Chapter 8. Corporate Ethics: Investors’ Rights, Privileges, Problems and Protection – Business Ethics and Corporate Governance


Corporate Ethics: Investors’ Rights, Privileges, Problems and Protection


The phenomenal growth of modern corporations, especially those which have been immensely successful so as to span space to become multinationals, have brought about the kind and order of material wealth to the international community that was never imagined possible even a few years ago. Some of them produce goods and services for most parts of the world. Some of them make profits that are bigger than the gross domestic products of several countries put together. This kind of almost exponential growth would not have been possible, but for the evolution and growth of the organizational structure called public limited or joint stock companies. A joint stock company is a business unit that requires a large amount of capital. This is obtained by the promoters by dividing it into equal shares of small denominations. This enables investors to invest small or large sums according to their capability and desire. The profit of the company is distributed in proportion to the number of shares held. The most important feature of such form of business organization that makes it most attractive to investors is that the financial liability of the shareholders is limited to the extent of the shares held by them. Though the limited liability clause of this type of investment is an attraction, the investor (generally defined as one who makes financial investment in bonds, stocks or shares) faces a serious problem. He or she being a part-owner normally located far away from the place where the company’s business takes place and with little or no knowledge of the type of business it is engaged in, has to delegate the work of running it, to managers who may do their job in a manner different from what he or she would have done himself or herself. This ‘agency’ problem causes the investor the ‘agency costs’ that can be minimized if the management follows certain ethical and corporate governance practices such as integrity, transparency, full disclosure of financial and non-financial information, accountability and compliance with the law of the land. If the corporate managements fulfil these obligations, it will result in long-term shareholder value.

Apart from these, the investor needs to be protected in a myriad ways. He or she should be allowed to participate in the decision making process to the extent possible. Appointments to the board of directors, auditors, etc., apart from decisions that involve heavy investments should have his or her concurrence and his or her rights should be protected and privileges zealously safeguarded. He or she should have his or her grievances amicably and adequately redressed. He or she should be paid his or her dividends in full and on time. In sum, he or she should be treated for what he or she is—a shareholder, who has a material stake in the corporation.

To realize such an investor protection, countries have evolved rules, regulations, systems and mechanisms—both internal (to the company) and external. All these internal features are covered if companies follow universally accepted ethical and corporate governance standards, while the external ones are taken care by public authorities of the countries concerned. It should be stressed here that corporate governance is a major instrument of investor protection. In the following pages, we will go through the various facets of responsibilities, problems and the protection available to investors both internally and externally.


Corporate governance is needed to create a corporate culture of consciousness, transparency and openness. It refers to a combination of laws, rules, regulations, procedures and voluntary practices to enable companies to maximize shareholders’ long-term value. It should lead to increasing customer satisfaction, shareholder value and wealth. Corporate governance deals with a company’s ability to take managerial decisions vis-à-vis its claimants in particular, its shareholders apart from other stockholders.


The most fundamental theoretical basis of corporate governance is agency costs. Shareholders are the owners of joint-stock, limited liability company, and are its principals. By virtue of their ownership, the principals define the objectives of the company. The management, directly or indirectly selected by shareholders to pursue such objectives, are the agents. While the principals might assume that the agents will invariably do their bidding, it is often not so. In many instances, the objectives of managers are quite different from those of the shareholders. This divorce between ownership and management leads to agency costs, which in turn leads to the need for corporate governance.

Two broad instruments that reduce agency costs and hence, improve corporate governance are

  • financial and non-financial disclosures; and
  • independent oversight of management, which consists of two aspects—the first relates to the role of the independent, statutory auditors and the second to the board of directors of a company.

There is a global consensus about the objective of ‘good’ corporate governance: maximizing long-term shareholder value. It is useful to limit the claimants to shareholders for three reasons:

  1. In most of the countries, generally labour laws are strong enough to protect the interests of workers in the organized sector, and employees as well as trade unions are well aware of their legal rights. In contrast, there is very little in terms of the implementation of the law and of corporate practices that protects the rights of creditors and shareholders.
  2. There is much to recommend in law, procedures and practices to make companies more attuned to the need for servicing properly debt and equity.
  3. Managers have to look after the right of shareholders to dividends and capital gains, because if they do not do so, over time, they face the real risk of take-over.

For a corporate governance code to have real meaning, it must first focus on listed companies. These are financed largely by public money (be it equity or debt) and hence, need to follow codes and policies that make them more accountable and value oriented to the investing public.

There have been various committees and boards that have been set up both internationally and in India to improve the situation of shareholders with regard to corporate governance. Before we see how a shareholder could help bring about good corporate governance we need to see the rights of the shareholders as laid down by the Indian Companies Act of 1956.


The members of a company enjoy various rights in relation to the company. These rights are conferred on the members of the company either by the Indian Companies Act of 1956 or by the Memorandum and Articles of Association of the company or by the general law, especially those relating to contracts under the Indian Contract Act, 1872.

Some of the more important rights of shareholders as stressed by the above acts are the following. The shareholder

  1. has a right to obtain copies of the Memorandum of Association, Articles of Association and certain resolutions and agreements on request on payment of prescribed fees (Section 39);
  2. has a right to have the certificate of shares held by him or her within three months of the allotment;
  3. has a right to transfer his/her shares or other interests in the company subject to the manner provided by the articles of the company;
  4. has a right to appeal to the Company Law Board if the company refuses or fails to register the transfer of shares;
  5. has the preferential right to purchase shares on a pro-rata basis in case of a further issue of shares by the company. Moreover, he or she also has the right of renouncing all or any of the shares in favour of any other person;
  6. has a right to apply to the Company Law Board for the rectification of the register of members;
  7. has the right to apply to the court to have any variation or abrogation to his or her rights set aside by the court;
  8. has the right to inspect the register and the index of members, annual returns, register of charges, and register of investments not held by the company in its own name without any charge. He or she can also take extracts from any of them;
  9. is entitled to receive notices of general meetings and to attend such meetings and vote thereat either in person or by proxy;
  10. is entitled to receive a copy of the statutory report;
  11. is entitled to receive copies of the annual report of the directors, annual accounts and auditors’ report;
  12. has the right to participate in the appointment of auditors and the election of directors at the annual general meeting of the company;
  13. has a right to make an application to the Company Law Board for calling annual general meeting if the company fails to call such a meeting within the prescribed time limits;
  14. can require the directors to convene an extraordinary general meeting by presenting a proper requisition as per the provisions of the Act and hold such a meeting on refusal;
  15. can make an application to the Company Law Board for convening an extraordinary general meeting of the company where it is impracticable to call such a meeting either by the directors or by the members themselves;
  16. is entitled to inspect and obtain copies of minutes of proceedings of general meetings;
  17. has a right to participate in declaration of dividends and receive his or her dividends duly;
  18. has a right to demand poll;
  19. has a right to apply to the Company Law Board for investigation of the affairs of the company;
  20. has the right to remove a director before the expiry of the term of his or her office;
  21. has a right to make an application to the Company Law Board for relief in case of oppression and mismanagement;
  22. can make a petition to the High Court for winding-up of the company under certain circumstances;
  23. has a right to participate in passing of a special resolution that the company be wound up, by the court or voluntarily; and
  24. has a right to participate in the surplus assets of the company, if any, on its winding-up.

However, whether the shareholder has these rights in reality or if he or she is even aware of his or her rights is a moot question that leads invariably to unscrupulous managements taking the unwary investors for a ride.


Protection of shareholders’ rights is very important in order to ensure long term shareholder value, which is the be-all and end-all of corporate governance. Several committees have been formed by the Government of India. Among these are the Securities and Exchange Board of India (SEBI), the country’s capital market regulator and the Confederation of Indian Industry (CII) the leading industry association. They have discussed the issue in great detail, and their considered views on the subject of shareholder/investor rights and how these can be achieved are given here.

Working Group on the Companies Act

Various committees have been set up both in India and elsewhere to guide the shareholders with regard to good corporate governance, especially their long-term interests. One among them is the Working Group on the Companies Act set up by the Government of India which has recommended many financial as well as non-financial disclosures. These disclosures call for greater transparency in the accounting of the organization. It calls for a tabular form containing details of each director’s remuneration and commission which should form a part of the Directors’ Report, in addition to the usual practice of having it as a note to the profit and loss account. Also, any cost incurred in using the services of a Group Resource Company must be clearly and separately disclosed in the financial statement of the user company. Again where the company has raised funds from the general public, it would have to give a separate statement showing the end-use of such funds, namely, how much was raised versus the stated and actual project cost; how much has been utilized in the project up to the end of the financial year; and where are the residual funds, if any, invested and in what form. There should also be a disclosure on the debt exposure of the company. With regard to the non-financial disclosure, the Working Group called for a comprehensive report on the relatives of directors either as employees or board members, to be an integral part of the Directors’ Report of all listed companies. The company should also maintain a register which discloses interests of directors in any contract or arrangement of the company and the fact that such a register is made and is open for inspection needs to be made known to the shareholders in the Annual General Meeting. Details of loans to directors should be disclosed as an annex to the Directors’ Report in addition to being a part of the schedules of the financial statements. Such loans should be limited to only three categories—housing, medical assistance and education for family members, and be available only to full-time directors. The detailed terms of the loan would need shareholders’ approval in a General Body Meeting. These are some of the disclosures that need to be made. The company should understand that though all other things being equal, greater the quality of disclosure, the more loyal are the company’s shareholders. Based on these recommendations, a number of changes were introduced in the Companies Bill, 1997. However, since many of these recommendations were not mandatory, it did not have much impact on the corporate governance scenario in India.

CII’s Committee on Corporate Governance

The next committee that had considerable impact on the corporate world with regard to the rights of shareholders to ensure corporate governance in the organization was the reports submitted by the CII. The CII has pioneered the concept of corporate governance in India and is an internationally recognized name in this area. Its code, the Desirable Code of Corporate Governance, was the first of its kind in India and is recognized as one of the best in the world. Corporate India has started recognizing the pivotal role that disclosures play in creating corporate value in the increasingly market-oriented environment.

The objective of the CII was to develop and promote a code of corporate governance to be adopted and followed by Indian companies, be these in the private sector, banks or financial institutions, all of which are corporate entities. This initiative by the CII flowed from public concern regarding the protection of investor interest, especially the small investor, the promotion of transparency within business and industry; the need to move towards international standards in terms of disclosure of information by the corporate sector and, through all of this, to develop a high level of public confidence in business and industry.

This code required listed companies to give the following information under ‘Additional Shareholder’s Information’:

  • high and low monthly averages of share prices in a major stock exchange where the company is listed for the reporting year; and
  • greater details on business segments up to 10 per cent of turnover, giving share in sales revenue, review of operations, analysis of markets and future prospects.

These recommendations just like those of the Working Group were not mandatory and therefore most of the companies did not take them seriously.

