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TMI Blog2013 (9) TMI 914X X X X Extracts X X X X X X X X Extracts X X X X ..... eing heard. - WRIT PETITION NO. 213 OF 2011 - - - Dated:- 14-3-2012 - DR. D.Y. CHANDRACHUD AND ANOOP V. MOHTA, JJ. C. Aryama Sundaram, J.J. Bhatt and Nitin Potdar for the Petitioner. Darius J. Khambatta, Shiraz Rustomjee, Aditya Mehta, Jayesh K. Ashar, Mihir Mody, Rajesh Talekar, Mobin Sheikh, Faiz Khan, Dr. Virendra Tulzapurkar, Ameet B. Naik and Abhishek Kale for the Respondent. JUDGMENT Dr. D.Y. Chandrachud, J. Rule, by consent returnable forthwith. With the consent of Counsel and at their request the Petition is taken up for hearing and final disposal. 2. The Whole Time Member of the Securities and Exchange Board of India has rejected an application filed by the Petitioner for permission to undertake business as a Stock Exchange, other than for the Currency Derivatives Segment. The order is under Section 4 of the Securities Contracts (Regulation) Act, 1956 (SCRA) and Sections 11(1) and 19 of the Securities and Exchange Board of India Act, 1992. The Petition challenges the legality of the order. 3. For convenience of exposition, this judgment is divided into Parts, which are as follows: I - Facts. II - Show Cause Notice by SEBI and the Impugne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oster the separation of ownership and control of stock exchanges from their trading members by implementing a scheme of corporatisation and demutualisation. When the MIMPS Regulations were issued in 2006, they were intended to provide for corporatisation and demutualisation of old Stock Exchanges and diversification of the ownership of Stock Exchanges. Full compliance with the provisions of MIMPS Regulations was mandated by SEBI in this background on 18 September 2008 when it granted recognition to the Petitioner for a period of one year under Section 4 of the SCRA. The MIMPS Regulations have introduced a cap of 5% on the holding of any resident in the equity capital of a recognised stock exchange. The cap applies to direct and indirect shareholding and the holding of "persons acting in concert". 6. On 5 November 2008, SEBI issued a framework for introducing trading of securities of Small and Medium Enterprises, following which on 8 December 2008, the Petitioner furnished a proposal for commencement of operations in that Segment. On 22 December 2008, the Petitioner applied to SEBI for permission to commence business in the Equities and Derivative segment on the Exchange platform ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ility to buy back the shares in future. On 12 August 2009, FTIL accepted the terms and conditions stipulated by PNB, but expressed its inability to execute a share purchase agreement. 12. On 20 August 2009, the Petitioner entered into a Share Purchase Agreement (SPA) with IL FS Financial Services Limited (IL FS) and the Fourth Respondent under which IL FS agreed to purchase shares of the Petitioner worth Rs.159.12 crores from the Fourth Respondent. On the same date, as the execution of the SPA, a company by the name of La-Fin Financial Services Pvt. Ltd. (La-Fin) addressed a letter to IL FS offering an exit option. La-Fin, which is a promoter of FTIL, furnished an undertaking accepting the obligation to purchase in its sole discretion during the agreed period all the shares purchased by IL FS under the share purchase agreement at any time after the completion of one year from the date of investment, but no later than three years from the date of investment after which the right of IL FS would lapse. The undertaking furnished by La-Fin to IL FS inter alia contained the following stipulation: "1. La-Fin Financial Services Pvt. Ltd. (LA-Fin) or its appointed nominees have an obli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of shares to IL FS was effected on 21 August 2009. 13. The recognition granted to the Petitioner as a Stock Exchange was renewed by SEBI for a further period of one year ending on 15 September 2010 by a notification dated 31 August 2009, subject to the following conditions: (i) The Petitioner shall ensure full compliance with the relevant provisions of the MIMPS Regulations within a period of one year; (ii) The Petitioner would permit trading only in securities in which trading was earlier permitted and shall not be eligible for introduction of any class of contracts in securities till such time as compliance in (i) above was ensured; and (iii) The Petitioner shall comply with such other conditions as may be imposed by SEBI from time to time. The renewal was without prejudice to the rights of SEBI to decide the application of the Petitioner dated 7 April 2010. 14. On 22 October 2009, the Petitioner submitted a report to SEBI under Regulation 11(2) of the MIMPS Regulations. The report included a statement of top ten shareholders of the Petitioner as on 30 September 2009. Among those shareholders were the Third Respondent with a shareholding of 35.05%, the Fourth Respondent with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es comprised of the following: (a) 61.71 crore equity shares held by MCX would stand cancelled; (b) 56.24 crore equity shares held by FTIL would stand cancelled; and (c) 1.70 crore equity shares held by IL FS would stand cancelled. (ii) Simultaneously, with the reduction of the equity capital, the Company would issue an aggregate of 119.66 crore warrants to the three reducing shareholders exactly corresponding to the share capital cancelled and reduced; and (iii) Each warrant would entitle the holder to subscribe to one equity share of the face value of Re.1 at any time after six months from the date of issue. The warrant holder was entitled to exercise its option to subscribe to the fully paid up equity shares of the Company at any time after six months from the date of allotment. The warrants were not to carry any voting rights in the Company. 17. On 18 December 2009, a Petition was filed in this Court for sanctioning a Scheme of Reduction-cum-Arrangement under Sections 100 to 104 and 391 to 394 of the Companies' Act, 1956. In the Petition that was filed before this Court, it was stated that though the reducing shareholders had a right to transfer the warrants to othe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... no enabling provision in the Articles of Association to issue warrants in lieu of a reduction of share capital to which it was submitted on behalf of the Petitioner that the warrants are securities convertible into shares and hence, the issuance of warrants was enabled under the Articles of Association. On 19 March 2010, the Registrar of Companies issued a certificate registering the order of this Court consequent upon which the reduction of capital and the scheme stood implemented. 20. On 7 April 2010, the Petitioner informed SEBI of having complied with the MIMPS Regulations and sought its approval to deal in interest rate derivative markets, equities, futures and options on equity and wholesale debt segments and in all segments which are permitted to the Bombay Stock Exchange and National Stock Exchange. On 13 April 2010, a copy of the order of the Company Judge sanctioning the Scheme together with the Scheme which was sanctioned was furnished by the Petitioner to SEBI. SEBI had conducted an inspection of the Petitioner in July and August 2009 in respect of which an inspection report was forwarded on 16 April 2010. 