INTERIM SUBMISSION

INVESTMENT LAW

ROLES & RESPONSIBILITES OF BONDS AND

INVESTOR PROTECTION- CASE STUDY

Submitted By: -
Khyati Bhatia
5th Year, Group II, PRN No: 13010224064

IN
AUGUST 2017

Under the Inspiring Guidance of:

Prof. Arjun Chaudhuri

Faculty In-Charge

Project Interim Submitted in partial fulfillment of the requirement

for the degree of BBA/LLB

Symbiosis Law School, Noida- 201301

(Constituent of Symbiosis International University, PUNE)
 TABLE OF CONTENTS

I. Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 01

II. What are Bonds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 02

II.1.Types of Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 03
II.2.Sub-types of Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 04

III. Roles & Responsibilities of Merchant bankers . . . . . . . . . . . . . . . . . . . 07

III.1 Roles & Responsibilities of Investors . . . . . . . . . . . . . . . . . . . . . . . 08

IV. Regulator of Securities markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 09

V. Case Study- Sahara Investor fraud scam . . . . . . . . . . . . . . . . . . . . . . . . 10

IV. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

VI. References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
 I INTRODUCTION

Corporate, governments and individuals rely on various sources of funding to meet their capital
requirements. Specifically, corporate use either internal accruals or external sources of capital to
finance their business. Funds are raised from external sources either in the form of equity or debt
or hybrid instruments that combine the features of both debt and equity. The capital raised by
companies through debt instruments is broadly referred to as corporate debt.

Corporate bonds are transferable debt instruments issued by a company to a broad base of
investors (including but not restricted to banks and other financial institutions). It is distinguished
between

a) Public debt (debt issued by central and state governments, municipal authorities) and
b) Private debt (bonds issued by private issuers: financial and non-financial corporate).

Certain typical features of corporate bonds are

a) corporate bonds are issued to the public (similar to equity instruments)

b) listed on stock exchanges and traded in secondary markets
c) transferable
d) possess a broad base of issuers (ranging from small companies to conglomerates and
multinationals) and investors (including retail participants), and
e) they come under the additional purview of the regulators of the securities market other
than the central bank or other banking supervisor.

Corporate bond markets are further defined as the segment of capital markets in the economy
that deals with corporate bonds.

There are three main pillars that make up the corporate bond market ecosystem which
includes: institutions, participants and the instruments. The study of corporate bond market is
essentially the study of these three pillars, their roles, responsibilities and actions in the corporate
bond market. The institutions comprise of the securities market regulator, the banking regulator,
the credit rating agencies, clearing houses, stock exchanges and the regulations and governance
norms prescribed by these institutions. The participants comprise of the market players

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investors on the demand side and issuers on the supply side. The term instruments is used to
indicate the form and features of securities issued in the corporate bond market.1 Further, certain
securities and derivatives, such as interest rate and currency derivatives and government
securities, even though, not a part of the corporate bond market, play a significant role in
ensuring its vibrancy and smooth functioning.

II. WHAT ARE BONDS

A bond represents a contractual obligation of a borrower to pay an agreed rate of interest on the
principal over a period of time, and to repay that principal at maturity. Bonds are issued by
government and nongovernment entities across the investment grade and sub-investment grade
credit spectrum, offering investors a range of choices in terms of risk, and prospective reward,
based on credit quality, as well as the type of coupon payment and term to maturity. Bonds in the
market generally have terms ranging from less than one year to 15 years. In the treasuries
market, bonds with 30 year maturities are quite common. Bonds with maturities of one year or
less are referred to in the market as short dated, while those with maturities of more than one
year are medium to long-dated. The further out along the maturity spectrum these investments
are, generally, the higher the rate of interest they pay. This is to compensate investors because
the risk of lending money over long periods of time is greater than the risk of lending over short
periods. In addition to categorizing bonds as short dated and medium- to long-dated, bonds are
further differentiated by the type of entity that issues them - government or nongovernment.

