SEBI regulations don't apply to MCX-SX: Expert

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Market regulator SEBI has rejected MCX-SX's application for an equity exchange. It says the application does not fully comply with norms and is not in the interest of trade and public.

In an interview with CNBC-TV18's Shereen Bhan and Sajeet Manghat, Sandeep Parekh, Founder, Finsec Law Advisors and Vivek Gupta, Partner, BMR & Associates gave their perspective on the latest SEBI order.

Below is a verbatim transcript. Also watch the accompanying video.

Q: Let me pick up the points that SEBI has put forward in its order. Let me start with point number one that it makes. The concentration of economic interest in a recognized stock exchange in the hands of two promoters is not in the interest of the well regulated securities market. This is the first point of contention that SEBI has made in its order. How would you respond to this? This has been a public battle and we have just had the MCX responding and its pretty much said the same thing in its letter to SEBI dated the 16th of September where it says that the conversion of equity into warrants was as per what SEBI had actually proposed to them to do?

Parekh: I think that clearly this is a regulation which I think is one of the silliest regulations. It is anti competitive but the fact is that it is a regulation of SEBI. I think the real core issue here is which is discussed in the order, I have read the 68 page order and the real core issue is whether these regulations apply to MCX-SX at all. I believe they don't because it applies only to exchanges which go through the corporatization and the mutualization process.

So though they need to fulfill that 51% shareholding by the public they don't really need to go through the process which is given in the regulation. So from what I can see I think the big picture MCX seems to be in a strong ground that the regulations don't even apply to them. So whether it's good regulation or bad regulation, it is a regulation but it doesn't seem to apply to them.

Q: You just heard Sandeep Parekh saying that this is a silly regulation that doesn't even seem to apply to the MCX. What do you make of the SEBI order?

Gupta: I think there are two parts to this order. One is the part which is a very technical part which relates to whether the holding of 5% shares and the holding of 55% warrants means that the promoters hold 60% economic interest in the company and whether that constitutes ownership within the meaning of these regulations or not. So that's a very technical part.

My personal view is this is a matter of interpretation but my personal view is that MCX is on good ground on this technical part. The order however is very cleverly crafted. The order goes on to talk about public interest and the way in which the entire order is written seems to suggest that they are alleging that MCX has not acted honestly and that therefore they should not be allowed to function as a stock exchange and therefore SEBI is using its discretionary power to regulate what comes into being in our economic field as an exchange.

They have said that the exchange is an instrument of the state and they have let through to an entirely substantive part of whether a company like MCX should be allowed to function as a stock exchange or not. That part becomes a little more difficult to refute on appeal.

Q: It very clearly says that both financial technologies and MCX hold 5% each and therefore they are persons acting and they are promoters and persons acting in consert and therefore they violate the 5% guideline of not holding more than 5%. Can both Financial Technologies (FT) and MCX be considered as mutually exclusive entities in this case?

Gupta: Persons acting in consert has a very clear definition. Again this is something that falls within question number one which is a technical question. I am sure that when such a complex scheme of restructuring has been proposed by the promoters, they have taken adequate care to say that FT and MCX do not form part of the same promoter group.

So technically I am sure that they have taken adequate care to be able to demonstrate that they are not persons acting in consert.

So on this part also I think on appeal they probably will have a good case. I am not aware of the exact facts pattern and I am not aware of exact build up of facts that they would have done but I would imagine that this is something that they would have done to ensure that both the promoter entities do not constitute persons acting in consert.

Q: The other aspect which the SEBI has raised is that MCX-SX is instrumental to buy back transactions. Now these are transactions which MCX-SX has entered with various banks to which it has already issued equity. Can that aspect also be taken against them because what SEBI is clearly saying is that these buyback transactions are illegal under the Securities Contract Regulation?

Gupta: I don't know whether the securities contract regulation act will apply to unlisted securities in this format technically. The fact that there is a buyback and if there is a buyback at a certain price which is assured will indicate in substance the promoters are in control of the company because other shareholders who are holding shares are holding shares only for guaranteed kind of buyback return.

