Order in the matter of MCX Stock Exchange Limited

1. MCX Stock Exchange Limited (hereinafter referred to as MCX-SX or the Applicant) filed a letter with Securities and Exchange Board of India (hereinafter referred to as SEBI) on April 7, 2010. This letter (hereinafter referred to as the Application) inter alia seeks permission to deal in interest rate derivatives, equity, futures and options on equity and wholesale debt segments and all other segments permitted to the Bombay Stock Exchange limited and the National Stock Exchange of India Limited. MCX-SX also requested SEBI to consider its application for SME Exchange as an additional segment within itself for operations. Subsequently, MCX-SX filed a writ petition (No. 1440 of 2010) before the Honourable High Court of Judicature at Bombay, which was disposed of by the Honourable High Court, vide order dated August 10, 2010 with the following directions: “(a) Respondent No.1 SEBI will take a final decision in the matter latest by 30th September, 2010. In order to ensure that the aforesaid time limit is treated as mandatory and peremptory, SEBI shall write letters to the shareholders of the petitioner-company, from whom such information is awaited, calling upon them to send necessary information to SEBI within 10 days from today.

(b) Respondent nos.2 and 3, through petitioner-company shall also convey to SEBI the Board Resolution of the respective co-promoters i.e. respondent nos.2 and 3 indicating their resolve to comply with the requirement of statutory regulations regarding the shareholding not exceeding the prescribed percentage. (c) Upon receiving such information from respondent nos. 2 and 3 and other shareholders of the petitioner-company, if SEBI requires further information/clarification from petitioner or others, the same shall be sought immediately and an opportunity of hearing shall be given to the representatives of the petitioner-company within four weeks from today, and thereafter a final decision shall be taken by SEBI latest by 30th September, 2010.” 2. Having made necessary enquiry on the aforesaid Application filed by MCX-SX, SEBI, prima facie, was not satisfied that it would be in the interest of trade and also in public interest to allow the application. Accordingly, a notice dated August 30, 2010 (hereinafter referred to as the Notice) was issued to MCX-SX, inter alia in terms of Section 4(4) of Securities Contracts (Regulation) Act, 1956 (hereinafter referred to as the SCR Act) read with Section 11(1) of the Securities and Exchange Board of India Act, 1992 (hereinafter referred to as the SEBI Act) detailing the prima facie observations of SEBI.

An opportunity of hearing was also afforded to MCX-SX on September 6, 2010, on which date, Mr. J.J. Bhatt, Senior Advocate made elaborate submissions on behalf of MCX-SX. Mr. Joseph Massey, Managing Director of MCX-SX along with other officials of MCX-SX was also present during the hearing. MCX-SX also filed its written submissions on September 16, 2010, as undertaken by it during the course of hearing.

3. I have considered the Notice dated August 30, 2010, the submissions made by the Learned Senior Advocate on behalf of MCX-SX, the written submissions of MCX-SX and other material available on record. Before proceeding further, I would like to summarise the background to the matter. MCX-SX was recognised as a stock exchange by SEBI under Section 4 of the SCR Act, vide notification dated September 18, 2008, subject to the condition that it shall ensure full compliance with the relevant provisions of Securities Contracts (Regulation) (Manner of Increasing and Maintaining Public Shareholding in Recognised Stock Exchanges) Regulations, 2006 (hereinafter referred to as the MIMPS Regulations) within a period of one year. MCX-SX was also directed to comply with such other conditions as may be prescribed by SEBI from time to time. It was further communicated to MCX-SX that it had been permitted to initially operationalize the Exchange Traded Currency Derivative Segment, for one year only from the date of effective grant of recognition. As MCX-SX did not comply with the requirements within the said period, it had requested further time for compliance and accordingly, its recognition was extended for a further period of one year up to September 15, 2010, vide notification dated August 31, 2009, subject to a condition, in addition to those imposed earlier, vide notification dated September 18, 2008 that it would operate only in securities in which trading was permitted and shall not be eligible for introduction of any new class of contracts in securities, till such time as the compliance referred to above are ensured. In the letter dated April 7, 2010 (the Application), MCX-SX had informed that it had successfully achieved compliance with the MIMPS Regulations and enclosed therewith a list of shareholders and the present shareholding in the stock exchange and sought permission from SEBI to deal in new classes of securities. It is this Application of MCX-SX, which would be disposed of herein. WRITTEN REPLY OF THE APPLICANT

4. I have perused the written submissions dated September 16, 2010 of the Applicant. In the hearing on September 6, 2010, the Learned Senior Counsel for the Applicant placed the facts of the case, objectively elaborating the merits of the Application before me. However I see a marked deviation in the written submissions. The letter dated September 16, 2010, signed by Mr. Joseph Massey, Managing Director of MCX-SX, presents me with an unusual situation. His letter, raises several allegations of bias, and questions the conduct with respect to the Applicant, of the Chairman and two of Members of SEBI including mine. I note that the letter is accusative in tone and raises several issues that are extraneous to the matter under consideration. I further note that the Applicant had not, made any such allegations or accusations of bias at the time of hearing. I also observe that the Applicant did not raise any allegations in the aforesaid Writ Petition filed by it before the Honourable High Court also.

5. Inter alia, Mr. Joseph Massey also raises the issue that the Applicant had sent more than twenty letters to SEBI, to which SEBI had not responded. It was further submitted that the idea of the Scheme of Capital Reduction through warrants emanated from SEBI through the conversations with an officer in SEBI, and that therefore SEBI is estopped from questioning the Scheme.

6. Mr. Joseph Massey further along with his letter and other written submissions, has filed an Affidavit. This Affidavit is to the following effect: a. that he actually got the idea behind the Scheme of Capital Reduction (viz. that of using warrants as against the practice of selling shares) from oral conversations with an officer in SEBI. b. that there were other oral conversations in some of the meetings between him and other representatives of MCX-SX and SEBI (as also referred to in Paragraph 2.7 and 2.8 of the Notice) where the Applicant had informed SEBI about the Scheme.

7. I am unable to see the reason why, at this juncture, the Applicant in his written submissions, at variance with its approach both at the time of hearing on September 6, 2010 and in its writ petition before the Honourable High Court, has raised allegations, in these proceeding before me. However, as these are extraneous to the disposal of this Application, I do not intend to dwell any further on these.

8. I shall, however, make the following observations for the record: a. On the non-response by SEBI to the large number of letters addressed by the Applicant, as mentioned above, I observe that almost all of them are requests for allowing the Applicant to operate in more segments and products. I note that, by public notifications referred to in Paragraph 3 above, SEBI had set the conditions for compliance that the Applicant had to fulfil. I have examined these letters of the Applicant, and find that they are simply repeated requests made without any one of them addressing the relevant issue – viz. whether the Applicant had complied with the conditions publicly notified and had to be mandatorily fulfilled.

b. I further note that the Applicant has relied on a reference to oral conversations with an officer of SEBI, as proof of the fact that the Scheme had been brought to the attention of SEBI. It would be beyond the scope of these proceedings and outside the powers vested in me, to go into these alleged conversations. But, on the face of it, there evidently seems to be a piece missing, that for an Applicant who had admittedly written more than twenty letters to SEBI, not one of them referred to the Scheme that was devised to comply with regulatory requirements or even to the alleged conversation with the SEBI officers about the scheme. I find it too far-fetched to believe that the Scheme for compliance did not merit a letter to SEBI, but was referred to SEBI through the alleged oral conversation. c. I also note that SEBI has a well laid out procedure for providing informal guidance. The Applicant has not sought any guidance from SEBI even under this procedure, as to whether the Scheme drawn up would be compliant with the MIMPS Regulations. It would be difficult for me to accept a premise that SEBI is estopped from objecting to the Scheme, because the idea for the same, allegedly originated from an officer in SEBI, in an oral conversation.

9. Having made these observations on the written submissions filed by the Applicant, I shall now proceed to carefully examine these submissions and try to sift the substantive grounds of fact and law therein from what is extraneous, for examining the merits of the Application before me.

LEGAL FRAMEWORK 10. Before going into the merits of the Application, it is useful to briefly set out the legal framework relevant to the same. Section 4(1) of the SCR Act provides that 4. (1) If the Central Government is satisfied, after making such inquiry as may be necessary in this behalf and after obtaining such further information, if any, as it may require,— (a) that the rules and bye-laws of a stock exchange applying for registration are in conformity with such conditions as may be prescribed with a view to ensure fair dealing and to protect investors; (b) that the stock exchange is willing to comply with any other conditions (including conditions as to the number of members) which the Central Government, after consultation with the governing body of the stock exchange and having regard to the area served by the stock exchange and its standing and the nature of the securities dealt with by it, may impose for the purpose of carrying out the objects of this Act; and (c) that it would be in the interest of the trade and also in the public interest to grant recognition to the stock exchange; it may grant recognition to the stock exchange subject to the conditions imposed upon it as aforesaid and in such form as may be prescribed.”

11. The Legislature has conferred the powers to grant recognition to a Stock Exchange under Section 4 of the SCR Act on the Central Government. These powers were thereafter passed on to SEBI for exercising the same. The aforesaid Section provides that the authority granting such recognition, (the Central Government or SEBI), should be “satisfied” that it would be in the interest of trade and in public interest to grant such recognition. In arriving at its satisfaction under Section 4 of the SCR Act, SEBI has to uphold the highest standards of fairness in deciding inter alia, whether it would be in the public interest and in the interest of trade to allow this Application. The standard for how any authority should arrive at this satisfaction is captured succinctly in the judgement of the Honourable Supreme Court of India in S.R. Bommai v. Union of India (AIR 1994 SC 1918). The guiding principle enunciated by the Honourable Supreme

Court is that it should not be “the personal whim, wish, view or opinion or the ipse dixit” of the Authority “dehors the material but a legitimate inference drawn from the material placed before him which is relevant for the purpose.”

12. The matter here before SEBI, while disposing of the Application, is not to consider whether recognition as a Stock Exchange should be granted to MCX-SX. The Applicant is already a recognized Stock Exchange. The recognition to MCX-SX as a Stock Exchange was granted for a period of one year (further extended twice for periods of one year each) and limited to operations in specific products. What comes up for consideration is whether the Applicant should be allowed to operate as a full fledged Stock Exchange in all segments and products as requested by it. The request in this Application is therefore to extend the scope of the recognition to the segments and products requested by it. SEBI has to dispose of this Application, in exercise of its powers under Section 4 of the SCR Act, the same provision in law, wherefrom it derives its authority to grant recognition to a Stock Exchange. In other words, the entire legal framework under which SEBI grants recognition to Stock Exchanges or grants extension of the operations of a Stock Exchange (as requested for in the Application) emanates out of Section 4 in the SCR Act. At the time of the hearing, the Learned Senior Counsel admitted that the Notice could be at best be considered maintainable under Section 4(4) of the SCR Act, while disputing the applicability of the other sections of law cited in the Notice. However, I note that in its written submission, the Applicant has questioned the maintainability of all sections cited in the Notice. The other provisions whose applicability is challenged by the Applicant are Sections 11(1), and 11B of the SEBI Act and Section 12A of the SCR Act. However, I do not think that the Applicant, in disputing the applicability of these provisions has advanced any valid arguments in support of its stand. Nonetheless, I observe in passing that these Sections merely underpin the powers to administer the Securities Market. I further note that the recognition conditionally granted to the Applicant was under Section 4 of the SCR Act. Therefore, a review of whether these conditions have been satisfied has to be done under the above provisions.

13. In its Notice dated August 30, 2010, SEBI has set out five grounds, why prima facie, it is not satisfied that it would be in the interest of trade and in public interest to allow the Application. These grounds in the Notice, in brief are the following: i. There is an excessive concentration of economic interest in the Stock Exchange, in the hands of the two promoters, Multi Commodity Exchange of India Limited (hereinafter referred to as MCX) and Financial Technologies (India) Limited (hereinafter referred to as FTIL). ii. The Applicant is not in full compliance with the MIMPS Regulations. iii. The conduct of the Applicant and its aforesaid promoters lacks honesty and therefore they are not fit and proper for the grant of the Application. iv. The aforesaid promoters of MCX-SX are persons acting in concert, and therefore they can together hold a maximum of 5% of shares in the Stock Exchange. v. The aforesaid promoters have entered into certain contracts with buy back arrangements that are in the nature of forward contracts and these are illegal under the SCR Act.

14. I find that in the Notice issued by SEBI, in Paragraphs 3.1 to 3.16 (the fit and proper status of the Applicant) therein, certain prima facie findings have been entered into, about the conduct and character of the promoters of MCX-SX. I also find that this Notice, in the context of disposing of the Application was issued only to the Applicant and not to the promoters. The promoters MCX and FTIL have not been given an opportunity for representation and have not been heard. Hence, I shall not discuss or enter into any findings on the individual conduct of the aforesaid promoters, MCX and FTIL, and shall confine myself to taking up this issue only to the extent that pertains to the Applicant itself.

15. I propose to discuss these grounds in the following sequence firstly, whether the Applicant is in full compliance with the MIMPS Regulations (Paragraphs 2.1 to 2.27 in the Notice), secondly, whether the two promoters of MCX-SX are persons acting in concert (Paragraphs 4.1 to 4.7, in the Notice), thirdly, whether the buy back arrangements referred to in the Notice are legal under the SCR Act (Paragraphs 5.1 to 5.4 in the Notice), fourthly, whether the Applicant is fit and proper (Paragraphs 3.1 to 3.16 in the Notice) and lastly, the concentration of promoter’s economic interest in the Stock Exchange and the consequences thereof (Paragraphs 1.1 to 1.8 in the Notice).

