There are now 22 recognised stock exchanges in India. Most of the stock exchanges have their own governing boards for self-regulation. The Bombay Stock Exchange (BSE ) and the National Stock Exchange (NSE) together hold a dominant position among the stock exchanges in terms of number of listed companies, capitalisation and trading activity. India had approximately 9000 listed companies at the end on March 2005. BSE and NSE had 4793 and 1099 companies listed as on July 2006, respectively.
Securities regulations do not differentiate between the listed companies on the basis of their sizes. However, the market analysts classify them as small cap (market capitalisation below INR 1 billion), mid-cap (from INR 1 billion to 10 billion) and large-cap (INR 10 billion and above).
No foreign company is currently listed in India.
At the end of 2003, market capitalisation was 46.5 per cent of GDP. The year 2004-05 saw a trading volume of INR 16,668,960 million.
The number of initial public offers (IPOs) in the year 2002-03 was a meagre six, with aggregate issues of INR 10,386 million, which increased to INR 137,490 for 23 IPOs in 2004-05. In 2002-03, the market was not as gloomy for already listed companies which saw 26 issues for a total size of INR 41,000 million. The figure increased to 37 issues raising INR 145,070 million in 2004-05.
Eighty-eight open offers were made in the year 2002-03 for acquisition of an average of 8,460,460 shares worth INR 726 million per offer. In 2003-04, there were 65 open offers having an average volume of 3,357,414 shares and INR 286 million each.
No hostile/un-recommended takeover bids were reported during the years 2002 and 2003.
2 NATURE OF REGULATORY AND LEGISLATIVE STRUCTURE
The securities market in India is governed by four main pieces of legislation:
The laws in India recognise companies as (i) private and (ii) public companies. Private companies can have a maximum of 50 members and are not permitted to make an offer of securities to the public.
The Securities and Exchange Board of India (SEBI) has framed regulations under these acts for registration and regulation of the market intermediaries, to regulate the business of Indian securities markets, to promote and monitor self-regulatory organisations (SROs), to prohibit fraudulent and unfair trade practices and insider trading, and to regulate substantial acquisitions of shares and takeovers of companies. The SROs, such as the stock exchanges, have also laid down their rules and regulations for the market participants to follow. The Central Listing Authority of India (CLA) has also been set up to address the issue of multiple listing of the same security and to bring about uniformity in the due diligence process by scrutinising all listing applications on any stock exchange in India.
SEBI has issued disclosure and investor protection guidelines (DIP guidelines) to ensure that the concerned entities observe high standards of integrity and fair dealing. The guidelines cast responsibility on the lead manager to ensure that the prospectus or letter of offer brings about all the facts and does not contain any incorrect or misleading information. The companies can access the market only if they fulfill minimum eligibility norms.
It was with the issue of the Companies (Issue of Indian Depository Receipts) Rules 2004 (IDR Rules) that a foreign company could be listed on the Indian market. Unlike securities of Indian companies, IDRs can only be issued to Qualified Institutional Buyers (QIBs) under the DIP guidelines.
3.1 Necessity for a foreign company to be registered in India and formal presence of local agent to accept legal process
Part XI of the Companies Act contains provisions regarding foreign companies to register a branch/project/liaison office in India, and requires certain documents to be delivered to the registrar of companies if a place of business is established in India. This is subject to prior approval of the Reserve Bank of India (RBI).
The issuing (foreign) company is required to appoint a merchant banker who has to file with SEBI and the registrar of companies a prospectus prepared in accordance with DIP guidelines before the issue. Foreign companies can get their securities listed on Indian stock exchanges irrespective of whether they have or have not established any place of business in India.
Under the Companies Act, a public offering of securities in India must be made by means of prospectus in the case of a company making a fresh issue, and through a letter of offer when the company makes a rights issue, which must contain information specified in the Companies Act and be filed with the jurisdictional registrar of companies.
The term ‘securities’ has been defined in the SCRA Act and includes shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities, government securities and right or interests in securities.
Several entities like clearing corporations, clearing members, custodians, clearing banks, and depositories are involved in the process of clearing. The stock exchanges in India operate on a trading day plus two, or T+2, rolling settlement system. At the end of the T+2 period, obligations are settled with buyers of securities paying for and receiving securities, while sellers transfer and receive payment for securities.
Section 4 of the SCRA Act empowers the government (exercisable by SEBI) to grant recognition to the stock exchanges and also to authorise the recognised stock exchanges to make their own bylaws.
Stock exchanges are required to maintain proper documents and records provided under the SCR rules and to furnish the annual report to SEBI with detailed information and also to submit periodic returns to SEBI. The bylaws made or amended by stock exchanges are required to be published in the gazette of India and the official gazette of the state in which the principal office of the exchange is located.
Schedule II of Companies Act delineates minimum information to be provided in the prospectus and reports to be set out in it. It includes general information about the company; capital structure of the company; terms of the present issue; particulars of the issue; company management and projects; outstanding litigation pertaining to the matters likely to affect operation and finances of the company and criminal prosecution launched against the company and the directors, particulars of defaults; any material development after the date of the latest balance sheet and its impact on performance and prospects of the company; risk involved in the business of the company and management perception of the risk factors; particulars in regard to the group companies and the companies under the same management; financial information for the five financial years preceding the issue of the prospectus of the company and its subsidiaries. In an unprecedented move, SEBI, on 22 March 2007, made it mandatory for companies planning an IPO to get rated by the rating agencies.
