Capital Markets and Securities Law

[By Gagireddy Vyshnavi Reddy] The author is a student of Tamil Nadu National Law University.   Part-1  With the advancement of technology, the incorporation of algorithm strategies into the trading of securities has emerged and has been growing at an exponential rate since then. The provision of algorithm strategies for the purpose of trading securities can be sought in two ways, where one of them is by the provision of such strategies by the stock brokers themselves, however, another way is through the third party algorithm strategy providers, where the stock brokers outsource the services of the third party algorithm strategy providers. SEBI in its Consultation Paper on Algorithm Trading by Retail Investors, 2021 has stated that the services provided by such third party algorithm strategy providers cannot be categorized as either investment advisor or a research analyst and thereby such third party service providers are not recognized. This article focuses on how there is mis-regulation of such third party algorithm strategy providers, and how their services cannot be interpreted as  investment advisors but can be categorized as research analysts henceforth eliminating the unnecessary burden placed on the stock brokers in gaining permission for each and every algorithm strategy employed from the third party algorithm strategy provider by not recognizing the third party algorithm strategy providers under a regulatory framework.   INTRODUCTION Algorithmic Trading has been used very widely in India from the past few years. According to report from the National Institute of Financial Management submitted to the Department of Economic Affairs indicates that over 50% of total orders at both the National Stock Exchange and Bombay Stock Exchange are algorithmic trades on the client side, while over 40% are trades on the prop side. Algorithmic Trading refers to an automated execution of logic that generates a buy or sell order of the securities in the securities market. It enables the investor in trading the securities when there is an appropriate market situation that enables the investor in gaining profits. This would not require the interference by the investor in analyzing and keeping a track on the market conditions in order to trade the securities.  The rise of algorithmic trading in India can be traced back to SEBI’s Circular on Introduction of Direct Market Facility in 2008 (2008 Guidelines) allowing institutional investors to use the direct market access (DMA) facility, which allowed brokers to offer their clients direct access to the exchange trading system without any manual intervention. Later, SEBI released the “The Broad Guidelines on Algorithmic Trading” (2012 Guidelines) and these 2012 Guidelines provide for seeking mandatory approval by the stock brokers from the stock exchanges for providing the service of algorithm trading to the investors. It also provides various other compliance for the stock brokers and the stock exchanges to be followed in order to enable the investors with the facility of algorithm trading by providing algorithm strategies. Further, SEBI has also released the Consultation Paper on Algorithmic Trading by Retail Investors (Consultation Paper) in 2021, wherein, it stated that there would be no recognition given by SEBI to the third-party algorithm strategy providers (ASPs) creating such algorithms and has instead placed multiple reporting requirements on the stock brokers in order to regulate such third party ASPs. It also mentioned in Consultation Paper, how it is unclear as to the categorization of the services provided by these third party ASPs as either investment adviser or research analyst and thereby concluded to not grant a recognition for such third party ASPs.  This article deals with the above mentioned aspect of the Consultation Paper, how the third part of how the third party ASPs are mis-regulated by first establishing that the third party ASPs do not come under the current Investment Advisor Regulations and later establishing that such third party ASPs can be interpreted under the Research Analyst Regulations. It concludes with the suggestion that instead of placing extra burden on the stock brokers for obtaining permission for every algorithm employed from the third party ASPs by eliminating the third party ASPs from the regulatory framework, SEBI can regulate these third party ASPs as under the Research Analyst Regulations, 2014.   REGULATORY OVERSIGHT ON THIRD PARTY ALGORITHM TRADING STRATEGY PROVIDERS   An Algorithm Trading Strategy is a logic employed by the investor to execute orders in the securities market. These include using a defined set of logic and instructions in the form of algos to generate trading signals and placing orders as mentioned in the Para 2.1 of the Consultation Paper. These orders would emanate with minimal human interference by placing them as and when the required criteria of the investor is met. This is done by constant analysis and monitoring of the stock market and employing the provided logic to understand if an order can be placed for such investor.   These algorithm trading strategies are majorly of two types, the first generation algorithm trading strategies and the second generation algorithm trading strategies. First generation strategies are those which consists of human-defined, rules-based strategies that are transformed into computer code and then executed through sophisticated technological infrastructures that connect firms to markets. Whereas, the second generation strategies consists of the machine learning approach wherein machine learning system in itself creates the strategy basing on the objective function of the investor and creates trading rules which are automatically implemented into the market in the form of orders to buy or sell the securities of such investor. This blog deals with only the first generation algorithm trading strategies and does not concern about the second generation algorithm trading strategies.   The usage of the first generation algorithm trading strategy can be predominantly provided in two ways (Algorithm Strategies). While stock brokers offer algorithm strategies to the investors in-house, at the same time, the brokers can outsource the services of the third-party ASPs. These strategies would be thereafter offered to the investors by the stock brokers. In the second scenario, it is important to understand the regulatory framework of such third-party ASPs. As mentioned earlier,

