SEBI notifies the new Takeover Code

SEBI has today notified the new Takeover Code “SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011”. The regulations shall come into force on the 30th day from the date of the notification i.e. from October 22, 2011.

A copy of the new Takeover Code is available here.

Former SAT chief C Achuthan passes away

Former Securities Appellate Tribunal chief and Chairman of SEBI's Takeover Regulations Advisory Committee, Mr C Achuthan passed away on Monday. He has made significant contributions to capital market jurisprudence in India.

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Bar and Bench

Economic Times

SEBI plugs the loophole in insider trading regulations: Promoters to disclose more often

Readers must be aware that under regulation 13(1) of the SEBI (Prohibition of Insider Trading) Regulations, 1992 (PIT Regulations), any person holding more than 5% shares or voting rights of a listed company is required to make an initial disclosure of his holding in terms of PIT Regulations. Under regulation 13(3), such a person is also required to make continuous disclosures about number of shares or voting rights held and any change therein from the last disclosure, if such change exceeds 2% of total shareholding or voting rights in the company. This disclosure is required to be made within two working days of receipt of intimation of allotment of shares or acquisition or sale of shares or voting rights, as the case may be.

Clause 35 of the Equity Listing Agreement, listed companies are inter alia required to make disclosures about the shareholding of promoter and promoter group of such company, on quarterly basis within 21 days from the end of each quarter. The Takeover Code also states that promoter or every person having control over a company is required to disclose the number and percentage of shares or voting rights held by such person(s), within 21 days of financial year ending on 31st March as well as the record date.

Issue

As explained above, under the past regulatory framework, the information about shareholding of promoter and promoter group comes in public domain at the end of each financial year and at the end of each quarter. There was no mechanism in place which ensured that the promoter and persons who are part of promoter group immediately disclosed to the market as and when a change (beyond certain threshold) occurs in their shareholding pattern unless such promoter/ person held more than 5% of the shares of the company (in such a case he would be liable to disclose under 13(1) of the PIT Regulations). Thus any person who is promoter and does not hold more than 5% of the shares of a company was not required to inform immediately any change in his shareholding even when such change is beyond the thresholds specified in PIT Regulations. Thus 'in a given case if shareholding of promoter and promoter group has been disclosed at the end of a quarter at say 40%, and promoter and promoter group is consisting of 10 persons so that none of them is holding more than 5% of the shares then information about any change in the shareholding of the promoter and promoter group comes in public domain within 21 days of the end of the relevant quarter. In such a case all the promoters and persons who are part of promoter group can exit from a company within a quarter without any information to the market regarding such change till the next quarterly filing'.

Amendment

By issuing the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2011, SEBI has made it mandatory for a promoter or member of promoter group to disclose all changes in their shareholding or voting rights from the immediate previous disclosure made under the PIT Regulations or the Equity Listing Agreement if such change exceeds Rs. 5 lakh in value or 25,000 shares or 1% of total shareholding or voting rights, whichever is lower. This disclosure has to be made within 2 working days of the receipts of intimation of allotment of shares, or the acquisition or sale of shares or voting rights, as the case may be. Also any person who is a promoter or part of promoter group of a listed company should disclose the number of shares or voting rights held by such person, within two working days of becoming such promoter or person belonging to promoter group.

A copy of the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2011 is available here.

A copy of the SEBI Board minutes in this regard is available here.

Put/Call Options & Mandatory Buyback are invalid

SEBI's has recently issued an informal guidance stating that a pre-agreed buyback of shares from an investor through put/call option is not legal/valid under the Securities Contracts (Regulation) Act, 1956 ("SCRA"). SEBI has stated that since these options would be exercised on a future date, such transactions would not qualify as spot delivery contracts as defined in section 2(i) of SCRA. These put/call options would not qualify as valid derivative contracts as per section 18A of the SCRA as these are exclusively entered into between two parties and not traded on stock exchanges and settled on the clearing house of the recognised stock exchanges. This informal guidance from SEBI reaffirms the view taken by it in Vedanta-Cairn deal wherein it repudiated the call/put/pre-emptive rights in their share purchase agreement citing its illegality.

