Sunday, September 7, 2014

The Securities Laws (Amendment) Act, 2014 – A Critical Analysis

[The following guest post is contributed by Mubashshir Sarshar, who is a lawyer and an alumnus of National Law University Delhi. The author can be reached at]

Two standalone incidents within a span of one year have managed to change the entire paradigm of the securities market transactions in India. The Sahara and Saradha episodes symbolised the stark loopholes that existed in the regulatory regime controlling the affairs of securities market transactions in India.

While a slew of legislative changes were brought into company law in the form of Chapter III, Part II of the Companies Act, 2013 in line with the Supreme Court judgment[1] to tackle the interpretation of ‘private placement’ given by Sahara.

As for Saradha, since the Parliament was not in session, the President after being satisfied about the gravity of the situation used his emergency law making powers and promulgated an ordinance three times in a row to tackle the situation in the interim. After the expiration of the third ordinance, a Bill was tabled in the monsoon session of the 16th Lok Sabha to give legislative sanctity and to amend certain unilateral provisions contained in the said ordinance. The Bill reinstated certain provisions in the SEBI Act, digressing from the Ordinance to an extent, in order to include a check and balance mechanism for the regulatory authority i.e. SEBI. The Parliament passed the Bill in the first week of August after which it received the assent of the President on 22 August 2014 and was simultaneously published in the official gazette to bring the Securities Law (Amendment) Act, 2014 (“Act”) into force.

As the recital of the Act provides, it is a legislation to amend and plug the existing loopholes in three cardinal legislations controlling the securities market transactions in India, namely the Securities and Exchange Board of India (SEBI) Act, 1992, the Securities Contracts (Regulation) Act, 1956 and the Depositories Act, 1996.

Although, certain reforms introduced under the Act have already been discussed in a previous post when the provisions were in the form of a Bill, the following are certain predicaments which could potentially become a point of judicial interpretation and construction in the days to come.

1.         Power to SEBI to seek permission for search and seizure from a designated Court/Magistrate in Mumbai

The erstwhile Section 11C (8) of the SEBI Act provided that in case the investigative authority had any reasonable ground to believe that any documents associated with securities market may be destroyed, it may make an application to a Judicial Magistrate of the first class having jurisdiction for an order for the seizure of such documents. Further, there were certain other pre-qualifications prescribed under the said section before a magistrate could authorize such search and seizures.[2]

The Ordinance on the other hand removed all such impediments and gave the Chairman of SEBI unfettered powers to authorize the search and seizures without any prior judicial approval.

However, the Act now reinstates the erstwhile position with a minor change,[3] requiring SEBI to approach a Magistrate or Judge of a designated court in Mumbai as may be notified by the Central Government before undertaking the operations.

This is positive step from the erstwhile position as pointed out by the Finance Minister in his introduction to the Bill in the Lok Sabha,[4] stating that while approaching a magistrate of an area where the search was to be conducted, the whole issue would become public and the purpose of a search was defeated as secrecy was an essential element of any search operation. On the other hand, power in the hands of executives without any safeguards is bound to be abused. Hence, the check and balance approach promulgated under the Act is a welcome step.

However, the latest position of the government to designate special magistrates/judges from where a sectoral regulator could obtain permission before conducting a search and seizure operation could have repercussions and judicial scrutiny of other sectoral regulators especially that of the Income Tax authorities under Section 132 of the Income Tax Act, 1961 and more recently that of the Competition Commission under the proposed Section 41(3) of the Competition (Amendment) Bill, 2012.

2.         Excessive delegation of power to SEBI with regard to Collective Investment Schemes

Under Section 11AA of the SEBI Act, two addendums have been added by the Act. The first one being a proviso to sub-section (1) which essentially brings under SEBI’s purview any corpus of funds amounting to Rs. 100 crore or more which is not regulated by any other sectoral regulator and the second one being a new sub-section (2A) which allows SEBI to frame regulations for any scheme to be considered as a collective investment scheme, without prescribing any guidelines on the criteria that SEBI may use to formulate such regulations.