21. On 4 June 2010, the Petitioner applied for renewal of i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hich held a 26% equity stake in FTIL was obligated to offer to purchase the shares held by the IL FS Group on the completion of one year and within a period of three years at a stipulated rate. The letter stated that on 10 August 2010, IL FS Financial Services Ltd. had, in a meeting of its Board, resolved to explore an exit from the investment made in the shares of the Petitioner, including by expediting the right to sell the investment in accordance with exit terms to the promoters of the Petitioner. 26. On 19 August 2010, PNB addressed a letter to SEBI regarding the buy back arrangement stating that in view of the Scheme sanctioned by this Court for reduction of capital, there would be an inference that PNB's arrangement with regard to buy back of shares has "implicitly been extinguished". 27. On 30 August 2010, SEBI renewed the recognition of the Petitioner for a period of one year with effect from16 September 2010 without prejudice to its right to decide upon the application submitted by the Petitioner on 7 April 2010. II : The Notice by SEBI and the impugned order: 28. A notice was issued by SEBI to the Petitioner on 30 August 2010 under Sections 4(4) and 12A of the SC ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns within one year; (ii) The approval granted by the High Court to the Scheme of capital reduction does not conclude the issue as to whether there was compliance with the requirements of the SCRA or the MIMPS Regulations since that was not a subject matter for consideration of the Court when it approved the Scheme; (iii) Since the object of the Scheme was to ensure full compliance with the Regulations, there was no reason as to why the Petitioner did not seek the opinion of SEBI as to whether the Scheme was in full compliance with the Regulations; (iv) Excluding the warrants held by a shareholder in computing the limits of ownership in a Stock Exchange would violate the spirit of the MIMPS Regulations. If the holding of equity shares in excess of the shareholding limits is not permissible, the holding of a right to equity shares cannot be held to be permissible; (v) The conversion of shares into warrants was not one of the four modes set out in Regulation 4 and was, therefore, not permissible; (vi) The undertaking furnished by the Petitioner together with its promoters not to violate the MIMPS Regulations in the Scheme of Capital Reduction will not render it compliant wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... public interest to allow the application. The Petitioner had knowledge of the buy back arrangements and failed to discharge its obligation to SEBI as a regulatory body to disclose these transactions. In none of the quarterly reports submitted under Regulation 11(5) were the arrangements disclosed. The buy back arrangements were material to a determination of whether the sale and transfer of ownership by promoters or shareholders whose holding was in excess of permissible limits is in full compliance with Regulation 8(1). There was a failure on the part of the Petitioner to fulfill its fiduciary responsibilities under Regulation 11 for making a full disclosure. The proposed Scheme ought to have been submitted to SEBI and a confirmation should have been sought as to whether it was in compliance with the MIMPS Regulations; (xiv) There is a concentration of economic interest in the Petitioner in the hands of the two promoters. The conclusions which have been arrived at by the Whole Time Member are as follows: "a. The concentration of economic interest in a recognised stock exchange in the hands of two promoters is not in the interest of a well-regulated securities market; b. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vided in Regulation 4 which does not meet with the standards of full compliance; (b) The Scheme of Capital Reduction is contrary to the understanding furnished to SEBI by the Petitioner; (c) The Petitioner cannot be permitted a different mode of compliance with the MIMPS Regulations than what is permitted to other Exchanges; (d) The right to acquire equity shares through warrants is contrary to the objectives of the MIMPS Regulations; and (e) The Scheme of Reduction has not led to diversification of ownership and economic interest. The submissions which have been urged on behalf of the Petitioner are that: A.(i) The initial permission to start a commodities exchange was subject to the condition of "full compliance with the MIMPS Regulations" which was subsequently changed to "compliance with the relevant provisions" of those Regulations. The Regulations do not ipso facto apply to the Petitioner since the Petitioner was not subjected to a scheme for corporatisation or demutualisation approved by SEBI, but were made applicable as a condition of a permission granted to establish an exchange. Regulation 4 applies to dilution of equity of persons having trading rights in a Stock Excha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ged that none of the relevant provisions of law embody the concept of economic interest in regard to the recognition of the Stock Exchanges. SEBI did not press the point during the course of the arguments, but merely relied on the order of the Whole Time Member. b. The Third Respondent's submissions 32. On behalf of the Third Respondent, which has supported the Petitioner as its promoter, it has been urged that SEBI has advanced the following grounds in regard to the buy back arrangements between the promoters on the one hand and PNB and IL FS on the other hand: (i) The buy back arrangement which is a forward contract, is illegal by reason of the provisions of the SCRA; (ii) Even if presently the buy back arrangement does not give rise to a concluded contract, a contract would stand concluded on the exercise of the option by PNB and/or IL FS to sell back the shares to the promoters. In that event, it has been presumed that the promoters upon the performance of the obligation to buy back would exceed the limit of five percent set out in the MIMPS Regulations; and (iii) The promoters are not fit and proper persons within the meaning of Regulation 9 since they are parties to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, 1992. B. The alternative submission of SEBI is that even if the buy back is not a forward contract, it amounts to an option in securities which is a contract in derivatives not traded or settled on any recognised Stock Exchange or with the permission of SEBI. Consequently, the buy back arrangement would be in violation of Section 18A of the SCRA. On this submission of SEBI, it has been urged that: (i) This submission was not part of the show cause notice, nor is it the basis of the order passed by SEBI. Hence, the submission cannot be urged for the first time in these proceedings; In the alternative: (ii) From the definition of the expression "derivative" in Section 45U(a) of the R.B.I. Act, 1934 and Section 2(ac) of the SCRA, it would be evident that a derivative is an instrument whose value is to be derived from an underlying asset. In the case of the buy back arrangement in the present case, the subject matter is the buy back of shares directly and there is no question of deriving the value of the shares from any underlying asset; (iii) In the case of an option contract, the right to buy or the right to sell is itself the subject matter of the contract and the option ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n be used to sustain the order if it is otherwise not sustainable. Public interest does not include mere future possibilities being taken into account. As a matter of fact, SEBI has acted against public interest, by perpetuating, the monopoly of one Stock Exchange which alone at present has permission to deal in the segments. The Petitioner is ready and willing to provide such safeguards as may be required by the Court; (iv) The only reason furnished by SEBI for holding that the promoters are not fit and proper persons is that they were parties to a buy back arrangement which is alleged to be illegal. This ground being misconceived, since the buy back arrangement is not illegal, there is no basis to hold that the promoters are not fit and proper persons; (v) Even though SEBI is a statutory regulator, it cannot claim immunity from judicial review though in a restricted field. If within the restricted area where judicial review is permissible, it is demonstrated that the order is arbitrary, based on irrelevant considerations and contrary to law, the Court ought to exercise its jurisdiction to set aside the order. c. The Fourth Respondent's submissions 33. On behalf of the Fou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... buy back arrangement increasing the shareholding of promoters to beyond five percent is not a relevant consideration. In spite of the exercise of the option under the buy back arrangement, the promoters' shareholding can still be within the limit of five per cent by the promoters (a) disposing of their other existing shareholding so that the total shareholding does not exceed five percent; (b) increasing the share capital so that the increased holding of the promoters does not exceed five percent; and (c) performing the buy back arrangement by nominating a third party to buy back the shares; (viii) The MIMPS Regulations do not upon their terms apply to the Petitioner, but they have been made applicable by notifications dated 18 September 2008 and 31 August 2009. Under the later notification, only the relevant Regulations are made applicable. This notification was issued to get over an impasse created by the earlier notification. If a limited Company already in existence applied for permission, such permission could not be granted because all promoters taken together would ordinarily hold more than five percent shares. In such an event, there would be no application made by an ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... basis of addressing one letter. In view of the provisions of Regulation 2(2) of the Takeover Regulations, the expression "Companies under the same management" shall have the meaning given in Section 370(1B) of the Companies' Act, 1956; (xiii) SEBI at all material times, was aware of the position of Mr. Jignesh Shah and that at no point of time was a grievance made; (xiv) The only basis on which the Petitioner has been held not to be a fit and proper person is that there was an option to convert the warrants and there was a buy back arrangement. Both are irrelevant. Even if an option is exercised, that would not necessarily result in increasing the shareholding beyond five percent. Moreover, the buy back arrangement is not going to be operated since the undertaking given is that the shareholding would not be increased; (xv) In any event, the findings which have been made against the promoters cannot be permitted to be used in any other proceedings, since the promoters are not parties to the proceedings in which the order was passed. d. Submissions of SEBI 34. On behalf of the First Respondent, the following submissions have been urged by the Additional Solicitor General o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The finding in the impugned order that FTIL and MCX are persons acting in concert for the purposes of Regulation 8 and that their combined holding of ten percent of the equity capital of the Petitioner is in breach of Regulation 8, is a finding of fact; (vi) Under Section 370(1B) of the Companies' Act, 1956, two Companies are deemed to be under the same management if inter alia they have a common Manager. FTIL and MCX have a common Manager (Jignesh Shah) and are, therefore, deemed to be persons acting in concert for the purposes of the MIMPS Regulations. This finding is based on certain letters addressed by Jignesh Shah, Director of La-Fin and the promoter of FTIL. He is a Chairman and Group Executive Officer of FTIL (a promoter of the Petitioner) and the Vice Chairman of MCX (the Second promoter of the Petitioner). He is also a non-executive Vice Chairman of the Petitioner. He issued an undertaking on behalf of MCX and FTIL and other group Companies that the Petitioner will not issue shares except as provided for. This shows that he was not only in a position to issue an undertaking for FTIL of which he is Managing Director, but also for MCX of which he is designated as non-exe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bsite of FTIL shows the Petitioner and MCX as part of the FTIL Group; and (e) La-Fin's letter dated 20 August 2009 and MCX's letter dated 14 December 2009 corroborates the position; (xii) As regards the buy back arrangements, the submissions are as follows: (a) Though the buy back agreements were entered into to comply with the MIMPS Regulations, these arrangements were not disclosed to SEBI, thereby withholding relevant information; (b) The entering into the buy back agreements and the conduct of the group are relevant factors that SEBI can take into account while deciding as to whether to recognize a Stock Exchange; (c) The buy back agreements are illegal, albeit for reasons different from those set out in the impugned order and in the show cause notice dated 30 August 2010. Hence, if a member of the Stock Exchange enters into an illegal contract, it is rendered unfit to run a Stock Exchange. SEBI should be allowed to plead the illegality of the agreements in these proceedings on grounds other than those contained in the show cause notice and the impugned order; (xiii) The Scheme of Reduction did not have any impact on the buy back agreements. IL FS was offered a fresh buy ba ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd the Scheme does not bind it under Section 391(2); (xviii) In the event that the Third and Fourth Respondents could not have complied with the shareholding limit prescribed in Regulation 8, they could have made an application under Regulation 9 for permission to exceed the shareholding limit. No such application was made; (xix) The doctrine of contemporanea exposito applied in the context of ancient statutes has no applicability to the interpretation of modern statutes. The mere silence of SEBI in the face of certain Red Herring Prospectuses mentioning the existence of the buy back agreements is not sufficient and some manifestation of a conscious act or clarification on the part of SEBI was necessary even assuming that the doctrine is attracted; (xx) In exercise of the power of judicial review, the Court will not sit in judgment over the decision of the regulator as an Appellate Forum, but will interfere only when the decision is so unreasonable that no reasonable authority could have come to that decision. When dealing with orders of the expert bodies, the interference of the Court is confined to those cases where an order is perverse, based on no evidence or on a misread ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntral Government; and (iv) maintenance and audit of accounts. 