In this article, Atipriya Gautam who is currently pursuing M.A. IN BUSINESS LAWS, from NUJS, Kolkata, discusses Criminal Liability on Officers and Directors for running an illegal Collective Investment Scheme.
The Securities and Exchange Board of India (SEBI), the Indian market regulator has been making huge strides in the course of the recent few years by ensuring the interests of retail investors because of their failure to take a well-informed decision about investing in various securities. For this, SEBI has escalated its investigation over various companies. From taking action against Sahara Group to unfurling Saradha Scam, SEBI has represented the benefit of such investors.
To direct such conduct and clamp down elements running illicit schemes, the market regulator introduced the Securities and Exchange Board of India (Collective Investment Schemes), Regulations, 1999 (“Regulations”). These Regulations, in addition to other things, manage the enlistment and commitments of the Collective Investment Management Company. In the first place, it is helpful to look at the meaning of “Collective Investment Scheme” and “Collective Investment Management Company”.
The expression “Collective Investment Scheme” (CIS) is defined under section 11AA of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”). As the name suggests, it is an investment scheme or arrangement where several individuals come together to pool their money for investing in a particular asset(s) and for sharing the returns arising from that investment as per the agreement reached between them. In order to be a CIS, it ought to fulfil the accompanying conditions:
- The payments or contributions made by the investors are pooled and utilized solely for the purpose of such arrangement or scheme.
- The payments or contribution are made by the investors with a view to receive income or profits from such scheme or arrangement.
- The payments, property or contributions forming part of such scheme or arrangement is managed on behalf of the investors.
- Investors do not have control over the day-to-day management of such scheme or arrangement.
Moreover, by the Securities Laws (Amendment) Act, 2014 a proviso was inserted to section 11 AA stating that any pooling of funds under any arrangement or scheme, which is not registered with SEBI, involving a corpus of Rs.100 crores or more, shall be deemed to be a CIS.
Any arrangement or scheme made or offered by a Co-operative society or under which deposits are accepted by, non-banking financial companies (NBFCs), or being a contract of insurance, or under which deposits are accepted by a company declared as a Nidhi Company or falling within the meaning of Chit Business shall not be a CIS.
A Collective Investment Management Company (Company) has been defined under regulation 2 (h) of the Regulations as a company incorporated under the Companies Act, 1956 and registered with SEBI, whose object is to organize, operate and manage a collective investment scheme.
SEBI has made it mandatory for every entity that is running the CIS to register itself under section 12(1B) of the Act and Regulation 3 of the Regulations. However, if any person is operating a CIS before the commencement of the regulations, such person shall make an application to SEBI for the grant of registration certificate[1].
A Company shall launch only close ended CIS for a minimum period of three years[2] in the form of a trust[3], appraised by an appraising agency[4] and obtain rating from a credit rating agency[5] with no guaranteed or assured returns[6]. The Company shall also obtain adequate insurance policy for the protection of the Scheme’s property[7].
Criminal Liability Provisions Provided Under the Act
In the interests of the securities market and the investors, SEBI shall initiate criminal prosecution under Section 27[8], Section 24[9] and Section 26[10] of The Securities and Exchange Board of India Act, 1992.
Section 24 of the Act provides for the punishment for the contravention of the provisions of this Act. It states that if any person contravenes the provisions of this Act then that person shall be punishable with imprisonment for a term which may extend to two years or with fine which may extend to rupees twenty-five crore, or with both.
Going through the combined provisions of sections 24 and 26, it is clear that prosecution for offences can be initiated by SEBI and the power to launch such prosecution is not in any way circumscribed by any of the provision of the Act. It is the discretion of SEBI to decide whether to launch or not to launch prosecution proceedings under the Act. It is also pertinent to mention that no order as such is required to initiate prosecution keeping in view the clear provisions of Section 26 of the Act because only SEBI which is competent to file prosecution and no one else. It is made clear under the Act that SEBI has uninhibited power to initiate prosecution against persons contravening the provision of the Act, regulations or rules made there under.
Section 27 provides that when an offence is committed under this Act by a company, every person who was in charge at the time the offence was committed and was responsible for the conduct of the business of the company shall be deemed to be guilty of that offence and liable to be punished and proceeded against accordingly. It is also provided that no person shall be held liable for any punishment under this Act if he successfully proves that such an offence was committed without his knowledge and that he had taken proper care and exercised all due diligence to prevent such an offence from occurring.
On a bare perusal of Section 27, it is clear that for an offence committed by a company its directors/officers are not automatically punished along with the company. The Section provides for safeguards by giving an opportunity to the directors/officers to prove their non-involvement in the commission of the offence, to escape the penal consequences. As per the provisions of section 27 only those persons who were in charge and responsible at the relevant point of time for the conduct of company’s business shall be deemed to be liable for such contravention. Thus, only on establishment of facts, the legal fiction shall come into operation against the persons. Such people can effectively oppose the prosecution by establishing want of knowledge about the contravention or activities of due diligence to prevent the same. Such an onus on any person is not a heavy one, and can ordinarily be discharged.
