WIDER CONSTRUCTION OF IPO OBJECTS – NOT A VALID DEFENCE AGAINST DIVERSION OF IPO PROCEEDS
INTRODUCTION:
The
Securities and Exchange Board of India (hereinafter “SEBI”) vide order dated
23rd October 2020 debarred
Birla Pacific Medspa Ltd. (hereinafter “the Company”), its Directors and
key managerial personnel (hereinafter collectively referred to as “the Noticees”)
from accessing the securities market and dealing in securities directly or
indirectly for a period of two years in connection with diversion,
misutilisation and siphoning of funds raised through Initial Public Offer (“IPO”).
This comes at the backdrop of the investigation by SEBI conducted during the
period July 07, 2011 to July 15, 2011 (hereinafter “Investigation Period”).
It is
an undisputed fact that investors and other stakeholders seek to channelize
their funds in entities that throng and promote good governance practices not
only in letter but in the spirit of law and the recent ruling by SEBI in case
of the Noticees deploy one more reason to look back at the lacuna in corporate
governance. The Hyderabad bench of the Income Tax Appellate Tribunal in the
case of “National Mineral Development Corporation Limited v. DCIT
(2017)” contemplated that “Investors
are becoming more concerned to invest in companies that act with good corporate
governance and social responsibility.”
THE
IPO EPISODE:
The
Company operated health care centres prior to IPO and resolved to raise
additional funds through IPO for establishing 55 more health care centres which
was expressly stated as the primary object in prospectus. The entity issued
6,51,75,000 equity shares of Rs. 10/- each at a price of Rs. 10/- per equity
share, resulting into aggregate issue size of Rs. 65.17 crores and the issue
was oversubscribed by 1.18 times. The Company got its shares listed and on the
first day of listing i.e. 7th July 2011, the share price at the
closure of the listing day stood increased by 154% more than the opening price.
The trading volume in the shares of the entity was observed to be extremely
volatile during the listing day.
ALLEGED
CONTRAVENTIONS:
The
bank statement of the Company and replies from the entity during the Investigation
Period revealed that the Company had advanced Inter Corporate Deposits
(hereinafter “ICD’s”) aggregating to Rs 31.54 crores (closer to 50
percent of the IPO funds) to several group entities for their operations. More pertinently,
the board of directors of the Company held a meeting 4 days post IPO and
resolved to issue ICD’s to various group companies at interest of 15% p.a.
repayable on demand on notice of 7 days which was not stipulated in the
prospectus in the first place. The minutes of the meeting cited depleting
macro-economic factors as the reason to stall the establishment of health care
centres for which funds were raised through IPO. The prospectus for IPO on the
other hand stated that money pending utilization would be invested in interest
or dividend bearing liquid instruments including deposits with banks and
investment in mutual funds and other financial products. It was alleged that 60
percent of the ICD’s issued to various companies remained unpaid along with
interest of 6.32 crores. Thus, it was alleged that the conduct of the Company amounted
to misstatement in prospectus to defraud the investors and the Company has
violated Regulation 57(1)[i], Regulation 57(2)(a)[ii] read with Clause 2 (XVI)
(B) (2) of Part A of Schedule VIII[iii] of SEBI (Issue of
Capital and Disclosure Requirements) Regulations, 2009 (hereinafter “SEBI
(ICDR) Regulations”).
DEFENCE
OF THE NOTICEES:
· The Noticees primarily expressed that ICD’s can
be construed as a liquid instrument since they are issued on the condition that
such ICD’s are repayable on demand by giving Notice of 7 days.
· The Noticees expressed that as stated in the
prospectus money pending utilization from IPO would be invested in interest or dividend
bearing liquid instruments including deposits with banks etc.
· The Noticees emphasised that the word
“including” in the IPO objects bear a wider meaning and include all types of
instruments which can have character of liquidity and thus the objects of the
IPO should be understood and construed with wider interpretation.
