This article on the ten fundamental principles of securities laws that every Indian businessman should know is written by Dheerajendra Patanjali, pursuing M.A. in business law from NUJS, Kolkata.

1)Introduction

The securities markets are vital to the growth, development and strength of market economies and the maturity of an economy is decided based on the robustness of securities market of an economy. Mature and well-regulated securities market not only supports corporate initiatives but also finance the exploitation of new ideas and facilitate the management of financial risk. Furthermore, since retail investors are placing an increasing proportion of their money in mutual funds and other collective investments, securities markets have become central to individual wealth.

Considering the importance of the securities market, it becomes very important for the players of the market to be fully aware of various laws and regulations governing the smooth operation and orderly movement of the market. Further, increasingly globalized and integrated financial markets pose significant challenges to the regulation of securities markets. Therefore, in a global and integrated environment, a market player must be in a position to assess the nature of permissible conduct if they wish to engage in the market.

The securities market is governed by various regulations enacted in the course of time by the competent legislative body and regulating bodies. It is important to note that authorities have been quite sensitive to requirements of the development of securities market, so much so that the decade, 1992-2003, witnessed nine special legislative interventions, including two new enactments, namely the Securities and Exchange Board of India (SEBI) Act, 1992 and the Depositories Act, 1996. The developmental need was so urgent at times, that a number of other legislations (the Income Tax Act, the Companies Act, the Indian Stamps Act, the Bankers’ Book Evidence Act, the Benami Transactions (Prohibition) Act etc.) having bearing on securities markets have been amended in the recent past to complement amendments in securities laws.

The legal reforms began with the enactment of the SEBI Act, 1992, which established SEBI with statutory responsibilities to (i) protect the interest of investors in securities, (ii) promote the development of the securities market, and (iii) regulate the securities market. This was followed by repeal of the Capital Issues (Control) Act, 1947 in 1992 which paved way for market-determined the allocation of resources. Then followed the Securities Laws (Amendment) Act in 1995, which extended SEBI’s jurisdiction over corporates in the issuance of capital and transfer of securities, in addition to all intermediaries and persons associated with the securities market.

In the course of time, through various amendments, market regulator SEBI has been given stronger teeth and wider power to properly regulate the smooth functioning of securities markets. And in turn, SEBI issued various rules, regulations and circulars to ensure securities market functions in an orderly manner.

In the era of plethora of legislations, rules, and regulations, a market player of securities market is supposed to know these rules and principles in good details as their compliance make his way smooth in securities’ market journey while violations leads to severe penalties. Taking cognizance of the above fact, the important securities laws, as applicable on the concerned, is discussed as under.

Further, the important principles applicable to market players can be seen from two perspectives –

a) Principles/Rules governing when they invest in the securities market,

1. KYC Requirements
2. Investor protections and grievance redressal

b) Principles governing when intend to receive public money from the market,

1. Public offer and debt securities issue and listing
2. Intermediaries  and their roles
3. Disclosure standard
4. Takeover regulations
5. Prohibition of insider trading and unfair trade practice
6. Delisting of securities
7. Corporate Governance
8. Grievance redressal mechanism

 

2) Principles/Rules governing when they invest in the securities market

   2.1 KYC Requirements

KYC is an acronym for “Know your Client”, a term commonly used for Client Identification Process. Market Regulator SEBI has prescribed certain requirements relating to KYC norms for Financial Institutions and Financial Intermediaries including Mutual Funds to ‘Know’ their Clients. This would be in the form of verification of identity and address, providing information of financial status, occupation and such other demographic information. Applicants must be KYC compliant while investing in the securities market.

However, clients may intend to open accounts with different SEBI registered intermediaries for the purpose of trading/investment in the securities market and have to undergo the process of Know Your Client (KYC) again and again. Therefore, to avoid duplication of KYC process with every intermediary, a mechanism for centralization of the KYC records in the securities market has been developed by SEBI.

The same is governed through SEBI (Know Your Client Registration Agency) Regulations, 2011. The regulations were notified for bringing uniformity in the KYC Requirements for the securities market and setting up a mechanism wherein one or more SEBI regulated KYC Registration Agency (KRA) shall undertake KYC for all clients in the securities market. The KRA system is intended to bring about uniformity in the KYC procedure across intermediaries and centralisation of the KYC records in the securities market. Once the client has undertaken KYC with a SEBI registered intermediary, he need not undergo the same process again when he approaches another intermediary.

