What now for the SEBI after Ordinance lapse?

DeekshaSinghIn July and September last year, the Securities Laws (Amendment) Ordinance, 2013 (“the Ordinance”) was promulgated to amend three key components of the securities law statutory framework—the Securities and Exchange Board of India Act, 1992, the Securities Contracts (Regulation) Act, 1956, and the Depositories Act, 1996.

The Ordinance was expected to enable the Securities and Exchange Board of India (“SEBI”) to effectively enforce the existing statutory and regulatory framework. We have discussed the provisions of the Ordinance here and here.

Despite being promulgated twice however, the Ordinance lapsed earlier this month and now cannot be reissued. What does this mean for the SEBI?

Diminished powers

Sections 10, 15, and 21 of the Ordinance had enhanced the power of the SEBI to take strict action against defaulters, including:

– attachment and sale of movable property;

– attachment of bank accounts;

– attachment and sale of  immovable property;

– arrest and detention in prison; and

– appointing a receiver for the management of the movable and immovable properties.

New-Programme-LaunchExercising the new powers it had been seeking for a long time, the regulator passed over 300 attachment orders for recovering close to Rupees 1,700 crore from defaulters. The lapsing of the Ordinance will not affect these orders, as they were made while the Ordinance was still in effect. However, the SEBI cannot pass such orders any longer even for defaults that may have occurred while the Ordinance was still in effect. While SEBI can adjudicate and declare fines and penalties against defaulters, they can no longer proceed against the property of defaulters or carry out arrests for non-compliance with orders.

New regulations

The Ordinance gave additional powers to the SEBI including the power to conduct search and seizure of persons and premises. The SEBI could also call for information and records relevant for information, including telephone call data records. Pursuant to the establishment of these new powers, the SEBI had, earlier this month, also issued the SEBI (Procedure for Search and Seizure) Regulations, 2014. Naturally, now that the SEBI no longer has the powers of search and seizure (more about those powers here), these regulations are no longer relevant.

At the same time that the search and seizure regulations were issued, SEBI had also issued the SEBI (Settlement of Administrative and Civil Proceedings) Regulations, 2014. These regulations established a proper procedure for cases involving settlement, including eligibility for settlement, application and so on. The SEBI Chief has expressed the view that the settlement regulations mentioned above were issued while the Ordinance was in effect, and therefore, they continue to have the force of law.

My view is that while the SEBI Chief may be right about any settlements made under the regulations while the Ordinance was still in effect, the argument cannot be extended to mean that the SEBI has the power to issue settlement orders under the regulations now. The Preamble to the regulations clearly states:

In exercise of the powers conferred by section 15JB of the Securities and Exchange Board of India Act, 1992, section 23JA of the Securities Contracts (Regulation) Act, 1956 and section 19-IA of the Depositories Act, 1996 read with section 30 of the Securities and Exchange Board of India Act, 1992, section 31 of the Securities Contracts (Regulation) Act, 1956 and section 25 of the Depositories Act, 1996, the Securities and Exchange Board of India hereby makes the following regulations to provide for the terms of settlement and the procedure of settlement and matters connected therewith or incidental thereto, namely:

The sections mentioned in the initial part of the Preamble were all inserted by the Ordinance, and since the Ordinance has now lapsed, these regulations cannot be made applicable to proceedings against defaulters. The SEBI should issue a revised set of regulations for now, without making reference to the amended sections introduced by the Ordinance.

The lapsing of this Ordinance is a setback to the growth of the SEBI, which had been armed to cope with the large number of securities laws defaulters in our country. We can only hope that the positive effects of this Ordinance are not rendered meaningless and that an amendment is enacted giving the SEBI the necessary powers to effectively regulate our markets.

(Deeksha Singh is part of the faculty on


SEBI officers should be trained in conducting legal searches

DeekshaSinghThe Securities and Exchange Board of India (“SEBI”) now has new powers of search, seizure, arrest, detention, and attachment of property. This followed the promulgation of the Securities Law (Amendment) Ordinance, 2013 and the securities regulator has turned to the Income Tax (“IT”) department for help in training its officers in the exercise of these powers. For a detailed analysis of these powers, see this link.

Jurisprudential background

The powers of search, seizure, arrest, and detention — whether exercised by civil authorities like the IT department or the police — are intrinsically linked to certain basic human rights. In particular, Articles 19 and 21 of the Constitution of India, 1950, have been interpreted, in a number of cases, to be directly linked to the right to due process of law.

In Kishore Singh Ravinder Dev v. State of Rajashthan, AIR 1981 SC 625 — a landmark judgment regarding the rights of accused persons — the Supreme Court highlighted the necessity of ensuring that the constitutional, evidentiary, and procedural laws of our country protect the dignity of the accused as a human being and grant him the benefits of a just and fair trial.

