Capital Markets and Securities Law

[By Jaskaran Singh Saluja and Khushi Sethia] The authors are students at the Institute of Law, Nirma University. Introduction The advent of The Working Group Report on the Social Stock Exchange (Report) is a gamechanger for restructuring the capital inflow of the social sector in the country. The Report got published on 1st June 2020. However, the idea of a Social Stock Exchange (SSE) was first proposed during the budget speech of 2019, wherein the Finance Minister Nirmala Sitharaman highlighted the need to strengthen the social enterprises by way of SSE under the aegis of the Securities and Exchange Board of India (SEBI). SSE is a fundraising structure following the principle of additionality. The organizations in each sector can be bifurcated into for-profit enterprises (FPEs) and non-profit organizations (NPOs). SSE is expected to provide a separate closed-ended fund structure under the current stock exchange. Pre-determined norms screens entities into FPEs and NPOs. SSE acts as an intermediary allowing the flow of capital from institutional investors to NPOs and FPEs by way of the market instrument. The investment funds are directed towards a social cause consequent to which outcome funders will payout following the social impact created by the entities. Such a mechanism of SSE will untangle the snag of capital-shortage, usually faced by the social enterprises in carrying out the activities for the betterment of societies. Thus, SSE will count as a trump-card for society. I.Financial Instruments & Its Operations a. For Non-Profit Organisations (NPO Zero-Coupon Zero-Principal Bonds: – Zero-coupon zero-principal bonds are capital raising instruments that remain active for a term equivalent to the span of the project and ends by writing-off the investee’s account by funds availed for the project. These bonds are appropriate for the investors, hoping to make any social impact without expecting back the principal funds. Mutual Funds: – An asset management company will act as an intermediary that accumulates capital from different individual and institutional investors. The gains produced by their investments will get directed towards financing the tasks of NPOs, working for social outcomes, in the form of grants. Lastly, the intermediary will restore the principal amount invested by the investors and offer certain tax-exemptions Social Impact Bond (SIB): – In SIB structure, an intermediary interposes between NPOs, investors, outcome funders, and independent evaluators. The intermediary unlocks the capital from investors and contractually connects it with NPOs. Further, only after observing the successful accomplishment of the outcome-metrics through evaluators, the outcome funders repay the principal amount and returns to the investors, or else, they withdraw their liability. Pay-For-Success: – In this apparatus, the outcome funders repay the principal amount and returns to the lending partners through the intermediaries, only after the successful completion of the set outcomes. However, if the set results will not get achieved, then the risk of economic loss will be dealt with by the lending partners. Moreover, the Pay-For-Success model is almost identical to the SIB model. The key difference discerned in this model is that the intermediary raises capital from the lending partners and through grants. Even the Report proposes that the SSE should lay down an aid fund for recovering the pandemic situations of COVID-19. It can be set-up in the mock-up of Pay-For-Success or SIBs or even through Zero Coupon Zero Bonds for CSR spenders, philanthropic donors, and various investors. Social Venture Funds (SVFs): – The umbrella of SEBI’s Alternative Investment Funds (AIFs) covers the instruments like SVFs. These SVFs already exist in the financial market by SEBI for FPEs, although it also acts as grants-in and grants-out apparatus for NPOs and other charitable enterprises. b. For For-Profit Enterprises (FPEs) Equity Issuance: – For FPEs, the issuing of equity through SSE will be the significant source of unlocking the funds from investors, subject to minimum reporting standards. It is akin to SEBI’s Innovators Growth Platform (IGP), which provides a separate locus for start-ups with its listing preconditions. Social Venture Funds (SVFs): – FPEs already deal with SVFs for its funding, with no social impact reporting. However, in SSE, these FPEs are subject to minimum reporting standards while raising funds through the channel of SVFs and other AIFs.   