Special 
On Friday, March 13, 2015, sparks flew at the Securities Appellate Tribunal (SAT). The Tribunal was pronouncing its verdict in an appeal filed by real estate major DLF . The verdict was split with the presiding officer, Justice J.P. Devadhar, a former judge of the Bombay High Court, finding DLF guilty, but reducing the penalty imposed by SEBI. His colleagues Jog Singh, a lawyer and former member of the Central Administrative Tribunal, and A.S. Lamba, a government officer, however ruled in favour of DLF and came down heavily on SEBI, quashing its order.
SEBI's lawyers then asked for a stay on the order so that it could appeal to the Supreme Court. The presiding officer was inclined to do so but the other two were fairly vehement about denying the SEBI request. Were it not for an immediate stay, cash-strapped DLF would have had a window of opportunity to raise funds immediately, potentially nullifying the impact of the three year ban from capital markets by SEBI.
The order indicting SEBI, three days before Lamba was to retire, raised a few eyebrows because of the reasoning that was used for reaching the majority opinion.
Land Bank, but no land
The case hinges around DLF's Rs 9,000-crore IPO in 2007. In the year preceding the IPO, over the space of 48 hours, DLF had effectively transferred about 280 subsidiaries to a holding company, Felicite Builders, which was then sold to three women, wives of top employees of the company, for about Rs 2 crore.
This allowed the company to omit disclosures about these 281 companies in its final prospectus, published in January 2007. These companies together held about 4,000 acres of land, which was shown in the prospectus as "land to which DLF has sole development rights-owned by DLF's subsidiaries". SEBI member Rajeev Kumar Agarwal, in an order last October, ruled against these transactions and barred the already cash-strapped company from accessing the capital markets for three years. (The SEBI investigation was on the basis of a complaint by Kimsuk Krishna Sinha, a Delhi based real estate agent.) The SAT was hearing DLF's appeal against this order.
The SEBI order had been initiated because in April 2007, Kimsuk Krishna Sinha had filed a case against Sudipti Estates, one of the 280 subsidiaries transferred to Felicite, for cheating him of Rs 31 crore when it was still a DLF subsidiary. Sinha alleges that DLF reneged on its agreement to transfer 35 acres of land for which he had joint development rights with DLF, and had paid the company Rs 34 crore. Sudipti was run by, among others, Praveen Kumar, the nephew of DLF chairman K.P. Singh. If Sudipti's accounts were supposed to be consolidated with DLF, then the pending case would also have to be disclosed in the prospectus.
Sinha wrote to SEBI. When he did not get a response, he approached the Delhi High Court, which ordered the regulator to look into the matter. In October 2011, SEBI member Prashant Saran ordered an investigation. After seven years, Sinha may not have proven his charges, but managed to cause an investigation into the IPO. But it is this Rs 31-crore case that took India's largest real estate company to the brink last year.
In an earlier conversation with this writer, a top DLF official, speaking off-the-record, explained the company's rationale for the transaction. The real estate business is tricky, he says, involving buying large parcels of land from multiple owners. The moment you say that DLF is in the market to buy, the price shoots up. So subsidiaries aggregate the lands and then transfer them to the main company, DLF. The sale of subsidiaries, which were essentially aggregators, was to assuage SEBI's concern that the land bank value was fluctuating due to continuous purchases by these subsidiaries. It was sold to the wives of the senior officers only to keep them just outside the ambit of the company's reporting requirements, but within the control of the company (due to the employment of the husbands) he says. To a questionnaire sent asking questions for this story, DLF informed us through its PR agency that the company would not be replying.
SEBI, however, saw it differently. In a written submission to SAT, the regulator stated that "If it would have been disclosed that 90 per cent of this 4575 acres is owned by entities other than DLF or DLF's subsidiaries then the risk involved for DLF in such arrangements clearly increases manifold for DLF Ltd and such a disclosure would have clearly played a major/material factor (sic) in the mind of any prospective investor before investing his money in the IPO of DLF Limited". It showed, as noted by Justice Devadhar's order, how the transaction was financed by money lent by DLF itself and that the original directors on the Board of Felicite as well as the signatories of their bank accounts remained.
