Aquarter of a century regulating the securities market and numerous enforcement actions later, the Securities and Exchange Board of India (Sebi) is facing an existential question.
Are its sweeping powers under Section 11 of the Sebi Act within the framework of the Constitution of India? Or are they ultra vires?
Raising this question are senior journalists Prannoy Roy and Radhika Roy through their privately held firm RRPR Holding. The company, which is a promoter entity of the listed broadcaster NDTV, has moved the Delhi High Court challenging Sebi’s powers under Section 11 and 11 B, saying these violate Article 14 of the Constitution. It has pleaded to the court to either strike down these provisions altogether, or suitably read them down.
The writ comes after a show-cause notice issued by the regulator to RRPR for alleged non-disclosure of certain loan agreements dating back to 2008 and 2009 with ICICI Bank and Vishvapradhan Commercial. These agreements contained clauses that had implications for the control structure and minority shareholders of NDTV, according to Sebi.
ET Prime had written about this earlier.
RRPR had sought an interim stay. Alleging that Sebi is both “the prosecutor and the judge” under these sections, it argued that “The impugned provisions are purportedly remedial but can lead to devastating consequences,” adding Sebi had “unguided, unbridled, arbitrary and excessive and whimsical power” to initiate proceedings under Section 11, or let off someone with financial penalty.
The company feared that the powers to issue directions barring any person from the securities market would have a “serious and irreparable consequence of [the] widest amplitude”.
There is no guidance or safeguard mechanism provided under the act clarifying the cases where proceedings under the impugned provisions are to be initiated, and where only financial-penalty proceedings are to be initiated, the petition argued.
However, securities lawyers pointed out that regulations formed by Sebi under these sections provide for adherence to principles of natural justice, and that Sebi usually gives the noticees several opportunities to be heard before passing restrictive orders.
In the RRPR matter, Sebi first sought information through summons and allowed inspection of documents on two occasions. However, RRPR was not satisfied with the volume of documentation sought.
There have been challenges to the Section 11 provisions in the past. In a judgment in 2010, in the matter of Allcon Estate, the Rajasthan High Court had upheld Sebi’s powers.
In the judgment, the court had said the Sebi Act was “pre-eminently a social-welfare legislation seeking to protect the interests of common men who are small investors. A restrained order for some period from accessing the securities market and prohibiting buying, selling and dealing in security was not held to be a penalty. Looking to the object of the Sebi Act, provisions of Sections 11(4) and 11(B) of the Sebi Act impose a reasonable restriction in conformity to Clause (6) of Article 19 of the Constitution of India.”
“This is in the larger interest of the investors and to achieve the objects of the Sebi Act. In the light of aforesaid, we do not find that provisions of Sections 11(4) and 11(B) of the Sebi Act are violative of Article 19(1)(g) of the Constitution of India. Accordingly, challenge to the constitutional validity of the aforesaid provisions is not accepted. Thus, the provisions are held to be intra-vires,” the Rajasthan High Court had held.
Article 14 of the Constitution, which RRPR has invoked now, pertains to right to equality before law or equal protection within India.
An e-mail sent to the Roys on Wednesday did not elicit any response. A Sebi spokesperson also did not offer any comment.
November 29, 2017: Sebi sends summons to RRPR Holding seeking information and documents relating to its loan agreements with ICICI Bank and VCPL in 2008-09.
December 2017-January 2018: RRPR sends replies to the summons along with copies of documents.
March 14, 2018: Sebi sends show-cause notice under Section 11 for alleged failure to make disclosures regarding the loan agreements.
April 4, 2018: RRPR seeks inspection of documents.
April 18, 2018: Sebi grants inspection of selected documents; RRPR seeks additional documents
July 4, 2018: Sebi sends e-mail seeking reply to show-cause notice within a week
July 11, 2018: RRPR files interim response denying all allegations and seeking personal hearing with whole-time member and inspection of complete investigation report.
