Markets regulator Securities and Exchange Board of India (Sebi) has recently issued a General Order on issuing observations on offer documents when there are pending regulatory actions, superseding a 2006 general order on the same subject. The General Order 1 of 2020, which was issued on February 5, 2020, sets out the circumstances under which SEBI can withhold observations on draft offer documents (companies cannot launch issues until SEBI provides observations).
We discuss the SEBI order, its implications, and whether this is a step in the right direction for a disclosure-oriented securities regime.
When a company decides to go public, pendency of regulatory proceedings and investigations against the company, its directors, promoters and, group companies are considered critical by the regulator for broader assessment of whether the entity can be taken to the market. The SEBI General Order derives its statutory foundation from Section 11A of the SEBI Act, which empowers the regulator to prohibit a company from issuing a prospectus or specify conditions subject to which the prospectus may be issued. Like its predecessor, this SEBI General Order also sets out various such scenarios in which the regulator can keep a draft offer document in abeyance, in cases where investigations, enquiries, adjudication, prosecution, disgorgement, recovery or other kind of regulatory action is pending.
A few thoughts on the SEBI General Order
The remit of the SEBI General Order covers, in addition to the proposed issuer company, its group companies, promoter and directors. At the threshold, from an applicability standpoint, it may have been useful for SEBI to keep group companies on a different footing and not subject them to the exacting standards applicable to the issuer or its promoters/directors. This is particularly relevant since the SEBI ICDR Regulations now specifically define group companies, which draw from related party concepts as well.
The SEBI General Order then commences with Regulation 3, which envisages a situation where a probable cause for investigation exists against these entities. In such cases, observations on the DRHP are to be kept in abeyance for 30 days after the probable cause arising or the date of filing the DRHP, whichever is later. The “probable cause” parameter is often difficult to objectively gauge and it remains to be seen what is deemed to be the bright line, particularly in an environment rife with whistle-blower letters, shareholder complaints and grievances. The SEBI General Order, however, is silent on whether after a month, the company can go ahead with the listing process without making any disclosures regarding the ongoing investigation. Given the confidentiality of such investigations and their potential impact on a wider cast of characters, not always limited to the prospective issuer alone, a disclosure, if any, and navigating the limitations of the same, will require case-specific guidance from SEBI.
Paragraph 4 deals with the next stage, i.e., where the regulator is convinced of a prima facie case against the parties and issues a showcause notice. SEBI has done well to recognise the distinction between an adjudication proceeding (where the consequences are necessarily monetary and hence quantifiable) and a proceeding under Section 11B of the SEBI Act, which can have wide-ranging penalties. Two other types of proceedings that can be initiated by SEBI find no mention here, through enquiry proceedings against intermediaries in terms of Regulation 27, SEBI Intermediaries Regulations as well as Section 11B(2), in terms of which SEBI can impose monetary penalties.
The phrase “conduct of parties” has been extensively used (but not defined) in the SEBI General Order as a standard to determine the period for which the offer document can be kept in abeyance. In other words, based on whether the conduct of the party connected with the IPO caused delay in the proceedings, SEBI will retain the discretion to protract the abeyance period. It is debatable if drawing a linkage between the conduct of parties in a proceeding that is independent from the offer document itself is a positive regulatory step, as it may be seen to nudge parties to a settlement even though the matters are not connected. In any event, practically, proceedings are delayed on a variety of grounds that can rarely be attributed to one party alone, especially where information sharing by parties is predicated on receipt of cooperation from various other players. While applying this standard, SEBI will have to ascertain not just conduct, but also whether the conduct is deliberate, contumacious and solely intended to cause delay in the pending investigation/proceedings, which will be difficult to do.
Interestingly, the SEBI General Order does not consider pendency of consent proceedings and what treatment will be accorded to parties who have chosen the settlement route. Admittedly, there could be complexities in legislating for this, since parties can always withdraw from consent midway and the adversarial proceedings also continue in parallel. However, it will be important to assess how pending consent applications are treated under the scheme of this SEBI General Order.
Implications for the securities market
The philosophy underlying the SEBI General Order is a curious union of certain key issues that impact the Indian securities market today and raises some critical questions on SEBI’s overall approach, which need deeper introspection across all stakeholders – (i) does the regulator assume the role of a parens patriae in public offers? (ii) how do our regulatory enforcement processes need to evolve to help in more predictable impact assessments?
With broad powers under Section 11A, SEBI has always been permitted to exercise discretion over the nature of companies which are permitted to raise funds from the public. Like any public authority, such discretion is not unfettered and should be exercised with care and when situations so warrant, the guiding principle being, the potential impact that the pending proceedings could have on the fit and proper nature of the issuer company. By issuing a General Order of this nature, SEBI has effectively relegated a principle-based decision-making process, to a formulaic, rule-based one. For a regulator of its vintage, SEBI must have a clearer mission statement on its role in the public markets today. In a disclosure-driven regime, two contracting parties (i.e., the company and its shareholders) should be allowed to formulate the terms of their engagement, with the role of the regulator being limited to ensuring information symmetry. If the consequences are reasonably ascertainable and can be disclosed clearly, a one-size-fits-all approach can hinder more than help.