TaxTMI 
TaxTMI 
2016 (6) TMI 805
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....Mr. Sanjay Dewan, and Appeal No. 301/2014 has been preferred by the Managing Director-cum-Chief Executive Officer of the Appellant against a common impugned order dated 21st March, 2014, passed by the Learned Whole Time Member of the SEBI under Sections 11(1), 11(4) and 11B of the SEBI Act, 1992, prohibiting the three Appellants from taking up any new assignment or involvement in a new issue of capital, including Initial Public Offering (IPO), follow-on issue, etc. in the Securities Market for a period of five years. 3. The impugned order dated 21st March 2014 has been, inter alia, passed for the alleged violation of Regulations 8(2)(b), (e)-(f); 64(1) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, hereinafter referred to as "ICDR Regulations", and violation of Regulation 13 read with Clauses 1-4, 6-7 and 21 of the Code of Conduct prescribed under Schedule-III of the SEBI (Merchant Banker) Regulations, 1992. The abovesaid regulations and provisions are reproduced herein for the sake of convenience : SEBI (Issue of Capital Disclosure Requirements) Regulations, 2009 "8(2). The lead merchant bankers shall submit the following documents to the Board a....
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........................ Clause 21. A merchant banker shall maintain an appropriate level of knowledge and competence and abide by the provisions of the Act, regulations made thereunder, circulars and guidelines, which may be applicable and relevant to the activities carried on by it. The merchant banker shall also comply with the award of the Ombudsman passed under the Securities and Exchange Board of India (Ombudsman) Regulations, 2003. "APPEAL No. 207/2015" 4. In addition to the debarment of five years imposed on the company the Appellant along with its Compliance Officer and the M.D.-cum-C.E.O., SEBI simultaneously initiated proceedings against the Appellant for violation of the provisions of SEBI (Intermediaries) Regulations, 2008, hereinafter referred to as "Intermediaries Regulations" and imposed a punishment of prohibition of two years on the same entities in a vague manner. Relying upon the report submitted by the Designated Authority "D.A", the Learned WTM of SEBI passed Impugned Order dated 20th March, 2015, by practically agreeing with the D.A. and observing that the effect and consequence of the two years' prohibition recommended by D.A. to be imposed on the Appell....
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....f 2015 which is also being finally decided today itself between the same parties. The relevant regulations are reproduced hereinbelow for the sake of convenience : SEBI (Merchant Banker) Regulations, 1992 Consideration of application. "6. The Board shall take into account for considering the grant of a certificate, all matters which are relevant to the activities relating to merchant banker and in particular the applicant complies with the following requirements, namely :- [(a) the applicant shall be a body corporate other than a non-banking financial company as defined under clause (f) of section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934), as amended from time to time : [Provided that the merchant banker who has been granted registration by the Reserve Bank of India to act as a primary or satellite dealer may carry on such activity subject to the condition that it shall not accept or hold public deposit;] Grant of certificate of initial registration "8. (1) The Board, on being satisfied that the applicant is eligible, shall grant a certificate of initial registration in Form B and shall send an intimation to the applicant. (2) The certificate of initial regis....
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....ntity can be considered to be fit and proper and consequently be deemed eligible for a registration as an MB. 7. In this background, we now proceed to deal with the Impugned Order dated 21st March, 2014, in respect of Appeal Nos. 275, 276 and 301 of 2014, taking the facts of Appeal 275 of 2014 pertaining to the Company as the lead case. Briefly stated the facts of the case are that the Appellant was incorporated as a Company in June, 1994, and since then it has been dealing in various branches of the Securities Market, including acting as Merchant Banker. The Appellant was appointed as Book Running Lead Manager "BRLM" to the IPO of P.G. Electroplast Limited "the Issuer Company" on 7th June, 2010. A Draft Red Herring Prospectus "DRHP" was, accordingly, filed on behalf of the Issuer Company by the Appellant on 23rd September, 2010. On 29th December, 2010, SEBI granted the clearance/approval for opening of the IPO of the Issuer Company. On approval of the said Red Herring Prospectus "RHP" by the Board of Directors of the Issuer Company on 17th August, 2011, the same day it was immediately filed with SEBI, and with the Registrar of Companies, NCT of Delhi and Haryana "ROC". 8. After ....
