SEBI’s Order and findings in Zenith’s case again present many disturbing things (Order No. WTM/RKA/ ISD/11/2013 dated 25th March 2013). How Promoters can take out monies from the Company belonging to creditors and shareholders. How existing laws seem ineffective in their prevention, enforcement of action against them and in recovery of lost monies which could end up being a prolonged process. Thus, creditors have to wait a long time and spend a lot of efforts and monies before they can get some of their dues. How shareholders would lose their monies – like in Satyam – and may finally have only some satisfaction that the Promoters are punished. And how SEBI resorts to drastic and desperate orders which though may appear to be justified and directly resolving the issue, may be tough to implement and have shaky foundation. It is quite possible considering certain related press reports that the role of Auditors here too may come under scrutiny. The audited accounts allegedly showed huge amount of liquid assets, which was higher than the liabilities but still the Company defaulted on its dues.
The unprecedented nature of the SEBI Order is that the SEBI has ordered the Board of Directors to give what is effectively a personal guarantee to SEBI, for an amount to cover those funds that have been used for purposes other than for which approval of shareholders was given.
Facts as per Order of SEBI
The Zenith case has been in the news for more than a year now. But a brief summary of the allegations leading to this Order may be worth recounting. It appears that Zenith was not in a position (despite supposedly having large liquid assets in its balance sheet) to repay the first tranche of its FCCBs that had become due for repayment. This, incidentally, caused default of 2nd of FCCBs tranche too on account of acceleration clause. To meet these liabilities, the Company approached shareholders for obtaining their approval for raising large sums of monies by borrowings and through sale of its divisions. SEBI states in its Order that the Company specifically communicated to shareholders that raising of funds through this manner was for repayment of FCCBs. Pursuant to this, the Company sold a division. This sale was in a fairly convoluted way for reasons not clear from the Order. More curiously, this also involved a series of related party transactions. Apparently, the division was first sold to a related party where the Promoters had a 60% stake. It appears (if one reads this Order with certain press reports), the division was eventually sold to a foreign entity.
However, the net sale proceeds of $ 48 million even through this route were not wholly and directly received by the Company. They were only partly received by the Company and the rest by a foreign subsidiary. Zenith received $21 million while the foreign subsidiary received $ 27 million. The Order states that such amount was paid to the foreign subsidiary “as consideration for Software & Intellectual Property Rights of MSD Division held by it”. A further consideration in the form of 15% of shares of another Company with the value of such shares, as stated by Zenith, was $7.4 million, was paid, again, to the foreign subsidiary.
Even after receipt of monies, these were used for payment mainly to related parties for purposes not wholly clear, for payment to creditors (not FCCBs holders) and purchase of capital assets. In other words, as SEBI alleges, not a rupee was paid to FCCBs holders.
Worse, SEBI alleges that the Company made several misleading/false statements and omissions though eventually it admitted the facts. The share price halved twice, once till the date of Company making disclosure and again after such date. In barely a few months, the price of the shares reduced from 190 to 45.
There were other allegations of false disclosures/ non-disclosures under the listing agreement, the SEBI Insider Trading Regulations, etc. Legal proceedings by the FCCBs holders for winding up, etc. are before the court.
Order of SEBI
SEBI passed an interim order directing two things. Firstly, it banned the specified Promoters from accessing the capital markets and dealing in securities.
Secondly, it directed the Board of Directors of the Company to give a bank guarantee in favor of SEBI within 30 days for the amount of $ 33.93 million allegedly diverted for uses other than repayment of FCCBs. The guarantee shall be valid for at least one year during which SEBI may invoke it to compensate the Company in case of adverse findings.
As is discussed later, the Board is not allowed to use the assets of the Company for giving this guarantee making it like a personal guarantee. As the Order states, the Board shall give such guarantee “without using the funds of ZIL or creating any charge on assets of ZIL”.
