Friday, July 31, 2015

Composite Caps for Foreign Investment Formalized

We had earlier discussed the Union Cabinet’s decision to create composite caps for foreign investment under various categories. That decision has now been formalized in the form of Press Note No. 8 of 2015 issued by the Department of Industrial Policy & Promotion, Government of India (“DIPP”).

In the previous post, we had highlighted two outstanding issues from the Cabinet decision that were left somewhat ambiguous. They have now been clarified in the Press Note.

The first issue relates to whether composite caps apply to the banking and defence sectors. Although the press release of the Cabinet decision seemed to include all sectors within the composite caps, subsequent press reports based on ministerial announcements suggested that the banking and defence sectors were to be kept outside the purview of the composite caps. That has now been confirmed in the Press Note. In the banking sector (in item, foreign investment is allowed up to 74%, but foreign portfolio investment is allowed only up to 49%. In the defence sector (in item, foreign investment is allowed up to 49%, but portfolio investment only up to 24%).

The second issue arose because the Cabinet decision specified that “portfolio investment, upto aggregate foreign investment level of 49%, will not be subject to either government approval or compliance of sectoral conditions, as the case may be” so long as ownership and/or control is not transferred to non-resident entities. This would have an impact on sectors that are currently eligible for foreign investment of less than 49%, that too under the Government route. Examples of this include terrestrial broadcasting (FM radio), news and current affairs TV channels and print media (news and current affairs) where foreign investment is permitted up to 26% under the Government route. The implications of the present change on these sectors were somewhat unclear. Now, Press Note clarifies that portfolio investment under the automatic route is available “upto aggregate foreign investment level of 49% or sectoral/statutory cap, whichever is lower”. Hence, in case of sectors where overall foreign investment is allowed up to less than 49%, that lower limit will continue to apply.

Participatory Notes

[The following guest post is contributed by Rishi A, a fourth year student of Hidayatullah National Law University]


The Supreme Court appointed Special Investigations Team (“SIT”), in its report on how best to curb black money, made a number of recommendations. One of these was to check the misuse of participatory notes (“p-notes”). When the markets opened on the following Monday, the fear caused by the possible government action on investments through p-notes saw the Indian stock markets decline by 2%.

The Securities and Exchange Board of India (“SEBI”) had permitted the issuance of p-notes in 1992, following the ‘balance of payments’ crisis in 1991, to encourage foreign investments. P-notes are instruments used by foreign funds, not registered in India, for trading in the domestic market. Issued by Foreign Institutional Investors (FIIs), they are a derivative instrument issued against an underlying security which permits the holder to share in the capital appreciation/income from the underlying security. As an Expert Group has noted, p-notes are like contract notes, issued to their overseas clients who may not be eligible to invest in the Indian stock markets. At last count, Rs. 2.75 lakh crore came in through p-notes, representing around 11.5% of the total assets held by foreign portfolio investors.

It is believed that p-notes generally attract four kinds of investors, (1) ones who are looking for attractive returns, (2) foreign governments/entities who want to invest to acquire/control Indian entities by taking them over, (3) terror financiers, and (4) people, including politicians, trying to generate profits by investing their black money in these instruments. While the first two types could encourage/ stimulate a healthy market, the other two kinds are the ones that need to be curbed.

Regulatory Approach to P-Notes

The Reserve Bank of India (“RBI”) has always been against the idea of p-notes. Raising the concern of the hidden identities of the investors, it feared that further trading of p-notes will lead to ‘multi-layering’ and therefore, it would become impossible to tell who the actual beneficiary is of the investment. Once, a p-note is acquired by a foreign investor from an FII, it gets re-bought/re-sold by various other foreign investors creating layers of beneficial owners. This is also commonly referred to as the problem of ‘multi-layering’. Believing that restrictions of suspicious flows would  enhance the reputation of markets and lead to healthy flows, the RBI has stated over and over again, following the recommendations made by the ‘Tarapore Committee’, that they should be banned.

However, SEBI has sought to place stricter rules for p-notes on an ongoing basis, but has refused to shun it so far. Initially, FIIs dealing in p-notes were required to submit an undertaking stating that the offshore derivative instrument (“ODI”) issued to the person and its beneficial owner were in compliance with Regulation 15A of SEBI (Foreign Institutional Investors) Regulations, 1995. Regulation 15A required that the FIIs issue these ODIs or p-notes only to ‘entities which are regulated by any relevant regulatory authority in the countries of their incorporation or establishment, subject to compliance of “know your client” requirement’. Thus, they also had to ensure that the know-your-customer (“KYC”) compliance norms had been complied with by the beneficial owner of the ODI.[1] However, this requirement proved to be quite ineffective when considering the number of times the p-note could change hands. The multi-layering caused by these investments made identifying the actual/ final beneficial owner extremely difficult.

