Background: History Repeats
Itself
Itself
The Securities and Exchange Board of India (“SEBI”) has in
recent year initiated actions pertaining to the alleged lack of accurate
disclosures in prospectuses issued by companies in public offerings of
securities. One high profile case involved the initial public offering (“IPO”)
of DLF Limited wherein SEBI issued an order restraining DLF, its directors and
CFO from buying or selling securities or otherwise accessing the capital
markets for a three-year period. However, on appeal, in a divided verdict the
majority members of the Securities Appellate Tribunal (SAT) quashed
SEBI’s order, thereby overturning the ban imposed by SEBI.
recent year initiated actions pertaining to the alleged lack of accurate
disclosures in prospectuses issued by companies in public offerings of
securities. One high profile case involved the initial public offering (“IPO”)
of DLF Limited wherein SEBI issued an order restraining DLF, its directors and
CFO from buying or selling securities or otherwise accessing the capital
markets for a three-year period. However, on appeal, in a divided verdict the
majority members of the Securities Appellate Tribunal (SAT) quashed
SEBI’s order, thereby overturning the ban imposed by SEBI.
In another IPO, this time involving Credit Analysis and Research
Limited (“CARE”), a credit rating agency, SEBI raised concerns regarding
non-disclosure of material information in the prospectus, but initiated actions
against six merchant bankers involved in the transaction.[1] An adjudicating officer
(“AO”) of SEBI found violations by the merchant bankers of the provisions of
the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (the
“ICDR Regulations”) and the SEBI (Merchant Bankers) Regulations 1992 (the
“Merchant Bankers Regulations”) and levied a penalty of Rs. 1 crore on the
merchant bankers. On an appeal preferred by the merchant bankers before SAT,
history repeated itself in a way. In another divided verdict, the majority of
the members of SAT overturned the AO’s order and the levy of the penalty.
Limited (“CARE”), a credit rating agency, SEBI raised concerns regarding
non-disclosure of material information in the prospectus, but initiated actions
against six merchant bankers involved in the transaction.[1] An adjudicating officer
(“AO”) of SEBI found violations by the merchant bankers of the provisions of
the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (the
“ICDR Regulations”) and the SEBI (Merchant Bankers) Regulations 1992 (the
“Merchant Bankers Regulations”) and levied a penalty of Rs. 1 crore on the
merchant bankers. On an appeal preferred by the merchant bankers before SAT,
history repeated itself in a way. In another divided verdict, the majority of
the members of SAT overturned the AO’s order and the levy of the penalty.
Facts and Decision:
Non-Disclosure Immaterial
Non-Disclosure Immaterial
Curiously enough, in this case the alleged failure to disclose
did not pertain to any fact or matter involving the issuer company or the
merits or risks of the investment itself. Rather, it pertained to the offering
process and the questions of what type of foreign investors were eligible to invest
in CARE’s IPO and on what terms. In a nutshell, it involved an interpretation
of the provisions of the foreign investment policy and the regulations issued
by the Reserve Bank of India (“RBI”).
did not pertain to any fact or matter involving the issuer company or the
merits or risks of the investment itself. Rather, it pertained to the offering
process and the questions of what type of foreign investors were eligible to invest
in CARE’s IPO and on what terms. In a nutshell, it involved an interpretation
of the provisions of the foreign investment policy and the regulations issued
by the Reserve Bank of India (“RBI”).
In order to analyse the disclosures, it would be appropriate to
briefly discuss the foreign investment policy articulated by the RBI. Under the
Foreign Exchange Management (Transfer or Issue of Security by a Person Resident
Outside India) Regulations, 2000 (the “FEMA Regulations”), the RBI permits various
types of foreign investors to invest in shares of an Indian company. These
include foreign direct investors (FDI) under Schedule 1, and several other
types of investors (under various other schedules) such as foreign
institutional investors (“FIIs”), non-resident Indians (“NRIs”), foreign
venture capital investors (“FVCIs”) and qualified foreign investors (“QFIs”). Moreover,
in the case of companies such as CARE that are classified as non-banking
finance companies (“NBFCs”), there is an additional condition imposed in
Schedule 1, which states that any FDI must be accompanied by the satisfaction
of minimum capitalization norms of US$ 0.5 million.
