Tag Archives: SEBI

Where the text trumps the context

The tension between a regulator and the courts in interpreting the real meaning and the “facial” meaning of a ruling is not going away anytime soon

By Somasekhar Sundaresan

The United States (US) Supreme Court’s ruling upholding the travel ban imposed by President Donald Trump brings to the fore a core question that often comes up in regulatory proceedings even in India. The question is whether a judge must look only at the text of an instrument or an order under challenge, ignoring all other attendant circumstances.

The US Supreme Court ruling is a watershed and will be discussed for decades. At the heart of the dispute was whether Trump aimed the travel ban at Muslims and if he did, would it violate the US Constitution. In a nutshell, here is what the court considered and ruled.

By a wafer-thin majority of 5:4, the majority of five judges of the US Supreme Court have literally written counters to the views expressed by the remaining four judges to hold that Trump’s face ban did not “facially” name Muslims and should therefore not be seen as aimed at Muslims. Trump ran an election campaign publishing a document called “Statement on Preventing Muslim Immigration”, which called for a “total and complete shutdown of Muslims entering the United States”. He spoke about how “Islam hates us” and that the US has “problems with Muslims coming into the country”. After he was elected, responding to whether he would proceed with “banning Muslim immigration” he said: “You know my plans. All along, I’ve been proven to be right.” When Trump first announced a ban on persons from specific Islamic societies entering the US, his campaign advisors used the term “Muslim ban” when explaining it.

Trump withdrew this ban and made changes to it. To the list was added a non-Muslim society and some exceptions and waiver proposals whereby the US would give waivers on a case-to-case basis. This is what came up for review by the US Supreme Court. Ruling that the travel ban proclamation was “facially neutral towards religion” and that the references to “extrinsic statements many of which were made before the President took the oath of office”, the five judges took the view that they would not hold the travel ban to be motivated by reference to one particular religion.

While the minority of four judges who disagreed have argued extensively with factual evidence to point out how specious the seemingly neutral language in the Trump ban proclamation was, the majority of five judges have ruled that it would not be swayed by the external evidence since they were not to sit in judgement over whether to denounce those statements but were to sit in judgement on whether on the face of it the President had the power to issue such a proclamation and whether it entailed reasonable measures for making it work. The majority of five found the waiver programme to be adequate although the minority of four dealt with how the waiver programme was a façade and that neither the ban proclamation nor the waiver was being put to work as they claimed to work.

Often, in the regulatory environment in India, instruments are written that seem to be drafted in a generic fashion but are effectively instruments that operate as an order that would clearly apply only to specific persons. One such example was a “circular” from the Securities and Exchange Board of India (Sebi), directing that inter-depository transfers should be effected free of cost. One of the depositories challenged it as an “order” (every order is appealable). The Securities Appellate Tribunal (SAT) held that it was indeed an order that was amenable to appeal and disagreed that the order, termed a circular, deserved to be set aside. The Supreme Court of India ruled that any circular that is “referable” to the legislation-making provisions of the Sebi Act would not be an order and cannot be appealed against — the only challenge then would be in a writ petition in the constitutional courts and not by way of an appeal in the SAT.

The SAT is often faced with situations where it has to take this call —whether an instrument is referable to law-making powers or executive powers. “Extrinsic” evidence such as the one that came up with the Trump ban too plays a role. Regulators often speak quite clearly about what they plan to do with the measures they introduce, and one would need to necessarily see the instruments issued, in context. Regulatory design in India, merging legislative and executive functions in the same authority, brings the position much closer to the Trump travel ban proposition. It is another matter that the generic term used by the regulators would read in motherhood terms such as “investor interest”, “policyholder interests” and “depositors’ interests”.

The tension between the regulator and the courts in interpreting the real meaning and the “facial” meaning will remain a long-standing one. It is somewhat like the proverbial priest answering a kid’s question about smoking and praying. When asked if one may smoke while praying, the answer is “no” while whether one may pray while smoking would beget the answer “yes”. One can often be trumped in the process.

This column was published under the head Without Contempt in editions of the Business Standard dated July 5, 2018

Much to thank Kejriwal and Baijal for

When a vague and open veto power resides with an external authority, the effectiveness of its usage lies in the absence of confrontation. Only a litigious battle can put these arrangements to rest

By Somasekhar Sundaresan

The stand-off between the elected Delhi government and the unelected bureaucrat Lt Governor appointed by the Union government has seen a ceasefire for now. There are lessons to be learnt from this for the regulatory system that governs almost all the business and the economic activities in the country — ranging from financial markets to telecommunications to food.

