India-Law.org

The “Securities Markets Code” proposes to specifically define ‘securities’ as including ‘Global Depository Receipts’ [GDRs] along with ‘Indian Depository Receipts’ [IDRs]. GDRs and its cousin American Depository Receipts [ADRs] are convertible instruments issued outside India, convertible into underlying shares/securities issued in India. IDRs are the converse: they are securities issued in India that can be converted into underlying instruments issued outside India.

The Honourable Supreme Court in SEBI v Pan Asia Advisors Ltd. & Ors. [2015 (14) SCC 71 : 2016 (134) SCL 311 (SC) : AIR 2015 SC 2782 : 2015 (7) SCALE 694] has laid down some difficult and contradictory propositions of law regarding Global Depository Receipts (GDRs) which merit examined. The court answered a fundamental question: What are GDRs and whether they will fall under the definition of ‘securities’ u/s 2(h) of SCR Act 1956? as follows, –

“Though it may appear that on the one hand underlying ordinary shares would be governed by the laws prevailing in India and the GDRs would be governed by the laws of the country in which such receipts are issued, the most relevant fact which is to be borne in mind is that the existence of GDRs is always dependent upon the extent of underlying ordinary shares lying with the Domestic Custodian Bank.

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In order to further appreciate the status of a GDR of an issuing company, it will be necessary to consider the definition of ‘securities’ as defined under Section 2(1)(i) of SEBI Act, 1992 read along with Section 2(h) of SCR Act 1956. In fact Section 2(1)(i) of the SEBI Act, 1992 simply defines ‘securities’ to mean the definition assigned to it in Section 2(h) of the SCR Act, 1956. Under Section 2(h) ‘security’ has been defined to mean as under in sub-clauses (i), (iia) and (iii):

“2 (h) “securities” include—

(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;

… …

(iia) such other instruments as may be declared by the Central Government to be securities; and

(iii) rights or interest in securities;”

The above definition is exhaustive and includes not only shares, scripts, stocks, bonds, debentures, debenture stocks or other marketable securities of a like nature in or any incorporated company. The further definition under sub-clause (iia) covers such other instruments as may be declared by the Central Government as Securities and under sub-clause (iii) rights or interest in securities are also to be construed as securities.

Going by the definition under Section 2(h)(i) ‘security’ would include other marketable securities of a like nature of any incorporated company. Therefore reading Section 2(h)(i) and 2(h) (iii) together and apply the same to GDRs, having regard to the fact that the issuance of GDRs are always based on the underlying Indian shares deposited with the Domestic Custodian Bank and thereby the GDRs possess in it right, as well as, interest in the shares, scripts etc., it will have to be straight away held that all GDRs would fall within the definition of ‘securities’ as defined under Section 2(h) of the 1956 Act.

Further, under Section 2(2) of the SEBI Act, 1992, words and expressions used and not defined but defined under the SCR Act, 1956, the said meaning would respectively assign wherever used in the SEBI Act, 1992. Therefore, for the expression ‘stock exchange’ one will have to fall back upon Section 2(j) of the SCR Act, 1956 which definition is as under:

“2(j) “stock exchange” means— (a) any body of individuals, whether incorporated or not, constituted before corporatisation and demutualisation under sections 4A and 4B, or

(b) a body corporate incorporated under the Companies Act, 1956 (1 of 1956) whether under a scheme of corporatisation and demutualisation or otherwise, for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities.”

The above definition makes it clear that a ‘stock exchange’ as formed under Section (2)(j)(a) & (b) are for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities. It is true that GDRs have no time limit and can be possessed as GDRs for any number of years. However, when the holder of the GDR apart from trading with the same as GDR in the global market at any point of time wish to redeem the same or go in for fungibility of the redeemed shares back into GDRs, necessarily the holder of a GDR will have to fall back upon the stock exchanges as per the definition under Section 2(j) of the SCR Act, 1956, who alone can assist, regulate or control the business of buying, selling or dealing with securities.

Having examined the above statutory provisions, we find that a GDR is one form of ‘security’ as defined under Section 2(h) of SCR Act, 1956, which is created by the issuing company of Indian origin based on underlying shares deposited with the Domestic Custodian Bank and created by the Overseas Depository Bank. Such creation is at the instance of the issuing company in India with a desire to earn foreign investments. Such investments made by the investors in the GDRs is facilitated by the Lead Manager at the time of its creation as well as its investment. Thereafter, the investors hold the GDRs either for further trading on it in the global market through the stock exchanges at global level and in the event of such investors interested in liquidating the GDR are entitled to liquidate the same through the Overseas Depository Bank, in which event the extent of underlying shares of the GDRs get transferred in the name of the investors themselves and thereby enabling such investors to trade on underlying shares in the Indian stock market or if so wish under the fungibility scheme once again get it redeemed in the form of GDR themselves.

