BEFORE THE ADJUDICATING OFFICER
SECURITIES AND EXCHANGE BOARD OF INDIA
[ADJUDICATION ORDER NO. AP/AO- 05/2006-07]
UNDER RULE 5 OF SEBI (PROCEDURE FOR HOLDING INQUIRY AND IMPOSING PENALTIES BY ADJUDICATING OFFICER) RULES,
1995 READ WITH SECTION 15I OF SECURITIES
AND EXCHANGE BOARD OF INDIA ACT, 1992
In the matter of acquisition of shares of
STILES INDIA LTD
AND
In respect of
SPARTEK CERAMIC INDIA LTD
1. Stiles India Ltd. (hereinafter SIL or target company) is a company whose shares are listed in the Stock Exchanges of Mumbai, Madras and Hyderabad. Spartek Ceramics India Ltd. (hereinafter, SCL or acquirer) filed a report with the Securities and Exchanges Board of India (SEBI) under Regulation 3(4) of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (hereinafter SAST Regulations) on January 10, 2006 seeking exemption from making public announcement to acquire further shares of SIL. From this filing, it came to the notice of SEBI, that SCL had earlier acquired shares of SIL on March 30, 2001, through preferential allotment, without making a public announcement in terms of Regulation 11(1) of SAST Regulations. Accordingly, the undersigned was appointed as Adjudicating Officer under Section 15 I of SEBI Act, 1992, read with Rule 3 of SEBI (Procedure For Holding Inquiry And Imposing Penalties By Adjudicating Officer) Rules, 1995 (hereinafter referred as 'Adjudication Rules') vide SEBI's order dated February 22, 2006 to inquire into and adjudge under Section 15H (ii) of the SEBI Act, 1992, the aforesaid alleged violation of SCL.
2. A Show Cause Notice (SCN) dated March 09, 2006 was issued to SCL under Rule 4(1) of Adjudication Rules, communicating the charges. It was alleged that SCL and persons acting in concert with it (PACs) acquired 194,294,457 shares of SIL on a preferential basis, on March 30, 2001, increasing its share holding in SIL from 28.00% to 70.56% of SIL’s post issue equity, as under:
Table – 1
|
Acquirer
|
Prior to preferential allotment
|
After preferential allotment
|
|
Shares
|
%
|
Shares
|
%
|
|
Spartek Ceramics India Ltd.
|
0
|
0.00
|
220,000,000
|
70.56
|
|
Persons acting in concert with acquirer
|
25,703,543
|
28.00
|
0
|
0.00
|
|
Sub total
|
25,703,543
|
28.00
|
220,000,000
|
70.56
|
|
Stiles India Ltd
|
91,798,370
|
100.00
|
311,798,370
|
100.00
|
3. It was alleged that for the aforesaid preferential allotment, the board resolution proposing the preferential allotment was not sent to all the stock exchanges, in which SIL scrip is listed, as required under Regulation 3(1) (c) (i) of SAST Regulations. It was further alleged that, in the notice, dated January 31, 2001, of the general meeting, called for the purpose of consideration of the aforesaid preferential allotment, the disclosures, required under Regulation 3 (1) (c) (ii) of the said regulations, pertaining to the following was not made:
- Consequential change in control
- Consequential change in Board of Directors
- Consequential change in voting rights and share holding
4. Since the aggregate shareholding of SCL in SIL, along with that of PACs, was more than 15% of SIL’s equity, SCL and PACs were prohibited from acquiring more than 5% of SIL’s equity in any period of 12 months, without making a public announcement to acquire further shares from shareholders of SIL, in terms of Regulation 11 (1) of (SAST) Regulations, 1997. The aforesaid public announcement is required to be made within 4 days of deciding to acquire shares of SIL, in terms of Regulation 14 (1) of the said Regulations. It was alleged that as SCL did not comply with the requirements of Regulation 3 (1) (c) of SAST Regulations, it was not exempt from making the aforesaid pubic announcement to acquire further shares of SIL. It was alleged that SCL did not make the public announcement as aforesaid, hence this proceedings.
