TaxTMI 
TaxTMI 
TaxTMI 
2014 (5) TMI 901
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....on Act, 1860 and is an association representing the interests of stock exchange brokers whose members are stated to have been engaged in trading shares and securities on the Regional Stock Exchange at Kanpur. The second petitioner is its President, while the third petitioner is a trading Member and Director of the governing body of the Uttar Pradesh Stock Exchange Limited, a body corporate, which is impleaded as the second respondent to these proceedings. The challenge has been confined at the hearing to the validity of Regulations 6, 7, 14, 16, 17, 19, 20, 21(1)(b), 23, 24 and 25. The validity of the regulations has been challenged on four grounds: (i)the regulations "completely muzzle" the fundamental right guaranteed by Article 19 (1) (c) of the Constitution, on a citizen to form an association by choosing its members and directors; (ii)the regulations "totally supplant" the provisions of Section 4(b), 5, 7A, 11 and 31 of the SCRA and Rules 4, 5 & 6 (read with Form A) of the Securities Contracts Rules "the Rules"; (iii)the regulations "sail far beyond the bounds set down by the SCRA and the rules and since they constitute sub delegated legislation, must yield to the statute ....
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....nance structure specified in these regulations; (e) the applicant satisfies net worth requirements specified in these regulations; (f) the applicant satisfies requisite capability including its financial capacity, functional expertise and infrastructure. Explanation.--For the purposes of this sub-regulation, the term "demutualised" means that the ownership and management of the applicant is segregated from the trading rights or clearing rights, as the case may be, in terms of these regulations. (3) An applicant seeking recognition as a stock exchange shall, in addition to conditions as specified in sub-regulations (1) and (2), comply with the following conditions, namely:-- (a) the applicant has the necessary infrastructure for orderly execution of trades; (b) the applicant has an online screen-based trading system; (c) the applicant has an online surveillance capability which monitors positions, prices and volumes in real time so as to ensure market integrity; (d) the applicant has adequate infrastructure to list securities for trading on its platform, wherever applicable; (e) the applicant has necessary capability to have a nationwide network of trading members and has a....
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....ge' means the aggregate value of paid up equity share capital plus free reserves (excluding statutory funds, benefit funds and reserves created out of revaluation) reduced by the investments in businesses, whether related or unrelated, aggregate value of accumulated losses and deferred expenditure not written off, including miscellaneous expenses not written off." Ownership Chapter IV of the SECC Regulations prescribes requirements in regard to the ownership of stock exchanges and clearing corporations. Regulation 16 (1) contains a stipulation that the shareholding or voting rights of any person in a recognized stock exchange or a recognized clearing corporation shall not exceed the limits specified in the Chapter at any point of time. Under clause (2), the shareholding is to include any instrument owned or controlled, directly or indirectly which provides for entitlement to equity or rights over equity at any future date. Regulation 17 is to the following effect: "17. (1) At least fifty one per cent of the paid up equity share capital of a recognised stock exchange shall be held by public. (2) No person resident in India shall at any time, directly or indirectly, either in....
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....dent in India cannot hold more than 5 percent of the paid up equity share capital directly or indirectly, either individually or together with persons acting in concert; (iii)in the case of stock exchanges, depositories, banking companies, insurance companies and public financial institutions, a cap of 15 percent is provided for holding of paid up equity share capital in a recognized stock exchange; (iv)a person resident outside India is subject to a cap of 5 percent of the holding of equity share capital in a recognized stock exchange; and (v) the combined holding of all persons resident outside India cannot exceed 49 percent of the total paid up equity share capital subject to (a) a cap of 26 percent on holding which has been acquired through the FDI route; (b) a cap of 23 percent for FIIs; (c) a prohibition on an FII acquiring shares of a recognized stock exchange through the secondary market. Fit and Proper criterion Regulation 19 defines the norms of eligibility for the acquisition or holding of shares. Under clause (1) of Regulation 19, there is a prohibition on a person acquiring or holding equity shares of a recognized stock exchange or recognized clearing corporation ....
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....estion shall be final." Under Regulation 21, every recognized stock exchange has to disclose to SEBI its shareholding on a quarterly basis including the names of ten largest shareholders together with the number and percentage of shares held and the names of shareholders falling under Regulations 17 and 18, who had acquired shares in that quarter. Governance Chapter V of the SECC Regulations makes provisions for governance of stock exchanges and clearing corporations. Regulation 23 contains stipulations about the composition of governing board. Under clause (1), the governing board of every recognized stock exchange is to include: (i)shareholder directors; (ii)public interest directors; and (iii) a managing director. The stipulations that have been contained in Regulation 23 are: (i) a requirement that the chairperson be elected by the governing board amongst public directors Regulation 23 (2); (ii) the number of public interest directors shall not be less than number of shareholder directors Regulation 23 (3); (iii) the number of public interest directors of a recognized clearing corporation will not be less than two-third and shareholder directors shall not exceed one-t....