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....s and circumstances of the case ? The purposes of the IPO in question, as seen in the Prospectus, were as mentioned below :- * Prepayment of the portion of the term loan and line of credit facility proposed to be availed by the Issuer Company for expansion under phase 1 - (Rs. 24.10 Crore) * Expansion of manufacturing facility at Unit III, Greater Noida under phase 2 - (Rs. 13.84 Crore) * Expansion of manufacturing facility at Unit IV, Ahmednagar under phase 2 - (Rs. 37.31 Crore) * Meeting long-term working capital requirements - (Rs. 15.00 Crore) * General Corporate Purposes - (Rs. 21.39 Crore) * Issue Expenses - (Rs. 9 Crore) 13. A perusal of the SCN and the Impugned Order shows that all the violations, alleged to have been committed by the three Appellants, can be summarised as under : (1) Failure to ensure disclosure of material fact in the RHP and Prospectus, such as :- (i) Funds raised by the Issuer Company through Inter Corporate Deposits "ICDs", which were in the nature of a bridge-loan. (ii) Decision by the Board of Directors of the Issuer Company to invest in ICDs of other companies. (iii) Purchase orders placed by the Issuer Company for plant and machinery.....
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....ade its own exhaustive enquiries independently as well with the management of the company commencing from June 2010 onwards. In addition, the Appellant had obtained relevant updated certificates, undertakings and affirmations certifying that there was no material change before presenting the draft RHP to the Respondent. Further, during the due diligence process, Appellant had periodic meetings with the promoters and management of the Issuer Company wherein Appellant, inter alia, discussed with them the business of the Issuer Company, their experience, visited various premises of the Issuer Company including its manufacturing units to better understand their products, production processes and, plant and machinery etc. All this was done purely with a view to keep a tab on the progress of the objects of their proposed IPO. Appellant had also verified various documents relating to the business, properties, capital structure, litigation, objects of the issue, government approvals, management, promoter and promoter group entities, etc. of the Issuer Company. During the process of due diligence of the Issuer Company, Appellant had also sought from the Issuer Company various documents/info....
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....wise. 20. The Statutory Auditor of the Issuer Company completed restatement of audited financial statements of the last five years ending 31st March, 2010 and submitted their report which was duly reproduced in its entirety in the DRHP. The same was updated in the RHP with the restated financials for the year ending 31st March, 2011, based on the updated report of the Statutory Auditor. As part of the due diligence process, the Appellant had also relied upon the confirmations/submissions of the Issuer Company's Statutory Auditor (Comfort Letters) specifically intended to provide an update of any material developments in the Issuer Company, subsequent to the date of the last audited financial statements. Further, in respect to the material disclosures, the Comfort Letters issued by the Statutory Auditor categorically confirmed that except as disclosed in the RHP, no material change was there in share capital, increase in current liabilities, secured and unsecured loans, deferred payment liabilities, contingent liabilities or total liabilities or decrease in current assets, loans and advances, fixed assets, total assets or net worth of the Issuer Company, etc. In addition to the abo....
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....four meetings, the discussion revolved around availing credit facilities from the Banks. It was, therefore, not within the reasonable apprehension of the Appellant as a Merchant Banker that the Loan Committee would conduct itself in this manner at its fifth meeting on 17th August, 2011. 23. Per contra, Shri Rustomjee, learned senior counsel for the Respondent has firstly submitted that the Appellant could not ensure disclosure of funds raised by the Issuer Company through ICDs in the nature of a Bridge Loan, i.e., the loan taken by the Issuer Company through ICDs in the form of a Bridge Loan, which would bridge the gap until it arises. Secondly; Shri Rustomjee submitted that the RHP and Prospectus did not disclose the Board's decision to invest the IPO proceeds in the ICDs of other companies. The Appellant's failure to ensure disclosure of these facts regarding taking and decision to grant loans through ICDs would amount to lack of due diligence. Therefore, the finding in the Impugned Order that the Appellant, as a Merchant Banker of the Issuer Company, for the IPO in question, had failed to ensure genuine and true disclosure of material facts regarding the decision of the Issuer ....
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....hat they were unable to express an opinion on the financial position/results of operations or cash flows of the the Issuer Company for a period post 31st March, 2011. This should have acted as a "red-flag" and the Appellant should have done further independent due diligence for the correct facts to be revealed in the RHP/Prospectus for public consumption. Various qualifications mentioned in the Statutory Auditors certificate negate their value in the eyes of law. 26. At this stage we deem it appropriate to summarise the basic submissions of the Appellant as under : * That the scope of due diligence is to conduct the review and examination of information provided by the Issuer Company to a practical and reasonable extent. The Respondent has not managed to point out any red flag in its investigation which should have aroused the suspicion of the Appellant in the affairs of the Issuer Company. * In 2012, the AIBI published its Due Diligence Manual basically comprising of the standards of the banking industry which had been adhered to so far while conduct such due diligence exercised by MBs in general. The Manual clearly identifies that the reports of Statutory Auditors and legal ad....
