Regulation of capital market | Management Optional Notes for UPSC PDF Download

Introduction

• Before the establishment of SEBI, the primary regulations overseeing the capital market in India comprised (a) the Capital Issues Control Act, 1956 for overseeing the primary market, and (b) the Securities Contracts (Regulation) Act, 1956 for governing the secondary market. The regulatory authority for the primary market was the Controller of Capital Issues, while the supervision of the secondary market was under the Stock Exchange Division in the Ministry of Finance.
• In April 1988, the Securities Exchange Board of India (SEBI) was established as a non-statutory body to regulate the capital market under the authority of the Government of India. Subsequently, on January 30, 1992, an Ordinance was promulgated to grant SEBI statutory status. This Ordinance was later replaced by a Bill passed by both Houses of Parliament, becoming an Act on April 4, 1992, upon receiving the President's assent.
• Concurrently, the Capital Issue Control Act was repealed, and amendments were made to the Companies Act to designate SEBI as the administrative authority for enforcing provisions related to capital issues. Consequently, the primary market fell under SEBI's jurisdiction. Additionally, several powers under the Securities Contracts (Regulation) Act were transferred from the Ministry of Finance to SEBI, entrusting it with the primary responsibility of safeguarding investor interests in securities and promoting the regulation and development of the stock market.

SEBI's responsibilities include:

• Regulating activities in stock exchanges and other securities markets.
• Registering and regulating market intermediaries such as registrars, transfer agents, portfolio managers, and underwriters.
• Restricting and regulating collective investment schemes, including mutual funds.
• Promoting and regulating self-regulatory organizations.
• Prohibiting fraudulent and unfair trade practices in the securities market.
• Promoting investor education and training for securities market intermediaries.
• Prohibiting insider trading, substantial acquisition of shares, and takeover of companies.
• Levying fees and charges for regulatory purposes.
• Conducting inspections, inquiries, and audits of stock exchanges, intermediaries, and self-regulatory organizations in the securities market.
• Exercising powers delegated by the Central Government under the Securities Contracts (Regulation) Act.

Furthermore, SEBI has been granted additional powers to facilitate the orderly development of capital markets and enhance its capacity to protect investor interests. This includes performing functions and exercising powers delegated by the Central Government under the SCR Act. Subsequently, we will discuss SEBI's guidelines for regulating capital issues, followed by the regulatory framework for controlling stock market operations under the SCR Act, including SEBI guidelines in this regard.

Regulatory Framework For Issue of Capital - Sebi Guidelines 

Before the establishment of SEBI, the primary legal framework governing the capital market in India consisted of the Companies Act, the Capital Issues Control Act, 1947, along with its associated Rules, and guidelines from relevant government bodies and stock exchanges. However, with the repeal of the Capital Issues Control Act in May 1992, the regulation of capital issues fell under the purview of SEBI, established under the SEBI Act, 1992. In June 1992, SEBI introduced its guidelines for capital issues known as the SEBI (Disclosure and Protection of Investors) Guidelines, focusing on comprehensive disclosures, investor protection, and prudent controls. These guidelines, coupled with provisions of the Companies Act, apply to all public issues of listed and unlisted companies, and all offers for and rights issues by listed companies, except for rights issues with an aggregate value of securities offered not exceeding Rs. 50 lakh. The procedural requirements as per the SEBI Guidelines, 2000 (updated till September 2005), are as follows:

Eligibility Criteria:

• Companies intending to make an initial public offering (IPO) must meet certain conditions, including not being barred by SEBI from accessing the capital market.
• The company must prepare a draft offer document (prospectus) and file it with SEBI through an eligible merchant banker at least 21 days before filing it with the Registrar of Companies.
• No public issue of securities can occur without an application for listing on stock exchange(s).
• Securities must be issued in dematerialized form, and the company must enter into an agreement with a depository for dematerialization.
• Unlisted companies can make an IPO under specific conditions related to net tangible assets, distributable profits, net worth, issue size, and existing financial instruments or rights.
• Listed companies can make a public issue provided the aggregate value of proposed and previous issues in the same financial year does not exceed five times its pre-issue net worth.

Exemptions:

• Certain exemptions from eligibility norms apply to private and public sector banks, rights issues by listed companies, and infrastructure companies with project appraisal from specified institutions.
• No public issue of equity shares can occur if existing partly paid-up shares have not been fully paid up or forfeited.
• The company must have firm arrangements for finance towards 75% of the stated means of finance, excluding the amount to be raised through the proposed public or rights issue.

