Capital Markets and Securities Law

[By Anenya & Yash Sharan] The authors are students of Hidayatullah National Law University, Raipur. Introduction On 26 May 2025, the Securities and Exchange Board of India (“SEBI”) issued a circular (“the Circular”) outlining the regulatory framework for the appointment and transition of Key Managerial Personnel (“KMPs”) within Market Infrastructure Institutions (“MIIs”), such as stock exchanges, clearing corporations, and depositories. The Circular aims to develop and enforce a better process for the appointment, re-appointment, termination, and resignation of certain KMPs in MIIs and add a cooling-off period for these KMPs so they cannot work for competing MIIs shortly afterward. It also tries to maintain consistency, transparency, and autonomy in managing MIIs using a defined process, even for Public Interest Directors (“PIDs”). Thus, it becomes imperative to analyse this circular and highlight SEBI’s reforms that seek to overhaul the framework and align India with global standards. Through this article, the author delves into the intricacies of the circular in three parts. Firstly, it discusses the major terms and tenets of the Circular and the changes it aims to bring. Secondly, it underscores the shortcomings and hurdles of the Circular. Thirdly, it also puts forth authors’ suggestions to resolve these roadblocks. Lastly, the article concludes with a summary and a way forward for moving upward and ahead. From Mandates to Monitoring: Unpacking SEBI’s Circular on MIIs Firstly, the Circular to oversee how KMPs transfer from one company to another, especially when the new institution is a competitor. With increased focus on monitoring how MIIs are run, it becomes important to enforce a sharper separation of interests and strengthen accountability in MIIs’ procedures. The Circular asks MII boards to go through formal stages with the , the main board and also seek SEBI’s approval ahead of any KMP transition. Using this system, unnecessary influence from board politics would be removed when decisions about appointments and resignations are made. KMPs within the scope of the Circular include Managing Director, Chief Regulatory Officer, Chief Technology Officer, Chief Operating Officer, and Chief Risk Officer among others, though the list may vary depending on the nature of the MII The aim is to safeguard confidential details or working methods from a person’s earlier job. In contrast to common practice, SEBI has decided that the burden of enforcing non-compete clauses belongs to the institution instead of any one individual. Hence, each MII must set up internal rules to define what counts as a ‘competing MII’ and ensure they deal with it according to relevant contractual commitments. With this regulation, SEBI is continuing to prevent a small group of individuals from gaining too much power and control in the market ecosystem. Secondly, another notable part of the Circular relates to the renewal of PIDs. PIDs are supposed to act as guardians of neutrality in MIIs’ governance. However, concerns have been increasing over their continued re-appointments which prompt questions about the independence of the institution. Now, SEBI has required that when an extension is granted, there needs to be a detailed evaluation of performance and a new approval from the regulator involved. The aim is to maintain a good mix of what was learned before and new ideas brought in. It demonstrates SEBI’s desire to ensure that public interest roles are active and not just a comfortable job for some people. Even though the initiative aims to improve accountability, some practical issues exist. For instance, SEBI has not prescribed a uniform duration for the cooling-off period. Such flexibility gives MIIs the float to select different standardisation schedules which could weaken the goal of being consistent. In addition, having the Circular go through many internal and external approvals can result in decision delays that limit the ability to respond to needs as they arise. Lastly, the scope of the term ‘key managerial personnel’ remains restricted to specific functions. In today’s digitised and risk-sensitive market environment, roles such as Chief Information Security Officer, Head of Surveillance, or Legal Compliance Officer are equally crucial. Hence, it becomes essential to assess whether SEBI’s substantial progress will effectively preserve the structural integrity of MIIs and to identify what further reforms may be necessary to ensure long-term stability and growth. Cracks in the Code: The Hidden Gaps in SEBI’s MII Overhaul and Plausible Solutions While the Circular is a watershed reform and has profound implications on the financial landscape, concerns persist over potential risks that could challenge its effectiveness. The Circular, while enhancing transparency, poses risks which this section elucidates on. Firstly, the Circular does not take into