Securities Market & The Laws Regulating It In India
Author: LawSphereX
Category: Corporate & Insolvency
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SECURITIES MARKET & THE LAWS REGULATING IT IN
INDIA
Shreshtha Khatri & Shreya Shukla, Institute of Law, Nirma University
ABSTRACT
An essential component of the world economy is the securities market. It is regulated by five key laws in India. Recent events, however, in light of the turmoil caused by the contested Adani-Hindenburg discovery, emphasize the urgent need to re-evaluate the necessity of regulating the securities market as well as the evident inefficiency of current rules to appropriately oversee the securities market in India. Moreover, stricter securities market regulation is necessary to support the SDGs in a way that promotes a more stable and resilient financial system.
INTRODUCTION
The securities market is a vital part of the global economy. It provides a platform for companies to raise capital through the issuance of stocks, bonds, and other financial instruments. 1 The securities market also delivers investors with a prospect to invest their money and earn returns on their investment. In India, five key laws regulate the securities market- SEBI Act 1992, Securities Contracts (Regulation) Act (SCRA), Companies Act 2013, Prevention of Money Laundering Act and the Depositories Act, 1996. However, recent developments, in light of the ruckus ensued from the impugned Adani-Hindenburg revelation, highlight the urgent need to re-evaluate the necessity of regulating the securities market and the glaring inefficiency of these laws to adequately regulate the securities market in India. What is the Securities Market?
The securities market is a marketplace where securities such as stocks, bonds, and other
1 ‘Part Three: Regulation of Securities Market’, Securities and Exchange Board of India,
https://www.sebi.gov.in/sebi_data/commondocs/regulation_p.pdf
financial instruments are bought and sold.2 It serves as a platform for individuals and institutional investors to purchase and sell securities as a means of investing and generating a return on their cash. Companies can raise funding by selling shares to investors on this platform. Over the past few years, a growing number of investors have entered the Indian securities market, which has seen significant growth. The ineffectiveness of the securities market regulation in India has drawn a lot of criticism, nevertheless. Market participants, regulators, and other stakeholders have voiced these worries. In this paper, the authors aim to explore the inefficiencies in the regulation of securities market in India.
NEED FOR REGULATION OF THE SECURITIES MARKET
Large sums of money are at stake in the security market, along with the possibility of fraud and abuse. The security market needs to be regulated in order to safeguard investors against fraud, insider trading, market manipulation, and other illicit activities that could devalue their assets. By guaranteeing that all investors have access to the same information and opportunities, these regulations are crucial for promoting fairness in the market. This aids in avoiding a scenario in which powerful institutions or insiders would have an unfair advantage over small individual investors. Unregulated markets have a tendency to be volatile and unpredictable, which can cause economic and financial instability. 3By establishing policies and processes that limit excessive speculating and other risky behaviours, regulations promote stability.
Regulations also assist in preventing systemic risk by providing protections and protocols that reduce the impact of a single event on the larger financial system due to the interconnectedness of the security market with other financial markets. Thus, regulating the security market is crucial for maintaining investor confidence, promoting fairness, maintaining stability, and preventing systemic risk.
2 ‘The Laws That Govern the Securities Industry’, U.S. Securities and Exchange Commission,
https://www.investor.gov/introduction-investing/investing-basics/role-sec/laws-govern-securities-industry
3 George J. Stigler, ‘Public Regulation of the Securities Market’, 19 Bus. Law. 721, 1963-1964,
https://heinonline.org/HOL/LandingPage?handle=hein.journals/busl19&div=70&id=&page=
THE MAIN LAWS AND REGULATIONS GOVERNING THE SECURITIES MARKET
IN INDIA
The securities market in India is governed by a multitude of regulations. Some vital regulations are discussed in this section. The Securities and Exchange Board of India Act, 1992 (SEBI Act) The SEBI Act is a key legislation that regulates the securities market in India. It empowers SEBI to regulate the securities market and protect the interests of investors. Here are some of the key provisions of the SEBI Act:
1. The SEBI Act enables the registration and control of market participants, including
brokers, sub-brokers, and other intermediaries.4 It is the responsibility of SEBI to make sure that these intermediaries abide by the rules set forth by it.
2. The SEBI Act forbids fraudulent and unfair trade practices in the securities market. It
specifies penalties for violations and offers compensation for impacted investors.
