SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

The Securities and Exchange Board of India was established by the Government of India on 12 April 1988 as an interim administrative body to promote orderly and healthy growth of securities market and for investor protection. It was to function under the overall administrative control of the Ministry of Finance of the Government of India. The SEBI was given a statutory status on 30 January 1992 throughan ordinance. The ordinance was later replaced by an Act of Parliament known as the Securities and Exchange Board of India Act, 1992.

Reasons for the Establishment of SEBI

The capital market has witnessed a tremendous growth during 1980’s, characterised particularly by the increasing participation of the public.This ever expanding investors population and market  capitalisation led to a variety of malpractices on the part of companies, brokers, merchant bankers, investment consultants and others involved in the securities market.

The glaring examples of these malpractices include existence of self – styled merchant bankers unofficial private placements, rigging of prices, unofficial premium on new issues, non adherence of provisions of the Companies Act, violation of rules and regulations of stock exchanges and listing requirements, delay in delivery of shares etc. These malpractices and unfair trading practices have eroded investor confidence and multiplied investor grievances. The Government and the stock exchanges were rather helpless in redressing the investor’s problems because of lack of proper penal provisions in the existing legislation. In view of the above, the Government of India decided to set-up a separate regulatory body known as Securities and Exchange Board of India.

Purpose and Role of SEBI

The basic purpose of SEBI is to create an environment to facilitate efficient mobilisation and allocation of resources through the securities markets. It alsoaims to stimulate competition and

encourage innovation. This environment includes rules and regulations, institutions and their interrelationships, instruments, practices, infrastructure and policy framework. This environment aims at meeting the needs of the three groups which basically constitute the market, viz, the issuers of securities (Companies), the investors and the market intermediaries.

• To the issuers, it aims to provide a market place in which they can confidently look forward to raising finances they need in an easy, fair and efficient manner.

• To the investors, it should provide protection of their rights and interests through adequate, accurate and authentic information and disclosure of information on a continuous basis.

• To the intermediaries, it should offer a competitive, professionalised and expanding market with adequate and efficient infrastructure so that they are able to render better service to the investors and issuers.

Objectives of SEBI

The overall objective of SEBI is to protect the interests of investors and to promote the development of, and regulate the securities market. This may be elaborated as follows:

1. To regulate stock exchanges and the securities industry to promote their orderly functioning.

2. To protect the rights and interests of investors, particularly individual investors and to guide and educate them.

3. To prevent trading malpractices and achieve a balance between self regulation by the securities industry and its statutory regulation.

4. To regulate and develop a code of conduct and fair practices by intermediaries like brokers,

merchant bankers etc., with a view to making them competitive and professional.

Functions of SEBI

Keeping in mind the emerging nature of the securities market in India, SEBI was entrusted with the twin task of both regulation and development of the securities market. It also has certain protective functions.

Regulatory Functions

1. Registration of brokers and sub brokers and other players in the market.

2. Registration of collective investment schemes and Mutual Funds.

3. Regulation of stock brokers, portfolio exchanges, underwriters and merchant bankers and the business

in stock exchanges and any other securities market.

4. Regulation of takeover bids by companies.

5. Calling for information by undertaking inspection, conducting enquiries and audits of stock exchanges and intermediaries.

6. Levying fee or other charges for carrying out the purposes of the Act.

7. Performing and exercising such power under Securities Contracts (Regulation) Act 1956, as may be

delegated by the Government of India.

Development Functions

1. Training of intermediaries of the securities market.

2. Conducting research and publishing information useful to all market participants.

3. Undertaking measures to develop the capital markets by adapting a flexible approach.

Protective Functions

1. Prohibition of fraudulent and unfair trade practices like making misleading statements, manipulations,

price rigging etc.

2. Controlling insider trading and imposing penalties for such practices.

3. Undertaking steps for investor protection.

4. Promotion of fair practices and code of conduct in securities market.

The Organisation Structure of SEBI

As SEBI is a statutory body there has been a considerable expansion in the range and scope of its activities. Each of the activities of the SEBI now demands more careful, closer, co-ordinated and intensive attention to enable it to attain its objectives. Accordingly, SEBI has been restructured and rationalised in tune with its expanded scope. It has decided its activities into five operational departments. Each department is headed by an executive director. Apart from its head office at Mumbai, SEBI has opened regional offices in Kolkalta,

Chennai, and Delhi to attend to investor complaints and liaise with the issuers,intermediaries and stock exchanges in the concerned region.

