Remember the basic rules of stock market

This was a matter in which, on April 29, 2020, SEBI passed three separate orders, holding a company to account for not utilising the proceeds of a preferential issue (when shares or securities are issued to a select group of people, unlike a public issue, when it is for all) for the purposes stated at the time the funds were raised on October 1, 2012. The approval of the shareholders was obtained for utilising the proceeds for five purposes: Capital expenditure, including the acquisition of companies/business; funding long-term working capital requirements; marketing; setting up of offices abroad; and other approved corporate purposes.

The proceeds were, however, not used for any of these purposes. Instead, the company used the amount for purchasing the shares of other companies, and extending loans and advances to other companies and entities. This escaped the notice of the audit committee, the board and auditors for five years. If they knew and did not act, it would have been worse.

On September 29, 2017, a special resolution was passed in the annual general meeting, wherein shareholders approved all acts and deeds conducted by the company in entering into and giving effect to, the utilisation of proceeds of the preferential issue, even though this was at variance with the original objectives.

On April 27, 2018, the SEBI AO issued show-cause notices to the company and its directors. After hearing them, the AO passed orders on April 29, 2020, against the company and the directors.

It is these orders that SAT set aside in June.

The view taken by the tribunal is that with shareholders ratifying the company’s action, the alleged misapplication of the proceeds will no longer be an issue. The tribunal looked at the meaning of “ratification” as mentioned in a ruling of the Supreme Court, and concluded that: “…ratification” means “the making valid of an act already done”.…. ratification assumes an invalid act which is retrospectively validated.”

The tribunal also refers to a judgment of a British court which explains “ratification” as “…the approval by act, word, or conduct, of that which was attempted (of accomplishment), but which was improperly or unauthorisedly performed in the first instance.”

Based on the above judgments, the tribunal saw this as “the making valid of an act already done.” It cannot be anyone’s intention to question the definition or explanation of “ratification”. It is the intent that is in question.

The apex court judgment states that ratification “assumes an invalid act, which is retrospectively validated”. The judgment of the British court uses the following words: “Which was improperly or unauthorisedly performed in the first instance”. Therefore, there is enough substance in the argument that the act of misapplying the proceeds was wrong, improperly or unauthorisedly performed.

To fault SEBI’s orders for pulling up the company would seem inappropriate. What lends complexity to the issue is that while the ratification was carried out in 2017, SEBI issued the notices in 2018, and passed the orders in 2020. To point out that SEBI’s show-cause notices came after the ratification was done is neither here nor there. It is to the original act of misapplication of funds that SEBI has directed its attention.

The basic questions that need to be addressed are: If a company can mobilise 75% or more of the shareholding, can it, at any point in time, in the name of ratification, legitimise what it has done? Should the firm not be held accountable for misleading the investors in 2012 when it had no intention of utilising the proceeds for any of the stated purposes? Why did it take five years for the firm to seek the shareholders’ approval and seek a change of objectives? If the majority shareholding, either directly or through persons acting in concert, exceeds 75%, can minority shareholders be taken for granted whenever the company chooses to do so?

Orderly conduct in the marketplace is premised on a regime of complete and correct disclosures. In a disclosure-based regime, the firm must honestly state to the shareholders the contemplated objectives of any fund-raising exercise.

The 2017 resolution merits comment. The explanatory statement accompanying the resolution of 2017 states blandly what the object of the issue was in 2012, and then indicates how the funds have been utilised. The basis on which approval has been sought for ratification is that the utilisation of funds, as it took place, was “considered advantageous compared to the proposed utilisation as disclosed in the Notice of the Extra Ordinary General Meeting held on 01/10/2012”. Put plainly, shareholders were taken for granted.

A comment on the behaviour of shareholders is also required. In 2017, all shareholders, all in the retail category, voted to ratify the management’s action over the previous five years. SEBI must be wondering what it can do to advance the protection of the interests of shareholders when they decide to score a self-goal, with no questions asked. Even God helps only those who help themselves.

M Damodaran is chairperson, Excellence Enablers Private Limited. He is former chairman, SEBI, UTI and IDBI. The views expressed are personal