Friday, October 24, 2014

SEBI’s Order in the DLF Case: A Summary

[The following post is contributed by Supreme Waskar, partner at Sterling Associates, Mumbai]

In its order dated October 10, 2014, the Securities and Exchange Board of India (“SEBI”) has restrained DLF Limited (“DLF”), its 5 directors and CFO (“Noticees”) from accessing the securities market and prohibited them from dealing in securities for the period of 3 years on the ground of active and deliberate suppression of material information in its red herring prospectus (“RHP”)/ Prospectus so as to mislead and defraud the investors in the securities market in connection with the issue of shares of DLF in its IPO, thereby violating the provisions of the SEBI Act, the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (“PFUTP Regulations”), the SEBI (Disclosure and Investor Protection) Guidelines, 2000 ("DIP Guidelines") and the SEBI (Issuance of Capital and Disclosure Requirements) Regulations, 2009 ("ICDR Regulations").


DLF had filed a draft RHP (“DRHP”) with SEBI in January 2007 for raising Rs. 9187.5 crore through an IPO. Thereafter, DLF issued the RHP on May 25, 2007and the Prospectus was filed with the Registrar of Companies (“ROC”) on June 18, 2007. One Mr. Kimsuk Sinha ("Mr. Sinha") had filed complaints with SEBI on June 4, 2007 alleging the Sudipti Estates Private Limited ("Sudipti") and certain other persons had defrauded him of 34 crore in relation to a transaction between them for purchase of land (“Complaint”) and also registered a first information report (“FIR”) dated April 26, 2007 alleging that two of DLF’s wholly owned subsidiaries (“WOS”) were the only shareholders of the Sudipti and requesting to disallow the listing of DLF pursuant to the IPO and for immediate action. Subsequently the allegations in Complaint were denied by DLF.

SEBI’s investigation pursuant to Delhi High Court’s order

Pursuant to the inaction of SEBI in relation to Complaint against DLF, Mr. Sinha filed a Writ Petition before the Delhi High Court (“DHC”) and the DHC vide order dated April 9, 2010 (“Order”) issued directions to SEBI to undertake an investigation into the aforementioned Complaints. Accordingly SEBI, vide an order dated October 20, 2011 ordered an investigation into the allegations levied by Mr. Sinha in his complaints to ascertain the violations, if any, of the provisions of the DIP Guidelines read with corresponding provisions of ICDR Regulations and the relevant provisions of the Companies Act, 1956 ("Companies Act") and issued a Show Cause Notice (“SCN”) to the Noticees.

Charges levied by SEBI

1.   Non disclosure of material information in relation to alleged subsidiaries by DLF in RHP/Prospectus

At the relevant time, 3 WOS of DLF held entire equity shares in Sudipti, Shalika Estate Developers Private Limited ("Shalika") and Felicite Builders & Construction Pvt. Ltd. ("Felicite"). On November 29, 2006, the entire shareholding in Felicite held by WOS of DLF was sold to 3 who were wives of key managerial personnel (“KMPs”) of DLF. On November 30, 2006, WOS of DLF sold their entire shareholding in Shalika to Felicite. On the same date, the 3 WOS of DLF sold their entire shareholding in Sudipti to Shalika. The said three “Housewives” were shareholders of Felicite until their respective husbands were KMPs of DLF and when they ceased to be KMPs, shares were transferred to other KMPs' 'Housewives'. Further payments even in respect of those transfers were made by the respective husbands of the purchasers. Hence SEBI alleged that DLF never lost control of Sudipti, Shalika and Felicite (“Alleged Subsidiaries”) and they were and are subsidiaries of DLF. In terms of the provisions of DIP Guidelines and AS-23, certain disclosures with respect to its subsidiaries should have been disclosed in the RHP/Prospectus of DLF and was not disclosed. Therefore, it was held that DLF has violated provisions of clause of the DIP Guidelines.

