By Jayant M. Thakur
Chartered Accountant
Finally, SEBI has
specifically recognised accounting frauds, manipulations and siphoning off of
funds in listed companies as offences. It sounds surprising that such acts were
not yet offences under Securities Laws and that the law-makers / SEBI took so
long, actually, several decades, to do this. Indeed, there have been rulings in
the past on such cases where parties have been punished. Now, however, such
acts attract specific provisions and will be punishable in several ways – by
penalty, debarment, disgorgement, even prosecution and more (vide amendment
to SEBI PFUTP Regulations dated 19th October, 2020).
The new provision is
broadly – albeit clumsily – worded. It is put within a strange context
in the scheme of the regulations. One would have thought that a separate and
comprehensive set of regulations would have been made to combat corporate
frauds just as, for example, in the case of insider trading cases, regulations
that would have given proper definitions, covered specific types of accounting,
financial and other corporate frauds, specified who will be held liable and
when, etc. Instead, the new provision has been introduced in the form of an Explanation
to a provision in a set of regulations which are generally intended to deal
with frauds and the like in dealings in securities markets. Interestingly, the
intention seems to be to give retrospective effect to this provision.
Certain
basic questions will need to be answered. What are the specific acts that are
barred? Who are the persons to whom these provisions apply? What is the meaning
of the various terms used? What are the forms of penal and other actions that
can be imposed against those who have violated these provisions? Is there a
retrospective effect to the new provision? Let us consider all these issues in
brief.
SUMMARY
OF PROVISION
The new provision, framed
as an Explanation, bars acts of diversion / siphoning / misutilisation of
assets / earnings and concealment of such acts. It also bars manipulation of
financial statements / accounts that would in turn manipulate the market price.
The principal provision is
Regulation 4(1) of the SEBI (Prohibition of Fraudulent and Unfair Trade
Practices relating to Securities Market) Regulations, 2003 (the PFUTP
Regulations). Regulation 4(1) prohibits fraudulent, manipulative and unfair
practices in securities markets. The newly-inserted Explanation to it says that
the acts listed therein (of diversion, siphoning off, etc.) are deemed to be such practices and thus
also prohibited.
What type
of acts are barred?
The following are the acts
barred by the new provision:
(a) ‘any act of diversion, misutilisation or
siphoning off of assets or earnings’,
(b) any concealment
of acts as listed in (a) above,
(c) ‘any device, scheme or artifice to manipulate
the books of accounts or financial statement of such a company that would
directly or indirectly manipulate the price of securities of that company’.
To which
type of entities do the bars apply?
The acts should be in
relation to those companies whose securities are listed on recognised stock
exchanges. This would cover a fairly large number of companies. The securities
may be shares or even bonds / debentures. The securities may be listed on any
of the various platforms of exchanges.
Who can be
punished?
The Explanation makes the
act of diversion, concealment, etc. punishable. Hence, whoever commits such
acts can be punished. Thus, this may include the company itself, its directors,
the Chief Financial Officer, etc. Any person who has committed such an act
would be subject to action.
How are
such acts punishable?
The provisions of the SEBI
Act and the PFUTP Regulations give SEBI wide powers of taking penal and other
actions where such acts are carried out. There can be a penalty of up to three
times the profits made, or Rs. 25 crores, whichever is higher. SEBI can debar
the persons from being associated with the capital markets. SEBI can order
disgorgement of the profits made through such acts. The person who has
committed such acts can also be prosecuted. There are other powers too.
ANALYSIS
OF THE ACTS COVERED
Acts of diversion /
misutilisation / siphoning off of the assets / earnings of the company are
barred. The terms used have not been defined. If read out of context, the term
diversion and misutilisation may have a very broad meaning. But taken in the
context of the scheme of the PFUTP Regulations and also the third term
‘siphoning’, a narrower meaning would have to be applied.
The act of concealment
of such diversion / misutilisation / siphoning is also barred by itself. The
word ‘concealment’ may have to be interpreted broadly and hence camouflaging
such acts in various forms ought also to be covered.
The third category has
three parts. There has to be a device, scheme or artifice. Such
device, etc. should be to manipulate the books of accounts or financial
statement of the company. The manipulation should be such as would directly or
indirectly manipulate the price of the securities of the company. Essentially,
the intention is to cover accounting frauds / manipulation. However, since such
acts should be such as would result in manipulation of the price of securities,
the scope of this category is narrower. A classic example would be inflating
(or even deflating) the financial performance of the company which would affect
the market price. The definition of ‘unpublished price sensitive information’
in the SEBI Insider Trading Regulations could be usefully referred to for some
guidance.
