NATIONAL LAW INSTITUTE UNIVERSITY,

BHOPAL

CAPITAL MARKETS AND SECURITIES

TRIMESTER- IX

REGULATORY FRAMEWORK FOR INVESTOR

PROTECTION:
A STUDY OF LEGAL ISSUES WITH SPECIAL FOCUS
ON THE ROLE OF SEBI

SUBMITTED TO – SUBMITTED BY –
ASST. PROF. PADMA SINGH Harsh Sahu
2017BALLB88
 SYNOPSIS

Brief introduction: Corporations have long been recognized as a social

organization,1 with their activities having far-reaching impacts on the economy
and polity of the nation- state. An important part of this theorization stems from
the fact that several influential and large companies derive the majority of their
funding from the public, through investors in the securities markets. The
regulation of corporate finance through the regulation of the securities markets
thus attains immense importance in safeguarding public money. An investor’s
confidence in the protection of her investment against fraud, or in the optimal
utilization of her investment, is the backbone of the functioning of the securities
markets.

Statement of problem: What are the various laws in the SEBI regulations
protecting the interests of investors in India.

Objectives of study: The objective behind this paper is to evaluate how well the
regulatory framework functions with respect to its stated purpose of investor
protection in India. Thus, the investors shall be deemed to be the primary
stakeholders in this enterprise. The researchers shall also be inclined to suggested
reforms where it appears to be necessary to improve the functioning of this
framework with regard to investor protection.

Aims of study: The aim of this paper is to attempt to understand the regulatory
framework set out especially under the Securities and Exchange Board of India for
investor protection and, to a limited extent, under the Companies Act. Particular
attention shall be paid to initial public offerings, private placements, and listing
and pricing mechanisms. The goal of this exercise shall be to examine the
framework in the backdrop of the history and jurisprudential issues of the
securities markets to evaluate its functioning.

Scope and Limitations: The scope of this paper is limited to the regulatory
framework set out under SEBI and the Companies Act, wherever necessary. The
paper is limited to evaluating the functioning of SEBI in so far as it deals with
investor protection alone, and the interests of other parties, such as issuers,
merchant banks and other third parties shall not be dealt with extensively.
Further, the paper is limited to offerings and related areas such as listing of
companies and pricing of securities, and does not focus on the adjudicatory and
educational functions that SEBI exercises.

Research questions:

1. Why is investor protection necessary? What are the jurisprudential issues

arising from the same?
2. What are the functions of SEBI? How has SEBI evolved with respect to
changing conditions in the Indian securities markets?
3. How is the securities market regulated under the Companies Act? How do
these provisions interact with the regulatory framework outlined under
SEBI?
 4. How does the process of IPO function? What are some of the main
challenges to investor protection in this area?
5. How does the process of private placement function? What are the
challenges to investor protection in this area and how are they dealt with?
6. How does the process of listing function? What are some of the main
challenges to investor protection in this area?
7. How does pricing of securities function? What are some of the main
challenges to investor protection in this area?
8. What is the economic impact of the present framework? Is it effective in its
stated goal of investor protection? Is investor protection even desirable?

Tentative chapterisation:

(i) Introduction
(ii) Investor Protection in India: A History of the Regulatory Framework
under SEBI
(iii) Landmark judgements elucidating investor protection
(iv) Measures taken for the benefit of investors
(v) A Cost-Utility analysis of SEBI’s Regulatory Framework

Scope: Scope of the project is limited to the Regulations of Securities and

Exchange Board of India. These regulations are only applicable for securities in
India.

Methodology: The paper involves an assessment of the various regulatory

frameworks under SEBI in terms of their functioning. Economic theory plays an
important role in evaluating the effectiveness of the same, and has been judicially
used by the researchers. The paper first attempts to understand the need for
investor protection and the nuances and history of the SEBI framework and Indian
securities markets. It then goes on to examine specific provisions on initial public
offerings, private placements, pricing and listing to evaluate their
functioning. In the ensuing analysis, the interests of investors have always been
foregrounded in assessing the utility or redundancy of the particular provision
under consideration. However, in assessing the system, Amar Bhide’s theory of
hidden costs has also been employed to ensure that risk remains at an optimal
level. Reforms to the system have also been suggested wherever found appropriate
by the researchers.

Literature review:

 SEBI and the Regulatory Framework by Srinivas Tapadia

The Book Covers Guidelines Issued By SEBI And Governing Issues Of Securities
By Corporates And Regulations Issued By SEBI And Relating To Merchant
Bankers, Stockbrokers And Sub-Brokers, Debenture Trustees, Portfolio
Managers, Mutual Funds.