Kumar Mangalam Birla Committee

The CII was the first to come out with its version of an Audit Committee. The SEBI, as the custodian of investor interests, did not lag behind. On 7 May 1999, it constituted an 18-member committee, chaired by the young and forward-looking industrialist, Kumar Mangalam Birla (a chartered accountant himself), on corporate governance, mainly with a view to protecting the investors’ interests. The committee made 25 recommendations, 19 of them ‘mandatory’, which were enforceable. The listed companies were obliged to comply with these on account of the contractual obligation arising out of the listing agreement with stock exchanges.

It is interesting to note that the Kumar Mangalam Birla Committee, while drafting its recommendations was faced with the dilemma of statutory versus voluntary compliance. As mentioned earlier, the Desirable Code of Corporate Governance, which was drafted by the CII and was voluntary in nature, did not produce the expected improvement in corporate governance. It was thus felt that under Indian conditions, a statutory rather than voluntary code would be far more effective and meaningful. This led the committee to decide between mandatory and non-mandatory provisions. The committee felt that some of the recommendations were absolutely essential for the framework of corporate governance and virtually would form its code, while others could be considered as desirable. Besides, some of the recommendations needed a change of statute, such as the Companies Act for their enforcement. Faced with this difficulty, the committee settled for two categories of recommendations—namely, mandatory and non-mandatory.

This committee made the following recommendations especially with regard to shareholders.

Recommendations Relating to Shareholders   The shareholders are the owners of the company and as such they have certain rights and responsibilities. But in reality companies cannot be managed by shareholder referendum. They are not expected to assume responsibility for the management of corporate affairs. A company’s management must be able to take business decisions rapidly, which cannot be done if they were to consult shareholders, who are too numerous and scattered for any meaningful consultation. Shareholders therefore, delegate many of their responsibilities as owners of the company to the directors who then become responsible for corporate strategy and operations. The implementation of this strategy is done by a management team. This relationship, therefore, brings in the accountability of the boards and management to shareholders of the company. A good corporate framework is one that provides adequate avenues to shareholders for effective contribution in the governance of the company while insisting on a high standard of corporate behaviour without getting involved in the day-to-day functioning of the company.

Responsibilities of Shareholders   The committee believed that the General Body Meetings provide an opportunity to shareholders to address their concerns to the board of directors and comment on and demand any explanation on the annual report or on the overall functioning of the company. It is important that shareholders use the forum of general body meetings for ensuring that the company is being stewarded for maximizing the interests of shareholders. This is important especially in the Indian context. It follows from the above that for effective participation, shareholders must maintain alertness and decorum during the General Body Meeting, so that it constitutes the forum in which they can get their doubts clarified, apart from airing their grievances, if any.

The efficiency or otherwise of the board would be dependent on both the quality of the directors as well as the financial information provided. It would also depend to a great extent on the efficacy or otherwise with which the auditors execute their tasks.

In order to ensure the quality and efficiency of directors and auditors, share holders must be actively involved in their appointment. The committee recommended that in case of the appointment of a new director or re-appointment of a director, shareholders must be provided with the following information:

  • a brief resume of the director;
  • the person’s expertise in specific functional areas; and
  • names of companies in which the person also holds directorship and membership of committees of the board. This is a mandatory recommendation.

Shareholders’ Rights   As we have seen earlier, the Companies Act of 1956 confer certain rights to shareholders to enable them to enjoy their rights as rightful owners of companies. The basic rights of shareholders include the right to transfer and registration of shares, obtaining relevant information on the company on a timely and regular basis, participating and voting in shareholder meetings, electing members of the board and sharing in the residual profits of the corporation.

The committee, therefore, recommended that as shareholders have a right to participate in, and be sufficiently informed on decisions concerning fundamental corporate changes. They should not only be provided information as under the Companies Act, but also be updated in respect of other decisions relating to material changes such as takeovers, and sale of assets or divisions of the company. They should also be informed of changes in capital structure that will lead to change in control or may result in certain shareholders obtaining control disproportionate to the equity ownership.

The committee recommended further that information such as quarterly results and presentations made by companies to analysts may be put on the company Web site or sent in such a form to the stock exchange on which the company is listed, to put this information on its Web site.

The committee also recommended that the company’s half-yearly declaration of financial performance including summary of significant events in the last six months, should be sent to each household of shareholders. This recommendation is mandatory.

The Kumar Mangalam Birla committee also prescribed that a company must have appropriate systems in place, which will enable shareholders to participate effectively and vote in shareholders’ meetings. The company should also keep shareholders informed of the rules and voting procedures, which govern the general shareholder meetings. This recommendation is mandatory.

The annual general meetings of the company should not be deliberately held at inconvenient venues or at timings which makes it difficult for most of the shareholders to attend. The company must also ensure that it is not inconvenient or expensive for shareholders to cast their votes. This recommendation is mandatory.

In today’s context in India, it is a practice that AGMs are held regularly by companies as a mere formality in order to comply with the law. This is because either very few of the shareholders are able to attend such AGMs because they are either not in the city where they are held or the shareholders are scattered through the length and breadth of the country as in cases of large companies. This makes corporate democracy a mere mockery.

Share holders who are unable to attend meetings should be allowed to vote by postal ballot for key decisions such as investment proposals, appointment of directors, auditors, committee members, loans and advances above a certain percentage of net worth, changes in capital structure which will lead to change in control or may result in certain shareholders obtaining control disproportionate to equity shareholding, sale of assets or divisions and takeovers etc. This would require changes in the Companies Act. The committee was informed that SEBI has already made recommendations in this regard to the Department of Company Affairs. The committee recommended that the Department of Company Affairs should again be requested to implement this recommendation at the earliest, if possible by issue of an ordinance, so that corporate democracy becomes a reality in the true sense.

The committee recommended that a board committee under the chairmanship of a non-executive director should be formed to specifically look into the redressal of shareholder complaints such as transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends, etc. The committee believed that the formation of such a committee will help focus the attention of the company on shareholders’ grievances and sensitize the management to the redressal of their grievances. This is a mandatory recommendation.

The committee further recommended that to expedite the process of share transfers, the board of the company should delegate the power of share transfer to the registrars and share transfer agents. This is a mandatory recommendation.

Naresh Chandra Committee

Another committee that was set up with a view to promote corporate governance and through it, long-term shareholder value, was the Naresh Chandra Committee. The Naresh Chandra Committee’s report on ‘Audit and Corporate Governance’ has taken forward the recommendations of the Kumar Mangalam Birla Committee on corporate governance. Two major issues the committee addressed and made appropriate recommendations were

  • representation of independent directors on a company’s board; and
  • the composition of the audit committee.

The Naresh Chandra Committee has made no distinction between a board with an executive chairman and a non-executive chairman. It recommended that all boards need to have at least half of its members as independent directors. As regards the audit committee, the Kumar Mangalam Birla Committee had stated that it should have three non-executive directors as its members with at least two independent directors and that the chairman of the committee should be an independent director. But the Naresh Chandra Committee recommended that all audit committee members should be independent directors.

The Naresh Chandra Committee has laid down stringent guidelines defining the relationship between auditors and their clients. In a move that could impact small audit firms, the committee recommended that along with its subsidiary, associates or affiliated entities, an audit firm should not derive more than 25 per cent of its business from a single corporate client. This, the committee said, would improve the independence of audit firms. While turning down the proposal for a compulsory rotation of audit firms, the committee stressed that the partners and at least 50 per cent of the audit team working on the accounts of a company need to be rotated by a firm once every five years.

While the committee said that it had no objection to an audit firm having subsidiaries or associate companies engaged in consulting or other specialized businesses, it has drawn up a list of prohibited non-audit services more or less on lines of the American Sarbanes–Oxley Act with certain modifications to suit the Indian corporate sector. The committee has recommended an increased role for independent directors by assigning them at least 50 per cent seats on the board of a public limited company with a paid up capital of INR 100 million and above, and a turnover of INR 500 million and above. It has significantly asserted that nominees of financial institutions (FIs) could not be counted as independent directors.

The committee has further recommended

  1. tightening of the noose around auditors by asking them to make an array of disclosures;
  2. asking the chief executive officers (CEOs) and chief financial officers (CFOs) of all listed companies to certify their companies’ annual accounts, besides suggesting; and
  3. setting up of quality review boards for the Institute of Chartered Accountants of India (ICAI), the Institute of Company Secretaries of India (ICSI) and the Institute of Cost and Works Accountants of India, (ICWA) and a Public Oversight Board similar to the one in the United States.

At a time when people are shying away from accepting the post of an independent director in a company because of the liabilities that might follow, the Naresh Chandra Committee has come up with recommendations that will help remove the fears. To attract quality independent directors on the board of directors of a company, the committee has recommended that these directors should be exempt from criminal and civil liabilities under the Companies Act, the Negotiable Instrument Act, the Provident Fund Act, the Factories Act, the Industrial Disputes Act and the Electricity Supply Act.

However, unlisted public companies that do not have more than 50 shareholders and carry no debt from the public, banks or financial institutions, and unlisted subsidiaries of listed companies have been exempted from these recommendations.

Thus, it can be seen that though the law has provided for the rights of the shareholder to have access to information as it may seem fit to the shareholder’s requirement, very rarely organizations make this information easily accessible to them. It is because of such prevalent situations that various committees have to intervene and see that they are taken care of. However, notwithstanding all these efforts nothing concrete has been done by public authorities to prevent corporate misgovernance.

Narayana Murthy Committee

This SEBI-appointed Committee on Corporate Governance, which submitted its report on 8 February 2003, has in its own words, ‘The management needs to act as trustees of the shareholders at large and prevent asymmetry of benefits between various sections of shareholders, especially between the owner-managers and the rest of the shareholders’.1

The committee recommended that in order to achieve the objectives of corporate governance and to realize long-term shareholder value, companies should agree that

  1. In case of appointment of a new director or reappointment of a director, the shareholders must be provided with the following information:
    1. a brief resume of the director;
    2. nature of his or her expertise in specific functional areas; and
    3. names of companies in which the person also holds the directorship and the membership of committees of the board.
  2. Information like quarterly result and presentations made by companies to analysts shall be put on the company’s Web site or shall be sent in such a form to the stock exchange on which the company is listed to put this on their own Web site.
  3. A board committee under the chairmanship of a non-executive director shall be formed to specifically look into the redressal of shareholder and investors complaints such as transfer of shares, non-receipt of balance sheet, declared dividends, etc. This committee shall be designated as ‘Shareholders/Investors Grievance Committee’.
  4. To expedite the process of share transfers the board of directors shall delegate the power of share transfer to an officer or a committee or to the registrar and share transfer agents. The delegated authority shall attend to share transfer formalities at least once in a fortnight.

Shareholders’ Rights and Postal Ballots   The Narayana Murthy Committee asserted shareholders’ rights to receive from the company half-yearly declaration of financial performance including summary of the significant events during the past six months.

The committee recommended the facility of postal ballot to those shareholders in absentia at the Annual General Meeting of the company, so as to participate effectively in corporate democracy and in the decision-making process. Key issues that may be decided by postal ballots could include

  1. alteration in the memorandum of association;
  2. sale of whole or substantially the whole of the undertaking;
  3. sale of substantial investments in the company;
  4. making a further issue of shares through preferential allotment or private placement basis;
  5. corporate restructuring;
  6. entering into a new business not germane to the existing business of the company;
  7. variations in rights attached to class of securities; and
  8. matters relating to change in management.

