[The following guest post is contributed by Shashank Prabhakar, a Senior Associate
with Finsec Law Advisors. These are the author’s personal views]
with Finsec Law Advisors. These are the author’s personal views]
The Whole Time Member of
SEBI (‘WTM’) recently passed an order
against certain relatives of Mr. Ramalinga Raju and entities belonging to the
promoter group of Satyam Computers for violation of Section 12A of the Securities
and Exchange Board of India Act, 1992 (‘SEBI
Act’), Regulations 3 and 4 of the SEBI (Prohibition of Fraudulent and
Unfair Trade Practices) Regulations, 2003 (‘PFUTP Regulations’) and Regulation 3 of the SEBI (Prevention of
Insider Trading) Regulations, 1992 (‘PIT
Regulations’). The order was passed under Section 11(1), 11(4) and 11(B) of
the SEBI Act.
SEBI (‘WTM’) recently passed an order
against certain relatives of Mr. Ramalinga Raju and entities belonging to the
promoter group of Satyam Computers for violation of Section 12A of the Securities
and Exchange Board of India Act, 1992 (‘SEBI
Act’), Regulations 3 and 4 of the SEBI (Prohibition of Fraudulent and
Unfair Trade Practices) Regulations, 2003 (‘PFUTP Regulations’) and Regulation 3 of the SEBI (Prevention of
Insider Trading) Regulations, 1992 (‘PIT
Regulations’). The order was passed under Section 11(1), 11(4) and 11(B) of
the SEBI Act.
One of the entities
against whom the order was passed is SRSR Holdings Pvt. Ltd., a holding
company, which owned almost all of the shares held by the promoter group of Satyam
(SRSR Holdings held 8.27% of the total shareholding of Satyam while the total
shareholding of the promoter / promoter group of Satyam was about 8.6%). The
shareholders of SRSR Holdings were Mr. Ramalinga Raju, his brother Mr. Rama
Raju and their respective spouses. I propose to analyze only that part of the
order which deals with SRSR Holdings.
against whom the order was passed is SRSR Holdings Pvt. Ltd., a holding
company, which owned almost all of the shares held by the promoter group of Satyam
(SRSR Holdings held 8.27% of the total shareholding of Satyam while the total
shareholding of the promoter / promoter group of Satyam was about 8.6%). The
shareholders of SRSR Holdings were Mr. Ramalinga Raju, his brother Mr. Rama
Raju and their respective spouses. I propose to analyze only that part of the
order which deals with SRSR Holdings.
The facts are that
during the period between August 2007 and November 2008, various promoter group
entities of Satyam had taken loans amounting to Rs. 1,258 crores from financial
institutions and SRSR Holdings had pledged the shares of Satyam on their behalf
as security for the loans. The weighted average price at which the shares were
pledged was Rs. 402.80 and most of the lenders required the borrowers to pledge
about 2.25 times the value of the loan as security. The lenders started
invoking the pledge between December 23, 2008 and January 7, 2009, on account
of shortfall in the margins. It may be recalled that Mr. Ramalinga Raju issued
the infamous letter disclosing financial irregularities in Satyam on January 7,
2009.
during the period between August 2007 and November 2008, various promoter group
entities of Satyam had taken loans amounting to Rs. 1,258 crores from financial
institutions and SRSR Holdings had pledged the shares of Satyam on their behalf
as security for the loans. The weighted average price at which the shares were
pledged was Rs. 402.80 and most of the lenders required the borrowers to pledge
about 2.25 times the value of the loan as security. The lenders started
invoking the pledge between December 23, 2008 and January 7, 2009, on account
of shortfall in the margins. It may be recalled that Mr. Ramalinga Raju issued
the infamous letter disclosing financial irregularities in Satyam on January 7,
2009.
SEBI issued a notice to
SRSR Holdings asking it to show cause as to why action should not be taken
against it under Section 12A of the SEBI Act read with Regulation 3 of the PIT
Regulations. SEBI alleged that SRSR Holdings had pledged shares of Satyam when
it had full knowledge of the ongoing financial irregularities in Satyam and
that these shares were pledged to obtain funds for the personal benefit of
promoters / directors of Satyam and entities connected to them. This, according
to SEBI, amounted to insider trading under the PIT Regulations. SRSR Holdings
in its reply claimed that it was not an “insider” as per the definition under
the PIT Regulations. SRSR Holdings claimed that it had no “unpublished price
sensitive information” or in other words, that it did not have any knowledge
about financial irregularities in Satyam. Although Mr. Ramalinga Raju and Mr.
