SECURITIES AND EXCHANGE BOARD OF INDIA
ORDER DECIDING PRELIMINARY OBJECTIONS TO JURISDICTION
IN THE MATTER OF DESIGN AUTO SYSTEMS LTD.
1.0 Background
1.1 SEBI conducted investigations into dealings in the shares of Design Auto Systems Ltd. (DASL) for the period between November 2001 and January 2002 pursuant to a preferential allotment made by the said company to another company called Bonanza Biotech Ltd. (BBL) in the swap ratio of 1:1. DASL shares were listed on the Bombay Stock Exchange Ltd (BSE), Madhya Pradesh Stock Exchange (MPSE) and Ahmedabad Stock Exchange (ASE). BBL shares were listed on BSE and MPSE. The investigations revealed as under:
(a) DASL made a preferential allotment of 10 crore of its shares (said shares) to BBL on October 29, 2001 which was about 14 times of the paid up capital of DASL before the allotment. The consideration was another preferential allotment of 10 crore shares made by BBL to DASL on the same date which was about 5 times of the paid up capital of BBL before the allotment.
(b) DASL made application for listing the said shares allotted to BBL to various stock exchanges where its original shares were listed. The MPSE granted listing permission. The BSE kept the listing application pending, as it apprehended that DASL would have committed certain violations of law in the process. No listing application was made to ASE. However, even MPSE had not granted the trading permission.
(c) Eventually, the listing application of DASL was rejected by BSE. On the basis of listing permission given by MPSE, the Central Depositories Services Ltd. (CDSL) dematerialized these shares and credited them to the beneficial owner account of BBL.
(d) BBL offloaded substantial portion of these unlisted shares on the trading platform of BSE through a network of entities. Though this is not permissible in terms of BSE Bye-laws and constitutes bad delivery thereunder, the BSE Clearing House or any other parties to the trades could not immediately detect the irregularity as these shares were in the dematerialized form and were fungible with the already existing and validly listed shares of DASL. As a result, a number of innocent investors were defrauded and saddled with unlisted shares which could not be legally transacted on the BSE.
(e) When this came to the notice of SEBI and BSE, many transactions were reversed and the demat account of BBL frozen after recovering a portion of the shares that were offloaded by it.
(f) Subsequently, investigations were initiated by SEBI to probe into the alleged and apparent malpractices committed by DASL, BBL and other entities.
1.2 During the course of the aforesaid investigations, summons was issued to DASL to appear before the Investigating Authority since it was one of the parties to the principal transaction. DASL challenged it before the Hon’ble High Court of Madhya Pradesh, Indore Bench by filing a writ petition, raising various objections to SEBI’s jurisdiction (WP No.673/2004). BBL had also challenged a similar summons issued by SEBI before the same Court (WP No.150/2004). Both the writ petitions were dismissed by the Hon’ble Court by orders dated March 04, 2005. Detailed order was passed in WP No.150/2004 and it was made equally applicable to DASL by a short order passed in WP No. 673/2004. While dismissing the petitions, the Hon’ble Court directed SEBI to ensure expeditious completion of investigation and further directed DASL and BBL to co-operate in the investigation so as to enable the Investigating Authority to complete the same expeditiously.
1.3 The findings of investigation as above, pointed to various violations including that of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices in the Securities Market) Regulations, 1995 (“the PFUTP Regulations”) by DASL, BBL and other entities suspected to be involved. SEBI, therefore issued show cause notices to DASL, BBL and other entities suspected to be involved in the transactions, requiring them to show cause as to why appropriate directions should not be passed.
1.4 DASL, instead of replying to the show cause notice, raised certain objections again to SEBI’s jurisdiction and further sought inspection of certain documents vide its letters dated July 21, 2005 and August 31, 2005. SEBI, thereupon replied vide letters dated August 22, 2005 and September 19, 2005 that the jurisdictional objections may be raised before the Whole Time Member, SEBI.
