Introduction to Merchant Banking — the concept, its evolution, and the regulatory framework

Where this chapter sits

Chapter 2 carries 15% of the paper and is the longest in the workbook. It is the regulatory map on which every later chapter depends.

Three things dominate: the merchant banking versus investment banking distinction, the SEBI Act penalty sections, and the takeover and delisting thresholds.

2.1.1 What merchant banking is

The primary activity of Merchant Banks is to provide fee-based advice to corporations and governments on the issue of securities.

And what they do not do: merchant banks differ from commercial banks in the sense that they do not take deposits from individuals or businesses.

Their other activities: financing foreign trade, underwriting of equity issues, portfolio management, and undertaking foreign security business, as well as foreign loan business, project appraisal, etc. Though not all merchant banks offer all these services.

Merchant banking versus investment banking

'Merchant Banking', as the term suggests, is the function of intermediation in the capital market. It helps issuers to raise capital by the placement of securities issued by the issuers with investors.

And it carries a duty to the other side: the merchant banker has an onerous responsibility towards the investors who invest in such securities. The regulatory authorities require the merchant banking firms to promote quality issues, maintain integrity, and ensure compliance with the law on their own account and on behalf of the issuers as well.

Therefore, merchant banking is a fee-based service for management of public offers, popularly known as 'issue management', and for private placement of securities in the capital market.

In India, the merchant banker leading a public offer is popularly known as the 'Lead Manager'.

Investment banking is wider: the term has a much wider connotation and is gradually becoming more of an inclusive term to refer to all types of capital market activity, both fund-based and non-fund-based. This development has been driven more by the way the American investment banks have evolved over the past century.

Investment banking encompasses not merely merchant banking but other related capital market activities such as stock trading, market making and underwriting, stock broking, and asset management as well.

Plus: investment banks also provide a host of specialized corporate advisory services in the areas of project advisory, business and financial advisory, and mergers and acquisitions.

And one operational difference: an investment banker will also provide investment advice and deal with securities in the secondary market, unlike a pure Merchant Banker.

A merchant banker works the primary market; an investment banker works both.

2.1.2 The evolution

Merchant banking originated in Italy, then came to France in the seventeenth and eighteenth centuries. In France, a merchant banker was a merchant who added the banking business to his various activities and utilized his accumulated profits better.

What set them apart: their activities differed from those of any other 'money changer' and involved dealing in bills of exchange with correspondents abroad and speculating on the rate of exchange.

Merchant banks flourished in the United Kingdom in the late eighteenth and early nineteenth centuries as England became a rich trading nation. Profits from colonial trade were diverted into merchant banking activities, and the chief activity was accepting commercial bills for domestic and international trade.

Italy → France → the United Kingdom.

The American story

Investment banks, as they are called in the United States, are one of the most important participants in the US capital market. They help businesses and governments sell their new security issues in the debt or equity markets to raise capital through primary market transactions. Once the securities are sold, they also create the secondary markets for these securities as brokers and dealers.

The legislative sequence is examinable:

The Glass-Steagall Act of 1933 differentiated the activities between commercial banks and investment banks and prevented depositories from underwriting.

The Securities Exchange Act (1934) in the United States sought to correct practices in securities trading with the formation of the Securities and Exchange Commission (SEC).

However, the relaxation of the rules set out in Glass-Steagall Act in 1997 led to a wider consolidation in the investment and commercial banking space.

Owing to the growing requirements of globalisation and the growth of financial markets, the Glass Steagall Act was repealed in 1999 and replaced with a liberal Financial Modernisation Act 1999.

After the exponential growth of investment banks in the US during the period 1990-2007 and the subsequent global financial crisis in 2008, investment banks were brought under tight regulation again with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.

What Dodd-Frank did: it sought to regulate investment advisers, derivative markets, the functioning of credit rating agencies, etc. And specific to investment banking, the Act sought to regulate them by segregating banking from proprietary trading and asset management (through the Volcker Rule) as well as to provide for regulatory supervision for capital adequacy, quantitative limits, and other restrictions.

1933 → 1934 → relaxed 1997 → repealed 1999 → Dodd-Frank 2010.

2.1.3 The international scenario

Merchant Banking in the UK. The primary role of the merchant bankers was to discount bills and to provide safety in transactions for merchants going from country to country. Later on, merchant banks diversified into capital issues, advisory as well and management of funds.

Their characteristics: a short chain of command, sophistication in services, and high liquidity.

And their income model: merchant banks are expected to be more focused on fee income rather than profits from investing funds.

Merchant Banking in the USA. In the United States, merchant banks have evolved into investment banks. Along with all the functions of a merchant bank, investment banks also risk their own capital and aim to earn profits from their proprietary trading activities.

And a structural separation: in the United States, commercial banks and investment banks have been separated in terms of the sources of capital as well as allowed activities.

The UK model earns fees; the US model also risks its own capital.

2.2 Merchant banking in India

The forerunners of merchant banking in India were the foreign banks, and the industry grew in several forms — nationalized banks have created new subsidiaries..., other domestic financial institutions have created separate divisions, and share brokers and consultancies have registered themselves as public limited companies or partnerships, or proprietary firms.

The chronology:

Grindlays Bank began merchant banking operations in 1967 with a license obtained from the RBI, followed by Citibank in 1970. These two provided services for the syndication of loans and raising of equity, apart from other advisory services.

In 1972, the Banking Commission Report asserted the need for merchant banking services in India to be provided by public sector banks. Based on the Glass Steagall Act of 1933, passed by the US, the commission recommended a separate structure for merchant banks so as to separate them from commercial banks and financial institutions.

Following the recommendation of the Banking Commission Report, SBI set up its merchant banking division in 1972.

Then: other banks such as Bank of India, Syndicate Bank, Punjab National Bank, and Canara Bank also followed suit. ICICI was the first financial institution to set up its merchant banking division in 1973. The later entrants were IFCI and IDBI, with the latter setting up its merchant banking division in 1992.

Grindlays 1967 · Citibank 1970 · Banking Commission Report and SBI 1972 · ICICI 1973 · IDBI 1992.

