Readers may recollect that the Securities Appellate Tribunal (SAT) in 2005 overturned the order of SEBI prohibiting UBS, its affiliates and agents from issuing offshore derivative instruments (ODIs) with underlying Indian securities for a period of one year (on account of UBS’ failure to provide infromation about investors to whom it had issued such ODIs). The SAT found that the SEBI (Foreign Institutional Investors) Regulations, 1995 were unclear as to the information required to be provided by foreign institutional investors (FIIs) in relation to the ODIs. It held that such information lacks precise definition, and in any event there was no requirement to provide information regarding directors and shareholders of entities (such as hedge funds) that held the ODIs.
In yet another order passed yesterday, SAT set aside an order of SEBI’s adjudicating officer who imposed a penalty of Rs. 1 crore (rupees ten million) on Goldman Sachs Investment (Mauritius) Limited in connection with its issuance of ODIs. SEBI’s allegation was that Goldman Sachs, through an FII entity, had invested in underlying shares of Himachal Futuristic Communications Ltd. and in turn issued ODIs on a back to back basis to Magnus Capital Corporation Limited, which is an overseas corporate body (OCB). SEBI alleged that Goldman Sachs had filed false declarations in its reporting to SEBI on ODIs (as regards their issuance to OCBs) and hence was liable for the penalty.
SAT set aside the order of SEBI primarily on two grounds:
1. Since there was no bar on the FIIs and their sub-accounts to issue/ subscribe/ purchase any derivative instrument to/ from Indian residents or OCBs, it would be reasonable to presume that many of them may have dealt with such persons in the course of their business activities. Consequently, they cannot be asked to furnish an undertaking in the absence of any bar to deal with such persons.
2. The adjudication officer’s show cause notice is confusing and does not spell out clearly the allegations against Goldman Sachs. This, in effect, represents a failure of natural justice.
In an unusual move, SAT also awarded costs to Goldman Sachs to the extent of Rs. 100,000.
This order is important for two reasons. First, it highlights several inadequacies in the existing FII Regulations prescribed by SEBI. There is lack of clarity in the reporting requirements by FII, due to which SEBI has been unable to succeed on two high profile actions it had initiated (being the UBS and Goldman Sachs cases). Perhaps it is necessary to specify the disclosures more clearly and to remove vagueness and ambiguity so as to avoid similar situations in the future. I have dealt with some of these issues in the paper on hedge funds which is abstracted in an earlier post on this blog.
Second, it highlights deficiencies in the adjudication process adopted, particularly with reference to compliance with principles of natural justice. This, as we have previously discussed, is a repetitive factor in numerous SEBI orders that have been set aside by SAT.