1.5 DASL challenged the aforesaid letter dated September 19, 2005 of SEBI by filing another writ petition before the Hon’ble Indore High Court. The Hon’ble Court disposed of the writ petition by an order dated February 13, 2006 with the following observations:
“Since only show cause notice has been issued, therefore, at this stage the petition cannot be entertained. The submission of petitioner is that petitioner should be heard first on the question of preliminary objection.
In view of this, the petition is disposed of with the direction that before proceeding further the Competent Authority shall take into consideration the preliminary objection regarding jurisdiction as raised by the petitioner and shall pass a reasoned Order after giving an opportunity of hearing to the petitioner. If the Competent Authority is of the view that it has the jurisdiction then it shall be at liberty to proceed further.
With the aforesaid observations the petition stands disposed of.”
1.6 The present proceedings have been initiated in compliance with the aforesaid order of the Hon’ble Court to decide the limited issue of jurisdiction raised by DASL as a preliminary objection.
2.0 Notice, hearing and reply
2.1 A hearing was granted to DASL to make its submissions on the jurisdiction on April 25, 2006. A letter dated April 17, 2006 was received from Adhia & Adhia, Advocates & Solicitors to DASL and its directors requesting adjournment of hearing to a later date. In consideration of their request, the hearing was postponed to April 28, 2006.
2.2 On April 28, 2006 the representatives of DASL appeared in the hearing and made submissions. They also made written submissions on May 2, 2006. The gist of their submissions is as follows:
(a) Sections 11B and 11(4)(b) have no application to the present case and the SCN is therefore ultra vires.
(b) Directions could be issued to the issuer company only and not to its directors under section 11B.
(c) SEBI can only issue directions under section 11B and cannot issue a show cause notice.
(d) Powers under sections 11B and 11(4)(b) are to be exercised by the Board and not by an individual Member of the Board.
(e) The proceedings are barred by double jeopardy under the Constitution of India as multiple proceedings have been launched against them for the same cause of action.
(f) SEBI did not furnish the entire investigation report, but has forwarded only ‘relevant’ portions thereof, whose relevance has also been decided by SEBI.
3.0 Consideration of issues
Applicability of sections 11 and 11B
3.1 Section 11B of the SEBI Act reads as follows:
“Power to issue directions.
Save as otherwise provided in section 11, if after making or causing to be made an enquiry, the Board is satisfied that it is necessary,-
(i) in the interest of investors, or orderly development of securities market; or
(ii) to prevent the affairs of any intermediary or other persons referred to in section 12 being conducted in a manner detrimental to the interest of investors or securities market; or
(iii) to secure the proper management of any such intermediary or person, it may issue such directions,-
(a) to any person or class of persons referred to in section 12, or associated with the securities market; or
(b) to any company in respect of matters specified in section 11A, as may be appropriate in the interests of investors in securities and the securities market.”
(Emphasis supplied)
3.2 DASL contends that section 11B(a) is applicable to intermediaries referred in section 12 and section 11B(b) is applicable to companies only in respect of matters specified in section 11A. Since the present case is not a matter relating to disclosures envisaged under section 11A, no directions can be passed under section 11B against DASL which is a listed company.
3.3 I find that the fundamental flaw in this argument is that the underlined portions of section 11B have been totally lost sight of by DASL. ‘Persons associated with securities market’ are also a class of persons against whom directions can be passed under section 11B. This expression has been categorically held by the Hon’ble Securities Appellate Tribunal to include listed companies, whose behaviour may affect the securities market. Accordingly, I find no merit in this contention of DASL.
3.4 The Counsel further contends that directions cannot be issued to directors of the listed company under section 11B. In this regard, I find that if listed companies are considered ‘persons associated with securities market’, it stands to reason that the directors through whom they act should also be considered as such. Further, the allotment made by DASL to BBL was a decision of its Board of Directors to which all its directors were party. I also further find that the Securities Appellate Tribunal has in several cases held that directors of listed companies are also ‘persons associated with the securities market’ within the meaning of section 11B.