5. Strangely, SIL replied to the SCN vide its letter dated March 24, 2006 and vide letter dated April 15, 2006 SCL confirmed that it was adopting the reply of SIL as its own. It was submitted that SIL was a sick company and is a subsidiary of SCL. The latter had provided unsecured loans from time to time to the former to revive it; as on March 30, 2001 the advances amounted to Rs. 22 crores. SCL submitted that SIL's lender, IDBI, preferred that the aforesaid unsecured loans be converted into equity, which was obliged by SCL to help SIL, as banks had called back their borrowing limits. Besides, SCL contented, that it was unlikely that even if the disclosures were made, the shareholders of SIL would have evinced interest in investing in SIL. It was also submitted that SCL was in management control of SIL since 1994 and the preferential allotment did not result in change of control, change in board of directors and change in voting rights, other than the of conversion of loan into equity.
6. SCL submitted that wrong advice that sick company is exempt from compliance, inability to hire competent staff for compliance, SIL being a sick company, were causes for the non compliance. SCL submitted that the default in compliance with 3 (1) (c) of SAST Regulations, was unintentional; conversion of loan to equity was done in the best interest of SIL. Citing Section 15J of SEBI Act, 1992, SCL pleaded that the default may be condoned. It was also pointed out that it was SCL which voluntarily brought the default to the notice of SEBI.
7. In the above circumstances the undersigned was of the opinion that an inquiry should be held in the matter and accordingly notice of inquiry dated April 04, 2006 was issued to SCL, fixing the date for inquiry for April 24, 2006. Mr. S. Ganesh, Director Finance, SCL appeared before me and reiterated the submission made vide SIL’s letter dated March 24, 2006. As agreed in the inquiry, SCL furnished auditors certificate dated May 06, 2006, evidencing conversion of loan of Rs. 22 crores to equity by allotment of shares to SCL on March 30, 2001.
8. I have carefully considered the submissions put forth by the party. Given the facts of this case it is important to have clarity on the objectives of SAST Regulations. Section 11(2)(h) of the SEBI Act, 1992 empowers SEBI to regulate substantial acquisition of shares and takeover of companies, even though these activities are in the corporate domain. This was done with the specific objective of protecting the interest of the investors, especially the small investors. Small investors are typically scattered, do not have a unified common voice to protect their interest, especially when there is a change in control or management or directors etc. To address these issues, the SAST Regulation 1994 was promulgated (subsequently replaced by the 1997 Regulations) with the avowed purpose of giving all category of shareholders a level playing field. The SAST regulation ensures “Equality of treatment and opportunity to all shareholders” through well defined process of disclosure and opportunity for exit. Therefore, the undisputed default in the instance case, needs to be viewed in the aforesaid context.
9. Shareholders are the owners of joint stock company, and they appoint the Board of Directors, who in turn appoint the management team to run the activities of the company. There are two possibilities when there is an addition to the equity of a listed company; rights issue would have no impact on the pattern of ownership, assuming all shareholders subscribe. However, in case of issue of further shares or preferential allotment of shares, there could be considerable alteration/dilution of existing shareholding. Therefore, informed consent of the existing shareholders is required before a company embarks on further issue of shares or preferential allotment, which is ratio behind the provisions of Sections 81(1)(a) and 81(1A), respectively, of the Companies Act, 1956.
10. Preferential allotment of shares can be made to any existing class of shareholders, say like promoters etc. or to any new class of shareholders say by foreign collaborator etc. Therefore, the informed consent of the existing shareholders is required to be obtained by a special resolution/proposal passed/voted in the general meeting of the target company in terms of Section 81(1A) of Companies Act, 1956. Regulation 3(1)(c)(i) of SAST Regulations further strengthens the investor protection under the said provision of the Companies Act, 1956, by requiring that the resolution of the board of directors of the company recommending the proposed preferential allotment be sent to all the stock exchanges in which the shares of the company are listed. This information is required to be notified on the notice board of the stock exchanges for wide dissemination to the investors. This enables investors to reformulate their perception about prospects of the company so at to enable them to acquire, dispose or hold the shares of the target company. In the instant case SIL was required to intimate the recommendation of its board of directors about the proposed preferential allotment to BSE, MSE and HSE. It is undisputed that SIL has not done so as required under Regulation 3(1) (c) (i) of SAST.
