By Somasekhar Sundaresan
There was one subject other than the corporate governance fracas at Bombay House that grabbed the attention of social media in the last fortnight — the Securities and Exchange Board of India’s (Sebi) consultative paper seeking to restrict free speech in the Indian capital market.
The securities market is running helter-skelter, regulator downwards. A short judgment of the Supreme Courtinterpreting the Securities and Exchange Board of India (Sebi) Act, 1992, has ruled that Sebi had no discretion at all in computing the quantum of monetary penalty for some violations between 2002 and 2014. Sebi is reported to have sought a review and a clarification from the court, and everyone in the market is waiting with bated breath.
The apex court’s order is an interpretation of carelessly drafted provisions in the Sebi Act that deal with imposition of monetary penalty for failure to furnish information. In 2002, the penalty for such failure (Section 15A) was changed from Rs 1.5 lakh for every failure to Rs 1 lakh per day of failure with a cap of Rs 1 crore. The language used was that a violator “shall be liable” to the stipulated penalty. In 2014, the same provision was amended to provide that the penalty “shall” be at least Rs 1 lakh but “may extend to” Rs 1 lakh per day of continuing non-compliance with a cap of Rs 1 crore.
The Supreme Court has ruled that between 2002 and 2014, there was no scope for Sebi to impose anything but Rs 1 lakh per day and where the violation continued for over a hundred days, the penalty would get capped at Rs 1 crore. Now, the process for imposing such penalties is through the initiation of “adjudication proceedings” under which an “adjudicating officer” adjudicates whether the violation alleged has indeed occurred, and whether the person accused of the violation has any valid defence. Once the occurrence of the violation is established, the officer proceeds to determine the penalty amount.
The Sebi Act provides for three objective criteria for determination of the penalty amount (Section 15J), namely, any unfair advantage or disproportionate gain made as a result of the default, the loss caused to any investor due to the default and the repetitive nature of the default. Disagreeing with Sebi’s plea that Section 15J shows legislative intent for discretion in assessing the quantum of penalty, the Supreme Court ruled that the provision had become redundant between 2002 and 2014, although it had not been repealed.
Now, let’s say the company secretary of a listed company who is in charge of filing a document under the listing requirements dies in an emergency and the company misses the deadline. The filing is forgotten and by the time the other officers get their act together, more than 100 days go by. If the adjudicating officer has no discretion at all, such a company would have to pay a penalty of Rs 1 crore without any gain being made, loss being caused, and even if the default were the first ever in its history. Another violator who deliberately disregards the filing obligation for the same period and complies only after coercive threats would be treated on a par with the former. According to the court’s judgment, all violations of this nature between 2002 and 2014 would enable no discretion at all to vary the penalty on the basis of the gravity of the facts. A person who deliberately defaulted would be treated on the same footing as a person who inadvertently defaulted.
There are numerous decisions of the Supreme Court that point to adopting a purposive interpretation of the law based on which the words “shall be liable” would mean “may be liable”. Indeed, the converse reading, too, would be possible by looking at the purpose of the legislation. Generally, no provision of law is lightly read as being redundant. All provisions are attempted to be read harmoniously to give the legislation its potentially intended meaning. This is how courts have read this provision for nearly 20 years, in a purposive manner, ruling that monetary penalties from Sebi would need to be fair, rational and equitable. They would test the quality of the discretion but not adopt the stance that discretion was absent.
The irony is that the observations of the court have come in a case where the court actually lowered the penalty originally imposed by Sebi. In the case before the court, there was a blatant violation in furnishing information sought by Sebi despite repeated reminders. Sebi imposed a penalty of Rs 1 crore against one person and Rs 75 lakh on five others. The Securities Appellate Tribunal had reduced the penalty to Rs 60,000 in one case and to Rs 15,000 each in five cases, taking into account the reality that the violators were near-bankrupt, had become dormant and were even left with no staff.