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The definition of ‘securities’ under Section 2(h) in particular sub-clause (iii) of Section 2(h)(a) of SCR Act, 1956 makes it clear that rights and interests in securities are also to be construed as securities as defined in Section 2(h). Therefore even if GDR as such is not specifically referred to under the definition of ‘securities’ under Section 2(h) by virtue of sub-clause (iii) of the said section, any rights or interests in securities would also fall within the definition of securities. Viewed in that respect, every issue of GDR is based on the underlying shares of the issuing company deposited with the Domestic Custodian Bank which clearly falls under the definition of securities of Section 2(h), the Global Deposit Receipts which create rights and interests in those securities, the Global Deposit Receipts would automatically fall and come within the definition of Section 2(h) viz. ‘securities’. Once when the said legal position is insurmountable, any argument based on the said submission should be rejected.” (emphasis supplied)

It is the Author’s humble view that, this approach has the following fundamental problems, –

1. The Apex Court applied the definition of ‘securities’ under Indian law, i.e. the SEBI Act and the Securities Contract (Regulation) Act, 1956 to GDRs issued outside India without considering that Parliament made it clear that both these securities laws enactments applied only to the territory of India i.e. section 2(h) of the Securities Contract (Regulation) Act, 1956 could not have applied when the instrument was issued outside India and Indian law had only territorial application. The Court should have first decided whether the territorial Indian laws extend to GDRs before referring to section 2(h).
2. GDRs are not ‘securities’ under Indian law, though they may be ‘securities’ under foreign law, of the country where they are issued, if foreign law so provides; just as ‘Indian Depository Receipts’ (IDRs) are ‘securities’ under Indian law because they are issued in India and no foreign regulator has ever claimed them to be ‘securities’ under foreign law because their securities laws also have territorial limitations. The court seemed to have been swayed by the fact that Depository Receipts are instruments that are convertible into the underlying Indian securities as thus should be classified as such. This can create regulatory problems if other regulators also start to classify IDRs issued in India as securities under their laws and assert their jurisdiction on the grounds that they are convertible into underlying securities in their jurisdiction, eventually leading to a clash between securities regulators if the principle laid down by the Hon’ble Supreme Court was applied on a reciprocal basis by other countries.
3. Merely, because a law can be made by Parliament with extra-territorial operation, does not mean that such a law has in fact been made. Nothing in this proposed Code or section 1 of the SEBI Act or of the Securities Contract (Regulation) Act, 1956 suggests that Parliament intended those Acts to be applied to instruments issued abroad where the law in force is different.
4. On conversion, the GDR holder no longer remains a GDR holder, he or she becomes a holder of Indian securities. But this cannot be understood to extend GDRs themselves to mean securities under Indian law. Such investor becomes a holder of securities under the Indian law only on conversion of the GDRs, not before;
5. The classification creates several contradictions, including, –

• If GDRs issued by a company are securities, then the entire Indian securities laws and companies act will become applicable to them as the same definition will apply to both legislations; something that has never been contemplated in the judgment. Could SEBI then issue a direction about listing on Indian stock exchanges on the ground that they are Indian securities issued to the public or large section thereof (exceeding 49/200 in number, as the case may be)?;
• The framework of listing of GDRs on foreign exchanges is contrary to the framework of listing under Indian laws which regulates listing of securities on Indian exchanges;
• SEBI has no way to enforce the actual issue or listing framework of GDRs in foreign stock exchanges, if it ever were to attempt making such regulations based on this judgment. Nor has, SEBI has never attempted to do the same.

