KHAITAN & CO ARTICLE

9 November 2012

SEBIs Jurisdiction | Analysis of the Supreme Court judgment in the Sahara case Ashwin Mathew, Consultant Khaitan & Co, Mumbai1 1. 1.1 Introduction Any business venture needs funds to grow. As a business vehicle, a company has two main avenues for raising funds share capital and debt. An important factor that determines the attractiveness of any investment in a company is the return on investment. By its very nature, debt carries interest which represents the return on the creditors investment. Dividends represent the return on share investments but unlike interest, dividends are not guaranteed and depend on the profitability of a company. Consequently, share capital is referred to as risk capital. Besides payments from the company in the form of interest or dividend, as the case may be, a market in securities, whether for share capital or debt, increases their attractiveness as investment instruments. This is because investors can trade in securities and realize returns on their investments without depending on the company. A vibrant securities market is, therefore, an important financial institution and its depth is often a measure of economic development and stability. As a result, dealings on the securities market must be fair and incapable of manipulation to ensure that the market is driven by the economic forces of demand and supply. History has shown that manipulation of the securities market is a recipe for economic disaster. Investor protection through various measures like stringent disclosure standards, safeguards against insider trading, takeover regulations, technological innovation and integrity, to name a few, hold the key to a level playing field and fair and transparent dealings in the securities market of a country. In the aftermath of the 1992 stock scam in India, the Securities and Exchange Board of India (SEBI) was constituted under the Securities and Exchange Board of India Act, 1992 (SEBI Act) to protect the interests of investors in securities and to develop and regulate the securities market2. Indian Securities Laws 1.3 In India, the Companies Act, 1956 (Companies Act), the Securities Contracts (Regulation) Act, 1956 (SCRA), the SEBI Act and the Depositories Act, 1996 (Depositories Act) are relevant to the regulation of companies, contracts in securities and the market for securities. Each of these laws is supplemented by rules and regulations that regulate various aspects of securities law. In addition, listing agreements between the company and the relevant stock exchange govern the terms on which securities of the company are listed on the exchange.

1.2

Views are personal and may not necessarily reflect the position of the firm. Prior to SEBI, the issue of capital by companies was regulated by the Central Government under the Capital Issues (Control) Act, 1947. The regulatory authority was the Controller of Capital Issues in the Ministry of Finance. With the constitution of SEBI, the Capital Issues (Control) Act, 1947 was repealed and the office of the Controller of Capital Issues was abolished. Cf. A. Ramaiya, Guide to Companies Act, Vol.1, 17th ed., (Lexis Nexis Butterworths Wadhwa Nagpur: Haryana, 2010), pp. 726 727.
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The Companies Act is the primary law governing all companies in India and lays down inter alia the basic rules for issue and transfer of securities by companies and issue of dividends by companies. The Central Government (acting through the Registrars of Companies and Regional Director, in most cases) is the main regulating authority under the Companies Act; The SCRA regulates dealings in securities and lays down the framework for setting up stock exchanges in India. An important objective of SCRA is to prevent undesirable transactions in securities. The Central Government is the main regulatory authority under SCRA. As noted above, the SEBI Act created SEBI to protect investors and regulate the securities market. Pursuant to the SEBI Act, SEBI has promulgated rules governing disclosure requirements for issue of securities, insider trading, takeover, market functionaries (brokers, portfolio managers, foreign institutional investors, merchant bankers) etc. The Depositories Act lays down the framework for dematerialisation of securities so that these may be traded in electronic form.

1.3.2

1.3.3

1.3.4

1.4

Under the Companies Act3, a company may be private or public. A private company, by its very nature and definition, is restricted from offering shares to the public and having more than 50 shareholders. A private company is also required to restrict the transferability of its shares. A public company, on the other hand, can offer its shares to the public without any restriction on the number of its shareholders. Also, the shares of a public company are required to be freely transferable. A public company is more stringently regulated than a private company, since public shareholders could potentially be involved. A public company which offers shares to the public must list on a recognized stock exchange. Consequently, public companies may be listed or unlisted depending on whether their shares have been offered to the public or not. Scope of this Article

1.5

An important issue related to the regulation of companies is the scope of SEBIs jurisdiction over companies. This issue is significant to determine the regulatory framework that applies to a particular company. A two judge bench of the Supreme Court examined this issue at length in Sahara India Real Estate Corporation Ltd. and Ors. v. Securities and Exchange Board of India and Anr.4 (Sahara Case) This article analyses this case by (i) summarising the important provisions of the relevant securities laws noted above; (ii) outlining the salient features of the judgment; and (iii) examining the implications of the judgment.