What the Commission said is worth noting: it has indicated the necessity of merchant banking service in view of the wide industrial base of the Indian economy... in favour of a separate institution to render merchant banking services... [and] suggested that they should offer investment management and advisory services particularly to the medium and small savers.

The liberalisation effect: the post-liberalization era (1991 onwards) brought about a marked transformation in the banking arena. The merchant banking industry during those days was mainly driven by the issue management activity, which fluctuated with the trends in the primary markets. In order to stabilise their businesses, several of the banks engaged in merchant banking activity and diversified to offer a broader spectrum of capital market services.

Today: some of them such as SBI, IDBI, ICICI, IL&FS, Kotak Mahindra etc., offer almost the entire gamut of investment banking services permitted in India. SBI set up SBI Capital markets in 1986 and ICICI spin off ICICI Securities as a subsidiary in 1995.

And the widening of activity: from simply providing issue management and capital raising advisory services, merchant banks have expanded into providing for many other services. The growth of Indian industry has given rise to further opportunities in mergers and acquisitions and takeovers. Merchant banks are also working on asset valuation, investment management and promotion of investment trusts.

2.2.1 AIBI

The industry body for merchant bankers in India that acts as a self-regulatory organisation is known as the Association of Investment Bankers of India (AIBI). It was founded in 1993 as the Association of Merchant Bankers of India.

Its recognition: it was granted recognition by SEBI to set up professional standards, for providing efficient services and to establish standard practices in merchant banking and financial services.

Its objective: AIBI's primary objective is to ensure that its members render services to all constituents within an agreed framework of ethical principles and practices. AIBI also works towards promoting the interests of the industry and of its members.

And its position: AIBI is the thought leader and a nodal point for assimilation and dissemination of information relating to the investment banking industry in India. It is also the industry's sole representative to all statutory authorities, and in particular, to SEBI.

2.3 The regulatory framework

There are various acts, regulations and guidelines which govern the different activities of Merchant Banking in India... in two categories – (1) Core Regulation and (2) Support Regulation.

CORE REGULATIONS

2.3.1 SEBI Act, 1992

The Securities and Exchange Board of India (SEBI) was established on April 12, 1992 in accordance with the provisions of the SEBI Act, 1992.

The preamble: "...to protect the interests of investors in securities and to promote the development of and to regulate the securities market and for matters connected therewith or incidental thereto..."

Section 11(2) functions include: regulate the business in stock exchanges · register and regulate... stockbrokers, share transfer agents, bankers to an issue, debenture trustee, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers and also depositories and depository participants, custodians of securities, foreign portfolio investors, credit rating agencies · register and regulate... venture capital funds and collective investment schemes including mutual funds · promote and regulate SROs · prohibit fraudulent and unfair trade practices · promote investors' education and training of intermediaries · prohibit insider trading · regulate substantial acquisition of shares and takeover of companies · require disclosure of information, to undertake inspection, to conduct inquiries and audits · levy fees · conduct research.

Section 11(3) gives SEBI civil court powers in respect of the discovery and production of books of account and other documents · summoning and enforcing the attendance of persons and examining them on oath · inspection of any books, registers and other documents of any person · inspection of any book, or register, or other document or record of the company · issuing commissions for the examination of witnesses or documents.

The penalty sections

Note the floors: ten lakh for 15G and 15H, five lakh for 15HA, one lakh for 15HB. All the first three cap at twenty-five crore or three times the profits, whichever is higher; 15HB caps at one crore.

What 15G covers: an insider who deals in securities... on the basis of any unpublished price-sensitive information, who communicates any unpublished price-sensitive information to any person, or who counsels, or procures for any other person to deal.

What 15H covers: failure to disclose the aggregate of his shareholding... before he acquires any shares, to make a public announcement to acquire shares at a minimum price, to make a public offer by sending letter of offer, or to make payment of consideration to the shareholders who sold their shares.

The Securities Appellate Tribunal

Section 15K (1) of the SEBI Act, 1992, empowers the Central Government to establish Securities Appellate Tribunal (SAT).

Its composition: a SAT shall consist of a presiding officer and two other members, to be appointed by the Central Government. The qualification for appointment is that the person should be a sitting or retired judge of the Supreme Court or a retired Chief Justice of a High Court.

Who may appeal, and when: any person aggrieved by the following may appeal to the SAT, provided the aggrieved person had not granted his consent to the order against which the appeal is being made. The appeal must be filed within a period of 45 days from the date on which a copy of the order is received — against an order of SEBI or an order made by an adjudicating officer under the Act.

Its procedure: as per Section 15U (1)... the SAT shall not be bound by the procedure laid down by the Code of Civil Procedure, 1908, but shall be guided by the principles of natural justice.

Its powers under Section 15U(2) are those of a civil court in respect of summoning and enforcing the attendance of any person and examining him on oath · requiring the discovery and production of documents · receiving evidence on affidavits · issuing commissions for the examination of witnesses or documents · reviewing its decisions · dismissing an application for default or deciding it ex-parte · setting aside any order of dismissal... or any order passed by it ex-parte.

Its status: every proceeding before the SAT shall be deemed to be a judicial proceeding and SAT shall be deemed to be a civil court.

Representation, under Section 15V: the appellant may either appear in person or authorize one or more chartered accountants or company secretaries or cost accountants or legal practitioners or any of its officers.

Section 15W: the provisions of the Limitation Act, 1963 shall apply.

Section 15Y: no civil court shall have jurisdiction to entertain any suit or proceeding in respect of any matter which SAT... is empowered to decide upon.

Section 15Z: any person aggrieved by any decision or order of the SAT may file an appeal to the Supreme Court within 60 days from the date of communication of the decision or order of the SAT to him, on any question of law arising out of the order.

45 days to SAT; 60 days to the Supreme Court, on a question of law only.

2.3.2 SC(R)A, 1956

The Securities Contracts (Regulation) Act, 1956 provides for the definition of "securities", covering shares, scrips, stocks, bonds, debentures... Derivatives... units... issued by any collective investment scheme... Security receipt... units... issued by any pooled investment vehicle... certificate or instrument, issued... by any issuer being a special purpose distinct entity... Government Securities... such other instruments as may be declared by the Central Government to be securities; and rights or interest in securities.