account the regulatory difference between publicly-held and privately-controlled MIIs. The Circular ensures that the selection, re-selection and cooling-off periods for KMPs are identical in all MIIs, regardless of who owns them. Such oversight matters significantly, now that private MIIs are often run by conglomerates, since this may increase the risk of conflicts, excessive regulation and policy changes. Instead of treating all situations equally such as SEBI does, the law, as interpreted in Swiss Ribbons Pvt. Ltd. v. Union of India, requires that all situations should be judged differently. The Financial Sector Legislative Reforms Commission in the financial sector also advised that the amount of regulatory oversight should depend on the ownership, size, and how connected market intermediaries are. Thus, the Circular does not take these systemic indicators into account. A plausible solution is to create a “Risk-Tiered KMP Transition Framework” that is based on how many shares are owned and the company’s history with regulators. So, when a single promoter group owns more than 25% of the MII or when the MII is a part of a financial conglomerate, as with the NSE co-location scandal, such MII should be obliged to disclose more, have longer cooling-off periods, and be audited for board independence. The Systemically Important Financial Institutions approach under Basel III and the IOSCO Principles 2 and 22 are both consistent with this method. A framework such as this would strengthen the rules that govern the markets and reassure investors about the security of India’s capital

[By Owais S. Khan] The author is a student of Government Law College, Mumbai. Introduction: On 11 October, 2024 the Securities & Exchange Board of India (SEBI) in the matter of Royal Orchid Hotels Ltd. (ROHL), imposed a monetary penalty upon ROHL, its Directors/ Promoters and the Chief Financial Officer (CFO) of the Ksheer Sagar Developers Pvt. Ltd. (KSDPL) under Section 11 of the SEBI Act, 1992 for violating multiple provisions of SEBI Act, the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations) and SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (PFUTP Regulations). The order held that ROHL has misrepresented its consolidated financial statement, by classifying KSDPL as an associate company, despite being its subsidiary. This inflated the consolidated profit of ROHL, thereby enabling the directors/ promoters of ROHL, to offload their holdings and making a considerable gain on the basis of the profit, which was calculated on the basis of a misrepresentation. The scrip price of ROHL, also recorded a jump due to the wrong classification.    The present article inter alia deliberates on firstly, the evolution of control and significant influence in determining the relationship of a company with the holding company, secondly, the relevance and application of the Indian Accounting Standards (IndAS) in determining this relationship and finally attempts to examine the impact of this order in broadening the scope of control and matters concomitant thereto.     Control vs Significant Influence: Section 2(87) of the Companies Act, 2013 (Act) defines that a company shall be deemed to be a subsidiary of the holding company if the holding company exercises or controls over more than one-half of the total voting power of subsidiary OR controls over the composition of the Board of the Directors (BoD). This establishes a holding – subsidiary relationship. Similarly, according to Section 2(6) of the Act, an associate company is the one in which another company has a significant influence, but is not a subsidiary of the company having influence.   In the ROHL matter, as per the Articles of Association (AoA) of KSDPL, the BoD of KSDPL would consist of 5 members, 3 of which would be appointed by ROHL. This dominance over the BOD was construed as a control, and KSDPL was initially declared as a subsidiary of ROHL. However, being a subsidiary of a listed company, KSDPL was under an obligation to appoint independent directors as per Sec. 149 of the Act. Thus, 2 independent directors were appointed on the board of KSDPL, taking the strength to 7. This resulted in ROHL having 3 members on the board out of 7. This change was interpreted to be a loss of its control over the composition of the BoD of KSDPL, classifying it as an associate company in the consolidated financial statement of ROHL.  The term Control has been defined in the Act under Section 2(27) which shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner. Also, in the Subhkam Ventures, it has been held that to determine control, the person must be on the driver’s seat, wherein he owes a proactive and not a reactive role. It is power by which one can command the company to do, what he desires it to do. Control is a positive power and not a negative power. Similarly, it has been an explicit legal position that the power to control the composition of the BoD is a necessary element of holding-subsidiary relationship in Vodafone International Holdings B.V vs. Union of India.  