Media companies to disclose details of ad-for-equity business

SEBI vide press release PR No.200/2010 dated August 27, 2010 has published the new Press Council of India ("PCI") guidelines for media companies. These guidelines require media companies to disclose the details of the stake held by such media companies in various companies. Disclosures regarding such stake should also be made in the news report/ article/ editorial in newspapers/television relating to the company in which the media group holds such stake. Not surprisingly, the mainstream media in India has abstained from reporting this new requirement from SEBI.

Ad-for-equity business model

Under the ad-for-equity business model a company ("Client") buys ad space in newspaper/ television in lieu of its shares. The Client does not pay cash to the media company but issues its own shares to newspapers (in turn, media company buys equity in the Client). The media company gets paid only when it sells the shares of the Client after a period of time. These agreements between the Client and the media company are usually known as 'Private Treaties'. It has been alleged that apart from ad space in newspaper/ television, these Clients also get editorial (advertorial) coverage in newspapers owned by these media companies.

SEBI and the new disclosure requirements

Earlier this year SEBI had taken up its concerns with PCI, on the practice of many media groups entering Private Treaties with Clients as it felt that such agreements may give rise to conflict of interest and may result in dilution of the independence of press. SEBI also felt that such biased and motivated dissemination of information without appropriate and adequate disclosures, guided by commercial considerations can potentially mislead investors in the securities market and would not be in the interest of securities market.

PCI has accepted the following suggestions of SEBI and has issued the following guidelines vide press release PR/3/10-11/PCI dated August 2, 2010.

1. 
   
   
   Disclosures regarding stake held by the media company should be made in the news report/ article/ editorial in newspapers/television relating to the company in which the media group holds such stake.
2. 
   
   
   Disclosure on percentage of stake held by media groups in various companies under such 'Private Treaties' on the website of media groups should be made.
3. 
   
   
   Any other disclosures relating to such agreements such as any nominee of the media group on the board of directors of the company, any management control or other details which may be required to be disclosed and which may be a potential conflict of interest for media group, should also be mandatorily disclosed.
   
   
   

PCI also has expressed its apprehension that the brand building activities pursuant to Private Treaties without appropriate and adequate disclosures would not be in the interest of securities market.

Issues and challenges

1. 
   
   
   Ensuring strict compliance of these disclosure requirements would be tough task for SEBI as well as PCI. Firstly, it is the PCI, which have issued these guidelines and as such SEBI would have no role in the enforcement of these disclosure requirements. It means that the PCI would have to ensure compliance of these guidelines. The enforcement capabilities of PCI are questionable when compared to the capabilities of SEBI. Secondly, the guidelines merely states that 'the above suggestions may be kept in mind by the media'. Thus these guidelines are just recommendatory in nature. The PCI does not prescribe any penalty for non compliance with these guidelines.
2. 
   
   
   The guidelines have failed to define the scope of media companies. Under the ad-for-equity business model, it may not be necessary that the media company (which runs the newspapers/television channels) itself acquires stake in the Client. It might also be an associate company of the media company which acquires stake in the Client. Thus, in order to ensure full compliance, the disclosure requirements should also be extended to investment by associate companies in the Client.
3. 
   
   
   Apart from the above issues, one may also wonder about the locus standi of SEBI in taking up these issues with PCI. In its press release SEBI has stated that 'such brand building strategies of media groups, without appropriate and adequate disclosures may not be in the interest of investors and financial markets'. In most cases of ad-for-equity business/ Private Treaties, both the media company and the Clients are unlisted. Thus these companies (both media company and the Client) do not possess any threat to the interest of investors or financial markets. If SEBI's aim was to cover companies which may come out with public issues in future, these disclosure requirements should have been made a part of the issue documents/ prospectus.
   
   
   

Existing ad-for-equity business models

The Times Group has a 'Private Treaties' division known as the Times Private Treaties ("TPT"). TPT invests with potential, emerging or established brands with the objective of building brand value by advertising in Bennett, Coleman & Co. Ltd.'s media properties (like ET, ET Now, TOI etc.). Currently TPT has entered into 'Private Treaties' with companies (complete list is available here) including Multi Commodity Exchange of India Ltd., India Infoline Ltd., Artha Money etc. (Source: http://www.timesprivatetreaties.com).