Repeated buy-back offers not to be encouraged: SEBI

SEBI has in its recent order, allowing the Deccan Chronicle Holdings Limited (“Deccan Chronicle”) to buy-back 3.45 crore shares, stated that “repeated buy-back offers by a company is not something that SEBI, as a regulator, would like to encourage, given the fact that it could be misused by entities to consolidate their holding at the expense of the company”. This was the second time in the last two years that Deccan Chronicle had sought the permission of SEBI for exemption from the requirements of Takeover Code to come out with an offer to buy-back its shares. In July 2009 SEBI had granted Deccan Chronicle exemption from the requirements under the Takeover Code for increasing its voting rights from 63% to 73.51% pursuant to buy-back offer proposed by the target company. Thereafter, the target company had made the buy-back offer during August, 2009, wherein 4.84% of the total voting capital of the target company was bought back. In the present case, the Promoters again sought exemption from the requirements under the Takeover Code for increasing their voting rights from 63.37% to 73.83% (assuming 100% response) pursuant to buy-back offer proposed by the target company. SEBI vide its order dated 15 April 2011 granted Deccan Chronicle Holdings exemption from the requirements under the Takeover Code for the second proposed buy back of shares. However SEBI directed Deccan Chronicle not to seek any further exemption pursuant to any further buy-back offers by the target company. SEBI also stated that repeated buyback offers could be misused by acquires to consolidate their holding at the expense of the company and this is not something that SEBI, as a regulator, would like to encourage.

SEBI restricts circulation of unauthenticated news by market intermediaries

Last week SEBI had issued a circular which prevented the circulation of unauthenticated news or rumours by market intermediaries. SEBI noted that market rumours can do considerable damage to the normal functioning and behavior of the market and distort the price discovery mechanisms. Towards this end, SEBI has issued the following directions to the market intermediaries:

New compliances for market intermediaries

1. Market intermediaries should have in place proper internal code of conduct and controls to prevent circulation of unauthenticated news or rumours.

2. Employees of market intermediaries should not encourage or circulate rumours or information obtained without verification.

3. Access of employees of market intermediaries to blogs/chat forums etc. should either be restricted under supervision or access should not be allowed.

4. Logs for any usage of such blogs/chat forums etc. shall be treated as records and the same should be maintained as specified by the respective Regulations which govern the concerned intermediary.

5. Employees should be directed that any market related news received by them either in their official mail/personal mail/ blog or in any other manner, should be forwarded only after the same has been seen and approved by the concerned Intermediary’s Compliance Officer. If an employee fails to do so, he/she shall be deemed to have violated the various provisions contained in SEBI Act/Rules/Regulations etc. and shall be liable for actions. The Compliance Officer shall also be held liable for breach of duty in this regard.

Challenges

1. The new direction from SEBI seeks to restrict circulation of rumours or unauthenticated news by market intermediaries i.e. the SEBI registered intermediaries like a stock broker or a portfolio manager. However, in many cases the sources of unauthenticated news or rumours are not SEBI registered intermediaries but private persons giving stock advice or websites, forums, blogs etc. managed by entities other than SEBI registered market intermediaries. Thus the new direction from SEBI has failed to address the threats posed by private persons or blogs and forums managed by entities other than SEBI registered market intermediaries.

2. SEBI has mandated that any market related news received by employees of market intermediaries, should be forwarded by the employee only after the same has been seen and approved by the concerned Intermediary’s Compliance Officer. However, it is difficult for Market Intermediaries having large number of employees to implement the same. Also it is difficult for any entity to monitor all the online activities of their employees like emails, chats, blog posts, forum posts etc.

Listing Agreement for Securitized Debt Instruments

Last week SEBI had issued the listing agreement for securitized debt instruments. The listing agreement provides for disclosure of pool level, tranche level and select loan level information. The listing agreement comes into force with immediate effect for all securitised debt instruments as defined under regulation 2(1)(s) of the Securities and Exchange Board of India (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008, seeking listing on the stock exchange. Readers may recall that in October last year SEBI had issued the draft listing agreement for securitized debt instruments for public comments/ suggestions.

Stock broker allowed to undertake referral activities for loan, mutual fund distribution etc.

Readers may recollect the SEBI order under the SEBI (Informal Guidance) Scheme 2003 wherein it was stated that a merchant banker cannot undertake referral activities for non-security related products and/or services ("Barclays Case"). SEBI has recently passed an order under the SEBI (Informal Guidance) Scheme 2003 wherein it has stated that stock brokers may undertake referral activities and may act as an agent on behalf of the lenders for referring/distributing third party loans without taking on any personal financial liability. SEBI stated that such activities fall under the exception provided at Rule 8(1)(f) of the Securities Contracts (Regulation) Rules, 1957.