The regulations regarding the issuance of ODIs were subsequently revamped, and henceforth, as per Regulation 22(4), any issuances of ODIs, like p-notes, under the SEBI (FII) Regulations, 1995, before the commencement of these set of regulations, would be deemed to have been issued as per the SEBI (Foreign Portfolio Investors) Regulations, 2014. These new norms restrict certain categories of FPIs from investing in ODIs. They also place the burden on the FPIs/ FIIs to make sure that the instruments are not sold to anyone who is not regulated by an appropriate foreign regulatory authority.[2]Furthermore, p-notes cannot be issued by a resident of a country identified by Financial Action Task Force as a ‘jurisdiction having a strategic Anti Money Laundering or Combating the Financing of Terrorism deficiencies to which counter measures apply’. SEBI also has all the powers to obtain information regarding the final holder/beneficiaries or of any holder at any point of time in case of any investigation or surveillance action. FPIs/ FIIs will thus be obliged to provide the information to SEBI.[3]Additionally, while stating that two or more p-note subscribers with the same beneficiary would be considered as one subscriber, the market regulator has also said that fund structures need to be transparent, failing which they will not be allowed.

At this juncture, it will be interesting to point out that SEBI later went on to clarify in their FAQs that the unregulated funds under the FII regulations, which were no longer eligible under the FPI regulations, could continue under the FPI regime.[4] Had SEBI refused to let these unregulated funds continue, it would have resulted in a large withdrawal of investments from the market, which could have possibly led to a market crash. Regulation 15A of the FII regulations states that any entity, who has already been issued an ODI, prior to February 3, 2004, but does not meet the eligibility criteria under clause (1), the contracts for such transaction would expire on the maturity of the transaction or within a period of five years fromFebruary 3, 2004, whichever is earlier.[5] This would mean that all unregulated funds, to transact in the future, would have to fulfil the KYC requirements laid down.

The SIT Report

The Third SIT report suggested that all details of the ‘beneficial owner’ must be disclosed in accordance with the KYC norms. Thus, in case the p-notes change hands, SEBI can still identify the ‘final beneficial owner’. And if these final beneficial owners end up being a company, then the details or information of its promoters/ directors must be obtained. It went on to further recommend that to avoid multi-layering the regulator should establish norms that will encourage investors to purchase p–notes issues afresh, instead of buying them from an existing owner.[6] The SIT strongly suggested that the Securities and Exchange Board of India (SEBI) put in place more stringent regulations to help identify individuals holding p-notes or other ODIs, and take other steps required to curb black money and tax evasion through the stock market route.


P-note holders find it conducive to side-step the capital gains tax (CGT) that is normally levied on the sales of any stocks/ securities on the stock exchange. In practice, p-notes are just taxed once, that is when they are finally sold from the FIIs account, but the numerous times that the p-notes may change hands in the middle, escapes getting taxed.

Moreover, when considering capital inflows, due to the above stated provisions of the SEBI (FPI) Regulations, 2014, they could see a large dip as most offshore investors who would want to invest in p-notes in India may no longer wish to do so for reasons such as not being incorporated in a jurisdiction recognised by SEBI. This could affect the investments made in p-notes. While, this might sound like a desirable phenomenon, it is important to keep in mind that majority of foreign portfolio investments in India are made in ODIs or p-notes.[7] It is estimated that the notional value of p-notes is somewhere around $90 billion.

In the author’s opinion what must be considered instead, is to, firstly, place stricter regulations regarding the information to be disclosed, via KYC Compliance norms, by not just the FIIs/FPIs but also the investors purchasing the p-notes, so that identities can be easily established when needed. The 2004 amendment in the FII regulations placed a compulsory maturity period of 5 years: this would effectively stop the issuance of ODIs/ p-notes to entities who have not complied with the KYC norms as provided for by clause (1) of Regulation 15A.[8]Therefore, this could prove to be a step towards transparency as now clients/ entities would have to disclose their identity and other information, to further transact in the future. Also, like stated by the SIT, SEBI must consider making p-notes more available for direct purchase, so that the inter-changing of the notes between people can be stopped. If the above stated recommendation can be implemented, then the issue of tax evasion would diminish, but in the chance that it is not, taxation will remain an issue. SEBI must consider implementing measures that will stop ‘cross-cutting’ that allows people to take their black money outside the country and subsequently, reinvest the same amount in p-notes. This will also require some heavy restrictions on ‘hawala’.

