Untitled

PATRONS

PROF. FAIZAN MUSTAFA

VICE CHANCELLOR

NALSAR UNIVERSITY OF LAW, HYDERABAD

MR. ROHIT TANDON

MANAGING AND FOUNDING PARTNER

T & T LAW

ADVISORY PANEL

MR. PRABHA SHANKAR MISHRA

SENIOR ADVOCATE, FORMER CHIEF JUSTICE OF ANDHRA PRADESH.

PROFESSOR JAMES EDELMAN

PROFESSOR OF LAW, OXFORD, U.K.

DR S. CHANDRA MOHAN,

PRACTICE ASSOCIATE PROFESSOR, SCHOOL OF LAW, SMU, SINGAPORE

DR. S. BALASUBRAMANIAN

FORMER CHAIRMAN, COMPANY LAW BOARD, INDIA

MR. P VENKATA SASTRY

ANTI CORRUPTION AND CRIME PREVENTION EXPERT, UNODC

MRS. PALLAVI SHROFF

MANAGING PARTNER, AMSS DELHI

MRS. SUPARNA SACHAR

SENIOR PARTNER, O.P. KHAITAN & CO.

MR. UDAY WALIA

PARTNER, S&R ASSOCIATES

MR. ANAND PATHAK

FOUNDING & MANAGING PARTNER P & A LAW OFFICES, DELHI

MR. RAVI VARANASI

SENIOR VICE PRESIDENT AND HEAD OF INVESTIGATION AND

SURVEILLANCE WING, NATIONAL STOCK EXCHANGE OF INDIA

EDITOR IN CHIEF

PROF. KVS SARMA

PROFESSOR OF LAW,

NALSAR UNIVERSITY OF LAW, HYDERABAD

EDITORIAL BOARD

TRISHALA KAVITI (STUDENT EDITOR-IN-CHIEF)

KARTHIK SURESH

ABHIJEET SAXENA

VASAVI KAPARATHI

RANJINI GOGOI

MANAGING EDITORS

KANISHKA MOHAN SINGH RATHORE

ROSHAN SANTHALIA

VARUN TANDON

PUBLISHED BY

THE REGISTRAR

NALSAR UNIVERSITY OF LAW

3-5-874/18, Hyderguda, Hyderabad - 500 029, India

ASSOCIATE EDITORS

AAYUSH MALIK

LOKESH KAZA

COVER DESIGN

RAKSHANDA DEKA

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DISCLAIMER

The views and opinions expressed in the Journal of Corporate Affairs

and Corporate Crimes are those of the authors and do not necessarily

reflect those of the NALSAR University of Law, Student Bar

Council, or the Editorial Board of the Journal of Corporate Affairs

and Corporate Crimes.

CITATION FORMAT

[VOLUME] JCACC [PAGE] ([YEAR])

TABLE OF CONTENTS

EDITOR’S NOTE I

PATRON‟S ADDRESS III

TRADING PLANS – A NEW SHIELD AGAINST

INSIDER TRADING CHARGES 1

RECONSTRUCTION OF SICK INDUSTRIES OVER

RECOVERY OF DEBT: AN ANALYSIS OF

KSL INDUSTRIES V ARIHANT THREADS LTD & ORS 11

CORPORATE CRIMINAL LIABILITY AND

SECURITIES OFFERINGS: RATIONALIZING THE

IRIDIUM-MOTOROLA CASE 25

LEVERAGED BUY OUTS: UTILITY AND LEGAL

ISSUES- A COMPARISON BETWEEN THE POSITION

IN INDIA AND UK. 51

LIABILITY OF COMPANY AND INTERMEDIARIES IN

RELATION TO ISSUE OF SECURITIES- A

COMPARATIVE PERSPECTIVE 75

SEBI ON TRACK? – AN ANALYSIS OF THE SEBI

(RESEARCH ANALYST) REGULATIONS, 2014 133

NOTE TO CONTRIBUTORS V

I

EDITOR’S NOTE

In an era of globalization and the proliferation of corporations

around the world, there is no doubt that corporate affairs and

corporate crimes has become an increasingly dynamic field. In such a

scenario, the importance of academic debate on issues related to

corporate law does not need to be elaborated. The Journal of

Corporate Affairs and Corporate Crimes was founded with the aim of

making a lasting contribution to corporate law scholarship and

remedying the lack of authoritative writings on the same.

The Journal is a motley of articles on contemporary issues in

the area by students and practioners alike. In the first article, Trading

Plans: A Shield Against Insider Trading Charges, Mr Akash Chobey,

Partner at Khaitan & Co., along with Mr Rohan Singh, Associate at

Khaitan & Co. have provided an analysis of trading plans in India,

specifically, the option to persons perpetually in possession of UPSI

to trade in securities in a manner which is in compliance with the

applicable law. The next article, Reconstruction of Sick Industries

over Recovery of Debt, analyses the implications of the judgment

rendered in KSL Industries v. Arihant Threads Ltd, in the Indian

banking scenario. The third, Corporate Criminal Liability and

Securities Offerings, also a case comment, deals with the decision of

the Supreme Court in Iridium v. Motorola, and analyses the reasons as

well as the justifications for corporate criminal liability. The legal

framework of leveraged buyouts in India and the UK has been

discussed in Leveraged Buy Outs: Utility and Legal Issues- A

comparison between the Position in India and UK. The article also

explains the characteristics of a typical leveraged buyout and

II

enumerates the advantages as well as the risks of opting for a

leveraged finance structure. The detailed regulations on the procedure

that must be followed in the issuance of securities in the UK and in

India, as well as the sanctions imposed for violation of these

regulations has been analysed in the next article, Liability of

Companies and Intermediaries in Relation to Issue of Securities. And

finally, SEBI on Track- An Analysis of the SEBI (Research Analyst)

Regulations, 2014, provides the reader with a comprehensive

deconstruction of the new regulations as well as the lacunae which

remains in the legal framework in terms of implementation of the

same.

This Journal would not have been possible without the

patronage and aid of Prof. Faizan Mustafa and Mr Rohit Tandon, as

well as T & T Law Associates, New Delhi, and Prof. K.V.S. Sarma, to

whom the Board of Editors extends its heartfelt gratitude.

III

PATRON’S ADDRESS

It gives me great pleasure to present the third volume of the

Journal of Corporate Affairs and Corporate Crimes, a publication

conceived by the students of NALSAR, University of Law in

collaboration with T & T Law Associates, New Delhi. The journal, an

initiative of the students of NALSAR, aims to bring the fore

important developments in the field of corporate law and laws on

corporate criminal liability. It seeks to fill the lacuna created in the

field of corporate law due to the lack of a student run forum to

specifically address issues on the subject matter, inspite of its vast

diversity and potential. The first two volumes of the journal,

published in 2011 and 2014, made a bold attempt towards this end,

providing a platform to law students and practioners alike to discuss

to air their views on concerns which were much in vogue including

the 2010 TRAC recommendations, transnational corporations and

their relationship with international law, shareholder agreements,

piercing the corporate veil, independent directors and the like. The

third edition, I am proud to say, promises to do the same, under the

capable guidance of our patrons and our esteemed advisory panel that

boasts of the best in this field.

The Journal is the only student run journal in India that is

exclusively dedicated to corporate affairs and corporate crimes. It

strives to achieve glorious heights in its contribution to the

jurisprudence of corporate affairs and corporate crimes in an era

marred with the overhaul of the Companies Act 1956.

IV

I have no doubt that the third volume of the Journal, which includes

contributions from students and scholars in India, covering a wide

range of issues, will prove invaluable to academia and the profession

alike. I wish the Journal and the Board of Editors success in their

endeavours and hope that they will keep up the good work. On behalf

of the students and faculty of NALSAR, I wish to express my sincere

gratitude to Mr. Rohit Tandon, founder and Managing Partner of T &

T Law Associates for wholeheartedly supporting this student

initiative.

PROF. (DR) FAIZAN MUSTAFA

VICE CHANCELLOR

NALSAR

TRADING PLANS – A NEW SHIELD AGAINST INSIDER TRADING

CHARGES

-Aakash Choubey



and Rohan Singh



The regulation of insider trading has shot into prominence in

the past few years as a result the prosecutions and subsequent

convictions of Raj Rajaratnam and Rajat Gupta on charges including

securities fraud, conspiracy and insider trading. The primary objective

of framing laws prohibiting insider trading is to protect public

investors from price manipulations and securities market distortions

which result from persons trading on the basis of, or with the

knowledge of, unpublished price sensitive information (“UPSI”).

Given the difficulty in tracking down the accused in insider

trading investigations, insider trading norms typically attribute

liability to persons who possess, or are in a position to acquire UPSI.

In the event that a particular trade or series of trades are investigated

by securities market regulators, the general presumption is that

insiders are liable for violations of insider trading norms, unless they

can establish a recognised or prescribed affirmative defence. Recent

instances of regulatory action include the Securities and Exchange

Board of India (“SEBI”) prohibiting Factorial Master Fund from

dealing in securities and/ or accessing the Indian securities market,

pending investigation,

1

based on a prima facie finding that it had



Partner, Khaitan & Co.



Associate, Khaitan & Co.

1

For further details, please see the SEBI order (WTM/RKA/ISD/ 56/ 2014)

dated 5 June 2014 under sections 11(1), 11(4) and 11B of the Securities and

Exchange Board of India Act, 1992 in respect of Factorial Master Fund in the

matter of L&T Finance Holdings Limited.

2 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

traded while possessing UPSI;

2

and the Securities Appellate Tribunal

(“SAT”) upholding the decision of SEBI pursuant to which VK Kaul,

a former non-executive independent director of Ranbaxy

Laboratories, and his wife were penalized where VK Kaul had traded

on behalf of his wife in the shares of Orchid Chemicals and

Pharmaceuticals Ltd (“Orchid”) with the knowledge of proposed

substantial investments in Orchid by Solrex Pharmaceuticals Ltd (for

which funds were arranged by Ranbaxy Laboratories Ltd).

Insider trading is regulated in India by SEBI pursuant to

sections 12A(e) and 15G of the Securities and Exchange Board of

India Act, 1992 and the SEBI (Prohibition of Insider Trading)

Regulations, 2015 (“PITS Regulations”). The PITS Regulations

prohibit an insider from trading

3

in securities which are either listed,

or proposed to be listed on stock exchanges when such insider

possesses UPSI.

4

Notwithstanding this general prohibition, certain

circumstances are recognised where an insider may be able to set up a

defence against insider trading allegations. Where the insider is not an

2

In its order, SEBI had noted that a message stating „likely to come in at a steep

discount about 70 types‟ was circulated amongst the equity team of CS several

hours before the formal announcement of the offer for sale (“OFS”) and floor

price, although however, the communication channel of such UPSI was

untraceable at later stages due to the involvement of several stakeholders.

Subsequently, there were media reports that SEBI had initiated investigation of

the Indian arm of the Credit Suisse Group, which had been mandated by L&T

to launch the OFS, and which had discussions with over 70 institutional

investors (including Factorial) in order to gauge potential investor interest and

prospective subscription price for the OFS.

3

The definition of „trading‟ has been broadly defined pursuant to the legislative

mandate under sections 12A(e) and 15G of the Securities and Exchange Board

of India Act, 1992. Accordingly, „trading‟ is defined to include (but not remain

limited to) subscribing, buying, selling, dealing (or agreeing to do any of these).

4

Regulation 4(1) of the PITS Regulations.

2015 TRADING PLANS: A NEW SHIELD AGAINST INSIDER TRADING CHARGES 3

individual, there are two circumstances which may be pleaded as

defences. The first situation is where, in an organisation that has

individuals who possess UPSI, the trading decisions were taken by

individuals who neither possessed UPSI nor were in a position to

obtain UPSI.

5

The second situation is where „appropriate and

adequate‟ arrangements are in place to ensure that the PITS

Regulations are not violated, and individuals possessing UPSI do not

communicate such UPSI to individuals taking trading decisions. Apart

from these defences, the PITS Regulations provide that an insider

may defend itself from an insider trading allegation if the relevant

trades were executed pursuant to a trading plan approved, disclosed

and set up in accordance with Regulation 5 of the PITS Regulations.

[A] TRADING PLANS IN INDIA

The concept of trading plans was developed in order to

provide a transparent framework for insiders who are constantly in

possession of UPSI to trade in securities throughout the year.

Accordingly, an insider can proceed with a trade in securities

specified in a trading plan, even when, at the time of the relevant

trade, the insider is in possession of UPSI. The SEBI (Prohibition of

Insider Trading) Regulations, 1992 did not provide an option to

persons perpetually in possession of UPSI to trade in securities in a

manner which was in compliance with applicable law. This option is

now available under the PITS Regulations. Pursuant to Regulation 5

of the PITS Regulations, an insider is entitled to formulate a trading

5

An example of this a situation where a person may obtain UPSI is where such

person is in the reporting line, or is a superior or subordinate of persons in

possession of UPSI.