38. Historically, Stock Exchanges were owned and controlled by persons who were also trading members of the Exchange. In August 2002, an Expert Committee headed by Mr. Justice M.H. Kania examined the ownership structures of Stock Exchanges and recommended that : (a) Stock Exchanges should be corporatised and demutualised; and (b) Ownership of Stock Exchanges should not be concentrated in the hands of a single entity or groups of related entities. In paragraph 9.30 of its report, the Committee stated that demutualisation demands that shareholding in a stock exchange should not remain exclusively with the brokers on the stock exchange. The Committee opined that dispersal of membership can be achieved in one of two ways: (a) by the shares initially issued to brokers being offered for sale to the public; and (b) by the stock exchange making an issue of shares to the public. The Committee opined that no specific form of dispersal need be prescribed, but there a time limit should be prescribed within which at least 51% of the shares would be held by non-trading members of the stock exchange. In paragraph 9.32, the Committee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rities market where it is satisfied that it is necessary: "(a) in the interest of investors, or orderly development of securities market; or (b) to prevent the affairs of any recognised stock exchange, or, clearing corporation or such other agency or person, providing trading or clearing or settlement facility in respect of securities, being conducted in a manner detrimental to the interest of investors or securities market; or (c) to secure the proper management of any such stock exchange or clearing corporation or agency or person, referred to in clause (b)." MIMPS Regulations 41. In exercise of the powers inter alia conferred by Section 31 read with sub-section (8) of Section 4B, SEBI notified the Securities Contracts (Regulation)(Manner of Increasing and Maintaining Public Shareholding in Recognized Stock Exchanges) Regulations, 2006. 42. Regulation 2 contains definitions. The expression "control" is defined in Regulation 2(e) to have the meaning assigned to it, in Regulation 2(1)(c) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. The expression "public" is defined in Regulation 2(h) to include any member or section of the public, bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has the power to require compliance with the MIMPS Regulations as a condition for the grant of recognition even to an exchange such as the Petitioner. As a matter of fact, these proceedings have been conducted by Counsel on the basis that it was as a result of SEBI's notification that the provisions of the MIMPS Regulations were attracted. 44. Regulation 4 provides that a stock exchange shall ensure that at least 51% of its equity share capital is held by the public either by a fresh issue of equity shares to the public through the issue of a prospectus or in the following manner: "(a) offer for sale, by issue of prospectus, of shares held by shareholders having trading rights therein; (b) placement of shares held by shareholders having trading rights to such persons or institutions as may be shortlisted by the recognised stock exchange with the approval of the Board; (c) issue of equity shares on private placement basis by the recognized stock exchange to any person or group of persons not being shareholders having trading rights or their associates subject to the approval of the Board; or (d) any combination of the above." Regulation 4 forms part of Chapter II of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "(a) that no transfer or issue of equity shares therein is made otherwise than in accordance with these regulations; (b) that at least fifty-one per cent of its equity share capital is continuously held by the public; and (c) that the restrictions contained in regulations 8 and 9 are complied with in respect of the shareholding therein." At the end of every quarter, every recognized stock exchange is required to submit a report to the Board on: (a) The names of ten largest shareholders together with the number and percentage of the shares held; (b) The names of the shareholders falling under Regulation 8, who had acquired shares in that quarter; and (c) The shareholding pattern in the stock exchange. An undertaking confirming compliance of the provisions of sub-regulation (1) has to be submitted to the Board on a quarterly basis within fifteen days from the end of each quarter. Regulation 11(4) confers an overriding power on SEBI to call for any information inter alia from a recognized stock exchange. Every exchange is required by Regulation 11(5) to maintain and preserve books, registers and documents and records relating to the issue or sale of equity shares under the Reg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rations) and those who supply capital (investors). Investors can reduce risk by spreading their investments. Stock exchanges make those investments liquid enough to invest and divest without significant price changes by providing liquidity. Traditionally, this function was performed on the floor of the stock exchange where brokers met, negotiated and agreed upon the price for stock transfers executed for their principals. In an electronic age, the trading floor of the stock exchange is becoming increasingly obsolescent with stock exchanges maintaining electronic systems world wide that can match orders for the buying and selling of shares automatically; (ii) Stock exchanges are information distributors. This function consists of the trades executed, the volume, price, and parties involved. This function has a considerable economic value in providing financial services such as market reports and analysis of stocks. Information about previous trades is of material significance in the market for derivatives which are financial instruments whose value is derived from an underlying asset such as stocks. Information about settled trades has a regulatory function since it is the basis o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which they are subject. They ensure in that capacity, compliance of the requirements established the statutory regulator. Apart from the regulation of members, market surveillance carried on by stock exchanges in certain jurisdictions regulates issuers. They do so by ensuring that the stocks of issuers are reliably traded and that issuers meet standards of corporate governance. In exercising these powers, stock exchanges may face issues involving a conflict of interest. Such conflicts of interest have to be handled and addressed effectively within the regulatory framework. 