Supreme Court’s Sahara ruling: Salute to the judges, but a huge question mark before financial regulators
With life savings of millions at stake, the question is—why was the administration sleeping while this Rs20,000 crore was raised through a million agents?
The ruling of the Supreme Court in the Sahara Real Estate Corporation (Sahara) case is a landmark ruling, not so much for the technical interpretation of the apparently conflicting or unclear provisions of the Companies Act, Securities Contracts Act or SEBI Act, but on the extremely candid and sharp observations of the judges on the conduct of the appellants. And also for upholding peoples’ pride and faith in the judiciary that legal sophistry cannot obfuscate what is so apparently a gross violation of the regulatory regime of the country.
Misplacing private placement
In fact, the details were so stark that the contention of the appellants could have been rubbished at the very outset by common intuition alone. To put in simple words, the appellants contended that they were unlisted companies and were not to be regulated by the Securities and Exchange Board of India (SEBI), and, that they had raised money by issuing “optionally convertible debentures” (OCDs) on a “private placement basis”. For the uninitiated, the concept of private placement of an issue is one where a company offers securities to persons who are associates, friends, relatives, employees, etc, and that the offer will not be available other than to the person to whom it is made.
In the heydays of the initial public offer (IPO) market in India, in 1980s, one would find see whole lot of the so-called private placements where application forms were freely distributed by newspaper vendors on the footpaths and companies got away by calling it a private placement. Obviously, there was no SEBI then—the whole system was managed by the Controller of Capital Issues. Much later, a provision was inserted in Section 67 (3) of the Companies Act to say that if securities were offered to 50 or more persons, the issuer could not call it a private placement. Read this provision with Section 73 of the Companies Act, wherein if it is not a private placement, it has to be a public issue. And, if it is a public issue, it requires the mandatory issue of a prospectus and listing of the securities, thereby bringing the full jurisdiction of SEBI into the picture.
The two Sahara entities (referred to as the ‘Saharas’ in the judgement) contended that theirs was a private placement. Now observe the sheer magnitude of the issuance.
Though correct facts have not been disclosed by the Saharas even before the Supreme Court, the strands of facts are: nearly Rs20,000 crore was raised from 22.1 million investors, using services of nearly a million agents at 2,900 branches. And this is claimed to be a private placement—as if to say these 22.1 million investors were friends, associates, employees or relatives of the company or company directors. If such an outrageous argument could be taken to the highest court of the country, and argued by the best legal brains, all one needs to do is to admire the audacity of the argument.
Vikramaditya lives on
That the court did not allow technicalities to come of upholding what is right helps maintain our tremendous faith in the judiciary. The observations of the judges are a feast for a student of corporate laws. Don’t be put of by the 263 page length, because the details outlined in the judgement are like a fascinating story.
Justice Radhakrishnan takes the reader through a complete background of corporate laws, securities regulations in India and comparing our regulatory scenario with that of England. His words are unburdened by heavy legal arguments and smooth as silk; justice Khebar, on the other hand, is sharp and scathing, when he refers to the almost obstinate resistance of the appellants in avoiding SEBI’s jurisdiction.
• The judge cites the example of an entry in the so-called OFCD register, and says: “One would not like to make any unrealistic remark, but there is no other option but to record that the impression emerging from the analysis of the single entry extracted above is, that the same seems totally unrealistic, and may well be, fictitious, concocted and made up.”
• On the evasive tactics adopted by the Saharas about supplying information to SEBI, the judge says: “It is not easy to overlook that the financial transactions under reference are not akin to transactions of a street hawker or a cigarette retail made from a wooden cabin. The present controversy involves contributions which approximate Rs40,000 crore, allegedly collected from the poor rural inhabitants of India. Despite restraint, one is compelled to record that the whole affair seems to be doubtful, dubious and questionable. Money transactions are not expected to be casual, certainly not in the manner expressed by the two companies.” Further, “One would therefore, have no hesitation in concluding, that a party which has not been fair, cannot demand a right based on a rule founded on fairness.”