In addition to the above, chapter VI of the DIP guidelines issued by SEBI provides the form and content of the prospectus.
In addition, the relevant provisions for public or rights issue of debt instruments are detailed below.
The prospectus is prepared by the merchant banker on the basis of information provided by the issuer company. In the case of a company going for further issue of capital, a certificate from a company secretary/chartered accountant is also required to the effect that all compliance was made by the company during the previous issues. The offering document is the primary responsibility of the issuer company and the company liaises with merchant bankers, lawyers and other advisors.
Prior to the issue, the lead merchant banker, with the help of legal advisors, has to exercise due diligence and the merchant banker satisfies himself about all the aspects of offering, veracity and adequacy of disclosure in the offer documents. The lead merchant banker needs to furnish to the SEBI a due diligence certificate in the specified format along with the draft prospectus.
The issuing company and its directors, the persons named in the prospectus as a director, proposed directors, promoters and every person who has authorised the issue of the prospectus, have primary responsibility for the information contained in the prospectus or letter of offer. Sections 62 and 63 of the Companies Act cast civil and criminal liability on the aforesaid persons for misstatements in the prospectus.
The prospectus contains a report from the auditors of the issuer company dealing with the profits or losses of the issuer company for each of the five financial years immediately preceding the issue of the prospectus. It also deals with the assets and liabilities of the issuer company at the last date to which the accounts of the issuer company were made up. In case the issuer company has subsidiaries, consolidated profit and loss statement and assets and liability statements form part of the prospectus.
The financial statement should disclose all significant accounting policies and standards followed in preparation of the financial statements.
The prospectus contains a brief statement about future prospects of the issuing company including the capacity and capacity utilisation, proposed capacities for existing as well as proposed products and assumptions for future capacity utilisation for the next three years (from the date of commencement of commercial production) in respect of existing as well as proposed products. A forecast of financial performance of the issuer company is not given in the prospectus.
Chapter X of the DIP guidelines provides for additional requirements in the case of issue of debt securities through prospectus or letter of offer. A company seeks a credit rating of not less than investment grade from two or more registered credit rating agencies and discloses the same in the offer document. The issuer company appoints one or more debenture trustees for such debentures in accordance with the provisions of the Companies Act. The company creates debenture redemption reserve in accordance with the provisions of the Companies Act.
The merchant banker files with the SEBI the draft offer document and necessary free of charge certificates from the bankers. The merchant banker also sees that the security created is adequate to ensure 100 per cent asset cover for the debentures.
The offer document is required to contain information regarding the security being applied for listing and the rights relating to dividends on shares and interest on debentures. The prospectus should contain the bylaws of the company for payment of dividends including the written policy regarding differential payment of dividends, if any.
The DIP guidelines provide for the inclusion of a disclaimer that the issue is not directed to the non-residents, except FIIs, QIBs, etc.
The prospectus for issue of shares to the public needs to be submitted to SEBI and is vetted by SEBI. Such prospectus is recognised at all the recognised stock exchanges in India.
The securities of a company can be issued to some identified persons eg institutional investors, or they can be offered to general public. The securities are also offered to the intermediaries such as underwriters, who shall further sell the securities to their clients. Other method of raising capital is through book-building process, where the lead manager uses offers of QIBs as a price discovery mechanism. Redistribution takes place in the secondary markets.
Underwriting is one of the many obligations undertaken by a category I lead merchant banker, though category II and III merchant bankers can do it but are not obliged. The primary responsibility is to manage the public issue of securities in terms of clearly defined roles of disclosures, allotment and refund. The lead merchant banker, responsible for the contents of the prospectus, has to submit a due diligence report in respect of such content to SEBI.
Every underwriter has to enter into an agreement with the body corporate delineating the period of agreement, amount of underwriting obligations, amount of commission to be paid and other arrangements to be made by the agreement.
The amount of commission or brokerage is as per the agreement between the underwriter and the issuer, and the regulator does not specify any limit in that regard.
Every person purporting to act as an underwriter has to obtain a registration certificate under the Securities and Exchange Board of India (Underwriters) Regulations 1993 (Underwriters Regulations). These regulations require an applicant to have necessary infrastructure like adequate office space, equipment, and staff to effectively discharge his or her responsibilities, past experience in underwriting or has in his or her employment a minimum of two persons having such experience. The applicant should fulfill the capital adequacy requirement under regulation seven and should be a fit and proper person.
A lead merchant banker is responsible for the verification of the contents of an offer document. No such obligation lies on any person quaan underwriter.
As per Underwriters Regulations, an underwriter, being called upon to subscribe for securities, has to subscribe to such securities within 45 days of the receipt of such intimation from the issuer.
The securities can be distributed to retail investors only through a public offer or a registered intermediary, who would sell these securities to its clients.
Rule 3 of the Securities and Exchange Board of India (Debenture Trustee) Rules 1993 (Debenture Rules) says that unless a person holds a certificate granted by the Board under the Securities and Exchange Board of India (Debenture Trustee) Regulations 1993 (Debenture Regulations), he cannot act as a debenture trustee. Chapter two of the Debenture Regulations lays down procedure for registration of the debenture trustee.
An application has to be filed with SEBI under regulation 3 of the said Regulations in Form A. SEBI considers the application keeping in view the office infrastructure and experience and expertise adequacy requirements. To act as a debenture trustee, the applicant has to be (a) a scheduled bank carrying on commercial activity; or (b) a public financial institution; or (c) an insurance company; or (d) a body corporate.
