The Supreme Court order asking Subrata Roy's Sahara Group to refund more than Rs 17,700 crore raised from 22 million small investors marks a sensational triumph for market regulator Sebi, which had come close to dubbing this a Ponzi scheme. A Ponzi scheme in one where a company uses money to pay early investors with funds raised from later ones.
Since the money will have to be repaid with 15 percent interest, actual payments by the Sahara Group could exceed Rs 20,000 crore since most of the money was raised between 2008 and 2011 and interest would be payable. A retired Supreme Court judge, BN Agarwal, has been appointed to oversee that the court's orders are complied with within three months.
The money was raised by two Sahara Group companies - Sahara India Real Estate Corporation (SIREC) and Sahara Housing Investment Corporation (SHIC) - between 2008 and 2009 in contravention of Sebi rules.
In its final order, the Supreme Court raised doubts about whether all the subscribers to the two companies' optionally fully convertible debentures (OFCDs) were real or imaginary.
In a stinging rebuke to the Sahara group, the Supreme Court said: "There can...be no hesitation in accepting that...there was a pre-planned attempt at the hands of the SIREC and SHIC to bypass the regulatory and administrative authority of Sebi...But having so concluded, it is essential to express, that there may be no real subscribers for the OFCDs issued by SIREC or SHIC. Or alternatively, there may be an intermix of real and fictitious subscribers." (Read the full judgment below)
The Sahara case marks a high point in Sebi's efforts to rein in powerful groups that use subterfuge and political connections to cock a snook at the law.
Sahara had probably reckoned without the fighting instincts of former Sebi member KM Abraham, who diligently argued in an order dated 23 June 2011 that Sahara was seeking to raise Rs 40,000 crore through two companies which had negligible net worth running into just a few lakhs. Abraham also argued that Sahara deliberately avoided obtaining Sebi's sanction for floating optionally fully convertible debentures (OFCDs) by terming it a private placement.
The following are some of the details of what Sebi wrote in its 23 June order (read the full order here), and which the Supreme Court has now upheld. (We are reproducing the details from an earlier report).
First, Abraham showed in his order that the Sahara Group, in contravention of Schedule II of the Companies Act, tried to deliberately exclude Sebi from vetting the DRHPs of the two companies. The schedule specifies that while filing the DHRP, company directors have to file a declaration saying that they have complied with all provisions of the Companies Act and the Sebi guidelines, among other things. But the directors of Sahara Commodity Services Corporation and Sahara Housing Investment Corporation excluded all references to Sebi while signing their declarations.
Says Abraham: "I also suspect that there has been a reprehensible attempt to conceal this applicability of the provisions of laws and the jurisdiction of Sebi on the issue itself, by making changes in the form and structure of the statutory declaration filed by the directors of the two companies."
Second, Sebi's alleged that Sahara tried to bypass its strict laws on investor protection. In this context, it points out that SHIC's privately placed issue of OFCDs opened in 2008 and SCSC's (earlier called Sahara India Real Estate Corporation, or SIREC) in 2009, but they had no closing date at all!
In fact, says Abraham, another Sahara company, Sahara India Commercial Corporation, had kept an issue for an overall size of Rs 17,250 crore open for 10 years!
How did this happen? Says Abraham: "Such an alternative conduit of capital mobilisation bypassing much of the regulatory framework applicable to issue of capital, could potentially subject our country's financial market and its investors to inordinate risks. Needless to say, the risk that such softer paths could be misused for massive money laundering is also dangerously real. Any dilution of the regulatory regime for the issue of capital by companies in India clearly is antithetical to our own objectives of investor protection."
Asks Abraham: "Can an issuer file an Information Memorandum, open the issue and keep the same open indefinitely? In fact, does it mean that an issuer need not even close the issue and keep it open perpetually?"
Third, the Sebi investigation clearly points to a lack of corporate governance at Sahara companies. The two companies, SCSC and SHIC - which were expecting to raise Rs 40,000 crore between them - did not even have a proper list of investors.
Says Abraham: "The two companies... are without doubt, clearly in gross violation of the provisions of the laws applicable to public companies making offers of securities to the public. (They) seem to be unable to furnish even basic data on the identity of its (sic) own investors..".
To find out the names of its investors, Sahara apparently needed the help of professional accounting firms. Asks Abraham: "If the identity of the investors and addresses themselves are not readily available with the firm - and the compilation and authentication of the data across the thousands of service centres will have to... require the support of professional accounting firms at this stage, then I wonder what real safeguards can possibly be there in place for investor protection?"
