Regulatory Framework

Lec-5
Topics to be covered:

• Company Law regulations

• Securities Contract (Regulation) Act & Securities
Contract (Regulation) Rules
• SEBI
• Ombudsman
• Sebi Intermediaries regulation
I. Company Law Regulations
• The Companies Act, 1956, is an Act of the Parliament of India,
enacted in 1956, which enabled companies to be formed by
registration, and set out the responsibilities of companies, their
directors and secretaries. (replaced by Companies Act, 2013)

• While providing for regulation of companies, it includes a general

framework for dealings in securities of public limited companies.

• It relates, inter-alia, to share capital/issue of shares,

prospectus/abridged prospectus, issue of shares on a rights basis,
issue of debentures, allotment of shares and issue of share
certificates.
Issue of shares
• The MOA of a limited company should state its authorized capital,
that is, the amount of shares up to which it can, at any time, raise
capital by issuing shares for subscription (issued capital) and
collect money from the shareholders (paid-up capital).

• A share is the right to a specified amount of the share capital of a

company, carrying with it certain rights and liabilities, while it is a
going concern as well as when it is winding up.

• It is transferable.

• Share certificate: is the evidence of ownership of shares issued by

a company under its common seal; specifies the name(s) of
person(s) in whose favour the certificate issued.
 Issue of shares
Alteration:
A company can :
a. Increase its share capital by issuing new shares,

b. Consolidate and divide it into shares of larger amount than the existing shares,

c. Convert its fully paid up shares into stocks and re-convert that stock into fully paid up shares
of any denomination,

d. Sub-divide its shares into shares of smaller amount and

e. Cancel its shares.

• All the above can be conducted through an ordinary resolution in the

company’s general meeting.

• Reduction in share capital requires special resolution and court approval.

• Cancellation versus Redemption of capital

• Issue of shares at a premium

Issue of shares
• There are two types of shares: equity and preference.

• Preference shares carry preferential rights to a fixed dividend

and return of capital, redeemable within 10 years.

• Types of preference shares: Cumulative and Non-cumulative,

Convertible and non-convertible.

• Shares other than preference shares are the equity shares.

• The power to issue shares is vested in the Board of Directors.

• Shares can be issued at a premium/discount.

 Issue of shares
Voting Rights

• Equity/ ordinary shareholders are entitled to vote on every resolution placed at

any general meeting of the company.

• Preference shareholders can vote only on those resolutions by which any of their
rights is directly affected.

• When dividend on cumulative preference shares remains un-paid for 2 years

(Companies Act 1956).

• Companies Act 2013 has removed this distinction between cumulative and non-
cumulative preference shares.

• It entitles a preference shareholder to vote on every resolution placed before the

company at any meeting if the company has not paid the dividend in respect of a
class of preference shareholders for a period of consecutive 2 (two) or more
years.
Shares with differential voting rights:
Any company, whether private or public, will now have to comply with the
below requirements for issuing shares with differential voting rights:

• The shares have to be ‘equity’ class.

• The company cannot convert its existing share capital to a differential voting
class but has to be fresh issuance of shares.

• Issuance requires prior shareholders approval through ordinary resolution

and the Articles of Association shall authorize issue of such shares.

• Also, there is a limit that such shares should not exceed 26% of the total post-
issue paid up equity share capital.

• Further the Company should not have defaulted in filing financial

statements and annual returns for 3 financial years. 
Shares with differential voting rights:

The Company should not have any subsisting default in the payment of:
• a declared dividend to its shareholders or
• repayment of its matured deposits or
• redemption of its preference shares or debentures that have become due for
 redemption or
• Payment of interest on deposits or debentures

Besides this, the Rules require that the Company should not have defaulted
on:
• Repayment of loans from banks and public financial institutions or interest
thereon
• Payment of dividend on preference shares
• Payment of statutory dues for employees
• Depositing moneys into the Investor Education and Protection Fund.
 II. Securities Contracts (Regulations) Act,
1956
• Bombay Securities Contracts Control Act, 1925

• 1951: A.D.Gorawala Committee; recommendations of Gorawala Committee report

culminated into SCRA, 1956.

• SCRA provides the broad framework of present scheme of stock exchange regulation in
India.

• A stock exchange means:

a) Any body of individuals, whether incorporated or not, constituted before
corporatization and demutualization or

b) A body corporate incorporated under the Companies Act, 1956 for the purpose of
assisting/regulating/controlling the business of buying, selling or dealing in securities.