In the recent case, Fullerton Securities & Wealth Advisors Limited ("Fullerton") a stock broker, registered with SEBI, had filed with SEBI a request for 'No Action Letter' under the SEBI (Informal Guidance) Scheme 2003 in relation to its proposed businesses including referral activity. Under its proposed business scheme Fullerton would refer /distribute loans provided by third party NBFCs/banks/HFIs/lending institution to its customers while acting in capacity as agent or broker, with no personal financial liability on Fullerton. Fullerton also proposed to undertake activities like distribution of mutual funds, setting up a corporate agency for distribute insurance products and act as a depository participant. SEBI in its reply stated the following:

(i)    Fullerton may undertake referral activities act as an agent on behalf of the lenders for referring/distributing third party loans without taking on any personal financial liability (as it is allowed under Rule 8(1) (f) of the Securities Contracts (Regulation) Rules, 1957).

(ii)    Fullerton may distribute mutual funds after obtaining requisite registration from AMFI.

(iii)    Fullerton may distribute insurance products in compliance with IRDA directives.

(iv)    Fullerton may provide services as depository participant in compliance with the SEBI (Depositories & Participants) Regulations, 1996.

In the Barclays Case, SEBI had stated that a merchant banker registered with SEBI cannot undertake any business other than in the securities market, under regulation 13A of the SEBI (Merchant Bankers) Regulations, 1992. Thus a merchant banker cannot undertake referral activities for non-security related products and/or services. However in the present case (Fullerton's case) SEBI allowed a stock broker registered with SEBI to under referral activity as there are no similar restrictions (as in the nature of regulation 13A of the SEBI (Merchant Bankers) Regulations, 1992) in the Securities Contracts (Regulation) Rules, 1957.

Creeping acquisitions under regulations 11 (1) and 11(2) in the same year: Did SEBI go wrong in its interpretation?

Regulation 11(1) of the SEBI (Substantial Acquisition of Shares Takeovers) Regulations, 1997 ("Takeover Code") allows an acquirer holding 15% to 55% of shares in a target company to additionally acquire up to 5% of shares of the target company (with post acquisition shareholding of the acquirer not exceeding 55%) in any financial year without making a public announcement/ offer under the Takeover Code. The second proviso to regulation 11(2) of the Takeover Code states that an acquirer holding 55% to 75 % of the shares in a target company may acquire additional shares up to 5 % in the target company without making a public announcement/ offer under the Takeover Code.

SEBI has recently in an 'Interpretive Letter" (under the SEBI (Informal Guidance) Scheme 2003) stated that acquisitions under regulation 11 (1) and second proviso to regulation 11(2) of the Takeover Code can be undertaken by an acquirer in the same financial year. SEBI also clarified that the 5% acquisition under second proviso to regulation 11(2) is a one-time exemption.

Thus an acquirer holding 50% of the shares in a target company may acquire an additional 5% of the shares in a financial year under regulation 11(1) of the Takeover Code. Later the same acquirer (who currently holds 55%) may also acquire another 5% of the shares under second proviso to regulation 11(2) in the same financial year. This would mean that an acquirer holding 50% of the shares in a target company can acquire an additional 10% of the shares in the target company in a single financial year without making a public offer under Takeover Code.

Going by SEBI's interpretation an acquirer holding 15% to 49.99% of the shares in a target company may acquire additional shares up to 5 % in the target company in any financial year without making a public offer under the Takeover Code. However the moment acquirer holds 50% in the target company, he is conferred with the right to acquire an additional 10% shares in the target company in any financial year without making a public offer under the Takeover Code.

The spirit of the Takeover Code is to provide the shareholders of a target company with a suitable exit in case of acquisition of certain quantity of shares/ control of the target company by an acquirer. As per SEBI's interpretation if an acquirer, holding 15% to 49.99% of the shares in a target company, acquires more than 5% of the shares in the target company in any financial year, the Takeover Code provides for an exit option to the shareholders. However if an acquirer, holding 50% to 55% of the shares in a target company, acquires more than 5% of the shares in the target company (up to 10% in cases where the acquirer is holding 50% shares) in any financial year the Takeover Code does not provide for an exit option to the shareholders.

