TUSSLE
OVER THE ISSUE OF OFCDs – HOW TO SAFEGUARD THE INTEREST OF THE INVESTORS?
By K P C Rao., LLB., FICWA., FCS
Practicing
Company Secretary
kpcrao.india@gmail.com
In the recent times, Optionally
Fully Convertible Debentures popularly known as OFCDs are in the news. The
reason is that two Sahara group companies had raised the money to the tune of ` 24,000 crores through
private placements to a mind-boggling three crore investors.
These two Sahara Group of companies are SIRECL[1]
and SHICL[2].
They had floated OFCDs schemes in 2008 and 2009 respectively, to raise money
from public, which was detected by SEBI in 2010. The market Regulator alleged
that these fund raisings violated several laws, including the Companies Act and
the SEBI Act, 1992. Subsequently, SEBI barred the two Sahara group companies
from raising any more investors through these instruments. Sahara group then
challenged the SEBI order in the Allahabad high Court, which initially stayed
the regulator’s order. SEBI then moved the Supreme Court and the apex court
directed the HC to hear the matter on a day-to-day basis. After the HC vacated
its earlier stay on the SEBI order, the Sahara Group moved the Supreme Court.
These bonds are unsecured, priced
at a steep premium and sold without the kind of disclosure about the financial
health and prospects of the company making the issue that accompanies a public
issue and cannot be freely traded. Undoubtedly, such a trust and confidence on
the part of such a large body of investors in a company goes beyond the ambit
of 'private'.
Tussle over the issue of OFCDs
The Supreme Court on 15/07/2011 sent the Sahara–SEBI case related to
raising of funds by the Sahara group through optionally fully convertible
debentures (OFCDs) to the Securities Appellate Tribunal (SAT) in Mumbai and the
Court said: “that the SEBI’s order dated
June 23, asking two Sahara group companies to refund money raised from the
public, shall be put on hold”.
The apex court also ordered that since the whole issue involved important
questions of Law under the Companies Act, 1956, under which the OFCDs were
issued by Sahara, the Ministry of Corporate
Affairs (MCA) should be made a party to the petition.
The SC has given SAT eight weeks to decide whether the two Sahara group
entities can raise money through OFCDs. The Sahara group has been directed to
file its petition in SAT within three weeks and the court also directed that
SAT shall not be influenced by any prior orders related to the case. On its
part, the Sahara group has said that it would not raise any money through OFCDs
till the case is decided in SAT.
Thereafter, SAT on 18/10/2011 upheld an order of SEBI which had
barred Sahara Real Estate Corp and Sahara Housing Investment, both Sahara Group
companies, from raising money and then asked these companies to refund the
money raised through OFCDs, along with 15% interest.
What
is the controversy in this OFCD issue?
The contention of the Sahara is that
i)
They are closely held and unlisted companies and SEBI is not having
jurisdiction.
ii)
OFCD (Optionally Fully Convertible Debenture) is neither a share nor a
debenture and a sort of Hybrid instrument and will not come within the ambit of
definition of ‘securities’ as defined under Section 2 of the SEBI Act.
Further, the SAHARA is contending that SEBI had taken
contradictory stands in two cases which were similar in nature. It is pertinent
to point out here that earlier a Mumbai based Company, Citicorp Finance India
Ltd, an unlisted entity, had raised money through the issuance of OFCDs through
private placement to thousands of investors. Subsequent to the issuance of
OFCDs, relating to some payment-related issues, a question was raised in the
Parliament in 2010 and the Parliament in turn had asked SEBI for comments on the
subject. At that time, SEBI in its reply had said that the private placement of
debentures was not under its jurisdiction but will fall under the jurisdiction
of the central government through the Ministry Of Corporate Affairs.
Existing
Legal Framework
The
major controversy is whether these types of investments come within the ambit
of Collective investment schemes under the provisions of the SEBI Act, 1992. In
this context we will discuss the legal frame work as to collective investment
schemes and the investments like OFCDs will come under the meaning of
Collective Investment Schemes.
a)
Meaning of Collective Investment
Scheme
According to
clause (ba), sub-section (1) of section 2 of Securities and Exchange Board of
India Act, 1992, the “collective investment
scheme” means any scheme or arrangement which satisfies the conditions
specified in section 11AA. (SEBI Act).
"11AA.
Collective investment scheme.
(1)
Any scheme or arrangement which satisfies the conditions referred to in
sub-section (2) shall be a collective investment scheme.
