The Corporate & Commercial Law Society Blog, HNLU

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  • Centralised Fee Collection Mechanism: Sebi’s Move To Shield Investors

    Centralised Fee Collection Mechanism: Sebi’s Move To Shield Investors

    BY SUKRITI GUPTA, THIRD-YEAR STUDENT AT NLU, ODISHA

    INTRODUCTION

    The Securities and Exchange Board of India (“SEBI”), has recorded around 33,00 registered entities according to its recognised intermediaries data. Amongst these, SEBI has close to 955 registered Investment Advisors (“IA”) and 1381 Research Analysts (“RA”) as of September 2024. 

    In common parlance, an IA is an entity that provides investment advice to the investors and an unregistered IA is simply the one who provides such advisory without having registration from SEBI. Interestingly, around 35% of IA are unregistered in India which entails a violation of the SEBI (Investment Advisers) (Amendment) Regulations, 2020.

    Additionally, RA also plays a pivotal role in preparing research reports by conducting investigations, research, and evaluation of financial assets. They provide advisory to investors to assist them in making decisions regarding investing, buying, or selling off financial securities, and they are administered by the Securities and Exchange Board of India (Research Analysts) Regulations, 2014.

    It was observed by SEBI through several accusations and grievances reported by investors that there is an incremental rise in the misconduct of unregistered analysts who falsely portray themselves as registered IA and RA to facilitate investment services. These entities exploit investors by giving them fake and unrealistic securities advisories to encourage investments. 

    Thus, pursuant to this, SEBI issued a circular dated 13th September 2024 to set in motion a uniform system for fee collection by IA and RA, known as the “Centralised Fee Collection Mechanism”. This initiative, co-drafted by BSE Limited followed rigorous consultations from common people and feedback from several stakeholders.

    The author in this post delves into the significance and objectives of SEBI’s new mechanism by highlighting its broader implications. Furthermore, the author critically inspects the potential concerns and queries related to this initiative. 

    HOW DOES THE CENTRALISED FEE MECHANISM WORK?

    Under this mechanism, SEBI has established a supervisory platform for IA/RA to offer a uniform and centralised fee collection process. It provides a portal through which the investors can pay the fees to registered IA/RA which will be overseen by a recognised Administration and Supervisory Body (“ASB”). Every transaction will be initiated by assigning a virtual account number, with the availability of various modes of payment like UPI, net banking, NEFT etc. For using this facility, there is likely to be a system where IA/RA shall enroll themselves in this platform and provide fee-related details for their clients and the fee collected will then be transferred to these registered entities. It is made optional for both investors and IA and RA. 

    It aims to increase the participation of investors in the securities market by creating a transparent and riskless payment environment to curb the activities of unregistered IA/RA from taking dominance of investors under the guise of regulatory compliance.

    SAFEGUARDING INVESTORS INTERESTS: NEED FOR A CENTRALISED FEE COLLECTION MECHANISM

    By introducing a Centralised Fee Collection Mechanism, SEBI aims to mitigate all possible misleading and fraudulent activities of the unregistered IA/RA. To ensure that the investor’s money is in safe hands, it is imperative to save them from becoming a victim of illegitimate entities. Since many investors may not know how to inspect whether an entity is a registered one or not, therefore, it is the onus of SEBI, being a market regulator, to guard the interests of investors by introducing such an appropriate mechanism. 

    In the author’s view, by providing a centralised platform for payments, SEBI might ensure that the investor’s personal information and data remain fully confidential and safe since there will be a very minute chance of data leakage due to all the services being provided in one designated sphere. Secondly, through various digital payment modes being facilitated, there remains a minimal chance of disruption in the payment mechanism, ensuring a seamless and steady payment. It will also keep a check on the fees charged by these registered entities concerning  SEBI’s guidelines regarding the fees charged by IA, thereby helping to reduce exorbitant charges. Additionally, investors will not be charged any platform fee thus reducing unnecessary expenditure.

    Also, by operationalisation of this centralised payment system, investors will easily identify which entity is a registered entity. This will in turn be beneficial to IA and RA because they will get due recognition as they will be distinguished from unregistered ones. This will help them to attract genuine clients seeking their assistance. Furthermore, it will also help IA/RA who do not have any automated platforms of their own, thereby saving time and reducing burden

    CRITICAL EXAMINATION OF THE MECHANISM

    To delve deeper into the implications and analysis of the Centralised Fee Collection Mechanism, it is essential to ponder on three major points. Firstly, for what purpose the mechanism is kept optional, Secondly, whether such an initiative enhance investor’s vigilance when hailing services from unregistered entities? Lastly, how will this mechanism ensure the security and privacy of investor’s data?

    Discussing the first point, in the author’s view, it is essential to note that keeping the mechanism optional for users to pay and IA/RA to collect fees, is providing a flexible choice by giving them time to adapt and integrate into the new framework of the mechanism. By not mandating its use, SEBI is trying to ensure that they don’t feel that it is being involuntarily imposed upon them. Rather, they have the discretion to avail it. Additionally, potential shortcomings, challenges and doubts can also be identified for allowing further incorporation of necessary amendments and improvements based on the experience and feedback of the users and entities. 

    Therefore, the main idea behind keeping it optional is to grab the attention and trust of the investors and entities in this platform and make them familiar with the procedures for gradual adoption. This flexibility will enable a smoother transition and necessary adjustments. According to the author, SEBI might eventually make it compulsory in the near future. 

    Gauging on the second point, while this mechanism has significant potential to reduce the number of unregistered entities and heighten investor’s attentiveness, it is crucial to recognise that not all users may be aware of the reforms and regulations brought by the regulator. Thus, according to the author, to attain the full purpose of the mechanism, SEBI needs to prioritise its promotion through advertisements, webinars, awareness activities etc., via authorised channels. If the targeted audience becomes aware of such a facility, the likelihood of success of such an initiative would increase, eventually serving a larger segment of the investing public.

    One concern of IA/RA regarding this mechanism could be the reluctance of investors to provide their personal information while paying fees. Many of them may not be comfortable sharing their details on an online platform like such. To cater to this, SEBI must ensure transparency by rolling out certain procedures for safeguarding investor’s privacy and trust. One approach could be to give a unique identification number to each investor for aid in digital enlisting. E-receipts, payment tracking and reconciliation could also be enabled. SEBI can also launch a portal alongside, which will enable the investors to report any issue encountered by them during transactions. It may operate like a customer care center to deal with and sort out the grievances faced by them. 

    While it appears that this mechanism is viable to ensure adequate safety and privacy of the investors, yet, there is a need for vigorous regulation to fully reassure the investors of their privacy and trust in IA/RA. 

    CONCLUSION

    SEBI’s introduction of Centralised Fee Collection Mechanism is a double-edged sword, safeguarding both investors and entities. By offering a compliant and centralised system for fee collection, it is not only protecting investors from deceitful and unauthorised entities but also fortifying the credibility of registered IA and RA. It also marks a noteworthy step towards establishing a transparent, viable and secured space in security’s advisory sphere. However, for initiatives like this to become successful, it is crucial to focus on its continued promotion, awareness, investor education and robust privacy safeguard standards to entrust confidence in the platform. Eventually, this mechanism aims to build a safer, systematic and coherent environment that benefits both the investors and advisory entities alike. Let us see whether it will be welcomed or feared.  

  • Assessing the Deal Value Threshold: Shortcomings and the Way Forward

    Assessing the Deal Value Threshold: Shortcomings and the Way Forward

    BY DHRUV MEHTA, FIFTH-YEAR STUDENT AT JINDAL GLOBAL LAW SCHOOL, SONIPAT

    introduction

    Recently, the Parliament passed the Competition Amendment Act, 2023, which makes substantial amendments to the Competition Act, 2002 (‘Act‘). Amongst the plethora of amendments, the most prominent amendment is the introduction of the deal value threshold (‘DVT‘). DVT is the additional threshold that requires notification (in the absence of any exemption) of a merger or acquisition with a deal value threshold of INR 2,000 crores (USD 0.24 billion) where either of the party to the deal has ‘substantial business operations in India’ (‘SBOI‘). Through the introduction of the Competition Commission of India (Combinations) Regulations, 2023 (‘Draft Regulations‘), the Competition Commission of India (‘CCI‘) has brought more clarity with respect to the ‘transaction value’ and ‘substantial business operations’ under the DVT framework. Through this blog post, the author examines the limitations in the CCI’s interpretation of the DVT and offers recommendations to enhance its clarity and effectiveness.

    Once the Amendment Act was passed, the onus was now on the CCI to quickly define what constitutes ‘value of transaction’ and ‘substantial business operations’. The CCI has followed the footsteps of Germany and Austria by rightly defining what exactly constitutes ‘value of transaction’ and ‘substantial business operations’. However, there are a few shortcomings as to how transaction value has been interpreted and defined by the CCI.

    Transaction Value: Shortcomings and Recommendations

    a. Incidental Arrangements

    Regulation 4(1)(c) of the Draft Regulations requires the value of a consideration to include ‘incidental arrangements’ for calculating DVT. The definition of ‘incidental arrangement’ is confusing and excessively broad. Examining whether a transaction is notifiable would be difficult if an incidental arrangement is accepted in its current form as it may encompass unconnected transactions that weren’t anticipated by the parties when entering into the main transaction.