Dr J. J. Irani Committee Report on Company Law, 2005

The Government of India constituted an expert committee on Company Law on 2 December 2004 under the chairmanship of Dr J. J. Irani to make recommendations on (i) responses received from various stakeholders on the concept paper; (ii) issues arising from the revision of the Companies Act, 1956; (iii) bringing about compactness by reducing the size of the act and removing redundant provisions; (iv) enabling essay and unambiguous interpretation by recasting the provisions of the law; (v) providing greater flexibility in rule making to enable timely response to ever-evolving business models; (vi) protecting the interests of the stakeholders and investors, including small investors; and (vii) any other related, or incidental, to the above.

Set up to structurally evaluate the views of several stakeholders in the development of company law in India in respect of the concept paper promulgated by the Union Ministry of Company Affairs, the J. J. Irani Committee has come out with suggestions that will go far in laying sound base for corporate growth.

The expert committee comprised experts drawn from trade and industry associations, professional bodies and institutes, chambers of commerce, leading senior advocates and auditors. Representatives of government departments, regulatory bodies and other organizations were included as special invitees. The committee deliberated on various issues on Company Law requiring a review on the basis of comments and suggestions received in response to the Concept Paper, opinions expressed by experts, professional bodies, etc. The committee submitted its report to the Government of India on 31 May 2005.

The committee’s report is a balanced and well-rounded document and attempts to equate the pulls and pressure of modern business and those of shareholder democracy. It is a step towards providing a growth-oriented modern company law, with the thrust on stakeholder democracy and self-regulation. The report has taken a pragmatic approach keeping in view the ground realities, and has sought to address the concerns of all stakeholders to enable the adoption of internationally accepted best practices.

Power to Shareholders   The main thrust of the committee’s recommendations was to give full liberty to the shareholders and owners of the company to operate in a transparent manner. The committee calls for a significant shift from a government approval regime to a ‘shareholder approval and disclosures’ regime. The report thus gives more power to shareholders, allowing them rather than the company law administration to decide on certain crucial matters. Mergers between willing companies will be quicker. They will not be subject to the vagaries of the legal system and imponderables. Ratification by shareholders will be enough. To protect the rights of minority shareholders and also to ensure investor protection, the committee has aptly suggested that the new company law should recognize principles such as ‘class actions’ and ‘derivative action’.

The capital market got plenty of attention from the committee. There are proposals to devise an exit option for shareholders who have stayed with a company and not participated in a buy-back scheme implemented earlier.


Though the above detailed analysis of shareholders’ rights as stressed by the Companies Act, other statues and various committees give any investor or the reader the impression that there are enough provisions in the laws of the land, there has hardly been any conviction under them all these years. The liberalization of the Indian economy since 1991 seems to have opened the floodgates of scams and provided vast opportunities to fly-by-night operators. These have destroyed shareholder values. As a result of some scams such as those involving UTI, non-banking finance companies, plantations and vanishing companies, millions of small investors lost their savings and investments. The plight of millions of such small shareholders was indeed pitiable and heart-rending. Most of them, especially those who invested in non-banking financial companies (NBFCs), lost their life-earnings and were driven to the street penniless. In spite of such misery caused to the poor investors and the high dent in their confidence, the government and regulatory authorities were grinding too slowly and did nothing to trace and penalize the scamsters or retrieve from them and return the poor investors’ money.

Since 1990, more than INR 600,000 million was collected from prospective shareholders by several companies that did the vanishing trick. Though their names are posted on the World Wide Web, none of the directors or promoters has been prosecuted either by the Registrar of Companies or the SEBI who can file criminal complaints against them under Section 621 of the Companies Act. Directors and promoters can be made personally liable for false statements found in the prospectus. Apart from civil liability, Section 63 of the Companies Act stipulates that persons issuing false or untrue statements will be punishable with imprisonment for two years. Section 68 stipulates that any person who dishonestly induces other persons to subscribe for shares or debentures can be imprisoned for five years. But neither the government nor SEBI has thought it fit to prosecute these scamsters for more than a decade.2 However, it is heartening to note that recently, after a decade of inactivity the ministry has cracked the whip on vanishing companies.

Prioritizing investor protection, particularly small investors, the Ministry of Company Affairs (MCA) has initiated prosecutions against vanishing companies under the Companies Act as well as other legislations. According to a spokesman of the MCA: ‘On review of the ongoing actions against the vanishing companies, those companies who came up with public issues during 1993–94 and 1994–95 and vanished with public money, focus has been laid on taking timely and effective action against such companies, their promoters and directors.’3 Besides, launching prosecutions under the Companies Act, action has been taken against such entities by way of registering first information report (FIR) under Indian Penal Code, and vigorously pursuing the prosecutions already launched.

In its report, the Special Cell on Vanishing Companies in the Ministry has stated that out of the 52 ‘vanishing companies’ cases in the western region, prosecutions have been filed against 48 companies, while the remaining four are under liquidation. ‘In fact, in the case of Maa Leafin & Capital Ltd, the accused has been convicted for non-filing of statutory return,’4 a Ministry official said. Further, FIRs have been launched against 40 companies, of which 28 have been registered. In the case of Trith Plastic Ltd of Gujarat, charge-sheet has been filed in the court and directors of the company have been arrested.

Of the 36 cases in the southern region, prosecutions have been filed against 32. For non-filing statutory returns, 21 prosecutions have been filed while FIRs have been filed against 19 companies. Of the 19 FIRs launched, nine have been registered. In the case of one company, Global Property Ltd, public issue money has been refunded.

In the northern region, prosecutions have been filed against all 20 ‘vanishing companies’. In the case of Simplex Holdings, the accused have been convicted. For non-filing of statutory returns, 19 prosecutions have been filed. In case of Dee Kartvya Finance Ltd, the accused has been convicted and fined. FIRs have been filed against 15 companies of which four have been registered.

In the eastern region, of the 14 ‘vanishing companies’ cases, prosecutions have been filed against 11 companies. The remaining three are under liquidation. FIRs have been filed in all 14 cases of which 13 have been registered. Further, 11 prosecutions have been filed for non-filing of statutory returns. In case of Cilson Organics Ltd, the managing director of the company has been convicted and a fine of INR 14,000 has been imposed.

However, it should be remembered that it has taken more than a decade for the government to initiate legal action against the scamsters. Besides, it should be kept in mind that the slow-grinding judicial processes will take its own time and if past experience is any guidance, it will take another decade or more at the fastest, to get the judgement. Even then, there is no guarantee that the guilty will be convicted and the poor investors’ money returned. This is the state of affairs that has caused untold misery to the poor Indian shareholder/investor.


To safeguard the rights and privileges of investors and to keep them aware of their responsibilities the SEBI in its guide titled A Reference Guide for Investors on Their Rights and Responsibilities describes the rights of a shareholder of a company (Box 8.1).


The Securities and Exchange Board of India (SEBI), the Indian capital market regulator, in its guidelines to investors/shareholders, makes it known that a shareholder of a company enjoys the following rights:

Rights of a shareholder, as an individual

  • To receive the share certificates on allotment or transfer as the case may be in due time.
  • To receive copies of the Annual Report, the Balance Sheet and the Profit & Loss Account and the Auditors’ Report.
  • To participate and vote in general meetings either personally or through proxies.
  • To receive dividends in due time once approved in general meetings.
  • To receive corporate benefits such as rights, bonus etc. once approved.
  • To apply to Company Law Board (CLB) to call or direct the Annual General Meeting.
  • To inspect the minute books of the general meetings and to receive copies thereof.
  • To proceed against the company by way of civil or criminal proceedings.
  • To apply for the winding-up of the company.
  • To receive the residual proceeds.

Besides the above rights one enjoys as an individual shareholder, one also enjoys the following rights as a group of shareholders:

  • To requisite an Extraordinary General Meeting.
  • To demand a poll on any resolution.
  • To apply to the Company Law Board to investigate the affairs of the company.
  • To apply to the Company Law Board for relief in cases of oppression and/or mismanagement.

As a debenture-holder, one has the right

  • To receive interest/redemption in due time.
  • To receive a copy of the trust deed on request.
  • To apply for winding-up of the company if the company fails to pay its debt.
  • To approach the debenture trustee with the debenture holder’s grievance.

However, one should note that the above mentioned rights may not necessarily be absolute. For example, the right to transfer securities is subject to the company’s right to refuse transfer as per statutory provisions.

Shareholders’ responsibilities

While a shareholder may be happy to note that he/she has so many rights as a stakeholder in the company, one should not be complacent; because one also has certain responsibilities to discharge, such as

  • To remain informed.
  • To be vigilant.
  • To participate and vote in general meetings.
  • To exercise one’s rights on one’s own, or as a group.

Trading of securities

A shareholder has the right to sell securities that he/she holds at a price and time that he/she may choose. He/she can do so personally with another person or through a recognized stock exchange. Similarly, he/she has the right to buy securities from anyone or through a recognized stock exchange at a mutually acceptable price and time.

Whether it is a sale or purchase of securities effected directly by him or through an exchange, all trades should be executed by a valid, duly completed and stamped transfer deed.

If he/she chooses to deal (buy or sell) directly with another person, he/she is exposed to counter party risk, i.e., the risk of non-performance by that party. However, if he/she deals through a stock exchange, this counter party risk is reduced due to trade/settlement guarantee offered by the stock exchange mechanism. Further, he/she also has certain protections against defaults by his/her broker.

When one operates through an exchange, one has the right to receive the best price prevailing at that time for the trade and the right to receive the money or the shares on time. He/she also has the right to receive a contract note from the broker confirming the trade and indicating the time of execution of the order and necessary details of the trade, and the right to receive good rectification of bad delivery. If he/she has a dispute with his/her broker, he/she can resolve it through arbitration under the aegis of the exchange.

If an investor decides to operate through an exchange, he/she has to avail the services of a SEBI-registered broker/sub-broker. He/she has to enter into a broker-client agreement and file a client registration form. Since the contract note is a legally enforceable document, he/she should insist on receiving it. He/she has the obligation to deliver the shares in case of sale or pay the money in case of purchase within the time prescribed. In case of bad delivery of securities by the shareholder, he/she has the responsibility to rectify them or replace them with good ones.

Transfer of securities

Transfer of securities means that the company has recorded in its books a change in the title of ownership of the securities effected either privately or through an exchange transaction. To effect a transfer, the securities should be sent to the company along with a valid, duly executed and stamped transfer deed duly signed by or on behalf of the transferor (seller) and transferee (buyer). It would be proper to retain photo-copies of the securities and the transfer deed when they are sent to the company for transfer. It is essential that one sends them by registered post with acknowledgement due and watch out for the receipt of the acknowledgement card. If one does not receive the confirmation of receipt within a reasonable period, one should immediately approach the postal authorities for confirmation.