The similarities are stark. The elected Delhi government owes its existence to the Constitution of India that was specifically amended to create the space it occupies. Regulators such as the Securities and Exchange Board of India (Sebi), the Insurance Regulatory and Development Authority of India (IRDAI) and the like owe their existence to special Acts of Parliament. The Lt Governor of Delhi has the functional power to formally take actions that the Delhi government decides upon (much like how it is the President of India who signs a bill passed by Parliament into law by granting his assent). Every legislation that creates a regulatory authority has a provision that stipulates that the Union government has the power to issue directions on matters of policy to the regulatory authority, and the decision of the Union government is final on what constitutes a policy matter.

Now, picture Sebi or the IRDAI or for that matter the pension fund regulator making regulations to regulate a certain activity — say insider trading. Picture the Union government stepping in to say that since it has the power to issue directions of policy, it would direct that the regulations should not be brought into effect until the Union government is satisfied that the outcome it desires has been fully reflected, and that it would take time to decide on what is the outcome that it desires. It is not that such intervention does not potentially happen. Perhaps nothing would pass through the regulatory authority’s board of directors unless the government is satisfied with what is ultimately passed. But assuming it does not work this way, imagine the regulatory authority’s board of directors taking its role seriously and doing its statutory bidding, only to be told that it should not be doing what it wants to do.

That is the institutional checks-and-balances design that is in play across the nation. And it is very easy to subvert that process if the oversight measures meant for usage in exceptional circumstances, become the norm. The exception would then become the rule. In other words, what happened in Delhi in the stand-off between the Lt Governor and the state government is a stand-off that indeed can happen across the board, across the society and across the nation.

The position with judicial appointments is not dissimilar at all. The appointing authority is the government — the warrant appointing a high court judge or a Supreme Court judge is executed and signed by the President of India. After the collegium system came into existence (let’s leave out why and how it did, out of the discussion for now) it is the judges’ collegium that would pick the candidates for appointment and the President executes the warrant of appointment.

When a vague power to issue policy directions is in place, the takeover of an institution is complete. It can never stand to reason to ask the question: “Show me one instance where such power is used.” That such power is effectively put to use would in fact be evidenced by the absence of a public stand-off of the nature that the Republic just witnessed in New Delhi. The power to sack a duly elected state government under Article 356 of the Constitution has been the subject of intense jurisprudence that has evolved over the years. As has been the case with the power of the President to second-guess the actions of the council of ministers. Case law has led to a reasonable and sane working of constitutional restraint being read into the checks and balances. Presidents have sent back proposals to sack elected state governments to the Union government, but if reiterated by the elected Union government, Presidents have been told by case law, that they have to sign it.

Unless there is confrontation, case law will not emerge to breathe life into written words in the law. A confrontation between the Union government and a regulator came to the fore when the Telecom Regulatory Authority of India had running battles with the Union government. More recently, two regulators fought but the then finance minister first asked them to resolve their battle in a court of law instead of using the power to issue directions – later their respective laws were amended on the subject matter of the dispute.

When a vague and open veto power resides with an external authority, the effectiveness of its usage lies in the absence of confrontation. Since an external agent can officially ask you to bend, you would crawl beforehand, instead of risking being asked to bend. Only a litigious battle can put these arrangements to rest by bringing in a reasonable framework in which the conflicts can be avoided with institutional dignity intact for both agencies. There is much to thank Kejriwal and Baijal for.

This post was published as my column titled Without Contempt published in the editions of Business Standard dated June 21, 2018

Surgical strike at a chronic ailment

Our regulators have to go beyond procedural reform and gaming of processes to improve rankings on Ease of Doing Business

By Somasekhar Sundaresan

It was a judgement waiting to be written. The conduct of the government in litigating on issues long-decided by courts and clogging the courts, even while mouthing platitudes about how the government must not indulge in frivolous litigation, has been called out by the Supreme Court in a crisp and precise judgement.

The seven-page order, imposing costs of Rs 100,000 on the government (yet again), is a must-read not only for every government department at the Centre and the states, but more importantly for every regulator that doubles up as civil courts and generates litigation by writing orders, even on closed issues, merely because the parties before it are different. Remarkably, in the order (passed in a government service litigation — titled Union of India & Others vs Pirthvi Singh & Others) the Supreme Court has pressed the right button by observing that India suffers badly in the World Bank’s Ease of Doing Business rankings primarily because of such conduct by government agencies.