Despite this limitation of control over the composition, SEBI held KSDPL to be a subsidiary of ROHL, owing to special rights which were conferred in favour of ROHL under the AoA of KSDPL. These were the rights to appoint the chairman of the BoD of KSDPL, and the right of the chairman to exercise a casting vote in case of a tie. SEBI held that this provides a virtual control to ROHL, to influence the decision-making power of the BoD, with the chairman, as a nominee of ROHL, exercising its power in favour of ROHL.   Associate vs Subsidiary in light of Ind AS SEBI held that holding-subsidiary relationship is determined not only by virtue of the definitions in the Act, but also by the accounting standard under Ind AS 110 and shall not be dependent on the number of independent directors.   SEBI, in its order relied on Ind AS 110, in determining the control of ROHL over KSDP, taking the following factors into consideration for determining the control of the investor over the investee.   Relevant activities and ability to direct the relevant activities: As per the Memorandum of Understanding (MoU), ROHL was conferred with the operational authority of KSDPL and all the key personnels managing the operations of KSDPL, including its CFO, were employees of ROHL, satisfying the criteria to control the relevant activities and decision making. Exposure or right to variable returns: ROHL had rights over management fees of KSDPL as a percent of its turnover and also as percent of earning over the gross profit. Thus, it was held that ROHL had exposure to variable returns, thus recognizing its control.  Ability to use the power to affect return: With the control over the BoD and the terms of MoU and AoA, ROHL was held to be a decision maker having the ability to use its power to affect the returns of KSDPL.  The author advocates that the Act providing for control of at least 20% shareholding to exercise significant influence in another entity needs to corroborated with other grounds laid down in  Ind AS 28 relating to investment in associate companies like representation in BoD, participation in policy making, material transactions, etc. to resolve this Associate/ Subsidiary relationship enigma.  Implications for

[By Gauravi Talwar] The author is a student of Gujarat National Law University.   INTRODUCTION The Securities and Exchange Board of India (SEBI), in its Consultation Paper dated July 29, 2024, has initiated a pivotal reform in its regulatory approach to insider trading. This proposed amendment to the SEBI (Prohibition of Insider Trading) Regulations, 2015, signals a decisive effort to strengthen the regulatory landscape in response to the growing sophistication of financial markets and insider trading practices. By focusing on closing historical loopholes and enhancing market integrity, SEBI aims to create a more comprehensive framework by revising key definitions, such as “connected persons” and “relatives.”   By aligning the definition of “connected persons” with the “related party” concept in the Companies Act, 2013, and expanding the definition of “relative” under Section 56(2) of the Income Tax Act, 1961, these amendments are designed to capture a broader spectrum of individuals and entities with access to Unpublished Price Sensitive Information (UPSI). This article conducts a comparative analysis of the proposed amendments and evaluates their potential impact on insider trading regulations in India.  EXPANDING THE DEFINITION OF “CONNECTED PERSON” The SEBI (Prohibition of Insider Trading) Regulations, 2015, define an “insider” as any individual who either is a connected person or has access to Unpublished Price Sensitive Information (UPSI). However, the current definition of “connected person” is insufficient in covering individuals with indirect access to UPSI through their associations with such persons. SEBI’s proposed amendments seek to remedy this by aligning the term “connected person” with the “related party” concept under Section 2(76) of the Companies Act, 2013. This alignment expands accountability, casting a wider regulatory net to capture those with indirect ties to companies and recognising the complex relationships that can facilitate insider trading. Additionally, amendments to Regulation 2(1)(d)(ii) broaden the scope of “deemed connected persons,” acknowledging that insider trading networks often extend beyond formal company roles.  A pivotal change is the expanded definition of “relatives,” now modelled on Section 56(2) of the Income Tax Act, of 1961. This revision includes a broader array of familial connections—spouses, siblings, and lineal ascendants—closing loopholes that previously enabled insiders to exploit indirect access to UPSI through family members. These amendments reinforce SEBI’s efforts to ensure comprehensive regulatory scrutiny and prevent circumvention of insider trading laws through intermediaries.  