briefly discuss the foreign investment policy articulated by the RBI. Under the
Foreign Exchange Management (Transfer or Issue of Security by a Person Resident
Outside India) Regulations, 2000 (the “FEMA Regulations”), the RBI permits various
types of foreign investors to invest in shares of an Indian company. These
include foreign direct investors (FDI) under Schedule 1, and several other
types of investors (under various other schedules) such as foreign
institutional investors (“FIIs”), non-resident Indians (“NRIs”), foreign
venture capital investors (“FVCIs”) and qualified foreign investors (“QFIs”). Moreover,
in the case of companies such as CARE that are classified as non-banking
finance companies (“NBFCs”), there is an additional condition imposed in
Schedule 1, which states that any FDI must be accompanied by the satisfaction
of minimum capitalization norms of US$ 0.5 million.
For the IPO in question, the merchant bankers approached the RBI
with a request to make the offering available to foreign investors. Although
there was considerable amount of correspondence between the merchant bankers
and the RBI after CARE’s red herring prospectus (“DRHP”) was filed with SEBI, of
greater relevance is RBI’s A.P. (DIR Series) Circular No. 43 dated November 4,
2011, wherein the RBI announced its decision to permit a transfer of shares from
a resident to non-resident without prior approval of the RBI, subject to two
conditions: (i) no-objection certificates (“NOCs”) are obtained from the
financial sector regulators of the transferor and transferee entities, and (ii)
the relevant foreign investment policy such as sectoral caps and minimum
capitalization norms are complied with.[2]
with a request to make the offering available to foreign investors. Although
there was considerable amount of correspondence between the merchant bankers
and the RBI after CARE’s red herring prospectus (“DRHP”) was filed with SEBI, of
greater relevance is RBI’s A.P. (DIR Series) Circular No. 43 dated November 4,
2011, wherein the RBI announced its decision to permit a transfer of shares from
a resident to non-resident without prior approval of the RBI, subject to two
conditions: (i) no-objection certificates (“NOCs”) are obtained from the
financial sector regulators of the transferor and transferee entities, and (ii)
the relevant foreign investment policy such as sectoral caps and minimum
capitalization norms are complied with.[2]
Accordingly, the RBI permitted CARE to proceed in accordance
with the Circular. However, CARE approached RBI again on the ground that
obtaining an NOC from non-resident investors was not a viable option as the
identity of such investors will not be known beforehand. After further
correspondence, the RBI wrote back to CARE agreeing to exempt non-resident
investors from the requirement of obtaining NOCs from their respective
regulators, subject to the condition that the minimum capitalization norms were
adhered to, and that certain other procedural requirements were complied with.
Upon receiving this intimation from the RBI, CARE (along with its merchant
bankers) decided to confine the offering to FIIs and NRIs, and to exclude other
investors (such as FDI) falling within the purview of Schedule 1 to the FEMA
Regulations since the minimum capitalization norms are applicable only
investors coming in through FDI under Schedule 1. However, following meetings
with RBI officials who indicated that the minimum capitalization norms would be
applicable to investments by FIIs and NRIs as well, CARE sought for time from
the RBI to comply with such norms for these investors as well, which were in
fact complied with.
with the Circular. However, CARE approached RBI again on the ground that
obtaining an NOC from non-resident investors was not a viable option as the
identity of such investors will not be known beforehand. After further
correspondence, the RBI wrote back to CARE agreeing to exempt non-resident
investors from the requirement of obtaining NOCs from their respective
regulators, subject to the condition that the minimum capitalization norms were
adhered to, and that certain other procedural requirements were complied with.