The SEBI also formed two advisory committees. They are the Primary Market Advisory Committee and the

Secondary Market Advisory Committee. These committees consist of the market players, the investors

associations recognised by the SEBI and the eminent persons in the capital market. They provide important inputs to the SEBI’s policies.

The objectives of the two Committees are as follows:

a. To advise SEBI on matters relating to the regulation of intermediaries for ensuring investors protection in

the primary market.

b. To advise SEBI on issues related to the development of primary market in India.

c. To advise SEBI on disclosure requirements for companies.

d. To advise for changes in legal framework to introduce simplification and transparency in the primary market.

e. To advise the board in matters relating to the development and regulation of the secondary market in the country. The committees are however nonstatutory in nature and the SEBI is not bound by the advise of the committee. These committees are a part of SEBI’s constant endeavor to obtain a feedback from the market players on various issues relating to the regulations and development of the market

Establishment of SEBI as a Regulator

A major initiative of regulation was establishment of a statutory autonomous agency, called SEBI, to provide reassurance that it is safe to undertake transactions in securities. It was empowered adequately and assigned the responsibility to (a) protect the interests of investors in securities, (b) promote the development of the securities market, and (c) regulate the securities market. Its regulatory jurisdiction extends over corporates in the issuance of capital and transfer of securities, in addition to all intermediaries and persons associated with securities market. All market intermediaries are registered and regulated by SEBI. They are also required to appoint a compliance officer who is responsible for monitoring compliance with securities laws and for redressal of investor grievances.

The structure and processes of the SEBI have been developed over the year. In 1602 when Amsterdam stock exchange was admitted by the East India Company for dealings in its own securities the establishment of the native share and stock Brokers Association (now remand as Bombay Stock Exchange) in 1875 in the existing India undoubtedly marked a beginning of the stock exchange in India despite being the first ever stock exchange in Asia. The earliest legislative efforts to regulate the securities market in India was made by the Bombay Securities Contracts control act 1925, which was enacted to regulate and control certain contras acts for purchase and sale of securities in the city of Bombay.

SEBI’s Regulation of the Indian Securities Market

The primary market is the market which provides a conduit for sale of new securities. This market provides chance to issuers of securities, the government as well as corporate, to raise capital to meet their requirements of investments or for liberation of their obligations. Securities laws are needed mainly because of the unique informational needs of the investors because selling securities to investors in the various capital markets provides the means for corporations, governments and government agencies to satisfy their need for capital. And to regulate and control various volatile natured reforms of the market the regulation of the capital market is highly needed.

The security market is regulated by various agencies, such as the Department of Economics Affairs (DAE), the Department of Company Affairs (DC), the Reserve Bank of India (RBI) and the SEBI.

The multi crore securities scam that rocked The Indian financial system in 1992 (Harshad Mehta, The 1992 Security Scam)had the existing regulatory framework to be fragmented and inadequate and hence, a need for an autonomous, statutory, and integrated organization to ensure the smooth functioning of capital market was felt. To fulfil this need, the Securities and Exchange Board of India (S.E.B.I), which was already in existence since April 1988, was conferred statutory powers to regulate the capital market.

The SEBI got legal teeth through an ordinance issued on 30 January 1992. The ordinance conferred wide- ranging powers on the SEBI, including the authority to prohibit insider trading and regulate substantial acquisition of shares and takeover of business. The function of market development includes containing risk, board basing, maintaining market integrity and promoting long-term investment. The SEBI Act, 1992 which establishes the SEBI with four-fold objectives of protection of the interests of investors in securities, development of the securities market, regulation of the securities market and matters connected therewith and incidental thereto. The capital market, i.e., the market for equity and debt securities is regulated by the Securities and Exchange Board of India (SEBI). The SEBI has full autonomy and authority to regulate and develop the capital market. The government has framed rules under Securities Contracts (Regulation) Act, 1956, Securities and Exchange Board of India Act, 1992 and Depositories Act, 1996. The SEBI has framed regulations under the SEBI Act and the Depositories Act for registration and regulation of all market intermediaries, for prevention of unfair trade practices, and insider trading. As everyone could know that these i.e. the Government and the SEBI issue notifications, guidelines and circulars which need to be complied with by market participants. All the rules and regulations are administered by the SEBI.

