The Securities and Exchange Board of India Act, 1992 (the SEBI Act) was amended in the years 1995, 1999 and 2002 to meet the requirements of changing needs of the securities

Security (finance)

A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...

 market and responding to the development in the securities market.

Based on the Report of Joint Parliamentary Committee (JPC) dated December 2, 2002 , the SEBI Act was amended to address certain shortcomings in its provisions. The mission of SEBI is to make India as one of the best securities market of the world and SEBI as one of the most respected regulator in the world. SEBI also endeavors to achieve the standards of IOSCO/FSAP.

In this background, the internal group constituted by SEBI consisting of its senior officers had proposed certain amendments to the SEBI Act. The SEBI Board had constituted an Expert Group under the Chairmanship of Mr Justice M. H .Kania (Former Chief Justice of India) to consider the proposals. The report of the Expert Group is placed for eliciting public comments on the recommendations. It may be noted that the Report does not necessarily reflect the views of SEBI on the various proposals and recommendations. SEBI would consider the comments received from various sources before taking any final view on the recommendations.

How SEBI came into picture

The World Bank and the International Monetary Fund (IMF) have introduced a benchmark i.e., Financial Services Assessment Programme (FSAP) to strengthen the monitoring of financial systems in the context of the IMF’s bilateral surveillance and the World Bank’s financial sector development

Financial sector development

Financial sector development in developing countries and emerging markets is part of the private sector development strategy to stimulate economic growth and reduce poverty....

 work. The FSAP is designed to help countries enhance their resilience to crisis and cross-border contagion, and to foster growth by promoting financial system soundness and financial sector diversity. The mission of SEBI is to make India as one of the best securities market of the world and SEBI as one of the most respected regulator in the world. SEBI endeavors to achieve the standards of IOSCO/FSAP. Amendments will be required to be made in the Securities Laws especially the SEBI Act, which will facilitate India and SEBI to achieve above objective.

Constitution of the Group

It is in this background, the SEBI Board had decided to constitute an Expert Group to identify the deficiencies / inconsistencies in the existing provisions of the SEBI Act and also to suggest new
provisions that can be incorporated in the SEBI Act to make it more effective and investor friendly, taking into account recommendations of the JPC as also recommendations of other expert groups constituted by SEBI from time to time in this regard.

The SEBI Board in its meeting held on August 5, 2004 constituted the Expert Group with the following members:

1. Mr. Justice M. H. Kania, ( Former Chief Justice of India) Chairman
2. Mr. Justice A. N. Mody ( Retd.)
3. Mr. Justice S. M. Jhunjhunwala (Retd.)
4. Ms. P. M. Umerji, Principal Secretary (Retd.) (Legislation),Govt. of Maharashtra
5. Shri. Jitesh Khosla*, Joint Secretary, Representative of the Department of Company Affairs(Govt. of India)
6. Shri. Prashant Saran , Chief General Manager, Representative of the Reserve Bank of India
7. Ms Parimala Rao, Principal, Govt. Law College, Mumbai
8. Shri. PGR Prasad, Managing Director,SBI Funds Management Pvt. Ltd., Representative of the Association of Mutual Funds of India(AMFI)
9. Shri. N. K. Jain**, Secretary and Chief Executive Officer, the Institute of Company Secretaries of India (ICSI), Representative of ICSI
10. Shri. Sushil Jiwrajka, Chairman,Western Regional Council , Federation of Indian Chambers and Commerce of Industry(FICCI) Representative of FICCI
11. Shri. K.R. Chandratre, Practicing Company Secretary & Ex-President Institute of Company Secretaries of India
12. Anil Singhvi, Director, Gujarat Ambuja Cements Ltd.
13. Shri. Pratip Kar, Executive Director , SEBI
14. Shri. R. S. Loona, (Member Secretary), sebi

Deliberation and Examination by the Expert Group

A paper containing few suggestions to amend the SEBI Act was prepared as a base material for discussion and deliberation by the Group. The said paper was sent to the representatives of all
stakeholders and market participants inviting their comments thereon and further suggestions regarding amendments in the SEBI Act.