    To ensure certainty for parties involved in a transaction and to reduce ambiguity in applying the DVT, the CCI should limit ‘incidental arrangements’ to those arrangements foreseen by the parties when the transaction was initiated. Such arrangements should also be explicitly documented in the transaction records. Furthermore, under Regulations 9(4) and 9(5) respectively, read along with Regulation 4(1)(b), the CCI has the power to review interconnected steps of a single transaction when the transaction meets the test of interconnection. In the past, the CCI has exercised its powers by reviewing interconnected transactions in proceedings against the Canada Pension Plan Investment Board and ReNew Power Limited under Section 43A of the Act.  

    This makes the proposed provision unnecessary if ‘incidental arrangements’ are linked to the transaction because the CCI already has the power to look at subsequent transactions that are interconnected. It is recommended that given CCI’s ambit to assess interconnected transactions, it should reconsider the need for incorporating ‘incidental arrangements’  under the value of a transaction. Furthermore, in the event that the CCI decides to retain the said clause, ‘incidental arrangements’ should only include, transactions foreseen by the parties which are included in the transaction documents during execution.

    b. Uncertainty in the Valuation of Non-Compete Clauses

    The draft regulations require that the value of any non-compete clauses be included while calculating the value of a transaction for DVT. There are a few shortcomings with the said requirement.

    Firstly, it is often difficult to attribute value to non-compete clauses. The value of such non-compete clauses is often reflected in the purchase price listed in the transaction documents. When a non-compete clause is not listed in the transaction document, it is often challenging to assign an exact value to such a clause, and assigning an exact value would compromise the DVT’s inherent predictability and clarity. This would be against the ICN Recommended Practices for Merger Notification and Review Procedures, which highlight how important it is for merger control systems to have clear, transparent rules- especially in light of the growing number of deals happening across several jurisdictions.

    Secondly, the value of the transaction is the value that is attributed to the non-compete provision. If the CCI wants to attribute a separate and distinct value to a non-compete agreement that is separate from the value of a transaction, it should not speculate on assigning the value to the non-compete agreement. Rather, when the board of directors of the acquirer or the seller gives a specific value to the non-compete agreement at the time of the transaction, the CCI should also value the non-compete at the same specific value as given by the board of directors.

    It is recommended that the CCI amend the Draft Regulations to include the value of non-compete clauses and agreements as part of DVT as listed in the transaction documents. It should also be made clear in the Draft Regulations that the CCI can only assign a value to a non-compete agreement if it has been given careful thought and approval by the boards of directors of the target company and the acquiring company.

    c. Valuation of Options and Securities

    According to the Draft Regulations, the whole value of the options and securities to be acquired, along with the assumption that such options would be exercised to the fullest extent possible, must be included in the consideration for the DVT for a transaction.

    It is observed that by including the whole value of options, DVT could be breached or relatively small transactions could also be flagged. Moreover, including the full value of options that could potentially be exercised may lead to an overstatement or understatement of their value, as the price at the time of exercise could differ from the price when the option is initially granted. In the USA, the Hart-Scott-Rodino (‘HSR‘) rules state that valuation reports presented to the board of directors would be used as a point of reference for determining the value of a consideration when the same value is unknown but capable of being estimated. The CCI could adopt the practice as stated by the HSR rules, where it could consider the value of an option not on the basis of assumption but instead based on valuation reports presented to the board of directors.

    In line with the stance in other countries and the CCI’s own decisional practice, it is advised that the whole value of shares received upon exercising an option be considered only if and when the option is exercised. Further, to eliminate any doubt regarding the value of the options, the CCI could only take into account the entire value of the options if they are exercised at the per-share price paid to shareholders (perhaps as a way to assign a portion of the transaction value to particular persons).

    Substantial Business Operations: Shortcomings and Recommedations

    Under the Draft Regulations, SBOI is established if, within the 12 months preceding the transaction, the business demonstrates that 10% or more of either (a) its global user/subscriber/customer/visitor base, (b) global gross merchandise value, or (c) global revenue from all goods and services in the prior financial year, is attributable to India. The author welcomes the CCI’s target-only approach for judging local nexus. However, to ensure that transactions having a limited nexus to the Indian markets are adequately filtered out, the CCI needs to make a few amendments to the SBOI framework in India.

    • Redefining ‘Users, Subscribers, Customers, and Visitors’

    Considering ‘every download’ as a ‘user’ would be an overstatement and therefore the threshold of ‘users, subscribers, customers, and visitors’ could lead to double counting as the said requirement is extremely expansive. For a single product business, such as a social networking website, there is a possibility to have a different number of subscribers than users or visitors, and these subscribers may not be active users or visitors. Thus, such ‘visitors’ might not contribute towards the economic value of the target enterprise and should be discounted from the threshold.

    Furthermore, the CCI could have taken inspiration from Germany and Austria who have provided adequate guidance on how to compute the user threshold for digital markets. The Digital Markets Act of the EU also includes clear definitions for terms such as ‘active end users’ and ‘active business users‘ tailored to various products and services such as online intermediation services, search engines, social networking platforms, video sharing services, and more. The measurement of such users, subscribers, customers, and visitors should be carried out according to industry standards as providing an exhaustive list is nearly impossible.

    The CCI through a guidance note could narrow down the ambit of ‘users, subscribers, customers, and visitors’ to that of ‘monthly active users’, ‘unique visitors’ and ‘daily active users’ in the digital markets for assessing SBOI as done by German and Austrian Competition regulators. The CCI could further bring more clarity to its implementation of DVT by referring to the rulings of Meta’s Acquisition of Kustomer and Meta’s acquisition of GIPHY.

    Under the ambit of ‘users’ the CCI could consider both direct and indirect users. Taking inspiration from the aforementioned cases, the CCI could define direct users as those who were paying for the product as well as who are licensed customers. Indirect users would be considered as those who accessed the application, for example, GIPHY library through third-party mediums/applications such as Facebook, Instagram, Twitter, and Snapchat. Moreover, it is important to highlight that the CCI ought to establish distinct standards for evaluating activities across various sectors, just as the German and Austrian guidelines on transaction value threshold do.

    Thus, the author suggests that the criteria of ‘users, subscribers, customers, and visitors’ be replaced by ‘active users which consists of daily, monthly, yearly, direct and indirect users, and unique visitors’. Further, as specific definitions are provided in the Digital Markets Act for ‘active business users’ and ‘active end users’ the CCI could provide guidance for the same across various sectors.

    Conclusion

    The CCI is seen to be taking some major strides in regulating competition in new-age deals within the digital sphere. Taking inspiration from Germany and Austria, the Competition Act was amended to introduce the deal value threshold, which effectively provides the CCI the jurisdiction to assess those digital mergers with little or no assets or revenue. The CCI has tried its best to bring more clarity with regard to the interpretation of transaction value and substantial business operations under the DVT framework. However, it remains to be seen as to how the practical implementation of DVT would be undertaken by the CCI. As highlighted, under the ‘substantial business operations’ prong, the CCI should bring more clarity by clearly redefining ‘users, subscribers, customers, and visitors’.  Towards the final step, the CCI also needs to streamline its approach to reviewing interconnected transactions and the valuation of non-compete clauses.

  • The Legal Conundrum: Is A New Mandatory Offer Possible During An Existing One? – I

    The Legal Conundrum: Is A New Mandatory Offer Possible During An Existing One? – I

    BY TANMAY DONERIA, FOURTH YEAR STUDENT AT RGNUL, PATIALA

    This article is published in two parts, this is the Part I of the article.

    I. Introduction: Understanding The Context And Conundrum

    The Securities and Exchange Board of India (‘SEBI’) implemented the Substantial Acquisition of Shares and Takeover Regulations, 2011 (‘Takeover Regulations’) with the intent to provide exit options for the shareholders of public-listed companies, regulate the acquisition of direct/indirect control in a company and hostile takeovers. These regulations were implemented on the recommendations of the Takeover Regulations Advisory Committee (‘TRAC’). Before delving into the specifics, we need to understand certain provisions.

    –       Understanding Key Provisions

    Regulation 3(1) of the Takeover Regulations, provides that any acquirer who has breached the threshold of 25% voting rights in a public listed company (also known as the target company) shall make a public announcement for an open offer. This is also known as a “mandatory open offer”. The intent behind this provision is to facilitate/mandate the complete acquisition of the target company or allow the acquirer to gain control of the target company. Furthermore, it also provides an exit option for the shareholders, who are granted an opportunity to sell their shares and exit the target company in case they disagree with the acquirer holding a significant stake in the company. It is to be noted that an acquirer may also announce an open offer even before breaching the requisite threshold or even after completing the mandatory open offer, in order to acquire more shares or voting rights. Such an offer is known as a voluntary open offer in terms of Regulation 6. 

    Pursuant to the public announcement due procedure is followed and an open offer is floated in the market. Thereafter, Regulation 20 provides an opportunity for other interested parties to raise competing open offers within 15 days from the date of publication of the open offer. Regulation 20(3), deems any voluntary open offer made within 15 days from the open offer to be a competing offer. The provision for competing offers is beneficial for the shareholders as well as the target company. From the perspective of the shareholders, this process allows them to get the best prices for their shares, and from the perspective of the target company, this allows them to bring in a friendly investor and resist the hostile takeover, also commonly known as the ‘white-knight defence’. Furthermore, to minimize confusion for the shareholders and prevent overlapping or simultaneous open offers in the target company Regulation 20(5), mandates that after the completion of the aforesaid 15 days, no person is “entitled to” make a public announcement for an open offer or “enter into” any transaction that will attract an obligation to make an open offer till the completion of the offer period.