SEBI’s efforts are to create effective surveillance mechanism for the securities market, and encourage responsible and accountable autonomy on the part of all players the market, who should discipline themselves and observes and observe the rules of the game. This would be possible, if the intermediaries set themselves up as effective self-regulatory bodies. Self-regulation is therefore the cornerstone of the regulatory framework advocated by SEBI, which like management by exception would result in regulation by exception. However, self-regulation can work only if there is an effective regulatory body overseeing activities of self-regulatory organisations. SEBI endeavours to provide a controller structure which would simplification an effective mobilisation and allotment of wealth through the securities market a structure, which would encourage effective of the market so that it could manage the essential services to business and commerce and personal investors in the most effective economic route jog competition and promote innovation, be responsive to international growth a structure which is flexible and cost effective so that it has clarity to guide and not cramp the changes, and finally in breath trust on the part of the investors and other users of the market by ensuring the market place is, and is also seen to be, clean to do trade in a fair, transparent and efficient manner

The judgment by the Delhi high court in Kimsuk Krishna Sinha v. SEBI throws interesting light on the role of SEBI in ensuring Correct Disclosure in offer documents and actions that SEBI can or should take.

“The purpose of inserting Section 55A in the Companies Act was to empower the SEBI to take both corrective and preventive action. This is perhaps because as a regulatory body SEBI gets to see the draft prospectus preceding a public issue by a company even before the public gets to see the RHP. SEBI is enabled and empowered to examine the DRHP and insist on complete and truthful disclosure of all relevant facts therein. The very purpose of having an independent regulatory authority like SEBI, and vesting it with statutory powers of inquiry, is to enable it to take prompt action in matters relating to issue and transfer of shares”

Role of SEBI in regulating Disclosures of Offer Documents and Code of Advertisement

Chapter VI of Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000 talks about the content of the offer document, Section I contents of the prospectus which says that other than disclosures specified in Schedule II of the Companies

Act, 1956, the prospectus shall contain all the information which shall be true and adequate so as to facilitate the investors to make an informed decision on the investments in the issue. The information must be substantial enough for the investor to make an informed choice.

In addition to regulations regarding the disclosure requirements SEBI also looks into the fact that investor does not get be fooled by misleading advertisement. SEBI has issued guidelines for the same to ensure that the advertisement is truthful, fair and clear. For e.g. it shall be the responsibility of the Lead Manager to ensure strict compliance with the code of advertisement by the issuer company.

Chapter IX of Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000 deals with guidelines on advertisement. It clearly mentions that an advertisement shall be in a clear, concise and understandable language. Excess use of technical terminology should be avoided. Along with that it also mentions what amounts to misleading advertisement. The code mentions that

“Advertisements shall be accurate, true, fair, clear, complete, unambiguous and concise. It should not contain statements which are false, misleading, biased or deceptive, based on assumption/projections. It should not be designed as likely to be misunderstood, it should not contain statements which directly or by implication or by omission may mislead the investor.”

Advertisements shall not be so framed as to exploit the lack of experience or knowledge of the investors. No advertisement shall directly or indirectly discredit other advertisements or make unfair comparisons and it shall be accompanied by a standard warning in legible fonts.

This is all done by SEBI with an aim to protect the investor, in reality the term “Investor Protection” is a very broad term encompassing a range of measures intended to protect the investors from malpractices of companies, brokers, merchant bankers, etc. Since all investments include some risk element, so “Investors Beware” should be the motto of all programs for enlistment of savings for investment. The investor can suffer the loss either by his own mistake of carelessness or by malpractice done by the company or by any broker. For the latter part they have every right to complain. The main purpose of SEBI behind all the above mentioned regulations is to protect the investor from being befooled. By providing all this information SEBI is trying to protect the shareholders interest by making him do transactions on the basis of informed decisions. As part of SEBI’s efforts to protect investors’ interests, it has initiated many primary market reforms which include improved disclosure standards in public issue documents, introduction of prudential norms and simplification of issue procedures.