11. Regulation 3 (1) (c) (ii) of SAST takes the concept of disclosure more deeper and meaningful by requiring that the notice of general meeting called for the purpose of consideration of preferential allotment contain the following disclosure:
Ø The identity of the class of the proposed allottee
Ø and if any of the proposed allottee is to be allotted more than 5% of the post issue, then the price at which the allotment is proposed and reason for such allotment,
Ø consequent changes in the board of directors of the company
Ø and in voting rights, shareholding pattern of the company
Ø and whether such allotment would result in change of control of the company
Accordingly, the shareholders of the target company get an opportunity to weigh the consequence of the proposed changes, envisaged through the preferential allotment, in an informed manner and then cast their vote in the GM.
12. As alleged, it is undisputed that the notice dated January 06, 2001 calling for extraordinary general meeting of the members of SIL on January 31, 2001 did not have details of change in board of directors of SIL, change in voting rights and shareholding pattern and change in control of the company. Since, the shareholder of SIL were forced to cast their vote in the absence of full disclosure, they ought to have been given an exit option by the acquirer.
13. The acquirers (SCL) and persons acting in concert had full information on the consequences and on the prospects of SIL, post the preferential allotment, whereas the remaining shareholders of SIL did not have it. Therefore, the shareholders of SIL were required to be given an opportunity to exit, in terms of Regulation 11 (1) of SAST Regulation by the acquirer, to satisfy the cardinal principle of SAST Regulation, namely, “Equality of treatment and opportunity to all shareholders”, as full disclosure under Regulation 3 (1) (c) of SAST was not made.
14. The contention of SCL that if full disclosure were to be made, the existing shareholders would not have subscribed, is completely out of context and irrelevant. The issue under consideration is disclosure to be made prior to a preferential allotment, where there is no question of subscription by all the existing shareholders, as in the case of rights issue.
15. It may be highlighted here that though it is the target company which would comply with the provisions of Regulation 3 (1) (c) of SAST, the consequences of default, if any, in this regard would be visited by the acquirer, as the benefit of the preferential allotment is borne by the acquirer! Therefore, if SIL has not fully complied with Regulation 3 (1) (c) of SAST Regulations, the acquirer, SCL will bear the consequences in this regard. This view is fully supported by the ruling of the SAT in its order sated March 20, 2002 in the appeal No.48/2001 in the matter of Luxury Foams vs SEBI, the relevant portion of the order is reproduced below:
“it is to be noted that regulation 3 provides exemption from complying with the requirements of regulations 10, 11, 12 in respect of certain type of acquisitions stated in the said regulation. The requirement of compliance in terms of regulations 10, 11, 12 is by the acquirer. So if the acquirer is keen to avail of the exemptions, it is for him to satisfy as to whether the preconditions required to be complied with to avail exemption have been complied with or not”.
16. I may also like to cite the order of SAT dated May 14, 2003 in appeal no.96/2002 in the matter of PC Surana vs SEBI. The facts pertaining to the cited case are comparable to the instant case and SAT upheld imposition of penalty by the Adjudicating Officer even though the promoters and others had infused funds into the sick company (Magnum Intermediates Ltd.) through a preferential allotment, without the full disclosure under Regulation 3(1) (c) (ii) of SAST. The relevant portion in the cited order is reproduced here for ready reference.
