Capital Markets and Securities Law

[Kartikey Kanojiya]   Kartikey is a 5th year student of Institute of Law, Nirma University Introduction Securities and Exchange Board of India (SEBI) by virtue of the consultation paper released on 20th of July proposed an idea whereby they will be making it mandatory for the Large Corporates to raise 1/4th (25%) of their finance through bond markets only. This idea was first proposed by Mr. Arun Jaitley, finance minister of India, during the budget session speech of 2018-2019. He said “SEBI will consider mandating, beginning with Large Corporates to raise 1/4th of the financial need through debt market only.”[1]Subsequently, SEBI took up this issue and finally released a consultation paper. In this article the author analyzes the feasibility of the proposed mandate of raising 25% of finance through bond market only. Applicability By virtue of this paper, the mandate will be applicable only to Large Corporates, which have been defined as: Any entity whose outstanding borrowing is more than 100 Crores; Has a credit rating of AA and above; An entity which intends to finance itself with long-term borrowings (Long term is defined here as any period above 1 year) and; Has listed its securities on any of the stock exchange.   The mandate will be applicable from April 1, 2019 on all the Large Corporates who as on 31st March of any financial year fulfills all four conditions mentioned above. Thus, if any entity as on March 31 of a financial year is identified as Large Corporate then from the next financial year i.e. from April 1, the mandate will be applicable. However, Scheduled Commercial banks as mentioned in Schedule 2 of the Reserve Bank of India Act, 1934 are exempted from this mandate.[2] Compliance Mechanism Under the compliance mechanism it says that the large corporate shall inform the stock exchange about the same. It also creates two blocks of compliances. The First block constitutes first two years of implementation and the second block constitutes the third and fourth year of implementation. Under First block i.e. first and second year of implementation, there is a process of comply and explain whereby, the Large Corporates will try to fulfill the requirements but if they fail to do so they have to explain the reasons for the failure in writing to the authority. Under second block i.e. third and fourth year of implementation it is mandatory for the Large Corporates to meet the mandate and if they fail to do so a penalty of 0.2% to 0.3% of the shortfall will be levied on them. [3] Analysis Trend of Bank v. Bond financing in India. If we look at the prevailing finance market in India, then there is a shift in the borrowing practices followed by the corporates. The data from financial year 2012-13 to 2016-17 i.e. data of 5 financial years shows that the trend line of bond financing is going upwards while the same of bank financing is sloping downwards. In future the trend of Bond Financing will increase because of the enactment of Insolvency and Bankruptcy Code, 2016. If we look at the preference which is given to the bond holders, then they are placed above the government and thus making it easy for the bond holders to recover during the liquidation period even before tax recovery.[4] General benefits of Bond Financing Better Borrowing terms: When a company goes for loan financing the rate of interest is already fixed but in the Bond financing the company can fix the interest keeping in mind the market conditions prevailing during the time and the predicted future of the company. This flexibility gives company an edge to go for Bond Financing.[5] Covenants and Restrictions: When a company goes for loan financing there may be a time where the lender puts some restriction such as that borrower cannot make any material change in the company without the affirmative vote of the creditor and thus making it difficult for the company to enter into any arrangement. In bond financing the only liability the bond issuer has is to repay the principle amount at the time of maturity and to pay interest as per the agreed terms. The bond holders do not get any control in the company as compared to the loan lender.[6] Non Dilution in the shareholding of the present shareholders: As and when new shares are issued to raise finance the shareholding of the present shareholder depletes because of the infusion of the shareholders. For example, I had 25% share in the company and thus, a material stake in the governance matters of the company but due to issuance of new shares and new shareholders entering the company my shareholding is reduced to 20% thus, making my clout in the governance of the company less. This is not the case with bond financing. Preference during the liquidation: After the enactment of Insolvency and Bankruptcy Code, 2016 the preference is given to the bondholders, and they are placed above the government and thus making it easy for the bond holders to recover during the liquidation period. This is a positive step to attract the the investors.[7] Disadvantages of Bond Financing Long and Complicated process: To issue bonds in the market SEBI (Issue and Listing of debt securities regulations), 2008 (“regulations”) are to be followed which makes it a complex process. As per the regulations, merchant bankers are to be appointed which also makes it financially difficult as compared to loan financing. Early Repayment: In bond financing the main issues is of repayment. Even if a company has money after some time they cannot pay the debt and settle it. In Bond financing there is no mechanism of early repayment of the claim and final setoff is done between the company and the bond holder. On the other side, in loan financing the money can be paid back soon after taking loan and there is no bar for doing the same except for a penalty which is levied upon the borrower. Bonds

