33rd National Convention of Company Secretaries
SEBI VS. INVESTOR PROTECTION
RAVI SINGHANIA* & S VENKITARAMAN**
Section 11 of the Securities and Exchange Board of
India Act 1992, which came into force from 13.01.1992
states that it shall be the duty of the Board to protect
the interest of the investors in securities and to promote
the development of and to regulate the securities market
by such measures as it thinks fit. Now that more than
14 years have elapsed since the Act came into force
in place of the Capital Issues (Control) Act, which
was abolished in the wake of the policy of liberalization
announced by the Government, a review is called for
as to how far the duty of protecting the interest of
investors or development of the Capital Market is
fulfilled by SEBI.
Types of investors who need protection
Another relevant aspect is to understand the types
of investors whose interest SEBI has to protect. The
types of investors in the Capital Market can be classified
as follows:
1. Promoters group as defined in the SEBI Investor
Protection Guidelines / SEBI Substantial
Acquisition of Shares and takeover code.
2. Qualified institutional investors including FIIs.
3. Retail investors who are allowed to invest upto
Rs. 1.0 lac in a public offer.
CORPUS AVAILABLE FOR COMMON INVESTORS
4. Multinational company investors.
In this context, an important aspect to be considered
is the corpus of public offer available at present in the
public issue of a company. According to Rule 19 (2)(b)
of the Securities Contract (Regulation) Rules 1957 only
10% of each class of securities issued by a company
need be offered to the public if the size of the offer
to the public is a minimum of Rs. 100 crores and 20
lacs securities and the issue is made through Book
Building Method with allocation of 60% of the size
to Qualified Institutional Buyers. In other cases, the
public offer need be only 25% of each class of
securities. This means only 10% to 25% of the total
capital of a company is available in an unreserved
offer to the public in any issue of capital as against
the bulk portion or majority of the shareholding held
by the promoters group and institutional investors and
high networth individuals.
5. Small investors who can be considered as small
shareholders u/s 252 of the Companies Act,
1956. For purposes of this section “small share
holder” means a shareholder holding shares of
nominal value of 25,000/- or less in a public
company.
*
Managing Partner, Singhania & Partners, New Delhi.
**
B.A., B.Com., FCS. Singhania & Partners, New Delhi.
Who require protection ?
The promoters group who promote the enterprise
and take the risk of huge investments, and being in the
control of the company should have analysed the risk of
their investments and do not require any education from
any government sponsored institution or SEBI for initiating
into their ventures. The qualified institutional investors,
as the name itself indicates, are institutions, funds, banks,
etc who are well qualified to make investments without
the guidance of either government or any government
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SEBI vs. Investor Protection
sponsored body. The retail investors who are now
allowed to invest upto Rs. 1.0 lac in a public offer also
are capable of seeking financial advisers for their
investments. Hence, the small shareholder is the only
investor who require the care and protection of an
Organization like SEBI to withstand the vicissitudes of
the market fluctuations or the manipulations in the
market.
Steps taken by SEBI in the interest of investors
and how far these help them
(i) SEBI issued the SEBI (Disclosure & Investor
Protection) Guidelines 2000 on 19.01.2000
consolidating classifications 1 to XVI to the
original guidelines issued in June, 1992. These
Guidelines are meant to be observed by the
issuers while preparing the offer documents to
be submitted to SEBI/ Stock Exchanges and
Registrar of Companies. The offer document
shall contain a disclaimer clause to the effect
that : “submission of the offer documents to
SEBI should not in any way be deemed or
construed that the same has been cleared or
approved by the SEBI”. This means that SEBI
has no responsibility for either vetting the offer
documents or conveying any indication to the
prospective investors that they can rely on SEBI
for vouchsafing any information in the offer
documents, on the basis of which the investors
can invest in a specific issue of securities. In
the absence of owning responsibility of any
action in the issue or the statement, it is not
known what protection is afforded to an investor
against the issuers at the time of issue. It is
also mentioned in the Preliminary of these
guidelines that these have been issued by SEBI
under section 11 of the SEBI Act 1992; but
section 11 A gives powers to SEBI to specify by
Regulations, for the protection of the investors,
the matters relating to the issue of capital,
transfer of securities and other matters
incidental thereto. The point to be considered
in this context is whether guidelines issued to
the public can be equated with Regulations and
a penalty can be imposed on a company for
any infringement of these guidelines.