Moreover, clause 10.2 of DIP Guidelines also requires that no debenture can be issued or offer made in this regard by any company unless it has appointed one or more debenture trustees.
Under the DIP guidelines, the debenture trustee acts as the agent.
Minimum contents of the trust deed are prescribed in Schedule IV to the Debenture Regulations.
A company making a public issue of securities files a prospectus with SEBI, through an eligible merchant banker, at least 21 days before the filing of the Prospectus with the Registrar of Companies (ROC).
Before making any public issue or rights issue or an offer for sale of securities a company needs to enter into an agreement with a depository for dematerialisation of securities already issued or proposed to be issued to the public or existing shareholders and give an option to investors to receive the security certificates or hold securities in dematerialised form with a depository.
Further, the company making the public offering of security has to meet certain eligibility conditions with regard to net tangible assets, three years’ track record of distributable profit, etc.
In a public issue, the promoters have to contribute not less than 20 per cent of the post issue capital. The DIP guidelines also provide for a lock-in period for promoters contributions.
As per the listing agreement of the stock exchanges, the issuer company is to deposit one per cent of the amount of securities offered to the public and/or to the holders of the existing securities of the company, as the case may be, with the designated Stock Exchange, which can be released by the concerned stock exchange only after obtaining an NOC from the Board.
For admission of security to the listing, an application, along with a draft offer document, has to be made to the CLA for issuance of letter precedent to the listing. The CLA aims to bring about uniformity in the due diligence process by scrutinising all listing applications on any of the stock exchanges in India. The functions of the CLA includes processing the application for the letter of recommendation to be listed at the stock exchange; making recommendations as to listing conditions; making suggestions with respect to investor protection development and regulation of the securities market and disclosures to be made in offer documents; and any other functions that may be specified by the SEBI from time to time.
In addition to the discussion above, where a company issues or allots securities with a view to sale to the public, any offer document is deemed to be a prospectus issued by the company; and all enactments and rules of law as to the contents of prospectuses and as to liability in respect of statements in and omissions from prospectuses, or otherwise relating to prospectuses, apply.
An appeal can be filed with the Securities Appellate Tribunal (SAT) in case the competent authorities refuse a prospectus or decline a licence to a mutual fund.
The issuer has to ensure, under the DIP guidelines, that pursuant to a public issue or offer for sale, the number of prospective allottees is not less than 1,000 and the minimum issue size is INR 100 million. Moreover, any listing agreement executed with the stock exchanges requires the company to maintain a minimum level of non-promoters shareholding of 25 per cent of its paid-up equity share capital.
Please see above.
The listing of securities on recognised stock exchanges is regulated by the Securities Contract (Regulations) Rules 1957 (SCRR) and the listing agreement of the respective stock exchange (Listing Agreement). Section 21 of SCRA provides that where the securities are listed on any recognised stock exchange, the issuer of those securities has to comply with the conditions of the listing agreement. Violation of the listing agreement is an offence under the SEBI Act.
8.8 Obligations of sponsor (merchant banker-book running lead manager)
Merchant bankers to the issue or book running lead manager (BRLM) undertakes the due diligence of the company’s operations, management, business plans, legal compliance, etc. The prospectus is prepared by the merchant banker on the basis of information provided by the issuer company. It is the duty of the merchant banker to ensure compliance with stipulated requirements and completion of the formalities with the stock exchanges, ROC and SEBI including finalisation of offer documents and ROC filing. The merchant banker also draws up the various marketing strategies for the issue.
The post issue activities including management of escrow accounts, co-ordination of noninstitutional allocation, intimation of allocation and dispatch of refunds to bidders etc are also performed by the merchant banker. The post offer activities involve essential follow-up steps including finalisation of trading and dealing of instruments and dispatch of certificates or delivery of shares in demat mode with the various agencies connected with the work such as the registrar(s) to the offer and bankers to the offer and the bank handling refund business. The merchant banker is responsible for ensuring that these agencies perform their functions and enable it to discharge this responsibility through suitable agreements with the company.
Under Section 15T of the SEBI Act, an appeal lies with the SAT in cases where a person is aggrieved by the order of SEBI or any adjudicating officer.
The fee payable by a company for listing securities on a stock exchange are of two types:
Part III of the Companies Act lays down the provisions for the matters relating to the prospectus, statement in lieu of the prospectus, return of allotment, issue of shares and redemption of irredeemable preference shares, etc. The procedure relating to issue and transfer of securities come within the remit of the SEBI Act and regulations and guidelines issued under it. Both sets of provisions require a great deal of information to be provided in the prospectus.
The DIP Guidelines read with the Companies Act allow an applicant to withdraw his application before the close of the offer. In a case of misstatement at the time of subscription of shares, the shareholder can rescind the contract and force the company to take back the shares and return the money with interest.
The Board has created an Investor Grievances Redressal and Guidance Division to assist investors who prefer to make complaints to it against companies. Each complaint is taken up with the company immediately and follow-up is made every quarter. The companies are warned of stern action for failure to redress complaints. Officers hold periodic meetings with errant companies. Recalcitrant companies are referred for prosecution.
There are other redressal provisions in the Companies Act as discussed above
General time limits for a damages suit under the Limitations Act is three years.
For misstatement in the prospectus, the investor can file a civil suit for damages under section 62 of the Companies Act.
SEBI has also issued the Securities and Exchange Board of India (Ombudsman) Regulations 2003, wherein an investor can file a complaint on any of the grounds enumerated in regulation 13. A mutual settlement is preferred, failing which a binding award is pronounced by the Ombudsman.
