Category: Corporate And Other Laws

(1) A recent decision of the Supreme Court throws light on
important issues relating to the SEBI Takeover Regulations. Some core concepts
of the Regulations such as ‘persons acting in concert’ and ‘persons deemed to be
acting in concert’ are interpreted. It is important to note the reliance placed
by the Supreme Court on the reports of Expert Committees for interpretation. The
decision is in the case of Daiichi Sankyo Company Limited v. Jayaram
Chigurupati & Others, C.A. No. 7148 of 2009, dated July 8, 2010.

(2) Of course, the real issue that was in dispute before the
Court, though interesting, has application in rare cases. It concerns a
situation where a listed company was acquired by another listed company and the
latter company, within a short time, got itself acquired by another company. The
question before the Court related to the pricing for the open offer of the
shares of the first company and the interpretation of the legal provisions
applicable to such a situation. Such quick and sequential takeovers do not
happen often and hence that part of the decision may have limited application.
But the other aspects have wider importance.

(3) Let us then broadly understand the facts, the relevant
provision of law and the issue, and then know what the Supreme Court held.

(4) The facts are quite simple. Ranbaxy Laboratories Limited
(‘Ranbaxy’), a listed company, agreed to acquire a significant stake in Zenotech
Laboratories Limited (‘Zenotech’), another listed company paying a price of
Rs.160 per share. As required under the Regulations, it made an open offer @
Rs.160 which was also the price as per the formula under the Regulations.
However, within six months, the Promoters of Ranbaxy agreed to sell more than
15% shares in Ranbaxy to Daiichi @ Rs.114 (rounded off) per share. Eventually,
Daiichi got more than 51% stake in Ranbaxy, thereby making Ranbaxy its
subsidiary. Daiichi thereby acquired indirectly more than 15% stake in Zenotech.
Hence, as required by law, Daiichi made an open offer for shares of Zenotech at
a price Rs.114. Shareholders of Zenotech, including its erstwhile Promoters,
complained to SEBI that the open offer should have been @ Rs.160 and not Rs.114.
As will be seen later on, particularly after considering the decision of the
Securities Appellate Tribunal (‘SAT’), the point at issue was that since the law
deems holding-subsidiary companies to be deemed to be acting in concert with
each other and since the law requires that price paid by a person acting in
concert to be taken into account, the open offer should be Rs.160 as paid by
Ranbaxy.

(5) The law relating to open offer pricing of such ‘indirect’
acquisitions, i.e., acquisition of shares of a listed company which in
turn controls another listed company, is as follows.

(6) Shredded of irrelevant complexities, it can be said that
when a listed company acquires another listed company indirectly, then it has to
make an open offer for the shares of the company in which such indirect
acquisition has been made. For the purposes of pricing of the open offer, the
law requires that, inter alia, the price paid by the acquirer or any
persons acting in concert with it during the preceding 26 weeks has to be taken
account of and if such price is higher, then such higher price shall be the open
offer price.

(7) In the present case, Daiichi acquired Ranbaxy. However,
it was during the preceding six months to this that Ranbaxy had acquired the
shares of Zenotech @ Rs.160. The law deems a holding and its subsidiary to be
acting in concert with each other. The issue thus was that since Daiichi and
Ranbaxy were deemed to be acting in concert and since Ranbaxy had acquired
shares of Zenotech @ Rs.160 during the preceding six months, whether such higher
price of Rs.160 should be the open offer price by Daiichi ?

(8) SEBI rejected the complaint by the shareholders of
Zenotech that such higher price should have been the open offer price. Such
shareholders appealed to the SAT, who held that the open offer should have been
at Rs.160. It held, in essence, that one has to consider the situation on the
date with reference to which the price formula of preceding 26 weeks was to be
applied. As on this date, Ranbaxy was a subsidiary of Daiichi. Thus, they were
deemed to be acting in concert. Since the law requires that acquisition by
persons acting in concert be taken into account, the SAT held that the higher
price of Rs.160 paid by Ranbaxy should be the open offer price.

(9) The matter reached the Supreme Court. The Supreme Court
considered, inter alia, the history of the provisions and numerous
provisions not just relating to indirect acquisitions, but even related and
incidental provisions.