Both these addendums, in my opinion invite huge ramifications for SEBI so far so it is not able to clearly cull out what ‘pooling of funds’ would be deemed to mean and what would constitute a collective investment scheme apart from the four attributes specified under the present Section 11AA(2) of the SEBI Act.

Further, if the delegated authority provided to SEBI to frame regulations for collective investment scheme is tested on the anvil of constitutionality and in the backdrop of the Supreme Court judgment in the case of In Re Delhi Laws Act,[5] it might be considered as a case of excessive delegation of power.

3.         Power of Disgorgement

A new sub-section in the form of sub-section (5) under Section 11 of the SEBI Act has been inserted by the Act to provide that any amounts collected through disgorgement (repayment) i.e. amount of profit made or the loss averted in the said fraudulent transaction, after an issuance of a direction under Section 11B of the SEBI Act or Section 12A of the Securities Contracts (Regulation) Act, 1956 or Section 19 of the Depositories Act, 1996 would be credited to the Investor Protection an Education Fund (“IPF”).

However, again the formulation of a framework to utilise such disgorged funds has been bestowed on SEBI. In my opinion, the amount credited in the IPF should primarily be used to recoup the innocent investors who would have a rightful claim to such amounts.

From the standpoint of SEBI, this addition has lent a fresh lease of life to disgorgement orders because of the clarity in the law that it has offered and the days to come should see SEBI come at par with the US Securities Exchange Commission (SEC) in terms of utilising disgorgement orders to effectively curb securities market malpractices.

4.         Securities Appellate Tribunal’s (“SAT”) power with regard to settlement proceedings

There is a significant change in the position of law with regard to SAT’s power to adjudicate upon an appeal from an order passed by SEBI under settlement proceedings.

The erstwhile Section 15T sub-clause (2) of the SEBI Act essentially provided that no appeal shall lie with the SAT when an order was made by SEBI with the consent of both the parties. However, both, the Ordinance as well as the Act has omitted the concerned sub-section and replaced it with a new addendum in the form of Section 15JB sub-clause (4) which provides that no appeal shall lie against any order passed by SEBI in settlement proceedings.

In my opinion, such a restriction under the new provision would also come under severe judicial scrutiny because once a party receives an adverse order from SEBI under the settlement proceedings and the SAT refuses to entertain the matter for want of jurisdiction, the natural course of action followed would be to file a writ petition before a High Court under Article 226 of the Constitution or challenge the said provision to be unconstitutional before the Supreme Court under Article 32 of the Constitution.

5.         Establishment of Special Courts

A set of new provisions in the form of Section 26A to 26E has been inserted by the Act, which provides for the establishment of Special Courts for speedy trial of all offences committed under the SEBI Act. The Special Court would consist of a single judge appointed by the Central Government with the concurrence of the Chief Justice of High Court within whose jurisdiction the judge to be appointed is working. The Special Court would however, only serve as a Court of Sessions under the jurisdiction of the designated High Court.

This amendment is in line with Section 435 of the Companies Act, 2013 which also provides for the establishment of special courts to deal with all offences under the Companies Act. One could assume that the idea behind this move by the government to designate special courts to deal with offences under a particular statute is to provide a more efficient and specialized system of judicial functioning.

However, in my opinion, the legislature has left a lot of leeway for supposition, as to the rationale for creating a fast track feeder within the criminal justice system, which is not created by the judiciary but at the discretion of the executive. Although, in the backdrop of the vast number of securities frauds’ surfacing of late, such a step is seen in a positive light by the various stakeholders.

- Mubashshir Sarshar

[1] Sahara India Real Estate Corporation Limited & Ors v. Securities and Exchange Board of India & Anr, Civil Appeal No. 9813 and 9833 of 2011.
[2] Proviso to Section 11C (9) of the SEBI Act.
[3] Section 5 of the Act.
[4] Lok Sabha Debates, August 5, 2014.
[5] 1951 2 SCR 747.

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