DLF, on the other hand, argued before the Tribunal that no investor has been affected by the non-disclosure. In fact, with the company owning sole developments rights over the land, the investor was in no way prejudiced by the transaction, the company would submit. In fact it went on to argue that having sold the subsidiaries, to now disclose them would be illegal.
J.N. Gupta, former Executive Director at SEBI and founder of the proxy advisory firm Shareholders Empowerment Services, does not buy that argument. He says that SAT should have asked more relevant questions, such as 'Were the 281 companies valued sold at arm's length? Who did the valuation? Were other bids invited? Were the housewives in the business of buying and selling land-owning companies, and so on?'
Jog Singh and Lamba, on the other hand, seem convinced by DLF's case. They accept the company's argument that it is not necessary that directors have to be changed after a sale (The DLF appointed directors remained on board even post the transaction). Their order says that there is no law barring women entrepreneurs from utilising money held in joint accounts with their husbands for investment purposes. It goes on to argue that 'nothing in the order (SEBI's order, which was being appealed) points towards any influence being exerted. It summarises the situation saying that nothing has been brought on record (by SEBI) that could "conclusively demonstrate that DLF had such unbridled discretion". Jog Singh did not reply to a questionnaire sent to him for this story.
The problem that reasoning is that while DLF's contentions are factually correct, they seem inappropriate to the context. Nothing exists on record to suggest that anybody other than DLF took decisions on behalf of Felicite. In a private company, where public scrutiny is scant, the onus should have been on DLF to prove that Felicite was not a front, says J.N. Gupta. More so because many of the companies that got transferred out of the Balance Sheet for the Prospectus reappear in the consolidated accounts a year later. DLF itself admitted to the SAT during hearings that the transaction was prompted by the fact that the said companies were like shell companies and had no commercial relevance once it had passed on development rights to DLF.
Justice Devadhar, in his minority order tears into DLF's claims that after the shares were transferred, DLF played no part in the decisions of the transferred subsidiaries. He points out how just a few days after the initial transfer, the three women diluted their stake to include seven other shareholders, also wives of key DLF managerial personnel, and that all ten of them paid for the shares through identical Rs 20 lakh loans sanctioned by Kotak Mahindra Bank.
SEBI's written submission to SAT during hearing also argues that the majority opinion chastising it for not being clear about whether the contentious companies were 'subsidiaries' or 'associates' ignores DLF's own submission that termed the 281 divested companies as subsidiaries (disclosure requirements apply to companies that were subsidiaries at any point during the year - so divestment does not take away responsibility to disclose).
The majority opinion banked heavily on the DLF argument that no investor suffered a loss. Shantanu Mitra, counsel at Phoenix Legal, and an expert on securities law, argues that while SEBI's primary mandate is to protect the investor, it cannot restrict its actions to cases where investor has been explicitly affected. "If any disclosure could have helped make a decision, then material non-disclosure should attract a penalty," he says. In the context of the case, disclosure was mandated by the Accounting Standard that deals with preparation of consolidated accounts. Here, the order erroneously reproduces the definition of 'control' from the accounting standard (replacing an 'or' with an 'and'), and then goes on to interpret the Standard accordingly in DLF's favour. Going by the standard, DLF would have been in control if it held, directly or indirectly, the voting power (that is, power to take decisions) in Felicite OR if it controlled the composition of its Board. DLF, by being employers of the husbands of all Felicite shareholders, would easily fit the first criteria.
For added measure it states that "Accounting Standards are generally issued by the ICAI, and may or may not be accepted by the government". What it omits to acknowledge is that this relevant Standard was accepted by the government. Later on, it states that the Accounting Standards are primarily meant to be followed by auditors while certifying the financial statements. Manoj Fadnis, President of the ICAI, says that the standards are issued through a consultative process that includes the government, so there is no question of it not being accepted. "Once it is issued, it is not just the auditors who have to follow, but the directors are also tasked with ensuring it is complied with under the Companies Act," he says.
In fact, summarising the order, J.N. Gupta says, "The order fixes responsibility on truthful and factual statements on everybody except the company and its directors - The merchant bankers should have done this, the auditors should have done that". Whereas, company officials sign both the financial statements as well as the prospectus.
