[Ashutosh Chandra is an associate at Veritas Legal, Mumbai and Shriyansh Singhal is a 3rd year B.B.A LL.B. (Hons.) Student at National Law University Odisha]
The debt capital market in India has recently witnessed an unprecedented surge in terms of participation from retail investors, thanks to the Securities Exchange Board of India (“SEBI”) bringing in regulations and relaxed norms for the issue of such instruments. SEBI’s 2022 circular on the registration and regulatory framework for online bond platform providers (“OBPPs”) made fixed-income instruments like non-convertible debentures (“NCDs”) more accessible to retail investors. However, with this democratization, there has been an increasing trend of down selling of these NCDs without appropriate disclosure or suitability assessments, putting investor welfare at risk.
Through this post, the authors explore the above issue brought to the forefront by SEBI’s ex-parte interim order issued late last year against three unregistered OBPPs – altGraaf, Tap Invest, and Stable Investments.
What is Down Selling in Context of NCDs?
Down selling of NCDs by OBPPs typically involves pushing lower-rated or riskier debentures to retail investors under the guise of higher-than-market returns, mostly without adequate disclosure of the instrument’s credit quality. This is particularly concerning in secondary markets, where platforms offload risky NCDs onto unsuspecting investors. Through the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (“NCS Regulations”), SEBI mandated compliance with certain disclosure norms and due diligence requirements by issuers and intermediaries at the time of issuance and listing, yet their applicability is limited. Regulation 3(1) of the NCS Regulations states that the framework applies only to listed NCDs (or proposed to be listed on stock exchanges). Hence, as soon as these securities hit the secondary market, there is a prevalent regulatory gap which undermines ongoing disclosures.
Additionally, rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 imposes certain restrictions on the issuance of secured debentures, but does not encompass post-issuance marketing or platform-level mis-selling practices. This regulatory vacuum paves way for OBPPs to pass over ‘secured’ or ‘guaranteed returns’ without enclosing the underlying issuer’s deteriorating financials or downgraded ratings. While SEBI’s OBPPs Regulationsbrought these entities under its ambit by mandating registration as stock brokers, there is still no strong oversight or fiduciary obligations – making down selling an evident threat to investor protection with the growing investment zeal in debt instruments.
A Case in Point: SEBI Order Against altGraaf, Tap Invest and Stable Investments
In November 2024, SEBI issued an interim order against three unregistered OBPPs – altGraaf, Tap Invest, and Stable Investments – for allegedly facilitating the public sale of unlisted NCDs which were privately placed. These platforms down-sold debt securities, in this case, unlisted NCDs, by structuring transactions in a way that initially they subscribe to private placements themselves and subsequently offer those instruments to the general public through their platforms, ultimately evading regulatory scrutiny. Likewise, altGraaf received unlisted NCDs worth Rs. 4 crores from Sri Merusri Properties via private placement and then down-sold them to retail investors through means of its platform.
This method contravenes many regulatory provisions including, section 42(2) of the Companies Act, 2013 read with rule 14(2) of the Companies (Prospectus and Allotment of Securities) Rules, 2014, which limits private placements to 200 pre-identified investors per financial year. By offering these privately placed unlisted NCDs for retail investors to buy, these platforms effectively convert private placement into a public offering. Section 25(2)(a) of Companies Act, 2013 deems any resale of such securities to the public as a public issue if carried out within a period of six months. This public offer would also trigger compliances under SEBI Regulations such as the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 and the NCS Regulations, among others. These norms include mandatory disclosures, credit ratings, and the appointment of registered intermediaries. However, these norms were evaded by the platforms.
Moreover, misrepresentations were made by these platforms about the regulatory status of their offerings, often marketed as SEBI-compliant and secured, even when they violated regulations 3 and 4(1) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Related to the Securities Market) Regulations 2003, (PFUTP Regulations) andsection 12A of the SEBI Act, 1992, bringing them within the ambit of securities fraud. Such structuring of transactions by all three platforms could constitute a scheme or artifice intended to defraud investors.
SEBI has previously taken action in the cases of Sahara, Maitreya Services, and Golden Life Agro, where private placements masked public issues.
Implications of the SEBI’s Order
SEBI’s ex-parte order serves as a reminder about the inherent risks for retail investors subscribing to opaque debt instruments marketed through online platforms. SEBI’s action reinforces the urgency to orient the operations of OBPPs with the prevalent regulatory framework. The concern is not merely procedural but deep-seated in policy formations. The statutory distinction between public offers and private placements are in place to ensure that whenever securities are marketed to the public, specifically to retail, non-institutional investors, they are accompanies with a proper set of disclosures, appropriate risk assessments, as well as other institutional safeguards. These include the issuance of an offer document containing material disclosures, appointment of debenture trustees, compliance with credit rating requirements, and introducing post-issue transparency to listing conditions.