A viable alternative in this case would have been to allow the acquirer to undertake acquisitions under regulation 11 (1) and second proviso to regulation 11(2) in the same financial year up to 5% of the shares of the target company. SEBI has already clarified that an acquirer may exercise his right under second proviso to regulation 11(2) in one or more tranches, without any restriction on the time-frame within which the same can be acquired. Thus if the cumulative acquisition of shares under regulation 11 (1) and second proviso to regulation 11(2) has been limited to 5% in any financial year, the acquirer can exercise his remaining right under the second proviso to regulation 11(2) in the following financial years.

2010 –The Big Year in securities enforcement

The year 2010 has been a landmark year for securities law enforcement in India. Last year SEBI aggressively pursued its investigations against companies and market intermediaries and it resulted in some of the landmark orders (like the penalty imposed on enam securities, prohibition of sahara group from accessing capital markets, prohibitions imposed on FIIs for violating reporting norms etc.). Many orders passed by SEBI/SAT in 2010 (like the Subhkam case, MCX case) were characterized by its comprehensive analysis of the applicable rules and implications on the capitals markets. In the legislative front, the proposed takeover code and report on ownership of stock exchanges proposed certain out of the ordinary rules and received much criticism from the industry. In addition, SEBI also issued certain important rules/ regulations like the mandatory 25% public shareholding rule, introduction of volatility index and the pre-open session, regulation of media companies and the private treaty business etc. At the same time, SEBI also had its own share of controversies like the ban of ULIPS, its refusal to grant permission for running stock exchanges in the case of MCX etc.

A brief summary of the important events of the year 2010 is given below:

1.    Ban on Sahara

In November 2010 SEBI banned the directors and promoters of Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited from accessing capital markets. This was pursuant to a possible violation by the Sahara Group of DIP Guidelines/ICDR Regulations and the other applicable laws in relation to raising capital from the public. This was followed by a number of legal developments including Sahara Group publicly challenging the authority of SEBI through newspapers etc. Later SEBI put up a notice on its website cautioning the investors against investing in the above mentioned companies and the matter is currently pending before the Supreme Court.

2.    Fine imposed on Enam

The year 2010 ended with the news of SEBI imposing a fine of 25 lakh rupees on Enam Securities for its failure to exercise due diligence in the public offer of YES Bank. SEBI also noted that Enam Securities, who were the BRLM to the IPO of Yes Bank, failed to disclose, in the offering document, Rabobank International Holding B.V. as the promoter of Yes Bank.

3.    Rejection of the application of MCX-SX

In September 2010 SEBI rejected the application of MCX-SX to run bourses trading various products, including stocks and equity derivatives, saying that it wasn't in "the interest of trade and public interest to allow the application". In its order SEBI has stated that MCX-SX is not fully compliant with Manner of Increasing & Maintaining Public Shareholding (MIMPS) norms for recognised stock exchanges. This SEBI order too unfolded into a controversy and it was followed by the submission of the report of the Bimal Jalan committee on "Review of Ownership and Governance of Market Infrastructure Institutions" which added fuel to the fire. The order of SEBI is currently under the review of the Bombay High Court upon a writ petition filed by MCX-SX challenging the same.

4.    Ban on issuance of ULIPS

SEBI in April 2010 stated that ULIPs (Unit Linked Insurance Plans) are a combination of investment and insurance and therefore it can be offered/launched only after obtaining registration from SEBI under section 12(1B) of the SEBI Act. Through its order SEBI directed insurance companies not to raise money from investors through ULIPs without obtaining prior registration from SEBI. Not surprisingly this order too lead to a war of words between the two regulators (SEBI & IRDA) until the Central Government stepped in and passed an ordinance amending the RBI Act 1934, Insurance Act 1938, SEBI Act 1992 and Securities Contract Regulations Act 1956 clarifying that life insurance business would include any ULIPs or scripts or any such instruments. This brought an end to the 2 months long battle between the regulators SEBI and IRDA, by giving IRDA the jurisdiction over ULIPs business.

