Introduction SEBI has recently levied the highest penalty in its history – a penalty of Rs.7,269 crore (more than $1 billion, to put it in a different way). The order is noteworthy not just for the fact that the maximum possible penalty under law has been levied, but for several other reasons. These include whether, even in the aggravated circumstances, does such a penalty make sense or is it arbitrary. This order is also noteworthy because the penalty has been levied jointly and severally on all the directors of the company, whether executive or non-executive, apart from the company itself.
The matter was of course serious. While more facts as laid down in the SEBI order will be discussed later, this case concerned Collective Investment Schemes (“CISs”) that have generally become the bane in India. Tens of thousands of crores have been collected from the public, either in blatant violation of the law or through regulatory arbitrage. The stated purpose of such schemes is rarely the actual purpose. The amounts are often collected with the help of well-paid commission agents who promise high returns to investors, the monies collected are usually squandered and when the ponzi schemes, which they usually are, come to a dead end, nothing much is left for the investors/depositors. Thus, the violators need to be punished strictly. Let us examine the facts of this case as stated by SEBI, the contentions of the parties and also the reasoning that SEBI has been given to levy the huge and maximum penalty.
Background and facts of the case
CISs have been in existence for a number of decades. For some reason, though there are several existing laws and though the law makers and SEBI made further specific laws to regulate / prohibit them, CISs seem to proliferate and collect monies in ever increasing amounts. Perhaps the promoters were emboldened by the relatively ambiguous laws and poor enforcement/punishment, which was prevalent till very recently. To regulate what CISs usually do, that is collecting monies in various forms by promising high returns, there are several and strict laws framed by SEBI, Reserve Bank of India, state governments, etc. However, multiple laws have resulted not only in multiple regulators but sector specific laws that enable, for determined persons, to find regulatory gaps.
Thus, a large number of “CISs” operating in India rarely accept deposits openly or investments which would straightaway fall foul of the laws framed by the Reserve Bank of India/Securities and Exchange Board of India. They, instead, create a camouflage of an apparently bonafide activity for which monies are raised. The earliest of examples were of so-called plantation companies. While some of the early ones did carry out plantation activity and linked the investments made with the planation, they were followed by companies that engaged in such activities only by appearance. Many of these latter companies claimed that they were collecting monies for sale of plants, which, when they grow, would result in high appreciation. They provided farming and similar services. Thus, on paper at least, they sold (or rented) plots to investors and also plants. They claimed to provide services to manage these plants and eventually cut and sell them at a profit. On paper, the plants and returns thereon, high or low (or even negative) belonged to the investors, after paying the service charges. In reality, it was usually found that fixed returns were promised. What is more, there did not exist plants/land corresponding to the amount paid by the “investors”. Thus, while the “investors” paid for specific/ earmarked plants, no such specific/earmarked plants existed. Usually, even in aggregate, the number of total actual plants with the companies were far smaller than the number of plants “bought” by investors. Thus, once the camouflage of plants was removed, the business was more or less of collecting deposits. SEBI has been recently passing orders in large numbers against such companies on the ground that they violated the various provisions of Securities Laws relating to CISs.
The present case, as per the SEBI order, is also of a similar type, though the amount collected is huge. It was claimed by PACL it was in the business of selling and developing plots of land. A person interested may buy a specific plot at a particular amount. PACL would then develop it and then transfer it to the buyer or sell it and pay the proceeds to the buyer. On paper, this would sound like an ordinary case of investment in property. However, on inquiry into facts, SEBI found that this was not so. The cumulative finding and conclusion was that the whole scheme was not of sale/development of land but a CIS.
The background of the litigation and the developments in law are also worth a review. The proceedings against PACL were going on since almost two decades. Securities Laws were first amended specifically relating to CISs in 1995. There have been progressive developments including framing of regulations relating to CISs, which required, inter alia, existing and new CISs to register with SEBI and comply with various stringent requirements. Action has been taken against various CISs that were in contravention of the regulations. Generally, the vires of these laws/amendments have also been upheld by the Supreme Court.
