By Jayant M. Thakur
Chartered Accountant
BACKGROUND
Three
consecutive recent rulings of the Securities Appellate Tribunal (SAT) have
placed limitations on the powers of SEBI to pass interim / ex parte
orders which restrain parties from accessing stock markets, require them to
deposit allegedly illegal profits in escrow accounts, etc. These precedents
also lay down guidelines and specify the circumstances under which such powers
may be exercised by SEBI and hence will help other parties obtain relief when
faced with similar arbitrary orders passed based on little or no credible
evidence. One of the decisions of SAT has been affirmed by the Supreme Court on
facts.
SUMMARY
OF RELEVANT LAW
SEBI does have
wide powers to pass penal, remedial and other orders / directions against those
who have been found to have committed violations of securities laws. Such
violations may include fraud on markets, insider trading, front-running, etc.
SEBI may pass orders to disgorge illegally made profits. However, there may be
concerns that while the investigation and due process is ongoing, the parties
may continue the frauds or other violations. They may even transfer the assets,
illegally made profits, etc., in such a way that their recovery later may not
be possible. SEBI has powers to pass interim orders to prevent such things from
happening and thus may restrain parties from continuing such violations,
transfer assets, etc. SEBI may also pass interim orders to impound the
estimated amounts and require that such monies be deposited in an escrow
account pending final orders of disgorgement.
Such interim
orders may be passed after giving an opportunity of hearing, or even without
such opportunity which may instead be given after the interim order. The
interim order in the case may be confirmed, modified or reversed after the
hearing. If confirmed, it may stay in place till the investigation is
completed, show cause notices issued to parties and after giving due opportunity
to respond, including a personal hearing, and then a final order may be passed.
Such interim
orders may be of various types and SEBI has wide general and specific powers in
this regard. SEBI may prohibit a person from accessing the securities markets.
It may prohibit a person from dealing in securities in such markets. It may
impound the proceeds or securities in respect of transactions that are under
investigation. Usually, such orders to impound such amounts are accompanied by
orders to freeze assets of such persons till such impounded amounts are duly
deposited in escrow accounts.
However, orders
that stop access to or stop dealing in securities markets may be economically
fatal. The amounts directed to be impounded may be far higher than the actual amount
later found to be correct, or may be directed on the wrong persons. Depositing
of such amounts at such short notice may be difficult or even impossible.
Considering that such orders are usually accompanied by directions freezing the
assets of parties, the effects may be even more far reaching.
Such orders are
also indefinite in nature in the sense that there is no statutory outer time
limit by which time the final orders have to be passed. Thus, the restrictions
may continue indefinitely. It is no solace to the parties if it is found later
that they have not committed any violations, or no or a lower amount can be
disgorged. At best, the amounts in the escrow account would be returned with
the minimal bank interest paid by nationalised banks, the parties being allowed
to resume their activities.
As the three
case studies summarised here will show, the orders have been arbitrary with
harsh consequences which SAT had no hesitation in setting aside or modifying.
In one case where the interim order has been finally disposed of, SEBI has
actually reversed the order stating that no purpose would be served in issuing
such interim directions. The Supreme Court affirmed the view that such orders
can be passed only in urgent cases, which the facts must bear out.
Case 1 – Cases
relating to ‘trading in mentha oil contracts’ on a commodity exchange
A unique
concern of commodity exchanges is the cornering of the market in a commodity by
a person / group. Such dominance may result in price distortion which could
also harm other participants in the market. In this case, SEBI had concerns
that a group of parties had accumulated a substantial percentage of mentha
oilstock [North End Foods Marketing (P) Ltd. vs. SEBI (2019) 105 taxmann.com
69 (SAT)]. It was prima facie believed that this was done to
manipulate the mentha oil market and dominate the price of mentha oil futures.
SEBI passed an interim order prohibiting the parties from dealing in or
accessing the securities markets and from being associated with it.
The parties
filed an appeal before SAT which recorded several findings. It noted that there
was no prima facie finding that the parties had accumulated large
quantities of mentha oil or that they had dominated the market. There was
merely suspicion to that effect. Further, no urgency was found for passing of
such orders. In any case, the order was passed at a much later stage when the
execution of trades was over and the facts did not show the alleged
manipulation. SAT thus set aside the said interim order.
This decision
of SAT has become a precedent for future cases and lays down guidelines,
restrictions and also circumstances under which such interim orders may be
passed.
At the outset,
SAT recognised that SEBI has wide powers to pass such orders. SAT also
confirmed that the opportunity to respond / of personal hearing may be given
later. That said, SAT noted that such orders can have serious consequences and
hence have to be passed only in urgent cases and sparingly. In particular,
there has to be prima facie evidence and finding of wrong-doing and its
continuance. Since none of this was present in the present case, SAT set aside
the order.
SAT observed, ‘In our opinion, the respondent is empowered to
pass an ex parte interim order only
in extreme urgent cases and that such power should be exercised sparingly.
In the instant case, we do not find that any extreme urgent situation existed
which warranted the respondent to pass an ex parte interim order. We
are, thus, of the opinion that the impugned order is not sustainable in the
eyes of law as it has been passed in gross violation of the principles of
natural justice as embodied in Article 14 of the Constitution of India.’
