Both the SEBI (Substantial Acquisition of Shares and Takeovers Regulations), 2011 (the Takeover Regulations) as well as the SEBI (Prohibition of Insider Trading) Regulations, 1992 (the PIT Regulations) require a timely disclosure of acquisition or change in shareholdings beyond certain thresholds by substantial shareholders and promoters. Such disclosure requirements are also captured in clause 35 of the listing agreement. The consequences of inaccurate disclosures came up in a decision of the Securities Appellate Tribunal (SAT) that was issued yesterday.
In the case involving GHCL Limited, SEBI has passed an order against the company, its company secretary, chairman and several promoters in connection with disclosures of shareholdings made by them. SEBI’s allegation was that the promoters “wrongly and illegally projected their shareholdings far in excess of their real shareholding by taking into consideration shareholdings of third parties as part of their own shareholding in an illegal manner”. The company had included shares of other parties as the promoters had informed it that the promoters had a mutual understanding with those other parties who held shares in the company in their own right (but to include those shares in the disclosures in the name of the promoters).
The decision of the SAT and its various grounds are set out below with some commentary as relevant.
In arriving at its decision, the SAT paid specific attention to the policy and philosophy behind shareholding disclosures:
18. … Next, the purpose underlying the requirement of making regular and true disclosures by a company as regards the shares which the promoters may come to hold from time to time is to bring about greater transparency in the functioning of the companies. It is through such disclosures that the investors take an informed decision in a given situation to invest in the scrip of that company or even to exit. This is extremely important for the growth of a healthy capital market. … Thus, true and correct disclosures as to the exact shareholding pattern of promoters assume greater significance.
Hence, SAT found that the company as well as the chairman and company secretary bore the primary responsibility to ensure proper disclosure in consonance with the applicable SEBI regulations.
Comment: The importance of disclosure and the need to sanction against its lapses is understandable. Readers may recall that the sensitivity of disclosures became quite apparent during the Satyam corporate governance scandal whereby the pledge of shareholding by the promoters was not made known to the markets. As a result, the Takeover Regulations have been amended to require disclosures of pledges as well, as discussed here. See also, chapter V of the current version of the Takeover Regulations.
Fraudulent and Unfair Trade Practices
What appears to have been a case of mis-disclosure got elevated to a case of fraudulent and unfair trade practice. The appellants were therefore also charged under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003 (the PFUTP Regulations). The relevant statutory provisions relating to fraudulent and unfair trade practices are as follows:
SEBI Act, 1992
12A. Prohibition of manipulative and deceptive devices, insider trading and substantial acquisition of securities or control. – No person shall directly or indirectly ---
(a) use or employ, in connection with the issue, purchase or sale or any securities listed or proposed to be listed on a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of this Act or the rules or the regulations made thereunder; …
Prohibition of certain dealings in securities
3. No person shall directly or indirectly –
(a) buy, sell or otherwise deal in securities in a fraudulent manner; …
The SAT found that the present mis-disclosure was not a result of an inadvertent error, but due to deliberate and conscious actions on the part of the promoters. Hence, it concluded that “the present case would undoubtedly amount to unfair trade practice, if not a fraud played upon the market”.
As for the interpretation of the aforesaid legal provisions, SAT explained as follows:
22. Similarly, a simple reading of section 12(A)(a) of the SEBI Act, 1992 read with Regulation 3(a) of the PFUTP Regulations, 2003 as reproduced above clearly reveals that it is not only the fraudulent or manipulative buy or sale of securities which is prohibited but any dealing in securities “otherwise” also may be illegal and hence amounts to fraud on the market. The expression “…otherwise deal in securities…” occurring in Regulation 3(a) read with section 12A(a) of SEBI Act, 1992 is vide enough to cover cases like the one in hand where general investors are sought to be drastically misguided by the promoters of the Company by inclusion of the third parties’ shares which the promoters admittedly do not own. The law is absolutely clear on this and there is no ambiguity as sought to be projected by the appellants. Whatever is not included in the Regulation has to be excluded in the interpretation.
Comment: The aforesaid interpretation supplied by SAT appears to be too wide. In this case, there is nothing from the decision to suggest that the promoters either bought or sold shares when the inaccurate disclosure was in force. Hence, it is unclear as to how Reg. 3(a) of the PFUTP Regulations can be attracted. Even the use of the expression “otherwise deal” ought to be read ejusdem generis with the “buy” and “sell”. The mere existence of incorrect disclosures, however deliberate, cannot without more be deemed to be a fraudulent or unfair trade practice. If this interpretation were to stick, then every deliberate non-disclosure or mis-disclosure of shareholding by substantial shareholders or promoters could potentially amount to a fraudulent or unfair trade practice. It is not clear if such is the intention.
Reliance on Legal Advice
The categorical stance of the SAT is that the company’s or promoter’s reliance on legal advice in making the disclosure is not an excuse for facing the consequences. It stated:
23. The Appellants should have acted more diligently and responsibly and should not have been guided by mere legal opinions. It is settled law that legal opinions are only advisory in nature and not binding on anyone. Therefore, no legal infirmity can be attributed to the impugned order which holds all the appellants guilty of violating the PFUTP Regulations, 2003 and imposes monetary penalties on them.
Comment: The SAT decision reinforces the point that violators of securities laws cannot escape blame by simply passing it on to their legal advisers. They ought to take full responsibility, and cannot seek any excuse or safe harbour in civil penalty cases.
Persons Acting in Concert
Finally, SAT found that Reg. 7(1A) of the Takeover Regulations were not attracted in the present case. It justified its finding as follows:
40. Moreover, Regulation 7(1A) requires an individual acquirer to disclose regarding any change in its shareholding if it goes 2% up or down and for the purpose of calculating such change of 2% shareholding, the shareholding of “person acting in concert” may not be clubbed unless they admittedly act in concert. Therefore, clubbing of the shareholdings of various promoter entities, without proving that they were persons acting in concert with each other by cogent and convincing evidence is untenable in law and such a finding is liable to be quashed and set aside qua the appellants in these 10 appeals as far as the violation of Regulation 7(1A) of FUTP Regulations is concerned.
As a matter of law, the SAT also clarified that Reg. 7(1A) of the Takeover Regulations are in pari materia with Regs. 13(3) and 13(5) of the PIT Regulations, due to which there is no violation of the latter as well.
On these grounds, the SAT affirmed a violation of Section 12(A)(2) of the SEBI Act and the PFUTP Regulations, but it set aside SEBI’s finding of a violation of Reg. 7(1A) of the Takeover Regulations.