SAT: Powers of SEBI vis-a-vis the Companies Act

Securities and Exchange Board of India (SEBI) is empowered under section 55A of the Companies Act to administer certain provisions of the Companies Act as far as they, inter alia, relate to issue and transfer of securities. These provisions which SEBI administers cover a major aspect of public offering and transfer of securities in India so far as they are contained under the Companies Act. However, there might still be certain provisions of the Companies Act or some other legislation that touch upon public offering of securities in India but for which SEBI has not been empowered to act upon. Hence the question that often arises is how SEBI should act in such cases.

The answer to the question is found in sections 11 and 11B of the Securities and Exchange Board of India Act (SEBI Act). The functions of SEBI have been provided under section 11 of the SEBI Act which consists of general and specific set of functions. The Securities and Appellate Tribunal in Bank of Baroda v. Securities and Exchange Board of India has held that the duty and function of SEBI is contained in Section 11. It has been entrusted to take such measures as it thinks fit and in order to discharge this duty, the power is vested under section 11B. Thus section 11B is one of the executive measures available to SEBI to enforce its prime duty of investor protection. The Delhi High Court in M.Z. Khan v. SEBI, AIR 1999 Delhi 164 held that the power of the SEBI under section 11 and 11B is of a very wide nature and not hedged by any restriction. Similarly, the Bombay High Court in Ramrakh R. Bohra v. SEBI, [1999] 96 CompCas 623 (Bom) has endorsed such an approach and held that section 11B being an enabling provision must be construed so as to subserve the purpose for which it is enacted.

Thus SEBI can act under sections 11 and 11B, which are of a very wide nature as it speaks of investor protection, irrespective of the fact that the subject matter might also be covered under the Companies Act for which some other authority has been empowered to act. Overlapping of powers is not legally impermissible. The Supreme Court in Radhe Shyam Khemka v. State of Bihar, (1993) 3 SCC 54 found no problem with proceedings initiated under the Penal Code, where proceedings could also have been initiated under the Companies Act. However, power under sections 11 and 11B will have to be exercised independently of the provisions of the Companies Act.

In this context, another section to look at is section 32 of the SEBI Act which states that the provisions of the SEBI Act shall be in addition to and not in derogation of the provisions of other laws. This provision curtails the power of SEBI and in the event of a conflict between the provisions of an existing legislation and the SEBI Act, the provisions in the existing statute will prevail over the provisions of the SEBI Act. In other words, the provisions of the SEBI Act in its application will be only supplemental to the provisions of other existing legislations. The section does not empower SEBI to supplement the provisions of any other law, but refers only to the extent of operation of the provisions of the SEBI Act vis-a-vis the provisions of other statutes.

Legal nature of the bank account in public offerings

The previous year’s public offering trend suggests that it was the year where the average size of the capital raised by a company was the highest. And given the number of disinvestments lined up in 2010, this year is not going to be any different. Consequently, the monetary size of the bank account, which contains the money submitted by the subscribers of the shares and holds it till the company fulfills its statutory obligations, will be very big. Hence it becomes imperative to analyse the legal nature of the bank account and the parties involved to understand how the money can be handled.

The English court in Ballantyne v. Nanwa Gold Mines Ltd., [1955] 3 All ER 210, held that money deposited by the subscribers and maintained in the bank account are not part of the general assets of the issuer company or the bank. They are in the nature of a trust property. The Bombay High Court in Reserve Bank of India v. Bank of Credit and Commerce, 1992 (3) Bom CR 81 approved the foregoing English decision and went on to add that by virtue of sections 73 of the Companies Act, a statutory trust is created whether in the hands of the issuer company or the banks.