 Investors protection in the Indian Capital Market by Jayashree Mehta

The Indian Capital Market is at a tipping point. Instances of fraud, scams
and mismanagement in India have resulted in erosion of confidence of small
investors. The role of capital market regulators assumes even more
significance. This study begins by tracing the genesis and growth of the
Indian Capital Market. There are several questions presently facing the
Indian Capital Market. This book aims to answer several of these questions
relating to the provisions which are relevant to the investors in the Indian
Stock Market.
Investor Protection in
India

TABLE OF CONTENTS

Table of Contents

2 Introduction

I. Need for Investor Protection: A Jurisprudential Outlook

Nature of shares
7
Separation of Ownership and Management
8
Investor Protection and Economic Development

10

II. Investor Protection in India: A History of the Regulatory Framework

Under SEBI
10
Securities and Exchange Board of India

11 Establishment and Functions 11

The Harshad Mehta Scam and the Securities Law (Amendment) Act, 1995
12 The Ketan Parekh Scam and the SEBI (Amendment) Act, 2002
13 The Securities Law (Amendment) Ordinance, 2013 and the Securities Law
(Amendment) Act, 2014
15 SEBI’s Role as an Investor Protector and Discretionary Powers
16
Landmark Decisions Elucidating on Investor Protection 17
Minimum Shareholding in a Listed Company 17
Disclosure of ‘material information’ 18
Measures taken for the benefit of investors 19
No exemption for former employees as ESOP Holder under Regulation 26(5)(b),
ICDR Regulations, 2009

19 Reduction of capitalization requirement for fast track issue 19

2
Investor Protection in
India

Limitations on the Objects 20

Minimum Promoters Contribution 20
Extent of Disclosure for Advertisement under Regulation 60 20

Conclusion: A Cost-Benefit-Utility Analysis of SEBI’s Regulatory Framework

22 Bibliography

24

3
 INTRODUCTION

Corporations have long been recognized as a social organization,1 with their

activities having far-reaching impacts on the economy and polity of the
nation- state. An important part of this theorization stems from the fact
that several influential and large companies derive the majority of their
funding from the public, through investors in the securities markets. The
separation of ownership, financing and management means that shareholders
have little practical control over the use of their investments – something
that is exacerbated in instances where scattered shareholding becomes
rampant.

The regulation of corporate finance through the regulation of the securities

markets thus attains immense importance in safeguarding public money. An
investor’s confidence in the protection of her investment against fraud, or in
the optimal utilization of her investment, is the backbone of the functioning of
the securities markets. While ordinarily market forces and self-interest ought
to be sufficient to protect the investor from manipulations in the market,
there exists a considerable amount of information asymmetry between
companies and investors. In the face of this information asymmetry, additional
external control by third parties is required to ensure effective investor
protection.

The Indian capital market is largely regulated by the Securities and Exchange
Board of India (SEBI) with respect to publicly listed companies on recognized
stock exchanges. Unlisted companies continue to be governed by provisions
under the Companies Act with regard to several aspects of obtaining public
financing. Although this parallel framework shall be dealt with incidentally, the
paper shall be focusing on the framework set out under SEBI for investor
protection.

SEBI began as a body with advisory powers and no practical means of

enforcing its recommendations. Over time, it has evolved to encompass more
powers and functions. As it approaches its 25th year of existence, it becomes
crucial to review its functioning as the key gatekeeper and regulator of the
1
A. A. Berle and G. Means, THE MODERN CORPORATION AND PRIVATE PROPERTY (1932).
Indian securities and capital markets since their liberalization from the
Capital Commission of India in 1992. It is for this reason that the researchers
have set forth to write this paper.

In this paper, we shall delve into the functioning of the regulatory

framework for the securities market – under SEBI and the Companies Act –
along with a focus on SEBI and the role of investor protection. The goal of
this exercise shall be to examine the framework in the backdrop of the
history and jurisprudential issues of the securities markets to evaluate its
functioning. The researchers also make a few suggestions for reform in this
paper to ensure optimal protection of investors’ interests, bearing in mind the
differing needs of retail and institutional investors.
I. NEED FOR INVESTOR PROTECTION: A JURISPRUDENTIAL OUTLOOK

Investor protection regulations by market regulator authority are considered

as one of the important aspects of corporate governance. In the era of
capitalism dominated by the idea of freedom contract, it is presumed that
market takes care of itself. Advocates of Law and Economics School, who
often believe in the rationality of the investors are of the opinion that
management of a company will take care of the interest of investors as losing
the investor’s confidence will cost them economically and will adversely affect
their remuneration which depends on the profits and goodwill of the
company.2 However, in practical life does not function on the presumption of
rationality and taking into account human nature special regulations
protecting investor’s interest need to be enforced. In this chapter
researcher explains and analyzes the reasons behind the need for the special
kind of protection given to the investors even in the era of capitalism.

NATURE OF SHARES

The most important reason for the investment protection is the inherent
difference in the nature of property owned by the shareholder. As per
Section 44 of Companies Act, 2013 and corresponding Section 82 of
Companies Act, 1956 shares are ‘movable property’.3 However the nature
of this property is completely different from any other kind of movable
property.
A share has been defined as
“[T]he interest of a shareholder in the company
measured by sum of money for the purpose of liability
in the first place, and of interest in the second, but
also consisting series of mutual covenants entered into
by all the shareholders inter se.”4

2
Rafael La Porta, Investor Protection and Corporate Valuation, 57(3) THE JOURNAL OF
FINANCE 1147, (June, 2002).
3
Section 44, Companies Act, 2013 states that,“The shares or debentures or other interest of
any member in a company shall be movable property transferable in the manner provided by
the articles of the company.”
4
Borland’s Trustee v. Steel Brothers, (1901) 1 Ch. 279.
Unlike the owner of any other movable property, shareholder of the share
does not have right to possession and right to use the shares.