II. A Setout to Revamp the CSR The Report proposes to get rid of the requisite enrolment of Section 8 enterprises for Corporate Social Responsibility (CSR) commitment under the draft of CSR Policy Amendment Rules, 2020. However, in SSE, the listing of  NPOs on the SSE or the existence of recipient NPOs in the SSE catalog will be adequate for setting up the validity of transactions. The CSR capital must be permitted to pile-up in an escrow account for three years. Further, if the CSR funders observe that the NPO has achieved its outcome, then they unlock the CSR capital from the escrow account and repay the partial amount to the interim funding partner for recovering the latter’s cost for executing the program. The residual amount in the escrow account will get transferred to the NPOs in the form of accelerator grants. If the CSR funders feel that the NPOs have not accomplished the social outcomes, then following the same, the said account will get liquidated, and the CSR capital will get utilized under Schedule VII of the Companies Act, like PM’s Relief Fund, etc. Moreover, the SEBI board prescribes that the Ministry of Corporate Affairs (MCA) should be permitted to approve the dealings of CSR capital between companies with surplus CSR funds and those who have a scarcity of CSR funds. Even the expenses incurred by various companies for capacity strengthening of SSE will also be considered as CSR handouts by altering Schedule VII of the Companies Act. III. Make A Killing Via Taxation Policy The Working Group (WG) has proposed to allow various tax-benefits to every player who will be part of the SSE transactions. The Committee believes that such tax-benefits will act as a spur for all the players. The Report commends for the same as follows: – The WG has suggested allowing donors

[By Aayush Khandelwal and Abhinav Gupta] The authors are students at National Law University, Jodhpur. Introduction Valuation of share during an open offer has been a constant subject of disputes. The acquirer and shareholders are often at loggerheads in relation to the offer price. Where the acquirer seeks to reduce its cost of acquisition, shareholders seek to extract most out of the exit opportunity.  This has led to multiple instances where the offer price was challenged by the shareholders before the Securities and Exchange Board of India (‘SEBI’). In this article, the authors seek to explore this conundrum surrounding the valuation of shares (offer price) during open offers. In doing so, we discuss the process of valuation of shares in case of open offers. Moreover, we discuss some recent cases where the valuation was challenged by the shareholders, and the price was revised by the regulator. Towards the end, we propose certain changes that can be accommodated in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (‘Takeover Regulations’) to provide better protection to shareholders. Process of Offer Price Determination In case of acquisition of control,[i] or voting rights beyond the prescribed limit in a company,[ii] the acquirer has to provide an exit opportunity to the shareholders of the company. The price of the open offer has to be determined in accordance with Regulation 8 of the Takeover Regulations. The above-mentioned Regulation categorizes the shares into two categories to calculate the offer price. One category is of the shares which are frequently traded on the stock exchange, and the other category is of shares that are infrequently traded on the stock exchange. The shares of a company are considered as frequently traded when the traded turnover of the company on the stock exchange in the last one year is more than ten percent of the total shares of the company.[iii] There arises no difficulty in determining the offer price of the company whose shares are frequently traded as it is determined from the stock trading data of the company.[iv] Whereas, a difficulty arises in determining the offer price of the company whose shares are not frequently traded. The merchant banker, to determine the offer price, is required to take into consideration certain factors such as book value, comparable trading multiple, or parameters as are customary for the valuation of such companies.[v] Book value is not useful for companies that have human capital as a primary asset. Further, the book value of a company can reduce during the time of recession. Therefore, the methods prescribed under the Takeover Regulations for such companies may not give the accurate value of the shares. In such circumstances, the SEBI has the power to appoint an independent merchant banker or chartered accountant to determine the valuation of shares.[vi] There have been many instances where the SEBI has appointed independent valuers to determine the fair price of a share and has directed the acquirer to revise the offer price accordingly. Challenges to Offer Price In this section, we have discussed certain recent cases where the shareholders have challenged the offer price provided by the acquirer. A leading case on the issue regarding the determination of the offer price is Tenneco Inc. v. SEBI,  before the Securities Appellate Tribunal (‘SAT’). In this case, Tenneco Inc. indirectly acquired Federal-Mogul Goetz (India) Limited, whose shares were infrequently traded. The acquirer appointed two valuers that determined the fair value per share at INR 372.10 and INR 397.66. Accordingly, the acquirer made an open offer with an offer price of INR 400 per share. Later, SEBI appointed a chartered accountant for the computation of the fair price of the share, per the powers conferred upon it by the Takeover Regulations. SEBI directed Tenneco Inc. to revise the offer price to INR. 608.46. Aggrieved by the direction of SEBI, the acquirer filed an appeal before the SAT. The SAT dismissed the appeal and upheld the direction of SEBI. Another instance where the open offer price was challenged was the merger of Praxair Inc. and Linde AG which triggered an open offer for the shareholders of Linde India