Secondly, with regard to RBI’s opinion to ban P-notes outright can prove to be harmful for the Indian market. In a market where 50% of the foreign institutional investment is through p-notes, any ‘knee-jerk’ reaction like a ban of the instrument, can spook the foreign investors and thus poses a huge systemic risk. An investor in that case, would immediately withdraw their investment made in the market, which could lead to the collapse of the entire market. What must be considered instead is to slowly phase out p-notes and simultaneously, provide other lucrative instruments, where regulation is not an insurmountable issue as in the p-notes, for the investors to invest in? This will provide an alternate avenue for the investors to invest their funds.­­­­

- Rishi A

[1] SEBI Circular CIR/IMD/FIIC/2011, January 17th, 2011, available at: (July 28th, 2015)

[2] Regulation 22(2), SEBI (FPI) Regulations, 2014.

[3] Regulation 22(3), SEBI (FPI) Regulations, 2014.

[4] Q.70, Frequently Asked Questions (FAQs), SEBI (Foreign Portfolio Investors) Regulations, 2014, available at: (July 28th, 2015).

[5] Regulation 15A (1), SEBI (FII) (Amendment) Regulations, 2004.

[6]‘Recommendations of SIT on Black Money as contained in the Third SIT Report, Press Information Bureau, Ministry of Finance, Government of India, July 24th, 2015, available at: (July 28th, 2015).

[7] Mohan, TT Ram. "Neither Dread Nor Encourage Them." Economic and Political Weekly (2006): 95-99.

[8] SEBI (FII) (Amendment) Regulations, 2004.

Thursday, July 30, 2015

Secretarial Standards – 1: Circulation of Signed Board Minutes

[The following guest post is contributed by Nivedita Shankar, Partner, Corporate Law Division at Vinod Kothari & Co.]

Paragraph 7.6.4 of Secretarial Standards - 1 (“SS-1”) states that signed board minutes have to be circulated to all directors within 15 days of their signing. This is a novel requirement and is an addition to the already lengthy process surrounding finalisation of board minutes. This post attempts to dissect the provisions of paragraph 7.6.4 to examine how and when companies should comply with paragraph 7.6.4, and if such a provision is at all in the best interests of a company. Should corporate boards choose not to comply, is there a way out?

Genesis of Paragraph 7.6.4 of SS-1

As much as the secretarial standards were introduced with the noble intention of ensuring uniformity of secretarial practices across companies, some of their provisions seeming appear contrary to the provisions of Companies Act, 2013 (‘Act, 2013’). More so, certain provisions defy the very intent behind certain provisions of Act, 2013. A case in point is paragraph 7.6.4 of SS-1 which reads as follows:

A copy of the signed Minutes certified by the Company Secretary or where there is no Company Secretary, by any Director authorised by the Board shall be circulated to all Directors within fifteen days after these are signed.

The intent behind introduction of paragraph 7.6.4 was to ensure that board minutes are not changed subsequently, i.e. after all the directors have affirmed to the contents of the board minutes. This is mainly to weed out the possibility of using minutes as a tool in cases of internal rivalry. For long, minutes have been the most favoured tool to misstate facts in cases of mismanagement or oppression. Hence, with the sole intention to thwart the plans of internal factions to use minutes as a tool to concoct facts, paragraph 7.6.4 has been introduced.

The Downside of Para 7.6.4

Although there is no doubt that the intent behind paragraph 7.6.4 is noble, it has led to a peculiar situation for all companies. It is important to understand that the secretarial standards were introduced with the intent to ensure uniformity of secretarial practices across companies i.e. they were intended to be an add-on to the provisions of Act, 2013. However they have stretched beyond the intent behind their enforcement such that they have taken the task upon themselves to prevent malpractices! By subjecting every company to paragraph 7.6.4, SS-1 has taken to writing rules for every company based on some instances of malpractices. In this pursuit, it has also threatened the sanctity of board minutes.

