Introduction
Unscrupulous promoters/directors usually make windfall gains by engaging manipulative or deceptive devices and defrauding the investors. One of such instances has caught the attention of SEBI where funds raised from the preferential issue were deviated and mis-utilised for unstated purposes different from the objectives mentioned in the offer letter.
There is one biggest advantage of raising money through preferential issue i.e., it saves a lot of cost and time as compared to going public. And the management makes pre-arrangements with the proposed investors who wish to invest in the company. However, defrauding these informed investors and mis-utilising their funds is unethical and most importantly illegal. In the matter of M/s. Achal Investments Ltd, similar concern was noticed which left the company barred from the securities market for 5 years and hefty penalties.
In this article, the author has discussed the facts in brief, relevant provisions, findings of the case and final judgement of SEBI. Also, key takeaways from this case are covered.
Factual Matrix
The company had issued equity shares on preferential basis to 47 entities.
The objects of the preferential issue of equity shares issued to the shareholders are as under:
1.To strengthen the equity base of the company,
2.To arrange the funds required for meeting the enhanced working capital requirements of the company,
3.To meet certain capital expenditure, and
4.To meet expenditure for general corporate purposes
The company, in response to a Bombay Stock Exchange Notice admitted that it has deviated from the stated objectives in utilization of the issue proceeds. Further, the company informed SEBI that it has obtained ratification for the deviation from its shareholders in the AGM.
The ratified details of utilization of proceeds of preferential issue are mentioned below:
- Loans & Advances
- Advance for purchase of shares
- Repayment of Loan
A Show Cause Notice (SCN) was issued to the Company which alleged, inter alia, that:
- The Company has mis-utilized and diverted the proceeds received through the preferential issue of equity shares.
- The Company, while seeking ratification from its shareholders after a delay of 5 years, has not made full and complete disclosure of facts and information pertaining to the alleged mis-utilization and diversion of proceeds.
- The Company by mis-utilizing and diverting the proceeds received through the preferential issue of equity shares has committed fraud on its shareholders.
- The Company failed to make the quarterly disclosure regarding utilization of preferential issue proceeds as required under Clause 43 of Listing Agreement.
Relevant Provisions
Securities and Exchange Board of India Act, 1992 (SEBI Act)
Section 12A: Prohibition of manipulative and deceptive devices, insider trading and substantial acquisition of securities or control
No person shall directly or indirectly:
(a) use or employ, in connection with the issue, purchase or sale of any securities listed or proposed to be listed on a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of this Act or the rules or the regulations made thereunder;
(b) employ any device, scheme or artifice to defraud in connection with issue or dealing in securities which are listed or proposed to be listed on a recognised stock exchange;
(c) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person, in connection with the issue, dealing in securities which are listed or proposed to be listed on a recognised stock exchange, in contravention of the provisions of this Act or the rules or the regulations made thereunder;
Section 15HA: Penalty for fraudulent and unfair trade practices
If any person indulges in fraudulent and unfair trade practices relating to securities, he shall be liable to a penalty which shall not be less than five lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of such practices, whichever is higher.
Regulation 2(1)(c)
“Fraud” includes any act, expression, omission or concealment committed whether in a deceitful manner or not by a person or by any other person with his connivance or by his agent while dealing in securities in order to induce another person or his agent to deal in securities, whether or not there is any wrongful gain or avoidance of any loss, and shall also include–
(1) a knowing misrepresentation of the truth or concealment of material fact in order that another person may act to his detriment;
(2) a suggestion as to a fact which is not true by one who does not believe it to be true;
(3) an active concealment of a fact by a person having knowledge or belief of the fact;
(4) a promise made without any intention of performing it; …
(7) deceptive behaviour by a person depriving another of informed consent or full participation;
Regulation 3. Prohibition of certain dealings in securities
No person shall directly or indirectly-
(a) buy, sell or otherwise deal in securities in a fraudulent manner;
(b) use or employ, in connection with issue, purchase or sale of any security listed or proposed to be listed in a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of the Act or the rules or the regulations made there under;
(c) employ any device, scheme or artifice to defraud in connection with dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange;
(d) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person in connection with any dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange in contravention of the provisions of the Act or the rules and the regulations made there under.
Regulation 4. Prohibition of manipulative, fraudulent and unfair trade practices
(1) Without prejudice to the provisions of regulation 3, no person shall indulge in a fraudulent or an unfair trade practice in securities.