[By Santripta Swain] The author is a student of National Law University Odisha.   Introduction  Recently, SEBI has been heavily criticised for its conflicting and lackadaisical approach in dealing with the securities matters. The Appellate Courts of different forums – the Supreme Court, High Court, or Securities Appellate Tribunal (SAT) have time and again been disappointed with the market regulator for its persistent non-compliance and, at times, non-uniformity in investigations as well as adjudication of various securities law matters. Thus, raising the question of its enforcement.  A similar instance was observed in the matter of IIFL Securities. SAT in the Matter of IIFL Securities has partly set aside the order of Whole Time Member (WTM) and Adjudicating Officer (AO). – The violation of misuse of clients’ funds along with the WTM order barring the Appellant from dealing with new clients for two years were set aside, and the order for not maintaining different nomenclature for clients’ account and proprietary account was allowed.  SEBI, at times, has been lauded for its strict norms. For instance, in the matter of Karvy Stock Broking Ltd – which gave us the perspective why stricter norms are necessary for preventing a series of fraudulent activities in the form of misuse of clients’ fund by the stock brokers (it has its own tales to tell). In another Adani-Hindenburg matter, the Supreme Court has sided with the SEBI for not blindly relying on the Hindenburg report, as such foreign reports should not be treated as gospel truth.  Premise  SEBI, based on its own investigation in the past, has found out that stock brokers have misused clients’ funds to meet their own settlement obligations or in some cases high net-worth clients’ settlement obligations. Additionally, SEBI found out that these intermediaries in order to raise fresh funds, pledge clients’ securities vehemently without their consent – such misuse of clients’ funds/securities was found to be in contrary to the principle and spirit of SEBI – protecting the rights of the investors.  Therefore, SEBI through a press release in 2020, stated that it has developed an in-house supervisory system to detect misuse of clients’ securities by the brokers.  Further SEBI, through various circulars on enhanced supervision of stock brokers has mentioned the standard operating procedures for the stock brokers and other intermediaries on how to segregate clients’ funds from their own proprietary funds. SEBI also made the NSE the watchdog in the workings of such intermediaries and initiate inspections as and when it felt necessary, while keeping the market regulator in loop in the matter.  The IIFL Securities (Appellant) is one of the many matters where SEBI has been criticised for its non-uniformity in penalising the alleged. Additionally, SAT also cautioned that SEBI should always work in the public interest. And in my humble opinion, the term public is inclusive of investors, brokers, and all other stakeholders in the securities market – meaning SEBI has a larger purpose to serve than to be termed as a rigid regulator.  Crux  The SEBI in the matter of IIFL Securities was concerned with the probable misuse of clients’ funds due to the non-segregation of such funds from proprietary trading fund. SEBI for the first time, through its Circular of 1993,  mandated segregation of clients’ funds from the proprietary ones, which, according to the SEBI Circular of 2016 and follow-up Circulars of 2017, were in furtherance of the Circular of 1993. And the whole crux of the matter revolves around how this mixing of funds is in violation to the SEBI Circular of 1993.  SEBI in the present matter took two things into consideration the Circular of 1993 and the Circular of 2016. SEBI’s whole stance was dependent on the fact that the Appellant failed to segregate clients’ funds from its own proprietary funds – potential misutilisation of clients’ funds. On top of that, SEBI’s Adjudicating Authority initiated two different proceedings for the same offence citing a long investigation period, hence the segregation – which the SAT found peculiar, as such segregation of matter was unnecessary and created an unwanted legal hurdle.  Case Issue  SEBI’s take on the issue was that the Appellant had failed to segregate the client’s fund from its own; therefore, there is a high possibility of misutilisation of client funds. I say this as a possibility because SEBI used a formula to establish such misutilisation without any concrete investigation to find such anomalies, which we would analyse in detail further as we go through the blog.  In order to understand the same, the Respondent (SEBI) referred to the formula that was first mentioned in the Circular of 2016.  G = (A+B) – C  A = Aggregate of fund balances available in all Client Bank Accounts, including the Settlement Account, maintained by the stock broker across Stock Exchanges  B = Aggregate value of collateral deposited with Clearing Corporation and/or clearing member in form of Cash and Cash Equivalents (Fixed deposit (FD), Bank guarantee (BG), etc.) (across Stock Exchanges). Only funded portion of the BG, i.e. the amount deposited by stock broker with the bank to obtain the BG, shall be considered as part of B.  C = Aggregate value of Credit Balances of all clients as obtained from trial balance across Stock Exchanges (after adjusting for open bills of clients, uncleared cheques deposited by clients and uncleared cheques issued to clients and the margin obligations.  From the aforementioned formula, if the value of G is negative, then it indicates that clients’ funds are being utilised for settlement obligations or for stock brokers own purposes.  Based on the recommendation of the Designated Authority (DA) – cancellation of the registration of certificate, the WTM (power exercised under Reg. 27 and Reg. 28 of the Intermediaries Regulation) restrained Appellant from onboarding new clients for a period of two years. Further, the AO also initiated parallel proceedings on similar facts and therefore issued two separate Show Cause Notices (SCN), and accordingly, a penalty of INR 1 Crore against each SCN was levelled against the Appellant. 