2.   Non-disclosure of related party transactions by DLF in RHP/Prospectus

There was no change in the members of board of Alleged Subsidiaries, who were also the employees of DLF and continued to be the directors of these companies even after the aforesaid sale of shareholding. Also there was no change in any of the authorized signatories of the bank accounts, registered office and statutory auditors of Alleged Subsidiaries even after the date of claimed dissociation. Hence, it was inferred by the SEBI that DLF was in a position to control the boards and through its employees was involved in day-to-day operations and associated with Alleged Subsidiaries even after the date of claimed dissociation. Therefore, the Alleged Subsidiaries were related parties of DLF in terms of AS-18. Hence, SEBI held that DLF has failed to disclose its related party transactions.

3.   Non-disclosure of outstanding litigation relating to Alleged Subsidiaries by DLF in

Further, the DIP Guidelines required DLF to disclose outstanding litigation in respect of its subsidiaries or any other litigations whose outcome could have a materially adverse effect on the financial position of DLF. However, the RHP/Prospectus of DLF did not provide any information of the FIR.

4.   Violations of DIP guidelines by five directors and CFO of DLF

Since the directors and CFO of DLF had authorised the RHP/Prospectus and signed the declarations certifying the compliance of DIP Guidelines, SEBI held that they have failed to ensure disclosures to be true and correct thereby violating provisions of DIP guidelines read with ICDR regulations.

5.   Deliberate and active suppression of material information amounting to Fraud in terms of PFUTP

In compilation of all the aforesaid facts, SEBI held that the entire share transfer process in the Alleged Subsidiaries was executed through sham transactions by DLF and its associates/subsidiaries by camouflaging the association of Sudipti with DLF as dissociation thereby failing to ensure disclosures of Alleged Subsidiaries.

DLF’s arguments before SEBI

1.      SEBI has transgressed its authority by not limiting its investigation to Complaint as directed in Order and extended its authority to invocation of DIP Guidelines, PFUTP Regulations, etc. without jurisdiction;

2.       SEBI has violated the principles of natural justice by denying request for inspection of documents;

3.       At the relevant point of time, Mr. Sinha was neither an investor nor a subscriber to the shares of DLF or related to the securities market and therefore had no legitimate cause to take recourse to the jurisdiction vested in SEBI;

4.       The RHP/Prospectus also fairly disclosed the developmental rights in the land owned by Sudipti and the risk relating to the said development rights;

5.       SEBI has exercised its regulatory powers at distant point of time, which would only be   counterproductive to the interests of the securities market and millions of investors who have invested in shares of DLF;

6.         SEBI had reviewed and issued comments/observations on DRHP;

7.         SEBI did not allege any motive behind the alleged acts;

8.        DLF acted in good faith on the basis of expert advice of Merchant Bankers and legal advisors and no mala fide intent can be imputed on them;

9.      SEBI has applied incorrect to test for determining Alleged Subsidiaries as “related party” or “subsidiary”;

10.       There was no dealing in securities, hence no fraud under PFUTP Regulations;

11.      No shareholding/voting rights in or control over Alleged Subsidiaries for the purpose of holding-subsidiary relationship;

12.   SEBI has adopted an incorrect yardstick to deduce control by relying upon the definition of “control” under AS-23 and the SAST Regulations;

13.     FIR is neither a litigation nor one which could affect the operations and finances of DLF, as required to be disclosed of DIP Guidelines.

Key Conclusions in SEBI’s order

SEBI concluded that non-disclosure/omission of material information in RHP/Prospectus makes the Issuer, its directors and CFO liable for violation of DIP guidelines/ICDR regulations. Active and deliberate suppression of material information in RHP/Prospectus amounts to fraud in terms PFUTP Regulations and consequently restraining access and prohibiting dealing by Issuer, its directors and CFO in securities market.

However, DLF has filed an appeal before the Securities Appellate Tribunal (“SAT”) against the order of SEBI which is pending.

- Supreme Waskar

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