[In an earlier
post, I had offered some initial overview and commentary on the SAT Order
in the DLF IPO Case.
post, I had offered some initial overview and commentary on the SAT Order
in the DLF IPO Case.
In the
following post, Vinod Kothari offers
another perspective that focus on certain specific aspects of the order and
analyzes their impact on SEBI’s role as an enforcer of securities regulation.
The author can be contacted at vinod@vinodkothari.com.]
following post, Vinod Kothari offers
another perspective that focus on certain specific aspects of the order and
analyzes their impact on SEBI’s role as an enforcer of securities regulation.
The author can be contacted at vinod@vinodkothari.com.]
The order
of the Securities Appellate Tribunal (SAT) in the case of DLF Limited makes
interesting reading, not because it is the first of its kind passing strictures
against the vehement use of punitive
powers by SEBI, but it provides an important opportunity to reflect on the question
whether massive penal powers in financial statutes are to be used in sync with
the gravity of the matter, or can simply be deployed casually?
of the Securities Appellate Tribunal (SAT) in the case of DLF Limited makes
interesting reading, not because it is the first of its kind passing strictures
against the vehement use of punitive
powers by SEBI, but it provides an important opportunity to reflect on the question
whether massive penal powers in financial statutes are to be used in sync with
the gravity of the matter, or can simply be deployed casually?
This post is not intended to cover the facts of the case,
but on significant points on which ruling has been given by the Securities
Appellate Tribunal (SAT). A brief review of facts has been given because the
judgement itself has been inspired, at least in part, by the stark facts surrounding the case. Author needs to submit that this article is no
endorsement or evaluation of the business practices followed by real estate
companies, which may encompass different shades of gray, replete with cash
deals, unfair practices and so on. However, that commercial dispute between a
party having a land deal with an alleged affiliate of the company should have
been raked up before SEBI, SEBI should have, 7
years after the closure of the issue, with absolutely no evidence of any
investor damage due to the alleged non-disclosure, passed strict penal orders,
is a matter of great interest. We need to understand civil disputes are civil
disputes ; while a complainant may go forum shopping to find the one which is
strongest and strictest, the temptation of assuming irrelevant jurisdiction has
to be avoided by securities regulators.
but on significant points on which ruling has been given by the Securities
Appellate Tribunal (SAT). A brief review of facts has been given because the
judgement itself has been inspired, at least in part, by the stark facts surrounding the case. Author needs to submit that this article is no
endorsement or evaluation of the business practices followed by real estate
companies, which may encompass different shades of gray, replete with cash
deals, unfair practices and so on. However, that commercial dispute between a
party having a land deal with an alleged affiliate of the company should have
been raked up before SEBI, SEBI should have, 7
years after the closure of the issue, with absolutely no evidence of any
investor damage due to the alleged non-disclosure, passed strict penal orders,
is a matter of great interest. We need to understand civil disputes are civil
disputes ; while a complainant may go forum shopping to find the one which is
strongest and strictest, the temptation of assuming irrelevant jurisdiction has
to be avoided by securities regulators.
Facts of the case in
brief
brief
The matter pertains to a red-herring
prospectus (RHP) for a public offer made by DLF. The complainant’s case is
that DLF had some affiliate entities, not disclosed as subsidiaries in the RHP,
and that these alleged subsidiaries were engaging in dealings, whereby the
complainant had allegedly been defrauded some Rs 34 crores worth cash which was
promised to be paid, but was never paid.
prospectus (RHP) for a public offer made by DLF. The complainant’s case is
that DLF had some affiliate entities, not disclosed as subsidiaries in the RHP,
and that these alleged subsidiaries were engaging in dealings, whereby the
complainant had allegedly been defrauded some Rs 34 crores worth cash which was
promised to be paid, but was never paid.
The civil nature of the complaint apart, the securities law
related issue is the non-disclosure in the offer document of some 281
subsidiaries, which were subsidiaries of a vertical chain of 3 companies. Once
again, do note that formation of special purpose vehicles (SPVs) for holding
land is quite a common feature in the real estate world for several reasons.