[By Shyama Singh] The author is a student of Gujarat National Law University, Gujarat.   Background  Through an informal guidance by way of an ‘interpretative letter’ dated 21st July 2023, the Securities and Exchange Board of India (“SEBI”) clarified whether open offer obligations under Regulation 3(3) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SEBI SAST Regulations”) or Takeover Code would be triggered. The clarification pertained to a situation where an increase in individual shareholding of promoters occurred, while the aggregate shareholding or voting rights of the promoter and promoter group did not exceed the 5% threshold. The guidance is significant since a plain reading of the SEBI SAST Regulations might initially suggest a contrary outcome than the guidance provided by SEBI.  As for the binding nature of such guidance, the Securities Appellate Tribunal (“SAT”) emphasized in paragraph 28 of JK Paper Ltd. v. SEBI that any guidance is not binding on the Board. Nevertheless, Clause 12 of the SEBI (Informal Guidance) Scheme, 2003, indicates that the Board generally aligns its actions with the letters issued as informal guidance.   Legal Framework  Under Regulation 3(1) of the Takeover Code, an acquirer, together with persons acting in concert (“PAC”), is obligated to make a mandatory open offer if their combined holding reaches 25% or more of the target company’s shareholding, conferring them the right to exercise 25% or more of the voting rights. Regulation 3(2) stipulates that an acquirer, along with PAC, holding 25% or more of the target’s shareholding, must initiate an open offer when acquiring an additional 5% or more of voting rights in the target during a financial year.  Subsequently, Regulation 3(3) elucidates that an acquisition leading to an individual’s shareholding surpassing the prescribed thresholds in either sub-regulations (1) or (2) necessitates an open offer obligation. This obligation holds true regardless of any change in aggregate shareholding with PAC. This means that if an individual acquisition exceeds the 25% threshold specified in sub-regulation (1) or surpasses the 5% threshold in a financial year after holding 25% or more under sub-regulation (2), Regulation 3(3) mandates a compulsory open offer, irrespective of whether the aggregate shareholding with PAC experiences any change or remains unchanged.  Brief facts   The informal guidance was sought by Kreon Financial Services Limited (“Kreon”), a publicly listed Non-Banking Financial Company registered with RBI and listed on BSE, concerning an increase in individual shareholdings of two promoters. These two promoters were Mr. Jaijash Tatia and Ms. Henna Jain. Through a board meeting dated 28.01.2021, board approval was received for the issuance of 95,00,000 warrants convertible to equity on a preferential basis to promoters, including Mr. Jaijash Tatia, Ms. Henna Jain, and other investors. The shareholders’ approval was received on 27.11.2021. Subsequently, an in-principle approval was received from BSE on 13.01.2022 for the allotment of these 95,00,000 warrants. On 24.01.2022, a board meeting approved the allotment of these 95,00,000 warrants. On 28.03.2023, another meeting approved the partial allotment of 28,77,000 equity shares against the partial conversion of the warrants. Resultantly, the shareholding of Mr. Jaijash Tatia and Ms. Henna Jain increased from 9.29% to 14.28% and 0% to 4.99%, respectively, in FY 2023. This increase was of 4.99% for both promoters.  Since the warrants were only valid for 18 months, Kreon enquired whether a further conversion of the pending warrants into shares in FY 2024 would trigger the Open Offer Obligation as per Regulation 3(3) of the SAST Regulations since the individual shareholding/voting rights of the two promoters would increase by 5.37% and 9.84% post-conversion. This was notwithstanding that the promoter and promoter group’s combined shareholding/voting right would not surpass 5%, as mandated by Regulation 3(2) of the SEBI (SAST) Regulations.  The shareholding of these promoters, along with PAC (i.e., the promoter group), was 50.60% in FY 2023. This aggregate shareholding was estimated to increase by 4.99%, i.e. to 55.59% after converting the remaining warrants in FY 2024. However, the individual shareholding of the two promoters would cross 5%. This was because the shareholding of other promoters in the promoter group decreased by 10.22% when the shareholding of the concerned promoters increased by 15.21%, resulting in a cumulative increase of 4.99%.   SEBI’s guidance and analysis  SEBI noted that the individual shareholding of Mr. Jaijash Tatia and Ms. Henna Jain was below 25%, and thus, open offer obligations were not triggered for them under Regulation 3(3) read with Regulation 3(2) of the SEBI SAST Regulations, 2011, even if they acquired 5.37% and 9.84% respectively.   The guidance tendered by SEBI might seem incorrect initially since the shareholdings of the two promoters increased by 5.37% and 9.84% when they aggregately held 50.60% along with PAC before the acquisition. One might conclude that this situation would attract Regulation 3(2) and mandate an open offer thereunder. This conclusion would be based on an understanding that Regulation 3(2) mandates an acquirer who acquires more than 5% when already holding 25% or more together with PAC, to make an open offer. However, this is an incorrect and partial understanding of the Regulation. A complete reading would reveal that SEBI’s guidance aligns with the SAST Regulations and no open offer is required.  As per Regulation 3(3), an open offer obligation is triggered when, ‘individually’, the thresholds under sub-regulations (1) and (2) are exceeded. In the present case, the 25% or 5% thresholds under sub-regulation (1) and (2) were not breached ‘individually’. However, under sub-regulation (2), one may argue that the shareholding of the promoter and PAC was well beyond 25%, after which the two promoters individually acquired more than 5%, mandating an open offer obligation. Such an interpretation is incorrect.   It has been noted that Regulation 3(3) addresses breaches at the individual level, contrasting with the provisions outlined in Regulations 3(1) and 3(2). Sub-regulations (1) and (2) cover situations wherein individuals and PACs ‘collectively’ exceed the prescribed thresholds. This can also be gathered from the language employed in these sub-regulations, which uses the word “them,” meaning the individual acquirer,