COMPARATIVE MODELS: UNITED STATES AND UNITED KINGDOM United States In the United States, insider trading is regulated under a broad legal framework, anchored in the Securities Exchange Act of 1934, the Insider Trading Sanctions Act of 1984, and the Insider Trading and Securities Fraud Enforcement Act of 1988. The U.S. Securities and Exchange Commission (SEC) treats insider trading as securities fraud, focusing on the improper use of non-public, material information rather than the individual’s formal association with the company.  This ideology has been reinforced by the landmark U.S. v. O’Hagan case  which introduced the “misappropriation theory”. The idea behind the theory is to extend liability beyond corporate insiders to include any individual who improperly uses confidential information for personal gain. U.S. regulations also emphasize flexible enforcement through civil penalties, disgorgement of profits, and criminal charges, allowing the SEC to adapt to evolving market practices, such as high-frequency trading.   United Kingdom The United Kingdom’s regulatory framework, governed by the Criminal Justice Act of 2003 and the Financial Services and Markets Act (FSMA), adopts a broad and inclusive definition of insider trading. It focuses on the misuse of non-public information, regardless of the insider’s relationship with the company, and places significant emphasis on the intent behind trading activities. The UK regulators impose both criminal and civil penalties, providing flexibility in enforcement. Notably, the UK’s approach is less focused on fraud and instead prioritizes preventing the unfair exploitation of confidential information. This is exemplified by the R v. McQuoid and Melbourne case, which emphasized possession and misuse of inside information over intent to commit fraud.  This concept of evaluating insider trading has not yet been explored by the Indian regime which only looks at the use of Unpublished price sensitive information from a unidimensional lens that does not evaluate the improper use of UPSI extensively, thereby increasing bureaucracy in the segment as most of the cases get overturned by SAT due to incorrect evaluation of an insider in possession of UPSI in general or lack of conclusive proof of improper use.   IMPACT OF SEBI’S PROPOSED INSIDER TRADING AMENDMENTS SEBI’s proposed amendments to the SEBI (Prohibition of Insider Trading) Regulations, 2015, mark a pivotal shift toward aligning India’s insider trading laws with global standards. By broadening the definition of “connected person,” these changes aim to enhance market fairness and investor protection, by encompassing a broader range of individuals with potential access to unpublished price-sensitive information (UPSI).  This will increase accountability, subject more individuals and businesses to regulatory oversight, and reduce opportunities for gaining unfair advantages. Drawing inspiration from U.S. and UK regulatory models, SEBI’s approach strikes a balance by expanding coverage while maintaining a focus on preventing unfair practices. These changes are expected to significantly bolster market integrity, foster greater compliance, and enhance investor trust, ultimately promoting a fairer, more transparent financial market.  LIMITATIONS OF THE PROPOSED AMENDMENTS: SEBI’s proposed amendments to the definition of “relatives” in insider trading regulations may have significant implications, particularly in high-profile cases akin to the Adani-Hindenburg affair. By expanding the scope to include a wider array of familial ties, SEBI acknowledges that insider trading frequently involves not just immediate associates but also extended family members. However, this expanded definition risks regulatory overreach, as seen in the SEBI ruling against Deep Industries. In that case, social media interactions were deemed sufficient to establish insider trading connections, a decision later overturned by the Securities Appellate Tribunal (SAT), highlighting the risk of overreach in interpreting personal relationships. The proposed amendments could significantly increase the number of insider-trading cases, potentially deterring legitimate market activities. Investors, fearful of being wrongfully accused, may curtail their trading activities, thereby dampening market liquidity and impeding growth. Additionally, the inclusion of extended familial relationships could pose