9.4 Possible criminal penalties
Section 63 of the Companies Act makes every person who authorised the issue of the prospectus with any untrue statements punishable with imprisonment for a term which may extend to two years. Moreover, section 24 of SEBI Act prescribes up to ten years imprisonment for a person who contravenes its provisions.
10 CONTINUING REQUIREMENTS
10.1 Nature of continuing requirements
All issuers, whose securities are listed on a stock exchange, have to comply with the listing conditions and requirements contained in the listing agreement.
Companies are required under the Companies Act to prepare, file with the ROC and circulate to the shareholders the audited annual accounts, in compliance with the Companies Act’s disclosure requirements and regulations governing their manner of presentation. In addition, a listed company is subject to continuing disclosure requirements pursuant to the terms of its listing agreement with the relevant stock exchange.
10.2 Financial information
A listed company is required to furnish to the stock exchange and publish unaudited financial statements (subject to a limited review by the company’s auditors on a quarterly basis and is required to inform the applicable stock exchanges immediately regarding any stock-price sensitive information.
The company has to mandatorily publish consolidated financial statements in its annual report in addition to the individual financial statements. The company also has to get its consolidated financial statements audited by the statutory auditors of the company and file the same with the stock exchange. The company makes disclosures, in compliance with the accounting standard, on related party transactions in its annual report.
10.3 Interim disclosure
Clause 36 of the listing agreement requires a company to inform the stock exchange immediately of any event which will have bearing upon the performance/operations of the company. Similarly, any price sensitive information is also required to be informed immediately.
10.4 Obligation to solicitation of proxies with agency
The listing agreement provides that the company will send out proxy forms to shareholders and debenture holders in all cases. The proxy forms should be adequately worded so that one can vote either for or against a resolution.
10.5 Disclosures on directors, management
Clause 49 of the listing agreement requires that all fees or compensation (other than the sitting fee within the limits provided under the Companies Act), if any paid to non-executive directors, including independent directors, should be fixed by the board of directors and be approved by the shareholders in general meeting. The shareholders’ resolution specifies the limits for the maximum number of stock options that can be granted to such directors in any financial year and in aggregate.
All pecuniary relationship or transactions of the non-executive directors vis-à-vis the company, their service contracts and stock options are required to be disclosed in the annual report.
10.6 Continuous requirements of reporting and notification of substantial shareholding
Under clause 35 of the listing agreement, the company has to file with the concerned stock exchanges on a quarterly basis the shareholding of promoters and others shareholdings in the company in the format specified.
Similar disclosure requirements are prescribed under the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 1997 (Takeover Code) and the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 1992 (Insider Trading Regulations).
10.7 Requirement of transfer agent, clearing agent
The transfer of securities work can be handled by a company either in-house or through a SEBI registered Registrar to an Issue and Share Transfer Agent (RTA). It has been made mandatory by SEBI that all the work related to registry in terms of both physical and electronic should be maintained at a single point.
The trades on BSE are settled through a clearing house. The trades on the CM segment of NSE are settled through National Securities Clearing Corporation and on its WDM segment, they are settled on a trade-by-trade basis on the settlement day.
10.8 Other continuing requirements
Apart from complying with the listing agreement and annual filing with ROC, the company has also to make necessary intimations to the ROC in the prescribed forms available at the portal of Ministry of Company Affairs (MCA).
11 CORPORATE GOVERNANCE
11.1 Law
The Companies Act provides for the basic structural framework for corporate governance. However, the SEBI Act makes the structure, thus provided, functional to achieve the desired objective. Based on the recommendations of the Narayana Murthy committee constituted by SEBI, clause 49 of the listing agreement was amended to incorporate changes to the definition of ‘independent directors’; for strengthening the responsibilities of the audit committee and improving the quality of financial disclosures. The adoption of a formal code of conduct for senior management and the certification of financial statements issued by the CEO or the CFO are the responsibilities of the board of directors as a whole now.
Clause 49 was included in the year 2000 on the basis of the recommendations of the Kumar Mangalam Birla Committee.
11.2 One – two tier
Unlike the German model of board structuring, a two-tier structure in Indian companies is unheard of. However, there is no obvious legal bar on adopting the same. Many companies, nevertheless, having a non-executive chairman, do have a separate CEO.
11.3 Obligations to issue regulations on internet
Under recently issued MCA 21, no information can be filed with the registrar of companies, except electronically. The RoCs have also automated or are in the process of automating every data or information available with them in respect of an incorporated company. Every public information, including the Memorandum and Articles of Association of a registered company, is available for public inspection on the internet.
11.4 Responsibility of directors
Company law does not differentiate between the responsibilities of the executive and independent directors. All directors act in fiduciary capacities. However, under clause 49, some of the committees are composed solely of independent directors, eg, nomination committee. Under the new corporate governance regime, independent directors have been given enhanced responsibilities.
11.5 Committees
Under section 292A of the Companies Act, every public company having paid-up capital of INR 50 million or more shall constitute an audit committee. As per clause 49, the chairman of the committee has to be an independent director. To adhere to the rules of corporate governance, the companies are also required to constitute a nomination committee, compensation committee, governance committee, etc.
