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Securities Laws
This series of articles introducing securities laws for
listed companies to the lay reader continues . . .
(1) Not one more Satyam article, please ! There is certainly
an overdose of reports, articles, blogs, even Twitter messages covering the
latest buzz or views on the Satyam episode. There is serious competition on the
net on how one writer could outdo others in eloquent outrage. However, the fact
remains that at least at the time of writing this article, which is many days
after Mr. Ramalinga Raju’s ‘confession letter’ that, except this very letter,
there are very little other facts brought out. Even the veracity of the contents
of this very letter is being questioned by some. However, as is usually the case
in Trial-by-Media, many parties have been already presumed to be guilty.
(2) However, for the purposes of this column, the Satyam
episode is a dream case study for students of securities laws. If one believes
even some of the reported statements in the press and elsewhere to be true, it
seems that violation of a host of securities laws would be alleged. There would
be question of violations of the SEBI DIP Guidelines while making of
disclosures. There would be allegations of fraud and unfair trade practices in
dealings in securities and making of statements by the Promoters of Satyam and
others. There would be allegations of violation of numerous provisions of
corporate governance requirements. There would be concerns about violations of
the Insider Trading Regulations, since it is reported that shares of Satyam have
been sold by the Promoters over the last many years, either directly or by the
lenders who lent funds against the securities of the shares and then sold the
shares. There could be violation of the Regulations and Code of Conduct for
intermediaries such as merchant bankers, brokers, etc. in their dealings in
relation to Satyam. And so on and on.
(3) However, as stated, it may be worth for us, as students
of this field, to examine one or more of such issues from time to time and then,
in the context of specific ‘facts’ as reported, examine the law and see how it
could apply. This way, we can understand the law in practice.
(4) Let us then, in this context, consider one such
allegation and that is that there has been violation of Insider Trading
Regulations in dealing of shares by the Promoters of Satyam. More specifically,
it is being alleged that the Promoters of Satyam pledged their shares in Satyam
to lenders who, in turn, on default or on margin calls, sold their shares. It is
alleged that this amounts to Insider Trading by the Promoters. It is also
reported that the SEBI Committee examining this issue will also consider whether
the law should be amended, whereby pledge of Promoters’ shares would now be
required to be disclosed. Let us examine here, in the light of the alleged
facts, whether pledge of shares can be held to be Insider Trading under the
existing law. Let us also examine the implications of the recommendation that
the law be amended to require disclosures of pledge of shares by Promoters.
(5) Let us examine the reasoning given in support of the view
that pledge of shares should amount to Insider Trading. The first line of
argument is that pledge of shares is indeed Insider Trading, apparently by
taking an extended meaning of ‘dealing’ in ‘securities’. It is stated that the
word ‘dealing in securities’, the very substance of Insider Trading, is broad
enough to include all transactions relating to securities including, therefore,
even pledge. However, I wonder if the wording of the scheme provides for
coverage of a bona fide pledge. The existing definition of ‘dealing in
securities’ in the SEBI Insider Trading Regulations is quite specific and
exhaustive though a bit clumsy. It says that ‘dealing in securities’ means
‘an act of subscribing, buying, selling or agreeing to subscribe, buy, sell or
deal in any securities by a person either as a principal or an agent’. Pledging
of shares is not subscribing or buying or selling of securities, nor is it
agreeing to do so.
(6) The definition has some clumsiness in terms of being
circumlocutory when it uses the word ‘deal’ again in the latter part of the
definition, but I doubt whether even this would be sufficient to cover bona
fide pledge of shares.
(7) Consider also the intention of these Regulations
prohibiting Insider Trading. It is obviously to restrict insiders from dealing
ahead of material disclosures, at a time when the price is significantly
different from what it may be if these disclosures were made. In Satyam, it is
being alleged that the Promoters pledged shares when prices were high and thus
obtained monies based on valuations that did not reflect the reality and which
reality was disclosed much later. The lenders allegedly sold shares when market
price started falling and Promoters could not meet margin calls. However, this,
by itself only, cannot make bona fide pledge of shares insider dealing.