[By Soham Niyogi] The author is a student of Rajiv Gandhi National University of Law, Punjab.   Introduction A calamity may be overkill, but when giant conglomerates drop like flies and wither away, it would certainly raise some eyebrows about how this disaster occurred, or how it could have been avoided. Some of these behemoths find themselves in the guise of the SREI Infrastructure Finance Ltd. (hereinafter, “SREI”) or Infrastructure Leasing and Financial Services (hereinafter “ILFS”), these two major companies are buried in the annals of India’s financial history as they threatened disaster for the thousands of people who had put faith in these companies’ instruments. Public opinion lay restricted to blaming these companies for falsely inflating their bonds’ value and then disappointing investors with a liquidity crisis of upwards of 90,000 crores (in the case of ILFS). The overlooked villains of the story are the Credit Rating Agencies (hereinafter, “CRA”) which hyped up the bonds of SREI and ILFS to be of AAA-grade quality, a complete lie brought about by cronyism, bribes, and favour politics.     CRAs are bodies regulated by the Securities and Exchange Board of India (hereinafter, “SEBI”), to determine the ability of an issuer company to make good on its debt instruments, and timely disburse the principal and the interest. In the IL&FS crisis, recklessly CRAs had tagged IL&FS’ bonds to be of the highest grade rating, proportionate to being least likely to default. This illusion was broken by the crisis that struck, ending the market prospects of thousands of investors. SEBI had noted CRAs to be ‘financial gatekeepers’ and petty bribes along with promises of gifts shaken up the corporate debt market. The Grant Thornton Forensic Audit Report which scoped out the financial transactions of the subsidiaries of IL&FS confirmed that there were inconsistencies regarding IL&FS’ strategy of short-term borrowings against its long-term lending. Aside from dealings between IL&FS and its subsidiaries through third parties, the report also observed that loans were sanctioned at a negative spread which would be a cause for concern to any CRA.  Primarily, the Indian version of the ‘issuer-pays’ model is the culprit behind this situation, as it is a focal point that creates the camaraderie between CRAs and the instrument issuers in a quasi-closed market where it is tough for outside players to infiltrate. What the model entails is that an issuer such as IL&FS would pay a CRA to rate their instrument, one can see how there might be a conflict of interest persisting in this relation. The income of a CRA is dependent on the revenue that it extracts from the ratings it does for a body corporate. This conflict of interest wherein the sustainability of an issuer is dependent on the CRA’s ratings showcases a symbiotic relationship. There would never be an instance where a company pays the fees to a critical CRA which could rate their instruments lowly (the CRA would lose business). Simply put, it is a legally mandated bribe.   This conflicting relationship brings forth a situation known as ‘rating shopping’, wherein the issuer subscribes to ratings from the top CRAs, and only publishes the most favourable one. Fear of being discharged is a motive for the CRAs to give the best ratings possible. Even after observing the fall of SREI and ILFS, such has not been looked into by the SEBI per the SEBI (Credit Rating Agencies) Regulations 1999 (hereinafter, “CRA Regulations”) except for a lacklustre standing committee, mentioned in the following text. The amendments up until 2023 do not address this logical fallacy as under regulation 14 of the CRA Regulations, and the vicious cycle is perpetuated till now, as could be seen in the case of SREI’s default in 2021.   Regulation 16 (2) of the CRA Regulations permits a CRA to issue a credit rating even if a client company refuses to cooperate, based on incomplete public information only. If we could refer to the Report, IL&FS had also sent incomplete information to the CRAs. Unfortunately, this is a great disservice to the ordinary investor who would suffer due to their reliance on uncredible credit ratings by globally acclaimed CRAs with or without disclosure as per 16(2).   Cross-Jurisdictional Analysis of the Issuer-Pays Model   India’s efforts to mitigate the chances of a like crisis are realised in the form of an advisory report by the Standing Committee on Finance, wherein they criticise the issuer-based model while recommending measures such as the disclosure of confidential information such as the liquidity position of the issuer. None of the recommendations made by the committee were ever implemented, but we can find a similar solution to this problem in other jurisdictions aside from India, where a successful version of the issuer-paid model is in work, from which India can be inspired.   A comprehensive solution may be sought from separate jurisdictions, starting with the Basel Committee on Banking Supervision which has in its leagues, 45 member banks and central regulators with authorities hailing from 28 jurisdictions. The committee’s stringent laws to encourage issuer-investor relationships are admirable since they also comply with the issuer-based model with the investor’s interests in mind. The supervisory committee concurs with a system of the disclosure of liquidity ratio. Liquidity ratio is the measure of a company’s capability to pay off its short-term obligations, at the moment, no such system of disclosure exists in India.   From 2015 onwards, the Basel Committee made it mandatory for its members to reveal its liquidity coverage ratio, guided by two base objectives, to improve a bank’s short-term resilience by warranting that it has high liquidity assets at all times to show for, and to reduce funding risk over a long time, to ensure that the company is only allowed to invest in projects when they have sufficiently stable sources of income, and high reserves of liquidity. The Basel Committee directs its members to have a common public disclosure framework for the ease of the market participants. This scheme is still in practice and could very well

