Friday, October 26, 2012

Rajat Gupta’s Sentencing Order

The order of the United States District Court, Southern District of New York, sentencing Rajat Gupta to 2 years’ imprisonment and US$ 5 million fine for insider trading is one that is carefully crafted and likely to be of significance in sentencing jurisprudence as far as securities law violations are concerned.

The order, pronounced by Judge Rakoff is detailed and well-considered, given that the judge preferred to deviate from the standard sentencing guidelines. More importantly, the case involved a balancing of various considerations and sensitivities that are siginficant not only to Mr. Gupta specifically, but also relevant to the overall impact of enforcing laws against insider trading and other securities laws violations.

One of the questions pertained to the appropriateness of sentencing Mr. Gupta when he did not personally profit from the insider trading. Usually, the amount of profit or gain to the insider or the loss caused to the counterparties or the market is a relevant factor for sentencing. In this case, the court therefore approached Mr. Gupta’s offence from a different standpoint, i.e. the essence of the act committed rather than its impact. Judge Rakoff observed:

The heart of Mr. Gupta’s offenses here, it bears repeating, is his egregious breach of trust.  …  While insider trading may work a huge unfairness on innocent investors, Congress has never treated it as a fraud on investors, the Securities Exchange Commission has explicitly opposed any such legislation, and the Supreme Court has rejected any attempt to extend coverage of the securities fraud laws on such a theory.  … In the eye of the law, Gupta’s crime was to breach his fiduciary duty of confidentiality to Goldman Sachs; or to put it another way, Goldman Sachs, not the marketplace, was the victim of Gupta’s crimes as charged.  Yet the Guidelines assess his punishment almost exclusively on the basis of how much money his accomplice gained by trading on the information. At best, this is a very rough surrogate for the harm to Goldman Sachs.

The other sensitive consideration pertained to Mr. Gupta’s background, past track-record and his previous impeccable reputation. The defence relied upon letters from various luminaries speaking to his conduct. Judge Rakoff was required to balance this factor against the grevious nature of the insider trading offence and its impact on the financial markets. Although this was weighed carefully, it was not sufficient for Mr. Gupta to avoid a jail sentence altogether. The careful process through which the court came to this conclusion cannot be expressed any better than in the powerful words of Judge Rakoff, which are worthy of extracting at some length below:

… The Court can say without exaggeration that it has never encountered a defendant whose prior history suggests such an extraordinary devotion, not only to humanity writ large, but also to individual human beings in their times of need. …

But when one looks at the nature and circumstances of the offense, the picture darkens considerably. In the Court’s view, the evidence at trial established, to a virtual certainty, that Mr. Gupta, well knowing his fiduciary responsibilities to Goldman Sachs, brazenly disclosed material non-public information to Mr. Rajaratnam at the very time, September and October 2008, when our financial institutions were in immense distress and most in need of stability, repose, and trust. …

So how does a court balance these polar extremes? …

As to specific deterrence, it seems obvious that, having suffered such a blow to his reputation, Mr. Gupta is unlikely to repeat his transgressions, and no further punishment is needed to achieve this result.  General deterrence, however, suggests a different conclusion.  As this Court has repeatedly noted in other cases, insider trading is an easy crime to commit but a difficult crime to catch.  Others similarly situated to the defendant must therefore be made to understand that when you get caught, you will go to jail.  Defendant’s proposals to have Mr. Gupta undertake various innovative forms of community service would, in the Court’s view, totally fail to send this message.  Moreover, if the reports of Mr. Gupta’s charitable endeavors are at all accurate, he can be counted on to devote himself to community service when he finishes any prison term, regardless of any order of the Court.

At the same time, no one really knows how much jail time is necessary to materially deter insider trading; but common sense suggests that most business executives fear even a modest prison term to a degree that more hardened types might not.  Thus, a relatively modest prison term should be “sufficient, but not more than necessary,” for this purpose.

Thursday, October 25, 2012

Paper on Shareholder Activism

Two years ago, any talk of shareholder activism in India would be brushed aside or even ridiculed. But, since then, things seem to have changed rapidly. The last couple of years have witnessed shareholders in Indian companies becoming more active and assertive. This space has also seen the proliferation of proxy advisory firms and other corporate governance intermediaries that have aided such activism.

All of these generated some curiosity in my mind, and I attempted to look into these developments with two objectives:

(i) to track the developments and trends that are emanating in India with respect to shareholder activism; and

(ii) to set out some basic observations on whether at all these activist measures are likely to have an impact on corporate governance in India.