[By Aashi Goyal] The author is a student of National Law School of India (NLSIU), Bengaluru.   Introduction On 27 June 2024, SEBI published a press release regarding its 206th Board Meeting. As per the press release, SEBI has approved the recommendations regarding restricting the association of SEBI-regulated entities with persons who directly or indirectly provide advice or recommendations without being registered with SEBI or make any implicit or explicit claim of return or performance in respect of or related to security. Moreover, the ASCI, on 17 August 2023, published “Guidelines for influencer advertising in Digital Media” wherein it has directed that any influencer providing information and advice on BFSI must be registered with SEBI.   In this context, this paper argues that the current regulatory framework is inadequate to deal with the unique challenges finfluencers pose and therefore there is a need for the development of a distinct regulatory framework tailored to these unique challenges. Firstly, the paper establishes the current regulatory framework seeking to regulate finfluencers. Secondly, it argues that the current ex-ante approach limits finfluencers to existing regulatory categories that do not fully encompass their activities. Thirdly, it argues that the ex-post approach requires proving intention and knowledge of dissemination of misleading or false information, which is a difficult standard to meet.   Current Regulatory Framework The Advertising Standards Council of India (“ASCI”) defines influencer as a person who has access to an audience and the power to affect their audience’s purchasing decisions or opinions because of the influencer’s knowledge and relationship with their audience. Therefore, a finfluencer refers to an influencer that provides advice or comments on merits/demerits on aspects related to commercial goods and services, in the field of banking, financial services and insurance (“BFSI”).  Currently, a specific legal regime does not exist that regulates finfluencers. However, a finfluencer may be implicated under section 12A of the Securities and Exchange Board of India Act (“SEBI Act”) and Rule 4(2)(k) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (“PFUTP Regulations”). This is the existing ex-post approach in the regulation of finfluencers. In an effort to take an ex-ante approach, the SEBI Board in its 206th meeting approved the recommendations in the Consultation Paper titled “Association of SEBI Registered Intermediaries/Regulated Entities with Unregistered Entities (including Finfluencers)”. As per the consultation paper, a SEBI registered intermediary shall not have any association or relationship in any form, for promotion or advertisement of their products and services with any unregistered entities including finfluencers. Echoing similar sentiment, ASCI published “Guidelines for influencer advertising in Digital Media” wherein it has directed that any influencer providing information and advice on BFSI must be registered with SEBI.  It is pertinent to note that the requirement of registration of finfluencers with SEBI has essentially restricted them to the category of Research Analysts (“RA”) and Investment Advisers (“IA”). The class of finfluencers has not been notified as a separate category of intermediaries as per Rule 1(2) of SEBI (Intermediaries) Regulations, 2008. Therefore, the only category they may be registered under is that of an RA or an IA. This is further indicated by the Consultation Paper’s conflation of the issue of unauthorised and unregistered IAs and RAs and the issue of regulation of finfluencers.  Gaps in the Ex Ante Approach SEBI and ASCI have erred in confining the finfluencers to the category of RAs and IAs. In the current framework, SEBI and ASCI are essentially regulating RAs and IAs that are utilising social media platforms and not the category of finfluencers as a whole. The SEBI (Investment Advisers) Regulations, 2013 (“IA Regulations”) excludes from its scope, the investment advice that is disseminated through any electronic or broadcasting medium, which is widely available to the public.i Therefore, by definition, a finfluencer providing investment advice on social media platforms such as YouTube, Instagram, Facebook, etc. does not come under the purview of IA regulations.    Although the SEBI (Research Analysts) Regulations, 2014 (“RA Regulations”) do not bar from its purview, communication through public media, it does exclude comments on general market trends, economic and political conditions, technical analysis, etc.ii This implies that a finfluencer that does not provide advice on which particular shares to sell, buy, hold or makes claims as to the future performance of specific sharesiii is not regulated by RA regulations. A finfluencer may create hype around a particular industry such as the psychedelics industry by analysing  the general market trends surrounding the industry. As a result, the followers of the finfluencer may start buying shares of psychedelic companies leading to an increase in the price of the shares. At this stage, the finfluencer might sell his or her shares at a significant profit. Further, there is a possibility of the creation of price bubbles in this scenario. However, the same cannot be regulated under RA regulations as mere speculation as to general market trends and market conditions are not within its purview.   