Pricing of Securities

Any company eligible to conduct a public issue has the autonomy to set the price of its equity shares or any convertible securities.

Differential Pricing:

• Listed or unlisted companies issuing equity shares or convertible securities in a public offering may offer such securities to applicants in the firm allotment category at a price different from the public offering price. 
• However, the price offered to firm allotment category applicants must be higher than the price offered to the public. Justification for the price difference must be provided in the offer document. Similarly, a listed company making a combined capital issue may offer securities at varying prices in its public and rights offerings.

Price Band:

• An issuer company can specify a price band of up to 20% (with the cap not exceeding 20% of the floor price) in the offer documents submitted to the Board. The actual price can be determined later before filing the offer document with the Registrar of Companies (ROCs). The final offer document should contain only one price and one set of financial projections, if applicable.

Freedom to Determine Share Denomination:

Eligible companies have the liberty to conduct public or rights issues of equity shares in any denomination as determined by them, complying with provisions of the Companies Act and SEBI norms. Companies that have previously issued shares in denominations of Rs. 10 or Rs. 100 may alter the standard denomination by splitting or consolidating existing shares. However, the denomination cannot be in decimal of a rupee under any circumstance.

Promoters' Contribution and Shareholding

• In a public issue by an unlisted company, promoters are required to contribute a minimum of 20% of the post-issue capital. Additionally, their shareholding after the offer for sale should not fall below 20% of the post-issue capital. Similarly, for listed companies, promoters can either participate to the extent of 20% of the proposed issue or ensure post-issue shareholding of 20% of the post-issue capital.
• In a composite issue of a listed company, promoters have the option to contribute either 20% of the proposed public issue or 20% of the post-issue capital. However, the rights issue component of the composite issue should be excluded when calculating the post-issue capital.
• If promoters' participation exceeds the required minimum percentage of the post-issue capital, it will be considered preferential allotment and subject to pricing provisions outlined in guidelines on preferential allotment if the issue price is lower than the price determined based on preferential allotment guidelines.
• Promoters must bring in their full contribution, including premium, at least one day prior to the issue opening date. This amount must be kept in an escrow account with a scheduled commercial bank and released to the company along with the public issue proceeds. If the promoters' minimum contribution exceeds Rs. 100 crore, they must bring in Rs. 100 crore before the issue opening, with the balance brought in as advance on a pro rata basis before calls are made on the public.
• Exemption from the requirement of promoters' contribution applies to public issues of securities listed on a stock exchange for at least three years, with a track record of dividend payment for at least three immediately preceding years. However, promoters must disclose their existing shareholding and their participation in the proposed issue in the offer document.
• Lock-in requirements stipulate that in any public issue of capital, the minimum promoters' contribution is to be locked in for three years. However, excess promoters' contribution above the required minimum is subject to a one-year lock-in period, except for public issues by companies listed on a stock exchange for at least three years with a track record of dividend payment for at least three immediately preceding years, where excess promoters' contribution is not subject to lock-in requirements.
• For unlisted companies, the entire pre-issue share capital, excluding that locked in as promoters' contribution, is to be locked in for one year from the date of commencement of commercial production or the date of allotment in the public issue, whichever is later. These lock-in requirements do not apply to pre-issue share capital held by venture capital funds and foreign venture capital investors registered with SEBI, as per relevant SEBI guidelines.