11.6 Obligation to ask consent of shareholders meeting
Under section 293 of the Companies Act, the board of directors of a public company, or of a private company which is a subsidiary of a public company, cannot, except with the consent of such public company or subsidiary in a general meeting, engage in (a) selling or leasing of any undertaking of the company; (b) remitting or giving time for the repayment of any debt due by a director; (c) investing the amount of compensation received by the company on compulsory acquisition of its property; (d) borrowing money where the total borrowing exceeds the paid capital of the company; and (e) contributing more than the prescribed amount, to a charitable fund. Similarly, section 294 requires approval of a general meeting for the appointment of a sole selling agent for an area.
11.7 Depth of information
Unlike the US, we do not have proxy solicitation rules in India.
11.8 Appointment/dismissal of directors
The shareholders in a general meeting can only appoint a regular director. However, an additional director can be appointed by the board of directors until the next general meeting. A separate resolution by the shareholders has to be passed in respect of each appointment, unless a resolution for motion for single resolution is passed unopposed. Under section 284 of the Companies Act, a company can remove a director by a resolution in a general meeting, upon giving him special notice to that effect.
11.9 Income and options for directors
Section 309 of the Companies Act allows a company to pay a director, who is either in the full-time employment of the company or a managing director, remuneration either by way of a monthly payment or at a specified percentage of the net profits of the company or partly by one way and partly by the other. Others may be paid remuneration, either (a) by way of a monthly, quarterly or annual payment with the approval of the central government; or (b) by way of commission if the company by special resolution authorises such payment.
11.10Earnings guidance
It is the responsibility of the audit committee of a listed company, under clause 49 of the listing agreement, to review earnings guidance as part of analysis of financial condition, etc, generally provided to analysts and credit rating agencies and discuss the same with management before finalisation and issuance.
11.11MD&A
Clause 49(F) sets out the outline of a management discussion and analysis report, which becomes a part of the annual report to the shareholders. It includes discussion relating to industry structure and development; opportunities and threats; segment-wise/product-wise performance; outlook; risks and concerns; adequacy of internal control systems; financial performance with respect to operational performance, etc. Any possible conflict of interest between members of senior management vis-à-vis the company is also disclosed to the board of directors.
11.12Directors’ liability
The Directors are responsible for the conduct of all the affairs of the company. They owe common law duties of care and diligence to the company and act as fiduciaries to the company. Among other things, they are responsible for reviewing and authorising major corporate actions; advising and counseling management on corporate decisions; reviewing and overseeing proper audit procedures; reviewing the corporation’s investments; informing themselves about the corporation’s financial status and legal developments; assisting management in decision-making; ensuring compliance with all applicable statutes, regulations and laws and monitoring management’s performance.
12 INSIDER TRADING
12.1 Laws and regulations
The SEBI Act and the Insider Trading Regulations wield all the means to prohibit and punish insider trading. Prohibiting insider trading and investigating cases of it are some of the statutory functions of SEBI. The regulations detail substantive and procedural law for such trading.
12.2 Codes of conduct
Chapter IV of the Insider Trading Regulations delineates very clearly the disclosure requirements and code of internal conduct for listed companies. It also mandates acquisition disclosure requirements on insiders eg directors and officers of such company. To prevent insider trading, a model code of conduct has been provided for in Schedule I to the Regulations. Regulation 13 requires an initial disclosure on acquisition of five per cent shares or voting rights and a subsequent change in shareholdings or voting rights by a margin of two per cent.
12.3 Definitions
The regulations prohibit communicating unpublished price sensitive information and dealing in any securities on the basis of it. The SEBI Act and regulations made under it have force in the Indian territory only.
12.4 Sanctions
Section 15G of the SEBI Act makes an insider dealer and a facilitator liable to a penalty of INR 250 million or three times the amount of profits made out of insider trading, whichever is higher. Section 24 prescribes a heavy penalty, including imprisonment up to ten years for any contravention of the SEBI Act.
12.5 Defences
Unlike the Criminal Justice Act of the United Kingdom, neither the SEBI Act nor the regulations have any explicit provision setting out defences for an insider. The only defences available are to rebut the charge of such dealing in the course of investigation, adjudication and subsequent appellate stages.
12.6 Major shareholders
If a major shareholder is also a director of the company, he is covered within the definition of a connected person and thus, is a potential insider.
12.7 Trading in certain periods
The model code for directors and employees in schedule I to the regulations prohibits dealing the securities of the company during the close of the ‘trading window’, when information relating to declaration of financial results, declaration of dividends, issue of securities by way of public/rights/bonus etc, any major expansion plans or execution of new projects, amalgamation, mergers, takeovers and buy-back, disposal of whole or substantially whole of the undertaking and any changes in policies, plans or operations of the company is unpublished. The window opens after 24 hours of publication of such information.
12.8 Buying before launch of takeover bid
Under the Takeover Code, the acquirer cannot pay less than the highest price paid by him for an acquisition of shares by way of public allotment or rights issue or preferential issue during the 26 week period prior to the date of public announcement. This neutralises any effect of insider information (in regard to the fact of takeover) on the subsequent offeree.
12.9 Buying after close of takeover bid
Under the takeover regulations mentioned above, a fresh acquisition offer within a period of six months from the date of withdrawal of offer in terms of the regulations is debarred. And if there has been a default by the acquirer in fulfilling the obligations under the regulations, he is debarred from making an offer for any listed company for a period of 12 months from the closure of the instant offer.
12.10Analysts
An analyst is not covered in the definition of an insider.