SEPARATION OF OWNERSHIP AND MANAGEMENT

Thus, the central idea of the working of the company is the division of
ownership and the management of the company.5 Thus, the capital provided
by the shareholders in form of shares, which is a property of the shareholder
is entrusted to management of the company, which is in the hands of Board
of Directors. By virtue of Section 179(1) of Companies Act, 2013, it is the
Board of Directors that has the managerial powers of the company.6

Without the presence of countervailing incentives, it is likely that

managers, promoters and controlling shareholders will attempt to manipulate
their control over the company's resources to their own advantage and to the
detriment of minority shareholders. Even though it is conceivable that
private contracting could help in reducing the scope of this agency problem
(via incentive-based compensation and various corporate governance
mechanisms), regulation may help restrain managerial opportunism.7

In big corporations thousands of people hold shares and generally these

investors are scattered and passive. Though they have ownership, they lack in
control. On the other hand, management does not have ownership but it has
control. In such a scenario investor protection is quintessential because in
many countries expropriation of minority shareholders and creditors by the
majority shareholders is extensive.8 When outsiders provide finance to the

firms,
5
Marco Pagano and Paolo Malpin, ‘Alfred Marshall Lecture: Shareholder Protection,
Stock Market Development and Politics, 4(2) JOURNAL OF EUROPEAN ECONOMIC ASSOCIATION
315, (May, 2006).
6
Section 179, Companies Act, 2013 states that,
“The Board of Directors of a company shall be entitled to exercise all such powers, and to do
all such acts and things, as the company is authorised to exercise and do:
Provided that in exercising such power or doing such act or thing, the Board shall be subject
to the provisions contained in that behalf in this Act, or in the memorandum orarticles, or in
any regulations not inconsistent therewith and duly made thereunder, including regulations
made by the company in general meeting.”
7
Pagano, supra note 10.
8
Sealy’s Cases and Materials in Company Law, 458 (9th edn., 2010).
their decision could possibly result in the non-materialization of returns on
their investments as the majority expropriates them. In some cases the
insiders sell the output, the assets, or the additional securities in the firm
they control to another firm they own at below market prices. Such
transfer pricing, asset stripping, and investor dilution, though often legal, have
largely the same effect as theft.9

In such a situation in order to prevent management from distorting with the

property of the shareholder, it becomes important to give protection to
investors to empower them against the tyranny of the management. This
aspect of investor protection in capital markets is closely related to
consumer law. It has dual objectives, firstly, to ensure that the prices of
publically traded securities are reasonably well-informed and secondly, to
ensure that the public shareholders are protected by effective corporate
governance institutions once they invest in public shares.10

Another reason why we need separate legislation for investor protection

instead of separate contracts is that shareholders have residual rights.
Moreover, they do not necessarily receive a fixed amount by way of
dividend. Thus, their 'contract' with the company is highly incomplete, as it
does not specify a date for repayment of their investment, nor does it promise
a rate of return on their dividends. On the surface, this apparent
uncertainly appears to leave them vulnerable to the machinations of other
stakeholders and the management. In contrast, other stakeholders have a
primary concern with their individual transactions with the firm, which are
usually well defined and enforced through contract law; normally they are
not and need not be dependent on the institutions of corporate governance.11

This is uncontrolled power given to the management of the company has

resulted in the depression of the 1930's when speculative abuse in the
9
Rafael La Porta, Investor Protection : Origin, Consequences, Reforms 7 (Working
paper No.7428, National Bureau of Economic Research, 1999).
10
Rainier Kraakman et al, THE ANATOMY OF CORPORATE LAW, 198 (2004).
11
Theodor Baums and Kenneth E. Scott, Taking Shareholder Protection Seriously? Corporate
Governance in the United States and Germany, 53(1) T HE AMERICAN JOURNAL OF COMPARATIVE LAW
31, (December, 2005).
corporate system became manifest. The marketplace had not provided
adequate control for our free enterprise-expanding society. Because abuse
was rampant, regulation was required for the protection of the market
itself.12

INVESTOR PROTECTION AND ECONOMIC DEVELOPMENT

Besides the economic stability, investors’ protection is important in long run

because, investors invest capital in the company, in case they are not properly
protected, it is unlikely that they would be willing to finance the companies.
Protection from expropriation incentivizes investors to pay more for securities,
which in turn has the effect of making it a more attractive option for
entrepreneurs to issue these securities. This applies equally to creditors and
shareholders. The development of lending is highly encouraged by creditor
rights. The exact structure of these rights is variable and may alternatively
favor bank lending or market lending. Shareholder rights protections
measures are believed to encourage the development of equity markets, as
evidenced by the valuation of firms, the number of listed firms (market
breadth), and the rate at which firms go public.

Usually if investors are better protected they are more likely to invest their
savings in the securities. As per the Securities and Exchange Board of India
(SEBI) - National Council for Applied Economic Research (NCEAR) report (June
2000), “despite the expansion of the securities market, a very small
percentage (1.4%) household savings is channeled into the securities market.
Out of 12.1 million equity investors, 84% have invested in equity market
through primary market. Thus primary markets play an important role in
bringing investments into equity markets.”13 Thus, in order to walk on
the path of economic development, investor protection is utmost
important.