The names of the stakeholders from whom the comments were sought are given in the annexure ‘A’ hereto. The Group received detailed comments to the proposals from certain stakeholders whose names are given in the annexure ‘B’ hereto. The Group deliberated on the proposals made regarding
amendments to SEBI Act in the light of comments thereon received from the stakeholders in its various meetings held on October 27, 2004, December 20, 2004, February 4, 2005, March 10, 2005, April 11, 2005, May 3, 2005, June 14, 2005 and on June 15, 2005 . After deliberating on the said proposals and comments of stakeholders, the Group seeks to make recommendations in respect of the following proposals:-
I Proposed Amendments for incorporating new provisions in the
SEBI Act.
II Proposed Amendments for changes in the existing provisions
III Consequential and related amendments in other Acts.

PART ONE

1.1 Investor Protection Fund

SEBI has been created inter alia for the purpose of protecting the interests of investors in securities. The investor education is more relevant in the context of complexities involved in various options and instruments of investments available in the securities market. Retail investors are not in a position to identify and /or appreciate the risk factors associated with certain scrips or schemes. With the result they are not able to make informed investment decisions. Since development of securities market largely depends upon proper education of investors, SEBI is committed to spread awareness amongst them.

The Joint Parliamentary Report (JPC) on securities scam of 2001 had recommended that in order to enable SEBI to undertake investor education and awareness campaign effectively, the investor education and protection fund established under section 205C of the Companies Act and investor education resources of RBI should be shifted to SEBI and a joint campaign for investor education and awareness under the leadership of SEBI must be undertaken.

The Group noted that majority of the stakeholders have agreed for the setting up of a separate investor protection fund under the SEBI Act. It is also suggested by the stakeholders that the said
fund should be utilized exclusively for the purpose of investor education, conducting awareness programme and for protecting the interest of investors.

The Group also noted that the proposed Investor Protection Fund is for the purpose of achieving the objective of Investor Education and awareness.

In terms of section 55A of the Companies Act, SEBI is required to administer the provisions of sections specified in section 55A in respect of issue of capital, transfer of securities and non payment of dividend in case of listed companies and the companies which intend to get their securities listed on the stock exchange. Further, SEBI is required to protect the interest of investors and enforce redressal of grievances of investors by listed companies.

In the light of the above provisions, the Group also discussed the proposition regarding payment of compensation to investors for the purpose of investor protection. In this regard, the Group also
deliberated on the suggestion for setting up of a Fund on the lines of Fair Fund established under the Sarbanes Oxley Act, 2002 of United States which is used for compensating the investors out of
the penalties received. Another view was expressed during deliberations that the investors in the equity market invest in risk capital and no assured return or compensation for non fulfilment of every expectation may be provided in the statute. However, compensation in respect of fraud or misrepresentations or misstatements by companies or intermediaries may be considered. Further the Group noted that the Pension Fund Regulatory and Development Authority, Ordinance, 2004 which mandated the Pension Fund Regulatory and Development Authority (PFRDA) to protect the interest of subscribers to the schemes of pension funds has permitted PFRDA to set up the Subscriber Education and Protection Fund. The said Ordinance also specifies the monies which should be credited to the said Subscriber Education and Protection Fund. The said Ordinance also provides that all sums realised by way of penalties by PFRDA under the Ordinance shall be credited to the Subscriber Education and Protection Fund.

The Group felt that to achieve the objective of investor protection by investor education and investor awareness, a separate fund under the SEBI Act on the lines of Subscriber Education and Protection Fund under PFRDA Ordinance 2004 to be administered by SEBI may be set up and administered by SEBI for investor education and awareness. Further, the compensation to small investors in respect of fraud or misrepresentations or misstatements by companies or intermediaries may be considered as a matter of investor protection out of the said Investor Protection Fund. In this regard it is felt desirable that SEBI may specify guidelines and parameters for administration of the Investor Protection Fund the for the purpose of Investor Education and Awareness and payment of compensation to small investors. In this regard, the guidelines issued by SEBI in respect of Investor Protection Fund of stock exchanges may be adopted with necessary changes.

