Algorithmic Trading by Retail Investors (Consultation Paper) in 2021, wherein, it stated that there would be no recognition given by SEBI to the third-party algorithm strategy providers (ASPs) creating such algorithms and has instead placed multiple reporting requirements on the stock brokers in order to regulate such third party ASPs. It also mentioned in Consultation Paper, how it is unclear as to the categorization of the services provided by these third party ASPs as either investment adviser or research analyst and thereby concluded to not grant a recognition for such third party ASPs.  This article deals with the above mentioned aspect of the Consultation Paper, how the third part of how the third party ASPs are mis-regulated by first establishing that the third party ASPs do not come under the current Investment Advisor Regulations and later establishing that such third party ASPs can be interpreted under the Research Analyst Regulations. It concludes with the suggestion that instead of placing extra burden on the stock brokers for obtaining permission for every algorithm employed from the third party ASPs by eliminating the third party ASPs from the regulatory framework, SEBI can regulate these third party ASPs as under the Research Analyst Regulations, 2014.   REGULATORY OVERSIGHT ON THIRD PARTY ALGORITHM TRADING STRATEGY PROVIDERS   An Algorithm Trading Strategy is a logic employed by the investor to execute orders in the securities market. These include using a defined set of logic and instructions in the form of algos to generate trading signals and placing orders as mentioned in the Para 2.1 of the Consultation Paper. These orders would emanate with minimal human interference by placing them as and when the required criteria of the investor is met. This is done by constant analysis and monitoring of the stock market and employing the provided logic to understand if an order can be placed for such investor.   These algorithm trading strategies are majorly of two types, the first generation algorithm trading strategies and the second generation algorithm trading strategies. First generation strategies are those which consists of human-defined, rules-based strategies that are transformed into computer code and then executed through sophisticated technological infrastructures that connect firms to markets. Whereas, the second generation strategies consists of the machine learning approach wherein machine learning system in itself creates the strategy basing on the objective function of the investor and creates trading rules which are automatically implemented into the market in the form of orders to buy or sell the securities of such investor. This blog deals with only the first generation algorithm trading strategies and does not concern about the second generation algorithm trading strategies.   The usage of the first generation algorithm trading strategy can be predominantly provided in two ways (Algorithm Strategies). While stock brokers offer algorithm strategies to the investors in-house, at the same time, the brokers can outsource the services of the third-party ASPs. These strategies would be thereafter offered to the investors by the stock brokers. In the second scenario, it is important to understand the regulatory framework of such third-party ASPs. As mentioned earlier,

[By Santripta Swain] The author is a student of National Law University Odisha.   Introduction  Recently, SEBI has been heavily criticised for its conflicting and lackadaisical approach in dealing with the securities matters. The Appellate Courts of different forums – the Supreme Court, High Court, or Securities Appellate Tribunal (SAT) have time and again been disappointed with the market regulator for its persistent non-compliance and, at times, non-uniformity in investigations as well as adjudication of various securities law matters. Thus, raising the question of its enforcement.  A similar instance was observed in the matter of IIFL Securities. SAT in the Matter of IIFL Securities has partly set aside the order of Whole Time Member (WTM) and Adjudicating Officer (AO). – The violation of misuse of clients’ funds along with the WTM order barring the Appellant from dealing with new clients for two years were set aside, and the order for not maintaining different nomenclature for clients’ account and proprietary account was allowed.  SEBI, at times, has been lauded for its strict norms. For instance, in the matter of Karvy Stock Broking Ltd – which gave us the perspective why stricter norms are necessary for preventing a series of fraudulent activities in the form of misuse of clients’ fund by the stock brokers (it has its own tales to tell). In another Adani-Hindenburg matter, the Supreme Court has sided with the SEBI for not blindly relying on the Hindenburg report, as such foreign reports should not be treated as gospel truth.  Premise  SEBI, based on its own investigation in the past, has found out that stock brokers have misused clients’ funds to meet their own settlement obligations or in some cases high net-worth clients’ settlement obligations. Additionally, SEBI found out that these intermediaries in order to raise fresh funds, pledge clients’ securities vehemently without their consent – such misuse of clients’ funds/securities was found to be in contrary to the principle and spirit of SEBI – protecting the rights of the investors.  Therefore, SEBI through a press release in 2020, stated that it has developed an in-house supervisory system to detect misuse of clients’ securities by the brokers.  