(ii) Dematerialisation
Guidelines No. 2.1.5.1 mentions that no
company shall make a public or right issue or
an offer for sale of securities unless the
company enters into an agreement with a
depository for dematerialisation of securities
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already issued or proposed to be issued to the
public or existing shareholders. This means
dematerialisation is made compulsory for all
listed companies.
In this context, it is reported in the press that
“The share depository system, introduced in
1996 as an economical, paperless system for
small investors to hold securities, has bent
backwards to attract only speculators, large
market participants and frequent traders. In
fact, the structure of the demat system has hurt
investors so much that “they are tending to
quit the equity market”, the exact opposite of
market regulator SEBI’s goal in 1996: “Reduced
risk and lower transaction costs, and improved
investor protection and service”. According to
the findings of Society for Capital Market and
Development, a survey to tap household
investors behavior reveals that only 70 odd
lakh of 2 crores retail shareholders have
converted their shareholdings to demat form.
This is because trading arrangements for paper
certificates have been dismantled in haste
without creating an alternative reasonably
economical trading system. Nearly 20% of the
investors who have not shifted to demat said
the cost was too high while 11% felt no need
for it. Another 6.3% found the procedure
complicated and 3.62% did not have the service
in their city or town.
It may be recalled that the Government in the
Ministry of Finance was toying with the idea of
dematerialisation in response to the requests
of financial institutions like UTI, LIC, GIC, etc
because this would relieve them of carrying
cart loads of share certificates for transfer during
the daily transactions. It was never the intention
of government to make the facility of
dematerialisation compulsory across the board
for all shareholders whether they want it or not.
An option to the small shareholders in the
matter of dematerialisation would have been
in their interest as against a compulsion, which
imposed delay and financial burden on them.
(iii) Despotic attitude of minority shareholders
Another direct consequence of the compulsory
dematerialisation of securities imposed by SEBI
is that anyone can purchase one share from
the market because the concept of marketable
lot is dispensed with. For servicing a share the
cost to the company is highly disproportionate
33rd National Convention of Company Secretaries
to the benefits derived by either the shareholder
or by the company. Further, it is common
knowledge that a group of minority
shareholders, purchasing one share each from
the market, disrupting meetings and raising
unreasonable demands. If marketable lot is
fixed at a reasonable level by SEBI the high
cost of serving the shareholders below that limit
could be reduced which would be in the interest
of the majority shareholders and the
embarrassment of a coterie of small number of
shareholders holding to ransom the
Management could be avoided.
(iv) Delisting policy followed by SEBI
The rules for continuous listing being what they
are, many foreign companies having majority
shares in Indian companies had made open
offers to gain full control and they had openly
mentioned in the offer documents their
intention of getting the shares delisted from
the Indian bourses. All these companies were
performing well and their shares were actively
traded. It is true that the price for the purchase
of the shares was near about or the prevailing
market price. But an important point which
has lost sight of is whether instead of developing
a capital market by encouraging more and more
companies to enter the capital market with
protentiality marketable scripts, SEBI should be
a party to deplete the capital market of a good
number of company’s shares which have great
growth potential by agreeing to delist these
shares.
(v) Policy frame work on pricing
There is no uniformity in the pricing guidelines
issued by SEBI, which the offerers are directed
to follow. The SEBI (Disclosure and Investor
Protection) Guidelines 6.13.1 want the issuers
to disclose for all issues, the basis for issue price
in an illustrative format which was based on
the Malegam Committee’s recommendation.
This is more or less to be followed in the issues
by the process of Book Building also, where a
higher issue price can be discovered by the
bidding process. In the SEBI guidelines for
Employee Stock Option Scheme and Employees
Purchase Scheme the fair value of the option is
to be determined by using the Black Scholes
formula or other similar valuation method.
While it is conceded that determination of price
should be based on the circumstances and the
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parties for whom the shares are issued, the
possibility of the small investors being
shortchanged can not be ruled out in the case
of Book Building process or an operation of an
employees stock option scheme, where
transparency will be at a discount. In the case
of Book Building where bids are invited a
cartelisation by bidders is possible as a result
of which a high offer price is fixed which is
well beyond the formula price and the common
investor is lured to subscribe to the issue; the
result is that after listing, the price quoted in
the stock exchange is below the issue price
and the lay investor is taken for a ride. Ministry
of Finance seem to have realized this defect in
the system which resulted in the announcement
of bloated and often misleading over
subscription figures. The proposal to have
separate books for qualified institutional buyers
and non-institutional and retail investors may
curtail the boosted demand for the scrips
offered through the Book Building process.