Sometimes, for an investors’ own convenience, he/she may choose not to transfer the securities immediately. This may facilitate easy and quick selling of the securities. In that case, he/she should take care that the transfer deed remains valid. However, in order to avail the corporate benefits such as dividends, bonus or rights from the company, it is essential that he/she gets the securities transferred in his/her name and become a shareholder.

On receipt of the investors’ request for transfer, the company proceeds to transfer the securities as per the provisions of the law. In case it cannot effect the transfer, the company returns the securities giving details of the grounds under which the transfer could not be effected. This is known as ‘Company Objection’.

When an investors’ happens to receive a company objection for transfer, he/she should proceed to get the errors/discrepancies corrected. He/she may have to contact the transferor (the seller) either directly or through his/her broker for rectification or replacement with good securities. Then he/she can resubmit the securities and the transfer deed to the company for effecting the transfer. In case he/she is unable to get the errors rectified or get them replaced, he/she can take recourse to the seller and his/her broker through the stock exchange to get back his/her money. However, if one had transacted directly with the seller originally, one has to settle the matter with the seller directly.

Sometimes, one’s securities may be lost or misplaced. One should immediately request the company to record a ‘stop transfer’ of the securities and simultaneously apply for issue of duplicate securities. For effecting stop transfer, the company may require to produce a court order or the copy of the FIR filled by him with the police. Further, to issue duplicate securities to him, the company may require him to submit indemnity bonds, affidavit, sureties etc. besides issue of a public notice. He/she had to comply with these requirements in order to protect his/her interest.

Sometimes, it may so happen that the securities are lost in transit either from the shareholder to the company or from the company to him/her. He/she has to be on his/her guard and write to the company within a month of his/her sending the securities to the company. As soon as it is noticed that either the company has not received the securities that was sent or he/she did not receive the securities that the company claims to have sent to him/her, he/she should immediately request the company to stop transfer and proceed to apply for duplicate securities.

Depository and dematerialization

Shares are traditionally held in physical or paper form. This method has its own inherent weaknesses such as loss/theft of certificates, forged/fake certificates, cumbersome and time consuming procedure for transfer of shares, etc. Therefore, to eliminate these weaknesses, a system called ‘Depository System’ has been established.

A depository is a system which holds shares in the form of electronic accounts in the same way a bank holds one’s money in a savings account.

Depository System provides the following advantages to an investor:

  • His/her shares cannot be lost or stolen or mutilated.
  • He/she never needs to doubt the genuineness of his/her shares i.e., whether they are forged or fake.
  • Share transactions such as transfer, transmission etc. can be effected immediately.
  • Transaction costs are lower than on the physical segment.
  • There is no risk of bad delivery.
  • Bonus/Rights shares allotted to the investor will be immediately credited to his/her account.
  • He/she will receive the statement of accounts of his/her transactions/holdings periodically.

When a shareholder decides to have his/her shares in electronic form, he/she should approach a Depository Participant (DP) who is an agent of the depository and open an account. He/she should surrender his/her share certificates in physical form and his/her DP will arrange to get them sent to and verified by the company and on confirmation credit his/her account with an equivalent number of shares. This process is known as demateralization. One can always reverse this process if one so desires and get his/her shares reconverted into paper form. This reverse process is known as ‘re-materialization’.

Share transactions (such as sale or purchase and transfer/transmission etc.) in the electronic form can be effected in a much simpler and faster way. All one needs to do is that after confirmation of sales/purchase transaction by one’s broker, one should approach his/her DP with a request to debit/credit his/her account for the transaction. The Depository will immediately arrange to complete the transaction by updating his/her account. There is no need for separate communication to the company to register the transfer.


Source: Securities and Exchange Board of India, A Reference Guide for Investors on Their Rights and Responsibilities, 1997. Reproduced with permission from the Securities and Exchange Board of India.

rities he or she holds in the firm. At the same time, while he or she makes an investment decision the investor would have obviously taken note of and evaluated the attendant risks that go with such expectations, especially the possibility of the risk that the income and/or capital growth may not materialize. This mismatch between the expectations of the investors and the unexpected final outcome in terms of income and/or capital growth arises mainly because their hard earned money is entrusted to managers in a corporation whose investment decisions, apart from carrying certain risks of their own, may not match those of the investors.

Why is Investor Protection Needed?

An appropriate definition of investor protection is very much needed to relate it to corporate governance and to establish the correlation between these two. As stated earlier, when investors finance companies, they take a risk that could land them in a situation in which the returns on their investments would not be forthcoming because the managers or those whom they appointed to represent them on the board may keep them or expropriate them either covertly or overtly. This kind of betrayal of the investors by the ‘insiders’ as the managers or board of directors of the company as they are called may shake their confidence, which in the long run would have a deleterious impact on the overall investment climate with serious repercussions on the economic development of the country. The economic parameters of a nation such as output, employment, income, expenditure, and above all, overall economic growth will be badly jeopardized due to declining investment. Therefore, there is a very strong reason to maintain the investors’ morale, protect their interests and restore their confidence as and when there is a tendency for investors to lose confidence in the system or when their investments are at a stake. Research findings also reveal that when the law and its agencies fail to protect investors, corporate governance and external finance do not fare well. If there is nil/inadequate investor protection, the insiders can easily steal the firm’s profits, whereas if the investors’ interests are well taken care of, it will be difficult to do the same.

Definition of Investor Protection

Investors by virtue of their investments in securities of corporations obtain certain rights and powers that are expected to be protected by the State, which gave the charter or legal entity to the corporate bodies or the regulators designated by the State to do so. Their basic rights include disclosure and accounting rules that will enable them to obtain proper, precise and accurate information to exercise other rights such as approval of executive decisions on substantial sale or investments, voting out of incompetent or otherwise ineligible directors and appointment of auditors. There are also laws that mainly deal with bankruptcy and reorganization procedures that outline measures and procedures that enable creditors to repossess collateral to protect their seniority and to make it difficult for firms to seek court protection in reorganization. In many countries, laws and legal regulations are enforced in part by market regulators such as SEBI, in part by courts or government agencies such as the Department of Company Affairs in India and in part by markets themselves. If the investors’ rights are effectively enforced by one or all of these agencies, ‘It would force insiders to repay creditors and distribute profits to shareholders and thereby protect external financing mechanism form breaking down’.5 Thus, investor protection can be defined by both (i) the extent of the laws that protect investors’ rights; and (ii) the strength of the legal institutions that facilitate law enforcement.

Relationship Between Investor Protection and Corporate Governance

Recent research confirms that an essential feature of good corporate governance is strong investor protection6. According to Rafael La Porta et al7 (1999), ‘Corporate Governance is to a large extent a set of mechanisms through which outside investors protect themselves against expropriation by the insiders”. Expropriation is possible because of the agency problems that are inherent in the formation and structure of corporations. Shareholders or investors of a firm who are too numerous and scattered cannot manage it, and therefore, entrust the management of the firm to managers who include the Board of Directors and senior executives such as the CEO and the CFO. However, managerial actions depart from those required to maximize shareholder returns. Such mismatch of objectives results in agency problem. Investors do realize and accept a certain level of self-interested behaviours in managers while they delegate responsibility to them. But when such self-indulgence by managers exceeds reasonable limits, principles of corporate governance come in to check such abuses and malpractices. The core substance of corporate governance lies in designing and putting in place mechanisms such as disclosures, monitoring, oversight and corrective systems that we can align the objectives of the two sets of players (investors and managers) as closely as possible and minimize the agency problems.

How Do Insiders Steal Investors’ Funds?

The insiders, both managers and controlling shareholders, can expropriate the investors in a variety of ways. Rafael La Porta et al.8 (1999), describe several means by which the insiders siphon off the investor’s funds. In some countries, the insiders of the firm simply steal the earnings. These arrangements take various forms. Sometimes, major shareholders who control the company and their managers resort to underselling the output investors, to units they own. Such malpractices are nothing short of thefts. There are other instances where unfit or under-qualified family members are appointed to senior perks management positions with excessive pay and perks. In all these instances, it is clear that the insiders use the profits of the firm to benefit themselves (either as excessive executive salaries or in the form unjustifiable perquisites) instead of returning the money to outside investors to whom it legitimately belongs. In this context, minority shareholders and creditors are far more vulnerable. Expropriation also is done by insider selling additional securities in the firm they control to another firm or subsidiaries they own at below market prices, with assistance from obliging interlocking directorates, and also by diverting corporate opportunities to subsidiaries and so on. Such practices, though often legal, have the same effect as theft. However, it must be stressed that these sharp practices of insiders vary from country to country depending on the existence or non-existence of democratic and corporate values, maturity or otherwise of the securities market, financial systems, pace of new security issues, corporate ownership structures, dividend policies, efficiency of investment allocation, the legal system and the competence of the securities market regulator.

Rights to Information and Other Rights

Investor protection is not attainable without adequate and reliable corporate information. All outside investors, whether they are shareholders or investors have an inalienable right to have certain corporate information. In fact, several other rights provided to them under the law cannot be exercised by shareholders unless companies in which they have invested disclose such information. For instance, a creditor would be hard-pressed to understand whether a debt agreement had been violated or not, in the absence of appropriate accounting data. If investors do not enjoy these rights to information, there is nothing to prevent insiders from not repaying the creditors or distributing dividends to shareholders. Apart from the rights to information, creditors have also certain other rights, and these are to be protected. Minority shareholders have the same rights as majority shareholders in dividend policies and in access to new security issues. The significant but non-controlling shareholders need the right to have their votes counted and respected. This is the reason why the SEBI-appointed Kumar Mangalam Birla Committee recommended postal ballot for the benefit of those who cannot attend the AGMs held by corporations in cities where their corporate offices are located. The committee recommended that in case of shareholders, who are unable to attend the meeting, there should be a requirement, which would enable them to vote by postal ballot on important key issues such as corporate restructuring, sale of assets, new issues on preferential allotment and matters relating to change in management. Likewise, even the large creditors such as institutional investors who are powerful enough by virtue of their large stakes and need relatively few formal rights, should be able to ‘seize and liquidate collateral, or to reorganize the firm’. Investors would be unable to protect their turfs even if they have a large number or percentage of the share, if they are not able to enforce their rights.

There are, however, rules and regulations that are designed to protect investors. Some of the important regulations are with regard to disclosure and accounting standards, which provide investors with the information they need to exercise other rights of investors such as the ‘ability to receive dividends on pro-rata terms, to vote for directors, to participate in shareholders’ meeting, to subscribe to new issues of securities on the same terms as the insiders, to sue directors for suspected wrongdoing including expropriation, to call extraordinary shareholders meeting, etc. Laws protecting creditors largely deal with bankruptcy procedures and include measures which enable creditors to repossess collateral, protect their seniority and make it harder for firms to seek court protection in reorganization. In different jurisdictions, rules protecting investors come differently from various sources, including not only company, security, bankruptcy, takeover and competition laws but also stock exchange regulations and accounting standards. In India, for instance, rules protecting investors emanate from the Department of Company Affairs of the Ministry of Finance, the SEBI, the Listing Agreements of Stock Exchanges, Accounting Standards of the ICAI, and sometimes decisions of the Superior Court of the country. It should be stressed though that the enforcement of laws by these agencies are as crucial as their content and in most emerging economies these are lax, delayed and dilatory, resulting in poor corporate governance.