A quick look at the facts would show what is regular and well-expected from the government, state agencies and regulators. The Supreme Court came to dismiss a bunch of appeals filed by the Union of India in December 2017. The very same issues came up again in a new appeal by the Union of India in 2018, and that appeal was dismissed in March 2018. When dismissing this appeal, the Supreme Court noted that the appeal in question was unnecessary and vexatious since many cases had already been decided in the same manner. To ensure this is taken seriously, costs of Rs 100,000 were imposed on the Central government.

The appeal now dealt with by the Supreme Court had agitated the same issue and was filed in March 2018. The government took no steps to withdraw the appeal despite the earlier misadventure having invited strictures and costs.

The judgement notes: “The Union of India must appreciate that by pursuing frivolous or infructuous cases, it is adding to the burden of this Court and collaterally harming other litigants by delaying hearing of their cases through the sheer volume of numbers. If the Union of India cares little for the justice delivery system, it should at least display some concern for litigants, many of whom have to spend a small fortune in litigating in the Supreme Court.”

The judgement quotes from a 2010 document titled, “National Litigation Policy” as part of a pompously-named “National Legal Mission to Reduce Average Pendency Time from 15 Years to 3 Years”. This document, made under the UPA government has been adopted by the current NDA government with a newer version in 2015, followed by an “Action Plan” formulated in 2017. One of the principles supposed to have been adopted is that the government would be an efficient and responsible litigant. One of the listed traits of an “efficient litigant” is that “bad cases are not needlessly persevered with” while a trait of a “responsible litigant” is “that litigation would not be resorted to for the sake of litigating”. Observing that that removal of unnecessary government cases would save valuable court time that could be spent in resolving other pending cases, the document notes that the “easy approach” of adopting the line of “let the court decide” must be eschewed.

The Supreme Court notes: “…under the garb of ease of doing business, the judiciary is being asked to reform. The boot is really on the other leg.” Having noted the Ease of Doing Business rankings (India ranks among the lowest in contract enforcement year after year, despite the gaming coupled with reform in other areas), the court has really touched upon a critical area. While government litigates blindly, regulatory agencies, that are mini-republics with the legislative, executive and judicial functions rolled up into one entity, are the worst. Regulatory agencies are themselves given the powers of the civil courts and they start the process of prosecuting and ruling all on their own. Often, the quasi-judicial rulings of regulators are upheld in appellate tribunals but many an order gets set aside. These are routinely appealed. Worse, even when earlier rulings are available, regulators persist with repeating their overruled rulings hoping that appeals to the higher courts (in most legislation, it is directly to the Supreme Court) would lead to different outcomes. Even when the court has not stayed the tribunal’s rulings, regulators continue to ignore appellate decisions. There are even cases where a newly appointed regulatory official wants to leave his mark and re-interprets decades-old jurisprudence, which despite failure in appeal, is further carried in appeal.

In the case at hand, the Supreme Court also noted that the government was blowing up money on 10 lawyers, including an Additional Solicitor General and a Senior Advocate, expending tax payers’ monies wastefully. This too is typical and par for the course with regulators. Engaging senior law officers of the government, and senior private lawyers with respectable names and standing, is the easiest way to project that the frivolous appeal has something unique on facts that would warrant ignoring earlier closed decisions, and overturn, at times, decades of jurisprudence. In the courts of many judges, appeals by regulators perceived to be “experts”, are admitted for the asking, while appeals by private litigants are put to a higher standard, often disposed of at the stage of admission — the wrong assumption being that regulators are more responsible in deciding what to appeal.

The apex court’s observations are a reminder of one serious facet of what ails the justice delivery system. Our regulators have to go beyond procedural reform and gaming of processes to improve rankings on Ease of Doing Business. Conducting a thorough 100-percent audit of all pending appeals filed by regulators to decide what ought to be withdrawn, would be a good way to start.

