9911796707
TMI Blog2013 (9) TMI 914X X X X Extracts X X X X X X X X Extracts X X X X ..... hallenges 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 Impugned order. * III- Submissions. * IV - The SCRA and MIMPs Regulations. * V - Role of Stock Exchanges. * VI - Regulation 4 and Regulation 8. * VII- The process of dilution. * VIII- Share warrants. * IX - Buy back arrangements. * X - Duty of disclosure. * XI - Legality of buy backs. * XII âEUR" Persons Acting in concert. * XIII- The Validity of the impugned order. * XIV- Conclusion. I : Facts. 4. The Fourth Respondent, Multi Commodity Exchange of India Limited, who is a promoter of the Petitioner made an application on 12 August 2008 for recognition of the Petitioner as a Stock Exchange. The Petitioner was incorporated on 14 August 2008 and received a certificate for commencement of business on 19 August 2008. The Petitioner has two promoters, Financial Technologies (India) Limited (FTIL) and Multi Commodities Exchange of India (MCX), the Third and the Fourth Respondents. On 22 August 2008, the Petitioner applied to SEBI for the grant of recognition as a Stock Exchange under t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 in addition to the Small and Medium Enterprise Segment. 7. On 31 March 2009, the Petitioner offered to issue shares on a preferential basis to Punjab National Bank (PNB) together with an exit option. The exit option stipulated that (i) PNB would be entitled to a simple rate of return at the rate of 16% per annum after completion of three years from the date of investment on the total amount invested; (ii) FTIL or its nominees would have a right to buy back shares from PNB at any time after the expiry of a period of one year from the date of investment; and (iii) If PNB retained the shares inspite of the buy back offer, it would not be entitled to an assured rate of return and FTIL would have no liability to buy back the shares in future. 8. On 21 May 2009, the Petitioner addressed a letter to SEBI seeking an extension of one year to ensure full compliance with the MIMPS Regulations. 9. Between May and November 2009, in order to comply with the MIMPS Regulations, the Petitioner in the first stage ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 obligation to offer to purchase at any time during the Agreed Period (as defined hereinafter) in its sole discretion considers appropriate, all the shares purchased by you under the SPAs in MCX-SX by giving a written notice at any time after completion of one (1) year from the date of investment but no later than three (3) years from the date of investment ("Agreed Period"), post which your rights herein stated shall lapse. You will have to confirm your acceptance/non acceptance for the offer within a maximum period of 30 days. The price at which such shares will be offered to be purchased by us will be at a price which will be higher of the following ("Buy Back Price"): (i) Price which provides an internal rate of return ("IRR") of 15% on the investment or; (ii) Price at which the most recent transaction MCX-SX equity shares is carried out by MCX-SX or MCX or FTIL Group. 2. It being clarified that in the event MCX-SX plans an IPO within one year from the date of investment we hereby covenant that we shall no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 a shareholding of 38.31% and IFCI Ltd. with a shareholding of 4.27%. Hence, the shareholding pattern reflected that the Promoter Companies had a shareholding of 73.36%. 15. On 31 October 2009, the Petitioner's Board of Directors called upon the initial promoters, the Third and Fourth Respondents, to reduce their shareholding by cancelling their shares in excess of the prescribed limit, by a scheme of reduction-cum-arrangement under Sections 391 to 393 of the Companies' Act, 1956 read with Sections 100 to 104. On 14 December 2009, the Fourth Respondent addressed a letter to IL&FS referring to the Share Purchase Agreement dated 20 August 2009 and La-Fin's letter of the same date and requested IL&FS to approve the scheme of reduction-cum-arrangement proposed to be considered at an Extra-ordinary General Meeting to be held on 15 December 2009. 16. The scheme for reduction of the equity shareholding of the promoters was approved by the shareholders of the Petitioner at an Extra-ordinary General Meeting on 15 December 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s' 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 other investors or to exercise the option under the warrants, the Petitioner would ensure compliance with the MIMPS Regulations as well as the regulatory regime: "The said Reducing Shareholders shall, over a period of time, transfer their warrants to other prospective investors or exercise the option attached to the warrants. However, the Petitioner Company shall ensure that such transfer or exercise shall always be in compliance with the Securities Contracts (Regulation) (Manner of Increasing and Maintaining Public Shareholding in Recognized Stock Exchanges) Regulations, 2006, or any other equivalent regulatory regime laid down by the competent regulator, which is for the time being in force." 18. On 21 December 2009, the Petitioner addressed a letter to SEBI highlighting the main features of the Scheme of Reduction. The letter accepted that the scheme "will be in contrast to the normal practice of reducing holding by selling shares and realising value". Among the main features of the Scheme which were highlighted were as fol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y 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 its recognition valid until 15 September 2010 to trade in the existing securities. The Petitioner also sought an expeditious grant of permission to commence operation in other segments. 22. On 16 July 2010, the Petitioner instituted a writ proceeding under Article 226 of the Constitution before this Court aggrieved by the delay on the part of SEBI in deciding upon the application for approval for commencing trading in other segments in addition to exchange credit currency derivatives. 23. On 21 July 2010, SEBI addressed a letter to the Petitioner stating that it had been brought to its notice that the Petitioner had entered into buy back arrangements with a Bank which was a shareholder of the Petitioner. This, it was stated, was observed from a news article published on 19 July 2010. On 2 August 2010, the Petitioner in a reply to SEBI's letter enclosed a copy of the "comfort letter" which was issued to PNB by FTIL, its promoter and the Third Respondent. 