Further SEBI, through various circulars on enhanced supervision of stock brokers has mentioned the standard operating procedures for the stock brokers and other intermediaries on how to segregate clients’ funds from their own proprietary funds. SEBI also made the NSE the watchdog in the workings of such intermediaries and initiate inspections as and when it felt necessary, while keeping the market regulator in loop in the matter.  The IIFL Securities (Appellant) is one of the many matters where SEBI has been criticised for its non-uniformity in penalising the alleged. Additionally, SAT also cautioned that SEBI should always work in the public interest. And in my humble opinion, the term public is inclusive of investors, brokers, and all other stakeholders in the securities market – meaning SEBI has a larger purpose to serve than to be termed as a rigid regulator.  Crux  The SEBI in the matter of IIFL Securities was concerned with the probable misuse of clients’ funds due to the non-segregation of such funds from proprietary trading fund. SEBI for the first time, through its Circular of 1993,  mandated segregation of clients’ funds from the proprietary ones, which, according to the SEBI Circular of 2016 and follow-up Circulars of 2017, were in furtherance of the Circular of 1993. And the whole crux of the matter revolves around how this mixing of funds is in violation to the SEBI Circular of 1993.  SEBI in the present matter took two things into consideration the Circular of 1993 and the Circular of 2016. SEBI’s whole stance was dependent on the fact that the Appellant failed to segregate clients’ funds from its own proprietary funds – potential misutilisation of clients’ funds. On top of that, SEBI’s Adjudicating Authority initiated two different proceedings for the same offence citing a long investigation period, hence the segregation – which the SAT found peculiar, as such segregation of matter was unnecessary and created an unwanted legal hurdle.  Case Issue  SEBI’s take on the issue was that the Appellant had failed to segregate the client’s fund from its own; therefore, there is a high possibility of misutilisation of client funds. I say this as a possibility because SEBI used a formula to establish such misutilisation without any concrete investigation to find such anomalies, which we would analyse in detail further as we go through the blog.  In order to understand the same, the Respondent (SEBI) referred to the formula that was first mentioned in the Circular of 2016.  G = (A+B) – C  A = Aggregate of fund balances available in all Client Bank Accounts, including the Settlement Account, maintained by the stock broker across Stock Exchanges  B = Aggregate value of collateral deposited with Clearing Corporation and/or clearing member in form of Cash and Cash Equivalents (Fixed deposit (FD), Bank guarantee (BG), etc.) (across Stock Exchanges). Only funded portion of the BG, i.e. the amount deposited by stock broker with the bank to obtain the BG, shall be considered as part of B.  C = Aggregate value of Credit Balances of all clients as obtained from trial balance across Stock Exchanges (after adjusting for open bills of clients, uncleared cheques deposited by clients and uncleared cheques issued to clients and the margin obligations.  From the aforementioned formula, if the value of G is negative, then it indicates that clients’ funds are being utilised for settlement obligations or for stock brokers own purposes.  Based on the recommendation of the Designated Authority (DA) – cancellation of the registration of certificate, the WTM (power exercised under Reg. 27 and Reg. 28 of the Intermediaries Regulation) restrained Appellant from onboarding new clients for a period of two years. Further, the AO also initiated parallel proceedings on similar facts and therefore issued two separate Show Cause Notices (SCN), and accordingly, a penalty of INR 1 Crore against each SCN was levelled against the Appellant. 

[By Shyama Singh] The author is a student of Gujarat National Law University, Gujarat.   Background  Through an informal guidance by way of an ‘interpretative letter’ dated 21st July 2023, the Securities and Exchange Board of India (“SEBI”) clarified whether open offer obligations under Regulation 3(3) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SEBI SAST Regulations”) or Takeover Code would be triggered. The clarification pertained to a situation where an increase in individual shareholding of promoters occurred, while the aggregate shareholding or voting rights of the promoter and promoter group did not exceed the 5% threshold. The guidance is significant since a plain reading of the SEBI SAST Regulations might initially suggest a contrary outcome than the guidance provided by SEBI.  As for the binding nature of such guidance, the Securities Appellate Tribunal (“SAT”) emphasized in paragraph 28 of JK Paper Ltd. v. SEBI that any guidance is not binding on the Board. Nevertheless, Clause 12 of the SEBI (Informal Guidance) Scheme, 2003, indicates that the Board generally aligns its actions with the letters issued as informal guidance.   Legal Framework  Under Regulation 3(1) of the Takeover Code, an acquirer, together with persons acting in concert (“PAC”), is obligated to make a mandatory open offer if their combined holding reaches 25% or more of the target company’s shareholding, conferring them the right to exercise 25% or more of the voting rights. Regulation 3(2) stipulates that an acquirer, along with PAC, holding 25% or more of the target’s shareholding, must initiate an open offer when acquiring an additional 5% or more of voting rights in the target during a financial year.  