52. Stock exchanges as institutional mechanisms have an important role to play in ensuring the stability of the financial and economic system. The orderly functioning of the market for securities is no longer a matter of a private concern, for those who transact on the market. The market for securities can be volatile. Transactions in the securities' market and the transparency of institutional mechanisms have a significant bearing on the wealth of investors. Inflows and outflows of capital from the stock market have an immediate and, often serious, impact on financial stability in the country. The orderly fun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... imination against old stock exchanges which were established prior to the enforcement of the Regulations by importing a requirement of compliance with the Regulations as a condition for the recognition of the Petitioner. VI : Regulation 4 and Regulation 8 54. Regulation 8 provides a restriction against the holding of more than five per cent of the equity share capital in a recognized stock exchange by a person resident in India directly or indirectly either individually or together with persons acting in concert. Regulation 4 also provides for the manner of increasing the public shareholding so as to ensure that at least 51% of the equity share capital is held by the public. Regulation 8 which contains a restriction on the holding of shares does not expressly incorporate the provisions of Regulation 4 in regard to the manner in which a reduction of the shareholding has to be brought about to ensure compliance with the five per cent norm. The order passed by the Whole Time Member proceeds on the basis that compliance with one of the modes specified in Regulation 4 is the only acceptable method for bringing about conformity with Regulation 8. SEBI in the course of its oral and wr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... MCX and FTIL was reduced to five per cent each. In addition, MCX was allotted 63.41 crore warrants and FTIL was alloted 56.24 crore warrants. 57. The Whole Time Member of SEBI in his impugned order has held that: (i) The issuance of warrants did not constitute a permissible method of ensuring compliance with Regulation 8 and only substituted equity shares into a right to equity shares with a view to circumventing Regulation 8(1); and (ii) The buy back agreements were forward contracts which violated the provisions of the SCRA. These two aspects of the determination in the impugned order fall for consideration. VIII : Issuance of Share Warrants 58. The Petition which was filed before the Company Judge under Sections 391 to 394 read with Sections 100 to 103 of the Companies' Act, 1956 on 18 December 2009, envisaged that in order to comply with the provisions of Regulation 8(1), the Petitioner was implementing a scheme of capital restructuring so that the voting rights of the promoters and their equity stake would be brought down to five per cent each. The scheme envisages that warrants would be issued to the shareholders, who are subject to the scheme of capital reduction, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f this Court that the promoters would pass Board resolutions to ensure that they would not increase their shareholding beyond the limit prescribed in the MIMPS Regulations, resolutions were, in fact, passed and intimated to SEBI. Having regard to this undisputed background, it is not possible to accept the finding of the Whole Time Member that the issuance of warrants to the two promoters is a device which would result in a restoration of their holding beyond the limit prescribed by the MIMPS Regulations. A mere possibility of what may happen is hypothetical, as the Supreme Court has held and cannot result in the invalidation of a transaction which is otherwise lawful. Hindustan Lever Employees' Union v. Hindustan Lever Ltd.. [1995] Suppl. 1 SCC 499/[1994] 2 SCL 157 (SC). The aspect as to whether the promoters can be regarded as persons acting in concert, will be dealt with separately. 62. Having regard to this finding, the submission which has been urged on behalf of the Fourth Respondent by Counsel, to the effect that the scheme when sanctioned, became binding on SEBI and would be res judicata of all issues involved in the Petition assumes subsidiary significance. A scheme unde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... after the expiry of one year from the date of investment. By a letter dated 19 August 2010 addressed to SEBI by PNB, it was stated that after the scheme was sanctioned by the Company Court, and keeping in mind the MIMPS Regulations, PNB's arrangement with regard to the buy back stood "implicitly extinguished" since the promoter could not hold more than five per cent of the equity shares. 64. On 20 August 2009, a Share Purchase Agreement was entered into between the Petitioner and MCX on the one hand and IL FS Financial Services Ltd. (IL FS) on the other for the sale of 4.42 crore shares of MCX for a consideration of Rs. 159.12 crores with a further option to purchase an additional 1.80 crore shares. Prior to the Scheme of Reduction, the shareholding of IL FS in the Petitioner was 2.54% of the equity capital. As a result of the Scheme of Reduction, the holding of IL FS would have increased to 8.13% of the equity capital of the Petitioner. Consequently, under the Scheme of reduction IL FS was to be allotted 1.70 crore warrants. Upon the Scheme of Arrangement-cum-Reduction, the shareholding of IL FS was brought down to five per cent, in addition to which, IL FS held 1.70 crore wa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... shares to be effected by an independent nominee. Hence, it was urged that the buy back agreements would not foreclose the possibility of MIMPS compliance in the future despite the exercise of the buy back option. That, in our view, did not absolve the Petitioner to make a full disclosure before SEBI that while compliance with Regulation 8 was being fulfilled by a divestment of shares, yet buy back agreements were entered into. The basic purpose underlying Regulation 8 is to ensure that no resident should own whether directly or indirectly with any other persons acting in concert, more than five per cent of the equity capital of a recognised stock exchange. Where the promoters hold more than five per cent of the equity capital, the divestment of their excess holding, so as to bring them in compliance with Regulation 8, must be genuine. The fact that the divestment of the shares held by a promoter in a stock exchange is accompanied by a buy back agreement is a material circumstance which must be disclosed to SEBI. On 21 July 2010, SEBI addressed a letter to the Petitioner adverting to a news article published on 19 July 2010, stating that the promoters of the Petitioner had entered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pply to such State or area and "thereupon every contract ... which is entered after the date of the notification otherwise than between the members of a recognized stock exchange ... shall be illegal". Section 2(h) defines the expression "securities" to include shares, scrips, stocks, bonds, debentures, debenture stock, or other marketable securities of a like nature in or of any incorporated company or other body corporate. Section 16 empowers the Central Government to declare, where it is of opinion that it is necessary to prevent undesirable speculation in specified securities, that no person in the State or area specified shall, save with the permission of the Central Government, enter into any contract for the sale or purchase of any security specified in the notification except to the extent and in the manner specified therein. Sub-section (2) provides that all contracts entered into in contravention of the provisions of sub-section (1) shall be illegal. 72. In exercise of the powers conferred by Sub-section (1) of Section 16, the Central Government by a notification dated 27 June 1969 declared that save with its permission, no person shall enter into any contract for the s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ard contracts " does not find support in the oral submissions urged by the Learned Additional Solicitor General or in the written submissions. 