4 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

plan according to which trades may be carried on behalf of the

insider. Any such trading plan should be approved by the „compliance

officer‟ (defined under the PITS Regulations) and disclosed to the

public (“Reg 5 Plan”). At the time of approving a Reg 5 Plan, the

person for whom the trading plan is created may need to provide

additional undertakings as stipulated by the compliance officer.

The content of Reg 5 Plans and the ability to trade under a Reg

5 Plan are regulated under the PITS Regulations. Regulation 5

prescribes certain guidelines in relation to the execution and

implementation of Reg 5 Plans which are briefly summarised below.

GUIDELINE FOR REG 5 PLAN

RATIONALE

Mere existence of a Reg 5 Plan

does not provide immunity from

market abuse proceedings

6

Trading pursuant to a Reg 5

Plan should not lead to market

abuse

Multiple, overlapping Reg 5 Plans

are prohibited

Eliminates the possibility of an

insider timing the publication of

UPSI to allow them to execute

particular trades

Mandatory duration of 12 months

Ensures the existence of a

reasonable time period between

the decision and the action to

trade

6

These are prohibited pursuant to Regulations 3 and 4 of the SEBI (Prohibition

of Fraudulent and Unfair Trade Practices relating to Securities Markets)

Regulations, 2003.

2015 TRADING PLANS: A NEW SHIELD AGAINST INSIDER TRADING CHARGES 5

Either the value of proposed trades

or the number of securities to be

traded and the nature of the trade

and the intervals/ dates on which

such trades are effected

Details prescribed are required

to be adhered to when trades

are executed in the future

No trading is permitted before the

expiry of 6 months from public

disclosure of the Reg 5 Plan

Ensures a statutory cool-off

period after the adoption of the

Reg 5 Plan

Trading is prohibited between the

20

th

trading day prior to the last day

of any financial period for which

results are required to be

announced by the issuer of

securities and the 2

nd

trading day

after the disclosure of such

financial results

Prescribed to prevent situations

in which UPSI would be

generated, and used for trading

[B] RULE 10B5-1 PLANS

Section 10(b) and Rule 10b5 of the (United States of America

(“US”)) Securities Exchange Act, 1934 (“SEC Act”) prohibits the

sale or purchase of any security based on material non-public

information (“MNPI”). The (US) Insider Trading and Securities

Fraud Enforcement Act, 1988 provides for the liability of employers

if they fail to prevent an insider trading violation (for example, failure

to maintain an insider trading prevention policy). The (US) Securities

Exchange Commission (“SEC”) adopted Rule 10b5-1 in August

6 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

2000, recording the SEC‟s position that the key factor in establishing

liability in insider trading prosecutions is „possession‟ and not „use‟ of

MNPI.

7

Rule 10b5-1 provides that a purchase or sale will constitute

„trading on the basis of MNPI‟ where the person trading was aware of

MNPI at the time the trade was undertaken.

Pursuant to Rule 10b5-1, directors, officers and other insiders

may take the defence that trades being investigated were made

pursuant to a pre-existing, written trading plan (“10b5-1 Plan”).

Accordingly, a person may have an affirmative defence if it can be

established that his/her 10b5-1 Plan was set up in good faith and such

person was unaware of the MNPI at a point of time in which 10b5-1

Plan was set up. In addition to the good faith and lack of MNPI

requirements, a 10b5-1 Plan should specify the number and price of

the securities to be traded and the date of the trade (or alternatively, a

formula/ algorithm or computer programme for determining these

amounts) and the person who trades under a 10b5-1 Plan should not

be able to exercise any subsequent influence on how, when or

whether to make trades.

There have been instances reported in the public domain in

2012 where executives of American public companies received

above-market returns on securities traded pursuant to 10b5-1 Plans

before major company announcements.

8

At the time, it was reported

7

For further details, please see: https://www.sec.gov/rules/final/33-7881.htm.

8

Jean Eaglesham and Rob Barry, „Trading Plans under Fire‟, 12 December

2012, The Wall Street Journal, available at:

http://www.wsj.com/articles/SB10001424127887324296604578177734024394

950.

2015 TRADING PLANS: A NEW SHIELD AGAINST INSIDER TRADING CHARGES 7

that the US SEC and federal prosecutors had initiated investigations

into such trades.

9

Given these regulatory investigations, the mere

existence of a 10b5-1 Plan is not a safe harbour, and accordingly does

not ensure immunity from regulatory action. However, proper

implementation of 10b5-1 Plans in accordance with Rule 10b5-1 and

market best practices would be a defence in such investigations.

Moreover, certain practices have been adopted by companies,

as a matter of market practice, in order to self-regulate the use of

10b5-1 Plans. These standards include restricting the adoption of

10b5-1 Plans only during open window periods of companies and

following earnings announcement, voluntary no-trade period

extending up to 3 months from the date of execution of the 10b5-1

Plan

10

, pre-clearance in accordance with a company‟s insider trading

policy, refraining from adoption multiple 10b5-1 Plans

simultaneously and avoiding multiple changes to existing 10b5-1

Plans.

[C] COMPARING REG 5 PLANS AND 10B5-1 PLANS

While 10b5-1 Plans and Reg 5 Plans are conceptually similar,

there are certain differences in terms of how they are regulated. These

are briefly summarised below

9

Skadden Securities and Regulation and Compliance Alert – Getting Back to

Basics with Rule 10b5-1 Trading Plans, p 1, available at:

http://www.skadden.com/insights/getting-back-basics-rule-10b5-1-trading-

plans.

10

WSGR Insight & Analysis (March 2013) – Rule 10b5-1 Trading Plans:

Considerations in Light of Increased Scrutiny, pp 1-2, available at:

https://www.wsgr.com/PDFSearch/Rule-10b5-1-trading-plans.pdf.

8 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

NO

PARAMETER

REG 5 PLAN

10b5-1 PLAN

Public disclosure

Required

Not required, but best

practice is to

voluntarily disclose

from a reputation

protection standpoint

Modification

Should be

implemented as

approved by

compliance officer

No modification

permitted

No deviation or

execution of trades

outside the scope of

such Reg 5 Plan are

permitted

Modification is

permitted, but best

practice is not to

make too many

changes

Multiple,

overlapping trading

plans

Prohibited

Not prohibited, but

best practice is to

avoid overlapping

10b5-1 Plans relating

to the same type of

securities

Duration flexibility

Must be for a

minimum of 12

months

Can range from 6 to

24 months

Termination

Cannot be terminated

by the insider, it is

irrevocable

Can be terminated by

insider

2015 TRADING PLANS: A NEW SHIELD AGAINST INSIDER TRADING CHARGES 9

[D] CONCLUSION

The introduction of Reg 5 Plans under the PITS Regulations is

a progressive move by SEBI as it addresses a realistic concern in

terms of trading by persons regularly in possession of UPSI, and

allows flexibility in terms of allowing such insiders a route to invest

in a compliant manner. The persons who may now be able to gain the

benefit of formulating and trading in accordance with Reg 5 Plans

include executives of companies (who are typically in a position to

obtain UPSI), employees of investment/ legal advisors advising on

transactions directly or indirectly involving listed companies on a

regular basis and employees of investment entities which regularly

undertake transactions directly or indirectly involving listed

companies.

Notwithstanding the flexibility introduced by recognising Reg

5 Plans, there are complications in being able to trade once a Reg 5

Plan is put into place. For example, there are „no trade‟ periods and

prescribed minimum durations for Reg 5 Plans, which reduce the

flexibility in trading in securities. Further, a Reg 5 Plan cannot be

implemented if an insider possesses UPSI at the time of formulating a

Reg 5 Plan, and such UPSI has not been become generally available

information to the public by that time.

11

Nonetheless, keeping in

mind the object of introducing Reg 5 Plans, the introduction of Reg 5

Plans under the PITS Regulations appears to be a step in the right

direction. Given the above, trading plans has been relatively unused

by investor groups.

11

Proviso to Regulation 5(4) of the PITS Regulations.

10 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

While both Reg 5 Plans and 10b5-1 Plans affirmative defences

available to insiders, they are not safe harbours, and accordingly,

automatic exemptions from insider trading allegations. Further, given

the recent introduction of Reg 5 Plans, their use as affirmative

defences in India remains untested. That being said, reference may be

had to the widespread use of 10b5-1 Plans in the USA as an indication

of the implementation, regulation and regulatory investigation of

trades executed pursuant to a Reg 5 Plan.

Finally, given the prescriptions under Regulation 5 of the

PITS Regulations, a Reg 5 Plan should be carefully drafted to address

commercial needs and remain within legal boundaries. The Indian

regulatory landscape with respect to trading plans will develop as a

greater number of persons adopt and implement Reg 5 Plans, and it

will be interesting to observe regulatory action in relation to trades

made pursuant to Reg 5 Plans.

RECONSTRUCTION OF SICK INDUSTRIES OVER RECOVERY OF DEBT:

AN ANALYSIS OF

KSL INDUSTRIES V ARIHANT THREADS LTD &

ORS

Deekshitha Srikant



In October 2014, the Supreme Court, by means of its judgment

in KSL Industries v Arihant Threads Ltd & Ors, shed clarity on the

hitherto contentious and delicate liaison between two special

legislations, the Recovery of Debts Due to Banks and Financial

Institutions Act, 1993 and the Sick Industrial Companies (Special

Provisions) Act, 1985. This comment seeks to study the repercussions

of this judgment both in the context of the decision by Indian banks to

lend against collateral as well as the wider impact of the judgment on

the statutory interpretation involved in the consideration of two

special enactments. The comment concludes by applauding the

decision in the milieu of statutory interpretation, but seeks to

highlight the unsolicited ripples it creates in the banking sector.

The judgment in KSL Industries v Arihant Threads Ltd & Ors

1

(hereinafter referred to as „KSL Industries case‟) came at a time when

the restructuring of corporate bonds was becoming an option

increasingly exercised by banks, post the tremors felt by the banking

sector largely due to the global meltdown, coupled with factors such

as a gradual domestic standstill and reckless lending in the past.

2

Coupled with this factual framework, the decision also came in the

wake of increased confusion on the question on the interpretive



IV Year Student, NALSAR University of Law

1

2014 SCC OnLine SC 846.

2

Nilesh Sharma and Sandeep Kumar Gupta, Chapter 13: India in CHRISTOPHER

MALLON ED., THE RESTRUCTURING REVIEW 164 (6

th

ed., Law Business

Research Ltd.).

12 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

interplay between two legislations: the Recovery of Debts Due to

Banks and Financial Institutions Act, 1993 (hereinafter „RDDB Act‟)

and the Sick Industrial Companies (Special Provisions) Act, 1985

(hereinafter „SICA‟), both enacted for specific purposes. Although the

bearing of the KSL Industries case in these two contexts are to be

viewed in their own separate realms, it is imperative to recognize the

differential impacts this judgment has on these two planes and

understand the decision in light of its repercussions on the banking

sector as well as in the broader framework of statutory interpretation.

Part I of this paper, therefore, delineates the factual matrix that

the decision was rendered in. Part II briefly lays down the main points

of contention in the judgment vis-à-vis the previous judgment by the

smaller, two-judge bench of the Supreme Court. Part III briefly

examines the merits of the judgment in the realm of statutory

interpretation, while Part IV studies the impact of the judgment on the

decisions of the banking sector in the wake of increased debt

restructuring (dubbed the „narrower impact‟). By weighing the pros

and cons of both aspects of the judgment and applauding it in the

wider context through the course of comment, the author

simultaneously attempts to highlight the issues it creates in the

narrower context.

[A] FACTUAL MATRIX AND PROCEDURAL HISTORY

The case revolves around KSL Industries („the Company‟)

entering a lease in order to set up a cotton yarn spinning unit for the

purposes of export in Punjab. The lease for the premises, which was

for a period of 99 years, was entered into on the condition that the

2014 RECONSTRUCTION OF SICK INDUSTRIES OVER RECOVERY OF DEBT 13

Company would not transfer any interest in the property without

obtaining the prior permission of the lessor for the first fifteen years.

However, the Company was permitted to transfer its leasehold rights

to a bank as security to obtain a loan. Subsequently, the Company

obtained a foreign currency loan from the Industrial Development

Bank of India („IDBI‟) to finance its project.

The Company, however, failed to repay the loan and IDBI

initiated legal action against it under the RDDB Act in the Debt

Recovery Tribunal, Chandigarh („DRT‟). The DRT passed an ex parte

order directing the Company to discharge its debt, failing which IDBI

could proceed against the mortgaged property. While tussles took

place as to the valuation of the Company‟s property and the appellant

was declared the highest bidder in the auction process, the Company

appealed against the ex parte order under Section 30 of the RDDB

Act.

3

The auction was set aside by the DRT in Delhi on the ground of

improper valuation of the property, subject to the fulfillment of

certain conditions, aggrieved by which the both parties approached

the Debt Recovery Appellate Tribunal, Delhi („DRAT‟).