Subsequently, Regulation 3(3) elucidates that an acquisition leading to an individual’s shareholding surpassing the prescribed thresholds in either sub-regulations (1) or (2) necessitates an open offer obligation. This obligation holds true regardless of any change in aggregate shareholding with PAC. This means that if an individual acquisition exceeds the 25% threshold specified in sub-regulation (1) or surpasses the 5% threshold in a financial year after holding 25% or more under sub-regulation (2), Regulation 3(3) mandates a compulsory open offer, irrespective of whether the aggregate shareholding with PAC experiences any change or remains unchanged.  Brief facts   The informal guidance was sought by Kreon Financial Services Limited (“Kreon”), a publicly listed Non-Banking Financial Company registered with RBI and listed on BSE, concerning an increase in individual shareholdings of two promoters. These two promoters were Mr. Jaijash Tatia and Ms. Henna Jain. Through a board meeting dated 28.01.2021, board approval was received for the issuance of 95,00,000 warrants convertible to equity on a preferential basis to promoters, including Mr. Jaijash Tatia, Ms. Henna Jain, and other investors. The shareholders’ approval was received on 27.11.2021. Subsequently, an in-principle approval was received from BSE on 13.01.2022 for the allotment of these 95,00,000 warrants. On 24.01.2022, a board meeting approved the allotment of these 95,00,000 warrants. On 28.03.2023, another meeting approved the partial allotment of 28,77,000 equity shares against the partial conversion of the warrants. Resultantly, the shareholding of Mr. Jaijash Tatia and Ms. Henna Jain increased from 9.29% to 14.28% and 0% to 4.99%, respectively, in FY 2023. This increase was of 4.99% for both promoters.  Since the warrants were only valid for 18 months, Kreon enquired whether a further conversion of the pending warrants into shares in FY 2024 would trigger the Open Offer Obligation as per Regulation 3(3) of the SAST Regulations since the individual shareholding/voting rights of the two promoters would increase by 5.37% and 9.84% post-conversion. This was notwithstanding that the promoter and promoter group’s combined shareholding/voting right would not surpass 5%, as mandated by Regulation 3(2) of the SEBI (SAST) Regulations.  The shareholding of these promoters, along with PAC (i.e., the promoter group), was 50.60% in FY 2023. This aggregate shareholding was estimated to increase by 4.99%, i.e. to 55.59% after converting the remaining warrants in FY 2024. However, the individual shareholding of the two promoters would cross 5%. This was because the shareholding of other promoters in the promoter group decreased by 10.22% when the shareholding of the concerned promoters increased by 15.21%, resulting in a cumulative increase of 4.99%.   SEBI’s guidance and analysis  SEBI noted that the individual shareholding of Mr. Jaijash Tatia and Ms. Henna Jain was below 25%, and thus, open offer obligations were not triggered for them under Regulation 3(3) read with Regulation 3(2) of the SEBI SAST Regulations, 2011, even if they acquired 5.37% and 9.84% respectively.   The guidance tendered by SEBI might seem incorrect initially since the shareholdings of the two promoters increased by 5.37% and 9.84% when they aggregately held 50.60% along with PAC before the acquisition. One might conclude that this situation would attract Regulation 3(2) and mandate an open offer thereunder. This conclusion would be based on an understanding that Regulation 3(2) mandates an acquirer who acquires more than 5% when already holding 25% or more together with PAC, to make an open offer. However, this is an incorrect and partial understanding of the Regulation. A complete reading would reveal that SEBI’s guidance aligns with the SAST Regulations and no open offer is required.  As per Regulation 3(3), an open offer obligation is triggered when, ‘individually’, the thresholds under sub-regulations (1) and (2) are exceeded. In the present case, the 25% or 5% thresholds under sub-regulation (1) and (2) were not breached ‘individually’. However, under sub-regulation (2), one may argue that the shareholding of the promoter and PAC was well beyond 25%, after which the two promoters individually acquired more than 5%, mandating an open offer obligation. Such an interpretation is incorrect.   It has been noted that Regulation 3(3) addresses breaches at the individual level, contrasting with the provisions outlined in Regulations 3(1) and 3(2). Sub-regulations (1) and (2) cover situations wherein individuals and PACs ‘collectively’ exceed the prescribed thresholds. This can also be gathered from the language employed in these sub-regulations, which uses the word “them,” meaning the individual acquirer,