Gaps in the Ex-Post Approach Rule 4(2)(k) of PFUTP Regulations states “Disseminating  information  or  advice  through  any  media,  whether  physical  or  digital,  which  the  disseminator  knows  to  be  false  or  misleading  in  a  reckless  or careless  manner  and  which  is  designed  to,  or  likely  to  influence  the  decision  of  investors dealing in securities.” From the bare reading of the provision it is evident that for one to be liable, there has to be knowledge as to the falsity or the misleading nature of the information. This belief is further backed by the Report of the Committee on Fair Market Conduct (“Report”), on the basis of which amendment to the PFUTP regulations was passed in 2019.  Prior to the 2019 amendment, Rule 4(2)(k) considered the publication of misleading advertisements or advertisements containing distorted information as manipulative, fraudulent and/or an unfair trade practice. The action of publication of misleading advertisement was not qualified by any requirement of intention or knowledge. This meant inadvertent mistakes could be penalised. Subsequently, the Report recommended that the action of “knowingly” influencing the decision to invest in

[By Anushka Aggarwal] The author is a student of National Law School of India University (NLSIU).   Introduction Recently, the Securities and Exchange Board of India (SEBI) sent a 31-point advisory to investment bankers via the Association of Investment Bankers of India, the investment banking industry’s representative to SEBI (IPO advisories), which increases the Initial Public Offering (IPO) disclosure requirements and due diligence requirements. This was a part of regulatory advisories that SEBI frequently issues to intermediaries like the AIBI. These advisories operate along with the existing legal framework including the Companies Act, 2013 and Part A of Schedule VI of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. I argue that SEBI’s authority to issue such advisories without a well-defined legal framework opens the door to potential regulatory substitution, i.e., using advisories to perform functions that would typically require a more formal legal framework, such as an amendment. This is concerning given the judiciary’s usual deferential stance toward SEBI which can fail to keep a check on SEBI’s advisory powers, and the implications of this on the securities market: First, the article describes the absence of a clear legal framework governing advisories, and second, addresses the broader implications of this, including how it fails to keep a check on regulatory substitution and contributes to increased transaction costs and inefficiencies within the securities’ market.  The Issue: (Lack of) Legal Framework The Securities and Exchange Board of India Act, 1992 (SEBI Act) which establishes SEBI and lays down its powers and functions does not use the term ‘advisory.’ Under S. 11A and 11B, SEBI has the power to issue ‘regulations,’ ‘orders’ and ‘directions’ to the securities market. I argue that none of these can encompass advisories. All rules and regulations made by the SEBI have to be tabled before the Parliament under S. 31. The Parliament can modify such regulations or invalidate these. However, none of the advisories issued have been tabled before the Parliament, or their validity subject to such tabling. Under S. 11B, a direction by a statutory authority is like an order requiring positive compliance. However, advisories are typically supposed to be clarificatory, offering guidance to help interpret existing law and align market practices. Whether advisories require positive compliance is unclear. Additionally, ‘directions’ is synonymous with ‘orders.’ Since ‘advisories’ cannot be considered ‘directions,’ they cannot be considered ‘orders’ either.    Thus, the SEBI Act not only lacks a clear framework authorizing the issuance of ‘advisories,’ but also the aforementioned ways of regulation cannot encompass ‘advisories.’ Arguendo, the SEBI Act gives SEBI overarching powers to protect the interests of investors and regulate the securities market, and advisories fall under this general regulatory function. However, the lack of a structured legal framework governing advisories leads to concerns about potential regulatory substitution: The content of the IPO advisories is not limited to guidance but effectively amends a regulation as elaborated upon subsequently, but due to its status as an ‘advisory,’ the SEBI circumvented the need for parliamentary tabling. Further, these advisories may blur the line between informal guidance and enforceable regulation, creating uncertainty. For example, the IPO advisories necessitate that the offer document not in conformity with the advisories shall be returned to the company.  