Security Token Offering – A compelling regulatory opportunity for India (Part III)

For Part I & II, click here and here respectively.

What India can learn?

RBI vide Press Release in December 24, 2013 cautioned users of Virtual Currencies against risks.[1]This was followed by another cautionary Press Release dated February 01, 2017 where the RBI advised that it has not given any license/ authorization to any entity/ company to operate such schemes or dealt with any virtual currency.[2] In its December 05, 2017 Press Release, it reiterated concerns conveyed in the earlier releases in light of ‘significant spurt in the valuation of many VCs and rapid growth in ICOs.[3] Additionally, the Ministry of Finance issued a Press Release against risks in investing currencies.[4] It has time and again been reiterated that cryptocurrencies are not legal tender.[5] On April o6, 2018, the RBI vide notification[6], prohibited entities regulated by it to not deal in VCs or provide services for facilitating any person or entity in dealing with or settling VCs. Regulated entities already providing such services were required to exit the relationship within three months from the date of this Circular.

The term securities has been defined under Section 2(h) of the Securities Contract Regulation Act, 1956 (“SCRA”) and fall under the regulatory oversight of Securities and Exchange Board of India (“SEBI”). SCRA is the primary legislation governing Securities transactions in India.

It is undeniable that, at present, there are no ICO specific regulations. The aforementioned jurisdictions have displayed relatively advanced jurisprudential wisdom in terms of facilitation of Blockchain technologies and crypto assets. Certainly, this was consequential of the presence of intensity and progression of commotion in this technology in both the countries. It is noteworthy that the United States has clamped down on illegal ICOs, its framework stipulates several conditions wherein ICO Tokens will not be deemed as investment contracts and consequently, as securities. FINMA also has made a distinction between the types of tokens and taken a comparable regulatory stance for those tokens as would be categorized to be securities. The stance of US and FINMA vary, in that US treats ICO similar to IPO, thus fetching relatively greater impediments for ICO holder. FINMA, on the other hand, treats ICO tokens as uncertified securities, which draw very little formal regulatory requirements.

It is not that the Indian Laws are so obstructive as to restrict ingress of new technology. Blockchain technology and smart contracts can be advantageous in numerous ways. Through equity tokens, token holders are able to participate in organizational decision making but unlike traditional IPOs where manipulation in voting is likely, by using Blockchain development, voting is unblemished. Due to these advantages, it is very likely that equity tokens are on embark to construct Blockchain financial markets substituting passé methods to raise funds. SEBI can consider regulating technology and facilitating technological advancement in the way companies raise funds. Various Indian Judgments have paved the way for such a regulatory coexistence with technology.

The Supreme Court of India in landmark Sahara judgment[7] sanctified SEBI’s absolute power to investigate into matters of not just listed, but also unlisted companies. The Apex Court, vide this judgment expelled few of the gray zones vis-à-vis the issue of securities by the so-called unlisted companies deriving the benefit of the loopholes in the law. India’s Supreme Court, in this case, observed that ‘any security which is capable of being freely transferable is marketable’. It also confirmed Sudhir Shantilal Mehta v. Central Bureau of Investigation[8] in observing that the definition of securities under Section 2(h) of the SCRA, is inclusive and not exhaustive in nature. It takes within its purview matters not only specified therein but also all types of securities as commonly understood. The term securities, thus, should be given an expansive meaning.

In Dahiben Umedbhai Patel v. Norman James Hamilton & Others[9], the Bombay High Court had observed that for the application of the Act is not limited merely to securities which are listed, but also to securities not listed on any stock exchange. All that is requires is that there must be marketability. Marketability was noted to imply ease of selling and includes any security which is capable of being sold in the market.

Additionally, the Securities Appellate Tribunal in Toubro Infotech and Industries Ltd. v. Securities and Exchange Board of India[10] laid down that the paramount test to determine whether an offer or invitation made to the public if it is established (a) that there was a calculated offer on the part of the company to bring in an uninvited guest to subscribe to the debenture and (b) that persons other than those receiving the offer or invitation had in fact actually subscribed to the offer.