As regards the monies to be credited to the said Investor Protection Fund, the Group took into consideration the representation of the National Stock Exchange that the big stock exchanges are utilising the monies for the purpose suitably. The Group also noted that the monies lying with the IPF of small stock exchanges are not being utilised to the full satisfaction. It is considered that the monies lying unutilized for substantial period in the Investor Protection Fund of the stock exchanges should be transferred to the proposed Investor Protection Fund.

The unclaimed dividend and interest lying with the mutual fund and Collective Investment Schemes or venture capital funds and the unclaimed monies or securities of the clients lying with the intermediaries for a period of 7 years should be used in a purposeful manner.

Further, all sums realised by way of penalties imposed by the Adjudicating Officer under Chapter VIA of the SEBI Act, should be credited to the proposed Investor Protection Fund.

1.2 Recommendation of the Group

The Group recommends that a separate Investor Protection Fund under the SEBI Act, on the lines of Subscriber Education and Protection Fund under PFRDA Ordinance 2004 may be established for the purpose of investor education and awareness and for compensation to the small investors in respect of fraud or misrepresentations or misstatements by companies or intermediaries.

The said fund be administered by SEBI to protect the investors and take measures for investor education and awareness and for compensation to the small investors in accordance with the established guidelines or parameters specified by SEBI on the lines of the guidelines in respect of stock exchanges.

There shall be credited to the said fund the following amounts, namely
a)unclaimed dividend or interest under any mutual fund or Collective Investment Scheme (CIS) or venture capital fund scheme for more than 7 years;
b) any unclaimed money or securities of a client lying with an intermediary in securities market for more than 7 years;
c) monies lying unutilised in the Investor Protection Funds of the stock exchanges;
d) all sums realised by way of monetary penalty under Chapter VIA of SEBI Act.

1.3 Nomination Facility

The concept of nomination has been recognized under section 109 of the Companies Act, 1956, Section 45ZA of the Banking Regulation Act, 1949 and Section 39A of the UTI Act, 1963 (since repealed). Under the aforesaid provisions, nominee of a shareholder or debenture holder, depositor or unit holder is
entitled to the rights in securities or money held by the deceased to the exclusion of all other persons, notwithstanding anything contained in any other law for the time being in force including the testamentary laws. However, SEBI Act does not contain any such provision of nomination facility for the unit holders of mutual funds and collective investment schemes.

The Group noted that SEBI (Mutual Funds) Regulations, 1996 provide for nomination facility to the unit holders. The Group felt that the provision for nomination facility is investor friendly but such provision should exist in the parent Act and not in the Regulations.

However, the Group is not in favour of giving any overriding effect as provided under section 109 of the Companies Act, 1956 wherein the nominee’s rights can defeat the claim of a legal heir.

1.4 Recommendation of the Group

In view of the above, the Group recommends for a suitable amendment in the SEBI Act for the incorporation of a provision to provide nomination facility to the unit holders of Mutual Funds and Collective Investment Schemes.

1.5 Advance Ruling

The Group was informed that SEBI receives a number of requests from various market participants for advance guidance on the interpretation of the provisions of SEBI Act and Regulations. As SEBI Act does not contain specific provisions like section 245B to section 245N of the Income Tax Act, 1961 authorising SEBI to give advance ruling, SEBI has evolved a system of giving interpretive letters/no action letters under the provisions of SEBI (Informal Guidance) Scheme, 2003. However, the guidance given under the scheme does not equate with the advance ruling under the Income Tax Act as it is not binding on SEBI Board.

The advance ruling system for the securities market would have the advantage of a market participant being able to obtain a binding ruling on the applicability of a particular provision of Securities Laws to a proposed transaction, before actually undertaking such transaction.

The Group felt that the system of advance ruling is certainly better than that of informal guidance given under the said scheme as the advance ruling given by SEBI would be binding on its Board. The binding effect provides, not only more comfort for the market participants, it also provides better legal status to the whole mechanism.

