The ministry of corporate affairs is looking to amend the disgorgement clause under Companies Act, 1956 to strengthen the mechanism for compensating duped investors by recouping funds from wrong-doers and paying them back to investors.
According to official sources, a new provision with this intent will be introduced in the Companies Bill 2009, currently being vetted by a parliamentary standing committee. (Disgorgement is a universal instrument to prevent unjust enrichment at the expense of someone to whom the profit is due. It is rooted in the principle of restitution).
Currently, Section 542 of the existing Companies Act 1956, which provides for disgorgement is “vague” and the necessary powers are drawn by the executive through its “interpretation.” In practice, it is very difficult to establish a link between ill-gotten gains of the wrong-doers from the company or outside and the loss of the aggrieved investors, creditors or depositors. “What is being planned is to make the legal provision more exact and less interpretative so that the link between the wrong-doing and the investor’s loss can be traced and established,” a ministry official told on conditions of anonymity.
In addition to equipping the law for disgorgement proceedings, penalty for such offences could also be substantially increased so as to make it a strong deterrent, the official added. Under the current law, the penalty is a maximum of two years’ imprisonment or a fine of Rs 5,000 or both.
Further, the provision would hold the person responsible for loss to creditors and investors culpable regardless of whether he was aware of the potential loss to the investor on account of his behaviour. Lack of intent to cause a loss won’t be an excuse.
Sources said the new disgorgement law would be comprehensive enough to deal with all possible cases of defrauding investors, designated directors of the company or the company itself vanishing after collecting funds as investments or deposits; denial of fair allotment of shares paid for etc.
The proposed change in the disgorgement clause was discussed at a meeting of the Coordination and Monitoring Committee (CMC) on vanishing companies held on March 8 this year. Corporate affairs secretary R Bandyopadhyay presided over the meeting, which was attended, among others, by officials from stock market regulator Sebi.
Section 542 of the Companies Act that deals with the liability of fraudulent conduct of business states: “In the course of the winding-up of a company …(if there has been) intent to defraud creditors of the company or any other persons or for any fraudulent purpose…(or) … that any persons who were knowingly parties to the carrying on of the business in the (specified) manner shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the 1(Tribunal) may direct.”
Experts concurred with the government’s view that the current sections were loose and needed to be tightened. Soumya Ray Chowdhury, advocate at the Calcutta High Court said that as per current norms, it had to be proven whether the defaulted directors of the company did it “knowingly” or not which made it difficult for the investors. “The bill should also look to increase the penalty so that there is a strong deterrent in it,” he added.
Commenting on the government’s move, Prithvi Haldea, chairman and managing director, PRIME database said that a system to track down absconding directors of a company needs to be evolved.
The move comes barely two months after Finance Minister Pranab Mukherjee distributed funds to lakhs of investors who had applied for shares in 21 initial share offerings between 2003 and 2005, but were denied rightful allotment due to fraud committed by scores of financiers and their accomplices. Sebi could trace the funds as the bank accounts of the financiers were frozen immediately after the scam came to light. In August 2006, Sebi appointed a committee headed by Justice DP Wadhwa to suggest ways to compensate investors. The new disgorgement provision in company law would be in conformity with Sebi’s powers in relation to duping of investors by market participants and intermediaries.
