The Supreme Court has directed the Sahara group to refund approximately Rs. 174 billion it had collected from investors by issuing optionally fully convertible debentures (“OFCDs“). The Supreme Court ordered Sahara to refund the amounts collected along with 15% interest per year to the Securities and Exchange Board of India (“SEBI“). The interest would be calculated from the date of receipt of the amounts until the date of repayment.
The order was passed pursuant to a statutory appeal by the two Sahara group companies, Sahara India Real Estate Corporation Limited (“SIRECL“) and Sahara Housing Investment Corporation Limited (“SHICL“) (together “Sahara“) against the order passed by the Securities Appellate Tribunal (“Tribunal“) in October 2011.
Sahara had issued OFCDs to approximately 30 million investors purportedly by way of private placement without adhering to the requirements applicable to a public issue. SEBI took cognisance of the issue while processing the red herring prospectus submitted by Sahara Prime City Limited, another Sahara group company, for its initial public offer. Sahara had issued an Information Memorandum (“IM”) through 1 million agents spread over 2900 branch offices. The IM was issued to approximately 30 million investors to invite subscription to the OFCDs. SEBI investigated the issuance of OFCDs by Sahara and passed its final order on 23 June 2011. SEBI concluded that the issuance of OFCDs was in fact public issue and that Sahara had contravened several provisions of the Companies Act, 1956 (“Companies Act”) in relation to public issue of securities, Securities and Exchange Board of India Act, 1992 (“SEBI Act”) and Securities (Contracts) Regulations Act, 1956 (“SCR Act”). SEBI also found Sahara guilty of having contravened the provisions of SEBI (Disclosure and Investor Protection) Guidelines, 2009 (“DIP Guidelines”) and SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“ICDR Regulations”).
On appeal by Sahara against the SEBI’s order to the Securities Appellate Tribunal (“Tribunal“), the Tribunal concurred with the findings recorded by SEBI and held that Sahara had contravened the provisions of the Companies Act, SCR Act, SEBI Act and rules and regulations framed thereunder. The order of the Tribunal was appealed before the Supreme Court.
B. Main ISSUES CONSIDERED BY the Supreme Court
(a) Nature of OFCDs
Sahara contended that OFCDs were “hybrids” as defined under the Companies Act and are not securities within the meaning of SCR Act, and consequently, SEBI would not have jurisdiction with respect to these securities. Sahara further contended that although the definition of securities was amended to include hybrids in the Companies Act, no corresponding amendment was made to the SCR Act and SEBI Act. Securities, as defined under the SCR Act, do not specifically include hybrids, and consequently, SEBI has no jurisdiction or control over hybrid securities.
The Supreme Court rejected this contention. The Supreme Court referred to section 2(19A) of the Companies Act, which defines a hybrid to mean any security that has the character of more than one type of security, including its derivatives. The definition of security under the Companies Act, in turn, is drawn from the Section 2(h) of the SCR Act. Hence, hybrids are securities within the meaning of the SCR Act as well, thereby, vesting jurisdiction to regulate hybrid securities with SEBI.
The Supreme Court referred to its own judgment in Sudhir Shantilal Mehta v. Central Bureau of Investigation where it was held that the definition of securities under the SCR Act is an inclusive definition and not exhaustive and it takes within its purview not only the specific securities listed in the definition, but also all other types of securities, and consequently will include hybrid securities. The Supreme Court observed that Section 2(h) of the SCR Act, which defines securities emphasizes the words “other marketable securities of a like nature”, which indicates the expansive meaning of the term securities under the SCR Act. The Supreme Court concluded that even if OFCDs are hybrid securities, under Section 2(19A) of the Companies Act, they will remain within the purview of the definition of ‘securities’ in Section 2(h) of SCR Act.
The court also concluded that the OFCDs also have the intrinsic characteristics, and are essentially, debentures within the meaning of the Companies Act.
(b) Public Issue
Sahara further contended that the issuance of OFCDs does not constitute a public issue as there was no intention to list the OFCDs. Sahara contended that it circulated the IM to issues OFCDs by way of private placement, to its associates, group companies, workers/employees, or other persons connected with the Sahara Group.