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....k exchange or a recognised clearing corporation shall not-- (a) be a shareholder or an associate of a shareholder of a recognised stock exchange or recognised clearing corporation or shareholder of an associate of a recognised stock exchange or recognised clearing corporation, as the case may be; (b) be a trading member or a clearing member, or his associate and agent, or shareholder of a trading member or clearing member or shareholder of an associate and agent of a trading member or a clearing member; or (c) hold any position concurrently in the subsidiary of a recognised stock exchange or a recognised clearing corporation, or in any other entity associated with a recognized stock exchange or a recognised clearing corporation:" SEBI, under clause (6) of Regulation 25 is empowered suo motu to remove or terminate the appointment of a managing director after a reasonable opportunity of being heard, if it so deems fit in the interest of securities market. We now proceed to deal with the constitutional challenges. SCRA The post World War - II boom in stock exchanges between 1945 and 1946 brought home the need and urgency for a reform of stock exchanges across the country. The ....
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....matters, conditions relating to,-- (i) the qualifications for membership of stock exchanges; (ii) the manner in which contracts shall be entered into and enforced as between members; (iii) the representation of the Central Government on each of the stock exchanges by such number of persons not exceeding three as the Central Government may nominate in this behalf; and (iv) the maintenance of accounts of members and their audit by chartered accountants whenever such audit is required by the Central Government." Section 5 provides for withdrawal of recognition by the Central Government in the interest of the trade or in public interest. Section 7A empowers recognized stock exchanges, inter alia, to make rules restricting voting rights. Sub-section (1) of Section 7A is as follows: "7A. (1) A recognised stock exchange may make rules or amend any rules made by it to provide for all or any of the following matters, namely:-- (a) the restriction of voting rights to members only in respect of any matter placed before the stock exchange at any meeting; (b) the regulation of voting rights in respect of any matter placed before the stock exchange at any meeting so that each member may ....
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....uary 2000 was introduced by a Parliamentary amendment to enable the Central Government to delegate its powers under the Act (except for the rule making power) to SEBI or to the Reserve Bank of India. Section 29A provides as follows: "29A. Powers to delegate.- The Central Government may, by order published in the Official Gazette, direct that the powers (except the power under section 30) exercisable by it under any provision of this Act shall, in relation to such matters and subject to such conditions, if any, as may be specified in the order, be exercisable also by the Securities and Exchange Board of India or the Reserve Bank of India constituted under section 3 of the Reserve Bank of India Act, 1934 (2 of 1934)." Section 31 has been amended and, in its present form, empowers SEBI to make regulations consistent with the provisions of the SCRA and the rules to carry out the purposes of the Act. This is to be without prejudice to the provisions contained in Section 30 of the SEBI Act. The regulations, amongst other things, may provide for the manner in which at least 51percent of the equity share capital of a recognized stock exchange is to be held by the public other than the sh....
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....orresponding provisions of Section 11 (2) (j) of the SEBI Act. Under Section 30 (1), SEBI is empowered to make regulations consistent with the provisions of the SEBI Act and the rules made thereunder, to carry out the purposes of the Act. Delegation to SEBI of the powers of Central Government In exercise of the powers which were conferred by Section 29A of the SCRA, the Central Government issued a notification on 30 July 1992 directing that the powers exercisable by it under Section 4 (5), Section 7 and Sections 8, 11, 12 and 16 were delegated concurrently to SEBI. Another notification for delegation was issued by the Union Government on 13 September 1994. The Press Note which was issued by the Union Ministry of Finance in the Department of Economic Affairs, to explain the reason for the delegation states that: "4. With the delegation of these additional powers, it is envisaged that SEBI will exercise most of the powers under the Act. The delegation of these additional powers to SEBI is intended to ensure a more effective protection of the interests of investors and to create an efficient and well-regulated stock market." (emphasis supplied). Consequently, the regulatory regime....