24. On 10 August 2010, a Division Bench of this Court disposed of the Writ Peti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tice 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 SCRA read with Sections 11(1) and 11B of the SEBI Act to show cause why the application dated 7 April 2010 should not be rejected. Five grounds were set out in support of the notice to show cause: (i) Concentration of the promoters' interest in the Petitioner as a stock exchange : the case being that both the Third and Fourth Respondents continue to retain the same percentage share (38.01% and 33.89%) of the issued equity shares and warrants taken together as they did when both the promoters were holding only equity shares of the Petitioner; (ii) The manner of compliance with Regulation 8(1) of the MIMPS Regulations did not accord with the modes set out in Regulation 4. All other Stock Exchanges had adopted one of the modes explicitly recognised in Regulation 4, whereas the Petitioner had merely substituted the holding of equity by a right to acquire equity; (iii) Neither the Petitioner nor its promoters, the Third and Fourth Respondents, could be regarded as fit and proper persons since inter alia the details of the buy back arrangement had b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ner together with its promoters not to violate the MIMPS Regulations in the Scheme of Capital Reduction will not render it compliant with the Regulations; (vii) The difficulty of the promoters in divesting shares was purely a commercial consideration. SEBI's interpretation of the meaning of full compliance under the Regulations should not be tailored to meet the business objectives of the promoters; (viii) Other Stock Exchanges have not adopted any method other than one of the methods referred to in the MIMPS Regulations; (ix) The meaning of the expression "acting in concert" is to be derived from the Takeover Regulations by virtue of Explanation (IV) to Regulation 8; (x) The meaning in the Takeover Regulations has to be adopted mutatis mutandis. Regulation 8 uses the expression "hold" in contrast to the Takeover Regulations which use the expression "acquire". This would mean that a common objective attaches itself to the holding of shares and not acquiring a target company. A person holding shares in a recognized Stock Exchange with a common objective would be a person acting in concert for the purposes of Regulation 8; (xi) FTIL and MCX are de jure, persons acting in concert ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... recognised stock exchange in the hands of two promoters is not in the interest of a well-regulated securities market; b. The Applicant is not fully compliant with the MIMPS Regulations as substitution of shares by warrants is an attempt to work around the requirements of Regulation 8 and the same is not a mode recognised as falling within the scope of the said Regulations; c. The Applicant has been dishonest in withholding material information on arrangements regarding the ownership of shares of its shareholders and therefore has not adhered to fair and reasonable standards of honesty that should be expected of a recognised Stock Exchange; d. The Applicant has failed to ensure compliance with Regulation 8 of the MIMPS Regulations as its two promoters (FTIL and MCX) are persons acting in concert and cannot hold more than 5% in the equity shares of a recognized stock exchange; e. The Applicant is instrumental to buy back transactions that are illegal under the SCR Act and cannot be considered to have adhered to fair and reasonable standards of integrity that should be expected of a recognized Stock exchange." 30. Before we deal with the rival submissions, it must be noted at th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stablish an exchange. Regulation 4 applies to dilution of equity of persons having trading rights in a Stock Exchange and cannot apply in terms to the Petitioner. At the highest, Regulation 4 can apply as regards the requirement of at least 51% shares being held by the public. Regulation 2(1)(h) defines the expression "public" as including a member of the public, but excluding a shareholder with trading rights. In the case of the Petitioner, the entire equity is held by persons other than those holding trading rights; (ii) The method of reduction of share capital has resulted in the Third and Fourth Respondents reducing their shareholding respectively to less than five per cent; (iii) The letter dated 21 December 2009 addressed by the Petitioner points out the manner in which the MIMPS Regulations would be complied with and it was the case of the Petitioner that the method of reduction was suggested by Senior Officers of SEBI; (iv) Other Stock Exchanges in India historically had trading members, whereas the Petitioner had no trading members at all. Consequently, the means adopted by other Stock Exchanges cannot apply to the Petitioner; (v) The submission of concentration of eco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omoters are not fit and proper persons within the meaning of Regulation 9 since they are parties to an illegal contract. A. The submissions which have been urged by the Third Respondent on the legality of the buy back arrangement are as follows: (i) The buy back arrangement does not constitute a concluded contract for the purchase and sale of shares, but only furnishes an option to PNB/IL&FS. This is in the nature of a privilege or concession entirely dependent on the volition of the PNB/IL&FS. An option involves a unilateral exercise of volition as distinct from a contract of sale and purchase which involves reciprocal obligations; (ii) If and when, the buy back arrangement fructifies into a contract, the contract will be for sale and transfer of shares necessarily on a spot delivery basis. Spot delivery contracts are expressly permitted by the notification issued under Section 16 of the SCRA. Spot delivery in Section 2(i) of the SCRA applies to shares in dematerialised form held in a depository account which is the case in the present case. The contract would, therefore, necessarily be on a spot delivery basis and would not suffer from any illegality; (iii) The buy back arran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to buy or the right to sell is itself the subject matter of the contract and the option is traded on the Stock Exchange. It is only such option contracts that are required to be traded on the Stock Exchange; (iv) The buy back arrangement in the present case does not result in an option being traded or sold. The arrangement is directly with reference to shares and is not an option contract. C. As regards the second contention of SEBI that the exercise of the option under the buy back arrangement will result in a contract coming into existence and which upon being performed by the promoters will result in their exceeding the limit of five percent under the MIMPS Regulations, it has been urged that: (i) SEBI is not entitled to take into consideration the mere possibility of future events taking place, particularly when there is no obligation on PNB and/or IL&FS to sell the shares to the promoters in future. A scheme which is otherwise valid cannot be questioned on an apprehension or speculation of what might possibly happen in future. SEBI, by taking this factor into account, has misdirected itself by proceeding on the basis of an irrelevant consideration; (ii) SEBI did not have a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... de the order. c. The Fourth Respondent's submissions 33. On behalf of the Fourth Respondent, the following submissions have been urged: (i) In view of the order of the Company Court dated 12 March 2010 sanctioning the Scheme of Capital Reduction, the issue as to whether the holding of the promoters stands reduced to five percent and the effect of the convertible warrants on promoters' shareholding stands conclusively decided in favour of the Petitioner. The object of the Scheme was solely to reduce the holding of the promoters to five percent to comply with the MIMPS Regulations. It was the function of the Company Court to