The Court observed that the issuance of OFCDs to millions of investor was indeed a public issue disguised as private placement. The Court relied on the proviso to Section 67(3) of the Companies Act, which was interpreted by the court to mean that where any security is offered to more than 49 persons it will be deemed to be a public issue. The Court concluded that since the impugned OFCDs issuance was by way of a public offer, the jurisdiction vests with SEBI and Sahara was subject to various provisions of the legal framework governing the public issue of securities.
The Court further noted that a company may prior to filing a prospectus, issue an information memorandum under Section 60B(1) of the Companies Act. The Court noted that Sahara was not under any legal obligation to issue an IM. The court observed that if the OFCDs issuance were indeed a private placement, then Sahara did not need to ascertain the demand and price of the OFCDs by issuing an IM.
The red herring prospectus issued by Sahara stated that they had no intention to list the OFCDs on a stock exchange, even though in reality the securities were issued to the public.The Supreme Court took note of Sahara’s conduct of issuing the IM through 10 lakh agents and through 2900 branch offices. The IM invited 30 million people to subscribe to OFCDs. Once shown as been issued to more than 49 persons, by virtue of the proviso to Section 67(3), the mandatory provisions of Section 73 are attracted. It is not open to a company to contend that there was no intention to offer shares to the public and that consequently Section 73 would not apply. The Court concluded that from Sahara’s conduct and action, of issuing IM to millions of investors, it is clear that their intention was to issue OFCDs to the public under the garb of private placement.
(c) Scope of Section 73 of the Companies Act
The Supreme Court held that Section 73(1) of the Companies Act is mandatory and requires a company intending to offer shares or debentures to the public to apply to a recognized stock exchange for listing of its securities. As discussed above, the Supreme Court found that Sahara’s overall conduct clearly demonstrated an intention to issue OFCDs to public. The Supreme Court rejected Sahara’s argument that it did not intend to offer OFCDs to the public for the purposes of Section 73(1), and hence, it was not obligated to list OFCDs on a recognised stock exchange. The Supreme Court concluded that it is the Sahara’s conduct and not the stated intention to list makes Section 73 applicable.
(d) DIP Guidelines and ICDR Regulations
Sahara contended that DIP Guidelines were only departmental instructions, not having the sanction of law and, therefore, would not apply to the OFCDs. However the Court held that DIP Guidelines had statutory force as they were framed by the SEBI in exercise of the broad powers conferred to it under Sections 11 and 11(A) the SEBI Act.
Sahara further contended that the OFCDs were issued in 2008 when no action was instituted under the then applicable DIP Guidelines. Further the ICDR Regulations (which rescind the DIP Guidelines) were without retrospective effect and came into force only 2009 therefore would not apply to the issue of OFCDs. The court held that regulation 111 of the ICDR Regulations, contains a saving clause, hence Sahara’s conduct was still covered under ICDR.
(e) Applicability of Unlisted Public Companies (Preferential Allotment) Rules, 2003 and the Unlisted Public Companies (Preferential Allotment) Amendment Rules 2011
Sahara argued that the Unlisted Public Companies (Preferential Allotment) Rules, 2003 (“2003 Rules“) did not require the OFCDs to be listed on a recognized stock exchange. The requirement was introduced only by the Unlisted Public Companies (Preferential Allotment) Amendment Rules, 2011 (“2011 Rules“). Under the 2011 Rules, an allotment under Section 81(1A) of the Companies Act would qualify as a preferential allotment only if it was restricted to 49 persons as provided under the proviso to Section 67(3) of the Companies Act.
The Supreme Court held that even the 2003 Rules framed under Section 81(1A) of the Companies Act are not applicable to any offer of shares or debentures to more than 49 persons. Section 81 of the Companies Act deals with further issue of securities and only gives pre-emptive rights to the existing shareholders of the company. Section 81(1A) is only an exception to the said rule, providing that further shares may be offered to any persons subject to passing a special resolution at a general meeting. Section 81(1A) cannot have an overriding effect on the provisions relating to public issue, and is subject to proviso of Section 67(3). A resolution under Section 81(1A) does not render a public issue as otherwise.
