[The following guest post is contributed by Prachi Pandya, who is the founding member of Corporate Attorneys and can be contacted at email@example.com]
It is a matter of interest that the trigger point of framing the SEBI (Collective Investment Schemes) Regulations, 1999 (the “CIS Regulations”) was owing to initiatives by private entrepreneurs undertaking plantation or agricultural activities on a commercial scale. Since the Income Tax Act exempts income from agricultural activities from taxable income, such schemes were becoming attractive and indeed popular.
However, during the mid-1990s, such entities began defaulting in making payments to their investors. This not only caused huge losses to the investors, but also eroded the confidence of the general public.
Thereafter, several press releases and newspaper advertisements/ notices were issued by the Securities & Exchange Board of India (“SEBI”) from time to time, bringing to the notice of the general investors and the public, on the functioning of collective investment schemes (“CIS”). The press releases further stated and clarified that instruments such as agro bonds and plantation bonds should be treated as CIS, and are subject to the jurisdiction of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”).
The CIS Regulations were implemented on the basis of recommendations of the Dave’s Committee. The primary objective of the CIS Regulations was to shield the interest of gullible investors expecting to earn profits by putting their life savings into schemes floated by various entities assuring them of exponentially high returns.
Since the introduction of section 11AA in the SEBI Act in February 2000 and formulation of the CIS Regulations, a wide range of schemes have been brought under its ambit (and scanner). Of course the most famous case relates to Sahara.
In two such cases, an interesting question of law arose as to whether ‘land’ can be termed and considered as an instrument or an unit or a security to fall within the ambit of the definition of “securities” as defined in section 2(h) of the Securities Contract (Regulation) Act, 1956 (“SCRA”). These two cases were that of Alchemist Infra Realty Limited (Order of the Securities Appellate Tribunal dated July 23, 2013) and PACL Limited (Wholetime Member’s Order dated August 22, 2014)
The term 'securities' in Section 2(h) of the SCRA was amended vide the Securities Laws (Amendment) Act, 1999 to include units or any other instrument issued by any CIS to the investors in such schemes.
The facts of both the aforementioned cases were more or less similar. Below in brief are facts of the more recent case of PACL:
1. PACL Limited (“PACL”) was running a CIS and had failed to submit the information / details to SEBI in terms of the press release dated November 26, 1997 and the public notice dated December 18, 1997.
2. In view of such default, SEBI by its letter dated March 04, 1998 informed PACL that it was not eligible to take the benefit under the proviso to Section 12(1B) of the SEBI Act and therefore could neither launch any new schemes nor continue raising funds under its existing schemes.
3. PACL by its letter dated March 23, 1998, replied to the SEBI and challenged the jurisdiction of SEBI, by stating that its transactions are in the nature of sale and purchase of agricultural land and thus outside the purview of the securities market.
4. A public interest litigation (“PIL”) was filed before the Delhi High Court by Mr. S.D. Bhattacharya against SEBI and others in the year 1998, bringing to light, the activities of various agro-plantation companies who had duped the hard earned money of several investors. PACL was also impleaded in the said PIL.
5. The Delhi High Court by another order dated May 26, 1999, directed SEBI to appoint auditors for ascertaining the genuineness of the transactions executed by PACL. Pursuant to the audit, several discrepancies were pointed out.
6. Thereafter, between November 1999 and December 1999 SEBI sent several letters to PACL to comply with the CIS regulations.
7. PACL would reply stating that SEBI did not have jurisdiction as, it was mainly dealing in the sale and purchase of agricultural land and development of the land.
8. Pursuant to an investigation, SEBI issued a show cause notice dated June 14, 2013 to PACL Limited and its director.
PACL’s primary defence was that since it was dealing in agricultural land which did not fall within the definition of ‘securities’, the CIS Regulations and the SEBI Act were not applicable to them. On this ground PACL challenged SEBI’s jurisdiction.