Main features of the KRA Regulations include the following:

1. KRA to be wholly owned subsidiary of any of the stock exchanges having nationwide terminals, depositories, SROs or intermediaries.
2. Identification of the customer and collection of initial KYC documents shall be carried by KRA through Points of Service (PoS) which will be SEBI registered intermediaries.
3. KRA would perform its role for such intermediaries that choose to rely upon its KYC at the account opening stage.
4. In case of mutual funds, the Registrar and Transfer Agent (RTA) appointed by them can also do the initial KYC for their clients.
5. Registration will be granted to KRA in terms of the KRA Regulations.
6. Functions and obligations of the KRA and the intermediaries availing the KYC related services of the KRA have been broadly defined.
7. KRA will be responsible for storing and retrieving the KYC information pertaining to all the clients and disseminating any changes in the KYC information of the clients to all the intermediaries.

 

2.2 Investor protections and grievance redressal

Investor is the most important player of the securities market at the same time most vulnerable one. Considering the same and to protect the interest of the investor, which is the statutory mandate of SEBI, SEBI has been taking various measures to protect the interest of investor and expedite the redressal of investor grievances against the errant entities. The grievances lodged by investors are taken up with the respective listed company and are continuously monitored. The company is required to respond in prescribed format in the form of Action Taken Report (ATR). Upon the receipt of ATR, the status of grievances is updated. If the response of the company is insufficient / inadequate, follow up action is initiated. Grievances pertaining to stock brokers and depository participants are taken up with concerned stock exchange and depository for redressal and monitored by the concerned department through periodic report obtained from them. Grievances pertaining to other intermediaries are taken up with them directly for redressal and are continuously monitored by concerned department of SEBI. SEBI takes appropriate enforcement actions (adjudication, directions, prosecution etc.) as provided under the law where progress in redressal of investor grievances is not satisfactory.

 

3. Principles governing when a player intend to receive public money from the market

      3.1 Public offer and listing

Listing of securities with stock exchange is a matter of great importance for companies and investors because this provides the liquidity to the securities in the market. Listing is the admission of securities to dealings on a recognized stock exchange. For a company to be listed on a stock exchange, the company has to enter into a listing agreement with the respective stock exchange(s).

Only public companies are allowed to list their securities in the stock exchange. Private Limited companies cannot get listing facility. They should first convert themselves into public limited companies and their Articles of Association should also contain prohibitions as laid down in the listing agreement and as applicable to public limited companies.

Listing of Securities on Indian Stock Exchanges, thus, is governed by the provisions in the Companies Act, 2013, the Securities Contracts (Regulation) Act, 1956, the Securities Contracts (Regulation) Rules, 1957, Rules, bye-laws, regulations of concerned stock exchange, the listing agreement entered into by the issuer and stock exchange and circulars/guidelines issued by the Central Government and SEBI.

The Listing Regulations provide the broad principles (in line with the IOSCO Objectives and Principles of Securities Regulation) for periodic disclosures by listed entities and also incorporate the principles for corporate governance (in line with the G20/OECD Principles of Corporate Governance). Further, Stock exchanges have been given the responsibility of monitoring compliance or the adequacy/accuracy of compliance with the provisions of the Listing Regulations and to take action for non-compliance. All disclosures to be made on the website of the listed entity have been enumerated in a single place for ease of reference and all requirements pertaining to disclosures in the annual report have been combined. Existing listed entities are required to sign the new listing agreement within six months of the notification of the Listing Regulations.

