Friday, March 29, 2013

Yet another CIS scam? Further loss of 100s of crores of rupees by investors?

Yet another CIS scheme is unearthed, by income-tax authorities who intimates the details to SEBI. SEBI investigates and passes an Order asking the Company to repay investors or face prosecution. However, it is almost certain that investors will lose significant part of their monies, considering the huge amounts collected and the low assets the company has. The liabilities in this case are at least Rs. 800 crores, while the stated market price of the assets are barely half of this amount. And this value too would not be wholly realised in case of a distress sale. On other hand, it is not wholly clear whether the amount of liability is all inclusive.

The modus operandi of the company, if one accepts the allegations of SEBI as fully true, is depressingly familiar and just one of the many variants seen in such cases. Highly paid agents are employed. In this case, the commission paid to agents are as high as 30% of the amounts collected in several years. The amounts are collected on the basis of an assured return which, in this case, is12% p.a. However, the company claims that this is really a booking amount for land but has option for refund with assured returns. SEBI rejects this submission as unacceptable considering various factors such as no land deeds being registered, the plot of land not even been identified, the almost nil record of any investor opting to buy land and so on.

Since this Scheme has been operating over several years, the amounts collected accumulate, far exceeding the assets. If the findings of SEBI are correct, then this seems to be yet another Ponzi scheme.

SEBI has ordered the company to refund the amounts raised with promised returns within three months. SEBI has stated that in case of non-compliance, it will initiate prosecution and refer matter to the State as well as Ministry of Corporate Afairs.

It is almost certain that the Company will not be able to make such payments. The book value of the assets, consisting of at least 50% immovable property, is about 50% of its dues. It is not wholly clear whether even such dues include the returns promised and if they do not, the shortfall will be even higher. The shortfall will also almost certainly increase since the land will realize much lesser value on distress sale. Considering the huge cumulative shortfall, it that the investors will lose substantial money and will be a long time before they see any of it.

Another interesting aspect is that the Company seems to have been operating at least from 1999, the year in which SEBI notified the CIS Regulations and continued upto 2009 till the income-tax department informed SEBI of the acts of the Company. Thus, in this case, there was neither prevention nor detection by SEBI. Remedy, as discussed above, also seems to be unlikely. At best, the Company and its Promoters will join the long list of parties against whom SEBI has instituted prosecution.

It is also curious that despite several states, including Maharashtra where this Company is located, have broadly framed and fairly stringent State laws for taking action against persons who raise monies in this manner, such Schemes continue to operate and collect huge amounts of monies. The Supreme Court has recently upheld these Acts reversing certain earlier decisions that had held them to be unconstitutional. SEBI too has stated in its Order that it will refer this matter to the concerned State authorities for taking action. It will have to be seen whether and how action would be taken under such acts will be.

The Mint also reported recently the fact that such schemes are rampant in West Bengal. As per this report, SEBI has asked the finance ministry that the task of overseeing such companies should be to a regulatory watchdog. One wonders how SEBI could say this, considering the provisions relating to CIS under the Act and specific Regulations therefor. Reserve Bank of India too, as per this article, is claiming that the manner in which the monies are raised do not fall under its jurisdiction.

A thorough review of the law and its implementation seems due not to ensure that a duly empowered body in a speedy and effective manner prevents, detects, investigates and remedies such cases and in appropriate cases levies stringent punishment. 

Amendments to Takeover Regulations

SEBI has recently made certain amendments to the Takeover Regulations 2011 which are as follows:-

Public announcement in case of preferential allotment
In case an open offer is triggered by a preferential announcement, it is now provided that the public announcement shall be made on the date when the Board of Directors authorizes such resolution. The erstwhile requirement was that public announcement shall be made on date of passing of special resolution approving the preferential allotment. A related amendment further provides that in case the acquisition through preferential allotment is not successful, the open offer shall still not be withdrawn.

There can be a valid concern that the acquirer would have to make an open offer and acquire shares even if he is unable to acquire shares pursuant to the preferential allotment. However, it is generally unlikely that the Board would initiate a proposal for preferential allotment and then the resolution is not approved.

This preponement may affect the pricing of the open offer since the minimum offer price is calculated with reference to the date of public announcement. The schedule of open offer would also change.

Revised trigger date for public announcement for multiple methods of acquisition
A new non-obstante clause 12(2A) provides for a revised trigger date for public announcement when the acquisition is proposed through (i) agreement and one or more specified modes, or (ii) otherwise through one or more of such specified modes. In such cases, the public announcement shall be made on the date of the first of such of such acquisitions and the acquirer cannot wait till the open offer trigger is actually crossed. Thus, if, say, an acquirer proposes to acquire 31% through 3 modes, 10%, 12% and 9% in that sequence, the public announcement needs to be made on making of the first acquisition of 10%. The acquirer shall disclose the proposal to make further acquisitions in such public announcement.

This would apply if all the acquisitions are together “proposed” at the first instance. If, however, shares are acquired below the trigger point and later further shares are acquired without the later acquisition being part of the original proposal, then I think the public announcement would be triggered only when the open offer trigger is crossed.

Completion of acquisitions during the offer period
Where the acquisition is proposed through preferential allotment or through stock market settlement process (other than bulk/block deals), the acquirer can now complete the acquisition while the open offer is in process. However, the shares shall be kept in an escrow account and the acquirer shall not exercise voting rights on such shares. The shares in escrow account may be released after 21 working days of the public announcement if the acquirer deposits 100% of the open offer amount assuming full acceptance.

Disclosures when acquirer’s holding goes below 5%
Disclosures of holdings are intended to begin when an acquirer acquires 5% or more shares and thereafter when he further acquires/sells 2% or more shares. A question that arose recently whether disclosure is required if there is a sale of 2% or more shares and the post-sale holding thereby goes below 5%. The amended clause now provides that disclosure is required also for the sale which results in the holding going below 5%. This was even otherwise an accepted interpretation as, for example, in Bhavesh Pabari v. SEBI (2012) 24 Taxman 64 (SAT).

Reference date in case of buyback of shares
Increase in percentage holding of a non-participating shareholder in buyback of shares may result in implications under the Regulations. A certain period is given to the shareholder to restore his shareholding so that there are no implications. It is now specified that this period shall be calculated from the date of the closure of the buyback offer.

Thursday, March 28, 2013

FSLRC Report

The report of the Financial Sector Legislative Reforms Commission, which has recommended elaborate reforms in the financial sector, is now available.

Volume 1 contains the findings and recommendations of the Commission, while Volume 2 contains a draft of the proposed Indian Financial Code, 2013.

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.