Supreme Court on Applicability of the Regime on Collective Investment Schemes

The Supreme Court of India earlier this month ruled on the
applicability of the regulatory regime relating to collective investment
schemes (“CIS”). In Securities
and Exchange Board of India v. Gaurav Varshney
, the legal question was rather straightforward. On 25 January 1995,
section 12(1B) was inserted into the Securities and Exchange Board of India
Act, 1992 (the “SEBI Act”). It provided that no person shall carry out a CIS
unless he or she obtains a certificate of registration from the Securities and
Exchange Board of India (“SEBI”) “in accordance with the regulations”. However,
the “regulations” referred to in the said provision were enacted by SEBI only
with effect from 15 October 1999 in the form of the SEBI (Collective Investment
Schemes) Regulations, 1999 (the “CIS Regulations”). In the interim, on 3 July
1995, the respondents in the principal appeal, Gaurav Varshney and Vinod Kumar
Varshney, began carrying out CIS operations through a company they incorporated.
The legal question therefore was whether by carrying out CIS activity during
the period when section 12(1B) (that imposes a bar on such activity without
registration) was in force but not the CIS Regulations (that prescribe the mode
of obtaining SEBI approval), the Varshneys were in breach of the legal regime
so as to be subject to criminal action. The High Court below quashed SEBI’s
action under section 482 of the Criminal Procedure Code. It is against this
decision that SEBI appealed before the Supreme Court.
The Ruling
In answering the legal question, the Supreme Court
interpreted section 12(1B) of the SEBI Act, which reads as follows:
No person shall sponsor
or cause to be sponsored or carry on or cause to be carried on any venture
capital funds or collective investment scheme including mutual funds, unless he
obtains a certificate of registration from the Board in accordance with the
Provided that any person
sponsoring or cause to be sponsored, carrying or causing to be carried on any
venture capital funds or collective investment scheme operating in the
securities market immediately before the commencement of the Securities Laws
(Amendment) Act, 1995 for which no certificate of registration was required
prior to such commencement, may continue to operate till such time regulations
are made under clause (d) of sub-section (2) of section 30.
After analyzing the provision, the Supreme Court concluded
that it has two parts. The first, signified by the main provision, relates to
persons who had not commenced CIS activity prior to 25 January 1995, when the
provision was brought into force, i.e. those who began the business afresh
after that date.[1]
The second, signified by the proviso, relates to those who were carrying on CIS
activity even prior to that date, i.e. existing activity.[2]
After doing so, the Court concluded that the case relating to the Varshneys would
fall within the first part of section 12(1B), i.e. new activity. The question
therefore was whether the bar against commencement of CIS activity after 25
January 1995 (when section 12(1B) came into force) would operate from that date
or only when the regulations prescribed by SEBI thereunder came into force.
Here, the court was emphatic in its conclusion that the bar against commencing
CIS activity without registration would operate with effect from the date that
the statutory provision (i.e. section 12(1B)) came into force and not only when
the regulations were notified. The Court observed:
21. … Our inevitable
conclusion is, that sponsoring or carrying on any collective investment
activity, for the first time, on or after 25.1.1995, was a complete bar, in the
absence of a certificate of registration from ‘the Board’. It accordingly
follows, that if a person/entity had commenced to sponsor or carry on a
collective investment scheme after 25.1.1995, without obtaining a certificate
of registration from ‘the Board’, it would tantamount to breaching the express
mandate contained in Section 12(1B) of the SEBI Act.
22. In our considered
view, there can be no doubt, that the date when the Collective Investment
Regulations came into force (-15.10.1999), has no relevance, insofar as the
breach of Section 12(1B) of the SEBI Act, with reference to such new entrepreneurs,
is concerned. The bar to sponsor or cause to be sponsored, or carry on or cause
to be carried on any collective investment activity by a new entrepreneur (-who
had not commenced the concerned activities, before 25.1.1995) under Section
12(1B) of the SEBI Act, was not dependent on the framing of the regulations.
The above bar was absolute and unconditional, till the new entrepreneur
(described above) obtained a certificate of registration, in accordance with
the regulations. …
Although on this legal question the Supreme Court held in
favour of SEBI, it upheld the decision of the High Court below in quashing the
criminal proceedings against the Varshneys. This was on account of procedural
issues. The Court placed considerable emphasis on the fact that SEBI’s
complaint was made under the proviso category, i.e. where a person was carrying
on existing CIS activity when section 12(1B) was brought into force. On the
other hand, the complaint ought to have been made under the non-proviso
category, i.e. in respect of new businesses that were commenced after the
section as brought into force on 25 January 1995. This distinction was found to
be rather crucial, and the fact SEBI proceeded under the wrong category was
found to be fatal to its prosecution.
Hence, while the substantive legal question was decided in
favour of SEBI, the procedural question was answered for the benefit of the
Varshneys, due to which SEBI’s complaint against them was quashed. Apart from
the case relating to Varshneys, the Supreme Court also dealt with the disposed
off certain related appeals on similar and other related questions.
From a broader perspective, the Supreme Court’s decision has
implications on restrictions of commercial activity imposed by legislation,
especially when such activity is subject to licensing or registration
requirements. Since such restrictions are subject to detailed rules or
regulations to be promulgated by the regulatory authorities, the decision has
implications on how persons may carry out such activities between the time that
the legislation has imposed a restriction and before the regulatory authorities
promulgate the rules or regulations. The Court’s resounding answer is that the
activity cannot be carried out in the interim, and this operates as a total
prohibition. That prohibition will be lifted only when the rules or regulations
are subsequently promulgated. The issue becomes even more acute when there is a
considerable delay between the imposition of the legislative restriction and the
subsequent promulgation of the rules or regulations, as was the case with
section 12(1B) and the CIS Regulations, which faced a delay of over three
years. This puts affected parties at a disadvantage, as no CIS activity could
have been carried on in the interim period. The lesson from this decision for
the regulatory authorities would be that they ought to institute mechanisms for
licensing or registration as soon as any such restrictions are imposed by
legislation, without any delays in the interim.
On the other hand, the procedural aspect of the decision has
the impact of imposing an onerous burden on the regulators in that they are
required to be more specific regarding the offence that has been committed by a
party. In circumstances such as in the present case, where section 12(1B)
contains two parts, i.e. for existing businesses and new businesses, the
regulator will have to specify whether the violation in a given case is under
either of the two parts. If the regulator fails to do so, then prosecution for
an offence under the SEBI Act could end up being futile as it turned out in the
present case.