Rama Raju were both directors in the company, it claimed that their personal
knowledge of financial irregularities in Satyam could not be attributed to the
company. Further, the company argued that in any case pledging of shares did
not amount to “dealing in securities” under the PIT Regulations and for that
reason Regulation 3 of the PIT Regulations was not violated in this case.[1]
SRSR Holdings asking it to show cause as to why action should not be taken
against it under Section 12A of the SEBI Act read with Regulation 3 of the PIT
Regulations. SEBI alleged that SRSR Holdings had pledged shares of Satyam when
it had full knowledge of the ongoing financial irregularities in Satyam and
that these shares were pledged to obtain funds for the personal benefit of
promoters / directors of Satyam and entities connected to them. This, according
to SEBI, amounted to insider trading under the PIT Regulations. SRSR Holdings
in its reply claimed that it was not an “insider” as per the definition under
the PIT Regulations. SRSR Holdings claimed that it had no “unpublished price
sensitive information” or in other words, that it did not have any knowledge
about financial irregularities in Satyam. Although Mr. Ramalinga Raju and Mr.
Rama Raju were both directors in the company, it claimed that their personal
knowledge of financial irregularities in Satyam could not be attributed to the
company. Further, the company argued that in any case pledging of shares did
not amount to “dealing in securities” under the PIT Regulations and for that
reason Regulation 3 of the PIT Regulations was not violated in this case.[1]
The WTM in his order
disregarded the claims made by SRSR Holdings and held that it was a “person deemed to be a connected person”
under Regulation 2(h)(i) of the PIT Regulations as Mr. Ramalinga Raju and Mr. Rama
Raju, who were chairman and managing director of Satyam respectively, were also
directors of SRSR Holdings. Therefore, SRSR Holdings was held to be an
“insider” as they were both under same management, as per Regulation 2(e)(i) of
the PIT Regulations.
disregarded the claims made by SRSR Holdings and held that it was a “person deemed to be a connected person”
under Regulation 2(h)(i) of the PIT Regulations as Mr. Ramalinga Raju and Mr. Rama
Raju, who were chairman and managing director of Satyam respectively, were also
directors of SRSR Holdings. Therefore, SRSR Holdings was held to be an
“insider” as they were both under same management, as per Regulation 2(e)(i) of
the PIT Regulations.
As regards the claim
that personal knowledge of the directors could be attributed to the company, it
was held that since the shares could not have been pledged without the active
connivance of Mr. Ramalinga Raju and Mr. Rama Raju who were in involved in and
were fully aware of the financial irregularities in Satyam, SRSR Holdings was
very much in possession of UPSI when the shares were pledged. The WTM does not
provide any other reasons for arriving at this conclusion nor does he cite any
authority in support of his conclusion.
that personal knowledge of the directors could be attributed to the company, it
was held that since the shares could not have been pledged without the active
connivance of Mr. Ramalinga Raju and Mr. Rama Raju who were in involved in and
were fully aware of the financial irregularities in Satyam, SRSR Holdings was
very much in possession of UPSI when the shares were pledged. The WTM does not
provide any other reasons for arriving at this conclusion nor does he cite any
authority in support of his conclusion.
Further, the WTM also
held that pledging of shares amounted to “dealing in securities” under the PIT
Regulations. Regulation 2(d) of the PIT Regulations defines the phrase to mean
“an act of subscribing, buying, selling or agreeing to subscribe, buy, sell or
deal in any securities by any person either as principal or agent”. [Emphasis
Supplied] The circular definition notwithstanding, the WTM concluded that from
the plain reading of the definition it was clear that the phrase would include “all commercial dealings related to the
securities which involve transfer of securities or any rights or interests
therein or issuance of securities.” He also held that the mode of transfer
is immaterial for the dealings to fall within the ambit of this definition. No
further authority has been cited by the WTM in support of his conclusion.
held that pledging of shares amounted to “dealing in securities” under the PIT
Regulations. Regulation 2(d) of the PIT Regulations defines the phrase to mean
“an act of subscribing, buying, selling or agreeing to subscribe, buy, sell or
deal in any securities by any person either as principal or agent”. [Emphasis
Supplied] The circular definition notwithstanding, the WTM concluded that from
the plain reading of the definition it was clear that the phrase would include “all commercial dealings related to the
securities which involve transfer of securities or any rights or interests
therein or issuance of securities.” He also held that the mode of transfer
is immaterial for the dealings to fall within the ambit of this definition. No
further authority has been cited by the WTM in support of his conclusion.
