SEBI’s Final Order in GDR Manipulation Case

In a September 2011 post, we had discussed
an ad-interim ex parte passed by SEBI
in relation to a specific transaction structure that involved the use of global
depository receipts (GDRs) to allegedly manipulate the stock price of several
The modus
operandi was as follows. The companies issued GDRs, which were acquired by
various foreign institutional investors (FIIs) or their sub-accounts. The GDRs
were all soon thereafter converted into underlying equity shares of the issuing
company, which were then sold in large (synchronized) deals to several buyers,
such as stock brokers. The stock brokers would in turn sell the shares to other
investors. After investigation, SEBI found that the companies, the lead manager
to the GDRs, the FIIs/sub-accounts and the stock-brokers were all acting in
common as a group. They were able to maintain the stock price of the company
through these transactions without symmetry of information to outside investors
who may have paid a high price given the issuance of GDRs by the companies and
large holdings maintained in them by FIIs. SEBI found this to be an instance of
market manipulation and passed an order restraining the relevant companies and
investors from participating in the capital markets.
In a final
passed last week, SEBI prohibited several entities from accessing the
capital markets and dealing in securities for a five-year period. The order
gives rise to a few legal issues.
SEBI’s Jurisdiction Over GDR Offerings
The entities affected by SEBI’s
investigation argued that SEBI did not have jurisdiction over GDR issuances as
they related to securities that are traded outside India. However, SEBI refused
to accept this argument on the ground that GDRs related to underlying Indian
securities which in turn affected the Indian securities markets. It observed:
5.1       i.          The
issuance of GDRs is from the authorised share capital of a company listed in
Indian stock exchanges. Any structuring or manipulation related to GDRs has a
direct impact on securities of companies trading in Indian market. Further, the
underlying security of GDRs are shares of Indian companies with two-way
fungibility, which allows for conversion of GDRs in Indian market and vice
versa. Hence, the impact of such issuance, cancellation/conversion and
sale/transfer of shares so converted has direct bearing on the securities
market in India. Such issuance, etc. of GDRs by Indian companies also greatly
influences decision-making by investors in the securities market. In view of
the same, it is seen that the issuance of GDRs, which are ‘marketable securities’ under Section 2(h) of the SCRA Act, cannot
be regarded as an exclusive activity totally insulated from and not impacting
the securities market in India.
The argument raised here seems
somewhat analogous to the one raised in the Sahara
as to SEBI’s jurisdiction over hybrid instruments such as optionally
fully convertible debentures (OFCDs), which the Supreme Court rejected, holding
that those instruments were within the purview of the SCRA and hence under
SEBI’s jurisdiction.
The matter relating to GDRs is,
however, not beyond doubt. On an appeal by one of the affected parties in this
GDR manipulation case, the Securities Appellate Tribunal (SAT) ruled that SEBI
did not have jurisdiction to investigate matters relating to GDRs. SEBI filed
an appeal against that ruling to the Supreme Court, which stayed SAT’s ruling.
The Supreme Court is seized of the matter on the question of law. Hence, SEBI’s
order on this issue will be subject to the outcome of Supreme Court’s opinion
on the same.
On the issue of manipulation, SEBI’s
investigations revealed that the GDR issues were devised and structured by Arun
Panchariya and Pan Asia Advisors Limited (owned 100% by Panchariya). SEBI has
sought to establish connections between them and the other entities involved to
demonstrate the existence of an orchestrated scheme. It notes:
8.3       In the factual context of the instant
proceedings, it is important to view the connection between the Noticees
amongst themselves and with Panchariya not in isolation but rather as a factor
in the totality of the circumstances. This is so because while each fact
standing alone may be insufficient, the combination of all the facts can be a
substantial basis for determining ‘manipulation’
or ‘fraud’ on the part of each
Noticee. The investigations in the instant proceedings reveal that the GDR
Issues were devised and structured by Panchariya and Pan Asia in connivance
with the Issuer Companies through a fraudulent arrangement. The existing
shareholders and prospective investors were aware of the ‘positive’ news that the Issuer Companies had raised foreign
capital through GDRs but were completely unaware of the activities of
Panchariya along with the connected entities, in such GDR Issues. The
Sub-Accounts, viz. IFCF and KII who were allegedly connected to Panchariya,
converted the GDRs held by them into shares and sold the same in the Indian
securities market where the counter parties to a major portion of such sales
were entities connected to Panchariya, i.e. Noticees 1-13. The objective of
such trading between the Sub-Accounts and Noticees 1013 inter alia was to create an impression of there being liquidity in
the market. As a result, the investors in India were lulled into thinking that
stocks of the Issuing Companies had been highly valued by foreign investors,
which in turn acted as an inducement for other persons to buy shares of the
Issuer Companies in the Indian securities market. The Indian investors were
therefore adversely affected by the misleading signals of Panchariya alongwith
the connected entities, i.e. Noticees 1-13, through trading done amongst
Noticees 1-13 and Sub-Accounts, creating liquidity in the market and their
subsequent offloading of the shares. In these circumstances, I am of the
considered view that the role played by each Noticee should not be seen in
isolation and that the case needs to be seen in its entirety in the light of
the large scale market abuse explained earlier.
In a nutshell, and as explained in
the previous post referred to above, the parties are alleged to have indulged
in regulatory arbitrage by taking advantage of a more lax regime pertaining to
GDRs over a more stringent regime for issuance of underlying shares in the
domestic markets.
Finally, the scope and sufficiency
of SEBI’s order raises some questions. As Mobis Philipose argues,
some entities have not been referred to in the final order. Moreover, the
direction to debar the concerned entities from the stock markets may be
insufficient as SEBI did not find it fit to impose penalties or order
disgorgement of profits arising from the transaction.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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