    Lastly, during this entire process Regulation 26, restricts the target company from entering any material transactions during the offer period outside the ordinary course of business without obtaining the consent of the shareholders through a special resolution. This ensures that no impediment arises during the acquisition process and the same is successfully completed. But there also exist certain exceptions that allow the target company to honour their obligations that were entered prior to the initiation of the acquisition process. The exception relevant to our discussion is found in Regulation 26(2)(c)(i), which permits the target company to issue or allot shares upon conversion of convertible securities issued prior to the announcement of the open offer. Having understood the legal provisions let us take a look at the problem being created by the interplay of these provisions.

    –       Illustration of the Conundrum

    Let us consider a situation, where the acquirer (ABC Ltd.), has breached the threshold of 25% of shares of the target company (TC Ltd.) and consequently, published a mandatory open offer under Regulation 3(1) after following the due procedure on 1.10.2024. Now other interested parties have 15 days i.e., time till 16.10.2024 to raise competing offers.

    A third party (XYZ Ltd.) holds 23% of shares and certain convertible security, that was purchased a long time ago, entitling them to 3% of shares. Hence, upon conversion XYZ Ltd. will hold 26% of shares of TC Ltd. Herein, we shall consider, two situations i.e., firstly, when the conversion occurs during the period of 15 days, let’s say on 12.10.2024 and secondly, when the conversion occurs after the period of 15 days but before the completion of the offer period, let’s say on 18.10.2024 (more on these two situations later). In both situations, XYZ Ltd. holds more than 25% of shares, making them liable to announce a mandatory open offer under Regulation 3(1).

    As noted, earlier Regulation 20 only permits competing offers within the period of 15 days when there is a subsisting open offer. Additionally, Regulation 20(3), only deems voluntary open offers as competing offers i.e., mandatory open offers are not covered within the ambit of this provision. Lastly, Regulation 20(5) specifically prohibits any person from making an open offer after the expiry of the 15 days till the completion of the offer period.

    This gives rise to an absurd situation where XYZ Ltd. who is under a statutory obligation (under Regulation 3(1)) to make an open offer cannot fulfil such obligation as at the same time the regulations (under Regulation 20(5)) are themselves barring them from making an open offer. In other words, XYZ Ltd. is being statutorily barred from fulfilling a statutory obligation. Such a situation gives rise to multiple questions such as- is the third party liable to make an open offer, if it does not make an open offer will there be penalties for non-compliance and what are the possible recourses with the third party in such a situation?

  • Rationalizing ‘Connected Persons’: Analyzing SEBI’s Proposed Insider Trading Amendments

    Rationalizing ‘Connected Persons’: Analyzing SEBI’s Proposed Insider Trading Amendments

    BY PRIYA SHARMA AND ARCHISMAN CHATERJEE, Fourth AND third YEAR STUDENTS AT NATIONAL LAW UNIVERSITY, ODISHA

    I. Introduction 

    Securities and Exchange Board of India (‘SEBI’), in the consultation paper dated 29 July 2024 (‘consultation paper’), proposed amendments to the SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’) to rationalize the scope of ‘connected person’. The consultation paper proposes to add additional categories to the current definition of connected persons in the PIT Regulations, and thereby cover more persons who may have access to unpublished price sensitive information (‘UPSI’) by virtue of their relation with an insider.

    While the proposed amendments will help SEBI target additional persons and raise a presumption of possession of UPSI against them, the existing ambiguities in the insider trading legal framework will increase the likelihood of false positives and overregulation in this arena.

    II. Proposed Amendments

    Under the PIT Regulations, an insider is defined as any person who is either a connected person or is in possession of or having access to UPSI. Presently, a ‘connected person’ is defined as a person who is or has, during the six months before the act, been associated with the company, directly or indirectly, in any capacity [Regulation 2(1)(d)]. The relationship with the ‘connected person’ may be contractual, fiduciary or employment-related, and may be temporary or permanent, that allows them access to UPSI or is reasonably expected to allow such access. The PIT Regulations also specify certain categories ‘deemed to be connected persons’, including immediate relatives of the connected person, a holding or associate company or subsidiary company, etc. within its ambit. 

    UPSI is defined as “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”. A person who falls under the scope of a ‘connected person’ will be presumed to have access to UPSI, and the person will carry the onus to disprove this presumption. If a person does not fall under the scope of a connected person, the onus to prove access to such information will lie on SEBI.

    The consultation paper notes that certain categories of persons, who have a close and proximate relationship with connected persons, may not be covered under the present definition of ‘connected person’. Therefore, it proposes to replace the term ‘immediate relative’ in section 2(1)(d)(a) with the term ‘relative’. It also proposes the inclusion of additional categories of people who will be deemed to be connected persons, including any person on whose advice, directions or instructions a connected person is accustomed to act, a body corporate whose board of directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a connected person, persons sharing household or residence with a connected person, and persons having material financial relationship with a connected person including for reasons of employment or financial dependency or frequent financial transactions. 

    In order to ensure ease of doing business, the definition of ‘immediate relative’ is proposed to be retained for the purpose of disclosures, and the definition of ‘relative’ is rationalized only for establishing insider trading.

    III. The Good: Targeting a Regulatory Gap

    The changes are proposed with the aim to include persons who may seemingly not occupy any position in the company but are in regular contact with the company and its officers. By virtue of this relationship, such persons may be aware of the company’s operations and get access to UPSI. 

    Under the current regime, the scope of connected persons does not include non-immediate relatives of the person. ‘Immediate relative’ includes the spouse of a person, parent, sibling, and child of such person or of the spouse, any of whom is either financially dependent on this person or consults such a person in making decisions relating to trading in securities. Under the proposed amendments, the term ‘relative’ would include spouse, siblings, siblings of spouse, siblings of parents, any lineal ascendant or descendant of the individual or spouse, or spouse of any of the mentioned persons. Evidently, the new definition will include many more persons.

    Many relevant relations remain uncovered in the present terminology, which requires that either (a) the mentioned person be financially dependent on such a person, or (b) consults such a person in making decisions relating to trading. Such facts are difficult to prove, as they involve the family’s internal affairs, and make it difficult to establish the presumption of insider trading. 

    For illustration, under the current regime, if A is a connected person, B, the father-in-law of A’s sister who lives in another city with her husband’s family, would not be deemed to be an insider unless he fulfills the criteria mentioned in the definition. The proposed amendments would bring B under the ambit of ‘deemed to be connected person’ since he is a lineal ascendant of the sister’s spouse. No other criteria are required to be fulfilled.

    The proposed amendments formulate a comprehensive definition of ‘relative’, much like the Income Tax Act, 1961, and do not limit it to immediate family members. This proposed change promises a stricter, and stronger, regulatory regime.

    IV. The Bad and the Ambiguous: Pre-existing issues

    Section 15G of the SEBI Act specifies that any individual who enters into a trade on the basis of UPSI would be penalized for insider trading. The emphasis here is on the term basis since it showcases the requirement of mens rea for the liability to be attracted. On the other hand, Regulation 4 of the PIT Regulations states that if any individual executes any trade while in possession of UPSI, the liability for insider trading shall be attracted. 

    In this regard, the Supreme Court, in Balram v SEBI, observed that ascertaining the intent of individuals is necessary to affix the liability for insider trading. On similar lines, in Abhijit Rajan v SEBI, the apex court highlighted the need to determine the profit motive of the individuals who are in possession of the UPSI. This showcases a clear conflict between the specific wording of the PIT regulations and the interpretation of the court in terms of the presence of mens rea and increases differences in interpretations. 

    If the proposed changes are implemented, many more individuals would be deemed to be connected persons, and the presumption of access to UPSI will be raised against them, even if the access is factual or not, or any mala fide intent to act upon it is present or not. For instance, B, being the father-in-law of A’s sister, who may be deemed to be a connected person by virtue of being a relative if the proposed amendments are made, is able to overhear certain UPSI at a family function, and despite the same, he sells his shareholding as he intended to do so even before possessing the UPSI. In such a scenario, B could still be liable for insider trading under PIT Regulations even though there was a lack of intent and profit motive. 

    Therefore, the present regulatory framework showcases the lack of uniformity and clarity about the threshold for attracting liability for insider trading, and the issue will be exacerbated if the definition of ‘deemed to be connected persons’ is widened. Additionally, such a low threshold (no mens rea required, according to the PIT Regulations) to hold a person liable might lead to false positives, which in turn may overburden SEBI as well as the accused persons. In fact, it was advised by the N. K. Sodhi Committee, which was formed to review PIT Regulations of 1992, that a defense should be incorporated into the provisions which would allow the insider to prove that the alleged illegal trade has an effect which is opposite to what the UPSI requires for one to draw an unfair advantage.

    To address this, we suggest implementing a higher threshold for those connected persons who are very remotely connected to the primary insider and a lower threshold for those who are directly connected. The current framework treats all immediate persons on the same footing. For instance, an individual who came into accidental possession of UPSI might get prosecuted for the offence of insider trading. 