Specifically with reference to procedure, in Maneka Gandhi v. Union of India, AIR 1978 SC 597, the Supreme Court underlined that the state must follow just, fair, and reasonable procedure.

While these principles, of course, form the backbone of criminal procedure, they are equally applicable to procedures for arrests, search, and seizure followed by civil authorities like the IT department and now, the SEBI.

In this post, we will discuss some key principles relating to the search and seizure powers of the IT department that are dealt with in Section 132 of the Income Tax Act, 1961. These principles should apply equally to the SEBI.

Basis of search and seizure

For an assessing officer to conduct a legal search and seizure process, that assessing officer should have information about undisclosed amounts of money and reasonably believe that that person is likely to suppress books of accounts and other relevant documents.

In Commissioner of Income Tax v. Ramesh Chander, (1974) 93 ITR 450 (Pun.), the Punjab and Haryana High Court held that the condition precedent for authorising a search and seizure is that the assessing officer must have reason to believe the necessity of carrying out such a search and seizure. The power can be exercised only if this condition is fulfilled.

On the same lines, a search and seizure operation by the SEBI, which would mostly occur — one would imagine — in insider trading cases, should be backed by a demonstrable belief on the part of the authorising officer that such an operation is, in fact, necessary.

Use of material from illegal searches

An interesting principle applicable to searches conducted by the IT department is that if a search is rendered illegal on a technicality, it will not result in the material obtained from such a search being excluded for the purposes of ordinary assessment.

Binoculars_search_seizureIn Pooran Mal Etc. v. Director of Inspection (Investigation), Income Tax, 1974 AIR 348, the Supreme Court held that materials obtained during an illegally or irregularly conducted search or seizure can be utilised for the purpose of an ordinary assessment. In this case, the Court upheld the validity of the provisions of Section 132. Further, on admissibility of evidence, it stated:

Courts in India and in England have consistently refused to exclude relevant evidence merely on the ground that it is obtained by illegal search or seizure. Where the test of admissibility of evidence lies in relevancy, unless there is an express or implied prohibition in the Constitution or other law, evidence obtained as a result of illegal search or seizure is not liable to be shut out.

This case was examined in later cases relating to admissibility of evidence obtained through illegal search, and the Supreme Court in State of Punjab v. Baldev Singh expressed a nuanced opinion of the decision in the Pooran Mal Case.

[T]he judgment in Pooran Mal’s case cannot be understood to have laid down that an illicit article seized during a search of a person, on prior information, conducted in violation of the provisions of Section 50 of the Act, can by itself be used as evidence of unlawful possession of the illicit article on the person from whom the contraband has been seized during the illegal search”.

We can conclude therefore, that while evidence will be admissible if there is an illegality during the search process, evidence obtained during the search can be rendered inadmissible if an illegality occurs at the threshold of the search.

While the same principles may apply to searches conducted by the SEBI, SEBI officers should still be trained in conducting legal searches. Given that these powers have been granted to expedite action by the SEBI in cases involving fraud, insider trading, and other serious violations, it is important that the SEBI does not allow proceedings to be stalled owing to technical flaws in process.

We should note that the principles mentioned above evolved over time through various decisions related to the IT department and stem from the language and intent behind Section 132 of the Income Tax Act, 1961. It still remains to be seen whether the provisions of the Securities Law (Amendment) Ordinance, 2013 will find their way into a statute and what principles will govern the SEBI’s exercise of its newfound powers.

(Deeksha Singh is part of the faculty on


REITs need to take concerns about India’s real estate sector into account

DeekshaSinghSome days ago, the Securities and Exchange Board of India (“SEBI”) issued a Consultation Paper on the Draft SEBI (Real Estate Investment Trusts) Regulations, 2013 (“Draft Regulations”). The SEBI had first issued draft regulations relating to setting up of REITs in 2008. Now with the current proposal, it is looking to provide impetus to the real estate sector.

REITs were created in 1960 in the United States to give investors the opportunity to invest in the real estate sector, which is a high-yield sector, using liquid securities. This allowed them to access this sector in the same way that they would invest in other asset classes. There are different types of REITs, classified on the basis of their investment strategy.

What_are_REITsThe Draft Regulations envisage trusts registered with the SEBI that invest in real estate assets, being operated by a manager, appointed by the trustee. They can invest in properties directly or through special purpose vehicles, but only in assets based in India. The Draft Regulations also specify the manner in which the units by the REITs can be issued and listed. You can read more about the proposed structure and guidelines for the kind of REITs that SEBI will permit in India, here.

A reading of the Draft Regulations indicates that the SEBI has given due importance to transparency to ensure that investors can invest through these vehicles with a complete picture of the risks and rewards involved. However, even if it enacts these Draft Regulations, both Real Estate Investment Trusts (“REITs”) and investors will need to take into account some of the concerns plaguing the Indian real estate sector.