3 4

See Section 3 of the Companies Act for the definition of a private company and a public company. MANU/SC/0702/2012; (2012) 8 SCALE 101.

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9 November 2012

SCRA provides the base definition of securities. Section 2(h) of SCRA defines securities to include (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; (ii) derivatives; (iii) instruments of a collective investment scheme; (iv) security receipts under securitization law; (v) mutual fund scheme units; (vi) Government securities; (vii) other instruments declared by the Central Government as securities; and (vii) rights or interests in securities. This definition of securities has been adopted by the SEBI Act5. The Companies Act also adopts this definition of securities but in 20006 this definition was amended and hybrids were expressly included. Hybrids are defined in the Companies Act as any security which has the character of more than one type of security, including their derivatives7. Section 55A of the Companies Act

2.2

Section 55A of the Companies Act, which was introduced in 20008, defines the powers of SEBI under the Companies Act and provides that the provisions contained in sections 55 to 58, 59 to 819 (including sections 68A, 77A and 80A), 108, 109, 110, 11210, 11311, 11612, 117, 118, 119, 120, 121, 12213, 206, 206A and 20714 so far as they relate to issue and transfer of securities and nonpayment of dividend shall (a) in case of listed public companies15; (b) in case of those public companies which intend to get their securities listed on any recognized stock exchange in India, be administered by SEBI; and (c) in any other case, be administered by the Central Government. The Explanation to Section 55A provides that for the removal of doubts, it is hereby declared that all powers relating to all other matters including the matters relating to prospectus, statement in lieu of prospectus, return of allotment, issue of shares and redemption of irredeemable preference shares shall be exercised by the Central Government, Company Law Board or the Registrar of Companies, as the case may be. Issue of securities under the Companies Act

2.3

Under the Companies Act, a public company can issue securities by way of a public offer, rights issue or private placement.

Section 2(i) of the SEBI Act. This amendment was made by the Companies (Amendment) Act, 2000 w.e.f. 13 December 2000. 7 Section 2(19A) of the Companies Act. 8 This amendment was made by the Companies (Amendment) Act, 2000 w.e.f. 13 December 2000. 9 Sections 55 to 58 and 59 to 81 of the Companies Act deals with the prospectus and matters related to the issue and allotment of shares and debentures. 10 Sections 108, 109, 110 and 112 of the Companies Act deals with transfer of shares. 11 Section 113 of the Companies Act deals with the time limit for issue of certificates on an issue or transfer of shares or debentures. 12 Section 116 of the Companies Act lays down the penalty for impersonation of a shareholder. 13 Sections 117, 118, 119, 120 and 121 of the Companies Act are special provisions in relation to debentures. 14 Sections 206, 206A and 207 of the Companies Act deal with the manner and time of payment of dividends. 15 Section 2(23A) of the Companies Act defines listed public companies as a public company which has any of its securities listed in any recognized stock exchange.
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9 November 2012

A rights issue is an offer of shares to existing shareholders of the company16. Section 67 of the Companies Act defines a public offer of shares or debentures. A public offer or invitation includes an offer or invitation to a section of the public. Section 67(3) further provides that no offer or invitation shall be treated as made to the public if the offer or invitation can properly be regarded, in all circumstances (a) as not being calculated to result, directly or indirectly, in the shares or debentures becoming available for subscription or purchase by persons other than those receiving the offer or invitation; or (b) otherwise as being a domestic concern of the persons making and receiving the offer or invitation: Provided that nothing contained in this sub-section shall apply in a case where the offer or invitation to subscribe for shares or debentures is made to fifty persons or more. A private placement is not defined in the Companies Act but is generally understood as an issue of securities that does not amount to a rights issue or a public offer.