Limited. Upon failure of the delisting offer, the acquirer commenced the open offer again and appointed a merchant banker to determine the offer price as the shares of the company were infrequently traded. The merchant banker arrived at a valuation of INR 276.09 per share. Later, SEBI appointed an independent chartered accountant to determine the fair price of the equity shares of the company. The valuer appointed by SEBI arrived at a valuation of INR 376.63 per-share value of the company. Recently, an indirect acquisition of ABB Power Products and Systems India Limited has triggered an open offer under the Takeover Regulations. The shares of the company were not frequently traded on any stock exchange, as the offer was announced on the day the company got listed. Accordingly, the independent valuers appointed by the acquirer have determined INR 851 per-share value of the company. Reports suggest that SEBI is scrutinizing the price offered by the acquirer and examining whether the valuation is fair for the investors. It remains to be seen whether SEBI will appoint an independent valuer to protect the interest of the investors. Way Forward Increasing the role of directors and appointment of independent adviser: One major reform in the valuation process during open offers could be providing clarity with respect to the role of directors during a takeover bid. Currently, only a committee of independent directors of the target company has to provide ‘reasoned recommendations’ on the open offer.[vii] Even the role of the board of directors (‘BoD’) is very limited to facilitating the verification of shares,[viii] and providing information on competing offers to shareholders.[ix] In our opinion, current provisions are ambiguous and do not ensure optimum protection to the shareholders. The regulator should consider providing more elaborate criteria for assessing an open offer by independent directors and increase the duty of BoD. We believe that changes can be made

[By Deepanshu Agarwal] The author is a student at the University of Petroleum & Energy Studies (UPES), Dehradun In July 2020, the Securities & Exchange Board of India (SEBI) notified the Investment Advisers (Amendment) Regulations to bring some regulatory changes to the Investment Advisers Regulations, 2013 (the Regulations). SEBI received a plethora of complaints from the investors regarding the malpractices done by the investment advisors (like charging excess fees, making fake promises for higher returns, non-disclosure of the complete service fee, extracting money in the name of various charges) due to which it became necessary to bring these changes. Thus, the main objective behind this new regulatory amendment is to give primary importance to the interest of investors over the interest of the investment advisors (IAs). As per regulation 2(m) of the  Regulations, ‘investment adviser’ means any person, who for consideration, is engaged in the business of providing investment advice to clients or other persons and includes any person who holds out himself as an investment adviser, by whatever name called. Investment advice in this regard means advice relating to investing in, purchasing, selling, or otherwise dealing in securities or investment products, and advice on investment portfolio containing securities or investment products for the benefit of the client (regulation 2(l)). Putting it in simpler terms, investment advice means advising the client regarding the best suitable investment options he can avail, by looking at his risk appetite and long term goals. With this backdrop, this post analyses the key highlights of the new amendment brought by SEBI and the way it affects the advisory market in India. Segregation of Advisory and Distribution Services Advisory service refers to the investment advice given by the IAs to the clients, whereas distribution service refers to making a product (or a scheme) available to the clients. Prior to the amendment, individual and partnership firms were not allowed to provide distribution service along with the advisory service. Only banks, NBFCs, and corporate entities (Non-individual entities) were authorized to do so subject to the condition that the IA shall maintain an arms-length relationship between its activities as an investment adviser and distribution services. This had to be achieved by ensuring that in such cases, the investment advice is given through the Separate Identifiable Division or Department (SIDD). According to the new amendment in Regulation 22 of the Regulations, non-individual entities are now required to segregate the advisory and distribution services at the client level itself. This means that even though such entities have different departments for both the advisory and distribution services, they cannot provide both of these services to a single client. An Individual adviser, on the other hand, shall have the option to register as an IA or provide distribution service as a distributor. This change brought by SEBI is a positive step towards ensuring the protection of investors. An investment adviser should act in the best interests of his/her/their clients when providing advisory services and should disclose to the client any actual or potential conflicts of interest. Due to the multiple