scrutinize the Scheme and once sanctioned, the Scheme binds SEBI and operates as res judicata on all issues involved in the Petition; (ii) The finding that a reduction can be achieved only in one of the modes prescribed in Regulation 4 is unsustainable: (a) Regulation 4 does not apply to the Petitioner which was already a demutualised exchange with no trading member shares to be divested and hence the modes specified are not exhaustive or mandatory; (b) The object of the Regulation is more important than the manner in which it is achieved especially because t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t shares. In such an event, there would be no application made by an existing Company and all the provisions would be rendered useless. Hence, that regulation has no application to the facts of the present case and there can be no occasion to commit a breach thereof; (ix) Alternatively, even if the combined shareholding of two promoters is to be considered, even then, unless it is established that they were acting in concert, there would be no violation of Regulation 8. Acting in concert pre-supposes a requirement of an overt act. Acting in concert in promoting a Company cannot be regarded as acting in concert while considering an application for permission unless an overt act post promotion is established; (x) The issue as to whether two promoters by holding more than five percent of the shares are acting in concert is a question of fact to be determined after considering the entire material. An inference of promoters acting in concert is negated by the fact that (a) The promoters have made efforts to bring down their shareholding from 49% and 51% respectively to five percent each; and (b) They have furnished an undertaking to keep their holding within limits; (xi) The essentia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... missions have been urged by the Additional Solicitor General of India: (i) Stock Exchanges play a vital and important role in the economy and are an instrument of regulation. Recognition under Section 4 of the SCRA has to be in the interest of trade and public interest. SEBI has to be satisfied of the suitability and integrity of an applicant; (ii) The initial approval granted by SEBI to the Petitioner on 18 September 2008 was subject to full compliance with the MIMPS Regulations. The fact that in the renewal notification dated 31 August 2009, the expression "relevant provisions" was used, does not make any difference; (iii) Between 2008 and 2010, the Petitioner adopted a number of steps to achieve compliance with the MIMPS Regulations including the sale of shares coupled with an obligation of the promoters to buy back shares and the Scheme of Reduction-cum-Arrangement to convert some of the equity shares into warrants. On scrutiny, SEBI discovered that the Petitioner has failed to comply with the MIMPS Regulations for the following reasons: (a) The buy back arrangement between the promoters with various Banks and Financial Institutions indicated that the transfers were not tru ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ut also for MCX of which he is designated as non-executive Vice Chairman. MCX is listed as a Group Company of FTIL. The two promoters are, therefore, under a common management; (vii) The expression "persons in concert" as it is used in the Takeover Regulations must apply mutatis mutandis to the MIMPS Regulations and hence, there is no requirement of a common objective of acquisition for the purposes of the MIMPS Regulations. This is buttressed by the use of the word "derived" in Explanation 4. Prior to its amendment in 2008, Regulation 8 provided that no person shall directly or indirectly acquire or hold more than five percent in the paid up equity capital of a recognized Stock Exchange. After the amendment, the reference to acquire has been deleted indicating that a common purpose of acquiring shares is not relevant to the MIMPS Regulations; (viii) Even the Takeover Regulations use the expression "persons acting in concert" in the context of a mere holding of shares without acquisition; (ix) FTIL and MCX continue to act in unison with a common object of continuing to hold equity shares of the Petitioner in excess of the limit specified in Regulation 8: (a) In response to a let ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... agreements. IL&FS was offered a fresh buy back agreement by MCX in respect of warrants that were issued to it pursuant to the Scheme of Reduction. IL&FS exercised that right on 26 March 2010 by requiring MCX to procure the purchase of some warrants. In fact, IL&FS in a letter to SEBI asserted that the buy back agreement is a valid contract; (xiv) The buy back agreements are valid contracts in praesenti though there is no obligation in praesenti. The enforceability of the contract is dependent on the volition of one of the parties and not on a contingent event; (xv) The SCRA applies equally to listed and unlisted companies and would apply to the shares of the Petitioner; (xvi) The impugned order proceeds on the basis that the buy back agreements are forward contracts and, therefore, illegal under Sections 13 and 16 of the SCRA. However, on a close scrutiny, it appears that the buy back agreements are actually option contracts and are, therefore, illegal under Section 18A and of the SCRA. A buy back agreement envisages that the institutional investor has a right, but not an obligation to sell shares to the promoters of the Petitioner and constitutes an option in securities under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... perverse, based on no evidence or on a misreading of evidence. On these grounds, it has been urged that the interference of the Court is not warranted in the exercise of the jurisdiction under Article 226 of the Constitution. 35. These submissions now fall for determination. 36. The adjudication in the present case is by the Whole Time Member of SEBI, which is an expert statutory body. While assessing the challenge to those findings, the Court must bear in mind that the interference of the Court under Article 226 of the Constitution is confined to certain well settled, if restricted, parameters. The view of the expert should not be disturbed unless it is perverse or not based on evidence or is based on a misreading of evidence. This principle was laid down by the Supreme Court even in the context of the appellate power of the High Court over a determination made by the Electricity Regulatory Commission. (West Bengal Electricity Regulatory Commission v. C.E.S.C. Ltd.) AIR 2002 SC 3588. The High Court under Article 226 of the Constitution would not be justified in substituting the view of an expert adjudicator for another view merely because it commends itself to the Court. IV : T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ge. In paragraph 9.32, the Committee was of the view that having regard to the public interest in the efficient functioning of stock exchanges, it is important that no single entity or groups of related entities should be allowed to control a stock exchange through a cornering of shares. The Committee's view was that there should be a ceiling of five per cent on the voting rights which can be exercised by a single entity or groups of related entities irrespective of the size of the ownership of shares. 