Other policies and programmes having a bearing on the working of the securities markets

An effective regulatory framework is predicated on strong enforcement. Such enforcement action helps sustain and foster confidence of investors and helps preserve the integrity and transparency of markets. With at view to achieving these objectives, SEBI continued with initiatives begun in previous years and further focused on its activities in the area of market surveillance, investigation and prosecutions. SEBI maintains a strong enforcement presence in the areas within its jurisdiction and exercised the powers available to it under the SEBI Act, the regulations thereunder, and powers delegated by or exercised concurrently with the central government under the Companies Act and the Securities Contracts (Regulation) Act. The market surveillance systems have been strengthened in SEBI and the stock exchanges under the oversight of SEBI. Besides, the investigation machinery has been reinforced for effectively dealing with securities law violations, the details of which are given in Part II.

Changes in the regulatory framework of securities market

• Depositories and the clearing and settlement system The settlement of transactions in the securities markets on the basis of physical movement of paper results in delays in the issue of share certificates in primary issues, in the transfer of shares, creates bottlenecks in the clearing houses or corporations of the stock exchanges. The movement of physical paper also creates risks for market participants. These risks arise from the delays mentioned above and problems of "bad delivery" on account of the inability of the exchange infrastructure to verify the quality of certificates in the time between securities pay in and pay out. Market participants and investors also have to contend with the problem of "objections" arising from differences in signatures; fraud, theft, and forgery of certificates.
  
  The need to transact in physical certificates in the face of expanding volumes (which nation-wide electronic trading has facilitated) has increased the pressures faced by the clearing infrastructure in the stock exchanges, and has required them to commit resources for dealing with paper that could have been more usefully deployed elsewhere. Further, the exchanges have been unable to shorten settlement cycles or to move to rolling settlement, both of which are essential for reducing settlement risk, and are a feature of all modern markets.
  
  The dematerialisation of securities in a depository and their transfer through electronic book entry will eliminate some of the risks described above, while significantly reducing others. It is expected that as the network of depository participants expands, and the proportion of securities dematerialised in the depository increases, the benefits of reduced risk and lower transaction costs will extend to the vast majority of market participants and lead to improved investor protection and service.
  
  
• The Depositories Act, 1996 The Depositories Act, 1996 has laid down the legislative framework for facilitating the dematerialisation and book entry transfer of securities in a depository. The Act, inter alia, provides for the following:
  
  1. registration with SEBI of a depository, which is required to be a company under the Companies Act, 1956, and of depository participants, who are agents of the depository
     
     
  2. the dematerialisation of securities in a depository with the records of beneficial ownership being recorded by the depository, and the transfer of beneficial ownership which takes place through electronic book entry by the depository
     
     
  3. indemnification, in the first instance by the depository, of beneficial owners for the negligence of the participant
     
     
  4. interfaces between the depository, participants, issuers and beneficial owners, several of which are required to be in the bye-laws which a depository has to make with the approval of SEBI
     
     
  5. option to investors to hold securities in physical or dematerialised form, or to rematerialise securities previously held in dematerialised form
     
     
  6. enquiries, inspection and penalties in case of default
     
     
  7. the Act also amends other statutes to facilitate the setting up and functioning of depositories and introduces the free transferability of securities.
• The Depositories Related Laws (Amendment) Ordinance, 1997 In January 1997, the Depositories Related Laws (Amendment) Ordinance, 1997 was promulgated, which amended certain other statutes to further facilitate the dematerialisation and book entry transfer of securities in the depository, especially securities of large financial institutions and public sector banks. The State Bank of India Act, 1955, the State Bank of India (Subsidiary Banks) Act, 1959, the Industrial Development Bank of India, 1964 and the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 were amended through this Ordinance to facilitate the dematerialisation and transfer by electronic book entry of the shares of the SBI, its subsidiaries and the IDBI. The Ordinance also amends the Indian Stamp Act, 1899 to exempt transfer of units of mutual funds through electronic book entry in a depository.
  