The DRAT confirmed the sale in favour of the Appellant, but

before the sale formalities could conclude the Company invoked the

SICA and filed for a reference before the Board of Industrial Finance

3

Section 30 allows for appeals from the order of a Recovery Officer to a

Tribunal within 30 days of issue, after which a Tribunal may modify the order

as it deems fit in accordance with its powers under Sections 25 to 28 (both

inclusive). See, The Recovery of Debts due to Banks and Financial Institutions

Act, 1993 (51 of 1993), §30.

14 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

& Reconstruction,

4

and subsequently filed two Writ Petitions before

the Delhi High Court on the maintainability of the suit in lieu of the

prohibition in Section 22 of the SICA. The case moved to the

Supreme Court on appeal, where it was first heard and decided by a

two-judge bench and then referred to a three-judge bench.

[B] JUDGEMENT

The two-judge bench comprising of Thakker J. and Kabir J.

took divergent stances on the issue of the interplay between the

RDDB Act and the SICA. Thakker J. was of the opinion that the

provisions of the RDDB Act took precedence over the SICA for the

simple reason that the RDDB Act was a later enactment, as even in

the absence of a specific provision stating its overriding effect, the

Parliament was aware of the existence of earlier legislations. Kabir J.,

on the other hand, was of the view that the Section 34(2) carved out

an exception to clause (1), effectively meaning that the RDDB act is

supplemental to (but does not override) the SICA. The provisions of

the SICA would, therefore, prevail.

5

Upon reference to the three-judge bench comprising of Dattu

J., Bobde J., and Sapre J., the Supreme Court enumerated the

following findings:

4

The Board of Industrial Finance and Reconstruction is a statutory body created

under the SICA in order to facilitate the revival and rehabilitation of sick

industrial companies. Its powers range from declaring a company to be „sick‟ to

sanctioning schemes of amalgamations or takeovers between a sick industrial

company and other companies. The Board is constituted under Section 4, and

comprises of a Chairman and other members ranging from two to fourteen in

number, whom the Central Government shall appoint. See, Sick Industrial

Companies (Special Provisions) Act, 1986 (1 of 1986), §4

5

KSL Industries case, supra n. 1

2014 RECONSTRUCTION OF SICK INDUSTRIES OVER RECOVERY OF DEBT 15

1. When interpreting two „special‟ legislations, both of which in

this case contained non-obstante clauses, the test to be utilized

is determination of the purpose of both legislations and

realizing the same. Part III will analyze this aspect of the

judgment in detail.

2. Utilizing the above test in the interplay between Section 22 of

the SICA and Section 34 of the RDDB Act, the former

prevails over the latter. Part IV of this paper will scrutinize the

same.

[C] WIDER IMPACT: INTERPRETIVE BREAKTHROUGH

In the KSL Industries case, the Court was faced with the

unique quandary of resolving a clash of two equally applicable rules

of interpretation in resolving which of the two special legislations

took precedence over the other. On one hand, the well-settled

principle of construction that a statute that was enacted later in time

would override an earlier statute applied. In Maharashtra Tubes Ltd v

State Industrial and Investment Corporation of India,

6

for example,

the Court was faced with an inconsistency between the Financial

Corporation Act, 1951 and the SICA. Both legislations were special

laws and contained non-obstante clauses, but Ahmadi J. ruled that the

non-obstante clause in the SICA had an overriding effect as it was a

later enactment.

7

The Calcutta High Court later utilized the same

principle in the inconsistency between certain parts of the Companies

6

(1993) 2 SCC 144; See, SRIVASTAV (REV.), SRIVASTAVA‟S SECURITISATION &

DEBT RECOVERY LAWS 656 (6

th

ed. 2009) .

7

See, SRIVASTAV (REV.), SRIVASTAVA‟S SECURITISATION & DEBT RECOVERY

LAWS 656 (6

th

ed. 2009).

16 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

Act, 1956 (namely, Sections 442, 446 and 537) and Section 34 of the

RDDB Act, and ruled that since the latter was a later enactment, it

took precedence over the former.

8

However, in the context of a

possible conflict between Sections 433 and 434 of the Companies

Act, 1956 and Section 34 of the RDDB Act, the Court observed that

the two legislations were not inconsistent with each other, as the

former Sections are not solely for the recovery of debts, and are

beneficial to the public at large. The two statutes, therefore, co-exist

comfortably.

9

Both statutes can be considered to be special

legislations, but the existence of a clause conferring an overriding

effect on the RDDB Act (Section 34) settles the issue of a collision

between the two.

The doctrine of of generalia specialibus non derogant

10

therefore applied on the other hand. The Court in LIC v D.J

Bahadur,

11

for example, had utilized in the context of determining the

„special law‟ between the Industrial Disputes Act, 1947

12

and the Life

Insurance Corporation Act, 1956.

13

The Court observed that the

determination of whether a statute was general or specific is particular

to the context; an LIC employee could not invoke the Industrial

Disputes Act, as the LIC Act was special law in the context of

nationalization of life insurance while the former was special law in

8

Allahabad Bank v Canara Bank AIR 2000 SC 1535.

9

Bank of Nova Scotia v RPG Transmission Ltd 2006 133 CompCas 172 Delhi;

See, SRIVASTAV (REV.), SRIVASTAVA‟S SECURITISATION & DEBT RECOVERY

LAWS (6

th

ed 2009) at 654.

10

That special provisions are to override general provisions.

11

(1981) 1 SCC 315.

12

Hereinafter referred to as the “ID Act”.

13

Hereinafter referred to as the “LIC Act”.

2014 RECONSTRUCTION OF SICK INDUSTRIES OVER RECOVERY OF DEBT 17

the context of resolution of disputes between employer and

employee.

14

In resolving this conflict of applicability of the above two

rules of interpretation in determining the more „special‟ statute, the

Court in KSL Industries undertook a purposive interpretation of both

statutes. Recognizing that the intent behind both statutes were

different (SICA focused on reconstruction of sick companies, while

the RDDB Act on speedy recovery of debt, as discussed in Part X),

the Court pointed out that the question of which statute was „special‟

depended entirely on the context of the situation in light of the object

of the statute, following the ratio laid down in the LIC v D.J Bahadur

case. In this particular case, SICA was the more special legislation in

the context of reconstruction of sick industrial companies, although it

would be the more general legislation in the context of debt recovery.

The Court, therefore, utilized this purposive test to resolve the

interpretive dilemma, as the contrary interpretation would result in an

anomalous result where a creditors can file applications for recovery

against sick industrial companies but execution against the property of

such company is barred under Section 22.

[D] NARROWER IMPACT: EFFECT ON BANKING SECTOR

The tussle, therefore, essentially involved prioritizing between

debt recovery and rehabilitation of sick companies, and transcends the

interplay between Section 22 of the SICA and Section 34 of the

RDDB Act and the interpretive predicament they pose. In India,

secured and unsecured creditors can file a suit under the Code of Civil

14

Supra n. 11.

18 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

Procedure, 1908 for recovery, whereas creditors who are banks or

financial institutions have the added options of filing an application

under the RDDB Act for recovery through the Debt Recovery

Tribunal (provided their claim amount exceeds INR 100,000).

Further, secured creditors such as banks, financial institutions and

asset reconstruction companies can also recover debts by taking over

the assets or management of the debtor company without court

intervention through the Securitization and Reconstruction of

Financial Assets and Enforcement of Security Interest Act, 2002.

15

If

the tussle is indeed between debt recovery and reconstruction, the

effects of this judgment are far more widespread in the narrower

context of banking than in the sphere of interpretation.

Section 13 of SARFAESI empowers certain institutions to

take possession of the debtor‟s assets without the intervention of any

court or tribunal. The act was is to facilitated faster recovery of

massive debts to financial institutions by securitization,

16

asset

reconstruction

17

or exemption from registration of security receipt, to

keep their non-financial assets from mounting in a country where

default is the norm as opposed to the exception. It was enacted due to

15

Hereinafter referred to as „SARFAESI‟. See generally, Purti Marwaha and

Varsha Banerjee, Chapter 20: India in THE INTERNATIONAL COMPARATIVE

LEGAL GUIDE TO: CORPORATE RECOVERY & INSOLVENCY 2014 (8

TH

ED.,

GLOBAL LEGAL GROUP).

16

Section 2(z) of the SARFAESI defines „securitization‟ to mean acquisition of

financial assets whether by raising of funds by such securitization company or

reconstruction company from qualified institutional buyers by issue of security

receipts representing undivided interest in such financial assets or otherwise.

17

Section 2(b) of the SARFAESI defines „asset reconstruction‟ to mean

acquisition of a right or interest in any bank or financial institution for the

purposes of realization of financial assistance.

2014 RECONSTRUCTION OF SICK INDUSTRIES OVER RECOVERY OF DEBT 19

recognition of the importance of liquidity and mobility of credit for

keeping the economy afloat, and its constitutional validity was upheld

in Mardia Chemicals v Union of India.

18

In fact, the Court earlier

granted financial institutions the leeway to initiate action under both

the SARFAESI and RDDB to recover their non-performing assets, by

holding that both acts co-exist in Transcore v Union of India.

19

One of

the primary arguments in the KSL Industries case was whether the

scope of „suit‟ or „proceedings‟ under Section 22 of the SICA covered

an application under the RDDB Act (which would entail an abatement

of the said proceedings), to which the Court answered that Section 22

did not specifically cover applications as the RDDB Act was a later

enactment. If the SICA is indeed „special‟ in the context of

reconstruction, could the same logic apply in a clash between the

SICA and the SARFAESI, also a debt recovery law?

The Parliament, through Section 41 and 37 read with the

Schedule of the SARFAESI Act, amended three acts including the

SICA by the insertion of the third proviso to Section 15(1), and

specified that where a reference is pending before the BIFR, the same

shall abate if creditors representing three-fourths the value of the

outstanding amount acted under Section 13(4) of the SARFAESI.

20

However, while this seems to put to rest any doubt, inconsistencies

due to the existence of the phrase „pending reference‟ – the Orissa

18

AIR 2004 SC 2371.

19

AIR 2007 SC 712.

20

See, Salem Textiles Limited v The Authorized Officer Writ Petition No.26905 of

2011.

20 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

High Court in Noble Aqua Pvt. Ltd vs. State Bank of India

21

ruled that

BIFR proceedings would abate as provided for by the proviso only

where BIFR proceedings are pending at the stage of reference, and

not where declaration of sickness had already taken place. This

decision, however, has found no judicial support subsequently, as the

Bombay High Court,

22

Gujarat High Court,

23

and Punjab and Haryana

High Court

24

have all disagreed with the decision and held otherwise.

In Integrated Rubian Exports Ltd v Industrial Finance Corporation of

India Ltd, for example, the Kerala High Court found that the

SARFAESI, as a later enactment, overrode the SICA.

25

It is in light of this plethora of decisions that uphold the

SARFAESI over the SICA that an anomaly arises when the KSL

Industries case is considered. The logic used by the Kerala High

Court is defeated upon the usage of the purposive test in KSL

Industries, creating a situation where some debt recovery laws (i.e,

the SARFAESI) take precedence over the SICA whereas others (the

RDDB Act) do not, seriously hampering the already difficult process

of debt recovery for banks. It is strange that recovery is allowed by a

select class of creditors under SARFAESI only for secured interests

without requiring BIFR permission, whereas claims under the RDDB

21

AIR 2008 Orissa 103.

22

Nouveaw Exports Private Ltd v Appellate Authority for Industrial and

Financial Reconstruction Company AIR 2010 Bom. 159.

23

Paschim Petrochem Ltd vs. Authorised Officer, Kotak Mahindra Bank Ltd

(2010) 51 GLR 1075.

24

Nabha Industries Ltd vs. Punjab State Industrial Development Corporation

(2010) 154 Comp. Cases 646 (P&H).

25

AIR 2009 Ker. 76.

2014 RECONSTRUCTION OF SICK INDUSTRIES OVER RECOVERY OF DEBT 21

Act (which is wider in scope than secured interests)

26

require such

permission, when (utilizing the purposive test used in KSL Industries)

all three legislations are enacted for the primary purpose of reducing

non-performing assets and enabling debt recovery.

27

Indian banks have been facing a steep rise in their non-

performing assets,

28

having resulted in the Finance Ministry to

constitute a panel to address this in mid 2014,

29

and the RBI has

raised alarms about the debt recovery process in India.

30

In addition to

adversely affecting profitability, NPA‟s also affect a bank‟s liquidity

as they reduce the funds available for a bank to recycle or lend.

31

26

Vinod Kothari, SARFAESI Act and woes of the „abated‟Business Line (31

January 2011), available at http://www.thehindubusinessline.com/todays-

paper/sarfaesi-act-and-woes-of-the-abated/article2327585.ece (last accessed 31

November 2014).

