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.


DISCLAIMER:

This is a personal blog. Any views or opinions represented in this blog are personal and belong solely to the blog owner and do not represent those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity, unless explicitly stated. All content provided on this blog is for informational purposes only. The owner will not be liable for any losses, injuries or damages from the display or use of this information. 

Comments

Popular posts from this blog

FORM VS. EFFECT BASED APPROACH – THE STORY OF COMPETITION

ASSERTION THROUGH THE LENS OF STATUTE COUPLED WITH ESTABLISHED CRIMINAL INTENT SACROSANCT FOR EFFECTUATING ATTENDANCE OF CHAIRMAN AND DIRECTOR

KNOW YOUR LAW #5 - ESSENCE OF NAME OF A COMPANY