Its scope: the Regulations provides for direct and indirect control of virtually all aspects of securities trading and the constitution, recognition and regulatory oversight of stock exchanges. This Act aims to prevent undesirable transactions in securities.

Its jurisdiction, given to the central government, covers (a) stock exchanges through a process of recognition and continued supervision, (b) contracts and options in securities, and (c) listing of securities on stock exchanges.

The objective of SCRA is to prevent undesirable speculation and to regulate contracts and transactions in securities. And the reasoning: a transaction in securities between two persons is essentially a contract. The law that specifically applies in the case of a securities contracts is the SCRA.

Two further powers: the Act provides for the setting up of clearing corporations by stock exchanges, and SEBI has been given explicit powers under the Act to make or amend by-laws of any stock exchange.

Key sections: Section 17A... stipulated that any issue of securities to the public or listing on a stock exchange shall conform to the regulations prescribed by SEBI. Section 21 and 22 deals with listing of securities, section 21A deals with delisting of securities and sections 23 to 26 provides for the different penalties.

Section 23A penalises failure to furnish information or maintain books, with a penalty which shall not be less than one lakh rupees but which may extend to one lakh rupees for each day during which such failure continues subject to a maximum of one crore rupees.

2.3.3 SCRR, 1957

SCRR provides for the actual procedures to be followed by applicants for recognition as a recognised stock exchange and the requirements with respect to listing of securities. It lays down conditions for the percentage of shares which need to be offered to the public in order to get the shares listed and also the percentage of shares which need to remain with public in order to remain listed.

And its relationship to the Act: SCRR needs to be read in conjunction with SCRA. SCRR are the rules created for compliance of SCRA.

Rule 19(2)(b) — the minimum public offer

And the catch-up obligations:

The company referred to in sub-clause (iv) shall increase its public shareholding to at least ten percent within a period of two years and at least twenty-five percent within a period of five years, from the date of listing.

The company referred to in sub-clause (ii) or sub-clause (iii) shall increase its public shareholding to at least twenty-five percent within a period of 3 years from the date of listing.

The other rules:

Rule 19(1) — an application for listing along with prescribed documents. Rule 19(4) — listing applications are needed for all new issues of any class or kind of securities of a company to be offered to the public and all further issues... if such class or kind of securities of the company are already listed. Rule 19(5) — an exchange may suspend or withdraw admission to dealings, but no such action shall be taken... without affording... a reasonable opportunity by a notice in writing, stating the reasons, to show cause. Rule 19(6) — restoration or re-admission. Rule 19(7) — SEBI may at its own discretion or on the recommendations of a recognised stock exchange, waive or relax the strict enforcement of any or all the requirements.

Rule 19A — the continuous listing requirement: every listed company other than public sector company shall maintain public shareholding of at least twenty-five per cent of its issued capital.

2.3.4 SEBI (Merchant Bankers) Regulations, 1992

Lists out the different criteria for registration of a merchant banker as an intermediary with SEBI. It also covers capital adequacy requirement, general obligation and responsibilities, conditions of registrations, grant and renewal of certificate etc. — all discussed in Chapter 3.

2.3.5 SEBI (ICDR) Regulations, 2018

SEBI (ICDR) Regulations, 2018 require that an issuer making an issue of securities to the public or to QIBs or to its existing shareholders by way of a rights issue is required to appoint a Merchant Banker registered with SEBI.

That single sentence is why this exam exists.

What ICDR covers: general conditions for capital market issuances like public and rights issuances, Qualified Institutions Placement (QIP), etc.; eligibility requirements; general obligations of the issuer and intermediaries in public and rights issuances; regulations governing preferential issues, qualified institutional placements and bonus issues by listed companies; Issue of IDRs.

2.3.6 SEBI LODR Regulations, 2015

These regulations govern a company that has listed any of its designated securities on a recognised stock exchange.

Designated securities mean specified securities, non-convertible debt securities, non-convertible redeemable preference shares, perpetual debt instruments, perpetual non-cumulative preference shares, Indian depository receipts, securitised debt instruments, security receipts, units issued by mutual funds and any other securities as may be specified by the Board.

Regulation 4's five areas: preparation and disclosure of financial information as per applicable accounting standards · compliance with the corporate governance requirements... for the protection of the rights of shareholders, ensuring equitable treatment to all shareholders · recognising the role of stakeholders in corporate governance · ensuring timely and accurate disclosure on all material matters including the financial situation, performance, ownership, and governance · significant board responsibilities both in terms of ensuring disclosure of information as well as in their core function of leading the company's strategy.

Plus: the company shall also have a grievance redressal mechanism to address investor grievances... and shall also have a full-time compliance officer.

The regulation numbers to know:

2.3.7 SEBI (Prohibition of Insider Trading) Regulations, 2015

Any dealing/trading done by an insider based on information which is not available in the public domain gives an undue advantage to insiders and affects market integrity. This is not in line with the principle of fair and equitable markets.

Who is an insider

SEBI Insider regulations define an 'insider' as any person who is: i) a connected person; or ii) in possession of or having access to UPSI.

A connected person is any person who is or has during the six months prior to the concerned act been associated with a company, directly or indirectly, in any capacity including by reason of frequent communication with its officers or by being in any contractual, fiduciary or employment relationship or by being a director, officer or an employee of the company or holds any position including a professional or business relationship... that allows such person, directly or indirectly, access to unpublished price sensitive information or is reasonably expected to allow such access.

Deemed connected persons include: an immediate relative of connected persons · a holding company or associate company or subsidiary company · an intermediary as specified in section 12 of the SEBI Act or an employee or director thereof · an investment company, trustee company, asset management company or an employee or director thereof · an official of a stock exchange or of a clearing house or corporation · a member of the board of trustees of a mutual fund · a member of the board of directors or an employee of a public financial institution · an official or an employee of a self-regulatory organisation · a banker of the company · a concern, firm, trust, Hindu undivided family, company or association of persons wherein a director of a company or his immediate relative or banker of the company has more than ten per cent of the holding or interest.