It is hard to see how the plain reading of the aforementioned
definition suggests that it includes all commercial dealings related to
securities, or in any case pledge of shares. The last part of the definition
uses the very term that is being defined as part of the definition and the WTM
assumes a prior understanding of the phrase “dealing in securities” to include
all commercial dealings related to securities. While it is true that it has
been given the widest of meanings in various decisions by the SAT and other
courts, this is the first time that the phrase has been used to include within
its scope pledge of shares, in the context of insider trading under the erstwhile
PIT Regulations. The WTM could have used this opportunity to carefully outline
the scope of the phrase “dealing in securities” in the context of insider
trading. To state that the definition also does not concern itself with the
mode of transfer in order for pledge to fall within its ambit is also incorrect
because pledge does not involve transfer of shares.
definition suggests that it includes all commercial dealings related to
securities, or in any case pledge of shares. The last part of the definition
uses the very term that is being defined as part of the definition and the WTM
assumes a prior understanding of the phrase “dealing in securities” to include
all commercial dealings related to securities. While it is true that it has
been given the widest of meanings in various decisions by the SAT and other
courts, this is the first time that the phrase has been used to include within
its scope pledge of shares, in the context of insider trading under the erstwhile
PIT Regulations. The WTM could have used this opportunity to carefully outline
the scope of the phrase “dealing in securities” in the context of insider
trading. To state that the definition also does not concern itself with the
mode of transfer in order for pledge to fall within its ambit is also incorrect
because pledge does not involve transfer of shares.
Regulation 2(b) of the PFUTP Regulations also defines the
phrase “dealing in securities” to include “an
act of buying, selling or subscribing pursuant to any issue of any security or
agreeing to buy, sell or subscribe to any issue of any security or otherwise transacting in any way in any
security by any person as principal, agent or intermediary referred to
in section 12 of the Act.” The definition of the phrase under PFUTP
Regulations is far more precise and it is clear from a plain reading of the
definition that it would include pledge of shares within its ambit. However,
there is no provision either in the PIT Regulations or the SEBI Act or the
PFUTP Regulations that allows SEBI to supplant the definition in PIT
Regulations by a definition of the phrase in PFUTP Regulations.
phrase “dealing in securities” to include “an
act of buying, selling or subscribing pursuant to any issue of any security or
agreeing to buy, sell or subscribe to any issue of any security or otherwise transacting in any way in any
security by any person as principal, agent or intermediary referred to
in section 12 of the Act.” The definition of the phrase under PFUTP
Regulations is far more precise and it is clear from a plain reading of the
definition that it would include pledge of shares within its ambit. However,
there is no provision either in the PIT Regulations or the SEBI Act or the
PFUTP Regulations that allows SEBI to supplant the definition in PIT
Regulations by a definition of the phrase in PFUTP Regulations.
Be that as it may, the WTM states that in order to prove the
charge of insider trading under Regulation 3(i), SEBI must prove that (a) the
person is an ‘insider’, (b) he is in possession of UPSI and (c) he deals in
securities of the company while in possession of the UPSI either on his own
behalf or on behalf of any other person. Since all the elements were present in
the case of SRSR Holdings, he concludes that SRSR Holdings is guilty of insider
trading. As has been stated above, the reasons provided by the WTM for arriving
at this conclusion are far from adequate.
charge of insider trading under Regulation 3(i), SEBI must prove that (a) the
person is an ‘insider’, (b) he is in possession of UPSI and (c) he deals in
securities of the company while in possession of the UPSI either on his own
behalf or on behalf of any other person. Since all the elements were present in
the case of SRSR Holdings, he concludes that SRSR Holdings is guilty of insider
trading. As has been stated above, the reasons provided by the WTM for arriving
at this conclusion are far from adequate.