This column was published under the title Without Contempt in the editions of Business Standard dated May 24, 2018

Retrograde Gag Order from Stock Exchanges

By Somasekhar Sundaresan

It is an extraordinary and unprecedented measure. All the players in a market got together to execute an agreement. They issued a joint press release. A press release that read more like legislation than like a piece of commercial communication being sent to the market. The only three relevant came together to announce that they would stop feeding price data to 

“It is observed that for various reasons the volumes in derivative trading based on Indian securities including indices have reached large proportions in some of the foreign jurisdictions, resulting in migration of liquidity from India,” the release said, adding for good measure, “which is not in the best interest of Indian ” With words straight out of the Act, this was an unprecedented press release that sounded like an order usually passed by citing Sections 11 and 11B of the Act, which empowers the market regulator to issue directions “in the best interests of the securities market”.

The content of the press release has to be read to know the unprecedented nature of what is being done. In a nutshell, the self-styled “Indian exchanges” announced the following:

  • Indian exchanges and their affiliates will not directly or indirectly provide data on data discovered on their platforms to any foreign stock exchange or platform that trades or settles derivatives in any form outside India;
  • Indian exchanges, their affiliates and also their third-party vendors will blank out any price data to index providers who construct or compute indices outside India;
  • indices that have an element of Indian securities too would be starved of price data if 25 per cent or more of the weightage involves Indian securities, and derivatives are written on the back of such indices;
  • Those who get price data from Indian exchanges would “not be permitted to use” it for any structured product or participatory notes traded abroad;
  • All existing agreements to provide such data will be terminated immediately with notice period commencing forthwith, and within a month, all arrangements would be terminated or modified to “comply with the contents of” the press release; and
  • The final closing prices of securities would be displayed on the stock exchange website and forwarded to media organisations, two hours after the close of the market.

 

Essentially, a on price discovery. An agreement of this sort is what is typically called a “horizontal agreement” under competition law — one in which competitors enter into an agreement. The effects of this agreement can impair competition in the global market for price discovery. The phone lines between the Competition Commission of India and the Securities and Exchange Board of India could be burning with activity (they are statutorily obliged to talk to each other). Overseas competition regulators and overseas securities regulators could demand explanations from their Indian counterparts. The seeds of a cross-border trade diplomacy spat seem to have been sown.

Soon, state agencies may need to take a call on whether to wash their hands off, terming this a private agreement from private market players to combat overseas competition, or whether to take ownership of the measure, or, at the least acknowledge having blessed it if not having authored it. If this measure had the blessings of the regulators, it would have had the blessings of the government.

Both competition law and securities law have provisions enabling the government to issue directions on matters of policy. There could emerge international pressure for government to use this power and direct the regulators to get involved — similar to the pressure to intervene in the spat that occurred years ago between the securities market regulator and the insurance market regulator over unit-linked insurance plans.Putting aside the tone and tenor of the press release, the content does read like the proclamation of an emergency measure.

The philosophy of such policy measures is precisely the philosophy underlying prohibitions, censorship and bans — cases in example are moratoriums on remittances abroad, prohibition on import of gold, and at an extreme, overnight prohibition on usage of certain denominations of currency. Such measures typically push economic activity underground — the expansive and unofficial flow of alcohol in states that have imposed prohibition are a great example.

As Indian companies go global, interest in how their securities are priced in India can only grow across the globe. The demand for live price data of Indian securities would necessarily expand. A great policy response to overseas competition could be to permit Indian platforms to enable trading derivatives on foreign securities within India. These could be denominated in Indian rupee and have foreign securities and foreign indices as their underlying. The Sahoo Committee recommendation to allow such activity through a concept called “Bharat Depository Receipts” has met with stiff resistance from the regulators and is gathering dust. (Disclosure: the author was part of the committee that has made this rejected recommendation.)

Instead, the argument that “we should prevent export of the Indian market” seems to have taken firmer root. This philosophy was used to effectively stop overseas listing by Indian companies. However, a well-known but little-acknowledged fact is that any initial public offering of securities in India is as much a securities offering made outside India as it is a domestic fund-raising exercise.The approach of starving global of Indian price data, risks the Indian market itself. It is like a throwback to the pre-1990s era, where imports and exports needed licensing with a view to protect the interests of the Indian market and instead distorted the domestic market.

This Without Contempt column was published in Business Standard edition dated February 15, 2018

Shun rhetoric, appreciate IBC problem

The IBC ordinance is another example of attempting to write a law to solve a problem that is not properly defined at the threshold

The debate over the presidential ordinance amending the Insolvency and Bankruptcy Code, 2016, (IBC) to insert disqualifications of potential participants in the resolution process of an insolvent has become bipolar and divisive. Television channels are going breathless airing alternative views on alternate days. Columns (including in this paper) have attributed motives and sought to call out “canards” — a classic “Hinduho-ke-Musalmaan” type of zeal seen only in “holy wars” claiming righteousness.