12
William L. Cary, Federalism and Corporate Law: Reflections upon Delaware, 83(4) THE YALE
LAW JOURNAL 663, (MARCH, 1974).
13
National Council of Applied Economic Research, How Households Save and Invest: Evidence
from NCAER Household Survey, (2011), available
at http://www.sebi.gov.in/cms/sebi_data/attachdocs/1326345117894.pdf (Last
visited on April 2, 2018).
II. INVESTOR PROTECTION IN INDIA: A HISTORY OF THE
REGULATORY FRAMEWORK UNDER SEBI
Investor protection in India is governed by a complex regime of statutes and
regulatory bodies. The Securities and Exchange Board of India (SEBI) and the
guidelines issued by it form the primary mechanism through which investor
protection is ensured in India. This is supplement by provisions under the
Companies Act, 1956, the Companies Act, 2013 and the Securities Contracts
(Regulation) Act.

SECURITIES AND EXCHANGE BOARD OF INDIA

ESTABLISHMENT AND FUNCTIONS

The Securities and Exchange Board of India (SEBI) was first constituted on
April 12, 1988 under a resolution passed by the Department of Economic
Affairs of the Central Government.14 Following difficulties in enforcement in
the capital markets in the early years,15 SEBI was given statutory powers: first
through an Ordinance on January 30, 1992,16 and then later through the
enactment of the Securities and Exchange Board of India Act, 1992 on
April 12 of the same year.17 At the time of its establishment, SEBI
encompassed both regulatory and developmental functions. In this paper, we
shall be focusing only on the former.

At the time of its establishment, SEBI was tasked with regulating, broadly,
stock exchanges, securities markets; stock-brokers, their agents and
other intermediaries; fifteen collective investment schemes, including mutual
funds; self-regulatory organizations; and regulating substantial acquisitions
and take-

14
Resolution of the Government of India in the Department of Economic Affairs No. 1(44)
SE/86, dated the 12th day of April, 1988.
15
Shaji Vikraman, From early battles to position of strength: Evolution of SEBI, THE
INDIAN EXPRESS (April 5, 2017), available at http://indianexpress.com/article/explained/from-
early- battles-to-position-of-strength-evolution-of-sebi-2/ (Last visited April 13, 2018).
16
Id.
17
Section 1(3), the Securities and Exchange Board of India Act, 1992.
overs.18 It was also responsible for the prohibition of fraudulent and unfair
trade practices relating to securities markets as well as insider trading.19 In
addition, it could be delegated functions under the Capital Issues (Control)
Act, 1947 and the Securities Contracts (Regulation) Act, 1956 by the Central
Government.20 Crucially, the regulation of the relationship between investors
and brokers had not been covered by the initially enacted functions of SEBI.21
This put the Board in an uncomfortable position when news of the Harshad
Mehta scam broke shortly after the enactment of the SEBI Act, on April 23.

THE HARSHAD MEHTA SCAM AND THE SECURITIES LAW (AMENDMENT) ACT, 1995

Harshad Mehta was a stock broker who had immense investor confidence on
the Bombay Stock Exchange before being associated with the scam. He used
this influence to selectively invest in certain kinds of stock, thus driving their
price up when other investors followed suit. Additionally, the money that he
invested in the stock market came from the amounts entrusted to him by
banks to purchase government securities from other banks. 22 SEBI was
powerless to effectively address the Harshad Mehta scam because the issue
of intermediary regulation did not then fall within its jurisdiction.

The Securities Laws (Amendment) Act of 1995 was subsequently enacted to

rectify this issue. The jurisdiction of SEBI was now extended over a wider
range of intermediaries: depositories, foreign institutional investors (FIIs),
credit rating agencies and “custodians of securities”.23 In addition, SEBI was
given the power to include other intermediaries by notification, if so
required.24 Another important change in the jurisdiction of SEBI was the
inclusion of issuers of securities. They were originally governed by the
provisions of the Companies Act, 1956, but were not mentioned in the
original SEBI Act.25 The disclosure

18
Section 11, the Securities and Exchange Board of India Act, 1992. [as originally
enacted] 19 Section 11, the Securities and Exchange Board of India Act, 1992. [as
originally enacted] 20 Section 11, the Securities and Exchange Board of India Act, 1992.
[as originally enacted]
21
S. Chandok, The Growth of SEBI: From Harshad Mehta to Subrata Roy, 1(2) INTERNATIONAL
JOURNAL FOR LEGAL DEVELOPMENTS & ALLIED ISSUES 205, 207 (2015).
22
Id.
23
Section 5, the Securities Laws (Amendment) Act, 1995.
24
Section 5, the Securities Laws (Amendment) Act, 1995.
25
M. S. Sahoo, Historical Perspectives on Securities Law, presented at the 31st
National
requirements put forth by SEBI were thus non-binding in the absence of a
clear statutory mandate. Section 11A was inserted to rectify this by
providing SEBI the power to issue guidelines binding on companies in relation
to issue of capital, transfer of securities and other incidental matters.26 SEBI’s
powers were also widened in order to enable it to enforce binding
consequences against defaulters. The insertion of Section 11B enabled the
Board to now issue directions to companies, and to stock-brokers, sub-brokers
and other persons associated with the securities markets listed in Section
12.27 A range of monetary penalties were also introduced for non-
compliance with SEBI’s directions. The new offences included failing to
furnish information requested by SEBI; failure to redress investor’s
grievances; defaults on rules and regulations by mutual funds, asset
management companies, and stock brokers; non-disclosure of acquisition or
merger; and insider trading.28 The Amendment Act also attempted to
safeguard the autonomy of SEBI and the newly established SAT. The
jurisdiction of the civil court was barred with respect to orders passed by
SEBI, with appeals being allowed only to the Central Government.29

