Capital Markets and Securities Law Archives - Page 13 of 14

To Disclose or Not to Disclose: Use of TRESA in the Takeover Code, 2011

Leave a Comment / Capital Markets and Securities Law / CBCL

[By Urja Dhapre] The author is a second year student of Institute of Law, Nirma University, Gujarat. Introduction Recent trends in corporate control [i]have shown an increase in the use of unregulated Total Return Equity Swap Agreements (“TRESA”) to eschew disclosure norms while covertly building up stakes in listed companies. Regulators from around the globe are now recognizing the challenges in governance and market distortions that potentially arise from these agreements which may bestow hidden and morphable ownership in the shareholdings of a listed company. Effectively, TRESA gives the investor an upper hand in dropping a bombshell on the target company by launching a hostile takeover out of the blue. The effect of TRESA seems to be contrary to the objective behind the disclosure regulation which is not only to ensure transparency that “the target company is not taken by surprise”, but also to acquaint the shareholders of the target company about any potential change in control. This article highlights the approaches in different countries while dealing with TRESA and also visits the lacuna in Indian law pertaining to the disclosure regulation. The instrumentality of TRESA These equity swaps are over the counter equity derivatives wherein one counter-party (“short party”) pays the other counter-party (“long party”) the total return of an underlying asset/shares including income that is generated from it along with the benefits in case the price of the asset appreciates over the life of the swap. In return, the long party is obligated to pay fixed floating payments and the amount by which the asset’s value has depreciated if its price reduces over the life of the swap. Effectively, the long party gains the economic exposure of the reference asset/shares without actually owning it. Similarly, hedge funds or Foreign Institutional Investors (“FIIs”) benefit from the avoidance of transactional costs associated with equity trades along with hedging their negative returns. These swaps can be either cash-settled, i.e., any value differences at the end of the relevant period of the swap are settled in cash or can be settled-in-kind, i.e., the short party has an obligation to transfer the reference asset to the long party upon termination of the arrangement. Treatment of TRESA in other jurisdictions Conventionally, market participants in the equity derivatives markets have not held TRESA as constituting a beneficial ownership in the underlying shares, since its aim is to merely decouple the voting control and the economic exposure in respect of the underlying shares. It is not an obligation but a market reality [ii]that the short party will further buy the reference shares as a hedge against its short position. Conversely, even if the holder of TRESA does not have any legal rights to acquire the shares or control the votes of the reference shares they are still able to influence the short party. This influence is witnessed by the long party’s ability to convert these underlying shares into actual shares by unwinding the swap. The regulators on either side of the Atlantic have approached disclosure norms very differently. Taking into account the global nature of the derivative market, a more uniform approach to disclosure of these instruments is highly desirable. In the past years, this decoupling has affected takeover battles and control of public companies in inter alia the U.S., the U.K., and New Zealand. The UK amended its Disclosure and Transparency Rules [amended (“DTR”) 5R] [iii]which triggers disclosure norms when an individual holds a financial instrument which renders an economic interest over the underlying shares. The new rules require that the holding of shares and relevant financial instruments be aggregated and disclosure be made when the aggregated holdings reach, exceed or fall below 3%, 4%, 5% and each 1% threshold thereafter up to 100% (amended DTR 5.1.2R).[iv] Further, The U.S Securities and Exchange Commission’s (“SEC”) stance on beneficial ownership was brought out by the US district court’s ruling in CSX Corporation v. The Children’s Investment Fund Management (UK) LLP [v],wherein the Southern District declined to take a firm stand on whether the cash-settled, total return swaps constitute beneficial ownership, as a general matter, under Rule 13(d)-3(b) of the Securities Exchange Act, 1934, which “deems a person to be a beneficial owner if he uses any contract, arrangement, or device as part of a plan or scheme to evade the beneficial ownership reporting requirements.” Albeit, the court relied on a provision of that rule which attributes beneficial ownership of a security to any person who enters into an arrangement as part of a “plan or scheme to evade the reporting requirements of the disclosure norms”. The same was later re-affirmed by the circuit court of appeals.[vi] A diametrically opposite approach was followed in New Zealand as per the Ithaca (custodians) v. Perry Corporation’s[vii] case. The court here discussed in detail about the market reality of the short parties hedging their position which can bring the target company within the reach but not under the control of the long party. It held that such a reality does not constitute an agreement or understanding between the two parties and therefore, the long party will not come under the purview of disclosure norms. However, due to the paucity of evidence, the magnitude of this problem in New Zealand has not yet been raised, but the panel is still considering amendments in the present disclosure norms. TRESA in the Indian context Under the Indian securities laws regime, disclosure norms are triggered under the helm of Regulation 29(1) [viii] of SEBI Substantial Acquisition of Shares and Takeovers, 2011 (“Takeover Code”). Regulation 29(1) of the Takeover Code requires the acquirer with an individual or combined shareholding with Persons Acting in Concert (“PAC”) of 5% or more in the target company to disclose these shareholdings. This regulation can be traced back to the Takeover Regulation Advisory Committee (“TRAC”) report [ix]which laid the foundation of the Takeover Code, 2011. The committee’s intent was to distinguish between the disclosure requirement of an individual holding and a group/concerted holding of any security or instrument that would entitle the acquirer to receive shares in

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The Curious Case of Karvy: SEBI’s Tale of Investor Protection?