     The incorporation of a threshold on the basis of a higher burden of proof or requirement of mens rea (possession or usage) could increase the efficiency of the framework. To elucidate, for proving insider trading in the case of relatives by birth, the mere possession of UPSI should be enough to hold them guilty, and the opposite can apply in case of relatives by marriage. Similarly, the burden of proof required to prove their innocence should be lesser for relatives by marriage and the contrary for those related by blood. Such a framework is more effective than the proposed changes, as it does not automatically deem ‘immediate relatives’ as connected persons (as is the case in the present scenario), and instead, creates comprehensive criteria for the regulator to implicate relatives in actions against insider trading. Moreover, SEBI should not overlook profit motive as mens rea and refine the insider trading provisions in the PIT Regulations, bringing it more in line with the Act. Lastly, the addition of more defenses in Regulation 4, such as those recommended by the Sodhi Committee, may help dilute the adverse impacts of the proposed amendments. 

    V. Conclusion

    While the proposed amendments aim to broaden the scope of ‘connected persons’ to encompass those in close proximity to insiders, thereby strengthening regulatory oversight, they also introduce challenges. The potential for increased false positives and ambiguities surrounding the intent requirement highlight ongoing concerns within the insider trading legal framework. To mitigate these issues, SEBI must strike a balance by refining definitions, clarifying thresholds for liability, and incorporating defenses against inadvertent breaches. Such measures are essential to uphold both the integrity of the securities market and the rights of individuals ensnared in the regulatory net.

  • From Hearsay to Hard Facts – SEBI’s Crackdown on Rumour Verification

    From Hearsay to Hard Facts – SEBI’s Crackdown on Rumour Verification

    BY RITUNJAY SINGH AND SEJAL SINGH, FIFTH-YEAR STUDENTS AT RMLNLU, LUCKNOW

    Introduction

    On May 17, 2024, the Securities Exchange Board of India (‘SEBI’) announced a pivotal change by notifying the SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2024 (‘2024 Amendment’). The amendment brings notable updates to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘LODR Regulations’) by mandating Market Rumour Verification (‘MRV’) by listed companies, particularly those that lead to material price movement (‘MPM’).

    Understanding the Regulation and its Evolution

    The 2023 Amendment focused on triggering rumour verification upon a ‘material event’ occurrence but failed to define ‘material event’, leading to unclear compliance requirements. Consequently, SEBI proposed the formation of an Industry Standards Forum (‘ISF’) by industry associations in July 2023. By August 2023, the ISF, a collaboration between the Associated Chambers of Commerce, the Confederation of Indian Industry, and the Federation of Indian Chambers of Commerce and Industry, was established to formulate standards for implementing specific circulars and regulations. This collaboration resulted in a Consultation Paper released in December 2023, which laid the groundwork for the 2024 Amendment.

    The 2024 Amendment builds on this foundation, which initially mandated MRV but delayed its enforcement. The new regulations mandate rumour verification for the top 100 listed entities from June 1, 2024, and aim to extend it to the top 250 listed entities from December 1, 2024. The entity must verify specific market rumours reported in mainstream media that lead to MPM, usually within 24 hours from the trigger of MPM. General or vague rumours do not necessitate a response. It shall be specific to the industry consisting of unpublished information. 

    Mainstream media includes Indian newspapers with substantial circulation and readership, their digital versions, designated online news sources, and select international newspapers and news channels. It excludes news sources behind paywalls, news aggregators, and social media platforms, except for verified accounts of recognised news sources. Such focused delineation may presumably provide entities with a manageable scope to monitor. However, excluding social media platforms may leave gaps in differentiating facts from fiction, as seen in the Sadhna Broadcast pump-and-dump controversy, where rumours on social media and YouTube videos artificially inflated stock prices, causing investors losses once the stock inevitably crashed. A similar scenario occurred in the infamous Reddit-fuelled GameStop frenzy, where a coordinated effort by retail investors caused an unexpected stock surge, defying traditional market expectations and forcing hedge funds into massive losses. Furthermore, SEBI’s recent efforts to caution the public against dealing with unregulated entities and clamping down on the association between regulated entities and ‘finfluencers’, SEBI acknowledges this pervasive influence. Excluding such platforms from rumour verification leaves a blind spot in the regulatory framework.

    Having mentioned price volatility, it is crucial to understand MPM. The Bombay Stock Exchange (‘BSE’) and the National Stock Exchange (‘NSE’) introduced the MPM Framework to standardise its assessment, providing clear criteria for its calculation. It considers the cut-off percentage to price variation in share price between the closing price of the previous trading day and the next trading day’s opening price, excluding the benchmark index’s impact (e.g., NSE’s NIFTY 50 and BSE’s SENSEX). Additionally, intraday price movements are analysed, focusing on volatility throughout the trading day rather than just the opening versus closing prices. This responsibility of identifying the MPM rests with the listed entity, which may delegate this role to a designated officer. Owing to the constant fluctuation in stock prices, notifying the listed entity regarding the MPM necessitates a sophisticated technology-based solution. Going forward, service providers will likely offer these alert systems to companies. The lookback period i.e. the timeframe within which companies must retrospectively examine previous market rumours that might have induced an MPM is not specified, allowing companies to tailor their verification procedures flexibly to ensure a thorough and context-appropriate assessment.

    On May 21 2024, SEBI released another circular regarding the “framework for considering the unaffected price for transactions upon confirmation of market rumour.” This framework calculates the unaffected price by excluding the effect of MPM and rumour confirmation on equity share prices. In mergers and acquisitions, if parties’ names are non-disclosable due to confidentiality, the unaffected price is valid for 180 days from rumour confirmation; if names are disclosable, it’s valid for 60 days post-confirmation (Paragraph 5.2.2). If the price variation due to rumour confirmation hits the price band on the next trading day, subsequent trading days’ price variation is included for adjustment until it no longer hits the price band. For example, if ‘A’ trades at Rs. 100 per share and a rumour about acquiring ‘B’ causes the stock price to rise to Rs. 400 per share, later proving untrue and falling to Rs. 50 per share, the rumour period causing the fluctuation is determined. The average stock price of ‘B’ prior to the rumour, over a fixed period (e.g., six months), is analysed. If this average is Rs. 100 per share and market trends align, the unaffected price is Rs. 100 per share. This benefit only applies if the rumour is confirmed within 24 hours of MPM.

    Bridging the Gaps: A Vision for the Future

    The 24-hour timeframe provided under Regulation 30(11) not only seems insufficient to locate the exact source of the rumour in order to effectively address it, given the vast trenches of media requiring navigation; but also, proves to be a very small window to provide the public with the necessary documents that support its confirmation or denial. Something similar took place in the short-selling saga of the Adani-Hindenburg case, wherein even after their quick response within 24 hours, Adani’s stocks continued to tread downwards. Moreover, such a stringent timeline could attract regulatory scrutiny under the PFUTP Regulations in the accidental case of a hasty and, incorrect disclosure. Conversely, the NYSE Manual allows the confirmation of a rumour without the ticking 24-hour time clock, alleviating any pressure and allowing the company to make an accurate statement that verifies the accuracy of a rumour without the risk of any regulatory repercussions for incorrect disclosures.

    Furthermore, in the event of a merger and acquisition, a Non-Disclosure Agreement, which more often than not governs these negotiations, may act as a significant impediment to the Regulation, restricting the information that can be publicly shared. A premature confirmation or outright denial may attract a weaker negotiating position for the entity. While an argument can be made that a rumour may be surfacing owing to an already existing breach, that is not an argument strong enough for intentionally breaching confidentiality agreements. Henceforth, if a company were to deny a rumoured merger and later go through with it, investor trust could still very well be damaged. Some countries, like the United Kingdom (‘UK’), have a standstill period of 6 months under section 2(6) of the UK Takeover Code, in case a company does not verify a rumoured merger within 28 days. However, while this prioritises investor clarity and market stability, it is done at the expense of corporate flexibility and strategic planning. Companies might be forced into premature decisions that misalign with their timelines or negotiation strategies. A premature confirmation could also lead to a failed negotiation and wasted resources in case the deal does not go through.  Nevertheless, missing the 28-day verification window would result in being barred from making any such offers within the next six months, potentially missing out on opportunities.

    A balance can be restored by allowing the company to delay disclosures if an immediate clarification poses potential harm. This postponement ensures that an entity can manage sensitive information without being forced into a premature disclosure that could disrupt ongoing negotiations. The same is ensured by Chapter 3 of the European Union Market Abuse Regulation. However, this ability to delay does not come without oversight. Entities choosing to delay shall have to provide regulators with an explanation for the same, demonstrating how exactly it aligns with their legitimate interests, thereby preventing the misuse of the provision for any unfair competitive advantage. Similarly, vis-a-vis leaving room for corporate flexibility, SEBI can also take note of Part III of Appendix 7A of the Corporate Disclosure Policy of Singapore that carves out exceptions to disclosure due to market rumours: (a) The information to be disclosed doesn’t breach any law (Rule 703(2)); (b) The issuer can temporarily refrain from publicly disclosing particular information if a reasonable person would not expect it to be disclosed, and the information is kept confidential (Rule 703(3)). This comes with the caveat of maintaining the strictest confidentiality to prevent leaks.