Further, the bond contract gives bondholders the right to take legal action if the issuer fails to
make the promised payments or fails to satisfy other terms specified in the contract. If the bond
issuer fails to make the promised payments, which are referred to as default, the debt holders
typically have legal recourse to recover the promised payments. In the event that the company is
liquidated, assets are distributed following a priority of claims, or seniority ranking. This priority

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For instance, corporate bonds can have tremendous diversity with regards to following features type debentures,
deposits, commercial paper, project bonds, infrastructure bonds, securitized instruments maturity long and short
term, perpetual bonds, redeemable bonds, fixed maturity bonds of varying durations interest payments fixed
coupons, floating rate, zero-coupon bonds, cumulative bonds, coupon only bonds embedded derivatives put and
call options, floors and caps on interest rates, convertibility features protection secured and unsecured bonds,
senior and subordinated bonds legal terms

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of claims can affect the amount that an investor receives upon liquidation. The par value
(principal) of a bond plus missed interest payments represents the maximum amount a
bondholder is entitled to receive upon liquidation of a company, assuming there are sufficient
assets to cover the claim. Because debt represents a contractual liability of the company, debt
holders have a higher claim on a companys assets than equity holders. But not all debt holders
have the same priority of claim: borrowers often issue debt securities that differ with respect to
seniority ranking.

II. 1 TYPES OF BONDS

A. Secured
When a borrower issues secured debt securities, it pledges certain specific assets as
collateral to the bondholders. Collateral is generally a tangible asset, such as property,
plant, or equipment that the borrower pledges to the bondholders to secure the loan. In
the event of default, the bondholders are legally entitled to take possession of the pledged
assets. In essence, the collateral reduces the risk that bondholders will lose money in the
event of default because the pledged assets can be sold to recover some or the
bondholders entire claim (missed coupon payments and par value).

B. Unsecured
Unsecured debt securities are not backed by collateral. Consequently, bondholders will
typically demand a higher coupon rate on unsecured debt securities than on secured debt
securities. A bond contract may also specify that an unsecured bond has a lower priority
in the event of default than other unsecured bonds. A lower priority unsecured bond is
called subordinated debt. Subordinated debt holders receive payment only after higher-
priority debt claims are paid in full. Subordinated debt may also be ranked according to
priority, from senior to junior.

C. Fixed-Rate Bonds
Fixed-rate bonds are the main type of debt securities issued by companies and
governments. Because debt securities were historically issued with fixed coupon rates

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 and paid fixed coupon payments, they may be referred to as fixed-income securities. A
fixed-rate bond has a finite life that ends on the bonds maturity date, offers a coupon rate
that does not change over the life of the bond, and has a par value that does not change. If
interest rates in the market change or the issuers creditworthiness changes over the life
of the bond, the coupon the issuer is required to pay does not change. Fixed-rate bonds
pay fixed periodic coupon payments during the life of the bond and a final par value
payment at maturity.

D. Floating-Rate Bonds
Floating-rate bonds sometimes referred to as variable-rate bonds or floaters, are
essentially identical to fixed-rate bonds except that the coupon rate on floating-rate bonds
changes over time. The coupon rate of a floating-rate bond is usually linked to a reference
rate. The London Interbank Offered Rate (Libor) is a widely used reference rate. The
calculation of the floating rate reflects the reference rate and the riskiness (or
creditworthiness) of the issuer at the time of issue. The floating rate is equal to the
reference rate plus a percentage that depends on the borrowers (issuers)
creditworthiness and the bonds features. The percentage paid above the reference rate is
called the spread and usually remains constant over the life of the bond. In other words,
for an existing issue, the spread used to calculate the coupon payment does not change to
reflect any change in creditworthiness that occurs after issue.

II. 2 SUB-TYPES OF BONDS

A. Inflation-Linked Bonds
An inflation-linked bond is a particular type of floating-rate bond. Inflation-linked bonds
contain a provision that adjusts the bonds par value for inflation and thus protects the
investor from inflation. Changes to the par value reduce the effect of inflation on the
investors purchasing power from bond cash flows. For most inflation-linked bonds, the
par value is not the coupon rate of the bond is adjusted at each payment date to reflect

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 changes in inflation (which is usually measured via a consumer price index). The bonds
coupon payments are adjusted for inflation because the fixed coupon rate is multiplied by
the inflation-adjusted par value. Examples of inflation-linked bonds are Treasury
Inflation-Protected Securities (TIPS) in the United States, index-linked gilts in the United
Kingdom, and iBonds in Hong Kong. Because of the inflation protection offered by
inflation-linked bonds, the coupon rate on an inflation-linked bond is lower than the
coupon rate on a similar fixed-rate bond.

