The Securities and Exchange Board of India (Sebi) has adopted an inexplicably combative stance against put and call options in shares. First, Sebi directed Vedanta and Cairn Plc. to delete put and call options over shares of Cairn India Ltd. from a share purchase agreement. Now, Sebi has refused to process an application for informal guidance on interpreting the takeover regulations on the basis that the facts in the query showed that a put option had been contracted.
According to Sebi, an agreement between two private parties, with one agreeing to acquire the other’s shares at a future date at a price to be determined in future on the basis of agreed valuation criteria, would be an option in securities. An option in securities would be a derivative contract, and according to Sebi, Section 18A of the Securities Contracts (Regulation) Act, 1956 (“SCRA”), which protects the legitimacy of derivatives listed on stock exchanges, would not protect unlisted derivatives.
Sebi approach is very narrow-minded, unsubstantiated, and mis-applies the law on the subject. Worse, its approach ignores the purpose, spirit and intent behind the regulations formulated and notified by none other than Sebi. Legally, such an approach runs counter to the mandate of orderly development of the capital market, enjoined upon Sebi by Parliament. Factually, the approach places India in a retrograde position distinct from how securities can be dealt with in other sophisticated markets.
Two shareholders who own property in the form of shares in a company are fully entitled to deal with their property upon the terms they contract. A shareholder has every right to contract an obligation to buy or sell shares upon the occurrence of a contingency. Such an arrangement would not constitute trading in a derivative contract – it would still be a transaction in shares.
When India was socialist in the pre-1990 era, the SCRA was amended to ban trading in options. The ban was lifted and SEBI was given powers to notify how and when options could be traded in. A private put option or a call option that would actually result in transfer of shares would not be a speculative contract for differences, or a “derivative”, and should therefore be declared by Sebi to be kosher.
When listed derivatives were introduced in India, to protect them from legal challenge under Indian contract law (for example, a bad loser could argue that derivatives represent gambling and that gambling is illegal), Section 18A was introduced to confirm that listed derivatives would not be regarded as illegal under any Indian law. That does not mean, even if one were to assume a put option or a call option in a share purchase agreement to be a transaction in derivatives, that every other derivative is illegal.
Sebi is tilting at the windmills here. If its stance were legally correct, every share purchase agreement with any conditions attached to completing the purchase would be an unlisted derivative, and therefore, illegal. Indeed, every share purchase agreement that triggers an open offer under the takeover regulations would fall under this category – it is an agreement to acquire shares with the right to acquire the shares getting crystallized only when compliance with the open offer obligations is completed.
Worse, it is SEBI that drafted the takeover regulations. In August 2001, these regulations were amended to explicitly recognize put and call options designed by the Government of India in its public sector disinvestment programme.
Sebi had resisted the Government’s desire to get all disinvestments exempted from open offer obligations, and instead legislated that when shares change hands at a future date upon exercise of such a put or call option, subject to certain conditions, another open offer would not be triggered.
Similarly, purchase of shares of an Indian listed company by its promoters from state-level financial institutions is a transaction explicitly exempted under the takeover regulations. Such institutions have a routine clause requiring purchase of their initial investment by promoters at a future date at a pre-agreed price or at a price to be determined in terms of pre-agreed criteria. Yet, when faced with identical facts involving an Italian government institution requiring an Italian promoter of an Indian company to buy out shares at a future date, Sebi has refused to answer the queries raised, and instead has ruled that the arrangement is patently illegal.
A regulator ignoring the very legislation authored by it is terrible public policy. In fact, Sebishould positively discharge its duty to ensure orderly development of the securities market, under the Sebi Act, 1992, and issue a notification clarifying that such provisions would not be regarded as illegal.
It would only be underlining the spirit, purpose and intent of explicit provisions of law contained in regulations authored by none other than Sebi. The settled rule of interpretation that regulatory provisions should be purposively construed, binds regulators too.
(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.) somasekhar@jsalaw.com