    Conclusion

    SEBI’s attempts to balance transparency and accountability are evident, even addressing possible concerns via its Guidance Note, including handling speculations regarding a Managing Director/Chief Executive Officer’s health. Yet, as noted earlier, the indeterminate lookback period tips the scales slightly against corporations. By adopting a more structured approach akin to international practices, Indian entities could be better equipped to safeguard their legitimate interests while maintaining investor confidence. Such regulatory evolution could demystify market speculations, enhance stability, and bring India’s disclosure standards into closer alignment with international standards, safeguarding the truth in trading.

  • Revamping Antitrust for Digital Ecosystems: Exploring ‘The Draft Digital Competition Bill, 2024’

    Revamping Antitrust for Digital Ecosystems: Exploring ‘The Draft Digital Competition Bill, 2024’

    BY GARIMA THAKUR AND AISHWARYA S. NAIR, THIRD-YEAR STUDENTS AT RGNUL, PATIALA

    I.      INTRODUCTION

    The digital realm has become integral to modern society, encompassing activities from banking to shopping and socializing, all conducted online. India’s digital economy is set to nearly double, reaching about 20% of GDP by 2026. While digitalization promotes market contestability and innovation, it also raises concerns about anti-competitive behaviour, unfair business practices, and discriminatory policies by enterprises. 

    In 2022 the Parliamentary Standing Committee on Finance presented the 53rd report on Anti-Competitive Practices by Big Tech Companies which discussed the network effects of large digital markets leading to a ‘winner takes most outcome’. It further identified ten Anti-Competitive Practices (‘ACPs’) undertaken by large digital enterprises abusing dominant positions. In response, the Ministry of Corporate Affairs (‘MCA’) created the Committee on Digital Competition Law (‘CDCL’) to suggest recommendations for regulating competition in digital markets. In March 2024, the CDCL released its report highlighting the fragmented and time-consuming legislative approaches under various legislations towards the digital economy, alongside unveiling the draft Digital Competition Bill, 2024 (the ‘Draft Bill’).

    II.      KEY FEATURES: REPORT OF THE COMMITTEE ON DIGITAL COMPETITION LAW, 2024
          1.         Ex-ante measures in Digital Competition Law:

    The Competition Law in India adopts an ex-post approach in addressing anti-competitive agreements and abuse of dominance, with investigations commencing after contraventions have occurred. However, ex-post investigations might take years to resolve and have proven to be too slow for the fast-evolving digital landscapes. By the time an investigation is underway, the market may irreversibly tilt in favour of the incumbent. Further, this approach provides only for specific claims and is thus unable to address repeat violations or similar conduct by different entities. For example, if an e-commerce giant, say, EcomTech forces suppliers into exclusive deals that harm smaller competitors, a smaller rival, ShopSmall, might file a complaint. This complaint would prompt an investigation by the Competition Commission of India (‘CCI’). However, the process takes years, allowing EcomTech to solidify its dominance in the meantime. By the time the investigation concludes, EcomTech’s market position is even stronger, and the approach only addresses ShopSmall’s specific complaint, not the broader issue. This highlights how the ex-post approach can be too slow and limited for fast-changing markets. 

    In contrast, Chapter III of the Draft Bill introduces ex-ante regulations that pre-emptively address issues by setting broad legal principles. Obligations will be tailored for various digital enterprises following expert consultations. The CCI is empowered to set specific conduct requirements for different business models within Core Digital Services (‘CDS’), which means means any service specified in Schedule I of the Draft Bill and includes major platforms like online search engines and social networks.

        2.         Regulation of Significant Enterprises in the Digital Economy: 

    Established enterprises benefit from larger, data-driven networks and user bases, giving them a competitive edge. New entrants face challenges not only in pricing and service quality but also in overcoming these established user bases. This creates a first-mover advantage for existing enterprises, which, even if not legally dominant, can influence the market similarly to dominant players. 

    The Draft Bill aims to regulate Systematically Significant Digital Enterprises (‘SSDEs’) that wield substantial influence in the digital economy and within the Indian Digital Market. The Draft Bill introduces two methods under Section 3 of the Draft Bill to determine the status of an enterprise as an SSDE. 

    Firstly, the ‘Significant Financial Strength’ test quantifies metrics such as turnover in India, global turnover, gross merchandise value, etc. to ascertain SSDE value. Secondly, the ‘Significant Spread’ test evaluates qualitative factors. The CDCL recommends adjusting these measures to suit Indian markets. Further, Section 3(3) grants the CCI discretion to designate an enterprise based on a set of qualitative criteria encompassing factors like enterprise resources, aggregated data volumes, direct and indirect network effects, and the entity’s bargaining position relative to its business users and consumers.

       3.         Exemptions:

    Chapter VIII of the Draft Bill provides the CCI and the Central Government power to exempt certain SSDEs from some obligations on grounds of national security and protection, economic viability, and other factors as may be prescribed. The committee recommends that such exemptions should be devised with regard to the uniqueness of each CDS, in a similar fashion as Section 54 of the Competition Act.

       4.         Enforcement and Remedies:

    The committee acknowledges concerns about potential overlapping proceedings under the Competition Act and the Draft Bill, which could lead to double or unfair penalties. However, it distinguishes between the regulatory interventions and procedures of both frameworks. The committee suggests that the CCI should handle overlaps on a case-by-case basis, ensuring enterprises are safeguarded from disproportionate penalties.

    The enforcement framework proposed in the Draft Bill draws heavily from the Competition Act, with the CCI being the enforcing authority for both legislations. It includes provisions mirroring the Competition Act, such as empowering the Director General, granting rights to seek compensation for damages caused by SSDEs, and the authority to issue interim orders. Moreover, recognizing the critical role of timelines in the digital economy, the committee has also integrated a settlements and commitments regime into the Draft Bill.

    III.      MAJOR CONCERNS AND CRITICISMS ALONG WITH SUGGESTIONS
          1.         The problem of ‘consent’:

    Section 12 of the Draft Bill prohibits SSDEs from using non-public user data to compete on their CDS, effectively outlawing practices like self-preferencing. However, an exception allows platforms to combine data from other sources with user consent. This implies that enterprises can still collect and utilize user data, including selling it to insurers or sharing it with interested third parties, as long as explicit consent is obtained and it doesn’t directly compete with the platform’s main business users.

    The Draft Bill employs an ‘opt-in’ model, wherein the user must provide express provision for the usage of data. Yet, amid consent fatigue, a consent-based approach may not effectively curb monopolistic behaviours. Moreover, enterprises may leverage tools like artificial intelligence and manipulative design (such as dark patterns) to micro-target and exploit the psychological vulnerabilities of people to give the creating the illusion of choice and consent. This can deceive consumers into making decisions they might not make if fully informed or aware of alternatives.

    The Chinese Antitrust Commission’s guidelines on Antitrust Regulations, which ban algorithms that “violate ethical and moral standards” by “inducing user addiction or excessive spending,” could effectively counteract the dark patterns and strategic models employed by digital platforms to collect consumer information for purposes beyond what is necessary.

        2.         Effect on Startups and Innovations

    The Internet and Mobile Association of India (‘IAMAI’) highlighted that regulations based on financial or size thresholds, might deter Indian tech firms from scaling up to avoid added regulatory burdens. This could impede their global competitiveness and profitability.  Critics also argue that such regulations could stifle digital start-ups and innovation, echoing IAMAI’s comparison to the pre-liberalization Monopolies and Restrictive Trade Practices (‘MRTP’) era. They suggest that the Bill could reintroduce restrictive policies that hinder growth, innovation, and investment in India’s digital sector.

    Further, it may be argued that it is difficult to gauge the effectiveness of ex-ante measures amid fears of economic loss, as there are only a handful of jurisdictions where such laws have been implemented. Comparisons cannot be drawn due to the novelty of these measures even in foreign nations like the EU (Digital Markets Act, 2024), the UK (Digital Markets, Competition and Consumers Act, 2024), and the US (American Innovation and Choice Online Act, 2023). 

       3.         Clarity is required on the exceptions:

    Due to uncertainty about defining the parameters and scope of this exemption, there is room for subjective interpretation during the act’s implementation. This oversight leaves powers arbitrarily with the Central Government, potentially affecting enterprise efficiency and harming consumers. To address these issues, the ‘countervailing benefits exemptions’ in the English Digital Markets, Competition, and Consumers Bill, 2023 (‘DMCC’), can be adopted.

    The “countervailing benefits exemption” in competition law permits practices that might seem to breach competition rules if they deliver substantial benefits that outweigh any potential harm. This exemption applies when the conduct provides clear advantages to users and these benefits exceed any negative impact on competition. Additionally, the conduct must be necessary and proportionate to achieving these benefits without undermining effective competition. Implementing this exemption would prevent arbitrary benefits for financially powerful companies and safeguard businesses from unintended consequences that could harm competition.

    IV.      CONCLUSION 

    Digital economies, benefit greatly from economies of scale and increasing returns. They can expand into related markets easily and utilize data to enhance their competitive edge, often assuming a “gatekeeper” role in the market. Addressing anti-competitive practices and monopolies posed by such technologies is difficult under traditional laws. In India, recent fragmented regulations have targeted big tech for data privacy issues. The Draft Bill, 2024 proposes new ex-ante obligations inspired by global standards to regulate anti-competitive behaviours of SSDEs. The bill’s potential impact on India’s Digital Ecosystem remains uncertain, but in a rapidly evolving industry, these proactive regulations could help align the law with digital innovation.