Implications

These guidelines, if fully implemented, would bring in transparency in the reporting of news by media houses. All reports/ news/ editorials published by a media house in relation to a company (who is Client) should be followed by a disclosure that the media company holds a stake in such company (Client) or that the media company has entered into a Private Treaty with such company. This may also restrict the freedom of a media house to criticize a particular stance taken by Regulator (including SEBI) against a company (who is a Client), because the readers may, pursuant to such disclosure, link such criticism with the interest of the media house in the Client.

A copy of the PCI guidelines is available here.

A copy of the SEBI press release is available here.

IOSCO report on Principles for Direct Electronic Access to Markets/ Direct Market Access and the SEBI regulations

What is Direct Electronic Access to Markets/ Direct Market Access?

Direct Market Access ("DMA") is a facility which allows brokers to offer clients direct access to the exchange trading system through the broker's infrastructure without manual intervention by the broker. In different markets, different terminologies are used for DMA. These include 'direct access', 'direct market access', 'pure direct market access', 'intermediated access', and 'sponsored access'. The International Organization for Securities Commission ("IOSCO") calls the DMA arrangement as 'Direct Electronic Access' ("DEA"), and defines it as the process by which a person transmits orders on their own (i.e., without any handling or re-entry by another person) directly into the market's trade matching system for execution.

IOSCO Report on Principles for Direct Electronic Access to Markets

On August 13, 2010, the technical committee of the IOSCO has published the report on the 'Principles for Direct Electronic Access to Markets' – containing principles designed to guide intermediaries, markets and regulators in relation to the areas of pre-conditions for DEA, information flow and adequate systems and controls. This final report is based on analyses of market and regulatory developments and of the responses received to the original consultation report. The report contains eight principles that should govern DEA to markets around the globe. They are as follows:

Principle 1 - Minimum Customer Standards: Intermediaries should require DEA customers to meet minimum standards, including that:

1. Each such DEA customer has appropriate financial resources;
2. Each such DEA customer has appropriate procedures in place to assure that all relevant persons:

• Are both familiar, and comply, with the rules of the market; and
• Have knowledge of and proficiency in the use of the order entry system used by the DEA customer.  

Principle 2 - Legally Binding Agreement: There should be a recorded, legally binding contract between the intermediary and the DEA customer, the nature and detail of which should be appropriate to the nature of the service provided.

Principle 3 - Intermediary's Responsibility for Trades: An intermediary retains ultimate responsibility for all orders under its authority, and for compliance of such orders with all regulatory requirements and market rules.

Principle 4 - Customer Identification: Intermediaries should disclose to market authorities upon request and in a timely manner the identity of their DEA customers in order to facilitate market surveillance.

Principle 5 - Pre and Post-Trade Transparency: Markets should provide member firms with access to relevant pre and post-trade information (on a real time basis) to enable these firms to implement appropriate monitoring and risk management controls.

Principle 6 - Markets: A market should not permit DEA unless there are in place effective systems and controls reasonably designed to enable the management of risk with regard to fair and orderly trading including, in particular, automated pre-trade controls that enable intermediaries to implement appropriate trading limits.

Principle 7 - Intermediaries: Intermediaries (including, as appropriate, clearing firms) should use controls, including automated pre-trade controls, which can limit or prevent a DEA customer from placing an order that exceeds a relevant intermediary's existing position or credit limits.

Principle 8 - Adequacy of Systems: Intermediaries (including clearing firms) should have adequate operational and technical capabilities to manage appropriately the risks posed by DEA.

SEBI regulations in relation to DMA in India

In India, SEBI vide circular MRD/ DoP/SE/Cir- 7 /2008 dated April 03, 2008 has allowed brokers to offer DMA to clients after obtaining permission from the respective stock exchanges. SEBI also stated that stock exchanges can specify from time to time the categories of investors to whom the DMA facility can be extendd. However, initially the permission was restricted to institutional clients.