Interestingly,
SEBI, after the interim order was set aside, re-examined the matter and
confirmed that there was no urgency or purpose served for passing the interim
directions. Hence, it desisted from passing any fresh interim order and also
vacated the interim order against those who had not gone in appeal. The
investigations, of course, continue.
Case 2 –
Alleged insider trading case
SEBI found that
the Managing Director of Dynamatic Technologies Limited (DTL) had sold some
shares during a time when it was alleged that there was unpublished
price-sensitive information of reduced profits. SEBI computed the reduction in
market price after such information was made public and accordingly computed
the losses allegedly avoided which amounted to Rs. 2.67 crores. SEBI added
interest thereon from such date and passed an interim order that an aggregate
amount of Rs. 3.83 crores be impounded and accordingly deposited by such person
in an escrow account. Till such time as this amount was so deposited, his
accounts were frozen.
The MD appealed
to SAT. SAT applied its own ruling in the North End Foods case (Supra),examined
the basic facts and noted that the sale of shares was in 2016. The
investigation commenced in 2017 and the interim order was passed in 2019. No
evidence was put forth on how the appellant had tried to divert the alleged
notional gains. SEBI in its order had expressed a mere possibility of diversion
of such gains. SAT affirmed that such orders can be passed only if there is
some evidence to show and justify the action taken. Accordingly, SAT set aside
the direction but it asked the appellant to file a reply within four weeks and
that SEBI shall give a personal hearing and thereafter pass a final order
within six months. However, SAT also required the appellant to give an
undertaking that he shall not alienate 50% of his holding in the company
[Dr. Udayant Malhoutra vs. SEBI (2020) 121 taxmann.com 326 (SAT)].
SEBI appealed
to the Supreme Court against the SAT order and the Court affirmed the decision
on facts [SEBI vs. Udayant Malhoutra (2020) 121 taxmann.com 327 (SC)].
It affirmed the view of SAT that such orders could be passed only in urgent
cases. Since the facts of this case did not demonstrate such urgency, the Court
refused to interfere with the SAT order.
Case 3 –Prabhat
Dairy Limited
In this case the company had sold its holding in its subsidiary and a
unit to another company. The sale proceeds were substantial and the company
had, while seeking approval of shareholders for such sale, stated that it will
use the net proceeds for distribution to its shareholders in an appropriate
form. It appears that such distribution was delayed. In the meantime, the
promoters of the company, who held about 51% shares, proposed to acquire the
shares held by the public and thereby de-list the shares of the company. This
de-listing proposal was approved by 99.13% of the shareholders and the
application was pending disposal by stock exchanges / SEBI.
SEBI received
complaints about this and there were media reports, too. SEBI asked stock
exchanges to examine the matter; the exchanges expressed some concerns and also
recommended appointment of a forensic auditor. The primary concern was whether
the proceeds may have been diverted.
SEBI appointed
a forensic auditor who inter alia reported that several matters of
information / documents were not made available to them. The company responded
that inter alia the pandemic had slowed down responses. SEBI,
considering all these factors, passed an interim order directing the company to
deposit Rs. 1,292.46 crores, being sale proceeds less certain adjustments /
expenses, in an escrow account. Since this direction was not complied with in
the time given, SEBI attached the bank / demat accounts of certain promoters.
The company /
promoters appealed to SAT. SAT found several issues with the SEBI order. It
noted that SEBI itself had recorded that a sum of Rs. 1,002 crores was already
lying in fixed deposits. Secondly, SEBI had ordered the whole sum of Rs.
1,292.46 crores to be deposited in an escrow account when the fact was that
more than half of it would go to the promoters who held about 51% shares. The
de-listing offer itself could have resulted in an attractive price paid to
public shareholders. Mandating deposit of such an unreasonably high sum in the
escrow account would cause severe disruption in the company and bring it to its
knees. It also found issue with the fact that SEBI had kept the de-listing
application on hold.
Taking all this
into account, SAT ordered the company to deposit Rs. 500 crores in an escrow
account which would not be used till the forensic audit was completed and SEBI
gave a decision regarding distribution of the amount and / or the de-listing
application. It directed the company to provide information to the forensic
auditor within ten days and he would thereafter give his report within four
weeks. SEBI was also directed to process the de-listing application within six
weeks. On deposit of the said Rs. 500 crores, the bank / demat accounts of the
promoters were directed to be defreezed (Prabhat Dairy Limited and others
vs. SEBI, order dated 9th November, 2020).
CONCLUSION
The series of
fairly consistent rulings of SAT has substantially settled the law relating to
the powers of SEBI to pass directions by interim orders. SEBI will have to
balance the interests of the securities markets / investors with the
inconvenience caused to those who are given such directions and also pass
orders in exceptional cases only where at least prima facie evidence is
available. Further, as the Supreme Court also affirmed, urgency for passing
such orders would have to be demonstrated.
However, it continues to be seen that such interim orders are being
passed and restrictions / impounding directed. Not all such parties can afford
to quickly approach SAT for relief. One hopes that SEBI itself will exercise
self-restraint and pass orders in accordance with the guidelines laid down by
the Supreme Court and SAT in their rulings.
