Public offer of securities—An analysis

Introduction

Section 67 of the Companies Act, 1956 contains the provisions wherein when an offer of shares or debentures to investors shall be construed as having been made to the public, meaning "public offering". According to the provisions, any offer of shares or debentures made to 50 persons or more will be considered a public offering, which will in turn require listing of the said shares or debentures on a recognised Stock Exchange in India. In case if a company does not want to come into the clutches of Regulatory Authorities and want to stay out of the provisions of this Section, then it should make distinct offerings of securities, with each such offering being made to less than 50 persons. In the wake of the probe into the modalities of raising funds by Sahara India Real Estate Corporation Ltd (SIRECL), as well as Sahara Housing Investment Corporation Ltd (SHICL), this Article captures the various provisions relating to public offering of securities according to the provisions of the Companies Act, 1956 and powers of SEBI.

Case relating to Sahara

 (a)  Background

In July, 2008 Reserve Bank of India banned Sahara India Financial Corporation from accepting any deposits beyond 30th June, 2011 and also ordered the Company to pay back all investors by June 30th 2015. Two unlisted companies of Sahara Group namely SIRECL and SHICL were resorting to the practice of raising funds from the public in the form of unsecured loans in the guise of private placement through Optional fully convertible debentures (OFCDs). As per records and reports, SIRECL has raised approximately4843 crores as on 30th June, 2009 where as Sahara India Commercial Corporation Limited (SICCL) has raised approximately 17,250 crores of unsecured debentures over a period of last 10 years and reportedly have 6.6 million as total investors. The contention of Sahara was that the issuance of OFCDs were made on private placement basis to friends, associates, group companies, workers/employees and other individuals who are associated / affiliated or connected in any manner with Sahara India Group of Companies and hence it is not an offer to the public. Further, they do not intend to get the OFCDs listed in India or abroad and therefore the issuance of OFCDs do not come under the purview of SEBI in terms of Section 55A of the Companies Act, 1956. Sahara has also filed a Red Herring prospectus with the Registrar of Companies concerned by adopting the process laid down under Section 60B of the Companies Act, 1956 with a clear intention that it does not intend to list its securities. Further, the Sahara companies on the basis of the legal opinion received by them, have stated and contended that they had passed the resolution under Section 81(1A) of the Companies Act, 1956 (which states that further shares may be offered to any persons in any manner whatsoever) and that their offer to a select set of persons should not be construed as a public offer. In the meanwhile,another Sahara Group company viz., Sahara Prime City in September, 2009 filed a draft red herring prospectus with the Securities Exchange Board of India (SEBI) for an Initial Public Offering. While processing the IPO, SEBI found that the issue of OFCD has violated the public issue norms. Since SEBI received certain complaints that SIRECL and SHICL had issued OFCDs in violation of statutory norms and rules and regulations, it has issued a notice to their Merchant Banker calling for certain information relating to the debentures. Thereafter, SEBI in November, 2010 through an Order banned the Sahara group companies and its promoters from raising money from the public for allegedly violating the public issue norms. Further, SEBI had forwarded the order to Ministry of Corporate Affairs (MCA) to take appropriate action.

 (b)  Power of SEBI

Aggrieved by the SEBI’s Order, SIRECL filed a writ petition before the Hon’ble Allahabad High Court stating that the provisions of Section 55A of the Companies Act, 1956 gives power and rights to SEBI only over listed entities or companies that intend to list its securities on the Stock Exchanges. SIRECL contended that its offer was made by a private placement to a select group of persons viz., friends, associates and employees and without advertising it to the public. Further, it also added that it had no intention to list on the Stock Exchange and thus the OFCDs which were offered were outside the purview of SEBI. SIRECL also added that the OFCDs were being issued pursuant to an Information Memorandum filed with the Registrar of Companies, which is coming under the MCA which had allowed the issue. Thus, Sahara argued that only MCA has right and jurisdiction over the issue of debentures by unlisted companies and SEBI do not have the jurisdiction in the matter.