Takeover Regulation provides exemptions to certain type of acquisitions. The exempted category of acquisition has been stated in regulation 3. Some of these exemptions are automatic and some of them are subject to fulfillment of certain specific conditions. The acquisitions falling under any one of the exempted category appearing under regulation 3 are out of the purview of Chapter III. One of such exemptions is preferential allotments as provided under regulation 3(1)(c). The said exemption is not automatic. To avail the exemption certain pre-requirements have to be followed. As per the said regulations provisions of regulations 10,11 and 12 are not applicable to preferential allotment, made in pursuance of a resolution passed under section 81 (1A) of the Companies Act provided the following conditions are fulfilled:
(i) Board resolution in respect of the proposed preferential allotment is sent to all the stock exchanges on which the shares of the company are listed for being notified on the notice board;
(ii) Full disclosures of the identity of the class of the proposed allottee(s) is made, and if any of the proposed allottee(s) is to be allotted such number of shares as would increase his holding to 5% or more of the post issued capital, then in such cases, the price at which the allotment is proposed, the identity of such person(s), the purpose of and reason for such allotment, consequential changes if any, in the board of directors of the company, and in voting rights, the shareholding pattern of the company and whether such allotment would result in change in control over the company are disclosed in the notice of the General Meeting called for the purpose of consideration of the preferential allotment”.
It is thus clear from the provisions of regulation 3 (1) (c) that an acquisition pursuant to a preferential allotment simplicitor will not be eligible for exemption unless the requirements stipulated in clauses (i) & (ii) are complied with. In this context it is pertinent to mention that since the law specifically provides that the exemption is subject to compliance of certain requirements specified therein, to avail such exemption, it is absolutely necessary to fully comply with the specified requirements. The regulation does not provide for any relaxation from compliance of the specified requirements.
Failure to disclose full details on the specific aspects provided in the regulation cannot be considered as trivial or of no consequence to be overlooked. Since the requirements of clause (ii) of regulation 3(1)(c) have not been complied with fully, the exemption under regulation 3(1)(c) is not available to the acquisition by the Appellant. Once it is held that the acquisition do not have the benefit of exemption as provided under the said regulation, the acquirer is required to comply with the requirement of making a public offer in terms of regulation 11, and failure to do so would attract the provisions of section 15H(ii). The need for strict compliance of the conditions provided in regulation 3 (1) (c) to avail exemption from the scope of Chapter III of the Takeover Regulations, has been clearly stated by this Tribunal in Arya Holdings (Supra).
For the reasons stated above it is clear that the Appellant has failed to fulfil the requirements of regulation 3 (1) (c) and therefore, the acquisition in question is not exempted from the purview of regulation 11(1).
…….It is to be noted the liability to pay the penalty is on the Appellant and on not the company and as such the submission that company is “sick”is of no consequence, as far as the Appellant’s obligation to pay penalty is concerned.
17. The cited SAT order more than clarifies the issues under consideration. I am not left with much to decide in this present case. SCL acquired 220,000,000 shares of SIL on March 30, 2001 through preferential allotment which increased its holding, along with that of PACs, from 28.00% to 70.56% of SIL’s equity as given in table - 1. Since the acquirers held more than 15% and less than 75% of SIL’s equity, they are prohibited from acquiring more than 5% of SIL’s equity in any period of 12 months without making a public announcement to acquire further shares from the shareholders of SIL, in terms of Regulation 11(1) of SAST Regulations.
As the aforesaid acquisition was through preferential allotment, exemption from making public announcement was available to the acquirers, subject to fulfilling the requirements of Regulation 3 (1) (c) of SAST Regulations. However, the acquirer has conceded that requirements of Regulation 3(1)(c) of SAST Regulations have not been fully complied with. Hence, it is not entitled to exemption from making the public announcement in terms of Regulation 11(1) of SAST, as elaborated in the SAT order.
18. It is therefore established that SCL has defaulted in respect of Regulation 11 (1) of SAST, which attracts penalty under Section 15H (ii) of SEBI Act, 1992 which reads as under:
"Penalty for non-disclosure of acquisition of shares and takeovers
15H. If any person, who is required under this Act or any rules or regulations made thereunder, fails to-
(i.) ………..
(ii) make a public announcement to acquire shares at a minimum price, he shall be liable to a penalty not exceeding five lakh rupees."