Notably, SAT in this case also recognizes the power to make Rues and to make Regulations. It states that the power to make rules vests with the Central Government and the power to make regulations vests with the SEBI Board. The Board can by notification make regulations consistent with the Act and the rules. SEBI can thus make Regulations to protect the interests of the investors in securities and to regulate the securities market.

It is further pertinent to note that Supreme Court in Bhagwati Developers Private Limited v. Peerless General Finance and Investment Company Limited and Another,[11] held that the purpose of SCRA was to prevent undesirable transactions in securities by regulating the business of dealings therein. The Court said that one cannot infer that it was to apply only to the transfer of shares on the stock exchange. It also fortified in its view from Naresh K. Aggarwala v. Canbank,[12] which held that the definition of securities under Section 2(h)(i) of the SCRA does not make distinction between listed securities and unlisted securities.

Conclusion

Notably, the test applied by the SEC and the definition of securities in the US varies from that in India. Even otherwise, Section 2(h)(iia), SCRA has kept an open door for potential securities. STOs comes with various benefits, including cost-effectiveness since it cuts down the company’s expenditure in relation to brokerage and appointment of other intermediaries to reach the desired threshold of the investor base. Smart contracts would bring in all of their advantages, avoided being repeated for brevity. Absence of intermediaries or middlemen contributes to the ease in access to the investment market. Additionally, post-offer compliances are less cumbersome.

In light of the promise that the technology holds, as also to check undesirable transactions in securities, the Regulator should attempt regulating the business of dealings therein. Several courses can be adopted by the regulator to regulate this new technology, existing norms for IPO could be made applicable with relaxations or a new framework could be introduced apposite to the technological demands. This is however left open for research. There is the peril that India may perhaps encounter economic hurdles and technical impediments for its tardy and overdue espousal. A proactive approach towards these technological advancements is the need of this hour for the Indian regulators. India’s existing securities legal framework, akin to that of aforementioned jurisdictions, does pave way for regulation of STOs. Keeping apace and by revisiting the fundamentals of securities law, the Regulator should be proactive in regulating these dealings, as against overlooking the benefits in light of potential risks.

MANAL SHAH


[1] RBI Press Release 2013-2014/1261 dated December 24, 2013, https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/IEPR1261VC1213.PDF (Last visited July 07, 2019).

[2] RBI Press Release 2016-17/20154 dated February 01, 2017, https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/PR205413F23C955D8C45C4A1F56349D1B8C457.PDF (Last visited July 07, 2019).

[3] RBI Press Release 2017-2018/1530 dated December 05, 2017, https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/PR15304814BE14A3414FD490B47B0B1BF79DDC.PDF (Last visited July 07, 2019).

[4] Ministry of Finance Press Release dated December 29, 2017, http://www.pib.nic.in/PressReleseDetail.aspx?PRID=1514568 (Last visited July 07, 2019).

[5] Ministry of Finance Press Release dated February 03, 2017, http://pib.nic.in/newsite/PrintRelease.aspx?relid=158024 (Last visited July 07, 2019).

[6] RBI notification no. DBR.No.BP.BC.104 /08.13.102/2017-18 dated April 06, 2018, https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NOTI15465B741A10B0E45E896C62A9C83AB938F.PDF (Last visited July 07, 2019).

[7] Sahara India Real Estate Corporation Ltd. and Ors. v. Securities and Exchange Board of India and Ors., (2013) 1 S.C.C. 1.

[8] Sudhir Shantilal Mehta v. Central Bureau of Investigation, (2009) 8 S.C.C. 1.

[9] Dahiben Umedbhai Patel v. Norman James Hamilton and Ors., 1983 (85) BOM. L.R. 275.

[10] Toubro Infotech and Industries Ltd. v. Securities and Exchange Board of India, [2004] 55 S.C.L. 243 (SAT).

[11] Bhagwati Developers Private Limited v. Peerless General Finance and Investment Company Limited and Another, (2013) 9 S.C.C. 584.

[12] Naresh K. Aggarwala v. Canbank, (2010) 6 S.C.C. 178.

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