Thursday, March 11, 2010

SEBI Order on Shareholding Disclosures

On March 8, 2010, SEBI passed an order in the case of Bank of Rajasthan (BoR).

SEBI commenced investigation into the shareholding pattern of BoR following a reference received from the Reserve Bank of India (RBI). Pursuant to the RBI Guidelines on Ownership and Governance in Private Sector Banks dated February 28, 2005, the promoters of BoR were required to reduce their shareholding in the company. SEBI’s order finds that while the promoters did in fact reduce their stake in the company, certain other companies fronting for the promoter group were acquiring BoR shares in parallel, and no disclosures were made regarding those acquisitions either under the listing agreement or the SEBI Takeover Regulations. SEBI’s order details a complex web of transactions through which inter-firm transfers of funds were made to the accounts of corporate bodies who purchased BoR shares; such purchaser entities had contact details similar to that of BoR’s promoters; and there were common directorships between the promoter group and the acquiring entities.

The SEBI order contains a summary of the transactions and their outcome:

18. The promoters of BoR have by way of their continuous disclosure publicly announced that their stake has been coming down from 44.18% as at quarter ending June 2007 to 28.61% as at quarter ending December 2009 which was clearly false. This evidently conveyed a misleading picture to investors, stock exchanges and to SEBI. While the promoters apparently conveyed the impression that they were reducing their shareholding, they did not in fact dilute their controlling stake in BoR. Indeed on the contrary they had actually increased their shareholding in a deceptive and fraudulent manner with the active connivance of others. It was planned in such a way that on paper their holding seems to have reduced but in reality, the holding of the promoters (controlled by the Tayal group) along with their front entities, had actually increased from 44.71% as at quarter-ending June 2007 to 60% as at quarter-ending March 2008 and stood at 55.01% as at quarter-ending December 2009. No disclosures related to acquisition were made to the stock exchanges by any of the acquiring groups or by BoR at any time over this extended period thereby providing misleading information to the investors in the scrip. In fact, the promoters of BoR and their connected entities have been trading in the shares of BoR without any disclosure to this effect to either the public or the stock exchanges.

19. The promoters and Tayal group entities had made fund transfers to the entities in the Yadav group so that these entities could purchase the shares of BoR from the open market. Later on, the Yadav group entities made off-market transfers to the promoter related Silvassa group entities. These Silvassa entities are located at addresses that are offices and manufacturing facilities of various other Tayal group companies. Thus, the Yadav group and Silvassa group were acting in concert with the promoters of BoR to disguise the actual stake of the Tayal Group in BoR. The artifice outlined above of disguising the ownership structure apparently also seems to have superficially resulted in compliance with the guidelines issued by RBI on ownership and shareholding. However, this has to be referred to RBI for further action as they may deem fit.
For these reasons, SEBI invoked the Takeover Regulations (in view of acquisition of substantial acquisition of shares by persons acting in concert without making disclosures or an open offer) and the Prohibition of Fraudulent and Unfair Trade Practices Regulations (stating that the transactions were prima facie fraudulent). In exercise of powers under the SEBI Act (including Section 11B), SEBI passed an far-reaching order restraining over 100 entities from accessing the securities markets and prohibiting them from buying, selling or dealing in securities in any manner whatsoever, until further directions.

The following are some quick thoughts:

1. It is heartening to note coordination and collaboration between regulatory bodies. SEBI’s investigation, culminating in its order, was initiated through a reference by the RBI. It is not known if such inter-regulatory body references to SEBI have occurred frequently, if at all, but it sets an interesting trend.

2. SEBI’s order is based on an analysis of fund flows and stock purchases. It relies on a determination of relevant facts, which represent several interconnected transactions, much of which is also arguably circumstantial. However, that usually tends to be the case in investigations concerning share transactions such as unfair trade practices or insider trading.

3. In the BoR case, SEBI has invoked its powers under Section 11B of the SEBI Act to debar several entities from dealing in the securities markets. That provision confers wide powers on SEBI to pass orders “in the interest of investors, or orderly development of securities market” and to rein in intermediaries. While the usage of this legal provision by SEBI has become quite widespread, the Supreme Court has recently provided some guidance on the nature and usage of the powers by SEBI. The Initial Private Opinion blog refers to a judgment of the Supreme Court of India in SEBI v. Ajay Agarwal, which holds that Section 11B is procedural in nature and can therefore be applied retrospectively, and that an order of SEBI under that section is not in the nature of penalty. There is also some general discussion about the nature and purpose of SEBI’s powers under Section 11B. (Update – March 16, 2010: Somasekhar Sundaresan reviews the Supreme Court judgment in his Business Standard column)

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