Note that the presumption is rebuttable: immediate relatives and other categories of persons specified above are also presumed to be connected persons, but such a presumption is a deeming legal fiction and is rebuttable.

Immediate relative means a spouse of a person, and includes parent, sibling, and child of such person or of the spouse, any of whom is either dependent financially on such person, or consults such person in taking decisions relating to trading in securities.

And the burden of proof: the onus of showing that a certain person was in possession of or had access to unpublished price sensitive information at the time of trading would, therefore, be on the person leveling the charge.

What UPSI is

Unpublished price sensitive information is any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities.

The five listed categories: (i) financial results; (ii) dividends; (iii) change in capital structure; (iv) mergers, de-mergers, acquisitions, delistings, disposals and expansion of business and such other transactions; (v) changes in key managerial personnel.

And its opposite: "Generally available information" means information that is accessible to the public on a non-discriminatory basis; and shall not include unverified event or information reported in print or electronic media. Information published on the website of a stock exchange would ordinarily be considered generally available.

"Trading" means and includes subscribing, redeeming, switching, buying, selling, dealing, or agreeing to subscribe, redeem, switch, buy, sell, deal in any securities.

What is prohibited

Regulation 3 — an insider shall not communicate, provide, or allow access to any unpublished price sensitive information... to any person including other insiders except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.

Regulation 3(2) — no person shall procure from or cause the communication by any insider of unpublished price sensitive information... except in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.

And the "need-to-know" principle behind them: Regulation 3(1) is intended to cast an obligation on all insiders... to handle such information with care and to deal with the information with them when transacting their business strictly on a need-to-know basis.

Regulation 3(2A) — the board of directors of a listed company shall make a policy for determination of "legitimate purposes" as a part of "Codes of Fair Disclosure and Conduct".

Regulation 3(2B) — persons in receipt of unpublished price sensitive information pursuant to a "legitimate purpose" shall be considered an "insider" and shall maintain confidentiality.

Regulation 3(3) permits sharing in two transaction contexts — where the transaction would entail an obligation to make an open offer under the takeover regulations where the board of directors... is of informed opinion that the sharing of such information is in the best interests of the company, or where it would not attract the obligation to make an open offer... but where the board... is of informed opinion that the proposed transaction is in the best interests of the company and the information... is disseminated to be made generally available at least two trading days prior to the proposed transaction being effected.

With confidentiality agreements required under Regulation 3(4).

The structured digital database

The board of directors or head(s) of the organisation of every person required to handle unpublished price sensitive information shall ensure that a structured digital database is maintained containing the nature of unpublished price sensitive information and the names of such persons who have shared the information and also the names of such persons with whom information is shared... along with the Permanent Account Number.

Two conditions: such database shall not be outsourced and shall be maintained internally with adequate internal controls and checks such as time stamping and audit trails to ensure non-tampering.

And preservation: such database is preserved for a period of not less than eight years after completion of the relevant transactions and in the event of receipt of any information from the Board regarding any investigation or enforcement proceedings, the relevant information... shall be preserved till the completion of such proceedings.

Defences and trading plans

Regulation 4 — no insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information. But the insider may prove his innocence through circumstances including an off-market inter-se transfer between insiders who were in possession of the same unpublished price sensitive information, a transaction through the block deal window mechanism, one pursuant to a statutory or regulatory obligation, one pursuant to the exercise of stock options in respect of which the exercise price was pre-determined, in non-individual cases a demonstrated separation between those with the information and those trading, or trades pursuant to a trading plan set up in accordance with regulation 5.

Off-market trades must be reported: such off-market trades shall be reported by the insiders to the company within two working days. Every company shall notify the particulars of such trades to the stock exchange... within two trading days from receipt of the disclosure.

Regulation 5 — Trading Plans. A plan must:

(i) not entail commencement of trading on behalf of the insider earlier than one hundred and twenty calendar days from the public disclosure of the plan; (ii) not entail trading for the period between the twentieth trading day prior to the last day of any financial period for which results are required to be announced... and the second trading day after the disclosure of such financial results; (iii) entail trading for a period of not less than twelve months; (iv) not entail overlap of any period for which another trading plan is already in existence; (v) set out... either the value of trade to be effected or the number of securities to be traded; nature of the trade; either a specific date or time period not exceeding five consecutive trading days; price limit; (vi) not entail trading in securities for market abuse.

The price limits: for a buy trade: the upper price limit shall be between the closing price on the day before submission of the trading plan and up to twenty per cent higher than such closing price; for a sell trade: the lower price limit shall be between the closing price on the day before submission... and up to twenty per cent lower.

The compliance officer's role: review for any potential for violation, and approve or reject the trading plan within two trading days of receipt... and notify the stock exchanges... on the day of approval.

Two exemptions: pre-clearance of trades shall not be required for a trade executed as per an approved trading plan, and trading window norms and restrictions on contra trade shall not be applicable.

And it binds: the trading plan once approved shall be irrevocable, and the insider shall mandatorily have to implement the plan, without being entitled to either execute any trade in the securities outside the scope of the trading plan or to deviate from it except due to permanent incapacity or bankruptcy or operation of law.

With one suspension: the implementation of the trading plan shall not be commenced if any unpublished price sensitive information in possession of the insider at the time of formulation of the plan has not become generally available at the time of the commencement of implementation.

Codes and the Chinese Wall

Regulation 8 — Code of Fair Disclosure: the board of directors of every company, whose securities are listed on a stock exchange, shall formulate and publish on its official website, a code of practices and procedures for fair disclosure of unpublished price sensitive information, adhering to Schedule A, and promptly intimated to the stock exchanges.

Code of Conduct: every listed company and market intermediary must have its chief executive officer or managing director... formulate a code of conduct... to regulate, monitor and report trading by its designated persons and immediate relatives of designated persons, adopting Schedule B (in case of a listed company) and Schedule C (in case of an intermediary).

And a compliance officer must be designated to administer it.

Designated persons include: employees... designated on the basis of their functional role or access to unpublished price sensitive information · employees of material subsidiaries · all promoters of listed companies and promoters who are individuals or investment companies for intermediaries or fiduciaries · Chief Executive Officer and employees upto two levels below Chief Executive Officer... irrespective of their functional role · any support staff... such as IT staff or secretarial staff who have access to unpublished price sensitive information.