  • CCI Needs to Reconsider its Approach-Balancing Patent Rights and Public Welfare

    CCI Needs to Reconsider its Approach-Balancing Patent Rights and Public Welfare

    RAVNEET KAUR, THIRD-YEAR STUDENT AT RGNUL, PUNJAB

    Introduction

    Section 4 of the Competition Act, 2002 (‘Competition Act’) lays down the practices, which if undertaken by a dominant enterprise, would amount to abuse of dominant position. One of such practices is ‘unfair’ or ‘discriminatory’ pricing. Generally, unfair pricing of a commodity can have two connotations. It can either be unreasonably high or unreasonably low compared to the expenses incurred in its production.  

    While predatory pricing, dealing with the latter scenario, has been specifically included within the ambit of unfair pricing under section 4(2)(a) of the Competition Act, excessive pricing has neither been mentioned nor defined. Does that imply that an enterprise possessing a dominant position could conveniently impose unreasonably high prices on people, prices that have no rational nexus with the costs incurred? This is certainly not the case. In the Indian context, excessive price forms a subset of unfair price.

    However, this inclusion has not been able to yield any outcome so far. In reality, excessive pricing is rarely considered as an abuse of dominant position. This policy of non-intervention in case of excessive pricing stems from two reasons. Firstly, regulation of prices might cut incentives for new players; secondly, the self-regulatory mechanism is assumed to operate in the market. However, this approach tends to get problematic when applied in the pharmaceutical industry where the commodity in question is an on-patent drug, resulting in the failure of a self-regulatory mechanism.

    Approach Towards Pharmaceutical Industry

    This policy of non-intervention in case of excessive pricing has been time and again applied in the pharmaceutical industry as well. The Competition Commission of India (‘CCI’) has been rather reluctant in making a prima facie case of abuse of dominance against an enterprise where it is accused of charging excessive prices.

    The reluctance of the CCI in this regard could be attributed to two factors-

    1. Research and Development Costs

    In the pharmaceutical industry, particularly, enormous and unwarranted margins between manufacturing cost and market price often go unchecked. This is because there is a general perception that the manufacturing of drugs is preceded by years of research and expenditure that comes with it. Therefore, it is argued that using conventional benchmarks (such as price-cost comparison) could reduce the incentive for further research and development (‘R&D’). It is primarily because if firms expect price regulation to capture a sizable share of a market, their incentives for innovation and entry into new markets will be diminished, damaging consumer welfare in the long run. In the case of Biocon Ltd. v. F. Hoffmann-La Roche AG, the complaint against the ‘excessive pricing’ of the anti-cancer medicine Trastuzumab was dismissed. The grounds cited were that the original drug price increase was justified by the enormous expenditures invested in R&D and innovation.

    • Interface of Patent Rights and Maintenance of Competitive Environment

    The prime argument that is offered to pitch for non-intervention in case of excessive prices is that it is an exercise of lawful monopoly. In the Indian context, the Patents Act, 1970 (‘Patents Act’) guarantees a statutory and time-exclusive right to the patentee to decide upon the commercial exploitation of the patented drug. This right includes the determination of prices. Touching upon the aspect of excessive pricing, it is argued that monopoly prices are an accolade that enterprises get for making uncertain and risky investments. The US Supreme Court, in the context of monopoly pricing, observed that “mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free market system”. A situation like this generates a collision between two statutes. While the Competition Act seeks to maintain competitive conditions in the market, the Patents Act safeguards the rights of a patentee.

    Analysing the Problematic Approach

    Regarding the clash between the Competition Act and the Patents Act, it is worth pointing out that while section 3 of the Competition Act provides some sort of exemption under section 3(5) to the actions arising out of rights vested under the Patents Act, no such exemption has been granted under section 4. In simpler words, if a certain action attracts applicability under section 3 of the Competition Act but has arisen out of the rights guaranteed under the Patents Act, it would be exempted from the rigours of the Competition Act. However, an action which results in the abuse of a dominant position would not be exempted even if it stems from the rights guaranteed under the Patents Act. The intention of the legislature is unambiguously clear in not permitting the rights of a patentee to get in the way of a competitive environment. With particular reference to the pharmaceutical industry, this distinction indicates that if the prices imposed by an enterprise qualify as ‘unfair’ within the meaning of section 4, it would amount to an abuse of the dominant position irrespective of the fact that the enterprise has a statutory right to decide upon the determination of prices of an on-patent drug.

    Further, the opinion on non-interference in the cases of excessive pricing is mostly premised on the principle of self-regulation. In the absence of market failures, excessive prices motivate potential competitors to enter the market and are, therefore, self-correcting. However, the application of this principle presupposes the availability of alternatives for the commodity in question and the absence of entry barriers for new players to enter the market. As for the pharmaceutical industry, primary and secondary manufacturing are the two fundamental steps in the production of drugs. Producing a drug’s active pharmaceutical ingredient is known as primary manufacturing. The process of incorporating the active ingredient into a delivery system is called secondary manufacturing. Therefore, it is this Active Pharmaceutical Ingredient (‘API’) that has therapeutic qualities.

    When a new drug is invented, the manufacturing enterprise gets the API patented. Now, in order to manufacture the drug of the same efficiency, the API used in the formerly manufactured drug is a pre-requisite. By patenting the API, the enterprise successfully eliminates the possibility of a new player entering the market and selling the drug at a lower price. The problem aggravates when the drug in question does not have any comparable or reasonable substitutes. In the pharmaceutical industry, ‘therapeutic substitutability’ is a mandatory requirement for some other drug to have the potential to cause competitive constraints over the drug in question.

    This essentially questions if consumers, faced with a price increase, could easily switch to other alternatives without the therapeutic efficiency being compromised. In the case of critical diseases like cancer, the availability of therapeutically substitutable drugs is unlikely. Seeking to reap the benefits of a situation like this, in the absence of competitors or reasonable substitutes, enterprises hike the prices of their drugs manifold. Consequently, the self-regulatory mechanism escapes applicability in a case like such, with heavy entry barriers and no substitutes. A consumer, faced with this adversity of unreasonable prices, is made to choose between life or death. If he chooses life, the financial burden continues to grow heavier until it becomes impossible to endure and if he refuses to pay the exorbitant prices, his life is on the line. Top of FormBottom of Form This clearly flies in the face of the idea behind the recognition of providing access to essential medicines at affordable prices as a core obligation under the right to life in the constitutional context.

    To date, the Indian authorities do not have a developed jurisprudence pertaining to excessive pricing. Owing to this, the authorities tend to seek aid from the jurisprudence developed in foreign countries. United Brands Company and United Brands Continental BV v Commission of the European Communities Brands case, for instance, is the most cited precedent in this regard which has its shortcomings, one of them being the determination of benchmark price. CCI’s indifferent approach towards this lacuna is highly problematic. The only apparent and discernible solution to this problem is establishing an authority to fill the void of undeveloped jurisprudence. CCI should formulate guidelines to govern cases about excessive pricing with special reference to pharmaceutical industries. These guidelines must ensure that public welfare and patent rights co-exist harmoniously.

    Conclusion

    The challenge here is to strike a balance between the rights of a patentee and the obligation towards the public. Allowing the prices of life-saving drugs to go unregulated would mean denying people the right guaranteed to them by the makers of the constitution under Article 21. The enterprises, undoubtedly, enter the market with a vision to gain maximum profits but these profits should not be permitted to come in the way of larger public interest. Going by business wisdom, it is needless to say that the market price of a drug has to exceed the expenses incurred and that there has to be a margin between the cost of production and the market price but this margin should not go unchecked. It is for the CCI to ensure that this margin is reasonable and caters to the interests of both the enterprise and the general public. The regulatory guidelines are the need of the hour to inhibit big players from benefitting from the masses’ helplessness.

  • Examining Loopholes and Challenges in the Draft Digital Competition Bill

    Examining Loopholes and Challenges in the Draft Digital Competition Bill

    BY KASHVI SINGH SHEKHAWAT, SECOND-YEAR STUDENT AT NLU, ODISHA

    Digital platforms have significantly transformed the global economy and society and are central to 21st-century technological advancements. They have introduced innovative products and services that were unimaginable a few decades ago which break down borders to deliver these benefits worldwide. 

    The COVID-19 crisis has highlighted the importance of digital platforms, but also raised concerns about market dominance and anti-competitive practices. In response, the Ministry of Corporate Affairs proposed the Draft Digital Competition Bill (‘the Bill’) on March 12 to curb these practices, promote fair competition, and improve market transparency.

    This Bill, which aims to regulate digital markets and curb anti-competitive practices contains potential loopholes that could undermine its effectiveness. This might impact the Bill’s ability to effectively curb anti-competitive practices, ensure fair competition, and promote market transparency. Thus, there is a crucial need to identify and address areas where the Bill may fall short ensuring a more robust and comprehensive regulatory approach.