39. Following the report of the Kania Committee, Sections 4A and 4B were introduced with effect from 12 October 2004 by the Securities Laws (Amendment) Act, 2004 into the SCRA. Section 4A stipulates that on and from the appointed date, all recognized stock exchanges if not corporatised and demutualised before the appointed date, shall be corporatised and demutualised in accordance with the provisions of Section 4B. Section 4B lays down the procedure for corporatisation and demutualisation. Under sub-section (1) all recognised stock exchanges referred to in Section 4A, were mandated to submit a scheme for corporatisation and demutualisation to SEBI for its approval within such time a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or section of the public, but not to include any shareholder of a recognized stock exchange having trading rights or any associate of such shareholder. The expression "associate" is defined in Regulation 2(b). In Regulation 2(j) a shareholder having trading rights means a shareholder, who has a trading interest in the stock exchange, whether directly or indirectly. 43. Regulation 3 provides that the MIMPS Regulations shall be applicable to all recognized stock exchanges in respect of which a scheme for corporatisation or demutualisation has been approved by the Board under Section 4B. Regulation 3 indicates that the MIMPS Regulations were to apply only to old mutualised stock exchanges for which a scheme is approved by SEBI. The application of the Regulations to the Petitioner was brought about initially by SEBI's approval on 18 September 2008 to set up a stock exchange which was subject to the condition that the Petitioner would ensure full compliance with the MIMPS Regulations. The approval being valid initially for a period of one year, it was renewed subsequently. In the course of the renewal dated 31 August 2009, the Petitioner was called upon to comply fully with the releva ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of Chapter II of the MIMPS Regulations which deals with the manner of increasing public shareholding. Regulation 8 forms part of Chapter III which deals with shareholding restrictions. Regulation 8(1) provides that no person resident in India shall, at any time, directly or indirectly, either individually or together with persons acting in concert hold more than five per cent of the equity share capital in a recognized stock exchange. Under the first proviso, the restriction of five per cent is enhanced upto fifteen per cent of the paid up equity share capital of a recognized stock exchange in the case of a stock exchange, a depository, a clearing corporation, a banking or an insurance company and a public financial institution. Explanation (IV) to Regulation 8 states that the expression "persons acting in concert" shall have the meaning derived from clause (e) of sub-regulation (1) of Regulation 2 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. 45. Regulation 8(1), in its present form, was substituted by an amendment which was with effect from 23 December 2008. Prior to its substitution, Regulation 8(1) contained a stipulation prohibiting a pers ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es under the Regulations for a period of ten years. The Board has the power under Regulation 12 to undertake inspection and conduct enquiries and audit of a recognized stock exchange or any shareholder having trading rights in the exchange. V : Role of Stock Exchanges 47. Stock Exchanges traditionally were constituted by brokers and dealers, who were in management. This position has undergone a radical change in several countries. Andreas M Fleckner in a seminal article titled "Stock Exchanges at the Crossroads" (Fordham Law Review - April, 2006) notes that with increased competition caused by deregulation, technological advances and globalization, the organisation of stock exchanges was at crossroads. The organization of stock exchanges was altered with the onset of demutualization: "Traditionally, stock exchanges were organized as not-for-profit organizations founded and owned by brokers and dealers who managed "their" stock exchange like an exclusive club, with high barriers for new entrants and a regional or even national monopoly, comparable to a medieval gild. Today, domestic and international competition increasingly compel stock exchanges to give up their exclusivity, un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n since it is the basis of market surveillance and helps in detecting securities fraud such as insider trading or market manipulation; (iii) Stock exchanges are regulators of the market which they organize. This ranges from compliance surveillance to enforcement. The broker-dealers who trade on the market are subject to rules of the stock exchanges. Stock exchanges also monitor compliance by participants with the regulatory regime including that directed by the statutory regulator. Stock exchanges perform an important role to ensure fair trading and accurate price discovery both of which are critical in creating investor confidence; (iv) Stock exchanges set standards of corporate governance through their listing rules; (v) Finally, while fulfilling this function, stock exchanges carry on business enterprises. As business enterprises (though the business of running a stock exchange may not necessarily be commercial), the performance of the stock exchange has a bearing on its competitive position in relation to its own competitors. 50. Commencing with the Stockholm Stock Exchange in 1993 stock exchanges worldwide transformed themselves from member-owned companies into publicly he ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ry. The orderly functioning of stock exchanges as institutions through which transactions in securities take place is a matter of public interest. The regulatory powers which have been conferred upon SEBI to recognise stock exchanges must be understood in the context of ensuring the protection of investors on one hand and the public interest that is involved on the other. SEBI is an expert regulatory body which is vested with the power to direct and regulate the functioning of stock exchanges. SEBI, as a regulatory authority, is vested with wide powers to ensure the protection of the interest of investors and the orderly development of the securities market. Ensuring the proper management of stock exchanges is a matter which falls within the regulatory framework which SEBI directs. Where the affairs of a recognized stock exchange are conducted in a manner detrimental to the interest of the investors or the securities market, it has consequences not just for the stock holders in the market, but for the financial stability of the nation. Stock exchanges are the first frontiers of regulation, for it is their duty to ensure, in the first instance, that transactions are conducted in a t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... its oral and written submissions also accedes to the position that Regulation 8, unlike Regulation 4, does not specify the manner in which shareholding should be reduced to below the specified threshold. 