Sahara further contended that the 2011 amendment to 2003 Rules were prospective in effect, hence 2003 Rules prior to amendment applied to Sahara’s issuance which was in the year 2008. Sahara further argued that in view of 2003 Rules, preferential allotment by unlisted public companies by private placement was permitted without any restriction on number of persons provided in the proviso to Section 67(3) of the Companies Act. Further, shares issued pursuant to such a private placement were not required to be listed on a stock exchange. The Supreme Court rejected this contention holding that the 2003 Rules cannot override the provisions of Section 67(3) and Section 73. If the preferential allotment is a public issue, then 2003 Rules would not apply. The definition of “preferential allotment” in 2011 Rules only clarified the implicit requirements of 2003 Rules. The Supreme Court further held that both 2003 Rules and 2011 Rules are subordinate regulations and are to be read subject to the proviso to Section 67(3) and 73 and other related provisions.
(f) Section 28 of SCR Act
Sahara also contended that the OFCDs issued by them are convertible bonds issued on the basis of the price agreed upon at the time of issue, and therefore, the provisions of SCR Act are not applicable in view of Section 28(1)(b) of SCR Act. Section 28(1)(b) makes the SCR Act inapplicable to the entitlement of a bondholder to convert the convertible bonds, provided the price of conversion was agreed upon at the time of issuance. However, the Supreme Court rejected Sahara’s argument and found the SCR Act to be applicable to OFCDs. The Supreme Court reasoned that the enactment of Section 28(1)(b) was necessary due to Sections 13, 16 and 20. Section 13 of the SCR Act empowers the Central Government to issue notifications declaring contracts to be illegal in any state. Section 16 of the SCR Act empowers the central government to issue notification, for preventing undesirable speculation. By a notification under Section 16, the central government can prohibit sell or purchase of specified securities in any manner other than specified in the notification. Section 20 of the SCR Act, prior to deletion, declared that options in securities were illegal. Section 20 was replaced with a notification, which too prohibited options. The Supreme Court observed that Section 28(1)(b) was enacted to preserve the entitlement of a convertible bond or share warrant holder to receive shares pursuant to conversion, in view of Sections 13, 16 and 20. The inapplicability of SCR Act, as contemplated in Section 28(1)(b), is not to convertible bonds itself, but only to the entitlement of a bond or warrant holder consequent to conversion.
(g) Jurisdiction of SEBI
The Supreme Court observed that SEBI has the power to investigate and adjudicate upon issuance of the OFCDs by the Sahara. The Supreme Court referred to section 55A of the Companies Act and held that in case of listed companies and companies that intend to get their securities listed, SEBI has jurisdiction in matters relating to issue and transfer of securities and non-payment of dividend. The Supreme Court held that Sahara’s conduct clearly demonstrated that it would not fall under the purview of Section 55A(c), hence rejected Sahara’s argument that it was the Central Government and not SEBI that had jurisdiction over the issuance of OFCDs. The Supreme Court emphasized that the SEBI Act is a special legislation that vests SEBI with special powers to investigate, adjudicate and to protect the interests of the investors.
While upholding the judgement of the Tribunal, the Supreme Court directed refund of the entire amount collected by Sahara. The funds were to be refunded along with an interest of 15% per year. It is important to note that, SEBI, SAT and the Supreme Court consistently held against Sahara. In addition to rejecting merely technical contentions by Sahara, the court emphasized the legislative intent of the relevant provisions of the Companies Act and policy behind establishment of SEBI, which is to protect investors and to maintain the integrity of capital markets.
The court placed emphasis on the overall conduct of Sahara, rather than its public statements of intent. Clearly, public unlisted companies are not permitted to mobilize public funds under the guise of a series of private placements; not that anyone (apart from Sahara’s counsel) could have argued otherwise even prior to this judgment. However, the reality remains that Sahara is not the only instance where public unlisted companies have thousands of shareholders, yet not be listed on stock exchanges, presumably relying on the technicality that these companies have not undertaken a public issue of securities. It is only due to the egregious manner in which Sahara mass mobilized public funds that regulatory intervention and sanctions were attracted. From this perspective, rather than being a remedy, the Sahara judgment is only a clearer articulation of the intent and purpose of existing companies and securities legislation. A more straightforward formulation for the malaise of mobilization of public funds without providing the benefits of listing would be to impose a limit on the number of shareholders (or holders of other convertible securities) and require compulsory listing once this limit is crossed.
Arvind Ray [firstname.lastname@example.org]
 (2009) 8 SCC 1