However, in view of the smooth and satisfactory functioning of the Informal Guidance Scheme in vogue, the Group felt that SEBI should analyse the option very carefully as the move of shifting from the scheme to advance ruling would require setting up of a separate department and infrastructure on the lines of Income Tax Act.

1.6 Recommendations of the Group

The Group recommends that as legally the advance ruling is preferable the adoption of the same may be considered and the Informal Guidance Scheme may also continue.

1.7 Self Regulatory Organisation (SRO)

The Group noted that section 11(2) (d) of the SEBI Act provides for promoting and regulating SRO. SEBI Act, however does not have specific provision for empowering SRO to make bye-laws having statutory force for admission of members. Further, SEBI Act does not have provisions relating to supersession of governing boards of SROs by SEBI or restricting the voting right of members of SROs, notwithstanding anything contained in the Companies Act, 1956. Proposed amendments seek to confer such powers on SEBI.

The Group noted that SEBI has already framed regulations, namely, SEBI (Self Regulatory Organisations) Regulations, 2004 under section 30 read with section 11(2)(d) of the SEBI Act for regulating the SROs, which require inter alia SROs to seek recognition from SEBI. The Regulations also empower the SRO’s to make rules and bye laws with the approval of SEBI. Regulation 23 of the Regulation governing SRO’s, provides for the power of SEBI to withdraw the recognition. In view of the said power, the Group felt that SEBI is already having the requisite power to require the SROs to regulate their activities in accordance with the Regulations. Consequently, there may not be any need for the amendment of the SEBI Act.

1.8 Recommendation of the Group

The Group recommends that there is no necessity of amending the SEBI Act as proposed. The Regulations framed by SEBI should suffice to address the concern of SEBI, as a regulator of SROs.

1.9 Rectification of errors in orders

The Group noted that there is no provision in the SEBI Act, which empowers SEBI to rectify the clerical or typographical errors apparent in its own orders. A view was also expressed that SEBI does not have powers to review its own orders even in cases when orders are passed ex parte.

The Group observed that “Review of orders” appears to give substantive powers which are usually not available with Authorities having original jurisdiction. However, the Group felt that enabling SEBI to rectify clerical or typographical errors apparent on the face of its order on the lines of section 26 (2) of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 is desirabl ans fds

1.10 Recommendation of the Group

An amendment should be made in the SEBI Act to enable SEBI to rectify clerical or typographical errors apparent on the face of its order, on the lines of section 26 (2) of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993.

1.11 Retrospective effect

The Group noted that the existing provisions of SEBI Act do not empower SEBI to frame the regulations with retrospective effect even for the limited purpose of giving relief to the market participants.

The Group felt that SEBI may be empowered to make regulations with retrospective effect in respect of matters relating to charging of fees or procedural matters on the lines of the Income Tax Act for the limited purpose of giving relief and not for imposing new liabilities and obligations. According to the Group such a benevolent provision may remove undue hardship to market participants in certain cases and hence should be viewed with favour.

1.12 Recommendation of the Group

The Group recommends that the SEBI Act may be amended on the lines of section 295(4) of the Income Tax Act, 1961 to empower SEBI to make regulations with retrospective effect in respect of matters relating to charging of fees or procedural matters for the limited purpose of giving relief and benefit and not for imposing new liabilities and obligations.

1.13 Overriding Effect

The Group discussed the suggestion to amend SEBI Act in order to provide overriding effect to SEBI Act over other laws in the matter of securities. In order to assess the need for such an amendment, the Group tried to identify those substantive provisions of the SEBI Act that deserve to be given an overriding effect. After due consideration, the Group felt that SEBI Act does not contain any such substantive provisions which deserve to be given an overriding effect. It also noted that where ever the substantive provisions deserved to be given an overriding effect, the SEBI Act has already done by non obstante clause.

1.14 Recommendation of the Group

The Group recommends that SEBI Act may not be amended for giving an overriding effect to the SEBI Act over other laws.

1.15 Power to issue circulars

The Group examined the proposal to amend the provisions of SEBI Act for giving statutory power to SEBI to issue circulars and guidelines.