(10) It held that, firstly, the persons acting in concert
have to actually come together to acquire the shares of a target company. There
has to be an agreement (or understanding, etc.) to acquire shares and such
shares should be of the target company.

(11) Further, the provisions deeming certain connected
persons (such as holding-subsidiary companies in this case) as persons acting in
concert does only that — i.e., it deems that they are acting in concert.
It does not deem that they have been acting in concert for acquiring shares of a
listed company and this would have to be established. Importantly, even the
provision that deems certain related persons as acting in concert has a
clarification that this deeming provision is subject to the contrary being
established.

(12) The Court gave its understanding of the term ‘person
acting in concert’ as follows :

“. . . . the concept of ‘person acting in concert’ under
Regulation 2(e)(1) is based on a target company on the one side, and on the
other side two or more persons coming together with the shared common objective
or purpose of substantial acquisition of shares, etc. of the target company.
Unless there is a target company, substantial acquisition of whose shares, etc.
is the common objective or purpose of two or more persons coming together, there
can be no “persons acting in concert“. For, de hors the target
company the idea of ‘persons acting in concert’ is as irrelevant as a cheat with
no one as victim of his deception. Two or more persons may join hands together
with the shared common objective or purpose of any kind, but so long as the
common object and purpose is not of substantial acquisition of shares of a
target company, they would not comprise ‘persons acting in concert’.” (emphasis
supplied)

(13) The other condition it laid down for the term persons
acting in concert to apply in the context of the Regulations is, in the Court’s
words :

“The other limb of the concept requires two or more persons joining together with the shared common objective and purpose of substantial acquisition of shares, etc. of a certain target company. There can be no ‘persons acting in concert’ unless there is a shared common objective or purpose between two or more persons of substantial acquisition of shares, etc. of the target company. For, de hors the element of the shared common objective or purpose, the idea of ‘person acting in concert’ is as meaningless as criminal conspiracy without any agreement to commit a criminal offence. The idea of ‘persons acting in concert’ is not about a fortuitous relationship coming into existence by accident or chance. The relationship can come into being only by design, by meeting of minds between two or more persons leading to the shared common objective or purpose of acquisition of substantial acquisition of shares, etc. of the target company. It is another matter that the common objective or purpose may be in pursuance of an agreement or an understanding, formal or informal; the acquisition of shares, etc. may be direct or indirect or the persons acting in concert may cooperate in actual acquisition of shares, etc. or they may agree to cooperate in such acquisition. Nonetheless, the element of the shared common objective or purpose is the sine qua non for the relationship of “persons acting in concert” to come into being.”

(14) Thus, it noted that “. . . . mere fact that two companies are in the relationship of a holding company and a subsidiary company, without anything else, is not sufficient to comprise ‘persons acting in concert’. . . . . There may be hundreds of instances of a company having a subsidiary company, but to dub them as ‘persons acting in concert’ would be quite ridiculous unless another company is identified as the target company and either the holding company or the subsidiary make some positive move or show some definite inclination for substantial acquisition of shares, etc. of the target company.”

(15)    In the light of this explanation of the terms ‘persons acting in concert’ and ‘persons deemed to be acting in concert’ that the words ‘unless the contrary is established’ are to be understood.

(16)    The Supreme Court finally reversed the view of the SAT that the deeming fiction could apply retrospectively and thus, if a person was deemed to be acting in concert on a later date, such connection would apply to an earlier date too. It held, “…..the deeming fiction under sub-regulation (2) can only operate prospectively and not retrospectively. That is to say the deeming provision would give rise to the presumption, as explained above, only from the date two or more persons come together in one of the specified relationships and not from any earlier date. Thus, in the case in hand, the deeming provision under sub-regulation (2) would give rise to the presumption that Daiichi and Ranbaxy were ‘persons acting in concert’, provided of course the other conditions as explained above were also satisfied, only from October 20, 2008, the date on which Ranbaxy became a subsidiary of Daiichi and not before that. Hence, the purchase of Zenotech shares by Ranbaxy in January 2008 cannot be said to be by a ‘person acting in concert’ with Daiichi.”