    Ex-Ante Regulation

    Ex-ante regulation involves setting rules and guidelines in advance to prevent market issues before they arise, as opposed to addressing problems after they occur (which is ex-post regulation). It’s a proactive approach aimed at maintaining fair competition and preventing market failures from the outset. This is typically used to address market failure but this is not the case with India. As per the ITIF’s Hamilton Index Report, India is a top producer in key industries with a thriving digital market and the third-largest startup ecosystem. However, concerns about market power in digital markets persist with claims that consumer data feedback loops, network effects, and economies of scale favor incumbents, potentially leading to market concentration. While network effects can benefit consumers, market concentration is not an inevitable outcome. Digital markets often exhibit multi-homing, where consumers use multiple platforms, enhancing competition. Market power in dynamic markets can drive innovation, reflecting Schumpeterian “gales of creative destruction” where firms continually innovate to compete.

    Even if market failure exists, ex-ante bans as proposed by the Bill must demonstrate that they improve the current system. The ITIF report suggests that ex-ante regulation might hinder market forces essential for correcting failures and enhancing consumer welfare. The report also highlights that the current ex-post enforcement model has limitations but that does not prove that ex-ante regulation would be better. The complementarity between ex-ante and ex-post regimes does not necessarily enhance consumer welfare and could maintain administrative costs while risking false positives. Thus, the questions arise that whether the benefits of an ex-ante regime outweigh the potential harms.

    Tailored Regulatory Approach

    The approach of implementing more tailored, company-specific rules, as seen in the Bill following the UK’s Digital Markets, Competition and Consumers model aims to mitigate false positives in theory. This strategy gives regulators the discretion to craft individualized conduct codes for each company rather than imposing blanket rules across entire industries. However, this strategy poses challenges. Firstly, it runs the risk of generating high administrative costs that the ex-ante regime was meant to avoid. For instance, the Bill anticipates extensive non-compliance inquiries involving costly processes like discovery, detailed fact-finding, and potentially adversarial proceedings. Secondly, as noted previously, such an approach could lead to concerns about regulatory capture, where regulatory decisions might favor established players over new entrants. This could result in disparate treatment within the digital market ecosystem. Thirdly, the government’s ex-ante regulatory approach could impose significant burdens on digital companies, potentially making operations untenable and stifling venture investments in tech startups. High regulatory risks can deter investors by affecting returns and business conditions, with increased compliance costs and scrutiny especially challenging for resource-limited startups. 

    In essence, instead of effectively addressing market failures, the Bill could potentially create a regulatory framework that escalates administrative expenses and selectively benefits certain digital entities while disadvantaging others.

    Systematically Significant Digital Enterprises

    The Bill’s definition of Systematically Significant Digital Enterprises (‘SSDE’) is problematic. Firstly, its quantitative threshold targets companies solely based on their size, without considering whether they possess market power—a necessary though not sufficient condition for market failure. Additionally, the Bill includes a vague and ambiguous qualitative test for identifying SSDEs if quantitative criteria are not met. This test vague because it involves assessing broad and subjective factors, such as a company’s influence on digital markets or its potential effect on competition, without clearly outlining how these factors should be measured. The absence of precise definitions makes it difficult for companies to understand the criteria they must meet, leading to inconsistent application by regulators. This uncertainty can result in varying interpretations, leaving digital firms unsure of how they will be classified.

    This could lead to an ad hoc regulatory regime, granting excessive discretion to regulators and creating uncertainty for many digital firms. This uncertainty is further compounded by the Bill’s company-specific approach to rulemaking, which raises concerns about regulatory capture and the potential for the Bill to be used to pick digital winners and losers in India.

    According to the Competition Commission of India, at least 580 companies from the digital service and e-commerce sectors alone would qualify as SSDEs in India. This contrasts sharply with the European Union’s Digital Markets Act (‘DMA’), which designates only 6 gatekeepers. Thus, this large number of designated SSDEs would impose significant compliance burdens on these companies, potentially hindering their ability to introduce new services and innovate. 

    Innovation

    The Bill proposed in India raises significant concerns regarding its potential impact on innovation. Firstly, unlike the EU’s DMA and the UK’s Digital Markets, Competition and Consumers Bill, the Indian Bill does not mandate a finding of market power as a prerequisite for applying its quantitative tests. This omission suggests that the Bill could target companies purely based on their size, rather than addressing genuine market failures, which regulation should ideally target. Moreover, the Bill’s provision for a three-year designation period with automatic renewal, coupled with limited opportunities for revocation, fails to account for the dynamic nature of market power in digital markets, potentially leading to regulatory overreach. Secondly, while the Bill proposes company-specific restrictions, its approach of imposing per se bans on various common business practices is likely to stifle pro-competitive behavior. For instance, prohibitions on practices like self-preferencing, where digital platforms prioritize their own products over third-party offerings could hamper innovation and reduce consumer choice. Such practices often enhance user experience and foster competition among digital platforms, as seen in cases where companies like Google leverage scale to improve search quality and compete effectively with rivals.

    Thus, the lack of clear market power criteria, broad SSDE designation criteria, and per se bans on common business practices raise significant concerns about the Bill’s potential negative impact on innovation in India’s digital economy.

    Cost- Benefit Analysis 

    The Bill in India raises critical questions about its potential impact and necessity in the digital sector. One fundamental concern is whether the costs and benefits of digital competition regulation have been adequately assessed. As it currently stands, the objectives of the Bill appear to diverge from traditional competition law principles, which aim primarily to safeguard consumer welfare. Instead, akin to the EU’s DMA, the Bill seems more focused on assisting competitors rather than directly benefiting consumers. This shift could open the door to rent-seeking behaviors from private entities with vested interests, potentially leading to demands for extensive product-design changes that may not align with consumer preferences. Thus, the costs of the Bill are palpable. In the EU, similar regulations have delayed products like Meta’s Threads due to compliance uncertainties. Consumer experiences have also been impacted, such as Google’s changes to search result functionalities under DMA rules, which affect user convenience and business outcomes.

    While proponents argue the Bill addresses digital market risks, India already has robust competition laws and sector-specific regulations under the Competition Commission of India (‘CCI’). Introducing the Bill would mark a departure by using size-based criteria reminiscent of older regulatory regimes which could potentially disrupt India’s current approach aligned with international best practices.

    Enforcing the Bill would demand significant resources and expertise across multiple domains, similar to challenges faced by the European Commission with the DMA. There are grounds for revisiting or reevaluating the proposed legislation unless the benefits of the Bill clearly outweigh its costs in enhancing public welfare. This includes ensuring regulatory interventions support innovation and do not unduly burden digital businesses in India’s dynamic market landscape.

    Conclusion

    There is a need to enhance the collaborative nature of enforcement by establishing regulatory dialogues involving gatekeepers, business users, end-users, and external stakeholders such as experts and auditors as designating SDSE’s will lead to more litigations. This inclusive approach aims to encourage gatekeepers to comply with regulations without allowing regulatory capture. Such dialogues are seen as essential for improving compliance monitoring. This dialogue should be meaningful and not merely procedural, ensuring that the obligations outlined by the CCI are genuinely developed through these interactions. CCI should also take a more proactive role in assisting and resolving complaints from businesses. This proactive stance would enable quicker and more effective resolution of issues, strengthening overall compliance with the Bill Furthermore, alongside enforcement efforts by the CCI and national authorities, there is a call for greater private enforcement. This would allow businesses using gatekeeper services to initiate legal actions in courts, seeking injunctions and damages for bill violations. Private enforcement mechanisms can swiftly identify infringements and act as a robust deterrent, thereby bolstering overall Bill compliance.

  • Redefining Derivatives: India’s Speculative Turn on Futures And Options Taxation

    Redefining Derivatives: India’s Speculative Turn on Futures And Options Taxation

    BY TAPAS JOSEPH AND ADITYA S. NAIR, FOURTH-YEAR STUDENTS AT NUALS, KOCHI

    Introduction

    Up until the early 2000s, derivatives revolutionized spot and futures markets, disrupting natural market relationships and attracting regulatory scrutiny due to potential negative effects. This increased leverage made futures leading indicators. Derivative markets, employing futures and options, became pivotal for trading stock risks, with legally binding contracts specifying asset transactions. Future contracts involves buyer and seller being legally bound to the purchase and sale of a specific asset at a specific price by a certain time. On the other hand, options contracts involve the buyer being given a right but not a responsibility to buy or sell a specific asset at a specified price before a given time, where the seller is also bound to fulfil the buyer’s right if they choose to exercise it. The income derived out of futures and options (‘F&O’) trading has always been classified in the realm of non-speculative business income for levying tax. However, due to recent increase in the retail participant trade activity, there is a plan to move the F&O income to speculative business income under the Income Tax Act, 1961 (‘Income Tax Act’). This reclassification would put F&O transactions under deterrent tax laws and tax deducted at source (‘TDS’) which will harm the traders to one extent or the other by implementing a niggardly tax system.

    The Indian government’s proposed reclassification of F&O trading reflects growing concerns over unprecedented retail investor participation in derivatives. This regulatory shift aims to address potential systemic risks from unchecked retail F&O trading. Regulators worry that a major market correction could cause significant losses for retail investors, leading to widespread financial distress at the household level. This could have profound implications for market sentiment and economic stability. To mitigate these risks and ensure long-term market health, the government is considering reclassifying F&O trading income as speculative.

    What is Speculative Transaction?

    A speculative transaction is a transaction of purchase or sale of a commodity, being stocks and shares, and includes (section 43(5) of the Income Tax Act) a transaction that is not completed by the actual delivery of or by the transfer of the commodity.

