The Supreme Court has held that the diversion of funds raised through a preferential issue for purposes other than those disclosed in the explanatory statement to the shareholders is a fraudulent and unfair trade practice under Regulations 3 and 4 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (PFUTP Regulations). Such an act, being illegal and contrary to statutory regulations that are a matter of public policy, is void ab initio and cannot be subsequently legitimized or validated by a resolution of ratification passed by the shareholders.
Furthermore, the Apex Court clarified that initiation of separate proceedings by the SEBI’s Whole Time Member for remedial directions (like debarment from the market) and by the Adjudicating Officer for imposing monetary penalties on the same set of facts is permissible, as these authorities exercise distinct jurisdictions and powers under the SEBI Act.
A Two-Judge Bench comprising Justice J.B. Pardiwala and Justice K. V. Viswanathan observed that the funds raised through the preferential issue were immediately diverted for purposes not disclosed in the notice of the Extraordinary General Meeting (EoGM). This act was held to be a clear breach of Regulations 3 and 4 of the PFUTP Regulations. The Bench emphasized that the disclosure of objects for a preferential issue, as mandated by Regulation 73 of the SEBI (ICDR) Regulations, 2009, is of utmost significance as it influences the decisions of investors and stakeholders.
The Bench noted that the definition of ‘fraud’ under the PFUTP Regulations is broad and does not require deceit; it includes any act, omission, or concealment that induces another person to deal in securities. The immediate diversion of funds upon receipt indicated that the respondents had no intention of using the funds for the stated objects from the very inception, making the disclosure untrue and misleading. This also constituted a violation of Section 21 of the Securities Contracts (Regulation) Act, 1956 (SCRA) read with Clause 43 of the Listing Agreement, which mandates reporting of variations between projected and actual utilization of funds.
The Bench also found the reliance on Section 27 of the Companies Act, 2013, to be misplaced as it applies to a ‘prospectus’ for a public offer, not a private placement, which was the nature of the preferential allotment in this case. The Bench distinguished between private rights, which can be waived or ratified, and matters involving public interest and public policy, which cannot. Since SEBI’s regulations are framed to protect the rights of multiple stakeholders in the securities market, a violation of these regulations is a matter of public law and cannot be condoned by a private resolution of shareholders.
An act that is ultra vires the regulations is void and cannot be ratified, even with unanimous shareholder consent. The diversion was contrary to the PFUTP Regulations and disclosure norms, making it a plainly illegal act that could not be legitimized post-facto, added the Bench.
On the validity of parallel proceedings by the WTM and the Adjudicating Officer, the Bench found no fault in the parallel proceedings, noting that the two authorities were vested with different powers and operated in separate fields during the period in question. The Whole Time Member (WTM), exercising powers under Sections 11, 11(4), and 11B of the SEBI Act, had the authority to take remedial measures like restraining persons from the securities market to protect investors’ interests. In contrast, the AO had the power under Section 15HA to impose monetary penalties for fraudulent and unfair trade practices.
The Bench observed that at the time of the proceedings, the power to levy a penalty under Section 15HA was not vested with the WTM (it was vested later by the Finance Act, 2018). Therefore, the AO rightly stepped in to exercise the distinct jurisdiction of imposing a penalty, and this did not amount to double jeopardy or an impermissible overlap of jurisdiction.
Briefly, the respondent company, formerly known as Moryo Industries Limited, issued a notice for an Extraordinary General Meeting (EoGM) on September 3, 2012, for the allotment of up to 74,50,000 equity shares on a preferential basis to non-promoters. The stated objects of this issue were to fund capital expenditure, acquire companies, meet long-term working capital needs, marketing, set up offices abroad, and for other approved corporate purposes. Following a Special Resolution on October 1, 2012, the company raised a total of Rs. 15.87 Crores through preferential allotment to 42 entities between October 16, 2012, and November 8, 2012.
Immediately after receiving the funds, between October 17, 2012, and November 9, 2012, the company diverted the proceeds to purchase shares of other companies and grant loans and advances, contrary to the disclosed objects. On December 4, 2014, the Whole Time Member (WTM) of SEBI passed an ad-interim order restraining the company, its promoters, and directors from the securities market. Subsequently, on March 12, 2014, the company amended the objects clause of its Memorandum of Association (MOA) to include financing, investment, and share trading. Later, on September 29, 2017, the company passed a resolution purportedly ratifying the diversion of funds.
The Adjudicating Officer (AO) of SEBI issued a show cause notice on April 27, 2018, for violations of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (PFUTP Regulations). Further, on April 29, 2020, the AO imposed a monetary penalty of Rs. 70 Lakhs on the company for violating PFUTP Regulations and Rs. 30 Lakhs for violating the Securities Contracts (Regulation) Act, 1956 (SCRA). Additionally, penalties of Rs. 25 Lakhs each were also imposed on the Managing Director and a Director. On appeal, the Securities Appellate Tribunal (SAT), however, set aside the AO’s order, holding that the shareholders’ ratification validated the company’s actions.
Appearances:
Senior Advocate Navin Pawha, AOR M/s Ads Legal, along with Advocates Dhaval Mehrotra and Aditi Desai, for the Appellant
Amicus Curiae, Mahfooz Ahsan Nazki, along with Advocates Vivek Rajan D.B. and Hemant Gupta, for the Respondent