55. SEBI, however, suggests that one would ordinarily expect the modes specified in Regulation 4 to be followed for the purposes of Regulation 8, even though they are not mandatory. Now, all the modes which are provided for in Regulation 4 may not be applicable to a situation involved such as in the case of the Petitioner. Among the modes which are specified, are an offer for sale of shares held by shareholders having trading rights; the placement of shares held by shareholders having trading rights to such persons or institutions as may be shortlisted by the exchange with the approval of SEBI. The third mode is the issue of equity shares on private placement basis by a stock exchange to any person or group of persons not being shareholders having trading rights or their associates. In a stock exchange having no shareholders with trading rights, the modes specified in clauses (a) and (b) of Regulation 4 would have no application. Hence, the issue as to whether there is compliance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uction, namely, MCX, FTIL and IL&FS. Each warrant would entitle the holder to subscribe to one equity share at any time after six months from the date of issue and an option to that effect could be exercised after six months from the date of allotment. The warrants were, however, not to carry any voting rights. Clause 2.4 of the scheme provided that the exercise of the warrant would be subject to the Regulations. 59. By a letter dated 21 December 2009, SEBI was informed of the Scheme. The letter intimated SEBI that (i) Post reduction, the shareholding of the two promoters would not be in excess of five per cent; (ii) The two promoters and another shareholder, a financial institution whose equity shares were being extinguished would to the extent of equity capital being extinguished be allotted an equal number of warrants; and (iii) The promoters once having reduced their shareholding to five per cent shall not be permitted to increase their shareholding beyond the limit specified in the MIMPS Regulations. 60. During the pendency of the earlier Writ Petition before this Court, a statement was made on behalf of the two promoters before the Division Bench on 10 August 2010 that Boar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under Section 391 of the Companies' Act, 1956 has statutory force and binds the creditors and shareholders of the Company. SEBI is not a creditor of the Company. SEBI, as a matter of fact, was not heard in the Company Petition. There can be no dispute about the principle of law that the powers of the Company Court, when it sanctions a scheme under Sections 391 to 393 of the Companies' Act, 1956, are wide. Before sanctioning a scheme, though approved by a majority of the creditors or members, the Court has to be satisfied that the Company or any other person moving the application for sanction, has disclosed all the relevant matters. The Court has to determine whether the scheme is fair, just and reasonable and is not contrary to the provisions of law or of public policy. The Court would not countenance a scheme which is unconscionable or illegal or which is otherwise unfair and unjust to the class of shareholders or creditors for whom it is meant. Miheer H.Mafatlal v. Mafatlal Industries Ltd. [1997] 1 SCC 579/[1996] 10 SCL 70 (SC). Once the scheme is sanctioned, it would bind even the dissenting minority shareholders or creditors. S.K. Gupta v. K.P. Jain [1979] 49 Com. Cases 342 (S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arrants. 65. On 20 August 2009, IL&FS entered into a buy back agreement with La-Fin Financial Services Pvt. Ltd. (La Fin). The terms of the buy back agreement stipulated that La-Fin or its nominees would be under an obligation to purchase back the shares at any time after the completion of one year from the date of investment and no later than three years. On 14 December 2009, MCX addressed a letter to IL&FS seeking approval of the Scheme of Reduction, but confirmed that this would not be construed as a dilution of the terms of the Share Purchase Agreement and of the letter issued by La-Fin. On 11 August 2010, IL&FS addressed a communication to SEBI reaffirming that the buy back agreement was alive and was intended to be enforced. 66. There are two aspects in relation to the buy back agreement upon which there is a dispute. The first relates to the non-disclosure of the buy back agreement. The second relates to whether the buy back agreement is a forward contract in violation of the provisions of the SCRA. X : Duty of disclosure 67. The fact that the buy back agreement was not initially disclosed to SEBI is not in dispute. The submission which has been urged on behalf of the Fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... buy back agreements with the Banks who are shareholders of the Petitioner. In a reply dated 2 August 2010, the Petitioner informed SEBI that FTIL, as its promoter, had issued a letter of comfort dated 12 August 2009 to PNB without entering into a formal binding buy back agreement or shareholding agreement. It was stated that once the Scheme of Reduction was approved, the letter addressed by FTIL to PNB became infructuous and irrelevant. The Petitioner stated that it has complied with the MIMPS Regulations by virtue of the Scheme as approved and the shareholding of FTIL and MCX stood reduced to five per cent with no right to acquire even a single share in violation of limit prescribed by MIMPS Regulations. Even at that stage, there was no reference to the buy back agreement which was entered into with IL&FS. On this aspect of the matter, we are unable to accept the contention of the Petitioner and of the Third and Fourth Respondents that the existence of the buy back agreements was a circumstance which was irrelevant and was not required to be disclosed to SEBI. 69. The relationship between a Stock Exchange and SEBI must be founded in trust and good faith. Both constitute importan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rchase of any security other than such spot delivery contract or a contract for cash or hand delivery or special delivery in any security as is permissible under the Act and the Rules, Bye-laws and Regulations of a recognized stock exchange. On 1 March 2000, the earlier notification was rescinded and a fresh notification was issued by which it has been declared that no person shall save with the permission of SEBI enter into any contract for the sale or purchase of securities other than a spot delivery contract or a contract for cash or hand delivery or special delivery or a contract in derivatives as is permissible under the SCRA or the SEBI Act, 1992; and the Rules and Regulations made under those Acts and the Rules and Regulations and Bye-laws of a recognized stock exchange. A spot delivery contract is defined in Section 2(i) of the SCRA to mean a contract which provides for actual delivery of securities and the payment of the price either on the same day as the date of the contract or on the next day, the actual period taken for the dispatch of the securities or the remittance of money through post being excluded if the parties do not reside in the same town or locality. The de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e to sell the shares at a future point in time. If the promisee declines to exercise the option, the promissor cannot compel performance. A concluded contract for the sale and purchase of shares comes into existence only when the promisee upon whom an option is conferred, exercises the option to sell the shares. Hence, an option to purchase or repurchase is regarded as being in the nature of a privilege. 