From the foregoing, one can conclude the subscribers will be deemed to be the beneficiary of the trust and applying the principles of trust law, any benefit that accrues out of the trust property viz. the bank account will be used for the benefit of the beneficiaries. Since the escrow amount does not form part of the general assets of the company or the bank, the creditors of the company or the banks cannot lay a claim on it in the event that the company or the escrow banks go into liquidation before the public offering is completed. The company and the banks will be acting in a fiduciary capacity when handling the money. One can also conclude that the trust would continue to exist until there is compliance with the statutory provisions such as making of the allotment of the shares to the subscribers and obtaining the permission from the stock exchange for the listing of the shares.

SAT: Locus standi before the SAT

Section 15T of the Securities and Exchange Board of India Act, 1992 (Act) provides for appeal to the Securities Appellate Tribunal (SAT). Section 15T, inter alia, states that any person aggrieved by an order of the Securities and Exchange Board of India (Board) or by an order made by an adjudicating officer under the Act may prefer an appeal to the SAT.

In CSX Members Welfare Association v. SEBI, decided on December 11, 2009, SAT interpreted the meaning of “person aggrieved” to address the preliminary issue of whether the appellant had the locus standi to file an appeal before the SAT. The facts in the CSX case were that the Board had ordered the suspension of certificates of registration of many brokers who had not paid their fee. Against this order, CSX Members Welfare Association, an association of stockbrokers on the Coimbatore Stock Exchange Limited and the Interconnected Stock Exchange of India Limited, had filed the appeal.

To resolve the issue, SAT relied on the test laid down by the Supreme Court in the case of Jasbhai Motibhai Desai v. Roshan Kumar and others, AIR 1976 SC 578. Briefly stated, the test laid down in the Jasbhai case is whether the appellant is the person “against whom a decision has been pronounced which has wrongfully deprived him of something or wrongfully refused him something, or wrongfully affected his title to something”. One must also see “whether the appellant has a special and substantial grievance of his own beyond some grievance or inconvenience suffered by him in common with the rest of the public”. To make it statute specific, the Supreme Court went on to hold that one must also look whether the statute “in the context of which the scope of the words person aggrieved is being considered, a social welfare measure designed to lay down ethical or professional standards of conduct for the community, or is it a statute dealing with private rights of particular individuals.”

Applying the above test, SAT held that CSX Members Welfare Association had no locus standi before it as it cannot be said to be a person aggrieved, and dismissed the appeal

Self-listing by the Indian stock exchanges: The regulatory challenges

Self-listing by the Indian stock exchanges has been on the cards for quite some time. Securities and Exchange Board of India (SEBI) in its annual report 2006-07 had referred to such a development. In fact a recent newspaper report suggests that SEBI has proposed setting up an expert body to look into the corporate governance and ownership structure of stock exchanges. One of the key issues that the committee will look at is the self-listing by a stock exchange.

Self-listing outside India is a common phenomenon. The Australian Stock Exchange, London Stock Exchange, Singapore Stock Exchange and New York Stock Exchange are all self-listed. However, since it is a novel phenomenon in the Indian context, it would be interesting to look at some of the legal and regulatory challenges that self-listing presents.

One of the primary challenges is conflict of interest. Since stock exchanges in general enjoy extensive regulatory powers, their organizational structure will need to be closely monitored. They might get diverted from fulfilling their regulatory duties and the trust with which they have been invested. It follows from the challenge of conflict of interest as to whether the stock exchange will continue to remain impartial and allow itself to remain under the same regulatory umbrella and be regulated as others. In order to boost trade in their own stocks, stock exchanges might misuse their broad powers over broker-dealers and other intermediaries.

Further, stock exchanges regulate issuers through the listing agreement. In case of self-listing, how will the stock exchange enter into a contract with itself? Even if one finds a way out of this, a new type of a listing agreement will have to drafted since most of the current listing rules cannot be literally applied to the stock exchanges.

In the light of the above, it would be interesting to see the views of the SEBI committee to restructure the legal and regulatory framework governing the Indian stock exchanges to combat the foregoing and the other challenges.