(17)    The Supreme Court thus held that the Daiichi and Ranbaxy were not acting in concert when the shares of Zenotech were acquired by Ranbaxy. The latter development of the holding-subsidiary position cannot alter, factually or in law, the earlier unconnected position. The provision relating to determination of price did not apply retrospectively so as to change the status as on the date of acquisition. Thus, the price paid by Ranbaxy on a date when there was no relation with Daiichi was not to be applied for the open offer by Daiichi of Zenotech.

(18)    Importantly, the Supreme Court relied considerably on the background of these provisions as put forth in the Bhagwati Committee Report to understand the rationale of this provision as well as for its interpretation generally. The Court also recommended that delegated legislations such as the Takeover Regulations should have the ‘objects and purposes’ clause that Acts have.

The following is what the Court said:

“Before parting with the records of the case we would like to say that in arriving at the correct meaning of the provisions of the Takeover Code specially regulation 14(4) and 20(12), we were greatly helped by the reports of the two Committees headed by Justice Bhagwati. We mention the fact especially because as per the legislative practice in this country, unlike an Act, a regulation or any amendments introduced in it are not preceded by the “Object and Purpose” clause. The absence of the object and purpose in the regulation or the later amendments introduced in it only adds to the difficulties of the Court in properly construing the provisions of regulations dealing with complex issues. The Court, so to say, has to work in complete darkness without so much as a glimpse into the mind of the maker of the regulation. In this case, it was quite apparent that the 1997 Takeover Code and the later amendments introduced in it were intended to give effect to the recommendations of the two Committees headed by Justice Bhagwati. We were, thus, in a position to refer to the relevant portions of the two reports that provided us with the raison d’etre for the amendment(s) or the introduction of a new provision and thus helped us in understanding the correct import of certain provisions. But this is not the case with many other regulations framed under different Acts. Regulations are brought in and later subjected to amendments without being preceded by any reports of any expert committees. Now that we have more and more of the regulatory regime where highly important and complex and specialised spheres of human activity are governed by regulatory mechanisms framed under delegated legislation, it is high time to change the old practice and to add at the beginning the ‘object and purpose’ clause to the delegated legislations as in the case of the primary legislations.”

(19)    In conclusion, the decision is welcome as it clarifies and gives the final word on important concepts in Takeover Regulations. The considerable reliance of the Court on the Expert Committee Reports, albeit in the absence of ‘objects and purpose’ clause, increases the value of such reports generally for the student in securities laws. Of course, the irony is that this only increases the complexity of the law for such students. Now, they will have to read and know the recorded history of such law, in addition to the very voluminous bare text of the Act, Regulations, etc.

(20)    P.S.: As this article goes to press, SEBI has released the report on revising the Takeover Regulations and has recommended changes in, inter alia, the subject matter of this article. More on this in the next issue.

(1) Is levy of penalty for violation of securities laws
mandatory ? Is there no discretion to the Adjudicating Officer on whether or not
to levy penalty ? Are adjudication proceedings a mere formality ? Is intention
to commit the violation a totally irrelevant factor in determining penalty ?
And, finally, are all the preceding questions answered in the affirmative
by the Supreme Court ?

(2) In the past couple of years, SEBI has repeatedly levied
stiff penalties citing certain sentences mainly from a decision of the Supreme
Court. It is claimed that the Supreme Court has held that if one does not comply
with securities laws, levy of penalty is mandatory. Good intentions and other
mitigating factors are irrelevant. And that the Supreme Court had mandated SEBI
only to find whether a particular provision is violated or not and their job
ends there. They are then left with the only choice of levying a penalty —
usually a stiff one.

(3) One of the following sentences from two Supreme Court
decisions is invariably cited :

And, from another decision, :

(4) Amongst the numerous SEBI orders levying penalty citing
the above and, very often, doing nothing more, are Platinum Finvest Private
Limited – AO No. SD/AO/-46/2009, dated April 20, 2009 in which a penalty of
Rs.10 lakhs was levied for non-filing of certain reports regarding their
holdings, the order in Jayesh Waghela’s case dated June 23, 2009 where a penalty
of Rs.15 lakhs was levied and the order in Santosh Narvekar’s case levying a
penalty of Rs.25 lakhs.