The Chinese Wall. The code of conduct shall contain norms for appropriate Chinese Wall procedures, and processes for permitting any designated person to "cross the wall". All information shall be handled within the organisation on a need-to-know basis.

The compliance officer is responsible for monitoring adherence to the Chinese Wall policy, investigating potential violations, and ensuring appropriate disciplinary actions are taken.

Two examples the workbook gives, both from this industry: a company's investment banking division working on a new IPO cannot disclose confidential information about the offering to the sales team who might be interacting with potential investors. And an analyst who has access to non-public information about a company's financial performance cannot share that information with a colleague managing client portfolios.

2.3.8 SEBI (SAST) Regulations, 2011

The regulations envisage acquisitions for: Change in Control of Management · Consolidation of Holdings · Substantial Acquisition of shares or voting rights (25% or more).

The triggers:

Regulation 3(1) — an acquirer must make an open offer before acquiring shares or voting rights that, with those of persons acting in concert, entitle them to exercise 25% or more of the voting rights.

Regulation 3(2) — an acquirer already holding 25% or more but less than the maximum permissible non-public shareholding, shall not acquire within any financial year additional five percent shares or voting rights without an open offer.

Regulation 4 — irrespective of acquisition or holding of shares or voting rights... no acquirer shall acquire, directly or indirectly, control over such target company without an open offer.

Regulation 5 — indirect acquisition.

Regulation 6 — a voluntary open offer where the acquirer already holds 25% or more. And a standstill: an acquirer and persons acting in concert with him, who have made a public announcement under this regulation... shall not be entitled to acquire any shares of the target company for a period of six months after completion of the open offer except pursuant to another voluntary open offer.

Regulations 6A and 6B — no person who is a wilful defaulter and no person who is a fugitive economic offender may make such an offer.

Regulation 7 — offer size: the open offer shall be for at least twenty-six per cent of total shares of the target company, as of the tenth working day from the closure of the tendering period.

Regulation 8 — offer price, at a price not lower than the price determined in accordance with sub-regulation (2) or sub-regulation (3).

Regulation 9 — modes of payment: cash or by issue, exchange or transfer of listed shares in the equity share capital of the acquirer or of any person acting in concert or by issue, exchange or transfer of listed secured debt instruments... or convertible debt securities... or a combination of any of the above.

Regulation 10 — exemptions. These include inter se transfer of shares amongst qualifying persons (immediate relatives; persons named as promoters for not less than three years; group companies with not less than fifty percent holdings; persons acting in concert for not less than three years), acquisitions in the ordinary course of business by named intermediaries, subsequent stages of a disinvestment, court or tribunal schemes, a resolution plan approved under section 31 of the Insolvency and Bankruptcy Code, 2016, SARFAESI acquisitions, delisting acquisitions, transmission, succession or inheritance, and lender debt conversions.

Note that merchant bankers appear twice in the exemption list — a merchant banker registered with the Board or a nominated investor in the process of market making or subscription to the unsubscribed portion of issue and a merchant banker registered with the Board acting as a stabilising agent.

And the inter se transfer price condition: if the shares of the target company are frequently traded, the acquisition price per share shall not be higher by more than twenty-five percent of the volume-weighted average market price for a period of sixty trading days preceding the date of issuance of notice.

2.3.9 SEBI (Delisting of Equity Shares) Regulations, 2021

Delisting can be done in two ways, viz., Voluntary Delisting and Compulsory Delisting.

Voluntary delisting is a condition when the issuer company no longer wants to be on the trading platform of the exchange and exits from the Exchange. Whereas compulsory delisting involves delisting by exchanges on account of any disciplinary action initiated by either the Exchanges or by SEBI on non-fulfilment of the listing criteria.

When delisting is not permitted

No company shall apply for, and no stock exchange shall permit delisting of equity shares:

a) Pursuant to Buy Back of equity shares or b) Pursuant to Preferential Allotment unless a period of six months has elapsed from the date of completion of such buyback or preferential allotment; or c) Unless a period of 3 years has elapsed since listing or d) Any instrument(s) which are convertible into shares that are sought to be listed are outstanding

And a promoter restriction: no promoter or promoter group shall propose delisting... if any entity belonging to the promoter or promoter group has sold equity shares of the company during a period of six months prior to the date of the board meeting in which the delisting proposal was approved.

The merchant banker's entry point: before making a Public Announcement, a Merchant Banker is required to be appointed to manage the delisting offer.

Voluntary delisting

If the equity shares continue to be listed on a stock exchange which has nationwide trading terminals and is proposed to be delisted from other stock exchanges, exit opportunity need not be given to public shareholders.

The procedure: (a) obtain the prior approval of its Board of Directors; (b) make an application to the relevant recognised stock exchange(s)...; (c) issue a public notice of the proposed delisting... in at least one English national newspaper with wide circulation, one Hindi national newspaper... and one vernacular newspaper of the region; (d) disclose the fact of delisting in its first annual report post delisting.

But: if the equity shares are proposed to be delisted & would not remain listed on any of the stock exchanges having nationwide trading terminals, the issuer shall provide an exit opportunity.

How the price is set: the offer price shall be determined through a book building process popularly known as Reverse Book Building (RBB), after fixing of floor price.

Or the fixed price alternative: the acquirer can specify a fixed price, which shall be at a minimum 15% premium over the floor price determined under the Delisting Regulations. The floor price calculation will now include, among other parameters, the calculation of an adjusted book value certified by an independent registered valuer.

The counter-offer: the acquirer can make a counter-offer if the acquirer's post-offer shareholding at the RBB price is 75% of the company's issued share capital, provided that at least 50% of the public shareholding has been tendered in the RBB process.

And its floor: the counter-offer price shall not be less than the higher of the volume weighted average price ("VWAP") of the shares tendered/offered during the RBB process and the indicative price, if any, offered by the acquirer.