· Few Noticees sternly opposed the allegations
out of investigation on the ground that they were non-executive directors and
were not involved in the day to day decision making of the Company and any act
on behalf of the Company without their knowledge cannot be substantiative
enough to hold them vicariously liable.
· The Noticees also contended that their position
in the Company does not stand pari passu with that of an executive
director.
· The Noticees defended that unforeseen external
factors halting the execution of the IPO objects empowered the board of
directors to source the IPO proceeds to alternative avenues of prospects namely
ICD’s to group companies.
· The Noticees also contended that a wider construction
of the IPO objects authorised the Company to give ICD’s to the group companies
and such sourcing of funds does not negate the IPO objects.
COMMENTAIRE ON THE SEBI ORDER
LACK
OF INFORMATION IN PROSPECTUS:
SEBI
relied on the IPO prospectus and minutes of the board meeting as the principal
evidence to substantiate its view. The market regulator vehemently stated that
the minutes of the board meeting did postulate that the funds pending
utilization would be deployed in liquid instruments including the instruments
of corporates whereas the prospectus did not state the fact that unutilized
funds shall be invested in the liquid instruments of corporates thereby clearly
signifying at the lack of disclosure of material information in the prospectus.
SEBI revealed that the board meeting minutes also contemplated that the board
had resolved to give guarantees and provide security to group companies for
which even a mere provision was not appropriated in the prospectus.
EXPOUDING
THE MEANING OF LIQUID INSTRUMENTS:
SEBI
expounded the meaning of the term “liquid instruments”. The regulator held that
liquid instruments attribute to those instruments which are capable of being
transferred and there is a scope of mitigating the risk to a third party in
case of a default. SEBI further contemplated that the bare perusal of the
prospectus signifies that the unutilized funds out of IPO shall be invested in
such instruments that are tradable in the market and which ensue quick
turnaround of finance. SEBI clarified that ICD’s are private lending and
borrowing arrangements between entities and do not attribute to liquid
instruments as their entailing obligation cannot be transferred to a third
person subject to the express consent of the lender in case the borrower fails
to honour his obligations. ICD’s are recognised as short-term financial assistance
by one corporate to another and includes unsecured loans on short term basis in
certain instances. The underling principle was elucidated by the Madhya Pradesh
High Court in the case of “Ajay Acharya v. State Bureau of Investigation (2011)” wherein it was postulated
that “Inter Corporate Deposits (ICDs) equates to Financial Assistance.
Inter Corporate Deposit is essentially a short-term assistance provided
by one corporate with surplus fund to another in need of funds. It is an
assistance given by cash-rich company to low rated cash and starved company
unable to get a loan. It may be considered as unsecured loan but may be co-
lateralized sometime for weaker companies to get benefit of
credit enhancement.”
VIABILITY
OF EXTENDING ICD’S TO GROUP COMPANIES:
SEBI
also elucidated that the prospectus under “risk factors” stated that the
Company did not at the time of floating the IPO and thereafter intend to
provide loans to any group company except in case of exigency. The market
regulator also expounded that such exigency ought to be seen from the
perspective of the group company and thus granting ICD’s to group companies
could not be substantiative to hold as exigency. The regulator also opined that
the signatories to the prospectus were incumbent to be aware of the short comings
as on the date of signing the final prospectus and the conduct of the Company
appeared deliberate to siphon IPO funds for the operations of the group
companies.
DISCLOSURE
IN FINANCIAL STATEMENTS:
SEBI
also pointed out that pursuant to the IPO prospectus, the quarterly, half
yearly and annual financial statements were to contain a statement on
utilization of IPO funds. These financial statements did outline that IPO funds
were deployed for setting up health care centres whereas the object was defeated
by the decision taken by the board of directors of the Company to defer the
establishment of health care centres citing macro-economic factors. Moreover,
these financial statements were approved by the board of directors and the
audit committee before being submitted to the BSE and such financial statements
did not even contain the value of ICD’s advanced to the group companies. SEBI
ruled that it appeared to be an intentional act to route the IPO funds to group
companies and such conduct tantamount to misstatement in prospectus.