27

See generally, Purti Marwaha and Varsha Banerjee, Chapter 20: India in THE

INTERNATIONAL COMPARATIVE LEGAL GUIDE TO: CORPORATE RECOVERY &

INSOLVENCY 2014 (8

TH

ED., GLOBAL LEGAL GROUP).

28

Hereinafter referred to as „NPA‟. An asset becomes a „non performing‟ asset

when it ceases to generate income for the lender. See, RBI, Master Circular on

Prudential Norms on Income Recognition, Asset Classification and

Provisioning - Pertaining to Advances (30 August 2001) available at

http://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?Id=449&Mode

=0 (last accessed 28 November 2014).

29

PTI, Finance ministry sets up panel to give more teeth to debt recovery laws

Live Mint (30 July 2014) available at

http://www.livemint.com/Politics/fMBl9FO7jNgtWAi28xQNyL/Finance-

ministry-sets-up-panel-to-give-more-teeth-to-debt-re.html?utm_source=copy

(last accessed 28 November 2014)

30

Reuters, RBI raises concerns about bank loans, debt recovery, Reuters (21

November 2013) available at http://in.reuters.com/article/2013/11/21/india-rbi-

banks-idINDEE9AK0B320131121 (last accessed 28 November 2014).

31

Infosys Finacle, Thought Paper on Non-Performing Assets: An Indian

Perspective, Infosys available at

http://www.infosys.com/finacle/solutions/thought-papers/Documents/non-

performing-assets-indian-perspective.pdf (last accessed 28 November 2013) .

22 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

One of the many prevalent reasons for the steep rise in NPA‟s,

recognized by the Reserve Bank of India, is willful default by

borrowers.

32

One of the consequences of such a reading between the

SICA and the RDDB Act is that any defaulter could not apply to the

BIFR for reconstruction and stay court proceedings, as Arihant

attempted to, negatively impacting the country‟s recovery climate.

Another cause was attributed to the complacency by banks on

following up a loan due to the existence of collateral, and one of the

consequences of such a reading entails a dent in the value of collateral

to banks as defaulters can just ensure that a court junks the collateral

on the basis of which the bank had initially extended the loan.

Cumulatively, such a reading clearly points towards a future where

banks will have to bear the burden of more bad loans.

33

[E] CONCLUSION

The KSL Industries case shows us how the utilization of SICA

even after the Eradi Committee report and the legislative shift to

replace the BIFR with the National Company Law Tribunal can cause

tremors in the already fragile sphere of debt recovery. The case also in

a way emphasizes the importance that the BIFR retains in light of the

decisions of Union of India v R. Gandhi,

34

since the path to the

32

Shashidhar M. Lokare, Re-emerging Stress in the Asset Quality of Indian

Banks: Macro-Financial Linkages, RBI (7 February 2014) available at

http://rbi.org.in/scripts/PublicationsView.aspx?id=15720 (last accessed 30

November 2014).

33

B Jagannathan, SC makes loan recovery tougher for banks, despite having valid

collateral Firstpost, (4 November 2014) available at

http://firstbiz.firstpost.com/finance/sc-makes-loan-recovery-tougher-banks-

despite-valid-collateral-107087.html (last accessed 30 November 2014).

34

2010 (5) SCALE 514.

2014 RECONSTRUCTION OF SICK INDUSTRIES OVER RECOVERY OF DEBT 23

creation of the National Company Law Tribunal replacing the BIFR is

still far from clear. While its formulation of the purposive test to

resolve the interpretive conflict may be applauded in the sphere of

statutory interpretation, the consequences of the utilization of this test

in the clash between debt recovery and reconstruction are many and

varied, some of which could prove catastrophic for banks and

financial institutions seeking to bring down their NPA‟s by efficient

debt recovery.

CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS:

RATIONALIZING THE IRIDIUM-MOTOROLA CASE

-Roumita Dey



“Corporate bodies are more corrupt and profligate than

individuals, because they have more power to do mischief, and

are less amenable to disgrace or punishment. They neither feel

shame, remorse, gratitude nor goodwill”.

– Hazlitt

Corporations today exist as an important actor in almost every

sphere of individual's political and social activity. Across the

globe, the position of law with respect to corporate criminal

liability has been shrouded in speculation, inconsistency and

controversy. The author proposes a theoretical justification by

examining the different legal theories of corporate criminal

liability for the wrongs committed by their employees.

Moreover this paper seeks to explore the criminal liability of

corporations in India, especially concerning itself with the

recent decision of the Supreme Court in Iridium India

Telecom v. Motorola Inc. The object of this article is to

analyze why the corporations are preferred as guilty and not

the employees in case of corporate crime, to critically examine

the theories of corporate crime, and to justify the reasons for

corporate being held criminally liable. The conclusion

summarizes the entire issue, briefly discussing the



Fifth Year Student, Jogesh Chandra Choudhuri College of Law (affiliated to

Calcutta University)

26 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

consequences of the decision and putting forth suggestions for

the future of the concept of corporate criminal liability.

[A] INTRODUCTION

A company, or corporation, enjoys a separate existence from

its owners and from those who manage its day-to-day affairs.

Although the separate legal personality of a company is a well-

established concept, whether a company‟s wrongdoing can be subject

to the sanction of criminal law has been a vexed question. While it is

trite law that the individuals managing a company may be liable under

criminal law for wrongful acts carried out by them, the thornier issue

pertains to whether the acts of such managers can be attributed to the

company (through its separate legal existence) thereby making it

liable to the consequences of an offence under criminal law.

Iridium is arguably one of the most significant judgments of

the Supreme Court on corporate criminal liability since the verdict of

a bench of five Judges in Standard Chartered v. Directorate of

Enforcement

1

. The Supreme Court in Standard Chartered had held

that a company can be prosecuted for offences which are punishable

with mandatory imprisonment

2

. In doing so, the Court overruled its

previous decision in Assistant Commissioner v. Velliappa Textiles

Ltd

3

., where it was held that a company cannot be prosecuted for an

offence imposing mandatory imprisonment. In Standard Chartered,

1

AIR 2005 SC 2622, (2005) 4 SCC 530 [hereinafter “Standard Chartered”].

2

The relevant legislation in that case, the Foreign Exchange Regulation Act,

1973, provided a sentence of imprisonment and fine to persons (including

companies) who are convicted of an offence.

3

(2003) 11 SCC 405.

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 27

however, the Court left open the question of whether a company

could be punished for crimes requiring mens rea (as opposed to

statutory „strict liability‟ offences)

4

.

[B] IRIDIUM: FACTS AND DECISION

As per the factual matrix of the case, Iridium India Limited

filed a criminal complaint against Motorola Inc. alleging offences

under section 420 (cheating) read with section 120B (conspiracy) of

the Indian Penal Code (IPC). The complaint alleged that Motorola

Inc. had floated a Private Placement Memorandum (PPM) to obtain

funds/investments to finance the „Iridium project‟. The project was

represented as being “… the world‟s first commercial system designed

to provide global digital hand held telephone data … and it was

intended to be a wireless communication system through a

constellation of 66 satellites in low orbit to provide digital service to

mobile phones and other subscriber equipment locally.”

5

On the basis

of the information contained in and representations made through the

PPM, several financial institutions invested in the project. The

criminal complaint alleged that the representations were false and that

the project turned out to be commercially unviable resulting in

significant loss to the investors.

Based on Iridium India‟s complaint, a judicial magistrate in

Pune commenced criminal proceedings against Motorola. Aggrieved

by this, Motorola filed a petition before the Bombay High Court

4

See e.g., Standard Chartered, supra note 3, where Justice K.G. Balakrishnan,

referring to the issue of mens rea, observed: “we express no opinion on that

issue”.

5

Iridium, supra note 2, at 4.

28 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

under article 227 of the Constitution and section 482 of the Code of

Criminal Procedure, 1973 (Cr.P.C.) to quash the proceedings against

it. By way of an order dated August 8, 2003, the Bombay High Court

quashed those proceedings

6

. Against this order, Iridium India

preferred an appeal to the Supreme Court. As for substantive matters,

the Supreme Court was concerned with the broad question of

corporate criminal liability. It concluded that companies can

undoubtedly be held criminally liable, as they immunity from

prosecution can no longer be claimed

7

. In that sense, a company can

be treated in the same manner as an individual for being convicted of

an offence, including one that requires mens rea

8

. Relying upon its

decision in Standard Chartered, the Supreme Court found that a

company cannot escape liability simply because the offence requires

mandatory imprisonment

9

.

As to the specifics of an offence of cheating as defined in

Section 415 of the IPC, the Supreme Court ruled that a complainant

needs to prove that an inducement of the victim was caused by

deception exercised by the accused

10

. Moreover, “non-disclosure of

relevant information would also be treated as a mis-representation of

6

Motorola Inc. v. Union of India, 2004 Cri. L.J. 1576 (Bom).

7

Id., at ¶ 35 (noting that “the companies and corporate houses can no longer

claim immunity from criminal prosecution on the ground that they are

incapable of possessing the necessary mens rea for the commission of criminal

offences. The legal position in England and the United States has now

crystallized to leave no manner of doubt that a corporation would be liable for

crimes of intent.”).

8

Id. at 38.

9

Id. at 40.

10

Id. at 42.

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 29

facts leading to deception”

11

. On the facts of the case, the Supreme

Court found that the High Court had exceeded its brief by examining

the PPM and other documents in detail in exercise of jurisdiction

under section 482 of the Cr.P.C. In doing so, the Supreme Court paid

scant regard to the existence of risk factors and disclaimer language in

the PPM that may have cautioned investors regarding risks of the

investment and thereby dilute the allegation of deception. It therefore

allowed the appeal and set aside the judgment of the Bombay High

Court.

[C] EVALUATING IRIDIUM

The factual backdrop of Iridium as well as the Supreme

Court‟s observations therein provide an ideal opportunity to analyze

Indian law on two questions: (i) attribution of mens rea to companies

for the purposes of criminal liability, and (ii) criminal liability for

misstatements in the context of securities offerings made to specific

investors on a private basis. This note briefly explores both these

issues in the context of the ruling in Iridium.

At the outset, however, it would be pertinent to note that the

Supreme Court did not conclusively deal with the issue pertaining to

securities offerings by companies on private basis and possible

criminal liability for misstatements thereon. This is understandable

given the nature of proceedings before the Court. In a petition

involving quashing of criminal proceedings under Section 482 of the

Cr.P.C., courts are required to only consider whether a prima facie

11

Id.

30 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

case has been made out in the complaint

12

. They must consider

whether the facts as disclosed in the complaint are sufficient to result

in conviction, without examining questions of how those facts would

be proved

13

. Thus, while courts considering a petition under section

482 would examine questions of law (in the sense of deciding

whether, assuming the facts as stated in the complaint are correct, an

offence is not made out), the standard of their review on questions of

fact or on mixed questions of fact and law tends to be significantly

less stringent

14

.

(1) Principles of Attribution -

As a general matter, principles of attribution are invoked to

ascertain the identity of individuals within a company whose mental

element will be attributed to that of the company for the purpose of

foisting criminal liability

15

. In Iridium, the Supreme Court held:

“The criminal liability of a corporation would arise when an

offence is committed in relation to the business of the

corporation by a person or body of persons in control of its

affairs. In such circumstances, it would be necessary to

ascertain that the degree and control of the person or body of

persons is so intense that a corporation may be said to think

and act through the person or the body of persons”

16

.

12

State of Haryana v. Bhajan Lal AIR 1992 SC 604 [hereinafter “Bhajan Lal”].

13

Id.

14

Id.

15

LEN SEALY & SARAH WORTHINGTON, CASES AND MATERIALS IN

COMPANY LAW 152 (8th ed., Oxford University Press, 2007).

16

Iridium, supra note 2, at 38 [emphasis supplied].

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 31

The Court thus ruled on two aspects. First, it affirmed that a

corporation is capable of possessing mens rea. Second, it laid down a

somewhat rigid test – affirming the judgment of the House of Lords in

Tesco Supermarkets Ltd. v. Nattrass,

17

that the person whose mens

rea is to be attributed to the corporation must be the directing mind

18

.

The Supreme Court appears to have accepted the rigid „directing mind

and will‟ test of Tesco and, in doing so, has failed to refer to a

subsequent significant judgment of the Privy Council in Meridian

Global Funds Management Asia Ltd. v. Securities Commission

19

that

leaves scope for a more flexible analysis for attribution

20

. Some

17

[1972] AC 153 (HL) [hereinafter “Tesco”].

18

Id. Tesco was prosecuted under Section 11 of the (UK) Trade Descriptions Act,

1968. One of Tesco‟s supermarkets had advertised that it was selling certain

packets of goods at the reduced price but a customer was told to pay the normal

price. This was because the shop manager was negligent in failing to notice that

the shop had run out of the low-price packets. Section 24(1) of the Act provided

a defence for a shop owner, if he could prove that the commission of the

offence was caused by “another person”, and that he had taken all reasonable

precautions and had exercised all due diligence so as “to avoid the commission

of such an offence by himself or any person under his control.” Tesco was able

to prove that its board had instituted systems of supervision and training which

amounted to taking reasonable precautions. The issue which arose was whether

it was the precautions of the board which counted, or whether the conduct of

the shop manager also had to be taken into account as being the conduct of the

company. The House of Lords held that the precautions taken by the board

were sufficient, and the manager‟s negligence was held to be not attributable to

the company.

