SEBI Rules on Misapplication of IPO Funds

In an order issued yesterday involving Birla Pacific Medspa Limited (“BPML”), the Securities and Exchange Board of India (“SEBI”) was faced with an alleged misapplication of IPO funds by the company way back in 2011. Through a prospectus issued on June 29, 2011, the company raised Rs. 65.17 crores to establish “Evolve” Medspa centres across India, which constituted the primary purpose of the capital raising effort. However, following an investigation surrounding a sharp volatility in the stock price on the listing date, SEBI found that the IPO funds were instead routed by BPML to various entities that in turn acquired shares of BPML, allegedly with a view to artificially inflate the stock price.[1] Hardly any of the proceeds were utilised for the purpose for which they were raised, and no new Medspa centre was set up. As SEBI found violation of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (the “ICDR Regulation”), it issued an order restraining the company and several of its then directors (the “noticees”) from accessing the capital markets for a period of time. This post focuses on three issues arising out of the SEBI order.

Delay in the Investigation and Issue of Show Cause Notice

Since the relevant events transpired in 2011, the noticees raised the objection that there was a considerable delay in SEBI’s investigation and the issue of show cause notice. However, SEBI’s order pins the blame on the noticees who, according to SEBI, did not respond adequately to its requests for information. Moreover, the order suggests that some of the noticees sought inspection of what SEBI found to be a lengthy list of irrelevant documents, which request SEBI declined. Accordingly, SEBI found that there was no “unexplained delay”, and rejected the noticees’ submissions alleging delays and laches in the issuance of the show cause notices.

While the specific circumstances, including conduct of the noticees, may have contributed to the situation, the process has indeed been unduly delayed. Such delays in regulatory action not only undermine effective enforcement of securities regulation, but they also subject affected parties (such as the alleged wrongdoers) to a great deal of uncertainty. Lessons from cases such as this enhance the call for more time-bound regulatory actions, particularly since the legal and factual issues involved in this cases do not appear overly complex or elaborate.

Misapplication of IPO Proceeds

The ICDR Regulations contains details regarding the disclosures to be made in a prospectus for issuance of securities, and place due regarding to the truthfulness of its contents. The issue at hand was whether the actions of BPML contravened the sections of the prospectus relating to “objects of the issue”, “interim use of funds” and “risk factors”. At question is whether BPML’s use of issue proceeds to place intercorporate deposits (“ICDs”) with other entities breached the terms of the prospectus. At the outset, the prospectus allowed BPML, pending the use of the proceeds for its business, to place them “liquid instruments” that were dividend or interest bearing. However, at a meeting on July 11, 2011 following the IPO, BPML’s board approved the interim use of funds through investment in ICDs to group companies. SEBI’s hinges its finding on a reading of the prospectus that does not permit deployment of funds in the interim with other corporates. Moreover, the SEBI order reasons that ICDs are not “liquid instruments” as they are incapable of being transferred from one person to another (unlike corporate securities). As SEBI’s order noted:

Liquidity signifies the ability of an instrument of being bought and sold in the market to third parties, without any involvement of the issue of the instrument. ICDs do not possess the ability to be transferred to third parties within a market, without the express consent of the investee. Thus, it lacks liquidity. Hence, ICDs do not quality as ‘liquid instruments’ as mentioned in the Prospectus.”

Hence, according to SEBI, BPML has breached the terms of the prospectus relating to the use of proceeds.

Role of Non-executive and Independent Directors

Unsurprisingly, the non-executive and independent directors (“NEIDs”) took the position that they ought to be exonerated as they were not involved in the day-to-day affairs of the company. However, SEBI was categorical in its refusal to accept the position. From a conceptual perspective, SEBI stated that whenever matters were dealt with at a board level, it is not possible for individual directors to disown responsibility on the ground that they were not part of the executive management of the company. The July 11, 2011 board meeting discussed earlier explicitly permitted the company to enter into ICDs by way of interim use of funds. Some of the NEIDs were also members of the audit committee, which reviewed the quarterly financial statements of the company that contained statements regarding the ICDs. Only one director received a reprieve as he had resigned in the wake of the IPO.

From a legal position too, SEBI’s ruling has the effect of stating that the liability of NEIDs cannot be any lower than that of executive directors even though they are not involved in the day-to-day affairs of the company. Although the Companies Act, 2013 introduces certain dispensations for NEIDs in section 149(12), which the Ministry of Corporate Affairs has further clarified in March this year (discussed here), SEBI was not bound to consider those as the case at hand predated these developments. In any event, on the assumption that these dispensations were applicable to the NEIDs in BPML, SEBI found that the acts in questions were within the knowledge of the NEIDs, as they were part of the “board processes”, and the NEIDs in BPML were therefore not entitled to the dispensations. The SEBI ruling, particularly given the relatively clearer facts regarding the involvement of the NEIDs, makes it difficult for outside directors to exonerate themselves from consequences of breaches of securities regulation by the company.


Although the BPML case appears relatively straightforward in terms of the fact situation involved, it does raise some questions regarding the delays in SEBI’s action as well as the role and liabilities of NEIDs in relation to securities regulation. These legal issues are bound to require further consideration if the noticees choose to appeal.

[1] From a company law perspective, as SEBI noted, the transactions had the effect of triggering the prohibition against financial assistance.

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.


  • It’s a good order and will reduce frauds.
    But how about the investor’s money. Is there anything said about this.
    Will the retail investor’s get back their hard earned money?

  • Hello sir, i have shares if birla pacific medspa. sebi declared fair value 8.72 inr per share. but sebi is not helping us to sell these shares to promotors. there is no mandate process set by sebi. they know shareholders will not able to catch these fraud promotors and sell shares. just to show they are trying to help shareholders. i raised 20+ tickets with sebi to get help to sell shares but they sebi are not helping me. i raised multiple tickets with pmo still no help. should we forget selling shares of birla pacific medspa shares? should we accpet loss. sir why sebi does this with shareholders. they know birla pacific medpsa promoters are fraud and they are using money for their own benifit. i think BPML company itself doesnot exist . there is no news nothing about birla pacific medspa doing now a days. why sebi and MCA is quite and allows all this to do.


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