Other key points:

Reference date, for calculation of floor price, shall be the date of the 'initial public announcement'. The final offer price shall be determined at the price at which the maximum number of equity shares is tendered by the public shareholders. Acquirers/Promoters shall not be bound to accept the equity shares at the offer price determined by the Reverse Book Building process. Issue is considered successful if promoter holding reaches more than 90% of the issued equity share capital. The delisting is considered successful if the shares tendered... result in the acquirer's post-offer shareholding being at least 90% of the issued share capital.

The workbook words the success test two ways in the same list: an issue is successful if promoter holding reaches more than 90%, and a delisting is successful if the acquirer's post-offer shareholding is at least 90% of the issued share capital. Both phrasings are in the workbook, so recognise either in a question. The acquirers/promoters shall continue to give post-delisting exit offer for a period of 1 year from the date of listing and the Escrow account shall continue to be maintained till the said period.

And a 2025 carve-out for PSUs: eligible PSUs — those where the aggregate shareholding of the promoter/promoter group together with other PSUs equals or exceeds 90% — may avail a fixed-price delisting route, discontinuing the reverse book-building process, with the fixed delisting price... at least 15% above the determined floor price.

Compulsory delisting

A recognised stock exchange may, by a reasoned order, delist any equity shares of a company on any ground prescribed in the rules, but no order shall be made... unless the company concerned has been given a reasonable opportunity of being heard.

The panel: (a) two directors of the recognised stock exchange (one of whom shall be a public representative); (b) one representative of the investors association recognised by the SEBI; (c) one representative of the Ministry of Corporate Affairs or Registrar of Companies; and (d) the Executive Director or Secretary of the recognised stock exchange.

The notice: in three newspapers, giving a time period of not less than fifteen working days from the notice, within which representations may be made.

Public shareholders' rights: the exchange shall appoint an independent valuer(s) who shall determine the fair value of the delisted equity shares, from a panel of expert valuers. Then the promoter of the company shall acquire delisted equity shares from the public shareholders by paying them the value determined by the valuer within three months of the date of delisting, subject to shareholders' option of retaining their shares.

And on delay: the promoter shall be liable to pay interest at the rate of ten per cent per annum, though SEBI may grant a waiver where the delay was beyond the control of the acquirer.

The consequences are severe: the company, its whole time directors, person(s) responsible for ensuring compliance with the securities laws, its promoters and the companies which are promoted by any of them shall not directly or indirectly access the securities market or seek listing for any equity shares or act as an intermediary in the securities market for a period of ten years.

Plus, where fair value is positive: promoter shares are frozen for transfer and corporate benefits like dividend, rights, bonus shares, split, etc. shall be frozen until an exit option is provided; and those persons shall also not be eligible to become directors of any listed company until then.

Small companies

The company has a paid-up capital not exceeding ten crore rupees and net worth not exceeding twenty-five crore rupees as on the last date of the preceding financial year. The number of equity shares... traded on each such recognised stock exchange during the twelve calendar months immediately preceding the date of board meeting is less than ten per cent of the total number of shares.

Plus: the company has not been suspended by any of the recognised stock exchanges having nation-wide trading terminals for any non-compliance in the preceding one year.

The process: write individually to all public shareholders, and at least 90% of public shareholders shall give positive consent in writing. The process must be complete within seventy-five working days of the first communication made, with payment in cash within fifteen working days from the date of expiry of seventy-five working days.

And a relisting bar: the application for listing of equity shares of any company which have been delisted under voluntary delisting shall not be made for a period of 3 years from the delisting.

Delisting through an open offer — Regulation 5A of SAST

In the event the acquirer makes a public announcement of an open offer... he may delist the company in accordance with... the SEBI (Delisting of Equity Shares) Regulations, 2021.

But intention must be declared up front: the acquirer should have declared upfront his intention to delist at the time of making the detailed public statement, and a subsequent declaration of delisting... shall not suffice.

And the acquirer must be genuinely new. In the preceding two years he must not have been a promoter/promoter group/person(s) in control, directly/indirectly associated with the promoter or any person(s) in control, or a person(s) holding more than twenty-five per cent shares or voting rights. Nor may he acquire joint control along with an existing promoter.

The two prices: the public announcement, the detailed public statement and the letter of offer shall mention the open offer price... and the indicative price for delisting, and if the delisting threshold is met, all shareholders who tender their shares shall be paid the indicative price; if not being met, all shareholders who tender their shares shall be paid the open offer price.

On failure, the acquirer must announce within two working days. Where a competing offer is made... the acquirer shall not be entitled to delist the company. And tendering shareholders may withdraw such shares tendered, within 5 working days from the date of the announcement.

A second attempt is possible: within 12 months from the date of completion of the open offer, succeeding only if the threshold is met and fifty per cent of the residual public shareholding is acquired — failing which the acquirer must restore minimum public shareholding within a period of twelve months from the end of that period.

2.3.10 SEBI (Buy-Back of Securities) Regulations, 2018

Companies are permitted to buy-back their own securities from the market under specific provisions of Companies Act 2013. A listed company must also comply with these regulations, which prescribe the conditions of buy-back, procedure for buy-back through tender offer, procedure for buy-back from the open market, general obligations from the Company, obligations of the merchant banker and the action that can be taken against intermediaries by SEBI.

SUPPORT REGULATIONS

2.3.11 FEMA, 1999

FEMA was enacted to replace the Foreign Exchange (Regulation Act) 1973 by separating the policy with regard to management of foreign exchange from enforcement provisions relating to serious economic offences.

Its objective: to consolidate and amend the law relating to foreign exchange with the objective of facilitating external trade and payments... [and] to promote the orderly development and maintenance of foreign exchange market in India.

And the split: the administrative provisions of foreign exchange management were enacted as FEMA and serious foreign exchange offences (including money laundering and round tripping) were included in the new Prevention of Money Laundering Act 2002 (PMLA).

Its reach: FEMA is applicable to the whole of India. The act is also applicable to all branches, offices and agencies outside India owned or controlled by a person who is a resident of India.

Who issues what: with regard to foreign direct investment (FDI) into India, the policy framework is issued by the Government of India, (Department for Promotion of Industry and Internal Trade) while the operative notifications under FEMA are issued by the RBI.