So from a fact point of view that is not a good fact for MCX if that fact is true. I don't know the way it has been written up in the order, the way I read it. I am not sure whether SEBI has sort of ruled that this is a definite fact. But if this fact exists even if technically refutable I think this is a bad fact from an MCX standpoint.

Q: Let me read out exactly what the order says and this is point number 5 in the order, The applicant is instrumental to buyback transactions that are illegal under the SCR Act and cannot be considered to have adhered to fair and reasonable standards of integrity that should be expected of a recognized stock exchange, what do you make of this?

Parekh: They are clearly saying to kind of make the legal case first, it is not permissible to have a buyback, basically you can't have a forward arrangement and I think the Supreme Court has said that already. It applies not just to listed securities but it applies to public limited companies, it doesn't apply to private limited companies. So prima facie it does seem to apply to MCX.

But I think the other issue really is of the fact that warrants were issued and that's where the MCX is on a much stronger wicket because not only is SEBI's argument that it violates the spirit, there is no such thing as spirit of the law. There is a spirit of the constitution but there is no spirit of the law. Either you comply or you don't comply.

And the other issue is that SEBI itself doesn't recognize warrants as equity shares. Look at the takeover regulations. There is no disclosure requirement at the time you acquire the warrants. Only at the time warrants are converted into shares do the takeover regulations take cognizance of them. So SEBI's own possession in their own regulations which are statutory in nature recognize those possessions. So I don't see how the SEBI is taking a different position in this case.

Q: Going back to that letter written by the MCX to SEBI on the 16 th of September, they go on to say the promoters converted the equity shares into warrants as suggested by SEBI and it used that capital to the extent that FT and MCX held only 5% each which was approved by the Bombay High Court. So you continue to believe that this is where MCX really has the advantage or really is not on shaky ground and is on a firm wicket as far as this order is concerned?

Parekh: Warrants is one and I think the biggest issue is whether the regulations apply to them at all. So I think they have the trump card there if they go to the High Court they can say that this doesn't apply to us, it didn't apply to NSE for instance. NSE out of their good heart they kind of complied with it, but it was very clear that it does not apply to exchanges which are already corporatized and demutualized. So they have got a trump card, they don't need to get into these micro issues in my opinion.

Q: Would you agree that they do have a trump card on their hands and hence they would be on a steady or a strong wicket if they decide to go in for an appeal which is perhaps what they are most likely to do at this point?

Gupta: They will definitely appeal I am pretty sure. I think I would reiterate what I said earlier. I think they are on good ground on the technical aspects of the case, they are on reasonably good ground there.

I don't however know that the introduction of this entire element of the fact that stock exchanges act as a instrument of the states, that they must function in a particular manner and that the conduct of the promoters has not been such that will behove a state. I don't know whether the introduction of all these elements however spoils their case a little bit on appeal.

So I am not as sanguine as Sandeep is on the fact that they have a very strong case. I think on technical grounds they have a good case to argue that the objective of the regulations is only to control dispersion of control. That they don't have control more than 5% each, that they have only economic interest. So that technical part I think is strong. But I think the way this order has been written up, it is an order which will get spot in appeal and it wouldn't be a straightforward fight.

Q: Respond to what Vivek Gupta said and I am going to read out exactly what SEBI says, "The prime concern of the SEBI should be to ensure to the best of its ability that the state so created under its seal and authority is invulnerable and immune to these risk therefore SEBI is justified in its stand in the notice that the concentration of economic interest in such an institution is not acceptable to it."

Parekh: My last two bits is I think these are probably the most hideous regulations of SEBI. I was in fact part of SEBI when these were passed. They clearly restrict competition from entering which is why we have 60-70% operating margins of stock exchanges. These regulations themselves should go, the requirement that you have to have a very diverse split ownership and try to replicate western models which have been in existence for 125-150 years, I think it is totally inappropriate. We need to give exchanges 5-10-20 years to comply with these kinds of regulations.