An analysis of the current SEBI regulations in the light of the IOSCO report reveals that the current SEBI regulations do not fully address issues like minimum customer standards (principle 1 of IOSCO report), customer identification (principle 4 of IOSCO report), pre and post-trade transparency (principle 5 of IOSCO report) and the roles and capabilities of clearing houses (principles 7 and 8 of IOSCO report).

SEBI proposes to double the retail investor’s cap to Rs 2 lakh

SEBI has released a discussing paper which proposes to raise the investment limit for retail investors from the current Rs 1 lakh to Rs 2 lakh. Regulation 2 (1) (ze) of SEBI (ICDR) Regulations, 2009 defines "retail individual investor" to mean an investor who applies or bids for specified securities for a value of not more than one lakh rupees. The discussion paper seeks to increase this limit to two lakh rupees on account of the following reasons:

• SEBI feels that retail individual investors who have the capacity and appetite to apply for securities worth above one lakh rupees were constrained from doing so because of the one lakh limit nor do they make an application under the non institutional investor category because the allocation there is limited to 15% as against 35% for retail individual investor category.
  
• Inconvenience faced by merchant bankers in big offerings to get enough number of retail investors because of the limit of one lakh rupees.
  
• Due to factors like inflation, currently one lakh rupees can buy only lesser number of shares as compared to 2005 (when the one lakh limit was fixed).
  

A copy of the discussion paper is available here.

Norms for investment by mutual funds in derivatives and related disclosures

SEBI vide circular Cir/ IMD/ DF/ 11/ 2010 dated August 18, 2010 has made the following modifications to the rules in relation to the investments by mutual funds in derivatives:

• Regulation 59 of the SEBI (Mutual Funds) Regulations, 1996 (“Regulations”) states that all mutual fund companies should publish half yearly results and it should contain the details as specified in twelfth schedule of the Regulations. As per the twelfth schedule, mutual funds should disclose, any exposure in derivative products for more than 10 per cent of the net assets of any scheme. However, the Regulations did not prescribe a format for this disclosure and as such and the disclosures being made by various mutual funds were not uniform across the industry. Now SEBI, vide this new circular, has prescribed the format and other details for such disclosure. SEBI has also defined the expression ‘exposure in derivatives’ and has also prescribed a manner for computation of the same. 
• The cumulative gross exposure through equity, debt and derivative positions should not exceed 100% of the net assets of the scheme.
• Mutual Funds cannot write options or purchase instruments with embedded written options (derivative instrument against another derivative).
• The total exposure related to option premium paid should be limited to 20% of the net assets of the scheme.
• However mutual funds can enter into plain vanilla interest rate swaps for hedging purposes. The counter party in such transactions has to be an entity recognized as a market maker by RBI. 

The rules will be effective from October 1, 2010 for all new schemes as well as the existing schemes.

A copy of the circular is available here.

The concept of Chinese wall in financial institutions – Part II (SEBI regulations)

The Chinese wall policy, in the context of financial institutions, was introduced in India by the Securities and Exchange Board of India (Insider Trading) (Amendment) Regulations, 2002. These regulations made it mandatory for (i) all listed companies and (ii) other organizations associated with securities markets (financial institutions), to have a Chinese wall policy as a part of their code of internal procedures and conduct (“Internal Code”). It also recognized implementation of a Chinese wall policy as a valid defense against insider trading allegations.

Chinese wall policy as a part of Internal Code

Financial institutions, by virtue of being organizations associated with securities market (broker/ sub-broker, depository participant, clearing/ trading member, merchant banker, custodian etc.) are under an obligation to implement an Internal Code which contains provisions of Chinese wall framework. Regulation 12 of the SEBI (Prohibition of Insider Trading) Regulations, 1992 (“Regulations”) requires such organizations to frame an Internal Code in accordance with the ‘model code’ specified in Schedule I of the Regulations (“Model Code”). The Internal Code should be framed ‘without diluting’ the Model Code prescribed by SEBI and the organizations should adopt appropriate mechanisms and procedure to enforce such Internal Code. Apart from the entities mentioned above, other entities like public financial institutions, all intermediaries registered with SEBI, asset management companies, trustees of mutual fund, self regulatory organizations, stock exchanges and professional firms who assist or advise listed companies are also under the obligation to frame such Internal Code.