Sandpapergate: ICC’s Failure to Save the Spirit of the Game from Orchestrated Cheating. [Ankit Sharma] Ankit Sharma is a 4th year student of B.Com.L.L.B (Hons.) at Gujarat National Law University. Introduction Given the evidentiary problems in insider trading cases, SEBI has resorted to the use of presumptions in its enforcement of the SEBI (Prohibition of Insider Trading) Regulations[1]. Hence, if an insider trades in securities whilst in the possession of Unpublished Price Sensitive Information (‘UPSI’ hereinafter) there is a presumption of guilt against him. The law also prohibits the immediate insiders from communicating UPSI to anybody who is not an insider. The research note seeks to examine if there exists any such presumption against the immediate insider also that he communicated UPSI to a relative or a spouse etc. in instances where any relative or spouse or any other connected person commits insider trading Analysis: SEBI (Prohibition of Insider Trading) Regulations, 2015 prohibit insiders from trading[2] in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information[3]. ‘Insider’[4] is anybody who is in possession of or has access to unpublished price sensitive information or is either a connected person, which includes spouse[5]. ‘Unpublished price sensitive information’ means any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities[6]. The note appended to regulation 4(1) casts a rebuttable presumption of guilt on a person who has traded in securities, whilst in possession of unpublished price sensitive information (UPSI), that such trade was motivated by the knowledge and awareness of such information in his possession, thereby making him guilty of Insider Trading. Further, regulation 3 prohibits any insider from communicating any UPSI relating to a company or securities listed or proposed to be listed, to any person including other insiders except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations. Thus, in case where a person is an insider possessing UPSI and the spouse or relative of such person commits insider trading, there will be a presumption of guilt against such individual  who is trading on securities but there has to be undertaken an inquiry as to whether such presumption of guilt will exist against the immediate insider possessing UPSI also that he communicated the information to spouse or relative and thus acted in contravention of prohibition under regulation 3. Though any express provision providing for such presumption under regulation 3 is absent, the existence of such presumption of guilt seems very natural and rational as the communication of UPSI by immediate insider is the only way that the spouse or any other connected person can garner such information. But be that as it may, such a presumption may not exist because of two cogent reasons. Presumption under Regulation 4 cannot be extended to                       Regulation 3. SEBI (Prohibition of Insider Trading) Regulations, 2015 is a penal statute[7]. It is a general rule[8] of construction that the provisions of a statute enacting an offence or imposing a penalty are strictly construed[9] and not be enlarged by implication[10]. If the statute requires the accused to disprove even by preponderance of probabilities a presumed fact which an essential element of the offence as distinguished from a proviso or exception, the statute may offend a due process clause in a constitution to design fair trial[11] and the provision may be read down strictly[12]. In any case a deeming provision which reverses the onus of proof in relation to an element of the offence has to be strictly construed and cannot be extended beyond its language to cover another offence[13]. In the instant matter also, the onus of proof and presumption under Regulation 4 should be read as to cover only the cases envisaged by the aforementioned regulation i.e. where there has been trading transaction on the basis of UPSI and should not extend to the cases where the immediate insider has communicated to UPSI to any insider/non insider when such communication was not made in furtherance of legitimate purposes, performance of duties or discharge of legal obligations. 