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....to promote investors' interest, to promote the development of the securities market and to regulate the securities market, has not been curtailed or whittled down in any manner by any other provisions under the SEBI Act, as no provision has been given overriding effect over sub-section (1) of Section 11 of the SEBI Act." Ultra Vires challenge Viewed in this background, it is not possible to accede to the submission that the SECC Regulations supplant or are ultra vires the SCRA or the rules which have been framed under it. Rule 3 of the Rules, in fact, contemplates that an application for recognition has to be made to SEBI and not to the Central Government. The regulations which have been framed by SEBI are in exercise of powers conferred by Sections 4, 8A and 31 of the SCRA. Section 31 of the SCRA expressly confers power upon SEBI to make regulations which are consistent with the Act and the rules, to carry out the purposes of the Act. SEBI, in framing the SECC Regulations, has acted plainly in pursuance of the statutory powers conferred upon it and has not traveled beyond the bounds of the statute. The Regulations are also referable to the provisions of Section 11 and Sectio....
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....hanges determine through the interplay of market forces capital allocation in the economy. Volatality in the stock market disturbs both the equilibrium and balance in the efficient allocation of resources for the economy. Traditionally, stock exchanges provided platforms for transactions in securities on the floor of the exchange where brokers met, negotiated and agreed upon the prices for stock transfers executed for their principals. With modern technology having permeated almost every aspect of life, the trading floor of the stock exchange has become obsolescent. Stock exchanges maintain electronic systems world wide that match orders for buying and selling of shares automatically. Stock exchanges are market organisers. Apart from the function of being market organisers, stock exchanges are (i) information distributors; (ii) regulators of the market which they organise; (iii) involved in setting standards of corporate governance through their listing rules; and (iv) at an institutional level, business enterprises. In the judgment of the Bombay High Court in MCX Stock Exchange Limited Vs. Securities and Exchange Board of India & Ors. (2012) 2 Comp LJ 473 (Bom) delivered by one o....
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....duced by stock markets as partaking of a public good. The price signals produced by these institutions was, in the view of the Committee, something which must be accessible to every one and must be governed by a transparent and efficient market economy. Unless the prices are fair, that would result in the expropriation of unjust profits by any one side to the transaction. The Jalan Committee observed that the nature of the public good that is supplied collectively by market infrastructure institutions is dependent exclusively on the quality and integrity of the process that accompanies its production. Hence, to ensure dependability of the process, some degree of regulatory powers have to reside within these institutions to varying degrees. The Jalan Committee emphasized that the position of MIIs in the country was capable of producing serious conflicts of interest which require SEBI to play an active role so as to ensure a level playing field. The Jalan Committee, in the course of its recommendations, emphasized the need for a dispersed ownership structure that would ensure that a single entity does not acquire a position of dominance. It was in that background that the Committee ....
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....d on 22 November 2010 after a wide ranging consultation involving all stakeholders. The report was placed on the website of SEBI on 23 November 2010. The Federation of Indian Stock Exchanges furnished its response on 25 December 2010 to SEBI. The agenda for the SEBI Board of 2 April 2012 included the comments of the Jalan Committee and the responses of various stakeholders. SEBI made its recommendations and eventually the regulations were notified with effect from 20 June 2012. MIMPS Regulations 2006 Even before the SECC Regulations were notified in 2012, SEBI had, in the exercise of its regulatory powers, notified in 2006 the Securities Contracts (Regulation ) (Manner of Increasing and Maintaining Public Shareholding in Recognised Stock Exchanges) Regulations, 2006. These regulations, known by the acronym 'MIMPS regulations', were applicable to all recognised stock exchanges in respect of which a scheme for corporatisation or demutualisation had been approved by SEBI under Section 4 (B) of the SEBI Act. The MIMPS regulations, amongst other things, provide: (i) a requirement under Regulation 4, that a recognised stock exchange shall ensure that at least 51 percent of its ....
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....arket. The expert regulator was guided, at every stage, by its own administrative experience in regulating the stock market. The conflicts of interest within stock exchanges, the impact of those conflicts on the stability of the securities market and the grave potential for danger by the concentration of power were within the knowledge of SEBI. That the fears of SEBI were not unreal is a matter borne out by precedent. Only by way of an illustration, a reference may be made to the judgment of the Bombay High Court in Anand Rathi & Ors. Vs. Securities and Exchange Board of India & Anr. (2002) Vol 110 CC 837) where an investigation by SEBI revealed that the President of a stock exchange had called for sensitive price information from the surveillance department to secure private ends. Article 19 (1) (c) of the Constitution Article 19 (1) (c) guarantees to all citizens the right to form associations or unions. The right is subject to the qualification in clause (4) by which nothing in sub-clause shall (i) affect the operation of any existing law insofar as it imposes or prevent the State from making any law imposing, in the interest of public order or morality, reasonable restriction....
