Friday, September 7, 2012

Some highlights of Supreme Court's decision in Sahara Companies' matter

As has been widely reported, the Supreme Court rejected all the contentions of the two Sahara companies (“Saharas”) against the order of SAT which in turn was against the order of SEBI. The matter of course is far more complex than being a linear sequence of orders and appeals and has several detours to Allahabad and other courts but, in essence, it is sufficient to consider this series of Orders only. The decision of the Supreme Court covers many important issues and, to clarify at the outset, this is only to highlight some important aspects of the decision. The decision covers many important areas – of powers of SEBI, of what constitutes an issue to the public, of the sanctity of Guidelines of SEBI and so on. There are concerns about the dubious role that the Registrar of Companies performed. The Supreme Court also appears to have endorsed the possibility of criminal action against the Saharas. These and other issues may need separate legal analysis as to its scope and implications. Further, the progress of implementation of the order of the Supreme Court in terms of payment of refund monies into the designated bank, identification of the OFCDs holders, etc. will have to be seen. There are reports that the Saharas may pursue further litigation and hence this matter may develop even further.     

The essential facts are summarized in a simplified manner below. However, one preliminary thought comes to mind. The facts are quite glaring and extreme. The Saharas offered their Optionally Fully Convertible Debentures (“OFCDs”) to crores of people, hiring lakhs of agents through thousands of branches and raised tens of thousands of crores of rupees. And then they claimed, clearly on technical grounds, that there was no issue of securities to the public that would result in need for compliance of SEBI Regulations and other laws for disclosure, investor protection, etc. Further, they refused to provide information to SEBI and adopted delaying tactics. In face of such facts, one wonders whether the decision – which rejects every contention of the Saharas and even removing several creases and gaps in law in the process – could be interpreted to some extent as restricted to the facts of the case.

To come to the facts, the Saharas, as the Supreme Court records, sought to raise funds through Optionally Fully Convertible Debentures (OFCDs”). They filed/circulated an information memorandum/ Red Herring Prospectus with the Registrar of Companies but no documents with SEBI. It took a view that issue of shares to a group of people – described in an extremely broad manner – did not amount to an issue to the public requiring compliance with the provisions of the Companies Act, 1956, the SEBI Act and Regulations, etc. that dealt with public issues. The Saharas, however, appointed about 10,00,000 agents, opened 2900 branches and offered the OFCDs to crores of people, and issued the OFCDs to some 66 lakhs people (it appears actual figures may be even higher). Contrast this with the maximum limit of 49 offerees permitted under Section 67(3) of the Companies Act, 1956, beyond which the offer would become a public offer.

When the Sahara Group filed an offer document through merchant banker for a public issue of shares of another group company, SEBI, having come to know through this offer document of the earlier issues of OFCDs, made preliminary inquiries with the merchant banker. The merchant banker essentially replied, relying on legal opinions, that the earlier issues of OFCDs were in compliance of law but did not provide more details. When SEBI pursued the matter further with the Saharas, they insisted that SEBI had no jurisdiction and that they had complied with the law and would respond only to the Registrar of Companies. In what was seen to be further delaying tactics, they claimed that the issue as to whether they are liable to provide information to SEBI was pending determination before the Law Ministry and SEBI should wait till the matter was resolved. This resulted in gathering of information by SEBI from ROC documents and passing of certain orders by SEBI, petitions before High Court, etc. and finally, the Order by SEBI which, alongwith the Order on appeal by SAT was upheld by the Supreme Court.

Several issues were raised before the Supreme Court. The rulings of the Supreme Court and their implications would need far more detailed analysis and at this stage, some important of these issues and rulings are highlighted below.

