Sahara case: SC order will pit Moily's MCA against Sebi

The Supreme Court’s order on Friday, directing the Securities Appellate Tribunal (SAT) to decide the Sahara group’s appeal on its optionally fully-convertible debentures (OFCDs) within eight weeks, is likely to see two regulators pitted against one another: the ministry of corporate affairs (MCA) and the Securities & Exchange Board of India (Sebi).

The Sahara group is caught between a rock and a hard place . One the one hand, it is under pressure from the Reserve Bank of India (RBI) to discontinue its para-banking activities and return the money to depositors.

On the other, Sebi, in an order dated 23 June, asked two Sahara companies - Sahara Commodity Services Corporation (SCSC) and Sahara Housing Investment Corporation (SHIC) - to return the OFCD money already collected from investors with 15 percent interest. The order was not given effect to since the Supreme Court has to confirm it.

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Little wonder, Sahara has been busy shopping for a favourable forum. Its appeal in the Supreme Court does not really talk about why it dislikes Sebi’s order, or what’s wrong with it, but that MCA is its regulator, not Sebi. It claims that its OFCDs were being privately placed and hence Sebi could not butt into it. (OFCDs are bonds that can be converted into shares at the option of investors at some specified future date.)

[caption id=“attachment_42600” align=“alignleft” width=“380” caption=“The Sahara group will now have the comfort of the ministry of corporate affairs batting on its side against Sebi, which asked it to pay back its OFCD investors. AFP”]  [/caption]

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But in a well-argued order, Sebi’s wholetime member KM Abraham made a strong case that when six million investors were being tapped for humongous amounts of money, the issue would be in the nature of a public offer and hence it has jurisdiction.

Even so, it will have to contend with what the MCA has to say on it. In its Friday order, the Supreme Court specifically observed that the MCA should be heard during the SAT appeal. “We make it clear, in the appeal which is proposed, that the ministry of corporate affairs should be a party as a respondent, particularly in view of issues arising in this statutory appeal.”

This is sure to bring the two regulators - MCA and Sebi - into conflict. It was the MCA that cleared Sahara’s OFCD issues, and thus may not be able to back off from its decision without looking foolish. This is what Sahara may be counting on.

On the other hand, the Sebi order is simply too well-argued to be brushed aside. There is very little doubt that the MCA did not do its homework while clearing the issue. The Sebi order of 23 June not only claims it has jurisdiction over the OFCD issue, but also that the two Sahara companies (Sahara Commodities and Sahara Housing) may be taking investors for a ride.

Sebi pointed out that they had minuscule net worth of a few lakhs of rupees when they started collecting money from investors in 2008 and 2009. But they were planning to collect a humongous Rs 40,000 crore for unclear reasons before Sebi stepped in. Not only that, the two companies were apparently planning to keep the private placement issue open ad infinitum.

The money was probably being raised because the group is under pressure from the RBI to wind down its para-banking operations. Three years ago, the RBI asked Sahara India Financial Corporation (SIFC), a residuary non-banking finance company, to stop accepting deposits maturing after 30 June 2011, and also return all remaining deposits by 30 June 2015.

This order was flouted, and the RBI had to take newspaper advertisements to warn investors once more to stop investing in the company.

Putting two and two together, it seems likely that the money raised through the OFCDs were probably meant to pay off the para-banking depositors. Since the OFCDs were apparently being placed largely with previous Sahara Parivar investors (and hence called private placement), it is more than likely that there is an overlap between the OFCD and SIFC investors.

Put another way, there is a strong probability that Sahara is raising money from its Parivar (apart from new investors) to pay back the same Parivar’s investments in another company that has to be wound up.

It is this kind of Ponzi activity that the Sebi order has tried to stop, and which Sahara is trying to thwart by trying to take the matter back to the MCA.

However, it is not going to be easy for SAT to rule fully against Sebi in view of the grave charges the latter has managed to prove fairly conclusively against Sahara.

Sebi’s Abraham has made out at least five major violations of law or contravention of good investor protection practices by the two Sahara group companies.

First, the group contravened Schedule II of the Companies Act, by deliberately excluding Sebi from vetting the draft red herring prospectuses (DRHPs) of the two companies while issuing OFCDs.

The Schedule specifies that while filing the DHRP, company directors have to file a declaration saying they have complied with all provisions of the Companies Act and the Sebi guidelines. But the directors of the two companies excluded all references to Sebi while signing their declarations.

Second, Sahara also tried to bypass Sebi’s 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 neither had any closing date at all!

Third, Sebi has accused Sahara of a lack of corporate governance. The two companies, SCSC and SHIC - which were expecting to raise Rs 40,000 crore between them through the OFCDs - did not even have a proper list of investors.

Fourth, Sebi says the two companies did not comply with even the basic rules for investor protection designed by Sebi. “SIREC did not have any distributable profit for the financial year ending 31 March 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.”

Fifth, 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.”

The MCA is sure to be embarrassed by Sebi’s order, which points out its own lack of diligence in clearing Rs 40,000 crore worth of capital raising without basic investor safeguards. But will it be able to swallow its own ego and go along with Sebi?

This is why an MCA-Sebi bout cannot be ruled out at SAT.