SEBI’s jurisdiction over entities/transactions/GDRs outside India – Supreme court decides

Securities markets of India have significant connection with non-residents and foreign countries. Numerous nonresident investors invest in Indian securities. Indian companies regularly issue various forms of securities abroad. There are certain securities like GDRs that are issued, traded and redeemed/cancelled abroad. There are nonresident advisors who advise Indian companies. There are also non-residents who invest/trade in securities outside India or in India. Thus, there are numerous cases in which entities located out of India carry out transactions in India or in securities issued by Indian companies or advise Indian companies, etc. The question is does SEBI have jurisdiction over such foreign entities and/or foreign transactions in respect of such matters? And thus, can SEBI take action against such persons including lead managers even if they are not registered with SEBI? The Supreme Court has dealt with some of these issues.

The case is important for other reasons too. The matter related almost wholly to GDRs that are governed by the Reserve Bank of India through the Foreign Exchange (Management) Act, 2000 (FEMA) and Regulations issued thereunder. Thus, the submission made was that RBI should have sole jurisdiction over it. The decision of the Supreme Court in Vodafone International Holdings BV vs. Union of India and Another ((2012) 6 SCC 613) in respect of transactions abroad and their implications under tax was also discussed. Whether the principles laid down in that case would apply here was also considered.

Facts of the case
In the present case, the dispute before the Securities Appellate Tribunal (SAT ) as well as the Supreme Court was jurisdiction of SEBI. Though the minority dissenting decision of SAT had ruled also on the facts, the majority decision of SAT as also of the Supreme Court was purely on jurisdiction. Thus, neither had examined the findings of facts as also other allegations made by SEBI. However, it will still be necessary to understand what is SEBI’s contention in this regard.

SEBI alleged that a conspiracy was hatched to create a charade that GDRs were issued and duly subscribed by foreign institutional investors. Such a charade would eventually help the issuing company to raise funds and that too at a higher price. Investors in India would be impressed that foreign institutional investors had invested at a certain price in the GDRs issued by the company. Certain parties allegedly acting together took a loan from a bank for investment in the GDRs of the Indian company. The GDR proceeds were required by the loan agreement to be deposited with the same bank and were pledged for the purpose of the repayment of such loan. The company itself was alleged to be a party/signatory to such agreements. The GDRs were then converted into equity shares of the company by cancellation and such shares sold on stock exchanges in India to outside investors. This modus operandi was employed by the same persons in six companies. Such persons including the lead manager were located abroad. The net result was that investors in India were deceived by such conspiracy. SEBI thus took action under the SEBI Act as well as the SEBI (Prohibition of Fraudulent and Unfair Trade Practice Relating to Securities Market) Regulations, 2003 and debarred the lead manager and another person alleged to be primary persons behind the conspiracy from accessing the securities markets in India, rendering services in respect of securites in India, etc.

These parties appealed to SAT and raised the preliminary issue of jurisdiction of SEBI. The SAT by a majority decision held that SEBI had no jurisdiction in such a case. On appeal by SEBI, the Supreme Court reversed the order of SAT and restored the matter back to SAT holding that SEBI does have jurisdiction.

To arrive at its answer to this issue, the Supreme Court gave several reasons for its decision and interpretation of the law in this regard. These are discussed in the following paragraphs

Connection of GDRs with India
The submission made was that GDRs are created, traded and cancelled outside India – i.e., from “cradle-to-grave”, they are outside India. In that case, what is the connection with India which is required for an Indian regulator to exercise jurisdiction?

The Supreme Court identified the link as follows (emphasis supplied here and in later extracts):-

“Though it may appear that on the one hand underlying ordinary shares would be governed by the laws prevailing in India and the GDRs would be governed by the laws of the country in which such receipts are issued, the most relevant fact which is to be borne in mind is that the existence of GDRs is always dependent upon the extent of underlying ordinary shares lying with the Domestic Custodian Bank.”

GDRs could not be issued but for underlying shares in India. The issue of GDRs thus has close linkages with India and frauds, etc. in relation to GDRs and connected transactions in India would thus have concern with India.

Implications of a company being able to successfully issue GDRs
The Supreme Court highlighted the intangible aspect that investors associate with a company being able to issue GDRs. This of course goes to the core of the allegations. That the charade of issuing GDRs was made to give such recognition to the issuing company so that its shares will be bought and that too at higher prices. This aspect was recognized by the SAT as well in its minority decision.

GDRs are securities
For SEBI to have jurisdiction, an important issue is whether GDRs are “securities”. The other hurdle is that GDRs are issued abroad. The Supreme Court, considering the relevant definition of securities under the Securities Contracts (Regulation) Act, 1956 held that GDRs were securities. It observed that, “..even if GDR as such is not specifically referred to under the definition of `securities’ under Section 2(h) by virtue of sub-clause (iii) of the said section, any rights or interests in securities would also fall within the definition of securities.”.