 

The very nature of this fight makes it evident that the ordinance is good politics. However, in the process, the sweep of the real problem posed by the ordinance, runs the risk of remaining unaddressed, thereby risking the very effectiveness of the IBC.

 

The disqualifications introduced should first be noticed. The ordinance lists various categories of persons who would stand disqualified from participating in any resolution plan for any insolvent under the IBC.  Any promoter of such disqualified person, and indeed any “connected person” with such disqualified person also stands disqualified. The term “connected person” includes all “related parties” and “associates” of the disqualified person. In other words, once any person is disqualified, the scope and sweep of the disqualification is wide and expansive.

 

Now, three categories of disqualifications in the list, clearly are amenable to the charge of not having been thought through, and will truly have mindless and unintended consequences.

 

First: the disqualification of any borrower that has been classified as a “non-performing asset” and has stayed in that status for over a year. At first blush, this would appear logical — obviously an entity that is unable pay its own debts cannot be involved in resolving the problems for any other insolvent. However, every “connected person” i.e. every “related party” of such entity and every associate too would automatically stand disqualified.

 

The term “related party” under the IBC is wide — for example, any company with common shareholding of just 2 per cent would be a related party. The term “associate” would be even more problematic — but the minute detail is not necessary to make this point in this column. Therefore, if a business goes bust for any reason whatsoever, every promoter of that business, and every related party and associate can never participate in any resolution plan for any other insolvent under the IBC. It is not even the case that only the participation of such related persons in the resolution of that disqualified person would be barred. Every resolution of every other insolvent under the IBC would also be barred.  This is extreme, an unreasonable restriction, and can substantially wipe out the supply of authors of resolution plans.

 

Second: the disqualification of any guarantor of any debt owed by any insolvent under the IBC. This is an inexplicable disqualification. A guarantor of a company’s debt is someone who believed in that debtor and agreed to guarantee that debtor’s promise. When a resolution plan is sought to be made, the guarantor would have skin in the game because it is his neck on the line.  While keeping out such a person from the resolution of the debtor is itself questionable, keeping out such a person and every person connected with him from every other resolution plan for every other insolvent under the IBC is not even intelligible.

 

Third: the disqualification of any person (and indeed, of every connected person, related party and associate of such person) to whom the capital market regulator may have issued directions not to deal in securities or access the securities market. No time frame of the period of prohibition on dealing in securities is set out. The capital market regulator is known to have been trigger-happy in the past, issuing such directions even on an “ex parte” basis (without a hearing). There is no settled science or rationale for the choice of the length of the directions in the law.  Courts disturb or uphold such directions on the basis of the human judgement of nature of the facts in the cases before them. This disqualification would remove from the resolution market for all insolvents, a wide range of persons for no plausible, objective or intelligible rationale.
Worse, the same principles of exclusion from the market, would apply to any affiliate outside India.  This would wipe out from the resolution market almost every single multinational company that has an interest in India.  If any person anywhere in the world has ever become insolvent, or has become a non-performing asset or has been issued any direction not to deal in securities. all affiliates of that person all over the world would be ineligible to participate in a resolution plan in India under the IBC.

 

One can go on to other disqualifications too — for example: the disqualification upon conviction with an imprisonment term for a period of two years, without regard to what the conviction was for. So, if one family member has had an unfortunate tragic criminal conviction, every relative and every “connected person” would be banned from participating in any resolution plan for any insolvent. However, the three examples above would suffice to show how the public debate is wrongly focussed on “good vs. evil” terms — without nuance, and with deployment of blunt weapons rather than sharp instruments.

 

The IBC ordinance is another example of attempting to write a law to solve a problem that is not properly defined at the threshold. If the problem sought to be solved was to keep out those responsible for the cause of an insolvency from the resolution of that insolvent, the ordinance as promulgated is not the solution.
The very concept of identifying persons responsible for causing insolvency is very difficult to define in a one-size-fits-all manner.  The ordinance has demonized the occurrence of insolvency instead of recognizing that business failure is a part of life.  Every star investor and global business would have insolvents among their related parties.
This is why the IBC clearly envisages a role for professional resolution professionals and bankruptcy professionals.  It is for these professionals to oversee a resolution plan for insolvent companies. A committee of financial creditors has to approve the resolution plan. It is open to the resolution professional and the financial creditors to weed out misfits from participation. If a resolution professional does not perform well, she is subject to regulatory intervention from the Insolvency and Bankruptcy Board of India, the regulator of these professionals. Instead of studying if this profession performs properly, the ordinance has put the very efficacy of IBC at risk, with an air of misplaced righteousness. It is time to cut out the noise and focus on the gravity of the problem.

