The Securities Appellate Tribunal (SAT) has done it again. On 2 June 2022, it issued a brief 9-page order which throws out of the window the very philosophy of disclosure-based regulations that have underpinned all of SEBI’s (Securities and Exchange Board of India’s) actions for three decades. In a nutshell, SAT says that companies involved in wrongdoing can be absolved, if they get a subsequent or post-facto ratification from their shareholders.
The alarming implications of the three operative pages of this order open the doors to companies seeking post-facto ratification of any action, irrespective of its legality. The legal community will snap this up as a precedent to condone wrongdoing by powerful corporate clients; but investors, who will bear its treacherous consequences, are largely clueless about the decision.
As is often the case, SEBI’s lumbering investigation and actions, in the Terrascope Ventures Ltd (Terrascope) case, have unfolded over a decade.
The issue dates back to October 2012 when Terrascope (known as Moryo Industries Ltd) obtained shareholders’ approval for a preferential issue of 63,50,000 shares. The proceeds were to be used for capital expenditure, marketing, working capital and offices abroad, etc. Instead, Terrascope used the money for other purposes—such as investments in shares and for providing loans and advances to 19 entities listed in the SEBI order.
In September 2017, Terrascope got a majority of shareholders to pass a special resolution at its annual general meeting (AGM) ratifying the use of funds for purposes that were completely different from what they had approved during the preferential issue. This was five years after the money was raised.
At that time, Terrascope had argued before SEBI’s AO that it has changed its object clause in 2014, through a special resolution, to include financing, investment and share trading. It claimed that part of the proceeds of the preferential issue were utilised as per the modified object clause.
PR Ramesh, a securities lawyer who has long experience with SEBI, also points out that Section 27 of the Companies Act, 2013, deals with modification to objects mentioned in prospectus. Although modification is far from ratification, this too provides for an exit to dissenting shareholders. Subscribers to the preferential offer were not offered any exit in2014, when the object clause was modified. The issue was neither considered or addressed by SAT, in its order
The SEBI order noted the following: first, that variance in use of funds was not disclosed in annual reports or quarterly disclosures required under the listing agreement of stock exchanges; second, that mis-utilisation of funds is a violation and does not have to result in any gains for the parties involved; thirdly, that shareholders cannot ratify a violation post-facto.
On 29 April 2020, SEBI’s AO issued an order, against Terrascope and its two directors, imposing a combined penalty of Rs1.5 crore for violations under the prohibition of fraudulent and unfair trade practices (PFUTP) regulations.
In a decision that has shocked the legal community, a bench of justices Tarun Agarwala and Meera Swarup of SAT, overturned SEBI’s order on 6 June 2022 with wide ramifications for India’s disclosure-based regulation system. It may have opened the doors to widespread cheating of investors in the future.
In quashing the SEBI order and approving Terrascope’s actions, SAT considered the definition of ‘ratification’ (making valid of an act already done) mentioned by the Supreme Court in a completely unrelated matter [National Institute of Technology and Another vs Pannalal Choudhury and Another (2015) 11 SCC 669] to conclude that post-facto ratification of a variance in the use of funds is valid.
It also held that once the action is ratified, there is no variance in the use of funds and it no longer needs to be reported to the stock exchange; hence there is no violation of clause 43 of the listing agreement. In effect, SEBI had no grounds to issue a show-cause notice in 2018 because no disclosure was required after shareholder ratification.
The last bit is especially shocking, since shareholders have no power to ratify a violation of statutory reporting requirements and the law does not provide for any such ratification.
Pertinently, SAT ignores the fact that Terrascope had failed to report the mis-utilisation/ variance in fund use to stock exchanges for almost five years (four quarters every year) and in its statutory annual reports for the period. How can a subsequent ratification condone these?
The order is of immense significance to investors, especially those who manage large pools of money based on research, analysis and corporate disclosures. They need to demand that SEBI appeals this order and works at putting in place legal safeguards to prevent its exploitation by unscrupulous companies.
Disclosure-based Regulation
India adopted disclosure-based regulation for the capital market in 1992. This already puts a huge burden on investors because the onus is on them to wade through offer documents, annual reports and disclosures to stock exchanges under the listing agreement. SAT has rendered all these disclosures meaningless by opening the door to post-facto ‘ratification’ by shareholders—long after misuse of funds or dubious actions have been committed.
This has serious ramifications for initial public offerings (IPOs) where investors are already facing massive losses on their investments in high-profile tech-companies.