Listed below are certain pertinent provisions of Act, 2013 and SS-1:

1. On a reading of section 118 of the Act, 2013 it is apparent that the minutes have to be maintained by the company. In fact, section 118(11) makes the company liable to a penalty of Rs. 25,000 and every officer in default liable to a penalty of Rs. 5,000 in case of any default in complying with the provisions of section 118;

2. Section 118 read with Rule 25 of Companies (Management and Administration) Rules, 2014 and paragraph 7.1.7 of SS-1 states that the minutes of board meetings have to be maintained at the registered office of the company or at some other place as the board may decide;

3. Further paragraph 7.7.2 of SS-1 states that a director is entitled to receive copy of board minutes. Of course the same has to be requisitioned for.

The Act, 2013 nowhere envisages the possibility of directors also maintaining copies of board minutes with themselves. The reason behind the same is also obvious. Board minutes record the management level decisions of a company. It is only the directors who are privy to such discussions and decisions. In fact, the sanctity of board minutes is even acknowledged by the provisions of paragraph 7.7.2 of SS-1 since it allows board minutes to be shared with the lone condition that the same has to be requisitioned for. In fact, there is no provision in the statute which allows complete copy of signed minutes to be provided to directors. At best, directors can inspect the board minutes.

In fact neither the UK Companies Act, 2006 nor the UK Corporate Governance Code, from which the Act, 2013 and clause 49 of Equity Listing Agreement are largely borrowed, prescribe circulation of signed copy of board minutes.

However, paragraph 7.6.4 has now led to a peculiar position wherein parallel minutes books could be maintained by all the directors of the company. Considering the sensitive matters contained in board minutes, the sanctity of board minutes book is seriously jeopardised by paragraph 7.6.4. Further, what if any director was to misuse the records of board minutes maintained with such director? Will such director subjected to similar penal provisions in section 118(11) as the company? This pertinent question remains unanswered.

Waiver of Provision by Corporate Boards

Before discussing the possibility of doing away with the need to circulate, it is first necessary to understand the repercussions of circulation of board minutes. By circulating board minutes, where on one hand parallel board minutes will be maintained with all directors, the sensitivity and security of board minutes is also at risk. This is because there is nothing in law which prescribes the method of maintaining minutes by the director. Hence, once the director is served with the copy of board minutes, there is the risk that multiple persons may have access to it. The sanctity of board minutes may be well known to directors of a company. But one cannot expect similar maturity from non-board members. Hence, the sensitive matters contained in board minutes run the risk of being misused.

Herein arises the question – can the provisions of paragraph 7.6.4 be waived by corporate boards? The only pre-requisite when it comes to waiver is that it must be an intentional act done with knowledge about the right that the individual has. The same has also been discussed by Mulla on the Contract Act at page 198 to say that “agreements which seek to waive an illegality are void on grounds of public policy”. Simply put, doctrine of waiver is applicable to such cases where a right has been bestowed by law. Hence where any right or protection has been bestowed by law, the same may be waived.[1]

In the instant case, the obligation cast upon the company to circulate signed copies of minutes cannot be said to be statutory obligations as the statutory obligation is limited to recording of the minutes as laid down in section 118. The additional requirement of the SS-1 to circulate the minutes once signed may merely be said to be for unauthorised alterations thereof, or for the ready reference of the directors and therefore, it is not a statutory obligation. Looking at the sensitivity of board minutes, the directors of corporate boards may choose to waive the requirement of paragraph 7.6.4. The waiver of such a requirement will not be construed to mean waiver of a statutory right - and hence, the waiver will not be void. In any case there is no public policy issue involved here. Further, the obligation to circulate board minutes is the obligation of the company towards the directors and not towards law. Hence waiver of requirement of paragraph 7.6.4 is an option that corporate boards may explore.

Period of Applicability of Paragraph 7.6.4

SS-1 came into force from July 1, 2015. Now consider the following scenarios:

1. Board meeting of A Ltd was held on 2 July 2015. The minutes were confirmed and signed at the board meeting held on 1 September 2015.

2. Board meeting of X Ltd was convened on 20 June 2015. The draft minutes were circulated on 2 July 2015. The minutes were then confirmed and signed at the board meeting held on 1 August 2015.

3. Board meeting of Y Ltd was convened on 24 May 2015. The draft minutes were circulated and confirmed within 30 days. However they were signed after placing the minutes in the board meeting held on 1 August 2015.

Will these companies have to comply with paragraph 7.6.4? In the first scenario, the answer is clearly in the affirmative. However for the remaining two scenarios, one is tempted to answer in the negative. This is because SS-1 was made effective from 1 July 2015. Both the board meetings were held prior to 1 July 2015. However considering the provisions of section 118(11), one may take a view that paragraph 7.6.4 have to be complied with by X Ltd and Y Ltd.