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....lity of cases it covers, not by the freaks and exceptions it martyrs..." Now, to Article 19 (1) (c). In All India Bank Employees' Association Vs. The National Industrial Tribunal (Bank Disputes), Bombay, & Ors. AIR 1962 SC 171, a bench of seven learned Judges of the Supreme Court, while interpreting Article 19 (1) (c), held that: "...It is one thing to interpret each of the freedoms guaranteed by the several Articles in Part III in a fair and liberal sense, it is quite another to read each guaranteed right as involving or including concomitant rights necessary to achieve the object which might be supposed to underlie the grant of each of those rights, for that construction would, by a series of ever expanding concentric circles in the shape rights concomitant to concomitant rights and so on, lead to an almost grotesque result." The same view was reiterated in a judgment of a constitution Bench of the Supreme Court in M/s. Raghubar Dayal Jai Parkash Vs. Union of India & Ors. AIR 1962 SC 263: "... An application for the recognition of the association for the purpose of functioning under the enactment is a voluntary act on the part of the association and if the statute impose....
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....ication to the Armed Forces, clearly brings out the fact that all citizens, including Government servants, are entitled to claim the rights guaranteed by Art. 19. Thus, the validity of the impugned rule has to be judged on the basis that the respondent and his co-employees are entitled to form Associations or Unions. It is clear that Rule 4-B imposes a restriction on this right. It virtually compels a Government servant to withdraw his membership of the Service Association of Government Servants as soon as recognition accorded to the said Association is withdrawn or if, after the Association is formed, no recognition is accorded to it within six months. In other words, the right to form an Association is conditioned by the existence of the recognition of the said Association by the Government. If the Association obtains the recognition and continues to enjoy it, Government servants can become members of the said Association; if the Association does not secure recognition from the Government or recognition granted to it is withdrawn, Government servants must cease to be the members of the said Association. That is the plain effect of the impugned rule." In Damyanti Naranga (supra),....
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....n and to continue the same. In the instant case, the composition of the Society has not been touched at all. All that has been done is to nationalise the Institute of the Society by the acquisition of the assets and properties relating to the Institute. The Society may constitute its governing body in accordance with its rules without any interference by the Government." In Asom Rastrabhasa Prachar Samiti & Anr. Vs. State of Assam & Ors. (supra), the state legislation provided for the taking over of the Samiti which was a registered society. In that context, the Supreme Court held as follows: "In the present case the Government has taken the power under Section 3 to appoint a Board and the Government can appoint any one not connected with the Society at all to be in the Board. In the Act which was being examined by the Constitution Bench there were some restrictions on the nominations of persons although the persons were to be nominated by the Central Government but in the present Act it is left to the discretion of the Government to appoint the whole of the Board which will take place of not only 'the Managing Committee i.e. the Karyapalika but also the place of Byabasthapik....
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....nferred by sub-clauses (a) to (g) of clause (1) of Article 19; (iii) While right to form an association is to be tested by reference to Article 19(1)(c) and the validity of restriction thereon by reference to Article 19(4), once the individual citizens have formed an association and carry on some activity, the validity of legislation restricting the activities of the association shall have to be judged by reference to Article 19(1)(g) read with 19(6). A restriction on the activities of the association is not a restriction on the activities of the individual citizens forming membership of the association; and (iv) A perusal of Article 19 with certain other Articles like 26, 29 and 30 shows that while Article 19 grants rights to the citizens as such, the associations can lay claim to the fundamental rights guaranteed by Article 19 solely on the basis of their being an aggregation of citizens, i.e. the rights of the citizens composing the body. As the stream can rise no higher than the source, associations of citizens cannot lay claim to rights not open to citizens or claim freedom from restrictions to which the citizens composing it are subject." In that case, the Supreme Court cons....
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....are controlled by the statute. Therefore, there cannot be any objection to statutory interference with their composition or functioning merely on the ground of contravention of individual's right of freedom of association by statutory functionaries." The challenge was on the ground that the Andhra Pradesh Mutually Aided Cooperative Societies (Amendment) Act, 1995, violated Article 19 (1) (c). The Supreme Court held thus: "Members of an association have the right to be associated only with those whom they consider eligible to be admitted and have right to deny admission to those with whom they do not want to associate. The right to form an association cannot be infringed by forced inclusion of unwarranted persons in a group. Right to associate is for the purpose of enjoying in expressive activities. The constitutional right to freely associate with others encompasses associational ties designed to further the social, legal and economic benefits of the members of the association. By statutory interventions, the State is not permitted to change the fundamental character of the association or alter the composition of the society itself. The significant encroachment upon associati....