The three inbound routes

FDI Route — all non-resident investments which are strategic in nature, i.e. for a business or long term investment purpose. And the test: for the purpose of being classified as FDI, the size of the investment shall not be less than 10% of the post-investment fully diluted paid-up capital of the investee company.

It is operationalised through the Foreign Exchange Management (Non-Debt Instrument) Rules ('NDI Rules') and the FEMA Master Directions, dealing with prohibited sectors for FDI, permitted sectors with sectoral caps... investments that can be made under automatic route without prior permissions... investments that require prior government and RBI approval, minimum capitalisation norms in select cases, pricing regulations.

FPI Route — available where the size of such investment shall not be more than 10% of the post-investment fully diluted paid-up capital of the listed Indian investee company. Registration with SEBI is required first, in accordance with the SEBI (Foreign Portfolio Investors) Regulations, 2019.

FVCI Route — available to off-shore funds that seek to make venture capital investments in eligible unlisted investee companies in India, registered under the SEBI (Foreign Venture Capital Investors) Regulations 2000.

FVCIs are allowed to invest only in stipulated priority sectors such as bio-technology, infrastructure etc. except in the case of start-ups which can be from any sector.

An FVCI can also acquire units of a Category I AIF, and its pricing is free: the pricing for such transactions... is not regulated and they can be at a price that is mutually acceptable to the buyer and the seller/issuer.

10% is the dividing line: at least 10% is FDI, not more than 10% is FPI.

2.3.12 Competition Act, 2002

Passed by the Parliament in the year 2002, to which the President accorded assent in January, 2003. It was subsequently amended by the Competition (Amendment) Act, 2007.

In accordance with the provisions of the Amendment Act, the Competition Commission of India and the Competition Appellate Tribunal have been established. The provisions of the Competition Act relating to anti-competitive agreements and abuse of dominant position were notified on May 20, 2009.

What it does: it prohibits anti-competitive agreements, abuse of dominant position by enterprises and regulates combinations (acquisition, acquiring of control and M&A), which causes or likely to cause an appreciable adverse effect on competition within India.

The Commission's four aims: prevent practices having adverse effect on competition · promote and sustain competition in the market · protect the interests of consumers, and · ensure freedom of trade carried on by other participants in markets, in India.

Section 6: "No person or enterprise shall enter into a combination which causes or is likely to cause an appreciable adverse effect on competition within the relevant market in India and such a combination shall be void".

And the merchant banker's role is limited: in an open offer the merchant banker may be required to follow up with the Competition Commission of India (CCI) so as to disclose the status of CCI approval for the proposed takeover... in the offer document. However, seeking the approval of the CCI is the primary responsibility of the acquirer or the companies in question and not that of the merchant banker under this Act.

2.3.13 Companies Act, 2013

Chapter III of the Act deals with "Prospectus and Allotment of securities" and is further divided into two parts, Part I deals with Public Offer and Part II deals with Private Placement.

Section 23 — a public company may issue securities to public through prospectus ("public offer"), through private placement, or through a rights issue or a bonus issue.

Section 24 — powers of SEBI to administer various sections of Companies Act, 2013 in case of listed public companies or Companies intending to go public.

Section 25 — the documents which could be deemed to be a prospectus.

Section 26 — a prospectus shall be dated, and that date shall be taken as the date of publication, with the matters and reports to be set out in it. It also requires that Experts should be unconnected with formation or management of company and obtain the Expert's consent.

Sections 36-38 — penalties on default.

Section 31 — Shelf prospectus. Any class of companies, as prescribed by SEBI may file a shelf prospectus with the Registrar at the stage of the first offer of securities included therein which shall indicate a period not exceeding one year as the period of validity.

Its benefit: in respect of a second or subsequent offer issued during the period of validity of shelf prospectus, no further prospectus is required.

But an information memorandum is needed for each later offer, containing all material facts relating to new charges created, changes in the financial position of the company. And where applicants have already paid, they shall intimate the changes to such applicants. If the applicants express a desire to withdraw their application, the company... shall refund all the monies received as subscription within fifteen days.

The definition: "Shelf Prospectus" means a prospectus in respect of which the securities or class of securities included therein are issued for subscription in one or more issues over a certain period without the issue of a further prospectus.

And the point of it: the concept of shelf prospectus will save expenditure and time of the companies in issuing a new prospectus every time they wish to issue securities to the public within a period of one year.

Section 32 — Red Herring Prospectus, defined as a prospectus which does not include complete particulars of the quantum or price of the securities included therein.

**It must be filed with the Registrar at least 3 days prior to the opening of the subscription list and the offer, shall carry the same obligations as are applicable to a prospectus, and any variation between the red herring prospectus and a prospectus shall be highlighted as variations in the prospectus.

Afterwards: upon the closing of the offer of securities, the prospectus shall be filed with the Registrar and SEBI which shall have all the details which were not there in the Red herring prospectus e.g. the total capital raised... and the closing price of the securities.

Abridged Prospectus — a memorandum containing such salient features of a prospectus as may be specified by SEBI.

Section 33 — no form of application can be issued for the purchase of any securities of a company unless it is accompanied by an abridged prospectus, except (a) where the offer is made in connection with the bona fide invitation to a person to enter into an underwriting agreement... (b) where the securities are not offered to the public.

And a penalty: if a company makes any default in complying with the provisions of this section, it shall be liable to a penalty of fifty thousand rupees for each default.

2.3.14 PMLA, 2002

India is a full-fledged member of the Financial Action Task Force, an international watchdog for money laundering.

PMLA was enacted to prevent the generation of black money and proceeds from criminal activities. The Act brings RBI, SEBI and IRDA under its purview and hence, is applicable to all financial institutions, banks, insurance companies, mutual funds and their intermediaries. The Act came into force from 1st July 2005.

The offence, under Section 3: whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming it as untainted property shall be guilty of the offence of money-laundering.

In plain terms: money laundering is the process of conversion of money obtained from criminal activity into apparently legitimate money by concealing its criminal origin.

Enforcement, under Sections 48 and 49: the officers of Directorate of Enforcement have been given the power to investigate cases of money laundering... [and] can launch prosecution in the designated Special Court. The ED can take actions like confiscation of property if the same is determined to be proceeds of crime derived from a Scheduled Offence.

