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The SEBI Way of Prohibiting Fraud in the Securities Market


The preamble of the Securities and Exchange Board of India Act of 1921 (hereinafter referred to as “SEBI Act,”) established that the Securities Exchange Board of India (hereinafter referred to as “SEBI Board,”) ultimately aims to promote development and regulate the securities market, while ensuring adequate protection of the interests of the investors therein. For this purpose, the SEBI board has often highlighted it as one of its primary duties to take any measures ‘as it thinks fit’ for the purpose of ensuring harmony in the securities market. In a similar context, one of the duties that the SEBI Board considers very diligently, is prohibiting fraudulent practices for the purpose of unfairly earning more money through the securities market.

Similar to the practical working of any other market, even the Indian share market is prone to scams and frauds; a state which the SEBI Board constantly aims to reduce in order to maintain harmony in the securities market while also ensuring protection of the interests of the millions of investors who choose to trade in the exchange boards on a daily basis.

According to the definition provided by SEBI’s Prohibition of Fraudulent and Unfair Trade Practices Regulations (hereinafter referred to as “PFUTP Regulations,”) which were passed on 17th July 2003, fraud is appropriately defined as,

“Fraud includes any act, expression, omission or concealment committed whether in a deceitful manner or not by a person or by any other person with his connivance or by his agent while dealing in securities to induce another person or his agent to deal in securities, whether or not there is any wrongful gain or avoidance of any loss”.

Thus, to be specific, an act of fraudulent trading refers to carrying out trading in the securities market that involves means of unfair practices for the mala fide purposes of misleading investors and agents.


The SEBI Board is credited for detecting such frauds that affect involved parties in an unjustified financial manner, who are then appropriately tried according to the litera legis of the prescribed law. Recently, in the matter of V. Shankar v. Securities and Exchange Board of India (SEBI), the Securities Appellate Tribunal of Mumbai provided insightful guidelines when trying to infer who might be guilty of initiating the fraudulent trade practices in a company.


The present is an article that will accordingly discuss the nuances touched upon in the decision given by the Securities Appellate Tribunal of Mumbai as on November 1, 2022.


The SEBI Interference in the Scrip of DCHL

By virtue of its powers specified under the SEBI Act, the SEBI Board conducted an investigation in the scrip of Deccan Chronicle Holdings Ltd. (hereinafter referred to as “DCHL,”) and found that the company along with its directors were guilty for violating several provisions prescribed by the SEBI, particularly between the months of October 2011 till December 2012.


On prima facie understanding of the crux of the case, the order pronounced by the Adjudicating Officer of SEBI is credited for imposing a penalty amounting to Rs. 10 Lakhs on the appellant-company under Section 15HA of the SEBI Act, particularly for violating Section 68 (penalty for fraudulently inducing persons to invest money) and Section 77A (power of the company to purchase its own securities) of the Companies Act of 1956 (hereinafter referred to as “Act of 1956,”) respectively. The primary question that lies before us, is whether the promoters and the directors of DCHL were to be held guilty for the subsequent violation of these provisions.


When SEBI Board initiated a show cause notice to investigate the books of the company, it was found that DCHL had gravely violated the provisions prescribed by the SEBI Board, since it was guilty for understating outstanding loans alongside other mischievous omissions in the annual reports for the financial years of 2008-09, 2009-10, and 2010-11, respectively. It was also reported that the company was guilty of carrying out buyback of shares which were more than 25% of the total paid up capital limit during the financial year 2011-2012 without having adequate free reserves; an act in itself that contributed to misleading investors in mala fide faith. Accordingly, it was contended that DCHL was in violation of Section 68 and Section 77A of the Act of 1956.


In furtherance to this, it is pertinent to note that DCHL had failed to disclose material price sensitive information to the stock exchanges on the date of entering into an agreement of Deccan Chronicle Marketers and continued to provide them misleading financial information and overstated profits in their annual reports. After due investigation and analysis, it was confirmed by the Adjudicating Authority that charge was liable for artificially inflating profits to shareholders while there was actually a loss.


Deciding the Liability; Board of Directors vs. Company Secretary

The material question in any case of violation of the law is with respect to deciding the liability for such offence. In the instant case, since DCHL had also failed to appoint a Company Secretary, it led to further failure to disclose related party transactions and led to an understatement of outstanding loans and interest and finance charges etc.

It is material to further state that since the appellant was responsible as the Company Secretary for DCHL for signing the public announcement made by the it on 6th May 2011 for the purpose of buyback of its equity shares, the appellant must be considered equally liable for violating Section 68 and Section 77A of the Act of 1956 read with Regulations 3 and 4 of the PFUTP Regulations and Section 12A of the SEBI Act along with the company and its directors.