Leave a Comment / Capital Markets and Securities Law / CBCL

[By Arnav Maru] The author is a fourth year student of Maharashtra National Law University, Mumbai. Background Karvy Stock Broking Limited (“Karvy”), a registered stockbroker, recently found itself in the crosshairs of the Securities and Exchange Board of India (“SEBI”) for perpetrating one of the biggest cases of financial misconduct involving misuse of client securities. Karvy was founded in 1995 with its head office in Hyderabad and had a net worth of over Rs. 650 crores as of March 2019. It served over 12 lakh clients, of which at least 300,000 were active clients. The fraud affected around 95,000 of its clients and involved a massive sum of Rs. 2,300 crores. While the fraud in question is not the first of its kind, the sheer magnitude of the amount involved makes it extremely relevant. This post will talk about the fraud under three major headings: understanding the law involved, how this law was subverted in the present case, SEBI’s action, and its effect on the various stakeholders. Understanding the law involved Put briefly, Karvy misused securities lying in dormant and unpaid accounts of its clients to pledge them with five lenders to secure loans of Rs. 2400 crore. This transaction was executed through a misuse of the power of attorney granted by clients in favour of Karvy. Securities of clients availing the margin trading facility with Karvy were majorly affected. A brief overview of the law regulating the use of power of attorney and the securities held in unpaid and margin trading accounts is outlined in the following paragraphs. A power of attorney (“PoA”) is executed by the client in favor of the stockbroker/depository participant to authorize the broker to operate the client’s demat account and bank account to facilitate the delivery of shares and pay-in/pay-out of funds. This may be a general PoA (one that grants a blanket authority), or a specific one (only confers authority for limited and outlined purpose). The PoA provided to brokers is specific and is for the trade settlements. Its use is limited to the transfer of securities from the demat account of the client for authorized purposes. SEBI, in its circular dated April 23, 2019 [i] laid down guidelines for the execution of PoA by the clients in favour of the stockbroker after noting irregularities and misuse of the document. Brokers were mandatorily asking clients to execute irrevocable and general PoAs in their favour, and then using them to execute unauthorized trades in their client’s names. SEBI mandated brokers and depository participants to comply with the guidelines laid down. SEBI limited the scope of the PoA to, first, the transfer of securities held in the beneficial owner account of the client towards stock exchange related margin and delivery obligations, second, pledging of the securities in favour of stock broker for the limited purpose of meeting the margin requirements, and third, to apply for various products like mutual funds, public issues, rights, etc. pursuant to the instructions of the client. Furthermore, it explicitly prohibited PoAs that facilitated off market trades, a charge that Karvy has been found guilty of. The usage of pool accounts and margin trading facility is common practice in the securities market. A pool account is a demat account of the stockbroker, which is used to facilitate pay-in and pay-out obligations. A pool account of a brokering firm typically includes unpaid securities (brought using a margin and not yet paid for by the client) and securities brought by clients not yet transferred to their demat accounts. When a client makes a purchase of shares, the clearing corporation sends it to the pool account of the broker, who has to then transfer it to the demat account of the client as per prevailing SEBI guidelines. Lastly, a margin trading account is one where the broker lends money to the client to enable him to purchase shares. This loan is collateralized by the shares that the client purchases, and comes with a periodic interest rate. The amount that the broker lends to a client may come from a bank that lends money to the broker. Client’s shares pledged with the broker could be validly pledged with the banks as a security until recently. SEBI, vide its circular dated June 20, 2019 [ii] restricted brokering firms from pledging client securities as collaterals even with a due authorization from the client. The most serious wrongdoing on part of Karvy was an illegal pledging of this sort. Facts of the case The National Stock Exchange (“NSE”) conducted a limited purpose inspection of Karvy upon noticing certain irregularities in pledging of client securities. This inspection was conducted on August 19, 2019 for a period starting from January 1, 2019 and a preliminary report was submitted to SEBI on November 22, 2019. SEBI, on the same day, through whole time member Anant Barua, pronounced an order [iii] highlighting the findings of the report and the entire misfeasance by Karvy. The first fault noticed by NSE on part of Karvy was the non-reporting of a depository participant account in its filings. Second, Karvy transferred the funds raised by pledging client securities to six of its own bank accounts, rather than the accounts of its clients, and further did not report these six accounts as it was required to. The order stated that the securities pledged by Karvy to the lenders belonged to its clients and therefore should not have been pledged as collaterals. SEBI highlighted a series of circulars that lay down client securities are not be used for any purpose other than for meeting client margin requirements. As stated earlier, this position was further made stringent when any pledging of client securities was barred, even with an express permission from the client. How do PoAs and the use of margin trading and pool accounts fit into the above stated facts? As is the business practice, and as has been highlighted above, the securities brought by clients are first transferred into the pool accounts of the stockbroker and then subsequently into

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The Constitutional Validity of SEBI’s Search and Seizure in the ‘Whatsapp Leak Case’