Pre-Issue Obligations

• Due Diligence Exercise: The lead merchant banker must conduct due diligence to ensure all aspects of the offering and the disclosure in the offer document are satisfactory.
• Payment of Fee: The lead merchant banker must pay the required fee along with the draft offer document filed with SEBI.
• Submission of Documents: The lead manager must submit several documents along with the offer document, including a memorandum of understanding, inter-se allocation of responsibilities, due diligence certificate, certificates regarding timely dispatch of refund orders and listing of securities, an undertaking regarding transactions in securities by promoters and their immediate relatives, and a list of persons constituting the Promoters' Group.
• Appointment of Lead Merchant Banker: An eligible merchant banker must be appointed to lead and manage the issue, ensuring other intermediaries are duly appointed and registered with the Board.
• Underwriting: The lead merchant banker must ensure underwriters are capable of meeting their obligations and incorporate details of underwriters in the offer document. The lead merchant banker(s) must undertake a minimum underwriting obligation of 5% of the total underwriting commitment or Rs. 25 lakh, whichever is less.
• Public Availability of Draft Offer Document: The draft offer document filed with SEBI must be made public for 21 days, and copies must be made available to the public.
• Pre-Issue Advertisement: After receiving final observations from the Board, the issuer company must advertise in English and Hindi national newspapers, as well as a regional language newspaper, disclosing certain minimum information.
• Despatch of Issue Material: The lead merchant banker must ensure timely dispatch of offer documents and other materials to various stakeholders.
• No Complaints Certificate: The lead merchant banker must file a statement with the Board listing complaints received and proposed amendments, if any, after 21 days from the date the draft offer document was made public.
• Collection Centres/Agents: The issuer company may appoint collection centres and agents, ensuring necessary disclosures are made in the offer document.
• Advertisement for Rights Post-Issues: For rights issues, an advertisement indicating the completion date of dispatch of letters of offer must be released at least seven days before the opening of the issue.
• Appointment of Compliance Officer: An issuer company must appoint a compliance officer to liaise with the Board on compliance matters.
• Abridged Prospectus: Every application form must be accompanied by a copy of the abridged prospectus.

Post-Issue Responsibilities

• Submission of Post-Issue Monitoring Reports: The post-issue lead merchant banker must ensure timely submission of post-issue monitoring reports according to the format specified in Schedule XVI of the Guidelines. These reports should be submitted within three working days from the specified due dates.
• Handling Investor Grievances: The post-issue lead merchant banker must actively engage in post-issue activities, such as allotment, refund processing, and dispatch, and continuously monitor the resolution of investor grievances arising from these activities.
• Coordination with Intermediaries: The post-issue lead merchant banker should maintain close coordination with registrars to the issue and periodically depute its officers to various intermediaries' offices to oversee the flow of applications, processing, and other related activities until the completion of the allotment process, dispatch of securities, and refund orders, and listing of securities. Any issues or discrepancies observed with intermediaries must be promptly reported to the Board.
• Underwriters: In case of underwriting devolvement, the lead merchant banker must ensure that underwriters fulfill their commitments within 60 days from the closure of the issue. If issues are undersubscribed, information regarding underwriters' failures to meet their commitments must be provided to the Board in the specified format within Schedule XVII of the Guidelines.
• Bankers to the Issue: The post-issue lead merchant banker is responsible for ensuring that funds received from the issue are held in a separate bank account and released only after obtaining listing permission from the stock exchanges where the securities are proposed to be listed.
• Post-Issue Advertisements: The post-issue lead merchant banker must ensure the release of advertisements within 10 days from the completion of various post-issue activities, providing details such as oversubscription, basis of allotment, number and percentage of applications, successful allottees, refund order dispatch date, certificate dispatch date, and filing date of listing application.
• Basis of Allotment: In a public issue of securities, the executive director/managing director of the designated stock exchange, along with the post-issue lead merchant banker and registrars to the issue, are responsible for finalizing the basis of allotment in a fair and proper manner, as specified in the SEBI Guidelines. If oversubscribed, allotment must be made in marketable lots on a proportionate basis within specified categories, with reservation for retail individual investors.
• Other Responsibilities: The lead merchant banker must ensure timely dispatch of share certificates, refund orders, and demat credits, submission of allotment and listing documents to stock exchanges, and completion of formalities for listing and commencement of trading within specified timeframes. They remain responsible for post-issue activities until subscribers receive shares/debenture certificates or refunds and the issuer company enters into a listing agreement with the stock exchange.

Other Requirements

• Public Issue of NCDS/DSCE: The lead merchant banker must ensure compliance with guidelines for the public issue and listing of non-convertible debt securities (NCDS) and debt securities convertible into equity (DSCE).
• Price Band and Determination: The lead merchant banker can include a price band of 20% in the offer document filed with the Board, with the specific coupon rate/price determined later in consultation with the issuer.
• Rule 19 (2) (b) of SCR Rules, 1957: Specifies the net offer to the public requirements for public issues by unlisted and listed companies, along with exemptions for infrastructure companies and provisions for reservations/firm allotments.
• New Financial Instruments: SEBI guidelines permit companies to issue new financial instruments subject to adequate disclosures regarding redemption, security, conversion, and other features.
• Terms of the Issue: Detailed requirements are provided for various terms of the public issue, including minimum application value, subscription period, minimum subscription, and compliance officer appointment, among others.