B. Zero-Coupon Bonds

As with fixed-rate and floating-rate bonds, zero-coupon bonds have a finite life that ends
on the bonds maturity date. Zero-coupon bonds do not, however, offer periodic interest
payments during the life of the bond. The only cash flow offered by a zero coupon bond
is a single payment equal to the bonds par value that is paid on the bonds maturity date.
Zero-coupon bonds are issued at a discount to the bonds par value, that is, at an issue
price that is lower than the par value. The difference between the issue price and the par
value received at maturity represents the investment return earned by the bondholder over
the life of the zero-coupon bond, and this return is received at maturity.

C. Callable Bonds

A call provision gives the issuer the right to buy back the bond issue prior to the maturity
date. Bonds that contain a call provision are referred to as callable bonds. A callable bond
gives the issuer with the right to buy back (retire or call) the bond from bondholders prior
to the maturity date at a pre-specified price, referred to as the call price. The call price
typically represents the par value of the bond plus an amount referred to as the call
premium. In general, bond issuers choose to include a call provision so that if interest
rates fall after a bond has been issued, they can call the bond and issue new bonds at a
lower interest rate. In this case, the bond issuer has the ability to retire the existing bonds
with a higher coupon rate and issue bonds with a lower coupon rate. For example,
consider a company that issues 10-year fixed-rate bonds that are callable starting 3 years

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 after issuance. Suppose that three years after the bonds are issued, interest rates are much
lower. The inclusion of the call provision allows the company to buy back the bonds,
presumably using proceeds from the issuance of new bonds at a lower interest rate.

D. Putable Bonds

A put provision gives the bondholder the right to sell the bond back to the issuer prior to
the maturity date. Bonds that contain a put provision are called putable bonds. A putable
bond gives bondholders with the right to sell (put back) their bonds to the issuer prior to
the maturity date at a pre-specified price referred to as the put price. Bondholders might
want to exercise this right if market interest rates rise and they can earn a higher rate by
buying another bond that reflects the interest rate increase. It is important to note that, in
contrast to call provisions, put provisions are a right of the bondholder and not the issuer.
The inclusion of a put provision is an advantage to the bondholder and a disadvantage to
the issuer. Consequently, the coupon rate on a putable bond will generally be lower than
the coupon rate on a comparable bond without an embedded put provision. Bondholders
are willing to accept a relatively lower coupon rate on a bond with a put provision
because of the downside price protection provided by the put provision. The put
provision protects bondholders from the loss in value because they can sell their bonds to
the issuing company at the put price.

E. Convertible Bonds (Hybrid security)

A conversion provision gives the bondholder the right to exchange the bond for shares of
the issuing companys stock prior to the bonds maturity date. Bonds that contain a
conversion provision are referred to as convertible bonds. A convertible bond is a hybrid
security. A hybrid security has characteristics of and relationships with both equity and
debt securities. A convertible bond is a bond issued by a company that offers the
bondholder the right to convert the bond into a pre specified number of common shares
of the issuing company at some point prior to the bonds maturity date. Convertible
bonds are debt securities prior to conversion, but the fact that they can be converted to

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 common shares makes their value somewhat dependant on the price of the common
shares. Because the conversion feature is a benefit to bondholders, convertible bonds
typically offer a coupon rate that is lower than the coupon rate on a similar bond without
a conversion feature.

III. ROLES & RESPONSIBILITIES OF MERCHANT BANKERS

Mobilization of resources from the capital market by way of public issues\offers for sale etc.
calls an expert study and proper evaluation of the prevailing market conditions for which the
companies seek the advice of merchant banks. Management of capital issues constitutes the most
important aspect of the services of the merchant bankers in India. The managing agents for a
particular corporate house used to manage public issues and raise capital from the market with
the help of stock brokers. With the abolition of management agency system, this function has
been taken over by the merchant bankers.

From 1969 onwards, The National Grindlays Bank and Citi Bank introduced new procedures and
techniques in the issue management services. They made the merchant banking as professional
institution in the area of issue management through separate divisions in their banks known as
Merchant Banking Division in Grindlays Bank and Investment Banking Division in Citi
Bank. From 1969 to 1992, merchant bankers performed issue management activities under the
legislative framework of Capital Issues (Control) Act, 1947. Under the SEBI (Merchant Bankers)
Regulations, 1992, SEBI has made it mandatory for every public issue to be managed only by a
registered merchant banker.

The public issue of corporate securities involves basically three functions, namely

a) origination of the issue

b) risk bearing and risk averting and
c) marketing of the securities.