76. In V.Pechimuthu v. Gowrammal [2001] 7 SCC 617. Mrs.Justice Ruma Pal, speaking for a Bench of the Supreme Court explained the nature of an option or privilege thus: "A privilege has been defined as a particular and peculiar benefit or advantage enjoyed by a person, and a concession as a form of privilege. An option to purchase or repurchase has been held to be such a privilege or concession (See Shanmugam Pillai v. Annalakshmi, (AIR 1950 FC 38; K.Simrathmull v. Nanjalingiah Gowder, AIR 1963 SC 1182). This is because an option by its very nature is dependent entirely on the volition of the person granted the option. He may or may not exercise it. Its exercise cannot be compelled by the person granting the option. It is because of this one-sidedness or "unilaterality", as it wer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stipulated quantity of shares of a Bank at a specified price within twelve months from the date on which the Bank was converted into a Financial Corporation and if at the end of twelve months, the Defendant was not able to sell off the shares for the Plaintiff, the Defendant accepted the obligation to take delivery of those shares against the payment of a stipulated amount to the Plaintiff without interest. The Defendant failed to sell off the shares within the time stipulated upon which the Plaintiff sued for damages on the strength of the contract. In that case, the provisions of the Bombay Securities Control Contract Act, 1925 came up for consideration. The Act defined a ready delivery contract as a contract for the purchase or sale of securities for the performance of which no time is specified and which is to be performed immediately or within a reasonable time. The contention of the Plaintiff was that this was a ready delivery contract and, therefore, was lawful. If the contract was not a ready delivery contract, it would be void under Section 6 of the Act of 1925. Chief Justice Chagla held that on a plain reading of the contract, it was clear that no obligation attached with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Judge of this Court held prima facie at the hearing of a motion for interlocutory relief that a transaction of shares of a public limited Company unlisted on the stock exchange is not intended to be governed by the SCRA. In Mysore Fruit Products Ltd. v. The Custodian [2005] 107 Bom. L.R. 955 another Learned Single Judge held that the forward sale of shares even of public limited Companies which are not listed on the stock exchange are prohibited by the SCRA. This aspect of the controversy is now resolved by the decision of the Supreme Court in Naresh K.Aggarwala & Co. v. Canbank Financial Services Ltd. [2010] 6 SCC 178/ 100 SCL 425 (SC). The Supreme Court observed that the definition of the expression "securities" in Section 2(h)(i) does not make any distinction between listed securities and unlisted securities and the notification dated 27 June 1969 issued under Section 16 of the SCRA will also apply to the securities which are not listed on the stock exchange. Finally, it will be necessary to advert to the decision of the Supreme Court in Bank of India Finance Ltd. v. Custodian AIR 1997 SC 1952/[1997] 12 SCL 99 (SC). In that case, the Appellant Bank had entered into a contract w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... here was a forward contract which is unlawful at its inception is lacking in substance. 81. The Learned Additional Solicitor General, however, sought to sustain the finding of illegality by submitting that the buy back agreements constitute an option in securities within the meaning of Section 2(1)(d) and derivatives under Section 2(ac) of the SCRA and are violative of the provisions of Section 18A. Section 18A stipulates that notwithstanding anything contained in any other law for the time being in force, contracts in derivatives shall be legal and valid if such contracts are traded in a recognised stock exchange in accordance with the rules and bye laws of such exchange. It has been urged that as the buy back agreements were not entered into on a recognized stock exchange, they are illegal. Moreover, no permission was obtained from SEBI in respect of such option (derivative) as required by the notification dated 1 March 2000. On this aspect, we find merit in the submission urged on behalf of the Petitioner and by Counsel for the Third and Fourth Respondents that this contention which is urged on behalf of SEBI has been raised for the first time during the course of the oral argu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rson acting in concert" is defined in Explanation (IV) to have the meaning "derived from" Regulation 2(1)(e) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. Regulation 2(1)(e) of the Takeover Regulations defines the expression "person acting in concert" as follows : (e) "person acting in concert" comprises.- (1) persons who, for a common objective or purpose of substantial acquisition of shares or voting rights or graining control over the target company, pursuant to an agreement or understanding (formal or informal), directly or indirectly co-operate by acquiring or agreeing to acquire shares or voting rights in the target company or control over the target company. (2) Without prejudice to the generality of this definition, the following persons will be deemed to be persons acting in concert with other persons in the same category, unless the contrary is established: (i) a company, its holding company, or subsidiary or such company or company under the same management either individually or together with each other;" Regulation 2(2) specifies that all other expressions unless defined therein shall have the meaning assigned to them under the S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ultimately the issue is one of legislative intent. The position has been elucidated in the judgment of the Supreme Court in Dattatraya Govind Mahajan v. State of Maharashtra [1977] 2 SCC 548 thus: "...the orthodox function of an explanation is to explain the meaning and effect of the main provision to which it is an explanation and to clear up any doubt or ambiguity in it. But ultimately it is the intention of the legislature which is paramount and mere use of a label cannot control or deflect such intention. It must be remembered that the legislature has different ways of expressing itself and in the last analysis the words used by the legislature alone are the true repository of the intent of the legislature and they must be construed having regard to the context and setting in which they occur. Therefore, even though the provision in question has been called an Explanation, we most construe it according to its plain language and not on any a priori considerations. (See in this context G.P. Singh Principles of statutory Interpretation pp. 204 & 205)" In Sundaram Pillai v. Pattabiraman [1985] 1 SCC 591 at page 613 the Supreme Court indicated that an explanation may have the fol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ose is the substantial acquisition of shares or voting rights or gaining control; (iii) The object or purpose must be referable to a target Company; (iv) Such persons must act in pursuance of an agreement or understanding, though the agreement or understanding may be formal or informal; (v) Pursuant to the agreement or understanding, there must be cooperation between those persons directly or indirectly by acquiring or agreeing to acquire shares or voting rights in the target Company or control over the target Company. 