Corporate Governance Through Legal Protection of Investors

The objective of corporate governance reforms in most countries including several Latin American and Asian countries is to protect the rights of outside investors, including both shareholders and creditors. These reforms have a focus to expand financial markets to facilitate external financing of new firms, to infuse large foreign investments in existing firms, to promote external commercial borrowings, to help local firms access foreign capital by listing themselves in stock markets overseas, to move away from concentrated ownerships, to expose native firms to foreign competition, to wholesome corporate developments elsewhere and also to improve the efficiency of investment allocation.

The importance of legal rules and regulations as a means to protect outside investors against insider expropriation of their money is in sharp contrast to the traditional ‘laws and economies’ perspective and has evolved over the past 45 years. As per this line of argument, financial market regulations are deemed unwanted, because most financial contracts are entered into between professional issuers and well-versed and knowledgeable investors. Investors generally know that there is a risk of expropriation of their investment by insiders. To avoid such occurrence, they would expect firms to contractually disclose financial and information about them routinely. If firms fail to abide by such contractual obligation, investors penalize them through the securities market. Entrepreneurs know this well and treat investors well by disclosing to them all relevant information besides limiting expropriation. It is the considered view of some authorities on the subject that under circumstances of enforcements of such contracts between issuers and investors, financial market regulation becomes unnecessary.9

A case in point is Russia, which has a good securities law, a good bankruptcy law and an equally good company law in books. Its Securities and Exchange Commission too is independent and aggressive but relatively has few enforcement powers. With an ineffective judiciary and weak enforcement of law, Russia’s financial market has not grown in an environment where blatant violations of the law are far too common.

So, in reality, laws and their enforcement are the major factors that help outsiders to invest in corporate firms. Although the reputation and goodwill of a firm do help it raise funds, law and its enforcement are the clinching factors to decide on investment. It is an indisputable fact that to a large extent shareholders and creditors decide to invest in firms because their rights are protected by the law. The outside investors are more vulnerable to expropriation, and therefore, more dependent on law, than their employees or the suppliers, who are useful to them and also have reliable source of information to ward off any problems and are at a lesser risk of being mistreated. Besides, available evidence also suggests that in countries where there is poor investor protection there may be a need to change many more rules simultaneously to bring them up to best corporate governance practice. But this may not be easy as families controlling corporations may object to these reforms. Therefore, law and its enforcement are important means to protect investors and help promote corporate governance.

Impact of Investor Protection on Ownership and Control of Firms

In many countries, firms are owned and controlled by promoter families and in such closely held firms, insiders use every opportunity to abuse the rights of other shareholders and steal their profits through devious means. In such cases where there is poor investor protection, large scale expropriation is feasible. Control through ownership acquires enormous value because it gives such owners opportunities to expropriate efficiently. Entrepreneurs who promote companies would not like to lose control and thereby give up the chances of expropriation by diffusing control rights when investor protection is poor. Promoter families in countries with poor investor protection would wish to have concentrated control of the enterprises they have floated. However, expropriation can be limited considerably in these family-owned firms, by dissipating control among several large investors, none of whom can control the decision of the firm without agreeing with others. But then this is a situation well entrenched, closely held firms’ promoters would wish to avoid. The evidence from a number of individual countries and the seven OECD countries with poor investor protection shows more concentrated control of firms than countries with good investor protection. In the East, except Japan where there is a fairly good investor protection, there is a predominance of family control and family management of corporations. The evidence available in many countries is in consonance with the proposition that legal environment shapes the value of the private benefits of control and thereby determines the ownership structures.

Therefore, the available evidence on corporate ownership patterns around the world supports strongly the importance of investor protection. Evidence also shows that countries with poor investor protection have more concentrated control of firms than countries with good investor protection.

Studies made by various researchers testify to the fact that in countries where there is a concentration of ownership in the hands of few families, there may be stiff opposition to legal reforms that are likely to reduce their control over firms and promote investor protection. From the promoter families standpoint, legal reforms that will enhance the rights of outside investors, would cause a reduction over their control of the firms and a marked decline in opportunities for expropriation. This, in turn, will promote the total value of the firm and prompt investors finance new projects on more attractive terms. The ultimate impact of the legal reforms will be a massive redistribution of insiders’ wealth to outside investors. It is no wonder, therefore, that insiders (promoter families) from many parts of the world, where they are prevalent, are opposed to legal reforms, be it in Asia, Latin America, or Europe.10 According to these researchers, there is also another reason why the insiders in such firms are opposed to reforms and the expansion of capital markets. Under the existing conditions, these firms can finance their own investment projects internally or through captive banks or subsidiary financial institutions. Studies show that a large chunk of credit goes to the few largest firms in countries with poor investor protection. This was also the case in India as R. K. Hazari and his researchers found out in the early 1960s. Even recently as late as in 2001, it was found out that there has been a rapid expansion of assets and turnover of industrial houses owned by families and there is a massive concentration at the top. The assets of the Ambanis of Reliance, the Munjals of the Hero group, Shiv Nadar of HCL Technologies, Tatas, Birlas, Jindals, R. P. Goenka, Azim Premji of Wipro, TVS, Chidambaram and Murugappa groups have grown tremendously mostly due to insider domination and poor investor protection in the country. As a consequence of this fertile situation, the large firms obtain not only the finance they need but also political clout that comes with the access to such finance in a corruption-ridden society, as well as the security from competition of smaller firms that require external capital. Thus poor corporate governance provides large family-owned firms not only secure finance but also easy access to politics and markets. The dominant families have thus abiding interest in keeping the status quo lest the reforms take away their privileges and confer protection to outside investors.

Impact of Investor Protection on the Development of Financial Markets

Investor protection provides an impetus for the growth of capital markets. When investors are protected from the expropriation of insiders, they pay more for securities, which makes it attractive for entrepreneurs to issue securities. Through investor protection, financial markets can develop with ease and perfection, which in turn can accelerate economic growth by (i) enhancing savings and capital information; (ii) channelizing these into real investment, and (iii) improving the efficiency of capital allocation, since capital flows into more productive uses. Further financial development improves efficient resource allocation and through this investor protection brings about growth in productivity and output, the two basic ingredients needed to speed up economic development.

Research studies point out that countries with well-developed financial markets regulated by laws allocate investment across industries more in line with growth opportunities in these industries than countries with weak financial markets or poor regulatory mechanism. These studies also reveal that (i) most developed financial markets are the ones that are protected by regulation and laws while unregulated markets do not work well, may be due to the fact they allow too much of expropriation of outside investors by corporate insiders; (ii) improving the functioning of financial markets confers real benefits both in terms of overall economic growth and the allocation of resources across sectors; (iii) one broad strategy of effective regulation and of encouragement of financial markets begins with protection of outside investors, whether they are shareholders or creditors; and (iv) enforced outside shareholders’ rights in many countries encourage the development of equity markets as measured by valuation of firms, the number of listed companies and the rate at which firms go for public issues.

However, investor protection does not necessarily mean rights just included in the laws and regulations alone, but the effectiveness with which they are enforced. In countries with poor investor protection, the insiders may treat outside investors fairly well as long as the firms’ future prospects are bright and they need the continued external financing by outsiders. But when the future prospects tend to deteriorate, insiders may step up expropriation. In such a scenario, unless there are effective laws against such malpractices and they are effectively enforced, outside investors will not be able to do anything but to withdraw their investments. Therefore, investor protection is absolutely essential for the orderly development and continued proper functioning of capital markets.

Bank and Corporate Governance

Banks play a significant role in the growth of the corporate sector by providing them finance for their operations. However, there is a difference in the roles they play in different countries and these diverse roles have different impacts, both on investor protection and its end result, corporate governance. There are considerable differences between bank-centred corporate governance systems such as those of Germany and Japan compared to market-centred systems such as those of the United Kingdom and the United States. In the former, the main bank provides both a significant share of finance and governance to firms while in the latter finance is provided by large numbers of investors and takeovers play a major governance role.

But the classification of financial systems into bank centred and market centred is neither straightforward nor particularly useful. Rafael La Porta et al.11 point out to studies that showed that in the 1980s when the Japanese economy was being touted as the best and worthy of emulation by other economies, such bank-centred governance was widely regarded as superior, since it enabled firms to make long-term investment decisions, delivered capital to firms facing liquidity crisis thereby avoiding costly financial distress, and above all, replaced the expensive disruptive takeover with more surgical bank intervention when the management of the borrowing firm under-performed. The rosy situation, however, did not last long enough. When the Japanese economy collapsed in the 1990s, this form of financing and governance was found faulty. Far from being the promoters of rational investment, Japanese banks were found to be the source of the soft budget constraint, over lending to loss making firms that required restructuring, and resorting to collusion with managers to prevent external threats to their control and to collect rents on bank loans. Likewise, banks in Germany too were found to be wanting in providing good governance, especially in bad times.

In the ultimate analysis of the two systems, the market based system with its focus on legal protection of investors, seems to be doing better as was demonstrated time and again, the latest being its successful riding of the American stock market bubble of the 1990s.

In conclusion, it is to be stressed that strong investor protection is an inalienable part of effective corporate governance. Financial markets, very vital constituents of economic growth, need some protection of outside investors, whether by courts, market regulators, government’s agencies or market participants themselves through voluntary codes or guidelines. There have to be radical changes in the legal structure, the laws and their effective enforcement. With the integration of capital markets, the necessity to bring about these reforms is more pertinent today than it was in earlier times.


Small investors are the backbone of the Indian capital market and yet a systematic study of their concerns and attempts to protect them has been relatively of recent origin. Due to lack of proper investor protection, the capital market in the country has experienced a stream of market irregularities and scandals in the 1990s. SEBI itself, though formed with the primary objective of investor protection, took notice of the issue seriously only after the Ketan Parikh Scam (2001) and the UTI crisis (1998 and 2001) and has developed sophisticated institutional mechanism and harnessed computer technology to serve the purpose. Yet, there are still continuing concerns about the speed and effectiveness with which fraudulent activities are detected and punished, which after all, should be the major focus of the capital market reforms in the country.

The SEBI–NCAER study12 estimated that the investor population in India was 12.8 million or nearly 8 per cent of all Indian households. The bulk of the increase in the number of shareholders had taken place during the boom years 1990–1994 and tapered off thereafter. By 1997 the capital market bubble had burst. The Household Investors Survey of SCMRD (1997) revealed the following: (i) a majority of investors reported unsatisfactory experience of equity-investing; (ii) 80 per cent of the investors said that they had little or no confidence in company managements; (iii) 55 per cent respondents showed little or no confidence on the market regulator, SEBI; and (iv) most preferred saving instruments and government saving schemes and banks’ fixed depositors. This reflected a considerable erosion of investor confidence in securities and corporations. Many subsequent investor surveys also found broadly the same investor reactions.