Also, it is quite a common device to use a chain-breaker company in between to
segregate a complete chain of de-facto subsidiaries from the parent company[1]. According to the version of the company and
the merchant bankers, there is no question of these SPVs being reported as
subsidiaries or affiliates as their equity capital stood transferred in the
name of the wives of some of the senior employees of the company. Neither was
there voting control, nor management control, with DLF.
related issue is the non-disclosure in the offer document of some 281
subsidiaries, which were subsidiaries of a vertical chain of 3 companies. Once
again, do note that formation of special purpose vehicles (SPVs) for holding
land is quite a common feature in the real estate world for several reasons.
Also, it is quite a common device to use a chain-breaker company in between to
segregate a complete chain of de-facto subsidiaries from the parent company[1]. According to the version of the company and
the merchant bankers, there is no question of these SPVs being reported as
subsidiaries or affiliates as their equity capital stood transferred in the
name of the wives of some of the senior employees of the company. Neither was
there voting control, nor management control, with DLF.
In fact, the complainant’s issue was not so much the
disclosure: his real issue lay in the financial
claim that he had against DLF promoters. He had filed a criminal case
for that purpose in Delhi courts, apparently 3 days before the merchant
bankers approved the company’s
prospectus. This was March 2007. Two
months later, SEBI gave its detailed observations on the offer documents, which
were duly incorporated. The pubic issue was floated in mid-June 2007.
disclosure: his real issue lay in the financial
claim that he had against DLF promoters. He had filed a criminal case
for that purpose in Delhi courts, apparently 3 days before the merchant
bankers approved the company’s
prospectus. This was March 2007. Two
months later, SEBI gave its detailed observations on the offer documents, which
were duly incorporated. The pubic issue was floated in mid-June 2007.
The complainant also put up a complaint with SEBI that DLF’s
sister concern had duped him – this was some days after the RHP had been
finalised and the public offer was just about opened. Once again, it is not
unusual for litigants to try to stall something like a public offer, which is
quite time sensitive and, if blocked or
delayed, may cause considerable costs and injuries to the issuer. As usual, SEBI sends complaints to the
merchant bankers and the company for appropriate response, and as usual, the
company and the merchant bankers would have denied the allegations, primarily
on the ground that the companies with which the complainant had an issue were
not even the subsidiaries of DLF.
sister concern had duped him – this was some days after the RHP had been
finalised and the public offer was just about opened. Once again, it is not
unusual for litigants to try to stall something like a public offer, which is
quite time sensitive and, if blocked or
delayed, may cause considerable costs and injuries to the issuer. As usual, SEBI sends complaints to the
merchant bankers and the company for appropriate response, and as usual, the
company and the merchant bankers would have denied the allegations, primarily
on the ground that the companies with which the complainant had an issue were
not even the subsidiaries of DLF.
The complainant went to the High Court with a writ petition,
to direct SEBI to investigate his complaint. This was October 2007 – almost 5
months after the public issue had already succeeded. The writ petition was
favourably disposed by a single judge of the High Court in April 2010 – almost
3 years after the relevant time. The company as well as SEBI went in appeal to
the Division Bench, which initially stayed the order, but later in July 2011
(that is, more than 4 years after the public issue) gave an order directing
SEBI to investigate the complaint of the complainant. In October 2011, a SEBI
whole-time member (WTM). In June 2013, SEBI issued a show cause notice alleging
various violations of the-then applicable regulations, the SEBI (Disclosure and
Investor Protection) Guidelines, 2000 (the DIP Guidelines).[2] Hearings took place around
January 2014, and the final penalty order was passed by a WTM 9 months after
the conclusion of the pleadings.
to direct SEBI to investigate his complaint. This was October 2007 – almost 5
months after the public issue had already succeeded. The writ petition was
favourably disposed by a single judge of the High Court in April 2010 – almost
3 years after the relevant time. The company as well as SEBI went in appeal to
the Division Bench, which initially stayed the order, but later in July 2011
(that is, more than 4 years after the public issue) gave an order directing
SEBI to investigate the complaint of the complainant. In October 2011, a SEBI
whole-time member (WTM). In June 2013, SEBI issued a show cause notice alleging
various violations of the-then applicable regulations, the SEBI (Disclosure and
Investor Protection) Guidelines, 2000 (the DIP Guidelines).[2] Hearings took place around
January 2014, and the final penalty order was passed by a WTM 9 months after
the conclusion of the pleadings.