roles played by the entities, it was necessary to segregate both the activities so as to minimize any such conflicts. This segregation will ensure the availability of complete information with the clients and the same may result in informed investment decisions by them. Moreover, there may be cases where the IAs distribute products on which they could earn higher commissions, thus leading to a serious conflict of interest with the client’s goals. In such cases, the advice given by the IAs may not be in the best interest of its client. Therefore, in order to tackle this issue arising out of the dual roles played by the IAs (both as adviser and distributor), it was imperative to segregate both the activities. No Consideration for Implementation Services Prior to the amendment, it was observed by SEBI that the IAs were charging extra consideration from the clients in the name of implementation (execution) fees. This practice followed by the IAs has been banned by SEBI. Now, the IAs are allowed to provide the implementation services only through direct schemes/products, without charging any consideration for the same. Agreement Between Investment Adviser and Client Unlike the erstwhile regulations, the requirement of an advisory agreement between the client and the adviser has been made mandatory by the new amendment. This will make the clients aware of the terms and conditions, provide transparency in the process, and would also ensure that the clients are able to prove their claim and exercise their rights with much ease. Fees As per the code of conduct specified under the Regulations, the IAs were required to charge a fair and reasonable fee for the advisory services given to its clients. There was no cap upon the fees to be charged and thus the amount of ‘reasonable fee’ was kept subjective. Thereafter, SEBI received more complaints from the investors regarding exorbitant fees charged by the IAs. In order to solve this issue, SEBI has prescribed two ways to calculate the amount of fees. IAs can charge either 2.5% of ‘Asset under Advice’ (AUA) or a fixed fee of INR 75,000 per annum. As per the regulation 2(aa) inserted by the new amendment, AUA means the aggregate net asset value of securities and investment products for which the investment adviser has rendered investment advice irrespective of whether the implementation services are provided by an investment adviser or concluded by the client directly or through other service providers. Practically, this model is very difficult to follow. There are certain portfolios that contain high-risk products that require more skills and essential time to provide any investment advice. These cases are to be treated differently, and therefore, fixing a maximum ceiling to be followed in every case may not be a good option. Net Worth Before the amendment, the IAs which are body corporate were required to have a net worth of not less than twenty-five lakh rupees and IAs who are individuals were required to have

[ By Tushar Oberoy] The author is a student at NALSAR University of Law, Hyderabad. Last year, the Securities and Exchange Board of India (SEBI) introduced the informant mechanism for insider trading violations. The mechanism incentivizes whistleblowers by rewarding them with monetary sums in exchange for their knowledge of insider trading violations.  This step by the securities market regulator is inspired by the US Securities & Exchange Commission’s (SEC) whistleblower bounty program incorporated under the Dodd-Frank Wall Street Reform and Consumer Protection Act[i]. Since then, several concerns have been raised regarding the SEBI’s informant mechanism like maintenance of confidentiality, increment in the probability of frivolous complaints, etc. Apart from these, one of the concerns that arise is what will be the effect of incentivizing whistleblowers on the internal corporate compliance programs implemented by companies for tackling and preventing such violations at the internal level. This has also been pointed out in the SEC’s whistleblower bounty provisions and this post aims at analyzing the same in the Indian context. Issue: SEBI’s informant mechanism is based on giving monetary incentives to people, who may be privy to insider trading violations, to come forward and report them to SEBI. Considering the fact that a company’s employees are most likely to know of any insider trading activity by the management, incentivizing them to come forward will also help SEBI to achieve its objective of tracking down insider trading cases. However, companies are also mandated to implement internal compliance programs for curbing insider trading by implementing checks and reporting to SEBI in case of a breach. [ii]. These internal compliance programs also require companies to frame a whistleblower policy to enable employees to report a leak of unpublished sensitive information (UPSI) or any violation internally[iii]. Since the informant mechanism gives monetary incentives to informants, an employee is more likely to report a violation directly to SEBI’s informant hotline, rather than making use of the internally established structures. Moreover under Regulation 7B of SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations), an informant is rewarded only if he