Wednesday, March 27, 2013

Zenith SEBI Order - disturbing findings and curious SEBI Order

SEBI’s recent interim Order and findings in Zenith’s case again present many disturbing things, as appears from SEBI's allegations in the orders. How Promoters can easily divert to related parties monies belonging to creditors and shareholders. How existing laws cannot prevent them and even their enforcement and recovery of lost monies could be a prolonged process. Thus creditors have to wait a long time and spend a lot of efforts and monies before they can get some of their dues. How shareholders would lose their monies – like Satyam – and may finally have only some satisfaction that the Promoters are punished. And how SEBI resorts to drastic and desperate orders which though may appear to be justified and directly resolving the issue, may be tough to implement and have shaky foundation.

The Zenith Infotech Limited's (Zenith/Company) case has been in the news for more than a year now. Here is a brief summary of SEBI's allegations that led to this order. Zenith defaulted (despite supposedly having large liquid assets in its balance sheet) to repay the first tranche of its FCCBs (which incidentally caused default of 2nd tranche too on account of acceleration clause). It obtained approval of shareholders in general meeting by borrowing money and sale of its divisions. This approval was taken specifically for repayment of FCCBs. It sold a division in a fairly convoluted way and through a series of related party transactions. The sale proceeds were only partly received by the Company and partly by a subsidiary. Even after receipt of monies, they were used for payment mainly to related parties for purposes not wholly clear, for payment to creditors (not FCCBs holders) and purchase of capital assets. Worse, the Company made several misleading/false statements and omissions though eventually it admitted the facts. The share price halved twice, once till the date of company making disclosure and again after such date. In barely a few months, the price of the shares reduced from 190 to 45.

There were other allegations of false disclosures/non-disclosures under the listing agreement, the SEBI Insider Trading Regulations, etc.

Legal proceedings by the FCCBs holders for winding up, etc. are on before the court.

SEBI passed an interim order directing two things. Firstly, it banned the specified Promoters from accessing the capital markets and dealing in securities. Secondly, it directed the Board of Directors of the Company to give a bank guarantee in favor of SEBI within 30 days for the amount of $ 33.93 million allegedly diverted for uses other than repayment of FCCBs. The Board, however, use the funds of the Company or secure its assets for this purpose. The guarantee shall be valid for at least one year during which SEBI may invoke it in case of adverse findings to compensate the Company.

The manner in which the transactions are carried out raises questions once again as to the effectiveness of laws relating to companies. The Company allegedly used funds for purposes other than for what the shareholder approved. However, the legal consequences of such act are curious. Firstly, this does not necessarily mean that the transactions carried out are null and void. Secondly, it is arguable that such transactions can be ratified in a subsequent general s meeting and since the Promoters held 64% shares, this should have been easy. Thirdly, the punitive consequences under the Act on the Company, its Board and the Promoters are not stringent. This is of course assuming that the payments were genuine and not diversion/siphoning off of funds as SEBI alleges.

But even if there was diversion/siphoning off, there are no quick remedies for recovery of the monies, repayment to creditors and punishing the directors/Promoters concerned.

The provisions concerning related party transactions again get highlighted. The restrictions on them seem flimsy in law and even flimsier in enforcement. Often, companies may get away by mere disclosure.  

Coming to the SEBI direction for bank guarantee, again many things are curious. Does SEBI have power in the circumstances to direct the Board to give such a bank guarantee without using company funds? On first impression, this appears not only justified but is also the only just way. The shareholders had authorized the Board to use the sale proceeds for repayment of FCCBs. However, they were used for other purposes. Thus, the Board ought to compensate the Company and for this purpose, giving a bank guarantee that SEBI may invoke to compensate the Company or perhaps directly the FCCBs may make sense. However, several questions arise.

Firstly, does SEBI have such powers at all?
Secondly, can it direct the Board of Directors as a whole without making a specific finding that it was they who approved such uses of funds? Or that they were negligent in monitoring the use of such funds?
Thirdly, why not allow the Company, at least as an alternative, to get the funds back? Why insist only on a guarantee?
Fourthly, even if assuming that they were used for other purposes, what if such uses were genuine? For example, funds were used for payment to creditors, acquisition of capital assets, etc. There are no findings on record that these were bogus, just that these purposes were not for which the Company took approval.
Fifthly, what if the Company had (and still can, though this is highly unlikely now) obtained ratification of shareholders which, considering the 64% holding of Promoters, would have been a breeze? SEBI's whole basis of passing this order, despite making a multitude of other allegations, is this approval of shareholders.
Sixthly, is an Order on the Board as a whole without making a finding of role of the Promoters on one hand and the non-promoter directors on the other, fair and valid? How would it be enforced and punitive action taken, if they are unable to provide such a guarantee? Will the liability of the Directors be joint and several?

Nevertheless, as the investigation progresses, the role of the Auditors in this case may also come under review, in view of reports that huge amounts of cash was supposedly shown in the balance sheet though the FCCBs remained unpaid even after raising further monies on account of sale of assets.

All in all, this case, assuming many of the allegations are found true, presents a murky and sordid state of affairs in listed companies and the ineffectiveness of laws, even though they are many and complex.

The case is likely to show several developments soon, since SEBI has provided post-decision hearing and SEBI may pass a revised order. 30 days are given to the Board to furnish this guarantee and it is possible that they are unable to so provide. It appears quite likely that the Promoters/Board may appeal to SAT. It will be worth seeing whether this case creates good precedents in law for keeping malpractices in check or it again shows that the action and remedies will be prolonged and perhaps finally ineffective for some or all of the parties who have lost money.


vswami said...


Historically speaking,not refraining from looking back, it is absurd or perverse to even suggest, unwittingly or otherwise, that this is the first instance of its kind that the SEBI's findings could be faulted to be 'disturbing' or its resulting order be dubbed 'curious'.

The zenith's episode, as one can well imagine, may prove a specimen for a purposeful 'case study'; more so, for the experts' purpose of analyzing and examining in-depth whether the lately brought in corporate law is, or how far it is going to prove, foolproof enough so as to effectively plug in the deficiencies in or improving upon the replaced law, as widely acclaimed, all in the name of protecting and pre4serving the rights and interests of the 'stake holders'. Do so,having in the backdrop the recently rebooted idea of a 'super regulatory authority'.

Prof Bala said...

Just a short comment on the passing reference to a resolution being passed in the shareholders meeting routinely since promoters have 64% equity holding. This is precisely the reason I have been arguing for over twelve years now that "interested shareholders" should not be permitted to vote on resolutions where they are involved. The companies Bill at long last does incorporate this provision but its drafting as usual leaves scope for litigation. I do hope when properly interpreted and implemented this provision will put paid to such plainly blatant diversion of company funds and assets.

CA Jayant Thakur said...

@Prof Bala

Agree with you. Related party transaction have inherent conflict of interest and just as interested directors are barred from discussing/voting on such matters, related parties should not be allowed to vote. Hope the present, though well intended but obviously leaky, provision in the Companies Bill is strengthened.