88. The existence of a common object or purpose is an essential requirement of Regulation 2(1)(e)(1). In Daiichi Sankyo Co. Ltd. v. Jayaram Chigurupati [2010] 7 SCC 449/[2010] 103 SCL 1 (SC) paras 48 and 49 pp. 471 & 472 a Bench of three Learned Judges of the Supreme Court while interpreting the provisions of Regulation 2(1)(e)(1) emphasised the requirement that there must exist a target Company on the one hand, and the coming together of two or more persons with a shared common objective or purpose on the other hand. This emerges from the following observations: "48. To begin with, the concept of "person acting in concert" under regulation 2(e)(1) is based on a ta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of this design postulates a meeting of minds, the holding of a shared common object or purpose, the existence of an understanding and the implementation of that understanding in fulfilling the shared purpose of acquiring shares or voting rights or gaining control over the target Company. 89. A similar view has been taken in a judgment of a Division Bench of this Court in K.K. Modi v. Securities Appellate Tribunal [2003] 113 Com. Cases 418/[2002] 35 SCL 230 (Mum.) where it has been held that "the mere fact that a person is a promoter does not make him an acquirer, unless it is shown that he either intends to acquire or is acting in concert with the acquirer for the acquisition of shares of the target Company." In order to establish that a person is acting in concert, a common objective or purpose must be shown to exist. 90. Clause (2) of Regulation 2(1)(e) raises a presumption in which certain persons will be deemed to be persons acting in concert with other persons in the same category unless the contrary is established. The presumption in clause (2) is, rebuttable. Sub-clause (i) of Clause (2) refers to a Company, a holding Company or subsidiary or such Company or Companies un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e definition of the expression in the Takeover Regulations must apply with due alteration of details. If such an interpretation is adopted, it was urged, there would be no requirement of a common objective of acquisition for the purpose of the MIMPS Regulations. 92. Now, it must be emphasized that Explanation (IV) to Regulation 8 provides that the expression "persons acting in concert" shall have the meaning derived from Regulation 2(1)(e) of the Takeover Regulations. The meaning ascribed to the expression "persons acting in concert" in Regulation 2(1)(e) is unless the context otherwise requires. But, Explanation IV of Regulation 8 incorporates specifically the definition from Regulation 2(1)(e) of the Takeover Regulations. In deriving the meaning of the expression "persons acting in concert" from the Takeover Regulations and applying it in the context of the MIMPS Regulations, it will be necessary for the Court to render the expression workable having regard to the context in which the term is used in the MIMPS Regulations. Regulation 8 of the MIMPS Regulations, as it now stands, regulates the holding of equity share capital of a recognized stock exchange. Though Regulation 8 pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l position is that the entire share capital is held by promoters. Hence, the law requires something more to establish a case of persons acting in concert. The essential ingredients of the definition in Regulation 2(1)(e) must be fulfilled. 93. In CIT v. East Coast Commercial Co. Ltd. AIR 1967 SC 768 the Supreme Court construed the provisions of Section 23A of the Income Tax Act, 1922, while analysing as to when it could be said that a Company is one in which the public are substantially interested. By the Explanation to Section 23A(1), it was enacted inter alia that a company shall be deemed to be a company in which the public are substantially interested if shares carrying not less than twenty-five per cent of the voting power have been allotted to or acquired unconditionally or are beneficially held by the public. Under Section 23A, the Assessing Officer was required, if satisfied that the profits and gains distributed as dividends by any company were less than sixty per cent of the assessable income of that previous year, as reduced by the income tax and super tax payable, to make an order that the undistributed portion of the assessable income of the company shall be deemed to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the issue. First, the impugned order adverts to the letters dated 20 August 2009, addressed by La-Fin to IL&FS and to the letter dated 14 December 2009, addressed by MCX to IL&FS. The letter dated 20 August 2009, was addressed by La-Fin to IL&FS, following on a Share Purchase Agreement signed between MCX, IL&FS and the Petitioner on the same date. By the letter, La-Fin furnished an undertaking to offer to purchase all the shares which under the SPA were sold by MCX to IL&FS within a stipulated period. The price at which the shares would be offered to be purchased would be (i) a price providing an internal rate of return of 15% on investment or the price at which the most recent transactions of the equity shares of the Petitioner was carried out by the Petitioner or by MCX or the FTIL group. Moreover, it was assured that in the event that the Petitioner plans an initial public offering within one year from the date of the investment, La-Fin covenanted that it shall not proceed with the IPO in case the price at the IPO is less than the buy back price. As promoter of the Petitioner, La-Fin further assured that save and except for the issuance of the shares of the Petitioner to some B ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... follows : "The letters referred to above are those of Mr. Jignesh P. Shah, Director of La-Fin Financial Services Private Ltd., the promoter of FTIL. I find that, as brought out in the Notice, Mr. Jignesh Shah holds the positions of Chairman and Group Chief Executive Officer of FTIL, (a promoter of MCX-SX) and the Vice Chairman of MCX (the second promoter of SCX-SX). The Applicant has in his written submissions explained that he is only a non-executive Vice Chairman of MCX. Mr. Jignesh Shah has issued the undertakings referred to on behalf of MCX, FTIL, and other group companies that MCX-SX will not issue shares except as provided for. He is in a position to issue an undertaking not only for the company (FTIL) that he is managing director of, but also for the Company (MCX) for which he is designated as its non-executive Vice Chairman. I find that MCX, as per publicly available information, has a regular Managing Director. But it is Mr. Jignesh Shah and not the Managing Director who has issued the undertaking on behalf of the Applicant as well - a fact that further brings out his position of dominance in the management of all these three institutions from the website of FTIL, that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ame called and whether under a contract of service or not. It will be clear that to satisfy the aforesaid definition