FULL COMPLIANCE WITH MIMPS REGULATIONS 16. In the Notice, SEBI has prima facie, found that the Applicant has not fully complied with the MIMPS Regulations for the following reasons: a. The Scheme of Capital Reduction adopted, is different from the specific modes laid down in Regulation 4 of the MIMPS Regulations and does not meet standards of “full” compliance with the MIMPS Regulations. b. The Scheme of Capital Reduction is contradictory to what the Applicant had given SEBI to understand as to how they would comply with Regulation 8(1) of the MIMPS Regulations. c. There are no valid reasons to allow the Applicant a different means to comply with the MIMPS Regulations through the Scheme of Capital Reduction, other than what has been permitted for, or adopted by other Stock Exchanges in India.

d. Given that the objective of the MIMPS Regulations is to ensure diversified ownership, any shareholder holding right to acquire equity share capital through warrants, in addition to the maximum limits allowed for holding equity share capital, runs contrary to the objectives of the MIMPS Regulations. e. The manner in which MCX-SX has attempted to comply with Regulation 8(1), has not led to the diversification of ownership and economic interest in the Stock Exchange in a manner that is conducive to the development of a well-regulated securities market in India.

17. The crux of the arguments of the Learned Senior Counsel for the Applicant is the following: a. The Applicant has complied with the shareholding restrictions in Regulation 8(1) of the MIMPS Regulations. b. The MIMPS Regulations refer to restrictions on equity shareholdings alone and not on warrants. c. Equity Shares and warrants are different, and there is no legal bar in holding warrants by the promoters of MCX-SX. d. The Notice attempts to circuitously bring in the modes referred to in Regulation 4 into Regulation 8 of the MIMPS Regulations. e. The Applicant has not wrongly led SEBI to believe anything about its divestment plans, as alleged in the Notice. f. It might be true that when representatives of MCX-SX visited SEBI, they may not have informed SEBI about the scheme, but that does not vitiate its action. g. The Scheme was public and advertised in the Newspaper – and the Applicant was transparent about it. h. The Applicant did not share what it proposed to do under the Scheme of Capital Reduction with SEBI, because it was not legally obliged to do so.

i. The Applicant and the promoters have given a solemn undertaking in the Scheme and before the Honourable High Court that it would not breach its shareholding limits of 5%. j. The Scheme of Capital Reduction, once approved becomes compliant with public policy and law. k. What is not explicitly prohibited under law is permissible and the mode adopted by the Applicant is legal.

18. The Applicant in its written reply further submitted that Chapter II including Regulation 4 of the MIMPS Regulations does not apply to it. Hence, despite the Notice specifying that the “manner of achieving shareholding restrictions specified in Regulation 8 have not been specified explicitly”, an attempt is being made to bring in the provisions of Regulation 4 to decide the recognised modes for compliance.

19. The quintessential thread that runs through this set of arguments of the Applicant is that the Scheme of Capital Reduction has made MCX-SX fully compliant with the MIMPS Regulations. Therefore, it becomes necessary to first consider the scope of the expression “full compliance” itself. For appreciating the scope of this expression, the relevant Statutes that govern Recognised Stock Exchanges have to be carefully examined first.

20. As mentioned, Section 4(1) of the SCR Act is the relevant section under law that deals with grant of recognition to a stock exchange. In 2004, about fifty years after the SCR Act was enacted, the Legislature amended it by the Securities Laws (Amendment) Act, 2004, to provide for the corporatisation and demutualisation of stock exchanges. By virtue of the said amendment a recognised stock exchange had to be necessarily ‘a company incorporated for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities carried on by such individuals or society.’

and also had to be demutualised viz: that an exchange would have to segregate “ownership and management from the trading rights of the members of a recognised stock exchange in accordance with a scheme approved by the Securities and Exchange Board of India”.

21. For the implementation of the corporatisation and demutualisation of stock exchanges, the SCR Act was amended to incorporate Sections 4A and 4B in the same. Section 4B(8) interalia provides that: “Every recognised stock exchange, in respect of which the scheme for corporatisation or demutualisation has been approved under sub-section (2), shall, either by fresh issue of equity shares to the public or in any other manner as may be specified by the regulations made by the Securities and Exchange Board of India, ensure that at least fifty-one per cent of its equity share capital is held, within twelve months from the date of publication of the order under sub-section (7), by the public other than shareholders having trading rights: Provided that the Securities and Exchange Board of India may, on sufficient cause being shown to it and in the public interest, extend the said period by another twelve months.” (Emphasis supplied)

22. The MIMPS Regulations therefore is a Regulation that was framed by SEBI, consequent to Section 4B (8) of the SCR Act, inter alia, to ensure that 51% of the equity capital of a Stock Exchange is held by non-trading members. The said Regulations is framed in exercise of the powers conferred under Section 31 read with Section 4B(8) of the SCRA. Section 4B only relates to the “Procedure for corporatisation and demutualisation”. Clearly, neither does it lay down the conditions precedent to or criteria to be adopted for recognition of a stock exchange, nor was it meant to be for the same. Therefore, I observe here, that save as provided for in Section 4(1) of the SCR Act, there is no statute in law to this date, that has been enacted to lay down the specific conditions that a Stock Exchange should fulfil to determine as to whether the grant of recognition to a Stock Exchange will be in public interest and in the interest of trade.

23. MCX-SX was recognised as a stock exchange by SEBI under Section 4 of the SCR Act in September 2008 subject to certain conditions. At the time of recognition, MCX-SX was not compliant with the requirements of MIMPS Regulations. It was given time of one year for fully complying with the same. As it did not comply with the requirements in this period of one year, and as requested by it, the recognition of the exchange was further extended for a period of one year up to 15th September 2010, vide notification dated August 31, 2009. In both the aforesaid notifications, SEBI imposed conditions on the grant/renewal of recognition as follows: “The Exchange shall ensure full compliance with the relevant provisions of Securities Contracts (Regulation) (Manner of Increasing and Maintaining Public Shareholding in Recognised Stock Exchanges) Regulations, 2006 (MIMPS Regulations) within a period of one year. The Exchange shall comply with such other conditions as may be prescribed by SEBI from time to time.”

24. At the time of application and recognition of MCX-SX as a stock exchange, it was already a corporatised and demutualised stock exchange. As seen from Regulation 3 of the MIMPS Regulations (reproduced below), the MIMPS Regulations is not applicable to stock exchanges that are already corporatised and demutualised. “Applicability 3. These Regulations shall be applicable to all recognised stock exchanges in respect of which the scheme for corporatisation or demutualisation has been approved by the Board under section 4B of the Act.” The Applicant has contended that Regulation 4 of the MIMPS Regulations does not apply to it. I note that, the MIMPS Regulations automatically apply only to recognised stock exchanges which have to be corporatized and demutualised. However, they are applicable to MCX-SX, because SEBI specifically imposed the condition inter alia, that the Applicant shall comply fully with the relevant provisions of the MIMPS Regulations within a period of one year. This has never been disputed by the Applicant at any time in the past, when it was granted recognition or renewal of its recognition.

25. The grant of recognition of a stock exchange is based on the satisfaction of the authority granting the same, as envisaged under Section 4(1) of the SCR Act. The determinants of how that satisfaction should be arrived at, have not been specified in the Statutes. MCX-SX was already corporatised and demutualised at the time of its recognition. SEBI imposed the condition of “full compliance with the relevant provisions of the MIMPS Regulations” on the Applicant, both at the time of original recognition and later at the time of the renewal. Clearly, there must be a reason why this was done. As explained further, an obvious inference that emerges is that SEBI recognised that the MIMPS Regulations is one of the useful measures and a ready touchstone for assisting it to arrive at the “satisfaction” prescribed in Section 4(1) of the SCR Act.

26. The rationale for this is not hard to find. The MIMPS Regulations, though formulated for an entirely different purpose (viz. for corporatisation and demutualisation of Stock Exchanges) encapsulates a wide range of principles and practices. Firstly, the Regulations themselves had its origin in Government’s intention to diversify ownership in stock exchanges through corporatisation and demutualisation. Secondly, it lists (in the context of corporatisation and demutualisation) all the admissible modes for increasing the public shareholding. Thirdly it lays down the restrictions on shareholders on the extent of shares that they could hold as well as restrictions on how such shares could be transferred. Fourthly it defines the eligibility criteria for persons acquiring or holding equity shares in a recognised stock exchange above five percent including the criteria for such a shareholder to be considered fit and proper. Fifthly, it lays down the obligations of a Stock Exchange including the responsibility to monitor the sale and transfer of shares. Lastly it provides for the powers of SEBI for inspections of stock exchanges and initiating action in case of default. In a nutshell, the MIMPS Regulations are a compendium of practices, procedures and standards, which SEBI finds useful to gauge compliance. Further, the MIMPS Regulations helps to ensure that the same set of conditions are uniformly applied over all exchanges whether corporatized and demutualized or not.

27. On the ambit of the expression “full compliance”, I therefore find that when SEBI prescribes “full compliance”, it is not in the narrow and restricted sense of Regulation 8(1) (i.e. shareholding limits) – as the Applicant would want it to be understood. If one were to extend the thread of this argument put forward by the Learned Senior Counsel, it would lead to a specious conclusion. The Applicant seems to be arguing that SEBI’s definition of “full” compliance should mean compliance with Regulation 8 [shareholding restrictions] alone. The Applicant conveniently ignores the question as to why then, if such was the intention, SEBI did not say so in its notifications - that all that is expected of the Stock Exchange is to comply with a specific provision(s) in the MIMPS Regulations. Clearly, the Applicant as a regulated Stock Exchange cannot prescribe what the scope of the term “full compliance” or what “the relevant provisions” should be, and how these should be circumscribed for the purpose of interpretation. Neither has it come before SEBI seeking clarification on what full compliance would be.

28. The next substantive argument of the Applicant is that by virtue of the Scheme of Capital Reduction being implemented, the requirements under the MIMPS Regulations will also stand complied with. The Learned Senior Counsel for the Applicant has strenuously argued that while approving a Scheme of Capital Reduction, the Honourable Court approving the same looks into all issues of compliance with law. The Learned Senior Counsel, cited the judgement of the Honourable Supreme Court in Miheer H. Mafatlal vs. Mafatlal Industries Limited (AIR 1997 SC 506) on the duties of a Court while approving a Scheme. As observed in this judgement of the Honourable Supreme Court, the “Court has to consider the pros and cons of the scheme with a view to finding whether the scheme is fair, just and reasonable and is not contrary to any provisions of law and it does not violate any public policy.” The Learned Senior Counsel submitted that the approval of the Scheme is therefore in conformity with public policy and law, including the MIMPS Regulations.

29. Needless to say, the submission of a Scheme under Sections 391 to 394 read with Sections 100 to 104 under Chapter V of the Companies Act, 1956 to a Honourable High Court/Tribunal is not a trivial matter. The reason is obvious. The powers given to Tribunal/Courts by Parliament under the aforesaid sections for arrangements and reconstruction of companies are exhaustive in nature.

30. From the papers relating to the Scheme of Capital Reduction filed by the Applicant, I observe that in the affidavit filed by the Regional Director (Ministry of Corporate Affairs) in the Honourable High Court, he has averred thus: “6. That the Deponent further submits that:- (a) The company is granted recognition as Stock Exchange by the SEBI being the regulating authority. The company has to inform to the SEBI about the proposed scheme of reduction of capital cum arrangement under section 100 to 104 read with section 391 to 393 of the Companies Act, 1956. In this regard the deponent respectfully submits that the company vide its letter dated 21-12-2009 has informed to the SEBI and obtained acknowledgement; a copy of the said letter is annexed and marked as Exhibit ‘D’. (b)….. Save and except as stated in para 6(a) & (b), it appears that the Scheme is not prejudicial to the interest of shareholders and public. In the light of aforesaid facts the Hon’ble Court may pass such orders as deem fit and proper.” (Emphasis supplied)

31. It follows that the Regional Director on behalf of the Central Government has averred that “save and except as stated in para 6(a) & (b)” (Emphasis supplied), the Scheme is not prejudicial to the interest of shareholders and public. Paragraph 6(a) in the Affidavit, (quoted above) refers to the regulatory authority for the Stock Exchange viz. SEBI. The affidavit sworn by the Regional Director, therefore was to the effect that the Scheme is not prejudicial to the interest of shareholders and the public – ‘save and except’ in so far as it relates to regulatory requirements, if any set by SEBI. In other words, the Regional Director, with respect to the issues of complying regulatory requirements cast on a Stock Exchange, very explicitly abstained from making a submission that the Scheme was not prejudicial to the interest of shareholders and the public in this regard. Thus, there was no averment by the Central Government or any other party before the Honourable Court as to whether the Scheme filed did actually comply with the regulatory requirements, as referred to in the objectives of the Scheme itself. What emerges is that, whether the Scheme was in compliance with the requirements arising out of the SCR Act or the MIMPS Regulations was at no time the subject matter for the consideration of the Honourable High Court. I also do not find any observations by the Honourable High Court in its order on the Scheme, on the question of whether the Scheme fully complies with the MIMPS Regulations.