[By Vidushi Dubey] The author is a student of Amity University.   Introduction  India’s stock broking landscape is on the cusp of a significant shift, empowered by the Securities Exchange Board of India’s (SEBI) recent circular. Announced on January 12, 2024 and set for implementation on July 1st, 2024, this initiative introduces a groundbreaking facility of voluntary online access freeze/block for trading accounts. This marks a crucial step towards promoting investor protection and fostering a more regulated securities market. Earlier, there was limited control over online trading accounts. This new facility empowers investors to take charge of enhanced security against suspicious activity or unauthorized transactions. The users can simply freeze their accounts, safeguarding the assets and reputation. They can also decide how long to restrict access, putting their online trading activity under your complete control. This move by SEBI tends to encourage continued participation in the online trading arena. Verification and validation of transactions will also became easier, potentially reducing conflicts and disputes between investors and trading members.  Legal Considerations for the Facility  SEBI’s landmark circular empowers investors with the legal right to freeze their online trading accounts, carries several legal implications to take in account. It is issued under Issued under SEBI Act, 1992 and SEBI (Stock Brokers) Regulations, 1992, which reflects SEBI’s commitment to investor protection and market regulation. It aligns with demat account regulations, SEBI (Depositories and Participants), 2018  ensuring consistency and familiarity for investors. The circular mandates clear communication and acknowledgement procedure for freeze/block requests. It also establishes new legal rights for investors to control their online access and imposes corresponding obligations on brokers to comply with ISF and SEBI guidelines. The update makes it clear that breach of the circular will attract penal provisions under SEBI regulations, triggering disciplinary actions. The redressal mechanism facilitates dispute resolution, enhancing legal recourse for investors. Overall, the update augments market stability through increased investor confidence and contributes to a more robust and transparent regulatory framework.  The Rationale Behind India’s Trading Account Freeze Facility  Prior to SEBI’s recent circular, Indian investors faced significant vulnerabilities in the online trading arena. The alarming prevalence of unauthorized activity, as evidenced by the 1,819 complaints to SEBI in 2019-20 (representing 12.5% of all complaints), exposed investors to financial losses and reputational damage. According to SEBI’s annual report for 2021-22, complaints related to unauthorized activity in online trading surged by 20% compared to the previous year, reaching a total of 2,235 complaints. This represents a 15% share of all complaints received by SEBI, highlighting the growing concern among investors. In 2022-2023, a concerning number of 1,481 complaints were registered with SEBI pertaining to unauthorized trading activity. Phishing scams, hacking incidents, and insider trading posed constant threats, highlighting the need for immediate action capabilities.  Further compounding the issue was the lack of control over online access. Unlike with demat accounts, investors had no option to directly freeze or block their trading accounts, leaving them reliant on brokers in case of suspicious activity. This dependence inevitably led to delays and inefficiencies in resolving concerns, leaving investors exposed during critical periods. The disparity in regulations between demat and trading accounts created additional challenges. The existing facility for freezing/blocking demat accounts demonstrated the feasibility and benefits of such a mechanism. The absence of a similar option for trading accounts not only caused confusion but also hindered investor confidence in the overall market structure.   Recognizing these critical issues, SEBI’s introduction of the voluntary trading account freeze/block facility aims to address them comprehensively. This initiative fosters a more secure and investor-centric environment by empowering individuals to take control of their online trading activity. The ability to immediately freeze accounts in case of suspected fraud or unauthorized transactions significantly enhances investor protection, while promoting increased confidence and participation in the market.   The new facility is recognized as a significant step in enhancing investor protection as it aligns with global best practices like The European Union’s Markets in Financial Instruments Directive (MiFID II), which mandates investment firms to provide clients with tools to control online access and prevent unauthorized activity. Similarly, the Securities and Exchange Commission (SEC) in the United States emphasizes investor education and encourages the use of strong authentication protocols to safeguard accounts. The framework established by the Brokers’ Industry Standards Forum (ISF) aligns with global efforts to standardize investor protection measures and ensure consistent practices across different markets.   Key Changes and Legal Implications  This legal and regulatory shift promises to transform online trading in India, fostering trust, stability, and growth for all stakeholders. While challenges remain, primarily for brokers in implementation, the long-term impact can be transformative, solidifying investor protection and establishing a robust regulatory framework for India’s online trading landscape. The circular enshrines the legal right for investors to voluntarily freeze or block their online access, empowering them to take control of their financial security. This aligns with principles of natural justice, granting individuals the legal authority to respond to suspected unauthorized activity or personal needs. The Brokers’ Industry Standards Forum (ISF), established as a pilot project by SEBI in collaboration with stock exchanges, will set up a clear framework. BISF will facilitate the formulation of clear guidelines to address the concerns of brokers as it was set up with the motive to empower brokers and investors to make informed decisions by establishing common standards for areas like risk management, client handling, and dispute resolution. Since its establishment, the Brokers’ Industry Standards Forum (ISF) has played a crucial role in shaping important SEBI circulars addressing concerns like upstreaming of client funds and the removal of duplicate submissions. The ISF will establish standardized communication templates for brokers to inform investors about their freeze/block options and the associated procedures. The forum can also develop uniform timelines for processing freeze/block requests, ensuring consistent investor experience across different brokers   SEBI oversight guarantees adherence to the framework, upholding accountability and legal compliance across market participants. This will be achieved by empowering investors to immediately freeze their accounts in case of any suspected unauthorized activity in their trading account, preventing further losses and allowing them to investigate the situation without relying solely on their broker. The regulations