19

[1995] 2 AC 500 (PC) [hereinafter “Meridian”].

20

In Meridian, id., a case concerning the attribution of knowledge and not the

attribution of actions, the Privy Council had to decide whether the knowledge

of an investment manager employed by the company would be attributed to the

company, so that the company would have the knowledge that it was a

“substantial security holder” under the New Zealand Securities Amendment

Act 1988. It was argued that the board of Meridian did not have knowledge that

it had become a substantial holder; and consequently, the company could not be

attributed with that knowledge. Lord Hoffman held (22):

32 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

further comment on both the aspects of this holding in Iridium is

apposite.

(a) Corporate Mens Rea

As was noted earlier, the question of whether a corporation is

capable of having mens rea is one which – until Iridium – was

unsettled under Indian law. The fact that Indian courts have displayed

ambivalence in holding a corporation guilty of acts involving mens

rea raises an element of surprise given the robust developments in

English law on the subject-matter, which have been extensive relied

upon by Indian courts.

Under principles of corporate law, in certain situations, the

acts or the mental state of certain individuals can be attributed directly

to the company, where the company carries the primary or direct

liability. In such situations, there is no requirement to invoke

doctrines of either agency or vicarious liability

21

. This so called

The policy of section 20 of the Securities Amendment Act 1988 is to compel, in

fast-moving markets, the immediate disclosure of the identity of persons who

become substantial security holders in public issuers. Notice must be given as

soon as that person knows that he has become a substantial security holder. In

the case of a corporate security holder, what rule should be implied as to the

person whose knowledge for this purpose is to count as the knowledge of the

company? Surely the person who, with the authority of the company, acquired

the relevant interest. Otherwise the policy of the Act would be defeated…” He

however also clarified (23), “… their Lordships would wish to guard

themselves against being understood to mean that whenever a servant of a

company has authority to do an act on its behalf, knowledge of that act will for

all purposes be attributed to the company. It is a question of construction in

each case…”.

21

In the case of agency or vicarious liability, the company carries secondary or

indirect liability. For the difference between primary liability and secondary

liability, see JASON HARRIS, ANIL HARGOVAN & MICHAEL ADAMS,

AUSTRALIAN CORPORATE LAW 220 (LexisNexis Butterworths, 2009).

Where the company carries primarily liability, law treats the company and its

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 33

“alter-ego” theory, which is premised on the company‟s primary

liability, was initially propounded by Viscount Haldane as a basis of

attribution distinct from agency or vicarious liability.

22

The Supreme Court of India had earlier considered this theory

in JK Industries v. Chief Inspector of Factories and Boilers

23

. The

Court specifically approved of Lennard‟s, but then it proceeded

nevertheless to state that the doctrine of vicarious liability comes into

play. This deployment of the phrase „vicarious liability‟ in that case

was unfortunate. Although the court was dealing with a statutory strict

liability case (where the mental element is immaterial or even

unnecessary) and the issue turned on wordings of the relevant statute,

the thesis under Indian law that the „directing mind and will‟ doctrine

relates to vicarious liability can perhaps be traced to this dicta of the

Supreme Court. Subsequently, in 2005, the Supreme Court held that

Tesco dealt simply with vicarious liability

24

. Again, this statement

was dicta and the Court was engaged in interpreting a strict liability

offence.

25

directing mind or will as one and the same; where the company carries

secondary liability, law recognizes the company as separate from its employee

or agent whereby the company becomes vicariously liable for the acts of the

employee or agent.

22

Lennard‟s Carrying Co. Ltd. v. Asiatic Petroleum Co. Ltd., [1915] AC 705,

713-14 (HL) [hereinafter “Lennard‟s”] (holding that “the fault or privity is the

fault or privity of somebody who is not merely a servant* *or agent for whom

the company is liable upon the footing respondent superior, but somebody for

whom the company is liable because his action is the very action of the

company itself”).

23

(1996) 6 SCC 665.

24

P.C. Agarwala v. Payment of Wages Inspector, M.P., (2005) 8 SCC 104

[hereinafter “P.C. Agarwala”].

25

Id.

34 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

In India, several statutes impose vicarious responsibility (for

strict liability offences) on officers who are in charge of and

responsible to the company for the management of its affairs. The

Supreme Court in JK Industries and PC Agarwala were both relying

on Lennard‟s and Tesco in order to determine the identity of persons

who would be “in charge of and responsible” for the purpose of the

statute in question, which only imposed strict liability. The Court had

to engage in this exercise as it was concerned with determining the

criminal liability of directors or officers of the company. Under

statute, a “person in charge of and responsible” is deemed to be an

offender, and the Court was only expressing that the specific statutory

formulation in that case made an exception from the general criminal

law rule that there is no vicarious liability in criminal law. The Court

was merely clarifying that under specific strict liability statutes, a

person in charge of and responsible would be vicariously liable for the

acts of the company. The principle of attribution in Tesco and

Lennard‟s, however, was the reverse, namely whether the company

will be held liable for acts of certain individuals.

Of course, even prior to JK Industries, the position in India

was far from clear. As long ago as the late 1940s, issues of this nature

arose before the Calcutta High Court. The view in Calcutta – from the

1940s to the 1990s – appeared to be that it was impossible for a legal

(as opposed to a natural) person to have any mens rea. Judgments of

the Calcutta High Court on the point proceeded on a rather simplistic

reasoning – effectively, that the ability to have „intention‟ was the

exclusive prerogative (or curse) of natural persons, and it was

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 35

impossible for a legal person like a company to have intention

26

. The

Bombay High Court, however, had taken a more convincing view,

noting developments under English law until Tesco. It is worthy of

note that in Esso Standard Inc. v. Udharam Bhagwandas

Japanwalla,

27

arguments were advanced before the Bombay High

Court not just on whether a company can have mens rea, but also on

how the process of attribution would in fact operate, with the precise

question being whose mens rea would be attributed to the company.

Interestingly, the arguments proceeded on the basis of whether, for

the purposes of criminal liability, a strict test of mens rea was

required (a la Tesco), or whether a contextual flexibility (such as that

subsequently adopted in Meridian) would be apposite. The Bombay

High Court accepted the Tesco approach, rejecting the application of a

flexible rule. The court was called upon, on the authority of Moore v.

I. Bresler Ltd.

28

, to decide whose mens rea is to be attributed to the

company. The Counsel suggested before the court that a flexible test

which allowed actions of branch-managers to be attributed to a

company went too far and negated the element of certainty which

ought to be inherent in criminal law. Support for the proposition that

26

Champa Agency v. R. Chowdhury, 1974 CHN 400; Sunil Banerjee v. Krishna

Nath, AIR 1949 Cal 689; AK Khosla v. Venkatesan, 1992 (98) CrLJ 1448

(Cal).

27

[1975] 45 Comp Cas 16 (Bom) [hereinafter “Esso”].

28

[1944] 2 All ER 515 [hereinafter “Moore”]. In this case, a company was

convicted of an offence requiring proof of an intention to deceive where those

responsible were its secretary and branch manager; and not the absolute

„directing minds‟.

36 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

Moore was wrongly decided was drawn from academic writings in

leading English journals.

29

These two judgments of the Bombay High Court are creditable

in as much as they prophesied the debate which intensified in England

after Meridian – over 25 years after the judgment in Esso: is a

flexible, case-by-case, approach suitable to criminal law?

Unfortunately, these Bombay judgments do not appear to have had

the required influence on the development of the Indian principles in

this regard. Part of the reason might have been that in intervening

years, until the Supreme Court decision in Standard Chartered, this

debate about mens rea did not really garner the requisite attention

under Indian law: the other issue of whether a company can be

prosecuted for offences which carry a mandatory punishment of

imprisonment operated as a distraction to absorb judicial attention in

the interim. Be that as it may, by 2010, the Bombay High Court

accepted the view that a corporation cannot have mens rea.

30

This

latest Bombay judgment was again based on the simplistic reasoning

of the early cases of the Calcutta High Court.

31

Most surprisingly,

Esso was not cited at all by the court.

In the backdrop of that prevailing confusion, the holding in

Iridium has finally clarified beyond doubt that a corporation is

capable of having mens rea. The Supreme Court has specifically

approved of the decision in Tesco. However, rather surprisingly,

29

For instance, R.S. Welsh, The Criminal Liability of Corporations, 62 L.Q.R.

345 (1946), which was cited before the Court by counsel.

30

Arvind Mafatlal, supra note 30.

31

Supra note 31.

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 37

Meridian does not even find a mention in the Supreme Court‟s

judgment. The significance of this comment depends on how one

understands Meridian, and to what extent did Meridian depart from

Tesco? If it did indeed depart substantially from Tesco, was the

Supreme Court justified in refusing to take the same path as of

Meridian? We now turn our attention towards unravelling the

jurisprudence on attribution as it has evolved more recently in

England, with Meridian being a leading light.

(b) Evolution of Principles of Attribution – From Tesco to Meridian

At the outset, it will be useful to keep in mind that there are

specific observations in case law stating the directing mind theory

applies with equal force in civil law and in criminal law

32

.40 Thus,

Lord Justice Nourse in El Ajou v. Dollar Land Holdings plc

33

stated

that the theory has been applied in civil and criminal cases alike,

“with no divergence of approach

34

.” El Ajou itself is in some ways the

genesis of a more flexible approach

35

; and the Court of Appeal

formulated the idea of there being different directing minds in respect

of different activities

36

. It is also far too easy to fall into the trap of

32

The most recent scholarly overview of the principles in Meridian is found in

Eilis Ferran, Corporate Attribution and the Directing Mind and Will

(forthcoming, 2011) L.Q.R. (draft available on file with the authors).

33

[1994] 2 All ER 685 (CA) [hereinafter “El Ajou”].

34

Id. at 695.

35

See Lebon v Aqua Salt Co Ltd. [2009] UKPC 2 [hereinafter “Lebon”], at 25,

where El Ajou is explained as an earlier example of the application of the

principles later laid down specifically in Meridian.

36

There are, it seems to me, two points implicit, if not explicit, in each of these

passages. First, the directors of a company are, prima facie, likely to be

regarded as its directing mind and will whereas particular circumstances may

confer that status on non-directors. Secondly, a company's directing mind and

will may be found in different persons for different activities of the company…

38 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

assuming Meridian to be a drastic change in the position of law. In

the recent decision of Stone & Rolls Ltd. (in liquidation) v. Moore

Stephens (a firm),

37

Lord Walker specifically stated that leading

academic commentators had “overstated” the effect of Meridian.

38

In Meridian, the Privy Council considered a case involving

disclosure obligations under the securities regulations of New

Zealand. On the facts of the case, it was held that the knowledge of

employees who had acquired the shares for the company counted as

the knowledge of the company. The Privy Council applied a

contextual and purposive interpretation, and no emphasis was placed

on whether the relevant employees were the “directing mind and will”

of the company. Meridian was immediately preceded by two cases –

Re Supply of Ready Mixed Concrete (No 2)

39

and Regina v. British

Steel plc

40

– which had distinguished Tesco as turning on the specific

statutory language. Thus, at first sight, these three cases indicated that

flexibility was the general rule, and the anthropomorphic

41

approach

of Tesco turned on the statutory language in Tesco.

El Ajou, supra note 41, at 699 (per Rose LJ),

37

[2009] UKHL 139, at 134 [hereinafter “Moore Stephens”].

38

Id., at 134.

39

[1995] 1 AC 456 (HL).

40

[1995] 1 WLR 1356 (CA).

41

The expression “anthropomorphic” literally means “relating to or characterized

by anthropomorphism”, and “anthropomorphism” is defined as “the attribution

of human characteristics or behaviour to a god, animal, or object” – CONCISE

OXFORD ENGLISH DICTIONARY (11th ed., 2006) at 56. The use of

“anthropomorphic” in this context refers to the treatment of a corporate body as

being similar to a human being, with the actions/intention of the “brain” of the

corporation being treated as the actions/intention of the body of the corporation.

By contrast, a flexible rule would not have any such predetermined

anthropomorphism, such that the person whose intention is attributed to the

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 39

The reason why judges have favoured applying the flexible

rule of Meridian more in civil cases, perhaps, is that certainty in result

is much more desirable in imposing criminal penalties than in

imposing civil penalties. Ultimately, once the matter is treated as one

of construction, a flexible construction is much more suitable for civil

law than criminal law

42

. In sum, it would appear that what Meridian

does is to provide judges with the choice of rules – the strict enquiry

continues as the default rule, but special circumstances may justify

courts adopting a flexible analysis. What these special circumstances

are would depend on the underlying legal rule, its language and

policy

43

. In the law of crimes, these considerations are likely to lead

to a strict approach a la Tesco. However, it is of course possible that

on a fair construction of even a criminal statute, the policy underlying

a rule may require a flexible approach. To that extent, it is arguable

company, may well be situated at different levels in the corporate hierarchy.