Additional Compliance Requirements

Not only does paragraph 7.6.4 require the certified copy of signed board minutes to be certified by the company secretary or an authorised director, it also requires a copy of the signed minutes to be circulated to all directors within 15 days after these are signed. This is in addition to the draft minutes being anyway circulated to all directors (paragraph 7.4) and also being placed in the ensuing board meeting following the date of entry (paragraph 7.3.5). Additionally, paragraph 1.3.8 of SS-1 also requires the draft resolution to be circulated as a part of notes to agenda or be placed at the meeting itself. Hence paragraph 7.6.4 is another addition to the already mundane clerical work pertaining to circulation of minutes.


With SS-1 already been implemented, companies are also gearing up to convene board meetings to approve quarterly results. Considering the enormity of the provisions of para 7.6.4, it is time that corporate boards take note of the same and act fast.

- Nivedita Shankar

[1] Held in the case of Jaswantsingh Mathurasingh & Anr. v. Ahmedabad Municipal Corporation & Ors (1991 AIR 385)

Wednesday, July 29, 2015

SEBI Regulations Inapplicable to “Phantom” Stock Schemes

The SEBI (Share Based Employee Benefits) Regulations, 2014 (the “Regulations”) regulate various types of schemes offered by companies to their employees relating to shares. In two separate letters issued pursuant to requests for informal guidance, SEBI has stated that the Regulations are not applicable to phantom stock options and similar schemes that do not involve the actual issue or transfer of shares to employees. SEBI issued the informal guidance in response to requests from Mindtree Ltd. and SAREGAMA India Ltd.

Mindtree’s request letter to SEBI encapsulates the nature of a phantom stock option scheme where stock appreciation rights (SAR) were issued to certain employees who also happened to be promoters:

3. As per the provisions of the Phantom Stock Option Scheme, only notional SAR units were issued at a pre-determined grant price and the Promoters were entitled to receive cash payment for appreciation in the share price over the grant price for the awarded units, based on the Company achieving the specified revenue targets. While the cash payouts pursuant to the Phantom Stock Scheme are linked to the share price of the Company’s equity shares, implementation of the Phantom Stock Scheme does not involve any actual purchase or sale of the equity shares of the Company.

The issue arose because Regulation 1(3)(iii) of the Regulations provides that the Regulations apply to SAR schemes in addition to other types of employee share benefit schemes. Furthermore, SAR and related matters have been expressly dealt with in the Regulations. At the same time, Regulation 1(4) states as follows:

The provisions of these regulations shall apply to any company whose shares are listed on a recognised stock exchange in India, and has a scheme:

(i)        for direct or indirect benefit of employees; and

(ii)       involving dealing in or subscribing to or purchasing securities of the company, directly or indirectly; and

(iii)      satisfying, directly or indirectly, any one of the following conditions:

SEBI’s conclusion as to the inapplicability of the Regulations to phantom stock schemes is based on the highlighted portion above. This indicates the necessity for actual subscription or purchase of shares by employees, which does not occur in the case of phantom schemes.

SEBI’s conclusion is understandable and is likely to provide greater flexibility to companies to design their employee share schemes as phantom schemes if they would like to stay outside the purview of the Regulations. However, less clear is the apparent conflict between Regulations 1(3), which expressly makes the Regulations to SAR and Regulation 1(4), which requires subscription or purchase of shares by the employees (which would never occur in a SAR). Moreover, it is not obvious as to why there is a fairly extensive treatment on SAR in the Regulations if they are not designed to cover these and similar phantom schemes in the first place.

Finally, due to the SEBI’s conclusion that the Regulations do not apply to SARs, another interesting question raised by Mindtree was found not to be relevant, which SEBI therefore left unanswered. That question relates to the interpretation of Regulation 2(1)(f), which reads as follows:

f. “employee” means, —

(i) a permanent employee of the company who has been working in India or outside India; or

(ii) a director of the company, whether a whole time director or not but excluding an independent director; or

(iii) an employee as defined in clauses (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company or of an associate company but does not include—

(a) an employee who is a promoter or a person belonging to the promoter group; or

(b) a director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company;

Specifically, the question is whether the exclusion of promoters and directors (holding substantial shares) applies only to sub-section (iii) above, i.e. employees of subsidiary, holding company or associate company or whether the exclusion applies to all categories of employees, including those contained in sub-sections (i) and (ii). This ambiguity may have to continue until it is clarified on a future occasion.