  
• The SEBI (Depositories and Participants) Regulations, 1996 SEBI had circulated a consultative paper on the framework of the draft regulations for depositories and participants in October 1995. Extensive discussion were then held with the stock exchanges, market participants and investors on this issue. In addition to the views expressed at these meetings, SEBI also had the benefit of written comments on the Consultative Paper submitted by chambers of commerce and industry, market participants and investors. Based on the above, the SEBI (Depositories and Participants) Regulations, 1996 were notified in May 1996. These regulations provide for the following:
  
  1. registration of depositories and participants under the SEBI Act
     
     
  2. grant of certificate of commencement of business upon satisfaction that adequate safeguards and systems to prevent manipulation of records and transactions have been put in place, as required by the Depositories Act
     
     
  3. the eligibility criteria for admission of securities to a depository
     
     
  4. the specific rights and obligations of depositories, participants and issuers in addition to those specified in the Depositories Act
     
     
  5. periodic reports to and inspections and enquiries by SEBI
     
     
  6. penal action and procedure in case of default
  
  In addition, the regulations contain the following provisions:
  
  1. the minimum capital of the company that is to be registered as depository, has been set at Rs. 100 crore
     
     
  2. the eligibility criteria for the sponsors of a depository, who have been restricted to financial institutions, custodians, non-banking finance companies and stock brokers with a minimum net worth of Rs. 50 lakh and subject to a ceiling of 25 times their net worth on the value of the portfolios for which they act as participant
     
     
  3. provisions for the indemnification of beneficial owners including insurance cover for the depository and participants
     
     
  4. the adequacy of safeguards and procedures that are to be put in place before commencement of business is allowed to the depository
     
     
  5. the internal and external controls and audit mechanisms that are to be instituted by the depository in order to ensure the integrity of data processing systems and the adequacy of systems and procedures to prevent systemic failure, manipulation or loss of records
• The SEBI(Depositories and Participants)(Amendment) Regulations, 1997 In February 1997, the SEBI (Depositories and Participants) Regulations, 1997 were amended to restrict foreign ownership of a depository, whether as sponsors or participants to 20% of its equity. The regulations were also amended to permit non-banking finance companies with a minimum net worth of Rs. 50 crore in addition to the net worth specified by any other authority to act as participants in a depository on behalf of other beneficial owners.
  
  
• The National Securities Depository Limited Following the notification of the SEBI (Depositories and Participants) Regulations, 1996, NSDL, a company sponsored by the IDBI, the UTI and the NSE was granted a certificate of registration as a depository on June 7, 1996. NSDL was granted a certificate of commencement of business on October 31, 1996. NSDL began the process of dematerialisation of securities with three participants and three securities eligible for dematerialisation.
  
  As of March 31, 1997, 28 participants had been registered by SEBI as participants in NSDL. Of these 10 were banks, 2 were financial institutions, 3 non bank custodians, 11 were stock brokers and 2 other non bank finance companies. All the major custodians of securities who act on behalf of FIIs, mutual funds and financial institutions had become participants in NSDL. For a security to be declared eligible for dematerialisation in NSDL, the issuer (and his registrar and transfer agent in case there is one) has to sign an agreement with NSDL. This agreement lays down the obligations and responsibilities of the issuer and NSDL with respect to each other, in addition to those prescribed in the Depositories Act and the SEBI regulations. As the Depositories Act permits investors to hold securities which are eligible for dematerialisation in a depository in physical form outside the depository, it is important that the issuer or the issuer's registrar and transfer agent have been required to reconcile the holdings of a security in physical form with those held in dematerialised form on a daily basis.
  
  As of March 31, 1997, issuers had signed agreements with NSDL in respect of 43 securities. The market capitalisation of securities for which issuers had established electronic connectivity with NSDL at the end of 1996-97 stood at Rs. 44,973 crore. As of March 31, 1997, the market value of dematerialised securities stood at Rs. 502 crore. These were held on behalf of 1,957 beneficial owners.
  
  At present, only the capital market segment of the NSE and the National Securities Clearing Corporation Limited (NSCCL), which acts as the clearing corporation for securities traded on the capital market segment of the NSE are integrated with the depository. Only trades which are executed on the dematerialised securities trading segment on the NSE can be cleared by NSCCL for settlement by electronic book entry within NSDL. The Depositories Act, 1996 amended the Indian Stamp Act, 1899, to exempt transfers of equity shares through electronic book entry from payment of stamp duty.
  
  
• Custodians of securities The SEBI (Custodians of Securities) Regulations, 1996 were notified in May 1996. The regulations prescribe eligibility criteria and a code of conduct to be followed by the custodians for the first time. Custodians, as service providers to institutional investors are an integral part of the securities markets, and it is important that their interactions and interfaces with stock exchanges, clearing corporations, clearing houses, stock brokers, registrars and investing institutions be streamlined and uniform. With this in view, SEBI prescribed uniform norms and practices for custodians of securities in October 1996 after discussions with custodians, stock exchanges and other market participants. The SEBI (Custodian of Securities) Regulations, 1996 were amended giving power to SEBI to give existing custodians time upto 5 years to raise their networth to Rs.50 crore.
  