The classic “anthropomorphism” in this context may perhaps be Lord

Denning‟s statement in H.L. Bolton (Engg.) Co. Ltd. v. T.J. Graham and Sons,

[1957] 1 Q.B. 169 [hereinafter “Bolton”], when the learned judge stated (at p.

172) that a company “has a brain and nerve centre which controls what it does.

It also has hands which hold the tools and act in accordance with directions

from the centre”. The anthropomorphic approach is thus a one-size-fits-all

approach; where the „brain‟ is to be identified, and the intention of the „brain‟ is

to be imputed to the company. A flexible approach on the other hand would

leave open contextual enquiries of attribution, without an a priori determination

that only the actions/intention of the „brain‟ will be attributed to the company.

42

See generally: Ferran, supra note 40. Professor Ferran writes:

Judicial caution in this sphere may also reflect the importance that is

attached to preserving the certainty and predictability of the criminal

law. These are features of the law that would be undermined by the rather

ad hoc approach that could be the product of over-enthusiastic reliance

on the concept of context-specific rules of attribution…”

Id., at 34-35 (of the draft available with the authors).

43

KR v. Royal & Sun, [2006] EWCA Civ 1454.

40 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

that Meridian is not a sea-change from Tesco, at least in its

application to the law of crimes.

(c) Supreme Court’s Analysis in Iridium

These developments in English law raise the question – was

the Supreme Court in Iridium justified in invoking only Tesco and not

Meridian? First, it is noteworthy that the Meridian approach could yet

have been brought implicitly into Indian law. The court seems to have

rejected this

44

.However, on the facts of the case, given the nature of

proceedings (based on the premise inherent in proceedings under

section 482 of the Cr.P.C. that the allegations in the complaint were

true), the Court was not required to express an opinion conclusively

as to the test for attribution. What was in issue was the „whether‟

question; not the „how‟ question: whether a corporation can have

mens rea – not how can mens rea be proved. Thus, these remarks are

obiter; and though the obiter of the Supreme Court is considered

binding on High Courts, what will be binding is that at the stage of

proceedings under section 482, when the requisite allegations have

been made, the mode of proving mens rea should not be taken into

account as a relevant factor. Nonetheless, it is unlikely that Courts

will feel free to reject a Tesco approach; particularly considering that

Meridian finds no mention whatsoever in the Supreme Court

judgment. Instead, the Supreme Court has preferred to rely on cases

such as Bolton

45

– which were rejected in Meridian as being too

anthropomorphic.

44

Iridium, supra note 2, at 38, see extract accompanying supra note 20.

45

Supra note 49.

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 41

Consequently, the researcher argues that while there may have

been reasons for the Court to adopt an apparently rigid approach in

Iridium, caution must be exercised to ensure that the Court‟s decision

is not treated as the final word on all aspects relating to attribution

under Indian law. Iridium should be seen as the first step on the road

to rationalizing Indian law on the point – not as the final destination in

and of itself.

(2) Criminal Liability for Misstatements in Securities Offerings

We now deal with the second principal issue at hand in

Iridium, namely the criminal liability of companies for misstatements

in the context of securities offerings. At the outset, it is necessary to

note that the scope of the Supreme Court‟s pronouncement in Iridium

was limited only to issues that have a bearing at the relatively

premature stage of deciding on an application for quashing

proceedings under section 482 of the Cr.P.C.

46

Nevertheless, since the

court was compelled (while making its determination on the case) to

comment on legal issues arising out of the specific facts, we consider

it essential to dwell upon some of those issues of substance.

(a) The Offence of Cheating

The Supreme Court was concerned with the precise

requirements for showing a charge of cheating in cases involving an

issue of securities by a company on a private basis using an offer

document such as a PPM. In this regard, the facts of Iridium present a

somewhat peculiar situation. Liability (whether criminal or civil) for

46

We subsequently return to the appropriate scope of review under section 482 of

the Cr.P.C. See infra sub-part 2.

42 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

misstatements in a prospectus are governed by specific provisions in

corporate and securities laws, which in India are represented primarily

by the Companies Act, 1956

47

and the Securities and Exchange Board

of India Act, 1992.

48

However, these specific provisions apply only to

a public offering of securities that are to be listed on one or more

stock exchanges.

49

Since the issue of securities in Iridium involved a

private placement rather than a public offering, the transaction was

essentially within the domain of private contract law and these

specific provisions in corporate and securities laws were inapplicable,

thereby requiring the complainant to resort to general principles of

criminal law under the IPC. In that sense, Iridium represents a

relatively less trodden path involving the use of the wider offence of

“cheating” to a more specific situation that is otherwise within the

purview of corporate and securities laws.

Cheating is defined under section 415 of the IPC as follows:-

Cheating.- Whoever, by deceiving any person, fraudulently or

dishonestly induces the person so deceived to deliver any

property to any person, or to consent that any person shall

retain any property, or intentionally induces the person so

deceived to do or omit to do anything which he would not do or

omit if he were not so deceived, and which act or omission

47

The provisions pertaining to issues of prospectus are administered by the

Securities and Exchange Board of India (SEBI). Companies Act, 1956, § 55A.

For criminal liability for misstatements, see Companies Act, 1956, § 63.

48

By way of the Securities and Exchange Board of India (Issue of Capital and

Disclosure Requirements) Regulations, 2009, SEBI has stipulated the detailed

requirements regarding disclosures in a prospectus

49

For factors that differentiate a public offering of securities from a private

placement, see Companies Act, 1956, § 67.

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 43

causes or is likely to cause damage or harm to that person in

body, mind, reputation or property, is said to "cheat".

Explanation- A dishonest concealment of facts is a deception

within the meaning of the section.”

Essential to the offence of cheating is fraudulent or dishonest

inducement or deception (defined to include a dishonest concealment

of facts). It has been held that bona fide mistakes in a prospectus do

not amount to cheating – this is obvious; when something is

established to be bona fide, no question of dishonesty or deception

would arise.

50

More interestingly, and rather less obvious is a holding

that even a “scheme (in a prospectus) which was speculative in the

highest degree” is not a dishonest statement.

51

Furthermore, the

Supreme Court has held.

52

“It is for the legislature to intervene if it

wants to protect people who participate in these schemes knowing

that sooner or later the scheme must fail.”

In Iridium, the Bombay High Court had placed weight on the

“Risk Factors” and the cautionary statement contained in the PPM.

53

In the view of the High Court, a dishonest intention could not be

50

Anil Khandelwal v. Maksud Saiyed, 9 January 2006 (Guj), Crl. Misc. App.

5389/2005.

51

Radha Ballav Pal v. Emperor AIR 1939 Cal 327; Kamal Chopra v State of UP

1999 (105) CrLJ 2345 (All).

52

State of MP v. Mir Basit Ali Khan AIR 1971 SC 1620 [hereinafter “Basit Ali”],

at 14.

53

The relevant clause in the PPM reads:

An investment in Iridium involves certain risks, many of which relate to the

factors and developments listed above, prospective investors should carefully

consider the disclosures set forth elsewhere in this memorandum, including

those under the caption „risk factors‟ (1992 PPM Pg. 5)

Iridium, supra note 2, at 43.

44 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

made out and the case was essentially in the nature of a civil dispute

between the parties. Before we discuss the Supreme Court‟s decision,

it would be important to note the context in which the phraseology of

“civil dispute” arises.

Under the IPC, several cases have discussed whether a breach

of contract is a case of cheating. Often, complainants have initiated

criminal proceedings in contractual disputes, alleging that a breach by

the counter party had resulted in the offence of cheating. In this

context, the Supreme Court has stipulated that it is important to

determine whether an essentially civil dispute is being given the

colour of a crime.

54

A mere breach of contract is not cheating – what

needs to be established is a dishonest intention at the time of entering

into the contract.

55

Unless such a pre-existing dishonest intention is

established, the dispute should be treated as civil in nature; and no

criminal case would be made out

56

. In Iridium, the High Court drew

on such reasoning – which is fairly settled in Indian law – and applied

the same to the somewhat different facts of a securities offering. In

the High Court‟s view, no intention to deceive was evident at the time

of issuing the PPM. The High Court placed substantial reliance on the

fact that the PPM contained elaborate “Risk Factors”.

54

For example, in G. Sagar Suri v. State of Uttar Pradesh, AIR 2000 SC 754, the

Supreme Court observed (at 7): “It is to be seen if a matter, which is essentially

of a civil nature, has been given the cloak of a criminal offence”.

55

Hriday Ranjan Verma v. State of Bihar, JT 2000 (3) SC 604; 2000 Cri. L.J.

2983.

56

Id.

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 45

(b). Scope of Review Under Section 482, Cr.P.C.

To answer the questions raised above, it is essential to

understand the rationale behind the exercise of powers under Section

482 of the Cr.P.C. The plain text of section 482 does not indicate that

it is concerned mainly with petitions for quashing criminal

proceedings. Indeed, Section 482 is only a provision saving the

inherent powers of the High Courts. The text states:

Nothing in this Code shall be deemed to limit or affect the

inherent powers of the High Court to make such orders as may

be necessary to give effect to any order under this Code, or to

prevent abuse of the process of any Court or otherwise to

secure the ends of justice… .

Thus, in substance, the High Court can quash proceedings

before lower courts when those proceedings amount to an abuse of

process. The Supreme Court has elaborated the guidelines to be kept

in mind while exercising the power of quashing under section 482.

The leading case on the point is the Supreme Court‟s judgment in

Bhajan Lal.

57

Hence, the High Court would exercise the powers of

57

Supra note 16. In a passage which has been cited frequently in subsequent

judgments, the court observed:

In the … exercise of the extra-ordinary power under Article 226 or the inherent

powers under Section 482 of the Code [of Criminal Procedure], … the

following categories of cases [are given] by way of illustration wherein such

power could be exercised either to prevent abuse of the process of any Court or

otherwise to secure the ends of justice…

1. where the allegations made in the First Information Report or the

complaint, even if they are taken at their face value and accepted in their

entirety do not prima facie constitute any offence or make out a case

against the accused.

2. where the allegations in the First Information Report and other materials,

if any, accompanying the F.I.R. do not disclose a cognizable offence,

46 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

quashing when the allegations against the accused do not qualify as an

offence under law, even when the allegations are assumed to be

factually true. Such tests have meant that courts do not usually

consider defences of an accused – the logic is that if a case is such

that a prima facie charge is made out, allowing matters to finally be

decided at trial cannot be an abuse of process.

58

It is arguable, however, that an absolute refusal to consider the

effect of Risk Factors in an offer document (such as the PPM in

Iridium) is not justified on such a basis. The Risk Factors are after all

justifying an investigation by police officers under Section 156(1) of the

Code except under an order of a Magistrate within the purview of Section

155(2) of the Code.

3. where the uncontroverted allegations made in the FIR or 'complaint and

the evidence collected in support of the same do not disclose the

commission of any offence and make out a case against the accused.

4. where the allegations in the FIR do not constitute a cognizable offence but

constitute only a non-cognizable offence, no investigation is permitted by a

police officer without an order of a Magistrate as contemplated under

Section 155(2) of the Code.

5. where the allegations made in the FIR or complaint are so absurd and

inherently improbable on the basis of which no prudent person can ever

reach a just conclusion that there is sufficient ground for proceeding

against the accused.

6. where there is an express legal bar engrafted in any of the provisions of

the Code or the concerned Act (under which a criminal proceeding is

instituted) to the institution and continuance of the proceedings and/or

where there is a specific provision in the Code or the concerned Act,

providing efficacious redress for the grievance of the aggrieved party.

7. where a criminal proceeding is manifestly attended with mala fide and/or

where the proceeding is maliciously instituted with an ulterior motive for

wreaking vengeance on the accused and with a view to spite him due to

private and personal grudge.

Id., at 105.

58

For example, see the judgment of the Supreme Court in Bharat Parikh v. CBI,

(2008) 10 SCC 109, as applied by the Kerala High Court in P.K. Sulaiman v.

State, Crl. MC. 1246/2010 (judgment dated 20 April 2010) (Kerala High

Court).

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 47

part and parcel of the very representation which is relied on by the

complainant itself; the Risk Factors are inseparable from the

representation.

59

Any representation must be looked at in its entirety

before determining whether a prima facie case exists for continuation

of proceedings.

60

Since the Supreme Court in Iridium was only dealing with an

appeal from an order section 482 of the Cr.P.C., its ruling in respect

of Risk Factors is at best a preliminary determination without a

detailed examination of countervailing arguments of the parties. We

therefore caution against treating Iridium as the final word of the

highest court of the land on the effect of Risk Factors in a securities

offering document. More generally, the significance of Risk Factors

cannot be undermined, as we note below.