[By Aditya Anand] The author is a Third Year student at NLU, Delhi. He can be reached at aditya.anand16@nludelhi.ac.in Towards the end of 2017, Reuters published a news report[i] in which it claimed that three days before Dr Reddy’s Laboratories Ltd announced quarterly results, a message was circulated on the popular social media platform, ‘WhatsApp’, stating that the company would be reporting a loss which in time proved to be true. In furtherance to the above-made claim, it named at least 12 more companies in which prescient numbers related to their financial results, and due for announcement were shared by the users on some of the WhatsApp groups. These 12 companies involved names like – HDFC Bank, Axis Bank, Tata Steel, Mahindra Holidays, to name a few[ii]. This lead to Securities and Exchange Board of India (“SEBI”) conducting an investigation which led to a search being conducted on 31 brokers and analysts in Mumbai, Delhi and Bangalore, by a team of 70 SEBI officials and they ended up seizing devices such as mobiles, laptops, computers and other documents with the intention of accessing the WhatsApp and other social media accounts, as well as the data that was stored in these devices.[iii] This was done because the leakage of the figures which were not yet declared by the Company, fell under the category of ‘unpublished price sensitive information’ and was in contravention of Regulation 3 of the Prohibition of Insider Trading Regulations, 2015 which states that no insider shall communicate, provide or allow access to any unpublished price sensitive information, relating to a company or its securities unless it is in furtherance of legitimate purposes, performance of duties or for discharging of legal obligations.[iv] Further Section 12A (d) and (e) of the SEBI Act[v] bars any person from indulging in insider trading and dealing with securities while being in possession of material or non-public information and also bars the person from communicating such information. Thereby, SEBI conducted an inquiry in this matter and even asked WhatsApp to share the specific data[vi], which was required in order to trace the origin of such messages that allegedly contained the Unpublished Price Sensitive Information and was crucial for the market regulator, in order to further its investigation. To SEBI’s disappointment, WhatsApp declined the same, citing its privacy policy[vii]. This entire incident was labelled as the ‘WhatsApp Leak Case’, but the real question that arises is whether this seizure of smart-phones can be justified or not, especially with the emerging jurisprudence of data security and privacy. The seizure of smartphones can be termed as a violation of the Fundamental Rights granted under Part III of the Constitution. Many experts argue that there is an urgent need to ensure that the privacy of the citizens is accorded and respected especially in this new and ever-growing era of cyberspace. The same has been opined by the Supreme Court in the case of Justice K.S. Puttaswamy (retd) and Anr v Union of India[viii] where the court opined that, ‘The existence of zones of privacy is felt instinctively by all civilized people, without exception. The best evidence for this proposition lies in the panoply of activities through which we all express claims to privacy in our daily lives. We lock our doors, clothe our bodies and set passwords to our computers and phones to signal that we intend for our places, persons and virtual lives to be private.[ix]’ In the same case, the Supreme Court held that the right to privacy is protected as an intrinsic part of the right to life and personal liberty under Article 21[x] and is guaranteed by the Part III of the Indian Constitution. Various legal systems around the world have prevented the attempt to extract such passwords or to gain access to the personal devices as an invasion of privacy and the United States Supreme Court in the case of Riley v California[xi] held that ‘a cell phone is unlike a physical lock box and is in a sense the extension of the person to whom it belongs as it is a vast repository of information pertaining to its owner.[xii]’ Therefore in the light of emerging jurisprudence relating to privacy, SEBI’s power to seize smart-phones and other electronic devices can be questioned. In addition to that, in the case of Indian Council of Investors v Union of India[xiii], SEBI had asked for the Call Data Records and the details related to the location of the towers from the telecom service providers in order to investigate a matter. The same was challenged but however, allowed by the Bombay High Court with a caveat that such a power should be used ‘carefully’[xiv] as it can lead to a situation wherein the privacy of a citizen can be compromised and stated that certain safeguards should be there in order to ensure the same. Talking about another Constitutional Law facet, Article 20 (3)[xv] guarantees protection against self-incrimination which basically means that no man, not even the accused can be compelled to answer any question, which may tend to prove him guilty of any crime, he is accused of. The concept of ‘personal knowledge’ was introduced in the case of State of Bombay v Kathi Kalu Oghad[xvi] and applying the same concept, it can be asserted that passwords, pass-codes etc. required in order to unlock such devices can be said to be a part of the personal knowledge of any given person, which he or she is not required to divulge during the course of investigation. But the real issue that exists is the absence of proper statutory framework, for the purpose of regulating the conduct of the social media platforms as observed by the Delhi High Court in the case of Karmanya Singh Sareen and Ors v Union of India[xvii]. Later the Supreme Court also constituted a committee of experts in the same case, under the leadership of Justice B.N. Srikrishna, to identify key data protection issues in India and to recommend methods for addressing the

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The curious cases of L&T, Jet and Renuka Sugars & Indian regulators’ overbearing interference