Shareholders Cannot Ratify an Illegal Action
Unlike nations, which have provisions for ‘ratification’ of certain corporate actions (with many checks & balances or specific circumstances under which ratification is permitted), the Companies Act, 2013, in India has absolutely no provision for ‘ratification’ of a breach of duty by directors.
Murali Neelakantan, principal lawyer at Amicus, who has a dual qualification as an Indian advocate and English solicitor, says, “The SAT order is perverse since it undermines the whole basis of capital raising and nullifies all the reporting and enforcement provisions. If ratification was possible why bother with reporting on end use of funds—all those provisions would be superfluous. Clearly, the fact that those provisions exist means that ratification was not contemplated by the law.”
A similar view is held by David Rasquinha, former managing director (MD) of the Export-Import Bank of India who points out that “such ‘ratification’, whatever its meaning, can be grossly misused; the number of cases where Indian promoters have misled shareholders is legion.”
Rights of Minority Shareholders
Furthermore, post-facto ratification of breach of duty by shareholders leaves rights of disgruntled minority shareholders in question. The Companies Act, 2013, is expressly silent on this precisely because it does not envisage a possible recourse to shareholders’ ratification.
Mr Neelakantan says, even hypothetically, a specific class of investors has to ratify the decision (those who participated in the preferential offer) decision on use of funds, in addition to a special resolution being passed by a majoroity investors. Since Indian law does not permit ratification, this is irrelevant; but any situation permitting ratification would have included conditions such as an exit for minority shareholders who disagree with the decision to ratify an illegal action.
Checks & Balances
Experts are particularly disturbed that the order does not discuss or impose any checks & balances on the use of post-facto ratification. Dr Rajendra Ganatra, a former banker says, “Terrascope’s diversion the preferential issue of Rs158.75 crore and its indictment under SEBI’s PFUTP shows that its act was mala fide. It is shocking that SAT has used the Supreme Court’s interpretation of the word ‘ratification’ to allow the company to get away with a fraudulent act. Hypothetically, any ratification, even if permitted by the law, would only cover an act that is bonafide and consistent with the company’s charter and the law. This order sets a precedent that can be misused by every unscrupulous company to whitewash its action.”
The specific case of Terrascope is itself relevant. As recently as in September 2021, Terracope was fined Rs5 lakh by SEBI for manipulating share prices of Tilak Ventures Limited. This fact alone ought to have given pause to SAT condoning its action, says Dr Ganatra.
Elaborating on the concept of ratification, Mr Neelakantan says, “There is what’s called a ‘white washing’ provision in many countries allowing annual ratification but that won’t apply in this case, where there are two classes that are affected and both would have to ratify the decision. The order does not consider any of these issues and has no discussion on limitations to ratification and whether shareholders can ratify the breach of law or a regulatory requirement".
Clearly, SEBI needs to file an appeal against the SAT order and, simultaneously, initiate a discussion on the issue at the board level, where the ministry of company affairs, ministry of finance and the Reserve Bank of India are all represented. After all, this is an order that affects the very fundamentals of disclosure-based regulation adopted by India. Does an appellate tribunal have the power to issue an order which has such sweeping ramifications for the capital market?
This is absolute bonkers! The SAT vs SEBI is just a microcosm of the judicial system in India -- full of holes and left to wide interpretation. I'd rather watch 50 Shades of Grey than the grey in our legal system.
Yes, Ma'm, agreed that a bonafide and legally consistent matter may be subject to post-facto ratification (presuming that it was not done before hand due to minor procedural lapse) is ok but not this kind of ratification involving possible financial mismanagement and money laundering, etc. SEBI must take up the matter legally otherwise it will be mockery of law.
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On 29 April 2020, SEBI’s AO issued an order, against Terrascope and its two directors, imposing a combined penalty of Rs1.5 crore for violations under the prohibition of fraudulent and unfair trade practices (PFUTP) regulations. 
Terrascope private placement stinks of possible money laundering.
•42 so-called investors subscribe to the shares in preferential allotment pump in Rs.157 crore.
•Money is placed as equity or advances in pre-decided entities in violation of SEBI guidelines.
•Investments are written off in due course without murmur from "investors".
•"Ratify" the fraudulent act and manage to get excellent order of the Adjudicating Officer of SEBI reversed by SAT ????
Normally preferential allotment is made to a big party - a PE fund or a strategic investor.
If the issue is very big like Jio, there can be half a dozen investors.
Forty two is a pure joke & smells of money laundering!