(8) When a person pledges shares, he keeps the risks and
rewards in the shares with himself. When the lender sells the shares on default
or margin calls, he sells at a time when the prices may have already fallen, but
then it is the borrower who has to bear such fall. He would be credited
obviously only to the extent of the amount realised by sale. If the borrower
bears the risk of such fall, then this goes against the very concept of Insider
Trading where the dealer profits from a fall in price that may be the result of
adverse information published later.
(9) The second and incidental line of argument is that the
definition of ‘securities’ — Insider Trading involves dealing in ‘securities’ —
under the Securities Contracts (Regulation) Act, 1956 includes ‘rights or
interest in securities’. It is argued, and to that extent rightly so, that
pledge of shares may involve grant of right or interest in securities. However,
from this, a conclusion is apparently being inferred that thereby dealing in
‘securities’ would cover pledge of shares.
10. One possible answer to this is that what is covered under Insider Trading is ‘dealing’ in securities i.e., the process and action itself. It is the word ‘securities’ that has been given an extended meaning under SCRA to cover ‘rights or interest’. The word ‘dealing’ has not so been artificially extended and in fact, as discussed above, is quite specific and exhaustive (except for the quirk, also discussed). If pledge of shares is held to be Insider Trading, then Insider Trading is being interpreted to mean ‘dealing in (dealing in securities)’!
11. Interestingly, the Takeover Regulations exempt acquisition of shares by ‘banks and public financial institutions as pledgees’. One may wonder whether, therefore, pledge was thus understood to be acquisition, since otherwise there was no need to specifically give this exemption. However, this conclusion may not be correct since, even here, what is really exempted is ‘acquisition of shares’ as ‘pledgees’ and not the pledge itself. In other words, the pledge has to be an acquisition first – e.g., in the case where the pledgee actually transfers the shares in its name and also does further acts. Also, there are decisions (of SAT,etc., not discussed here) that have held that pledge does not amount to acquisition of shares.
12. The above discussion though applies to bona fide pledge of shares and the moot question of course is whether the pledge of shares in Satyam was bona fide. Obviously, no one knows this yet and it may take a long time before the truth is established. However, clearly, if a pledge is not a bona fide pledge and is actually a sale in disguise, then it would be sale of securities and in that case the Insider Trading Regulations would squarely apply. But this would be by applying the regular and plain inter-pretation of Insider Trading and not by a crisis-driven, extended meaning.
13. If in the heat and pressure of action, to some-how find the Promoters of Satyam guilty of Insider Trading, a stretched interpretation is taken that any pledge of shares should also be deemed to be Insider Trading, it can cause a serious crisis to the whole corporate world generally. Firstly, Promoters of numerous other companies would also be deemed to have committed Insider Trading through pledge. Secondly, this process may bring out the real picture of the status of finances of Promoters in India post-stock market meltdown !
14. It is then that the second suggestion of SEBI can be discussed and that is whether Promoters should be required to disclose the pledge of their shareholdings. I think this is a sensible suggestion and it would be valuable information for shareholders and the markets in general to know to what extent the Promoters are vulnerable and what is their real, net and clear holding and stake. Not that there is anything per se wrong in pledging shares or that it is ‘disclosure’ of Insider Trading. Pledge may be for many reasons – for raising of finance for persons or corporate purposes or even further acquisition of shares, etc. In fact, if funds are raised by Promoters for financing further acquisitions of shares, then this may be even indicative of their own confidence in the Company. Of course, in some cases, this disclosure may help initiating investigation of the bona fide nature of the pledge.
15. However, as stated earlier, making Promoters to disclose, at this juncture, the pledge of their holding would also result in the discovery – probably shocking – of the reality as suggested by the oftquoted statement of Warren Buffet – “You only find out who is swimming naked when the tide goes out”. We may thus find out how many Indian Promoters are swimming dressed very skimpily and how many are swimming stark naked!