Interestingly, in the meantime, the FIR filed by the complainant
was found to be false and frivolous,
and Delhi police closed the matter. That
is, the root cause of all this uproar was anyway out; however, SEBI had, in the
meantime, concluded that there were misstatements in the prospectus on the
ground of the huge chain of subsidiaries not reflected in the prospectus. There
was no finding of any investor losses by reason of the non-disclosure.
was found to be false and frivolous,
and Delhi police closed the matter. That
is, the root cause of all this uproar was anyway out; however, SEBI had, in the
meantime, concluded that there were misstatements in the prospectus on the
ground of the huge chain of subsidiaries not reflected in the prospectus. There
was no finding of any investor losses by reason of the non-disclosure.
Principal legal issue in
the case: the meaning of “control”
the case: the meaning of “control”
One of the significant legal issues discussed in the ruling
is the meaning of “control” in the DIP Guidelines, since it is based on determination
of control that the alleged chain of subsidiaries could be said to be
affiliated with DLF. Interestingly, there was no definition of “control” in the
DIP Guidelines[3].
In absence of a definition, SEBI WTM ran
for various definitions of control, including the age-old Companies Act
definition, definition under the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011 (SAST Regulations), definition under accounting
standards, and so on.
is the meaning of “control” in the DIP Guidelines, since it is based on determination
of control that the alleged chain of subsidiaries could be said to be
affiliated with DLF. Interestingly, there was no definition of “control” in the
DIP Guidelines[3].
In absence of a definition, SEBI WTM ran
for various definitions of control, including the age-old Companies Act
definition, definition under the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011 (SAST Regulations), definition under accounting
standards, and so on.
The SAT order eventually settles on the classic meaning of
control as combination of voting control and control over policy decisions. It
deals with the meaning of “significant influence” which quite often people read
as “control”. Control is control over policy-making; significant influence is
merely right of participation in policy-making. The holding of 20% equity is
merely a rebuttable presumption as to existence of significant influence – it
is possible that there is less than 20% stake and yet significant influence,
and also possible that there is more than 20% stake, and yet no significant
influence.
control as combination of voting control and control over policy decisions. It
deals with the meaning of “significant influence” which quite often people read
as “control”. Control is control over policy-making; significant influence is
merely right of participation in policy-making. The holding of 20% equity is
merely a rebuttable presumption as to existence of significant influence – it
is possible that there is less than 20% stake and yet significant influence,
and also possible that there is more than 20% stake, and yet no significant
influence.
This SAT order and lots of other orders of SAT or bodies
such as the Competition Commission of India highlight the draftsmen of
regulations try to rope in the myriad ways in which corporate control is held,
by using expressions such as “or otherwise” or “directly or indirectly”, but it
is impossible for regulators to grab all the devices that corporates may use,
including layers of entities with a circuit-breaker in between.
such as the Competition Commission of India highlight the draftsmen of
regulations try to rope in the myriad ways in which corporate control is held,
by using expressions such as “or otherwise” or “directly or indirectly”, but it
is impossible for regulators to grab all the devices that corporates may use,
including layers of entities with a circuit-breaker in between.