(2)
Any scheme or arrangement made or offered by any company under which, --
(i)
the contributions, or payments made by the investors, by whatever name
called, are pooled and utilized for the purposes of the scheme or arrangement;
(ii)
the contributions or payments are made to such scheme or arrangement by
the investors with a view to receive profits, income, produce or property,
whether movable or immovable, from such scheme or arrangement;
(iii)
the property, contribution or investment forming part of scheme or
arrangement, whether identifiable or not, is managed on behalf of the
investors;
(iv)
the investors do not have day-to-day control over the management and
operation of the scheme or arrangement.
(3)
Notwithstanding anything contained in sub-section (2), any scheme or
arrangement—
(i)
made or offered by a co-operative society registered under the
Co-operative Societies Act, 1912 (2 of 1912) or a society being a society
registered or deemed to be registered under any law relating to co-operative
societies for the time being in force in any State;
(ii)
under which deposits are accepted by non-banking financial companies as
defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934 (2
of 1934);
(iii)
being a contract of insurance to which the Insurance Act, 1938, (4 of
1938) applies;
(iv)
providing for any scheme, pension scheme or the insurance scheme framed
under the Employees' Provident Funds and Miscellaneous Provisions Act, 1952 (19
of 1952);
(v)
under which deposits are accepted under section 58A of the Companies Act,
1956 (1 of 1956);
(vi)
under which deposits are accepted by a company declared as a Nidhi or a
Mutual Benefit Society under section 620A of the Companies Act, 1956 (of 1956);
(vii)
falling within the meaning of chit business as defined in clause (e) of
section 2 of the Chit Funds Act, 1982 (40 of 1982);
(viii)
under which contributions made are in the nature of subscription to a
mutual fund;
shall not be
a collective investment scheme.”
Therefore,
a Collective Investment Scheme means any scheme or arrangement, which
satisfies the conditions, referred to in sub-section (2) of section 11AA of the
SEBI Act. In other words, any scheme or arrangement made or
offered by any company under which the contributions, or payments made by the
investors, are pooled and utilised with a view to receive profits, income,
produce or property, and is managed on behalf of the investors is a CIS.
Investors do not have day to day control over the management and operation of
such scheme or arrangement.
b) Schemes do not constitute CIS
The
following do not constitute a collective investment scheme:
1) any scheme
or arrangement made or offered by a co-operative society or a society being a
society registered or deemed to be registered under any law relating to
co-operative societies for the time being in force in any State;
2) any scheme
or arrangement under which deposits are accepted by non-banking financial
companies
3) any scheme
or arrangement being a contract of insurance to which the Insurance Act,
applies;
4) any scheme
or arrangement providing for any Scheme, Pension Scheme or the Insurance Scheme
framed under the Employees Provident Fund and Miscellaneous Provisions Act,
1952
5) any scheme
or arrangement under which deposits are accepted under section 58A of the Companies
Act, 1956 (1 of 1956);
6) any scheme
or arrangement under which deposits are accepted by a company declared as a
Nidhi or a mutual benefit society under section 620A of the Companies Act, 1956
(1 of 1956);
7) any scheme
or arrangement falling within the meaning of Chit business as defined in clause
(d) of section 2of the Chit Fund Act, 1982 (40 of 1982);
8) any scheme
or arrangement under which contributions made are in the nature of subscription
to a mutual fund;
c)
Circumstances
that a company registered as a Collective Investment Management Company (CIMC) can raise funds from the
public
A
registered Collective Investment Management Company is eligible to raise funds
from the public by launching schemes. Such schemes have to be compulsorily credit
rated as well as appraised by an appraising agency. The schemes also have to be
approved by the Trustee and contain disclosures, as provided in the
Regulations, which would enable the investors to make informed decision.
A copy of
the offer document of the scheme has to be filed with SEBI and if no
modifications are suggested by SEBI within 21 days from the date of filing then
the Collective Investment Management Company is entitled to issue the offer
document to the public for raising funds from them.
d) Investor’s rights to receive information about the
schemes where they have invested
The
investor are entitled to receive a copy of the Balance Sheet, Profit and Loss
account and a copy of the summary of the yearly appraisal report from CIMC
within two months from the closure of the financial year.