Provision of a safety net upto Rs.10,000/- face
value of the shares for the retail individual
investor for a period of 6 months from the date
of allotment will instill confidence in them that
their investment is protected from high
speculation by a handful of dealers.
After the introduction of the original SEBI
protection guidelines in January 1992 investor
SEBI desired that as a justification of the issue
price, the issuers might indicate the erstwhile
CCI formula price. As the common investor
has greater confidence in the CCI formula price,
many issuers took advantage and had their
issues oversubscribed. But for reasons best
known to themselves SEBI declared that the
CCI formula price need not be disclosed and
the Malegam Committee also recommended
an illustrative format where this formula price
was conspicuous by its absence. As a matter
of fuller disclosure SEBI should have allowed
the issuers to indicate the CCI formula price if
they felt it desirable. In this connection it is
relevant to point out that the RBI in their FEMA
rules have directed that in certain cases, price
fixation under the erstwhile CCI formula should
be indicated by the companies in their
application to RBI. In the case of mergers and
inter-corporate investments, the Ministry of
Company Affairs also insists on valuations similar
to the CCI guidelines. In the interest of the
SEBI vs. Investor Protection
common investor who may have more
confidence in a Government formula a
disclosure in the offer document on the price
based on the CCI formula should be welcome.
(viii) Upsurge of Foreign Institutional Investors
(vi) Indifference of Multinationals to Indian
shareholders
Foreign companies which hold majority
shareholding in Indian listed companies change
hands abroad by take over, merger or acquisition
by other foreign entities. In this process the
management control of the Indian Company
also changes hands and the management
control falls in the hands of the foreign entities
which take over the foreign holding company.
As both the companies are incorporated abroad
no permission from any Government
department is required for such managerial
change. The recent example is the Gillette
merger with Protector & Gamble. In such cases
the Indian shareholders’ interest is ignored. For
small shareholders in the Indian companies their
interest is affected on account of a lower share
valuation for compulsory sale of their shares to
the foreign majority shareholder leading to
erosion of an attractive investment opportunity.
Government and RBI are helpless in the matter
because the transaction which ultimately affects
the Indian shareholders takes place between
two foreign companies incorporated abroad
over which the Indian corporate laws have no
control. It is anybody’s guess whether SEBI
can prevent such transactions which are not in
the interest of the Indian shareholders.
(vii) Shrinking capital market for common investor
According to Prithvi Haldea of Prime Database
between January 2003 and June 2005 an
amount of Rs.42.789 crores was raised through
public issues of which Rs.41,288 crores forming
96% was through Book Built issues. Allocation
to small investors was only 9174 crores forming
only 3% of the issuing companies total capital
of Rs.306909 crores. This does not speak well
of the efforts of SEBI towards development of
a capital market where small investors will have
an opportunity to play a profitable role instead
of being shunted to the Mutual Funds against
their wishes.
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In the last two months of July and August 2005
it is observed that the foreign institutional
investors with deep pockets entered the capital
market in a big way, creating a chase of too
much money after too few scrips resulting in
the index crossing 7800. This sudden upsurge
leads one to wonder whether the day may not
be far off when the Indian Capital Market will
be dominated by the foreign players only to
the exclusion of the Indian Mutual Funds and
High networth individuals, thus leaving the
individual retail investor to fend for himself with
less investment opportunities.
(ix) Confiscation of investors ?
Section 205C of the Companies Act, 1956
imposes a condition for establishment of an
Investor Education and protection Fund to which
among others the two amounts to be paid are
(I) the application moneys received by
companies for allotment of any securities which
are due for refund and (ii) matured debentures
with companies. In both these cases the
related securities in the form of share and / or
debentures were offered to the public
according to the terms and conditions
mentioned in the offer document and the
investment is made by the public on the implicit
faith in the terms of the offer. In none of the
offer documents so far companies have
mentioned a condition that the investor would
be deprived of his application money unless
he claims it back from the company within 7
years from the date it is due for return in the
case of unallotted shares or debentures. In
the interest of investors who made proposals
for investment in shares and / or debentures
out of their hard earned money SEBI should
take up the matter with Government to see
that they are not deprived of their application
money for non allotment of shares / debentures
for no fault of theirs.
It is hoped that a review of the action taken by
SEBI in the interest of investors and
development of capital market in the light of
the observations made above may lead to
removing certain blocks in the investment
opportunities for the common investor in
future.