Was the offer of OFCDs by the Saharas a “private placement” or an issue to the public?
It was noted that the offer was made to “friends, associates, group companies, workers/ employees and other individuals associated/affiliated or connected in any manner with Sahara India Group of Companies”. These persons in reality turned out to be nearly 3 crores in number. When finally details of the allottees were provided, the Supreme Court was dissatisfied with the details and noted that the front page was enough to cast doubt on the genuineness of the persons. An allottee was named merely “Kalavati” and the person introducing her was named “Haridwar”. No details were provided how the allottees even formed part of the group described above.
It was held that in view of the first proviso to Section 67(3), offer to more than 49 persons would be deemed to be an offer to the public. The fact that the offer was clearly made to more than 49 persons attracted this provision. Apart from the offer to more than 49 conditions, another preceding that the offer should have been made as a matter of domestic concern between the persons making and receiving the offer was also not satisfied in view of the extremely broad description of the offerees. Further, since the OFCDs were transferable, yet another preceding condition – that the offer should not be calculated to be received by persons other than the offerees – was also not satisfied.
Thus, the offer was clearly a offer to the public under Section 67(3) of the Companies Act, 1956.
Whether there was violation of rules of natural justice in the Order of SEBI (FTM) as held by SAT?
This issue was not pursued before the Supreme Court though held against SEBI by SAT. However, the Supreme Court still felt it appropriate to consider this issue.
SEBI, on basis of certain investor data made available, had approached randomly four of the investors. It found that two of the “investors” were not traceable. The other two stated that they had invested because agents approached them. SEBI held that thus this showed that the offer was made to the public and not even to the broadly described group. SAT held that relying on such findings without providing them to the Saharas and giving them an opportunity to rebut them amounted to violation of the rules of natural justice.
The Supreme Court held that this was not correct. The rules of natural justice were “available only to a party which has itself been fair, and therefore, deserves to be treated fairly”. The Saharas had not at all cooperated with SEBI in providing the data despite having been provided with several opportunities. Further, instead of countering the findings of SEBI with correct data, it merely contested this issue on the basis that the rules of natural justice were violated.
Thus, it was held that the Order of the SAT on this aspect could not be sustained.
Whether the OFCDs which admittedly were “hybrids”, were securities and hence amenable to jurisdiction of SEBI?
The Saharas contrasted the definition of securities under the SEBI Act/SCRA and the Companies Act, 1956 to submit that the term securities under the SEBI Act/SCRA did not cover hybrids while that under the Companies Act, 1956, covered it. Reliance was placed on the definition under the Companies Act, 1956, which reads:-
“2(45AA) “securities” means securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956), and includes hybrids;” (emphasis supplied)
Thus, it was argued by Saharas that since hybrids were specifically included as an addition, it showed that the basic definition of securities under SCRA could not have included hybrids. Thus, in short, the OFCDs, being hybrids were governed only by the Companies Act, 1956, and SEBI – who obtained jurisdiction under the SEBI Act/SCRA, could not govern issue of securities.
The Supreme Court first held that since under Section 55A, SEBI had powers to administer various specified provisions of the Companies Act, 1956, in matters of issue of securities and since securities specifically included hybrids, SEBI did have jurisdiction to that extent.
Then, the Supreme Court examined the definition of hybrid under the Companies Act, 1956, and noted that it covered any security that had the character of more than one type of security including their derivatives. The definition under SCRA defines securities inclusively and not exhaustively. Since, by definition, a hybrid is a “security”, it is covered by definition of “securities” under SCRA. Further, securities under SCRA included “other marketable securities of a like nature” and thus hybrids would be once again be covered. It was particularly noted that the OFCDs were transferable, i.e., “marketable” as understood in this context.
Thus, hybrids were held to be securities under SCRA too and hence SEBI was held to have jurisdiction over them.
It is submitted that this does not fully explain why the definition under the Companies Act, 1956, specifically included hybrids.
Whether the listing of OFCDs on stock exchanges was optional or mandatory?
The Saharas argued that under Section 60B, there was clear demarcation of listed and unlisted companies and unlisted companies were required to file the RHP only with the Registrar of Companies. The Saharas were neither listed nor intended to be listed. SEBI countered that Section 73 clearly requires that a company seeking to offer securities to the public has to apply for listing to the stock exchanges.
The Supreme Court read Section 60B and Section 73 harmoniously and held that it was concluded by it earlier that the offer was indeed an offer to the public. In view of this, there was no option left in manner of applying for listing. Listing was an inevitable consequence of such an offer and thus not optional but mandatory. Requirement of listing automatically brings in the jurisdiction of the SEBI, as it transforms a “public company” into a “listed public company” and thus covered by Section 60B too.
Whether Section 55A gave powers to SEBI to administer specific provisions on unlisted companies that did not intend to get their securities listed?
Section 55A gives powers to SEBI to administer certain provisions in case of listed companies and unlisted companies that intended to get their securities listed on recognized stock exchanges. The Saharas were neither listed nor, they claimed, they intended to get listed. This was even clearly specified in various documents.
The Supreme Court held that intention could not be grasped and determined out of context of the actions of the Saharas. The Saharas did make an issue to the public. Such a public issue necessarily resulted in their being mandatorily required to get such securities listed. Thus, there is a deemed intention since they could not carry out acts which require listing and then claim that they do not intend to list their securities.
Even otherwise, the Supreme Court held, Section 11 of the SEBI Act was wide enough to give powers to SEBI to protect the interest of investors in securities and to regulate the securities markets by such measures as it thinks fit. This is wide enough to give powers to SEBI under the present facts. Later provisions of the Act do state that SEBI has certain powers over “other persons associated with the securities markets” and public companies which intend to get their securities listed on recognized stock exchanges. Even if these are taken to be restrictions for those sections and purposes, they do not apply to the former provisions. Thus, SEBI has adequate powers to govern the unlisted Saharas.
Furthermore, Section 11A is even more specific in matters of issue of prospectus, etc. Section 11B/11C reinforce this conclusion that SEBI has powers to govern listed and unlisted companies. Being a stand alone statute, the SEBI Act cannot be limited even by the provisions of the Companies Act, 1956.
Thus SEBI had jurisdiction to regulate and administer the unlisted Saharas.
Whether the SEBI DIP Guidelines had statutory force or were mere “departmental instructions”?
The Supreme Court held that the DIP Guidelines did have “statutory force” and that the OFCDs were issued in contravetion of the DIP Guidelines as also of the SEBI ICDR Regulations that succeeded them.
Whether there was a pre-planned attempt by the Saharas to by pass the regulatory and administrative authority of SEBI in respect of issue of OFCDs?
It was pointed out by SEBI that the Saharas had modified the explicit format of declaration required to be given in the prescribed format. The prescribed format required the companies issuing a prospectus to state, inter alia, that the guidelines of SEBI have been complied with and no statement is made contrary to the provisions of the SEBI Act or rules made thereunder or guidelines issued thereunder. The Saharas omitted these declarations. There was further attempt to misguide by stating that the offer was by way of private placement when the invitation was extended to approximately 3 crores persons. The Supreme Court said that it certainly seemed so that there was a pre-planned intention to bypass the regulatory and administrative authority of SEBI.
The manner of issuing the information memorandum/RHP showed that the procedure adopted was “obviously topsy-turvy and contrary to the recognized norms in company affairs”. All this made, the Supreme Court said, the entire approach of the Saharas “calculated and crafty”.
Their repeated refusals to share information and their non-cooperation, the unrealistic and possibly fictitious information provided and other similar factors made the Supreme Court to also state that the whole affair was “doubtful, dubious and questionable”.
Accordingly, the Supreme Court upheld the proceedings initiated by SEBI and the Orders of SEBI and SAT. It upheld the Order of SAT for refund of the amounts collected by issue of OFCDs alongwith interest @ 15% per annum. Mechanism was laid down to ensure this including deposit of the amounts with a nationalized bank, appointment of a retired Judge of the Supreme Court to oversee the process and several other directions for safeguarding various interests.