However, this does not mean that SEBI could not have passed the order of debarment that it did. The actual nature of the SEBI order that was in dispute needs to be considered in proper perspective. SEBI Order [SEBI order No. WTM/SR/ISD/06/09/2013 against Pan Asia Advisors Ltd & Arun Panchariya in the matter of GDR manipulation, 2013 SCC OnLine SEBI 126] effectively debarred Pan Asia Advisors Ltd & Mr. Arun Panchariya from accessing or being associated from the Indian securities market for a period of 10 years. This has certain implications, –

1. The operative part of the SEBI order is confined to India territory, i.e. the order is essentially an injunction from operating in the Indian securities market, which is within the territorial jurisdiction of SEBI to enforce. That order itself did not have any operation outside India, in fact as a necessary implication he was free to buy, sell and deal in GDRs, ADRs outside India as long as they were not converted;
2. SEBI’s order did not proceed on the argument that its jurisdiction to recognise the fraud in GDR’s is because the GDRs are to be considered as ‘securities’ under Indian law. The argument that GDRs are ‘securities’ under Indian law appears to be a subsequent development during the appeals. The issue whether GDRs are securities under Indian laws arose in the first appeal filed by the appellant before SAT [Pan Asia Advisors & Anr. v SEBI, 2013 SCC OnLine SAT 80 : 2014 (119) CLA 187 : MANU/SB/0081/2013 : MANU/SB/0081/2013.], the original order never proceeded on this basis. It finally ended up being the main issue even before the Supreme Court;
3. In the Author’s view the issue as originally framed by SEBI was the appropriate one. SEBI’s order had indicated that its jurisdiction was based on the effects doctrine referred to in GVK Industries Ltd. & Anr. v Income Tax Officer & Anr. [2011 (3) SCR 366 : 2011 (4) SCC 36 : 2011 (3) SCALE 111], in relation to the effect on the investors in India. The shift from ‘effects doctrine’ to a broader holding that ‘GDRs are securities under Indian law’ has huge unforeseen consequences, which seem to go unrecognised.
4. Interestingly, the Supreme Court in later paragraphs of its judgment considers the question as framed by it as part of the ‘effects doctrine’, which it is not. The entire controversy of holding GDRs as ‘securities’ under Indian law is unnecessary and irrelevant to the effects doctrine and does more harm than good when seen from the wider perspective. By holding that the GDRs are ‘securities’ under Indian law, the fraud in GDRs becomes essentially a fraud in Indian securities, in which case application of the ‘effects doctrine’ is moot because there would be no need for it to come into play. The effects doctrine does not say that the transactions carried outside India become governed by law in India, rather only the effects resulting in India from such acts and omissions done in such extra-territorial jurisdiction can be recognised and controlled by Indian law. [See,Haridas Exports v All India Float Glass Manufacturers’ Association & Ors., 2002 (6) SCC 600 : 2002 Supp (1) SCR 229 : AIR 2002 SC 2728 (Though relied upon the Supreme Court in its judgement, its holding that GDRs are ‘securities’ under Indian law is contrary to this very judgment it relied upon, because it virtually treated the fraud in GDRs as a fraud in the Indian securities, in which case the entire issue of ‘effects doctrine’ for frauds happening outside the Indian securities markets becomes irrelevant.)] It is the effect on the Indian shares caused by the GDR conversion that is within the remit of Indian laws, not the GDR themselves. The impugned SEBI order can be simplified to mean that a fraud happened outside India which affects the securities markets in India is a fraud in connection with the securities market; it never said that the fraud happened in Indian securities. This distinction is critically important; however, the Supreme Court failed to recognise this and instead opened a Pandora’s box by treating GDRs as securities under Indian law. It ended up giving SEBI a jurisdiction which it is not conferred upon it by law nor one which SEBI had sought to exercise in the first place;
5. Interestingly, the judgment of the US Supreme Court in Morrison et al. v National Australia Bank Ltd. et al., [561 U.S. 247 (2010) : 130 S. Ct. 2869 : 177 L. Ed. 2d 535] where the court declined to apply similar anti-fraud provisions in US securities laws to securities issued and traded outside USA when there no effect on US securities markets is quite instructive. In that case the US Supreme Court inter alia held that the anti-fraud provisions of American securities laws (similar to section 12A) do not focus on where the deception originated (outside or inside USA) but on the effect, if any, on purchases and sales of securities listed on domestic exchanges and domestic transactions and also referred to the effects test. It does not require that the deception must originate in securities, all that is required is that it should affect domestic securities for anti-fraud provisions to apply. Given the similarity between the Indian and USA anti-fraud law, this judgment is most relevant;

It is the Author’s view that SEBI’s jurisdiction could be sustained because of Section 12A of that Act and SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) 2003 [SEBI (PFUTP) Regulations, 2003] were framed on the lines of American securities laws, and inter alia recognise two different kinds of frauds:

1. Frauds directly occurring in the Indian securities markets:
2. Regulation 3 (a) of the SEBI (PFUTP) Regulations provide as under, –

“3. Prohibition of certain dealings in securities.