2.3.3

Preferential Allotment 2.4 A public offer and a private placement could involve the issue of shares to persons who are not existing shareholders of the company. Under Section 81(1A) of the Companies Act any issue of shares to persons who are not existing shareholders of the company can only be done if a special resolution is passed by the company in general meeting17. Further, the Unlisted Public Companies (Preferential Allotment) Rules, 2003 (Preferential Allotment Rules) govern such issues by unlisted public companies if the issue falls within the definition of preferential allotment. Prior to 2011, the Preferential Allotment Rules defined a preferential allotment to include issue of shares on preferential basis and / or through private placement made by a company pursuant to a special resolution passed under Section 81(1A) of the Companies Act and issue of shares to promoters and their relatives either in public issue or otherwise. In 201118, the Preferential Allotment Rules were amended and a new definition of preferential allotment was inserted which provided that preferential allotment means allotment of shares or any other instrument convertible into shares including hybrid instruments convertible into shares on a preferential basis pursuant to Section 81(1A) of the Companies Act: Provided that the name, fathers name, address and occupation of persons to whom such allotment is proposed to be made shall be mentioned in the resolution passed by the members under that sub-section: Provided further that persons to whom such offer is proposed, shall not be more than forty-nine as per the first proviso of Section 67(3) of the Companies Act. A new Rule 8 was also introduced by the 2011 amendment, sub-rule (2) of which provided that any offer or invitation not in compliance with Section 81(1A) of the Companies Act read with Section 67(3) of the Companies Act will be treated as a public offer and the provisions of SCRA and the SEBI Act must be complied with. Thus, post the 2011 amendment it became clear that the Preferential

Section 81(1) of the Companies Act lays down the conditions for a rights issue. Please note that Section 81 of the Companies Act applies at the earlier of (i) two years from the formation of the company; or (ii) at any time after the expiry of one year from the allotment of shares in the company made for the first time after its formation. 18 The amendments took effect on 14 December 2011.
17

16

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9 November 2012

Allotment Rules would not apply to a public offer, which would need to comply with the requirements of SCRA and the SEBI regulations promulgated pursuant to the SEBI Act. Prospectus 2.5 A prospectus is defined in the Companies Act to mean any document described or issued as a prospectus and includes any notice, circular, advertisement or other document inviting deposits from the public or inviting offers from the public for the subscription or purchase of any shares in, or debentures of, a body corporate19. Under Section 56 of the Companies Act a prospectus issued by or on behalf of a company must contain various particulars specified in Schedule II of the Companies Act. Issued generally is defined to mean in relation to a prospectus, issued to persons irrespective of their being existing members or debenture holders of the body corporate to which the prospectus relates. Further, Section 56 of the Companies Act does not apply to (a) the issue to existing members or debenture holders of a company of a prospectus or form of application relating to shares or debentures of the company, whether such persons have a right to renounce or not; or (b) the issue of a prospectus or form of application relating to shares or debentures which are in all respects uniform with shares or debentures previously issued and dealt with on a recognized stock exchange. From these provisions, it appears clear that a public offer of shares or debentures requires the issue of a prospectus which fulfills the requirements of Section 56 of the Companies Act unless such offer falls within the specifically excluded categories. A prospectus must be dated and such date, unless the contrary is proved, is taken as the date of publication20. On or before the date of publication of a prospectus it must be registered with the Registrar21. The penalties for mis-statement in a prospectus are dealt with by Sections 62 and 63 of the Companies Act while the penalty for fraudulently inducing persons to invest in a company is contained in Section 68 of the Companies Act. IM and RHP under Section 60B of the Companies Act 2.6 Section 60B (1) of the Companies Act22 provides that a public company making an issue of securities may circulate an information memorandum to the public prior to filing of a prospectus. An information memorandum is defined as a process undertaken prior to the filing of a prospectus by which a demand for the securities proposed to be issued by a company is elicited, and the price and the terms of issue for such securities is assessed by means of a notice, circular, advertisement or document23. Further, the company inviting subscription by an information memorandum must file a red-herring prospectus24 at least three days before the opening of the offer. A red-herring prospectus does not have complete particulars on the price of securities offered and the quantum of securities offered25. The information memorandum and red-herring prospectus carry the same obligations as are applicable to a prospectus. Upon closing of the offer of securities, a final prospectus stating the total capital raised and the closing

19 20

Section 2(36) of the Companies Act. Section 55 of the Companies Act. 21 Section 60 of the Companies Act. 22 This provision was inserted by the Companies (Amendment) Act, 2000 w.e.f. 13 December 2000. 23 Section 2(19B) of the Companies Act. 24 The section is not clear on who the red herring prospectus must be filed with. In A Ramaiya, op. cit., p. 958 the author states that a red-herring prospectus must be filed with SEBI for a listed public company and with the Registrar for an unlisted public company. 25 Explanation to sub-sections (2), (3) and (4) of Section 60B of the Companies Act.