74. Now, it is in this background that the finding of illegality in the impugned order must be assessed. The buy back agreements furnish to PNB and IL FS an option. The option constitutes a privilege, the exercise of which depends upon their unilateral volition. In the case of PNB, the buy back agreements contemplated a buy back by FTIL after the expiry of a stipulated period. But, in the event that PNB still asserted that it would continue to hold the shares, despite the buy back offer, FTIL or its nominees would have no liability for buying back the shares in future. In the case of IL FS, La-Fin assumed an obligation to offer to purchase either through itself or its nominee the shares which were sold to IL FS after the expiry of a stipulated period. In both cases, the option to sell rested in the unilateral decision of PNB and IL FS, as the case may be. 75. In a buy back agreement of the nature involved in the present case, the promissor who makes an offer to buy back shares cannot compel the exercise of the option by the promisee to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n. Under the notification that has been issued under the SCRA, a contract for the sale or purchase of securities has to be a spot delivery contract or a contract for cash or hand delivery or special delivery. In the present case, the contract for sale or purchase of the securities would fructify only upon the exercise of the option by PNB or, as the case may be, IL FS in future. If the option were not to be exercised by them, no contract for sale or purchase of securities would come into existence. Moreover, if the option were to be exercised, there is nothing to indicate that the performance of the contract would be by anything other than by a spot delivery, cash or special delivery. Where securities are dealt with by a depository, the transfer of securities by a depository from the account of a beneficial owner to another beneficial owner is within the ambit of spot delivery. 78. Reliance is sought to be placed by the Additional Solicitor General on a decision of Chief Justice M.C.Chagla, speaking for a Division Bench in Jethalal P.Thakkar v. R.N. Kapur AIR 1956 Bombay 74. In that case, an undertaking was furnished by the Defendant to the Plaintiff to sell off for the Plaintiff ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ely or within a reasonable time. The suit filed by the Plaintiff was, therefore, held not to be rendered bad by reason of the provisions of the Bombay Act. The judgment of a Learned Single Judge in Niskalp Investments and Trading Co. Ltd. v. Hunduja TMT Ltd. [2008] 143 Com. Cases 204/[2007] 79 SCL 368 (Bom.) has been rendered on a Summons for Judgment in a Summary Suit in which the Learned Judge granted unconditional leave to defend, and does not advance the discourse. 79. The ambit of the expression "securities" in Section 2(h) of the SCRA has fallen for determination in several judgments of this Court. Would the expression cover listed and unlisted securities? The issue, as would be noted hereinafter, has been settled in a judgment of the Supreme Court. In Dahiben Umedbhai Patel v. Norman James Hamilton [1983] 85 Bom. LR 275/[1985] 57 Comp. Cas. 700 (Bom.) a Division Bench of this Court held that the definition of 'securities' requires marketability which the shares of a private Company do not possess and hence, that expression will only take in shares of a public limited company. In Brooke Bond India Ltd. v. U.B. Ltd. [1994] 3 Comp. LJ. 279/ 79 Comp. Cas. 346 (Bom.) a Learned ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to be ignored. What the notification under Section 16 was held to prohibit is the entering into of a forward contract that is a sale at a future date for a fixed price. This latter part of the agreement could not have been entered into, but was clearly severable and would not affect the transaction which has already taken place at the time of the execution of the ready leg. The decision of the Supreme Court in Bank of India Finance therefore, dealt with a situation where the ready leg of the contract had been duly fulfilled while the forward leg had remained to be performed. The latter, involving a contract for the purchase and sale of shares in future at a specified price was a ready forward contract and was unlawful. 80. In the present case, there is no contract for the sale and purchase of shares. A contract for the purchase or sale of the shares would come into being only at a future point of time in the eventuality of the party which is granted an option exercising the option in future. Once such an option is exercised, the contract would be completed only by means of spot delivery or by a mode which is considered lawful. Hence, the basis and foundation of the order which is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... citor General, we are of the view that it is manifestly inappropriate for this Court to render an adjudication on the issue at this stage. That is even more so, because a violation of the provisions of Section 18A on the basis that the buy back agreements constitute options in securities or derivatives was not a ground taken in the show cause notice which resulted in the impugned order of the Whole Time Member, nor for that matter, is it a ground in the impugned order itself. XII : Persons Acting in concert. 82. The impugned order contains a finding that MCX and FTIL are persons acting in concert and consequently their combined equity shareholding of ten per cent of the total equity capital of the Petitioner is not in compliance with Regulation 8 of the MIMPS Regulations. These findings have been challenged on behalf of the Petitioner and a substantial area of submission has covered the ambit and purview of Explanation (IV) to Regulation 8. 83. Regulation 8 contains a bar on a person resident holding directly or indirectly either individually or together with persons acting in concert, more than five per cent of the equity share capital of a recognized stock exchange. The exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... quity holding of a person resident has been imposed. The regulation seeks to ensure that its provisions should not be diluted through an indirect holding of shares and the use of the expression "directly or indirectly" are indicative of the fact that the net of Regulation 8 is set in wide terms. 85. The expression "persons acting in concert" is to have the meaning derived from Regulation 2(1)(e) of the Takeover Regulations. The expression "derive" means "to draw or receive, or obtain as from a source or origin". (P. Ramanatha Aiyar's The law Lexicon, Second Edition Reprint 2007 page 530). The process of derivation is to trace or show the origin. The act of deriving, it has been stated, is immediate and direct and is perhaps distinguishable from an act of tracing which may be a some what more gradual process. To derive a meaning is to obtain that meaning from a source or origin. The source indicated in Explanation (IV) is Regulation 2(1)(e) of the Takeover Regulations. 