Fourth, Sebi goes as far as it can to dub the OFCD schemes of the two companies as a threat to investor safety, if not actually a Ponzi scheme. Says Abraham: "The learned counsel (the Sahara lawyer), at one point in the submissions before me, mentioned the fact that there are no investor complaints at all, from any investor in the OFCDs raised by the two companies. Going by the history of scams in financial markets across the globe, the number of investor complaints has never been a good measure or indicator of the risk to which the investors are exposed.
"Most major 'Ponzi' schemes in the financial markets, which have finally blown up in the face of millions of unsuspecting investors, have historically never been accompanied by a gradual build up of investor complaints. But when financial catastrophes have indeed finally erupted, they do so with little warning and lead to major collapses in the financial markets with disastrous consequences to investors."
Fifth, the Sebi order points out that the two companies have not complied with even the basic rules for investor protection designed by Sebi (which, in retrospect, is explained by the fact that the companies were all along try to evade Sebi's jurisdiction).
Worse, the companies were planning to raise Rs 40,000 crore without having the basic financial strengths to do so. While one company "did not have any distributable profit for the financial year ending March 31, 2008" another had "a negative net worth at the time of the offer".
"The subscribed capital of the two companies is very small in comparison to the liabilities on their balance sheets. The OFCDs raised are of the order of at least a few thousand crores of rupees, with the requirements for funds indicated at Rs 40,000 crore. To compound these concerns, all the OFCDs are unsecured - there is no charge on either the assets of the companies or on the revenue streams from the various projects undertaken by the two companies."
Sixth, the group apparently intended to rotate money between one group company and another without reference to investors. The DRHPs of both companies state that "the money not required immediately by the company may be parked/invested inter alia by way of circulating capital with partnership firms or joint ventures or in the fixed deposits of various banks."
Observes Abraham: "This means that such funds mobilised beyond the pale of law, could be potentially diverted into various activities of the group companies, without any significant accountability or reporting requirements."
This is what the final Supreme Court order has finally put a stop to.
As we noted before, Sebi stumbled onto the case almost by accident, when the Sahara Group filed a Draft Red Herring Prospectus (DRHP) to raise equity for real estate company Sahara Prime City Ltd through an initial public offering (IPO). Sebi discovered through the DRHP that two associate group companies, Sahara Commodity Services Corporation (SCSC - the previous name of Sahara India Real Estate Corporation) and Sahara Housing Investment Corporation (SHIC), were raising huge amounts of money from the public without so much as a Sebi by-your-leave.
It fired its first shot and asked the two to stop raising money through an order dated 24 November 2010. Sahara rushed to the Lucknow bench of the Allahabad High Court, which stayed Sebi's order but not its investigation. Sebi moved the Supreme Court, which merely directed the high court to expedite the case. The high court vacated its stay on 7 April, when it found that the Sahara group was not cooperating with Sebi as it had directed. This is where Sahara received it first rap.
On 29 April, the Allahabad High Court dismissed the Sahara Group's petition with these caustic remarks: "A person, who comes to the court, is supposed to come with clean hands and bona fide intentions, and has to abide by the orders passed by the court, more so in a case where the parties' counsel agree for certain actions to be undertaken. If some assurance is given by any person to the court, as has been done in the present case, and the said assurance/understanding is not honoured, the court would not come to his rescue. The application is therefore, rejected."
The matter then went back to the Supreme Court which asked Sebi to conduct its enquiry after giving the company officials a fair hearing. The final Sebi order, which incorporates the details of those hearings, is a telling indictment of how close to the wind the group has been sailing. Here are the key takeouts:
The Sahara Group primarily challenged Sebi's intrusion into the affairs of SCSC (SIREC, that is) and SHIC saying that OFCDs were not under Sebi's jurisdiction since they were hybrid instruments- neither shares nor debentures. Sebi demolished this argument easily since they were debentures that could be converted into shares.
In any event, said the Sahara group, the OFCDs were being privately placed with the Sahara Parivar and not the general public. When no public offer was involved, how could Sebi intervene?
Sebi kayoed this argument simply: when Sahara offices and agents were vending these OFCDs, and when the two companies had garnered several million investors, many of whom had no connection with the Sahara group, the offers was effectively not a private placement.
The Supreme Court has given the lie to Sahara's claim that its efforts to raise humongous amounts of money from the public were really a private affair in which Sebi need not meddle.
More than one year after Sebi's order, Sahara's goose is cooked.
(Editor's note: The Rs 20,000 crore refund figure is for one company, SIREC, with interest. Since there are two companies involved, the total refund, including interest, would amount to over Rs 27,000 crore).