The findings thus far are contained in a working paper titled “The Advent of Shareholder Activism in India” that I have posted on SSRN. The abstract is as follows:

The recent spate of crises afflicting the corporate and financial sectors around the world has triggered a new wave of corporate governance reforms, which call for greater empowerment of institutional and retail shareholders. The need for such reforms cannot be greater than in India where controlling shareholders, or promoters, dominate the corporate landscape.

Consistent with reforms in several countries that seek to confer greater power in the hands of shareholders, the recent regulatory developments in India signify a greater opportunity for shareholder participation in the form of postal ballot, e-voting and the like. The rapid proliferation of proxy advisory firms, a hitherto non-existent phenomenon in India, bestows shareholders with the advice necessary to exercise their corporate franchise in an informed manner. The presence of activist institutional shareholders such as private equity funds and hedge funds has already caused an upheaval in some corporate boardrooms in India.

While these developments pave the way for a transformation in the tenor of the governance debate, shareholder activism encounters certain structural and institutional weaknesses embedded in the Indian markets. The dominance of controlling shareholders in most Indian companies operates to dampen the effects of shareholder activism. The legal system and institutions in India are not conducive to rendering timely and cost-effective remedies to shareholders who adopt a litigation strategy to counter managements that are perceived to act inimical to shareholder interests. This paper finds that although shareholder activism is becoming palpable in the Indian markets, its impact as a measure of corporate governance enhancement is far from clear.

Readers’ comments and critiques are welcome.

Wednesday, October 24, 2012

World Bank’s Doing Business 2013

The World Bank and IFC have published the Doing Business report and country rankings for the year 2013. India still remains at 132 with no signs of overall changes, although its position has improved on some of the parameters, while it has fallen on several others. India’s country report is available here.

As these newspaper reports also suggest (here and here), India’s ranking is below its neighbours and also other BRICS economies.

Monday, October 22, 2012

Regulatory Reforms in the Capital Markets

SEBI has taken steps in the last few weeks to bring about reforms in the capital markets, particularly in the primary market segment.

The first set of reforms essentially gives effect to decisions taken at SEBI’s board meeting on August 16, 2012. These include matters relating to both the equity markets, where the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009 have been amended, and to the debt markets, where the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 have been amended.

The more contentious set of reforms relates to additional protection that SEBI has sought to offer investors in initial public offerings (IPOs). This is by way of two measures,

(i) a proposal for a mandatory safety net mechanism by way of a discussion paper; and

(ii) the issue of the SEBI (Framework for Rejection of Draft Offer Documents) Order, 2012 that deals with specific circumstances where SEBI is entitled to reject an offer document.

These reforms have generated a substantial discussion, principally on the ground that a safety net mechanism takes away the equity risk of an investor, and that the guidelines on rejection of offer documents effectively introduces merit-based regulation of capital markets that was done away with the abolition of the Controller of Capital Issues (CCI) following the liberalised economic policies introduced in 1991.

A detailed discussion and analysis of these proposals are available at the following sources:

- Somasekhar Sundaresan in Business Standard;
- Report in the Economic Times; 
- Discussion in the Financial Express; and
- Discussion on The Firm – Corporate Law in India.

Saturday, October 20, 2012

IPR, Infringement and Remedies: Review of Ananth Padmanabhan's book

A striking feature of Mr Ananth Padmanabhan’s recent book is the close attention it pays to concepts of intellectual property law. It is in the last decade or two that India has witnessed an explosion in intellectual property litigation; and it is generally the case that the shape of the law is formed by the answers the courts give, in the early years, to the conceptual questions that are at its heart. Ananth’s book opens with an analysis of the nature of injunctive relief, and contains a valuable account of the way in which American Cyanamid has been understood in the English and Indian courts (pp 29-31, especially the analysis of Cayne [1984] 1 All ER 225). The importance of this subject is heightened by the fact that the interlocutory battle is typically the end of the dispute in the Indian courts, especially in a field, such as intellectual property, in which a money award is often inadequate. The book’s title (Infringement and Remedies) reflects this fact.

The rest of the book is devoted the main types of IPRs – trademark, copyright, patent, design and common law rights. Each chapter contains a comprehensive account of the law on the subject, and especially valuable is the author’s analysis of the controversial questions. I highlight a few of these in the areas of trademark and copyright. In the chapter on trademark, the author considers whether the Madras High Court in Aravind Laboratories was correct to distinguish between the “classical trinity” test and other tests to establish passing off (pp 62-64). He rightly points out while it is common to pursue remedies for infringement and passing off in respect of the same act of the defendant, the focus of passing off is different, since it is a specialised form of the tort of deceit.

