The Supreme Court of India earlier this month ruled on the applicability of the regulatory regime relating to collective investment schemes (“CIS”). In Securities and Exchange Board of India v. Gaurav Varshney, the legal question was rather straightforward. On 25 January 1995, section 12(1B) was inserted into the Securities and Exchange Board of India Act, 1992 (the “SEBI Act”). It provided that no person shall carry out a CIS unless he or she obtains a certificate of registration from the Securities and Exchange Board of India (“SEBI”) “in accordance with the regulations”. However, the “regulations” referred to in the said provision were enacted by SEBI only with effect from 15 October 1999 in the form of the SEBI (Collective Investment Schemes) Regulations, 1999 (the “CIS Regulations”). In the interim, on 3 July 1995, the respondents in the principal appeal, Gaurav Varshney and Vinod Kumar Varshney, began carrying out CIS operations through a company they incorporated. The legal question therefore was whether by carrying out CIS activity during the period when section 12(1B) (that imposes a bar on such activity without registration) was in force but not the CIS Regulations (that prescribe the mode of obtaining SEBI approval), the Varshneys were in breach of the legal regime so as to be subject to criminal action. The High Court below quashed SEBI’s action under section 482 of the Criminal Procedure Code. It is against this decision that SEBI appealed before the Supreme Court.
In answering the legal question, the Supreme Court interpreted section 12(1B) of the SEBI Act, which reads as follows:
No person shall sponsor or cause to be sponsored or carry on or cause to be carried on any venture capital funds or collective investment scheme including mutual funds, unless he obtains a certificate of registration from the Board in accordance with the regulations:
Provided that any person sponsoring or cause to be sponsored, carrying or causing to be carried on any venture capital funds or collective investment scheme operating in the securities market immediately before the commencement of the Securities Laws (Amendment) Act, 1995 for which no certificate of registration was required prior to such commencement, may continue to operate till such time regulations are made under clause (d) of sub-section (2) of section 30.
After analyzing the provision, the Supreme Court concluded that it has two parts. The first, signified by the main provision, relates to persons who had not commenced CIS activity prior to 25 January 1995, when the provision was brought into force, i.e. those who began the business afresh after that date. The second, signified by the proviso, relates to those who were carrying on CIS activity even prior to that date, i.e. existing activity. After doing so, the Court concluded that the case relating to the Varshneys would fall within the first part of section 12(1B), i.e. new activity. The question therefore was whether the bar against commencement of CIS activity after 25 January 1995 (when section 12(1B) came into force) would operate from that date or only when the regulations prescribed by SEBI thereunder came into force. Here, the court was emphatic in its conclusion that the bar against commencing CIS activity without registration would operate with effect from the date that the statutory provision (i.e. section 12(1B)) came into force and not only when the regulations were notified. The Court observed:
21. … Our inevitable conclusion is, that sponsoring or carrying on any collective investment activity, for the first time, on or after 25.1.1995, was a complete bar, in the absence of a certificate of registration from ‘the Board’. It accordingly follows, that if a person/entity had commenced to sponsor or carry on a collective investment scheme after 25.1.1995, without obtaining a certificate of registration from ‘the Board’, it would tantamount to breaching the express mandate contained in Section 12(1B) of the SEBI Act.
22. In our considered view, there can be no doubt, that the date when the Collective Investment Regulations came into force (-15.10.1999), has no relevance, insofar as the breach of Section 12(1B) of the SEBI Act, with reference to such new entrepreneurs, is concerned. The bar to sponsor or cause to be sponsored, or carry on or cause to be carried on any collective investment activity by a new entrepreneur (-who had not commenced the concerned activities, before 25.1.1995) under Section 12(1B) of the SEBI Act, was not dependent on the framing of the regulations. The above bar was absolute and unconditional, till the new entrepreneur (described above) obtained a certificate of registration, in accordance with the regulations. …
Although on this legal question the Supreme Court held in favour of SEBI, it upheld the decision of the High Court below in quashing the criminal proceedings against the Varshneys. This was on account of procedural issues. The Court placed considerable emphasis on the fact that SEBI’s complaint was made under the proviso category, i.e. where a person was carrying on existing CIS activity when section 12(1B) was brought into force. On the other hand, the complaint ought to have been made under the non-proviso category, i.e. in respect of new businesses that were commenced after the section as brought into force on 25 January 1995. This distinction was found to be rather crucial, and the fact SEBI proceeded under the wrong category was found to be fatal to its prosecution.
Hence, while the substantive legal question was decided in favour of SEBI, the procedural question was answered for the benefit of the Varshneys, due to which SEBI’s complaint against them was quashed. Apart from the case relating to Varshneys, the Supreme Court also dealt with the disposed off certain related appeals on similar and other related questions.
From a broader perspective, the Supreme Court’s decision has implications on restrictions of commercial activity imposed by legislation, especially when such activity is subject to licensing or registration requirements. Since such restrictions are subject to detailed rules or regulations to be promulgated by the regulatory authorities, the decision has implications on how persons may carry out such activities between the time that the legislation has imposed a restriction and before the regulatory authorities promulgate the rules or regulations. The Court’s resounding answer is that the activity cannot be carried out in the interim, and this operates as a total prohibition. That prohibition will be lifted only when the rules or regulations are subsequently promulgated. The issue becomes even more acute when there is a considerable delay between the imposition of the legislative restriction and the subsequent promulgation of the rules or regulations, as was the case with section 12(1B) and the CIS Regulations, which faced a delay of over three years. This puts affected parties at a disadvantage, as no CIS activity could have been carried on in the interim period. The lesson from this decision for the regulatory authorities would be that they ought to institute mechanisms for licensing or registration as soon as any such restrictions are imposed by legislation, without any delays in the interim.
On the other hand, the procedural aspect of the decision has the impact of imposing an onerous burden on the regulators in that they are required to be more specific regarding the offence that has been committed by a party. In circumstances such as in the present case, where section 12(1B) contains two parts, i.e. for existing businesses and new businesses, the regulator will have to specify whether the violation in a given case is under either of the two parts. If the regulator fails to do so, then prosecution for an offence under the SEBI Act could end up being futile as it turned out in the present case.
 This the Court referred to as the “non-proviso category”.
 This the Court referred to as the “proviso category”.