Demutualization means segregation of ownership and management from the trading

rights of the members of a recognized stock exchange in accordance with a scheme
by SEBI.
Securities Contracts (Regulations) Act

• The object of SCRA is to prevent undesirable transactions in

securities.

• It sets up a general framework of control that makes the influence

of Government /SEBI all pervasive.

• At the same time, as an enabling legislative measure, it provides

the SEBI with a flexible apparatus for the regulation of the stock
market in India.

• The main elements are: securities, recognition, periodical returns,

clearing corporation, listing and offences.
What is meant by Securities?
Securities include:

1. Shares, scrips, stocks, bonds/debentures, other marketable securities;

2. Derivatives which include (a) a security derived from another security and (b) a
contract which derives its value from the prices/index of prices of underlying
securities;

3. Units of mutual funds;

4. Government securities;

5. Such other instruments as may be decided by Government/SEBI to be security,

6. Rights or interests in securities;

7. Security receipts issued by asset reconstruction companies; and

8. certificates/instruments issued by securitization companies.
Securities Contracts (Regulations) Act

1. Recognition of stock exchanges (includes application, conditions, terms,

withdrawal, periodical returns, inquiries, annual reports, making
amendments, bye-laws of SE and powers of SEBI )

• Stock exchanges require SEBI’s recognition to carry on the business of dealing in

securities.
• All recognized stock exchanges should be companies (corporation) and ownership,
management and trading rights of members should be segregated (demutualization).
• In the interest of trade or in public interest, government/SEBI may withdraw recognition.

Periodical Returns
• Recognized stock exchanges have to furnish to the SEBI with periodical returns relating
to their affairs.
• The SEBI has power to direct an inquiry into the affairs of the governing body/any
member, in relation to the affairs of the stock exchange.
• Every recognized stock exchange has to furnish to the SEBI, a copy of its annual report.
• The SEBI can make/amend any rule or direct the stock exchange(s) to do so.
Securities Contracts (Regulations) Act
2. Clearing Corporation
• A recognized stock exchange, with prior approval of SEBI, may transfer the
duties and functions of clearing and settlement to a Clearing Corporation.

• A clearing corporation is a company registered under the Companies Act for

(a)periodical settlement of contracts and
(b)delivery of and payment for securities and so on.

• It may, with the prior approval of SEBI, make bye-laws for the regulation and
control of contracts.

• The SEBI has the power to make as well as amend the bye-laws. It can also
supersede the governing body of the stock exchange and appoint person(s)
to exercise and perform all the powers and duties of the governing body.

• It may also issue directions in the interest of the investors and the
securities market.
Clearing Corporation: NSE

• The National Securities Clearing Corporation Limited (NSCCL), a subsidiary of

National Stock Exchange of India Ltd., was incorporated in August 1995 to carry
out the clearing and settlement of the trades executed in the Equities and
Derivatives segments of NSE.

• It also operates Subsidiary General Ledger (SGL) for settlement of trades in

government securities and undertakes settlement of transactions on other
stock exchanges like the Over the Counter Exchange of India (OTCEI).

• NSCCL commenced clearing operations in April 1996.

• The purpose behind setting up NSCCL was to bring and sustain confidence in
clearing and settlement of securities and promote and maintain, short,
consistent and well defined settlement cycles without any deviations.

• BSE: Indian Clearing Corporation Ltd

 Securities Contracts (Regulations) Act

3. Listing
Listing denotes registration of a security as officially approved for
dealing/trading on a stock exchange.

The principal objectives of listing are to provide easy marketability

and impart liquidity and free negotiability to securities, ensure
proper supervision and control of dealings in them and protect the
interests of the investors. A recognized stock exchange may delist
securities.
 Securities Contracts (Regulations) Act

4. Offences
• Any offence committed by a person/company/manager/ secretary/other officer under the
specific provisions of the SCRA, is punishable with imprisonment up to ten years or with a fine
upto a maximum of Rs. 25 crore or with both.

• Such offence is deemed to be a cognizable offence.

• The penalty for failure to furnish information to a stock exchange/maintain books and records
as per the listing agreement/to enter into an agreement with clients/redress investor
grievances by brokers, is Rs. one lakh for each day of failure or Rs. one crore, whichever is
less.

• The penalty for a failure to comply with provisions of the listing agreement and delisting
norms/furnish periodical returns/amend bye laws/comply with SEBI regulations can be upto
Rs. 25 crore.

