Thursday, January 26, 2017

SEBI Order in the United Spirits Case

Over the last year or so, there has been considerable discussion in the press about the allegations of diversion of funds by the erstwhile management of United Spirits Limited (USL) to other companies within the United Breweries (UB) group, including Kingfisher Airlines Limited (KFA). This was also a result of investigations conducted by USL through certain audit firms. Subsequently, this became a subject matter of SEBI investigation, which yesterday resulted in an ad interim ex-parte order passed by a whole-time member of SEBI.

The transactions that led to SEBI’s investigations and the present order are too detailed to be discussed in this post, and are available in SEBI’s order. However, SEBI’s key ground is that by these transactions value was diverted from USL, which is a listed company, to other companies within the UB group, thereby adversely affecting the minority shareholders of USL. This was done so not only in contravention of various regulations prescribed by SEBI, but at the instance or with the knowledge and involvement of the key managerial personnel (KMP) of USL at the time, including Mr. Vijay Mallya.

After discussing the various transactions and the possible justifications provided by USL, SEBI concluded its findings as follows:

2.2       Considering the aforementioned facts and circumstances, it appears that Mallya in his capacity as Chairman of USL during the relevant period was instrumental in the diversion of funds from USL. In his endeavor to supply funds from USL to various companies/entities of the UB Group including KFA, he had exerted pressure on the aforementioned KMPs to comply with his instructions and the same were complied with …. Similarly, in his capacity as the Managing Director of USL during the period when funds were diverted, Mr. Ashok Capoor was in charge of and was responsible to USL, for the conduct of its business. It is therefore prima facie clear that Mallya, Mr. Ashok Capoor alongwith the other KMPs were active in facilitating and/or had knowledge of the diversion of funds from USL to the companies of the UB Group. The individuals holding key managerial positions in such listed companies have to follow high standards of integrity and ensure good governance. By diverting substantial funds from USL to companies of the UB Group, Mallya and other KMPs have engaged in an act or practice which prima facie operated as a fraud or deceit on the public shareholder/investors of USL.

2.3       Mallya and the other KMPs i.e. Mr. Ashok Capoor, Mr. P.A. Murali, Mr. Sowmiyanarayanan, Mr. S.N. Prasad, Mr. Paramjit Singh Gill and Mr. Ainapur S.R. are therefore prima facie alleged to have committed fraudulent and unfair activities prohibited under Section 12A(c) of the SEBI Act , 1992 (“SEBI Act”) and Regulations 3(d); 4(1) alongwith 4(2)(e), (f) and (k) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 (“PFUTP Regulations, 2003”).

2.4       The alleged prima facie violations observed in this case are serious and have larger implications on the safety and integrity of the securities market. Investors might have based their investment decisions on the manipulated books of accounts prepared and presented by these persons. It would therefore not be in the interest of the securities market and the interest of investors to allow persons of such doubtful demeanor to continue to act as KMPs in the company or in other listed companies or allow them to deal in the securities market. Therefore, pending investigations in the matter, effective preventive and remedial actions needs to be taken against the persons in order to safeguard the integrity of the securities market. Accordingly, the facts and circumstances of the case necessitates the issuance of this Ad Interim Ex-Parte Order. …

Accordingly, SEBI ordered that several persons mentioned above are prohibited from buying, selling or otherwise dealing in any securities, with two of them (Mr. Mallya and Mr. Capoor) being restrained from holding position as directors or key managerial personnel of any listed company. Finally, SEBI ordered that USL shall take steps to recover the amounts which have been diverted (being Rs. 655.55 crores as mentioned in a report by PWC-UK and Rs. 1225.24 crores mentioned in a report by E&Y).

Since this is an interim order, we may be yet to hear the last word on this. Nevertheless, this order is an important step not only in relation to the USL case, but also in relation to curbing related party transactions (RPTs) in India generally. RPTs, if not carried out properly, amount to transfer of value from listed companies to other entities that may enrich the controlling shareholders at the cost of the minority shareholders. There is evidence of such diversion, known in academic literature as “tunneling”, even in the Indian context, as discussed in a paper by Bertrand, et al. Hence, the regulation relating to RPTs has been considerably enhanced in regulatory reforms culminating in the Companies Act, 2013 and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. In this context, the USL case will be an important test to determine the robustness of the regulatory framework governing RPTs in India and, more importantly, the effectiveness of the enforcement of RPT regulation.


Badrinath Srinivasan said...

There seems to be several papers on tunnelling in India. Would be great if you could share the best of those.

Umakanth Varottil said...

@Badrinath Srinivasan. Thanks for your comment. A few useful references are contained at the end of this quarterly briefing ( by Professor Vikramaditya Khanna.