Why it matters: money laundering is a serious economic offence as it undermines the integrity of the market participants, distorts economic performance, misallocates capital flows, evades taxes and finances criminal and terrorist activities.

Reporting entities' duties: a reporting entity is to maintain records (Section 12) and furnish information as and when required to the Director – Financial Intelligence Unit – India (Section 12A). They are also required to verify and maintain records of the identity of their clients.

And the retention period: such records are required to be maintained for a period of 5 years from the date of cessation of the transaction between the client and the reporting entity.

The remaining support regulations

SEBI (Bankers to an Issue) Regulations, 1994 — governing (a) Acceptance of application and application monies; (b) Acceptance of allotment or call monies; (c) Refund of application monies; (d) Payment of dividend or interest warrants. Every BTI must have an agreement specifying the number of centres, the time for forwarding statements, and that a daily statement will be sent by the designated controlling branch... to the registrar to an issue.

SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993 — the RTA is appointed by the issuer in consultation with the lead manager, and its work spans the period before the issue opens, during the period of issue and after the issue closes.

Its post-issue duties include collecting the final certificates from all the SCSBs... within two working days from the closure of the Offer, obtaining Demographic Details of the Bidders (including PAN and MICR code), ensuring that the Basis of Allotment is in accordance with the SEBI ICDR Regulations, preparing a technical rejection list, sending the Confirmation Allocation Note ("CAN") to the Anchor Investors and the Allotment Advice to Bidders, and instructing the depositories on lock-in for the pre-Offer share capital.

SEBI (Intermediaries) Regulations, 2008 — prescribing the procedure for registration of intermediaries, general obligations, inspection and disciplinary proceedings and inter alia, criteria for determining a fit and proper person and code of conduct. Merchant Bankers are also required to comply with these in addition to the SEBI (Merchant Bankers) Regulations.

SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 — covering ESOS, ESPS, SARS, GEBS and RBS, with Regulation 12 requiring the appointment of registered merchant banker for implementation of schemes.

SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 — for a public issue, the Company shall appoint one or more merchant bankers registered with SEBI at least one of whom shall be a lead merchant banker, who must ensure the draft offer document specifies compliance officer contacts and that all comments received on the draft offer document are suitably addressed, furnishing a due diligence certificate... prior to the filing of the offer document with the Registrar of Companies.

SEBI (REIT) Regulations, 2014 — the manager appoints the merchant banker among other intermediaries, and the REIT through the merchant banker shall file a draft offer document... not less than thirty working days before filing the offer document. The draft is public for a period of not less than 21 days, and must carry a due diligence certificate signed by the lead merchant banker. Manager reports to the trustee include quarterly reports... within 30 days of end of such quarter, valuation reports within 15 days, and material facts within 7 working days.

SEBI (InvIT) Regulations, 2014 — the manager is responsible for all activities pertaining to issue of units and listing, with reporting timelines of thirty days for quarterly reports, fifteen days for valuation reports and seven working days for material facts, plus an audit not less than once annually submitted within 60 days of end of financial year ending March 31st.

The Depositories Act, 1996 and SEBI (Depositories and Participants) Regulations, 2018 — with two registered depositories in India viz. Central Depository Services (India) Limited (CDSL) and National Securities Depository Ltd. (NSDL).

SEBI (FPI) Regulations, 2019 — issued on 23rd September 2019, merging all existing Foreign Institutional Investors (FIIs) and QFIs... into one category called FPI. Eligibility requires that the applicant should not be resident in India or a Non-Resident Indian or an overseas citizen of India, be resident of a country whose securities market regulator is a signatory to IOSCO's Multilateral MOU or a signatory to a bilateral MOU with SEBI, whose central bank is a member of the Bank for International Settlements, and against whom the Financial Action Task Force (FATF) has not issued any warnings — and must meet the prescribed criteria of a fit and proper person.

SEBI (AIF) Regulations, 2012 — an AIF is any fund established or incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate which is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign. Category I invests in start-up or early stage ventures or social ventures or SMEs or infrastructure; Category II does not fall in I or III and does not undertake leverage or borrowing other than to meet day-to-day operational requirements; Category III employs diverse or complex trading strategies and may employ leverage. An Angel Fund is a sub-category of Venture Capital Fund under Category I.

SEBI (Research Analyst) Regulations, 2014 and SEBI (Investment Adviser) Regulations, 2013 — governing those two activities, with registration mandatory in each case.

2.3.24 SEBI (CAPSM) Regulations, 2007

Regulations 7 and 8 delegate powers to NISM, whose functions shall include putting in place and implementing the certification process, procedure and policies.

The obligation: an associated person employed prior to the date specified by SEBI may continue to be employed... if he obtains the certificate within two years from the said date. One employed on or after the date specified by SEBI shall obtain the certificate within one year.

How to obtain it. A Principal may pass the examination, complete classroom credits, or deliver such number of formal classroom sessions. A person who has attained 50 years of age or who has 10 years of experience in the securities market may pass the examination or complete classroom credits. All other persons may only pass the relevant certificate examination.

Validity: valid for a period of 3 years from the date of the grant of the certificate or revalidation, revalidated for a period of 3 years on completing a programme of continuing professional education during the 12 months preceding the date of expiry, or by passing the examination.

And who must take this exam: employees working with SEBI registered Merchant Bankers and performing various SEBI regulated functions such as those relating to IPO, FPO, Open Offer, Buy-Back, Delisting etc. and involved with the investors, issuers or clients of intermediaries; assets or funds of investors or clients; redressal of investor grievances; internal control or risk management; activities having a bearing on operational risk; [or who] maintain books and records are mandatorily required to take the NISM-Series-IX: Merchant Banking Certification Examination.

Accessibility

The Hon'ble Supreme Court in its judgement dated April 30, 2025, emphasized the need for equal and accessible inclusion of persons with disabilities for availing financial services and directed to ensure that the process of digital KYC is accessible to persons with disabilities.

And SEBI is committed to the cause of enabling equal access of services of its registered intermediaries to persons with disabilities, including persons with visual impairments.