• The Government/SEBI can make rules/ regulations for carrying out the objectives of the SCRA
consistent with the provisions of the SCRA so as to carry out the purposes of the SCRA
Securities Contracts (Regulations) Rules

The main elements of the Securities Contracts (Regulations) Rules are:

1. recognition of a stock exchange;

2. qualification of membership;

3. contracts between members of a recognized stock exchange;

4. nominees of SEBI,

5. obligations of the governing body;

6. audit of accounts of members,

7. books of accounts and other documents of a recognized stock

exchange;
8. manner of inquiry,

9. submission of annual report/periodical returns and requirements with

respect to listing of securities on a recognized stock exchange and
10. continuous listing of securities.
 III. Securities and Exchange Board of India
• The SEBI has been set up to protect the interest of the investors in the securities market
and to promote the development of, and to regulate the securities market by measures,
inter alia, such as regulating the business in stock exchanges/any other securities
market(s);

• registering and regulating the working of intermediaries (i.e.) brokers, share transfer
agents, bankers to an issue, trustees, registrar to an issue, merchant bankers,
underwriters, portfolio managers, investment advisors, depositories, custodian,
depository participants, FIIs, credit rating agencies, venture capital funds, mutual funds,
and so on);

• prohibiting fraudulent and unfair trade practices/insider trading; regulating acquisition of

shares and takeover of companies;

• promoting investor education and training of intermediaries; performing functions and

exercising powers under the provisions of the SCRA; taking action against defaulters.

• The SEBI may, for the protection of investors, specify regulations/prohibition of issue of
prospectus, offer document, advertisement or soliciting money for issue of securities.
Prohibition of Fraudulent and Unfair Trade Practices

• The prohibition of fraudulent and unfair trade practices relates

to
(1) prohibition of certain dealings in securities and
(2) manipulative, fraudulent and unfair trade practices.

• Dealings in securities which are prohibited are:

(i) buying, selling or otherwise dealing in a fraudulent manner,
(ii) employing a manipulative/deceptive device or contrivance in
contravention of the provisions of the SEBI Act/regulations,
(iii) employing any device/artifice/scheme to defraud and
(iv) engaging in any act, practice, course of business which
operates/would operate as a fraud/deceit on any person, in
contravention of the provisions of the SEBI Act/regulations.
III. Securities and Exchange Board of India
• As per SEBI (Prohibition of Insider Trading) Regulations, 1992,
"insider" is any person who, is or was connected with the
company, and who is reasonably expected to have access to
unpublished price-sensitive information about the stock of that
particular company, or who has access to such unpublished price
sensitive information.

• Information that could be price sensitive includes periodical

financial results of a company, intended declaration of dividend,
issue or buyback of securities, any major expansion plans or
execution of new projects, amalgamation, merger, takeovers,
disposal of the whole or substantial part of the undertaking and
any other significant changes in policies, plans or operations of
the company.
 Matters relating to Insider Trading

• Definition of Insider: The definition of `Insider` has been widened to include person

connected on the basis of being in any
a) contractual;
b) fiduciary or
c) employment relationship that allows such a person to access unpublished price
sensitive information (UPSI). Further, Insider will also include a person who is in
possession or has access to UPSI.

• Immediate Relatives: Immediate relatives will be presumed to be connected persons, with

a provision of right to challenge this presumption.

• SEBI in past has faced several difficulties in showing evidence for passing of UPSI to an
immediate relative.

• With this proposed amendment, the burden of proof will now shift on the immediate relative
to prove that he or she did not hold UPSI before trading the securities.
 Matters relating to Insider Trading
• Legitimate Business Transaction:: Aligning insider trading norms
with international practices and facilitate legitimate business transaction,
SEBI now intends to permit access of UPSI though due ‐diligence with
appropriate safe guards.

• This provision will make it easier for private equity and strategic investors
for accessing UPSI during their due diligence. However to maintain the
information cemetery, UPSI must be disclosed at least 2 days before the
trading.

• Management holding UPSI: Insiders who are liable to possess UPSI

all round the year i.e. CEO, CFO and senior management of the company,
would now have the option to formulate pre ‐scheduled trading plans.

• Trading plans would, however, will be required to be disclosed on the

stock exchanges and have to be strictly adhered to.
Matters relating to Insider Trading
• Ease of Compliance Burden: Repeated
disclosures have been removed so as to ease
compliance burden and to align with the SEBI
(Substantial Acquisition of Shares and Takeovers)
Regulations, 2011 (``Takeover Code``).