Foremost amongst these is the lack of clear title in most real estate transactions in India. Before investors can be brought in to invest in these real estate assets, REITs will need to ensure that sound due diligence is conducted on each of these assets.

Grading system?

Securities-LawA possible solution lies in the implementation of a grading system. The assets that form part of a REIT’s corpus must be mandatorily graded before it can issue and list units. This system should not only take care of the valuation of assets, but also be used to establish a clear and marketable title. These assets should only be deemed investment-grade if these stringent requirements are satisfied. Thus, while there will be no reduction of the obligation on investors to go through the disclosures carefully before investing, a grading system will help ensure that issues specific to the real estate sector in India are taken into account.

The SEBI will need to revise the Draft Regulations to provide mechanisms to account for issues specific to the real estate sector in India. The Draft Regulations are open for comments from the public till October 31, 2013.

(Deeksha Singh is part of the faculty on


Put and call options: New legitimacy but doubts remain

DeepaMookerjee.jpgIn what is being termed as an “investor friendly” move, the Securities and Exchange Board of India (“SEBI”), permitted put and call options in shareholders agreements through a notification dated October 3, 2013. It appears that it will help clear up some of the ambiguity regarding the validity of these options under Indian law.

Simply, a “call option” is a right but not an obligation to purchase shares at a specified price, on the happening of a specified event. Assume that there are two investors — A and B — in a joint venture company. A has a call option over twenty-six per cent shares held by B, which he can exercise once the foreign direct investment (“FDI”) cap is raised. This means that once the FDI cap is raised, A has a right to purchase twenty-six per cent shares from B. If A exercises this right, B cannot decline to sell the shares to A.

A “put option” on the other hand, is a right but not an obligation to sell shares upon the occurrence of a specified event at a specified price. Here, assume that A has a put option over twenty-six per cent of his own shares in the company. A can exercise this option once the company is insolvent. If the company declares insolvency, A can sell his shares to B. Once A exercises his put option, B cannot decline to purchase A’s shares.

Historically, put and call options, along with other rights such as pre-emption rights and right of first refusal have been the subject of much controversy in India.

Prohibition under company law

Section 111A of the Companies Act, 1956 stated that shares of all public companies were freely transferable. Hence, any restriction on the transfer of shares (including options in shares) would be illegal. Since, put options and call options restricted a person’s right to transfer shares, such options were illegal. Based on this, some market players took the view that even though these options were prohibited in a public company, private companies were free to incorporate such conditions.

This issue has been put to rest in the Companies Act, 2013, which states in the proviso to Section 58(2) that any contract or arrangement between two or more persons in respect of the transfer of shares will be enforceable. Though there has been no formal explanation for its insertion, one could argue that the proviso recognises shareholders’ competence to contract. It appears therefore, that this proviso lends legal sanctity to put and call options, which are essentially agreements for the transfer of shares between shareholders.

Prohibition under securities law

The Securities Contracts (Regulation) Act, 1956 (“SCRA”) and the Securities and Exchange Board of India (“SEBI”) are the next set of roadblocks to these options. This is because, the SEBI had issued a notification in 2000, which provided that no person can enter into any contract for the sale or purchase of securities other than spot delivery contracts (Section 18, SCRA) or permissible contracts in derivatives. A “spot delivery” contract is one where the delivery and payment of shares takes place on the same or following day. (For a more detailed understanding of the development of the law, please look at Investment Agreements in India: Is there an “Option?”)

Through a number of decisions (the Cairn Vedanta case and the Vulcan case), the SEBI reiterated its view that call and put options were prohibited because:

  • they were not valid derivative contracts that can only be traded on a stock exchange (Section 18A, SCRA); and
  • put or call options give parties the right to trade on shares at a future date which makes it an invalid “spot-delivery” contract under Section 2 (i) of the SCRA.

Contingent contracts and the Bombay High Court

Securities-LawMoreover, the Bombay High Court in Niskalp Investments held that a clause permitting the buy back of shares if certain conditions were not met would be hit by the restriction in relation to spot delivery contracts. Contingent contracts were also therefore, hit by prohibitions on spot delivery contracts. One can argue that call and put options are contingent contracts that come into effect once they are exercised. Once exercised, the delivery of shares and payment can take place simultaneously. These clauses therefore, are not invalid spot-delivery contracts. This position gained legal backing in MCX Exchange, where it was held that options come into existence only once the option is exercised. Till such exercise, the option is not fructified and therefore not hit by the prohibition. From all this, it was clear that there was much judicial debate on this issue. No clear answer was emerging.

In its recent notification, the SEBI has permitted options in shares and rescinded its 2000 notification. Put and call options are now permitted provided the seller owned the “underlying securities” for at least one year from the date of the contract, the transfer is priced according to existing laws, and the underlying securities are delivered. This puts the controversy to rest as far as SEBI is concerned, to a certain extent.