5.    Rules/ Regulations

It was in year 2010 that SEBI effectively addressed the need for consolidated circulars by issuing master circulars following the footsteps of the RBI. These master circulars are compilations of the circulars/communications issued by SEBI up to the date of the master. As on today SEBI has issued master circulars for stock exchanges and depositaries, mutual funds, anti-money laundering, administration of stock exchanges, stock exchanges- cash market and Exchange traded derivatives.

SEBI also introduced call auction mechanism in pre-open session and permitted stock exchanges to introduce derivative contracts on volatility index in the year 2010.

6.    Committee Reports

Two major committee reports were submitted in the year 2010 namely (i) Report of the Bimal Jalan committee on "Review of Ownership and Governance of Market Infrastructure Institutions" and (ii) Report of the Achuthan Committee on Takeover Regulations. It is worthy to note that SEBI so far has not acted upon these reports.

7.    Others

Veto rights not to constitute 'Control'

In January 2010, SAT in the matter of Subhkam Ventures (I) Private Limited v. SEBI held that that veto rights in favour of certain shareholders to veto certain actions proposed to be undertaken by the company (affirmative voting rights in the shareholders agreements) do not constitute 'Control' under the Takeover Code and that the shareholders having such affirmative rights need not make an open offer under the Takeover Code to the other public shareholders of the target company. This SAT decision is currently under Supreme Court's scrutiny. In the event the Supreme Court agrees with the SAT decision it would be beneficial to private equity (PE) and venture capital (VC) firms in India.

Offerings

In the offerings front, Standard Chartered Bank, for the first time, successfully raised capital from India through Indian Depository Receipts (IDR) route.

Regulation of media companies

SEBI made it mandatory for media companies to disclose the details of the stake held by such media companies in various companies. SEBI stated that such disclosures should be made in the news report/ article/ editorial in newspapers/television relating to the company in which the media group holds such stake.

What to expect in 2011?

The year 2011 started with the news of SEBI settling a case with Anil Ambani group companies for a record settlement amount of Rs. 50 crore. SEBI also barred two Anil Ambani group companies from investing in the secondary markets till December 2012 for allegedly routing money raised through overseas bonds to the stock market in 2007. This was followed by news reports that SEBI plans to levy a record penalty upto 1500 crores on Reliance Industries (RIL) for its alleged involvement in insider trading.

In light of the above, one may safely assume that SEBI is getting stricter with its enforcement measures and going forward SEBI enforcement measures would assume more importance than its role as a law maker. Recently Shri U K Sinha took charge as the Chairman of SEBI replacing the Shri CB Bhave. As his predecessor is credited as one of the best heads SEBI ever had, Shri U K Sinha has big shoes to fill.

Can directions of SEBI under Section 11B of the SEBI Act be punitive in nature?

SAT recently pronounced an interesting order (available here) in the matter of G.M. Bosu and Company Private Limited (the “Appellant”) versus SEBI and Central Depositary Services (India) Limited (the “Respondent 2”) and Mrs. Atreyee Chakraborty (the “Respondent 3”) wherein it held that the directions of SEBI under section 11B of the Securities and Exchange Board of India Act, 1992 (the “SEBI Act”) cannot be punitive in nature.

Section 11 of the SEBI Act empowers SEBI to protect the interests of the investors in securities and to regulate the securities market by taking measures it deems fit and Section 11B reads as under:
“11B. Power to issue directions – Save as otherwise provided in section 11, if after making or causing to be made an enquiry, the Board is satisfied that it is necessary,-
(i) in the interest of investors, or orderly development of securities market; or
(ii) to prevent the affairs of any intermediary or other persons referred to in section 12 being conducted in a manner detrimental to the interest of investors or securities market; or
(iii) to secure the proper management of any such intermediary or person, it may issue such directions,-
(a) to any person or class of persons referred to in section 12, or associated with the securities market; or
(b) to any company in respect of matters specified in section 11A, as may be appropriate in the interests of investors in securities and the securities market.”

The facts of this matter in brief were that the husband of Respondent 3 was a registered holder of 1100 equity shares of ITC Limited, which were held by him in physical form. On his death, Respondent 3 approached one Mr. Pyne, who was an ex-employee of the appellant and was working with her husband for getting the shares transferred in her name. Mr. Pyne advised her to open a demat account to facilitate the transfer and Respondent 3 handed over the share certificates representing the aforesaid shares to Mr. Pyne. Mr. Pyne opened the demat account with the Appellant, a depositary participant of Respondent 2, which is a depositary. The Appellant issued printed receipts acknowledging the receipt of share certificates representing the said shares.