  (c)  Outcome of Court’s hearing

Supreme Court hearings

On 2nd May, 2011, the Apex Court has adjourned the hearing of the Petition filed by Sahara against the orders of the Allahabad High Court which necessitated the company to share full details of investors participating in its fund raising exercise with the market Regulator viz. SEBI. The Apex Court has allowed some more time to file certain additional documents on the requests o the Counsels appearing for Sahara Group. Further the Apex Court on 12th May, 2011 asked the market regulator SEBI to proceed with its investigation into the nature of investment scheme floated by Sahara Group to raise money from the public. Since in the hearing the Counsels of Sahara Group could not properly explain the meaning and nature of the instrument OFCDS, the Bench of the Apex Court appeared unconvinced with the logic given by Sahara group firms that OFCDs schemes do not come under the purview of the SEBI Act. Finally the Apex Court observed that the question of OFCD requires the decision of SEBI and held that SEBI order would not be operational till the Court gives further directions on it and the Apex Court want to see the order of SEBI on OFCD. Also, the counsels of Sahara could not produce any copies of advertisement or brochure showing the nature of the scheme or investment and in view of the vague nature of the investment, the Apex Court asked SEBI to come up with an explanation in July, 2011. The Apex Court also stated that the Allahabad High Court can proceed with the case pending before it.

While we await the final verdict of the Supreme Court in the matter, this Article has been written to make the readers aware of the various provisions in the Companies Act and corresponding provisions of SEBI and an analysis of the same is given hereunder:-

Provisions of the Companies Act,1956 relating to offering of Securities to Public, Jurisdiction of SEBI, SEBI Guidelines and comments

An analysis of the various provisions of the Companies Act, 1956 reveals the following:-

   1.  SEBI can exercise its jurisdiction with respect to listed public companies or in case of those public companies which intend to get their securities listed on any recognized Stock Exchange in India. (Section 55A). There are various sections mentioned in Section 55A and on analysis of the same one can come to conclusion that all these sections mentioned are relating to matters concerning investors and protecting the interests of the investors. It is to be noted that SEBI has right and power to conduct an enquiry and seek information from SIRECL, since the said company was named in the Draft Red Herring Prospectus (DRHP) filed by Sahara for an IPO for Sahara Prime City. Further, Sahara has erroneously interpreted the language in Section 55A i.e. " intended to get listed" as "choice to be listed".

   2.  In case a company allots or agrees to allot any shares in or debentures of the company with a view to all or any of those shares or debentures being offered for sale to the public, any document by which the offer for sale to the public is made shall, for all purposes, be deemed to be a prospectus issued by the Company.(Section 64)

   3.  Section 67 of the Companies Act, 1956 explains what is to be construed as offer of shares or debentures to the public. This section explicitly states that any reference in the Act or in the Articles of Association of a company to offering (or inviting to subscribe) for shares or debentures to the public shall be construed as including a reference to offering them (or inviting them to subscribe) to any section of the public whether selected as members or debenture holders of the Company concerned or as clients of the person issuing the prospectus or in any other manner. Thus, the terms "public" includes any section of the public. But such construction as above is subject to Section 67(3) and (4) and any other provision to the contrary contained in the Companies Act. Whereas it is stated that Section 67(3) of the Companies Act exempts such offer or invitation from the purview of the construction laid down in Section 67(1) and (2) thereof, if such offer or invitation can properly be regarded, in all the circumstances:-

 (a)  As not being calculated to result, directly or indirectly, in the shares or debentures becoming available for subscriptttion or purchase by persons other than those receiving the offer or invitation; or

 (b)  Otherwise as being a domestic concern of the persons making and receiving the offer or invitation.

        Proviso Section 67(3) states that nothing contained therein shall apply in a case where the offer or invitation to subscribe for shares or debentures is made to fifty persons or more.