86. In construing the words of an explanation in a statute, it must be borne in mind that while traditionally, the function of an explanation is to explain the meaning of a word used in a statutory provision or to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Indeed, as the Supreme Court has observed in Dattatraya Govind Mahajan (supra), the essential task in construing an explanation is to deduce the legislative intent from the words used. 87. Prior to its amendment in 2008, Regulation 8(1) contained a reference both to the acquisition or holding of more than five per cent in the paid up equity capital in a recognized stock exchange. Following the amendment and the recasting of Regulation 8, the reference now is to the holding of not more than five per cent of the equity share capital. In the Takeover Regulations, Regulation 2(1)(e) defines the expression "person acting in concert" in two parts. Clause (1) of Regulation 2(1)(e) refers to a situation where persons who, for a common objective or purpose of substantial acquisition of shares or voting rights or gaining control over the target Company, pursuant to an agreement or understanding, formal or informal, directly or indirectly cooperate by acquiring or agreeing to acquire shares or voting rights in the target Company or control over the target Company. The elements which go to comprise clause (1) of Regulation 2(1)(e) are: (i) A group of persons who share a common object or pur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arget company. For, dehors the element of the shared common objective or purpose the idea of "person acting in concert" is as meaningless as criminal conspiracy without any agreement to commit a criminal offence. The idea of "persons acting in concert" is not about a fortuitous relationship coming into existence by accident or chance. The relationship can come into being only by design, by meeting of minds between two or more persons leading to the shared common objective or purpose of acquisition of substantial acquisition of shares etc. of the target company. It is another matter that the common objective or purpose may be in pursuance of an agreement or an understanding, formal or informal; the acquisition of shares etc. may be direct or indirect or the persons acting in concert may cooperate in actual acquisition of shares etc. or they may agree to cooperate in such acquisition. Nonetheless, the element of the shared common objective or purpose is the sine qua non for the relationship of "persons acting in concert" to come into being." Hence, it is now a settled principle of law that the relationship which the words "persons acting in concert" encompasses is one which comes i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lding, whether by themselves or together with their relatives, the majority of shares in that body corporate also hold, whether by themselves or together with their relatives, the majority of shares in the other body corporate." 91. The Additional Solicitor General submitted that since the provisions of the Takeover Regulations have been incorporated by reference into the MIMPS Regulations, the Court may make due alterations in the details of Regulation 2(1)(e) based on the context of the incorporating regulations. In Paresh Chandra Chatterjee v. State of Assam AIR 1962 SC 167, the Supreme Court held while construing the provisions of the Assam Land (Requisition and Acquisition) Act, 1948, that the legislature having provided that the provisions of the Land Acquisition Act, 1894, shall apply mutatis mutandis in respect of a reference made to the Court under the State Act, appropriate changes in the phraseology used in Section 23 of the Central Act may have to be made to apply the principles underlying those provisions to the state legislation. The Additional Solicitor General urged that there is a difference in the context and setting of the expression "persons acting in concert" ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... latter constitute the source of the meaning. The essential attributes of the expression are those which are to be found in the Takeover Regulations. In extrapolating the meaning contained in the Takeover Regulations to the MIMPS Regulations, the essential features of the meaning cannot be destroyed. The process of extrapolation may legitimately involve necessary changes in points of detail. To incorporate the meaning mutatis mutandis may be permissible so as to adapt matters of detail to impart effective content to the expression when it is used in the context of the MIMPS Regulations. But that process must necessarily adopt the heart and soul of the meaning and the existence of a common object and purpose constitutes the essence of the meaning of the expression "persons acting in concert". Regulation 8 is being applied to a situation where the promoters of a stock exchange held the entire equity capital before the process of divestment commenced. The mere fact that they are promoters is not sufficient to hold that they are acting in concert for the purpose of Regulation 8. If such an extreme position of interpretation were to be adopted, compliance with Regulation 8 norms would be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eld as follows: "It is the holding in the aggregate of a majority of the shares issued by a person or persons acting in concert in relation to the affairs of the Company which establishes the existence of a block. It is sufficient, if having regard to their relation etc., their conduct, and their common interest, that it may be inferred that they must be acting together; evidence of actual concerted acting is normally difficult to obtain, and is not insisted upon." XIII : The validity of the impugned order 94. In the notice to show cause that was issued to the Petitioner, FTII and MCX were regarded as persons acting in concert on the basis of a letter dated 14 December 2009 addressed by MCX to IL FS and a letter dated 20 August 2009 addressed by La-Fin to IL FS Financial Services. Moreover, it was alleged that FTIL and MCX are under the same management in terms of Regulation 2(1)(e)(2)(i) of the Takeover Regulations read with Section 370(1B) of the Companies' Act, 1956. Moreover, it was alleged that FTIL as on 31 March 2010, held 31.18% of the equity share capital of MCX and that by its dominant holding, FTIL is in control of MCX. 95. There are two limbs to the finding whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l the warrants issued on capital reduction are converted into shares by the existing shareholders. On 26 March 2010, when IL FS exercised its rights under the buy back agreements, the warrants were purchased not by La-Fin, but by MCX. 96. During the course of the hearing, certain factors have been set out to on behalf of SEBI to indicate that the three companies, the Petitioner, MCX and FTIL form part of one group. These are: (i) Jignesh Shah and his wife held 100% of the equity share capital of La-Fin as admitted during the course of the hearing by the Petitioner and by the Third and Fourth Respondents; (ii) La-Fin together with Jignesh Shah and his family hold 45.53% of the equity share capital of FTIL; (iii) FTIL holds 31.18% of the equity share capital of MCX; and (iv) The website of FTIL shows the Petitioner and MCX as part of the FTIL group. In paragraph 52 of his impugned order, the Whole Time Member has concluded that FTIL and MCX are Companies under the same management under Section 370(1B)(i) of the Companies' Act, 1956 on the ground that they have a common manager, Mr. Jignesh Shah, and are, therefore, deemed to be persons acting in concert for the purpose of MIMPS Reg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... agement of the whole or substantially the whole of the