1 Comment / Capital Markets and Securities Law, Contemporary Issues / CBCL

[By Rohan Kohli] The author is a 5th year student of NLIU Bhopal and the Co-convenor of CBCL. The Indian corporate story that took off in the 1991 liberalisation reforms to its success today has had a great part to thank the paradigm shift in the Indian regulatory behaviour. From the License-Raj era protectionist and red-tape bureaucracy to today’s times where the regulators actively engage in consultations with stakeholders, the Indian regulator has morphed into a modern beast that has by and large kept in-tune with the changing times, even if a little belatedly. However, a slew of recent examples in the past few months has threatened to undo these years of liberal outlook that the regulators have developed at great pains. I will analyse three such recent examples playing the devil’s advocate to the regulators. Larsen & Toubro (L&T), which is currently in news for a hostile takeover bid by one of its subsidiary L&T Infotech in IT company Mindtree, was earlier also in news for a stunning derailment of its ambitious buyback attempt. L&T Board on 23 August 2018 approved a buyback proposal of 4.29% of its shares amounting to INR 9000 crore, the first in the company history. [1] The draft letter of offer was submitted to SEBI, which inexplicably took 102 days to reject this buyback proposal with the reason that the post-buyback debt-equity ratio would exceed 2:1. [2] This decision has taken the corporate world by surprise and been widely criticized by foreign and Indian media alike, the unanimous opinion being that the regulator erred in its opinion. The reason why this is being questioned is because neither section 68, Companies Act, 2013 nor SEBI Buyback Regulations make any mention of whether the consolidated group financials or the standalone financials of the entity be taken to calculate the ratio of secured and unsecured debts vis-à-vis paid-up capital and free reserves (which both mandate it to be maximum 2:1). SEBI took the former approach – where L&T Financials (one of the group companies), which has a debt-equity ratio of 6:1, brings the group’s debt-equity ratio to above 2:1 both pre and post-buyback – which is a very strict and literal interpretation and contrary and singularly opposite to its past practice. L&T has accordingly filed for a review of the decision instead of approaching SAT. If this does not fall through, L&T may have to go ahead with a special dividend to return money to its shareholders, which attracts significantly higher tax implications. The troubled aviation giant Jet Airways recently saw a resolution plan under the 12 February RBI Circular [3] with equity infusion for the lenders and exit of its promoters and other management (nominee of Etihad Airways) from the Board. [4] While it promises to be a close-knit fight now for the company once the bidding deadline are invited on 9 April as banks exit the company, [5] this entire process could have been pre-empted if not for the regulators’ hawkish and unyielding stance. When the first reports of Jet’s troubles began to emerge, it was Etihad who was expected to step in and assume the majority of the equity in Jet by increasing its 24% (at that time) stake. But SEBI’s move to deny open offer exemptions changed the story and finally pulled the plug on Etihad’s plans. SEBI declared that any exemptions from applicability of conditions for preferential issue and making a mandatory open offer under Takeover Code for corporate debt restructuring made other than under IBC, will only be given to banks and financial institutions. [6] This effectively removed Etihad’s option of seeking an open offer exemption by referring to SEBI under Regulation 11 of the Takeover Code. Further, SEBI also removed any exemptions pursuant to scheme of arrangement pursuant to order of competent authorityunder any law, removing Etihad’s option of seeking open offer exemption under Regulation 10 (1) (d) (iii). The latter seems to be a belated admission of SEBI’s earlier mistake to SpiceJet’s open offer exemption done under similar circumstances in 2015 that brought Ajay Singh in majority of the company. [7] SEBI’s present move makes it difficult for Etihad to even make a future bid for Jet Airways, since the FDI Policy allows for a maximum of 49% FDI under automatic route [8]. This would mean that Etihad cannot make an open offer for singlehandedly replacing the lenders (since 26% offer beyond the threshold of 24% would breach the 49% mark), and thus Etihad would have to make a joint bid with another Indian entity to keep them with in the 49% mark. If Etihad would still want to make an individual bid without attracting open offer obligations, they would have to structure the transaction as an internal corporate restructuring under Section 230, Companies Act which would mean seeking approval of NCLT and fulfilling the condition of a scheme of arrangement pursuant to order of Tribunal under Regulation 10 (1) (d) (iii). [9] All this process could have been pre-empted if not for SEBI’s outdated approach in this regard. This entire process of lenders’ having to take up equity, then opening up bids would not have been needed to be done in the first place if Etihad would have been allowed to increase its stake, saving substantial amount of time and legal and economic costs. However, we will see in the example below that another regulator may make it even more difficult for Etihad to do this. Renuka Sugars is another classic ongoing case that continues in the same vein of regulatory overreach as above. Shree Renuka Sugars was a company undergoing debt restructuring in 2018, in Wilmar Sugar Holdings increased its stake from 27.24% to 38.57% as part of the restructuring process and finally to 58.34% through an open offer. [10] Interestingly, this restructuring was done after the 12 February 2018 RBI Circular came into force, which mandates all accounts above INR 2000 crore (the present case falls under this bracket) and where restructuring may have been initiated under

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Analysis: SEBI (Settlement Proceedings) Regulations, 2018