• Disclosure of any change of 2% for persons holding

more than 5% shares or voting rights has been
removed as they are prescribed under Takeover
Code.
III. Securities and Exchange Board of India

• In case of

(i) violation of any provision of the SEBI

Act/rules/regulations/ directions or

(ii) transactions being dealt with in a manner detrimental

to the securities market/investors, SEBI can conduct an
investigation into the affairs of the violators.

• The SEBI is empowered to prohibit manipulative and

deceptive devices and substantial acquisition of shares.
III. Securities and Exchange Board of India

• Penalties can be imposed by the SEBI on different

intermediaries, for failures/defaults, such as,
i. a failure to furnish information/return and maintain books
of accounts/records/ documents;
ii. failure to enter into an agreement with clients/to redress
investors grievances;
iii. failure by an AMC to observe rules/regulations;
iv. defaults in case of mutual funds/stock brokers;
v. insider trading;
vi. non-disclosure of substantial acquisition of shares and
takeover bids;
vii. fraudulent and unfair trade practices and so on.
IV. Ombudsman Regulations, 2003

• To redress the grievances of investors, the SEBI has established an

ombudsman/stipendary ombudsman.

• The ombudsman would receive complaints, facilitate their

resolution by amicable settlement, approve an amicable settlement
between parties and adjudicate complaints in the event of failure of
amicable settlement.

• http://www.sebi.gov.in/legal/regulations/aug-2003/sebi-ombudsman-
regulations-2003-last-amended-on-nov-09-2006-_34634.html
SEBI Intermediaries Regulations
Intermediary means:
1. brokers/sub-brokers
2. share transfer agents
3. bankers to an issue
4. trustees
5. registrar to an issue
6. merchant bankers
7. underwriters
8. portfolio managers
9. investment advisors
10.depositories/participants/ custodians
11. credit rating agencies
• Other intermediaries associated with the securities market in any manner/specified
by the SEBI including an asset management company, clearing member of a
clearing corporation/house and a trading member of a derivative exchange but
does not include a FII, foreign venture capital investor, mutual fund, collective
investment scheme and venture capital fund.
SEBI Intermediaries Regulations
The main elements of the regulation of intermediaries is registration,
obligations, inspection and disciplinary proceedings and action in case of
default.

Registration:
• To act as an intermediary, a registration with the SEBI under the applicable
regulations is necessary. Separate registration would be necessary to carry on each
activity.

• For granting registration, the SEBI would take into account all relevant matters
including whether (1) the applicant/associate has been refused registration, (2) the
applicant/director/ partner trustee/principal officer is involved in any pending
legislation, (3) the applicant satisfies the eligibility criteria and (4) the registration is
in the interest of the investors and the development of the securities market.

• The applicant should also be a fit and proper person in terms, inter-alia, (1) integrity
reputation and character, (ii) absence of conviction and restraint order and (iii)
competence including financial solvency and networth.
 SEBI Intermediaries Regulations

• The registration would be permanent but subject to the following conditions:

(i) obtain prior approval of the SEBI to change its status/constitution, (ii) pay
the applicable fee; abide by the securities laws; continuously comply with
disclosures requirements; and meet the specified eligibility criteria.

• Obligations: The obligations of the intermediaries are: general obligation,

redressal of investor grievances, appointment of compliance office,
investment advice and code of conduct.

• The compliance officer should certify on April 1 every year its compliance
with all obligations/responsibilities and the fulfilment of eligibility criteria on a
continuous basis and that all disclosures are true and complete.

• Investors grievances should be redressed within a maximum of 45 days.

• While giving any investment advice, its interest in the security should be
disclosed.
SEBI Intermediaries Regulations
• Inspection: The SEBI may appoint inspecting authority/ auditor/valuer to
undertake inspection of books/ accounts/records/documents of an
intermediary
(i) to ensure maintenance in the required manner,
(ii) establishment and following of adequate internal control
systems/procedures/safeguards,
(iii) to ensure compliance with the provisions of the securities laws,
(iv) enquire into a complaints from any concerned party and so on.

• Action in default: Failure of a registered intermediary to comply with any

conditions subject to which registration has been granted and contravention of
provisions of the securities laws would result in
(1) its suspension/cancellation of its registration,
(2) prohibition on taking up new assignment,
(3) debarring (a) principal officer from employment, (b) branch from carrying out
activities, and
(4) issue of warning.