    Section 43(5) defines ‘Speculative Transaction’ as a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scripts. For example, intra-day trading in shares could be one such kind of trade that comes under the head of speculative transaction.

    Understanding F&O Contracts in Financial Markets

    F&O are types of financial derivatives that enable traders to speculate on the price movements of an underlying asset without owning it. A futures contract binds the buyer to purchase and the seller to deliver the asset at a set price and future date. Conversely, an options contract grants the buyer the right, but not the obligation, to buy or sell the asset at a specified price by a certain date, while the seller is required to fulfil the contract if the buyer opts to exercise their right.

    Fiscal Implications for F&O Transactions

    An eligible transaction in respect of trading in derivatives referred to in Clause (ac) of section 2 of the Securities Contracts (Regulation) Act 1956 carried out in a recognized stock exchange is not a speculative transaction.

    Related to this, the Income Tax Act under section 43 (5) classifies F&O transactions as business income. This condition provides an exemption for trading in derivatives under clause (d). The section also includes subsection 5, which has clauses (a) to (e), and it specifically excludes speculative transactions. These include:

    • Hedging contract with respect to raw materials or merchandise.
    • Hedging contract with respect to stocks and shares.
    • Forward contract.
    • Trading in derivatives.
    • Trading in commodity derivatives.

    This makes trading under derivatives like F&O fall under the ambit of non-speculative business income, which is taxed under tax slabs based on the trader’s annual turnover.

    In essence, the profits from F&O trading are taxed like other business income, allowing taxpayers to claim deductions for expenses incurred, such as telephone bills, electricity bills, internet bills, etc.

    Prior to the addition of Clause (d) to the proviso of sub-section 5 of section 43, the Bombay High Court in Commissioner of Income Tax v. Bharat R. Ruia, determined that exchange-traded derivative transactions carried out by the assessee before January 24, 2006, were deemed speculative transactions. With the insertion of Clause (d) in section 43(5), an explanation was also introduced to define the term ‘Eligible Transaction’ as used in Clause (d). According to this explanation, only specific types of derivative trading transactions conducted on recognized stock exchanges are classified as non-speculative transactions. This was formalized by Notification No. S.O. 89(e) dated January 25, 2006. In this regard, from the date of Securities and Exchange Board of India (‘SEBI’), both Bombay Stock Exchange (‘BSE’) and National Stock Exchange (‘NSE’) were officially accorded recognition only for this particular purpose. Therefore, any derivative trades that were carried out in those exchanges and any others that may be entered in the future under the provision of this section are, in effect, non-speculative if they meet the conditions in the explanation of section 43 (5). These classifications apply to each of the transactions that satisfy the above conditions after January 25, 2006. The fact that for eligible derivative trades, there is a change of status from speculative to non-speculative is a major overhaul in tax and regulation.

    Analytical Assessment of Derivatives Taxation Reclassification: Implications for Market Participants

    F&O trading is considered a non-speculative business, and loss from its trading is allowed to be set against income from any other resource except salary income. This has been vividly described under section 71(2A) of the Income Tax Act.

    Unadjusted losses can be offset against income from other sources, except salary. Any remaining loss can be carried forward for up to eight years. In these subsequent years, the carried forward loss can only be offset against income under “Profit and Gains of Business and Profession.”

    Under section 73A, if a taxpayer incurs a loss from a speculative business transaction, they can only set off this loss against profits earned from other speculative business transactions. This means that a taxpayer cannot use a speculative business loss to offset gains earned from non-speculative business transactions, such as income from salaries, rent, or interest.

    In case a taxpayer is unable to set off the entire speculative business loss against profits earned from other speculative business transactions in the same financial year, they can carry forward the unabsorbed loss to the subsequent year. The unabsorbed loss from speculative business can only offset profits from similar transactions and be carried forward for four assessment years, as per section 73. This differs from non-speculative business losses, which can be carried forward for eight years.

    Examination of the Potential Impact on Market Behaviour and Investor Sentiment.

    The imposition of increased taxes on F&O trading could potentially reduce liquidity and trading volumes in these markets by dissuading active traders. While there are numerous drawbacks associated with such changes, they may also serve to influence market participants. For instance, the growing presence of retail investors in derivatives markets raises concerns about their vulnerability to significant losses during market corrections. Reclassifying F&O transactions as speculative could function as a deterrent, aiming to mitigate these risks and dissuade retail investors from exposure to substantial losses.

    However, there is also a risk that heightened taxes could redirect retail investors towards unregulated and potentially riskier investment alternatives. While these alternative channels offer the potential for greater profits, they operate outside the regulatory framework of traditional markets. This lack of oversight may expose retail investors to increased risks, potentially compromising their financial security. Institutional investors, who constitute a substantial segment of the F&O market, may reassess their strategies in response to these developments. The increased tax burden might influence their assessments of risk versus reward, altering market dynamics and potentially increasing volatility. Moreover, smaller market participants could face heightened operational costs and complexities as a result of these changes.

    Conclusion and a Way Forward

    The proposed reclassification of F&O transactions from ‘business income’ to ‘speculative income’ in India aims to protect retail investors but risks driving them to unregulated alternatives. To balance investor protection with market vitality, we propose:

    1) A tiered tax structure with lower rates for small investors and higher rates for large traders, curbing speculation while maintaining liquidity;

    2) Partial reclassification to a hybrid category, retaining some non-speculative tax benefits while introducing restrictions;

    3) Extending the loss carry-forward period beyond four years for speculative transactions. These amendments could foster a stable yet dynamic F&O market, ensuring fairness without unduly burdening traders. A robust regulatory framework remains crucial for maintaining transparency and investor confidence.

  • Navigating Open Market Purchases Under The Competition (Amendment) Act, 2023

    Navigating Open Market Purchases Under The Competition (Amendment) Act, 2023

    BY BIANCA BHARDWAJ, A THIRD-YEAR STUDENT AT NLU, JODHPUR

    [Note: The following post is Part-II in a two-part series]

    Having expounded upon the merger control regime in India along with the dilemma of open market purchases as well as compliances in the previous part, the following part details the impact of the draft combination regulations along with the global position and suggestive solutions.

    V. Impact of the Draft Combination Regulations, 2023 

    The CCI Draft Combination Regulations, 2023 further clarify the rights that can be safely acquired in such transactions. Under Regulation 6, the acquirer would be allowed to avail certain rights such as dividend, subscription to rights issue, bonus shares, etc. The acquirer can also dispose the shares or securities acquired and exercise voting rights only to the extent of liquidation and/or insolvency proceedings. 

    These regulations are crucial because they adequately address the problem of acquiring de facto control through such transactions. By specifying that the voting rights of the acquirer would only be allowed in limited circumstances, it does away with the problem of acquisition of control in public bids.  The European Commission, for example, recognised this issue in the case of Marine Harvest ASA, whereby it was held that exemption to a public bid would not be provided if the seller acquires a significant block of shares amounting to de facto control. The element of de facto control is adjudged based on the votes cast at previous ordinary and extraordinary general meetings. Lastly, even the proviso to Regulation 6 also states that exemption would not apply where the acquirer directly or indirectly, influences the target enterprise.

    VI. Global Position 

    A quick sojourn of international antitrust laws would also reveal that similar dispensations have been made worldwide.Article 7(2) of the European Union Merger Regulation (‘EUMR’) provides that standstill obligations shall not prevent the implementation of a public bid or of a series of transactions in securities including those traded on a stock exchange and Article 7(3) gives the Commission the power to grant derogations. However, statistics reveal that the EU has rarely granted such exemptions. These derogations are subject to a twofold-criteria: (1) high degree of urgency in the transaction and (2) the lack of any plausible competition issues raised by the proposed transaction. Moreover, the EU has repeatedly held that while acquiring voting rights is not prohibited on securities purchases, the exercise of these rights is actively discouraged to prevent gun jumping. 

    Similarly, in Brazil, the transactions made through stock markets or organized over the counter market do not need the approval of the antitrust authority for their consummation. On the other hand, certain sophisticated merger regimes of UK and Italy do not impose any standstill obligations and parties are free to implement transactions without approval 
    by undertaking a self-assessment of the potential competition concerns. 

    In comparison, the Indian regime reflects a balanced approach as the regime retains its suspensory character without any absolute derogations. At the same time, there is no absolute ban on exercise of voting rights attached to shares bought in such transactions like in the EU. Moreover, there is sufficient scope for the parties to provisionally implement their transaction and subsequently wait for clearance while retaining certain rights. 

    However, a suggestion must be noted in this regard. It is not clear why the amendment did not adopt the CLRC report’s recommendation to mandate an escrow account. If the transaction is later disapproved by the CCI, the reversal of the transaction could be eased by selling the shares in the escrow account and undo any competitive harm.  

    VII. Way Ahead

    The rationale behind merger control in antitrust is to promote economic efficiency and enhance the process of corporate restructuring in the country. In this context, the amendment is welcome as it aligns with international best practices and will boost transactional efficiency in India. However, there is still uncertainty regarding how the Takeover Code would complement the amendment, given the requirement of obtaining a statutory approval for open offer still stands. In the meantime, as fertile jurisdictional ground develops and the Draft Regulations are adopted, it is crucial that parties tread with caution and avoid acquiring beneficial rights before securing the watchdog’s approval and attract potential scrutiny.