Role of SEBI in Preserving the Shareholders’ Interests through Regulation over Intermediaries

One of the main objectives of SEBI is ‘Promotion of efficient services by brokers, merchant Bankers and other intermediaries so that they become competitive and professional.’

Risks are inherent in any competitive market, and investors benefit from competitive markets so therefore management of the intermediaries are required to develop and implement effective processes and management systems commensurate with their business operations and risk characteristics in accordance with the general principles set out in the regulation.

In order to interpose between issuers and investors, regulators recognize various classes of intermediaries in the capital market. Regulation through intermediaries has been found, perhaps more effective in certain spheres of activity. SEBI, over the period, has recognized many types of capital market intermediaries in India. Intermediaries such as merchant bankers, underwriters, debenture trustees, bankers to an issue, registrars to an issue and share transfer agents and portfolio manager are the intermediaries that function in the inter alia in the primary markets. Regulating and registering the workings of such intermediaries’ forms and essential function of the SEBI.

Role of SEBI in regulating Insider Trading

Company insiders have information unavailable to the public. These individuals have firsthand knowledge of what the company is doing and better information concerning what the future might hold. If there are likely problems for the company in the future, such as poor earnings, slow growth, or lawsuits, then insiders can sell their stock before these events happen. When this information becomes public, the stock’s price should decrease. However, this price decrease occurs after the insider has sold his or her shares, thus avoiding the loss. In this case the insider beats the market. On the other hand, insiders know when their company has a bright future, high potential earnings, innovative products being developed, etc. When the future looks bright, insiders can buy shares before the public becomes aware of these facts. The price, later, fully increases to represent the positive information. In both cases, insiders use private information to beat the market.

Earlier, the concept of insider trading was limited to the aspect of a company insider tipping of an outsider and the outsider using the tip and trading in the company’s shares, this constitutes a breach of fiduciary duty owed by the insider to the company’s shareholders; it was called the classical theory of insider trading. Later US Supreme Court in the case

United States vs James Herman O'Hagan

in 1997 extended the scope of insider trading by including the misappropriation theory which said that a person commits insider trading when he obtains material confidential information and uses it in securities transactions in breach of fiduciary duty or similar relationship of confidence to the source of information but not necessarily to the shareholders of the company whose stocks are traded.

It is said that the information captured by insider trading modifies the responsiveness of returns to annual unexpected earnings and also the information captured by insider training differs from that captured by annual unexpected earnings.

Insider trading weakens the confidence of the investor in the fairness and honesty of the securities markets and this is reason SEBI has treated the recognition and suit of insider trading violation as one of its main concern. SEBI’s first enactment to restrain insider trading, namely, SEBI (Prohibition of Insider Trading) Regulations, 1992 did not make much advancement due to poor enforcement. These regulations, again, have been amended substantially over time. SEBI’s current approach centers around prevention of insider trading by requiring listed companies, intermediaries, and advisors to set up internal systems for preventing insider trading and reporting on compliance or otherwise to SEBI. The insider trading regulations provide for disclosure of smaller amounts and provides for disclosure on selling shares (something which the takeover code does not mandate).

Regulation 2 (e) of SEBI (Prohibition of Insider Trading) Regulations defines an ‘insider’ as a person connected or deemed to be connected and who is reasonably expected to have access to any unpublished price sensitive information in respect of securities of a company, or who has received or has had access to such unpublished information.

The directors, officer, employers of the company, & persons involving a professional or business relationship including Charted accountants and legal advisors are connected person as per regulations 2 (c).

The insider trading Regulations provide for disclosure of smaller amounts and provides for disclosure on selling shares (something which the takeover code does not mandate).

Regulation 3 & 3A enumerates the various acts that an insider and company are prohibited to do; these regulations prohibit an insider and a company to ‘deal’ in certain circumstances; The term ‘deal’ is defined under regulation 2(d) which describe dealing in securities to mean an act of subscribing, buying, selling or agreeing to do so by any person either as principal or agent.