Furthermore, the line of reasoning adopted by the WTM
renders all pledge transactions by promoters of listed companies vulnerable to
the charge of insider trading. All promoters are insiders and they tend to have
UPSI of their companies on an ongoing basis and a transaction involving even a
bona fide pledge of shares will squarely fall within Regulation 3(i) of the PIT
Regulations. The issue of what constitutes a bona fide pledge transaction is
also far from clear. The WTM in his order has not inquired into whether or not
the pledge of shares by SRSR Holdings was genuine or bona fide. That does not
seem to be a factor that needs to be taken into consideration in order to
decide whether a pledge transaction amounts to insider trading. What remains to
be seen is whether SEBI, based on this decision, will now start looking into
old pledge transactions to see whether there was any “insider trading”.
renders all pledge transactions by promoters of listed companies vulnerable to
the charge of insider trading. All promoters are insiders and they tend to have
UPSI of their companies on an ongoing basis and a transaction involving even a
bona fide pledge of shares will squarely fall within Regulation 3(i) of the PIT
Regulations. The issue of what constitutes a bona fide pledge transaction is
also far from clear. The WTM in his order has not inquired into whether or not
the pledge of shares by SRSR Holdings was genuine or bona fide. That does not
seem to be a factor that needs to be taken into consideration in order to
decide whether a pledge transaction amounts to insider trading. What remains to
be seen is whether SEBI, based on this decision, will now start looking into
old pledge transactions to see whether there was any “insider trading”.
The WTM also makes a rather specious claim that the “act was manipulative and deceptive in nature
devised to defraud unsuspecting investors” and concludes that the SRSR
Holdings has made a “wrongful gain” of Rs. 1,258 crores, presumably at the
expense of unsuspecting investors and ordered SRSR Holdings to disgorge the
said amount along with a simple interest of 12% p.a. from January 7, 2009 till
the date of repayment. The WTM could have used this opportunity to articulate
as to how pledge of shares affects the interests of the investor community as a
whole instead of treating it in a self-evidentiary manner. It is hard to
understand just how the mere act of pledging shares by SRSR Holdings resulted
in defrauding investors. Further, he could have also provided reasons as to how
these transactions resulted in a wrongful gain to SRSR Holdings at the expense
of investors and not the lenders. It is probable that the borrowers and the
pledgor may have misrepresented or even defrauded the lenders in order to
induce them to advance loans, but it is hard to see how it affects the investor
community as a whole. The WTM has also not considered the fact that the lenders
would have recovered at least a part of their dues from the borrowers after
having sold the pledged shares upon invocation, between December 23, 2008 and
January 7, 2009 and the lenders would have a right to legal recourse to recover
the remaining dues from the borrower and / or enforce other security that they
may have obtained, based on the loan documents. Assuming for a moment that the
lenders have already been paid off, any “wrongful gains” made by SRSR Holdings
would have been duly paid back and there is also no evidence of any
shareholders having suffered any injury on account of these transactions.
devised to defraud unsuspecting investors” and concludes that the SRSR
Holdings has made a “wrongful gain” of Rs. 1,258 crores, presumably at the
expense of unsuspecting investors and ordered SRSR Holdings to disgorge the
said amount along with a simple interest of 12% p.a. from January 7, 2009 till
the date of repayment. The WTM could have used this opportunity to articulate
as to how pledge of shares affects the interests of the investor community as a
whole instead of treating it in a self-evidentiary manner. It is hard to
understand just how the mere act of pledging shares by SRSR Holdings resulted
in defrauding investors. Further, he could have also provided reasons as to how
these transactions resulted in a wrongful gain to SRSR Holdings at the expense
of investors and not the lenders. It is probable that the borrowers and the
pledgor may have misrepresented or even defrauded the lenders in order to
induce them to advance loans, but it is hard to see how it affects the investor
community as a whole. The WTM has also not considered the fact that the lenders
would have recovered at least a part of their dues from the borrowers after
having sold the pledged shares upon invocation, between December 23, 2008 and
January 7, 2009 and the lenders would have a right to legal recourse to recover
the remaining dues from the borrower and / or enforce other security that they
may have obtained, based on the loan documents. Assuming for a moment that the
lenders have already been paid off, any “wrongful gains” made by SRSR Holdings
would have been duly paid back and there is also no evidence of any
shareholders having suffered any injury on account of these transactions.
