Capital Markets and Securities Law

[By Devansh Parekh and Yuuvraj Vaidya] The authors are students at the Government Law College, Mumbai. Introduction In October 2020, the Securities and Exchange Board of India (“SEBI”) issued a circular[1] with respect to the issuance, listing, and trading of perpetual non-cumulative preference shares and perpetual debt instruments (“SEBI Circular”). The special focus herein is on certain instruments by the name of perpetual non-cumulative preference shares (“Perpetual Non-Cumulative Preference Shares”) and perpetual debt instruments (“Perpetual Debt Instruments”) which are issued as part of the additional tier of capital. This article centers on the provisions of the guidelines for implementation of Basel III which deals with instruments that form the layer of additional tier capital in a bank.   These instruments form a part of the special layer of capital that banks are permitted to issue which is commonly referred to as the regulatory capital. The SEBI Circular on the recommendation of the Corporate Bonds and Securitization Advisory Committee (CoBoSAC) proposed additional guidelines noting that the discretion under AT1 Instruments is reserved by the issuer and that retail individual investors may not be fully able to understand the true form of these instruments. This has become relevant after the recent Yes Bank controversy and the ensuing case of Piyush Bokaria vs Reserve Bank of India [1] which have been analyzed in this article. Implementation of Basel III Capital Regulations In India Due to globalization, there has been a great integration of international banks and interdependence of financial markets that prompted the birth of the Basel Accord, which brought in standardized measurements. It is imperative to understand the Basel Accord and how it functions. The Basel Accord was set up by the Basel Committee on Bank Supervision that provided recommendations on banking regulations. It has three series of recommendations – Basel I, II & III. The Basel III capital regulations were implemented in India from April 1, 2013, in a phased manner. The Reserve Bank of India published its Master Circular dated July 1, 2015, consolidating guidelines pertaining to the Basel III norms along with guidelines for implementation of Basel III. (“Basel III Framework”) The accords were drafted to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses.[2] Tier 1 capital deals with the primary funding of banks that are disclosed on financial statements, such as common shares, free reserves, statutory reserves, etc. Tier 2 capital includes general provisions and loss reserves, debt instruments, share premium, etc. Not until a long time ago, there existed a third layer i.e., Tier Capital 3 that had a great variety of debt but was of inferior quality than the above tiers and has been abrogated. These instruments are distinguishable from ordinary securities because of certain peculiar rights the issuer has upon them which could be considered onerous for the holder, viz., loss absorption capacity which has been discussed in further detail below. Loss Absorption of Non-Equity Regulatory Capital Instruments  As per the Basel III Framework, non-equity instruments, which form the additional tier of capital for banks, shall have the inherent characteristic of absorbing losses of the bank even as the entity remains a going concern. As per the Basel III Framework, the terms of issuance of Perpetual Debt Instruments and Perpetual Non-Cumulative Preference Shares in Additional Tier 1 (collectively referred to as “AT1 Instruments”) shall include provisions for either (1) conversion to common shares at the occurrence of a pre-specified trigger point or (2) a write-down mechanism allocating the losses at the occurrence of a pre-specified trigger point. The Based III Framework stipulates that upon the capital conservation buffer [3] falling below a certain threshold it will trigger a write-down/conversion of the AT1 Instruments, described hereinbefore, to ensure the bank is operating above a certain CET 1 ratio.[4] The conversion/ write-down is intended to replenish the equity which is depleted due to losses. The risk under these AT1 instruments is evidently amplified by the fact that if the bank goes into liquidation after the AT1 instruments have been written down permanently, there shall be no claim remaining upon the liquidator for recovery of the principal under these instruments. The write-down will essentially mean that the AT1 instruments have been erased from the balance sheet and existence and all rights and obligations have ceased. The repercussions of write off or conversions arise in a situation of non-viability of the bank which means “A bank which, owing to its financial and other difficulties, may no longer remain a going concern on its own in the opinion of the Reserve Bank unless appropriate measures are taken to revive its operations and thus, enable it to continue as a going concern.”[5] Therefore upon the occurrence of ‘Point of Non-Viability Trigger Event’ which could be (1) the RBI directing the write off/conversion of the AT1 instruments or (2) decision to infuse public sector capital without which the bank would not be able to sustain its going concern status, as determined by the relevant authority, the appropriate action of write-down or conversion shall be initiated. SEBI Circular  The pertinent changes proposed by the SEBI Circular include: (1) All issuance is to be done on the electronic book platform. (2) Only Qualified Institutional Buyers (“QIB”) shall be allowed to participate in the issue. (3)The minimum allotment size for an investor shall be INR 1 Crore. (4) An important disclosure that would be required as per the SEBI Circular is the disclosure of risks, particularly the discretion in terms of writing down the principal/interest, to skip interest payments, to make an early recall, etc. without commensurate right for investors to legal recourse, even if such actions of the issuer might result in a potential loss to investors.[6] QIB such as scheduled commercial banks, mutual funds, FPIs, AIFs, etc are perceived to bring in sophisticated capital and have the financial wherewithal and understanding to commit investments in complex and/or sizeable transaction, as they undertake comprehensive legal and financial due diligence on their investee targets. YES Bank Case