provides SEBI with “original information”[iv]. One of the important features of “original information” is that the Informant should be the sole source of information for SEBI and SEBI should not have knowledge of the insider trading violation from anywhere else[v]. Thus, employees who come to know of any insider trading violation in their organization would be in a race to first report the information to SEBI for successfully obtaining the reward. The implications of this would be that companies wouldn’t get a fair chance to self-investigate and self-report the violation to the market regulator, which goes against the crucial objective of developing a corporate compliance program. Carrying out an internal investigation of the alleged violation would also become difficult, as companies will not receive the required cooperation from its employees who might have crucial information regarding the breach. There are also cases where there may be a lapse from the side of the company itself (eg. failure to close the trading window, non-disclosure of the required information, etc.) that amounts to a violation of the PIT Regulations. Due to a lack of cooperation from employees, companies might not be able to self-report, self investigate and assist SEBI in probe of any alleged breach. A probable consequence of this would be that mitigating circumstances for determining settlement amounts under SEBI (Settlement Proceedings) Regulations, 2018[vi] (example- applicant’s conduct during the investigation) would become inapplicable to them. This would result in higher settlement amounts being passed against them if they choose to settle the matter with SEBI. From the above, it can be seen that the informant mechanism might undermine companies’ internal compliance programs, as the informant’s and the companies’ objectives will be at crossroads. Undermining of internal controls would also render useless the effort and monetary investment that a company had made for developing such institutional compliance programs. However, another question, equally pertinent that arises is whether such internal programs can be completely relied upon by SEBI for the prevention of insider trading or are external checks like the informant mechanism needed despite institutional controls. Can companies’ internal compliance programs and processes be sufficiently relied upon to curb insider trading? Observations from the Whatsapp Leak Case: One of the foremost failures of internal checks and compliance programs in matters of insider trading can be seen from the Whatsapp leak case. In this case, UPSI in the form of financial results of various companies was circulated through Whatsapp before they were publicly released. During the probe of the same, SEBI had also criticized the internal checks put in place by Axis Bank Ltd., which was one of the entities whose financial results had been leaked and also called it to improve its internal compliance mechanisms. In its order, SEBI observed that: “Such leakage is prima facie attributable to the inadequacy of the processes/controls/systems that Axis Bank as a listed company had put in place. While procurement or communication of UPSI by any person is identified as a violation of reg. 3 of PIT Regulations and section 12A(e) of the SEBI Act, it becomes incumbent upon every listed company to put in place processes/controls/systems that would ensure that such procurement or communication of UPSI does not take place.” Ineffective management of whistleblower hotlines by Indian companies: In a survey carried out by global consultancy firm Deloitte, it was found that Indian companies were merely following a “tick in the box” approach regarding the maintenance and implementation of internal whistleblower programs. The survey reported that only 68% of the firms were equipped with proper whistleblower programs/hotlines. The survey results further mentioned that in the majority of Indian companies, whistleblowing programs are often not functional, are failing to promise confidentiality to users, and are being run by without a dedicated team and mostly by persons of the human resources department. Hence, due to the casual approach adopted by Indian companies in implementing whistleblower systems, the regulator cannot expect to receive information about

[By Tanuj Agarwal] The author is a third year student of Institute of Law, Nirma University, Ahmedabad.  Introduction Covid-19 pandemic has raised serious apprehensions surrounding health and safety causing a lockdown in India.  