Companies that issue securities are not expected to guarantee

future prospects and results to prospective investors. Hence, they tend

to include cautionary language in offer documents that moderates

59

Recently, in Harshendra Kumar, supra note 68, the Supreme Court has

clarified that in appropriate cases, a defence emerging ex facie from

uncontroverted documents can be considered even in the exercise of

jurisdiction under section 482 – to not do so could amount to a “travesty”. So

too, “[i]t is one thing to say that the Court at this juncture would not consider

the defence of the accused but it is another thing to say that for exercising the

inherent jurisdiction of this Court, it is impermissible also to look to the

admitted documents…” All Cargo Movers v. Dhanesh Jain, (2007) 12 SCALE

39. An analogous principle can well be applied insofar as the question of the

relevance of risk factors is concerned.

60

Of course, we do not claim that the mere inclusion of risk factors may be

sufficient to avoid all criminal liability at the stage of section 482 proceedings.

Our point is narrower – which is that risk factors are at least relevant in section

482 proceedings, while assessing the „representations‟ made by the issuer. At

the stage of trial, the risk factors would have greater weight – a point which the

Supreme Court in Iridium does not seem to have disregarded.

48 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

investor expectations. It is in this background that securities

regulations governing public offerings of securities require issuers to

include detailed Risk Factors. Even the SEBI (Issue of Capital and

Disclosure Requirements) Regulations, 2009 provide detailed

guidelines on the types of Risk Factors to be included in a prospectus.

These regulations in fact encourage rather than restrict the inclusion

of Risk Factors.

61

Surely, it cannot be intended that these Risk Factors

would become immobilized once criminal proceedings are initiated

against the issuer company for misstatements in the prospectus. That

would make Risks Factors rather redundant, a position that would

operate against the goals of full disclosure to prospective investors.

An extreme approach of disregarding Risk Factors would not only

dis-incentivize full and fair disclosure of future prospects by issuers

that would enable investors to gauge their investment appetite, but it

could chill securities offerings by imposing too onerous a cost on

issuers.

Finally, the Supreme Court in Iridium pays scant regard, if at

all, to the sophistication of the investors while determining whether

they were subjected to „deception‟ so as to constitute an offence of

cheating. In that case, the securities offering was made to institutional

investors on a private placement basis and not to individual investors

61

A useful parallel is contained in the U.S. context where the “bespeaks caution”

doctrine provides protection to issuers of securities from liability that arises

from forward looking statements as long as they are tempered by cautionary

language. The doctrine has largely been used in civil claims for securities

frauds and has also received statutory recognition in the Private Securities

Litigation Reform Act of 1995. See Palmer T. Heenan, Jessica L. Klarfeld,

Michael Angelo Roussis and Jessica K. Wash, Securities Fraud, 47 Am. Crim.

L. Rev. 1015, 1064-66 (2010).

2015 CORPORATE CRIMINAL LIABILITY AND SECURITIES OFFERINGS 49

or the public in general. Institutional investors generally possess

levels of sophistication that enable them to make investment decisions

without advice from the issuer company. Moreover, Risk Factors and

disclaimers of the nature contained in the PPM in Iridium seek to pass

on the risks of uncertainty to the investors. Where Risk Factors form

an important mitigating feature for public offerings of securities to

even unsophisticated investors, as we have seen earlier, there seems to

be no reason to grant better levels of protection to sophisticated

investors who have the information, expertise and wherewithal to

absorb greater risks. Any reading of Iridium that suggests complete

disregard of Risk Factors in a private offering of securities would

place sophisticated institutional investors on an even higher pedestal

than unsophisticated public investors, a matter surely not intended by

the scheme of regulation of securities offerings.

[C] CONCLUSION

The Supreme Court‟s decision in Iridium is momentous as it

clarifies the previously ambiguous position under Indian law that a

legal person such as a company is capable of having mens rea. It is an

important step in promoting the use of criminal sanctions to regulate

corporate behaviour. At the same time, it is crucial to note that the

Supreme Court stops short of ruling convincingly on the methods by

which mens rea of a company can be proved. It places reliance on the

anthropomorphic approach of the English courts in Tesco without in

any way considering the subsequent crucial development in the form

of the more flexible approach in Meridian. Similarly, the Supreme

Court does not conclusively deal with the effect of Risk Factors in

50 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

determining the existence of „deception‟ as an ingredient of an

offence of cheating due to misrepresentation in a private placement

offering document. Of course, it is hard to be critical of the Supreme

Court as it was concerned only with an appeal on preliminary aspects

relating to an order of quashing under section 482 of the Cr.P.C. In

sum, we argue that while Iridium must hold the field on the ability of

a company to have mens rea, its rulings on the other aspects must be

accepted in measured terms only as possible guidance for further

specific judicial determination.

LEVERAGED BUY OUTS: UTILITY AND LEGAL ISSUES- A

COMPARISON BETWEEN THE POSITION IN INDIA AND UK

Megha Krishnamurthi and Haya Arif



Despite the growing investment into India in some form of

Leveraged buyout, there is very little discussion regarding it

within and amongst the regulators in India such as the RBI,

FIPB and SEBI. The sensation that leveraged buyouts have

created across the global market cannot be overemphasized.

Some of the greatest acquisitions in the past few decades have

been financed through a high degree of leverage. The primary

objective of this paper is to draw comparisons between the

legal framework in which leveraged buyouts operate in the UK

and in India, while also explaining in brief the characteristics

of a typical leveraged buyout and enumerating the advantages

the associated risks of opting for a leveraged finance structure.

While recognizing that Leveraged Buyouts are beneficial at the

micro economic level one needs to be wary of its impact in the

economy as a whole. An analysis of the financial crisis post

2012 makes clear the dangers to the financial system of using

too much leverage and therefore the question that most

economies are facing today and which we attempt to highlight

through this paper is “How much restriction is too much?

[A] INTRODUCTION

The sensation that leveraged buyouts have created across the

global market cannot be overemphasized. Some of the greatest

acquisitions in the past few decades have been financed through a



IV Year Students, NALSAR University of Law

52 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

high degree of leverage. Even though acquisitions financed through

leveraged buyouts have always been considered to be lucrative to

both private equity firms and lending banks, they have faced

considerable amount of restrictions in the legal environment of most

jurisdictions. The global financial crisis of 2008 has further resulted in

leveraged buyouts facing scathing criticism and an increased scrutiny.

The primary objective of this paper is to draw comparisons

between the legal framework in which leveraged buyouts operate in

the UK and in India. The structure and characteristics of a typical

leveraged buyout are briefly explained at the outset, followed by

enumerating the advantages of opting for a leveraged finance

structure, while also listing out the associated risks and disadvantages

that might arise from the high degree of leverage used to finance an

acquisition. The development of the Leveraged Buyout Market in the

UK is then traced, in context of the legal impediments posed to

leveraged buyouts in the form of the restrictions against financial

assistance. The change in the position of law over time, and the

impact of the global financial crisis on the leveraged buyouts has been

discussed at length in an attempt to understand the change in trend of

leveraged buyout activity in the UK, following which the focus is

shifted to the story of leveraged buyouts in India. In this part, the

operative legal restrictions and the behaviour of regulatory authorities

towards financing leveraged acquisitions are discussed at length.

Interestingly, it was observed during the course of research that

despite legal restrictions, there is considerable amount of leveraged

buyout activity in India. This is primarily done by structuring

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 53

transactions in a manner so as to not infringe on the restrictions in the

law.

The researchers have relied on secondary sources for research.

Various secondary sources like literature, working papers of various

governmental bodies and contemporary newspaper articles have been

utilized by for the purpose of carrying out their research. Due to a

paucity of time and space, the scope of this paper is restricted to

typical leveraged buyout transactions in context of private companies

and consequently management buy-outs, buy-ins, etc. are not dealt

with in this paper.

[B] LEVERAGED BUYOUTS (LBOS): CHARACTERISTICS AND

UTILITY

A leveraged buyout is a transaction wherein a company is

acquired by an investment firm; usually a private equity firm

financing a large portion of the acquisition through debt, or leverage.

1

Because of the highly leveraged nature of these transactions, such

transactions have likewise been alluded to as 'bootstrap acquisitions'.

2

This debt portion of the financing is repaid by the future receivables

and the cash flow of the target, and the assets of the target are used as

a security for the debt obtained, thus making the target finance its own

acquisition in a way.

1

Steven N. Kaplan & Per Stromberg, Leveraged Buyouts and Private Equity,

JOURNAL OF ECONOMIC PERSPECTIVES, Vol. 22(4) (Sept., 2008),

http://faculty.chicagobooth.edu/steven.kaplan/research/ksjep.pdf.

2

Suresh A.S. & Sharavanth S.S., A Study on leveraged Buyouts- Opportunities

and Challenges, ASIA PACIFIC JOURNAL OF RESEARCH, Volume III(X) (Oct.,

2013), http://apjor.com/files/1383065450.pdf.

54 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

This acquisition, or buy-out is financed with 60-90% debt and

the remaining is paid in equity. Usually, a 90:10 debt to equity ratio is

employed in a typical leveraged buyout, however the ratio of debt to

equity to be used is ascertained by a cost-benefit analysis keeping in

view the financial state of the target and thus differs from acquisition

to acquisition. Thus, a relatively smaller portion of equity is used,

compared to a significantly larger portion of debt. Even though the

capital structures in the financing of a leveraged buyout vary from one

transaction to the other, it typically involves different levels of

financing, from senior debt, to various subordinate or mezzanine

debts and finally to an element of equity.

3

Major investors of the

equity portion of the financing are private equity firms, management

of the target companies, or other companies, in some cases.

4

As a general rule, a leveraged buyout comprises of three

elements – the „leverage‟ (financing the acquisition through

considerable amount of borrowing), „control‟ (assuming role in the

management of the entity) and „going private‟ (removing the firm

from public markets and converting it to private in case of public

companies).

5

3

Loan Market Association, A Guide to Syndicated Loans and Leveraged

Finance Transaction,

http://www.lma.eu.com/uploads/files/LMA%20Guide%20to%20Syndicated%2

0Loans%20144801-3-472%20v0%203%20_2_.pdf.

4

Chen Liu, Debt Structure, Private Equity Reputation, and Performance in

Leveraged Buyouts, (Sept. 10,

2014),http://web.business.queensu.ca/Faculty/fmoneta/Seminar/2013_2014/Job

%20Market%20Paper_Chen%20LIU.pdf.

5

Aswath Damodaran, The Anatomy of an LBO: Leverage Control and Value,

CFA INSTITUTE CONFERENCE PROCEEDINGS QUARTERLY, Vol. 25(3), 2 (Sept.,

2008), http://www.cfapubs.org/doi/pdf/10.2469/cp.v25.n3.4.

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 55

(1) Utility of these Buyouts

Leveraged buyouts have been perceived to be highly

advantageous to both acquiring private equity companies as well as

banks. One of the greatest advantages of going for a leveraged buyout

is that in most jurisdictions, the interest paid on debt financing is tax

deductible, as opposed to cash flows to equity, which are not tax

deductible in most cases.

6

Thus, the higher the tax rate, greater would

be the consequent tax benefit of using leverage or debt. Another

advantage arising out of a leveraged buyout is often known as the

„discipline of debt‟, a concept that means that the high levels of

interest and principal payments act as a driving force to improve

performance and efficiency of the management through focusing on

cost cutting and improvement enhancement initiatives. Furthermore,

leveraged buyouts are seen to reduce agency problems. When a

company is acquired through a high degree of leverage, there is

usually a concentrated ownership that is in control of the private

equity firm; as opposed to a dispersed ownership that otherwise exists

in a public company which is the root cause of agency problems i.e.

an externality that occurs when A controls the assets of B. When the

ownership is concentrated instead, the performance of the

6

Tim Jenkinson & Rüdiger Stucke, Who benefits from the leverage in LBOs?,

(Feb., 2011),

http://economics.ouls.ox.ac.uk/15362/1/Who_Benefits_from_the_Leverage_in_

LBOs.pdf.

56 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

management improves, as there is a close connection between the pay

and their performance, in addition to an increased leverage.

7

Another potential advantage is that leveraged buyouts can

sometimes act to revitalize an adult organization. Also, by expanding

the organization's capital, leveraged buyouts empower it to enhance

its market position. And not only for the company, effective

acquisitions through leveraged finance could be profitable for the

shareholders of the company as well, as well as the post acquisition

speculators who stand to earn vast returns from the date of the

acquisition completion to the period of the IPO or resale.

8

(2) Associated Disadvantages

However, even though the leveraged buyouts are considered to

be generally advantageous to the lender, they are nonetheless risky.