[By Arnav Gulati] The author is a student of Jindal Global Law School.   Introduction:  In the burgeoning digital finance arena, financial influencers, termed as ‘finfluencers’ have emerged as influential arbiters of financial decision-making, however their actions continue to be uncontrolled. The absence of regulatory oversight in this domain has created a vacuum that has been used by such finfluencers, who often lack the requisite credentials, to propagate inaccurate and deceptive financial information. The Securities and Exchange Board of India (SEBI) has acknowledged the significant effect of social media on stock markets, the process of price discovery, and the susceptibility of novice investors who are prone to being swayed by “tips” or suggestions. Through the notorious ‘Telegram Case,’ i the dark underbelly of unregulated financial advice was brought to the fore. In the aforementioned case, titled “Re: Stock Recommendations using Social Media Channel (Telegram)” – the trading activity in a particular stock was momentarily influenced by the quantity of channel members and the number of tips/recommendations shared on Telegram, which gave rise to concerns within the framework of the Prevention of Unfair Trade Practices Regulations (PFUTP). The decision made by SEBI signified a noteworthy advancement in acknowledging the impact of social media on stock markets, while simultaneously ensuring market integrity by combating unregistered operations and unfair activities. This decision of January 2022 served as a strong indication from SEBI that persons without sufficient regulatory control are prohibited from offering financial advice or suggestions, hence imposing challenges on finfluencers seeking to perform their services in an unregulated way. The Telegram case, along with other cases such as Sadhna Broadcast Limitedii and Mansun Consultancyiii have drawn attention to the recognition by SEBI of the potential for stock price manipulation associated with a substantial subscriber base.   SEBI’s new consultation paper and the Advertising Standard Council of India’s (ASCI) revised guidelines mark India’s foray into uncharted regulatory waters. Herein, I critically appraise these emerging regulatory propositions, dissecting their potential efficacy, overreaches, and the nuanced challenges they may inadvertently usher in.  The Double-Edged Sword of Transparency Mandates:  Right off the bat, I firmly believe that SEBI’s insistence on rigorous disclosure norms is a commendable attempt to infuse transparency into the finfluencer ecosystem. However, the mandate’s viability teeters on practical enforcement. The digital sphere’s fluidity, coupled with the sheer volume of finfluencer-generated content, raises significant concerns about the effective monitoring of these disclosures. Moreover, there’s a thin line between ensuring transparency and inundating consumers with excessive information, potentially leading to decision paralysis rather than informed financial choices.  Furthermore, the requirement for finfluencers to disclose all affiliations (Paragraph 4.4 of the consultation paper) could inadvertently create a skewed perception. For instance, a finfluencer with multiple disclosures might either be seen as more trustworthy due to transparency or be perceived as biased due to numerous affiliations, regardless of the actual content quality. This paradox underscores the need for a more nuanced approach to disclosures, perhaps emphasizing the quality and relevance of affiliations over sheer quantity.  The Quagmire of Defining ‘Financial Advice’:  One of the most contentious aspects of the emerging regulations will be to define what constitutes as ‘financial advice.’ SEBI currently defines ‘investment advice’, but not ‘financial advice’.   This legislative uncertainty might place influencers, regulatory agencies, and consumers at risk. Without a defined, legally enforceable definition of ‘financial advice,’ content providers might design their messages to avoid seeming to give explicit investment advice while nevertheless driving audience behaviors. Known as “dog-whistling” in other situations, this phenomenon uses coded language to send specialized signals to those who understand it.  This offers a complicated issue for regulators. First, monitoring the large amount of information on numerous platforms, each with its own language and regulations, is logistically tough. Not only is content volume important, but linguistic complexities demand sophisticated comprehension and interpretation, which is not readily scalable for wide regulatory supervision. Second, regulating this disguised communication without infringing on casual financial talk is very difficult. Regulators must safeguard customers from deceptive information that might harm their finances without intruding on free speech and expression, protected under Article 19 of the Constitution. The framework should define what is and is not ‘financial advice’, giving content providers and customers more clarity and safety. To empower people in this digital era of information overload, authorities should examine ways to spread awareness on how to distinguish expert financial advice from informal comments.  Potential Pitfalls in the Enforcement Mechanism:  As we delve deeper into the regulatory landscape, it becomes clear that good intentions alone may not suffice. The real test lies in how these rules are put into practice. While the emerging regulations are well-intentioned, their success hinges on the robustness of the enforcement mechanism. SEBI has used the current framework comprising of the SEBI PFUTP Regulations, Settlement Proceedings Regulations 2018, and Investment Advisers’ Regulations 2013 to address the activities of social media influencers. To create investment advisors as a separate category of market intermediaries, SEBI enacted the Investment Advisers Regulations. These rules were created to protect investors’ interests and avoid any potential conflicts of interest that could result from advisors also serving as financial product distributors. Additionally, SEBI significantly changed these laws in July 2020 to coincide with the rise in finfluencer activity during the COVID-19 lockdown period. The consequences of non-compliance are not sufficiently addressed by these adjustments, which included revisions to the qualification, certification, and net worth criteria for investment advisers. This strategy is not, however, streamlined. The upcoming regulations run the danger of becoming paper tigers without severe fines and a methodical enforcement strategy. Furthermore, platforms that host finfluencer material will bear the bulk of the responsibility for maintaining compliance. This assumption might result in uneven enforcement as platforms with different competencies will try to implement laws consistently. As a result, there is a growing risk of “regulatory arbitrage,” in which finfluencers move to less restrictive platforms, so evading the same scrutiny that regulations aim to provide.   Overlooking the Consumer’s Role:  The Ministry of Consumer Affairs’ most recent “Endorsements Know-hows” will have