32. The status of a Scheme approved under Sections 391 to 394 of the Companies Act, 1956 vis-à-vis requirements under other laws and statutes have been brought out vividly in the judgement of the Honourable High Court of Madras in Pentamedia Graphics Ltd. vs. The Bombay Stock Exchange 2008 (145)CC 327: “41. In the face of such requirement, it must be noted that the compliance of the provisions of Securities Laws, the Stock Exchange requirements and the Listing Agreement is absolute if any company wishes to have the shares listed thereon. While the requirement of No Objection is not a mandatory requirement for granting a Scheme, at the same time, it must be noted that any Scheme approved containing a clause for listing before an Exchange must necessarily comply with the mandate of the Securities Laws, rules and regulations and guidelines made under the Acts and the Listing Agreement. Hence, even after the sanction of the Scheme, it is open to the Stock Exchange to insist on compliance of its Regulations as a condition for listing, and in the event of any violation thereof, reject an application. By such rejection, the Scheme, per se, does not become bad or the order of this Court granting sanction violated. It must be noted that when the Court grants an approval to the Scheme, it is on the satisfaction that the arrangement or the compromise is not violative of the provisions of the Companies Act and is not against public interest. But where in the process of implementing the Scheme as approved by the Court, an authority, in exercise of its statutory power or a Regulation, finds that the implementation of a Clause in the Scheme as approved may not be implemented for violation of the Securities Laws and thus, the public interest would suffer, I do not think any objection could be taken to such view taken by an authority validly constituted. When an expert body assesses various aspects as regards the requirement on listing as required under law, it is well within its jurisdiction to pass an order rejecting the plea for listing, if it is satisfied on the materials therein, such listing is in violation of the Securities laws. In considering the scope of the jurisdiction of the authorities functioning under the Securities Act of this Court under Section 391, one must keep in mind the clear-cut respective jurisdiction on matters before it. (Emphasis supplied)

This principle has also been referred to by the Honourable High Court of Madras in Shree Karthik Papers Ltd vs. SEBI [2010 (155) CC 201]. Hence, I am unable to accept the argument of the Learned Senior Counsel, that by virtue of the Scheme being approved, it would have also fulfilled all requirements of law including that of compliance with MIMPS Regulations.

33. The Learned Senior Counsel for the Applicant has also argued that the Scheme for Capital Reduction and Arrangement was not shared with SEBI, because it was not necessary under law to do so. A Scheme of Capital Reduction is filed under Sections 391 to 394 read with Sections 100 to 104 of the Companies Act, 1956. So there can be no quarrel with the contention of the Applicant that there was no obligation on its part, to consult SEBI on a scheme for reduction of its capital. But in this instance, the Scheme of Capital Reduction filed by MCX-SX had a sole and specific objective. This objective is set out in Section III of the same. The Scheme is solely intended to meet the requirement viz: “condition of recognition of the Company, as stipulated by SEBI is that it has to ensure full compliance with the SCR Regulations.” In fact, this Scheme of Capital Reduction has no other objective defined therein. I further note that the letter of the Applicant to SEBI dated December 21, 2009 mentions that the “Scheme” visualized will be “in contrast to the normal practice” of complying with the MIMPS Regulations. Thus, the Applicant formulated a Scheme of Capital Reduction only to comply with the MIMPS Regulations. Admittedly, the Applicant knows that the mode for compliance with the Regulation is not normal. Therefore, it defies understanding as to why the Applicant did not, at the least, ask SEBI if the Scheme formulated solely to comply with MIMPS Regulations in a manner that is admittedly not normal, was in full compliance with the Regulations.

34. The Notice makes reference to meetings held between officials of MCX-SX and SEBI, immediately prior to the formulation and approval of the Scheme by its Board of Directors, and how even in these meetings, the proposed Scheme to comply with MIMPS Regulations was not disclosed. In the affidavit filed by Mr. Joseph Massey, Managing Director of MCX-SX, he states that he had orally informed officers in SEBI. However, in the absence of records on what transpired in these meetings, I do not find it necessary to consider this argument in the Notice any further.

35. I now go into the submission of the Applicant on the legality of holding warrants by a shareholder in a Stock Exchange. The thrust in the arguments of the Applicant is that, holding warrants should not be objectionable because the warrant holders cannot convert the warrants into shares in breach of the MIMPS Regulations. Warrants are the ‘right to equity shares’ in a company. It is not the case of SEBI that holding warrants of a Stock Exchange is illegal. The standard that SEBI has adopted here is simply that excluding the warrants held by a shareholder in computing the limits of ownership in an Exchange would violate the spirit of the MIMPS Regulations and would not be in consonance with it. The question for me to consider is whether it would be fair for SEBI to do so. I observe here that the MIMPS Regulations do not explicitly provide that shareholders of a stock exchange should not hold warrants. To that extent, I agree with the argument of the Learned Senior Counsel. But then equally, I cannot consider the holding of these warrants in isolation or in a vacuum. It has to be viewed in the context of the MIMPS Regulations itself and its objective of ensuring wider ownership in a Stock Exchange. For the purpose of the MIMPS Regulations, it would be fallacious to argue that holding ‘equity shares’ (in excess of the shareholder limits) is not permissible, but holding the ‘right to equity shares’ would be permissible. If something is illegal under a certain statute, then it stands to good reason that the ‘right’ to that something, which is illegal, should be equally illegal under the same statute. I cannot therefore accept this argument of the Learned Senior Counsel as a basis for finding that the Applicant is not in breach of the MIMPS Regulations.

36. This leads to another substantive issue as to the manner in which a shareholder holding shares in a stock exchange beyond the permissible limits can reduce the holding to below the permissible limits. As discussed above, the MIMPS Regulations embody the set of principles and practices that assist SEBI to gauge the regulatory compliance of a stock exchange and how full compliance goes beyond Regulations 8 and 9. Therefore, SEBI will be justified in using the MIMPS Regulations to determine the modes admissible to the Applicant for complying with Regulation 8(1) of the same.

Regulation 4 therein specifies four methods or their combination for the purpose of how a Stock Exchange should raise the public (non trading members) holding to 51%. These four methods are: i. fresh issue of equity shares to the public, ii. offer for sale, iii. placement i.e. sale of shares by non compliant members of the Exchange and iv. issue of equity shares by private placement. I also observe from the Notice and the documents submitted by the Applicant, that it had informed SEBI that it would be “working towards further broadbasing of our shareholding”. I further observe that initially, MCX-SX and its two promoters had been adopting the methods specified in the MIMPS Regulations. For instance, MCX-SX had issued fresh shares to PNB. The two non-compliant promoters, MCX and FTIL, had also sold their shares to other investors. Thus the stock exchange and the two promoters had, at various stages adopted two of the four methods specified above. I find that subsequently, the Applicant abandoned the modes explicitly provided in the MIMPS Regulations for broadbasing its shareholding, and decided to convert the excess shares of non compliant promoters into warrants.

Clearly, conversion of shares into warrants is not among the four modes contemplated in the MIMPS Regulations. The Applicant has contended that Regulation 4 does not apply to it, as it is already a corporatised and demutualised exchange. I have dealt with this argument elsewhere herein. A plain reading of Regulation 4 shows that it was intended to specify the manner of broadbasing shareholding, albeit when member-shareholders with trading rights hold excess shares. Clearly, the principle remains equally applicable even in the context of compliance by other shareholders without trading rights. If warrants are not available as a permissible mode for shareholders with trading rights to comply with shareholding restrictions, then unless there is any particular reason to the contrary, it should not be treated as a permissible mode for shareholders without trading rights either. If the MIMPS Regulations are used as a package of compliance standards, imposed as a condition on a recognised stock exchange to comply with, then I do not see how a mode not mentioned in the MIMPS Regulations becomes admissible for such compliance.

I therefore find that SEBI is justified in concluding that there is no reason in public interest to allow the Applicant to adopt a mode other than what is specified in the MIMPS Regulations to achieve compliance.

37. The Applicant submits that it, along with its promoters and other shareholders have undertaken not to violate the MIMPS Regulations in the Scheme of Capital Reduction. The promoters have also adopted shareholder resolutions stating that they will not breach the MIMPS Regulations. I have taken careful note of these resolutions. The restrictions on ownership in shares in a Stock Exchange have been prescribed under the MIMPS Regulations. I am unable to see how these assertions in the resolutions referred to above, will render the Applicant fully compliant with the MIMPS Regulations.

38. In the Notice in Paragraph 2.11, SEBI has observed that all Stock Exchanges in India have altered its capital structure consistent with the manner outlined in the MIMPS Regulations and that it does not find any reason to allow the Applicant to adopt a mode that is contrary to such practice. The Applicant has not furnished any particular reason, beyond maintaining its stand that it has not been expressly prohibited under law. MCX-SX in the scheme for capital reduction has cited the only reason for why it had to resort to such a scheme for achieving the shareholding restrictions laid down in Regulation 8 of the MIMPS Regulations. In Paragraph 2.4 of the approved scheme, it is mentioned that “the conventional method of bringing down the existing stake of Promoters by selling to investors may substantially delay the regulatory compliance.” Furthermore, (as averred in Paragraph 10(d) in its Writ Petition No.1440/2010 before the Honourable High Court), MCX-SX resorted to the scheme of capital reduction, because their divestment process “received a set back”, citing economic reasons for the same.

39. I note from the material referred to in Notice, that the sale in August 2009, of 44.2 million shares of MCX-SX by the promoter (FTIL) to ILFS was at a price of Rs.36 per share, each of par value Re.1. I further observe that the sale of shares by FTIL to IFCI of 71.875 million shares was at Rs.35 per share each of par value Re.1. I also note that PNB purchased 40 million shares at Rs.10 per share each of par value Re.1 in the fresh issue of shares. Thus the Applicant has issued shares at Rs.10 each and the promoters have sold shares at prices ranging from Rs.35 to 36 per share. The Scheme of Capital Reduction, ostensibly intended to restructure the capital to meet the stipulation of Regulation 8 was undertaken because, MCX- SX and its promoters could not carry out the divestment. The reasons for the delay and the inability to divest are not spelt out clearly, though it is stated that the process received a setback because SEBI did not allow new products to the Applicant. The Applicant, in the documents available before, has also referred to the losses being incurred in its operations. On August 30, 2010, SEBI has, for the second time, on the request of MCX-SX renewed its recognition by one more year till September 15, 2011, without prejudice to the disposal of this Application, thereby allowing three years in all from September 2008 to September 2011, to achieve the required compliance. So, the difficulty to divest shares could not therefore have been on account of any time restrictions that SEBI imposed on the Applicant. What emerges from the submissions of the Applicant is that the two promoters (holding shares in excess of the prescribed limits) may not have been able to sell their shares at a price that was satisfactory to them. SEBI grants the recognition to a stock exchange. At what price a promoter or a shareholder wants to sell its shares in a Stock Exchange, needless to say, should not be the concern of SEBI. These are purely commercial considerations of the shareholders. However, I am of the considered view that SEBI’s interpretation of “full compliance” under MIMPS Regulations should not be tailored for meeting the business objectives of the promoters. It would patently be a failure on the part of SEBI as a Regulator, were it to do so.

40. As stated in the Notice, SEBI is of the view that merely converting all the shares in excess of the limits prescribed, into warrants does not constitute “full compliance” with the MIMPS Regulations. Allowing a Stock Exchange to work around the MIMPS Regulations through a scheme similar to the one adopted by the Applicant would have far reaching implications for the regulation of the securities market. For instance, assume that a single corporate entity promotes a stock exchange and is allowed recognition by SEBI conditionally, subject to compliance with the MIMPS Regulations and that the promoter owns 100% of the total issued shares (say 100) in the company. All that the promoter would need to do would be to just issue 95 new shares; find the required number of investors to buy these shares; then switch an equivalent number of its 95 shares as warrants, and claim compliance. In this exercise, all shareholders including the promoter would arithmetically be brought within the limits on ownership set in Regulation 8(1), but it would be difficult for a reasonable person to accept that the Stock Exchange would have adequately satisfied the objectives of diversification embodied in the MIMPS Regulations and would be in full compliance of the same.

41. I am of the considered view that converting ‘equity shares’ into ‘right to equity shares’ – is an attempt to work around the requirements and attempting to merely meet the letter of Regulation 8(1). I note that SEBI has never given the Applicant any assurance that “full compliance” with the MIMPS Regulations will be achieved when the shareholding restrictions under Regulation 8(1) are met in any manner that the Applicant deems appropriate. Neither has the Applicant sought nor obtained any clarification from SEBI as to whether the mode adopted by it is fully compliant, even though it admits that the method adopted by it is not normal. I note that the Applicant has not adduced any reasons in public interest, as to why it is unable to adopt one of the methods specified in the MIMPS Regulations. I further also note that other recognised stock exchanges in India have neither sought permission nor adopted any method other than one of the methods referred to in the MIMPS Regulations.

