Tag Archives: SEBI

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

A tale of two jurisdictions

By Somasekhar Sundaresan
The standard for treating as illegal, by those tipped off with price-sensitive information by insiders, underwent yet another yo-yo in the last week. The constant change in standard on what constitutes illegal insider is a hallmark of insider law in that country.

 

An appellate court has ruled that it would not be necessary to show that the person, who receives a tip-off from an insider, has to have a “meaningfully close personal relationship” with the latter. The same court had ruled in December 2014 that such a relationship would be vital to hold that insider took place. In that case, two men, who had traded in securities, were held to have had only vague and casual acquaintance with the source of the inside information. In the absence of any meaningfully close personal relationship, it was held that they could not be said to have been gifted or sold the tip by the insider for the to be violative. In short, no benefits could be inferred for those giving them the information.

 

Two years later, in December 2016, the ruled in a case that involved by a person, based on information received from a sibling who was the insider, that there would be no need to look for a benefit or gain to provide the tip. Applying that rationale, the appeals court has now ruled that there is no real need for any “meaningful close personal relationship” to exist to render the illegal. The court has gone on to say that if an insider were to give a tip to a doorman instead of a tip in the form of money, he would still be achieving his objective of providing gratification and, therefore, the by the person receiving the tip would be illegal.

 

Cut to India. Virtually every man on the street here would believe that the US has a far greater regime for punishing insider and that India is lax on the matter. The truth is far more nuanced. First, under Indian law, by definition, any person receiving unpublished price-sensitive information becomes an “insider”. Therefore, by the recipient of any price-sensitive inside information would become violative “insider trading”. Second, the very act of communicating unpublished price-sensitive information has been rendered illegal by law in India — unless, of course, a legitimate purpose for such communication can be shown, for example, providing an auditor with draft accounts.

 

In practice, how this is enforced makes in securities quite dangerous in India. It is now becoming routine for any trade by any person to be rendered vulnerable to attack as being illegal if a link between the person who traded and an insider, however tenuous, is found. It is this extreme that the is zealously wary of — an exposure of innocent traders to the charge of insider leads that system to err on the side of caution in favour of presuming bona fides by those  The Indian regulator has chosen to err on the side of caution in favour of presuming mala fides by those trading: So long as some form of link is found, it would be presumed to be illegal motivated by inside information, regardless of whether information was actually communicated.

 

Surprisingly, despite the law having been amended to empower the regulator to demand and get call data records from telecom companies to demonstrate circumstantially the communication links between the insider and the person who has traded, the regulator never uses this power. Usage of such power would bring with it the necessity of having to prove the intensity of the link. Worse, informal guidance has been issued to say that without even going into evidence of communication between a discretionary portfolio manager and his client who may be an insider, trades on behalf of an insider by the portfolio manager, even if made without reference to his insider client, would be illegal (not “could be illegal if the client indeed exercised his own discretion in the decisions”).

 

The legal status of a person, who has actually received unpublished price-sensitive information from an insider, as an “insider” is easy to understand if evidence (circumstantial evidence) reasonably shows that the person who traded indeed received such information. However, for those who are actually insiders themselves, the treatment becomes even more dangerous. A “connected person” is one who is reasonably likely to have access to inside information. Whether such a person indeed had access and who would need to show that she had such access are questions that are routinely given the go-by, hoping that courts would give enforcement a long rope.

 

This is the kind of outcome that a dissenting judge in the appeal judgment has warned against. According to her, prosecutors would “seize on this vagueness and subjectivity”, which, to her mind, “radically alters insider law for the worse”.

 

There is one material distinction that makes the problem exponentially worse in India. US enforcement agencies have to satisfy a neutral judge of the strength of their charges, with cogent evidence. This leads to the finely nuanced and, at times, abstruse judicial analysis of the standards necessary to bring home a charge. In India, the regulator has to convince no one for declaring a person to be guilty of insider  How well it has to explain itself depends on the quality of the challenge mounted in an appeal that can only be filed after the event of being held guilty.

 

Twitter: @SomasekharS

This column was published under the head Without Contempt in the Business Standard editions dated September 7, 2017

ON EX PARTE ORDERS, IT PAYS TO BE CIRCUMSPECT

It is raining ex parte orders again in the Indian securities market.  Essentially, orders that are passed without hearing the person against whom it is passed, the practice is justified in the eyes of the law if the circumstances demonstrate grave urgency and warrant action.

Yet, when an ex parte action is taken, the authority taking the action is expected to do its homework to demonstrate the urgency and get its facts right to defend the action when challenged.  Take the case of the 331 listed companies, which the capital market regulator was told — by none less than the Ministry of Company Affairs — were “shell companies”.

A shell company is one that is merely a shell — without substance in its operations and functions.  The Securities and Exchange Board of India appears to have blindly taken the list it received and declared all these companies to be shell companies.  Media reports suggest that some noteworthy names have been declared in one sweep to be “shells”. Declaring them to be shell companies, suggesting forensic audit of their existence and giving them pariah status on the stock market, where trades in them would be permitted only once a month, would cause serious injury to every holder of securities in these companies.

Some investors would have pledged their shares to lenders, who would determine such an event to be one of default. The underlying asset over which they had security would suddenly become illiquid. Others would have taken trading positions in these securities with a certain assessment of facts in; if they were suddenly told that regardless of facts, these companies deserved to be shunted to the periphery of the stock market, it would cause them serious losses.

Such a drastic action would, therefore, warrant giving notice to the parties concerned, giving them a chance to explain themselves. At the least, one would expect basic due diligence to be carried out before action were taken so that the (well-intentioned) objective of investor protection, far from being met, is not undermined. If a basic internet check would have shown that some of these are well-functioning, profit-making, loan-taking operating companies, the embarrassment of terming them “shells” could have been avoided.