        The above proviso was inserted through the Companies Amendment Act, 2000 in order to prevent companies from offering shares or debentures to a wider group of people by disguising it as " domestic concern". Hence, if an offer is made to fifty or more persons, it would be deemed to be a public issue, even if it is of "domestic concern" or proved that " the shares or debentures are not available for subscriptttion or purchase by persons other than those receiving the offer or invitation". Thus, an issue which is made by way of private placement to 50 or more people is deemed to be a public issue irrespective of whether it was offered to the public at large or to just a section of the public chosen in whatever manner possible and the issuer has to comply with SEBI guidelines relating to public issue of securities. {Section 67(3)}. The only way a company can escape the provisions of this Section is if it makes different /distinct offerings with each such offering of shares or debentures being made to less than 50 persons, which is a rare possibility in the instant case of Sahara and not practicable since there are millions of shareholders as per records well above 49 persons which is the threshold limit. The only exception or the possibility is where a company is a Non-Banking Finance Company (NBFC) or to a Public Financial Institution within the meaning of Section 4A of the Act, as the 50 limit of offeree restriction does not apply so long as the offer is made in accordance with guidelines prescribed by SEBI for the purpose in consultation with RBI.{Section 67(3A)}

        In a nutshell, in the following circumstances, it will not be regarded as an offer made to public :-

 (a)  If the offer or invitation to subscribe for shares or debentures can be accepted only by persons to whom it is made.

 (b)  If it is offered only to the existing shareholders of the company.(Rights Issue)

  (c)  If the offer or invitation is issued by the issuer writing " Private and Confidential" and it is the domestic concern of those making and receiving the offer.

 (d)  If the issue of shares or securities are offered to less than 50 persons.

   4.  A public limited company has no obligation to have its shares listed on a recognised stock exchange. But every company intending to offer shares or debentures to the public for subscriptttion by the issue of a prospectus shall, before such issue, make an application to one or more recognized Stock Exchange for permission for the shares or debentures intending to be so offered to be dealt with in the Stock Exchange or each such Stock Exchange. {Section 73(1)}. Provisions of Section 73 are not applicable in cases of private placement of shares or debentures i.e. offer of shares and debentures to less than 50 persons. Since SIRECL has allotted OFCDs to more than 49 persons, it tantamount to offering of shares or debentures to the public and as per Section 73 of the Companies Act, 1956, the Company ought to have applied for permission for the listing of the issue. Therefore, the intention of the Sahara companies to list or not is immaterial, in so far as Section 73 of the Act is concerned, as once the offer is public, the companies are statutorily bound to apply for listing permission. This statutory obligation cannot be evaded by merely stating in the prospectus that the company does not intend to list its securities. The intention of the Legislation is that the companies offering its shares or debentures to the public through a prospectus, should compulsorily list the same and it is regardless of the intention of the companies. This provisions is stipulated because of the protection and benefit to the investors who subscribe to such offers since it provides liquidity and easy exit opportunity for the investors to sell it through Stock Exchanges.

5.  It is to be noted that on a combined reading of Section 67(3) together with Section 55A and Section 73 of the Companies Act, 1956 will signify and provide for compulsory listing of securities on a recognised Stock Exchange, if the issue of securities is offered to more than 49 persons since it will be deemed to be a public issue of securities and all the rules and regulations relating to issuance of prospectus, listing of the securities and obligation to fulfil the disclosure norms as per SEBI arises. It may also be interesting to note that Section 73(4) states that any condition purporting to require or bind any applicant for shares or debentures to waive compliance with any of the requirements of Section 73 shall be void. Hence there is no escape from complying with this provision.

   6.  Sections 55 to 81 that deal with " prospectus" are applicable if the offer is made to 50 persons or more.  Sahara Group companies have filed Red Herring Prospectus with Registrar of Companies would also make it clear that their offer of OFCDs were intended to be offered to the public since Section 2(36) of the Act states that " prospectus" means any document described or issued as a prospectus and includes any notice, circular, advertisement or other document inviting deposits from the public or inviting offers from the public for the subscriptttion or purchase of any shares in, or debentures of, a body corporate.  Thus, the conduct of Sahara of filing prospectus for their issue of OFCD with the concerned Registrar of Companies is nothing but they intended to mobilize money through subscriptttions from the public and not through private placement.