3. The SEBI Act outlines rules for insider trading, which is the practice of using
confidential information to profit from the securities market. The statute defines insider trading and outlines the penalty for infractions.
4. The SEBI Act provides for the regulation of the issuance of securities and the disclosure
requirements for companies. SEBI is responsible for ensuring that companies comply with the conditions prescribed by it.
5. The goal of the SEBI Act is to safeguard investors' interests in the securities industry.
It also provides for the creation of an Investor Protection Fund and the adjudication of disputes between investors and intermediaries.
6. SEBI is given the authority to oversee the securities market and punish offenders under
the SEBI Act. SEBI has the authority to look into and inspect the intermediaries, to issue rules and regulations, and to impose sanctions for non-compliance.
4 ‘Regulation of Securities Markets’, https://www.sec.gov/pdf/annrep01/ar01marketr.pdf
Securities Contracts (Regulation) Act, 1956 (SCRA) The SCRA is another key legislation in this regard. Its main objective is to prevent undesirable transactions in securities, ensure fair trading practices, and protect the interests of investors. Here are some of the key provisions of the SCRA:
1. The SCRA outlines the procedures for registering and governing stock exchanges in
India. Each organization that wants to establish a stock exchange must register with SEBI and adhere to its requirements.
2. The SCRA establishes guidelines for the control of securities contracts in India. It
outlines the requirements for trading securities and defines the term "securities."
3. The SCRA forbids insider trading, which is the practice of using secret knowledge to
benefit financially from the trading of securities. The statute defines insider trading and outlines the penalty for violations.
4. The SCRA regulates intermediaries such as brokers, sub-brokers, and other market
participants. It lays down the conditions for their registration and prescribes their rights and obligations.
5. The SCRA empowers SEBI to regulate the securities market and take appropriate action
against violations.5 SEBI has the power to investigate and inspect intermediaries, issue guidelines and directions, and impose penalties for non-compliance. Companies Act 2013 The Companies Act 2013 also indirectly regulate the securities market. Here are some of the ways in which the Companies Act 2013 regulates the securities market:
1. The Act enables corporations to issue stock and other securities. It outlines the
prerequisites for the issuance of securities, such as the minimal subscription amount, the method of payment, and the distribution of shares. 5 ‘Securities laws and Capital Markets’, ICSI, https://www.icsi.edu/media/webmodules/Final_SecuritiesLaw.pdf
2. The Act outlines the obligations and rights of shareholders, including their right to vote,
attend meetings, and earn dividends. This influences the securities market by ensuring accountability and transparency in how businesses operate.6
3. The Act establishes the guidelines for corporate governance, including the
composition of the board of directors, the audit committee, and other significant committees. This ensures that businesses are run transparently and honestly, which is essential for preserving investor confidence.
4. The Act specifies the guidelines for how businesses must prepare and submit their
financial reports, as well as the selection of auditors and the disclosure of related party transactions. This makes it possible to guarantee that investors have access to timely and accurate financial information, which is necessary for making wise investment choices.
5. The Act also addresses the regulation of corporate mergers and acquisitions. As it
influences the ownership structure of companies and the movement of securities in the market, this has an indirect effect on the securities market. Prevention of Money Laundering Act, 2002 (PMLA) The PMLA is another key legislation that impacts the securities market indirectly. Here are some of the ways in which the PMLA regulates the securities market:
1. The PMLA requires securities market intermediaries such as stockbrokers, depository
participants, and mutual fund distributors to follow Know Your Customer (KYC) norms while opening and maintaining accounts of their clients. This helps to prevent the use of the securities market for money laundering activities.
2. The PMLA requires reporting entities such as banks, financial institutions, and
securities market intermediaries to monitor and report suspicious transactions to the 6 Joby Mathew, ‘Explained | How is the stock market regulated in India?’, The Hindu, February 22, 2023, https://www.thehindu.com/business/markets/explained-how-is-the-stock-market-regulated-inindia/article66526291.ece
Financial Intelligence Unit - India (FIU-IND).7 This helps to identify and prevent money laundering activities in the securities market.
3. The PMLA provides for the freezing of assets of persons who are involved in money
laundering activities. This helps to prevent the use of illicit funds for investments in the securities market.