THE KETAN PAREKH SCAM AND THE SEBI (AMENDMENT) ACT, 2002

The Harshad Mehta scam of 1991-92 was hardly the last such scam to expose
the weaknesses in the Indian securities market. In March 2001, with the crash
of the Madhavapura Mercantile Co-operative Bank and the payment crisis of
the Calcutta Stock Exchange, Ketan Parekh’s attempts to manipulate the
securities markets were discovered. Parekh was found to have diverted funds
received from banks (in the form of loans and overdrafts) to acquire shares. 30
Like Mehta, Parekh attempted to create an impression of market interest in
certain scripts. He identified companies with relatively low floating
stocks, before setting about to acquire shares in them, often using FIIs,
mutual funds and

Convention of Company Secretaries.

26
Section 6, the Securities Laws (Amendment) Act, 1995.
27
Section 6, the Securities Laws (Amendment) Act, 1995.
28
Section 9, the Securities Laws (Amendment) Act, 1995.
29
Section 11, the Securities Laws (Amendment) Act, 1995 read with Section 20, the Securities
and Exchange Board of India Act, 1992.
30
Joint Parliamentary Committee Report, STOCK MARKET SCAMS, 21 (2002).
other institutions to indirectly acquire substantial shareholdings. As stock
exchanges have different settlement dates, he would manipulate shares and
shift them between exchanges to add to his profits.31 He would also enter
into ‘circular trades’ – sell orders where he was aware of the corresponding
buy orders – that he claimed were for the purpose of arranging for short-
term funds.32 In his written statement before the Joint Parliamentary
Committee constituted to look into the scam, Parekh pointed out that
he was not individually registered as a stockbroker, but held funds in a
corporate broking entity. He denied having violated any SEBI guidelines in his
dealings.33

Towards the end of its report, the Joint Parliamentary Committee produced
a scathing set of observations regarding the role of SEBI. Highlighting that
SEBI had only been able to initiate proceedings in only one insider trading
case and seven unfair trade practices cases in the ten years of its
existence, it pronounced SEBI’s track record as ‘unsatisfactory’.34 Further,
the penalty of cancellation for offenders was only resorted to in 7 out of 181
cases, with the rest being let off only after a warning or suspension.35 It
observed that SEBI was not utilizing the powers it was already vested with to
the fullest possible extent.36

The SEBI (Amendment) Act of 2002 conferred most of the powers

recommended by the Joint Parliamentary Committee in its report. SEBI was
thus empowered to call for information and records from public banks and
authorities,37 inspect the documents of listed public companies,38 and
issue commissions while exercising either of these powers. 39 SEBI was also
empowered to exercise several adjudicatory functions in the interests of
investors or the securities markets, irrespective of whether an investigation
was

31
Id.
32
supra note 40, at 29.
33
supra note 40, at 22.
34
supra note 40, at 478.
35
supra note 40, at 478.
36
supra note 40, at 482.
37
Section 4(a), The Securities And Exchange Board Of India (Amendment) Act,
2002. 38 Section 4(b), The Securities And Exchange Board Of India (Amendment)
Act, 2002. 39 Section 4(c), The Securities And Exchange Board Of India
(Amendment) Act, 2002.
pending or completed. These included the suspension of trading of security,
restraint of accessing the stock market, suspension of office-
bearers, impounding of proceeds or securities, attachment of bank accounts of
persons involved in the securities markets, and issuing directions to
intermediaries to not alienate assets under investigation. 40 These powers with
regard to listed companies can only be exercised if SEBI has strong grounds to
believe their involvement in insider trading. 41 Additional powers that SEBI
could wield included the prohibition of the issue of any offer document or
prospectus on grounds of investor protection,42 and cease-and-desist orders to
prevent certain persons from committing offences under the SEBI Act.43

THE SECURITIES LAW (AMENDMENT) ORDINANCE, 2013 AND THE SECURITIES LAW
(AMENDMENT) ACT, 2014

In 2013, the Securities Law (Amendment) Ordinance was promulgated on the

18th of July. The corresponding amendment act was passed on August 22,
2014. The amendments made crucial changes to the structure and functioning
of SEBI, broadening its mandate considerably. In this section, some of the
key changes, as well as the differences between the ordinance and the
act are examined. It is notable that both the Ordinance and the Act followed
closely in the wake of the scam perpetrated by the Sahara Group, which
raised objections to the jurisdiction of SEBI.

One of the most striking features in this light is the widening of SEBI’s
investigative powers. SEBI was conferred the power of calling for information
from banks, and from authorities within and outside India if it was
deemed relevant.44 On the non-provision of information, the Chairman of
SEBI could authorize the Investigative Authority to conduct a search, with
immense powers to search property and person, including breaking in if
needed.45 This has been

40
Section 4(d), The Securities And Exchange Board Of India (Amendment) Act,
2002. 41 Section 4(f), The Securities And Exchange Board Of India (Amendment)
Act, 2002. 42 Section 6, The Securities And Exchange Board Of India (Amendment)
Act, 2002.
43
Section 6, The Securities And Exchange Board Of India (Amendment) Act, 2002.
44
Clause 2, The Securities Law (Amendment) Ordinance, 2014.
45
Clause 2, The Securities Law (Amendment) Ordinance, 2014.
substituted in the Amendment Act by a much narrower provision authorizing
the Judicial Magistrate to call on the assistance of the police on the failure
of investigation.46