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9 November 2012

price of securities and any other incomplete details in the red-herring prospectus must be filed with SEBI and the Registrar for a listed public company and the Registrar for an unlisted public company26. The Preferential Allotment Rules as amended also provides that a fresh issue or offer cannot be made unless the final prospectus has been filed in terms of Section 60B(9) of the Companies Act for an earlier offer or invitation. Mandatory listing requirement under Section 73 of the Companies Act 2.7 Under Section 73 of the Companies Act every company intending to offer shares or debentures to the public for subscription by the issue of a prospectus must, before such issue, make an application for listing of such shares or debentures to one or more recognized stock exchanges27. The company has ten weeks from the closure of the subscription lists to get permission from the stock exchanges28. Failure to dispose the application within this period is deemed a refusal of permission29. Where such an application has not been made or permission has been refused by the stock exchanges, the company is required to forthwith refund money received from applicants within eight days of the relevant date failing which the company and every officer in default is liable to refund the money with 15% interest for the period of delay30. SCRA 2.8 Based on the interpretation of marketable securities of a like nature in the definition of securities in Section 2(h)(i) of the SCRA, it has been held that SCRA would only apply to public companies, whether listed or not, and not to private companies31. The provisions of SCRA regulate the formation and operation of recognized stock exchanges, which power is concurrently held by the Central Government and SEBI, listing of securities, dealings in securities including what constitutes a valid contract in securities and measures to prevent undesirable speculation in securities, and penalties for violation of SCRA. Section 28(1)(b) of SCRA provides that the SCRA would not apply to any convertible bond or share warrant or any option or right in relation thereto, to receive shares from the issuer company or its shareholders, whether by conversion of the bond or warrant or otherwise, on the basis of a price agreed at the time of issue of the bond or warrant. SEBI Act 2.9 Under the SEBI Act, SEBI is entrusted with the duty to protect the interests of investors and to promote and regulate the development of the securities market by such measures as it deems fit including, without limitation (a) regulating the business in stock exchanges and any other securities market; (b) registering and regulating the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees, registrars, merchant bankers, underwriters, investment managers and other market intermediaries; (c) registering and regulating various

26 27

Section 60B(9) of the Companies Act. Section 73(1) of the Companies Act. 28 Section 73(2) of the Companies Act. 29 Section 73(5) of the Companies Act. 30 Section 73(2) of the Companies Act read with Rule 4D of the Companies (Central Governments) General Rules and Forms, 1956. 31 Norman J Hamilton v. Umedbhai S Patel, MANU/MH/0066/1979; [1979] 49 CompCas 1(Bom).

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9 November 2012

other entities like foreign institutional investors, credit rating agencies, etc. (d) registering and regulating venture capital funds and mutual funds; (e) prohibiting fraudulent and unfair trade practices relating to the securities market; (f) prohibiting insider trading; (g) regulating takeovers, etc. In discharge of its functions, SEBI is given wide powers of enforcement including suspending trading of any security on an exchange, restraining persons from accessing the securities market, etc32. Under Section 11A of the SEBI Act, SEBI may (i) without prejudice to the Companies Act specify, by regulations, matters related to the issue of capital, transfer of securities, disclosure requirements, issue and content of prospectus and matters incidental thereto; and (ii) without prejudice to SCRA, specify the requirements for listing and transfer of securities. SEBI also has power to issue directions in the discharge of its functions33 and investigate the affairs of persons associated with the securities market34. Section 12A of SCRA specifies the general prohibition on manipulative and deceptive devices, insider trading and takeovers in compliance with the SEBI Act and rules and regulations passed there under. Chapter VIA of the SEBI Act lays down the adjudication process to be followed by SEBI for noncompliance with the SEBI Act and the penalties that may be imposed. Appeal from the decisions of SEBI under the SEBI Act lies to the Securities Appellate Tribunal (SAT) constituted under the SEBI Act35 with a final appeal to the Supreme Court from the decisions of SAT36. SEBI Regulations 2.10 Pursuant to the SEBI Act, SEBI has passed the following regulations among others: 2.10.1 SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (SEBI (ICDR) Regulations). These regulations lay down the issue and disclosure requirements for public issues, rights issues, preferential issues, bonus issues, qualified institutions placement (all by a listed issuer) and the issue of Indian Depository Receipts. Before the SEBI (ICDR) Regulations, SEBI (Disclosure and Investor Protection) Guidelines, 2000 (DIP Guidelines) applied; 2.10.2 SEBI (Issue and Listing of Debt Securities) Regulations, 2008 on the public issue of debt securities and the listing of debt securities on a recognized stock exchange; 2.10.3 SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to the Securities Market) Regulations, 2003. 2.10.4 SEBI (Prohibition of Insider Trading) Regulations, 1992; 2.10.5 SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011; 2.10.6 SEBI (Investor Protection and Education Fund) Regulations, 2009;

