Clause and effect

Sebi had no right to revise Clause 49 of the listing agreement to regulate corporate governance

On August 26, 2003, the Securities and Exchange Board of India (Sebi) revised Clause 49 of the listing agreement for improving the standards of corporate governance.

The move came at a time when most of the aspects incorporated in the revised Clause 49 were also included in the Companies (Amendment) Bill, 2003 (introduced in the Rajya Sabha on May 7, 2003).

These pertained to the implementation of the recommendations of the Committee on Corporate Audit and Governance and contained clauses relating to directors' report, qualifications and disqualifications of auditors, independent directors, meeting of the board of directors and powers to be exercised only at the meetings of the board and restrictions on board's powers, remuneration, inter-corporate loans and so on.

Even while this Bill was pending for consideration of Parliament, Sebi revised Clause 49 and included in it almost the same matters that were present in the Amendment Bill, with the stipulation in sub-clause (4) of Clause 49 that the sub-clauses in this clause "shall be suitably modified or new clauses shall be added following the amendments to the Companies Act, 1956 by the Companies (Amendment) Bill/Act, 2003" to harmonise with the provisions in the Companies Act and the listing agreement.

Sebi's decision raises the following important issues:

Why did Sebi resort to a hurried revision of Clause 49 when the Amendment Bill was still to become law?

Can Sebi make regulations in respect of matters that fall within the jurisdiction of the Department of Company Affairs (DCA)?

Before discussing these issues, further developments with respect to the government's withdrawal of the Amendment Bill, 2003 for reconsideration and about Clause 49 needs to be mentioned.

Since the government decided to reconsider the Companies (Amendment) Bill, 2003, Sebi, in all fairness, should have suspended the operation of revising Clause 49 till the Companies (Amendment) Bill was passed in its new form.

However, instead of doing that, because of severe criticism of the revised Clause 49, Sebi referred it to the Narayana Murthy Committee for its views, which have since been received and the Committee has almost in toto endorsed what is contained in the clause as issued by Sebi.

Coming to the two issues mentioned earlier, there was apparently no justification for Sebi to revise Clause 49 when the Amendment Bill, 2003 was pending.

By acting hurriedly, it threw work on the corporations, which was avoidable, infructuous and, perhaps, also illegal, if the proposals in the Bill were changed at the time of passing of the Act.

The second issue is more fundamental and raises questions about the jurisdiction of Sebi's rule-making powers vis-à-vis the Companies Act.

The original and revised versions of Clause 49 have been issued in exercise of power conferred by Section 11(1) of the Sebi Act, 1992 read with Section 10 of the Securities Contracts (Regulation) Act, 1992, which reads as:

"Subject to the provisions of this Act, it shall be the duty of the Board to protect the interests of investors in securities and to promote the development of and to regulate the securities market, by such measures as it thinks fit."

Obviously, the power conferred is in a limited direction and does not empower Sebi to regulate the functioning of companies in general.

This becomes clear on reading sub-section (2) immediately following sub-section (1), which inter alia, provides for regulation of stock exchanges and other securities markets; registering and regulating the working of depositories, custodian of securities, foreign institutional investors (FIIs), credit-rating agencies, venture capital funds, self-regulatory organisations; prevention of fraudulent and unfair trade practices; regulating substantial acquisition of shares and takeover of companies; calling for information from various sources/undertakings, banks; levying fees or other charges to carry on the functions mentioned in sub-section (1) of Section 11; and so on.

It nowhere states that Sebi has been conferred the power to regulate the functioning of the companies in the matter of regulation of the board of directors, their tenure, remuneration, audit of companies and various other functions concerning a company's working.

Even Sections 4(3) and 11B of the Sebi Act, 1992 do not authorise Sebi to traverse areas that fall within the jurisdiction of the DCA. This view gets endorsed by a recent decision of the Securities Appellate Tribunal (SAT), Mumbai, in the case of Gold Multifab Ltd & Ors vs Sebi (2003) 4 Comp LJ 361 (SAT).

In this decision, the SAT has considered Sebi's order in regard to violation of Sections 69, 73(3A) and 77 of the Companies Act, 1956. Section 69 relates to the prohibition of allotment unless minimum subscription is received; Section 73(3) and (3A) concerns the allotment of shares and debentures to be dealt in on stock exchanges; and Section 77 pertains to the restrictions on purchase by a company or loans by a company for purchase of its own or its holding company's shares.

Sebi had issued a show-cause notice to the company for alleged violation of these sections of the Companies Act and violation of the provisions of Sebi guidelines on disclosure and investor protection and conditions of prospectus issued by the company.

In the show-cause notice, the conclusions arrived at were that after the investigation by Sebi, the contravention in respect of the above matters are established and, hence, in exercise of the powers conferred under Sections 4(3) and 11B (supra), Sebi issued impugned directions.

The question for the SAT's decision was whether on the facts, Sebi has the jurisdiction to issue the impugned directions for violation of the provisions of the Companies Act by invoking powers conferred on it by Sections 4(3) and 11B of the Sebi Act.

Regarding Sebi's jurisdiction concerning Sections 69, 73(3A) and 77 of the Companies Act, the SAT has said that it is clear that the power to administer provisions stated in Section 55A, so far as they relate to the issue and transfer of securities and dividend in respect of listed companies and those companies that intend to get their securities listed on any recognised stock exchange in India, is vested with the respondent, Sebi.

In this context, it is to be noted that the said Section 55A only vests the authority of administering the section stated therein with Sebi. Section 621 empowers Sebi to prosecute those who contravene the provisions of those sections. Section 55A does not empower Sebi to invoke the provisions of Sebi Act to administer those provisions of the Companies Act.

The Companies Act recognises Sebi as an enforcement authority for administering certain specific sections. Sebi has to enforce those sections under the Companies Act.

It cannot resort to the provisions of the Sebi Act to enforce the provisions of the Companies Act in the absence of an enabling provision for the purpose in the Sebi Act.

Section 11B has no over-riding effect on the provisions of the Companies Act, as has been made clear in Section 32 of the Sebi Act that the provisions of the Act "shall be in addition to and not in derogation of the provisions of any other law for the time being in force".

Section 11B cannot be invoked to take action against those who contravene the provisions of Sections 69, 73 and 77 of the Companies Act and, in that view of the matter, the impugned order made under Section 11B in the light of the respondent's finding that the appellant had contravened Sections, viz, 69, 73(3A) and 77 of the Companies Act, is without jurisdiction and as such, the order cannot be sustained.

Section 55A gives powers to Sebi in respect of sections mentioned therein only and clarifies that in respect of the rest, the jurisdiction would be of the Central government.

The "explanation" to the Section clarifies that all powers relating to all other matters, including the matters relating to prospectus, statement in lieu of prospectus, return of allotment, issue of shares and redemption of redeemable preference shares shall be exercised by the Central government, (Tribunal) or the registrar of companies, as the case may be.

Hence, Sebi must accept that its powers are limited and subordinate to DCA and not coextensive with it and, hence, it has to refrain from framing its own rules concerning corporate governance.

It can adopt the Companies Act provisions concerning these for listing agreements, but cannot frame independent rules in this regard coextensive or more than what is there in the Companies Act for these and say that their non-compliance would affect listing. Doing so, would be ultra vires its powers.

(The writer is former chairman of the Central Board of Direct Taxes)