Unit 5

Investor protection

Q1) Discuss the role of SEBI in protection of investor interest.       5

A1) Protection of investor is one of the objectives of SEBI. It performs the following activities to achieve this objective-

Figure: Role of SEBI regarding protection of interest of investors

The first and foremost step taken by SEBI is issuing of various guidelines to the companies, merchant bankers, to various underwriters etc. through the help of these guidelines, SEBI ensures that there is transparency in functioning of the above agencies so that the investors are protected.

2.  Introducing Takeover Code:

It had brought in takeover code which also talks about mergers and amalgamations. This code has issued certain guidelines which will govern the substantial acquisition of shares as well as takeovers. The investors are protected through this because it protects their interests when they are not directly involved with such takeovers.

3.  Bringing Stock Invests:

This new concept by SEBI gives protection to investor in a way that they will now get interest on the application money for the time in between the application money and the allotment of shares.

4.  Awareness Campaigns:

SEBI has made special arrangement for small investors and had for the same organized many conferences, seminars, exhibitions, etc.

5.  Special Measures for Insider Trading:

There were many instances of insider trading which had led SEBI to come up with SEBI (Prohibition and Insider Trading) Regulations, 1992 and necessary steps have been taken by keeping a check on malpractices by those who have better access to information than the investors.

Q2) Discuss the role of stock exchange in investor protection.              6

A2) The objective of the Securities Contracts (Regulations) Act, 1956 (SC(R)A) and the Securities and Exchange Board of Inida Act 1992 (SEBI Act) primarily is to protect the interest of the investors and development of the market through regulations. Until the SEBI Act came into effect, most of the investor protection system was primarily centralised with the Stock Exchanges.

Q3) What are the different types of investor grievance?           5

A3) Investors protection is a wide term, it encompasses all the measures designed to protect investors from malpractices of brokers, companies managers to issue, merchant bankers, registrar to issues etc. The main complaints are against brokers of stock exchanges, against listed companies and mutual funds.

a)  Usual grievances against companies

1. Delay in registering transfer of securities.

2. Non-payment or delay in payment of dividend.

3. Non-repayment or delayed repayment of public deposits.

4. Non-receipt of rights issue offer.

5. Non-receipt of duplicate share certificate.

 6. Transmission of shares

7. Non-receipt of notice of meeting

b) Usual grievances against brokers

1. Delay or default in payment for securities sold.

 2. Delay or default in delivery of purchased security to the client.

3. Non-Issue of contract note.

4. Charging brokerage from clients.

5. Non-passing of corporate benefits.

c) Grievance against depository participants

Depository Participant is an institution which acts as an agent to hold securities either in certificated or uncertificated form, dematerialization of securities etc. of the holder. Various banks and other institutions are doing this work. Every depository participant must forward all the dematerialization or materialization requests of his clients to the concerned company within 7 days of the receipt of the request but delays are quite common.

Q3) What are the different types of grievance redressel system for investors? 8

A3)  An investor can seek redressal of his grievances from, the following agencies:

All the recognised stock exchanges have established Investors services cells to redress the grievances of investors. These cells have played an important role in settlement of grievances and have infused confidence among investor. Investors approach these investors grievance cells to lodge complaints against companies and members of the stock exchange acting as brokers. Both BSE and NSE too have their grievance cells.

2.  Grievance of investors against companies

After receiving the complaint from investors, these are forwarded to the concerned company which is directed to solve the matter within 15 days, progress is monitored. If, in spite of reminder, the company fails to resolve the complaints and the total number of pending complaints against the company exceeds 25 and if these complaints are pending for more than 45 days, the cell issues a show cause notice of 7 days to the company. If the company still fails to resolve the complaint within 7 days of issue of show cause notice the scrip of the company is suspended from trading. Investors grievance cell can also transfer scrips of defaulting company to Z category for non-resolution of investors complaints Companies which have a long history of not resolving investors grievances and have large number of pending complaints are instructed to employ special personnel to clear pending complaints on priority basis.

3.  Investors grievances against stock broker

 When a complaint is lodged with the stock exchange authorities, they forward it to the investor service cell which refers the complaint to the concerned broker and asks him to settle the complaint and send a reply within 7 days. If no reply is received or the received reply is not satisfactory the matter is placed before the Investors Grievance Redressal Committee (IGRC) of the stock exchange. This committee hears both, the complainant, the broker and efforts are made the solve the matter failing which, it is referred for arbitration which is a quasi judicial process. A sole arbitrator is appointed if the sum is for less than Rs. 25 lakhs, for claims above Rs. 25 lakhs, a penal of 3 arbitrators is appointed. An aggrieved party can file an appeal against the award given by the arbitrator in appropriate court.

