By Jayant M. Thakur
Chartered Accountant
Background
In August 2017, SEBI issued
directions to Stock Exchanges to severely restrict trading in the shares of
certain companies. SEBI had received a list of 331 companies from the Ministry
of Corporate Affairs (“MCA”). It appears that the reason for this restriction
is that these companies were shell companies (i.e., having no substantive
operations) and may have been used for money laundering post demonetisation in
November 2016. The directions caused severe distress to these companies and
their shareholders, and some of the companies appealed to the Securities
Appellate Tribunal and got relief. SEBI’s directions were remarkable, have
far-reaching impact and involve issues of law, and hence, it is worth
discussing and understanding these directions.
Overview of what happened
SEBI stated that it had
received a list of companies from MCA that were allegedly shell companies
(which apparently compiled the list after taking inputs from other authorities
such as SFIO). The list included listed companies.
In the ordinary course of
business, stock exchanges do place restrictions on trading of companies. Under
stock exchange regulations, depending on what is suspected (which may include
disproportionate rise in price/trading without underlying fundamentals),
restrictions in trading are placed. These restrictions progressively increase
by levels till the most restrictive level VI is reached. At this stage, trading
is allowed only once a month, with the price being the last traded price. Thus,
increase or decrease in price is not possible.
The
buyer is also required to pay 200% margin for five months as deposit with the
stock exchange. There are other restrictions also. Needless to say, while this
is marginally better than total delisting/suspension of listing, however, for
all practical purposes, trading in shares of such companies drops to virtually
zero. In the ordinary course, it is for the stock exchange to decide the level
of restrictions.
However, in the present
case, SEBI issued a directive to stock exchanges to place all these companies
at level VI. Exchanges are bound to obey such directions. Thus, trading was
effectively stopped and it could be done only in the restricted manner
mentioned earlier. The directions also imposed restrictions on `off market
transactions.’
Curiously, SEBI did not
clarify that the authorities that had forwarded the list had required SEBI to
place restrictions on all companies. It appears that MCA wanted SEBI to
investigate and thereafter take action. It also appears that not all the companies
were listed on stock exchanges! Hence, even SEBI had to ask the exchanges to
first check the list to find out which of the companies are listed and then
take action.
Factually, many of the
companies were large profitable companies with considerable operations and
active trading. Trading in their shares on exchanges suddenly ceased. These
companies had no choice but to urgently approach the Securities Appellate
Tribunal (“SAT”). Appealing to SAT could have been difficult, because of the
manner in which the directions were given. However, SAT gave prompt relief,
staying the orders in case of companies which appealed and ordered SEBI to
investigate and give opportunity to the said companies to present their case.
The
present status is that except for the handful of companies that appealed and
got a stay, trading in the remaining listed companies stands suspended.
Directions issued against the shell
companies
The
following extract from the directions dated 7th August 2017 of SEBI
to stock exchanges make clear what was ordered:-
“Trading in all such listed securities shall be placed in Stage VI
of the Graded Surveillance Measures (GSM) with immediate effect. If any listed
company out of the said list is already identified under any stage of GSM, it
shall also be moved to GSM stage VI directly. Under the Stage VI of GSM,
trading in these identified securities shall be permitted to trade once in a
month under trade to trade category. Further, any upward price movement in
these securities shall not be permitted beyond the last traded price and
Additional Surveillance Deposit of 200% of trade value shall be collected from
the Buyer which shall be retained with Exchanges for a period of five months.
Exchanges shall initiate a process of verifying the
credentials/fundamental of such companies. Exchanges shall appoint an
independent auditor to conduct audit of such listed companies and if necessary,
even conduct forensic audit of such companies to verify its credentials/
fundamentals.
On verification, if Exchanges do not find appropriate credentials/
fundamentals about existence of the company, Exchanges shall initiate the
proceedings for compulsory delisting against the company, and the said company
shall not be permitted to deal in any security on exchange platform and its
holding in any depository account shall be frozen till such delisting process
is completed.”
MCA had only suggested investi-gation by
SEBI, not orders
In its defense before SAT,
SEBI made a plea that it was required by the Ministry of Corporate Affairs to
pass such directions. This contention was rejected by SAT. Even otherwise, it
was held that SEBI cannot blindly follow directions of MCA. SEBI, being an
entity bound by the SEBI Act, could not issue such directions without following
due process prescribed under the SEBI Act. SAT also noted that MCA had merely
required SEBI to investigate such companies, whether they were shell companies,
etc. and to take action, if required under law.
Issue of directions as a circular which
could be non-appealable
SEBI took an interesting
mode of taking action against such companies. In the ordinary course, it would
examine the facts of each company, notify and put the facts before them, make
specific allegations and ask them to explain their side before passing an
order. In extreme cases, SEBI can even pass interim ex parte order and
could grant the company a post-order hearing. But, even such orders would
require at least basic investigation and also be a speaking order.