The Ordinance and the Amendment Act also provided for the enhancement of
the adjudicatory and penal functions of SEBI. They allowed for the
designation of certain courts as special courts, to be notified by the Central
Government.47 Other notable features of the Ordinance and the Amendment
Act are the provisions for disgorgement and the provisions regarding
collective investment schemes. The amount disgorged was required to be
credited to the Investor Protection and Education Fund. 48 The definition of a
collective investment scheme was also considerably broadened to include the
deeming of certain arrangements as collective investment schemes. This is to
be done regardless of their registration with SEBI, as long as the base corpus
is one hundred crore rupees.49

It is evident from a perusal of the history of SEBI that the institution has
steadily gained greater powers over time. From its beginnings as a
recommendatory body, SEBI has evolved into a more powerful entity with
administrative and adjudicatory functions.

SEBI’S ROLE AS AN INVESTOR PROTECTOR AND DISCRETIONARY POWERS

Section 15J of SEBI Act provides for certain parameters to take into account
while determining punishment in case of discretionary wrong. The factors
provided in the section are:
“(a) the amount of disproportionate gain or unfair advan¬tage,
wherever quantifiable, made as a result of the default;
(b) the amount of loss caused to an investor or group of
investors as a result of the default;

46
Section 5, The Securities Law (Amendment) Act, 2014.
47
Section 20, The Securities Law (Amendment) Act, 2014; Clause 10, The Securities
Law (Amendment) Ordinance, 2014.
48
Section 21, The Securities Law (Amendment) Act, 2014; Clause 11, The Securities
Law (Amendment) Ordinance, 2014.
49
Section 9, The Securities Law (Amendment) Act, 2014; Clause 3, The Securities Law
(Amendment) Ordinance, 2014.
 (c) the repetitive nature of the default.”50

Though these factors are provided usually quantum of penalty imposed is

disproportionate. Thus, SAT in JM Mutual Fund v. SEBI51reduced the quantum
of penalty based on the factor that no disproportionate loss caused to the
investors. Recently in DLF IPO Case,52 SAT criticized SEBI’s disproportionate
imposition of penalty. In this case due to non-obligation of certain disclosure
requirements SEBI imposed massive penalty. However in this case investors’
interest was not in any way affected. SAT opined that when the
considerations to take into account while exercising discretionary power are
given in Section 15J, due regards to be paid to that.
According to research SAT here is right in criticizing the exercise of
discretionary power without giving due regards to statutory considerations
and investor’s protection is one of such considerations. Though role of SEBI
is to act as an investor protector and penalize the wrongs committed in issue
and transfer of securities, in cases like this where investor’s interest is not
really compromised, penalizing companies disproportionately will only
deter small companies to contribute to the economic development of a
country in long run. Thus, SEBI should decide the penalty taking into account
factors given and not be over enthusiastically driven by investor protection.

LANDMARK DECISIONS ELUCIDATING ON INVESTOR PROTECTION

MINIMUM SHAREHOLDING IN A LISTED COMPANY

It is very important to have a distributed shareholding pattern in a company

as it prevents concentration of control only in the hands of certain few,
especially promoters who might abuse the power using majority of the
control in the company. SEBI as a market regulator is in favour of widely
distributed public shareholding because it increases the liquidity in the
market and ensures fair price. Thus, in order to increase participation of
general public in the

50
Section 15J, SEBI Act, 1992.
51
JM Mutual Fund v. SEBI, (2005) CLJ 544 SAT, (Securities Appellate Tribunal).
52
DLF v. SEBI, Appeal No. 331 of 2014 (Securities Appellate Tribunal).
 shareholding of the company, SEBI has amended Rule 19(2)(b) of
Securities Contracts Regulations (Rules), 1957.53 The crux of this
notification is that it primarily focuses on two things firstly, expressed
definition of ‘public’ and ‘public sector shareholding’54 and secondly
mandatory requirement of maintaining minimum public shareholding of 25%
of all the listed companies by June 3, 2013 through any of the following
methods prescribed by SEBI:

1. Issuance of shares to the public through prospectus;

2. Offer of sale of shares held by promoters through prospectus; or,

3. Offer for sale by promoters on the floor of stock exchanges.

4. Institutional Placement Programme ("IPP")

5. Rights issue/bonus issue to public shareholders, with promoters and promoter

group shareholders forgoing their rights entitlement/bonus entitlement,

6. Any other method as approved by SEBI on a case to case basis.

53
Rule 19(2)(b) of Securities Contracts Regulations (Rules), 1957 states that,
“(2)(b) At least twenty-five per cent of each class or kind of securities issued by the
company was offered to the public for subscription through advertisement in newspapers for
a period not less than two days and that applications received in pursuance of such offer
were allotted fairly and unconditionally:
Provided that a recognised stock exchange may relax this requirement, with the previous
approval of the Central Government, in respect of a Government Company and subject to
such instructions as that Government may issue in this behalf from time to time.
Explanation.- Where any part of the securities sought to be listed have been or are agreed
to be taken up by the Central Government, a State Government, development or investment
agency of a State Government, Industrial Development Bank of India, Industrial Finance
Corporation of India, Industrial Credit and Investment Corporation of India Limited, Life
Insurance Corporation of India, General Insurance Corporation of India and its
subsidiaries, namely, the National Insurance Company Limited, the New India Assurance
Company Limited, the Oriental Fire and General Insurance Company Limited and the United
Fire and General Insurance Company Limited, or Unit Trust of India, the total subscription to
the securities, whether by one or more of such bodies, shall not form part of the twenty-five
per cent of the securities to be offered to the public.”
54
The new definitions added in Rule 2 of SCCR, 1957:
“d) public means persons other
than – the promoter and
promoter group;
subsidiaries and associates of the company.
Explanation: For the purpose of this clause the words "promoter" and "promoter group" shall
have the same meaning as assigned to them under the Securities and Exchange Board of India
(Issue of Capital and Disclosure Requirements) Regulations, 2009;
(da) public sector company means a body corporate constituted by an Act of Parliament or
any State Legislature and includes a government company:
e) public shareholding means equity shares of the company held by public and shall exclude
shares which are held by custodian against depository receipts issued overseas.”
This provision applies to both new issuance of securities and further issue of
securities.

DISCLOSURE OF ‘MATERIAL INFORMATION’

ICDR Regulations mandates the disclosure of ‘material information’ specified

therein in order to help investors take informed decisions regarding
investment in the stock. Regulation 73 gives an elaborate list of such
disclosures. However, in order to constitute what exactly is material
information, reliance has to be placed on certain judgments, primarily DLF
Ltd. v. SEBI.55In this case there was an FIR initiated against one of companies
which were wholly owned subsidiaries of DLF. The relevant issues here were,
firstly non-disclosure of related party transaction with these companies
and secondly, outstanding litigation on subsidiary or related company.

According to the researcher, this case is important mainly because it sets a

standard for what should constitute ‘material information’. Secondly, the
researcher would like to criticize this judgment on the ground that, it has
gone into the technical meaning of ‘litigation’. Considering the purpose of the
SEBI, if importance is given to the technical understanding of terms, it will
defeat the purpose of the existence of SEBI.

MEASURES TAKEN FOR THE BENEFIT OF INVESTORS

NO EXEMPTION FOR FORMER EMPLOYEES AS ESOP HOLDER UNDER REGULATION 26(5)(B),

ICDR REGULATIONS, 2009

Regulation 26 of ICDR Regulation, 2009 provides for certain

eligibility requirements to be followed before going for Initial Public Offering
(IPO). Regulation 26(5) prohibits issuer from IPO, “if there are any
outstanding convertible securities or any right entitling any person with an
option to receive equity shares in the issuer.” 56 However exception has been
drawn in favour of

55
DLF Ltd. v. SEBI, Appeal No. 331 of 2014 (Securities Appellant Tribunal).
56
Regulation 26(5), Issue of Capital and Disclosure Requirement Guidelines, 2009.
employees holding ESOP.57In terms of Regulation 2(1)(m) of the SEBI ICDR
Regulations, the definition of “employee” inter alia, includes a permanent and
full-time employee of the issuer, or of the holding company or
subsidiary company or of that material associate(s) of the issuer.

In this case, though the definition of employee is broader it cannot reasonably

be considered wide enough to include former employees also because of the
basic difference between shareholders holding shares and employees holding
shares. Employees receive shares as recognition of their contribution to the
company.

As former employees choose to stay as an investor and considering the

greater prevalence of the ESOP schemes, it would not be in the best interest
of new investors to allow former employees to exit on IPO.

REDUCTION OF CAPITALIZATION REQUIREMENT FOR FAST TRACK ISSUE

As per the latest amendment to Regulation 10, ICDR Regulation 58 the average
market capitalization of the issuer is reduced to minimum of Rs. 1000 crore
in case of public issue, which was Rs. 3000 crores earlier.59 This
encourages smaller companies to raise funds in lesser time from public and
thus increase the small investor participation.

LIMITATIONS ON THE OBJECTS

SEBI has not imposed any limits on the objects of issuer at the time of IPO.
However SEBI proposes to impose cap of 25% on utilization of IPO proceeds in
the furtherance of ‘General Corporate Purposes’. According to the researcher
this is a very important move in order to protect the interest of the investors
because this cap eliminates the ambiguity and reduces scope for misusage of

57
Regulation 26(5)(b), Issue of Capital and Disclosure Requirement Guidelines, 2009.
58
Issue Capital and Disclosure Requirement (Third Amendment) Regulations, 2015,
w.e.f. 11.08.2015
59
Earlier the quoted words were substituted for "five" by the SEBI (Issue of Capital and
Disclosure Requirements) (Fourth Amendment) Regulations, 2012, w.e.f. 12-10-2012 and "five"
was substituted for "ten" by the SEBI (Issue of Capital and Disclosure Requirements)
(Amendment) Regulations, 2009, w.e.f. 11-12-2009.
investor’s money, thus, proceeds can be channelized to better ends which are
pre-informed.

MINIMUM PROMOTERS CONTRIBUTION

Under the erstwhile DIP Guidelines, minimum promoter’s contribution in a

public issue could be brought in by promoters/ persons belonging to promoter
group/ friend/ friends, relatives and the associates of the promoters. Under
the ICDR Regulations, only promoters are permitted to contribute the
minimum promoters’ contribution. While this may compromise the ability of
promoters to make this contribution, this provision is more meaningful since it
recognizes the importance of a promoter in a company by increasing the onus
on such person to show his commitment to the company, which is raising
funds from the public.