32 33

Section 11 of the SEBI Act. Section11B of the SEBI Act. 34 Section 11C of the SEBI Act. 35 Chapter VIB of the SEBI Act. 36 Section 15Z of the SEBI Act.

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2.10.7 Various regulations on registration and regulation of market functionaries like financial institutional investors, brokers, sub-brokers, merchant bankers, registrars to the issue, etc. 2.11 Based on the above provisions, the critical issue that came up before the Supreme Court was the scope of SEBIs jurisdiction and the consequent compliance requirements for issue of shares by a public company. The Sahara Case Facts 3.1 In Sahara India Real Estate Corporation Ltd. and Ors. v. Securities and Exchange Board of India and Anr.37, two unlisted public companies of the Sahara Group, Sahara India Real Estate Corporation Limited (SIRECL) and Sahara Housing Investment Corporation Limited (SHICL) had issued and allotted unsecured Optionally Fully Convertible Debentures (OFCDs) to approximately 3 crore investors and collected an amount of approximately Rs. 24,000 crores from such investors. 3.1.1 On 3 March 2008, the shareholders of SIRECL passed a special resolution pursuant to Section 81(1A) of the Companies Act for the issue of OFCDs on a private placement basis to friends, associates, group companies, workers / employees and other individuals connected with the Sahara Group on such terms as may be decided by the Board of Directors of SIRECL. A similar resolution was passed by the shareholders of SHICL on 16 September 2009. On 13 March 2008, SIRECL filed a red-herring prospectus (RHP) with the Registrar of Companies, Kanpur, Uttar Pradesh pursuant to Section 60B of the Companies Act for the issue of OFCDs on a private placement basis. The RHP stated that SIRECL did not intend to list the OFCDs on a recognized stock exchange and only the persons to whom the Information Memorandum was circulated could apply. The RHP was registered on 18 March 2008. Similarly, SHICL filed an RHP with the Registrar of Companies, Mumbai, Maharashtra on 6 October 2009, which was registered on 15 October 2009. After registration of the RHPs, SIRECL and SHICL issued information memoranda (IMs) along with application forms for private placement of OFCDs to various investors. The IMs carried a recital that they were private and confidential and not for circulation. The IMs also stated that the companies did not intend to get the OFCDs listed since the issue was a private placement and the offer should not be construed as a public offer. The issue of OFCDs by SIRECL commenced on 25 April 2008 and that of SHICL commenced on 20 November 2009. On 12 January 2010, while processing the RHP submitted by Sahara Prime City Limited, another company of the Sahara Group, for an initial public offer, SEBI discovered the issue of OFCDs by SIRECL and SHICL. A private complaint was also received in this regard by SEBI alleging the violation of various statutory requirements by SIRECL and SHICL.
37

3.

3.1.2

3.1.3

MANU/SC/0702/2012; (2012) 8 SCALE 101.