The Group noted that SEBI has been issuing circulars and guidelines under section 11 of the SEBI Act. The Group felt that there is no legal infirmity in issuing circulars or guidelines under the existing provisions of section 11 which is the source of inherent powers of SEBI.

1.16 Recommendation of the Group

The Group recommends that SEBI Act may not be amended for inserting a specific provision for the issuance of circular and guidelines as SEBI has inherent powers to do so under Section 11 of the SEBI Act.

1.17 Transaction / Issue of securities to be treated void in certain circumstances

The Group was informed that in cases of fraudulent issue of securities, excess dematerialisation of securities etc. SEBI should be empowered to declare such transactions as void. For this purpose suitable provisions in the SEBI Act on the lines of section 9(3) & section 14 of the SCRA may be made to provide that such transaction, if they are in violation of any specified regulation, shall be void.

The Group felt that such power should be performed by an independent body, preferably by the civil courts. Administrative bodies may not be conferred with such jurisdiction.

1.18 Recommendation of the Group

SEBI Act should not be amended as proposed. Such power should preferably be left to be exercised by a civil court.

1.19 Winding up of intermediaries

The Group was informed that one of the principles of Securities Regulations as specified by IOSCO/FSAP is that there should be procedures for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk

Systemic risk

In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system. It can be defined as "financial system instability, potentially catastrophic, caused or exacerbated by...

. The Group noted that there is no specific power conferred upon SEBI under SEBI Act for taking steps for winding up of an intermediary in case such intermediary goes bankrupt or the continuance of such intermediary is considered to be detrimental to the interest of investors or clients of such intermediary.

The Group noted that Reserve Bank of India (RBI) has power to file winding up petitions against a Non Banking Finance Company under section 45 MC of RBI Act. The Group felt that SEBI should have similar power to file winding up petition under SEBI Act.

The Group further observed that in case of winding up of such intermediary company, the claim of the clients of such intermediary should have priority over other claims or debts i.e. even over secured creditors and sovereigns authorities such as Income Tax. The Group in this regard noted that under Section 43A of Banking Regulation Act, 1949 there is a provision for the preferential payment to depositors in priority to all other debts from out of assets of the Banking Company. The Group felt that similar provisions should also be made in respect of claims of clients of intermediary companies while empowering SEBI to file a winding up petition against an intermediary in case such intermediary goes bankrupt or the continuance of such intermediary is considered to be detrimental to the interest of investors or clients of such intermediary.

1.20 Recommendation of the Group

The Group recommends that suitable provision in the SEBI Act may be made to enable SEBI to file winding up petition in respect of the intermediary companies on the lines of section 45MC of the Reserve Bank of India Act and section 43A of Banking Regulation Act.

1.21 Non attachment of assets of clients with intermediaries

The Group noted that one of the IOSCO principles for securities market regulations is that the regulatory system should enable the pool of investors’ funds to be distinguished and segregated from the assets of other entities. Further, the investors should be protected from misleading, manipulative or fraudulent practices, including insider trading, front running or trading ahead of customers and the misuse of client assets.

It was brought to the notice of the Group that by the Securities Laws (Amendment) Bill, 2003, a section 27B was proposed to be inserted in the Securities Contracts (Regulation) Act, to provide that an investor may entrust his money or securities to any intermediary who shall hold such money or securities in trust and shall deal with them as directed by the investors. Such monies and securities shall not be part of the assets of the intermediaries and no authority shall attach or seize such assets of investors. However, in the Securities Laws (Amendment) Act, 2005 this provision was omitted.

The Group observed that the money or securities entrusted by an investor to an intermediary should be held by such intermediary in trust of such investors. Such money or securities of investors should not form part of asset of intermediary and no authority shall attach or seize such assets of investors which are in custody or possession of such intermediary.

1.22 Recommendation of the Group

The Group recommends that there should be a specific provision in the SEBI Act to the effect that the monies or securities of the clients should be held in the form of a trust by intermediaries and no authority shall attach or seize such assets of investors which are in possession of the intermediary. For this purpose the provisions as proposed in the Securities Laws (Amendment) Bill, 2003 may be made.