Upon receiving this intimation from the RBI, CARE (along with its merchant
bankers) decided to confine the offering to FIIs and NRIs, and to exclude other
investors (such as FDI) falling within the purview of Schedule 1 to the FEMA
Regulations since the minimum capitalization norms are applicable only
investors coming in through FDI under Schedule 1. However, following meetings
with RBI officials who indicated that the minimum capitalization norms would be
applicable to investments by FIIs and NRIs as well, CARE sought for time from
the RBI to comply with such norms for these investors as well, which were in
fact complied with.
The issue at hand for which SEBI initiated action against the
merchant bankers was that they “failed to ensure that full and complete
disclosures were made in the RHP of CARE which amounts to suppressing material
facts in the RHP and attempt to mislead investors into believing that RBI had
unconditionally exempted non-residents from obtaining NOC from their respective
regulators for participating in the offer of CARE.”
merchant bankers was that they “failed to ensure that full and complete
disclosures were made in the RHP of CARE which amounts to suppressing material
facts in the RHP and attempt to mislead investors into believing that RBI had
unconditionally exempted non-residents from obtaining NOC from their respective
regulators for participating in the offer of CARE.”
SAT commenced its analysis by consider the objective of
disclosure in a public offering as follows:
disclosure in a public offering as follows:
6. Object of the disclosure
provisions contained in the ICDR Regulations and Merchant Bankers Regulations
is to ensure that the offer document contains all material disclosures which
are true and adequate so as to enable the applicants permitted to participate
in the offer to take an informed investment decision. In other words, the
disclosures made in the offer documents must be those disclosures which are
material to the applicants permitted to participate in the offer to take an
informed investment decision.
provisions contained in the ICDR Regulations and Merchant Bankers Regulations
is to ensure that the offer document contains all material disclosures which
are true and adequate so as to enable the applicants permitted to participate
in the offer to take an informed investment decision. In other words, the
disclosures made in the offer documents must be those disclosures which are
material to the applicants permitted to participate in the offer to take an
informed investment decision.
Ultimately, the issue here boiled down to whether the conditions
imposed by the RBI for exempting from the requirement of the investors
obtaining NOCs, i.e. “strict compliance of minimum capitalization norms
applicable to NBFCs was a material information required to be disclosed in the
RHP so as to enable the investors permitted to participate in the offer to take
an informed investment decision.” Here, SAT found that under the foreign
investment policy and FEMA Regulations compliance with the minimum
capitalization norms was required only for foreign investments made through
Schedule 1 (i.e. FDI) and not through other methods such as FII and NRI
investments. This position was not disputed by SEBI as a matter of law. Hence,
“non disclosure of the information relating to compliance of minimum
capitalization norms cannot be said to be failure to disclose material
information, because the said information was not applicable to the investors
permitted to participate in the offer of CARE to take an informed investment
decision.” To that extent, SAT read RBI’s condition on minimum capitalization
to mean that it applies only if an offer is made to investors specified in
Schedule 1, but not otherwise.
imposed by the RBI for exempting from the requirement of the investors
obtaining NOCs, i.e. “strict compliance of minimum capitalization norms
applicable to NBFCs was a material information required to be disclosed in the
RHP so as to enable the investors permitted to participate in the offer to take
an informed investment decision.” Here, SAT found that under the foreign
investment policy and FEMA Regulations compliance with the minimum
capitalization norms was required only for foreign investments made through
Schedule 1 (i.e. FDI) and not through other methods such as FII and NRI
investments. This position was not disputed by SEBI as a matter of law. Hence,
“non disclosure of the information relating to compliance of minimum
capitalization norms cannot be said to be failure to disclose material
information, because the said information was not applicable to the investors
permitted to participate in the offer of CARE to take an informed investment
decision.” To that extent, SAT read RBI’s condition on minimum capitalization
to mean that it applies only if an offer is made to investors specified in
Schedule 1, but not otherwise.