The RBI’s view

The Reserve Bank of India (“RBI”) had also expressed doubts on put and call options. It felt that granting put options to non-resident investors was akin to a debt investment made by such an investor. This is because an investment backed by a put option meant that the non-resident was guaranteed a specific rate of return. Such a transaction would therefore need to comply with the External Commercial Borrowing (“ECB”) Regulations. In fact, the Consolidated FDI Policy of October 1, 2011 contained a provision that stated that equity instruments issued or transferred to non-residents having in-built options or supported by options sold by third parties would lose their equity character and such instruments would have to comply with the extant ECB guidelines.

Interestingly however, this statement was later deleted from the policy by a notification issued by the Foreign Investment Promotion Board. This led to further confusion. Did the withdrawal mean that the RBI had implicitly permitted these transactions or that it was simply a withdrawal due to public pressure? The RBI has not clarified matters and this confusion still exists. Therefore, even though listed companies may get the go ahead from the SEBI, the RBI may still be a roadblock.

The Bombay High Court, the RBI, the SEBI, and the Ministry of Corporate Affairs have all made their views on put and call options heard.
The Bombay High Court, the RBI, the SEBI, and the Ministry of Corporate Affairs have all made their views on put and call options heard.

To conclude therefore, the SEBI Notification has not put the controversy to rest. Since the SEBI Circular is only prospective, it only protects investments from October 3, 2013. Clarity is still required on the treatment of those arrangements entered into prior to October 3, 2013. Will those clauses be void?

Till these final issues are put to rest, the question mark still remains over the validity of put and call options.

(Deepa Mookerjee is part of the faculty on



Companies Bill – Of public offers and private companies

The inclusion of two definitions — “private company” and “listed company” — in the Companies Bill, 2012 (“Bill”) raises some questions. Our current understanding of company law suggests that the two terms cannot apply to the same company at the same time. Let us see how the Bill has changed that.

Private company

Under Section 3(1)(iii) of the Companies Act, 1956 (“Act”), a “private company” cannot have more than fifty members. The definition in Clause 2(68) of the Bill says a “private company”:

… means a company having a minimum paid-up share capital of one lakh rupees or such higher paid-up share capital as may be prescribed, and which by its articles,—

(i) restricts the right to transfer its shares;

(ii) except in case of One Person Company, limits the number of its members to two hundred…

So the Bill has proposed that the limit on the maximum number of members that can constitute a private company be increased from fifty to 200.

When is a public offer necessary?

There is a problem when this proposal is read with Clause 42 of the Bill. Clause 42 is part of Chapter III, which deals with the allotment of securities by companies and features in Part II of Chapter III, where private placement is discussed. It states that:

42. (1) Without prejudice to the provisions of section 26, a company may, subject to the provisions of this section, make private placement through issued of a private placement offer letter.

(2) Subject to sub-section (1), the offer of securities or invitation to subscribe securities, shall be made to such number of persons not exceeding fifty or such higher number as may be prescribed, [excluding qualified institutional buyers and employees of the company being offered securities under a scheme of employees stock option as per provisions of clause (b) of sub-section (1) of section 62], in a financial year and on such conditions (including the form and manner of private placement) as may be prescribed.

Explanation I. – If a company, listed or unlisted, makes an offer to allot or invites subscription, or allots, or enters into an agreement to allot, securities to more than the prescribed number of persons, whether the payment for the securities has been received or not or whether the company intends to list its securities or not on any recognised stock exchange in or outside India, the same shall be deemed to be an offer to the public and shall accordingly be governed by the provisions of Part I of this Chapter.

Publicoffer_PrivateCompanyClause 42(2) will therefore create a contradiction when it becomes law. Private companies are permitted to have more than fifty members but any offer to more than fifty people will amount to a public offer and trigger all the requirements to be fulfilled under Part I of Chapter III of the Bill, which deals with public offers.

Listed company

Another question arises when we consider the definition of “listed companies” in the Bill. Currently, Section 2(23A) of the Act defines the term “listed public companies”. The Bill, however, defines the term “listed company” in Clause 2(52), thus proposing an increase in the scope of the current definition. The new definition is not limited to public companies and includes any company that has any securities listed on a recognised stock exchange.

Securities-LawThe proposed change will impact companies that have so far listed securities like debentures without technically falling within the ambit of the definition of “listed public companies”. Additionally, where such companies are private companies and have offered these securities to more than fifty people, it will be difficult to determine how they are to be treated under the proposals of the Bill.

The proposed definitions therefore, can create a dichotomy in the law — a company can be a private company and still be forced to make a public offer, while remaining a private company under the provisions of the same law. Until this position is clarified, it remains to be seen how securities lawyers and companies issuing securities will tackle it once the bill is notified.

(Deeksha Singh is part of the faculty on