By Chetan Soni

Abstract

The securities market has seen transcendental growth and newer financial innovations have led to a greater influx of capital, including making foreign investment more accessible.  The development of the securities market has necessarily had to be accompanied by various regulatory reforms, including changes in its definition and liberalization measures. However, while such foreign capital inflows and greater access have helped India’s securities market, infrastructure development, technology transfer, and job creation, the creative moulding of the term has facilitated the greatest economic frauds.Through this article, I will be arguing the need to come up with a staunch criterion for defining securities to prevent any scams which will affect capital generation, and thus impact the economy’s credibility across the world. 

Introduction

Security as a term used in general parlance refers to a state of being free from danger or threat. This is quite in contrary to the entangled legal definition given to the same in the financial world, wherein it is used as a means of providing capital to burgeoning businesses while promising an investor the hopes of achieving ‘financial security’. 

Any emerging country’s securities market is a key factor in economic growth. It provides a platform for businesses to raise cash, makes resource allocation more effective, encourages investment, and helps people build wealth. The expansion of the Indian securities market has made a major contribution to the overall expansion and transformation of the economy. It has enhanced corporate governance, attracted foreign investment, encouraged savings and investment, allowed businesses to grow, and accelerated economic integration and globalisation.

Functions of Securities

One of securities market’s primary functions is Capital formation. By giving businesses the option to issue shares or bonds, it enables them to raise capital for growth, and invest in research and development, and other corporate endeavours. Going back to Economics 101, the Keynesian theory of investment multiplier, the securities market is the catalyst for generating new job possibilities and boosting economic activity, this financial infusion is responsible for innovation, and entrepreneurship, and inadvertently propels economic expansion.

Most importantly, it mobilizes savings from individuals and institutions, while using these funds to churn growth. Previously idle savings now act as the basis for company growth, while allowing an individual the opportunity to make wealth. Moreover, with the funds of the general people involved, the market is heavily regulated to comply with stringent disclosure and transparency norms, while ensuring that they provide timely and accurate information to investors. This promotes transparency, accountability, and good corporate governance standards, safeguarding the interests of shareholders and enhancing investor confidence. Effective corporate governance practices contribute to a healthy investment environment and attract both domestic and foreign investors.

The term Securities has been broadened at times to bring within its ambit instruments like Global Depository Receipts (GDRs) and American Depository Receipts (ADRs), which has allowed Indian enterprises have been able to reach foreign markets. This has made it possible for them to access finance from international markets, grow their business internationally, and promote India’s economic integration with the world economy.

The long journey of the Indian definition of ‘Securities’ has in fact gone through numerous amendments and judicial interpretations through the years, and the same continues to grow with the most recent amendment to the definition coming through the Finance Act in 2021, which took effect from April 1, 2021. The ever-growing and creative financial sphere has time and again presented the legislature and the judiciary with questions of which type of investment schemes may or may not be covered under the ambit of the definition of ‘Securities’ and thus in an extension under the compliance requirements of the chief regulatory body of India- The Securities and Exchange Board of India (established through the SEBI act, 1992). 

How Can We Define Securities?

The Securities Contracts Regulation Act, 1956 (SCRA) through Section 2(h), rather than attempting to outline the salient features as such, had attempted to define Securities exhaustively. An attempt was made to specify each instrument while covering any creativity under the statement “other marketable securities of a like nature”. The most relevant part of the updated definition post numerous amendments has been reproduced below: –
“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 a pooled investment vehicle or other body corporate

• units or any other instrument issued by any pooled investment vehicle.
• any certificate or instrument (by whatever name called), issued to an investor by any issuer being a special purpose distinct entity, which possesses any debt or receivable, including mortgage debt, assigned to such entity, and acknowledging beneficial interest of such investor in such debt or receivable, including mortgage debt, as the case may be].

(ii) Government securities.

• such other instruments as may be declared by the Central Government to be securities.

However, the provision seemingly outlining and covering the essential nature of security that is sub-section (ie) was added only for debt instruments through an amendment in 2007. Further, the reluctance of the government to provide a well-outlined definition is visible through the residuary provision (iia) wherein the government has reserved the right to read in the definition of a securities to any instrument it deems fit and wishes to bring under the purview of SEBI. The application of the same was seen in 2013 when the Reserve Bank of India declared onshore rupee bonds as securities. Whether a financial instrument not explicitly mentioned to be one under Section 2(h), and not notified by the Government is covered under ‘Securities’ or not? A conundrum which has been time and again attempted to be exploited by corporations.

In Naresh K. Aggarwala & Co. v. Canbank Financial Services Ltd., the contention was raised that in the absence of any specific provision, only listed securities could be read as marketable for public companies. However, the Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992, thereafter backed by the Supreme Court distinguished the Apex Court’s ruling in the case of B.O.I. Finance ltd. v. Custodian and Ors., as the court had not dwelled into the question of whether the circular applied to unlisted securities or not and worked under the assumption that it did. Therefore, as no distinction is drawn in the definition of “securities” as provided under Section 2(h), thus there is none between listed securities and unlisted securities. Thus, bringing any kind of private investment contracts in the nature of securities to be under the ambit of SEBI, and safeguarding investor’s interests.