In the present case, the directors of the three alleged
subsidiaries continued to be on the board, despite the transfer of
shareholding. The SAT did not regard this fact as indicating “control” on the
ground that it is up to the shareholders of the companies as to who do they choose
as their directors, and unless a case is made that it was DLF who dictated the
appointment of directors, merely because the directors have continued cannot
indicate board control. It does not seem if the age-old concept of “acting as
per instructions” or absentee control was at all pressed into service in the
original SEBI order. The show-cause notice seems to have brought factors like
transfer of shares without any payment therefor, possibly hinting that the
transfers might have been back-dated, but SAT did not regard these allegations
as valid.
subsidiaries continued to be on the board, despite the transfer of
shareholding. The SAT did not regard this fact as indicating “control” on the
ground that it is up to the shareholders of the companies as to who do they choose
as their directors, and unless a case is made that it was DLF who dictated the
appointment of directors, merely because the directors have continued cannot
indicate board control. It does not seem if the age-old concept of “acting as
per instructions” or absentee control was at all pressed into service in the
original SEBI order. The show-cause notice seems to have brought factors like
transfer of shares without any payment therefor, possibly hinting that the
transfers might have been back-dated, but SAT did not regard these allegations
as valid.
Non disclosure of FIR:
knowledge by directors is not knowledge by the company
knowledge by directors is not knowledge by the company
On the allegation as to why the FIR had not been disclosed in the RHP, the case of SEBI was
that the FIR named some person who was a close relative of DLF promoters.
Therefore, there was an implicit knowledge. SAT order, in its
characteristically caustic style, say we are not living in the Vedic age, where
relations between relatives were so strong that knowledge by a relative can be
deemed knowledge by the others. SAT also relied upon a 1981 ruling of Bombay
High court in Killick Nixon[4] wherein, in a matter of
transfer of shares of a deceased person, it was held that knowledge of death of the shareholder by the
directors cannot be deemed to be knowledge by the company.
that the FIR named some person who was a close relative of DLF promoters.
Therefore, there was an implicit knowledge. SAT order, in its
characteristically caustic style, say we are not living in the Vedic age, where
relations between relatives were so strong that knowledge by a relative can be
deemed knowledge by the others. SAT also relied upon a 1981 ruling of Bombay
High court in Killick Nixon[4] wherein, in a matter of
transfer of shares of a deceased person, it was held that knowledge of death of the shareholder by the
directors cannot be deemed to be knowledge by the company.
Respectfully, this point in the ruling seems a little
far-fetched. A company has no sensory organs – there is no basis of knowledge
by the company other than its principal officers. There are rulings that wrongs
by the company cannot be attributed upon the directors, but it is difficult to
argue that knowledge of the executive directors cannot be attributed upon the
company.
far-fetched. A company has no sensory organs – there is no basis of knowledge
by the company other than its principal officers. There are rulings that wrongs
by the company cannot be attributed upon the directors, but it is difficult to
argue that knowledge of the executive directors cannot be attributed upon the
company.
The SAT ruling also
cites several precedents to hold that filing of an FIR is by itself not a case
of litigation. This is an important point, and may be of relevance for
disclosures by corporates. Details of pending litigation by or against the
company are also to be given as a part of corporate governance codes.
cites several precedents to hold that filing of an FIR is by itself not a case
of litigation. This is an important point, and may be of relevance for
disclosures by corporates. Details of pending litigation by or against the
company are also to be given as a part of corporate governance codes.
Punitive vehemence of
SEBI
SEBI
The ruling makes several
lashing remarks against SEBI’s vigorous exercise of its punitive powers,
and more particularly, of the 9 months’ delay with which the order was passed
after conclusion of pleadings. To wit:
lashing remarks against SEBI’s vigorous exercise of its punitive powers,
and more particularly, of the 9 months’ delay with which the order was passed
after conclusion of pleadings. To wit:
–
Therefore, reference made to the definition of ‘Control’ under the Takeover
Code reflects a complete non-application of mind in this regard. This act of
the Respondent to shop for clauses and provisions in different statutes, in an
arbitrary manner, needs to be condemned. In fact, the pari materia principle
ought to be invoked to promote uniformity and predictability in law in order to
supplement and not supplant a rule of law by another.
Therefore, reference made to the definition of ‘Control’ under the Takeover
Code reflects a complete non-application of mind in this regard. This act of
the Respondent to shop for clauses and provisions in different statutes, in an
arbitrary manner, needs to be condemned. In fact, the pari materia principle
ought to be invoked to promote uniformity and predictability in law in order to
supplement and not supplant a rule of law by another.