The court ruled that the tribunal could not have taken into account such factors. The court also ruled that the original date of the violation was prior to the 2002 amendments and that Sebi, too, was wrong in imposing a penalty of Rs 1 crore. The court reduced the penalties to Rs 1.5 lakh on each person, adopting the pre-2002 position of the law when the reference to non-disclosure being a continuing offence was absent.
Both Sebi and market players are stumped. The outcome of the fight over one case has laid down an interpretation of the law for all alleged violations that took place over this 12-year period – typical of uncertain outcomes for an entire market from litigation involving one case of violation.
The newly coded listing regulations remove materiality as a relevant factor for disclosure of acquisitions
The terms on which companies get listed on Indian stock exchanges just got codified into regulations. The Securities and Exchange Board of India (Sebi) has notified the Securities and Exchange Board of India (Listing obligations and disclosure requirements) Regulations, 2015, (Listing Regulations). They will take effect on December 1, 2015.
For far too long, the terms of listing have been governed by an unhelpful legal construct – the listing agreement, an agreement between the stock exchange and the listed company.
Typically, an agreement is “private law” and governs only the parties to the agreement. However, the listing agreement has been wrongly treated like an instrument of “public law” that would bind the world at large. One did not even need to sign it – it was modified at will by an agency that was not even a party to the agreement, viz Sebi.
Fortuitously, this legally infirm policy belief never came up for serious challenge except in the Mallya-Chhabria takeover dispute over Herbertsons (there, the issue was that the listing agreement had a provision that shareholders who buy more than five per cent shares should report it and the acquirer in that case argued that an agreement that he was not party to, could not bind him). That dispute got settled without the law truly getting tested.
Sebi has now reproduced the provisions of the listing agreement in the Listing Regulations – which would now legally govern the world at large – not just listed companies and stock exchanges, but also the regulator.
While a large part of the exercise has been to consolidate the provisions, there is one area of new policy which is retrograde and lays the ground for adverse regulatory outcomes, no matter how well-intentioned it may be. The Listing Regulations, now mandate that any and every acquisition including an agreement to acquire would need to be disclosed by a listed company without applying any test of materiality for the disclosure.
The term “acquisition” has been defined as acquisition of control or acquisition of five per cent of shares or voting rights by the listed company in any other company. Absence of materiality would mean that regardless of the scale and size of the listed company, acquisition of any tiny company would need to be disclosed. This is a new measure. So far, listing agreement has only required disclosure of price-sensitive information, which by definition, would be information that could have an impact on the price of the securities in the market.
For example, a company with a net worth of Rs 1,000 crores would need to report purchase of shares of 5 per cent or more in another company, or purchase of control over another company, even if the value of the other company were just Rs 10 crores. Often, residential apartments are bought by way of buying companies that own them. Now, if one were to buy the company that owns the apartment it would require a public disclosure under this new requirement, while if one were to buy just the apartment there may be no requirement to make a public disclosure.
This is because the absence of materiality is an element stipulated only for acquisition of companies and not for other assets. The special definition for the term “acquisition” to cover acquisition of companies and not other types of business organisations, is inexplicable. Therefore, if one were to buy a bunch of assets, or, if one were to acquire a stake in a limited liability partnership, one would need to make a disclosure to the public only if the deal were material. But once it is a company that is being bought, materiality would be given the go-by.
The removal of materiality as a relevant factor is a step backwards. Offer documents in the Indian securities markets are extraordinarily bulky and contain a lot of irrelevant information, primarily because in a number of areas, disclosures are not truly linked to materiality. In other words, our regulatory framework requires issuers of securities to err on the side of excessive disclosures, which drowns out what is really necessary (read material) for taking an informed decision.
All pointers to reform of the primary market have been pushing for making offer documents meaningful by cutting out unnecessary, irrelevant and noisy non-material content. Even in the regulations governing insider trading, typical types of price-sensitive information are listed to create only rebuttable presumptions of their being price-sensitive – the contrary may be established.