Justice Devadhar's minority order even points out how SEBI had powers to proceed against the merchant bankers and auditors but did not do so. That stands out because during hearings, SEBI filed affidavits highlighting lapses on the part of the auditor (M/s Walker Chandiok & Co, part of the multinational audit network, Grant Thornton, was the auditor of DLF. The subsidiaries had different auditors). In one affidavit, SEBI says, "… raises serious doubts of the conduct of the auditors as it seems they are certifying documents as per the directions of the appellant (DLF)' - As serious an indictment as can be. Grant Thornton did not respond to an email asking for their take on SEBI's allegation.
The DLF case is a bit of a landmark because SAT's order could well set the precedent by which all future cases involving subsidiaries that have been transferred are dealt with.
Now, the question in this seven-year-old dispute was whether DLF should have disclosed this FIR in its DRHP or RHP in May-June 2007.
A Delhi magistrate has, meanwhile, found the complaint not proved and Sinha has appealed against that order. The appeal is awaiting final arguments in the Delhi High Court. But the question before SEBI and SAT was whether DLF concealed the FIR and whether that was a violation.
DLF and other appellants (before SAT) argued that they did not know of the existence of the FIR until June 25, 2007 when SEBI wrote to them. (That is, after Sinha wrote to SEBI and SEBI had written to DLF.) The IPO issue had closed on June 14, 2007. But at least two of the accused, including Praveen Kumar, (signatory of bank account of Sudipti Estates) seem to have written to the police on May 2 and May 3, 2007 seeking time to join the investigation.
Despite seven years of litigation before two whole time members (WTMs) of SEBI, several benches of the Delhi High Court and now the securities appellate tribunal (SAT), there is no clear finding on whether Sudipti Estates or the KMP, and therefore DLF Ltd, was aware of the FIR before the IPO.
In fact, by the minority order of SAT, Justice Devadhar has castigated SEBI for failing to investigate this critical issue. (On this, the minority and majority orders agree.)
SEBI, it seems, had enough occasion to do so. After they were ordered by the High Court to look into it, the whole time member (Prashant Saran, by order of October, 2011) directed SEBI to conduct an inquiry into the allegations made by Sinha.
Another WTM of SEBI (Rajeev Kumar Agarwal) held (by the October 2014 order, the impugned order before SAT) that the existence of the FIR should have been disclosed. He referred to the show cause notice issued by the SEBI and noted that the (IPO) prospectus had mentioned Praveen Kumar as key managerial employee of DLF reporting "directly to its Board of Directors".
However, the majority order of SAT, per Jog Singh and A.S. Lamba (March 13, 2015) held that the alleged knowledge of Praveen Kumar about the FIR cannot be foisted upon DLF and other appellants on the basis of insufficient facts and evidence. They also recorded that the FIR was proved false.
"The FIR lodged by KKS on 26th April, 2007 was found to be false and meritless after thorough investigation into the allegations against the Appellant levelled by KKS. It was found by the Police that the allegation in the complaint against the Appellant was mainly advanced with a view to avoid liability to pay Short Term Capital Gains tax by KKS. Accordingly, the Police filed a Closure Report in the matter of such FIR before the Metropolitan Magistrate, who was pleased to dismiss the protest petition filed by KKS and to uphold the filing of the Closure Report by order dated 27th August, 2009.''
Justice J.P. Devadhar, in his order (the minority order) set aside Rajeev Kumar Agarwal's order on this issue. Devadhar held that DLF's contention could not be rejected by the WTM because neither had it been ascertained when Sudipti or Praveen Kumar were served the FIR nor when they were interrogated by the police.
Justice Devadhar, however, had given the appellants an occasion to comment on the alleged summons dated May 1, 2007 addressed by the Sub-Inspector of Police Station at Connaught Place, New Delhi to Mr. Praveen Kumar, and a letter dated May 2, 2007 addressed by Mr. Praveen Kumar seeking time to attend the Police Station and a reminder letter dated May 26, 2007 addressed by the Sub Inspector of the Police Station at Delhi to Mr. Praveen Kumar.
The appellants before SAT challenged the genuineness of the documents and also argued that they could not be taken on record at the belated stage in the arguments.
Justice Devadhar, in conclusion said that the failure of the investigating officer of SEBI to probe this issue is "gross misconduct and dereliction of duty".
So much ado about one material fact, and yet no clear finding.
(The authors are freelance writers)
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