(5) These Supreme Court decisions are also cited in ongoing
penalty proceedings and parties are sought to be persuaded that their
intentions, whether good or bad, are now irrelevant and adjudication proceedings
are a mere formality now. Penalty is a foregone conclusion. Considering that
typically SEBI has power to levy penalty of Rs.25 crores or even more and Rs.1
lakh per day of delay, parties find settling through consent orders a better
option rather than fight a battle that is lost to begin with since it amounts to
payment of penalty where otherwise penalty may not be warranted. Of course,
settling through consent order means that one is forced to accept a stiff
penalty.

(6) However, is it true that the above mentioned statements
are really what the Supreme Court has decided ? What was the
context in which it has said that ? What are the qualifications to such
statements ? What are the related observations ? What were the facts of these
decisions that led the Supreme Court to make these statements ? And, thus,
finally, what conclusions should one draw regarding the state of law on levy of
penalty for violation of securities laws ?

(7) To begin with, the Supreme Court has said exactly what
the SEBI orders say and what has been cited above. The Supreme Court has made
the above statements in Swedish Match AB v. SEBI, (122 Comp. Cas. 83 (SC)
(2004)) and SEBI v. Shriram Mutual Fund, [68 SCL 216 (SC)], respectively
(let us refer these decisions as Swedish Match & Shriram).

(8) It is worth reviewing these decisions briefly. However,
before we do that, let us consider the background of the issue.

(9) Violations under securities laws could be broadly and
loosely bifurcated between what are non-compliances of civil obligations and
what amounts to criminal violations. The former would typically involve civil
proceedings to levy penalty, etc., while the latter may result in prosecution.
Secu-rities Laws have numerous provisions that amount to civil obligations such
as requirements of filing of information and documents. When faced with penalty
proceedings for such non-filings, parties often argue that levy of penalty
requires that SEBI should prove that there was mens rea — i.e.,
guilty mind or intention. In other words, the argument was that a guilty state
of mind has to be proved and, further, the onus to prove it was on SEBI. If SEBI
could not establish mens rea, no penalty could be levied. As we will see
further, the decisions of Shriram and Swedish Match have settled the law by
holding that establishing of mens rea by SEBI is not a pre-condition for
levy of penalty.

(10) However, this is what the Supreme Court has said and
nothing further, if one reads the decisions as a whole, reads the same into
context and reads the qualifying and incidental statements.

(11) Since Shriram is the decision consistently cited, let us
review this decision. In that case, Shriram Mutual Fund was alleged (all
statements made in this article are allegations of SEBI and not necessarily
established to be true) to have repeatedly exceeded the trading limits placed on
mutual funds for dealings through associated brokers. Penalties were levied on
the mutual fund and the matter went finally to the Supreme Court. The Supreme
Court observed (incidentally the decision was ex parte) that this
violation was conclusively established. The question then was, when such
violation is conclusively established, does “imposition of penalty becomes a
sine qua non of the violation” ?

(12) The Supreme Court described the scheme of the Act and
particularly the framework for levy of penalty. It pointed out that various
factors were specifically laid down as relevant for consideration for
determination of the quantum of penalty, and that “The Legislature in its wisdom
had not included mens rea or deliberate or wilful nature of default as a
factor to be considered by the Adjudicating Officer in determining the quantum
of liability to be imposed on the defaulter”.

(13) It also pointed out that the provisions relating to
penalty contained in S. 15A to S. 15H, etc. provide that the violator ‘shall be
liable’ to penalty and therefore, it held that penalty is mandatory.
Incidentally, it was not brought before the Court that S. 15I which provides for
levy of penalty by the Adjudicating Officer specifically uses the words ‘he
may impose such penalty’ as he deems fit.

14) It further held that the provisions relating to penalty under the aforesaid Sections were ‘neither criminal nor quasi-criminal’ and were actually breaches of civil obligations. Thus, it held that “Therefore, there is no question of proof of intention or any mens rea by the appellants and it is not essential element for imposing penalty under SEBI Act and the Regulations.” This issue is thus well settled now.

15) The issue, however, is not whether mens rea has to be proved by SEBI or not. The issue is whether mens rea is wholly irrelevant as SEBI claims. Or that even absence of mens rea is irrelevant. Or that mens rea does not appear into the picture at all.