There is another reason why Listing Regulations positively making materiality irrelevant is a step backwards. It would create fertile ground to mislead investors in the market with noisy, irrelevant and non-material disclosures. Investors would think that such non-material information is indeed material, since the law requires it to be published in the public domain. Such an approach would militate against another regulatory objective of Sebi, which has had occasion to chase listed companies for falsely talking up the share price by making disclosures of non-material acquisitions, leading the market to believe that things are positive.
Now, the defence would be to just point to the new law to say that the surfeit of irrelevant disclosures is in fact a regulatory mandate. At times, the quest to achieve the utopian “best” can easily turn out to be enemy of the “good”.
Insider trading regulations are all about prohibiting someone with asymmetrical access to inside information
The new insider trading regulations notified by the Securities and Exchange Board of India (Sebi) took effect last weekend. While the regulations are largely based on draft regulations made by the N K Sodhi Committee, they do deviate on some material issues. (Disclosure: the author was a part of the Sodhi Committee and any critique should be taken with a pinch of salt.) This column will not dwell on the deviations in what is covered by the regulations but would pick up one element of something that has been left out.
One of the recommendations in the draft regulations was to treat “any person who is a public servant or occupies a statutory position that allows such person access” to unpublished price sensitive information of companies (colloquially, “inside information”), as a “connected person”. This was an explicit definition that would have brought this category of persons within the ambit of “insiders”. This element has been dropped. It is argued by some that such language is unnecessary because the definition of the term “insider” covers apart from “connected persons”, any person who has access to inside information. Clearly, that would not be a complete answer.
Insider trading regulations are all about prohibiting someone with asymmetrical access to inside information of an issuer of securities from monetising the access ahead of the rest of the market. The access to the workings of the business and the financial position of the issuer would enable access to information that could impact price discovery of such securities but is not generally available. Therefore, it necessarily has to emanate from inside the issuer, which it is even necessary to define a connection as one to the insides of an issuer. For example, a chief financial officer of a company that is listed on the stock market is clearly privy to the draft financial statements way before the information becomes generally available.
On the other hand, take a judge who is writing a judgement on a material tax dispute. All the information presented to him is generally available – anyone sitting in the court room would see exactly what is being argued before him. Now, his decision on which way to rule in the dispute is price-sensitive information, will impact the price of securities of the company involved in the dispute, but would be known only to him because it is he who would take the decision and until he makes the decision public, no one would know which way the fortunes of the price of those securities is headed. The staff in his office, his fellow judges who may get wind of which way his decision is headed, and his relatives who may discern his views from his views on the dining table, would all be “outsiders” and not “insiders”. The information relating to the final decision in the judgment would emerge from outside the company and not from inside.
Such persons would be connected to the outsider judge and not to those inside the company who would be eagerly awaiting the outcome themselves. If they were to trade ahead of the market, there would be no legal basis for treating such “outsiders” to listed companies as “insiders”. Unless, of course, there is an explicit definitional coverage of such a person as a “connected person”, which is precisely what has been deleted. Replace the judge with a bureaucrat who determines government policy that can have an impact on price discovery for securities in the market, and the picture remains the same. Replace the bureaucrat with a lawmaker in Parliament who gets to decide on policy and the effect would be the same. Indeed one could argue that an income-tax official who gets to see advance tax data filed by various listed companies or an investigator, who conducts a search and seizure into a listed company and gets access to inside information, would be covered as a recipient of information from an insider. The information they would get, would not be information that they generate but information generated from the insides of the company they are assessing or raiding. Trades by them when being privy to such information could indeed be covered by the regulations since they were recipients of information from insiders.
Given the stakes involved – of whom the law would protect against rather than who would be protected – this is not an easy piece of reform to implement. Every piece of law protects someone from someone else. It is not surprising that this piece of reform did not come through.