 

A substantial part of this piece was published as the Without Contempt column in the Business Standard editions dated November 29, 2017

Between what’s said and left unsaid

If at the end of reading this piece, you feel it is an “impractical” and “theoretical” approach to “Indian realities”, you may not be alone. Yet, the following has to be said: Our policymakers just demonstrated doublespeak in relation to market integrity. They have flinched in making truth available to financial markets, a vital element for informed market decisions.

A terse one-line press release, appropriately drafted in passive voice, was issued by the (Sebi) on September 29, 2017. It read: “It has been decided to defer implementation of Sebi circular no CIR/CFD/CMD/93/2017 dated August 4, 2017, until further notice.”

The press release is significant for what it did not say rather than for what it did. What the circular being deferred was about, when it was meant to take effect, what weighed with the regulator in introducing it and what weighed with the regulator to indefinitely defer its introduction, what transpired in the time between the two events were all left unsaid.

This column is not another iteration of lawlessness in the process of law-making. Indeed, pre-legislative consultations are to be expected only for measures that the regulators are reluctant to introduce or repeal. On measures that could beget bouquets or brickbats, it is normal not to expect any pre-consultations.

Back to the circular that has been put off. On August 4, 2017, Sebi issued a circular to provide that effective October 1, every listed company would have had to disclose within one day, the occurrence of any default in payment of interest or principal on the due date. A simple measure that would have brought cleanliness and transparency to financial markets, it would also have spurred the solvent but indolent to buck up and ensure they did not inadvertently err in servicing financial obligations.

The measure was vital for integrating the with the rest of the financial market system. That a company is unable to meet its obligations when due could be material information that would inform investors’ decision on what to pay for or what to expect for the securities of that company. The disclosure obligation was introduced on this premise. However, the known inability to pay would make it clear to the market for banking and financial services that a company, which is unable to pay its debts when due, is borrowing from the system. This would enable a clearer profiling of the risk in dealing with such a borrower.

When the circular was issued, a retiring whole-time member of Sebi spoke about its virtues at length in public interviews. Sebi was happy to take credit for being the harbinger of a game-changing measure. The withdrawal, on the other hand, has been made in a whimper.

However, it seems these are not good times for dissemination of bad news.  Perhaps it was felt that a spate of disclosures of defaults would follow, lending credence to the gnawing belief that the economy is in a spiral, headed for a hard landing. Inexplicably, without any articulation of the cause for change of heart, the regulator has given credence to that assumption.

“India is not ready for it” is an argument one usually hears in relation to any inconvenient policy reform measure — for example, making an open offer to acquire all the residual shares during a takeover of a listed company; and getting every listed company to publish a prospectus-type document to bring material information about the state of affairs into the public domain even without a securities offering being involved.

This circular had also imposed a statutory obligation on listed companies to inform credit rating agencies about such defaults. Virtually every credit rating agency of relevance is facing proceedings with Sebi for not having downgraded a certain listed company’s debt-servicing capacity. When this company’s inability to service debt was discovered, the effect was so severe that a certain mutual fund with exposure to that debt had to shut the gate for redemption of units. If the regulator now believes that full and clear transparency to rating agencies is not in public interest, surely it should stop making fall guys out of them.

Sebi is quick and prone to lashing out with premature actions against alleged insider trading. Even bank accounts get impounded for periods longer than the law permits in the garb of securing proceeds of insider trading. The introduction of an obligation to make timely disclosures would have served the regulatory war against insider trading. It would have prevented wrongdoing and obviated punishment — the quicker the dissemination of material information, the lesser the scope for those in possession of it, thereby reducing the ability to trade ahead of the rest of the market, without fear of also violating the law mandating dissemination.

The leadership at Sebi has been actively involved in a policy game changer in the financial system — the introduction of the Insolvency and Bankruptcy Code, a legislation that has so far largely received a resounding endorsement from the higher judiciary. World markets were looking at this circular as a game changer in aiding the effectiveness of this new law. Now, it is not to be.