   9.  Section 81 of the Companies Act, 1956 deals with further issue of securities and only gives pre-emptive rights to the existing shareholders of a company so that the subsequent offer of securities have to be offered to them as their "rights". Further, Section 81(1A) is only an exception to the said rule that the further shares may be offered to any persons subject to passing of special resolution by the company in general meeting. But, Section 81(1A) of the Companies Act, 1956 cannot have an overriding effect on the provisions relating to public issue, specified in the Act. Thus, any further issue of capital to persons other than the shareholders even pursuant to a resolution made under Section 81 (1A) of the Act, is subject to the provisions of Section 67 of the Act, i.e. if the offer is made to fifty persons or more then it will have to treated as public issue and not a private placement. If we analyse the provisions of Section 81(1A), it was never intended to dilute the provisions of the Act relating to the definition of public issues. Thus, the resolution passed under Section 81(1A) of the Companies Act, 1956 does not take away the public nature of the issue if it is issued to more than 50 persons as contemplated under Section 67(3) of the Companies Act, 1956.

Analysis of SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009 (ICDR Regulations) relating to public offer of securities

 (a)  Regulation 26(4) of ICDR Regulations mentions that an issuer shall not make an allotment pursuant to a public issue if the number of prospective allottees is less than 1000. It has been contended by Sahara that no listing is permitted if the number of allottees are less than 1000 whereas the plain reading of the Section 67(3) suggests that the company issuing securities to fifty or more persons would require their securities listed on any recognized Stock Exchange. If a company has attracted Section 67(3) of the Act, then it has to comply with various statutory requirements such as registering the prospectus with Registrar before making the public issue (Section 60), making an application to list their securities to recognized Stock Exchanges (Section 73) etc. It has to further comply with the provisions of SEBI Act and guidelines of SEBI namely ICDR Regulations. Thus, once the issuer decides to offer its securities by way of shares or debentures to 50 or more persons, then the issue is an offer to public at large and has to comply with ICDR guidelines and Regulation 26(4) mandates that an issuer shall not make an allotment pursuant to a public issue if the number of prospective allottees is less than 1000 only to ensure that there is sufficient liquidity in the securities post listing.

 (b)  As per Regulation 6 of the ICDR Regulations, no issuer shall make a public issue unless a Draft offer document has been filed with SEBI through the lead Merchant Banker at least thirty days prior to registering the prospectus / Red Herring prospectus with the Registrar of Companies. Sahara Group did not file the draft offer document with SEBI for processing before filing the Red Herring Prospectus with Registrar since their issue of OFCD is offer to public and has violated Regulation 6 of the ICDR Regulations and upon analysis one can safely mention that the Sahara Group has violated many other ICDR Regulations relating to the issue of OFCD.

Conclusion

The intention of the Companies Act as well as SEBI are very clear and subscriptttion received from a group of investors pursuant to an offer of shares or debentures, if it exceeds fifty or more in number should be classified as a "public issue" and cannot be treated as "private placement". SEBI’s ICDR Guidelines have been framed to provide necessary checks and balances in the public issue frame work. Regulations include inter-alia eligibility norms for the issuers, requirement of promoter’s contribution and lock in, IPO grading, comprehensive disclosure requirements in prospectus and guidelines for issue process etc. Further, in the case of OFCD additional requirements relating to credit rating, appointment of Debenture Trustee, to create Debenture Redemption Reserve are to be complied with by an issuer. In view of the above analysis, it appears that Sahara has prima facie has violated various Sections of the Companies Act as well as the ICDR Regulations of SEBI. The tussle between Sahara and SEBI with respect to the issue of OFCD is sub judice. The final judgement of Supreme Court will definitely settle whether the issue relating to OFCD is a public issue or not and will also settle various other issues relating to offer of public issue of Securities and the jurisdiction of SEBI.