4. The PMLA empowers the authorities to investigate and prosecute cases related to
money laundering and terrorist financing activities. This helps to deter such activities in the securities market. The Depositories Act, 1996 The Depositories Act, 1996 plays a crucial role in the trading and settlement of securities in the securities market. Here are some of the ways in which the Depositories Act, 1996 regulates the securities market:
1. The Depositories Act, 1996 provides for the dematerialization of securities, which
means converting physical securities into electronic form. This helps in reducing the risks associated with physical certificates and facilitates faster and more efficient trading and settlement of securities in the securities market.
2. The Depositories Act, 1996 provides for the transfer of securities through electronic
book entries between the accounts of the depository participants. This helps in eliminating the need for physical transfer of securities, reducing the time and cost of transfer, and providing a more efficient system for trading and settlement of securities in the securities market.
3. The Securities and Exchange Board of India (SEBI) is given the authority to oversee
the operations of depositories in India by the Depositories Act, 1996. In relation to the operation of depositories in India, SEBI has the authority to establish guidelines, directives, and rules. This contributes to maintaining the integrity of the securities market and ensuring that depositories function effectively and transparently.
7 ‘Securities Laws and Compliances’, ICSI,
https://www.icsi.edu/media/webmodules/publications/Securities%20Laws%20and%20Compliances.pdf
4. The Depositories Act, 1996 ensures that investors' interests in the securities market are
protected. It outlines the duties and responsibilities of depositories, investors, and other securities market players. In case a depository participant defaults, it also allows for the creation of an Investor Protection Fund to reimburse investors.
GAPS IN THE REGULATION OF THE SECURITIES MARKET IN INDIA
Even though there are several laws and regulations in India that govern the securities market, there are still some regulatory loopholes that must be filled.8 Here are a few areas where India's securities market regulation is lacking:
1. Insider trading: Although insider trading is prohibited by Indian law and regulations,
there have been instances of insider trading that went undetected.9 There is a need for stronger enforcement and harsher sanctions for those found guilty of insider trading because the current legislation might not be sufficient to prohibit all types of insider trading.
2. Market manipulation: Market manipulation is a practice of influencing the market for
personal gain. Notwithstanding the measures implemented by SEBI to stop market manipulation, it often goes unnoticed. To stop market manipulation, the regulation of cutting-edge technology, including high-frequency trading, algorithmic trading, and dark pools, needs to be strengthened.
3. Corporate governance: While the Companies Act, 2013 and SEBI regulations prescribe
corporate governance norms for companies listed on the stock exchange, there have been instances of non-compliance with these norms. There is a need for stronger enforcement of corporate governance norms to ensure that companies operate in a transparent and ethical manner.
4. Investor protection: While there are regulations and mechanisms in place to protect
investors, there have been instances of investors being defrauded. There is a need for 8 Joby Mathew, ‘Explained | How is the stock market regulated in India?’, The Hindu, February 22, 2023, https://www.thehindu.com/business/markets/explained-how-is-the-stock-market-regulated-inindia/article66526291.ece 9 Marcel Kahan, ‘Some Problems with Stock Exchange-Based Securities Regulation’, Virginia Law Review, Vol. 83, No. 7, Oct. 1997, https://www.jstor.org/stable/1073766
stronger mechanisms for investor education, awareness, and protection to ensure that investors are able to make informed investment decisions.
5. Cross-border transactions: With the increasing globalization of the securities market,
there is a need for stronger regulation of cross-border transactions. The existing regulations may not be adequate to prevent money laundering and other illicit activities in cross-border transactions, and there is a need for stronger international cooperation and coordination to address these issues. In summary, while the securities market in India is regulated by several laws and regulations, there are still some gaps in the regulation that need to be addressed. These include insider trading, market manipulation, corporate governance, investor protection, and regulation of cross-border transactions.
INEFFICIENCIES IN THE REGULATION OF THE SECURITIES MARKET IN
INDIA
The lack of coordination between the various regulatory authorities is one of the primary inefficiencies in the regulation of the securities market in India. The Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), and the Ministry of Finance, all have jurisdiction over the securities market in India. 10 These bodies have different roles and responsibilities, and sometimes their regulations can conflict with each other. This lack of coordination can lead to confusion and delays in decision-making, which can have a negative impact on the market. Moreover, in recent years, India's securities market has seen major changes, but regulatory reforms have progressed slowly. Many things, such as bureaucratic delays, political reasons, and opposition from special interests, have been blamed for this delayed progress.