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....re dealt with hereinafter. Regulation 2(1)(f) explains book building as the process whereby the demand and price of certain securities is assessed and determined. Regulation 2(1)(g) defines a book runner as an appointed by the issuing company to undertake the book building process. Regulation 2(1)(r) defines issuer as any person, meaning any judicial entity, making an offer of securities. Regulation 2(1)(x) defines the term 'offer document' as red herring prospectus, prospectus, shelf prospectus and information memorandum in case of a public issue and letter of offer in case of a rights issue. Regulation 2(1)(zc) defines "public issue" as initial public offer and further public offer. Regulation 2(2) states that all words and expression not defined in the ICDR Regulations shall be the ascribed meaning as per the Companies Act, the SCRA and the Depositaries act, and rules and regulations made thereunder. 29. Chapter 2 deals with Common Conditions for Public Issues and Rights Issues. Regulation 4 contained in this chapter provides for initial steps to be taken and conditions to be fulfilled by an issuing company before the filing of the draft offer document. This regulation needs to....
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....n passed by the board of directors of the issuer for allotting specified securities to promoters towards amount received against promoters' contribution, before opening of the issue; a certificate from a Chartered Accountant, before opening of the issue, certifying that promoters' contribution has been received in accordance with these regulations, accompanying therewith the names and addresses of the promoters who have contributed to the promoters' contribution and the amount paid by each of them towards such contribution; a due diligence certificate as per Form D of Schedule VI, immediately before the opening of the issue, certifying that necessary corrective action, if any, has been taken; a due diligence certificate as per Form E of Schedule VI, after the issue has opened but before it closes for subscription. Once the offer document has been displayed on the websites of SEBI and the stock exchanges for a period of 21 days as per Regulation 9 for the public's comments, the merchant bankers shall file with SEBI a statement giving information of the comments received by them or the IC on the draft offer document during that period and the consequential changes, if any, to be made....
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....meters within which such an option can be made available in an effort to stabilize the post-listing price of the securities offered in a public issue. Regulation 46 prescribes the minimum and maximum period for which a public issue must be kept open for subscription, viz., 3 days and 10 days respectively. Regulation 49 stipulates that the IC shall stipulate in the offer document, the minimum application size in terms of number of specified securities which shall fall within the range of minimum application value of ten thousand rupees to fifteen thousand rupees. Regulation 50 lays down that the allotment procedure shall be spelt out by the managing director along with the lead post-issue MBs in a fair and proper manner in accordance with Schedule XV of the ICDR Regulations. Regulation 51 stipulates that the post-issue lead merchant banker shall ensure that the amount received in respect of the issue is released to the IC as per section 73 of the Companies Act, 1956. Finally, Regulation 51A provides that the information provided in the offer document shall be updated annually by the IC in accordance with the manner prescribed by SEBI. 33. Chapter 5 deals with Manner of Disclosures ....
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....that a list of suppliers was disclosed in the RHP on page 76 and page 44, based on the information provided by the Issuer Company, which was duly verified by the Appellant thereafter from the Issuer Company's records. It appears that the names Nimbus Industries Ltd. or Supreme Communications Ltd have not been mentioned anywhere in the list. This fact has been corroborated by SEBI's observations in its ad interim order dated 28th December 2011 stating "the names of Nimbus Industries Ltd. and Supreme Communications Ltd. do not appear in the list of its suppliers provided by the Issuer Company in the offer document". It is thus borne out that the Issuer Company had never entered into any longterm supply agreement for purchase of plastic granules. This has been reinforced by the Issuer Company in their response letter dated 3rd December 2011 wherein they have stated that "There are no sale/purchase agreements with our customers and suppliers, we receive periodical orders from our customers on the basis of which we place orders to our suppliers". SEBI has rightly observed in its ad interim order dated 28th December 2011 that the reply of the Issuer Company in relation to this is in cont....