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The public issues are managed by the involvement of various intermediaries like underwriters,
registrar to the issue, bankers to the issue, brokers, advertising agency, printers and legal
advisers. Merchant banker as issue manager to the public issue plan, coordinate and control the
entire issue activities and direct different intermediaries to contribute to the success of the issue.

As merchant bankers play the role of apex intermediary in the issue management process, they
are called lead managers or lead merchant banker. In case of book building mechanism, the
merchant banker has the primary responsibility of preparing and maintaining records of book
building process. So, merchant banker is called book runner lead manager (BRLM). The issuer
company can appoint more than one merchant banker as lead manager/BRLM for its issue.

Presently, public issue management activities by merchant bankers are regulated and monitored
by SEBI through the guidelines and clarifications thereto; 15 circulars containing instructions to
merchant bankers, stock exchanges and other constituents of the capital market.

III. 1 ROLES & RESPONSIBILITY OF INVESTOR

The investor should be clear in his objectives of income, capital appreciation, short term gains or
long term gains, etc. he should have made already enough investment in housing and for a
regular income to meet his minimum needs and comforts of life. Even if all the stock market
investments are wiped out due to a market crash, investor should not be a pauper on the streets.
Investors desiring to invest in stocks require a lot of preparation. Investors entering the stock
market should also get into a habit of detailed and careful study of the balance sheets of
companies in which they wish to invest.

Similarly, they should examine carefully the detailed prospectus before subscribing to the new
issues of the companies. The habit of replying on rumors, or advice of brokers or friends should
be replaced by the habit of self study of balance sheets and prospectuses of companies. The
factors which should be looked into and ratios that should be analyzed. They should as far as
possible deal only with the registered members of recognized stock exchanges.

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 IV REGULATORS OF SECURITIES MARKET

Primary securities market is regulated by the following governing bodies:-

i. Securities & Exchange Board of India

ii. Department of Economic Affairs
iii. Department of Company Affairs
iv. Stock Exchanges

The significant legislations for the securities market are as follow:-

a) The Companies Act, 2013 - It deals with issue, allotment and transfer of securities and
various aspects relating to company management. It provides norms for disclosures in the
public issues, regulations for underwriting and the issues pertaining to use of premium
and discount on various issues. Powers under this Act are exercised by SEBI in case of
listed companies.

b) The Securities Contract (Regulation) Act, 1956 - It provides regulation for direct and
indirect control over stock exchanges. It aims at prevention of undesirable transactions in
securities. The Act mainly governs the recognized stock exchanges, contracts in
securities and listing of securities by public companies. Most of the powers under this
Act are exercised by Department of Economic Affairs and SEBI.

c) The SEBI Act, 1992 - The Act empowers SEBI to protect the interest of investors in the
securities market and to regulate the securities market. SEBI regulates the business of
stock exchange and the intermediaries working in primary and secondary market.

d) Reserve Bank of India Act, 1934 - The preamble of the Reserve Bank of India Act,
1934 states that the objectives of the RBI are to regulate the issue of bank notes and the
keeping of reserves with a view to securing monetary stability in India and generally to
operate the currency and credit system of the country to its advantage. Thus, the basic
functions of the RBI as stipulated in the Preamble of the RBI Act are threefold: First, the

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 RBI performs the function of regulating the issue of bank notes (the RBI also exchanges
or destroys currency and coins not fit for circulation). In fact, by virtue of being the sole
authority for the issue of currency in the country, the RBI is empowered to control money
supply in the country; Second, the RBI keeps reserves in order to maintain monetary
stability in India; Third, the RBI must operate the currency and credit system of India to
its advantage. In pursuance of this function, the RBI also has the responsibility to
maintain the internal and external value of the Indian Rupee

e) The Depositories Act, 1996 - It provides for electronic maintenance and transfer of
ownership of dematerialized securities. SEBI administers the regulations of this Act.

IV.1 CASE STUDY- SAHARA INVESTOR FRAUD SCAM

The Supreme Court on 31st August, 2012 in one of its most anticipated judgment of recent times
has directed the Sahara Group and its two group companies Sahara India Real Estate Corporation
Limited (SIRECL) and Sahara Housing Investment Corporation Limited (SHICL) to refund
around Rs 17,400 crore to their investors within 3 months from the date of the order with an
interest of 15%. The Supreme Court while confirming the findings of the SAT has further asked
SEBI to probe into the matter and find out the actual investor base who have subscribed to the
Optionally Fully Convertible Debentures (OFCDs) issued by the two group companies SIRECL
and SHICL.