      3.2 Intermediaries And Their Roles

The capital market intermediaries are vital link between investor, issuer and regulator. The objective of these intermediaries is to smoothen the process of investment and to establish a link between the investors and the users of funds. Corporations and Governments do not market their securities directly to the investors. Instead, they hire the services of the market intermediaries to represent them to the investors. Investors, particularly small investors, find it difficult to make direct investment. A small investor desiring to invest may not find a willing and desirable borrower. He may not be able to diversify across borrowers to reduce risk. He may not be equipped to assess and monitor the credit risk of borrowers. Market intermediaries help investors to select investments by providing investment consultancy, market analysis and credit rating of investment instruments. In order to operate in secondary market, the investors have to transact through share brokers. Registrars and Share Transfer Agents, Custodians and Depositories are capital market intermediaries that provide important infrastructure services for both primary and secondary markets. According to SEBI (Intermediaries) Regulations, 2008, “intermediary” means a person mentioned in clauses (b) and (ba) of sub-section (2) of section 11 and sub-section (1) and (1A) of section 12 of the Act and includes an asset management company in relation to the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, a clearing member of a clearing corporation or clearing house and a trading member of a derivative segment or currency derivatives segment of a stock exchange but does not include foreign institutional investor, foreign venture capital investor, mutual fund, collective investment scheme and venture capital fund.

 3.3 Disclosure standard

Transparency in the securities market enables market participants to have equal opportunities to receive relevant information to make informed decisions. Such transparency covers public dissemination of information through various disclosures. Greater transparency not only helps the market to fight fraud and manipulation, but it also improves market efficiency and investor protection.

In order to rationalise disclosure requirements for all issuers, whether intending to list on the main board or the institutional trading platform, it has been provided that all the relevant disclosures will be available on the issuer’s website. Also, product advertisements of an issuer will not be required to give the details of the public/ rights issue.

All material disclosures which are necessary for the subscribers of the debt securities to take an informed investment decision shall be disclosed, including promotor’s holdings. In the interest of investors, SEBI issued Disclosure and Investor Protection (DIP) guidelines. The guidelines allow issuers, complying with the eligibility criteria, to issue securities the securities at market determined rates. Because of such move, the market moved from merit-based to disclosure-based regulation.

Recently, SEBI has issued guidelines for the disclosure of ‘reasons for encumbrance’ on the shareholding of the promoters. For example, the reason may be for the purpose of collateral for the loans taken by the company, personal borrowing and a third party pledge. Henceforth, the ‘name of the entity in whose favour shares were encumbered’ will also contain the disclosure of the names of both the lender and the trustee who may hold the shares directly or on behalf of the lender.

  3.4 Takeover regulations

The existence of an efficient and smooth functioning market for takeovers plays an important role in the economic development of a country. When an “Acquirer” takes over the control of the “Target Company”, it is termed as Takeover. When an acquirer acquires “substantial quantity of shares or voting rights” of the Target Company, it results in substantial acquisition of shares.

Existence of an efficient and well-administered set of takeover regulations ensures that the takeover markets operate in a fair, equitable and transparent manner. Regulatory system ensures that the interests of the shareholders of listed companies are not compromised in case of an acquisition or takeover. It also protect the interests of minority shareholders, which is also a fundamental attribute of corporate governance principle. SEBI (Substantial Acquisitions of shares and Takeovers) Regulations, 2011.

SAST aims at protecting interest of the investors in securities of a listed company providing amongst others, an opportunity for the public shareholders to exit where there is a substantial acquisition of shares or voting rights or control over a listed company, consolidation of holdings by existing shareholders and related disclosures and penalties for non-compliance etc.. SAST requires an acquirer to make an offer to shareholders of the target company on acquiring shares exceeding stipulated thresholds. It also contains provisions relating to open offer size and price, time bound process for making an open offer, exemption from making an open offer, etc.

      3.5 Prohibition of insider trading and unfair trade practice

‘Insider trading’ is buying or selling a security, in breach of a fiduciary duty or other relationship of trust, and confidence, while in possession of material, non-public information about the security. Therefore, preventing such transactions is an important obligation for any capital market regulatory system, because insider trading undermines investor confidence in the fairness and integrity of the securities markets.

The concept of Insider Trading in India started fermenting in the 80’s and 90’s and came to be known and observed extensively in the Indian Securities market. However, due to inadequate provisions in the Companies Act, 1956 and rapidly advancing Indian Securities market needed a more comprehensive legislation to regulate the practice of Insider Trading, thus resulting in the formulation of the SEBI (Insider Trading) Regulations in the year 1992, which were amended further to be in tune with the devlopment.

Now a big step taken forward by introduction of the insider trading provisions in the Companies Act, 2013. As per the Companies Act, 2013 provisions it prohibits directors and key managerial personnel from purchasing call and put options of shares of the company, its holding company and its subsidiary and associate companies as if such person is reasonably expected to have access to price-sensitive information (being information which, if published, is likely to affect the price of the company’s securities).