16) I repeat and submit that the only thing the Supreme Court has laid down is that there is no onus on SEBI to prove mens rea as a pre-condition to levy penalty. Violation is by itself sufficient to attract penalty. However, mens rea is certainly a factor to determine the quantum of penalty, when the penalty provided is within a range of amount. Further, I would even submit that absence of mens rea and presence of other mitigating factors should actually mean that SEBI should use its discretion not to levy any penalty at all. As one reads the decision further, this is actually what the Supreme Court has laid down.

17) One should also note the peculiar facts of the case which the Supreme Court specifically listed. Firstly, the offender was a mutual fund which is expected to know the law. Secondly, the facts showed that the mutual fund had repeatedly violated the law – as many as 12 times. The nature of the violation that was violated is also of interest. The mutual violated the restriction on not dealing through associated brokers beyond 5% – the intention of the restriction is obvious – the mutual fund should not farm out business of brokerage to group concerns beyond a specified limit. In fact, the mutual fund farmed out business even to the extent of 91% and 52% in a couple of cases.

18) It was also felt that when a knowledgeable mutual fund violates the limit, then ex facie, the violation    was intentional.

19) Importantly, the Supreme Court emphasised that the discretion of the Adjudicating Officer in levy of penalty and held that “the quantum of penalty is discretionary”.

20) It also held that “the respondents have wil-fully violated statutory provisions with impunity and hence the imposition of penalty was fully justified”. In other words, far from holding that intention or mens rea is irrelevant, it has actually given weight to the fact that the violation was wilful, made with impunity and this factor made the levy of penalty justified.

21) The Supreme Court further observed, “it has been established by the Adjudicating Officer as well as admitted by the respondents that there has been a conscious disregard of the obligation inas-much as the respondents were aware that they were acting in violation of the provisions of Regulations.”. In other words, while, to begin with, there was no onus on SEBI to establish mens rea as a pre-condition to levy penalty, the Court itself gave full weight to the fact that the violation was a conscious one, that the mutual fund was aware that they were acting in violation and, finally, the mutual fund itself admitted that they were so conscious and aware. Thus, mens rea was given its full and due weight as regards the quantum of the penalty and also as regards whether the discretion to waive penalty should be exercised or not. In the face of such words, it does not at all lie on SEBI to contend that mens rea is irrelevant.

22) I submit that discretion to levy penalty is actually discretion not to levy any penalty and the Supreme Court made observations confirming this position of law. The Supreme Court observed,” The facts and circumstances of the present case in no way indicate the existence of special circumstances so as to waive the penalty imposed by the Adjudicating Officer.” In other words, it, firstly, recognized that penalty can be waived, and that under special circumstances, it, should be waived. It then proceeded to discuss the various factors in that case that, on one hand justified a lesser penalty and on the other hand justified a higher penalty. An important adverse factor was whether the violation was made for benefit by the mutual fund.

23) The summary and essence of the decision – which strangely none of the SEBI decisions ever cite is beautifully and succinctly laid down in the following observation – “On particular facts and circumstances of the case, proper exercise or judicial discretion is a must, but not on a foundation that mens rea is an essential to impose penalty in each and every breach of provisions of the SEBI Act.”

24) It is in the above light, then, the words of the Supreme Court cited at the start of this article need to be reread. To repeat, the Supreme Court observed, “In our considered opinion, penalty is attracted as soon as the contravention of the statutory obligation as contemplated by the Act and the Regulation is established and hence the intention of the parties committing such violation becomes wholly irrelevant.” Thus, it is only for deciding the question whether penalty is to be levied or not that the intention is wholly irrelevant. However, for determining the quantum of penalty – from zero to Rs.25 crores – indeed for even waiving the penalty intention and mens rea are very much relevant. Indeed, the Supreme Court itself, in this very decision, repeatedly relied on the intention and mens rea.

25) Then let us consider the apparently even more drastic words of the Supreme Court that in Swedish Match’s case that, “The Board does not have any discretion in the matter and, thus, the adjudication proceeding is a mere formality. Imposition of penalty upon the appellant would, thus, be a forgone conclusion.”

26) Let us first consider the facts of this second case. To summarise them very briefly, in this case, the appellant was held to have violated the requirements of open offer and thus was required to make an open offer and also pay interest for the period of delay. The appellant, however, expressed concern that SEBI may levy penalty on them. The Supreme Court noted that the appellant was by the decision required to comply with all its obligations and, in fact, taking into account also the interest, the appellant was being made to pay a large amount. The Supreme Court had already decided the dispute of law before it as to whether the open offer was required to be made or not. The issue of penalty was not at all a matter of appeal. There was no order or even Notice of SEBI relating to penalty.