a person, which could include a firm, body corporate or an association of persons, apart from being in management of the whole affairs of a company had to be "subject to the control and direction of the directors". This definition has undergone a substantial change under the Companies Act, 1956. Under this Act s. 2(24) defines the expression "manager" thus. 2(24) "manager means an individual (not being the managing agent) who, subject to the superintendence, control and direction of the Board of directors, has the management of the whole, or substantially the whole, of the affairs of a company, and includes a director or any other person occupying the position of a manager, by whatever name called, and whether under a contract of service or not." In this definition three conditions are required to be satisfied: (a) the manager must be an individual, which means that a firm or a body corporate or an association is excluded and cannot be a manager (a fact which is expressly made clear in s. 384), (b) he should have the management of the whole or substantially the wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4 jointly and severally hereby undertake to reduce their total shareholding in the Petitioner so that they do not collectively exceed 5% shareholding in the Petitioner or such limits as prescribed under the MIMPS Regulations from time to time. Such reduction shall take place within such time line as directed by SEBI. Further the Respondent no.3 and 4 jointly and severally hereby undertake that in the event the options either under buy back or under the warrants is exercised then their shareholding either jointly or severally will not exceed 5% of the Petitioner or such limits as prescribed under the MIMPS Regulations from time to time." 99. The Third and Fourth Respondents have now unequivocally stated before the Court that they would undertake together not to exceed five per cent in the shareholding of the Petitioner or such limit as may be prescribed under the MIMPS Regulations from time to time. A further undertaking has been tendered that even if the option under the buy back or under the warrants are exercised, the holding of the Third and Fourth Respondents jointly or severally shall not exceed five per cent. This is an aspect which SEBI must be required to reconsider upon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pliance with the requirements of the Regulations. The Petitioner and its promoters may be correct in asserting that the existence of the buy back agreements does not ipso facto result in a violation of the MIMPS Regulations, in the present, once the shareholding of the promoters is brought within the permissible limit. The buy back involves an option which may or may not be exercised in the future. The promoters submit that they have several courses of action open to ensure that their shareholding does not exceed the statutory limit if the option is exercised. New capital can be infused by increasing the authorised capital; or the promoters may find an independent third party to purchase the shares on the exercise of the buy back option. But these are evidently matters which SEBI as regulator must be informed about. The buy back casts an obligation on the promissor to purchase though an option is given to the promisee to sell in future. The regulator is entitled to be in the know of full facts and the existence of a buy back agreement is a relevant fact. Even assuming that the promoters would make legitimate arrangements in future upon the exercise of the buy back option to ensure ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er cent. There has, hence, been a bona fide effort on the part of the Petitioner and its two promoters to ensure that they do not breach the provisions of the MIMPS Regulations by undertaking to the Court that the shareholding of the promoters together shall not exceed the limit of five per cent prescribed under the MIMPS Regulations for a resident. XIV : Conclusion: 104. In this view of the matter, the conclusions which have been arrived at in the course of the judgment may now be revisited in determining the appropriate final order to be passed in the case: (i) Though the MIMPS Regulations in terms apply to a stock exchange in respect of which a Scheme for demutualisation and corporatisation has been approved under Section 4B, the application of those regulations was extended to the Petitioner by SEBI as a condition for the grant of recognition. Though initially SEBI demanded full compliance with the MIMPS Regulations, the requirement which was imposed while extending recognition thereafter, was full compliance with the relevant Regulations. In either view of the matter, there must be a genuine, bona fide and honest attempt to comply with the MIMPS Regulations; (ii) SEBI as a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... otment of shares. Both the promoters have now held themselves down to hold together, jointly and severally no more than five per cent of the equity capital. There is no reasonable basis to reject the undertakings which have been filed; (vii) The buy back agreements cannot be held to be illegal as found in the impugned order of the Whole Time Member of SEBI on the ground that they constitute forward contracts. A buy back confers an option on the promisee and no contract for the purchase and sale of shares is made until the option is exercised. The promissor cannot compel the exercise of the option and if the promisee were not to exercise the option in future, there would be no contract for the sale and purchase of shares. Once a contract is arrived at upon the option being exercised, the contract would be fulfilled by spot delivery and would, therefore, not be unlawful. (viii) The alternate submission which has been urged on behalf of SEBI at the hearing that the buy back agreements constitute an option in securities and being derivatives violate the provisions of Section 18A of the SCRA is not the basis either of the notice to show cause that was issued to the Petitioner or of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2(24) of the Companies' Act, 1956 must have the management of the whole or substantially the whole of the affairs of the Company and be subject to the superintendence, control and directions of the Board of Directors. The findings which have been arrived at in the impugned order are contrary to law since they ignore the relevant legal tests which have been laid down by the Supreme Court; (xi) In any event, both the promoters of the Petitioner have, during the course of the hearing of these proceedings, tendered undertakings to the Court to the effect that notwithstanding the exercise of the option conferred by the warrants and by the buy back agreements, their shareholding jointly and severally in the petitioner shall not exceed five per cent as prescribed in Regulation 8 of the MIMPS Regulations; (xii) On the aspect as to whether the Petitioner is a fit and proper person for the grant of recognition, the finding which has been arrived at in the impugned order is inter alia based on a conclusion as to the illegality of the buy back agreements on the ground that they are forward contracts, which is found to be erroneous in the present judgment. The effect of the non-disclosure of ..... 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