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....ecessarily governed by the rights, duties and obligations which are cast by the enactment. This distinction is emphasised in the judgment in the Andhra Pradesh Dairy Development Corporation Federation case. The right to form an association cannot be infringed by a forced-imposition of persons in the association. By statutory intervention, the State cannot alter the composition of the association. But when a group of persons gets itself registered under a particular legislative enactment, it subjects itself to the discipline of the law and of the subordinate legislation. Hence, when an association of persons seeks legislative recognition for the purposes of carrying on a business or activity, the legislature can subject that business or activity to regulatory control. Legislation which has a nexus with the preservation of the public interest in the transparent and accountable functioning of the activity or business is clearly permissible an does not violate Article 19 (1) (c). The stock exchange is a vehicle created by individuals or entities which come together to provide a platform for transactions in securities. A regulation of the stock exchange is nothing but a regulation of ....
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....eans must be adopted. The restrictions on ownership and on voting rights, it is asserted, is abhorrent to the fundamental right under Article 19 (1) (g). Similarly, the dispersal of ownership to the effect that 51 percent of the paid up equity capital be held by the public, it is claimed, would destroy the autonomy of the stock exchange. The provision that no person shall hold share unless he is a fit and proper person, is urged, to be vague and, therefore, destructive of the right to carry on business. Similarly, it has been submitted that the powers which SEBI has assumed over the inclusion of public interest directors would destroy the right to carry on business. The decision of the Constitution Bench of the Supreme Court in State of Madras Vs. V.G. Row AIR 1952 SC 196 is the locus classicus on the exposition of the test of reasonableness which must be applied when a law which imposes a restriction on a fundamental right guaranteed by Article 19 is questioned. The judgment of Chief Justice Patanjali Shastri, requires that in assessing the reasonableness of the restrictions, the Court must bear in mind several factors amongst them being: (i) an examination of both the substanti....
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....upreme Court was drawn to the fact that the 'fit and proper person' criterion has been applied in the context of regulations framed by SEBI. The use of that concept in the SEBI regulations was distinguished by the Supreme Court on the ground that the purpose and object of those regulations was not similar to the regulations in question which were framed under the Electricity Act in regard to the grant of a licence to a trader in electricity. This is clear from the observations of the Supreme Court: "Our attention has been drawn to some other legislations wherein the concept of `fit and proper person' had been applied, namely, Securities and Exchange Board of India (Criteria for Fit and Proper Person) Regulations, 2004. We have not been shown as to how the purpose and object of the said Regulations can be said to be in pari materia with the Regulations in question. It must also be borne in mind that an elaborate public hearing process is provided for grant of licence in terms of Section 15 of the Act. Such an independent inquiry cannot be carried out de hors the statute. But the Parliament thought it fit to confer a hearing as regards public objection only. The Consume....
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....are not just individual investors but institutional investors. Investments in the stock market are not confined to national boundaries but have a transnational character. Institutional decisions to invest in the stock market have a close and integral connection with the state of the economy, financial stability and the nature of regulatory governance. The market for securities has an integral connection with the allocation of capital and financial resources in a modern economy. Anything which affects the stability of the capital market has an impact on investor wealth and can severely imperil a stable financial order. Hence, the requirements which have been imposed by the SECC regulations must be assessed in the backdrop of the need to ensure transparency in the functioning of the securities market. Coupled with this is a felt necessity of ensuring the financial stability of stock exchanges, the dispersal of ownership and the avoidance of conflicts of interest which can jeopardize a stable and efficient market for securities. Regulation 3 casts an obligation to obtain recognition from SEBI before a person can conduct, organise or assist in organizing a stock exchange. The circumst....
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....ly be an integral part of a policy which seeks to create a barrier to subversion. We have carefully considered the challenge to the fit and proper person criterion. Regulation 20 (1) SECC Regulations stipulates when a person shall be deemed to be fit and proper. Undoubtedly, the considerations which have been specified in Regulation 20 (1) (a) have a broad connotation, but the Court must be circumspect in striking down such a provision on the anvil of a scrutiny with a fine-tooth comb because so long as they fall within the general ambit of reasonableness, the regulation must be sustained. Financial integrity, reputation, character and honesty are matters which have a serious bearing on the objective, transparent and fair functioning of the securities market. Regulation 20 (1) (b) similarly specifies that the person should not have undergone any of the stated disqualifications. Though, the decision of SEBI on whether a person is fit and proper person has been made final, such finality would exclude the jurisdiction of a civil court. At the same time, a right of appeal is available under Section 15T (1) (a) of the SEBI Act to the Securities Appellate Tribunal to any person aggrieve....