The chapter on copyright is undoubtedly the book’s tour de force. The author begins by rightly pointing out that the care with which Parliament has divided copyright into its constitutive categories in section 14 is no accident; the structure of the provision contains important clues as to the nature and width of each type of work (p 290). The chapter thereafter contains a deep and careful analysis of some of the most important questions in Indian copyright law today: copyrightability, in light of the Supreme Court’s decision in EBC v Modak (2008) 1 SCC 1 (p 291 et seq, see in particular the author’s analysis of the American and Canadian law at p 296); tests for determining infringement (p 307 et seq); the nature of a cinematograph film copyright (p 328) and the fair use defence. It is worth highlighting the author’s views on two of these issues: first, he rightly points out that an imitation of a cinematograph film (for example, a new Harry Potter film series with exactly the same actors) is not a “copy” of a film under section 14(d)(i) (as the Bombay High Court has pointed out in Leo Burnett 105(2) Bom LR 28, a “copy” is a duplicate, not an imitation); secondly, he argues that the Copyright (Amendment) Act, 2012 has “misfired”, because the legislature has failed to confer any positive right through the amendment, and has attempted to “save” rights which do not otherwise exist. It is no doubt tempting to conclude that Parliament would not legislate without purpose, but one hopes the courts resist this temptation: the author’s view that the amendment has misfired must stand or fall on the text of the amendment, properly construed, and not on the subjective aspirations of those who enacted it (pp 318-322).

It must also be said that the final chapter on common law rights is of invaluable assistance to any practitioner. In particular, the author’s analysis of the springboard doctrine, which has recently been the subject of litigation in the English courts, is a reminder that the Indian law on this point has some way to go to acquire a coherent shape.   

Ultimately, this is a book that is as useful for the practitioner as it is for the academic and the student; it offers, in equal measure, a fully comprehensive description of the law with a reference to virtually every important case on the point, and analysis of the conceptual questions that shed light on the nature of the question at issue. Published by LexisNexis, it is available here and here.

Wednesday, October 17, 2012

AIF Regulations: Meaning of Ownership Interests and Investor Interests in a Company – Part III

[The following post is the last of the series contributed by Vinod Kothari and Soma Bagaria. The authors can be reached at and respectively. The first two posts in the series can be found here and here.]

In India, a company form of a fund is not very prevalent because of several constraining and restricting reasons. Some of those can be summarized as hereunder:

1.             Separation of management and investment

As can be noted, a scheme or a fund contemplates management by an external manager and does not constitute an in-house management mechanism. Where the funds are privately pooled for a common purpose and managed in-house on the bases of a private arrangement, agreement or understanding, it cannot be construed as an AIF.

The intention of SEBI is clear: (a) to protect interests of the investors; and (b) ensure proper management of the capital of the investors. Where there is no public money involved, SEBI clearly cannot have any intent to monitor.

2.             Difficulties with a company form of AIF

Despite the flexibility in organisational form that might have been SEBI’s objective in giving the choice of the organisational form, the company form is eminently unsuitable for an AIF. Reasons are several.

First, Category III AIFs may be open-ended. In case of companies, open-ended company would mean free buyback of shares of a company, which is not permissible under the Companies Act, 1956 where buyback of shares by a company is restricted.

Second, whether closed-ended or open-ended, most AIFs have a limited life span – in case of companies, thinking of taking the company to winding up will be an extremely protracted exercise.

Third, in addition to the above, there are entry and exit norms applicable under the FDI policy, which do not apply in case of LLPs and trusts.

Last, needless to mention the continuous compliance issues associated with a company.

The reason why the corporate form might have made sense elsewhere in the world is that the US regulation (Investment Company Act) is an overarching law on all investment companies. In India, the idea of SEBI could not have been to regulate investment companies.

Our recommendation will be that companies should be completely excluded from the AIF regulations, or it should be clarified that in case of companies, only such part of investment corpus as is different from the share capital of the company is counted as size of the AIF. In case of LLPs, general partners are in the nature of owners/managers of the LLP, while limited partners are external investors. The AIF Regulations should be focused only on the limited partners’ investments.