27) However, the concern arose on whether, after the appellant makes the open offer, SEBI may initiate penalty proceedings and even levy a penalty of Rs.25 crores. The appellant argued that SEBI cannot initiate such proceedings. SEBI rightly pointed out that this matter was not at all the subject matter of proceedings before the Supreme Court and therefore should not be discussed or decided.

28) It is in this light that the Supreme Court raised the concern that since the appellant is complying with its obligations and also even paying interest, should it also face penalty the levy of which is a matter of course. It also apparently referred to a peculiar wording of the law where the penalty leviable is exactly Rs.25 crores and not upto Rs.25 crores. It observed that in such a case, levy of penalty of Rs.25 crores would be ‘a foregone conclusion’ and the adjudication proceedings being reduced to a mere formality.

29) The Supreme Court thus directed that SEBI should not initiate penalty proceedings. It gave this direction by exercising its jurisdiction under Article 142 of the Constitution of India. In fact, it even stated specifically that “This may not, however, be treated to be a precedent”.

30) I submit that the issue as to whether levy of maximum penalty is automatic or not, and whether adjudication proceedings are required or not were not matters for consideration before the Supreme Court. Hence, at best, these were mere obiter dicta and not a considered decision on issues raised. With great respect, I would also state that the view that adjudication proceedings are now a mere formality is not correct. In any case, this decision was followed by Shriram which in fact laid down the objective factors for levy of penalty.

32) To conclude, unfortunately for SEBI, the Supreme Court has not made its job easy so that it needs only to establish the default to levy the maximum penalty. Adjudication proceedings are not a formality – at least not in the manner which SEBI would like us to believe. Far from ignoring the intentions of parties, SEBI will have to consider them. If it wants to levy very high penalties, it may even have to establish mens rea. It will have to consider other factors such as disproportionate gain, loss caused to investors and repetitive nature of the default. It will have to consider mitigating factors. Of course, all these will have to be put forth by the party – obviously SEBI may not go out of its way to help the party. And, in the right and special facts, SEBI will even have to exercise its judicious discretion to waive the penalty.
 
32) In other words, the presumption that has been invalidated is ‘no mens rea, no penalty’. But, there is no new rule that ‘mere violation = maximum penalty’.

1. It was a long-standing vision of SEBI that there should be
common regulations relating to all intermediaries not only as regards procedures
for registration but also for continuing matters such as restrictions and
punishment. That dream is finally achieved, though partly (and perhaps
anomalously) by the Notification of the SEBI (Intermediaries) Regulations, 2008,
on 26th May 2008.

2. SEBI had issued a consultative paper in July 2007 giving
the Draft Regulations for discussion. These Draft Regulations have now been
given the status of law.

3. To recap, we see today a multitude of regulations
providing for matters relating to registration, regulation and finally
reprimands and retributions. We have separate regulations for stockbrokers,
merchant bankers, bankers, registrars, etc. Each of these regulations provide
for substantially similar requirements. Such a multitude of regulations does not
merely make the law complex, but also results in conflicting provisions. Later,
amendments or innovations are often not updated at all places. Further, because
of separate regulations for each type of intermediary there also arises a need
for having common regulations for dealing with some aspects or provisions that
apply to all intermediaries. A good example of this is ‘enquiry and punishment’
for violations of law. A separate set of regulations for this purpose applicable
to all intermediaries was required. Yet another example is of certain
eligibility requirements for registration that are common to all intermediaries.
These too were required to be put into yet another set of regulations (the ‘Fit
and Proper’ regulations) since otherwise these provisions would have had to be
inserted in regulations for each category of intermediaries. Thus, the existing
multiple regulations became more complex and voluminous.

4. There was a need for having a common set of regulations
which deal with all common matters relating to all
categories of intermediaries. The common regulations would deal with :

The recently notified regulations do just that. In effect,
these regulations do not provide for anything new except for consolidation and
reduction of complexity and volume. However, the process goes beyond the effort
of mere compilation, as attempt has been made to remove inconsistency as well as
provide for common approach.