SAT Affirms SEBI’s Power to Lift the Corporate Veil

In an order passed yesterday in Sahara Asset
Management Company P. Ltd v. Securities and Exchange Board of India
the Securities Appellate Tribunal (“SAT”) considered an appeal from an order of
the Securities and Exchange Board of India (“SEBI”) in which SEBI had found
that Sahara India Financial Corporation Ltd. (“Sahara Sponsor”) is not a “fit
and proper” person and hence the Sahara Mutual Fund and Sahara Asset Management
Company P. Ltd. (“Sahara AMC”) are not long eligible to carry on the business
of a mutual fund. While the SAT affirmed SEBI’s order and dismissed Sahara’s
appeal, it was required to consider some important questions of law.
To paraphrase the SAT:
The legal question
that … arises is if the Promoter-Director of the Sponsor of a mutual fund is
found to be not a fit and proper person whether the sponsor itself becomes not
fit and proper and if so whether it would impact the fit and proper status of
the mutual fund and the AMC under the Mutual Fund Regulations.
Under the SEBI (Mutual Fund)
Regulations 1996 (“MF Regulations”), a sponsor makes an application to SEBI for
a mutual fund licence. Under regulation 7 of the MF Regulations, the applicant
must, among other conditions, be a “fit and proper” person. The criteria for
determining a “fit and proper” person are set out in Schedule II of the SEBI
(Intermediaries) Regulations, 2008 (“Intermediaries Regulations”), which permit
SEBI to review whether the applicant, its principal officer and key management
persons possess the requisite integrity, reputation and character, whether they
have convictions or restraint orders against them and their competence
(including financial solvency and net worth).
On facts, the Sahara group had
acquired another mutual fund in 2004. But, in 2011, SEBI passed an order
against two Sahara group companies for raising funds in violation of securities
laws, which was confirmed by the Supreme Court. Orders were passed against the
promoter Mr. Subrata Roy Sahara as well. In the mutual fund scenario, these led
to SEBI’s ruling that the Sahara sponsor is not a “fit and proper” person. The
two Sahara group companies against whom orders were passed in relation to the
fund raising episode did not hold any shares in the mutual fund companies.
Hence, the question before the SAT ultimately boiled down to the extent to
which the integrity, character and other factors pertaining to Mr. Subrata Roy
can be considered in determining whether the Sahara Sponsor is a “fit and
proper” person.
Here, the SAT was required to
analyse Mr. Subrata Roy’s role in relation to the Sahara Sponsor. He was
related to the Sahara Sponsor in two ways. First, the SAT relied on facts which
showed that Mr. Subrata Roy was the managing director and chairman of the
Sahara Sponsor until September 2, 2014 when he resigned from that position.
Hence, he was a principal officer and key managerial person of the Sahara
Sponsor at the time the application was made to SEBI for a mutual fund licence,
and hence fell within the purview of Schedule II of the Intermediaries
Regulations (outlined earlier).
Second, and more importantly, the
question related to whether the fact that Mr. Subrata Roy exercised control
over the Sahara Sponsor would automatically imply that the criteria for fitness
would have to be judged against him as a promoter and not just the applicant.
In other words, can SEBI apply the criteria for “fit and proper” person not
just to the Sahara Sponsor that was the applicant for the mutual fund licence
in accordance with the Mutual Fund Regulations, but whether those criteria can
also be extended to the promoter of such sponsor. While the Mutual Fund
Regulations expressly apply the fitness criteria to the “applicant” (being the
mutual fund sponsor”), the stretch to ensnare the promoter within the fitness
criteria will have to be achieved by an extension through legal fiction: and
that is where the question of lifting the corporate veil came into the picture.
The facts indicated that Mr.
Subrata Roy holds 79.80% of the equity share capital of the Sahara Sponsor and
53.34% of its preference share capital, which continued even after his
resignation. The SAT placed considerable reliance on the continued control that
Mr. Subrata Roy exercised over the Sahara Sponsor, both in law (de jure) and in fact (de facto). For instance, the SAT referred
to the Supreme Court’s observations that Mr. Subrata Roy continued to oversee
the affairs of the Sahara group and that “nothing can move without his active
Moving to the legal question of
whether the corporate veil of the Sahara sponsor can be lifted, the SAT was not
persuaded by various judgments of courts cited by the Sahara group to establish
that the Sahara Sponsor is a separate legal entity that is distinct from its
shareholders and promoters. According to the SAT, none of those judgments
pertained to the securities markets. The SAT preferred instead to apply first
principles in considering the powers of SEBI under the SEBI Act, 1992 and
various regulations issued thereunder. The SAT noted:
In the securities
market, SEBI Act empowers SEBI to take actions in the interest of protecting
the interests of the investors and hence lifting the corporate veil to the
extent to identify who controls a regulated entity cannot be faulted. Without
such a power SEBI will be a mute spectator to many of the corporate misdeeds
which may jeopardize the interests of investors. Given the mandate of SEBI to
protect the interests of the investors in the securities market SEBI is
statutorily empowered to lift the corporate veil and find out the truth
whenever interests of the investors are affected or likely to be affected. In
the instant case SEBI itself found that two group companies of Sahara and its
Directors were not conducting their business following the rules relating to
public issue and were restrained from associating themselves with any listed
Company or Company which intends to raise money from the public. It was also
found that one of the Promoters / Directors is prima facie holding absolute
control over the group companies. Given these facts and circumstances, lifting
the corporate veil to the extent of identifying the role of the Promoter /
Director in the impugned order cannot be faulted.
For these reasons, the SAT
dismissed the Sahara group’s appeal.
This decision is important as it
recognises SEBI’s power to look beyond the registrant (or applicant for
registration) with which it has a relationship, and to examine factors such as
the owners, promoters and managers of those entities. While a purposive
interpretation of the SEBI Act and the regulations would command such a result,
there could be practical problems in the implementation of such principles. For
example, if the promoters are holding their stake in a registrant (or
applicant) through a chain of intermediate companies, how far along the chain can
SEBI probe to determine the fitness of the person under question? Moreover, matters
may get rather complicated when the promoter entities are situated outside
India where not only the disclosure and transparency could be different, but
also fitness criteria.
The SAT’s approach resonates with
the “concealment principle” laid down by the UK Supreme Court in the landmark
case of Prest v. Petrodel Resources Limited, where Lord Sumption stated:
The concealment
principle is legally banal and does not involve piercing the corporate veil at
all. It is that the interposition of a company or perhaps several companies so
as to conceal the identity of the real actors will not deter the courts from
identifying them, assuming that their identity is legally relevant. In these
cases the court is not disregarding the “facade”, but only looking behind it to
discover the facts which the corporate structure is concealing.
In any event, the issues may not have
been fully put to rest as the Sahara Group has indicated its intention to
appeal to the Supreme Court, due to which the SAT has granted a stay of six
weeks to its order.

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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