This slow pace of regulatory reforms can hinder the growth and development of the securities market in India. Another issue is the lack of transparency in India's securities market legislation. Investors frequently lack access to timely, accurate information about the securities market, which can
10 Regulation of Securities Markets, https://www.sec.gov/pdf/annrep01/ar01marketr.pdf
undermine their faith in it. Additionally, this lack of transparency may result in insider trading and market manipulation, which can harm the investors. The regulatory framework in India also lacks clarity in some areas. This ambiguity often leads to confusion amongst the m market participants and can lead to regulatory arbitrage. For instance, the complex and often unclear regulatory framework for foreign investments in India may deter international investors from participating in the country's securities market. Finally, there is a lack of resources and experience among India's regulatory bodies. This lack of resources could make it difficult to adequately regulate the securities market. For instance, SEBI, the primary securities market regulator, frequently finds it difficult to keep up with the shifting demands of the market due to staffing issues.
Thus, it is critical that India's securities market is not adequately regulated. These inefficiencies may impede market expansion and development and harm investors. All stakeholders, including the government, regulators, and market participants, must work together to address these inefficiencies. These parties must collaborate to construct a regulatory framework that is open, effective, and efficient and that supports the expansion and development of the Indian securities market.
CASE STUDY- THE ADANI-HINDENBURG CLASH
Every loss makes us dive deeper into to the problems, it makes us willing to finally address what was always existent but never addressed before, awaiting the loss to actually become big enough to be noticeable. For any investor in India today what can be a word more sensitive than ‘ADANI’. US short seller Hindenburg is a household name now, particularly for Indians after its report on Indian conglomerate Adani Group created a storm that wiped off billions of promoters' and investors' wealth. It is important to note here that the Hindenburg report has only brought the issue in highlight, SEBI has already investigated and prosecuted more than 70 entities and individuals over the years, including Adani promoters, for pumping Adani Enterprises’ stock.11
11 ‘Adani Group: How the World’s 3rd Richest Man Is Pulling the Largest Con in Corporate History’,
Hindenburg Report, Jan 24, 2023, https://hindenburgresearch.com/adani/
If even a big of all that Hindenburg alleges is a truth, it is a matter of huge concern for India. Among a plethora of allegations, some that particularly concern us within the ambit of our topic is, the allegation of Stock manipulation, pump and dump and accounting fraud. As per the Hindenburg report, the stock price of the seven listed companies spiked an average
819 per cent in a period of three years. It said that these 7 companies have 85 per cent down
sided “purely on a fundamental basis owing to sky-high valuations”. Key Adani companies have taken on substantial debt, including pledging shares of their inflated stock for loans. These revelations are not new, “SEBI has already investigated and prosecuted more than 70 entities and individuals over the years, including Adani promoters, for pumping Adani Enterprises’ stock,” stated the report. 12 It also cited the 2007 SEBI ruling that stated that the Adani promoters aided and abetted Ketan Parekh, the most notorious stock market manipulator in India, in manipulating the scrip of Adani. The companies were penalized with bans, which were later reduced to fines.
The investigation showed that 14 Adani private entities transferred shares to entities controlled by Parekh who then engaged in market manipulation One of the main concerns raised by the Hindenburg Research report is the issue of corporate governance at Adani Group. The report claims that the company is controlled by its founder, Gautam Adani, to the detriment of minority shareholders. As per the report, the Adani Group companies are intricately and distinctly linked and dependent upon one another. None of the listed entities are isolated from the performance, or failure, of the other group companies. And that one serious liquidity event at a single entity to trigger a negative cascade of events at other group entities which could affect the entire Adani Group.
Hindenburg confirmed in September 2022 that SEBI is still investigating Adani’s suspicious Mauritius owners, but thus far has taken no action. The report’s release is a reminder of the need for increased transparency and accountability in the business world and the importance of ensuring that companies operate ethically and
12 ‘Adani Group: How the World’s 3rd Richest Man Is Pulling the Largest Con in Corporate History’,
Hindenburg Report, Jan 24, 2023, https://hindenburgresearch.com/adani/
sustainably. What we can consider a bit of relief is the denial by the supreme court to accept the sealed cover suggestion of the government and the denial to stop media from reporting until the final judgement of the court.
A ROADMAP TO ACHIEVE SUSTAINABLE DEVELOPMENT GOALS
Although most of the securities regulators do not consist a crystal-clear organizational mandate to foster sustainable development; still sustainability issues in and of themselves, besides policy responses to such matters, are of direct significance to their prevailing mandates. This is due to the potential of sustainability issues to create financially material risks and opportunities for investors and to affect the permanency of the financial system in its entirety. In this report, we have tried to draw five main action areas where securities regulators can subscribe to an unwavering, resilient financial system which will bolster the aim to achieve Sustainable Development Goals.