EXTENT OF DISCLOSURE FOR ADVERTISEMENT UNDER REGULATION 60

Regulation 60, ICDR Guidelines, 2009 provides for the information that can be
used for the publicity, marketing and advertising of prospectus.60 It prohibits
any material ‘extraneous to the contents of the offer document’. The question
here relates to how exactly this phrase should be interpreted - whether it
should be interpreted to mean ‘any information not mentioned in offer
document’ or ‘any information inconsistent with offer document’. Considering
the objective of SEBI is to protect investors from misinformation, it is
important that we interpret it to mean that publicity material should not
include any material outside whatever is mentioned in the offer document. If
this interpretation is not adopted, companies might make other estimations
which need not be certainty but mere possibilities. Thus, according to the
researcher this interpretation should be adopted.

60
Regulation 60 (1), Issue of Capital and Disclosure Requirement Guidelines, 2009 states that:
“Any public communication including advertisement and publicity material issued by the
issuer or research report made by the issuer or any intermediary concerned with the issue or
their associates shall contain only factual information and shall not contain projections,
estimates, conjectures, etc. or any matter extraneous to the contents of the offer document.
CONCLUSION: A COST-BENEFIT-UTILITY ANALYSIS OF SEBI’S
REGULATORY FRAMEWORK

In this paper so far, we have proceeded on the assumption that investor

protection is necessarily always a good thing. This assumption is also based
on the fact that a robust system of investor protection helps procure the
much- needed capital that could otherwise be diverted exclusively into
savings. Moreover, in the absence of strong investor protections, firms would
be more likely to rely heavily on debt to finance their growth.61 However, while
a certain degree of investor protection is required, there is an alternative
argument that can be made against investor protection that goes beyond that
degree.

In the U.S., the state, which ordinarily shuns interventionism in the markets,
has been relatively more interventionist in the securities market. 62 While
this has had the effect of bolstering market liquidity, it is believed that this
has come at the expense of efficiency in governance of firms. 63 Having a too
robust system of investor protection prompts scattered shareholding, with a
large number of retail investors with no connection to the firm financing
it. In practice, this means that shareholders do not form any long-term ties
or loyalties to the company, and are solely concerned with their capital
generating adequate returns.64 The managers of the company, on the other
hand, remain concerned with promoting the long-term growth of the
company, but are constrained by the pressure of shareholders to continue to
generate returns on their capital. This divergence of interest is combined
with a system that is inherently adversarial, and results in the destruction
of the mutual trust between shareholders and managers that is essential
for effective corporate governance.65 Therefore a degree of risk is necessary
to prevent scattered shareholding, and to allow for investors on average to
remain more informed.

61
C. F. Foley and R. Greenwood, The Evolution of Corporate Ownership after IPO: The Impact
of Investor Protection, 23(3) THE REVIEW OF FINANCIAL STUDIES 1231-1260 (2010).
62
A. Bhide, The hidden costs of investor protection: lessons from the US, 142(5452)
RSA JOURNAL 27-36 (1994).
63
Id.
64
Bhide, supra note 258.
65
Bhide, supra note 258.
In the Indian context, the majority of corporate management is carried out by
family-run businesses. This naturally increases the stake of the management
in ensuring the long-term interests of the company are adequately met.

A certain degree of investor protection is a necessary evil. However, a certain

degree of risk is also essential in order to ensure that the majority of
investors tend to be informed investors, thus only rewarding those
companies with profitable issues.

In the matter of pricing of securities, the present systems are clearly

insufficient to counteract the problem of underpricing. The solutions that
have been proposed – GSOs and mandatory safety mechanisms – both involve
the manipulation of markets to a considerable degree. Of these, GSOs
are the preferable system of reform, as they do not artificially eliminate the
risks arising out of the securities markets, while they also continue to provide
a degree of protection against underpricing in case of price drops.

In addition to these cases there are many other provisions adopted by SEBI
Reduction of capitalization requirement for fast track issue, Limitations on the
Objects of ‘General Corporate Purposes’, clarity as to what is minimum
promoter’s contribution, Extent of Disclosure for Advertisement etc.
These measures show that an active role is played by SEBI in order to take
care of the interest of retail investors. However in the SEBI regime there are
certain flaws, some of them being, higher threshold for Retail Investors,
ambiguities about minimum public subscription, sooner elimination of
special rights of existing shareholder, relaxed conditions for refilling of
prospectus etc. However these flaws are not irreparable. The overall
progress of SEBI as a regulator is remarkable. Still, in course of time after
implementation of various regulations of SEBI certain implementation flaws
have been discovered which can be overcome considering the solutions
proposed in this paper.
 BIBLIOGRAPHY

 S. Chandok, The Growth of SEBI: From Harshad Mehta to Subrata Roy,

1(2) INTERNATIONAL JOURNAL FOR LEGAL DEVELOPMENTS & ALLIED ISSUES 205
(2015).
 Ramaiyya, GUIDE TO THE COMPANIES ACT (18th edn, 2015).
 A. Bhide, The hidden costs of investor protection: lessons from the US,
142(5452) RSA JOURNAL 27-36 (1994).

 L. C. Gupta, Challenges before Securities and Exchange Board of India ,

31(12) ECONOMIC AND POLITICAL WEEKLY 751, (March 23, 1996).