Technical issues: The judgement also answers several technical questions raised on certain provisions of the Companies Act, Securities Act and SEBI Act. Regrettably, while many countries have consolidated their securities-related provisions in course of time, in India, the provisions remain scattered partly in the Companies Act, partly under the Securities Act, and now largely under the departmental guidelines issued by the SEBI known as ICDR regulations. In fact, until Section 55A was inserted in the Companies Act, even the administrative control of provisions relating to issue of securities was split between ministry of corporate affairs (MCA) and the SEBI.
The language of Section 55A itself became an issue in Sahara litigation. The section seems to suggest that in case of listed companies, or those that intend to list securities, the jurisdiction shall vest with SEBI, and in other cases, it shall vest with the MCA. The appellants were unlisted companies, and did not intend to list securities—hence claimed that the question of SEBI’s jurisdiction did not arise. Clearly, the language of Section 55A is not sensible, but the Supreme Court supplied meaning to this flawed language by holding that where securities were mandatorily required to be listed in terms of Section 73, the question of the issuer not intending to list them did not arise at all. Hence, the question of SEBI’s jurisdiction was settled.
There were several questions raised about whether an OCD, which is a ‘hybrid’ instrument containing features of equity and debt, was at all covered by the provisions of the Securities Act. These questions have also been answered by harmoniously interpreting the inclusive definition of ‘securities’ under the Securities Act. An OCD is after all a debenture, and hence, it is well covered by the provisions of the Acts.
The appellants also sought shelter under the provisions of the Unlisted Public Companies (Preferential Allotment) Rules 2003, which, prior to their amendment in December 2011, did not contain a restriction on number of allottees as is there in Section 67 of the Act. This was apparently a lapse in the 2003 Rules, which was plugged later. But one would expect the judiciary of today not to be shackled by literal interpretation or be the slave of the flawed language of a law. The court held that after all, the 2003 rules could not have gone beyond the provisions of Section 67. If an issue of securities has been made to 50 or more persons, and is therefore deemed to be a public offer under Section 67 (3), the contention that it is made a preferential issue under the Preferential Allotment rules will not hold any significance.
The apex court also held that DIP and ICDR guidelines of SEBI are statutory instruments and have the force of law. In addition, the ICDR regulations apply to all companies, listed or unlisted.
The ruling supplies meaning to the very flawed language of Section 28 (1) (b) of the Securities Contracts Regulation Act. Section 28 (1) (b) is, in fact, an exception to the prohibition under the SCRA on issue of options. The section intends to exclude the option available to the holder of convertible bonds, but in the flawed language of the section, seems to exempt convertible debentures from the whole of the Act. The apex court has made sense out of this erroneously worded section by holding that Section 28 (1) (b) excludes merely the entitlement of a convertible bondholder to the shares, and does not exempt convertible bonds in toto.
Huge question mark for the regulators
The apex court has delivered what is almost an administration order for the appellants—ordering them to refund all monies raised by the issue of OCDs within three months from the date of the order. A retired judge of the Supreme Court has been appointed to oversee the compliance of the order, and the SEBI full-time member has been tasked with the responsibility of carrying out the liquidation of debentures.
Obvious enough, tens of thousands of crores are not lying liquid with the company, and it would not be easy to liquidate the money. Since even the details about the bondholders have not been supplied in over two years of investigation, fixing all details and repaying all monies will be nearly impossible. It is quite likely that of the 22 million investors, several millions lose their money. Who would these investors be? They could well be daily wage earners, farmers, rural folks, and generally, anyone who could have been enticed with offers of a decent rate of interest.
With life savings of millions at stake, the question is—why was the administration sleeping while this Rs20,000 crore was raised? Obviously enough, this money was not raised overnight. If services of a million agents were utilised, it could not have escaped the notice of the government.
The schemes in question were probably floated in 2008, but it is quite well known that money has been raised through similar schemes over the years. How is it that we let the problem reach to such massive scales, and then have to reach up to the apex court to pass an order which will, in all likelihood, be impossible to execute? The identity of the investors, if presented, will solve at least one mystery.
(Vinod Kothari is a chartered accountant, trainer and author. He is an expert in such specialised areas of finance as securitisation, asset-based finance, credit derivatives, accounting for derivatives and financial instruments and microfinance. He has written a book titled “Securitisation, Asset Reconstruction and Enforcement of Security Interests”
, published by Butterworths Lexis-Nexis Wadhwa. He can be contacted at [email protected]
. Visit his financial services website at www.vinodkothari.com