List of abbreviations:-
OFCDs – Optionally Fully Convertible Debentures
ROC - Registrar of Companies
Saharas – the two Sahara Companies – (i) Sahara India Real Estate Corporation Limited and (ii) Sahara Housing Investment Corporation Limited.
SAT – Securities Appellate Tribunal
SCRA – Securities Contracts (Regulations) Act, 1956
SEBI – Securities and Exchange Board of India
SEBI (FTM) – SEBI (Full Time Member) or SEBI (Whole-time Member)
SEBI ICDR Regulations – Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements), 2009
SEBI DIP Guidelines – Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines 2000


Nanana said...


Any comments on the Goodwill/Amortization ruling by the Supreme Court on Aug 22?

Nanana said...

Any comments on the the supreme court ruling on goodwill amorization?

Anonymous said...

Quite a win for the regulators...

aishmghrana said...

Credibility of MCA is now under question. Whether they have any regulatory mechanism?

Anonymous said...

Maybe more meticulous drafting would prevent people from trying to exploit the loopholes. The definition of securities was added to the Companies Act in 2000 that reads "securities means securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956), and includes hybrids”. This allowed Sahara to plausibly argue that by implication, hybrids are not covered in SCRA definition of securities. Since the SCRA is the principal legislation dealing with securities contracts, it would be logical to effect any change in the definition of securities in that law. Other laws, such as the Companies Act, may then simply reference the same. Similarly, many provisions of Part III of the Companies Act have been explicitly made applicable to `securities’, but Section 67 (public offer) still talks about only shares and debentures! So, as per Sahara’s (two of the many) contentions – OFCDs are hybrids (so not securities as per SCRA), and are neither shares nor debentures, so Section 67 provisions reg. public offers do not apply to them! One may call it the Narsimha Doctrine, which the Supreme Court refused to accept.

Mangesh Patwardhan