Further, the scheme wise annual
report or an abridged form thereof has published in a national daily as soon as
possible but not later than two calendar months from the date of finalisation
of accounts. Also, scheme wise un-audited quarterly
financial results have to be published in a national daily by CIMC within one
month from the close of each quarter. It is
to be distinctly understood that submission of offer document to SEBI should
not in any way be deemed or construed that the same has been cleared or
approved by SEBI. SEBI does not take any responsibility either for the
financial soundness of any scheme for which the offer document has been filed
or for the correctness of the statements made or opinions expressed in the
offer document. It is the responsibility of the Collective
Investment Management Company to ensure that the disclosures made in the offer
document are generally adequate and are in conformity with the Regulations.
e)
Circumstances
for Winding up of an existing Collective Investment
Scheme
An existing collective investment scheme which
failed to make an application for registration, or was not desirous of
obtaining provisional registration, or has not been granted provisional registration,
or having obtained provisional registration fails to comply with the provisions
as laid down in the Regulations, was / is required to wind up the existing
scheme.
f) Procedure for winding up of an existing Collective
Investment Scheme
First of all an existing collective investment
scheme has to send an information memorandum to the investors who have
subscribed to the schemes, detailing the state of affairs of the scheme, the
amount repayable to each investor and the manner in which such amount is determined. The
said information memorandum has to be dated and signed by all the Directors of
the scheme. The information memorandum has to explicitly state that investors
desirous of continuing with the scheme will have to give a positive consent,
within one month from the date of the information memorandum, to continue with
the scheme. If, positive consent to continue with the
scheme is received from only 25% or less of the total number of existing
investors, the scheme shall be wound up and payment be made to the investors
within three months of the date of the information memorandum. Investors
may note that many of the existing collective investment schemes had collected
funds from the public prior to coming into force of the regulatory jurisdiction
of SEBI and any action by SEBI against defaulting entities does not necessarily
ensure the refund of money invested by the investors in such entities.
g) Authorities for Grievance Redressal
Investors should approach CIS in this regard. If
investors do not get satisfactory response thereto, they may write to SEBI.
Further, investors can approach district consumer redressal forums in case
entities fail to honour their commitments or for any deficiency in service. For
bouncing of cheques, investors can move the courts under section 138 of the
Negotiable Instruments Act as the right to file criminal complaint exclusively
vests with the beneficiary of the cheque.
Investors should further note that wherever they do
not have a right to the land or to the produce arising out of the land such
investment may be a deposit and where a company fails to repay the deposits, it
attracts the provisions of section 58A of the Indian Companies Act, 1956.
h) Penal provisions if a registered collective
investment management company violates certain provisions of the Regulations
If, a registered collective investment management
company violates
certain provisions of the regulations,
then action in terms of suspension/ cancellation of certificate may be initiated against the entity. Further,
SEBI may, in the interests of the securities market and the 'investors,
initiate criminal prosecution under Section 24 of the SEBI Act, apart from passing of directions such as:
1)
requiring
the person concerned not to collect any money from investor or to launch any
scheme;
2)
prohibiting
the person concerned from disposing of any of the properties of the scheme
acquired in violation of the Regulations;
3)
requiring
the person concerned to dispose off the assets of the scheme in a manner as may
be specified in the directions;
4)
requiring
the person concerned to refund any money or the assets to the concerned
investors along with the requisite interest or otherwise, collected under the
scheme;
5)
prohibiting
the person concerned from operating in the capital market or from accessing the
capital market for a specified period.
Conclusion
Sahara
tried to argue that its debentures were, as hybrid instruments, not securities
and therefore outside SEBI's purview. This
also has rightly been dismissed by the tribunal. Since the financial industry
keeps innovating new derivative instruments, it is vital that SEBI's definition
of what it can regulate remain inclusive and open-ended. Yes, Sahara will have
to unwind some of their investments to return the money to investors and some
projects would be hurt. This is an
acceptable price to pay for making the mediation of society's savings a safer
exercise. That completely opaque, unsecured investment opportunities can tempt
crores of people to part with tens of thousands of crore rupees is an
indictment of the limited reach of formal finance in this country. It is not
enough to damn a Sahara for its disingenuous ways.
Unless, Stringent Legal Framework is in place to penalize
these culprits, these un-scrupulous businessmen will continue to do their
activities by circumventing the provisions of the Law and continue to dupe the
investing community. Therefore, to curb this menace and to safeguard the investors
from falling prey to these dubious schemes, the Regulator SEBI should come out
with a separate set of Guidelines/ Regulations to govern Alternative Investments,
Portfolio Wealth Managers and cover all type of CIS Schemes. Globally, alternative investments are quite in vogue among the
rich investors, who are estimated to allocate 5–10 percent of their investment
portfolio on these products.
[Published in Corporate Secretary, a Monthly magazine of ICSI, Hyderabad]
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