Market watchdog Sebi has shown that it has fine investigative instincts. Its probe into the affairs of two Sahara group companies - Sahara Commodity Services Corporation (SCSC) and Sahara Housing Investment Corporation (SHIC) - have forced it to conclude that they were up to no good.
It has, therefore, ordered that they should return all the money raised through the ongoing issue of optionally fully convertible debentures (OFCDs) with 15 percent interest. SHIC was formerly called Sahara India Real Estate Corporation (SIREC). OFCDs are bonds which can be converted into equity at the investor's option.
Till the money is returned, the regulator has banned promoter Subrata Roy and some Sahara directors - Vandana Bhargava, Ravi Shankar Dubey and Ashok Roy Choudhary - from accessing the capital market or being associated with any listed public company. The order, though, is subject to a confirmation by the Supreme Court.
The order was delivered by wholetime Sebi member KM Abraham on 23 June. He retires on31 July and has not been given an extension for unexplained reasons.
A brief recap will explain the circumstances under which Sebi gave its path-breaking order. (See here)
It stumbled into 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, SCSC and 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 Apri, 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 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 over six million investors, many of whom had no connection with the Sahara group, the offers was effectively not a private placement.
Sahara's clout in the corridors of power was visible when it produced opinions from the Law Ministry supporting its case. But the ministry had its own discordant views. While one Additional Solicitor General (ASG), Mohan Parasaran, leaned towards the Sahara Group's claim that the OFCDs were not a public issue, another ASG, Parag Tripathi, held otherwise. Section 67(3) of the Companies Act clearly says that where the number of investors exceeds 50, it cannot be termed a private placement.
However, so far it was all about interpreting the law on hybrid instruments and private placement of shares. But things get murkier from now on. Here's where the Sahara Group's efforts to avoid Sebi guidelines come through clearly.
First, Abraham shows how the 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."
Sebi's second major charge against Sahara is that it 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? Asks 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?"
Apparently, for Sahara everything's possible.
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, SIREC 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, as admitted by SIREC, 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. Says Sebi: "SIREC did not have any distributable profit for the financial year ending March 31, 2008. SIREC had a negative net worth at the time of the offer and the net worth of SHIC was around Rs 11 lakh.
"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, and this is simply reprehensible, 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."
The Sebi order also points out that cheques from investors were sought in the name of Sahara India, Subrata Roy's partnership firm, but OFCD certificates were issued in the name of Sahara Housing Investment Corporation. Money apparently moves from one pocket of Sahara to another without investors really getting to know.
Clearly, Subrata Roy's companies were taking investors for a ride, even if they fully intended to return their money.