RoC: The dog that did not bark when Sahara came in

Sebi's comprehensive victory against the Sahara Group in the Supreme Court last Friday, where the court ordered Sahara India Real Estate Corporation (SIREC) and Sahara Housing Investment Corporation (SHIC) to refund over Rs 24,000 crore collected through optionally fully convertible debentures (OFCDs) in three months, is as much an indictment of the regulatory system as it is of Sahara (read more on what the SC said here).

While the Sahara group, in full-age advertisements issued to the print media, has railed against "the system" for the "injustice" and "unjustified tortures" (sic) meted out to it (both the Reserve Bank of India and Sebi asked it to shut down operations), there is, however, some point to this rant.

In fact, Sebi's victory is more the result of the doggedness of one whole-time member, KM Abraham, and his investigation team in pursuing Subrata Roy's efforts to evade regulation, but "the system" managed to evict Abraham from Sebi by denying him an extension that was his due last year. (Read Abraham's order here, and the SC's order here)

On the other hand, even Sebi cannot take full credit for cracking the case since Sahara's efforts to cock a snook at the law were not discovered by the market watchdog. Sebi caught Sahara only because Subrata Roy made the mistake of trying to raise money from the stock market by filing a draft red herring prospectus with the regulator for yet another company called Sahara Prime City Ltd.

 RoC: The dog that did not bark when Sahara came in

The Sahara case clearly shows that the surveillance gaps between different regulators can be exploited easily - and needs to be closed. PTI

It was while going through this prospectus that Sebi discovered that the Sahara Group was already raising money through what it called housing bonds - the OFCDs whose scrapping has now been upheld by the Supreme Court.

Here are the key takeouts from the Supreme Court verdict in the Sahara case.

First, there's the case of the sleeping watchdog. Sebi has done a stellar job only because evidence was lobbed in its court. This was not a case of the Sahara money-raising plot being discovered through active surveillance. That two companies seeking to raise Rs 40,000 crore between them - something no one in India has ever done before - can only be discovered by chance is a telling indictment of the lack of watchfulness of the watchdog. It's frightening how easy it is to evade the regulator even when such large sums are involved. What happens if the sums were smaller - says, Rs 100-200 crore?

Second, the chief villain is not Sebi but the ministry of corporate affairs at the centre. It was the registrar of companies (RoC) under the ministry of company affairs which cleared Sahara's twin OFCDs. By calling it private placement, Sahara sought to evade Sebi's jurisdiction even though it was planning to raise money from 30 million investors. But the RoC found nothing wrong with Sahara's intention - and didn't even bother to ask.

Can one presume that RoC was such a sucker that anyone can take it for a ride? The Securities Appellate Tribunal (SAT), to whom Sahara appealed against Sebi's order to return the OFCD money, not only upheld Abraham's order of 23 June, but also blasted the RoC for "dereliction of duty."

SAT said the sheer size of the OFCD issue "should have alerted him (the RoC) and he should have made necessary queries in this regard. It is reasonable to assume that he knew that an offer/invitation made to 50 or more persons would make it a public issue and he ought to have enquired as to the number of persons to whom OFCDs were proposed to be offered and their particulars. The appellants tell us that no such queries were made. Had he made such a query he would have known that the offer would be made to more than 50 persons which would have made the issue of OFCDs a public issue. In that event, he would have had no option but to insist upon the company to make all the necessary disclosures required to be made in a public issue. As already observed, no such disclosure has been made."

The moot point is: was the RoC merely sleeping on the job and not applying his mind, or was he in collusion with Sahara to deny Sebi a look-see at his fund-raising plans?

Clearly, heads have to roll in the RoCs of Uttar Pradesh and Uttarakhand which allowed the Sahara OFCDs.

Third, it is little coordination between the three regulators -, RBI, Sebi and RoC. After the RBI ordered Sahara India Financial Corporation to stop taking deposits from the public in 2008, two Sahara companies - SIREC and SHIC - started raising OFCDs by avoiding both RBI and Sebi. This could not have been a mere coincidence. Did the RBI not inform the minister of company affairs and Sebi to warn them against Sahara?

The Sahara case clearly shows that the surveillance gaps between different regulators can be exploited easily - and needs to be closed.

Fourth, there is one point where Subrata Roy does make sense. It is clear that his money-raising efforts are focused on reaching the people whom banks do not service. Eight years after the UPA and the Reserve Bank have been talking of "inclusive banking" it is the likes of Sahara and various microfinance institutions that seem to be more inclined to reach out to the poor (read here).

Clearly, both RBI and Sebi need to rethink the way they regulate. In particular, is it better to just ban the Saharas of the world, or is it better to impose stronger regulation on them through the banking system so that we have both better regulation and more inclusive banking. In particular, the RBI needs to ask itself: where do microfinance institutions and para-banking of the Subrata Roy kind fit in with the mainstream banking system - and how can one institution support the other without jeopardising the safety of investors savings?

Fifth, the Supreme Court verdict should lead to more public issues. The verdict establishes a clear law under which any company taking money from more than 50 individuals will have to make a public issue and get the shares listed. The ministry of company affairs will have to go through the entire list of registered companies and see if there are more Saharas lurking in their books - unregulated, undetected and a threat to investor savings. Many may have to list or return the money like Sahara. The RoCs have to become more proactive.

Sixth, there is going to be a huge logistical exercise in trying to return Rs 24,000 crore (Rs 27,000 crore including interest). Some 30 million investors have to be repaid after authenticating each entry. How is Sebi going to do this without creating a huge, even temporary, system of inspectors and investigations. In fact, the Supreme Court has put even Sebi on trial by appointing a retired judge, BN Agarwal, to oversee Sebi's work.

Seventh, Sahara is going to face a huge challenge in trying to return the money. It cannot just return the money to investors directly, but has to give it to Sebi. The money first comes to Sebi, and only then can it go to investors. The money also has to be raised by, possibly, selling many of the real estate properties that were purchased by Sahara. Will the real estate market be able to withstand so much selling in so short a time?

Eighth, the banking system will also come under pressure. Banks will have to be prepared for this logistical challenge. The Sahara group will probably seek bank loans to make the payments while the underlying securities are sold or mortgaged. The RBI will again have to ensure that money lent is lent against the right, marketable collateral.

Clearly, it is not just Sahara at the receiving end. The regulators, despite valiant efforts by isolated officers, are equally at fault and they seem ill-equipped to police the system. Who knows how many more Saharas there are in the dark corners of the system?

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Updated Date: Dec 20, 2014 11:41:36 IST