4.  Redressal of grievances through SEBI

 SEBI has a dedicated department viz., Office of Investor Assistance and Education (OIAE) to receive investor grievances and to provide assistance to investors by way of education.  Complaints arising out of activities that are covered under SEBI Act, 1992; Securities Contract Regulation Act, 1956; Depositories Act, 1996 and Rules and Regulations made there under and provisions that are covered under Section 55A of Companies Act, 1956 are handled by SEBI. Grievances pertaining to stock brokers and depository participants are taken up with respective stock exchange and depository for redressal and monitored by SEBI through periodic reports obtained from them. Grievances pertaining to other intermediaries are taken up with them directly for redressal and are continuously monitored by SEBI. Grievances against listed company are taken up with the respective listed company and are continuously monitored. The company is required to respond in prescribed format in the form of Action Taken Report (ATR).. Upon the receipt of ATR, the status of grievances is updated.

5. Redressal by Company Law Board

Company law Board which was constituted in May 1991 has been entrusted with many powers which were previously exercised by high courts. Every bench of company Law Board is deemed to be a civil court and every proceeding before it is deemed as judicial proceeding. To protect the interests of investors it has the power of inspection of records and documents and enforcing attendance of witnesses. An aggrieved investor can apply to the Company Law Board (i) To investigate the affairs of the company (ii) For relief in case of oppression of management and/or mismanagement investors can also lodge complaints about delay and non-payment of fixed deposits and interest thereon with the Company Law Board.  Representations about desired changes in the Companies Act for investors protection can also be made to the Company Law Board.

6.  Redressal of grievances through courts

When an investor has tried all other ways of getting his grievance settled there is no other way left with him except to proceed against the company or the intermediary by way of civil and criminal proceedings. Suits against companies can be filed in the high courts of the states. Every high court has special designated benches about company affairs and all complaints against companies in breach of Companies Act are heard there. An aggrieved party can file cases in high courts against the companies to get justice but the process of law is quite time consuming and costly and hence beyond the reach of small investors.

7.  Redressal of investors grievances through press

If an investor fails to get his grievance remedied from concerned company or authorities, he thinks of bringing bad publicity to the company or to the authorities not listening to him, by reporting the matter to the press. Investors form unfavorable opinion about such company and think that this may happen to them also. So they avoid investing in this company. Such a situation can prove suicidal for the company. To avoid bad publicity the concerned company or the stock exchange management or the government agency like SEBI settles his grievance and report back to the newspaper as to what they have done about the complaint.

Q4) Write a small note on insider trading?          5

A4) ‘Insider trading’ in financial markets refers to trading in securities such as equity and bonds by company insiders who have access to exclusive information about the issuer of a particular security before such information is released to the general public. This allows insiders to benefit from buying or selling shares before they fluctuate in price. The SEBI Act was enacted in the year 1992 to provide a regulatory framework to promote healthy trading and protect investors’ interest to ensure growth of securities market. Under Section 11(1), 11(2) of SEBI Act and Section 30, SEBI has the legal power to intervene and prevent insider trading while the said sections also implement further regulations to limit illegal activities. For example, A government employee acts upon his knowledge about a new regulation to be passed which will benefit a sugar-exporting firm and buys its shares before the regulation becomes public knowledge.

Real-life Examples of Insider Trading

1. Martha Stewart

Shares of ImClone took a sharp dive when it was found out that the FDA rejected its new cancer drug. Even after such a fall in the share price, the family of CEO Samuel Waskal seemed to be unaffected. After receiving advance notice of the rejection, Martha Stewart sold her holdings in the company’s stock when the shares were trading in the $50 range, and the stock subsequently fell to $10 in the following months. She was forced to resign as CEO of her company and Waskal was sentenced to more than seven years in prison and fined $4.3 million in 2003.

2. Reliance Industries

The Securities and Exchange Board of India banned RIL from the derivatives sector for a year and levied a fine on the company. The exchange regulator charged the company with the intention of making profits by skirting regulations on its legally permissible trading limits and lowering the price of its stock in the cash market.

3. Joseph Nacchio

Joseph Nacchio made $50 million by dumping his stock on the market while giving positive financial projections to shareholders as chief of Qwest Communications at a time when he knew of severe problems facing the company. He was convicted in 2007.