Leave a Comment / Capital Markets and Securities Law / CBCL

[ Debayan Gangopadhyay ] The author is a 3rd year student of ILS, Law College. Introduction Settlement Proceedings in relation to violation of provisions in securities laws have been conducted under a mechanism by the Securities Exchange Board of India (“SEBI”) since 2007. The last legislation on settlement proceedings was stipulated by SEBI in 2014[i]. The said regulations apart from giving SEBI other powers of initiating proceedings on its own, also gave it the power to initiate settlement proceedings. However, to quantify the number of settlement cases more, a committee was set up by SEBI as the Justice Anil Dave Committee (“Committee”). The committee submitted its report in December, 2017 pursuant to which the SEBI notified the SEBI (Settlement Proceedings) Regulations, 2018 (“Settlement Regulations”) on 30thNovember, 2018 which are effective since 1stJanuary, 2019. The Settlement Regulations are the first piece of legislation in securities laws in India solely created for the purpose of regulating settlements in cases. These regulations provide for new scope in different factors of settlement proceedings and if implemented properly, is quite beneficial for the entire procedure. This article will discuss and review certain key highlights of the Settlement Regulations which provide for wider scope and sophisticated methods in settlement proceedings. “Securities Laws” and “Specified Proceedings” re-defined Securities Laws under the previous SEBI regulations on settlement proceedings[ii]had only given scope to the SEBI Contract (Regulations) Act, 1956 and Depositories Act, 1996. These regulations widen the scope by defining “Securities Laws” as: “securities laws” means the Act, the Securities Contract (Regulations) Act, 1956 (42 of 1956), the Depositories Act,1996 (22 of 1996), the relevant provisions of any other law to the extent it is administered by the Board and the relevant rules and regulations made thereunder;[iii] By adding “any other law”, the Settlement Regulations provide for the inclusion of other laws as well in relation to securities laws. There is an explicit recommendation of the Committee in the draft Settlement Regulations to include the contravention of the provisions of any other law (such as Companies Act, 2013) to the extent it is administered by the Board within the definition of ‘securities laws’ in the regulations, in order to settle any matter under the securities laws.[iv]This clause has widely increased the ambit of applicable laws to these regulations. Further, “specified proceedings” in the Settlement Regulations have been defined as: “specified proceedings” means the proceedings that may be initiated by the Board or have been initiated and are pending before the Board or any other forum, for the violation of securities laws, under Section 11, Section 11B, Section 11D, sub-Section (3) of Section 12 or Section 15-I of the Act or Section 12A or Section 23-I of the Securities Contracts (Regulation)Act, 1956 or Section 19 or Section 19H of the Depositories Act, 1996, as the case may be;[v] The definition provides for scope to cases which are pending before the SEBI Board or any other forum which is an effective tool to quantify settlement proceedings. The scope of pending cases has been re-iterated in further regulations of the Settlement Regulations. The Settlement Regulations have further introduced a new term called “settlement schemes”. SEBI shall specify the procedure and terms of settlement of specified proceedings under a settlement scheme for any class of persons involved in respect of any similar defaults specified. A settlement order issued under such a settlement scheme shall deemed to be a settlement order under the regulations.[vi] Also, the terms of settlement may include monetary or non-monetary terms or a combination of the two. This is given under Chapter IV of the Settlement Regulations.[vii]Non-monetary terms may include suspension or cessation of business activities for a specified period, disgorgement on account of the action or inaction of the applicant, exit from the management of the company, submit to enhanced internal audit and reporting requirements, locking – in securities, etc.[viii] Confidentiality The Settlement Regulations provide for the scope of seeking confidentiality on the proceedings before the SEBI Board. The Committee recommendations in the draft regulations provide for a chapter similar to the practices of securities regulators globally and that provided in the Competition Commission of India (Lesser Penalty) Regulations, 2009 for “settlement with confidentiality” to any person that provides material assistance to the Board in its fact-finding process and proceedings.[ix]The said provisions are given under Chapter IX of the Settlement Regulations. These lay down the factors essential to the entitlement of confidentiality and the procedure thereof. As observed time and again, most of the provisions in SEBI have been adopted from US laws. The insertion of provisions dealing with confidentiality have been adopted though an understanding from the US Securities Exchange Commission and the Competition Commission of India. According to the regulations, such privilege of confidentiality shall be provided to such applicants who agree to provide “substantial assistance in the investigation, inspection, inquiry or audit, to be initiated or ongoing, against any other person in respect of a violation of securities laws”. However, the application herein shall be considered only in cases prior to or pending investigation, inspection, inquiry or audit.[x] Limiting the scope of settlement proceedings There are provisions in the new Settlement Regulations which deny settlement proceedings to certain categories of individuals under Chapter III which talks about the scope of settlement proceedings. Regulation 5 (2) lays down factors affecting which an alleged default will not come under the scope: (2) The Board may not settle any specified proceeding, if it is of the opinion that the alleged default, – has market wide impact, caused losses to a large number of investors, or iii. affected the integrity of the market.[xi] Similar restriction is provided for where the applicant is a wilful defaulter, a fugitive economic offender or has defaulted in payment of any fees due or penalty imposed under securities laws.[xii]The earlier regulations provided that breach of laws governing insider trading, fraudulent and unfair trade practices shall not be considered for settlement. However, in the Settlement Regulations, the scope of the settlement has been limited to

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Time to Allow SEBI to Wiretap?

Leave a Comment / Capital Markets and Securities Law / CBCL

[Karan Yadav] The author is a 4th year student of GNLU, Gandhinagar Introduction India is seeing a rise in the number of insider trading cases. Even the top blue chip firms are struggling with the leak of such sensitive information by some or the other source. This includes companies like ICICI Bank, Axis Bank, Videocon, Sun Pharma, Tata Motors and many more. Securities Exchange Board of India (SEBI) was constituted in the wake of the Harshad Mehta Scam in 1992. The powers conferred to SEBI was a result of analysis of different Securities Market Watchdogs all over the world especially the US’s Security Exchange Commission (SEC). However, from the day of its inception, SEBI has been criticized for its failure to investigate and prosecute perpetrators of insider trading in India. If we look at the number, the convictions pronounced in such cases of Insider Trading are very low. This is because of a number of limitations that SEBI is facing in bringing such perpetrators to book. It is known that the white collar crimes often need a solid string of evidences which can prove intention of the wrongdoer. The best way that this can be proved in the cases of insider trading is if the sensitive information being passed on is itself intercepted by the authorities. This tool is a long shot for SEBI as for a number of years, it has been deprived of a number of investigative privileges. The malpractices of insider trading are not new to India, but still SEBI lacks basic powers like the power to call in for phone records. It took a USD 6 billion scam for legislators to realize this and bestow the power to SEBI. Hence, only after the aforementioned Saradha Scam of 2013, Parliament through an ordinance amended the Securities Laws (Amendment) Act, 2014[i]and this certainly was a welcome move in order to bring SEBI’s power at par with other regulators all over the globe. As far as the concept of phone tapping is concerned, in India, as per the Indian Telegraphic Act, 1885, both the Central and State governments have the power to tap phones. When any authority of the governments seek to do so, Home Ministry’s or State Home Secretary’s prior approval is needed. This was challenged in the Apex Court of being violative of a number of fundamental rights, but the court still upheld the legislation citing nation’s security as one of the reasons why it cannot be scrapped off in entirety. Though the admissibility of such records in the courts is still unclear, the Courts have certainly asked the authorities to use the power as a last resort and sparingly. There are a number of authorities such as Crime Bureau of Investigation, Intelligence Bureau, etc. which have such powers in place to collect evidences, but SEBI is yet to be conferred with the same. SEBI has been requesting government to allow it to wiretap in order to improve the conviction rates, but time and again it has been denied to do so. In 2012, the then SEBI Chairman U.K. Sinha requested the government to grant them such powers, but they were denied and informed that SEBI has investigative powers of a civil court and hence does not possess power to wiretap[ii]. More recently in 2018, a SEBI committee headed by Dr. T.K Viswanathan suggested want of sweeping reforms to the watchdog which included powers to intercept calls in order to aid investigations.[iii]The committee has suggested for direct call interception powers akin to the Central Board of Direct Taxes. This will also help SEBI collect strong evidence against repetitive offenders in cases of insider trading, front running or market manipulation. While the committee has realized and mentioned the possibility of misuse of such power, it still asserts that call interception would be an improvement over the present case. We need to draw our attention on the world’s most active securities market regulator in order to better understand the robust approach which should be applied and hence the same has been discussed hereunder. The American Approach – Security Exchange Commission’s Powers The concept of “wiretapping” was discussed by the US Congress for the first time in 1934. Pursuant to this, they enacted the “Communications Act of 1934”. The statute categorically made the activity of wiretapping a federal offence and also inadmissible evidence in the court. But, by the next half of the century, the prosecutors were struggling in proving several offences and hence in 1968, the Congress passed the “Omnibus Crime Control Act”. The Act deals with interception of communication and it states that for such an interception, an application shall be made in writing upon oath or affirmation to a judge of competent jurisdiction and shall state the applicant’s authority to make such application and it also lays down the specific information that must be included in the application. Earlier, this statute was perceived to be covering certain blue collared crimes until the technology started taking over. As the use of non-interceptable phone calls, e-mails, etc. increased, the authorities concerning white collared crimes were also drawn towards the concept of “wiretapping”. The Securities Exchange Commission has made multiple insider trading crackdowns using this power which includes the high profile conviction of the Indian poster boy abroad- Rajat Gupta and one Rajaratnam. Here, Rajat Gupta was serving as a board member of corporations like Procter & Gamble and Goldman Sachs and he was accused to have passed sensitive information of these corporations to his business partner Rajaratnam who made illicit profits because of this. Though this method has received severe public flak, it still appears to be a necessary one since it aides in obtaining direct evidences in knowing the defendant’s intention to commit such act. The 1968 Act expressly lists out the nature of offences for which wiretapping can be used. This includes mail fraud, wire fraud, kidnapping, money laundering[iv]and a few other offences introduced later by amendments. However, this does not include securities fraud and this question