All these surveys underlined the need for restoring the investor’s confidence in private corporations, which enjoy little credibility with investors who have badly burnt their fingers in a series of scams. This calls for a credible programme of corporate governance reform, focusing on outside minority shareholder protection. The situation does not seem to have changed much today notwithstanding the CII’s code and SEBI’s guidelines and is the reason why investors prefer government securities rather than corporate securities. The sooner this trend is reversed, the better it will be for the development of the capital market in the country.


The committee chaired by N. K. Mitra submitted its report on investor protection in April 2001, with the following recommendations:

  1. There is a need for a specific Act to protect investor interest. The Act should codify, amend and consolidate laws and practices for the purpose of protecting investors interest in corporate investment;
  2. Establishment of a judicial forum and award of compensation for aggrieved investors;
  3. Investor Education and Protection Fund which is under the Companies Act should be shifted to the SEBI Act and be administered by SEBI;
  4. SEBI should be the only capital market regulator, clothed with the powers of investigation;
  5. The regulator, SEBI should require all IPOs to be insured under third party insurance with differential premium based on the risk study by the insurance company;
  6. SEBI Act, 1992, should be amended to provide for statutory standing committees on investors protection, market operation and standard setting; and
  7. The Securities Contracts (Regulation) Act, 1956, should be amended to provide for corporatization and good governance of stock exchanges.

Investor protection is a wide term that covers various measures to protect the investors from malpractices of companies, brokers, merchant bankers, issue managers, registrar of new issues and so on. It is also incumbent on the investor to take necessary and appropriate precautions to protect their own interest, since all investments have some risk elements. But where they find that their interests are adversely impacted because of malpractice by companies, brokers or any other capital market intermediaries, they can seek redressal of their grievances from appropriate designated authorities. Most of the investor complaints can be divided into three broad categories:

  1. Against member-brokers of stock exchanges: Complaints of this category generally centre around the price, quantity etc at which transactions are put through defective delivery, delayed payments or nonpayments from brokers.
  2. Against companies listed for trading on stock exchanges: Complaints against companies generally centre around non-receipt of allotment letters, refund orders, non-receipts of dividends, interest, etc.
  3. Complaints against financial intermediaries: These complaints may be against sub-brokers, agents, merchant bankers, and issue managers and generally centre around non-delivery of securities and non-settlement of payment due to investors. However, these complaints cannot be entertained by the stock exchanges, as per their rules.

There are several agencies in India that are expected to protect investors. In fact, there are so many with overlapping functions that they cause confusion to the investors as to whom they should go to for redressal of their grievances. The stated primary objective of the country’s sole capital market regulator, the Securities and Exchange Board of India, popularly known as SEBI, is protection of investors’ interests. SEBI has provided guidelines for an efficient redressal process in its reference guide for investors (Box 8.2). But, investor protection is a multi-dimensional function, requiring checks at various levels, as shown below:

  • Company level: Disclosure and corporate governance norms.
  • Stock brokers level: Self regulating organization of brokers.
  • Stock exchanges: Every stock exchange has to have a grievance redressal mechanism in place as well as an Investor Protection Fund.
  • Regulatory agencies: These include:

    Investors’ Grievances and Guidance Division of SEBI

    Department of Company Affairs

    Department of Economic Affairs

    Reserve Bank of India

Inventory Information Centres have been set up in every recognized stock exchange which in addition to the complaints related to the securities traded/listed with them, will take up all other complaints regarding the trades effected in the exchange and the relevant member of the exchange.

Moreover, two other avenues always available to the investor to seek redressal of his or her complaints are

  1. complaints with Consumers Disputes Redressal Forums; and
  2. suits in the court of law.

In this context, it is pertinent to note that already law courts have started imposing exemplary punishments to directors who violated codes and guidelines on corporate governance provided by competent authorities. In May 2004, Citigroup agreed for a US$ 2.0 billion settlement, and more than a dozen other banks including JP Morgan Chase and Deutsche Bank are likely to fall in line. In January 2005, at the insistence of a US Court, former directors of WorldCom (now known as MCI) have agreed to pay US$ 18 million out of their pockets as part of a shareholder law suit. Likewise, 18 former directors of the collapsed energy conglomerate Enron, agreed to pay US$ 13 million as part of a settlement in another shareholder lawsuit.15 Though these settlements are subject to confirmation by the concerned US District Court, corporate governance experts had hailed these settlements for setting a new standard in accountability of directors when companies they oversee go astray. In India too, as per the dictates of a lower court, recently the directors of a non-banking finance company have agreed to pay back to the company a large sum of money it lost, due to their indiscretion in an investment decision.


Though there is a redressal mechanism in place in the country, investors could not get their complaints adequately addressed to, much less solved to their satisfaction by these public authorities. Multiplicity of authorities, overlapping functions, lack of knowledge and understanding of the common investor about these agencies and lack of enforcement have all acted against investor protection. Notwithstanding the existence of this seemingly comprehensive network of public institutions established for investor protection in India, a series of scams has taken place that has shaken the confidence of investors since 1991, the year of economic liberalization.


There will be occasions when an investor has a grievance against the company in which one is an investor. It may be that one has not received the share certificates on allotment or on transfer; or the dividend/interest warrant or refund order; or perhaps the Annual Accounts etc. The investor should first approach the company, Mutual Fund (MF) or the Depository Participant (DP) as the case may be. If he/she is not satisfied with their response, the investor can approach SEBI or the regulatory authority in whose purview the grievance falls.

Implementation of steps that will ensure lasting shareholder value will vary among companies depending to a large extent on top management support, the nature and diversity of the business portfolio, the degree of decentralization and on its size, global reach, employee mix, culture, management style and the sense of urgency. However, bringing about long term shareholder value is the right thing to do and competitive pressures, greater awareness among shareholders, government regulations and institutional shareholders seeking maximum returns will ensure that the redressal system is there to stay.


Source: Securities and Exchange Board of India, A Reference Guide for Investors on Their Rights and Responsibilities, 1997. Reproduced with permission from the Securities and Exchange Board of India.

Loss of investor confidence due to these scandals that conveyed an image of fraud and manipulation was so great that even after several years of moribund stock market, things have not improved.

The series of scams has cast a shadow over the credibility of SEBI, and its capacity to create a safe and sound equity market.


The SEBI, the designated capital market regulator has a sort of mixed record in fostering and nurturing corporate governance in the Indian corporate sector. Since its inception in 1992, SEBI has registered substantial growth in its stature and reach. Presently, its regulatory framework is robust. It has also played a significant role in creating the country’s capital market infrastructure that is recognized as one of the more advanced in the world. If SEBI’s growth and reach over the past five years have been significant, its failure too has been spectacular. S. Vaidya Nathan lists the following failures:13

  1. Poor tackling of price manipulation and insider trading issues: ‘Insider trading and price manipulation ahead of key corporate actions still continue to be rampant.’ SEBI has not effectively tackled—unlike its American counterpart SEC—issues such as price manipulation and insider trading. It has to strengthen enforcement and surveillance and impose deterrent penalties to stop these wrong-doings.
  2. Poor conviction rate: A ‘regulator’s credibility hinges on its ability to achieve a fairly high conviction rate against errant market players’. However, SEBI has not been able to penalize effectively violators of various corporate laws. In most cases, the appellate authority SAT has set aside SEBI’s penal measures against top market players for violation of its laws. It is necessary for SEBI to build up strong cases with impeccable evidences to ensure conviction of market violators, rather than let them go scot free because of SAT’s intervention.
  3. Need to enhance its manpower skills: SEBI, as a capital market regulator, lacks the required manpower with necessary skill sets, especially in areas such as financial services, legal acumen, knowledge of various business functions, etc. to carry out its regulatory functions efficiently. It needs to invest heavily in the recruitment and training of such qualified manpower. SEBI has to build a coterie of professionals of competence, honesty and integrity.
  4. It should simplify and trim regulations: SEBI has ‘to simplify and trim the regulations, so that they are compact, easy to follow and comprehend’. There is an urgent need for SEBI to place in the public domain in good time the large number of reports filed by innumerable market players, corporations and institutions in the process of complying with its regulations. This will facilitate analysts chronicle and spot market trends in different areas. Such efforts would enhance and compliment SEBI’s attempts to regulate the market effectively.
  5. It should tone up quality of disclosures: It is also necessary to improve the quality of SEBI’s disclosures with a view to providing more useful information to investors, especially in matters of mergers and acquisitions, earnings of companies and FII inflows. It is also important that SEBI streamlines its thus far poorly managed Web site so that it is made into a valuable source of information.
  6. It should solve issues of IPOs and mutualfunds: There are a host of other issues it has to tackle, such as confusion over the clearance of IPOs in the INR 200 million range; ensure that SEBI files and maintains its internal databases accurately and efficiently; and formally shelf the move to convert the Association of Mutual Funds of India into a self-regulatory organization, as the time for it has not come and such a move could lead to conflicts of interest with SEBI itself.

The foregoing analysis clearly shows that though SEBI has emerged as the one and only capital market regulator in the country, its functioning has been ineffective so far due to its failure to exercise its authority and bring to book the violators and the wrong-doers. It has also let itself to be influenced unduly and unjustifiably by some corporate big-wigs. Therefore SEBI badly needs to improve administration and accountability and restore its credibility as a powerful regulator.14

The phenomenal growth of modern corporations, have brought about the kind and order of material wealth to the international community that was never possible a few years ago. But this growth was possible, due to the evolution of public limited or joint stock companies, which are most attractive to investors. In such organizations, financial liability of the shareholders is limited to the extent of the shares held by them. However, the investor needs to be protected from insiders as he is not involved in the day-to-day management of the company. To realize such an investor protection, countries have evolved rules, regulations, systems and mechanisms—both internal (to the company) and external.

There is a global consensus about the objective of ‘good’ corporate governance: maximizing long-term shareholder value. The members of a company enjoy various rights in relation to the company. These rights are conferred on them either by the Indian Companies Act of 1956 or by the Memorandum and Articles of Association of the company or by the general law, especially those relating to contracts under the Indian Contract Act, 1872.

Various committees have been set up both in India and elsewhere to guide the shareholders with regard to good corporate governance, especially their long term interests. The Working Group on the Companies Act set up by the Government of India recommended many financial as well as non-financial disclosures. The objective of the CII was to develop and promote the Desirable Code of Corporate Governance, corporate governance to be adopted and followed by Indian companies. The SEBI, as the custodian of investor interests constituted an 18-member committee, chaired by Kumar Mangalam Birla. The committee made 25 recommendations, 19 of them ‘mandatory’, that is, these were enforceable. The Naresh Chandra Committee’s report on ‘Audit and Corporate Governance’ has taken forward the recommendations of the Birla Committee. Two major issues the committee addressed and made appropriate recommendations were: representation of independent directors on a company’s board, and the composition of the audit committee

The SEBI-appointed Narayana Murthy Committee on Corporate Governance focused on investors and shareholders. The Government of India-constituted J. J. Irani Committee has come out with suggestions for laying sound base for corporate growth. Though the Companies Act, other statutes and recommendations of various committees give an investor the impression that there are enough provisions in the laws of the land, there has hardly been any conviction under them all these years. Since 1991, the liberalization of the Indian economy seems to have opened the floodgates for scams and provided vast opportunities to fly-by-night operators to destroy shareholder values. Strong investor protection is associated with effective corporate governance. Investors by virtue of their investments in securities of corporations obtain certain rights and powers that are expected to be protected by the State which gave the legal entity to the corporate bodies or the regulators designated by the State to do so. Their basic rights include disclosure and accounting rules that will enable them to obtain proper, precise and accurate information to exercise other rights such as approval of executive decisions on substantial sale or investments, voting out of incompetent or otherwise ineligible directors and appointment of auditors.