2.Such presumption in Regulation 3 was intentionally omitted by        legislature. A statute is an edict of the Legislature[14]. The duty of judicature is to act upon the true intention of the Legislature—the mens or sententia legis”[15]. In the matrix at hand it can be reasonably presumed that the legislating authority never intended any such presumption against the communicator of UPSI under Regulation 3(1). According to the test laid down by Blackburn J. in R v. Cleworth[16], to determine what the correct presumption, arising from an omission in a statute should be, was whether what was omitted but sought to be brought within the legislative intention was “known” to the law makers, and could, therefore, be “supposed to have been omitted intentionally”[17]. To re-iterate, note appended to the regulation 4 unequivocally mentions that there will be a presumption against the trader that the transacted on the basis of UPSI if he did so while in the possession of UPSI. And hence it can be well deduced that the legislature was well aware that a presumption could be imposed in case of other offences also, or to be specific on the communicators of UPSI as envisaged in regulation 3(1). But the legislature chose to omit any such presumption in case of regulation 3(1) thereby satisfying the absence of any intention to treat the communicators of UPSI at par with the person who trades in securities while in possession of UPSI. Conclusion While it remains to be seen as to how judiciary clarifies the issue, the reasons suggesting the absence of presumption of guilt under Regulation 3 are highly persuasive and convincing. As a general rule of interpretation of penal statutes, presumptions are usually given a restricted effect and hence,

Understanding the SEBI Order in the Matter of PwC. [Udyan Arya] The author is a fourth-year student at National Law Institute University, Bhopal. On January 10, 2018, the Securities and Exchange Board of India (“SEBI”) passed an order against accounting firms practicing under the brand Price Waterhouse (“PwC”). The order bars PwC from issuing audit and compliance certificates to listed companies for a period of two years and imposes a penalty of Rs. 13.09 crores with interest. The genesis of the present order can be traced back to the 2010 Bombay High Court judgment in the case of Price Waterhouse & Co. v. SEBI,[1] wherein the Court ruled that SEBI possessed the necessary powers to initiate investigations against an auditor of a listed company for alleged wrongdoing. PwC’s challenge to this ruling, by way of a special leave petition in the Supreme Court, was dismissed in 2013.[2] Background SEBI issued Show Cause Notices (“SCNs”) to PwC pertaining to PwC’s audit of Satyam Computer Services Limited (“Satyam”). SEBI, in its investigation, had found false and inflated current account bank balances, fixed deposit balances, fictitious interest income revenue from sales and debtors’ figures in the books of account and the financial statements of Satyam for several years. The SCNs alleged that the statutory auditors of Satyam had connived with the directors and employees in falsifying the financial statements of Satyam. The SCNs sought to initiate action against PwC under Sections 11, 11(4), and 11B of the SEBI Act, 1992 and Regulation 11 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003. The Bombay High Court Judgment PwC filed a writ petition before the Bombay High Court challenging the SCNs claiming that SEBI did not have jurisdiction to initiate action against auditors discharging their duties as Chartered Accountants (“CAs”). Only the Institute of Chartered Accountants of India (“ICAI”) established under the Chartered Accountants Act, 1949 could impose restrictions on CAs and determine if there has been a violation of the applicable auditing norms. SEBI, therefore, was encroaching upon the powers of ICAI by issuing the impugned SCNs. The Court observed that SEBI’s powers under the SEBI Act were of wide amplitude and could take within its sweep a CA if his activities are detrimental to the interests of the investors or the securities market,[3] and that taking remedial measures to protect the securities market could not be equated with regulating the accounting profession.[4] Since investors are guided by the audited balance sheets of the company, the auditor’s statutory duties may have a direct bearing on the interests of the investors and the stability of the securities market.[5] The Court, however, asked SEBI to confine the exercise of its jurisdiction to the object of protecting the interests of investors and regulating the securities market and, ultimately, its jurisdiction over CAs would depend upon the evidence which it could adduce during the course of inquiry.[6] If the evidence showed that there were no intentional or wilful omissions or lapses by the auditors, SEBI could not pass directions. The Supreme Court, on appeal, upheld the decision. The SEBI Order Jurisdiction of SEBI Taking note of the decision of the Bombay High Court, SEBI held that if the evidence sufficiently indicates the possibility of there being a role of the auditors in the alleged fraud, then SEBI, as a securities market regulator, is empowered to protect the interests of the investors and could proceed to pass appropriate directions as proposed in the SCNs. Duties of Auditors The order has extensively dwelled upon the duties of auditors under the regulatory framework in India and whether the auditors in question had discharged their professional duties in accordance with the principles that regulate the undertaking of an independent audit.