  
• The SEBI (Venture Capital Funds) Regulations, 1996 India has a vast pool of entrepreneurial talent, which needs to be channelled and nurtured. Venture capital funds have an important role to play in providing entrepreneurs with risk capital, and in many cases, management expertise and mentoring from venture capitalists. SEBI (Venture Capital Funds) Regulations, 1996, have been crafted with the objective of helping venture capital funds to foster entrepreneurship in India. The regulations were notified in December 1996. At the end of March 1997, 13 venture capital funds had applied for registration with SEBI. In terms of these regulations, venture capital funds may be set up as companies or trusts. A considerable deterrent to the use of the trust structure for venture capital funds was the inability of trusts to vote. This has been removed with the amendment to the Companies Act, 1956, which permits venture capital funds set up as trusts to vote their shares. The regulations permits venture capital funds to raise funds only from institutional and high networth individuals, and to ensure this, the minimum amount that may be raised from any one investor has been kept at Rs. 5 lakh. The regulations aim to provide a lot of flexibility to venture capital funds to facilitate the growth of this segment of the market. The only investment restrictions that have been prescribed is that at least 80% of the funds raised by a venture capital fund.
  
  1. must be invested in unlisted companies
  2. may be used to invest in financially weak companies which may be listed or unlisted
  3. may be used to provide loan assistance to investee ventures
  
  In terms of the rules announced by the Central Board of Direct Taxation on July 18, 1995, venture capital funds are exempt from taxation provided that they invest in accordance with the rules in certain sectors of the economy, and such investment, among other requirements, is for a minimum period of three years. The SEBI (Venture Capital Funds) Regulations, 1996 impose no such “lock in” of investment or restrictions on industrial sectors in which investment has to be made. However, to avail of the tax benefits under the Income Tax Act, 1961, venture capital funds registered with SEBI are required to meet with the requirements of the rules and obtain an exemption from the income tax authorities.
  
  Foreign investors may invest fully in domestic venture capital funds, whether set up as trusts or companies. This investment is governed by the Guidelines for Overseas Venture Capital Investment issued by the government on September 20, 1995. The initial investment in the domestic venture capital fund by an overseas investor may be made with the approval of the FIPB and the RBI. Subsequent investment by the venture capital fund after it obtains SEBI registration into investee ventures does not require any further approval. The guidelines impose a three year “lock in” on investment by venture capital funds with foreign investment. Such funds may invest in only upto 40% of the equity capital of an investee venture, and not more than 5% of the corpus of such funds may be invested in one single investee venture. This limit is to be raised to 10% following the announcement by the Finance Minister in the Budget Speech for 1997-98.
  
  
• Substantial acquisitions of shares and take-overs The SEBI (Substantial Acquisitions of Shares and Take-overs) Regulations, 1994 were notified in November 1994. The regulations were aimed at making the take-over process more transparent, and to protect the interests of minority shareholders. A committee was set up under the chairmanship of Justice P N Bhagwati, former Chief Justice of India to examine the deficiencies in the 1994 regulations and to make them more fair, transparent and unambiguous, and to protect the interests of investors and all parties concerned in the acquisition process. The committee had a wide representation from chambers of commerce and industry, investor associations, stock exchanges, market participants, legal experts and professional bodies. The report of the committee was widely circulated, and was one of the most debated reports on the securities markets in the country. After discussions on the comments on the report and the draft regulations framed by the committee, the SEBI (Substantial Acquisitions of Shares and Take-overs) Regulations, 1997 were notified in February 1997.
  
  The 1997 regulations aim at:
  1. Investor protection in the take-over process
  2. Greater transparency
  3. Fairness and equity of treatment to all investors
  4. Timeliness and accuracy of disclosure of information to investors
  5. Prevention of frivolous offers
  6. Enforcement against violations
  
  The salient features of the new regulations are:
  