Instead, SEBI directly
issued directions to stock exchanges requiring them to put the companies on the
highest restriction level. The result of this was that – the companies faced
restrictions just as they would have under a direct order on them. It seems,
SEBI did that to avoid an overturning of its order by claiming protection under
a recent decision of the Supreme Court (in NSDL vs. (2017) 5 SCC 517,
discussed in an earlier article in this column) that administrative orders
cannot be the subject matter of appeal. Thus, the only course of action against
such directions would have been a writ petition to the High court.
When the companies appealed
to SAT, SEBI contended that such directions being of administrative nature,
were not appealable as held by the Supreme Court.
However, SAT rejected this
contention. The following observations of SAT are relevant in this regard:-
“4. We see no merit in the preliminary objection raised by SEBI.
In the case of NSDL (Supra) the Apex Court after considering the scope of the
expression ‘administrative orders’ held that in that case the administrative
circular issued by SEBI was referable to Section 11(1) of SEBI Act and hence
falls outside the appellate jurisdiction of this Tribunal.
…
6. Thus, the impugned communication is not a general direction
given by SEBI to the three stock exchanges in the interests of investors or
securities market as contemplated u/s. 11(1) of SEBI Act, but a specific
direction given in respect of only 331 listed companies which MCA suspected to
be shell companies. Moreover, specific direction given in the impugned
communication prejudicially affects the interests of only those companies
covered under the list of 331 companies identified by the MCA as ‘suspected to
be shell companies’. Therefore, in the facts of present case, the impugned
communication of SEBI which has serious civil consequences cannot be said to be
an administrative order. In other words, the impugned communication which
prejudicially impairs the rights and obligations of the appellants, its
promoters and directors would fall in the category of a quasi judicial order
and hence appealable before this Tribunal u/s. 15T of SEBI Act.
7. It is contended on behalf of SEBI that appeal u/s. 15T of SEBI
Act is maintainable only against an order passed by the Board or the
Adjudicating Officer of SEBI and therefore, the impugned communication issued
by the Chief General Manager of SEBI is not appealable u/s. 15T of SEBI Act. We
see no merit in the above contention, because, it is admitted by counsel for
SEBI during the course of arguments that the impugned action was approved by
the WTM of SEBI on 28.07.2017 and only thereafter on 07.08.2017, the Chief
General Manager has issued the impugned communication. Since the impugned
communication which is approved by the WTM of SEBI seeks to suspend the trading
in the securities of the appellants, on day to day basis the impugned
communication is in effect referable to a quasi judicial order passed u/s.
11(4) of SEBI Act and not an administrative order passed u/s. 11(1) of the SEBI
Act. Accordingly, we see no merit in the preliminary objection raised by SEBI.”
Whether matter was urgent?
SEBI often passes interim
orders before concluding investigation to ensure that status quo is
maintained. In the instant case, SAT rejected the view that there was an
urgency. SEBI received the letter from MCA dated 9th June 2017, but
issued directions after nearly two months.
Striking off of names of companies by
Registrar of Companies
A similar action against
allegedly shell companies was initiated earlier by the respective Registrar of
Companies of various states. However, due process of law was followed whereby a
notice was issued, giving reasons as to why their names were sought to be
struck off and an opportunity was given to the companies to respond.
Reportedly, such companies were more than 2.50 lakhs in number. However, SEBI,
did not issue any such notice.
What laws have such companies violated?
An interesting question
that arises is: What Securities Laws have such companies violated, even if it
was found that they were guilty of money laundering? Though SEBI does have wide
powers to issue orders, generally they are passed where Securities Laws are
violated, or to protect interests of investors, etc.
If there was any money
laundering, the company and its directors could face action under appropriate
law. However, that may not enable SEBI to pass orders under the
Securities Laws. In particular, if restrictive orders are passed, it is the
public shareholders of such companies who may get affected probably for no
fault of theirs as it happened in the instant case. Earlier, in cases where it was alleged that price manipulation
and other wrongs was carried out for helping parties to earn tax free long term
capital gains, there were several grounds to take action under Securities Laws.
However, in the present case, it is not evident on the face of it as to what
action SEBI could take.
Conclusion
This is an
example of arbitrary action by SEBI. The prices of the shares of the companies,
even of those who got a stay order, crashed. There was no formal investigation
as required by law and no hearing was granted before or after such directions.
While the companies who rushed to SAT got a stay, the SAT has not granted a
stay for operation of the directions on all companies. Even the route adopted
by SEBI of issuing directions to stock exchanges with a hope that it cannot be
appealed against was not justifiable. The silver lining in all this is how
SAT promptly distinguished the decision of the Supreme Court and thus created a
precedent for questioning SEBI’s orders.
The
concerns about abuse of corporate form for money laundering and other crimes
and even of listing remain. However, a well thought out strategy would be
needed to ensure that the action hits those entities who engage in such
activities – and them only.