[7] The auditor’s conduct was checked against the applicable accounting standards and principles, and significant departures were found in the audit. It was noted that 70 percent of the Satyam’s assets comprised of bank balances, which, being a high-risk asset prone to fraud and misappropriation, warranted significant audit attention. However, the auditors failed to maintain essential control over the process of external confirmations and verifications, as mandated under the Audit & Accounting Standards of ICAI. The role of independent auditors in a public company was emphasized.[8] Since the certifications issued by auditors have a definite influence on the minds of the investors, it was held that the auditors owe an obligation to the shareholders of a company to report the true and correct facts about its financials since they are appointed by the shareholders themselves. Findings Finding PwC grossly lacking in fulfilling their duties as statutory auditors, SEBI noted that the acts of the auditor induced the public to trade consistently in the shares of the company. It was noted that the auditors made material representations in the certifications without any supporting document, pointing towards gross negligence and fraudulent misrepresentation. The auditors failed to show any evidence to the effect that they had done their job in consonance with the standards of professional duty and care as required and they were well aware of the consequences of their omissions which made them liable for commission of fraud for the purposes of the SEBI Act and the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.[9] Liability of the PwC Network The SCNs sought to impugn liability on all firms operating under the banner of PwC in India. The PwC network firms were found to be linked to each other on the basis of the following facts: The firms forming part of the network are either members of or connected with Price Waterhouse Coopers International Ltd. (“PwCIL”), a UK-based private company; The said firms entered into Resource Sharing Agreements with each other. The webpage of PwC global (https://www.PwC.com/gx/en/about/corporategovernance/ network-structure.html), showed PwC as “the brand under which the member firms of PricewaterhouseCoopers International Limited (PwCIL) operate and provide professional services.” Member firms of PwCIL were given the benefit of using the name of PwC and

Minimum Public Float Under the Securities Contracts (Regulations) Act, 1956 [Ashlesha Mittal] The author is a student of National Law University, Jodhpur. The Securities Contracts (Regulation) Act, 1956 (SCRA) was enacted to prevent undesirable transactions in securities by regulating the business of dealings therein, and by providing for certain other matters connected therewith. Section 21 of the SCRA mandates all listed companies to comply with the conditions of the listing agreement with the stock exchange. The provisions of the Securities Contracts (Regulation) Rules, 1957 (SCRR) and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR) provide a framework to maintain this balance. The blog article examines the framework, the rationale therefor and the implications of the same on the market in general and the shareholders in particular. Regulatory Framework and its Evolution The SEBI regulates financial markets, and minimum public shareholding ensures that listed companies offer their shares to the public in order to increase liquidity and ensure maximum protection of interest. The SEBI regulations have been centered around the protection of individual shareholders, and hence strict compliance of all the laws is mandatory. Any deviation leads to imposition of penalty, and even delisting of securities in some instances. The framework relating to minimum public shareholders has evolved through the years. From a regime of extensive restrictions, it has moved towards a liberated market, and recently the trend has again been to increase restrictions. Prior to 1993, listed companies were required to issue 60% of their shares to the public. This was eventually relaxed to 25% and then to 10% to ease listing requirements as companies with large amount of share capital did not require such amount of outside funds.