In an extension of the same, a plain reading of the section reveals the marketable nature of all securities mentioned. However, the term ‘marketable’ has not been defined in the act, and the court while noting the same attempted to provide a working definition in Bhagwati Developers (P) Ltd. v. Peerless General Finance & Investment Co. Ltd. The court, while  referring to the dictionary meaning, referred  to the term marketable as ‘saleable’, that is, anything capable of being bought and sold was referred to as saleable. The court went on to clarify that the size of the market is insignificant and of no consequence. As a clarification, it referred to a situation where there may not be any purchaser of listed shares on the respective stock exchange, however, the same cannot be referred to as not being marketable. The key to the same, per the court, remained  ‘free transferability’. Therefore, barring certain limited statutory or contractual restrictions, if shareholders possess the right to transfer their shares, when and to whom they desire. This right is said to satisfy the requirement of free transferability. However, the court then went on to say that if a statute prohibits or limits the transfer of shares with onerous conditions or restrictions, curbing the right of shareholders, and that of free transferability is jeopardized, then those shares with such limitations cannot be said to be marketable securities. Thus, concluding that the shares of a public limited company even when not listed on the stock exchange, in the absence of any onerous condition with respect to transferability come within the definition of “securities”.

Another infamous contention on similar lines was brought through the legislation changing Sahara India Real Estate Corpn. Ltd. v. SEBI case. In the same, the Appellant Company had brought forth a hybrid investment scheme. As was the case, there was no mention of a ‘hybrid’ in the SCRA, but the same was mentioned under Section 2 Clause (19A) of the Companies Act, 1956. The learned Senior counsel had argued that since there was a need to provide a separate definition of a ‘Hybrid’ thus, it cannot be read to  be the same as a security. However, the court, while  relying on an argument based on public policy, and disregarding the distinct definition as provided under the Companies Act, ruled that any variation or combination of ‘securities’ will be considered to be covered in the ambit of SEBI, whose role is to protect the innocent public investors. Thus, the Optionally Fully Convertible Debentures (OFCDs) issued by the appellants had to be read as such. The combination of the financial instruments used by them to create the hybrid, in themselves was marketable in nature. An argument with respect to free transferability was hence not legally tenable. Additionally, in the absence of any prescribed terms and conditions barring the transfer of the securities concerned, other than standard contractual ones, the securities issued to the subscribers had to be held marketable.  

At this juncture, as one realizes that the Indian legislators have relied on no standard definition, but rather on the ‘established’ definition. It is essential to view other legislations, such as the view as adopted in the strongest economy, that is, the United States of America. The current statutory definition currently relied upon is based on the 1946 Supreme Court judgment  of the Securities and Exchange Commission v. W.J. Howey. Here, the court pronounced the definition of a security offering as one based on economic  realities: “An investment contract is any contract, transaction, or scheme in which a person invests money in a common enterprise and expects profits solely from the work of a third party”. Thus, the four essential criteria; –

(i)         the existence of an investment contract,

(ii)       the formation of a common enterprise,

(iii)     a promise of profits by the issuer, and

(iv)      use of a third party’s substantial labour.

While marketability has not been explicitly mentioned, it can arguably be read into the elaborate definition under the ‘promise of profits’, and as provided in Bhagwati Developers (P) Ltd. v. Peerless General Finance & Investment Co. Ltd. it has been highlighted how the size of the market in itself may remain insignificant. Further, the lack of a functioning definition was felt in the debate surrounding the taxation of Import License  (Replenishment) Licence or REP Licence)/Exim Scrip (Export-Import Licence) as they are freely saleable in the market  along with having an independent value of its own. In the apex court’s decision Vikas Sales Corporation. v. Commissioner of Commercial Taxes and Another, the court however simply held the same in the negative, basing the argument under the fact that the government had not exercised its residuary power to declare such Scrips as securities. A similar conundrum is now faced by the government with the global rise and prominence of cryptocurrencies. The innovation in financial technology has led to the issuance of such token money which in fact have an underlying value based in real world application, along with the potential of loss and profit owing to future prospects, functionality, and labour of a third party. The same is already freely transferable  on numerous virtual platforms. The rise has seen a total amount of $10 billion invested solely in the Indian market, according to an estimate in  November, 2021. All in absence of any firm footing with respect to the legal validity of the same. As along with the prominence, there have been growing instances of fraud, seemingly easy in the absence of any regulatory body or framework to keep the market players in check. The growing uncertainty towards the legal validity of fintech  has not impacted its significant rise in terms of valuation. Even though it seemingly fits the bill of a security, due  to the absence and lack of any standard definition, along with an absence of a lack of resemblance to conventional securities, it has now become imperative for the government to act soon and act quickly .

Conclusion

While the definition as provided in the SCRA, may have been sufficient to safeguard the public’s interest in terms of reading onshore rupee bonds, and Global Depositary Receipts into the definition, it has not been able to keep up with the growing creativity in other financial instruments, and the time has arrived to be proactive and the legislature should take out a leaf out of the American judiciary, and provide specific guidelines with respect to the definition of securities, making space rather than ignoring contracts which significantly affect the general public. The same is necessary to prevent another Sahara Scam case which could possibly shock the conscience of the Indian financial system post which necessary amendments would be brought in.     

About the Author 

The Author is a 5th Year BA-LLB Student from Jindal Global Law School. He is interested in the intersection between law and economics, and how intrinsically this interaction impacts the daily lives of the common man. In his free time you can catch him discussing the implication of the country’s macroeconomic policies, or weirdly engrossed in a debate of whether the present Indian cricket team is the greatest ever!

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