The case presented by Respondent 3 was that Mr. Pyne was responsible for fraudulently transferring some of the shares to third parties and some in his own name, given the fact that she had had signed a number of blank printed forms and other documents including delivery instruction slips (the “DIS”) in good faith, under the impression that those documents were necessary for opening a demat account. Respondent 3 produced a hand written note (the “Note”) signed by Mr. Pyne and witnessed by her wherein Mr. Pyne confessed that he had cheated Respondent 3 and had obtained her signatures on some forms including DIS without her consent and transferred the shares illegally. In the Note, Mr. Pyne made a commitment to deliver the shares to Respondent 3 in the time stipulated therein and also committed that upon his failure to pay the dues with interest to Respondent 3, his legal heirs would be liable to pay the said dues.

Respondent 3 made a complaint to the Board that she had been defrauded of the shares by Mr. Pyne and that she had suffered a financial loss amounting to INR 3 lakhs and sent a copy of the note therewith. She also complained to the Appellant that she had been defrauded of the said shares by Mr. Pyne and she further alleged that Mr. Pyne was acting as a sub-broker of the Appellant and, therefore, she claimed damages to the tune of INR 3 lakhs for harassment and loss suffered by her. On getting no response from SEBI she filed a writ petition in the Calcutta High Court seeking a mandamus directing SEBI to initiate proceedings against Respondent 2 and the Appellant. The said writ petition was disposed by the Hon’ble High Court with an order to SEBI to give a reasonable opportunity of being heard to Respondent 3, Respondent 2 and the Appellant and give a decision regarding the question whether complaints made by Respondent 3 called for initiation of proceedings under any provisions of law.

Accordingly, SEBI conducted the relevant hearings and communicated to Respondent 3 its conclusion that the complaint of Respondent 3 did not call for initiation of proceedings by SEBI. SEBI was of the opinion that Respondent 3’s complaint was in the nature of a ‘private arrangement’ between her and Mr. Pyne, ‘an unregistered entity’, wherein Mr. Pyne acted contrary to her instructions, so SEBI had no role to play in this regard. Being dissatisfied with this order by SEBI, Respondent 3 again filed a writ petition in the Calcutta High Court contending that Respondent 2 and the Appellant were negligent in not ensuring that payment had been received by her before they transferred her shares in the name of third parties and, therefore, they violated Regulation 32 (as it then stood) of the Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996 (the “DP Regulations”). This writ petition was disposed by the Hon’ble High Court ordering SEBI to make an enquiry as to how Respondent 2 has ensured in terms of Regulation 32 that the depositor was paid before effecting transfer, upon notice to the Appellant and upon hearing the necessary parties including Respondent 3 and if found that proper mechanism under Regulation 32 was not in place, to take steps accordingly.

Pursuant to the aforesaid order, the whole time member of SEBI, after hearing Respondent 3, Respondent 2 and the Appellant passed an order holding that the Appellant and Respondent 2 had violated Regulation 32 of the DP Regulations (as it then stood) and treating this order as a show cause notice called upon the Appellant and Respondent 2 to show cause why they should not be directed jointly and severally to compensate Respondent 3. The Appellant replied to the said show cause notice stating that it was in compliance with Regulation 32 of the DP Regulations. The Appellant stated that the DIS is required to be filled by the client and the appellant as a participant, is only to ensure the transfer of securities as per the instructions contained therein. The Appellant claimed to have enquired from both Respondent 3 and Mr. Pyne about the validity of the DIS and the relevant payment and only on being informed that everything was in order, the Appellant recommended the transfer of the securities. The whole time member of SEBI passed an order under holding that both the Appellant and Respondent 2 were negligent in not ensuring that Respondent 3 had received the payment before transferring her shares and were, thus, guilty of violating Regulation 32 of the DP Regulations. Further, he issued direction under sections 11 and 11B of the SEBI Act directing the Appellant to transfer the shares (along with the accrued benefits) to Respondent 3 and file a compliance report with SEBI, failing which SEBI would initiate appropriate proceedings in accordance with law. The Appellant appealed against this order to SAT.