[1] However, to maintain liquidity of shares and prevent price manipulations, the SCRR was amended vide the Securities Contracts (Regulation) (Amendment) Rules, 2010 to amend rule 19(2)(b) and insert rule 19A, and increase the public shareholding threshold from 10% to 25%. Companies with capital above Rs. 1600 crore were given a period of 3 years to achieve the threshold, by using methods prescribed by SEBI. Rule 19A of the SCRR provides that maintaining public shareholding of at least 25% is a requirement for continued listing. Where the public shareholding in a listed company falls below 25% at any time, such company shall bring the public shareholding to 25% within a maximum period of twelve months from the date of such fall. The increased threshold of 25% was made applicable on listed public sector companies in 2014 by the Securities Contracts (Regulation) (Second Amendment) Rules, 2014 and had to be met within three years from the commencement of the amendment. The amendment not only increased opportunities for investors to invest in PSUs, but also assisted Government’s disinvestment programme. To avoid undervalued transfer of shares of the public-sector companies and distress sale of government stocks, the period for compliance was increased to four years by the Securities Contracts (Regulation) (Third Amendment) Rules, 2017. Further, regulation 38 of the LODR provides that the listed entity shall comply with minimum public shareholding requirements in the manner as specified by the SEBI from time to time. This was earlier provided in clause 40A of the Listing Agreement. SEBI via its circular has also prescribed methods by which the minimum level of public shareholding specified in rule 19(2)(b) and/or rule 19A of the SCRR can be achieved.[2] These methods are: issuance of shares to public through prospectus; offer for sale of shares held by promoters to public through prospectus; sale of shares held by promoters through the secondary market in terms of SEBI circular CIR/MRD/DP/05/2012 dated February 1, 2012; institutional placement programme in terms of Chapter VIIIA of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009; rights issue to public shareholders, with promoter/promoter group shareholders forgoing their entitlement to equity shares, that may arise from such issue; bonus issues to public shareholders, with promoter/promoter group shareholders forgoing their entitlement to equity shares, that may arise from such issue; any other method as may be approved by SEBI on a case to case basis. Implementation of the Regulations Shareholders of a public company have an advantage that the shares are freely transferable and that there is quick liquidity of investment. The liquidity arises due to ready availability of buyers and sellers in the market, and an established procedure for the transfers. However, if the promoter group refrains from trading in their shares, the number of buyer and sellers reduces in the market, thus affecting the liquidity factor. In June 2013, when the deadline for complying with the requirement of 25% public shareholding ended, SEBI issued an order against 108 companies which failed to do so. The rights of the promoters with respect to shares exceeding the maximum promoter shareholding were frozen. Restrictions were imposed on trading of shares of these companies by promoters except for the purpose of complying with the minimum public shareholding, and also on the promoters holding any new position of director in any listed company. All the restrictions were to apply till the minimum public shareholding threshold was finally met by the company.[3] In the Bombay Rayon’s case,[4] the delay in compliance with minimum public shareholding requirement occurred on account of the CDR process pursued by Bombay Rayon with its lenders. Sufficient period of non-compliance had lapsed in ensuring implementation of the CDR package, which inter alia was also subject to necessary approvals from SEBI. As noted in the confirmatory order dated December 11, 2015, the restructuring of Bombay Rayon’s debt by CDR–EG was for the company’s “sound growth, which in effect will benefit its shareholders also.” Since the non-compliance was beyond the control of the company and was only due to the conversion of GDRs into equity, the SEBI reversed the penalty imposed on the company. Rationale and Implications Minimum public participation in listed companies has always been advocated by the regulators as this ensures liquidity in the market and discovery of fair price.[5] Further, the availability of requisite floating stock ensures reasonable market depth. This enables an investor

From Blurred Line to Bright Line: Concept of Control under the Takeover Law. [Deeksha Malik] The author is a Fifth Year B.A. LL.B. (Hons.) student at NLIU, Bhopal The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (hereinafter “Takeover Code”) prescribes a threshold limit of 25% of shares or voting rights in the target company which, when triggered, would require the acquirer of such shares or voting rights to make an open offer by way of a public announcement.[1] Irrespective of such acquisition, an acquirer is also obligated to make such an offer when he acquires control over the target company.