July 27, 2018: Personal hearing given. But RRPR says access given only to selective documents.
August 27, 2018: RRPR moves Delhi High Court challenging powers.
Source: RRPR petition to Delhi High Court
In an exchange disclosure, NDTV has said that since it was not a party to the show-cause notice or the writ petition, there won’t be any financial implications for the company (NDTV) from the outcome of the show cause or the writ.
However, Sebi’s position seems to be that the non-disclosures affected the interests of the public shareholders.
Separately in an order in June, Sebi directed Vishvapradhan Commercial (VCPL) to make an open offer to NDTV shareholders for transfer of control through the terms in an INR350 crore loan agreement inked in July 2009.
ET Prime has seen the show-cause notice dated March 14. Apart from RRPR, the Roys are named as noticees number 2 and 3.
The show-cause notice discusses three loan agreements in detail: namely, VCPL loan agreement 1, VCPL loan agreement 2, and ICICI Bank loan agreement.
VCPL loan agreement 1
This is an agreement dated July 2009 pertaining to INR350 crore borrowed from VCPL, in return for which RRPR was required to issue warrants which were convertible into equity shares totalling 99.99% of its share capital.
VCPL was unilaterally entitled to convert these warrants into equity any time during the tenure of the loan. RRPR was also required to maintain a 26% stake in NDTV. For this, the Roys transferred 11.56 million NDTV shares to RRPR. The company was also required to take VCPL’s prior approval for any action like merger or buyback in relation to the NDTV shares it held.
Sebi said, “Investigation revealed that VCPL loan agreement 1 had certain clauses, which imposed certain binding conditions on NDTV and required prior written consent of VCPL for matters pertaining to NDTV, alleging to be affecting the interest of public shareholders of NDTV. Therefore, the VCPL loan agreement is alleged to be material and price sensitive in nature and the same ought to have been disclosed to the company (NDTV), by the noticees, who in turn should have disclosed the same to the stock exchange.”
Further, a precondition in the agreement was that VCPL would have to complete due diligence for the investment of USD85 million by NDTV Four Holdings Limited in NDTV Studios. This sum was then to be transferred to NDTV through a merger or other methods. But these details were also allegedly concealed from common shareholders of NDTV, even as transfers of shares happened between promoters, Sebi alleged.
RRPR contended in its replies in December and January that the VCPL agreements were not required to be disclosed because they “were private agreements entered into by shareholders with the lender in which NDTV was not a party and it did not affect NDTV”.
VCPL loan agreement 2
This agreement was signed about six months after the first, in January 2010, for a smaller sum of INR53.85 crore. The major conditions of the first agreement were applicable to this agreement, too. The NDTV stake that was to be indirectly acquired went up to 30% with this agreement, according to the Sebi notice. Like the earlier loan, this also did not carry any interest.
ICICI Bank loan agreement
This pertains to the corporate rupee term-loan facility entered into between RRPR and ICICI Bank in October 2008. Unlike the later loans from VCPL, the ICICI Bank loan carried an interest rate of 19%.
Despite this, there were several clauses affecting NDTV’s common shareholders. “On perusal of documents provided by notices vide letter dated December 22, 2017, investigation revealed that … the noticees had agreed not to permit any merger, demerger, consolidation, reorganisation, scheme or arrangement or compromise with its creditor or shareholders or affect any scheme of amalgamation or reconstitution of NDTV without prior written approval of ICICI Bank.”
Do the agreements affect the listed entity?
The promoter-loan agreements were eventually disclosed by Prannoy Roy to the NDTV board only in August 2015, after some media reports alleging transfer of control surfaced.
In its reply on January 2, NDTV said: “It is submitted that the disclosure requirement with regard to any transaction is dependent upon the precondition that the transaction must affect the listed entity directly. This requirement only covers material transactions in which the listed entity is a party. However, in the present case, the loan agreement is a private agreement in which the company is not a party, and hence there was no requirement for the company to disclose the same to stock exchanges.”