PACL further contended that its business relates to buying and selling of agricultural land, including development of such land into cultivable land and providing other infrastructure on it. PACL further submitted that the transactions were similar to that of a builder or a developer of property and that it does not promise any 'assured return' or 'profit' to the customer.
However, SEBI took the view that ‘land’ falls within the definition of ‘securities’ and PACL’s business of dealing in agricultural land falls within the framework of the CIS Regulations. The following were SEBI’s reasoning and findings:
1. Schemes floated by PACL fall squarely within the definition of CIS as defined under Section 11AA of the SEBI Act and are thus required to comply with the provisions of the CIS Regulations.
2. PACL was mobilizing money from the public or from the investors under their existing schemes.
3. SEBI relied on the Punjab High Court’s Judgement in the matter of P.G.F. Limited vs. Union of India & Another where it was held that Section 11AA and the CIS Regulations were intended for 'investor protection' and the same fall within the residuary clause i.e., Entry 97 of the Union List under the 7th Schedule of the Constitution of India.
In the said judgment, the Hon’ble Punjab High Court observed, on which SEBI placed reliance:
The pith and substance rule is relatable to the objects and reasons of a legislation, and not to the activities of a party. …... Stated in other words, while examining the issue of legislative jurisdiction, it is the pith and substance of the legislation, and not the pith and substance of the activities of a party, which are relevant. In drawing our conclusion, therefore the relevant question to be examined would be, whether the pith and substance of the legislation under challenge is "investor protection", and sale and purchase of agricultural land is an activity ancillary thereto; or whether, the pith and substance of the legislation under challenge, is sale and purchase of agricultural land and 'investor protection' is ancillary thereto. In answering the aforesaid quarry, the conclusion undoubtedly is in favour of the former i.e., the pith and substance of the legislation in question is "investor protection", whereas sale and purchase of agricultural land and/or development of agricultural land is incidental thereto.
This finding was upheld by the Apex Court in the same matter in appeal [(2013) AIR SCW 2420].
4. It was further observed by SEBI:
Out of the sample of 500 customers selected randomly from the list of customers provided by PACL, who according to it were allotted land in the year 2005-2006, not a single customer had finally received the land even after the passage of more than eight (8) years. This shows clearly that the real estate business is only a facade for running a CIS.
5. PACL was soliciting and inviting investments from prospective customers by way of written materials, under which one of the aims of PACL is to offer maximum return on investment and benefits to the customers.
6. PACL pools the money received from the customers for the purchase of the land.
7. The agreement entered into between PACL and its customers along with the application form is not a registered document and hence any restrictions on alienation or transfer of the immovable property are not a valid restriction under law.
The Securities Appellate Tribunal in the matter of Alchemist Infra Realty Limited has held:
We further note that the said certificate falls completely within the scope of the definition of the terms “securities” as provided in Section 2(h) of SCRA which as amended by the Securities Laws (Amendment) Act, 2004, w.e.f. October 12, 2004, now includes units or any other instrument issued by any Collective Investment Scheme to the investors in such schemes. Therefore, the certificate issued to the investors readily falls within the meaning of the expression “securities”.
The Supreme Court in the case of M/s. P.G.L. Ltd. has held:
A detailed analysis of sub-section(2) of Section 11A, which defines a collective investment scheme discloses that it is not restricted to any particular commercial activity such as a shop or any other commercial establishment or even agricultural operation or transportation or shipping or entertainment industry, etc…..Inasmuch as the said Section 11AA seeks to cover, in general, any scheme or arrangement providing for certain consequences specified therein vis.-a-vis. the investors and the promoters, there is no question of testing the validity of Section 11AA in the anvil of Entry 18 of List II (of the Constitution of India).”
To summarise, over the years and with the changing dynamic of business, SEBI too has evolved itself and its regulations to cover and encompass within its ambit all kinds of activities which directly or incidentally affect the rights of investors. It has made efforts to address the loopholes by expanding and modifying its regulations such that no activities go unnoticed which in any manner prejudices the interest of gullible investors.
- Prachi Pandya