Issues in Question and Observations of the Supreme Court: The Supreme Court of India
while interpreting various provisions of the Companies Act, SEBI Act, Securities Contract
(Regulation) Act,1956, (SCRA) and various Rules and regulations formulated there-under made
some interesting observations on the issues raised before it which includes the following issues
and will be dealt in detail in the final project:

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Issue 1: Whether SEBI has the power to investigate and adjudicate in this matter as per Sec 11,
11A, 11B of SEBI Act and under Sec 55A of the Companies Act. Or is it the Ministry of
Corporate Affairs (MCA) which has the jurisdiction under Sec 55A (c) of the
Companies Act.

Issue 2: Whether the hybrid OFCDs fall within the definition of "Securities" within the meaning
of Companies Act, SEBI Act and SCRA so as to vest SEBI with the jurisdiction to
investigate and adjudicate.

Issue 3: Whether the issue of OFCDs to millions of persons who subscribed to the issue is a
Private Placement so as not to fall within the purview of SEBI Regulations and various
provisions of Companies Act.

Issue 4: Whether OFCDs are Convertible Bonds and whether exempted from application of
SCRA as per the provisions of sec 28(1)(b) of the Act.

V. CONCLUSION

The Indian bond market has matured significantly during the past decade. The amount raised by
the government, public sector and quasi-government entities and corporate organizations from
the market for fixed income securities far outstrip the amount raised by way of equity. This has
been matched by an increase in the depth and width of the secondary market for bonds, both in
terms of the face value of the bonds traded and in terms of the average frequency of trading per
bond. At the same time, the fixed income instruments have become increasingly sophisticated.
Both the government and corporate organizations issue floating rate bonds, and bonds with
embedded options have made their appearance. Indeed, with the abolition of stamp duty, and the
introduction of rupee denominated interest rate derivatives, the bond market may be poised for a
takeoff. However, the growth of the secondary market for bonds has been held back by three
factors that continue to haunt the Indian market. First, while there has been a significant
improvement of the Indian economy in so far as macroeconomic stability is concerned, high
fiscal deficit and the need to frequently change the short-term stance of monetary policy still
makes it difficult to form accurate expectations about future short-term interest rates. Second, the

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market is dominated by large buyers and sellers like the UTI and SBI who can influence the
market price significantly, and many of the large buyers and sellers are commercial banks who
buy and sell bonds largely to mitigate problems associated with asset-liability mismatch.

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 REFRENCES

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Society 491

2. Agrawal, A. (2012), FII Debt Limits in Bond Markets A Review, STCI Primary
Dealer Limited, www.stcipd.com

3. Asian Development Bank, Asian Bonds online, Asian Bond Markets Initiative,
http://asianbondsonline.adb.org

4. Bank of International Settlements (2006), Developing Corporate Bond Markets in Asia

Proceedings of BIS/PBC seminar held in Kumning, China on 17-18 November 2005,
BIS Paper No 26

5. Bessembinder, H. and W. Maxwell (2008), Transparency and the Corporate Bond

Market, Journal of Economic Perspectives, Volume 22 Number 2, 217-234

6. Centre for Economic Policy Research (2006), European Corporate Bond Markets:
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7. De Fiore, F. and H. Uhlig (2005), Bank Finance versus Bond Finance What explains
the differences between US and Europe, European Central Bank Working Paper Series,
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8. Edwards, A., L. Harris, M. Piwowar (2007), Corporate Bond Market Transaction Costs
and Transparency, The Journal of Finance, Vol. 62 No. 3, 1421-1451

9. Endo, T. (2000), The Development of Corporate Debt Markets, Financial Markets

Advisory Department International Finance Corporation, The World Bank Group,
www.worldbank.org

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10. Khanna V. and U. Varottil (2012), "Developing the Market for Corporate Bonds in
India", NSE Working Paper No. 6/2012

11. Luengnaruemitchai, P. and L. LianOng (2005), An Anatomy of Corporate Bond

Markets: Growing Pains and Knowledge Gains, IMF Working Paper, www.imf.org

12. NSE, Indian Securities Market: A Review, 2011-12, www.nseindia.com

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