If media reports are to be believed, the circular was considered to be utopian enough to make many in the banking system chicken out. If we send a signal that bringing out the full truth would be unpalatable not only for listed companies but also for banks that have exposure to such listed companies, it would mean that we are happy to let the truth — not just about borrowing listed companies but also listed banking companies — be shoved under the carpet.

“Being practical” is in itself a dangerous phrase. Many a social problem today ranging from domestic violence to female foeticide has been compounded by living in denial and enforced silence. Perhaps, we just got the financial markets version. If inadvertent payment defaults by solvent companies sending avoidable panic signals to the markets was what the Sebi was worried about, it could have tweaked the timing of the mandatory disclosure to the date on which the cure period for the default expires without the default getting cured.

 

This column was published as Without Contempt in Business Standard editions dated October 5, 2017

 

Sebi on the right path over control of companies

Its decision to desist from amending the Takeover Regulations is acknowledgement of the fact that one size doesn’t fit all

The (Sebi) has announced that it would refrain from amending the Takeover Regulations to specify situations in which it would rule that there is no change of control over a listed company. This is a right step for a variety of reasons.

When one acquires control over the management and policy decisions of a listed company, an offer to buy shares from other is mandatory.   Likewise, acquisition of shares with voting rights of 25 per cent or more mandatorily triggers an open offer. Typically, acquisition of control occurs along with acquisition of shares. However, the regulations contain a provision that makes it an obligation to make an open offer when acquiring control regardless of the quantum of shares acquired.

This is an important regime. One can acquire control without crossing the 25 per cent voting rights that would trigger an open offer. This could take shapes and forms that cannot be predicted in advance — through contractual rights and arrangements embedded in documents to which the listed company is bound. Now, when investors execute investment agreements with listed companies and desire a degree of say in decisions that could alter the very foundation of the company they invested in, the question often arises whether they have taken over control.

For example, if a company that manufactures paper seeks to change its activity to manufacturing steel, and an investor secures a contractual right to stop it, that would not represent the capacity to control the day-to-day management of the company. It would only be a right to insist that a company stays its course truthfully. On the other hand, if an investor were to have a right to approve every contract above a threshold value, it would point to control over how to manage the company.

Life is never led in either extreme, but there is a lot of truth in between the two extremes. For example, an investor may secure a right to object to a transaction that is a substantial component of the value of the net worth of the company — in other words, the right to scuttle a risky proposition.  What the size of the net worth is and how much percentage of it is the threshold, what nature of transaction is sought to be covered — these are all factors that would answer the question of whether such a right constitutes control over management and policy decisions. For example, the right to approve the room tariff policy of a hotel owned by a listed company could be control over the company if the only business of the company was to run that one hotel. Such a right over one hotel, which does not constitute a major source of revenue for a company that owns multiple hotels, would not constitute control.

Now it would be impossible to stipulate by legislation what constitutes control in a manner that wold cover all possible factual situations. Therefore, beyond stating that rights, which merely constitute some influence over material and fundamental changes to the ordinary course of conduct would not necessarily constitute control, it would not be possible to stipulate more. Such guidance could emerge from rulings and case law rather than by legislation that would lay down hard rules, which may not fit every situation. That even undertook a public exercise of considering these issues points to its acknowledgement that a one-size-fits-all approach of alleging control would be wrong — just as it would be impossible to provide immunity that certain types of rights would never constitute control.

In recent orders, has adopted a mature stance of acknowledging this position. Other legislation, too, have references to “control” and pretty much sail in the same boat. To legislate that unless 25 per cent is owned there would be no control would be a lazy option and can have a deleterious effect, with an incentive to fly just under the radar and actually wield control. To legislate that certain types of rights can never ever constitute control or that they would always and necessarily constitute control would also be fundamentally flawed. This is why the Achuthan Committee, whose draft is the basis of the current version of the Takeover Regulations (Disclosure: The author was a member), consciously left this to case law to evolve on the facts of each case.

Indeed, can issue guidance notes explaining the principles that it would apply in its approach to enforcement in this regard. Beyond that, whether or not any person has acquired control will necessarily be left to a “question of fact” to be answered from the facts and circumstances of each case. It may well sound like a fallback on the Justice Potter Stewart’s famous ruling in a case involving a charge of “hard-core pornography” against a movie. He ruled: “I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description, and perhaps I could never succeed in intelligibly doing so. But I know it when I see it, and the motion picture involved in this case is not that.”

This column was published as Without Contempt in editions of Business Standard dated September 21, 2017