The amendment specifically relevant for the present case were made as late as in 2013 and these are the provisions that have formed the basis for levy of penalty. Regulations 4(2) of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (“the FUTP Regulations) was amended to include the following clause making illegal mobilisation of funds by CISs to be deemed to be a fraudulent/unfair trade practice.
“4. Prohibition of manipulative, fraudulent and unfair trade practices
(1) Without prejudice to the provisions of regulation 3, no person shall indulge in a fraudulent or an unfair trade practice in securities.
(2) Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice if it involves fraud and may include all or any of the following, namely:—
…
(t) illegal mobilization of funds by sponsoring or causing to be sponsored or carrying on or causing to be carried on any collective investment scheme by any person.” The result was that various forms of action, including levy of penalty, could be taken against persons who indulged in such activity.
Interestingly, the amendment was made with effect from 6th September 2013. In the present case, thus, SEBI investigated into and made a finding of the amount collected from 6th September 2013 to June 15, 2014 (since SEBI did not have exact figures for the broken period in September 2013, it took the proportionate amount from 1st October 2013). It thus concluded that the amount collected during this period was Rs.2,423 crore.
Section 15HA of the SEBI Act, 1992, deals with violations of the FUTP Regulations. It reads as under:-
“Penalty for fraudulent and unfair trade practices. 15HA. If any person indulges in fraudulent and unfair trade practices relating to securities, he shall be liable to a penalty which shall not be less than five lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of such practices, whichever is higher.”
This provision is the basis for levy of the penalty in the present case.
SEBI’s Order
SEBI made several findings pursuant to which it conclud-ed that PACL was engaged in the business of a collective investment scheme and not dealing in and development of land as it claimed. Thus, it held that the company had committed fraudulent/unfair trade practices as specified in Regulation 4(2)(t) of the FUTP Regulations. SEBI also took a view that a case of this type deserved the high-est amount of penalty. Thus, it levied the maximum pos-sible penalty permissible u/s. 15HA, viz., three times the amount of profits made or Rs.25 crore, whichever is high-er. Since the amount collected was Rs.2,423 crore, SEBI levied a penalty of Rs.7,269 crore.
The penalty was levied jointly and severally on the com-pany and all its directors. Individual directors had given reasons why, for various reasons, penalty should not be levied on them. SEBI rejected these submissions.
Some observations
Considering that huge losses are made by the common man in such schemes, stringent action is needed and is inevitable. A large penalty would act, amongst other things, as a strong deterrent for others too.
Curious, however, is the manner in which the penalty was determined. SEBI has stated that the amount of Rs.2,423 crore represents the gross amount collected by PACL. In other words, this represents the amount “invested” or deposited by the public. Section 15HA, however, provides for penalty of “three times of profits made”. There is no finding as to what were the costs and what were the net profits made. There does not appear to be any finding on whether any amount was been refunded and whether the amount represents gross or net collections.
Levying penalty on the basis of gross collection sounds arbitrary for another reason. The company has collected Rs.2,423 crore. Thus, though the underlying facts are not on record, this would be the total and maximum funds available with the company as assets. In reality, considering also that the SEBI order refers to commission paid to agents out of such collection, and considering other costs, the net amount actually available with the company would be much less. To levy a penalty of three times this amount thus sounds arbitrary and unrealistic since there is no possibility of a company which has available a fraction of the gross amount collected, to pay an amount three times the gross amount collected.
Interestingly, as is evident from other orders of SEBI/SAT on the company, the amount collected by the company in earlier years and the assets available with them have been referred to. It appears that the assets available are a small fraction of the amount totally collected. Hence, it appears, even if one were to add the fresh collections made, the company does not have any net assets. In any case, SEBI has already directed that these earlier collections should be promptly refunded.
All the directors too are made jointly and severally liable to the penalty. No finding or distinction has been made on the role of individual director including the special role, if any, by the non-executive directors.
It will have to be seen whether such penalty is at all recovered or it just remains on paper. It will also have to be seen whether such order is upheld, for reasons as stated above, in appeal. If it is reversed, it would do injustice not only to the investors in PACL but investors in other CISs too.
In any case, the order will have to be welcomed at least as a deterring example to would be CISs and generally other entities that commit such frauds/unfair trade practices.