Case Law Dealing With Collective Investment Schemes
- Maitreya Services Pvt. Ltd. Case (2013)
SEBI started the probe against Maitreya Services Pvt. Ltd. (“Maitreya”) after a reference from the Income Tax office in September 2010 affirming infringement of SEBI directions by Maitreya. Amid the inquiry, Maitreya presented that it carries out the business of real estate and its business incorporates purchasing and selling of land, development of the land, construction and other land related activities. SEBI found that Maitreya had propelled different schemes under which cash was gathered from the general population. These schemes varied on the basis of the instalment to be made by the investor, and the time period for which such investments were to be made. During the course of its inquiry, SEBI found that the Company had launched and operated Collective Investment Schemes without getting registered under Section 12(1B) of the Act and Regulation 3 of the Regulations and an amount of Rs. 804 crores was outstanding with it was to be reimbursed to the investors. In perspective of the same, a show cause notice was issued to Maitreya and its executives asking them to show cause for what valid reason suitable action should not be taken against them for the infringement of Regulation 3 of the Regulations read with section 11AA of the Act.
While answering the show-cause by SEBI, Maitreya denied being in CIS operations and invalidated all charges leveled against it and asked for the procedures be terminated and released from the show-cause notice. In 2012, Maitreya sought to settle the proceedings through a consent procedure, however, that was dismissed by SEBI. SEBI’s probe found that Maitreya had mobilized Rs. 1,332 crores from public as “advances” as on March 31, 2011 and had reimbursed Rs. 538 crores as “reimbursement” to investors, resulting in an amount of Rs. 794 crores as outstanding to be reimbursed as on that date. SEBI likewise found that the assests were deficient to meet the liabilities and its repayment obligations were almost double the value of its total movable and immovable assets.
Therefore, SEBI ordered for winding up of the CIS being run under the disguise of real estate business, asking the concerned authority to refund the money to the investors within a period of three months. SEBI additionally banished Maitreya, and its directors from accessing the securities market till all its collective investment schemes are wound up and decided to initiate prosecution proceedings against them. SEBI also made a reference to the police to register a civil/criminal case against Maitreya and their Directors and people responsible for the Collective investment scheme business for “offences of fraud, cheating, criminal breach of trust and misappropriation of public funds”.
Alchemist Infra Realty Ltd Case (2013)
During the initial inquiry, the company refused to provide details which were sought by SEBI, stating that the regulator did not have jurisdiction and the company was not running any collective investment scheme. Although later, Alchemist Infra did provide some details to SEBI after continuous reminders and show cause notices issued to the company and its Directors. In the meanwhile. The company tried to settle the case through SEBI’s consent mechanism, but the plea for the same was rejected by the regulator. However, the regulator later found that the company was running CIS in the name of real estate business and had generated Rs.1087 crores as on March 31,2011 from the people. It was also revealed that in the Investment Application Forms the company had mentioned that it was a part of Alchemist Group, which was engaged in diverse activities such as steel, hospitality, food, tea estate, beverages, IT, education, healthcare, aviation and media, among others, with assst base of over Rs.5000 crores. Thus, an investor was misled into believing that the company, Alchemist Infra Realty Ltd, was part of the Alchemist Group, whereas the company had contended that it was not associated with that group. SEBI ordered Alchemist to wind up all such illicit activities and refund the money of public investors within a period of three months. The SEBI also warned the company and its directors that it will initiate prosecution proceedings and criminal case for “offences of fraud, cheating, criminal breach of trust and misappropriation of public funds” if the orders of SEBI were not complied with.
BPL Limited v. SEBI[11](2001)
Large volumes of money coupled with abnormal price movements were observed in the stock exchanges in respect of the shares of the company, specifically during the period between April and May, 1998. Suspecting price manipulation, SEBI initiated investigate and based on those findings spanning over a period of approximately 18 months, on 20.12.1999, show cause notices were issued, asking them to explain their conduct with regard to the prima facie finding that the company had indulged in market manipulation, thereby violating regulation 4(a) and (d) of the 1995 Regulations read with section 11(1) and 11(2)(e) of the Act, and also to show cause as to why directions prohibiting it from dealing in securities and accessing the capital market and any other suitable direction in the interest of investors and securities market under section 11 read with section 11B of the Act and regulation 11 of the 1995 Regulations, should not be issued and proceedings under section 24 of the Act should not be initiated for such above violations made by the company.
The show cause notice was answered by the company and it was adjudicated by the Chairman of SEBI and in exercise of the powers conferred by sub section (3) of section 4, read with sections 11 and 11B of the SEBI Act, the company was barred from accessing the capital market for a period of four years. It was further directed that prosecution proceedings under Section 24 of the SEBI Act for violation of clauses (a) and (d) of regulation 4 of the said Regulations shall be initiated against BPL through its directors/officers.
Powers conferred Upon SEBI
In India, SEBI itself is furnished with powers to take actions against defrauders in absolute terms and not just as interim measures. On an everyday schedule, SEBI issues directions under Sections 11 and 11B of the SEBI Act asking people not to deal in securities or to access capital markets or to be associated with capital markets. Utilizing this power, final orders have also been passed against people accused of defrauding the investors and to disgorge the profits made out of the alleged wrong-doing.