42. SEBI has been mandated under the SEBI Act, 1992 to “protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit.” The SCR Act provides that the recognition of a stock exchange should be based on the satisfaction of SEBI and that it would be in public interest to grant such recognition. Based on the reasons elaborated in the preceding paragraphs, I find that SEBI is justified in holding that the Applicant has simply tried to work around the condition of full compliance imposed on it. Therefore, it is fair and reasonable on the part of SEBI to object to a mere substitution of shares held by non-compliant promoters with warrants. I also find that SEBI is reasonable in its stand that it does not find any reason in public interest to allow a mode for compliance that has not been mentioned anywhere in the MIMPS Regulations. The Act, Rules and Regulations do not envisage a perfunctory and superficial approach to the recognition of a regulatory institution like a stock exchange. Cleary such an approach would amount to irresponsibly diluting the standards for recognising stock exchanges in India. It will be fraught with perilous possibilities of compromising the integrity of the securities market. For the same reason, a mechanistic view that anything that is not expressly prohibited in law is permissible – and that hence the mode for compliance adopted by the Applicant is in order – is also not admissible. In the light of what has been discussed in the preceding paragraphs, I find that the Applicant is not fully compliant with the MIMPS Regulations. PROMOTERS OF MCX-SX AS PERSONS ACTING IN CONCERT

43. In the Notice, it was prima facie, observed that MCX and FTIL, the two promoters of MCX-SX are persons acting in concert, conjunctively taking into account the following viz. a. the conduct of the parties determining their identity, b. that they are under the same management, and c. that one has a dominant shareholding in the other.

44. The Learned Senior Counsel for the Applicant, has argued that by the proviso to Regulation 8 of the MIMPS Regulations, the term ‘persons acting in concert’ has the same meaning as in Regulation 2(1) (e) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (“Takeover Regulations”). In the Takeover Regulations, the necessary ingredient is that the “persons acting in concert’ should have a common purpose of acquisition. The Learned Senior Counsel argued that since there is no such intent to acquire, they cannot be “persons acting in concert”. The argument of the Learned Senior Counsel essentially is that the definition “person acting in concert” is acquisition-centric and since there is no active acquisition, MCX and FTIL are not persons acting in concert. Regulation 2(1)(e)(2)(i) of the Takeover Regulations, lays down that unless the contrary is established, a company, its holding company or subsidiary or such company or company under the same management either individually or together with each other shall be deemed to be “person acting in concert” with each other.

45. The Applicant reiterates the same in its written submissions. It is also submitted that none of the essential ingredients of Section 370(1B) is attracted in this case. There is no presumption in law or in fact that MCX and FTIL once co-promoters of the Applicant shall remain co-promoters or are persons acting in concert or deemed to be acting in concert in all case. The extracts from the letters (quoted in Paragraph 4.2 of the Notice) are extraneous and imprecise considerations to decide on the question of whether FTIL and MCX are ‘persons acting in concert’. It was further submitted that MCX and FTIL who wish to sell their shares in the Applicant cannot be persons acting or deemed to act in concert, firstly because their objective is not to acquire shares but to divest its existing shareholding in Applicant and secondly the objective is to ensure compliance with the provisions of the MIMPS Regulations. Similarly, Mr. Jignesh Shah holds executive position only in FTIL and his Vice Chairmanship with MCX and in the Applicant are non-executive.

46. I shall now examine these arguments of the Applicant. Regulation 8 of the MIMPS Regulations prohibits persons resident in India on holding more than five percent equity share capital in a recognized stock exchange, at anytime, directly or indirectly, either individually or together with persons acting in concert. Clearly, therefore, the objective of this provision is to ensure wider participation of public shareholders in the recognized stock exchanges, given the importance of such institutions in the securities market.

47. I note here, that subsequently, Regulation 8 of the MIMPS Regulations was amended on December 23, 2008, to specifically limit the holding of individual persons along with “person acting in concert” to five percent shareholding as contemplated under Regulation 8. The amendment was made to ensure that the objective of the MIMPS Regulations to ensure diversified ownership in a Stock Exchange is not diluted or circumvented in any manner.

For the purpose of the definition of “person acting in concert” as used under Regulation 8 of the MIMPS Regulations, Explanation IV of Regulation 8 provides that it shall have the same meaning as derived from Regulation 2(1)(e) of the Takeover Regulations. The expression “derived” was used in the MIMPS Regulations to explicitly convey the intention that the meaning of “persons acting in concert” (in the Takeover Regulations) shall not be pari materia applied but should be read mutatis mutandis keeping in view the objective of the MIMPS Regulations.

48. Under Regulation 2(1)(e) of the Takeover Regulations, “person acting in concert” comprises persons who, for a common objective or purpose of substantial acquisition of shares or voting rights or gaining control over the target company, pursuant to an agreement or understanding (formal or informal), directly or indirectly cooperate by acquiring or agreeing to acquire shares or voting rights in the target company or control over the target company. This requires that there should be common objective or purpose of substantial acquisition of shares or voting rights or gaining control over the target company. For the purpose of the MIMPS Regulations, this definition has to be read in the light of the amendment to Regulation 8 therein. The objective of Regulation 8 in the MIMPS Regulations is to ensure that the ownership of the exchange is not concentrated, whereas the objective of the Takeover Regulations is to ensure that there is no acquisition of substantial shares or control, without an open offer. Further, Regulation 8 of the MIMPS Regulations uses the expression ‘hold’ in contrast to the Takeover Regulations which uses the expression ‘acquire’. This would mean that the ‘common objective’ attaches itself to ‘holding’ the shares and not to ‘acquiring’ a target company. Therefore, if a person holds equity shares in excess of the permissible limits, in concert with others, he would be in violation of Regulation 8 of the MIMPS Regulations.

49. Applied in the context of a Stock Exchange, subsequent to amendment of the MIMPS Regulations, the persons holding shares in a recognized stock exchange with a common objective would be “persons acting in concert” for the purpose of Regulation 8. Accordingly, FTIL and MCX are de jure persons acting in concert for the purpose of Regulation 8.

50. The Learned Senior Counsel also submitted that the two promoters do not share a common management as defined in Section 370(1B) of the Companies Act, 1956. Section 370 of the Companies Act, 1956 deals with loans etc. to companies under the same management. Sub-Section (1B) of the said Section provides that for the purposes of sub-sections (1) and (1A) two bodies corporate shall be deemed to be under the same management:- “(i) if the managing director or manager of the one body, is managing director or manager of the other body; or (ii) if a majority of the directors of the one body constitute, or at any time within the six months immediately preceding Constituted, a majority of the directors of the other body; (iii) if not less than one-third of the total voting power with respect to any matter relating to each of the two bodies corporate is exercised or controlled by the same individual or body corporate; or (iv) if the holding company of the one body corporate is under the same management as the other body corporate within the meaning of clause (i), clause (ii) or clause (iii); or (v) if one or more directors of the one body corporate while holding, whether by themselves or together with their relatives, the majority of shares in that body corporate also hold, whether by themselves or together with their relatives, the majority of shares in the other body corporate.”

51. I have before me, the letters referred to in Paragraph 4.2 of the Notice. Relevant portions from these are reproduced below for ease of reference: “We undertake for and on our behalf of FTIL, La-Fin and our group companies, not to sell/issue any equity shares of MCX- SX until the warrants issued on capital reduction are converted into shares by the existing shareholders.” (Letter dated December 14, 2009 addressed by MCX to IL&FS Financial Services Limited)

“5. We as promoters of MCX-SX shall ensure that, save and except issuance of shares of MCX-SX to (a) banks as listed in annexure to this letter to enhance its share capital to Rs.180 crores, and (b) to the employees of MCX-SX in terms of employees stock options plans/schemes formulated by MCX-SX, MCX-SX shall not issue any shares to any person at a price below Rs.35/- per equity share, without the written consent of IL&FS Financial Services Limited which consent shall not be unreasonably delayed ordered by IL&FS Financial Services Limited. 6. We agree that pursuant to purchase of the MCX-SX shares from you as per point 1, we undertake for an on our behalf and on behalf of FTIL, MCX and our group companies, not to sell/issue any equity shares of MCX-SX for a period of three months commencing from the date of purchase as per point 1 above, for a price exceeding the Buy Back Price.” (Letter dated August 20, 2009 addressed by La-Fin to IL&FS Financial Services Limited)

52. The letters referred to above are those of Mr. Jignesh P. Shah, Director of La-Fin Financial Services Private Ltd., the promoter of FTIL. I find that, as brought out in the Notice, Mr. Jignesh Shah holds the positions of Chairman and Group Chief Executive Officer of FTIL, (a promoter of MCX-SX) and the Vice Chairman of MCX (the second promoter of MCX-SX). He is also the non-executive Vice- Chairman of MCX-SX. The Applicant has in his written submissions explained that he is only a non-executive Vice Chairman of MCX. Mr. Jignesh Shah has issued the undertakings referred to on behalf of MCX, FTIL, and other group companies that MCX-SX will not issue shares except as provided for. He is in a position to issue an undertaking not only for the company (FTIL) that he is managing director of, but also for the Company (MCX) for which he is designated as its non-executive Vice Chairman. I find that MCX, as per publicly available information, has a regular Managing Director. But it is Mr. Jignesh Shah and not the Managing Director who has issued the undertaking on behalf of MCX. In fact, he has issued these undertakings even on behalf of the Applicant as well – a fact that further brings out his position of dominance in the management of all these three institutions. Furthermore, I notice, from the publicly available information from the website of FTIL, that MCX is listed as one of the group companies of FTIL and that Mr. Jignesh Shah is designated as the Group CEO. One does not have to go farther, to see that Mr. Jignesh Shah is de facto, a ‘manager’ for both the promoter companies viz. FTIL and MCX. Using the test of common management in Section 370(1B)(i) of the Companies Act, 1956, it is reasonable to conclude that the two promoters are under a common management.

53. It is also not disputed before me that FTIL holds 31.18% of the shares in MCX. As on March 31, 2010, the rest of the shares are held by a wide group of institutions, and the second biggest shareholding is at 5.17% by an investment fund. Clearly FTIL enjoys a position of dominance in MCX by virtue of this. There is no denying that, at the least, FTIL has de jure, the right of negative control in MCX. Negative control by virtue of holding 31.18% is reactive in nature, and legally may not constitute control. But the real test of control is whether it is effective in nature. The Honourable Securities Appellate Tribunal in Subhkam Ventures (I) Private Limited vs. SEBI, Appeal 8/2009 dated January 15, 2010, laid down the essential ingredients for effective control, as follows: “The test really is whether the acquirer is in the driving seat. To extend the metaphor further, the question would be whether he controls the steering, accelerator, the gears and the brake. If the answer to these questions is in the affirmative, then alone would he be in control of the company. In other words, the question to be asked in each case would be whether the acquirer is the driving force behind the company and whether he is the one providing motion to the organization. If yes, he is in control but not otherwise. In short control means effective control.”

The idea of effective control or de facto control has further been clarified in the decision of the Honourable Securities Appellate Tribunal in Ashwin K. Doshi and others vs. SEBI, Appeal 44/2001 dated October 25, 2002 that de facto control can exist without any legal power at all. Judged against this yardstick, it is quite too obvious that Mr. Jignesh Shah is in effective control and clearly the driving force for the affairs of both FTIL and MCX.

54. Regulation 8(1) of the MIMPS Regulations provides that “No person resident in India shall at anytime, directly or indirectly, either individually or together with persons acting in concert, hold more than five per cent. of the equity share capital in a recognised stock exchange”. I observe that the said Regulations do not allow even an indirect holding in excess of five per cent of the shares of a stock exchange. Applied to the MIMPS Regulations, indirect holdings can happen in two ways. Firstly, as seen above, FTIL also indirectly holds shares in MCX-SX through MCX, as FTIL and MCX, share a common manager and are de facto controlled by the same entity. Therefore the holding of FTIL together with that of MCX exceeds the permissible limit of 5 per cent limit of ownership in a stock exchange. Secondly, FTIL holds 31.18% of shares in MCX. This implies that FTIL also indirectly holds 31.18% of the shares of MCX-SX owned by MCX. Hence indirectly FTIL holds 1.559% (viz. 31.18% of 5%). In this manner too, FTIL holds, directly and indirectly more than the permissible limit of 5 per cent of shares in MCX-SX.

55. Therefore, I find that for the reasons discussed above, MCX and FTIL are “persons acting in concert” in MCX-SX, and their present combined equity shareholding (of ten percent of the total equity shares) in MCX-SX is not in compliance with Regulation 8 of the MIMPS Regulations. BUY BACK ARRANGEMENTS IN VIOLATION OF THE SCR ACT

56. In its Notice, SEBI has observed that the promoters of MCX-SX and their associates had arrangements with three shareholders of MCX-

SX, (PNB, IL&FS and IFCI) where sale of shares between the parties were based on offers to buy back the shares at or within specified time in the future. The relevant details from the Notice, are reproduced below (Para 5.1): “a. PNB vide their letter dated August 19, 2010 has informed that the buy back offer is implicitly extinguished in view of their agreement to the Scheme of Capital Reduction, through which promoters of MCX-SX viz. MCX and FTIL cannot hold more than 5% shares in MCX-SX. They have further clarified that post this extinguishment, no fresh buy back offer had been signed with any other entity. However, they have not denied that there were buy back arrangements in the first instance, prior to their being extinguished by virtue of the Scheme of Capital Reduction. b. In case of IFCI, MCX-SX in their letter dated 20th August, 2010 have confirmed that FTIL had signed a supplementary agreement dated 16th December 2009 with IFCI offering an arrangement which indicated a fixed return and price protection to the purchaser i.e. IFCI. …………. c. In case of ILFS it, vide their letter dated August 11, 2010 have informed that the Committee of Directors in their meeting on August 10,2010 resolved to implement interalia “to explore the exit from the investment in MCX-SX which would interalia include expediting the right to selling its investment in MCX-SX as per the exit terms with the promoters of MCX-SX .”