Recent research confirms that an essential feature of good corporate governance is strong investor protection. The ‘insiders’—both managers and controlling shareholders—can expropriate the investors in a variety of ways. Investor protection is not attainable without adequate and reliable corporate information. There are rules and regulations that are designed to protect investors. The objective of the corporate is to protect the rights of outside investors, including both shareholders and creditors. In many countries, firms are owned and controlled by promoter families and in such closely held firms, insiders use every opportunity to abuse the rights of other shareholders and steal their profits through devious means. Investor protection provides an impetus for the growth of capital markets. Due to lack of proper investor protection, the capital market in India has experienced a stream of market irregularities and scandals in the 1990s. There are several agencies in India that are expected to protect investors. These include the SEBI, Department of Company Affairs, Department of Economic Affairs, Reserve Bank of India, Consumer Courts and Courts of Law.

An objective analysis of the problems faced byinvestors in countries like India, leading to an erosion of their confidence in the capital market with the attendant adverse impact on the economic growth, shows that the major problems arise due to corporate misgovernance and not due to minor aberrations in following the procedures set by SEBI. To rectify such a situation, actions that lead to corporate misgovernance should be codified and small investors provided with statutory rights to enforce civil liability against the directors whose misdeeds and non-application of minds in investment or other decisions have adversely impacted the company and its shareholders. Some of the misdeeds would include (i) breach of fiduciary duty; (ii) siphoning off corporate funds; (iii) misapplication of company’s funds; (iv) price manipulation or insider trading; (v) manipulation of accounts; (vi) failure to disclose conflicts of interests; (vii) fraud or cheating; (viii) misappropriation of corporate assets; and (ix) losses caused due to mismanagement or negligence.

Another important protection to the investor would be by strengthening the enforceability of accounting standards in India, as has been done in the US through the Sarbanes–Oxley Act. In India, though all the accounting standards have been made mandatory as a result of forceful pleas by various committees on corporate governance, they have not still acquired the legal status, in practice. This lack of legal sanction enables violators and wrongdoers go scot free. Therefore, it is absolutely necessary that all the accounting standards should be legally enforced and exemplary punishments meted out to violators if the investor is to be protected and corporate governance ensured for the larger benefit of the economy and the nation.

  • Agency costs
  • Joint stock company
  • Limited liability company
  • Long-term shareholder value
  • Extraordinary general meeting
  • Shareholder
  • Investor
  • Disclosure
  • Transparency
  • Listed companies
  • Code of corporate governance
  • Appropriate systems
  • Investment proposals
  • Share transfers
  • Affiliated entities
  • Unlisted public companies
  • Postal ballots
  • Shareholder protection
  • Debenture holder
  • Trading of securities
  • Transfer of securities
  • Depository
  • Dematerialization
  • Grievance redressal
  • Investor protection
  • Rights to information
  • Ownership and control
  • Financial markets
  • Stock brokers
  • Stock exchanges
  • Regulatory agencies
  • Legislative provisions
  • Initial public offers
  • Mutual funds
  1. What is the need to protect the interests of investors? Discuss this in the context of family-promoted companies and corporations in emerging economics.
  2. Discuss the rights of shareholders. Also explain the corresponding responsibilities of investors.
  3. Several committees have discussed the issue of investor protection. In this context, discuss the views of the following committees on this issue:
    1. Working Group on the Companies Act
    2. Kumar Mangalam Birla Committee
    3. Narayana Murthy Committee
    4. Dr J. J. Irani Committee
  4. Discuss the problems that have led to poor investor protection in India. What are the investor grievances redressal mechanisms that have been put in place by SEBI and other authorities? How effective are these mechanisms?

Academic Foundation, Reports on Corporate Governance (New Delhi: Academic Foundation, 2004).

Cadbury, A., Cadbury Report. The Financial Aspects of Corporate Governance (London: Financial Reporting Council, 27 May 1992).

De Fond, M. L and Hung, M., “Investor Protection and Corporate Governance: Evidence From Worldwide CEO Turn-over,” Journal of Accounting Research (Vol. 42, No. 2): 269–312.

Economica India Info-Services, Reports on Corporate Governance (New Delhi: Academic Foundation, 2004).

Fernando, A. C., Corporate Governance, Principles, Policies and Practices, (New Delhi: Pearson Education, 2006).

Khanna, S. R., Financial Markets in India and Protection of Investors (New Delhi: VOICE, Voluntary Organization in Interest of Consumer Education, New Century Publications, 2004).

Neelamegam, R. and Srinivasan, R., Investors’ Protection, A Study of Legal Aspects (New Delhi: Raj Publications, 1998).

Parikh, K. S. and Radhakrishna, R. eds., India Development Report 2004–05, (New Delhi: Indira Gandhi Institute of Development Research, Oxford University Press, 2006).

Porta, R. L, DeSilanes, F.L., Shleifer, A., and Vishny, R., “Investor Protection and Corporate Governance,” Harvard University and University of Chicago, June 1999, available at

Report of J. J. Irani Committee on Company Law, 2005, available at

The Confederation of the Indian Industry, “Desirable Corporate Governance: A Code,” April 1998, Available at

(The case is based on reports in the print and electronic media. The case is meant for academic purpose only. The writer has no intention to sully the reputations of the corporate or the executives discussed.)


The Indian capital market has witnessed several price-rigging and insider trading activities both of which are considered unlawful by the Securities and Exchange Board of India (SEBI). Price rigging occurs when persons acting in concert with each other collude to increase or decrease artificially the price of a security. Insider trading refers to a situation when a person having unpublished price-sensitive information such as financial results, expansion plans, take-over bids, etc. by virtue of his or her association with a company, trades its shares to make undue profits.1 This is a case that studies one such instance of alleged insider trading by officials of Hindustan Lever Limited (HLL, now known as Hindustan Unilever) when the company wanted a merger with its sister concern Brooke Bond Lipton India Limited (BBLIL). This is the first ever case of insider trading in India which was taken up by SEBI to scrutinize the manner of the involvement of a big company, HLL. It also exposes the major flaws in SEBI’s insider-trading regulations and the need to plug the loopholes in them. Although SEBI was investigating the case from May 1996, the final verdict was passed two years thereafter by the market regulator, which took the whole of corporate India by storm.


SEBI in its order that tried to establish an insider trading case against HLL management observed that it could be conclusively stated that while entering into the transaction for the purchase of 8,00,000 shares of BBLIL from the Unit Trust of India (UTI), HLL was acting on the basis of the privileged information in its possession, regarding the impending merger of BBLIL with HLL. It was pointed out by SEBI that in matters such as these it would be difficult to provide direct evidence by pointing out motives and intentions of the concerned individual players. ‘However, the chain of circumstances, the timing of the transaction, and other related factors demonstrates beyond doubt that the transaction was founded upon and effected on the basis of unpublished price sensitive information about the impending merger.’2

On 4 August 1997, SEBI issued a show cause notice to HLL claiming that there was prima facie evidence of the company indulging in insider trading, through the use of ‘unpublished price sensitive information’ prior to its merger with Brooke Bond Lipton India Ltd. (BBLIL). In March 1998, SEBI passed an exhaustive order, which sent shock waves through the country’s corporate sector. SEBI found HLL guilty of insider trading because it bought shares of BBLIL from UTI with the full knowledge that the two sister concerns were going to merge. Since it bought the shares before the merger was formally announced, SEBI held that HLL was using unpublished, price-sensitive information to trade, and was therefore, guilty of insider trading. SEBI directed HLL to pay UTI INR 34 million in compensation, and also initiated criminal proceedings against the five common directors of HLL and BBLIL: S. M. Datta, K. V. Dadiseth, R. Gopalakrishnan, A. Lahiri and M. K. Sharma, who were on the core team which discussed the merger.


The case dates back to 1996 when the fast-moving consumer goods (FMCG) giant, Hindustan Lever, had decided to merge with its sister concern, Brooke Bond Lipton India Limited, so as to enable their parent company, Uniliver have a major stake in the merged entity. Both the companies informed the concerned stock exchanges of their desire to become a single entity by entering into a merger on 19 April 1996. However, much before the merger move became public, the share price and the volumes of BBLIL traded on the stock exchanges witnessed a steep hike. On 12 May 1996 SEBI, the market regulator, in an uncharacteristically swift move launched an investigation on HLL and on 4 August 1997 charged the company of indulging in insider trading. SEBI did not accuse any individual for the wrongdoing, but the company itself was accused of it. The culmination of the proceedings of the case took place on 11 March 1998 in the form of SEBI holding HLL guilty and prosecuting the five above-cited HLL directors for the offence of insider trading.


Naturally enough, Hindustan Lever decided to appeal against SEBI’s verdict to the Union Ministry of Finance, the appellate authority in such cases. The questions which were in everyone’s mind were two-fold: (i) Is HLL guilty of insider trading?; and (ii) Would SEBI’s charges stand legal scrutiny when contested, as there were several questions of law and its interpretations which would have to be settled?

SEBI took the stand that only HLL knew about the forthcoming merger and it acted on the basis of such unpublished information it was privileged to know. According to SEBI, HLL and its directors misused such information. HLL was an ‘insider’ and by buying 800,000 shares of BBLIL from UTI (pre-merger), it violated the insider trading regulation. Shares were purchased from the UTI to ensure 51 per cent stake to Unilever in the post-merger company with the prior knowledge of share-swap ratio. On 17 January 1996, the merger decision made by the parent company, Unilever was communicated to the core team of directors by C. M. Jemmett, the parent company’s representative. In March 1996, HLL bought the shares from UTI. HLL announced the merger with BBLIL in April 1996.

SEBI also charged HLL of acting in a manner inimical to the interests of thousands of ordinary shareholders. Besides, Hindustan Lever depleted its own resources by helping its holding company, Unilever obtain major stake in the merged entity. The funds that were shelled out by HLL to purchase BBLIL’s shares were to be extinguished and that too for the holding company. As per SEBI’s contention, this was against the interest of the ordinary shareholders. Further, SEBI charged that HLL deprived the country of precious foreign exchange, as Unilever would have invested nearly INR 450–500 million to raise its holding to 51 per cent in the post-merger consolidated company.