VIOLATIING
THE GOLDEN RULE:
Prospectus
is a key document that facilitates the investors to make a proper investment
decision and deviation from making material facts in the prospectus often poses
an opportunity to channelize the investors funds in undesirable ways. The
Calcutta High Court in the case of “Pramatha Nath Sanyal v. Kali Kumar Dutt (1924)”
held that “A reference to the different sections of the Companies
Act makes it abundantly clear that the provisions relating to a prospectus are
most stringent, and the duty of preparing it and filing it in accordance with
law is extremely onerous.”
SEBI’s
view signifies that the Company has violated the golden rule as to framing of
prospectus as laid down in “New Brunswick and Canada Rly. Co. v. Muggeridge (1860)” wherein
Vice Chancellor Kindersley contemplated that “Those who issue prospectus to
the public inviting them to take shares on faith of the representations therein
contained are bound to state everything with strict and scrupulous accuracy.” The
market regulator held that by not disclosing the material particulars
intentionally, the Company had coloured the true objects behind IPO and mislead
the investors.
CULPABIITY
OF NON-EXECUTIVE DIRECTORS:
Against
the claim on immunity against liability to directors occupying position in
non-executive capacity, SEBI clarified that the examination in the present case
is independent of the designation that the board members hold and the greater
attention to the role of the directors and key managerial personnel is drawn
concerning the gravity of the offence involved and since the directors and key
managerial personnel were signatories to the prospectus issued to public. Foster
J in “Dorchester Finance Co Ltd v. Stebbing (1989)” held
that “It is a well settled fact that the duty of care extends uniformly to
all the directors whether irrespective of whether they are executive or
non-executive directors.” To further comprehend the culpability of
non-executive directors, reliance can be placed in the ruling of the apex court
in the case of “Pooja Ravinder Devidasani v. State of Maharashtra & Ors.
(2014)” wherein it was held that “A
Director of a Company is liable to be convicted for an offence committed by the
Company if he/she was in charge of and was responsible to the Company for the
conduct of its business or if it is proved that the offence was committed with
the consent or connivance of.” The minutes of the board meeting held after
IPO to approve advancing of ICD’s states that the Noticees were present at the
board meeting and the resolutions for advancing ICD’s to the group companies
were passed by the board of directors. SEBI has relied on the presence of the
directors at the meeting and stressed on the fact that if the directors were
against the notion of advancing ICD’s such conversation or opposition should
have formed part of minutes but the passing of such resolution denotes common
consensus of the directors holding non-executive directors liable.
CONCLUSION:
Constricting
the order to the issue of ICD’s, SEBI opined that the intention of the Noticees
behind floating the IPO appeared to be carefully pre-planned and malafide to
loot the genuine investors. SEBI also postulated that wider interpretation of
IPO objects would have been under consideration if the prospectus had
accurately disclosed the issue of ICD’s out of unutilized funds and had there
been such a disclosure, the approach to the case would have seen a different
end. SEBI held the Noticees guilty of violation of Regulation 57(1), Regulation
57(2)(a) r/w Clause 2 (XVI) (B) (2) of Part A of Schedule VIII of SEBI (ICDR)
Regulations, 2009. Accordingly, the regulator debarred the Noticees from accessing
the securities market and trading in securities directly or indirectly for a
period of 2 years.
[i] Regulation 57(1) - The offer document shall contain all material disclosures which are true and adequate so as to enable the applicants to take an informed investment decision.
[ii] Regulation 57(2)(a) - The red-herring prospectus, shelf prospectus and prospectus shall contain the disclosures specified in Schedule II of the Companies Act, 1956 and the disclosures specified in Part A of Schedule VIII, subject to the provisions of Parts B and C thereof.
[iii] Clause 2 (XVI) (B)
(2) of Part A of Schedule VIII – The signatories shall further certify
that all disclosures made in the offer document are true and correct.
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