(2) Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice if it involves fraud and may include all or any of the following, namely: – …
(f) publishing or causing to publish or reporting or causing to report by a person dealing in securities any information which is not true or which he does not believe to be true prior to or in the course of dealing in securities; …
(k) an advertisement that is misleading or that contains information in a distorted manner and which may influence the decision of the investors”;
Findings of the case
1. One of the reasons for deviation of funds was advance for purchase of shares to the SEBI registered Sub-brokers. However, it was found that the MoUs which were executed by the Company do not stipulate even the basic details of the names of the scrips that need to be purchased, quantity of shares, price, whether the shares have to be purchased in the primary market or in the secondary market through Stock Exchanges or in off market, etc. Hence, it was observed that the transfer of funds by the Company to the Sub-brokers could not have been for the purpose of purchasing shares. To the contrary, it was alleged that the funds were transferred for the Sub-brokers’ own use since no KYC formalities were completed and no orders were made.
SEBI concluded that the company has mis-utilized the proceeds received from the preferential issue of equity shares. This action is not only detrimental to the interest of the company but also to the interest of its shareholders.
2. Another allegation was in relation to a loan given to an individual which was also ratified by the shareholders. SEBI noticed that the said loan amount cannot be considered as a normal business transaction of the Company as deployment of funds out of the working capital. No legally binding agreement had been entered into by the Company, no interest was charged from the borrower and no collateral was taken from the borrower. It was deduced that the company had no intention to secure the return of funds.
In light of the aforesaid discussion, which brings out the alleged mis-utilization and diversion of proceeds of preferential issue of equity shares by the Company, it was alleged that the company has committed fraud as defined under Regulations 2(1)(c)(2) and 2(1)(c)(4) of the PFUTP Regulations.
SEBI observed that the company has employed, in connection with the preferential issue of securities, a manipulative device to defraud the existing and prospective shareholders and has engaged in a practice which has acted as a fraud on them. These acts of the Company in making such a suggestion are a fraudulent or an unfair trade practice as it knew the same to be not true and the Company was aware that such misleading information would influence the decision of investors and induce them in dealing in securities.
Ratification of deviation by shareholders
The company contended that it sought shareholders approval for ratification of deviation of proceeds of preferential issue. However, SEBI noted that the company had merely informed the shareholders that it had deviated from the purpose for which the proceeds were raised and had not made full and complete disclosure of facts and information pertaining to the alleged mis-utilization and diversion of proceeds of preferential issue of equity shares.
SEBI concluded that the Company in order to ratify the alleged mis-utilization and diversion of proceeds of preferential issue of equity shares from its shareholders, has in the said process, misled and influenced its shareholders. Further, the act of the Company not to make true and complete disclosure and diversion of proceeds of preferential issue of equity shares is not only a device to manipulate its shareholders to ratify the mis-utilization and diversion of proceeds of preferential issue of equity shares but it is also meant to deprive the shareholders of giving informed consent regarding the ratification process. SEBI held that the said act of the Company has led to the violation of provisions of Regulations 3 (a), (b), (c) and (d), 4(1), 4(2)(f), 4(2)(k) and 4(2)(r) of the PFUTP Regulations read with Sections 12A (a), (b) and (c) of SEBI Act.
Final Judgement
SEBI issued the following directions to the company:
- That it is restrained from accessing the securities market and from buying, selling or dealing in securities, either directly or indirectly, in any manner whatsoever, for a period of five (05) years from the date of this Order.
- That it shall bring back the amount due to it, which has been extended either directly or indirectly, to the entities mentioned in this Order, along with due interest, expeditiously and take all necessary action, including legal actions, towards bringing back the said sum. It shall file a quarterly report stating the compliance of this direction to SEBI.
- Penalty of Rs. Ten Lakhs under Section 15HA of the SEBI Act, 1992 and Rs. Ten Lakhs under Section 23E of the SCRA was levied.
Key Takeaways
This case is only one of its kind, in general also, deviation from the objects which are mentioned in the offer documents is pre-planned even before seeking approval of the shareholders. In this case also, it was clearly stated by SEBI that “The Noticee has misled and influenced its shareholders by putting in place a device to manipulate them. Further, such a device was already in place even before the approval of shareholders was sought for making preferential issue. I note that the Noticee has not adhered to the high standards of ethics and corporate governance that it is required to meet in order to protect shareholder interest and has instead, put its own interest before the shareholder interest. I am of the view that appropriate directions and penalty need to be issued against the Noticee for its acts.”
The mis-utilisation of the proceeds is considered as violation of ethics and corporate governance standards. Apparently, if the intention of the management is to keep something under wraps it is not in the interest of the shareholders of the company. Therefore, caution is necessary on part of the investors also to keep a check how their funds are being utilised by the company.
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