[By Soham Niyogi] The author is a student of Rajiv Gandhi National University of Law, Punjab.   Introduction A calamity may be overkill, but when giant conglomerates drop like flies and wither away, it would certainly raise some eyebrows about how this disaster occurred, or how it could have been avoided. Some of these behemoths find themselves in the guise of the SREI Infrastructure Finance Ltd. (hereinafter, “SREI”) or Infrastructure Leasing and Financial Services (hereinafter “ILFS”), these two major companies are buried in the annals of India’s financial history as they threatened disaster for the thousands of people who had put faith in these companies’ instruments. Public opinion lay restricted to blaming these companies for falsely inflating their bonds’ value and then disappointing investors with a liquidity crisis of upwards of 90,000 crores (in the case of ILFS). The overlooked villains of the story are the Credit Rating Agencies (hereinafter, “CRA”) which hyped up the bonds of SREI and ILFS to be of AAA-grade quality, a complete lie brought about by cronyism, bribes, and favour politics.     CRAs are bodies regulated by the Securities and Exchange Board of India (hereinafter, “SEBI”), to determine the ability of an issuer company to make good on its debt instruments, and timely disburse the principal and the interest. In the IL&FS crisis, recklessly CRAs had tagged IL&FS’ bonds to be of the highest grade rating, proportionate to being least likely to default. This illusion was broken by the crisis that struck, ending the market prospects of thousands of investors. SEBI had noted CRAs to be ‘financial gatekeepers’ and petty bribes along with promises of gifts shaken up the corporate debt market. The Grant Thornton Forensic Audit Report which scoped out the financial transactions of the subsidiaries of IL&FS confirmed that there were inconsistencies regarding IL&FS’ strategy of short-term borrowings against its long-term lending. Aside from dealings between IL&FS and its subsidiaries through third parties, the report also observed that loans were sanctioned at a negative spread which would be a cause for concern to any CRA.  Primarily, the Indian version of the ‘issuer-pays’ model is the culprit behind this situation, as it is a focal point that creates the camaraderie between CRAs and the instrument issuers in a quasi-closed market where it is tough for outside players to infiltrate. What the model entails is that an issuer such as IL&FS would pay a CRA to rate their instrument, one can see how there might be a conflict of interest persisting in this relation. The income of a CRA is dependent on the revenue that it extracts from the ratings it does for a body corporate. This conflict of interest wherein the sustainability of an issuer is dependent on the CRA’s ratings showcases a symbiotic relationship. There would never be an instance where a company pays the fees to a critical CRA which could rate their instruments lowly (the CRA would lose business). Simply put, it is a legally mandated bribe.   This conflicting relationship brings forth a situation known as ‘rating shopping’, wherein the issuer subscribes to ratings from the top CRAs, and only publishes the most favourable one. Fear of being discharged is a motive for the CRAs to give the best ratings possible. Even after observing the fall of SREI and ILFS, such has not been looked into by the SEBI per the SEBI (Credit Rating Agencies) Regulations 1999 (hereinafter, “CRA Regulations”) except for a lacklustre standing committee, mentioned in the following text. The amendments up until 2023 do not address this logical fallacy as under regulation 14 of the CRA Regulations, and the vicious cycle is perpetuated till now, as could be seen in the case of SREI’s default in 2021.   Regulation 16 (2) of the CRA Regulations permits a CRA to issue a credit rating even if a client company refuses to cooperate, based on incomplete public information only. If we could refer to the Report, IL&FS had also sent incomplete information to the CRAs. Unfortunately, this is a great disservice to the ordinary investor who would suffer due to their reliance on uncredible credit ratings by globally acclaimed CRAs with or without disclosure as per 16(2).   Cross-Jurisdictional Analysis of the Issuer-Pays Model   India’s efforts to mitigate the chances of a like crisis are realised in the form of an advisory report by the Standing Committee on Finance, wherein they criticise the issuer-based model while recommending measures such as the disclosure of confidential information such as the liquidity position of the issuer. None of the recommendations made by the committee were ever implemented, but we can find a similar solution to this problem in other jurisdictions aside from India, where a successful version of the issuer-paid model is in work, from which India can be inspired.   A comprehensive solution may be sought from separate jurisdictions, starting with the Basel Committee on Banking Supervision which has in its leagues, 45 member banks and central regulators with authorities hailing from 28 jurisdictions. The committee’s stringent laws to encourage issuer-investor relationships are admirable since they also comply with the issuer-based model with the investor’s interests in mind. The supervisory committee concurs with a system of the disclosure of liquidity ratio. Liquidity ratio is the measure of a company’s capability to pay off its short-term obligations, at the moment, no such system of disclosure exists in India.   From 2015 onwards, the Basel Committee made it mandatory for its members to reveal its liquidity coverage ratio, guided by two base objectives, to improve a bank’s short-term resilience by warranting that it has high liquidity assets at all times to show for, and to reduce funding risk over a long time, to ensure that the company is only allowed to invest in projects when they have sufficiently stable sources of income, and high reserves of liquidity. The Basel Committee directs its members to have a common public disclosure framework for the ease of the market participants. This scheme is still in practice and could very well