SEBI and Corporate Law

Some of the previous posts on this Blog (SEBI prohibits issue of shares with “superior” rights and Shareholders and Their Duties under Indian Law) have generated reactions from readers on a significant issue, which is the role that SEBI has recently been playing in altering provisions of basic company law as far as listed companies are concerned. It may be worthwhile to ponder whether this approach by SEBI is appropriate in the overall regulatory set up in India regarding corporate law.

Historically, the Companies Act, 1956 did not envisage any direct role either for SEBI or its predecessor (the Controller of Capital Issues). Since the establishment of SEBI in 1992 and until 2000, SEBI’s role was confined to the SEBI Act and regulations thereunder without any specific role under the Companies Act. It is only with the Companies (Amendment) Act, 2000 that SEBI was granted a role in the Companies Act. Section 55A of the Companies Act states:

Powers of Securities and Exchange Board of India.-The provisions contained in sections 55 to 58, 59 to 81 (including sections 68A, 77A and 80A) , 108, 109, 110, 112, 113, 116, 117, 118, 119, 120, 121, 122, 206, 206A and 207, so far as they relate t issue and transfer of securities and non-payment of dividend shall,-

(a) in case of listed public companies;

(b) in case of those public companies which intend to get their securities listed on any recognized stock exchange in India, be administered by the Securities and Exchange Board of India; and

(c) in any other case, be administered by the Central Government.

SEBI was made responsible for administering provisions regarding securities regulation under the Companies Act in relation to listed companies or companies which were going to be listed on stock exchanges. In these circumstances, SEBI’s role was expected to be one of “administering” the provisions rather than altering the fundamental basis of companies law (or in other words to exercise any legislative functions).

However, in recent practice, it has been found that several of SEBI’s regulatory powers are being exercised in a manner that dilutes (or even sometimes supersedes) basic provisions of company law. Of course, SEBI’s powers extend only to listed companies (or those that are being listed), but those companies are required to comply with requirements that are at variance with provisions of company law.

Just to take a few illustrations (discussed at some length in the posts referred to above), while the Companies Act permits shares with differential rights as to voting and dividend, SEBI has proscribed the issue of shares with “superior” voting rights. While the Companies Act does not prevent shareholders from exercising voting rights even if they are interested in a resolution, SEBI has required promoters (controlling shareholders) to abstain from resolutions involving delisting of shares of a company, and has also proposed to extend such abstention requirements to other resolutions generally. Such anomalies continue even in relation to the Companies Bill, 2009. It is not necessary for our present purposes to list these out in detail.

This approach creates certain difficulties. First, it creates uncertainty in interpretation due to inconsistencies in various provisions of law governing companies and securities. It also leads to multiplicity of regulators. Second, and more importantly, it gives short shrift to the process of lawmaking. For instance, provisions the Companies Act that contain basic principles and concepts can be amended only through statute that requires approval of the Parliament and assent of the President. However, any dilution of those provisions through SEBI regulation, which is only subordinate legislation, entirely bypasses that process. Although SEBI has also begun the practice of issuing concept papers and draft regulations on various matters and obtaining public comment before promulgating regulations, it is not the same as following the extensive legislative process through elected members of Parliament as required by the Constitution.

Similar, but not identical, debates have been witnessed in other prominent jurisdictions. For instance, although corporate law is a state subject in the U.S., it has been subject to constant encroachment more recently by way of federal legislation. The Sarbanes-Oxley Act of 2002 and more recent proposals on shareholder bill of rights in the wake of the global financial crisis are instances on point, although they have occurred much to the consternation of several corporate law academics and commentators who denounce the “creeping federalization of corporate law” and argue for preservation of separation of lawmaking at the state and federal levels.

Returning to the Indian scenario, the point is not to undermine SEBI’s efforts on substance regarding several initiatives it has taken and is proposing to take (such as requiring interested shareholders to abstain from voting) with a view to protection of the interests of minority shareholder. These are precisely matters that some of us having been advocating on this Blog too. But, what is in question is the exact process to be adopted. On aspects involving foundations of company law, it is necessary for SEBI to initiate the proper legislative process, rather than resort to its own rule-making powers on an ongoing basis. What is in question here is the means and not the end.