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SEBI then addressed letters to Ministry of Corporate Affairs (MCA) enclosing the complaint. SEBI also sought various details from the Sahara Group on the issue of OFCDs by its letter dated 12 May 2010. The Sahara Group consistently disputed the jurisdiction of SEBI under Section 55A of the Companies Act over the issue of OFCDs and correspondence was exchanged between the MCA, SEBI and the Sahara Group in this regard. The Sahara Group also stated that it would comply with the requirement to file a final prospectus under Section 60B(9) of the Companies Act to signify closure of the issue of OFCDs. After further requests for information by SEBI, the Sahara Group appears to have sent an encrypted CD to SEBI with details of the investors, which SEBI could not access. After the issue of notice by SEBI on 20 May 2011 and a detailed reply by the Sahara Group on 30 May 2011, the whole time member of SEBI passed its final order against SIRECL and SHICL on 23 June 2011 holding that the issue of OFCDs by these companies was a public issue under Section 67(3) of the Companies Act and not a private placement as contended and consequently various provisions of the Companies Act (including Sections 56 and 73) and the SEBI (ICDR) Regulations dealing with public issue of securities had not been complied with by the companies. SIRECL and SHICL were ordered to refund the money collected from the issue of OFCDs to the investors with interest. The appeal of SIRECL and SHICL to SAT was dismissed on 18 October 2011. Thereafter, SIRECL and SHICL filed appeals before the Supreme Court. Issues 3.2 On the above facts, the Supreme Court was called upon to decide whether (i) the issue of OFCDs by SIRECL and SHICL was a public issue under the Companies Act; (ii) in light of issue (i), SEBI had jurisdiction over the issue of such OFCDs; (iii) SEBIs order against SIRECL and SHICL to refund the money with interest to the investors was valid. Both Justice K.S. Panicker Radhakrishnan and Justice Jagdish Khehar decided in favour of SEBI in separately reasoned judgments and dismissed the appeal of SIRECL and SHICL. Judgment and Reasoning 3.3 The decision and reasoning can be summarized as follows: 3.3.1 The issue of OFCDs by SIRECL and SHICL was a public offer pursuant to the proviso to Section 67(3) of the Companies Act since the offer was made to more than forty nine persons. (a) Section 67(3) of the Companies Act is an exception to Sections 67(1) and 67(2) of the Companies Act. As a result of the proviso to Section 67(3) of the Companies Act, if an offer of shares or debentures is made to fifty or more persons, it would be deemed to be a public issue even if the requirements of Section 67(3)(a) or Section 67(3)(b) of the Companies Act are met. Justice Khehar also relied on Section 114 of the Indian Evidence Act to raise the presumption that the issue of OFCDs was an offer to the public since SIRECL and SHICL had willfully avoided furnishing information requested by SEBI on the issue of OFCDs. The presumption, therefore, was that if these companies had furnished the information to SEBI it would be detrimental to them. He also concluded that even without the application of the proviso to Section 67(3) of 9

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the Companies Act, the issue of OFCDs did not meet the requirements of Section 67(3)(a) and Section 67(3)(b) since there was nothing to show that it was a domestic concern of the investors and the OFCDs were transferable; (b) OFCDs were hybrid securities. The argument that since Section 67 used the phrase shares or debentures it would not apply to hybrid securities like OFCDs was not valid. No doubt, the Companies Act included hybrids in the definition of securities unlike the SEBI Act and SCRA. However, OFCDs are debentures which could become shares in future. The definition of debenture in Section 2(12) of the Companies Act includes debenture stock, bonds and any other securities of a company. The definition of securities in the Companies Act is derived from SCRA. Since the definition of securities in SCRA is inclusive and wide, OFCDs would be included and hence, would be debentures for the purposes of the Companies Act. This is also borne out by the fact that SIRECL and SHICL treated OFCDs as debentures in the IM, RHP, application forms and balance sheet. The argument that prior to the 2011 Amendment of the Preferential Allotment Rules, which introduced the proviso restricting the number of investors to forty nine in the definition of preferential allotment, the Preferential Allotment Rules permitted a private placement of securities by unlisted public companies pursuant to Section 81(1A) of the Companies Act without the restriction on the number of investors contained in Section 67(3) of the Companies Act was devoid of merit. Section 81(1A) of the Companies Act does not override the provisions relating to public issue in the Companies Act. The Preferential Allotment Rules do not apply to a public issue as described in Section 67(3) of the Act. These Rules as subordinate legislation cannot supersede the express provisions of the Companies Act. The 2011 Amendment only made what was implicit in the Preferential Allotment Rules explicit.