[By Aniket Panchal & Shubhankar Sharan] The authors are students of Gujarat National Law University.   Introduction An interesting chain of events transpired centered on Edelweiss (a registered Professional Clearing Member (“PCM”), against whom appeals were filed in response to directives from the Member and Core Settlement Guarantee Fund Committee (“Committee”) of NSE Clearing Ltd (“NCL”). These directives ordered Edelweiss to reinstate securities that were disposed of in violation of the Securities and Exchange Board of India (“SEBI”) Circular and NCL Regulations. The contentious issue arose when Edelweiss, providing clearing and settlement services, sold collateral worth Rs. 460 Crore from broker and trading member Anugrah to fulfill clearing obligations.   The central issue here was that the PCM liquidated the securities of the Trading Member’s clients to offset the trading member’s debit balance. The Committee found Edelweiss on the wrong side, underlining a failure to ensure that clients’ securities were used solely for meeting their obligations, thus violating NCL Rules. Similarly, accusations regarding the misuse of client securities emerged in appeals involving other Clearing Members, including Yes Bank and SMC Global.   The Edelweiss order sheds light on the pressing issue of intermediary misconduct in handling client funds.  In light of this, the authors examine SEBI’s previous initiatives in curbing such malpractices and then discuss the roles of clearing members and the ambit of powers vested with NCL.   Past to Present: SEBI’s strides in countering misuse of client funds  Throughout the course of its existence, SEBI has actively tried to curb the menace of misuse of clients’ funds by Stock Brokers (“SB”) and Clearing Members (“CM”). A string of circulars has been released to further the objective. The premise was set by its 1993 circular, which prescribed maintenance of separate accounts of Member Brokers and their clients. It set the course for future actions against misuse. A brief leap in time necessitated SEBI to release another set of circulars in this regard. More importantly, all of them have been laid out prima facie to combat misuse of funds and client collaterals. Several actions in the form of alerting and monitoring mechanisms and enhanced supervision over SBs have been devised by SEBI. Not to mention, SEBI has been proactive in not only outlining the measures but also prescribing guidelines for implementing those measures. A look at some of the circulars, as mentioned in the SAT Order, underscores the principle highlighted in the 1993 Circular.   Precisely, the Circular dated 20 June 2019 proscribes the usage of clients’ funds by SBs for themselves or any other client (as provided in Securities Contracts (Regulation) Act 1956 (“SCRA”) and Securities Contracts Regulation Rules, 1957 (“SCRR”). Lastly, some of the immediate circulars dated 11 November 2022 and 12 December 2023 fortify SEBI’s position on misuse of clients’ funds. The former deals with handling clients’ securities by Trading Members (“TMs”)/CMs, while the latter lists the criteria for receipt/payment of funds by SB and CMs from/to clients. An essential requirement that stands out is establishing clear time frames for completing the transactions with clients.  Stock Exchanges, too, have been on the heels of SEBI. NSE circulars, for instance, reproduce the intent of the SEBI circulars. A case in point can be that of its June 2023 circular, wherein it established detailed guidelines for immediate actions against misuse of clients’ funds. “Enhanced Supervision” principles form the bedrock of implementing those administrative guidelines. The administrative actions referred to in the circular are in addition to pre-defined measures against Trading Members, as existing in the NSE circular no. 82/2022.   Several cases have been reported on misutilization of clients’ funds, of which the case of Karvy Group takes most of the light. The concerned company was involved in creating a labyrinth of transactions in order to misuse clients’ securities. Subsequently, it was expelled by the NSE and deregistered by SEBI on account of misutilizing clients’ funds and securities.  Analysis PCM and CM – Cut from the same cloth?   On this count, the main contention of Edelweiss was that based on the bye-laws of NCL, a PCM cannot be considered as a CM; therefore, circulars issued by SEBI/NSE/NCL will hold no applicability on the PCM. As a corollary, it was argued that the word “constituent” under NCL bye-laws can only encompass trading members with which a PCM has an agreement and not the end clients of the trading member. Based on this, it was contended that a PCM has no duty of care to a TM’s clients. Edelweiss urged that the clients of trading members do not have any legal or beneficial ownership over their shares once the trading members transfer the same to a PCM.  To rebut Edelweiss’s contention that a PCM is not the same as a CM, the tribunal referenced two provisions of the Futures & Options (“F&O”) Regulations. Firstly, the definition of F&O CM defines it as a member of the Clearing Corporation and includes all categories of clearing members. Secondly, a PCM is defined as a clearing member admitted by the relevant authority. Based on this, the tribunal noted that a PCM is nothing but a type of CM.   In any case, the whole discussion, at best, was academic since the tribunal found Edelweiss was registered as a CM and not as a PCM. As stated in the Order too, it is by virtue of the recent amendment to the Securities and Exchange Board of India (Stock Brokers) Regulations, 1992, that a PCM got defined under Section 2(ca). the reason being that, as per the Schedule appended to the Regulations PCM requires higher net worth than other sub-categories of CM. Otherwise, any member having clearing and settlement rights is a CM.   Interestingly, Edelweiss drew parallels between a PCM and a Senior Counsel to further its contention that PCM bears no liability to the trading member’s client. The analogy rested on the premise that Senior Counsel’s accountability lies only with the instructing advocate and not the end client. Likewise, PCM shall be answerable only to trading members (its client) and