SEBI’s notice to Hindustan Lever, the penalty the market regulator imposed on the company and its indictment of the Directors of the company not only created a storm in the Indian corporate sector, but also raised a number of legal issues relating to SEBI’s penal action and its sustainability by appellate authorities when contested by the company. These issues were as follows: (i) Whether HLL was an ‘insider’ or not; (ii) Whether or not the pre-merger information HLL had access to was ‘unpublished’; (iii) Whether or not HLL had any price-sensitive information with regard to the merger; and (iv) Whether or not HLL had gained any unfair advantage out of the deal.

The first and most debated issue was concerning whether HLL was an insider at all. According to Clause 2(e) of SEBI’s regulations: ‘Insider means any person who is or was connected with the company or is deemed to have been connected with the company, and who is reasonably expected to have access, by virtue of such connection, to unpublished price-sensitive information in respect of securities of the company, or who has received or has had access to such unpublished price-sensitive information.’3

To rebut this allegation of SEBI, HLL countered that though it was deemed to be connected to BBLIL, and though it knew about the merger before it bought BBLIL’s shares, it received the information only because it was one of the parties to the merger itself and not merely because of its connection to BBLIL. HLL stressed this distinction because, to be an ‘insider’, HLL should have received the information ‘by virtue of such connection’ with the other company. HLL’s defense centred on the fact that as an initiator and also as the transferee, it was the ‘primary party’ to the merger. M. K. Sharma, the Legal Director of HLL argued: ‘Nowhere in the world is the primary party to a merger considered to be an insider from the point of view of insider-trading.’4

SEBI refused to accept the company’s interpretation of the clause. It argued: ‘The phrase “by virtue of such connection” applied only to one kind of insider, ‘the connected’ or ‘deemed connected person’, who was expected to have access to information because of his/her connection.’ SEBI underscored the point that HLL also fell under the definition of someone ‘who was reasonably expected to have access by virtue of such connection’, as the core team of five common directors discussed the merger, and Unilever, the common parent, granted the ‘in principle’ approval, and besides, HLL was free to use the information to further the merger, but not to buy shares. There is a second part of the clause, argued SEBI that defined another kind of insider, who might not be connected to the company at all, but ‘who had received or has had access to such unpublished price sensitive information’. Therefore, SEBI argued that even if BBLIL was construed to be unconnected, HLL could still be an insider of the second type. Its order said, ‘If we were to accept HLL’s argument … it would permit a ‘connected’ or ‘deemed connected’ person to misuse the price-sensitive information because he has received the information independently’.5

The second issue raised in the case was whether or not the information, which HLL had access to, was ‘unpublished’. According to Clause 2(k) of SEBI’s Regulation on Insider Trading: ‘Unpublished price-sensitive information means any information which is of concern, directly or indirectly, to a company, and is not generally known or published by such company for general information, but which if published or known, is likely to materially affect the price of securities of that company in the market.’6

While SEBI argued that HLL has gone against this regulation, HLL contended that before the transaction, the merger was the subject of wide market and media speculation. After the formal announcement, press reports highlighted the fact that the merger caused no surprise at all to anyone as it was part of the market grapevine for long. HLL pointed out that before the transaction, the share price of BBLIL moved up from INR 242 to INR 320 between January and March 1996, showing that the merger was ‘a generally known information’. HLL also pointed out that the Public Sector Mutual Fund, UTI was a large enough institutional player and, given the speculation, how could UTI have remained unaware that the merger was forthcoming? In spite of its being the second largest shareholder in both BBLIL and HLL, UTI did not complain against the transaction either formally to SEBI, or informally to HLL after the formal merger announcement. Moreover, HLL had, between the transaction and the formal announcement, privately told UTI of the merger. UTI also hosted an inter-institutional meeting to discuss it. UTI even sold HLL some more shares nine months later, though at a higher price.

SEBI tried to show as proof that the information was not generally known to people at large by relying on an UTI official’s testimony that he was unaware of the merger, though he was, in his official capacity, concerned with the company. Though it had not defined either ‘unpublished’ or ‘generally known information’, SEBI officials were of the view that these could include press reports, even if unconfirmed by the company. ‘Since these reports were speculative, technically HLL’s knowledge was qualitatively better’. SEBI also claimed that one of the press reports carried a denial by the company. The third legal issue concerned the price-sensitive nature of the information regarding the merger. Section 2(k) of SEBI’s regulation laid down eight examples of price-sensitive information, which included inter alia ‘amalgamations, mergers, or takeovers’.7

HLL asserted that it was unaware of the swap ratio when the company bought BBLIL shares in March 1996. Further, it was not privy to any special price-sensitive information on the merger, as it had been highlighted by the media even before the official announcement. HLL also argued that both the companies, namely, itself and BBLIL involved in the deal were sister concerns and subsidiaries of Uniliver; operated in the same industry, and were large profit making enterprises with common recruitment of personnel. They had some common directors on their boards and were listed in several of the country’s stock exchanges, and their securities were actively traded. HLL argued that such being the case, information of the merger by itself was not enough to induce a reasonably knowledgeable investor to buy its shares until the share-swap ratio was known. The company thus argued that the merger information per se had little relevance to the issue. The only thing that was price sensitive was the swap ratio, and HLL was not aware of it when it purchased BBLIL shares from UTI.

However SEBI, emphasized that the regulation cited explicitly defined ‘mergers’ as price-sensitive information. It said, ‘(the) swap ratio may be price-sensitive information, but that does not mean that information of the overall fact of merger is not price-sensitive.’8

The fourth issue that was debated between the contending parties was whether HLL had profited from the deal or gained any unfair advantage. In regard to this, neither the Act nor the Regulations stated that SEBI must prove that a profit was made or a loss was avoided. However, Section 15 of the Act prescribed that the regulator should consider ‘the amount of disproportionate gain or unfair advantage wherever quantifiable’,9 when levying penalties.

With regard to this issue, HLL contended that the onus of proof of insider trading and the resultant gain by the concerned party rested with SEBI. The company also argued that it made no gain out of the deal: (i) After the merger, the company cancelled its BBLIL shareholding, and so financially there was no gain; (ii) HLL bought 800,000 shares from UTI at INR 350 per share at a premium of almost 10 per cent over the market price of INR 318; and (iii) HLL also contended that its intentions were only to consolidate Uniliver’s shareholdings, and to achieve this, it had cheaper options which it did not resort to, such as the issue of preferential shares either to Uniliver or to HLL.

According to SEBI, HLL quoted the very provisions that helped the regulator to determine the penalty, not the violation itself. SEBl’s order said, ‘Making profit or avoiding loss is not a legal requirement under the regulation to establish the charge of insider trading. Section 15 …(is) only applicable in cases of levy of monetary penalties (and) has no bearing on determination of the contravention’.10 SEBI’s contention was that HLL did benefit from the deal inasmuch as the company could not predict how prices would move, after the merger announcement it might well have had to pay more for the BBLIL shares then. In support of its argument, it cited the instance that immediately after the merger announcement, BBLIL’s share price closed at INR 405, though it fell subsequently. Alternatively, if UTI had not sold, it would have got shares worth INR 488.3 million in the merged HLL, INR 208.3 million more than its sale price.


Experts maintain that SEBI as a market regulator has erred in its decision by favouring UTI and imposing a fine on HLL to pay INR 30.4 million as compensation to the public sector mutual fund. But being a regulator also calls for protection of the interests of all market players which essentially includes investors, both small ordinary and large institutional shareholders. Therefore, SEBI argued that it was justified in awarding compensation to UTI. But this line of argument also was countered by HLL when it explained that it had paid UTI INR 350 per share as against the then market price of INR 318. The interest for INR 280 million for 9 months at the rate of 18 per cent works out to INR 37.8 million, which is far more than the compensation set by SEBI.


On 15 July 1998, the Union Finance Ministry, the appellate authority in all such cases had absolved HLL of charges of insider trading and struck down SEBI’s order of March 11, 1998 for prosecution of five of the company’s directors. The appellate authority consisting of Montek Singh Ahluwalia, Union Finance Secretary and C. M Vasudev, Special Secretary (Banking) upheld HLL’s view that its impending merger plan with BBLIL was “generally known” as it was widely speculated in the national media. The ministry said in its order: ‘An order of prosecution should be based on conclusive determination of all aspects of insider trading and on specific justification in terms of the gravity of the offence for these reasons. We hold that SEBI was not justified in ordering prosecution of the applicants.’11 The ministry held the view that the order of SEBI suffered from ‘procedural deficiencies and was also lacking in jurisdiction’.12 Stung by the tone and content of the ministry’s order, SEBI challenged the order before the Mumbai High Court. The appellate authority while reiterating its view as explained in the order saw it ‘as a good opportunity to clear up differences of opinion between the duo on the interpretations given to some crucial provisions of the SEBI Act. There are several grey areas in the SEBI Act’13 which led to conflicting interpretations in the HLL insider trading case. Moreover, the ministry would want the court to define clearly whether SEBI has the claimed powers to adjudicate a matter, go for prosecution or impose monetary penalties, all of which in the opinion of the Ministry was violative of the spirit in which the SEBI Act was legislated by the Parliament.


The charge against HLL had brought to the fore the debate over SEBI’s role as a watchdog of the Indian capital market and its ability to control financial crimes such as insider trading. It also highlighted the inability of its legal machinery to handle such cases. The case has also triggered the need for an urgent rehaul of SEBI’s regulations. With the changing scenario in the capital market, there is a pressing need to fine tune various policies and regulations guiding the transactions in the securities market. With tremendous growth in the capital market, and the diverse nature of transactions in a multiple product range, all of which have been impacted by technology-driven operations and explosion in communications, there is an urgent need for a system and structure of market regulation that will respond immediately, adequately and efficiently to challenges such as price rigging and insider trading.

  • Insider trading
  • Hindustan Lever Ltd
  • Parent company
  • Merger
  • Brooke Bond Lipton India Ltd.
  • Unit Trust of India
  • Legal controversy
  • SEBI
  • Public announcement
  • Conducting enquiries
  • Show cause notice
  • Criminal proceedings
  • Compensation
  • Appellate authority
  • Mumbai High Court
  • Union Finance Ministry
  1. Explain in your own words the insider trading case relating to HLL-BBLIL.
  2. In your perception and judgement, do you think SEBI had sufficient reasons to charge HLL of insider trading and slap a fine on the company?
  3. On what grounds did the Union Finance Ministry, the appellate authority, turn down SEBI’s orders and absolve HLL of the charge of insider trading? Was it justified in doing so?

Fernando, A. C., Corporate Governance, Principles, Policies and Practices (New Delhi: Pearson Education, 2006).

ICMR, “The Case of Insider Trading (HLL-BBLIL Merger)” (Hyderabad: ICFAI University, 1998).

Krishnan, V. C. and Dutta S., “The Case of Insider Trading (HLL-BBLIL Merger),” March 2002 (Hyderabad: ICMR, ICFAI University, 2002).

Puliani, R. and Puliani, M., eds., Bharat’s Manual of SEBI, Rules Regulations, Guidelines Circulars Etc., (New Delhi: Bharat Law House, 2003).

Reports on Corporate Governance, ECONOMICA India (New Delhi: Academic Foundation, 2004).