[2] Regulation 2(1)(e) of the Takeover Code provides an inclusive definition of “control”, taking within its ambit the right to appoint majority of directors to the Board of the target company or to control the management or policy decisions of the said company by a person acting individually or in concert with other persons, either directly or indirectly, including by virtue of their shareholding, management rights, shareholder agreements, voting agreements or in any other manner. The definition expressly excludes exercise of control by a director or other officer of the target company merely by virtue of his holding such position. At this juncture, it is pertinent to note that the Bhagwati Committee, the recommendation of which formed the basis on which the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 were framed, suggested that though it is difficult to lay down a precise definition of “control” on account of the numerous different ways in which it could be exercised over a company, it is necessary to provide a broad inclusive definition which would “serve to indicate the circumstances when compliance with the provisions of the Regulations would be necessitated, even where there has been no acquisition of shares, so that SEBI would not be on an unchartered sea in investigating whether there has been change in control.”[3] It is against this backdrop that SEBI on March 14, 2016 came out with a discussion paper seeking comments from the public over the issue of the concept of control under the takeover law.[4] Various Approaches to Determination of Acquisition of Control Essentially, there are both objective and subjective tests to determine acquisition of control. The quantitative approach focuses on numerical thresholds in order to ascertain whether or not there has been an acquisition of control over the target. Many jurisdictions, including the European Union[1], Hong Kong[2], Italy[3] and Austria[4] opt for this approach on account of the relative efficiency and consistency in its application; such standards also significantly reduce the need for litigation. However, there appears to be considerable variation as regards the fixation of the shareholding percentage threshold for voting rights which would trigger the mandatory offer rule (ranging from 20% to 50% voting rights).[1] Much depends on the shareholding pattern that generally prevails in a particular jurisdiction; if shareholding is dispersed in that it is spread over a large number of shareholders, the trigger limit should be kept low, and vice-versa.[2] Objective standard has its own share of disadvantages. Being ‘mechanical’ in its application, it increases the possibility of sophisticated avoidance attempts. Let us take example of an acquirer ‘A’ in India, the takeover law of which provides for a trigger limit of 25% voting rights. ‘A’ acquires 24.5% of the voting rights in a company, thereby doing away with the requirement of an open offer and the economic cost it entails. If there is no other shareholder that exercises similar voting rights, one may reasonably draw the inference that A has a de facto control over the company. Similarly, there could be various kinds of agreements enabling a ‘stealthy’ acquisition of voting rights, and a takeover regulation providing for only an objective standard would not be able to catch hold of such an acquirer. On the other hand, some countries adopt the subjective route, enabling courts and regulators to check any kind of de facto control over the target. In countries such as Canada, France and Spain, an entity is deemed to be having control over another company if it is has the right to exercise majority of the voting rights at the general meeting of the company or has the ability to control the composition of a majority of the board members of the company.[3] Likewise, countries such as Brazil, China and Indonesia define control in terms of the ability to exercise influence over the company’s policies or its shareholder meetings.[4] Therefore, we find that a de facto concept of control essentially encompasses various modes through which an acquirer may gain control. Some of these modes could be the right of an acquirer to appoint or remove majority of the board of directors, ability to directly or indirectly determine the management or policy of the company[5], and the like. The process envisages fact-specific determination, making the law highly uncertain and unpredictable. In fact, many jurisdictions which previously had subjective definitions of control switched to objective definitions.[6] Indeed, such standards fail to take into account many situations where, as a protective measure, financial investors or borrowers seek certain rights in the company without any intention to seek control. The Combined Approach in India India follows both quantitative and qualitative approaches to determination of acquisition of control, providing a numerical threshold of 25% while at the same time giving a subjective definition under regulation 2(1)(e). As a result, the jurisprudence developed over time shows inconsistency among judicial decisions and multiple opinions as regards the scope of control. In 2001, the Securities Appellate Tribunal (SAT) held the acquirer in question to be in control over the target as it had veto rights on major decisions on structural and strategic changes.[7] More recently, in 2010, SAT significantly changed its stance in the much-talked-about case of Subhkam Ventures (I) Pvt. Ltd. v. SEBI[8]. In this case, Subhkam acquired more than 15% in the target company and made a public announcement in term of Regulation 10