As stated in its Notice, SEBI has found that the above arrangements referred to are in the nature of forward contracts in securities and are in contravention of the provisions of the SCR Act.

57. The main argument that the Learned Senior Counsel for the Applicant has made, is that the SCR Act concerns only with securities listed in Stock Exchanges, and that shares of MCX-SX is therefore not covered under the provisions of the same.

58. In the written submissions of the Applicant the arguments were a. The alleged buy back agreements have been extinguished as they cannot be executed in violation of the MIMPS Regulations. b. In the light of the judgements in Brooke Bond India Ltd. vs. U B Ltd. (1994) 3 Com LJ 279 (Bom) and Jagdishchandra Champaklal

Parekh vs. Deccan Paper Mills Ltd. (1994) 80 Com Case 159 (CLB), the shares of the Applicant being unlisted do not fall within the purview of the SCR Act. c. Buy back or price protection is common across the market even in the case of listed companies. SEBI has in the past not objected to any such agreements that have been disclosed in red herring prospectuses. d. SEBI has also given legal sanction to similar agreements in places such as in the Takeover Regulations, as seen, for instance, from Regulation 3(1)(ia) therein.

59. I propose to examine whether SCR Act covers unlisted securities and if so, whether these arrangements are legal. There cannot be any serious dispute that these arrangements are in the nature of buy back arrangements, as the parties, in the correspondence amongst themselves have variously defined these contracts as buy back arrangements. There cannot also be any doubts as to the involvement of the Applicant itself in these arrangements as evident from the letter, dated March 31, 2009, addressed by the Applicant to PNB.

60. As per Section 13 of the SCR Act, contracts in securities, in notified areas, shall be legal if they are executed between members or through or with such member of a recognised stock exchange in India. The Central Government by its notification dated November 29, 1957 extended the provisions of Section 13 of the SCR Act and made it applicable to the area comprising Greater Bombay. Further, the Central Government on June 27, 1969 issued a notification under Section 16(1) of the SCR Act, viz: “S.O.2561. In exercise of the powers conferred by sub-section (1) of section 16 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) the Central Government being of opinion that it is necessary to prevent undesirable speculation in securities in the whole of India, hereby declares that no person in the territory to which the said Act extend, shall save with the permission of the Central Government enter into any contract for the sale or purchase of securities other than such spot delivery contract or contract for cash or hand delivery or special delivery in any securities as is permissible under the said Act and the rules, bye-laws and regulations of a recognised stock exchange:” (Emphasis supplied)

The above Notification was rescinded by Notification No.S.O.186(E) dated March 1, 2000. The Central Government further issued a fresh Notification No.S.O.184 (E) dated March 1, 2000, that “Notification No. S.O. 184(E) dated 1st March, 2000.- In exercise of the powers conferred by sub-section (1) of section 16 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956), read with Government of India Notification No. S.O. 573(E), dated 30th July, 1992, and Notification No. 183(E), dated 1st March, 2000, issued under section 29A of the said Act, the Securities and Exchange Board of India (hereinafter referred to as “the Board”) being of the opinion that it is necessary to prevent undesirable speculation in securities in the whole of India, hereby declare that no person in the territory to which the said Act extends, shall, save with the permission of the Board, enter into any contract for sale or purchase of securities other than such spot delivery contract or contract for cash or hand delivery or special delivery or contract in derivatives as is permissible under the said Act or the Securities and Exchange Board of India, Act, 1992 (15 of 1992), and the Rules and Regulations made under such Acts and rules, regulations and bye-laws of a recognized stock exchange…”(Emphasis supplied) The term ‘securities’, vide definition in 2(h) of the SCR Act include “shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or any incorporated company or other body corporate”. So from, a plain reading of these Notifications along with the definition of the term Securities in this Act, it would follow that the above notification would apply to shares and warrants of MCX-SX also.

61. Having observed so, I also find that there have been, judicial pronouncements in the past, in support of the view that the SCR Act applies only to securities listed on a stock exchange. For example, In the Brooke Bond India case cited by the Applicant in its written submissions, the Honourable High Court has held that “...., I consider myself bound to take the view that the Securities Contracts (Regulation) Act, 1956 is not intended to regulate private transactions in shares of public limited companies, not listed on the stock exchange.” Similarly in the Jagdishchandra Champaklal Parekh vs. Deccan Paper Mills Ltd. case, also cited by the Applicant, the Honourable High Court has held a similar view.

62. However, in the case of A K Menon v Fairgrowth Financial Services Ltd. (1995) 2 Comp LJ 59, the Honourable Court differed with the judgements in both the Brooke Bond and the Jagdishchandra Champaklal Parekh vs. Deccan Paper Mills Ltd. cited above and held that provisions of the Securities Act do not relate merely to securities which are listed but relate also to securities which may not be listed in any stock exchange, and that all that is required is that there must be marketability of the security. The learned Judge arrived at the finding that the provisions of the SCR Act embrace the transactions and dealings in the securities of unlisted public limited companies also.

63. In B.O.I Finance Ltd. v. Custodian [1997] 12 SCL 99 (SC), the Division Bench of the Honourable Supreme Court examined the severability of the two legs of a ready forward transaction. In the said case, the Honourable Supreme Court, while concluding that the two legs of a ready forward transaction are severable, recognised the findings of the Special Court (whose order was appealed against), that the contracts themselves were illegal under the provisions of the SCR Act, and the notification issued under Section 16 thereof.

64. This position has been further affirmed, more recently by the Honourable High Court of Mumbai in Mysore Fruit Products Ltd And Others vs. The Custodian And Others (2005) 107 BOM LR 955. In this case, the Honourable High Court considered both the judgements the Brooke Bond and the A.K. Menon vs. BOI cases. The Honourable High Court observed thus: “……To accept the argument of the learned Counsel for the Petitioners, would amount to saying that in areas where there are stock exchanges and the securities are listed on that stock exchange, ready forward transactions would be prohibited in these securities but in areas where there are no stock exchange, ready forward transactions in the same security could be carried on. This would be contrary to the plain reading of both Section 16 as well as the said notification. Further, it is an admitted position that the list of securities of the various stock exchanges will not be identical. Some securities may be listed on one stock exchange, but they may not be listed on other stock exchanges.” (Para 8)

“9. Thus it is clear that forward sale of shares even of the public limited companies which are not listed on the stock exchange are prohibited by the Securities Act.” (Para 9 ibid)

65. So, in view of the judgement of the Honourable Supreme Court and the judgements of the Honourable High Court, it has become the settled legal position in the Indian Securities market that such buy back (forward contracts) arrangements in unlisted shares of public limited companies are illegal under the SCR Act. I am therefore unable to find any merit in the argument of the Applicant that the SCR Act applies only to listed securities.

66. On the argument of the Applicant, that SEBI has not objected to such arrangements in the past, I would not like to go into the same, as this is irrelevant to the issue of whether the impugned buy back arrangements are legal or not. I also find that Regulation 3(1)(ia) of the Takeover Regulations cited by the Applicant refers to agreements between funds and are not relevant to the issue under consideration.

67. I find that that the buy back arrangements listed above are illegal for the reasons discussed above, and further that the Applicant has been instrumental to these contracts that were made in violation of the SCR Act. It is germane in this context that this Application too has been made under the SCR Act. The Applicant has submitted that these buy back arrangements were to help achieve compliance with Regulation 8(1). But compliance with Regulation 8(1) has certainly to be through legal means. I find that the Applicant has been instrumental to contracts illegal under the SCR Act, and therefore falls short of fair and reasonable standards of integrity required of a Stock Exchange in India. THE APPLICANT AS A FIT AND PROPER PERSON 68. Another ground on which SEBI is prima facie, is satisfied that it would not be in public interest and in the interest of trade, to grant the application is briefly stated below: 1. Promoters of MCX-SX or their related entities had entered into buyback arrangements with a few investors while selling their shares to them. MCX-SX had not disclosed any details of such buyback arrangements to SEBI, though such information is material to determining whether the Applicant conforms to Regulation 8(1) of MIMPS Regulations.

2. In the Notice, SEBI further found that MCX-SX had filed the Scheme, as stated therein, to comply with the regulatory requirements under the MIMPS Regulations administered by SEBI. That being so, MCX-SX had not informed the Honourable Court of Bombay, that necessary regulatory approvals from SEBI had neither been sought nor obtained. SEBI also observed that at the time of filing the Scheme with the Honourable High Court, MCX-SX had filed the mailing acknowledgement on its letter to SEBI dated December 21, 2009 before the Regional Director (Ministry of Corporate Affairs). Based on this, the Regional Director subsequently, in his affidavit, informed the Honourable High Court, that MCX- SX had filed the Scheme with SEBI. SEBI found that MCX-SX, had by filing the mailing acknowledgement on its letter with the Registrar, sought to convey the impression to the Honourable High Court that the Scheme complied with the Regulations applicable to it as a Stock Exchange. 3. Based on the above, SEBI, prima facie, found that MCX- SX cannot be considered fit and proper for the expansion of the operations into other products and segments as requested in their application dated April 7, 2010.

69. In response to this ground, the Learned Senior Counsel for the Applicant submitted the following arguments which are summarised below: a. Any alleged buy back arrangement is immaterial to this case now, as the Applicant cannot exercise any buyback in breach of the MIMPS Regulations. b. These buyback arrangements, if any, are all prior to the scheme. These arrangements are extinguished with the implementation of the Scheme. c. MCX-SX, its promoters and associates have passed Board Resolutions to the effect that they would be in compliance with the MIMPS Regulation d. The shareholders of MCX-SX had agreed to the Scheme of Capital Reduction, and hence there are no buyback arrangements now. e. MCX-SX did not take approval for the Scheme of Capital Reduction from SEBI, as no such approval was required under law. f. It was the Regional Director, Ministry of Corporate Affairs and not MCX-SX that filed the affidavit in the Honourable High Court that referred to the acknowledgement.

g. Even after furnishing information with SEBI on December 21, 2009, about the Scheme filed before the Honourable High Court, SEBI did not ask any further questions. h. MCX-SX has been given renewal of recognition to function as an Exchange for one year. This implies that it is a fit and proper person.

70. In the written submissions, the Applicant has additionally made the following submissions: a. There were no buyback arrangements as provided for in Section 77A of the Companies Act, 1956 and it was only in the nature of an exit option in line with customary and accepted market practice. b. MIMPS Regulations do not require disclosure of the inter se agreements between shareholders to SEBI. c. The contracts referred to were all contingent in nature and were subject to the MIMPS Regulations. d. There is no suppression of information in the disclosures made by the Applicant to SEBI. e. The Applicant denies that it had used the mailing acknowledgement issued by SEBI to convey misinformation. f. The Applicant also submitted that there were some oral conversations where SEBI was informed of the scheme.

71. Before carefully examining the substantive arguments of the Applicant on their merits, it might be useful to briefly address the question as to whether these buy back arrangements still subsist or whether they have all been extinguished by virtue of all the parties agreeing to the Scheme. Suffice it to say that one of the parties viz. ILFS, in its letter to SEBI, has informed that it proposes to exercise its rights under the agreement. So the claim of the Applicant that all its buyback rights have been extinguished is not entirely borne out in the facts and circumstances.

72. The main plank in the arguments advanced by MCX-SX, is that even if buy back arrangements have been entered into, the Applicant or its promoters could not have done anything in violation of the shareholder restrictions imposed under the MIMPS Regulations. The argument seems to be that even if a regulated entity enters into contracts which can potentially violate a law and does not disclose the same, it should not be a cause for concern for its Regulator. I am unable to find merit in this as such an argument would be quite contrived. That is not a reasonable understanding of how a regulatory system should work.

73. In this regard, what is more important is whether the information on the buyback was material and should have been shared with SEBI to determine whether Regulation 8(1) has been complied with or not. Regulation 11 (1) obligates a Stock Exchange to monitor and ensure: “(a) that no transfer or issue of equity shares therein is made otherwise than in accordance with these regulations; (b) that at least fifty-one per cent. of its equity share capital is continuously held by the public; and (c) that the restrictions contained in regulations 8 and 9 are complied with in respect of the shareholding therein.” Regulation 11(2) of the MIMPS Regulations makes it mandatory on a recognised Stock Exchange to disclose every quarter, the names of ten largest shareholders with the extent of the shares held by them, the names of shareholders who had acquired shares in that quarter and the shareholding pattern. Regulation 11(3) provides that a recognised stock exchange shall submit an undertaking confirming the compliance of the provisions of sub-regulation (1) to the Board on a quarterly basis within fifteen days from the end of each quarter. Regulation 11(5) requires that the recognised stock exchange shall maintain and preserve all the books, registers, other documents and records relating to, the issue or sale of equity shares under these regulations for a period of ten years. Clearly Regulation 11 and its various sub-regulations impose an important regulatory responsibility on a Stock Exchange for overseeing compliance of the MIMPS Regulations. Such oversight is continuous [Regulation 11(1)(b)] and compliance with the regulations have to be confirmed quarterly to SEBI [Regulation 11(3)]. In fact, I also note here that other than this disclosure and self-regulation by the Stock Exchange itself, there is no other instrument under the Regulations that SEBI has designed to monitor compliance with the shareholding restrictions under these Regulations.