– In quest of a more befitting definition of ‘Control’,
the Respondent has gone astray by even applying the definition of ‘Control’ as
given in an entirely different context in the Takeover Code, 1997 or even
certain Accounting Standards, primarily meant for auditors to be followed.
Neither the Division Bench of the Hon’ble High Court of Delhi nor the first WTM
of Respondent, who ordered investigation pursuant to the Hon’ble Delhi High
Court’s direction for possible violation of DIP Guidelines, gives any direction
or observation which would have the consequence of entwining an element of
fraud with the case of violation of DIP Guidelines in the issuance of the IPO
in question. If interlacing two completely different concepts emanating from
the same word, as defined in two different pieces of regulation/ legislation,
were to be adopted in every matter, it would give rise to the most preposterous
situation, viz., the conclusion that having different regulations/legislations
for different areas of the law is pointless.
the Respondent has gone astray by even applying the definition of ‘Control’ as
given in an entirely different context in the Takeover Code, 1997 or even
certain Accounting Standards, primarily meant for auditors to be followed.
Neither the Division Bench of the Hon’ble High Court of Delhi nor the first WTM
of Respondent, who ordered investigation pursuant to the Hon’ble Delhi High
Court’s direction for possible violation of DIP Guidelines, gives any direction
or observation which would have the consequence of entwining an element of
fraud with the case of violation of DIP Guidelines in the issuance of the IPO
in question. If interlacing two completely different concepts emanating from
the same word, as defined in two different pieces of regulation/ legislation,
were to be adopted in every matter, it would give rise to the most preposterous
situation, viz., the conclusion that having different regulations/legislations
for different areas of the law is pointless.
– Instead of there being different laws and statutes for
different circumstances and entities, there would be one statute defining all
the wrongs and their respective remedies. There is a reason that has not been
done. Every Act of the Parliament, just like every set of rules framed by the
Respondent, has a distinct rationale behind it. The blurring of lines between
different laws and regulations cannot lead to any desirable outcome. Yet, the
second WTM, who passed the Impugned Order, has applied the PFUTP Regulations in
total disregard of the due procedure incorporated in the said Regulations for
alleging and proving a charge of fraud against a company. The allegation of
fraud against any company is an extremely serious matter and cannot be pressed
into service in a casual manner, as has been done in the present case.
different circumstances and entities, there would be one statute defining all
the wrongs and their respective remedies. There is a reason that has not been
done. Every Act of the Parliament, just like every set of rules framed by the
Respondent, has a distinct rationale behind it. The blurring of lines between
different laws and regulations cannot lead to any desirable outcome. Yet, the
second WTM, who passed the Impugned Order, has applied the PFUTP Regulations in
total disregard of the due procedure incorporated in the said Regulations for
alleging and proving a charge of fraud against a company. The allegation of
fraud against any company is an extremely serious matter and cannot be pressed
into service in a casual manner, as has been done in the present case.
Proportionality of
penalties with the gravity of offence: a shunned issue
penalties with the gravity of offence: a shunned issue
The otherwise bold ruling of SAT shuns the issue of
proportionality of punishment to the gravity of the cause. Penalties are deterrent
in nature: they are not compensatory,
they are punitive. Therefore, the extent of penalty is necessarily connected
with the gravity of the offence, mindset of the offender, and the damage caused
thereby. For example, if the traffic
rules were to say, if you jump a signal, you pay a fine of Rs 5 lacs, it is
disproportionate. Lately, SEBI has been imposing penalties running into lakhs
for purely mundane and innocent failures to file, for example, the particulars
of trades in securities by the employees of a company.
proportionality of punishment to the gravity of the cause. Penalties are deterrent
in nature: they are not compensatory,
they are punitive. Therefore, the extent of penalty is necessarily connected
with the gravity of the offence, mindset of the offender, and the damage caused
thereby. For example, if the traffic
rules were to say, if you jump a signal, you pay a fine of Rs 5 lacs, it is
disproportionate. Lately, SEBI has been imposing penalties running into lakhs
for purely mundane and innocent failures to file, for example, the particulars
of trades in securities by the employees of a company.