NDTV also said VCPL or any other entity did not conduct any due diligence.
But Sebi’s investigation found these contentions unacceptable. It said the promoters have made off-market transactions in NDTV shares among themselves during the period these agreements were in force, even as these were concealed from the common shareholders.
Sebi said concealing of such material information amounted to a fraud on minority public shareholders of NDTV.
“The aforesaid conduct on the part of promoters/directors of the company is alleged to be fraudulent and it is thus alleged that noticees have violated the provisions of Section 12A (a), (b), (c) of the Sebi Act read with Regulations 3 (a), (b), (c) and (d) and 4 (1) of PFUTP Regulations.” PFUTP refers to prevention of fraudulent and unfair trade practices.
In a response to an e-mail seeking comments, Sanjay Dutt of Quantum Securities, which had complained to Sebi against these transactions, says, “Without prejudice to our position in the matter sub judice, the overriding issue here is not of validity of Sec 11 or any other provisions of Sebi Act/regulations, etc.
“What is important to understand and appreciate here for the entire investing community and more importantly for promoters and directors of public listed companies is the issue relating to corporate governance and probity in public life while being custodians of public money (promoters and interested directors). This money (and listed-company assets) not only belong to shareholders, but also to banks and public financial institutions. Some promoters being in control, at times, compel their boards and management to act in ways that are completely detrimental to all other constituents and more importantly do not comply with disclosure norms and ethical governance practices.”
Further, the above actions meant the directors violated the company’s code of conduct laid down in Clause 49 provisions which were in force at that time. This in turn meant an affirmation in annual reports of FY10 and FY11, saying that all senior members of management complied with the code of conduct, which required compliance “with all applicable laws, rules and regulations and engage in and promote honest ethical conduct free from fraud or deception”, was false.
So, Sebi alleged the Roys and their company had violated the provisions of the Securities Contracts (Regulation) Act, too.
Over to the Delhi High Court now, which has posted the matter to November 27.
Are its sweeping powers under Section 11 of the Sebi Act within the framework of the Constitution of India? Or are they ultra vires?
Raising this question are senior journalists Prannoy Roy and Radhika Roy through their privately held firm RRPR Holding. The company, which is a promoter entity of the listed broadcaster NDTV, has moved the Delhi High Court challenging Sebi’s powers under Section 11 and 11 B, saying these violate Article 14 of the Constitution. It has pleaded to the court to either strike down these provisions altogether, or suitably read them down.
The writ comes after a show-cause notice issued by the regulator to RRPR for alleged non-disclosure of certain loan agreements dating back to 2008 and 2009 with ICICI Bank and Vishvapradhan Commercial. These agreements contained clauses that had implications for the control structure and minority shareholders of NDTV, according to Sebi.
ET Prime had written about this earlier.
RRPR had sought an interim stay. Alleging that Sebi is both “the prosecutor and the judge” under these sections, it argued that “The impugned provisions are purportedly remedial but can lead to devastating consequences,” adding Sebi had “unguided, unbridled, arbitrary and excessive and whimsical power” to initiate proceedings under Section 11, or let off someone with financial penalty.
The company feared that the powers to issue directions barring any person from the securities market would have a “serious and irreparable consequence of [the] widest amplitude”.
There is no guidance or safeguard mechanism provided under the act clarifying the cases where proceedings under the impugned provisions are to be initiated, and where only financial-penalty proceedings are to be initiated, the petition argued.
However, securities lawyers pointed out that regulations formed by Sebi under these sections provide for adherence to principles of natural justice, and that Sebi usually gives the noticees several opportunities to be heard before passing restrictive orders.
In the RRPR matter, Sebi first sought information through summons and allowed inspection of documents on two occasions. However, RRPR was not satisfied with the volume of documentation sought.