The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 1992 requires that a person who is connected with a listed company and is in possession of any unpublished price sensitive information likely to materially affect the price of securities of company, shall not (i) On his behalf or on behalf of any other person deal in securities or (ii) Communicate such information to any other person, who while in possession of such information shall not deal in securities.

“Price sensitive information” means any information which relates directly or indirectly to a company and which if published is likely to materially affect the price of securities of company.

It is thus reasonable to claim that the regulatory framework is fairly comprehensive in its coverage of the securities trade. SEBI has mandated an enormous increase in the flow of information at the time of listing, after listing and relating to the trade. The long history of the functioning of the capital market and securities industry in India suggest that voluntary disclosure may not have become a pervasive trend and that without a regulatory push, there would have been underproduction of information. The cost of transaction and the risk of settlement have been minimized, making Indian stock exchanges one of the safest and the lowest cost securities markets in the world. The Indian mechanism for securities issuance is among the more sophisticated in the world with the introduction of the guidelines for book-building of issues.

The complex web of contracts that govern the issuance process provide a mechanism by which the responsibility for defaults and non-compliance may be affixed on either or both of the important factors in the issuance process, namely, the issuer and the issue manager. Many of the agency problems that affected the securities trade have been addressed through the corporatization and demutualization of securities exchanges.

Significant Developmental & Regulatory Functions

These functions are performed by the SEBI to promote and develop activities in stock exchange and increase the business in stock exchange. Under developmental categories following functions are performed by SEBI:

i. SEBI promotes training of intermediaries of the securities market.

ii. SEBI tries to promote activities of stock exchange by adopting flexible and adoptable approach in following way:

iii. SEBI has permitted internet trading through registered stock brokers.

iv. SEBI has made underwriting optional to reduce the cost of issue.

v. Even initial public offer of primary market is permitted through stock exchange.

vi. SEBI undertakes steps to educate investors so that they are able to evaluate the securities of various companies and select the most profitable securities.

vii. SEBI promotes fair practices and code of conduct in security market by taking following steps:

viii. SEBI has issued guidelines to protect the interest of debenture-holders wherein companies cannot change terms in midterm.

SEBI has achieved considerable progress in terms of detecting and disposing of instances of non-compliance. There have also been concerns that SEBI awards penalties too late and too little in comparison to the financial scale of the infraction. SEBI is also said to have had a poor record in carrying its award through the appellate and the judicial systems.

The regulatory activity of SEBI imposes a cost on issuers. However, in the absence of an analysis that measures the impact of the regulation on the efficiency of the market, it is not possible to assess whether the cost incurred is justified by the benefits. The vigorous pace at which the SEBI Act and SC(R)A have been amended in the last decade in response to the requirements of the equity market— has helped position SEBI to take on new challenges of:

i. Dematerialization of share certificates; The need for this initiative was felt to avoid the threat of forgery or theft of share certificates coupled with inordinate delay by transfer agents and post offices.

ii. Approvals to Foreign Institutional Investors and is consistently revising the FII investment limit in both corporate as well as government debt.

iii. Keeping with the times, SEBI has also introduced e-IPO procedure for electronic bidding in public offers to help investors bid for shares in a cost-effective manner.

iv. SEBI has a web-based centralized grievance redress system called SEBI Complaints Redress System – SCORES for assisting investors to lodge their complaints in a structured way.

Proposed Amendments to the Framework

With effect from May 15th 2015 there is a broadening to the definitions of unpublished price-sensitive information (USPI), insider and connected persons, the legal perspective to have graver consequences for company officials involved in selective exchange of information.

The Budget talks of 2015 proposed the merger of commodity futures market regulator Forward Markets Commission (FMC) with stock market regulator Securities and Exchange Board of India (SEBI), a move intended to strengthen regulation of the 11-year commodities market, facilitate domestic and foreign institutional participation and launch of new products like options. SEBI would therefore find it easier to regulate trading of non-farm products like gold, silver, crude oil and base metals, of which the latter two are traded in the paper form and are non-deliverable.