- Vinod Kothari & Soma Bagaria

Tuesday, October 16, 2012

AIF Regulations: Meaning of Ownership Interests and Investor Interests in a Company – Part II

[The following post is part of the series contributed by Vinod Kothari and Soma Bagaria. The authors can be reached at and respectively. The first post of the series can be found here.]

As the AIF Regulations are unclear on the extent of its applicability in case of companies, guidance can be sought from other jurisdictions.

1.             United States

In the US, the Investment Company Act, 1940 (“US Act”) regulates an investment company, which has been defined as an issuer of securities that:

(a)           is, holds itself out to be, or proposes to be engaged primarily in the business of investing, reinvesting, or trading in securities;

(b)          is engaged or proposes to engage in the business of issuing face amount certificates of the instalment type, or has been engaged in this business and has such a certificate outstanding; or

(c)           is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of government securities and cash items) on an unconsolidated basis.

The Financial Accounting Standards Board (“FASB”) sets out the following criteria for determination of an ‘investment company’:[1]

1. An investment company is an entity that does both of the following:

a.    Obtains funds from an investor or investors and provides the investor(s) with professional investment management services

b.    Commits to its investor(s) that its business purpose and only substantive activities are investing the funds for returns from capital appreciation, investment income, or both.

2. An investment company and its affiliates do not obtain or have the objective of obtaining returns or benefits from their investments that are either of the following:

a.    Other than capital appreciation or investment income.

b.    Not available to noninvestors or are not normally attributable to ownership interests.” [emphasis supplied]

Of course, the above criteria are only indicative and cannot be construed as a litmus test for determination of an investment company. However, it is pertinent to note that a clear distinction has been made between the investment interest and ownership interest, the latter being excluded as an investment company.

2.             United Kingdom

Section 235 of the Financial Services and Markets Act, 2000 defines a collective investment scheme to mean:

any investment arrangements with respect to property of any description, including schemes, money, the purpose or eect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income.

It has been further stated that the participants in such scheme shall not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions.

Furthermore, both of the following characteristics shall be satisfied:

(a)           the contributions of the participants, and the profits or income out of which payments are to be made to them, shall be pooled; and

(b)          the property shall be managed as a whole by or on behalf of the operator of the scheme.

Therefore, a collective investment scheme is an arrangement that enables a number of investors to pool their assets and have these professionally managed by an independent manager.[2] The segregation between management and investors, therefore, is quite clear.

3.             European Union

The Directives relating to undertakings for collective investment in transferable securities (“UCITS Directive”)[3] excludes a collective investment undertaking undertakings of the closed ended type from the purview of the UCITS Directive.[4] In other words, a closed-end vehicle, which is what all companies are, is completely excluded from the UCITS Directive.

The Directive on AIF Managers by the EU Committee of the House of Lords, AIF was defined to include hedge funds, private equity funds, venture capital firms, commodities and real estate funds.[5]

4.             Singapore

The Securities and Futures Act (Cap 289) of Singapore defines a collective investment scheme to mean:

(a) an arrangement in respect of any property —
(i) under which —
(A) the participants do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions in respect of such management; and
(B) the property is managed as a whole by or on behalf of a manager;
(ii) under which the contributions of the participants and the profits or income from which payments are to be made to them are pooled; and

but does not include —
(i)   an arrangement operated by a person otherwise than by way of business;
(ii) an arrangement under which each of the participants carries on a business other than investment business and enters into the arrangement solely incidental to that other business;
(iii)         an arrangement under which each of the participants is a related corporation of the manager;
(x) a closed-end fund constituted either as an entity or a trust;

Here again, one would notice a complete exception carved for closed-end funds, which would include all investment companies.

(to be continued)

- Vinod Kothari & Soma Bagaria

[1] See Investment Companies Summary of Decisions Reached to Date During Redeliberations as of September 5, 2012. Available at: (last visited on October 10, 2012)
[2] (last visited on October 11, 2012)
[3] Directive 2009/65/EC of the European Parliament and of the Council. Available at: (last visited on October 10, 2012)
[4] Article 3(a) of the UCITS Directives.

Monday, October 15, 2012

AIF Regulations: Meaning of Ownership Interests and Investor Interests in a Company – Part I

[The following is the first in a series of posts contributed by Vinod Kothari and Soma Bagaria. The authors can be reached at and respectively]

1.          BACKGROUND

There has been a speculation and confusion regarding the extent of applicability of the SEBI (Alternative Investment Fund) Regulations, 2012 (“AIF Regulations”), particularly in the case of alternative investment funds (“AIFs”) set up as companies. It is notable that the AIF Regulations permit an AIF to be organised either as a company, a limited liability partnership (“LLP”), or a trust. In case of the SEBI (Venture Capital Funds) Regulations, 1996, the options of organising a fund as a company, trust or a body corporate were available. However, most venture capital funds were actually orgnaised as trusts.