1. Facilitate investment in order to encourage the delivery of the SDGs: Various
research and statistics have shown the factors that can influence or rather manipulate the investors’ willingness to invest. There are various factors that influence investors’ willingness to invest in prospects related to the SDGs. As per UNCTAD, amount of US$5trn to US$7trn per year will be required to comprehend the SDGs by 2030. 13 This statistical data includes investments made under infrastructure, agriculture department, clean energy, clean water and sanitation.
For example, securities regulators could convene and support projects to develop innovative financing solutions (such as green securities, green bonds, and social bonds) for the SDGs; develop guidance and case studies on how to access the investment opportunities presented by the SDGs; and identify the role of various financial institutions in supporting investment that supports the delivery of the SDGs to the extent that they have jurisdiction over or influence over such matters.
13 ‘Part Three: Regulation of Securities Market’, Securities and Exchange Board of India,
https://www.sebi.gov.in/sebi_data/commondocs/regulation_p.pdf
2. Reinforce corporate sustainability-related disclosures: According to research, one
of the primary reasons investors do not fully consider sustainability-related concerns and the generation of long-term value in their methods for making decisions is due to shortcomings and inconsistencies in the data and information given by businesses. In India, the Securities and Exchange Board of India (SEBI) mandated the publication of Business Responsibility Reports in the annual reports of the top 100 companies (by market capitalization) listed on the country's two major stock exchanges in August
2012. The top 500 businesses were added to the scope in December 2015. The nine
principles laid out by SEBI, which address topics like company ethics, employee welfare, participants, human rights, environmental protection, and consumer accountability, form the framework for the company Responsibility Report. The top 500 Indian businesses received a memo from SEBI in February 2017 facilitating them to create a comprehensive report. The correspondence made reference to Principle 16 of the IOSCO objectives and Principles of Securities Regulations, stating: "There should be full, accurate, and timely disclosures of every significant information."14
3. Elucidate investors’ duties on sustainability: The goal of responsible investment is
to integrate ESG considerations into investment choices in order to improve risk mitigation and produce sustainable, long-term benefits. Over the past ten years, ethical investment has grown significantly. Many companies today have made the choice to include ESG considerations in their processes for making decisions. There is mounting evidence that concentrating on sustainability concerns may encourage value creation and long-term financial returns and that these initiatives are consistent with investors' obligations and responsibilities (or fiduciary responsibilities in common law countries) towards individuals and the beneficiaries.
4. Strengthen corporate governance to support sustainability: A number of initiatives
acknowledge the importance of corporate governance in ensuring businesses function sustainably. For instance, one of the four essential components of climate-related
14 ‘Regulatory Management and Reform in India’, Background Paper for OECD, CUTS International,
https://www.oecd.org/gov/regulatory-policy/44925979.pdf
financial disclosures, according to the Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD), is administration. The increasing evidence suggests that successful businesses typically have long-termfocused cultures and governance procedures, supported by an organizing principle of unchanging beliefs and principles. The fact that they have committees supporting these attitudes and governance procedures is crucial. Within the context of their corporate compliance and risk mitigation processes, these businesses frequently take into account a broad range of sustainability concerns.
5. Build market capacity and expertise on sustainability: Assessment of how the
financial system could promote sustainable development often points to a lack of capability and knowledge regarding sustainability and long-term value drivers. All relevant stakeholder groups, including policymakers, regulators, stock exchanges, businesses, investors, and organizations from the civil society, have identified skills and understanding gaps as a result of the projects, meetings, and reports mentioned in the introduction to the report.
CONCLUSION
Imagining, drafting and enacting reforms is a cumbersome procedure. However, the incentives to do so are high when it comes to the regulation of the securities market in India. In the light of the recent Adani stock market crash, this has become an even more pressing issue. Therefore, the regulatory bodies must strengthen the regulatory frameworks, enhance investor protection, improve market surveillance, strengthen enforcement mechanisms, promote market transparency, and encourage participation of small investors. SEBI should collaborate with other financial regulators to ensure no overlap in regulatory functions and to promote market stability. Securities regulators can support the SDGs by promoting a more stable and robust financial sector.