13 MUTUAL FUND AND ITS UNITS
13.1 Special regulation for mutual fund
Substantive provisions relevant to mutual funds are enshrined in the SEBI Act. Registering and regulating the working of mutual funds are among the outlined functions of SEBI. The SEBI Act provides for penal provisions for operating as a mutual fund without registration and for not complying with the provisions of the SEBI Act and rules/regulations made under it. The Securities and Exchange Board of India (Mutual Funds) Regulations 1996 (MF Regulations) detail the procedural and other provisions for the registration and the regulation of the funds.
13.2 Controlling authority
SEBI is the regulatory authority in respect of all mutual funds.
13.3 Regulated functions
Section 12 of the SEBI Act mandates that every entity which sponsors or causes to be sponsored or carries on or causes to be carried on any mutual funds, is required to obtain a certificate of registration from the board. The regulated and/or approved entities include the sponsor, trustee, asset management company (AMC), custodian, broker, registrar, etc.
13.4 Exemption
Unlike the FSMA [CIS] order, the MF Regulations do not outline, specifically, any category of activities exempted from their operations.
13.5 Requirements
The MF Regulations require the prior approval of SEBI for appointment of the trustees and AMC. Similarly, the trust deed of the fund and the investment management agreement between the trustees and the AMC have also to be approved by SEBI. Any scheme, before being launched by the AMC, has to be approved by the trustees and its offer document has to be filed with SEBI.
13.6 Foreign entities
All mutual funds, including those promoted by foreign entities, are governed by the same set of regulations. There is no distinction in regulatory requirements for these mutual funds and all are subject to monitoring and inspections by SEBI.
13.7 Relationship with clients
Relationships with the investors are governed by the MF Regulations only. Schedule V of these regulations prescribes dos and don’ts for the trustees and the AMCs. Likewise, Schedule VI requires that an advertisement should be truthful, fair and clear and should not contain a statement, promise or forecast which is untrue or misleading. The aim is to furnish the investors with sufficient and correct information to facilitate judicious investment decisions.
13.8 Reporting/guarantee systems
Mutual funds are required to send an annual report or abridged annual report to the unit-holders at the end of the year. Unit-holders are also entitled to receive a report on winding up from the mutual funds which gives all necessary details.
Guarantee can only be provided in a scheme if: (a) returns are fully guaranteed by the sponsor or the asset management company; (b) a statement indicating the name of the person who will guarantee the return is made in the offer document; (c) the manner in which the guarantee to be met has been stated in the offer document.
13.9 Extra disclosure requirements
Any change in the fundamental attributes of the scheme can be carried out only after a written communication to each unit-holder and an issue of an advertisement to that effect. The MF Regulations outline continual disclosure requirements upon the trustees and AMCs, eg regulation 48 requires the calculation and publication of net asset value of a scheme at least in two daily newspapers at intervals of not exceeding one week. Under regulation 60, the trustees are under an obligation to keep the investors informed about any information which may have an adverse bearing on their investments.
13.10Typical mutual fund
As per regulation 14 of the MF Regulations, a mutual fund can be constituted in the form of a trust only. A mutual fund scheme can be classified into an open-ended scheme or closed-ended scheme depending on its maturity period. These regulations also provide for conversion of a closed ended scheme into an open-ended scheme.
13.11Registration and requirement for manager
Chapter IV of the MF Regulations contains provisions relating to the approval (registration not required) of an AMC by SEBI. The chapter requires that the AMC, if already existing, should have a sound track record. It should have a net worth of at least INR 100 million.
13.12Registration and requirement for custodian
Regulation 26 says that a custodian is to be appointed by the fund and SEBI is required to be intimated regarding the appointment within 15 days. The provision forbids the appointment of an entity as custodian in which the sponsor of the fund has a controlling right.
13.13Registration and requirement for redemption agent
An AMC acts as a redemption agent for the fund.
13.14Regulation on investment power
Chapter VI specifies the investment objective for the money collected in a scheme. Regulation 43 says that the moneys collected under any scheme of a mutual fund shall be invested only in transferable securities in the money market or in the capital market or in privately placed debentures or securitised debts. The restrictions on these investments are specified in Schedule VII of the MF Regulations. Eg, a mutual fund scheme shall not invest more than 10 per cent of its NAV in un-rated debt instruments issued by a single issuer.
14 SECURITIES INSTITUTIONS
14.1 Regulation
SEBI is the regulating authority for all the securities institutions in India. It is a body corporate established by central government under the SEBI Act. The SEBI Act also gives regulatory power to it. SEBI may issue regulations for the performance of its statutory functions.
14.2 Controlling powers of SEBI
The SEBI Act spells out the duty of the board to protect the interest of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit. The measures include registering and regulating the businesses of various securities institutions. To ensure investors’ protection, SEBI keeps a tab on fraudulent and unfair trade practices, promotes investors’ education and training, etc. SEBI has been given powers to seek information, to cause enquiry and adjudicate and to impose penalties and issue directions.
14.3 Regulated functions
As per section 11 of the SEBI Act, SEBI regulates the activities of stock brokers, sub-brokers, bankers to an issue, trustees of trust deeds, portfolio managers, investment advisers, merchant bankers, share transfer agents, registrars to an issue, underwriters, depositories, foreign institutional investors, credit rating agencies, other intermediaries associated with the securities markets in any manner, venture capital funds, collective investments schemes, etc. SEBI also regulates the business in stock exchanges. Substantial acquisitions and takeovers are also activities coming within the remit of SEBI.
14.4 Exemptions
Section 28 of the SEBI Act which permitted the central government to exempt, by order published in the Official Gazette, any person or class of persons buying or selling securities or otherwise, dealing with the securities market from the registration requirement under subsection (1) of section 12, has been deleted by the Securities Laws (Amendment) Act 1995 (9 of 1995) (w.e.f. 25.1.95).