The pandemic has caused a worldwide recession and has spooked investors’ sentiment. Prior to the coronavirus outbreak, Indian stock market was in full positive swing as Sensex and Nifty had reached their all-time intraday peak of 42,273.87 and 12,430.50 respectively in the month of January, 2020. Even after attaining such progress, Indian stock market is witnessing the most difficult period for the past few weeks. The stock market has observed lower circuit levels after 12 years on March 13, 2020. Afterwards, the equity index discerning a continuous downfall. On March 19, 2020, Sensex crashed below 27,000 and Nifty breached the level of 7,900, thereby attained their five-year closing low levels. Consequently, an approximate downfall of 37% is evident in both the equity indices within a period of just 2 months. The stock market has seen a considerable collapse due to high market volatility. This downfall has degraded the financial market and faded interest of investors and corporates. Thereby, the concern is whether such market downturn can be controlled by restricting short-selling. Short-Selling and its Impact on the Stock Market Short-selling means selling a stock which the seller does not own at the time of trade. It is a practice in which financial traders hold bets on specific shares that they expect a fall in price. A modest fee is paid to borrow some stock in the company to sell them. Further in case the market obliges, the financial trader will buy the shares at the lower price and book the profit. All classes of investors including retail and institutional investors are permitted to do short-selling. The mechanics of short-selling are such that it inflows supply of specific shares in the stock market. These are the shares which are not even owned by the supplier. Consequently, such a scenario creates an excessive supply in the stock market. Thereby, this excess supply leads to a decrement in the price of these shares to settle for an equilibrium with the demand in the market. The mechanism is at times also useful for real price discovery of overpriced share. However at the same time, excessive short selling may decrease the price more than the actual worth of the company, as apart from the business competence, the prices in stock market are highly determined by market forces.  Covid-19 and Short-Selling With the advent of Covid-19, there is shutdown of almost all cities in India. This raises serious business concerns and results in depression of various industries. Thereby, there is an apparent market expectation of fall in stock market too. In pursuance of such expectation, the market speculators are expected to do massive short-selling with a view to pocket profit in case of fall in price of shares. Consequently, the huge amount of shorting by big market players leads to decrease in price of shares in excess of what it naturally (through market forces) might have observed because of business downturn. The fall in price of shares because of business disgrace due to coronavirus is very much conceived, however the question is regarding the excessive decrease in price due to excessive short-selling. In view of corona-pandemic, market players would be very much tempted to capitalise the downfall of share price caused by business loss. Indian stock market has observed a huge short-selling in future segments of index such as Sensex, Nifty and Bank Nifty. During the last week, the net shorting in equity index reached 173,000 contracts. Moreover, foreign portfolio investors have also piloted enormous shorting in India. These investors have perceived Rs. 26.32 lakh crore of speculative volume in derivatives. Such a scenario of extreme shorting resulted in incessant fall in stock market. Ban on short-selling: A temporary yet effective solution The permanent solution to improve the market condition is to get rid of coronavirus which seems to be difficult considering the present set-up. However, effective steps are required to be taken to control the ongoing menace in the capital markets. As demonstrated that short-selling plays a vital role in downturn of equity index and leads to abnormal fall in share prices in such panic business conditions, ban on short-selling practice for the time being can be an effective solution to control the continuous drop in stock market. Short-selling market speculators worsen the general market scenario. Amid excessive panic triggered short-selling, the capitalisation on the reduction of a share value intensifies market fluctuations. Such stock market instability impersonated a serious threat to confidence of retail market players in India as shorting can surge price swings which lead to deterioration of financial markets. The ban on short-selling will help to restore steadiness in the distressed financial market. Notably, the ban can diminish the speculative hammering of the shares and consequently, to some extent, would aid in alleviating the market. Many countries such as Italy, Spain, France, and Belgium banned short-selling with a view to control the fall in their equity index. On the other hand, the U.S. has not suspended the practice of short-selling, even after observing huge market crash. The U.S. short-sellers have made a profit of $343.67 billion in a month, at the cost of public investment in such an ongoing darkened stock market. India should not adopt the U.S. approach which permits short-sellers to make profit by using excessive market volatility due to coronavirus pandemic. Increase in short-selling doesn’t indicate improvement in bearish market. This would be detrimental to public shareholders and may expose Indian stock market at risk, likewise of 2008 financial crisis. China has also wisely handled the corona-outbreak with respect to its volatility of stock exchange. China is miserably shaken by the colossal flood of cases of coronavirus, yet Shanghai Composite Index (SCE) has observed a deterioration of mere 2.53% since the first case was reported in the country. To stabilise the effect of such panic