affairs of the Company. The test that must be applied in determining as to whether a person must be regarded as a 'manager' in Section 2(24) was elucidated in the judgment of the Supreme Court in CIT v. Alagappa Textile (Cochin) Ltd. [1980] 1 SCC 214/[1979] 49 Comp. Cas. 947 (SC), Mr. Justice V.D. Tulzapurkar, speaking for the Bench of the Supreme Court held as follows: "Before we consider the principal question relating to the proper construction of the Agreement dated November 10, 1957, it will be desirable to note the relevant provisions of the Indian Companies Act, 1913 as also the new Companies Act, 1956, which have a bearing on the question at issue. Since the Agreement between the assessee on the one hand and the Kamala Mills Ltd. On the other was entered into at a time when the Indian Companies Act, 1913 was in force it will be proper first to refer to the definition of 'Manager' given in s. 2(9) of the said Act. Section 2(9) ran thus: "2(9) "manager" means a person who, subject to the control and direction of the directors has the management of the whole affairs of a company, and includes a director or any other pe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... L and MCX primarily on the basis of one letter and the undertaking contained therein. The test which has been adverted to in the judgment of the Supreme Court in Alagappa Textile (Cochin) Ltd. (supra) has not been considered while assessing the applicability of Regulation 2(2)(e)(2). Moreover, several of the circumstances which have been adverted to during the course of the submissions by the Learned Additional Solicitor General of India do not form the basis of the impugned order. This is apart from the fact that in deciding the issue as to whether FTIL and MCX are persons acting in concert, the Whole Time Member of SEBI has not dealt with whether the principal requirement of a common objective or purpose has been fulfilled. The impugned order is, therefore, rendered vulnerable on account of its failure to apply the requisite legal standard that must determine whether the promoters were acting in concert within the meaning of Regulation 2(1)(e). 98. During the course of the hearing, a joint statement has been tendered to the Court on behalf of the Third and Fourth Respondents in the form of an undertaking signed by their Advocates in the following terms: "Joint Statement by Re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n shared with SEBI in order to enable it to determine whether Regulation 8(1) has been complied with; (ii) The buy back agreements were illegal under the SCRA and the Petitioner was either instrumental to those agreements or has knowledge of them; and (iii) The Petitioner should have submitted the proposed Scheme of Reduction to SEBI and ought to have sought a confirmation of whether it fully complies with the MIMPS Regulations. The Whole Time Member has, however, concluded that he cannot go so far as to agree with what has been stated in the notice that the Petitioner has been dishonest in not giving SEBI adequate information about the Scheme itself. 102. In the earlier part of this judgment, the issue of disclosure has been elaborated upon at length. The relationship of a stock exchange with SEBI must be founded on utmost good faith. Material and relevant facts which have a bearing on compliance with the Act and the Regulations which SEBI enforces must be disclosed. When SEBI, as a condition for the recognition of a stock exchange imposes a stipulation of compliance with the provisions of the MIMPS Regulations - and it may be compliance of the relevant provisions as the sub ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat it would not be justifiable in the facts of the present case to reject the application merely on that ground. From the perspective of the Whole Time Member who made the impugned order, the non-disclosure of the buy back agreements is coupled with his finding that the buy back is a forward contract and, is therefore, illegal. This aspect of the finding of the adjudicating officer has been held to be erroneous in the earlier part of the judgment. Once the buy back agreement is held not to be a forward contract, then the alleged illegality of the agreement as a ground for holding that the Petitioner is not a fit and proper person necessarily ceases to exist. Another circumstance which must be borne in mind is that during the course of the proceedings before SEBI, an undertaking has been tendered on behalf of the promoters that the statutory limit which has been prescribed under the MIMPS Regulations would not be exceeded. Moreover, during the course of the proceedings before this Court, the undertaking which has been tendered by the promoters is even more specific and stringent: that notwithstanding the exercise of the option under the buy back or the warrants, the shareholding of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... based on trust and utmost good faith. A stock exchange is duty bound to make a full and honest disclosure of all material and relevant facts which have a bearing on the issue as to whether the requirements of the MIMPS Regulations have been fulfilled. The existence of the buy back agreements was a material circumstance which ought to have been disclosed to SEBI; (v) The sanctioning of the Scheme of capital reduction by the Company Judge under Sections 391 to 393 read with Sections 100 to 103 of the Companies' Act, 1956, does not preclude SEBI as a statutory regulator from determining as to whether the provisions of the MIMPS Regulations have been complied with. SEBI is independently entitled to ensure compliance with the MIMPS Regulations which have been made a condition for the grant of recognition. The statutory functions conferred upon SEBI under the SCRA and cognate legislation are not diluted; (vi) During the course of the proceedings before SEBI as well as before this Court, undertakings have been filed by the promoters to the effect that the provisions of the MIMPS Regulations including the ceiling on the holding of the shares would be complied with notwithstanding the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... acting in concert" in the Takeover Regulations cannot be abrogated. SEBI when it incorporated the definition of "persons acting in concert" from the Takeover Regulations was conscious of the definition in those Regulations and must be attributed with the knowledge of the manner in which it has been interpreted. The Supreme Court has held that the existence of a common objective or purpose is a necessary requirement of the expression which must be fulfilled by an agreement, formal or informal; (x) The impugned order passed by the Whole Time Member has failed to apply the principal test enunciated by the judgment of the Supreme Court in Daiichi Sankyo Co. Ltd. (supra) in determining as to whether certain persons may be held to be acting in concert. The mere fact that two persons have come together in promoting a Company does not lead to the inference that they are acting in concert for the purposes of the Takeover Regulations. The further finding of the Whole Time Member of SEBI that the two promoters of the Petitioner had a common Manager is based primarily on the execution of one letter. The finding does not take into account the test spelt out by the Supreme Court in Alagappa T ..... X X X X Extracts X X X X X X X X Extracts X X X X
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