The Appellant submitted before SAT that it had not violated Regulation 32 of the DP Regulations and assuming arguendo if there was any such violation by the Appellant, the only course open to SEBI is to proceed against them under Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008 (the “Intermediaries Regulations”) and that it was not proper for SEBI to exercise powers under section 11B of the SEBI Act and issue directions. This argument of the Appellant was accepted by the SAT and it set aside the order made by the whole time member of SEBI.

Regulation 32 of the DP Regulations (prior to the Securities and Exchange Board of India (Depositaries and Participants) (Second Amendment) Regulations, 2008, available here ) read as under:

“32. Transfer to be effected only after payment– The depository shall satisfy the Board that it has a mechanism in place to ensure that the interest of the persons buying and selling securities held in the depository are adequately protected and shall register the transfer of a security in the name of the transferee only after the depository is satisfied that payment for such transfer has been made.”

By the said amendment, the words “and shall register the transfer of a security in the name of the transferee only after the depository is satisfied that payment for such transfer has been made” in Regulation 32 were deleted.

Also, the relevant part of Regulation 64 of the DP Regulations reads as under:

“64. Liability for action in case of default – A depository or a participant who-
(a) contravenes any of the provisions of the Act, the Depositories Act, the bye-laws, agreements and these regulations;
(b) …………..
(c) …………...
(d) ……………
(e) ……………
(f) ……………
shall be dealt with in the manner provided under Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008”

Chapter V (Regulations 22 to 33) of the Intermediaries Regulations (titled “Action in Case of Default and Manner of Suspension or Cancellation of Certificate) contains the detailed procedure to be followed to deal with the delinquents. It envisages a two stage inquiry before taking any action against the delinquent. A designated authority is required to be appointed which shall issue a show cause notice to the delinquent and after holding an inquiry, a report shall be submitted. The report will then be considered by the designated member after issuing a notice to the delinquent who will also be furnished with a copy of the report. It is only then that the designated member can take any one or more of the actions referred to in Regulation 27 of the Intermediaries Regulations (viz. suspension/cancellation of registration certificate; prohibiting, debarring or warning the intermediary) keeping in view the facts and circumstances of the case.


On the issue of violation of Regulation 32 by the Appellant, the SAT held that-
“The plain language of regulation 32 makes it clear that the obligation to satisfy itself is only on the depository and no such duty is cast on the participant. A participant is only an agent of the depository. It is relevant to point out that this obligation of the depository has also been done away with when this regulation was amended with effect from August 8, 2008. The words “and shall register the transfer of a security in the name of the transferee only after the depository is satisfied that payment for such transfer has been made” were deleted. We cannot, therefore, agree with the Board that the appellant violated this regulation.”
SAT further held that- “Assuming (though not holding) that there was such a violation, Regulation 64 (of the Depositaries Regulations) requires that the depository or a participant who contravenes any provision of the regulations ‘shall be dealt with in the manner provided under Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008.’ ” [emphasis provided].

From above, it can be inferred that in the instant case, SAT's stance was that what necessarily had to be done, was to follow the procedure under Chapter V of the Intermediaries Regulations and not an issuance of directions by SEBI under section 11B of the SEBI Act. As regards section 11B of the SEBI Act, SAT remarked that “It is true that the powers of (SEBI) under section 11B are wide enough to issue directions to any intermediary or person associated with the securities market but such powers are to be exercised only to protect the interests of investors in securities or for orderly development of securities market and to preserve its integrity. These directions cannot be punitive in nature and cannot be issued to punish a delinquent. Punitive action against any delinquent intermediary could be taken only in accordance with (the Intermediaries Regulations).”

Undoubtedly, the facts in this matter would not have been fit for directions to be issued by SEBI under section 11B, but the aforesaid observations of SAT amounts to reading a restriction on the powers of SEBI under section 11B of the SEBI Act which is not there in that section nor the SEBI Act. With all due respect, there appears to be no logical reason whereby a punitive action against a delinquent intermediary cannot be said to be a direction issued by SEBI under section 11B ‘in the interest of investors or to prevent the affairs of an intermediary conducted in a manner detrimental to the interest of investors’. Another important aspect in this regard is that the Intermediaries Regulations itself is made by virtue of powers conferred on SEBI by section 30 of the SEBI Act.

