Brief Facts
DLF issued 17,50,00,000 equity shares in an IPO in 2007. DLF had submitted its DRHP for the aforementioned IPO with SEBI on January 2, 2007. DLF had previously submitted a DRHP on 11th May, 2006, which it subsequently withdrew, thereafter filing a second DRHP on 2nd January, 2007. Finally, on June 18, 2007, Red Herring Prospectus was submitted with the Registrar of Companies. Thereafter, DLF’s shares were listed on the BSE and NSE Ltd. after the IPO’s allotment was completed.
Mr. Sinha claimed to have been duped by a DLF subsidiary and had filed a complaint with SEBI alleging information suppression and misrepresentation in the prospectus against DLF. A show cause notice was given to DLF’s 7 key management personnel in response to this allegation. As a result, SEBI ordered an investigation into the complaint for the public interest.
Procedural History
The Securities and Exchange Board of India, Mumbai, evaluated the matter on 10th Oct, 2014 under the jurisdiction of:
- Section 19, SEBI Act, 1992.
- Section 11, 11A, 11B SEBI Act, 1992.
- Regulation 11, SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.
- Clause 17.1 SEBI (Disclosure and Investor Protection) Guidelines, 2000.
- Regulation 111 SEBI (Issuance of Capital and Disclosure Requirements) Regulations, 2009.
Post the SEBI order, DLF filed an appeal to SAT where the Tribunal reversed the order passed by SEBI. The observations of SAT shall be accounted for in the following sections of this paper.
Issues
- Whether in spite of share transfer process in Sudipti, Shalika and Felicite they remained to be subsidiaries of DLF? If so, did Noticees deceive the public by representing Sudipti’s dissociation from DLF?
- Whether DLF failed to ensure that the Prospectus contained material information that was both factual and adequate to allow investors to make an informed IPO investment decision?
- Whether DLF was in ‘control’ of the subsidiaries Sudipti, Shalika and Felicite?
Rules
- Section 4(1)(a), Companies Act, 1956: When a company controls the Board of directors of another company, the latter is a subsidiary of the former.
- Regulation 2(1)(c), SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997: Defines ‘control’ to establish holding-subsidiary relationship as; when a company exercises control over the management policies of another, the former is the holding company of the latter
- SEBI (Disclosure and Investor Protection) Guidelines, 2000:
2: Violation for non-disclosure
9.5.8 : obligation to disclose Key Managerial Persons
9.6.6: obligation to disclose related party transactions
10.2.3: obligation to disclose financial details of related parties
11.1.1: obligation to disclose exiting litigation
15.2: declaration for prospectus
1: truthful advertisement
1: defines related parties
- Regulation 111, SEBI (Issuance of Capital and Disclosure Requirements) Regulations, 2009: Applicability of ICDR regulations.
- Clause 10.2, Accounting Standards-18: Defines related party transactions
- Clause 3.3(b), Accounting Standards-23: When a company is in control of the composition of Board of Directors of another, the latter is deemed to the subsidiary of the former.
Analysis/Application
DLF and its subsidiaries
DLF Estate Developers Ltd (DEDL), DLF Home Developers Ltd (DHDL), and DLF Retail Developers Ltd (DRDL) are the three wholly owned subsidiaries (WOS) of DLF. Sudipti, Felicite, and Shalika were incorporated by these three WOS. The following is the shareholding allocation in three subsidiary companies: Shalika, Sudipti and Felicite:
Sudipti: DHDL – 50% & DEDL – 50%
Shalika: DHDL – 30% ; DEDL – 30% ; DRDL – 40%
Felicite: DHDL – 30% ; DEDL – 30% ; DRDL – 40%
Analysis of the Observations by SEBI
Retention of control by DLF
The main allegation brought before SEBI was that the share transfer transaction was not genuine and that the DLF retained control of the shares even post disinvestment. As per the factual matrix, on 29th Dec, 2016, the subsidiaries of DLF had transferred shares among each other. Sudipti’s whole interest was transferred through shares to Shalika, who in turn transferred its entire shareholding to Felicite, which finally became the holding company.
As affirmed in the case of Technip SA v. SMS Holding (P) Ltd.[1], if one company controls the composition of another’s Board of Directors[2], , has control over management policies[3], more than half of the voting authority in an organisation[4], significant influence over financial/operating decisions[5], or has a controlling interest in another (Vodafone International Holdings BV v. Union of India[6]), the two companies form a holding-subsidiary relationship, with the former acting as the latter’s holding company. As a result, Shalika Sudipti and Felicite are legitimate subsidiaries of DLF Ltd since their other subsidiaries controlled the membership of the Board of Directors, the governing policies, and possessed voting authority.[7]
SEBI also relied on the definition of control as provided in SEBI (SAST) Regulations, 1997; resultantly, opined that DLF retained control over Felicite and functioned as Felicite’s legal holding company.
Violation of disclosure guidelines
Based on the aforementioned conclusion of SEBI, it was established that holding-subsidiary relation existed between DLF and Felicite.[8] Therefore, according to DIP Regulations, it becomes necessary for the entity to disclose following details in the Prospectus:
– Clause 6.9.5.8: Name of the Key Managerial Persons
– Clause 6.9.6.6: Disclosure of related party transactions
– Clause 6.11.1.1: Disclosure of existing litigation against subsidiaries
The question before SEBI was firstly, whether FIR is litigation under DIP Regulations and secondly, whether such information is vital to be disclosed in Prospectus. Here, SEBI held that Regulation under DIP has vast interpretation and ongoing litigation is inclusive of FIR. According to SEBI, FIR had a direct influence on DLF’s activities and the potential of subscriptions issued in the IPO. It would also have a significant influence on DLF’s and its subsidiaries’ business. As a result, failure to disclose the information was constituted a breach of the DIP Regulations.