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....chant Banker. 39. Be that as it may, in relation to the charges with respect to nondisclosure of agreement for purchase of plastic granules, land, plant and machinery, these three appear to be acts undertaken by the the Issuer Company in the post-IPO stage and hence, in our considered opinion, the Appellant could not have incorporated the same despite any degree of DD that could have been applied. SEBI itself has accepted that the Appellant was not privy to the Issuer Company's intentions, and the Appellant's conduct to that extent is undisputedly unimpeachable. As held hereinabove, the Appellant ought to have perused the bank statements of the company, particularly regarding the period in respect of which even the Statutory Auditors had not gone through the unaudited accounts of the company i.e. ranging from 1st September, 2011 to the date of discharge of Escrow. 40. Moving on to the contradictory disclosure regarding Term Loan alongwith Line of Credit availed by the Issuer Company, undoubtedly, the Appellant has mentioned in the table on page 30 that the amount disbursed by the Bank was 'NIL'. However, disclosures by the Issuer Company to the Merchant Banker regarding the amoun....
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....en supplied to the Appellant on August 17, 2011 itself, there would have been no occasion for the the Issuer Company to provide an extract of the Board Meeting dated 17th August, 2011, over and above the minutes. This would have been superfluous. It would lead to the erroneous conclusion that RHP was approved in the same meeting held on 17th August, 2011 in which the ICDs were allegedly approved by the Board. This situation, if accepted, would lead to an inherent dichotomy inasmuch as it is unfathomable that the ICDs were approved in the same meeting wherein the RHP, without containing this factum regarding approval of ICDs, was also approved. In the absence of any evidence to the contrary, we, therefore, find that the Appellant was only supplied with an extract, and not the minutes of the Board Meeting dated 17th August, 2011, by the the Issuer Company. In this factual backdrop the Appellant cannot be condemned for not disclosing the matter regarding the raising of funds through ICDs by the Issuer Company in the Offer Documents. 44. As far as the decision of deployment of funds through ICDs is concerned, it appears from the facts of the case that this was only done once the IPO p....
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....e SEBI on the same date itself. Subsequently, it was also filed with the concerned ROC on August 20, 2011. * September 7, 2011- Accordingly, the IPO opened on for public subscription. * September 12, 2011 - The public subscription was closed. * September 14, 2011 - Thereafter, the final Prospectus after incorporating the changes suggested by the ROC as per the requirement of law. * September 16, 2011 - The Prospectus was preferred before SEBI as well. * September 16, 2011 - Shares were, thus, allotted to the public investors. * September 26, 2011 - Shares listed on BSE and NSE. 46. The above chronology makes it abundantly clear that the Appellant could not have incorporated such a fact of giving ICDs to the three companies taken by the Issuer Company after the conclusion of the IPO in the DRHP, RHP or even in the Prospectus. This charge, therefore, can also not be sustained against the Appellant. However, it must be said that the Appellant seems to have acted in a hurry to issue the RHP on the same date. It should have been more vigilant and careful in filing the RHP on August 17, 2011 itself. As such, we would hasten to add that the filing of Prospectus, which was done two ....
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....lause 4.5 the Issuer Company declared that any information made to the BRLM by the the Issuer Company shall be true and accurate and under no circumstance would any information be withheld; vide clause 4.9 the the Issuer Company undertook to update the information provided to the BRLM in case of any material change subsequent to the submission of the DRHP and upto the listing of the Equity Shares of the company. * Clause 5 puts forth provisions regarding independent verification to be conducted by the BRLM to ascertain the true state of affairs of the the Issuer Company. * Clause 8 provides for duties of the BRLM and states that the BRLM shall follow the code of conduct as provided in the MB Regulations. Further, the BRLM shall also perform all duties stemming from the Memorandum of Understanding. 48. From the abovesaid, it is evident that the the Issuer Company is primarily responsible for making complete and accurate disclosures in the Offer Documents through the MB. Undoubtedly, the MB has to employ its own independent Due Diligence, but in effect an MB relies upon the information / documents / records furnished by the Issuer Company to be included in the Offer Documents at v....