(c)

3.3.2

Since the issue of OFCDs by SIRECL and SHICL was a public offer, SEBI had jurisdiction over such an issue of OFCDs under Section 55A of the Companies Act. (a) OFCDs as hybrid securities fell within the purview of Section 55A of the Companies Act as also the SCRA and the SEBI Act. Therefore, SEBIs jurisdiction could not be questioned on this ground. Since Sections 56, 62, 63 and 73 of the Companies Act relate to issue of securities, SEBI had power of administration under these provisions pursuant to Section 55A of the Companies Act and separate regulations under Section 642(4) of the Companies Act were not required; The argument that Section 60B was outside the scope of Section 55A of the Companies Act thereby excluding SEBIs jurisdiction over an issue pursuant to Section 60B was invalid. Even though Section 60B of the Companies Act was not included in the bracketed portion after the reference to Section 81 in Section 55A of the Companies Act, Section 60B fell within SEBIs jurisdiction since Section 55A applied to Sections 59 to 81 implying all provisions in between irrespective of the bracketed portion. When certain provisions like Section 108A 10

(b)

(c)

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to 108I of the Companies Act were intended to be excluded from Section 55A reference was made to Section 108 and Section 109 separately and not to Sections 108 to 109. Consequently, SIRECL and SHICL should have filed the final prospectus with SEBI under Section 60B(9) of the Companies Act. Failure to do so would give rise to criminal consequences. 3.3.3 The issue of OFCDs must comply with the listing requirements in Section 73 of the Companies Act and Section 56 read with the SEBI (ICDR) Regulations. (a) Under Section 73(1) of the Companies Act, a company intending to offer shares or debentures to the public must apply to a recognized stock exchange for listing before the issue. Companies inviting subscription from over forty nine persons have no option or choice but to list their securities. After 2000, every private placement to fifty persons or more would be treated as an issue to the public. Therefore, SIRECL and SHICL were legally obliged to list the OFCDs from the moment the prospectus was issued. Merely because the process under Section 60B of the Companies Act was followed would not lead to an inference that Section 73(1) of the Companies Act need not be complied with. The companies cannot argue their lack of intention from statements made in the prospectus since their conduct clearly showed an intention to offer the OFCDs to the public. On the same lines as noted above, the Preferential Allotment Rules cannot override the requirements of Section 73(1); Pursuant to Section 56 of the Companies Act and the SEBI (ICDR) Regulations, the RHP for the OFCDs issued by SIRECL and SHICL should have contained a statutory declaration in terms to Part I of Schedule II of the Companies Act, which was absent. SIRECL and SHICL have also violated the disclosure requirements and investor protection requirements contained in the SEBI (ICDR) Regulations and its predecessor, the DIP Guidelines. The argument that the listing requirements would not apply to the OFCDs issued by SIRECL and SHICL since Section 28(1)(b) of SCRA excluded convertible bonds from the purview of SCRA thereby precluding any listing requirement for convertible bonds or debentures was without basis. Section 28(1)(b) did not exclude application of SCRA to convertible bonds but to the option attached to such bonds to receive shares. This provision became necessary since Section 20 of SCRA dealing with options was deleted in 1995.

(b)

(c)

3.3.4

There appears to be a pre-planned attempt on the part of SIRECL and SHICL to bypass the regulatory and administrative authority of SEBI. SEBI had adequate powers under Section 11A and 11B of the SEBI Act as well as Regulation 107 of the SEBI (ICDR) Regulations to order refund of the money with interest by SIRECL and SHICL to the investors in OFCDs.

4. 4.1

Implications of the Sahara Case The judgment in the Sahara case is clear and unequivocal. The approach of the Supreme Court was pragmatic and unswayed by technical distinctions and arguments related to the nature of 11

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securities and the scope of public issues. The scope of SEBIs jurisdiction over an issue of shares by an unlisted public company has thus been clarified. Propositions 4.2 From the judgment in the Sahara case the following important propositions can be postulated: 4.2.1 A private placement of securities pursuant to a preferential allotment under Section 81(1A) of the Companies Act, would only be outside the jurisdiction of SEBI if it is made to less than fifty persons and meets the requirements of Section 67(3)(a) or Section 67(3)(b) of the Companies Act. If it does, the Preferential Allotment Rules would apply; If a public company issues shares or debentures to fifty persons or more the offer would be a public offer pursuant to the proviso to Section 67(3) of the Companies Act. The term shares or debentures in this context would include any hybrid (having the features of both shares and debentures) as defined by Section 2(19A) of the Companies Act. In such a case, the public company must apply for listing to a recognized stock exchange under Section 73(1) of the Companies Act prior to the issue of shares or debentures. Further, any prospectus issued by the company must meet the requirements of Section 56 of the Companies Act. These requirements would not be affected if the company follows the process under Section 60B of the Companies Act and terms the offer a private placement in the offering documents like the IM and the RHP. SEBI would have jurisdiction over all public companies that make a public offer of shares or debentures under Section 55A of the Companies Act since such companies are required to list such shares or debentures under Section 73(1) of the Companies Act. The extent of SEBIs jurisdiction would be to the issue and transfer of securities and the non-payment of dividend by such companies. Therefore, public companies who make a public offer of shares or debentures must comply with the requirements of the SEBI (ICDR) Regulations and any other applicable SEBI regulation. If a company fails to meet the requirements of the Companies Act and the SEBI regulations as outlined above, SEBI can order refund of the money collected by the company to its investors with interest and impose sanctions in accordance with the provisions of the SEBI Act. The company could also be liable for civil and criminal sanctions under the Companies Act. A negative presumption can be raised against a company that fails to furnish information within its control to a regulatory authority when asked to do so.