In the present case, since the offer was not so made available,
the question of compliance with such norms does not arise. SAT concluded: “In
other words, non-disclosure of an information which is not at all material for
the investors permitted to participate into an offer to take an informed
investment decision would not amount to suppressing material information in the
RHP.” SAT therefore found that the AO’s order imposing a penalty of Rs. 1 crore
on the merchant bankers of CARE was no sustainable.
the question of compliance with such norms does not arise. SAT concluded: “In
other words, non-disclosure of an information which is not at all material for
the investors permitted to participate into an offer to take an informed
investment decision would not amount to suppressing material information in the
RHP.” SAT therefore found that the AO’s order imposing a penalty of Rs. 1 crore
on the merchant bankers of CARE was no sustainable.
The dissenting member of SAT adopted a more strict view of the
disclosure requirements. In his opinion, it was improper for the merchant
bankers to have disclosed RBI’s exemption from the NOC requirement without
disclosing the condition upon which it was granted (i.e. compliance with the minimum
capitalization norms). Placing reliance on SAT’s decision in Almondz
Global Securities, the dissenting view noted: “Even if the BRLMs are
ever in doubt as to the materiality of information, they should opt to include
such information in the offer documents, unless cogent and strong reasons exist
for the merchant bankers to not disclose the information concerned. The
standard to be applied is what a prudent merchant banker under similar
circumstances would have done …”
disclosure requirements. In his opinion, it was improper for the merchant
bankers to have disclosed RBI’s exemption from the NOC requirement without
disclosing the condition upon which it was granted (i.e. compliance with the minimum
capitalization norms). Placing reliance on SAT’s decision in Almondz
Global Securities, the dissenting view noted: “Even if the BRLMs are
ever in doubt as to the materiality of information, they should opt to include
such information in the offer documents, unless cogent and strong reasons exist
for the merchant bankers to not disclose the information concerned. The
standard to be applied is what a prudent merchant banker under similar
circumstances would have done …”
Implications: Relevance of
the Information
the Information
Ultimately, the decision (as well as the difference between the
majority and dissenting opinions) hinged upon the materiality of the
information that was not disclosed in the RHP. This was tested against the
touchstone of whether that information was relevant to the investors in making
an investment decision. In other words, SAT placed emphasis on the element of
“relevance” (although not expressly). While there was non-disclosure, it
related to a matter that was not relevant in the ultimate scheme of things
because the persons to whom the information was relevant (i.e. foreign
investors under Schedule 1) were not permitted to invest in the IPO in the
first place.
majority and dissenting opinions) hinged upon the materiality of the
information that was not disclosed in the RHP. This was tested against the
touchstone of whether that information was relevant to the investors in making
an investment decision. In other words, SAT placed emphasis on the element of
“relevance” (although not expressly). While there was non-disclosure, it
related to a matter that was not relevant in the ultimate scheme of things
because the persons to whom the information was relevant (i.e. foreign
investors under Schedule 1) were not permitted to invest in the IPO in the
first place.
The other take away from SAT’s decision is that this information
had to do with the issue process rather than the merits of the investment
itself. Although SAT has not explicitly addressed this in its decision, it may
have had a bearing on the outcome. While it is not to say that disclosure of
process related issues is unimportant, they could be looked at differently from
the fundamentals of the company, unless the process related issues strike at
the heart of the investment decision. Here it was only incidental.
had to do with the issue process rather than the merits of the investment
itself. Although SAT has not explicitly addressed this in its decision, it may
have had a bearing on the outcome. While it is not to say that disclosure of
process related issues is unimportant, they could be looked at differently from
the fundamentals of the company, unless the process related issues strike at
the heart of the investment decision. Here it was only incidental.
[1]
While SEBI’s actions in the DLF IPO were targeted at the company and its
directors, here they were directed against the merchant bankers.
While SEBI’s actions in the DLF IPO were targeted at the company and its
directors, here they were directed against the merchant bankers.
[2]
RBI’s policy relating to transfer of shares from
residents to non-residents was relevant for CARE’s IPO as it was effected by
way of an offer for sale by existing shareholders.
RBI’s policy relating to transfer of shares from
residents to non-residents was relevant for CARE’s IPO as it was effected by
way of an offer for sale by existing shareholders.