Liability of Issuers for Misleading Advertisement in a Public Issue of Securities

[Neha Sinha is a 3rd Year B.A. LL.B. student at National University of Study and Research in Law (NUSRL), Ranchi]

In an order dated February 26, 2020, the Securities and Exchange Board of India (SEBI) imposed penalty on Muthootu Mini Financiers Ltd. (MMFL) in a matter relating to misleading advertisement made to the public at large regarding the issue of debt securities. The matter was decided by the Adjudicating Officer (AO) of SEBI in relation to the violation of the SEBI (Issue and Listing of Debt Securities) Regulations 2008 (or ILDS Regulations) by MMFL. In this post, I analyze the points of law clarified by the AO and expound on the nature of the liability of an issuer under ILDS Regulations.

MMFL had advertised online for the public issue of non-convertible debentures (NCDs). The advertisement stated that the “issue was rated stable by SEBI and RBI”, which was found to be false. SEBI issued a show cause notice to MMFL, which in turn clarified their position that the impugned statement was added by the advertising agency. The addition was made by the advertiser without MMFL’s prior approval or knowledge. Besides, out of the 242 people who had shown interest in investing through this advertisement, only eight people had invested with them based on their faith upon MMFL. However, when the error came to the notice of MMFL, they immediately sought an explanation from the advertising agency, which duly accepted the error. MMFL submitted that such a misleading statement was not made intentionally or with any ulterior object to mislead or cheat the public.  

The primary question to be decided was whether using the names of the regulators in the advertisement of a public issue tends to impart a sense of security to investors and thus creates a misleading impression to the public. An act of such a nature would stand in violation of regulation 8 of the ILDS Regulations.

Liability for Misleading Advertisement

According to regulation 2(b) of the ILDS Regulations, one of the essential conditions for the public issue of debt securities is that the issuer must have obtained credit rating from at least one rating agency. Regulation 8(2) of the ILDS Regulations prohibits the issuer from issuing an advertisement which is misleading, or contains any distorted information so as to appear manipulative or deceptive. Furthermore, Regulation 8(3) mandates that the advertisement should be “truthful, fair and clear and shall not contain a statement, promise or forecast which is untrue or misleading”.

The rating is essential, as it estimates the credit risk of the issue. This creditworthiness is a determining factor that shapes the quantum of confidence the prospective investors show towards the issuer. Thus, it is imperative that the rating must be in consonance with the ILDS Regulations, and any information relating to the same must be truthful and untarnished. It is an obligation incumbent upon the issuer to not mislead the public with a distorted advertisement by puffing up the creditworthiness of the issue.

Besides, SEBI deals with regulation of securities, and the RBI has the domain over the banking framework. SEBI and the RBI do not rate issues. It is the credit rating agencies, regulated under the SEBI (Credit Rating Agencies) Regulations 1999, which are vested with the task of evaluating the strength and potential default of the company.

The representation made by MMFL that the issue was rated “stable by SEBI and RBI” was blatantly false and deceptive to the prospective investors. The use of the names of the primary regulatory bodies and the representation that the rating by these regulatory bodies is favourable “tend to impart a sense of security”, in as much as it bolsters the confidence of the public regarding the creditworthiness of the issue. Thus, the advertisement was prima facie deceptive, untruthful and in contravention of regulations 8(2) and (3) of the ILDS Regulations.

Necessity (or Otherwise) of Mens Rea

The AO then decided upon the relevance of mens rea in the matters of default under the SEBI Act, 1992. MMFL took the plea of absence of mens rea and contended that they did not have the intention to mislead the public. The said error had occurred owing to the advertising agency. In this context, the AO referred to the SEBI ruling against M/s The First Custodian Fund (I) Ltd. wherein it was held that a matter related to securities and stock brokers is civil in nature. The standard of proof required in such cases is different from that required in criminal cases in so far as the strict rule of Evidence Act and proof beyond reasonable doubt are not applicable to a civil proceeding. Preponderance of probabilities indicating the misconduct of the delinquent is sufficient proof. A reference in the same ruling was made to Seth Gulabchand v. Seth Kudilal, wherein the Supreme Court had held that the Evidence Act makes it clear that the same standard of proof applies in all civil cases. It makes no difference between cases in which charges of a criminal character is made or not.

Further reliance was placed upon UOI v. M/s Dharamendra Textile to clarify the nature of liability presented under the scheme of the SEBI Act. Chapter VI-A of the SEBI Act has provisions for penalties and adjudication. However, this chapter does not deal with criminal offences. The defaults or failures are default or failure of statutory obligations provided by the Act and Rules made thereunder. The proceedings under Chapter VI-A are neither criminal nor quasi-criminal. The penalty levied under this Chapter is a penalty in cases of breach of statutory obligations. In the provisions under Chapter IV-A, there is no element of any criminal offence or punishment as contemplated under criminal proceedings. Thus, there arises no question of proof of intention as mens rea is not an essential element for imposing penalty under the SEBI Act.

The AO ruled upon the merits of the case that MMFL has violated the provisions of regulation 8 of ILDS Regulations and, thus, this breach of statutory obligation attracted monetary penalty under Section 15HB of the SEBI Act.

Monetary Penalty for Violation

The quantum of penalty has to be determined according to rule 5(2) of the SEBI (Procedure for Holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules 1995 read with section 15J of the SEBI Act. The factors to be taken into account while adjudging the quantum are the amount of disproportionate gain or unfair advantage in so far as it is quantifiable, the amount of loss caused to the investor due to the breach in the obligation, and the repetitive nature of the default. With due regard to the merits of the matter, and the AO imposed a penalty of rupees ten lakhs to be paid within 45 days of the receipt of that order.

The provisions under regulation 8 of the ILDS Regulations are intended to ensure fair and ethical practices by the issuers. This ruling reaffirms the absolute nature of obligation an issuer has while inviting investors. Since the rating or any information related to it is an essential element of public issue which influences the decision of the public whether to invest or not, any representation discovered to be distorted, manipulated or outright false, attracts penalty. The strict guidelines by SEBI regarding the advertisement of such issues are essential to ensure the transparency at the initial stage of the issue.

Concluding Remarks: Code of Advertisement

To further the aim to reinforce the fair practices in the securities market, the Code of Advertisement provided by SEBI lists exhaustive measures to be taken by the trading members of the stock exchange while advertising for public issue in media. The Code mandates that the information advertised in the media must be “accurate, true, fair, clear, complete, unambiguous and concise.” A noteworthy provision in the Code is clause (f) of para 1.4, which states that the advertisement shall not contain any statement designed to exploit the lack of experience or knowledge of the investors. The Code acknowledges that a prospective investor may not be well versed with the rubrics of the securities market and can as well be misled with even subtly manipulated information. Upon any inclusion or omission of any statement giving false implications or one that is likely to be misunderstood, the regulatory bodies, acting as the watchdog, can initiate proceedings against the defaulter. Strict adherence to these guidelines shall not only ensure fair practice by the issuers and stock brokers, but also create an investor friendly market.

– Neha Sinha



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