Thursday, May 18, 2017

SAT Order in the Satyam Case

In July 2014, we had discussed the order of the Securities and Exchange Board of India (SEBI) then passed against several members of Satyam’s senior management for their role in perpetrating the colossal financial fraud involving the company. In its order, SEBI found several individuals guilty of violating various regulations issued by SEBI, and restrained them from accessing the capital markets for a period of 14 years and required them to disgorge the wrongful gains made to the extent of nearly Rs. 1,850 crores (Rs. 18.5 billion) with interest @ 12% per annum from January 7, 2009 till the date of payment.

Against this, the senior management, including Mr. Ramalinga Raju, the former chairman of the company, preferred an appeal to the Securities Appellate Tribunal (SAT). Last week, the SAT passed its order on the appeal wherein it concurred with SEBI’s findings on the breaches of various SEBI regulations by the senior management, but overturned the sanctions imposed by SEBI and remanded the matter to SEBI for a review of the sanctions afresh. While the fulcrum of SEBI’s findings on the merits stand, its order on the consequences and sanctions has suffered a setback.

In its order, the SAT considered three issues, of which the first two were held in SEBI’s favour, and the third in favour of Satyam’s management. The first issue related to procedure and the question of natural justice. The individuals against whom SEBI passed the order argued that they were not conferred adequate opportunity to present their case, such as to cross-examine witnesses. However, the SAT refused to entertain the arguments and concurred with SEBI’s findings that the individuals sought adjournments to prolong the proceedings, and that their interests were not adversely affected.

Second, on the merits of the case too, the SAT had no difficulty in finding that SEBI’s order is sustainable. SAT’s finding was also well-supported in this regard by the facts of the case, because the chairman himself had confessed to wrongdoing in his well-known letter of January 9, 2009. Similarly, the other members of the top management who had been arraigned were also party to the wrongdoing or had knowledge of the same.

It is the third issue pertaining to the sanctions to be imposed on the top management where the SAT disagreed with SEBI’s findings, and effectively quashed that portion of SEBI’s order. For instance, the SAT found no basis for SEBI’s order that debarred the individuals for accessing the capital markets for 14 years. Moreover, the sanction was imposed uniformly on all of them, without any regard to their individual levels of complicity in the wrongdoing. Similarly, the SAT found some discrepancies in the precise amounts in respect of which SEBI had passed an order for disgorgement of profits. For example, in the case of Mr. Ramalinga Raju and Mr. Rama Raju, the disgorgement order covered the two individuals as well as other entities connected with them. SEBI had in addition passed disgorgement orders against the connected entities thereby causing some amount of double-counting. For these and other reasons, the SAT decided to overturn the sanctions, and asked SEBI to reconsider these and pass an order expeditiously within four months.

This state of affairs reveals significant concerns relating to SEBI’s investigation of cases of such magnitude. While SEBI’s investigation efforts on the merits of establishing a violation have been upheld (which, arguably was a fait accompli given the chairman’s confession that laid bare all the shenanigans), it raises questions about the extent to which SEBI must support its sanctions with logic and reasoning. For instance, the Securities and Exchange Board of India Act, 1992 and the relevant regulations provide considerable discretion to SEBI while passing its orders. However, when it comes to imposing sanctions such as restraining persons from capital markets for as long as 14 years, it must be supported by strong reasoning. While some may argue that there could have been no better case than Satyam that warranted such stiff sanctions, the issue relates to one of equity in whether all the individuals concerned were equally responsible or whether some (such as the chairman and managing director) were required to shoulder a greater burden. It is the absence of such considerations in the SEBI order that may have led to its fatality on this count.

Similarly, disgorgement of profits can be a rather complicated exercise. Courts in several jurisdictions have sought to set out principles on how to compute wrongful profits or gains in case of securities offences such as insider trading or market manipulation, but this area is riddled with controversies. In the end, it might be necessary for SEBI to establish clearer guidelines on determining sanctions so that the outcome experienced in the Satyam case can be avoided in the future.

1 comment:

Shailendera Singh said...

Agreeably, the principles of disgorgement are riddled with conflicting principles. For instance, how do we ascertain the exact gain made or loss avoided, considering that there could have been several other factors at play that influenced the price of the securities.

However, it is undeniable that disgorgement seeks to prevent the wrongdoer from enjoying the fruits of the illegal gain or the loss he managed to avoid.

Taking this as a given, do you think that SAT made a fundamental logical fallacy in agreeing, that one must deduct the cost of acquisition and taxes paid from the sale amount of the securities. One can hazard a guess that this instinctive approach stems from one's practice of direct taxation of capital gains.

Let us examine this application through a simple hypothetical example. Suppose, the cost of acquisition and taxes paid on a security is Rs. 10. The real price of the security, post acquisition, fluctuates to Rs. 5, but the insider is able to inflate and hold the price to Rs. 15. He also manages to sell the security at the market price of Rs. 15.

Post discovery, if the price falls to say Rs. 6, it would be bizarre to apply the principle enunciated by SAT, and order disgorgement of only Rs. 5. This misses the point that it is not only the illegal gain but also the illegal loss avoided that needs to be disgorged.

Would the correct principles therefore not dictate that one must not take into account the cost of acquisition (and tax) but only the intrinsic value of the security, or if such value if difficult to determine, the value post the discovery when the market had settled?

To state it in the form of the example above, the disgorgement must extend to either Rs. 10 (15-5) or Rs.9 (15-6).

Would love to know your view on this.