Impact of SEBI Order on Governance of Exchanges

The concept of demutualization of stock
exchanges has given rise to some questions regarding the governance of
demutualized exchanges. That concept requires exchanges to separate ownership
and governance from that of its trading members. Some issues pertaining to
demutualization have come up before SEBI in its investigation into the affairs
of the United Stock Exchange of India Limited (USE). SEBI issued a recent order
warning USE “to be more cautious and perceptive in the discharge of its
function and the regulatory duties”. It also required USE to amend its articles
of association (which is the subject matter of discussion in this post).
SEBI found concentration of volumes in trading
on the USE through two trading members, with one of them Jaypee Capital
Services Limited being a promoter of USE. An analysis of SEBI’s order on the
issue of trading concentration can be found in Mobis Philipose’s column
in The Mint; but this post focuses on the observation of SEBI regarding the
board rights of the key shareholders of USE. Specifically, it relates to an
insertion in the articles of association of a clause that provides for specific
quorum, whereby no board meeting shall be constituted unless at least one
director representing Jaypee Capital, BSE and Federal Bank (being the key
shareholders) are present. SEBI found such a quorum requirement to impinge upon
the governance of the stock exchange. The SEBI member observes:
I note that such kind of special arrangements
as did by USE is not in the interests of independent functioning of the stock
exchange. The Special Articles i.e., Part II of AoA has overriding effect over
its General AoA and these rights to certain shareholders appear to be
detrimental to the interest of other stakeholders. These are inconsistent,
imprudent and contrary to the best corporate governance practices. In my
opinion, such special arrangements surely constrain the independent functioning
of the Stock Exchange. … I note that these defaults on the part of USE not only
reflect bias on the part of the Exchange towards certain shareholders, but also
reveals that such provisions in AoA are against the spirit of demutualization
of stock exchanges.
This suggests that even a customary provision
for quorum in shareholders agreements (that may be incorporated in the articles
of association) can be found to go against the independent governance of a
stock exchange. In that sense, the impact of SEBI’s order is to impose high
standards of governance in an exchange, which may obviate special clauses in
favour of particular shareholders that are common in other types of companies.
Moreover, this may be contrasted with cases
involving other companies, where such protective provisions in shareholders’
agreements and articles of association in favour of particular shareholders are
treated more liberally. For instance, in the controversy involving the
definition of “control”, the Securities Appellate Tribunal (SAT) had
that not only such quorum provisions but even affirmative voting
rights (or veto) rights would not confer “control” on the shareholder so as to
trigger mandatory takeover offer requirements (although that ruling has been
somewhat disturbed by a consent
on appeal before the Supreme Court).

The key take away from this
order of SEBI is that shareholders’ agreements and articles of association of
stock exchanges may be subject to closer scrutiny by regulators who appear
averse to special rights in favour of any particular shareholder.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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