19. To determine the quantum of penalty under Section 15H (ii), the undersigned considered the following factors as provided in the section 15J of SEBI Act, 1992 viz.(a) the amount of disproportionate gain or unfair advantage, wherever quantifiable, made as a result of the default ; (b) the amount of loss caused to an investor or group of investors as a result of the default and; (c) the repetitive nature of the default. The loss caused to the investors as a result of the default can be computed by working out the value of open offer which SCL had to make to the shareholders of SIL. SCL was required to make an open offer to acquire a minimum of 62,359,674 shares constituting 20% of SIL equity of 311,798,370 shares, in terms of Regulation 21(1) of SAST Regulation which inter-alia reads as under:
Regulation 21(1) of SAST, 1997
"Minimum number of shares to be acquired
21. (1) The public offer shall be made to the shareholders of the target company to acquire from them an aggregate minimum of 20 per cent of the voting capital of the company: Provided that where the open offer is made in pursuance of sub-regulation (2) of regulation 11, the public offer shall be for such percentage of the voting capital of the company as may be decided by the acquirer."
Since SIL scrip was not regularly traded, the price at which SCL had to make the open offer was Rs. 10/- per share, in terms of Regulation 20 (3) (c) of SAST Regulations as SCL was allotted SIL shares @ Rs. 10/-. The said provisions read as under:
Regulation 20 (3) (c) of SAST, 1997
"Minimum offer price.
20. (3) Where the shares of the target company are infrequently traded, the offer price shall be determined by the issuer and the merchant banker taking into account the following factors:
(a) ……..
(b) …….
(c) the price paid by the acquirer under a preferential allotment made to him or to persons acting in concert with him at any time during the twelve month period up to the date of closure of the offer; and"
Accordingly the value of the default works out to Rs. 62.36 crores. Since, as per SCL's own admission the SIL was a sick company, then it can be fairly said that the shareholders of SIL missed a golden opportunity of exit when they were not given the opportunity to offer their shares @ of Rs. 10/- to SCL. In all possibilities, the shareholders of SIL had not been in a position to sale their shares for the obvious reason of buyers having less/or no interest in the shares of a sick company. Since the maximum penalty imposable u/s 15H (ii) of SEBI Act, 1992, is Rs. 5 lakhs, I restrict myself to the maximum penalty. It may be emphasized here that the default of not making public announcement was by the acquirer and therefore penalty is payable by the acquirer; that the target company is sick has no bearing on the penalty imposed on the acquirer. This view is well supported by the ruling of SAT in its order in the appeal of P.C. Surana, cited earlier. Further, the contention by SCL that the default was not intentional is of no avail. It is a settled position of Law that 'mens rea' (motive) is not a condition precedent for imposition of penalty for contravention of provisions of civil nature, which has been laid down in many orders of the Supreme Court, including the recent judgment in the case of SEBI v Sriram Mutual Fund wherein the Hon'ble Court held that mens rea is not an essential ingredient for contravention of the provisions of a civil act. It is further held that the penalty is attracted as soon as contravention of the statutory obligations, as contemplated by the Act, is established and, therefore the intention of the parities committing such violations becomes immaterial. A news article in DNA (24/5/06) has been published which has reported the said judgment of the Supreme Court.
20. Therefore, in exercise of the powers conferred under section 15-I (2) of the SEBI Act, 1992, read with Rule 5 of SEBI Adjudication Rules, I hereby impose a penalty of Rs. 500,000 (Five lacs only) on Spartek Ceramic India Ltd. under Section 15H (ii) of SEBI Act, 1992.
21. The penalty amount shall be paid by way of demand draft in favour of “SEBI- Penalties Remittable to Government of India”, payable at Mumbai within 45 days of receipt of this order. The said demand draft should be forwarded to Shri S.V.M.D. Rao, General Manager, Securities and Exchange Board of India, Mittal Court, ‘B’ Wing, 1st Floor, 224 Nariman Point, Mumbai–400 021.
22. This order of adjudication is made and passed on 25th day of May 2006 at Mumbai.
AMIT PRADHAN
ADJUDICATING OFFICER