SAT: The menace of parallel proceedings under the SEBI Act

The Securities Appellate Tribunal (SAT) in a recent order dated December 30, 2009 in the matter of Opee Stock Link Limited and another v. SEBI has highlighted the menace caused by parallel proceedings under the Securities and Exchange Board of India Act, 1992 (Act).

The Act enables the Securities and Exchange Board of India (Board) to initiate parallel proceedings on the same set of facts against an offender for issuing directions by the Board under Section 11B of the Act on the one hand and adjudication proceedings by an adjudicating officer under Chapter VIA of the Act for the imposition of monetary penalty on the other. An adjudicating officer, in an adjudication proceeding under Chapter VIA of the Act, is a subordinate officer of the Board. As both sets of proceedings are independent of each other, there is a possibility of conflicting views on the same set of facts. For example, in the Opee Stock Link Limited case, while the Board had come to the conclusion that the unlawful gain made by the appellant was approximately Rs. 12 lakhs, the adjudicating officer had come to the conclusion that it was Rs. 24 lakhs.

In the Opee Stock Link Limited case, SAT has observed that such an anomalous situation, where conflicting views are arrived at, is not in public interest. It went on to observe that if only one enquiry is held against the offender and on the basis of the findings recorded therein, the same body is given the power to issue directions and impose monetary penalty as well, it would expedite the matter and resolve the anomaly. For this to happen, an amendment to the Act would be required.

From bookbuilding to auction: The winner is the Government

Securities and Exchange Board of India (SEBI), pursuant to a notification dated December 11, 2009, has introduced an additional method for allotment of securities, the Auction Method, in case of further public offers by amending the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009.

Briefly stated, under the Auction Method, the issuer shall disclose a floor price in the red herring prospectus and investors other than retail individual investors shall bid at any price above the floor price. The bidder who bids at the highest price shall be allotted the number of securities that he has bided for and then the bidder who has bided at the second highest price and so on, until all the specified securities on offer are exhausted. Allotment shall be on price priority basis for investors other than retail individual investors.

It seems that in the Auction Method, apart from the retail individual investors, other investors will be allotted securities at different prices depending upon their bids. Thus there will be no uniform pricing of securities as it is in the bookbuilding or a fixed price issue. This Auction Method can be contrasted with another auction method in public offering of securities in other jurisdictions popularly referred to as the “Dutch Auction”. In a Dutch Auction, the price is initially set high, and gradually lowers depending on the bids received. Investors bid on the offering by stating the number of shares they want to purchase and their preferred price. The price continues to lower until all the shares are spoken for. At auction's end, bidders get the number of shares they agreed to buy, but at the price bid by the last bidder. For details see, what is a Dutch auction IPO? Thus, even in a Dutch Auction, the selling price is uniform for all the bidders. This does not seem to be the case for the Auction Method.

The price and share allocation in Auction Method is determined by the investors as opposed to by the investment bankers and the company in the traditional bookbuilding method. Hence one can argue that in the Auction Method under pricing of securities will be much lesser that in the bookbuilding method. This is because in bookbuilding, inter alia, investment bankers tend to underprice so as to make the issue successful. On the other hand, when investors directly participate in setting up the market price, the real market price is arrived at. Thus Auction Method adds substantial gains to the issuer. This outcome will be of substantial importance to the Government of India which is planning a series of disinvestment in the coming months. Provided one develops the infrastructure for the Auction Method before the disinvestment- 2010 kicks in, Government will end up earning more money through the Auction Method than the bookbuilding method. From government’s standpoint, Auction Method is more beneficial than the Dutch Auction since every bidder is allotted securities at the price bid by him unlike in a Dutch Auction where allotment is made at the price bid by the last bidder.

Another point to note is the possible lacunae in the Auction Method. Since there is no uniform price for allotment, the amendment does not provide for the price at which underwriters will subscribe to the issue in case there is under subscription. One can argue that it would be left to the discretion of the company and the underwriters to arrive at a price, provided it is above the floor price.