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PIPE Transactions: A failure in the Indian Scenario?

Leave a Comment / Capital Markets and Securities Law / CBCL

[ Arushi Gupta & Durga Prasad Mohapatra ] The authors are 3rd year students of NLU Odisha. Introduction The concept of PIPE(Private Investment in Public Equity), developed in the US with separate provisions regulating the same. However, Indian law has no such specific regulations which guide the PIPE deals .The PIPE deals in India are regulated by the preferential allotment rules elucidated by SEBI. Considering the fact that the PIPE deals in India are not really developed, the article attempts to draw a distinction between the take of the US and Indian laws by analyzing the relevant provisions. SEBI (Issue of Capital and Disclosure Requirements), 2009 The SEBI (Issue of Capital and Disclosure Requirements), 2009 (“ICDR”)deals with various modes of issuance of securities wherein Chapter VII of the ICDR Regulations lay down the provisions regarding preferential issue of securities. The main area of emphasis with regard to PIPE transactions will be upon Section 72(1)(a) and Section 78(2) of the ICDR Regulations. Section 72(1)(a)[i]lays down the conditions for preferential issue whereby a special resolution passed by the shareholders is a prerequisite in cases of preferential allotment. However, in the US, the shareholder approval[ii]is not mandatory and is guarded by threshold limits. With regards to the NASDAQ, the shareholder approval is not required in case of bonafide private financing. A bonafide private financing[iii]is a sale whereby the issuer sells the securities to multiple investors, provided, that no individual investor would have more than 5% of the shares of the common stock. This is an effective way to avoid dilution of control and may act as a safeguard for the shareholders in the cases where their approval is not taken. The NYSE rules, on the other hand, impose a threshold limit of 20%, whereby shareholder approval is required in cases where the issue would amount to more than 20% of the outstanding common stock. This rule is also shareholder centric as it aims at prevention of dilution of control unless otherwise approved by the shareholders. It can be inferred from the practices in the 2 jurisdictions that ‘control’ as a factor is relevant in case of PIPE transactions and an attempt is made to prevent the dilution of control in both the cases but by the usage of different mechanisms and techniques. Section 78(2)[iv]provides for a lock-in period of 1 year in case of preferential allotment of specified securities being made to persons other than the promoter. A lock in period[v]is basically a time frame within which an investor is forbidden from selling or redeeming shares.Under Section 144, Securities Act 1933,[vi]such securities are restricted in nature but can be resold on the trading market once a registration statement has been declared effective[vii]by the SEC. In case of US, the transaction provides a higher level of liquidity as the statement is declared effective within 45-90 days[viii]of closing of the deal. Liquidity is one of the key factors which make a PIPE deal suitable for investors. PIPE transactions are preferred over other alternatives due to the increased liquidity they offer to purchasers of registered security with the certainty and speed of a private placement.[ix]The problem of liquidity which the Indian law poses in this matter can be cited as one of the reasons for PIPE deals still being at a nascent stage. SEBI (Prohibition of Insider Trading) Regulations, 2015 An area of prime concern with regards to PIPE transactions is that it leaves room for insider trading. A due diligence test[x]i.e. a process by which the investor gathers all the necessary information in order to evaluate the potential risks involved is conducted by the investor in order to better understand the potential pitfalls associated with the deal . Due diligence is not a concern in law, provided that the process does not lead to dissemination of Unpublished Price Sensitive Information (“UPSI”). UPSI[xi]refers to all such information which is directly or indirectly related to the company and has the potential of affecting the prices of securities of the company. Regulation 6 of Schedule II[xii]deals with disclosure of Price Sensitive Information to institutional investors whereby only public information can be provided to investors by the listed companies. With the recent amendment to the Insider Trading Regulations, any person who while conducting due diligence comes across UPSI would be referred to as an insider[xiii]. Furthermore, such a person is not allowed to deal with the securities of the company even if a confidentiality /non-disclosure agreement has been signed[xiv]between the parties. On the other hand, in US, the disclosures are governed by the Regulation Fair Disclosure[xv]wherein the acquirer of UPSI is allowed to trade in the securities of the company, provided that a confidentiality agreement has been signed between the parties. The disclosure regulations in India are stringent and hence may pose a threat to the investors as they would always apprehend the possibility of a liability being imposed upon them while conducting due diligence and consequently refrain from investing in PIPE deals. Conclusion The aspect of control whereby under the ICDR Regulations, the PE firms willing to invest in public companies have to deal with a lock in period of one year and hence cannot exit the companies even when they face heavy losses. With regards to the questions of insider trading, SEBI has put forth certain conditions such as appropriate confidentiality and nondisclosure agreements which have to be signed before any due diligence process begins as provided under Regulation 3(4) of the SEBI (Prohibition of Insider Trading) Regulations. Further, promoters often do not expect to cede any sort of control to private investors as they do not consider them to be an added source of expertise, they only expect them to be passive investors instead of a genuine source for newer perspective who can provide business guidance. Even though PIPE investments are a quick fix to gain financing especially by smaller companies who want immediate capital for working, the market environment in the country has still to be made conducive to such financing methods as a

