Chapter 5: Securities Contracts (Regulation) Act, 1956 and SCRR, 1957

The Securities Contracts (Regulation) Act, 1956 (SCRA) was enacted to prevent undesirable transactions in securities by regulating the business of dealing therein and providing for matters connected therewith.

The Broad Definition of 'Securities' (Section 2(h))

Section 2(h) provides an inclusive definition of securities that establishes the jurisdictional boundaries of SEBI and stock exchanges:

1. 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;
2. Derivative instruments: Contracts whose value is derived from underlying equity, debt, commodity, currency, interest rate, or index values;
3. Units or instruments issued to investors by a Collective Investment Scheme (CIS) or Mutual Fund;
4. Security Receipts defined under the SARFAESI Act, 2002;
5. Government Securities (G-Secs) and State Development Loans (SDLs);
6. Rights or interests in securities, including subscription rights and warrants;
7. Any other instrument declared by the Central Government to be a security.

SECTION 2(h) SECURITIES SPECTRUM

Recognition and Demutualization of Stock Exchanges

• Application for Recognition (Section 3): Any stock exchange desiring recognition must apply to SEBI, providing copies of its rules, bye-laws, and operational constitution.
• Grant of Recognition (Section 4): SEBI grants recognition if it is satisfied that the rules and bye-laws ensure fair dealing and protect investor interests.
• Demutualization Mandate (Sections 4A & 4B): Historically, Indian stock exchanges were mutually owned associations where trading brokers were also owners and board managers, creating severe conflicts of interest. Under the corporatization and demutualization reforms, all stock exchanges converted into public limited companies where ownership, management, and trading rights are strictly separated. Brokers cannot hold more than 49% of the aggregate equity or voting rights of an exchange.

The SCRA classifies contracts in securities to prevent illegal wagering and off-market bucket-shop transactions.

Classification of Securities Contracts

1. Spot Delivery Contract (Section 2(i)): A contract that provides for:
   • Actual physical or electronic delivery of securities and payment of the purchase price on the same day as the contract or on the next business day (T+0 or T+1).
   • In electronic demat mode, delivery and payment are executed through clearing corporation book entries.
2. Derivatives Contracts (Section 18A): Contracts in derivatives are legally valid and enforceable only if:
   • Traded on a recognized stock exchange;
   • Settled on the clearing house of a recognized stock exchange;
   • Executed in accordance with the rules and bye-laws of such stock exchange. Any off-market, unhedged OTC derivative contract that does not comply with Section 18A is void and illegal.
3. Illegal / Void Contracts (Sections 13, 16, 20):
   • Contracts entered into in notified areas other than between or through members of a recognized stock exchange are illegal.
   • The Central Government or SEBI may prohibit contracts in specified securities under Section 16 to prevent undesirable speculation.

Central Government & SEBI Supervening Powers

• Section 9 & 10: Power of stock exchanges to make bye-laws, and power of SEBI to direct amendment of exchange bye-laws.
• Section 11: Power of SEBI to supersede the governing body of a recognized stock exchange for up to one year in the public interest.
• Section 12: Power to suspend the business of a recognized stock exchange for up to seven days (extendable) in emergency market conditions.

The Securities Contracts (Regulation) Rules, 1957 (SCRR) outline the operational mechanics of stock exchange membership and public company listing standards.

Stock Exchange Membership Requirements (Rule 8)

• No person can be admitted as a broker-member unless they are of Indian nationality (or meet reciprocal foreign partnership norms), at least 21 years old, and not insolvent or convicted of fraud.
• Members cannot engage as principals in any business other than securities or commodities broking without prior exchange approval.
• Audit of Member Accounts (Rule 16 & 17): Members must maintain designated books of accounts, client ledgers, journal books, and bank accounts, retaining them for at least five (5) years.

Listing Regulations & Minimum Public Shareholding (MPS)

+-----------------------------------------------------------------------------------+
|               MINIMUM PUBLIC SHAREHOLDING (MPS) ARCHITECTURE                      |
+-----------------------------------------------------------------------------------+
|  STATUTORY BENCHMARK: 25% Minimum Public Shareholding (MPS)                       |
|  - Applies continuously to all listed commercial non-PSU entities                 |
|                                                                                   |
|  NEW LISTING GLIDE PATHS (Rule 19(2)(b)):                                         |
|  * Post-issue capital <= ₹1,600 Cr   --> Must offer at least 25% at IPO           |
|  * Post-issue capital ₹1,600 - 4,000 Cr -> Min ₹400 Cr issue; achieve 25% in 3 yrs  |
|  * Post-issue capital > ₹4,000 Cr    --> Min 10% issue; reach 25% within 5 years  |
+-----------------------------------------------------------------------------------+

Rule 19: Requirements for Listing

Specifies requirements for draft offer documents, allotment transparency, minimum subscription, and public share allocation.

Rule 19A: Continuous Minimum Public Shareholding (25% Rule)

• Every listed company must maintain a public shareholding of at least 25% on a continuous basis.
• Approved Methods for Diluting Promoter Holding to Achieve MPS:
  1. Offer for Sale (OFS) through stock exchange bidding screens;
  2. Qualified Institutions Placement (QIP);
  3. Rights Issue to public shareholders (promoters forgo entitlement);
  4. Bonus shares issued to public shareholders;
  5. Open market sale up to 2% within 12 months;
  6. Any other mechanism specifically permitted by SEBI.
• Penalties for Non-Compliance with MPS: Stock exchanges may freeze promoter demat accounts, levy daily fines (₹5,000/day), suspend trading, and initiate compulsory delisting.

The SCRR and SEBI's subordinate regulations establish the framework for ongoing listing compliance and exit mechanisms for listed companies.

The Mechanics of Public Shareholding Maintenance

Under Rule 19A of the SCRR, every listed entity must continuously maintain at least 25% public shareholding:

• If public shareholding falls below 25% due to an open offer or corporate restructuring, the company must bring it back to 25% within twelve (12) months.
• Exchange Enforcement Framework: Stock exchanges continuously track shareholding patterns. Where a company fails to maintain MPS, exchanges issue notices, freeze the promoter group's entire shareholding, bar promoters from holding new directorships, and impose daily financial fines on the non-compliant company.

Delisting of Equity Shares

Delisting refers to the permanent removal of a company's securities from a recognized stock exchange, after which they can no longer be traded on the exchange:

1. Voluntary Delisting: Initiated by the company/promoters through the Reverse Book Building (RBB) process.
   • Floor price is determined in accordance with SEBI Delisting Regulations.
   • Public shareholders tender their shares, and the final exit price is discovered at the price at which the promoter's holding crosses the 90% delisting threshold.
   • If the discovered price is accepted by the acquirer, public shareholders are paid, and the company is delisted.
2. Compulsory Delisting: Initiated by the stock exchange as a punitive measure for prolonged non-compliance, continuous trading suspension, failure to pay listing fees, or corporate liquidation.
   • An independent valuer determines the fair value of shares.
   • Promoters are required to acquire the public shares at the fair value so determined.
   • Promoters and whole-time directors of compulsorily delisted companies are barred from accessing the securities market and listing any other venture for a period of ten (10) years.