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....cular in light of the fact that Statutory Auditors are also governed and regulated by SEBI. Although, a Comfort Letter cannot be treated as an excuse for an independent due diligence to be undertaken by a Merchant Banker, yet it is a statutorily recognized step in furtherance of due diligence undertaken by an M.B. and, hence, its value cannot be undermined. The requirement of the Statutory Auditors' Certificate (Comfort Letter) flows from Schedule VIII Section IX of the ICDR Regulations and it is provided therein that audited statements for the purposes of the Offer Document are needed for periods above six months and not before. The Comfort Letters obtained by the MB have been for specifically those periods which had not been covered in the last audit, which had been conducted less than six months ago. It is the admitted position that 4 Comfort Letters were provided by the Statutory Auditors which have not been assailed in any manner, nor have the Statutory Auditors been called upon to explain the statements made therein by the Respondent. 51. In fact, a perusal of the Comfort Letters, in question, clearly reveals that the Statutory Auditor did take into account and definitely re....
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....al Court. After the evidence was over, the Appellant before the Supreme Court filed an amendment application bringing on record a written agreement executed between the parties in the year 1982. The Trial Court allowed the amendment subject to certain cost but the High Court, in appeal, reversed the same. This is how the matter eventually reached the Apex Court. While interpreting Order 6 Rule 17 of the Code of Civil Procedure, the Hon'ble Supreme Court noted that Rule 17 makes it clear that amendment of pleadings is permitted at any stage of the proceeding, but the proviso imposes certain restrictions and provides that after the commencement of trial no application for amendment shall be allowed. However, if it is established that in spite of "due diligence", the party could not have raised the matter before the commencement of trial depending on the circumstances, the court is free to order such application. 54. In this context, elaborating the concept of due diligence, Hon'ble Supreme Court has pertinently held as under :- "........The words 'due diligence' have not been defined in the Code of Civil Procedure, 1908. According to Oxford Dictionary (Edn. 2006), the word "diligen....
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....ed to make disclosure of related party transactions in the offer document of TSL F. made incorrect disclosures of the business over view of TSL. G. failed to carry out due diligence while verifying the address of Mr. Ramaswamy Kuchana, Director of TSL. 56. Further, in paragraph 10 of SEBI's order dated 5th August, 2014, it has been categorically held by the learned WTM while exonerating a similarly situated Merchant Banker, namely - PNB Investment Services Limited, held as under :- "10. .....In view of the above, the due diligence expected from the merchant banker is reasonable diligence. Such obligation has to be enquired into and found out on the higher degree of preponderance of probability taking into account the facts and circumstances of the case. The merchant banker cannot be expected to look into each and every statement and information provided by the issuer with suspicion unless the facts and circumstances at the relevant time demand so. Accordingly, the obligation of the Noticee in this case has to be examined keeping in mind the above principles...." 57. From the above-said we can conclude that SEBI itself has not taken as harsh a view as in the Appellant's case i....
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....ad siphoned off funds to the tune of Rs. 4.75 crore. Keynote had failed to report this since it based its Due Diligence on primarily two points. The first being a declaration for the Board of Directors stating simply that all statements in the approved offer document were true and correct. Secondly, Keynote relied on the Capitalisation Statement received from a Statutory Auditor, which did not fulfill the requirements of a Comfort Letter as understood from a reading of the relevant provisions of the ICDR as discussed above. In the case of Keynote, it was evident that nothing concrete was done to verify the statements of the Board of Directors and that everything as portrayed by ESL was accepted without question. Even after such a serious misconduct had been established against Keynote, it was penalized only with a monetary penalty of Rs. 10 lac. In this case however, it cannot be said that the Appellant did not take any proactive measure. 60 In fact, it is pertinent to point out, even at the cost of repetition, that the Appellant took the following steps to confirm the information provided to it by the Issuer Company: * Detailed undertaking/confirmation obtained from the Issuer C....
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....ade in the Offer Documents. True and accurate disclosures are important for common investors to take an informed decision regarding investment in the upcoming IPO. The purpose for which the disclosures are required to be made will, thus, be frustrated if the same were inaccurate or untrue or incomplete. 62. Again, in the case of PNB Investment Securities Limited, it was clearly stated by the WTM that the MB could not be expected to look into each and every bank statement with suspicion unless there is a red flag which propels the Merchant banker to do so. However, apart from vital and material developments, there may be some trivial insignificant aspects which may be inadvertently overlooked by an M.B. without any mala fide intentions. In the absence of any connivance with the the Issuer Company, an M.B., therefore, cannot and should not be held liable for alleged lapses which may not have any effect on the decision-making process of the investors to invest or not to invest in the upcoming IPO. 63. Except, non-examination of the bank statement of the Issuer Company, we do not find any major lapse / flaw in the process of due diligence carried out by the Appellant. In fact, even h....