However, the same had been contended by the Board of Directors of the company in the present case, and it lies before the honourable court, i.e., the Securities Appellate Tribunal of Mumbai to determine whether the appellant, i.e., the Company Secretary in the instant case, shall be burdened with such liability thereof. Ultimately, the Securities Appellate Tribunal of Mumbai decided the case on its merits in the following manner:


Fiduciary Responsibility of the Board of Directors of DCHL

It is well-understood in the jurisprudence of corporate that there is a fiduciary duty imposed on the Board of Directors of any company to mandatorily verify the contents of any important document before approving it and letting the contents of such document determine the future undertakings of the company.

Hence, in the present case, the fact that the appellant, i.e., the company secretary had been held liable for the penalties imposed by the Adjudicating Officer under Section 77A of the Act of 1956 after a perusal of Section 215 of the Act of 1956 clearly indicates that there is a fiduciary responsibility placed before the Board of Directors of DCHL to verify the contents of the balance sheet before approving it. Thereafter, Section 215(1) of the Act of 1956 also prescribes an obligation upon the secretary and two directors of the company to sign the balance sheet for further approval.

After such ministerial task is given effect to, the company secretary then has to authenticate the contents of the balance sheet as approved by the Board of Directors, and does not mandatorily need to look into the veracity of the buyback offer document and its legal compliance, as such duty does not fall under the obligations imposed upon a Company Secretary. Thus, from the above analysis, it is clear to the Securities Appellate Tribunal that the question with regard to the verifying the veracity of the buyback offer document does not lie with the Company Secretary, but the Board of Directors of the concerned company.


Understatement of Finances in Annual Report and Buyback Offer Document

On a simple understanding of the roles and responsibilities of the duties of a Company Secretary, it is understood that Section 5 of the Act of 1956 allows a Company Secretary to act as the “officer in default.” However, on further interpretation of the said provision, it must be realised that merely being an officer in default does not make a Company Secretary responsible for the noncompliance of the company with regard to Section 77A of the Act of 1956.

In order to hold the Company Secretary responsible for such noncompliance, the burden of proof lies on the company to establish that the Company Secretary himself was responsible for the noncompliance under Section 77A of the Act of 1956, such that the company’s Board of Directors must prove themselves innocent by disbursing that they had no role in committing such violation. However, in the present case, this specific finding has not been established by the Board of Directors of DCHL, making the case in favour of the appellant, i.e., the Company Secretary. Moreover, the fact that the Board of Directors were solely responsible for making such understatements in the balance sheet, leading to further misleading statements in the open offer has been clearly acknowledged by the Adjudicating Officer in the present case.


Hence, from the above analysis of the facts and circumstances, the Securities Appellate Tribunal of Mumbai is satisfied that the Board of Directors of DCHL were the ones who were actually involved in understating finances in the annual reports and the buyback offer document, thus violating Section 68 of the Act of 1956 with a mala fide intention to induce investors by inflating profits of the company.


Role of the Company Secretary

In the instant scenario, it has been clearly established that the appellant, i.e., the Company Secretary only had a responsibility for complying with the resolution made by the Board of Directors of DCHL, and thus had no role in violating the provisions of the Act of 1956, and thus, must not be found guilty for the superseding penalties imposed due to the false and misleading open offer made by the company.

In furtherance to the above, it has also been established under Section 19(3) of the Act of 1956 that the appellant, as a Company Secretary was to additionally act as a Compliance Officer, and thus, his role was limited to redressing grievances of the investors. Hence, the above findings in relation to the duties of the Company Secretary has appropriately satisfied the Securities Appellate Tribunal of Mumbai that the liability lies with the Board of Directors of DCHL, rather than the Company Secretary.


Conclusion

The present case in relation to the matter of V. Shankar v. Securities and Exchange Board of India (SEBI), the Securities Appellate Tribunal of Mumbai is credited for providing guidelines for deciding the liability in instances of fraud, with special focus on the duties of a Company Secretary. After insightful analysis by the honourable court, it is now a part of jurisprudence that the role of Company Secretary is limited to what it is prescribed to, and it must not be held as the officer in default despite Section 5 of the Act of 1956, when a clear fiduciary duty between the Board of Directors of the concerned company and its Company Secretary has been drawn.

The burden of proof lies on the Board of Directors of that company to establish that they had no role in committing such violations, and that the Company Secretary is solely responsible for such offence. However, such a finding has not been established by the Board of Directors of DCHL, and hence, the Company Secretary should not be held liable for such violations, when in fact, the Board of Directors were the ones who are actually responsible for recklessly inducing investors by inflating profits of the company with a purely mala fide intention.



References

Harsh Dhude & Pranay Bhardwaj, Evaluating the Standard of Evidence Used in Insider Trading Cases, SCC Online (Jan 3, 2023) https://www.scconline.com/blog/post/2023/01/03/evaluating-the-standard-of-evidence-used-in-insider-trading-cases/.

V. Shankar v. SEBI, 2022 SCC OnLine SAT 797.

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