SEBI is empowered under Chapter VIA of the Sebi Act, 1992 to directly inflict monetary penalties without the intervention of any court. The adjudicating officers are the employees of SEBI, who act as quasi-judicial officers and have the power to impose civil monetary penalties. Such penalties can be as high as Rs.25 crore or three times the benefit gained due to the violation of the provisions.
Without the intervention of the court SEBI does not have power to send people to jail and this is the only area where it does not have powers for direct action. Section 24 of the SEBI Act requires it to file a complaint before a criminal court to get an accused convicted for contravention of any provision of the Act, Regulations or Rules made thereof. For all other regulatory action, it has powers to act independently and without having to knock the doors of a court or any other judicial body and thereafter present convincing evidence to make such a move. The main check and balance on SEBI’s power is the Securities Appellate Tribunal, which is empowered to hear appeals from any order passed by SEBI. It is to be noted that judicial intervention of any sort can come up only after SEBI has taken action.
An Analysis
SEBI has played an important role in protecting investors against such schemes and tightened the noose around people running such illegal collective investment schemes. SEBI has also notified new norms to classify certain activities as fraud and impose penalties of up to thrice their profits. Moreover, the new rules have expanded the list of activities which shall come under fraudulent and unfair trade practices to hold companies as well as individuals equally guilty for illicit activities and manipulations.
The rules and regulations were amended to plug the loopholes predominant in the existing laws which were misused by the companies blatantly. However SEBI has also come across several cases where it has been claimed that the rules do not explicitly allow penal action against people for certain ‘fraudulent and unfair trade practices’ like front running, withholding of essential information from the investor, misrepresentation and making false promises.
SEBI has already taken action against several so called collective investment schemes that were in violation of the regulatory norms. SEBI had ordered Sahara group entities to refund approximately Rs.24,030 crores along with 15% interest to around 30 million investors and in April 2013, SEBI ordered Kolkata based Saradha to close all its collective schemes and refund the money collected from investors within three months. It also threatened to initiate criminal proceedings against the entities who did not comply with its orders. In a recent case, SEBI asked Capacious Farming to refund the money of the investors within a period of three months. The company and its directors were asked to abstain from collecting money from the investors and carry out any collective investment scheme. The regulator had also warned the company and its directors for registering a civil as well as criminal case for non-compliance of the orders.
However, at the same time, it is also important for the investors to be vigilant of such schemes and take significant steps in protecting their investment funds. Therefore, investors should apply proper due diligence and take informed decision while investing in such schemes.
References
[1] Regulation 5 of the (Collective Investment Schemes) Regulations, 1999.
[2] Regulation 24(4) of the (Collective Investment Schemes) Regulations, 1999.
[3] Regulation 16 of the (Collective Investment Schemes) Regulations, 1999.
[4] Regulation 24(3) of the (Collective Investment Schemes) Regulations, 1999.
[5] Regulation 24(2) of the (Collective Investment Schemes) Regulations, 1999.
[6] Regulation 25 of the (Collective Investment Schemes) Regulations, 1999.
[7] Regulation 24(5) of the (Collective Investment Schemes) Regulations, 1999.
[8] Section 27. Offences by Companies.—
(1) Where an offence under this Act has been committed by a company, every person who at the time the offence was committed was in charge of, and was responsible to, the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly: Provided that nothing contained in this sub-section shall render any such person liable to any punishment provided in this Act, if he proves that the offence was committed without his knowledge or that he had exercised all due diligence to prevent the commission of such offence.
(2) Notwithstanding anything contained in sub-section (1), where an offence under this Act has been committed by a company and it is proved that the offence has been committed with the consent or connivance of, or is attributable to any neglect on the part of, any director, manager, secretary or other officer of the company, such director, manager, secretary or other officer shall also be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly. Explanation.—For the purposes of this section,—
(a) “company” means any body corporate and includes a firm or other association of individuals; and
(b) “director”, in relation to a firm, means a partner in the firm.
[9] Section 24. Offences.—
(1) Without prejudice to any award of penalty by the adjudicating officer under this Act, if any person contravenes or attempts to contravene or abets the contravention of the provisions of this Act or of any rules or regulations made thereunder, he shall be punishable with imprisonment for a term which may extend to 2[ten years, or with fine, which may extend to twenty-five crore rupees or with both].
(2) If any person fails to pay the penalty imposed by the adjudicating officer or fails to comply with any of his directions or orders, he shall be punishable with imprisonment for a term which shall not be less than one month but which may extend to 3[ten years or with fine, which may extend to twenty-five crore rupees or with both.
[10] Section 26. Cognizance of offences by courts.
(1) No court shall take cognizance of any offence punishable under this Act or any rules or regulations made thereunder, save on a complaint made by the Board.
(2) No court inferior to that of [a Court of Session] shall try an offence punishable under this Act.
[11] (2001) 32 SCL 95.