The history of financial markets is replete with examples of such decisions. Ex parte orders purporting to be interim measures get passed and routinely become permanent measures. They are often known to continue for as long as five years.

Examples of every kind of sudden shock and surprise are now easily available. We have had securities being introduced into the derivatives segment in the middle of a month. We have had securities removed from derivatives in the middle of a month. Issuers of securities with derivatives riding on them, declaring record dates in the middle of a derivatives trading cycle, too have been seen.

Abnormal or extraordinary decisions invariably also point to the need to check if there was any abnormal pattern of trading just before they were announced. Often, that leads to probes and allegations of insider trading. In fact, a recent ex parte order froze every bank account of every individual named in it overnight, rendering them penniless. The suspicion in that order was that publicly known regulatory proceedings against a company had been the motive for every sale in listed securities of affiliates of that company.

Another type of development is in the risk of being repeated so often that it would become a trend. Relying on private “forensic reports” (often conducted by accounting and audit firms with little training in the rigours of investigative discipline), regulators take ex parte actions. Typically, these reports are riddled with disclaimers that render them poor evidence in law. However, in the post-truth world, by the time it can be demonstrated that there is no real legal evidence, the damage is done, and destruction of individuals and institutions is complete.

Is there a better way to handle this?  Surely, if one asks oneself multiple times if the use of emergency powers to pass ex parte orders is warranted, the reckless usage of such a blunt weapon would get tempered. The value one attaches to the concept of the “rule of law” is best tested when the most provocative circumstances present themselves.

 

It is easy to adhere to the rule of law if one’s patience is not being tested to the brink. If one loses all vestiges of being circumspect and stops checking and regulating oneself, the rule of law would be replaced by the rule of men, risking the very credibility and majesty of law enforcement.

(This was published as a column titled Without Contempt in the Business Standard editions dated August 10, 2017.  Disclosure: The author represents (after publication) for some companies affected by it.)

A tighrope walk for Sebi

If news reports are right, the Securities and Exchange Board of India (Sebi) is coming full circle with (CIS) and is seeking to “relinquish” the statutory mandate to regulate such schemes.

 

It was only in 1995 that the term found its way into the Act through an amendment to the list of intermediaries that ought to be registered with to be able to carry on business in India. Then, too, had been a reluctant regulator. Schemes promising returns on the basis of plantations, animal farming, chain-marketing and the like mushroomed in the 1990s. The term “collective investment scheme” was not even defined in the Act. Therefore, despite the amendment to the Act, did not want to hold the baby.

 

Public interest litigation, a plethora of complaints and a lot of angst later, the term got defined for the first time through an amendment in the Act in 1999. also made regulations in 1999, which, if reduced to one sentence, would have read: “No one shall operate a collective investment scheme”. The terms on which one could legitimately register and operate a was akin to Christian states in the US stipulating norms for abortion agencies — keep the standards so rigid and tough that they pose an entry barrier and cannot be complied with. Not surprisingly, right since 1999, there has been only one reported registered in the history of

 

The problem with such an approach to regulation is fundamental — pretending that making it illegal to carry out an activity would put an end to it. The activity continued, the monies raised grew even faster, some of which are even feared to be from non-existent investors — read: money laundering schemes. An even more bizarre amendment sailed into the Act in 2013. The 1999 amendment had set out four ingredients to be met for any scheme or arrangement of affairs to be regarded as a — essentially, schemes entailing a contribution of funds for earning of profits, management of the funds pooled by someone on behalf of the contributors and the contributors not having day-to-day control over managing the pool. Now, in 2013, the law was amended to say that even if these ingredients were absent, if the corpus of any arrangement of affairs was of Rs 100 crore or more, it would be “deemed to be” a

 

This set the cat among the pigeons. Any and every pooling of funds that would have a corpus value of Rs 100 crore would be a CIS, which meant that a registration with would be necessary for the activity to be legitimate. A pooling of resources by neighbours owning apartments in an expensive city like Mumbai to rebuild and redevelop their building would arguably be a The provision of holiday schemes where the contribution by guests would give them the right to use a property from the pool of properties built or rented with the contributions would arguably be a Provision of valuables such as gold coins with contributions in instalments would arguably be a

 

None of these would involve issuing securities and therefore, none of these can ever comply with the regulations governing that had made in 1999. Therefore, all of it would be illegal. Those who cared for the law, shut down such activity or moulded them. Those who did not care, kept at it — eroding the majesty of the law even further by reason of formulation of law not properly thought through.
Meanwhile, with public furore over some that failed led to some judicial comments about sleeping on its job, which got reported in the media and then led to crack down by ordering that monies collected be refunded within a few weeks or months. Now, this would spur asset-liability mismatches further and lead to either a run on the schemes that could not be met, or worse, led to operators starting newer schemes underground to fund repayment of schemes ordered to be closed. In a nutshell, a royal mess is on the regulator’s hands.
It is in this context that reports of wanting to relinquish this statutory role is interesting. Around the time piloted legislative amendments to treat any corpus of Rs 100 crore or more as a CIS, it had a muscular tone about how anyone speaking about the need for a predictable framework for running a compliant could only have been aligned with the bad guys. Now, it seems, is conscious that pushing an entire industry underground is actually counterproductive and brings about worse outcomes. Whether it would at all be politically possible to amend the Act yet again to remove of this kind from Sebi’s ambit is doubtful. But one must assume that it the mind is set on an outcome, the government will find ways to get that done — whether through a Presidential Ordinance, a or blanket provisions in the Finance Act.
If pulls off this one, the would have come full circle back to the 1990s. Who then, would bell the cat?
This column was first published as Without Contempt in all editions of Business Standard edition dated May 5, 2017