74. I have carefully examined the correspondence referred to in the Notice, between MCX-SX, MCX, FTIL, La-Fin and a few of the shareholders of MCX-SX. I have already considered the legality of the buy back arrangements drawn up in these letters and have come to the finding that these buy back arrangements are illegal under the SCR Act. Without going any further into the contents of these letters, I find that what emerges is that MCX-SX either had been instrumental to the arrangements or was in the know of all such buy back arrangements. These buy back arrangements allowed the non-compliant promoters of MCX-SX, to retain a lien on the shares sold or transferred to others in order to comply with the MIMPS Regulations. If shares are sold or transferred with a lien on them to buy it back in the future, then for the purpose of the MIMPS Regulations, such sale or transfer would not be a true sale or transfer. The information of buy back or any arrangement underlying such sale or transfer is evidently material for the purpose of determining compliance with the MIMPS Regulations.

75. The arrangements between the promoters and their associates with investors in the Stock Exchange are material to SEBI for a determination of compliance under Regulation 8(1). An analogy might clarify this further. If (say) there is a restriction on an airline passenger visiting India that allows him to carry five kilograms of gold into the country and he is actually in possession of ten kilograms. He gives the excess of five kilograms to a fellow passenger to carry the same across the Customs Line and enters into an agreement with him to take it back some time thereafter (promising him a certain incentive for doing so). Would such an airline passenger be in violation of the law? The answer is self-evident. Would this transaction become legal, if he takes the plea that after all there are regulatory authorities that can apprehend him, when and if, he actually repossesses the gold from the fellow passenger?

76. In this instant case, the similarities with the analogy above are only too striking. In all buy back arrangements referred to above; there was a promise of an incentive accompanying these arrangements. In these transactions referred to: “The price at which such shares will be offered to be purchased by us will be at a price which will be higher of the following (“Buy Back Price”): (i) Price which provides an internal rate of return (“IRR”) of 15% on the investment or (ii) Price at which the most recent transaction of MCX-SX equity shares is carried out by MCX-SX or MCX or FTIL Group.” (Letter from La-Fin Financial Services Private Ltd. to ILFS Financial Services Limited and others dated August 20, 2009) “We here by accept & agree the terms and conditions no. 1 to 3 as mentioned in your letter dated July 20, 2009 which are: 1. PNB shall be entitled to simple rate of return @ 16% after completion of three (3) years from the date of investment on the total amount invested. ……. 2. Financial Technologies (India) Limited (FTIL) or its appointed nominees have a right to buy back the shares from PNB at any time after expiry of 1 year from the date of investment with a notice to the investor. The simple rate of interest will be paid on prorata basis @ 16% p.a.………………………” (Letter from FTIL to PNB dated August 12, 2009)

77. There has been serious failure of the Applicant as the first line regulatory body in fulfilling its duties to disclose these transactions to SEBI. The Applicant was aware that its promoter shareholders had while selling/transferring their shares retained a lien on the shares so transferred. In fact, SEBI has little other means to verify such rather elaborate arrangements underlying the ownership and transfer of shares other than depend on the Stock Exchange itself. This also reminds us of the critical position of an Exchange as a self-regulator. Needless to say, regulatory arrangements on matters like this can only be based on trust between the Regulator and a self-regulatory organisation like a Stock Exchange. In none of the quarterly reports [under Regulation 11(5)], has MCX-SX disclosed any of these buy back/incentive arrangements to SEBI that underpinned the sale of shares by promoters FTIL and MCX to other investors, admittedly to comply with the MIMPS Regulations.

78. Equally reprehensible is the fact, that even after SEBI sought and obtained disclosures on the buy back arrangement between FTIL and PNB, the Applicant did not disclose but persisted in withholding facts about a similar arrangement between MCX (through La-Fin) with IL&FS. As pointed out in Paragraph 3.5 of the Notice, it needed further enquiry by SEBI and a subsequent letter from SEBI to elicit this. MCX-SX has not provided any cogent reason as to why it did not disclose this information to SEBI.

79. It has already been brought out above that such buyback arrangements were illegal. In addition, these arrangements are directly material to a determination of whether the sale and transfer of ownership by promoters or shareholders, who own in excess of permissible limits, are in true and full compliance with Regulation 8(1) of the MIMPS Regulations. I have little hesitation in holding that MCX-SX has been dishonest in its disclosures to SEBI on material information and has failed to fulfil its disclosure and fiduciary responsibilities cast on it under Regulation 11 of the MIMPS Regulations.

80. I have perused the letter addressed by the Applicant to SEBI on December 21, 2009, paying careful attention to the details therein. As stated in the Notice, the letter states that “The “Scheme” visualized will be in contrast to the normal practice of reducing holding by selling shares and realizing value.” The letter contains a tabular summary of the shareholding pattern under four groups (that of MCX, FTIL, Banks and FIIs and MCX-SX ESOP Trust). As regards, what the Scheme itself was all about, the letter had the following details to offer: “The main features of the Scheme are as under: a) The shareholdings of FTIL and MCX each would not be in excess of 5% (post reduction) and excess shares would be extinguished by corresponding reduction of paid up equity capital of the company. b) One Financial Institution, which is not a PFI, and would be in excess of MIMPS Regulation post implementation of the Scheme and therefore, their partial shareholding will be reduced under the scheme. c) The Exchange shall be fully compliant to MIMPS Regulations after implementation of the Scheme and shall continue to have necessary networth as stipulated. d) MCX, FTIL and the other shareholders whose equity shares are extinguished as above shall be allotted an equal number of warrants as part of the Scheme. e) Promoters once having reduced their shareholding to 5% shall not be permitted to increase their holding beyond limits specified under MIMPS Regulation, thereafter.”

The letter further stated that the proposal was unanimously approved in an extraordinary general meeting held on 15th December 2009, and necessary papers have been filed in the Court. It further referred to its plans to complete the various steps under the Companies Act and that it would report to SEBI further developments in this regard. The letter did not seek any approval from SEBI on whether the Scheme complied with the MIMPS Regulations.

81. The Applicant has now filed a copy of its letter (Annexure 14A to its written submissions) to the Regional Director, Ministry of Corporate

Affairs. I have gone through the contents of this letter. The actual scheme filed by the Applicant (thereafter made available in May 2010 to SEBI) is an extensive document that details out a complex restructuring of the capital structure of MCX-SX, through the conversion of shares into warrants, setting off the mutual liability of the non-compliant shareholders against that of the company and accompanied by a recasting of the Balance Sheet of the Company. Despite having given the limited information on the Scheme to SEBI contained in the few sentences quoted above, in the aforesaid letter to the Regional Director, the Applicant notes that a “detailed” letter on the Scheme has been filed with SEBI and that “SEBI has not expressed any reservation or objection to the said scheme”. Evidently, SEBI could not have objected to the Scheme, because it does not enjoy any powers or have any locus under Sections 391 to 394 of the Companies Act, 1956. I have to note therefore that, even without asking SEBI as to whether the Scheme was in full compliance with the MIMPS Regulations, it represents before the Regional Director in the aforesaid letter, that “SEBI has not expressed any reservation or objection”. I have to observe here that the Applicant clearly sought to convey an impression to the Regional Director that the Scheme had complied with all the applicable regulatory requirements.

82. I fail to understand, why the Applicant could not furnish a copy of the Scheme itself to SEBI, even though the Scheme was ostensibly filed with the objective (as stated in Section III of the Scheme) of complying with the MIMPS Regulations; or why the Applicant had to file with the Regional Director, Corporate Affairs, the mailing acknowledgement issued by SEBI on its letter dated December 21, 2009 instead of seeking a letter of endorsement from SEBI and filing the same, as would be expected in usual business practice; or why it represented to the Regional Director that SEBI had expressed no reservations or objections to the Scheme even without seeking

SEBI’s views on compliance; or why, in fact, even a copy of the Scheme was not furnished to SEBI at least along with the letter dated December 21, 2009.

83. Even while submitting that MCX-SX was not legally bound to consult SEBI prior to filing the Scheme, the Learned Senior Counsel for the Applicant, has strenuously argued that nothing prevented SEBI from seeking further details on the basis of the letter of the Applicant dated December 21, 2009. The implication of this argument is interesting. It would suggest that SEBI should have called for details, conducted an inquiry, if necessary, and hurried to intervene in the matter quick enough before the Scheme of Capital Reduction filed before the Honourable High Court got approved. And as the corollary thereto - because SEBI did not show this degree of alacrity and nimbleness in pursuing the Applicant and seeking details, it presumed that the Scheme complies with the applicable regulations and that SEBI had no objections to its Scheme. I would be loathe to think that the process of regulatory compliance of a stock exchange is a trivial game of getting the ball past the post first.

84. I pause to reflect on what SEBI could have possibly done on the letter dated December 21, 2009 on a matter that was before the Honourable High Court. Section 391 to 394 of the Companies Act, 1956 makes it clear that the arrangement contemplated there under is between the Company, its creditors and members. There is no locus for any other party under these provisions. Neither the provisions of the SCR Act nor the MIMPS Regulations can take away the freedom of a company to restructure its capital through a scheme under Sections 391 to 394 of the Companies Act. Clearly, all that SEBI could have done under law would be to examine whether the Applicant after the approval of the Scheme, complies with the applicable Regulations.

85. The Learned Senior Counsel for the Applicant has also argued that SEBI has already granted the Applicant recognition for an additional year to operate as a Stock Exchange in products already allowed to it. This therefore implies that SEBI has already found and declared the Applicant to be a fit and proper person. On a perusal of the Notification dated 30th August, 2010, granting such renewal for a further period of one year from September 16, 2010, I note that this renewal has been granted without prejudice to the disposal of this Application before me. The relevant clause of the Notification is reproduced below: “The renewal of recognition is without prejudice to the right of SEBI to decide on the application of MCX-SX dated 7th April, 2010, on its merits in accordance with the relevant laws, rules and regulations are applicable in stock exchange/trading in securities.” In fact, on the contrary, withholding this renewal of the Stock Exchange without a proper examination would have been unjust in law. So I therefore find no substance in this argument put forward by the Applicant.

86. To sum up, in this instance a Scheme of Capital Reduction and arrangement had been filed by a Stock Exchange before the Honourable High Court with the declared objective of complying with the MIMPS Regulations. The Stock Exchange, for reasons it knows best, did not deem it necessary or appropriate to verify with SEBI the proposed Scheme is in full compliance with these Regulations.

87. My concerns stated above in Paragraph 82 remain. I feel that the Applicant should have sent the proposed scheme to SEBI, and sought confirmation that it was fully compliant with the MIMPS Regulations. But I cannot go as far to agree with what has been stated in the Notice, that the Applicant has been dishonest in not giving SEBI adequate information about the Scheme itself, for the reason that it was not obliged to do so under law.

88. However, as discussed above, on the issue of withholding information on buyback arrangements from SEBI, I find that the Applicant has clearly been dishonest in withholding material facts about the arrangements underlying the ownership and sale of shares by its promoters. It certainly should not have required, (as stated in Paragraph 3.8 of the Notice,) a third party’s intervention under the Right to Information Act, 2005 for SEBI to ferret out the information from the Applicant, who evidently was reluctant to part with the same. Given the position of a Stock Exchange as a first line regulator, I find that this dishonesty on the part of the Applicant is serious.

89. In the Notice, the charge has been raised that the above actions do not make the Applicant ‘fit and proper’. The issue before me is not to determine whether the Applicant is fit and proper to function as a recognised stock exchange. But, I am of the considered opinion that the Applicant has failed to adhere to fair and reasonable standards of honesty that should be expected of a Stock Exchange.

CONCENTRATION OF ECONOMIC INTEREST OF THE PROMOTERS IN A RECOGNISED STOCK EXCHANGE

90. This ground as set out in the Notice issued by SEBI is summarised as follows. A Stock Exchange enjoys a special regulatory position. SEBI is of the view that it is not in the interest of trade or in public interest to allow the Applicant to operate as a full fledged stock exchange, given that the total economic interest of two of its founder promoters is in excess of seventy percent. In setting out this ground in the Notice, SEBI has briefly outlined the manner in which a Stock Exchange is conferred this position of primacy in the regulatory framework that governs the securities markets in India.

91. The Learned Senior Counsel for the Applicant has put forward a threefold argument, which I shall consider on merits in the next few paragraphs that follow: i. the term ‘economic interest’ is not defined in the statutes, ii. that the Notice merely makes conjectures, as regards the possibility of deviant behaviour, and does not specify as to how any concentration of such interest in MCX-SX has had or will have any consequences as apprehended in the Notice. iii. there is no underlying principle of diversified ownership for Stock Exchanges that has been violated as stated in the Notice.

92. The written submissions of the Applicant are on the same line as in the representations of the Learned Senior Counsel and are briefly summed up below: a. Concept of Economic interest has not been defined or mandated in MIMPS Regulations or the SCR Act. b. Diversification refers to diversification of the Equity Capital and not of any assumed economic interest. c. Framers of the Regulations have only limited the equity share capital and not any form of economic interest. d. The concept of economic interest has not been intimated to it, at any time. e. The alleged economic interest would not render the Applicant vulnerable to any deviant commercial incentive. f. Warrants do not have any voting rights or dividends and do not confer any economic interest in the Company.