The difficulty arises from a reading of the definition of an AIF, and is further compounded by the definition of “units”. Regulation 2(1)(b) of the AIF Regulations defines the term an AIF to mean, subject to the exceptions set out therein, any fund established or incorporated in India in the form of a trust or a company or an LLP or a body corporate which:

(a)        is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors; and

(b)        is not covered under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities.

The AIF Regulations do not define the word “investor”. However, the definition of the term “unit” includes shares, and therefore, every shareholder becomes a unitholder, and by extension, an investor. If, therefore, every shareholder of a company is taken to be an investor, then every company, other than a listed public company, irrespective of what business the company carries on, is a privately pooled vehicle which collects money from its sareholders to be used in a particular manner. The question that, therefore, arises, and in relation to which no clarification has been issued by SEBI, is whether all privately pooled capital, such as contribution of ownership capital to a company, would fall within the purview of the AIF Regulations.

If any application of funds by a company is taken to be covered by the expression “investing it in accordance with a defined investment policy”, then every company becomes an AIF. And if the expression “investing it in accordance with a defined investment policy” is taken to mean investments as commonly understood, then every investment company becomes an AIF. There are thousands of investment companies registered with the Reserve Bank of India (“RBI”) and yet other  thousands which are not registered. Obviously, the idea of AIF Regulations could not have been to bring all such investment companies, currently under RBI’s non banking finance company regime, also under AIF Regulations. If the idea of the AIF Regulations was to include only such funds as companies gather and manage other than shareholders’ money, then that meaning is not at all clear from the extant definition of either AIF or units.

2.          WHAT IS REGULATED?

SEBI intends to regulate a pooling vehicle which essentially pools capital from various investors and investing such capital in accordance with defined investment policy. The idea is to ensure benefit to the investors.

Who are investors? The Black’s Law Dictionary (9th Edition) defines an investor as a buyer of a security or other property who seeks to profit from it without exhausting the principal, i.e. a person who spends money with an expectation of earning profit. Under common parlance, investors are outsiders who are neither the owners of the pooling vehicle, nor are they the managers. Therefore, it makes good sense to have excluded owners and managers.

2.1       Meaning of investment

The Blacks’ Law Dictionary (9th Edition) defines investment to mean expenditure to acquire property or assets to produce revenue, a capital outlay. Furthermore, P Ramanatha Aiyar’s, The Law Lexicon, (3rd edition) has also similarly defined the term investment to signify the laying out of money in such a manner that it may produce a revenue, whether the particular method be a loan or the purchase of stocks, securities, or other property.[1]

The term investment is defined in the Accounting Standard AS 13 as assets held by an enterprise for earning income by way of dividends, interest and rentals, for capital appreciation, or for other benefits to the investing enterprise and assets held as stock-in-trade are not investments.

It is true that behind every outlay of capital the ultimate purpose is to earning revenue. However, there is a difference in the intentions and purposes while outlaying capital (a) by way of an ownership capital and (b) solely with the purpose of earning profit.

To our understanding where two or more persons come together with a common objective and work together to pursue that common objective, it cannot be said to constitute an AIF. There is an element of control is present in an ownership interest.

2.2       Key determinants of an AIF

The key deciding factors, as set out in the definition, are:

(a)        a privately pooled investment vehicle;

(b)        collection of funds from investors;

(c)        investment made in accordance with a well defined investment policy; and

(d)        investments are made for the benefit of the investors.

Therefore, funds are collected from investors on a private placement basis which are invested in accordance with an investment policy is drawn with an idea to earn returns in form of dividends, etc., for the benefit of the investors.

In an ownership capital scenario, the primary benefit is attributable to the entity (the company or a LLP, for instance) and the purpose is the growth of such entity. Furthermore, unlike an AIF, there are no third party funds involved.

(to be continued)

- Vinod Kothari & Soma Bagaria

[1] In case of Surat Peoples’ Co-Operative Bank v. CIT, 1958 33 ITR 396 Bom, it was stated that the word “investment” in itself literally means nothing more or less than to lay out money; and, therefore, where a person purchase securities whether as his stock-in-trade or by way of capital investment, he is in either case investing in securities.