Observations of SAT in Appeal
Pursuant to observations at the hearing at SEBI, it imposed 85 crore penalty on DLF for violation of several regulations and Acts. Against such penalty order, DLF moved an appeal in the Securities Appellate Tribunal, which in turn reversed the order of the SEBI.[9] The observations of SAT are provided in the foregoing sections.
Disinvestment and alleged ‘control’
While discussing whether DLF had control over its subsidiaries, it delved into the definitions of control provided under several corporate statutes and regulations. SAT pointed that the definition under Companies Act provides that if one company controls the composition of its Board of Directors, it is considered a subsidiary of another. The subsequent clause, however, provides that the composition of Board is considered to be controlled by only if that other company can appoint or remove the holders of all majority of the directorships at its full discretion without the permission or concurrence of any other person. Therefore, to substantiate that DLF had control over Felicite, it had to be proved that DLF had exclusive power to appoint and remove the Directors; which the SEBI failed to prove.
Furthermore, SAT categorically pointed out regarding the application of SAST Regulations for defining control. SAST come into force for listed entities, thus having no application in context of unlisted companies. SEBI’s act of scouring several statutes for clauses and sections was deemed arbitrary and thus reprimanded by SAT.
SAT also stated that once DLF decided as a policy matter to disinvest all of its subsidiaries, followed by the actual divestment in such companies, DLF is not required to refer to the three companies as subsidiaries or associates, as this would have been a factually incorrect statement on DLF’s part.
The case of Subhkam Ventures v. SEBI[10] provides an accurate and logical interpretation of ‘control’ under company laws. Control is a proactive rather than a reactive skill. It is the ability of an acquirer to demand the target company to do anything he wants. The test here is whether the acquirer is in the driver’s seat, acting as the driving force and carrying the company ahead.
Disclosure Requirements
Another primary issue before SAT was whether DLF had failed to adhere to the disclosure requirements under SEBI Regulations. SAT observed that had DLF filed the ‘Delta View’ document alongwith second DRHP, explicitly stating the variations between the two DRHPs. It was with SEBI for at least five months and in the public arena before SEBI could provide thorough and extensive observations. If DLF had intended to hide the fact that Shalika, Sudipti, and Felicite were subsidiaries from SEBI or public, it would not have included it in the second DRHP at all. SAT emphasised that once SEBI has reached a thorough and well-informed conclusion, the possibility of the decision being overturned must not be allowed to hang over companies’ heads, except in extraordinary situations.
According to SAT, no DLF KMP’s had any influence on these three enterprises. The WOSs of DLF in Felicite transferred their equity shares in the company to the wives of DLF workers. As a result, the wives of Felicite shareholders and directors, Shalika, and Sudipti were not KMPs for the purposes of Accounting Standard 18.[11] Resultantly, the claim of non-disclosure of ‘related party transaction’ against DLF was found to be unsubstantiated and unproved by SEBI. No doubt, SEBI is expected to ensure that Companies are in complying the guidelines under N Narayanan case[12], however, SEBI cannot take a retrospective and prospective view at the same time to set a faulty precedent in the corporate directories.
Conclusion
In the economic process such as IPO and stock listing, not only companies looking to be listed, but public at large are also largely involved. As a result, the acts of an intelligent and respectable regulator such as SEBI itself has an extreme responsibility to be expedient and definitive. Companies, shareholders, investors, and other capital market intermediaries will all be overwhelmed with uncertainty as a result of indecisiveness, premature, and excessively belated acts of such respected regulators.
The decision of SEBI was accusatory and strict in nature where the Company was slammed with a heavy amount of penalty without any legal violation. It is pertinent to note that in the order of SAT which reversed SEBI order, SAT has made several points reprimanding SEBI for undertaking a strict view with respect to the companies and the compliance guidelines. As subsequently upheld in SAT, DLF did not override any legal provisions which disinvesting in Shalika, Sudipti and Felicite. Therefore, such order of penalizing the company without any prima facie legal violation can affect the Capital Markets in long term, discouraging companies from initiating IPO procedures.
Suggestions
Based on the analysis of the case and subsequent appeal in the same, the author would attempt to provide some holistic recommendations. In concurrence with several orders of SAT, SEBI is required to forbear on its reprimanding approach, which could otherwise lead to a mass discouragement amongst the upcoming start-ups to initiate listing in securities. Secondly, from the perspective of strengthening the internal management of listed or to-be-listed companies, such entities should adopt better governance practices including transparent disclosures and optimum compliances, to avoid any such aggressive action to be taken by SEBI.
[1] Technip SA v. SMS Holding (P) Ltd., (2005) 5 SCC 465.
[2] Companies Act, 1956, § 4(1)(a), No. 1, Acts of Parliament, 1956 (India).
[3] SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, Regulation 2(1)(c).
[4] Accounting Standard- 23, Clause 33.3.
[5] Accounting Standard- 18, Clause 10.1.
[6] Vodafone International Holdings BV v. Union of India, [2012] 1 SCR 573.
[7] Balwant Raju Rai v. Air India, (2014) 9 SCC 407.
[8] SEBI (Disclosure and Investor Protection) Guidelines, 2000, Clause 10.1.
[9] DLF Limited v. SEBI, 2015 SCC OnLine SAT 54.
[10] Subhkam Ventures Pvt. Ltd. v. SEBI, 2010 SCC OnLine SAT 35.
[11] Accounting Standard-18, Clause 10.8.
[12] N Narayanan v. Adjudicating Officer, SEBI, AIR 2013 SCC 3191.
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