There have been challenges to the Section 11 provisions in the past. In a judgment in 2010, in the matter of Allcon Estate, the Rajasthan High Court had upheld Sebi’s powers.
In the judgment, the court had said the Sebi Act was “pre-eminently a social-welfare legislation seeking to protect the interests of common men who are small investors. A restrained order for some period from accessing the securities market and prohibiting buying, selling and dealing in security was not held to be a penalty. Looking to the object of the Sebi Act, provisions of Sections 11(4) and 11(B) of the Sebi Act impose a reasonable restriction in conformity to Clause (6) of Article 19 of the Constitution of India.”
“This is in the larger interest of the investors and to achieve the objects of the Sebi Act. In the light of aforesaid, we do not find that provisions of Sections 11(4) and 11(B) of the Sebi Act are violative of Article 19(1)(g) of the Constitution of India. Accordingly, challenge to the constitutional validity of the aforesaid provisions is not accepted. Thus, the provisions are held to be intra-vires,” the Rajasthan High Court had held.
Article 14 of the Constitution, which RRPR has invoked now, pertains to right to equality before law or equal protection within India.
An e-mail sent to the Roys on Wednesday did not elicit any response. A Sebi spokesperson also did not offer any comment.
November 29, 2017: Sebi sends summons to RRPR Holding seeking information and documents relating to its loan agreements with ICICI Bank and VCPL in 2008-09.
December 2017-January 2018: RRPR sends replies to the summons along with copies of documents.
March 14, 2018: Sebi sends show-cause notice under Section 11 for alleged failure to make disclosures regarding the loan agreements.
April 4, 2018: RRPR seeks inspection of documents.
April 18, 2018: Sebi grants inspection of selected documents; RRPR seeks additional documents
July 4, 2018: Sebi sends e-mail seeking reply to show-cause notice within a week
July 11, 2018: RRPR files interim response denying all allegations and seeking personal hearing with whole-time member and inspection of complete investigation report.
July 27, 2018: Personal hearing given. But RRPR says access given only to selective documents.
August 27, 2018: RRPR moves Delhi High Court challenging powers.
Source: RRPR petition to Delhi High Court
In an exchange disclosure, NDTV has said that since it was not a party to the show-cause notice or the writ petition, there won’t be any financial implications for the company (NDTV) from the outcome of the show cause or the writ.
However, Sebi’s position seems to be that the non-disclosures affected the interests of the public shareholders.
Separately in an order in June, Sebi directed Vishvapradhan Commercial (VCPL) to make an open offer to NDTV shareholders for transfer of control through the terms in an INR350 crore loan agreement inked in July 2009.
ET Prime has seen the show-cause notice dated March 14. Apart from RRPR, the Roys are named as noticees number 2 and 3.
The show-cause notice discusses three loan agreements in detail: namely, VCPL loan agreement 1, VCPL loan agreement 2, and ICICI Bank loan agreement.
VCPL loan agreement 1
This is an agreement dated July 2009 pertaining to INR350 crore borrowed from VCPL, in return for which RRPR was required to issue warrants which were convertible into equity shares totalling 99.99% of its share capital.
VCPL was unilaterally entitled to convert these warrants into equity any time during the tenure of the loan. RRPR was also required to maintain a 26% stake in NDTV. For this, the Roys transferred 11.56 million NDTV shares to RRPR. The company was also required to take VCPL’s prior approval for any action like merger or buyback in relation to the NDTV shares it held.
Sebi said, “Investigation revealed that VCPL loan agreement 1 had certain clauses, which imposed certain binding conditions on NDTV and required prior written consent of VCPL for matters pertaining to NDTV, alleging to be affecting the interest of public shareholders of NDTV. Therefore, the VCPL loan agreement is alleged to be material and price sensitive in nature and the same ought to have been disclosed to the company (NDTV), by the noticees, who in turn should have disclosed the same to the stock exchange.”