[By Ananya Sahu and Ketan Priyadarshee] The authors are students at Maharashtra National Law University, Aurangabad. High-Frequency Trading (HFT) is a wide term with no precise definition in any statute. It is usually explained as a subset of algorithmic trading that uses “latency-sensitive strategies”, “co-location”, “high-speed networks”, and deploys technology to place orders and execute it as trades in a fraction of a second. This technology in the realm of securities has drawn notable consideration of investors and regulating bodies with respect to its responsiveness to the directives and accurate decision making which manually could have never been thought of and concerns regarding defeating fairness in the market respectively. Ever since COVID-19 has hit the Indian capital market, banking on technology to help sustain and fuel the growth would be a good call. However, it has its downsides and risks associated. Securities and Exchange Board of India (SEBI) as a regulating body has proposed measures, some of which might turn out to be far-reaching, while others might undermine the potential of HFT. This article attempts to highlight the opportunities and obstacles algorithmic trading is chained with. While discussing it the article tries to emphasize how the most controversial form of algorithmic trading can be appreciated and adopted by the market players to triumph over the menace of COVID. Benefits and Obstacles of HFT The advent of technology in the stock market has had many benefits over the years. HFT has played a huge role in improving the traditional market quality measures like depth and liquidity; it has the potential to reduce market volatility and trading costs. HFT has had an important role in reducing the bid-ask spread and tends to skim less off each trade when compared to old school market makers. It is a competitor to itself and therefore the claims that it will make markets one-sided is false. Markets are always fixed in favor of those with the best information and it is with the enhanced use of computers that the informational advantage has somewhat been neutralized. Academics are divided about whether HFT is beneficial or harmful. There is a potential to lose control of computers. There have been instances of software malfunctions that have wiped off millions from the market within hours. The high speed of HFT also raises the potential for more vigorous market manipulation and acts like spoofing. Many contend that HFT provides pseudo-liquidity to the market. Others believe that HFT only operates for short term profit and has no meaningful contribution to the markets. There are various ways to keep HFT in check and reduce the risks associated with it and a lot of these have already been put in place or are being used in markets and exchanges globally. Technological innovation is crucial for market development but there must be a simultaneous adoption of safeguards at the same pace as technology develops. SEBI’s Functions as a Check Post  SEBI was established essentially to regulate the capital market of India. One of its primary functions under section 11 (e) of SEBI Act, 1992 is, prohibiting fraudulent and unfair trade practices associated with the market. In pursuant to that SEBI has released numerous guidelines addressing the potential threats and widespread concerns of HFT since 2012, the latest of which came in June 2020; to regulate the functioning of HFT in the Indian capital market. It strives to set up a level playing field for the market players. At the very outset, the discussion paper has identified the following proposals: To hold back the algo traders from placing huge orders and canceling them within a very short span of time, it has introduced a “minimum resting time” with respect to orders taking place through HFT. Resting time appertains to the period between the actual execution of the orders and the receipt of the orders by the respective exchanges. This step shall lower down the instances of frequent cancellation of orders by the traders that intends to create phantom liquidity in the. Co-location is one of the major advantages of HFT where traders are present in close proximity and the information and signals travel fast to the other trader. This has caused more harm than good since only a handful of the traders can afford this facility. To stricture such activity, SEBI has proposed to match orders in a system where the exchanges would first accumulate all the orders for a specific duration of time later matching orders of that batch. The substantial difference which this technology has given rise to is with respect to time. Transactions are completed within a blink of an eye, which seems to be unattainable if the trading is restricted to human intelligence. To make sure that speed, as a discrete strategy does not help, SEBI has suggested incorporating a delay of few milliseconds while the processing of orders is in transit. This would hardly affect the non-algo traders. However, authors believe that time plays a significant role in algorithmic trading, and measures that defeat the purpose of bringing technology into use might discourage the traders involved in HFT. A large number of orders take place and are canceled the next moment. SEBI proposes to limit the Order to Trade Ratio (OTR). It refers to the ratio between orders taking place, modifications, and cancellations to the actual execution of orders that generates confirmed trades at any exchange. For securing a minimum of one trade for a set of orders, capping on OTR is suggested. Traders exceeding the ratio shall be penalized while placing the next set of orders. SEBI has taken drastic steps to curtail the shortcoming of HFT. However certain proposals in the discussion paper have overshadowed the incentive of time enjoyed by the users of HFT and should also take the prospect of issues like insider trading associated with algo trading into consideration. Any set of regulations shall strive to provide a comprehensive solution, which while addressing the potential threats simultaneously, preserve the quintessence of HFT. The Road Ahead