14.5 Requirements
Requirements for each kind of institution are set out in separate regulations specifically issued for that kind of institution.
14.6 Special requirements for foreign entities
SEBI has issued a special set of rules for the foreign institutional investors (FIIs) termed ‘SEBI (FII) Regulations 1995’. No person can deal in securities as an FII unless he is granted a certificate by SEBI. The application is decided on the basis of the applicant’s track record, professional competence, financial soundness, experience, general reputation of fairness and integrity. Another relevant factor is the fact of the applicant being already registered with and regulated by an appropriate foreign regulatory authority in the same capacity in which the application is filed with SEBI. The applicant should be a fit and proper person and should have been in existence for at least one year.
14.7 Relationship with clients
If a registered intermediary, when required under the SEBI Act or any rules or regulations made under it to enter into an agreement with his client, fails to enter into such agreement, he is liable to a penalty under Section 15B of the SEBI Act. Section 11A gives power to SEBI to issue special orders to prohibit any company from issuing an advertisement or specifying conditions for issue of such advertisement soliciting money from the public for issue of securities.
14.8 Reporting/guarantee system
The board has issued separate regulations relevant to different kinds of institutions. For instance, SEBI (Merchant Bankers) Regulations 1992 seek to regulate the activities of a merchant banker. As each of these institutions have different sorts of relationships with its clients, the report sought from it is also specific to the activity they are engaged in. However, Section 15A of the SEBI Act makes a person liable to a penalty if he fails to furnish any return or report to SEBI required under the SEBI Act or any rules or regulations made under it.
15 NOTIFICATION OBLIGATIONS
15.1 Notification of substantial shareholdings, thresholds, public access
The notification requirements upon a substantial acquisition of shares by a person in a listed company are enshrined in the Takeover Code and the listing agreement between the listed company and the stock exchange. The relevant provisions of the Takeover Code are discussed below. Clause 35 of the listing agreement requires a listed company to submit a statement showing the shareholding pattern on a quarterly basis. Among other things, the holdings of persons belonging to the category ‘public’ and having more than one per cent of the total number of shares and also shares held by the promoters are to be separately stated. The statement is available on the listed company’s website for investor viewing.
16 PUBLIC TAKEOVERS
16.1 Applicable laws and regulations
Public takeovers and substantial acquisition of shares are regulated by the Takeover Code. The code has force of law. It is based on the recommendations of Justice PN Bhagwati Committee on Takeovers and gives effect to the cardinal principles of equality of opportunity to all shareholders, protection of minority interests, transparency and fairness. The code sets out disclosure and mandatory bid requirements upon reaching different thresholds of shares or voting rights acquisition.
16.2 Competent authority
Takeovers are regulated by SEBI and a panel constituted by it. However, the panel is constituted for the limited purposes of regulation 4 of the Takeover Code, to consider an application made by an acquirer seeking exemption from the applicability of the code and making a recommendation to SEBI to that effect. For the rest of the provisions, SEBI is the sole competent authority.
16.3 Relevant thresholds
On an acquisition of shares or voting rights, which entitles the acquirer to more than five per cent or 10 per cent or 14 per cent or 54 per cent or 74 per cent of the shares or voting rights in a company, the acquirer is required to disclose his aggregate shareholding or voting rights at every stage to the company and the stock exchanges where the shares are listed (regulation 7). There is also an obligation of continual disclosure on a yearly basis, if any person holds more than 15 per cent of the total shares or voting rights (regulation 8).
An acquisition entitling the acquirer to exercise 15 per cent or more of voting rights can only be permitted by making a public announcement to acquire such shares as per the provisions of the Regulations (regulation 10). An addition of five percentile points in a financial year to the existing holding of more than 15 per cent, but less than 55 per cent of shares or voting rights can also be made by public announcement only (regulation 11(1)). Beyond the threshold of 55 per cent, no acquisition, whatsoever, can be made without such announcement (regulation 11(2)).
16.4 Offer price obligation
The offer price can be paid in cash; or by issue, exchange and/or transfer of equity shares of the acquirer company, if the latter is a listed body corporate; or by issue, exchange and/or transfer of minimum ‘A’ grade rated secured instruments of the acquirer company; or any combination of them (regulation 20(2)). As per sub-regulation (4) and (5) of regulation 20, the offer price cannot be less than the highest price paid by the acquirer for the acquisition of shares by way of public allotment or rights issue or preferential issue during the 26 week period prior to the date of public announcement.
16.5 Timing of events
Within four working days of an acquisition agreement or decision to acquire shares or voting rights exceeding the different thresholds discussed above, the merchant banker, appointed by the acquirer, has to make a public announcement to purchase the shares (Regulation 14). The change in control of the target company, even without transfer of any shares or any voting rights, shall trigger the need for a public announcement (Regulation 12).
Regulation 18 requires that within 14 days of a public announcement, a draft offer letter is to be filed with SEBI. The acquirer is required to dispatch the offer letter to the shareholders and the gap between the draft letter to SEBI and offer letter to the shareholders should not be less than 21 days. For the purpose of determining the names of the shareholders for sending the offer letter a date (specified date) is required to be specified in the public announcement, which cannot be later than the 30th day from the announcement (Regulation 19).