Further, a precondition in the agreement was that VCPL would have to complete due diligence for the investment of USD85 million by NDTV Four Holdings Limited in NDTV Studios. This sum was then to be transferred to NDTV through a merger or other methods. But these details were also allegedly concealed from common shareholders of NDTV, even as transfers of shares happened between promoters, Sebi alleged.
RRPR contended in its replies in December and January that the VCPL agreements were not required to be disclosed because they “were private agreements entered into by shareholders with the lender in which NDTV was not a party and it did not affect NDTV”.
VCPL loan agreement 2
This agreement was signed about six months after the first, in January 2010, for a smaller sum of INR53.85 crore. The major conditions of the first agreement were applicable to this agreement, too. The NDTV stake that was to be indirectly acquired went up to 30% with this agreement, according to the Sebi notice. Like the earlier loan, this also did not carry any interest.
ICICI Bank loan agreement
This pertains to the corporate rupee term-loan facility entered into between RRPR and ICICI Bank in October 2008. Unlike the later loans from VCPL, the ICICI Bank loan carried an interest rate of 19%.
Despite this, there were several clauses affecting NDTV’s common shareholders. “On perusal of documents provided by notices vide letter dated December 22, 2017, investigation revealed that … the noticees had agreed not to permit any merger, demerger, consolidation, reorganisation, scheme or arrangement or compromise with its creditor or shareholders or affect any scheme of amalgamation or reconstitution of NDTV without prior written approval of ICICI Bank.”
Do the agreements affect the listed entity?
The promoter-loan agreements were eventually disclosed by Prannoy Roy to the NDTV board only in August 2015, after some media reports alleging transfer of control surfaced.
In its reply on January 2, NDTV said: “It is submitted that the disclosure requirement with regard to any transaction is dependent upon the precondition that the transaction must affect the listed entity directly. This requirement only covers material transactions in which the listed entity is a party. However, in the present case, the loan agreement is a private agreement in which the company is not a party, and hence there was no requirement for the company to disclose the same to stock exchanges.”
NDTV also said VCPL or any other entity did not conduct any due diligence.
But Sebi’s investigation found these contentions unacceptable. It said the promoters have made off-market transactions in NDTV shares among themselves during the period these agreements were in force, even as these were concealed from the common shareholders.
Sebi said concealing of such material information amounted to a fraud on minority public shareholders of NDTV.
“The aforesaid conduct on the part of promoters/directors of the company is alleged to be fraudulent and it is thus alleged that noticees have violated the provisions of Section 12A (a), (b), (c) of the Sebi Act read with Regulations 3 (a), (b), (c) and (d) and 4 (1) of PFUTP Regulations.” PFUTP refers to prevention of fraudulent and unfair trade practices.
In a response to an e-mail seeking comments, Sanjay Dutt of Quantum Securities, which had complained to Sebi against these transactions, says, “Without prejudice to our position in the matter sub judice, the overriding issue here is not of validity of Sec 11 or any other provisions of Sebi Act/regulations, etc.
“What is important to understand and appreciate here for the entire investing community and more importantly for promoters and directors of public listed companies is the issue relating to corporate governance and probity in public life while being custodians of public money (promoters and interested directors). This money (and listed-company assets) not only belong to shareholders, but also to banks and public financial institutions. Some promoters being in control, at times, compel their boards and management to act in ways that are completely detrimental to all other constituents and more importantly do not comply with disclosure norms and ethical governance practices.”
Further, the above actions meant the directors violated the company’s code of conduct laid down in Clause 49 provisions which were in force at that time. This in turn meant an affirmation in annual reports of FY10 and FY11, saying that all senior members of management complied with the code of conduct, which required compliance “with all applicable laws, rules and regulations and engage in and promote honest ethical conduct free from fraud or deception”, was false.
So, Sebi alleged the Roys and their company had violated the provisions of the Securities Contracts (Regulation) Act, too.
Over to the Delhi High Court now, which has posted the matter to November 27.
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