Role of SEBI vis-à-vis protection of investors
GDRs have a base in and close connection with India. If there is a fraud, merely because the transactions were carried out outside India is not reason to disarm SEBI. In any event, the transactions that were entered into abroad were part of a total chain of transactions starting with issue of shares in India and culminating with transactions of securities in India. The Court observed:-

“Therefore, if there is going to be a false pretext or misleading information circulated with a view to lure both the foreign investors as well as Indian investors and in that process the very purpose of creation and trading in GDRs are found to be not true or bona fide, it cannot be said that simply because creation of such GDRs and its trading is in global market, SEBI should keep its mouth shut on the ground that it cannot extend its long statutory arm beyond Indian territory to control any such misdeeds deliberately committed with a view to defraud the Indian investors and thereby their interest in the investment of securities and its protection is at great stake.”

Applicability of FEMA does not prevent SEBI from exercising jurisdiction
A point strongly made was that GDRs are governed by the Foreign Exchange (Management) Act, 2000 and Regula-tions issued thereunder. It was even contended that this not only resulted in GDRs being solely governed by this law but it also gave the Reserve Bank of India exclusive jurisdiciton. Thus, SEBI has no jurisdiction, except purely in matters specifically stated in such law. The Supreme Court pointed out that these were two different issues. In particular, as far as frauds and the like were committed in respect of securities markets in India, SEBI did have juris-diction. The two regulators operate under different laws for different purposes and can thus act to further the objects of the respective laws they deal with.

Circumstances under which SEBI can exercise “extra-territorial” jurisdiction

It was claimed that SEBI was seeking to extend its powers beyond India. The transactions took place, and the parties were located, outside India. The question was whether action by SEBI in respect of such transactions/parties was extra-territorial and thus prohibited by law. Further, under what circumstances can SEBI exercise such powers.

Firstly, the decision in the case of GVK Industries Limited and another vs. Income Tax Officer and another – (2011) 4 SCC 36 was applied here. The following observations of the Supreme Court in that case were relied on:-

“…the Parliament may exercise its legislative powers with respect to extra-territorial aspects or causes, – events, things, phenomena (howsoever commonplace they may be), resources, actions or transactions, and the like — that occur, arise or exist or may be expected to do so, natu-rally or on account of some human agency, in the social, political, economic, cultural, biological, environmental or physical spheres outside the territory of India, and seek to control, modulate, mitigate or transform the effects of such extra-territorial aspects or causes, or in appropri-ate cases, eliminate or engender such extraterritorial as-pects or causes, only when such extra-territorial aspects or causes have, or are expected to have, some impact on, or effect in, or consequences for: (a) the territory of India, or any part of India; or (b) the interests of, welfare of, well being of, or security of inhabitants of India, and Indians.”

The “effects doctrine” was also applied. In other words, applying this doctrine, even if the transactions took place abroad, if the effect was that certain things prohibited by Indian law took place in India, the Indian regulator could have jurisdiction.The following observations in the case of Haridas Exports vs. All India Float Glass Manufacturers’ Assn. and Others – (2002) 6 SCC 600 were relied on and applied (emphasis supplied):-

“46. It is possible that persons outside India indulge in such trade practices, not necessarily restricted to the effectuation of prices within India, which have the effect of preventing, distorting or restrict-ing competition in India or gives rise to a restrictive trade practice within India then in respect of that re-strictive trade practice, the MRTP Commission will have jurisdiction. The counsel for the respondents is right in submitting that if the effect of restrictive trade practices came to be felt in India because of a part of the trade practice being implemented here the MRTP Commission would have jurisdiction. This “effects doctrine” will clothe the MRTP Commission with jurisdiction to pass an appropriate or-der even though a transaction, for example, which results in exporting goods to India at predatory price, which was in effect a restrictive trade practice, had been carried out outside the territory of India if the effect of that had resulted in a restrictive trade practice in India. If power is not given to the MRTP Commission to have jurisdiction with regard to hat part of trade practice in India which is restrictive in nature then it will mean that persons outside India can continue to indulge in such practices whose adverse effect is felt in India with impunity. A competition law like the MRTP Act is a mechanism to counter cross border economic terrorism. Therefore, even though such an agreement may entered into outside the territorial jurisdiction of the Commission but if it results in a restrictive trade practice in India then the Commission will have jurisdiction under Section 37 to pass appropriate orders in re-spect of such restrictive trade practice.”

The decision of Vodafone was cited to support the argument that without specific powers in the law, transactions could not be “looked through” to determine the alleged underlying transactions. The Supreme Court rejected this argument stating that SEBI had specific and adequate powers in law to examine such transactions of alleged frauds.

Conclusion

The ruling of the Supreme Court will surely have larger ramifications. Transactions/persons abroad will not be beyond SEBI’s long hand solely on the ground that SEBI cannot have extra-territorial jurisdiction. This would have implications not just for GDRs, but also for almost any type of transaction/person connected with securities markets in India directly or indirectly. However, the limits are also ob-vious and clear as per the decision. There will have to be connection to and implications in India of such transac-tions. The decision also would have to viewed in light of the special fact in this case – that the GDRs could not have been issued without underlying shares in India. The issue cycle of GDRs – even if cradle-to-grave as argued

– did have direct implications to the underlying shares as well as other shares in India. The fact that shares arising out of cancelled GDRs were sold in India was also a relevant factor.