Effectiveness of laws in such situations
The manner in which the transactions were carried out raises questions once again as to the effectiveness of laws relating to companies. The Company allegedly used funds for purposes other than for what the shareholder approved. However, the consequences of this are curious. Firstly, this does not necessarily mean that the transactions carried out are null and void. Secondly, it is arguable that such transactions can be ratified in a subsequent general meeting and since the Promoters held 64% shares, this should have been easy. Thirdly, the punitive consequences under the Act on the Company, its Board and the Promoters are not stringent. This is of course assuming that the payments were genuine and not diversion/siphoning off of the funds as SEBI alleges. SEBI states:-
“…I note that the promoters/directors of ZIL have in a devious manner attempted to take away the assets of a listed company directly and indirectly for their own benefit or for benefit of entities owned and controlled by them. Such conduct of promoters /directors not only defeats the whole purpose of seeking shareholders’ approval for crucial decisions but also jeopardises the integrity of the securities market.”
However, even if there was diversion/siphoning off, there are no quick remedies for recovery of the monies, repayment to creditors and punishing the directors/promoters concerned.
The provisions concerning related party transactions again get highlighted. The restrictions on them seem flimsy in law and even flimsier in enforcement. Often, companies may get away by mere disclosure.
Direction to the Board of Directors to give guarantee
Coming to the SEBI direction for bank guarantee, many things are curious. Does SEBI have the power in the circumstances to direct the Board to give such a bank guarantee without using the Company funds? On first impression, this appears not only justified but the only appropriate way. The shareholders had authorised the Board to use the sale proceeds for repayment of FCCBs. However, they were used for other purposes. Thus, the Board ought to compensate the Company and for this purpose, giving a bank guarantee that SEBI may invoke to compensate the Company or perhaps directly the FCCBs holders may make sense. Nonetheless, several questions arise.
• Firstly, does SEBI have such powers at all? The powers are to be seen from several angles. Whether SEBI has the have power to punish/ remedy a violation of a provision of the Companies Act, 1956? Whether it has the power to direct the Board of Directors in this manner?
• Secondly, can it direct the Board of Directors as a whole without making a specific finding that it was they who approved such uses of funds? Or that they were negligent in monitoring the use of such funds?
• Thirdly, why not allow the Company, at least as an alternative, to get the funds back? Why insist only on a guarantee?
• Fourthly, even if assuming that the funds were used for other purposes, what if such uses were genuine? For example, if the funds were used for payment to creditors, acquisition of capital assets, etc. There are no findings on record thatthese were bogus, just that these purposes were not for which the Company took approval.
• Fifthly, what if the Company had (and still can, though this is highly unlikely now) obtained ratification of shareholders which, considering the 64% holding of Promoters, would have been quite easy?
• Sixthly, is an Order to the Board as a whole without making a finding of role of the Promoters on one hand and the non-promoter directors on the other, fair and valid? How would it be enforced and punitive action taken, if they are unable to provide such a guarantee? Will the liability be joint and several?
Role of Auditors
While the Order, perhaps because it is directed towards role of the Board, does not discuss the Auditors’ role, if any. However, several press reports had stated that as per the audited accounts, the Company had huge amount of liquid assets, which was more than the total liability under both the tranches of the FCCBs. The Company still defaulted and in fact proposed to raise further funds.
While the SEBI Order does not discuss this, the memory of the Satyam’s case is too recent and one remembers how a large amount of liquid assets shown in that case turned out to be not genuine. One will have to see whether there are any problems in this case too and the implications on this on the role of the Auditors.
All in all, this case, assuming many of the allegations are found true, presents a murky and sordid state of affairs in listed companies and the ineffectiveness of laws, even though they are many and complex.
The case is likely to result in further developments soon, since SEBI has provided post-decision hearing and SEBI may pass a revised order. 30 days are given to the Board to furnish this guarantee and it is possible that they are unable to so provide. It appears quite likely that the Promoters/ Board may appeal to SAT. It will be worth seeing whether this case creates good precedents in law for keeping malpractices in check or it again shows that the action and remedies will be prolonged and perhaps finally ineffective for some or all of the parties who have lost money.