4.2.2

4.2.3

4.2.4

4.2.5

Intention to List: Need for Objective Criteria 4.3 While the Sahara case is a positive development, one issue remains on which further judicial clarity would be welcome. Section 55A of the Companies Act gives SEBI jurisdiction over companies that intend to list in relation to the matters stated therein. Given the facts of the case, the judges in the Sahara case did not need to look into the parameters that would determine whether a company intends to list or not. Intention unsupported by action is always 12

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difficult to ascertain. In Kalpana Bhandari and Ors. v. Securities and Exchange Board of India and Ors.38, a division bench of the Bombay High Court considered a writ petition against SEBI. The petitioners were shareholders of Sesa Goa Limited (Sesa Goa), a listed entity. Sesa Industries Limited (Sesa Industries) was a subsidiary of Sesa Goa. The petitioners sought relief from SEBI for fraudulent representations made by Sesa Industries in relation to a preferential allotment of shares made by Sesa Industries to the petitioners. Counsel for the petitioners argued that based on various speeches by the Chairman of Sesa Industries and its Annual Reports, Sesa Industries intended to list its securities and was, therefore, within SEBIs jurisdiction under Section 55A of the Companies Act. SEBI resisted the petition on the ground that Sesa Industries had not made an application to list its securities under the SCRA and rules framed thereunder and hence its intention to list was not manifest. Justice Lodha speaking for the Bench upheld SEBIs contention and observed: The approach of SEBI cannot be faulted. Even the learned Counsel for the petitioners did not dispute the criteria applied by SEBI is not relevant. However, the learned Counsel for the petitioners submitted that every year the Chairman in his speech in the annual general meeting, expressed companys intention to have their shares listed at the recognized stock exchanges. The intention is always a question of fact and unless the opinion of regulatory body on this aspect is palpably perverse and grossly erroneous, it would not be proper for the Court in extraordinary jurisdiction to interfere with such opinion of regulatory body. Moreover not a single resolution of the Board of Directors has been placed on record by the petitioners to indicate that the Board of Sesa Industries took decision to have their securities listed at the recognized stock exchanges. Besides that the yardstick applied by SEBI that by making an application to recognized stock exchange, the intention of the company to have its securities listed at recognized stock exchange is manifested cannot be said to be unreasonable. In the circumstances SEBIs stand that it has no jurisdiction in the matter cannot be said to be without basis. (emphasis supplied) The Court further observed that SEBIs lack of jurisdiction would not leave the petitioners remediless since the petitioners could approach the Central Government to investigate the affairs of Sesa Industries pursuant to Section 55A of the Companies Act read with Section 237 of the Companies Act. The approach of the Bombay High Court in this case seems fair. However, the judgment does not definitively identify the criteria that would help determine whether a company intends to list or not. The standard of proof to prove a companys intention to list should be reasonable and not overly restrictive since SEBI is the regulatory body responsible for investor protection and is supposed to be specially qualified for this purpose. Granted that mere management assurances may not be sufficient evidence of a companys intention to list but a formal decision by the Board of Directors of the company or its shareholders should suffice. This would be a more reasonable standard when compared to the requirement of an application under SCRA as contended by SEBI. Further, the judgment does suggest that a Board resolution to list could indicate an intention to list. It is hoped that the view of the Bombay High Court in this case is not the final word on the matter since the decision only examined whether SEBIs approach was reasonable. A more definitive judgment with objective criteria to determine a companys intention to list will go a long way in clearing up any confusion on the scope of SEBIs jurisdiction under the Companies Act.

38

MANU/MH/1065/2003; [2005] 125 CompCas 804(Bom).

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