[By Srishti Multani & Aryan Birewar] The authors are students of Symbiosis Law School, Pune.   Introduction   The Securities and Exchange Board of India (‘SEBI’) on 31st August 2023, issued a Consultation Paper to propose a Performance Validation Agency (‘PVA’). The objective of such an institution is to validate performance claims of SEBI-registered intermediaries. Such validation will enable the entities to catapult their customer-base in the securities market. There was a pressing need ​for transparency and authenticity in the claims made to attract investors. In this article, the authors examine the rationale behind a PVA, stress-points of the consultation paper, and critically analyze the benefits and challenges posed by the establishment of a PVA. Furthermore, they suggest certain solutions to address the forthcoming said challenges.   Need & Rationale   The urging requirement of credibility in the securities market pushed the regulator to produce this proposal. All the SEBI-registered intermediaries seek to increase their customer-base, which requires them to build investor trust. Such validation by the PVA will allow the intermediaries to attract investor clients in the market by highlighting their performance claims. An independent body like the PVA will facilitate the trust-building process ​between market intermediaries and investor entities.   Presently, SEBI has imposed differential restrictions on the market intermediaries in making performance claims to expand their service-base to more investor clients.   ​​​Claims of Asset Management Companies (‘AMC’) and Portfolio Managers are self-verified. There is absence of any independent body to validate their claims.   Claims of Investment Advisers (‘IA’) and Research Analysts (‘RA’) cannot be made in reference to their past performance. As per the existing SEBI Advertising Code, any ‘buy/sell/hold’ recommendation by these intermediaries cannot be made in reference to past performance and by usage of any superlative terms. For example, ‘best’, ‘top’, ‘leading’, etc.   Claims of Stockbrokers pertaining to past or future returns ensuing from algorithmic trading is not permissible.   The regulator recognized the need for intermediaries like IA’s, RA’s, Stockbrokers, etc. to showcase their performance claims to increase their clients. The same must be predated with an independent and impartial performance claim validation agency to ensure accuracy and correctness of claims floated in the securities market.   The functioning of such an agency will preclude eventualities of false, misleading, and inflated performance claims floated to attract investors. It will ensure that all participating intermediaries resort to fair and correct practices to expand their services to the investor clients. It is important to recognize that relying on verification from just one brokerage company can be misleading for investors, as it does not offer a comprehensive view of trading performance across all accounts. This makes the existence of a PVA all the more important.   Proposal by SEBI  The following proposals encapsulate the major highlights in SEBI’s Consultation Paper:  Criteria for Grant of Recognition   SEBI has mandated the PVA’s to be subsidiary entities of Market Infrastructure Institutions (‘MII’s). The rationale provided by them is that MII’s are the sole components of the securities market, which deal with ​a large​​ amount of investor data daily. As per the Bimal Jalan Panel (2010), they defined MII’s to be inclusive of Stock Exchanges, Depositories, Clearing Corporations, etc.   PVA’s are thus mandated to be wholly-owner or jointly-owner subsidiary entities of MII’s.   PVA’s will be recognized by SEBI only, when their parent MII fulfill the eligibility criteria prescribed by SEBI.   Obligations of a PVA  The paper prescribes the task of claim validation to be based on the parameters of risk, return, volatility, or any other parameter deemed suitable by SEBI. It is PVA’ duty to ensure that all information shared to them by the investors or intermediaries is kept confidential. Since, the major function is validation of investor data, SEBI permits ​PVA to partner with credit rating agencies for the purpose of validation, who aid in evaluating credit worthiness of debt securities and their issuers. Notably, the PVA can charge a reasonable fee for the validation of performance claims.   Categories of Claims validated by PVA.   Actual Profit – The PVA validates the actual profit minted by the investor basis the advice rendered by the SEBI-registered intermediary.   Algorithm – The recommendation rendered by PVA is derived from a certain algorithm. PVA undertakes performance evaluation of such algorithms over a prospective reasonable test period.   Stock/Portfolio – In order to evaluate recommendation of a stock/portfolio, the PVA must ​furnish​​ the recommendation on the day of recommendation and period of holding by the SEBI-registered intermediary.   Display of Recommendations   ​​​Exclusive Access– The validation of such recommendations is required to be published on their websites with access exclusively with clients.  Public Recommendations – Once the intermediaries publish the recommendations they can be accessed on the websites of the intermediaries and PVA both.  Specific Recommendation – When the intermediaries seek validation of a specific portfolio recommendation, then it shall be published on the websites of the intermediary and PVA in the format prescribed by the industry practice.  The unique attribute in these proposals is the “No Cherry-Picking” principle. As per this principle, the PVA cannot arbitrarily select clients, results, or events to their favor. Any validation of a performance claim must be done for all clients to prevent ​biases in the results. Furthermore, all such claims must be verified from third-party independent sources excluding the entity making the claim.  Analysis of the Proposals   The principal reason for this proposal was the pressing need ​for transparency​​ ​and investor reliance. By virtue of ​being an​​ independent verification body, it benefits both the investor and registered intermediaries – eliminating inflated performance claims and permitting marketing of successful investment advice, respectively.   For the investors, they place reliance on the stock and portfolio recommendations furnished by the SEBI-registered intermediaries to reap good returns. It becomes vital that an independent, third-party evaluator validates these recommendations. Especially, in cases of claims made by Asset Management Companies and Portfolio Managers, they are self-verified sans being subject to any external system of checks.  For the SEBI-registered intermediaries, they pressed the regulator for such an initiative as they want to increase their service-base to maximum investors. By