The landmark judgement by the Bombay High Court, which has upheld
an innovative divestment method followed by the MCX Stock Exchange (MCX-SX) to
comply with shareholding norms, may have far-reaching impact on various
financial sector regulators and entities governed by them. The judgement, has
opened possibilities for others who are facing similar regulations across the
financial services industry, say legal experts.

Pavan K Vijay of Corporate Professionals said, “They (MCX-SX) have
shown the way. Others might also look to use similar structures to bring down
holdings for compliance. Competition is good for everyone, as long as the new
players expand the pie, rather than eat into the existing market.”

The
court set aside an order by the Securities and Exchange Board of India (Sebi),
which had rejected the divestment process followed by MCX-SX, that involved
several steps, including a capital reduction scheme, an issue of warrants and
several buyback agreements. The court held existing regulations do not limit
the modes of divesting stake. Sebi’s lawyers said they will study the order
thoroughly before deciding on an appeal.

While
the direct impact is on Sebi and other potential players interested in
launching stock exchanges, the verdict also affects other regulators like the
Reserve Bank of India (RBI), the Forward Markets Commission and the Department
of Industrial Policy and Promotion (DIPP), lawyers said, adding, these
regulators may have to amend rules to protect their rights. “There may be a
case for amendment of laws,” said Ramesh Vaidyanathan, partner, Advaya Legal.
The court seems to have followed the principle that future possibilities cannot
affect present legal status. “However, as a regulator, I have to look at both
the possibilities, present and future.”

He
cited the example of a convertible instrument, like the share warrants issued
by MCX-SX in an industry where there is a cap on FDI. “Say, a convertible
instrument is issued to a foreign investor. If the equity, on dilution at a
future date, exceeds the prescribed caps for the sector, should DIPP allow it
or not?” he questioned. Similar questions on legality of buyback arrangements
could prop up, said Kumar Desai, advocate, Bombay High Court.

The
high court held the buyback agreements entered into by MCX-SX could not be held
illegal on the grounds cited by Sebi. “A buyback confers an option on the
promisee and no contract for the purchase and sale of shares is made until the
option is exercised. The promissor cannot compel the exercise of the option and
if the promisee were not to exercise the option in future, there would be no
contract for sale and purchase of shares. Once a contract is arrived at upon
the option being exercised, the contract would be fulfilled by spot delivery
and would therefore, not be unlawful.”

Desai,
who has represented Sebi in several cases, said, “The judgement gives an aura
of legitimacy to buyback agreements. Both RBI and Sebi may not be comfortable
with this. While in this case, the agreements might have been genuine, not all
buyback agreements are.”

Some
lawyers point out that many angel investments by foreign investors are often in
the nature of loans masquerading as equities. These agreements have riders,
which assure a specific IRR and specific terms of repayment, against the very
nature of equity investments.

Like
Sebi, which has put the maximum holding by an individual entity in a stock
exchange at five per cent, the central bank and the commodities regulator have
also put caps on shareholding in their respective domains to ensure public
financial institutions, like banks, and market infrastructure institutions,
like exchanges, have broad-based ownership.