Taken all together,
however, the three categories cast the net wide and cover several types of corporate
/ financial frauds. There is no minimum cut-off amount and hence the provisions
can be invoked for such acts of any amount.
RETROSPECTIVE
EFFECT?
It appears that the
intention is to give retrospective effect to the new provision. The relevant portion
of the Explanation reads:
‘Explanation – For the removal of doubts, it is clarified that
any act of… shall be and shall always be
deemed to have been considered as manipulative, fraudulent and an
unfair trade practice in the securities market’ (emphasis supplied).
Thus, a quadruple effort
has been made to give the provision a retrospective effect. The amendment is in
the form of an ‘Explanation’ to denote that this is merely an elaboration of
the primary provision and not an amendment. The Explanation states that it is
introduced ‘for removal of doubts’. It is also stated to be a ‘clarification’.
It is further stated that the specified acts ‘shall always’ be said to be
manipulative, etc. Finally, it is also stated that these acts are ‘deemed’ to be
manipulative, etc.
While the intention thus
seems more than apparent to give retrospective effect, the question is whether
acts as specified in the Explanation that have taken place before the date of
the amendment would be deemed to be covered by the Regulations and thus treated
as fraudulent, etc.? And accordingly, whether the various punitive actions
would be imposed even on offenders who may have committed such acts in the
past?
Giving
retrospective effect to provisions having penal consequences is fraught with
legal difficulties. While siphoning off of funds, accounting manipulation, etc.
are abhorrent, there have to be specific legal provisions existing at the time
when such acts are committed and which prohibit them and make them punishable.
It may also be remembered that the Regulations are subordinate law notified by
SEBI and not amendments made in the SEBI Act by Parliament. Of course, the
amendments are placed before Parliament for review and for amendments to them,
if desired.
There is another concern.
When a fresh provision is introduced, a fair question would be that this may
mean that the existing provisions did not cover such acts. Hence, if the
retrospective effect of the provision is not granted, then there can be an
argument that the existing Regulation 4(1), which otherwise bans all forms of
manipulative and other practices, be understood as not covering such acts.
However, it is also
arguable that if the existing provision, before the amendment, was broad enough
to cover such acts, then there is really no retrospective effect. SEBI has in
the past taken action in several cases of accounting manipulation / frauds,
etc.
The Supreme Court has held
in the case of N. Narayanan vs. SEBI [(2013) 178 Comp Cas 390 (SC)]
that accounting manipulation can be punished by SEBI under the relevant
provisions of the SEBI Act / the PFUTP Regulations. In this case, SEBI recorded
a finding that the accounts of the company had been manipulated by inflating
the revenues, profits, etc. The promoters had pledged their shares at the
inflated price. SEBI had debarred the directors for specified periods from the
securities markets. On appeal, the Supreme Court did a holistic reading of the
SEBI Act along with the Companies Act, 2013 and held that such acts were subject
to adverse actions under law. However, it was apparent that the general objects
of the law, the generic powers of SEBI, etc. were given a purposive
interpretation and the SEBI’s penal orders upheld. Interestingly, the Court
even observed that, ‘…in SEBI Act, there is no provision for keeping proper
books of accounts by a registered company.’ Thus, while this decision is
authoritative on the matter, it was also on facts. There was thus clearly a
need for specific provisions covering financial frauds, accounting
manipulation, etc. The new provisions do seem to fill the gap to an extent, at
least going forward.
CONCLUSION
The
amendment does serve the purpose of making a specific and focused provision on
accounting and financial frauds that harm the interests of the company and its
shareholders and also of the securities markets.
However, there is also
disappointment at many levels. It took SEBI almost 30 years to bring a specific
provision. Arguably, such frauds are as much, if not more, rampant and serious
as most other frauds including insider trading. However, while insider trading
is given a comprehensive provision with important terms defined, several
deeming provisions made, etc., financial frauds have a clumsily drafted and
clumsily placed provision, almost as a footnote. Such frauds not only deserve a
separate set of regulations but also a specific enabling provision in the SEBI
Act and a provision providing for specific punishment to the wrongdoers.
Giving the provision
retrospective effect may appear to be well intended but it may backfire if
there is large-scale action by SEBI for past acts.
Nonetheless,
finally, despite the warts and all, our Securities Laws now do have a specific provision
covering financial frauds in listed companies. One can expect to see action by
SEBI on this front in the form of investigations and punitive orders against
wrongdoers.