Regulation 22 delineates the timing of different events. Sub-regulation 2 mandates that the acquirer should send a copy of the draft letter to the target company within 14 days from the public announcement. He is also to ensure, as per sub-regulation 3, that all the target shareholders, as on the specified date, get the offer letter within 45 days of the public announcement. The date for opening the offer should not be later than the 55th day from the public announcement date (sub-regulation 4) and such offer should remain open for 20 days (sub-regulation 5). A shareholder can withdraw the acceptance tendered by him up to three working days prior to the date of closing of the offer (sub-regulation 5A).
An escrow account has to be created by the acquirer on or before the date of public announcement (sub-regulation 10). All procedures relating to the offer, including the payment of consideration, have to be completed within 15 days of offer closure (subregulation 12). No acquisition offer can be made by the offeror for the shares of the target company within a period of six months from the date of withdrawal of the offer in terms of the regulations (sub-regulation 14). In case of default by the acquirer in fulfilling the obligations under the regulations, he is debarred from making an offer for any listed company for a period of 12 months from the closure of the instant offer (sub-regulation 15). No asset of the target company can be disposed of or otherwise encumbered by the acquirer during a period of two years from the closure date, unless an intention to do so is stated in either the public announcement and/or in the letter of offer to the shareholders (sub-regulation 18).
16.6 Strategy
The Takeover Code has a mandatory offer requirement, in the event of reaching the specified thresholds. The acquirer is required to approach (i) the shareholders of the target company so that they have an equal opportunity to take an informed decision on the offer,
(ii) the target company itself so that it can place the offer before its board of directors for consideration and (iii) SEBI to enable it to examine the draft offer regarding sufficiency of the information to be disclosed to the shareholders.
16.7 Irrevocables
Unlike the UK Takeover Code, there is no provision requiring a majority shareholder to tender an irrevocable undertaking.
16.8 Buying on exchange
The acquirer is prohibited from buying the shares through any route, except through public offer, if the aggregate holding exceeds the specified thresholds.
16.9 First announcement
A public announcement is required only when the acquisition of additional shares takes the holding beyond the specified thresholds. The offer is in the nature of a mandatory offer, akin to rule 9 under the UK Code. Unlike rule 2.5 of the UK Code, the Indian code does not provide for a voluntary offer. As, under the code, a public offer has to be for a minimum of 20 per cent of the voting capital of the company (Regulation 21), and the minimum threshold for a mandatory offer is 15 per cent, every offer has to be in the nature of a mandatory offer.
16.10Period between first announcement and offer document
This must be 14 days for the draft offer letter to SEBI and the target company and 45 days for receipt of the offer letter by the target shareholders.
16.11Offer document content
The offer letter contains information/disclosures specified by SEBI. These generally refer to disclosures of the acquirer/PACs, target company, their financials, justification of the offer price, the offer price, number of shares to be acquired from the public, purpose of acquisition, future plans of acquirer, if any, regarding the target company, change in control over the target company, if any, the procedure to be followed by acquirer in accepting the shares tendered by the shareholders and the period within which all the formalities pertaining to the offer would be completed.
16.12Drafting of offer document
The offer is drafted and filed by the merchant banker, on behalf of the acquirer (Regulation 18(1)).
16.13Addresses of offer document
A letter of offer is addressed to the shareholders of the target company. However, its draft is also required to be sent to SEBI and the target company.
16.14Due diligence
There is no provision in the Regulations which either facilitates the flow of information from the offeree or restricts it. The supply of information by and conduct of due diligence of the target company are matters to be mutually decided by the offeror and the offeree. However, the merchant banker has to furnish a due diligence certificate to the board, along with the draft offer document ensuring compliance by the acquirer of provisions of the Regulations (Regulation 24).
16.15Conditions
As per Regulation 27, once made, a public offer cannot be withdrawn except in the following circumstances:
16.16Obligation of financing
Regulation 22 says that an acquirer should make a public announcement only when he is able to implement the offer. He is also required to ensure that firm financial arrangements have been made for the public offer (sub-regulation 11). He has also to create an escrow account before or on the date of the public offer (sub-regulation 10). The merchant banker is also obliged to ensure that the acquirer is able to implement the offer and that provision relating to the escrow account has been made (Regulation 24).
16.17Mixed consideration
Consideration can be mixed.
16.18Break-up fees
These are to be mutually agreed upon by the offeror and the offeree. The Regulations do not provide for such fees. We do not have a provision parallel to Rule 21.2 of the UK Code.
16.19Defence mechanisms
Regulation 23 forbids the board of directors of the target company to take any frustrating measures vizdisposing of or encumbering the assets of the target, issuing or allotting any voting security and entering into any material contract during the currency of the offer period, without the approval of the general body of the shareholders. However, under sub-regulation 4, the board of directors can send their unbiased comments and recommendations to the shareholders, keeping in mind their fiduciary responsibility to the latter.
16.20Nature of listed securities
The Companies Act does not permit the issue of bearer securities.
17 FOREIGN INVESTMENT CONTROLS
Foreign investment in India is governed by the Foreign Exchange and Management Act (FEMA) and circulars and regulations issued under it. FEMA authorises central government to take policy decisions on the question of permitting foreign investment on a sectoral basis. The government announces its policy via press notes issued by it. Annex to Press Note 4 of 2006 series has summarised foreign investment caps in different industrial sectors. The permitted investment can be as low as 26 per cent with prior Foreign Investment Promotion Board (FIPB) approval as in the case of defence production and as high as 100 per cent on automatic route in alcohol distillation and breweries.
The Reserve Bank of India also monitors foreign acquisition by Indian residents by issuing circulars from time to time.
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