To state that SRSR Holdings made a wrongful gain of Rs.
1,258 crores would, therefore, be incorrect. In any event, the rightful
recipients of the loan amount and interest thereon are the lenders. Issuing
directions under Regulation 11(1), 11(4) and 11(B) to remit the funds to SEBI’s
Investor Protection Fund as they are required to under this order is neither
fair nor just and it does not serve the investor community in any way other than
adding to the substantial cash pile that SEBI is already sitting on. SEBI has
wide powers to issue directions under the aforementioned provisions and the
importance of using them wisely and judiciously can never be overstated.
1,258 crores would, therefore, be incorrect. In any event, the rightful
recipients of the loan amount and interest thereon are the lenders. Issuing
directions under Regulation 11(1), 11(4) and 11(B) to remit the funds to SEBI’s
Investor Protection Fund as they are required to under this order is neither
fair nor just and it does not serve the investor community in any way other than
adding to the substantial cash pile that SEBI is already sitting on. SEBI has
wide powers to issue directions under the aforementioned provisions and the
importance of using them wisely and judiciously can never be overstated.
Conclusion
The SEBI order is the first of its kind – where a pledge
transaction has been held to be insider trading under the erstwhile PIT
Regulations. As has been stated above, the order of the WTM does not seem to
consider genuineness or bona fides of the pledge transaction to be one of the
factors in deciding whether it amounts to insider trading. This aspect of the
order does not portend well for promoters of listed companies, given the
proclivity of SEBI to investigate old cases. Perhaps it would have been wiser
to have charged SRSR Holdings under the PFUTP Regulations given the clarity in
the definition of “dealing of shares” and the wide definition of “fraud” under
Regulation 2(c) of the PFUTP Regulations. However, in that case, the burden of
proof would have been on SEBI to prove that the pledge transaction was
fraudulent, unlike the PIT Regulations where the burden of proof is on SRSR
Holdings to prove its innocence.
transaction has been held to be insider trading under the erstwhile PIT
Regulations. As has been stated above, the order of the WTM does not seem to
consider genuineness or bona fides of the pledge transaction to be one of the
factors in deciding whether it amounts to insider trading. This aspect of the
order does not portend well for promoters of listed companies, given the
proclivity of SEBI to investigate old cases. Perhaps it would have been wiser
to have charged SRSR Holdings under the PFUTP Regulations given the clarity in
the definition of “dealing of shares” and the wide definition of “fraud” under
Regulation 2(c) of the PFUTP Regulations. However, in that case, the burden of
proof would have been on SEBI to prove that the pledge transaction was
fraudulent, unlike the PIT Regulations where the burden of proof is on SRSR
Holdings to prove its innocence.
However, the new SEBI
PIT Regulations, 2015 and the Guidance
Note that was issued recently by SEBI explicitly states that SEBI’s intent
is to prohibit creation and invocation of pledge when in possession of UPSI.
The silver lining, if one can call it that, is that the pledgor or pledgee can
use the defenses available to them under Regulation 4 and demonstrate that the
creation or invocation of the pledge was bona fide, unlike the view taken by
the WTM in this order.
PIT Regulations, 2015 and the Guidance
Note that was issued recently by SEBI explicitly states that SEBI’s intent
is to prohibit creation and invocation of pledge when in possession of UPSI.
The silver lining, if one can call it that, is that the pledgor or pledgee can
use the defenses available to them under Regulation 4 and demonstrate that the
creation or invocation of the pledge was bona fide, unlike the view taken by
the WTM in this order.
– Shashank Prabhakar
[1]
Regulation 3 (1) of the PIT Regulations states that no “insider” shall either
on his own behalf or on behalf of any other person, deal in securities of a
company listed on any stock exchange when in possession of any unpublished
price sensitive information.
Regulation 3 (1) of the PIT Regulations states that no “insider” shall either
on his own behalf or on behalf of any other person, deal in securities of a
company listed on any stock exchange when in possession of any unpublished
price sensitive information.