On a separate point, SAT opined that since Respondent 3 was duped by Mr. Pyne, it is not fair to direct the Appellant to compensate her and her remedy would be against the heirs of Mr. Pyne(since Mr. Pyne had deceased). SAT further remarked that “….why did she (Respondent 3) sign the blank DIS form(s) which are like cheques and since she did that, she has herself to blame.” This gives an impression that an investor will not be remedied for losses suffered due to his own negligence, viz. signing the blank DIS forms, as in this case.

Outcome of the SEBI Board Meeting on 7 February 2011

The outcome of the SEBI Board meeting held on 7 February 2011(press release available here) is as follows:

1. The ASBA facility will become mandatory from 1 May, 2011 for non retail investors (QIBs and NIIs) making applications in public / rights issues.
2. The certificate of registration granted to an intermediary will now be for an initial period of five years and only on assessment of the performance of the intermediary and its track record during the initial five years, it will be granted registration on permanent basis. If the performance is not satisfactory the certificate of registration granted to an intermediary may be terminated or may be temporarily granted for an additional term of five years- As per the existing regulation 11 of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008, the certificate granted to an intermediary is permanent unless surrendered by the intermediary or suspended/cancelled in accordance with the said regulations.
3. The currency derivative segment will have self clearing members and the self clearing members are required to have a net worth of INR five crores.
4. SEBI will recommend to the Ministry of Corporate Affairs to suitably amend Clause 166 of the Companies Bill, 2009 to disallow interested shareholders from voting on the special resolution of the prescribed related party transaction- This will protect small and diversified shareholders in listed companies from abusive related party transactions. This view was taken based on the findings from the investigation in the matter of Satyam Computer Services Limited. Section 300 of the Companies Act, 1956 does not allow an interested director to participate or vote in Board proceedings in which the director is interested. If the recommendations of SEBI are accepted, similar restrictions may apply to shareholders voting on a special resolution. This issue has been discussed insightfully in the Indian Corporate Law blog here.

Merchant bankers cannot undertake referral activities for non-security related products and/or services

SEBI has recently stated that a merchant banker cannot carry on any business other than in the securities market. In June 2010 Barclays Securities (India) Pvt. Ltd. ("BSIPL"), a merchant banker registered under the SEBI (Merchant Bankers) Regulations, 1992, had filed with SEBI a request for 'No Action Letter' under the SEBI (Informal Guidance) Scheme 2003 in relation to its proposed referral business. Under the proposed referral business BSIPL would refer its clients to other service providers for non-security related products/ services. The other service providers are in the nature of investment banking firms and/or intermediaries who may assist clients to invest in corporate deposits or property consultants who can advise clients on purchasing or selling real estate assets etc.

SEBI in its reply stated that a merchant banker cannot carry on any business other than in the securities market, under regulation 13A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI also stated that regulation 13A was further clarified by the circular dated June 05, 1998, whereby certain other activities such as 'advisory services for projects', 'syndication of rupee term loans', 'international financial advisory services' have been specifically permitted. Since referral activities for non-security related products and/or services does not fall within the purview of the activities permitted by regulation 13A nor is specifically enumerated in the aforesaid circular, SEBI disallowed BSIPL from undertaking such business.

SEBI Master Circulars and new SEBI website

SEBI has recently issued the following master circulars:

1. Master Circular on Matters Related to Exchange Traded Derivatives (available here) issued with a sunset clause of one year
2. Master Circular on Administration of Stock Exchanges, Arbitration in recognised Stock Exchanges and Stock Exchanges / trading platform for Small & Medium Enterprises including guidelines for Market Makers (available here)
3. Master Circular for Depositaries (available here)
4. Master Circular for Stock Exchanges and Depositaries (available here)
5. Master Circular for Stock Exchanges- Cash Market (available here)
6. Master Circular on Anti-Money Laundering (available here)
7. Master Circular for Mutual Funds.(available here)

It was in December 2008 that SEBI started issuing master circulars, following the footsteps of the RBI (which has various master circulars on FEMA, NBFCs, etc.). The first master circular issued by SEBI was the consolidated Master Circular on Anti Money Laundering (AML) and Combating Financing of Terrorism (CFT) on December 18, 2010 (covered in this blog here). This was followed by a Master Circular on Mutual Funds (covered in this blog here) which was issued on January 1, 2010.

On a separate note, SEBI has come up with a new website (currently in Beta), which depicts trend graphs and live feeds of SEBI/SAT orders. This new SEBI website can be accessed here.