3.5 The Learned Counsel further contends that SEBI can only issue directions under section 11B but not a show cause notice. It is a well settled position that no directions involving civil consequences can be passed by an administrative authority without giving an opportunity of hearing to the concerned person except where the pre-decisional hearing is dispensed with. The show cause notice only seeks to give such an opportunity to DASL. Further, as required by express terms of section 11B, SEBI can pass directions thereunder only “after making or causing to be made an enquiry”. It was precisely to make such enquiry and to hear DASL submissions therein that the show cause notice was issued. Hence, the contention that the show cause notice cannot be issued by SEBI is highly untenable.
3.6 The Learned Counsel further contended that as section 11B will not sustain the action, section 11(4)(b) which was read with section 11B in the SCN will not independently sustain it. As I have found that the objection based on section 11B is untenable, this contention has no further significance.
Exercise of powers by Member
3.7 DASL further submits that powers under sections 11(4) and 11B of the SEBI Act vest with the SEBI Board and therefore cannot be exercised by a Member of the Board. This submission is untenable in view of the fact that the SEBI Board has, under section 19 of the SEBI Act, delegated its powers under sections 11(4) and 11B inter alia to its Whole Time Members.
Double jeopardy
3.8 DASL further contends that “SEBI and other authorities have sought to take legal action against DASL and its directors on multiple fronts on the same cause of action” and this is ultra vires the constitutional protection against double jeopardy. In support of this contention, DASL has referred to two other proceedings apart from the current one – one initiated by SEBI for alleged violation of the Takeover Regulations and the other alleged to have been commenced by the Serious Fraud Investigation Office (SFIO) in respect of the swap allotments made by DASL and BBL. No documents which show details of the SFIO proceedings have been submitted. From the written submissions, it does not seem that the said proceedings have attained finality by either a conviction or an acquittal.
3.9 The prohibition against the double jeopardy contained in Article 20(2) of the Constitution is applicable only when a person who has already been convicted or acquitted in criminal proceedings is again being tried under criminal jurisdiction for the same offence. This Article is not applicable to the facts of the present case for more reasons than one – that the present proceedings are not criminal in nature, that he has not been convicted or acquitted earlier in any criminal proceedings for the same violations and that the different proceedings are not for violation of the same legal provisions. As is abundantly clear, SEBI is the only competent authority for deciding whether the PFUTP Regulations have been violated or not. Of all the proceedings referred to by DASL, only the present proceedings are concerned with this question. Thus, there is no double jeopardy caused by the present proceedings, as contended by DASL.
3.10 It is further seen that the same contention of double jeopardy was one of the grounds raised by DASL in WP No. 673/2004. As already noticed, the said writ petition has been dismissed as being devoid of merit by the Hon’ble Indore High Court. As a result, the issue has been conclusively settled against DASL and it is barred by res judicata from raising the same objection again.
Natural Justice
3.11 DASL contends that copy of the entire investigation report was not given to it. The Learned Counsel submitted that the entire report ought to have been made available. I find in this regard that the investigation authority has already given extract of the report which is relevant to the conduct of DASL. It is seen that the investigation report contains details of many other transactions which are not relevant to DASL and which may pertain to other third parties. Under principles of natural justice, only such documents are required to be disclosed to the party as are being relied upon by the authority.
3.12 Learned Counsel further submitted that investigation report is like a Court order and it should be understood in its entirety. However, I find that there is no legal basis for such a statement. A Court order as is mentioned by the Learned Counsel is a pronouncement on the legal position, whereas, an investigation report contains only factual findings arrived at by the Investigating Authority. It is well settled that furnishing of the relevant extract of a bulky investigation report would meet the requirements of natural justice, as also held by the Hon’ble Securities Appellate Tribunal in Mega Resources Ltd. vs SEBI .
3.13 In view of the above, I find that the preliminary objections raised by DASL are not sustainable. The proceedings initiated against DASL under sections 11 and 11B of the SEBI Act by show cause notice dated June 30, 2005 shall therefore be continued in accordance with law. DASL is directed to file its reply to the aforesaid show cause notice within 15 days of this order.
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Mumbai
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T.C. NAIR
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June 22, 2006
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WHOLE TIME MEMBER
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SECURITIES AND EXCHANGE BOARD OF INDIA
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