  1. definition of “control” and “parties acting in concert”, and requirement of a mandatory public offer by an acquirer once he acquires more than 10% of the voting rights of a listed company or if there is a change in control of the company
  2. consolidation of holdings in a company at the rate of 2% in every 12 month period by any person who holds between 10% and 51% of the shares or voting rights of a company without triggering a mandatory public offer
  3. person holding more than 51% of the shares or voting rights cannot consolidate unless he makes a public offer to acquire the required number of shares
  4. elaborate and stringent disclosure requirements
  5. the introduction of the requirement of establishing an escrow account by an acquirer in which the acquirer is required to deposit some percentage of the consideration payable. For consideration payable by the offeror upto and including Rs. 100 crore, 25% of the consideration payable required to be placed in escrow, and for the consideration payable exceeding Rs. 100 crore 10% of the consideration payable required to be placed in escrow. This amount would be forfeited in case of default or non compliance by the acquirer
  6. cash as well as exchange offers, conditional offers, competitive bidding and revision of offers
  7. indirect take-over of companies through the acquisition of control of holding investment companies brought under the purview of the regulations, and such a change in control requires a mandatory public offer to be made.
• Amendment to the Companies Act, 1956 relating to the securities markets
  1. At the request of SEBI, to deal with the problem of supervision of end use of funds, Schedule VI of the Companies Act, 1956 was amended in September 1996 by the central government under Section 641(1) of the Companies Act, 1956 to provide that all unutilised monies out of an issue must be separately disclosed in the balance sheet of the issuing company indicating the form in which such unutilised monies have been invested.
  2. The Companies Act, 1956 was further amended through the Companies Amendment Act, 1996 which inter alia provides for:
  3. Grant of voting rights to mutual funds, venture capital funds in respect of their shares in the companies
  4. Permitting companies to issue redeemable preference shares upto a maximum period of 20 years
• Working group for re-codification of the Companies Act, 1956 A Working Group to re-write the Companies Act, 1956 was constituted in August, 1996 by the government. The views of SEBI were considered by the Working Group in its report submitted to the government in March 1997. The main recommendations of the group having bearing on the capital market are described in brief below.
  
  1. The regulation and the disciplinary control over public listed companies for the purpose of issue of securities and the related matters should be unified and SEBI should be the sole authority for the monitoring, regulating and policing functions of such companies.
  2. Schedule II of the Companies Act in respect of prospectus should be under the domain of SEBI
  3. In the event of any person, group or body corporate acquiring 95% shares of a public listed company either through a take-over or otherwise and the company getting delisted, the residual shareholders should sell their shares to 95% owner at a price based upon SEBI guidelines
  4. The Employees Stock Option (ESOP) should be explicitly incorporated in the new Act. The capital market rules for ESOP should be framed by SEBI for public listed companies. Such rules should allow buy-back of options
  5. Buyback of shares by a company should be allowed subject to certain conditions
• Amendment of Listing Agreement of Stock Exchanges In 1996-97, the stock exchanges were required by SEBI to amend the Listing Agreement to provide for the following:
  
  1. The issuer shall pay interest at the rate of 15% if the allotment has not been made or if the refund order has not been dispatched to the investors within 30 days from the closure of the issue
  2. It was made mandatory for the body corporate making a public issue to have at least 5 public shareholders for every Rs.1,00,000 of net capital offer made to the public. In the case of offer for sale, there should be atleast 10 shareholders for every Rs.1 lakh of equity offered to the public.
  3. The cash flow statement is required to be issued by listed companies as a process of continuous disclosure shall be in the manner provided for authentication of balance sheet and profit and loss account under Section 215 of the Companies Act, 1956.
  4. Issuers allowed to list debt securities on stock exchanges without equity shares being first listed, and the listing agreements were modified to reflect this.
• Amendment to the Securities Contracts (Regulation) Rules, 1957 The central government in exercise of powers conferred on it under Section 30(1) of SC(R) Act, 1956 amended the Securities Contracts (Regulation) Rules, 1957, inter alia, to empower SEBI to hear appeals in the matter of suspension, withdrawal or delisting of securities, to exempt the requirement of experience in respect of brokers, to empower SEBI to require brokers to get their accounts audited by a Chartered Accountant, to require stock exchanges to furnish an annual report to SEBI and to relax the requirement of 25% offer to the public
  
  
• Delegation under the Companies Act, 1956 The central government in exercise of its power under Section 621 of the Companies Act authorised 14 officers of SEBI to file complaints for prosecutions in the Criminal Courts, inter alia, for the violation of following sections 56(3), 59(1), 63, 68, 73(2), 73(2B), 113(2) and 207 of the Companies Act, 1956.
  
  
• Constitution of committee for amendment of the securities laws In February 1997, SEBI constituted a committee under the chairmanship of Justice D R Dhanuka, retired Judge of the High Court of Mumbai for review of the undermentioned laws relating to securities in India in terms of the following:
  
  1. To examine the areas of deficiencies in the SEBI Act, Securities Contracts (Regulation) Act, 1956 and the Depositories Act, 1996
  2. To suggest amendments to the provisions of the SEBI Act, SC(R) Act and Depositories Act with a view to enable SEBI to regulate and develop the securities market and protect the interests of investors
  3. To examine the provisions of the Companies Act and to make recommendations for amendments to the Companies Act in order to enable SEBI to better regulate issue of capital, listing of securities, transfer of securities and protect the interests of investors
  
  SEBI would consider the recommendations of the committee and convey them to the government.