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Securities and Exchange Board of India (Appointment of Administrator and Procedure for Refunding to the Investors) Regulations, 2018: An Overview

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[Utkarsh Jhingan & Akhil Kumar] Utkarsh and Akhil are 4th year students of NUALS, Kochi. Introduction Securities Exchange Board of India (hereinafter “SEBI”) vide Notification Number: SEBI/LAD-NRO/GN/2018/39, dated October 3, 2018 notified the Securities and Exchange Board of India (Appointment of Administrator and Procedure for Refunding to the Investors) Regulations, 2018, (hereinafter “Regulation”). These Regulations have been made by SEBI in exercise of the powers conferred by Section 30 read with sub-section (1) of Section 11 and Section 28A of the Securities and Exchange Board of India Act, 1992[i] (15 of 1992), Section 23JB of the Securities Contracts (Regulations) Act, 1956[ii] (42 of 1956) and Section 19-IB of the Depositories Act, 1996[iii] (22 of 1996). The Regulation aims to recover investors’ money in cases of felonious collective investment schemes. The provision of this Regulation shall apply mutatis mutandi in respect of the proceedings under the Securities Contracts (Regulation) Act, 1956 or the Depositories Act, 1996. These Regulations are a follow up to an earlier decision by the SEBI to empanel third party workers as receivers for management and sale of assets attached through regulatory orders for recovery of penalties and investors’ money from defaulters who have failed to return monies to the investors. The order in the case of Opee Stock Link[iv] was the first disgorgement order that was passed by the Supreme Court. In this case, shares of Jet Airways Limited and Infrastructure Development Finance Company Ltd. were offered to the public at large. The issue of shares in relation to both the companies had been oversubscribed. However, there were several irregularities that had been committed by certain persons related to both the companies. As a result of these irregularities, the Supreme Court ordered to compensate the retail investors. Further, the passing of these Regulations is a step taken forward by SEBI to seek disgorgement of unlawful gains from the culprits. Applicability The Regulation shall only be applicable in cases where a non-compliant entity of SEBI’s orders is untraceable. In such cases, the Recovery Officer (hereinafter “RO”) can appoint an administrator for the purpose of selling the attached properties and refunding the promoters. According to Provision 5 of the Regulation, only persons registered with Insolvency and Bankruptcy Board of India (hereinafter “IBBI”) as Insolvency Resolution Professionals (hereinafter “IRPs”) are eligible for such appointment. The administrator under Regulation 5(4) has a duty to provide an undertaking to the Board of absence of any conflict of interest with the defaulter, directors, promoters, key managerial personnel and the group entities.[v] Additionally, he should also be a person who is independent/impartial and devoid of any conflict of interest throughout the tenure. It has been provided that any dispute regarding the conflict of interest of the Administrator shall be decided by the RO. Terms of Appointment Regulation 6 provides that both the terms of appointment and remuneration shall be decided on a case to case basis after taking into consideration the amount of work, number of investors and the amount involved. Functions The administrator shall perform his functions as per the directions of the RO. He is empowered to obtain any document regarding ownership and possession of properties, claims of investors, details of amounts raised and the amount of settled debt from the defaulter or any other person. He shall also maintain a record of the properties attached in the process, the bank as well as dematerialized accounts and the value of monies and securities held by the defaulter. Furthermore, he shall also sell the attached properties as per the directions of the RO. The Regulations also empower the Administrator to carry out any act with the prior approval of the RO essential for the purpose of carrying out his duties thereto. In the process of discharging his functions, the Administrator can appoint independent charted accountants to verify the details of amount raised and the quantum of debt already settled. He shall also submit monthly report(s) as and when called by the RO for the purpose of determining the progress made by him. Sale of properties The process of sale of properties will be undertaken by the Administrator after he conducts an independent valuation of the property. The Administrator also has the option of undertaking the sale of property via e-auction for which he can engage an e-auction agency. The RO after considering the valuation report may put a reserve price on the property. Regulation 9 states that the Administrator shall also issue advertisements in an English and Hindi Newspaper having nationwide circulation for the purpose of inviting claims from the investors. The defaulting company and its officers are also supposed to furnish an undertaking that they shall be liable for payment if any complaint is received in future by the Board from any investor. Cost incurred in Administration and Repayment Process The entire cost that is incurred in relation to the sale of properties, verification, remuneration of the administrator and any other person appointed by him in connection to the repayment process shall be borne by the defaulter. If he fails to pay, then the cost incurred in the administration and repayment process shall be given priority over other liabilities. Furthermore, the cost and expenses incurred should be reasonable, should be directly related to and necessary for the act and purpose mentioned in the Regulations. Priority in Distribution of Sale Proceeds The amount recovered from the sale of properties of the defaulters shall firstly be used for the purpose of adjusting the costs incurred by the Board including the charges to be paid to the administrator and persons appointed under him. Thereafter, the remaining amount shall go to the investors and the penalty/fee due from the defaulter to SEBI in the order of priority. Return of Monies Exceeding the Liability In circumstances where excess monies exist after the completion and payment of all the defaults and the amount due, it shall be paid to the defaulter upon the completion of three years after the completion of the refund process. It is