SEBI has overhauled the entire framework for regulation of insider trading, which is seen to be a deep rooted problem in India, with a view to ensure a level-playing field in the securities market and to safeguard the interest of the investors.

Amendments were carried out to include disclosure requirements from promoters. These, inter alia, included disclosure of interest or holding in listed companies, the total number of shares or voting rights held and changes in shareholding or voting rights, if there has been a change in such holdings of such promoters.

     3.6  Delisting of securities

Corporates are now aiming at reducing costs, which do not have any returns. Payment of listing fees to the stock exchanges today is considered by some Companies as a burden because the companies feel that neither the shares are traded on the stock exchanges nor the exchanges provide any value added service to the companies. The Company has an option to delist any or all class of securities. 

Delisting’ denotes removal of the listing of the securities of a listed company from the Stock Exchange. Delisting differs from suspension or withdrawal of admission to dealing of listed securities, which is for a limited period.

A company may delist from stock exchange where its securities are listed. Provided that the securities of the company have been listed for a minimum period of 3 years on any stock exchange.

     3.7 Corporate Governance

“Corporate governance is an ethically driven business process that is committed to values aimed at enhancing an organization’s wealth generating capacity. This is ensured by taking ethical business decisions and conducting business with a firm commitment to values, while meeting stakeholders’ expectations” – N. R. Narayana Murthy

Corporations pool capital from a large investor base both in the domestic and in the international capital markets. In this context, investment is ultimately an act of faith in the ability of a corporation’s management. When an investor invests money in a corporation, he expects the board and the management to act as trustees and ensure the safety of the capital and also earn a rate of return that is higher than the cost of capital. In this regard, investors expect management to act in their best interests at all times and adopt good corporate governance practices.  Corporate governance is the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal and corporate funds in the management of a company

Corporate governance is an ethically driven business process that is committed to values aimed at enhancing an organization’s wealth generating capacity. This is ensured by taking ethical business decisions and conducting business with a firm commitment to values, while meeting stakeholders’ expectations.  Corporate governance framework ensures effective engagement with stakeholders and helps evolve with changing times. Furthermore, an active, well-informed and independent board is necessary to ensure the highest standards of corporate governance. Availability of such mechanism will not only improves transparency in corporate working culture but also instils confidence of investor

     3.8 Grievance redressal mechanism

Market regulator SEBI, which has got statutory mandate to regulate and promote the securities market, passes various orders, penalties against the market players. These orders affect the players in many ways. However, sometimes, the stand of regulator requires further scrutiny and for this purpose, a statutory body known as Securities Appellate Tribunal was formed. This tribunal is formed especially for the grievances faced by the orders of the SEBI or the other adjudicating authorities.

Thus, Securities Appellate Tribunal is a statutory body established under the provisions of Section 15K of the Securities and Exchange Board of India Act, 1992 to hear and dispose of appeals against orders passed by the Securities and Exchange Board of India or by an adjudicating officer under the Act and to exercise jurisdiction, powers and authority conferred on the Tribunal by or under this Act or any other law for the time being in force. Moreover, though recent amendment, the jurisdiction of Tribunal has been expanded and it now hears appeal not only against the decision of SEBI but also against other functionaries. The appeal against the order of SAT directly lies before Supreme Court.

Further, inter-se grievances of players are resolved through the various mechanism available in our existing legal framework, however most differences are shorted out though ADR mechanism.

Conclusion

Stock Market plays a significant role in development of Economy. Stock Market facilitates mobilization of funds from small investors and channelizes these resources into various development needs of various sectors of the economy. In order to prevent undesirable transactions in securities by regulating the business of dealing therein, and to maintain orderly movement of the Securities Market various legislations, rules and regulations have been passed by legislatures, market regulator SEBI and respective stock exchanges.

A player of the securities market is required to understand the basic principles of securities laws to smoothly sail the ship in the securities market. A good knowledge of these laws, rules and regulations not only protect the interest of the player, be it an investor or an entity engaged in getting investment, but also ensures a well directed transparent and robust growth of securities market leading to development of the overall economy.