No person shall directly or indirectly—

(a) buy, sell or otherwise deal in securities in a fraudulent manner;”

1. Clause (a) of the Regulation 3 is limited to fraudulent trading within the securities markets.
2. Frauds connected with the Indian securities markets:
3. Regulation 3 (b), (c) & (d) [which clauses relate to Section 12A (a), (b) & (c) of the SEBI Act, 1992] of the SEBI (PFUTP) Regulations reads as under, – 

“3. Prohibition of certain dealings in securities.

No person shall directly or indirectly— 

(b) use or employ, in connection with issue, purchase or sale of any security listed or proposed to be listed in a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of the Act or the rules or the regulations made there under; 

(c) employ any device, scheme or artifice to defraud in connection with dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange; 

(d) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person in connection with any dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange in contravention of the provisions of the Act or the rules and the regulations made there under.” (emphasis supplied)

1. The words ‘in connection with’ which originated in US anti-fraud laws are of great significance. It is not necessary that the fraud is carried out in the securities markets, it is enough for a fraud to be connected with the securities market for the penal jurisdiction of SEBI to be invoked. Both, i.e. frauds carried out in the securities market as well as frauds that impact the securities markets are covered under these clauses. In essence, it is in these provisions of the SEBI Act, 1992 whereby Parliament has followed the US to embody the ‘effects doctrine’ into law, and the SEBI (PFUTP) Regulations made thereunder reflect the same;
2. Section 12A (a), (b) & (c) of the SEBI Act, 1992 and Regulation 3 (b), (c) & (d) have been borrowed from Section 10(b) of the U. S. Securities Exchange Act of 1934 and Rule 10b-5 issued by the Securities and Exchange Commission. These words have been interpreted to not convert every common-law fraud relating to securities [Marine Bank v Weaver, 455 U.S. 551 (1982) (USSC) : 102 S. Ct. 1220 (1982)], but are wide enough to cover frauds that are linked to or coincide with a transaction of securities [Securities and Exchange Commission v Zanford, 535 U.S. 813 (2002) (USSC) : 122 S. Ct. 1899 : 2002 U.S. LEXIS 4023 : 70 U.S.L.W. 4485 : 153 L.Ed. 2d 1].  It need not involve any manipulation of any particular security or anyone to be misled about the price of any security. [Securities and Exchange Commission v Zanford, interpreting: Superintendent of Insurance of the State of New York, as Liquidator of Manhattan Casualty v Bankers Life & Casualty Co., 404 U.S. 6 (1971) (USSC) : 92 S. Ct. 165 : 30 L. Ed. 2d 128]

If Indian securities laws are interpreted like the pari materia provisions of US securities laws, the right of SEBI to exercise jurisdiction in the present circumstances is easily recognizable;

1. Reference can be made to the Supreme Court’s previous judgment [Sudhir Shantilal Mehta v Central Bureau of Investigation, 2009 (8) SCC 1 : 2009 (13) SCR 682 : 2009 (11) SCALE 217] wherein it held that the Special Court had jurisdiction even in respect of frauds committed in respect of non-securities (discounting of Bills of Exchange) if they were relating to securities [in the context of the Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992]. Thus, it is the humble view of the Author that law in India and USA is in fact the same and it does not matter where the fraud originates, as long as it affects the Indian securities markets. On the lines of that judgment it is easy to envisage the fraud in GDRs as relating to the securities market, given that the SEBI Act, 1992 uses both the term in connection with [Section 12A of the SEBI Act] and relating to [Sections 11(2)(e), 11(2A), 11(4) and 15HA of the SEBI Act] securities in respect of fraudulent and unfair trade practices.
2. Also see, sections 92 and 93 of the proposed Code for the words in connection and relating to.

Generally, foreign entities conducting their business entirely in foreign jurisdictions cannot be required to follow registration requirements under securities laws. However, a foreign entity such as a Foreign Portfolio Investors may be regulated by SEBI since their transactions are in connection with the Indian securities market and therefore fall within the effects doctrine of international law.

Hopefully the final version of the Securities Markets Code will not classify GDRs are ‘securities’ under Indian law.

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-Suraj Chaudhary, Advocate, Bombay High Court