The
SAT, however, shunned the issue in the following words: “For the same reason[5], we do not propose to
consider the true import of Hon’ble Supreme Court’s judgment in the case of (
i) SEBI Vs. Shriram Mutual Fund reported in 2006 (5) SCC 361 and (ii) Bharjatiya
Steel Industries Vs. Commissioner, Sales Tax, Uttar Pradesh reported in 2008
(1) SCC 617, regarding the scope of Sebi’s power to impose punishment whenever
any violation of Securities Laws is committed by a Company. We leave this
question also open to be considered in future if any eventuality arises in a
given case so also the question of proportionality.”
SAT, however, shunned the issue in the following words: “For the same reason[5], we do not propose to
consider the true import of Hon’ble Supreme Court’s judgment in the case of (
i) SEBI Vs. Shriram Mutual Fund reported in 2006 (5) SCC 361 and (ii) Bharjatiya
Steel Industries Vs. Commissioner, Sales Tax, Uttar Pradesh reported in 2008
(1) SCC 617, regarding the scope of Sebi’s power to impose punishment whenever
any violation of Securities Laws is committed by a Company. We leave this
question also open to be considered in future if any eventuality arises in a
given case so also the question of proportionality.”
Conclusion
Needless to say, the ruling makes a very interesting
reading. Particularly the extracts from the recommendations of the Dhanuka
Committee, based on which massive powers were given to SEBI, that SAT should
counterbalance the slant that may most likely be caused by an ambitious drive
for penalties by SEBI adjudicating officers. Hopefully, the ruling will give
SEBI a reason to offer lessons in reasonableness to its prosecuting officers.
reading. Particularly the extracts from the recommendations of the Dhanuka
Committee, based on which massive powers were given to SEBI, that SAT should
counterbalance the slant that may most likely be caused by an ambitious drive
for penalties by SEBI adjudicating officers. Hopefully, the ruling will give
SEBI a reason to offer lessons in reasonableness to its prosecuting officers.
– Vinod Kothari
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[1] One of the commonest device is to use a
small equity size, and much large size of preference capital, which, being
non-voting, non-convertible, does not make the holder a holding company. The
equity may remain dispersed so that no
single holder has a controlling or significant block. This is precisely
the device apparently used in this case. In Companies Act 2013, MCA did bring
convertible preference shares into the fold for capturing holding status, but
it is easy to structure preference shares as non-convertible and thereby avoid
this change of law. It is strongly recommended that India should put a
thin-capitalisation rule where preference stock cannot exceed a certain
proportion of equity.
small equity size, and much large size of preference capital, which, being
non-voting, non-convertible, does not make the holder a holding company. The
equity may remain dispersed so that no
single holder has a controlling or significant block. This is precisely
the device apparently used in this case. In Companies Act 2013, MCA did bring
convertible preference shares into the fold for capturing holding status, but
it is easy to structure preference shares as non-convertible and thereby avoid
this change of law. It is strongly recommended that India should put a
thin-capitalisation rule where preference stock cannot exceed a certain
proportion of equity.
[2] Precursor the now-applicable ICDR
Regulations.
Regulations.
[3] The ICDR Regulations imbibe the meaning
of “control” from the SAST Regulations. There have been several rulings on the
meaning of “control” under the SAST Regulations. “Control” is defined in the
SAST Regulations 2011, with primarily two indicia, such as right to appoint
majority directors, or control policy decisions, though the words “directly or
indirectly” and sources from which control flows such as management rights,
shareholders’ agreements, etc. seek to make the ambit wide.
of “control” from the SAST Regulations. There have been several rulings on the
meaning of “control” under the SAST Regulations. “Control” is defined in the
SAST Regulations 2011, with primarily two indicia, such as right to appoint
majority directors, or control policy decisions, though the words “directly or
indirectly” and sources from which control flows such as management rights,
shareholders’ agreements, etc. seek to make the ambit wide.
[4] MANU/MH/003/1981;
http://indiankanoon.org/doc/580207/
http://indiankanoon.org/doc/580207/
[5] That is, since the order is being
quashed on merits.
quashed on merits.
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