This the Court referred to as the “non-proviso category”.
This the Court referred to as the “proviso category”.

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.


  • Prima facie, from your post (I haven’t read the SC order yet), it seems that order is incorrect on at least the following grounds:

    i) Parliament’s delegation of power to SEBI to frame rules cannot be construed as a power to prohibit, especially by inaction;
    ii) it is quiet doubtful if Parliament itself had the power to impose a blanket ban (which is what the situation comes to) especially since CIS may not be described as res extra commercium;
    iii) what SEBI could not do under the regulations (i.e. prohibit any and every person irrespective of her credentials, from carrying on CIS activity) it cannot do without framing the regulations.

  • IMPROMPTU (thoughts shared, in order to provoke more)
    “….Here, the court was emphatic in its conclusion that the bar against commencing CIS activity without registration would operate with effect from the date that the statutory provision (i.e. section 12(1B)) came into force and not only when the regulations were notified. The Court observed:…”
    As quickly read and instantly understood, going simply by the write-up, the implications of the Proviso do not seem to have been addressed and /or duly considered, in the court proceedings. Should that be so, it might not be possible to readily appreciate and fully reconcile the emphatic view handed out by the apex court; especially, should the new set of regulations, which came to be lately made under clause (d) of sub-section (2) of section 30, in 1999- albeit not gone into and dealt with by the writer,-as is to be guessed, are materially different, unlike the erstwhile regulations, so as to squarely cover the freshly brought in requirement of ‘registration’.

    May be contd.

Top Posts & Pages


Recent Comments


web analytics

Social Media