Wednesday, September 24, 2014

SEBI’s Final Order in GDR Manipulation Case

In a September 2011 post, we had discussed an ad-interim ex parte passed by SEBI in relation to a specific transaction structure that involved the use of global depository receipts (GDRs) to allegedly manipulate the stock price of several companies:

The modus operandi was as follows. The companies issued GDRs, which were acquired by various foreign institutional investors (FIIs) or their sub-accounts. The GDRs were all soon thereafter converted into underlying equity shares of the issuing company, which were then sold in large (synchronized) deals to several buyers, such as stock brokers. The stock brokers would in turn sell the shares to other investors. After investigation, SEBI found that the companies, the lead manager to the GDRs, the FIIs/sub-accounts and the stock-brokers were all acting in common as a group. They were able to maintain the stock price of the company through these transactions without symmetry of information to outside investors who may have paid a high price given the issuance of GDRs by the companies and large holdings maintained in them by FIIs. SEBI found this to be an instance of market manipulation and passed an order restraining the relevant companies and investors from participating in the capital markets.

In a final order passed last week, SEBI prohibited several entities from accessing the capital markets and dealing in securities for a five-year period. The order gives rise to a few legal issues.

SEBI’s Jurisdiction Over GDR Offerings

The entities affected by SEBI’s investigation argued that SEBI did not have jurisdiction over GDR issuances as they related to securities that are traded outside India. However, SEBI refused to accept this argument on the ground that GDRs related to underlying Indian securities which in turn affected the Indian securities markets. It observed:

5.1       i.          The issuance of GDRs is from the authorised share capital of a company listed in Indian stock exchanges. Any structuring or manipulation related to GDRs has a direct impact on securities of companies trading in Indian market. Further, the underlying security of GDRs are shares of Indian companies with two-way fungibility, which allows for conversion of GDRs in Indian market and vice versa. Hence, the impact of such issuance, cancellation/conversion and sale/transfer of shares so converted has direct bearing on the securities market in India. Such issuance, etc. of GDRs by Indian companies also greatly influences decision-making by investors in the securities market. In view of the same, it is seen that the issuance of GDRs, which are ‘marketable securities’ under Section 2(h) of the SCRA Act, cannot be regarded as an exclusive activity totally insulated from and not impacting the securities market in India.

The argument raised here seems somewhat analogous to the one raised in the Sahara case as to SEBI’s jurisdiction over hybrid instruments such as optionally fully convertible debentures (OFCDs), which the Supreme Court rejected, holding that those instruments were within the purview of the SCRA and hence under SEBI’s jurisdiction.

The matter relating to GDRs is, however, not beyond doubt. On an appeal by one of the affected parties in this GDR manipulation case, the Securities Appellate Tribunal (SAT) ruled that SEBI did not have jurisdiction to investigate matters relating to GDRs. SEBI filed an appeal against that ruling to the Supreme Court, which stayed SAT’s ruling. The Supreme Court is seized of the matter on the question of law. Hence, SEBI’s order on this issue will be subject to the outcome of Supreme Court’s opinion on the same.


On the issue of manipulation, SEBI’s investigations revealed that the GDR issues were devised and structured by Arun Panchariya and Pan Asia Advisors Limited (owned 100% by Panchariya). SEBI has sought to establish connections between them and the other entities involved to demonstrate the existence of an orchestrated scheme. It notes:

8.3       In the factual context of the instant proceedings, it is important to view the connection between the Noticees amongst themselves and with Panchariya not in isolation but rather as a factor in the totality of the circumstances. This is so because while each fact standing alone may be insufficient, the combination of all the facts can be a substantial basis for determining ‘manipulation’ or ‘fraud’ on the part of each Noticee. The investigations in the instant proceedings reveal that the GDR Issues were devised and structured by Panchariya and Pan Asia in connivance with the Issuer Companies through a fraudulent arrangement. The existing shareholders and prospective investors were aware of the ‘positive’ news that the Issuer Companies had raised foreign capital through GDRs but were completely unaware of the activities of Panchariya along with the connected entities, in such GDR Issues. The Sub-Accounts, viz. IFCF and KII who were allegedly connected to Panchariya, converted the GDRs held by them into shares and sold the same in the Indian securities market where the counter parties to a major portion of such sales were entities connected to Panchariya, i.e. Noticees 1-13. The objective of such trading between the Sub-Accounts and Noticees 1013 inter alia was to create an impression of there being liquidity in the market. As a result, the investors in India were lulled into thinking that stocks of the Issuing Companies had been highly valued by foreign investors, which in turn acted as an inducement for other persons to buy shares of the Issuer Companies in the Indian securities market. The Indian investors were therefore adversely affected by the misleading signals of Panchariya alongwith the connected entities, i.e. Noticees 1-13, through trading done amongst Noticees 1-13 and Sub-Accounts, creating liquidity in the market and their subsequent offloading of the shares. In these circumstances, I am of the considered view that the role played by each Noticee should not be seen in isolation and that the case needs to be seen in its entirety in the light of the large scale market abuse explained earlier.

In a nutshell, and as explained in the previous post referred to above, the parties are alleged to have indulged in regulatory arbitrage by taking advantage of a more lax regime pertaining to GDRs over a more stringent regime for issuance of underlying shares in the domestic markets.

Finally, the scope and sufficiency of SEBI’s order raises some questions. As Mobis Philipose argues, some entities have not been referred to in the final order. Moreover, the direction to debar the concerned entities from the stock markets may be insufficient as SEBI did not find it fit to impose penalties or order disgorgement of profits arising from the transaction.

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