The Relevance: Why is This An Issue? This section first examines how issuing advisories bypasses the formal processes required for making regulatory changes, such as passing amendments or issuing new regulations, thereby amounting to regulatory substitution. Instead of following the more rigorous procedures that ensure accountability and transparency, advisories are used to introduce changes informally. This may remain unchecked due to the judiciary’s deferential. Second, it analyzes how the advisories increase transaction costs and lead to inefficiencies in the securities market.  1. Regulatory Substitution Under the IPO advisories, SEBI notified that “any entity or person having any special right under articles of association or shareholders’ agreement should be cancelled before filing the updated draft red herring prospectus.” Before these advisories, such rights were cancelled after the listing of a company as per Regulation 31B of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. These special rights, like veto powers, Right of First Offer/Right of First Refusal, etc., are important for private equity (PE) investors. Retention of special rights, during the critical phase of the company’s transition to a public entity, provides them with a safety net and the ability to influence major decision that could impact their rights vis-à-vis the company. PE investors usually have limited day-to-day control over the company. Their special rights compensate for this by providing mechanisms to protect their investment.  Thus, the SEBI effectively amended a Regulation that secures important rights for PE investors through the use of advisories, which are part of an informal framework. This constitutes regulatory substitution because by issuing advisories, SEBI was able to introduce a significant change without going through the formal process that would normally require parliamentary approval. This not only undermines the transparency and accountability checks required for rule-making but also impacts the regulatory landscape. Although SEBI later withdrew the advisory, this action did not fully resolve the issues created by the initial substitution. The next section will explore how these negative impacts cannot be undone by the withdrawal.  The potential for SEBI to engage in regulatory substitution through advisories could remain insufficiently addressed due to the judiciary’s deferential stance towards SEBI. In Prakash Gupta, the court defers to SEBI remarking that SEBI’s actions are guided by public interest and its role in maintaining market integrity and investor protection. The courts have avoided substituting their judgment for that of SEBI, acknowledging the latter’s extensive regulatory and adjudicatory powers, and specialized knowledge. A stronger form of deference is displayed here since the statute was clear that the offences could be compounded (only) by the SAT or a court. The court concludes that SEBI’s consent cannot be made mandatory owing to the language of the statute, but held that the views of SEBI must necessarily be considered by the SAT and the court, and

[By Debangana Nag] The author is a student of the West Bengal National University of Juridical Sciences.   Introduction In its recent board meeting on 30th September, SEBI outlined maintaining pari-passu rights of the investors in Alternate Investment funds to maintain a level playing field among them. The Board approved proposals to amend the AIF Regulations to state that, in all other respects (barring specified exemptions), investors’ rights in an AIF scheme shall be pro-rata and pari-passu, meaning investors must have equal rights (pari passu) in all investments within the scheme, thereby stating that no investor will be prioritised over another. Additionally, any returns or distributions from the scheme will be allocated proportionally (pro rata) based on the amount each investor had contributed, ensuring that their share of returns is directly in line with their investment. However, to prevent existing investments from being disrupted, the SEBI has allowed them to continue.  In May 2023, a consultation paper was released by SEBI seeking comments from the public. This paper emphasised that the pro-rata principle should be regarded as of utmost importance in AIFs, highlighting it as crucial for maintaining fairness. In contrast, the pari-passu principle was highlighted as a means to guarantee equality in economic rights among all investors. SEBI identified key issues concerning the use of the Priority Distribution Model by AIFs, which classifies investors into distinct groups, raising concerns about its implications for equitable treatment.  By examining this decision in light of SEBI’s consultation paper on pro-rata and pari-passu rights, this article shall critically analyse how the decision fails to balance investor protection and flexibility required by managers for creating innovative investment products along with emphasising the need to prevent regulatory arbitrage.  