4. Yoshiaki Murakami

In 2006, Yoshiaki Murakami made $25.5 million by using non-public material information about Livedoor, a financial services company that was planning to acquire a 5% stake in Nippon Broadcasting. His fund acted upon this information and bought two million shares.

5. Raj Rajaratnam

Raj Rajaratnam made about $60 million as a billionaire hedge fund manager by swapping tips with other traders, hedge fund managers, and key employees of IBM, Intel Corp, and McKinsey & Co. He was found guilty of 14 counts of conspiracy and fraud in 2009 and fined $92.8 million.

Q5) Write a brief note investor awareness and investor activism.        8

A5) Investor awareness means educating investors about their rights, duties and responsibilities. Investor Awareness Programme Investor protection measures by SEBI follows the slogan ‘An informed investor is a safe investor’. SEBI has thus launched the Securities Market Awareness Campaign in January 2003. Such programmes are now regularly organised by SEBI to educate and create awareness among the investors. The programme covers major subjects like portfolio management, Mutual Funds, tax provisions, Investor Protection Fund, Investors’ Grievance Redressal system of SEBI. It also conducts workshops on derivatives, stock exchange trade, Sensex, etc. SEBI has now conducted over 2000 workshops in more than 500 cities across the country. SEBI has marketed the Investor Awareness Programme across all formats like print media, radio, television, and the internet. 

An activist investor is an individual or group that holds a considerable number of shares in a public company. Their aim is to apply pressure on the company’s management. They want to influence senior management’s decisions. Activist investors usually seek companies that they believe demonstrate a structural flaw within their management and look to add value either by influencing the current management’s decisions or by replacing them with new management.

  Its classifications are discussed below-

1. Individual Activist Investors

Activist investors who are individuals are usually very wealthy and influential. They can leverage their capital to purchase a large number of a company’s shares to gain enough voting rights on the board of directors. They aim to influence the strategic direction of the target company. The individuals are usually well known within the finance industry and use their influence to make structural changes to a company’s strategy. For example, if an individual activist does not believe management is allocating capital properly, they can use their influence over the board of directors to push for different capital allocation.

Advantages of Individual Activist Investors

Individual activist investors may be able to add value for current shareholders by guiding management actions to the shareholders’ best interests. The activist investors can provide a voice for fragmented shareholders who do not own enough shares to gain influence on management decisions.

Disadvantages of Individual Activist Investors

Individual activist shareholders may not share the same interests or goals as other shareholders and, therefore, may destroy shareholder value. For example, an activist shareholder may only prefer a short-term holding time horizon;. They will influence management to make decisions that benefit the company in the short term to the detriment of shareholders with a long-term holding time horizon.

 2. Private Equity Firms

Activist investors in the form of private equity firms employ many different strategies but usually will take control of a public company with the intention of taking it private. The structure of a private equity firm includes limited partners who own a significant amount of the fund and enjoy limited liability and a general partner who assumes unlimited liability. Private equity firms use capital from various investors who are willing to invest large amounts of capital for an extended period of time.

Advantages of Private Equity Firms

Private equity firms give many companies and start-ups access to liquidity and capital in situations where they might be able to access to conventional financing. Additionally, private equity firms may provide value for current investors of a company that is underperforming in the public markets, allowing the company to steer away from the scrutiny of the public market.

Disadvantages of Private Equity Firms

Private equity firms face a more difficult time liquidating holdings since there is no official market to find buyers and sellers. It can take a significant amount of time to find a buyer to sell a private company. Furthermore, pricing is done through negotiations and, therefore, the realized return is subject to variations based on conditions not determined by the market.

3. Hedge Funds

Activist investors in the form of hedge funds can take control of a public company in a variety of ways. Hedge funds can take the approach of an individual activist investor or can act like private equity firms. The underlying goal of a hedge fund is to generate a return for investors no matter what, and the funds are not subject to constraints on the strategies that they can employ to do so. Many individual activist investors act through opening hedge funds, and similarly to private equity firms, they are established with investments from several limited partners and a general partner. The investments are illiquid since they are usually locked up for at least one year to provide hedge fund managers with flexibility.

Advantages of Hedge Funds

Hedge funds do not have a mandate on how they generate alpha and, therefore, can employ many different strategies without having to worry about conforming to investors or an . It allows hedge funds to be aggressive in how they target companies and make changes. It provides them with opportunities to make activist investments and increase target shareholder value. 

Disadvantages of Hedge Funds

Hedge funds are largely unregulated and, therefore, are prone to numerous controversies. Furthermore, hedge funds are more expensive to invest in; they are typically used by wealthy investors. Also, the funds typically underperform the broad market and provide very volatile returns.