The Model Code acts as the basic framework of Chinese wall policy in India, in the context of financial institutions. It contains two parts namely, (i) Part A which contains the model code for listed companies (the title reads as ‘Model code of conduct for prevention of insider trading for listed companies’) and (ii) Part B which contains the model code for organizations associated with securities markets (the title reads as ‘Model code of conduct for prevention of insider trading for other entities’). It appears from the Regulations that if the entity is associated with securities market and is listed, such an entity should implement an Internal Code which is a combination of Part A and Part B.

Part A (Model Code for listed companies)

Clause 2.1 of the Model Code (Part A) for listed companies requires the employees/ directors of such organisations to maintain confidentiality of all price sensitive information. They are prohibited from passing on such information to any person directly or indirectly by way of making a recommendation for the purchase or sale of securities. Clause 2.2.1 states that price sensitive information should be handled on a “need to know” basis. This means that such information should be disclosed only to those within the company who need the information to discharge their duty. Clause 2.3.1 mandates that the files containing confidential information should be kept secure and should have adequate security of login and pass word etc.

Part B (Model Code for other entities)

The Model Code for other entities (Part B) contains, in addition to the above mentioned restrictions under Part A, certain other requirements which details out Chinese wall policy, in further. Clause 2.4 and 4 require the organisation to adopt a "Chinese Wall" policy which separates “inside areas” from “public areas” for preventing the misuse of confidential information. The “inside areas” are defined as those areas of the organization which routinely have access to confidential information and “public areas” are defined as those areas which deal with sales, marketing, investment advise or other departments providing support services. The Regulations stipulates the following measures to be adopted by organizations for separating “inside areas” from “public areas”.

• The employees in the “inside area” should not communicate any price sensitive information to anyone in “public area”.
• The employees in “inside area” may be physically segregated from employees in “public area”.
• Demarcation of the various departments as “inside areas”
• Only in exceptional circumstances, employees from the public areas may be brought "over the wall" and be given access to confidential information on the basis of "need to know" criteria.

The Model Code for other entities (Part B) also requires that securities or shares of a listed company should be put on a “restricted/grey list” while the organization is handling any assignment for such listed company or while preparing appraisal report or while handling credit rating assignments and is privy to price sensitive information. Additionally, any security which is being purchased or sold or is being considered for purchase or sale by the organisation on behalf of its clients/schemes of mutual funds, etc. should also be put on the “restricted / grey list”. The effect of putting/ adding a security on the “restricted / grey list”’ is that any trading in such securities by employees/directors/partners of the organization would require the pre-clearance of trade by compliance officer. As a result of this, trading in these securities may be blocked or may be disallowed at the time of pre-clearance by the compliance officer after taking into account, all the relevant circumstances. This can be explained by way of simple example. If ‘Company A’ (a listed company), appoints ‘Only profit’ (an investment banker/ merchant banker) to find out an investor in ‘Company A’ to fund its new projects. This would be followed by ‘Company A’ sharing confidential information (which may be price sensitive) with ‘Only profit’ for preperation of IM, financial projections etc. In such a case ‘Company A’ would be added to the “restricted/grey list” maintained by the compliance officer of ‘Only profit’ and henceforth any trade made by employees/directors/partners of ‘Only profit’ would require pre-clearance of such trade by compliance officer of ‘Only profit’. The compliance officer would also have the option to restrict such trades, taking into account ‘relevant circumstances’.

In the next post, I will discuss the scope of “Chinese wall policy” as a defense to insider trading.

“The concept of Chinese wall in financial institutions – Part I (origin & mechanisms)” is available here.