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Commodity Derivative Trading : A Unified Exchange Regime

2 Comments / Capital Markets and Securities Law / CBCL

[Vaidehi Soni] Vaidehi is a 4th year student of NUALS , Kochi Background The Securities and Exchange Board of India (SEBI) announced to have a unified exchange regime from October 1, 2018, wherein stock exchanges would be allowed to offer to trade in commodity derivatives. Pursuant to the said approval, Bombay Stock Exchange (BSE) is set to launch commodity derivatives segments for the delivery-based futures contract in Gold (1 kg) and Silver (30 kg) and later add metals, energy products following by agricultural commodities such as processed/Un-processed farm produce whereas NSE apart from gold and silver will begin with mini gold (100 grams) contracts so as to attract small investors from October 12, 2018. Additionally, considering the fact, Multi Commodity Exchange (MCX) being the market leader, dominates in the trade volumes in non-agricultural commodities derivatives, BSE has decided to waive off the transaction charges for the first year of commodities market operations in order to encourage more participants to join commodity markets. Understanding Commodities market Commodities markets, globally and in India can be broadly categorised into two segments, namely, the market for spot transactions and the market for derivative transactions. The former market deals with the purchase (or sale) of commodities and the settlement of the transaction takes place simultaneously i.e. trade in commodity takes place either on a physical market place or on an electronic platform whereas the latter market deals with the exchange-traded commodity futures markets, which offer a highly standardized platform for trading financial instruments which derive their value from underlying physical commodities including settlement of trade at a future date. The commodity derivative market provides a platform for discovery of future prices of a commodity and also offer an opportunity to the participants in the spot market to hedge themselves against fluctuations in future prices of the underlying commodities. A sound derivative market through hedging delivers price discovery and price risk management by stakeholders including commodity traders, farmers, and market participants. Derivative trading in India takes place either on a separate segment of an existing Stock Exchange or on a separate and independent Derivative Exchange. The settlement & clearing of all trades on the Derivative Exchange/Segment would have to take place through a Clearing Corporation/House, which is unimpeded in governance and membership from the Derivative Exchange/Segment. Legal Framework for Derivative Market The derivatives market is governed by a central legislation, viz., Securities Contracts Regulation Act, 1956 (SCRA) which provides for the legal framework for organized derivatives trading and SEBI acts as the oversight regulator. In pursuance of recommendations made by the commodities derivatives advisory committee (CDAC), vide circular dated September 28, 2016, certain amendments/omissions were made to Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012 (SECC) so as to enable commodity derivatives exchanges to deal in Options. As per section 2(bc) of The Securities Contracts (Regulation) Act, 1956 (SCRA) a commodity derivatives contract can either be: Physical delivery of goods (not being a ready delivery contract) as notified by Central Government or For differences, which derives its value from prices or indices of prices of such underlying goods or activities, services, rights, interests and events, as may be notified by the Central Government, but cannot have securities. As per section 2(1) (fa) of SCRA, the commodity derivative exchange means a recognized stock exchange which assists, regulates or controls the business of buying, selling or dealing only in commodity derivatives. Since the Commodity derivative exchange cannot deal in any other product except for commodity derivatives, an option contract with commodity futures may not be eligible for trading on commodity derivatives exchanges. To overcome such legal hurdle, multifarious amendments are made including omission of the category of “Commodity Derivatives Exchange” under SECC regulation” with effect from October 1, 2018 so as to enable commodity derivatives exchanges to also organise trading in option contracts with commodity futures and accordingly all norms issued for commodity derivative exchanges till date shall be applicable to commodity derivative segments of recognised stock exchanges/recognised clearing corporations to the extent of its applicability. Need for Integration of Spot and Derivative Markets With increasing commercialisation and changing demands of consumers, traders and other market participants; BSE’s foray into commodities derivatives The need for integration is more felt for the overall benefit to the primary producers and value chain participants as: Firstly, A comprehensive mechanism for integration would improve cohesion between futures and physical markets. Secondly, in case, the commodity is assayed before trading, it may also lead to lead to the standardization and assurance regarding the quality of commodity to the buyers. Thirdly, on an electronic spot exchange, as the price of a commodity would be determined by a wider cross-section of people from across the country in contrast to the present scenario where price discovery for commodities takes place only through local participation, such platform will bring about efficient price determination and will ensure transparency in price discovery. Fourthly, A single market may also lead to lower operational cost, reduction in timelines, wider market penetration as technological advancement would result in amelioration of accounting of all the transactions that are taking place in the market. Additionally, the Derivative market would achieve better convergence pursuant to development of a regulated electronic spot platform and/or regulated commodity spot exchanges as is evident from the success achieved by the securities market or the commodity derives market after moving to the electronic platform. Since the derivatives market assures that the future and spot price of a commodity converges on the day the derivative contract lapse for settlement, the discovery of real-time spot prices of a commodity on a pan-India electronic spot exchange will unequivocally strengthen the convergence of future and spot prices of a commodity thereby increasing efficiency of both spot and derivatives market. Thus, the functioning of these two markets could help Indian commodity markets improve its efficiencies and enhance the effectiveness of the overall functioning of the commodity ecosystem so as to benefit all the stakeholders.[1] Challenges and Recommendations Such integration poses a

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