93. The first of these arguments is that the term ‘economic interest’ is not defined anywhere in the statutes. As mentioned earlier, Section 4(1) of the SCR Act is the relevant section under law that deals with grant of recognition of a stock exchange. The Legislature amended the SCR Act by the Securities Laws (Amendment) Act, 2004, to provide for the corporatisation and demutualisation of stock exchanges. The SCR Act was further amended to incorporate Sections 4A and 4B in the same for the implementation of the corporatisation and demutualisation of stock exchanges. Section 4B in sub-section (8) inter alia provides that: “Every recognised stock exchange, in respect of which the scheme for corporatisation or demutualisation has been approved under sub-section (2), shall, either by fresh issue of equity shares to the public or in any other manner as may be specified by the regulations made by the Securities and Exchange Board of India, ensure that at least fifty-one per cent of its equity share capital is held, within twelve months from the date of publication of the order under sub-section (7), by the public other than shareholders having trading rights: Provided that the Securities and Exchange Board of India may, on sufficient cause being shown to it and in the public interest, extend the said period by another twelve months.” (Emphasis supplied) 94. The recognition of a stock exchange is to be granted after arriving at the satisfaction under Section 4(1) after a fair and reasonable application of mind.

However, there is no other statutory provision that lays down the specific conditions that a Stock Exchange should fulfil. As mentioned elsewhere herein, the MIMPS Regulations was framed for stock exchanges that are not corporatised and demutualised. Therefore, absent any statute(s) that explicitly provide for how recognition should be granted under Section 4(1) of the SCR Act, I do not see merit in the argument of the Applicant, that the term ‘economic interest’ has not been defined in the Statutes and therefore, the concentration of economic interest in the exchange cannot be a valid reason for denial of the Application. I also note that the idea of economic concentration is a very valid consideration in similar financial regulations that are intended to ensure diversification and prevent concentration. For instance, in Hindustan Motors Limited vs. MRTP Commission (AIR 1973 Cal 450), the Honourable High Court observed that “If that is object and the scheme of the Act, I find no reason why concentration of economic powers in de facto hands would not equally come within the prohibition of the Statute.

I think the object of the Statute would be materially be frustrated if the Central Government or the commission is made to go by the veil of incorporation in finding out the real control and is not allowed to disregard the corporate personality.” Therefore, I am of the view that the locus of the decision cannot lie on whether the term ‘economic interest’ is in the statutes – as evidently, there are no separate statutes that have been laid down defining the manner in which recognition under Section 4(1) of the SCR Act has to be granted to an exchange.

95. The second argument that the Learned Senior Counsel has made in this regard is that SEBI has not specified what exactly is the deviant behaviour that concentration of economic interest in a Stock Exchange can possibly induce. The Notice refers to the importance of ensuring that the “Stock Exchange is not vulnerable or appear to be vulnerable even to the slightest degree, to any deviant commercial incentive.” To spell out what deviant commercial incentive is, would be merely a tautological exercise. However, suffice it to say, that it is not hard to see that deviant commercial incentive, in the context of the functioning of a stock exchange in the securities market, means commercial benefits derived in any unlawful manner and that is detrimental to the investors of the market. Beyond this, I do not think it is necessary to spell out what deviant commercial incentive is, for the purpose of this case.

96. The third argument put forward on behalf of the Applicant is that there is no such underlying principle behind diversified ownership as referred to by SEBI in Paragraph 1.7 of the Notice. The said paragraph is reproduced below for greater clarity: “The principle on which a diversified ownership for stock exchanges has been mandated by law is that there should be no perverse incentive for any promoter or shareholder in an exchange, to derive any undue advantage based on any excessive concentration of ownership. This principle would have to necessarily be held sacrosanct, regardless of whether such concentration of interest comes through holding equity shares or warrants convertible to equity shares.”

97. The issue that arises for my consideration is whether the Central Government and/or SEBI has intended that stock exchanges should have diversified ownership and if so what was the motivating principle behind it. The answer to this is not too far to find. As stated earlier, the Legislature amended the SCR Act to mandate that Stock Exchanges shall be Companies. It further amended the same Act to ensure that “at least fifty-one per cent of its equity share capital is held”, by the “public other than shareholders having trading rights.” Needless to say, corporatisation of a Stock Exchange automatically provides for a legal structure that admits more shareholders as owners. Furthermore, it is the expressed intention of the Legislature that ownership in a Stock Exchange should be diversified to the extent that there should be public (viz. non trading members) shareholding of 51% in it. But Section 4B of the SCR Act did not specify, how such 51% allocated to the public should be distributed. Absent the MIMPS Regulations, the public shareholding of 51% of shares in a Stock Exchange, could have been held by one single individual or institution – the only rider would have been that such individual or institution cannot hold rights to trade on the Stock Exchange. Regulation 8(1) of the MIMPS Regulations provides as follows: “8. Shareholding and transferability restrictions.- 1[(1) No person resident in India shall at anytime, directly or indirectly, either individually or together with persons acting in concert, hold more than five per cent. of the equity share capital in a recognised stock exchange: Provided that a stock exchange, a depository, a clearing corporation, a banking company, an insurance company and a public financial institution defined under section 4A of the Companies Act, 1956 may hold, either directly or indirectly, either individually or together with persons acting in concert, upto fifteen per cent. of the paid up equity share capital of the recognised stock exchange:”

98. Therefore, Regulation 8(1) of the MIMPS Regulations lays down that a person will be allowed to hold a maximum of 5% in the shares of the Stock Exchange, while another select class of financial institutions can own up to a maximum of 15% each in the shares of the Stock Exchange. Parliament amended the SCR Act itself, to corporatize Stock Exchanges and ensure a minimum of 51% of public ownership in a Stock Exchange. SEBI widened the scope of such public ownership through the MIMPS Regulations. This means that it was the intent of public policy, to ensure that the public shareholding (with the minimum being 51% as mandated under Section 4B of the SCR Act) got widely distributed. It is not difficult to see that the obvious principle behind this was that a wider ownership in a public institution like the Stock Exchange is desirable in public interest. This answers the third issue raised by the Applicant as to whether there was in fact any such underlying principle behind mandating diversified ownership in a Stock Exchange.

99. So clearly therefore, it is not the determination of whether the term ‘economic interest’ or ‘deviant commercial incentive’ have been so defined or whether there is any underlying principle behind diversified ownership in a Stock Exchange that is vital to disposing this application. But, what is of paramount importance is whether, SEBI would be reasonable if it concludes that it is not satisfied that such concentration of economic interest of promoters in a Stock Exchange is not in the interest of trade and in public interest. I propose to consider this in the succeeding paragraphs.

100. To appreciate this, it will become necessary to first address an issue, which is central to a decision on this Application: “What is the position that a Stock Exchange holds in the financial markets in India?” As brought out in the Notice vividly, the Stock Exchange enjoys a special regulatory role in the Securities Market and consequently an exalted position among market participants. On this, the Appellant does not have any dispute to the contrary.

101. This unique role has been brought out in Para 1.17 of the Notice and is reproduced below: “Every Stock Exchange provides the vital function of being the first line of regulation in the securities market. Stock exchanges as market regulatory institutions are the pillars on which the stability and integrity of the financial market rests. By their very nature, stock exchanges co-share the responsibility of regulating the market along with SEBI. SEBI relies on the surveillance systems of the Stock Exchange for an accurate assessment of fraud and manipulation in the market. A Stock Exchange is also the arbitrator in a dispute between clients and brokers and seeks to protect the interest of investors and address regulatory concerns ensuring compliance by Companies with the Listing Agreement entered into by them. Further more, the Stock Exchange is in possession of the entire trading information pertaining to clients. Given this position of a Stock Exchange, it becomes necessary to ensure that a Stock Exchange is not vulnerable or appear to be vulnerable even to the slightest degree, to any deviant commercial incentive on the part of its shareholders, big and small, promoters and non promoters.” In short, SEBI has in its Notice pointed out that a Stock Exchange is also a regulatory body. It is the first line of regulation in the market. It is an arbitrator committed to protection of the investors. It serves as a market watchdog through its surveillance machinery and monitoring mechanisms.

102. It is admittedly the position, that prior to the Scheme, the total number of issued shares in MCX-SX was 173,99,33,000 in number. The promoters, MCX and FTIL held 64,43,00,000 and 58,96,25,000 shares respectively. MCX held 37.03% of the equity shares and FTIL held 33.89% of the equity shares, both together holding 70.92% of the total issued capital.

103. Following the implementation of the Scheme of Capital Reduction, the number of issued shares in MCX-SX is 54,33,03,000 and the number of warrants issued against the shares so reduced is 119,66,30,000, so that the total number of shares and warrants in MCX-SX remains at the same number as before viz. 173,99,33,000. MCX retained 2,71,65,000 shares and 61,71,35,000 warrants issued in lieu of the shares reduced. So also, FTIL retained 2,71,65,000 shares and 56,24,60,000 warrants issued in lieu of the shares reduced. Thus, after the implementation of the Scheme, MCX (37.03%) and FTIL (33.89%) accounted for 70.92% of the total of shares and warrants in the company, as was the situation when MCX and FTIL held only equity shares of the company.

104. In March 2010, MCX purchased 1,70,35,000 warrants from IL&FS, thus raising the number of warrants held by them to 63,41,70,000, raising its stake in the combined shares and warrants issued from 37.03% to 38.01% of the total. I observe that, effectively therefore, MCX and FTIL have together now a holding of 71.90% in the shares and warrants issued by the company as against the 70.92% when the two were holding only the shares of MCX-SX, prior to the Scheme of Capital Reduction.

105. Article 12 of the Constitution of India reads thus: “Definition.- In this Part, unless the context otherwise requires, "the State" includes the Government and Parliament of India and the Government and the Legislature of each of the States and all local or other authorities within the territory of India or under the control of the Government of India.” The Honourable Supreme Court of India, in K.C.Sharma vs. Delhi Stock Exchange and Others, (2005) 4 SCC 4, confirmed and upheld the finding of the Honourable High Court of Delhi that a Stock Exchange is a “State” within the meaning of Article 12 of the Constitution. In the order of the Hon’ble High Court of Delhi (Delhi Stock Exchange and Anr. Vs. K. C. Sharma and Ors.), the Honourable High Court observed thus: “Having regard to the various decisions, we are of the opinion that the appellant satisfies the following conditions laid down by the apex court in Ramana Dayaram Shetty v. The International Airport Authority of India viz: 1. there is control over the management of the Corporation by the State 2. the corporation enjoys state conferred or state protected monopoly status; and 3. the functions carried out by the corporation closely relate to the governmental functions in as much as i. that is under deep rooted, all pervasive and extensive control of the Government through the Securities Exchange Board of India under the SEBI Act of 1992 and SCR Act of 1956. ii. It has a complete monopoly status within the specified territorial limits. iii. It carries out important public/state functions that of completely controlling and regulating the transactions in securities in the country.”

106. In the above case, the Honourable High Court of Delhi has laid down an insightful and elaborate exposition as to why a Stock Exchange is a “State” in fact in Paragraphs 13 to 61 of its judgement. I find these very pertinent to the issue on hand. I also note that the Honourable Delhi High Court in WP (Civil) No. 4748/2007, in National Stock Exchange of India Limited v. Central Information Commission and Others, has held that a Stock Exchange is a public authority as defined by Section 2(h) of the Right to Information Act, 2005. I have relied on the guidance that the Honourable High Court has set out in both these cases even though I have not reproduced them here verbatim. The short point that emerges is that the Honourable Supreme Court has confirmed that a Stock Exchange enjoys state conferred or state protected monopoly status; carries out important public/state functions that of controlling and regulating the transactions in securities in the country and is “State” under Article 12 of the Constitution of India.

107. The realisation that a recognised stock exchange is “State” and is an extended regulatory arm of the Central Government and SEBI, is reflected in the provisions of the SCR Act itself. Section 8 therein, provides for powers of the Central Government to make or direct the rule making process in a stock exchange. Section 9 vests SEBI with powers to make or amend byelaws of a Stock Exchange. Section 11 arms the Central Government and SEBI the powers to supersede the governing body of a recognised stock exchange. Section 12 vests the Central Government with powers to even suspend the business of recognised a stock exchange if it thinks that there is an emergency.

108. In the light of the above discussion, I cannot adopt a view that the recognition of a stock exchange is on par with granting of license or registration to any market intermediary. The design of the process attached to the recognition of a stock exchange is evidently for a valid reason. The Legislature left it to the satisfaction of the Central Government/SEBI. This is because financial institutions like Stock Exchanges are central to the national economy and at the core, there would be the issue of safety of the wealth of the citizens who avail of the services they offer.

109. It is for precisely this reason, that the SCR Act and the Rules made thereunder, did not specify a list of conditions that a stock exchange has to comply with and left it to the satisfaction of Central Government/SEBI, without defining what precisely that satisfaction is. As is also evident from the SCR Act, Parliament has not imposed any condition or any restraint on what should constitute the satisfaction of the Central Government/SEBI. Neither has it defined any measure of such satisfaction. I also observe apropos, that in contrast to most of the provisions of the SCR Act, Section 4(1) therein, deliberately uses the word “may” and not “shall” when it comes to granting of recognition of an Exchange. Thus, the SCR Act leaves it to the Central Government/SEBI to determine whether it is in public interest to grant recognition to a stock exchange after fulfilling such conditions, as it considers appropriate in public interest.