When OBPPs repackage privately-placed debt instruments for public down-selling, but overstep these obligations, the main purpose of public offer framework is frustrated. Retail investors get exposed to the same risks as public offerings, but are deprived of the minimum safeguards that the law envisions for such offerings. This structuring also offers a regulatory arbitrage, providing an unfair hand to non-compliant entities leading the debt market to credibility risks and instability. The platforms under investigation collectively facilitated transactions amounting over Rs. 4,800 crores, and serviced hundreds of thousands of investors, amplifying the systemic implications and magnitude of the risk exposure in case of such regulatory breaches.
This scrutiny also highlights the inadequacy of the present regulations in addressing post-issuance transactions of unlisted securities. The OBPP framework lacks suitability checks or investor profiling. The reselling of unlisted privately-placed NCDs by OBPPs like altGraaf and Tap Invest falls outside of the direct regulatory oversight of SEBI. This limitation allows platforms to create a regulatory blind spot for investor protection by down selling such instruments without any mandatory disclosures, credit ratings or trustee appointment.
Recommendations and Policy Solutions
To eliminate the policy loopholes in down selling of unlisted NCDs through OBPPs, SEBI must consider broader and more integrated oversight. The scope of NCS Regulations and the OBPP framework should be extended to govern secondary market sales of unlisted debt instruments, applying investor protection norms not merely at the issuance stage but throughout the instrument’s lifecycle. SEBI should also mandate suitability assessments for retail investors – necessitating platforms to evaluate financial capacity and risk appetite prior to offering high-risk or unrated NCDs. This would avert the indiscriminate push of risky instruments under the guise of attractive returns.
Along with this, standardized and uniform label for every debt instrument sold – whether listed or unlisted – indicating whether it is secured, credit-rated, privately placed, or otherwise, must be mandated, to enable informed decisions by investors. To curb the wide exposure to opaque and high-risk products, SEBI can consider outright restrictions on the resale of privately placed NCDs to non-institutional investors, or impose quantitative limits on such transactions. Ultimately, SEBI must also address the pecuniary incentives that drive platform misconduct by putting caps on intermediary commissions for secondary sales. This mitigates the financial motivation that reinforces the aggressive marketing of lower-rated or unsuitable instruments.
An Out-of-the-Box Approach
India can take cues from regulatory reforms adopted in jurisdictions like the United Kingdom, Singapore and Australia to redress the changing fintech-debt market interface. For example, the Monetary Authority of Singapore (“MAS“) and the UK Financial Conduct Authority (“FCA“) have implemented regulatory sandboxes that enable fintech platforms to test new business models – including debt issuance firms– under a tight-knit regulatory overwatch along with conditional exemptions. These frameworks have helped balance the evolving nature of markets with investor protection, particularly in peer-to-peer lending and digital bond platforms.
The Singapore Exchange uses blockchain to streamline bond issuance. The Australian Securities and Investments Commission (“ASIC“) also allows the use of distributed ledger and blockchain technology in bond issuance, optimizing transparency and traceability of fixed-income securities.
Likewise, SEBI could take inspiration to implement a sandbox for online bond platforms, expediting the use of new age tech-based blockchain registries or smart contracts to regulate secondary sales, restrict unauthorized transfers, and initiate programmable disclosures. To a greater extent, a Debt Product Risk Score – akin to the mutual fund risk-o-meter in India or FINRA’s bond risk profile tools in the US – based on liquidity, creditworthiness, and issuer history, could help retail investors compare unlisted NCDs leading, and make informed decisions.
Conclusion
Even though SEBI’s interim ex-parte order does not impose pecuniary penalties yet, it is significant. SEBI has issued directions under sections 11(1), 11(4), and 11B of the SEBI Act to the platforms concerned to promptly cease public offering operations and save all records for the impending investigation. The order also effectively halts their core activities and firmly signals the entire OBPP industry that digital distribution models will not be allowed to bypass any rules, regulation, norms issued by the securities regulator, if investor protection is at stake. In case of continued violations, SEBI can impose penalties up to Rs. 25 crore or 3x the gains, under sections 11B and 15HA of the SEBI Act. There also exists a very real threat of permanent ban or possible debarment from the securities market.
The SEBI order is a wake-up call for OBPP regulation. As OBPPs become essential to India’s debt retail market, it is critical to make sure that robust post-issuance oversight measures are in place. Down-selling of NCDs in an opaque and under-regulated landscape endangers investors all the while threatening the credibility of the capital market ecosystem. A proactive and tech-enabled regulatory approach is crucial to safeguard retail investors’ participation in India’s growing debt securities market.
– Ashutosh Chandra & Shriyansh Singhal