[By Anurag Shah] The author is a student at the School of Law, Christ (Deemed to be University), Bangalore. Introduction The online trading system of the Indian Stock Exchange works on the ‘blind trading system’. Such a system does not permit a buyer and a seller to have any form of interaction on the platform while undertaking a trade. The system works in such a way that after the buy order is placed on the trading platform, the system matches the same with a sell order and then a trade is executed on a price-time priority basis by the system. However, even in such a spill-proof system, time and again buyers and sellers have indulged in manipulative trades which lead to market rigging. The players have identified multiple ways to execute this rigging, which include illegal synchronized trades or trades that manipulate the Last Traded Price. However, the securities regulator in India has tried to prosecute players undertaking such trades through the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (PFUTP Regulations). This regulation prohibits manipulative, fraudulent, and unfair trade practices. Whether a manipulation has been done or not is largely gathered from the intentions of the parties, however, most of the time there is no direct or conclusive evidence to such intentions. Therefore, in the absence of the same, the Courts have time and again looked into different aspects to ascertain manipulation. One such aspect is the connection between the parties to a trade. Whether it is an inter se connection between the brokers and the parties or a connection between seller and buyer, the Courts have used the same to conclusively conclude manipulation. However, recently the Securities Appellate Tribunal (SAT) has been stressing excessively on the presence of this connection. This can be analyzed through two recent orders by the SAT passed in August 2020. SAT order in the matter of Bharti Goyal v. SEBI The SAT in the matter of Bharti Goyal v. SEBI, modified a penalty of Rs. 5 lakhs issued by SEBI into a warning for the alleged violation of the PFUTP Regulations. SEBI had passed an order against sixteen entities for manipulating the price of the scrip of Mapro Industries Limited. The order held that even though no connection could be established between the suspected entities, by the very nature of their trades they manipulated the prices and disturbed the market equilibrium. The aggrieved appellants approached the SAT. The first appellant defended his trades by submitting that he was a salaried employee who occasionally engaged in the stock market trading and therefore undertook the trade only based on the rumors and had no intention to manipulate the prices. The second appellant as well maintained that the trades were done in the normal course of business without any intent to manipulate. Moreover, both the appellants stressed the fact they had no connection or relationship with any connected or suspected entity. SEBI maintained its position that making such trades was completely irrational and no rational person would do such trades until they wanted to manipulate scrip. SEBI contended that the appellants had manipulated both the price and volume of the scrip and therefore violated Regulations 3 and 4 of the PFUTP Regulations. SEBI reiterated that even though no connection/relationship of the two appellants with other authorities in question could be established, the nature and pattern of their trade itself could be found to be foul of the provisions. For this they relied upon the decision of the Supreme Court of India in the case of Securities and Exchange Board of India vs. Kishore R. Ajmera wherein the Hon’ble Court was of the view that in absence of hard evidence, the conclusion has to be gathered from various circumstances like that volume of the trade and such other relevant factors. The tribunal was not satisfied with the contention of the appellants that they made the trades because they were keen to invest in Mapro Industries owing to its extremely promising nature. This was because the scrip was not liquid or lucrative for investment. On the other hand, the tribunal also took note of the fact that the SEBI order could not join the dots concerning the connection or relationship between the suspected entities and the appellants. Therefore due to the nature and pattern of the trades, the appellants violated the regulations, but since no conclusive relationship/connection or interaction between the appellants and the other suspected entities is established, the SAT modified the penalty into a warning. SAT order in the matter of Rajesh Jivan Patel v. SEBI The SAT in the matter of Rajesh Jivan Patel v. SEBI quashed an order by a Whole Time Member (WTM) of SEBI through which SEBI had restrained the appellants and other noticees from accessing the securities market for six months and further froze the mutual funds and other securities of the appellants. The order was passed by SEBI after an investigation was conducted on the alleged violations of Regulations 3 and 4 of the PFUTP Regulations. SEBI had alleged that the appellants along with a few parties, without any intention to sell, had sold meager amounts of the shares of a company over a period of time to establish a price above the Last Trading Price (LTP). The same, if done in collusion would amount to price manipulation under the PFUTP Regulations. The WTM while adjudicating on the order held that even though there was no connection between the buyer and the seller, they had unilaterally manipulated the price. SEBI also stated that a connection between a buyer and a seller was immaterial in the question of price manipulation under the PFUTP Regulations 2013 unless it a synchronized trade. The aggrieved appellants had appealed to the said order in the SAT. While quashing the order SAT held that the WTM had traveled beyond the specific charges listed by the SEBI in the Show Cause Notice (SCN), which included inter alia a collision to manipulate

[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