110. The Applicant has submitted that warrants do not hold voting rights and will not give rise to control of the company. Therefore, warrants cannot be construed as economic interest in the company. In this Notice, SEBI has used the percentage of the total of shares and warrants issued as a measure of economic interest of the promoters in the Stock Exchange. What SEBI has said in the Notice, is that the promoters who hold 71.90% of the total of shares and warrants issued by the Stock Exchange as a Company, will derive economic benefit to that extent from any increase in the economic value of the Stock Exchange. In other words, any economic gain arising from the growth and profitability of the Stock Exchange accrues, in this case, in proportion to the total of shares and warrants held by an investor. A simple example will make this clear. For instance, if the price of a share goes from (say) Rs.100 to Rs.101, then a person holding one share and one warrant will see the a similar increase in the value of his holding as a person holding two shares. In this case, the promoters hold 71.9% of the shares and warrants of MCX-SX. So, in the example above, the promoters would stand to benefit to the same extent as they would, were they to hold the same percentage solely as equity shares. Hence whether warrants hold voting rights or not, or whether it will give rise to any control of the Stock Exchange is clearly irrelevant to the consideration of the concentration of economic interest.

111. India, in contrast to many other jurisdictions in the world, has a predominant share of promoter run Companies. Indian Securities Laws have recognised this position of dominance of a promoter in a promoter set up company. In India, this understanding is best seen reflected in the Takeover Regulations, which imposes disclosure requirements on promoters, regardless of the extent of their shareholding in the company and in the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009, which stipulates that promoters be locked in from exiting their companies for a specified period.

112. For a better appreciation of the issues involved, it is necessary to put aside the corporate veil and take a closer look at MCX-SX as an institution, pre and post, adopting the Scheme of Capital Reduction. It is an admitted fact that MCX-SX as a Stock Exchange was created by the two promoters, MCX and FTIL. The institution was set up by the promoters, and managed by them. These promoters have appointed all key personnel. The management and control of the MCX-SX was fully with the two promoters, and both these promoters together held 70.92% of the shares. After the adoption of the Scheme and a subsequent purchase of warrants from another shareholder, the two promoters now own 71.90% of the shares and warrants together. All the other shareholders in the MCX-SX are investors in the Exchange, with each of them owning shares at or below the shareholding limit of 5/15% as applicable to them. They have purchased the shares as part of their investment in their portfolio. Effective control and management continues unchanged with the promoters and promoter-appointed senior management of the company. Further, in the case of a Stock Exchange, the stipulated caps of 5/15% ownership naturally preclude the non-promoter shareholders from assuming a significant role in the management and control of the Stock Exchange. The observations of the Honourable Securities Appellate Tribunal, reproduced below in Ashwin K. Doshi and others vs. SEBI, Appeal 44/2001 dated October 25, 2002¸are pertinent to this discussion. “But defacto control over the Board can exist without any legal power at all. Thus it is well known that in a company with a large and dispersed membership, a comparatively small proportion of shares, if held in one hand may enable actual control to be exercised.” (Emphasis supplied)

113. I am of the view that the adoption and implementation of the Scheme can do little to change the intrinsic character of the institution. The relative roles of all persons, the promoters and those appointed by the original promoters vis-à-vis the governance of the Exchange remains unchanged. All that the Scheme has done is to repackage the economic interest enjoyed by the promoters as ‘shares’ and give it a new nomenclature as ‘warrants’. The Scheme has simply led to a rearrangement of the Balance Sheet of the Company. It clearly alters the form but not the substance of how the institution is managed or governed or its commercial incentives. For all practical purposes and intent, the institution continues to be the same. In this instance, a new mode, no doubt clever, of financial engineering has been adopted under the Scheme, to bring down the ownership of the promoters in shares to 5%, converting the excess of shares beyond 5% into warrants. The character of the institution remains the same, the institution marked with the same imprint as before on its governance and profit making incentives. Equally important is it to note that the share of economic gains of the promoters who have created the exchange too remain exactly the same. I further note that the Applicant is, even today, listed as one of the group companies of FTIL, in the publicly disclosed information on its website. What is evident here is that the two majority shareholders have garbed themselves as minority shareholders continuing to hold majority economic stake in the Stock Exchange.

114. I find it pertinent to observe here that a Stock Exchange is the only regulated institution in the securities market in India in which the extent of ownership by any single entity/persons acting in concert is restricted by law. Given the character of corporate governance and management that tends to get perpetuated in promoter run organisations, often uncorrelated to their shareholding, the least that should be done to safeguard the interests of the investors trading on the exchange, is to ensure that the divestment in a recognised stock exchange to comply with the MIMPS Regulations is real and fulfils both the letter and spirit of the law. The considerations discussed above, on the character of an organisation, would not matter to SEBI in the least, if the Applicant were merely a Company engaged in a line of business not regulated by SEBI. They would matter little, if the Applicant were a market intermediary like a broker, a depository participant or a sub-broker. But these are considerations that are directly relevant in deciding whether permission should be granted to the Applicant to operate as a full-fledged stock exchange in India.

115. The role of a Stock Exchange has been defined lucidly by the Honourable Supreme Court of India in Union of India v Allied International Products Ltd [(1970) 3 SCC 594] in these words: “A Stock Exchange fulfils a vital function in the economic development of the nation: its main function is to ‘liquefy capital by enabling a person who has invested money in, say a factory or a railway to convert it into cash by disposing of his shares in the enterprise to someone else’ …… To prevent malpractices, Parliament enacted legislation which aimed at securing control over the proper functioning of the stock exchange, and also placed stringent restrictions upon the representations made by the companies in issuing prospectus inviting subscriptions. The Parliament enacted the Securities Contracts (Regulation) Act, (42 of 1956), and …….”

116. Dwelling upon the object of the institution of stock exchange, the Honourable Supreme Court (Madhubai Amathalal Gandhi v Union of India AIR 1961 SC 21), observed inter alia as follows: “If the stock exchange is in the hands of unscrupulous members, the second and third categories of contracts to buy or sell shares may degenerate into highly speculative transactions or, what is worse, purely gambling ones. …………..These mischievous potentialities inherent in the transactions, if left uncontrolled, would tend to subvert the main object of the institution of stock exchange and convert it into a den of gambling which would ultimately upset the industrial economy of the country.”

117. In a similar vein, commenting on the various transactions possible in dealing in stocks and shares, and the manner that the securities market could potentially be jeopardised by spurious transactions, the Honourable High Court of Karnataka in its judgement in R. Jagadeesh Kumar vs. P Srinivasan and Others [1995 (2) Ka LJ 218) observed thus: “If the stock exchange is under the influence of unscrupulous members, the second and third categories of contracts to buy or sell shares would lapse to highly degenerating and speculative transactions amounting to pure gambling………..…Such obnoxious potentialities are inherent in the transaction and if left uncontrolled would tend to subvert the main object of the stock exchange and convert it into a den of gambling which would ultimately upset the economy of the country.”

118. The Indian Securities Market has allowed “for profit” stock exchanges. The issue of conflict of interest that happens when Stock Exchanges function as ‘for profit’ organizations has been engaging the mind of SEBI in recent years. This has been discussed extensively within SEBI and in December 2009, the full Board of SEBI took up this matter for deliberation. Extracts from the relevant Agenda Note to the SEBI Board, available in the public domain on its website are instructive in this regard: “2.4.4.1. Under the scheme of Corporatisation and demutualization, most exchanges have adopted the route of incorporating themselves as regular companies under the Companies Act, 1956 and not as companies falling under Section 25 of the Act. The National Stock Exchange (NSE) was at its inception itself formed as a company. Therefore, as regular companies, stock exchanges are free to pursue commercial interests, as long as this is not to the detriment of investors. This extends to all aspects of their operations including the determination of prices charged for various services offered by them to investors and intermediaries, as long as it is done in a manner that is fair, transparent and does not discriminate between classes of investors and intermediaries. The pay and incentive structure of the management/employees of Stock Exchanges is also closely tied to the profits earned by the exchanges.

2.4.4.2. Exchanges have traditionally been the first line of regulation in the securities market. It merits careful consideration whether there is conflict between the ‘profit maximization goal’ of an Exchange vis-à-vis its ‘regulatory role’. With the growth of the securities market both in its depth and breadth, more exchanges are likely to emerge. With growing commercialisation of the exchanges, and the aggressive competition between exchanges that will naturally ensue, there is a worry that exchanges might compromise on its regulatory role in its urge to canvass larger volumes of business from intermediaries and investors. The quest for profits might, along the way dilute the unswerving commitment that is required from an Exchange to uphold market integrity and the rules of the capital market. 2.4.4.3 In many jurisdictions across the world including India, exchanges as part of the trading infrastructure are viewed as public utilities. As a public utility, an Exchange becomes the organization that maintains the infrastructure, (the trading avenues and platforms and offers services incidental to this) for a public service (running a market for securities trading). In this view of an Exchange as a public utility, there is evidently a strong reason why profit maximization cannot be allowed to become an overriding priority for an exchange. Clearly, the goals of profit maximization for an exchange and that of public welfare maximization for the public (in this case the investors that make up the securities market) may not always run parallel. Therefore an equally important area that needs to be examined is whether there is any inherent conflict of interest between the ‘profit maximization’ imperative of a ‘for profit exchange’ vis-à-vis its role as a ‘public utility’.”

At its Board Meeting on December 22, 2009, SEBI considered this issue extensively. Recognising the vital importance of these issues, the Board decided to constitute a High Level Committee on Market Infrastructure Institutions to frame suitable recommendations on this and other issues related to such institutions.

119. Thus a major issue of concern for SEBI, as stated in the Agenda Note referred to above, is that the drive for profits by a Stock Exchange might, along the way detract from the regulatory duty of an Exchange to uphold market integrity and the rules of the capital market. This is not for a moment to suggest that a Stock Exchange with minority shareholders holding a majority economic stake in the Stock Exchange, ipso facto, will necessarily imperil the functioning of the Securities Market. Any Stock Exchange can, if it chooses to violate the law, jeopardise the safety and integrity of the Securities Market. But, when a small group of individuals stands to gain disproportionately from the profit motive of a Stock Exchange, the risk is more real and enhanced. It would be a dereliction of duty on the part of SEBI, if it were to wish it away.

120. The level of care and prudence that should accompany recognition of stock exchanges is emphasized in the Report of the Joint Parliamentary Committee on Stock Market Scam and related matters presented to the Parliament in December 2002. The Committee stressed the need for effective mechanisms for “the creation and perpetuation of fair and transparent financial markets and institutions like stock exchanges and banks”.

121. Therefore, in arriving at a decision on this application, I have to necessarily bear in mind that SEBI is dealing with the formation of a full-fledged Stock Exchange, whose impact extends, as the Honourable Supreme Court (supra) points out, to the “economy of the country” and the investors at large. The standards of prudential safeguards and the level of stringency that SEBI adopts in recognising stock exchanges have to reflect this. The various provisions of the SCR Act, the judgements of the Honourable Supreme Court and the Honourable High Court of Karnataka and the Report of the Joint Parliamentary Committee cited in the previous paragraphs, collectively affirm the need to safeguard the securities markets from the risks arising from “malpractices” and the “potentialities” of spurious transactions on any exchange. I am of the considered view that every time, SEBI grants recognition to a Stock Exchange, it has to keep in mind that this results in the birth and creation of an institution that is recognised as “State” under Article 12 of the Constitution. Under Section 4 of the SCR Act read with Section 11 of the SEBI Act, SEBI in discharging its duty to protect investors has to take into account these considerations, while arriving at its decision on the Application. The prime concern of 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 risks. Therefore, I find that SEBI is justified in its stand in the Notice, that the concentration of economic interest in such an institution is not acceptable to it.

122. In the light of the discussion above on the role and position of a Stock Exchange as the first line regulator in the Securities market, classified, pari passu with other public bodies, as “State” under Article 12 of the Constitution, and based on all relevant material before me, I am not satisfied that it will be in the interest of trade and in public interest to allow the Application, for the reasons summarised below: a. The concentration of economic interest in a recognised stock exchange in the hands of two promoters is not in the interest of a well-regulated securities market. b. The Applicant is not fully compliant with the MIMPS Regulations as substitution of shares by warrants is an attempt to work around the requirements of Regulation 8 of the same and the same is not a mode recognised as falling within the scope of the said Regulations. c. The Applicant has been dishonest in withholding material information on arrangements regarding the ownership of shares of its shareholders and therefore has not adhered to fair and reasonable standards of honesty that should be expected of a recognised Stock Exchange. d. The Applicant has failed to ensure compliance with Regulation 8 of the MIMPS Regulations as its two promoters (FTIL and MCX) are persons acting in concert and cannot hold more than 5% in the equity shares of a recognised stock exchange. e. 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 recognised Stock Exchange.

123. On the basis of the aforesaid findings, I, in exercise of the powers conferred under Section 4 of the Securities Contracts (Regulation) Act, 1956 read with Sections 11(1) and 19 of the Securities and Exchange Board of India, 1992 hereby reject the Application of MCX Stock Exchange Limited dated April 7, 2010.

DR. K. M. ABRAHAM WHOLE TIME MEMBER SECURITIES AND EXCHANGE BOARD OF INDIA

PLACE: MUMBAI DATE: SEPTEMBER 23, 2010