Understanding SEBI’s Decision on Pro-Rata and Pari-Passu Rights Although the pro-rata is not explicitly stated in the AIF Regulations, ensuring proportional rights for investors particularly in the distribution of investment proceeds is a fundamental feature of the AIF framework. However in a PD Model in the event of a loss, money from the residual capital of junior-class investors could be utilised to reimburse the senior-class investors. A hurdle rate is a performance-based benchmark for a fund that guarantees minimum returns. Senior class investors have lower hurdle rates which are prioritised during the payment. In the event of a profit, the senior class investors receive distributions until their hurdle rate is satisfied, after which the junior class investors get any residual funds.   As discussed in the Introduction, this decision by SEBI aims to uphold equitable distribution of profit and loss to ensure fairness and investor protection while emphasising that the principle of fairness that must be secured in a pooled investment like AIF.  Furthermore, SEBI granted exemptions from these regulations to certain entities like those owned by the Government, multilateral development financial institutions, State Industrial Development Corporations and other specified entities as designated by SEBI. Importantly, only these entities will be allowed to give less than pro-rata rights to persons who subscribe to junior-class units of the AIF scheme. This exemption has also been granted to Large Value Funds (LVF) but only if each investor explicitly agrees to waive off their Pari-passu rights. According to SEBI regulations, Section 2(1)pa, an LVF is an AIF where each investor commits a minimum of ₹70 crore.  It is pertinent to mention here that the SEBI Board has authorised that only in the above-mentioned AIFs, certain differential rights can be granted to some investors while the rights of other investors remain unaffected. The permitted terms for offering differentiated rights will be determined by the Standard Setting Forum for AIFs in collaboration with and certain principles outlined by SEBI.  Critical analysis of SEBI’s stance on the Priority Distribution modelSEBI has categorically banned AIFs following the Priority Distribution model (PD Model) from raising fresh commitments or making investments in a new investee company. In its consultation paper, SEBI identified that in a PD Model, investors are categorised into senior and junior groups. Senior investors are accorded priority in the distribution of returns, typically enjoying reduced risk and assured repayment before any allocation is made to junior investors. Junior investors, by contrast, assume a higher level of risk as they are compensated only after the senior class has been fully satisfied. This often results in the junior class disproportionately bearing losses in adverse scenarios. However, in exchange for this elevated risk, junior investors may realise greater returns contingent upon the overall performance of the fund. This hierarchical structure prioritises the protection of senior investors while exposing junior investors to greater risk for potentially higher rewards.  In addition, SEBI noted that this model led to a regulatory arbitrage which is prone to misuse for unethical financing like evergreening of loans.  A Working Group had recommended allowing the PD Model in limited scenarios; however, SEBI decided against this, stressing that the model’s risks outweigh its benefits.  Balancing flexibility and investor protection: Differential Rights and Operational Flexibility for AIFs To balance investor protection with operational flexibility, SEBI has allowed AIFs to offer certain differential rights to certain investors provided that they do not affect the rights of other investors to prevent conflict of interests. The rationale for this decision, highlighted earlier, was to prevent scenarios similar to those that led to the 2008 financial crisis, where investors were disproportionately impacted by differential tranches in collateralized debt obligations (CDOs), causing widespread financial instability. In such cases, investors, particularly those holding junior tranches often did not fully understand the associated risks. Junior tranche holders were typically the last to receive payments and the first to absorb any losses, making these tranches riskier.   However, it is important to underscore the trade-off between providing investors with choice and regulating AIFs, especially for those seeking opportunities through differential tranches that offer higher risk and potentially greater rewards. AIFs are investment products specifically designed for people who are considered experienced enough to negotiate their own terms. The move to prohibit fresh investments into AIFs following these structures signals SEBI’s low tolerance for financial innovation in a move towards strict regulations over risk-laden flexibility. Units with