Any form of financial distress, for instance events like recession (as

was more than clear from the global financial crisis of 2008),

litigation, or changes in regulatory environment can have a highly

negative impact on the acquirer private equity firm, the banks as well

as the target company.

9

Furthermore frail administration at the target

organization or misalignment of motivations in the middle of

administration and shareholders can likewise pose threats to a

7

Joacim Tåg, The Real Effects of Private Equity Buyouts, RESEARCH INSTITUTE

OF INDUSTRIAL ECONOMICS, IFN WORKING PAPER NO. 851 (2010),

http://core.kmi.open.ac.uk/download/pdf/6396753.pdf .

8

Pooja Tripathi, Leveraged Buyout Analysis, JOURNAL OF LAW AND CONFLICT

RESOLUTION, Vol. 4(6), 85-93 (Dec., 2012),

http://academicjournals.org/article/article1379862777_Tripathi.pdf.

9

Jonathan Olsen, Note of Leveraged Buyouts, CENTRE FOR PRIVATE EQUITY AND

ENTREPRENEURSHIP, TUCK SCHOOL OF BUSINESS AT DARTMOUTH,

http://pages.stern.nyu.edu/~igiddy/LBO_Note.pdf.

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 57

successful leveraged buyout transaction. The high degree of leverage

does in a manner also increase the risks of bankruptcy, in an extreme

scenario. However, this exists as a theoretical possibility because

there are no empirical studies to indicate otherwise. In a study

conducted in 2009 with a sample of 17,171 buyouts, for a period from

1970 and 2007 and mapping buyouts globally, a bankruptcy rate of

6% was found.

10

Furthermore, even though the benefits of leveraged

buyouts are indeed real, yet they are often criticized severely by

labour unions and worker groups, as the pressure of the debt results in

layoffs and wage cuts. Also, since private equity firms are seen only

as short term investors, always on the lookout of a quick exit, critics

hold that leveraged buyouts result in a detrimental impact to the long

term investment of a company.

(3) Legal Issues

Leveraged buyouts are a controversial subject in most

jurisdictions and invite legal restrictions in most countries. Courts in

some jurisdictions like Italy had also gone to the extent of deeming

leveraged buyouts to be out rightly illegal, though safe harbor

provisions have been created now. In most other jurisdictions,

however, while leveraged buyouts per se are not illegal, they

nonetheless infringe the rule against financial assistance present in the

company law of most states. The rationale behind the financial

assistance prohibition rests on the idea that if a company bears the

costs of the purchase of its own shares it leads to the penury of

shareholders. Thus, one of the key reasons leveraged buyouts are

10

Supra no. 1.

58 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

frowned upon by the company laws of most jurisdictions is that these

transactions often do not entail a full disclosure to shareholders with

the knowledge often restricted to insiders of the company.

11

This

amounts to a serious breach of the fiduciary duty that the management

of the company owes to the creditors and shareholders.

In the following sections, a comparative analysis is drawn

between the legal restrictions on leveraged buyouts between the

jurisdictions of India and the UK.

[C] THE LEVERAGED BUYOUT MARKET IN THE UK

The leveraged buyout market has its roots in the United States,

however this phenomenon spread quickly to the UK as well, and has

seen rapid growth in UK ever since. UK has the largest buyout market

in the Europe today, with leveraged buyouts accounting for about half

the acquisitions in terms of value in 2005.

12

Prior to 2008, leveraged buyouts in the United Kingdom were

restricted by the rule against financial assistance embodied in the

Companies Act, 1985

13

of the UK. According to Section 151 of the

1985 Act, any company (whether public or private) and its

subsidiaries were prohibited from providing any financial assistance

11

Douglas Cumming & Simona Zambelli, Illegal Buyouts, JOURNAL OF BANKING

AND FINANCE, Vol. 34(2), 441-456 (Aug., 2009),

https://www.ecb.europa.eu/events/pdf/conferences/ecbcfs_conf9/Buyouts_Revi

sion.pdf?93907ef27e0bbeff1220f24bc62d331f.

12

Mike Wright, Luc Renneboog, Tomas Somins & Louise Scholes, Leveraged

Buyouts in the UK and Continental Europe: Retrospect and Prospect, ECGI

WORKING PAPER SERIES IN FINANCE, FINANCE WORKING PAPER NO. 126/2006,

(July, 2006), http://ssrn.com/abstract_id=918121.

13

Hereinafter referred to as the „1985 Act‟.

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 59

for the purpose of acquisition of shares.

14

This restriction extends to

providing any sort of financial assistance to discharge or reduce any

debt (for instance, a loan) or liability for the same purpose. An often

raised problem with this limitation was that the 1985 Act did not

provide any clear definition for the term „financial assistance‟ and this

led to an ambiguity in the law. Section 152 merely gives certain

examples as to the transactions that qualify as financial assistance.

15

However, these instances were highly fact based and did not provide

clarity as to the scope of the restriction.

Despite these stringent restrictions, however, the 1985 Act

provided for certain „whitewash‟ procedures given for private

companies in Sections 155-158 that relax the absolute restriction

embodied in Section 151. The whitewash procedure cleanse out what

would otherwise be considered to be an illegal buyout. According to

Section 155(2), financial assistance could only be provided if it did

not reduce net assets of a company, or to the extent of reduction of net

assets, if the assistance was provided from the distributable profits of

the company.

16

Section 155(6) laid down the requirement that

Directors of the target company had to furnish a statutory declaration

in accordance with the requirements prescribed in S. 156, stating that

the company shall be able to pay its debts when due for a minimum

period of 12 months after the financial assistance had been provided.

17

Furthermore, S. 156 also required a report by the auditors of the

14

Sec. 151, UK Companies Act 1985.

15

Sec. 152, UK Companies Act 1985.

16

Sec. 155(2), UK Companies Act 1985.

17

Sec. 155, UK Companies Act 1985.

60 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

company confirming the same.

18

In addition to this, there is also the

requirement of passing a special resolution by the general body

provided in S. 155(5).

19

Thus, even though the rule against financial

assistance was indeed diluted by the exceptions in the whitewash

procedures, the threshold of requirements was indeed very high and

made it a highly cumbersome procedure.

This procedure was highly time consuming and entailed high

costs. Public to private deals have been completed after the public

company re-registered itself as a private company and only then could

its assets be used as a security for the lending banks.

20

Thus,

compliance with this whitewash procedure was problematic because it

created complexities and delays and was highly expensive as well. In

2000, the Law Commission of the United Kingdom‟s estimate was

that the whitewash procedure cost the economy about £20 million

($39.45 million), and since leveraged lending has exponentially

increased ever since, these costs can reasonably be assumed to have

increased as well.

21

This existing requirement to comply with the whitewash

procedures has changed from 1st October 2008, after the passage of

the new Companies Act, 2006 of the UK and the rules corresponding

to financial assistance, which came into force on 1st October, 2008

18

Sec. 156(4), UK Companies Act 1985.

19

Sec. 155(5), UK Companies Act 1985.

20

Private Equity and Venture Capital Review, United Kingdom: Liberating

LBOs, INTERNATIONAL FINANCIAL LAW REVIEW, (Jan., 2008),

http://www.dechert.com/files/Publication/5840e57f-c4e7-4594-ace3-

a9c016d9ebaf/Presentation/PublicationAttachment/bc5c7bc6-9ab4-49cc-b092-

b741ebc337b5/Liberating%20LBOs.pdf.

21

Ibid.

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 61

and have eased the restrictions regarding financial assistance in case

of private companies. For public companies, the restriction still

operates. This change in the law has come forth after a Directive to

this effect was issued by the European Union in 2006 following which

the „financial assistance‟ regulations were eased in most member

states.

22

The main reasons for this policy were the increasing

complexity and costs associated with the whitewash procedure, the

ambiguity in the law as to what precisely amounted to „financial

assistance‟ and the ever increasing frequency of leveraged buyouts

and their perceived benefits to both private equity firms and the

lending banks. When leveraged buyouts rose in popularity in the years

following the 1980s, it was predicted that this would become the

dominant form of corporate restructuring.

23

The financial crisis of 2008 altered the scene completely. The

impact of the financial crisis has invited increased restrictions from

lending regulatory authorities due to its considerable impact on banks.

In its recent publication, the Bank of England has expressed its

concerns over the risks to the UK financial system over the high debt

levels.

24

According to this, leveraged buyouts are increasing the

22

Directive 2006/68/EC of the European Parliament and of the Council,

http://eur-

lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2006:264:0032:0036:EN:P

DF

23

Michael Jenson, Agency Costs of Free Cash Flow, Corporate Finance and

Takeovers, THE AMERICAN ECONOMIC REVIEW, Vol. 76(2), 323-29 (May,

1986), http://www.jstor.org/stable/1818789.

24

David Gregory, Private Equity and Financial Stability, MARKETS, SECTORS

AND INTERLINKAGES DIVISION, BANK OF ENGLAND QUARTERLY BULLETIN,

(Q1, 2013), http://www.bankofengland.co.uk/publications/Documents

/quarterlybulletin/2013/qb130104.pdf.

62 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

vulnerability and the frailty of the corporate sector in the UK, because

steeper debt levels could result in companies showing reluctance to

undertake long term investment as the costs of servicing the debt and

the regular interest payments reduce the free cash flow of the

company. This lower investment would in turn affect the profit

generating ability of the company in the long run and could indirectly

result in a deleterious impact on an already fledgling economy.

25

Higher levels of debt also increase the likelihood of the company to

default on the debt obligation. This has a direct effect on the financial

system due to losses incurred on lending through banks and a high

risk exposure of banks to private equity firms. Since the percentage

of exits of private equity firms is quite low, and if this is taken in

context of the economic crisis of 2008, which paints a dark picture of

a weak economic stage, and the possibility that private equity firms

will not be able to repay the debt, even the options of refinancing

seem bleak as banks already have a high degree of exposure to the

private equity firms. This would negatively impact the resilience of

the entire financial system, at a time where the country is still

staggering from the effects of the 2008 crisis.

Thus it is submitted, that in the case of the UK, it is not the

legal restriction as such, but rather the impact of the financial crisis

and its repercussions like the freezing of loan markets, and a general

reluctance on part of banks that has actually impacted leveraged

buyout activity in the country.

25

Ibid.

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 63

[D] THE STORY OF LEVERAGED BUYOUTS IN INDIA

Unlike UK, the restrictions in India against LBOs are not only

economic but also legal. Before delving into Leveraged Buyout

scenario in the Indian context, it is important to draw a distinction

between the Leveraged Buyouts of Indian Companies from those

Buyouts that an Indian company does of foreign target companies.

This is because in the case where the Buyout by an Indian Company

of a target situated in foreign countries, the buyout is governed by the

laws of the country where such a target is situated. On the other hand,

the leveraged buyout of an Indian Company by an Indian or foreign

company needs to comply with the legal framework in India and the

scope of execution permissible in India. An analysis of such

transaction would give us a clear picture of the legal and regulatory

hurdle against a successful Leveraged Buyout in India.

(1) Restrictions to Leveraged Buyouts in India:

Generally, three factors are considered essential for a

successful buyout. An acquiring company must have the ability to

borrow significant sums for the acquisition. It should be able to retain

or attract a strong management team and have the potential to enhance

the values of each investment. And last, the ability to service the

principle and interest payment obligation as well as to exit with a

significant profit on the investment.

26

On analysis of the Indian legal and commercial/economic

scenario, one is appalled by the number of barriers that are in place in

26

NEW AGE INTERNATIONAL, MERGERS, ACQUISITIONS AND TAKEOVERS 184,

185 (2007).

64 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

the Indian legal as well as commercial environment which render the

process of Leveraged Buyout difficult. Although there is no direct

statutory restriction against leveraged buyouts in the commercial laws

of India, the requirements and the structuring of a leveraged buyout is

hit by a lot of small but significant restrictions. It should then not be

surprising that Buyouts comprise a mere 3-5% of the PE activity in

India.

27

In this paper, these restrictions have primarily been divided

into three parts. Each of these part corresponds to the restriction on

the three factors illustrated above which are essential for a successful

buyout.

1.1 Restrictions on the ability of the potential acquirer to borrow:

(a) Restrictions on Indian Banks from financing such acquisitions:

Historically, the policy of the Reserve Bank of India

discouraged bank financing of share acquisition on the ground that it

could lead to lending towards speculative activities resulting in undue

risk being posed on the banks.

28

RBI has issued a number of

guidelines to domestic bank in regard to making advances against

shares of a company which cumulatively prohibit banks from granting

loans to acquirers to take up equity shares of other companies. This is

because it promotes the principle that promoters‟ contribution towards

the equity capital of a company should come from their own

27

Deepti Chaudhary & Shraddha Nair, Buyout firms find the going tough in India,

(Oct. 14, 2009),

http://www.livemint.com/Companies/DIsuQZEAGZCrSCbaw6pl3L/Buyout-

firms-find-the-going-tough-in-India.html.

28

C. Achutan (Chairman), Report of the Takeover Regulations Advisory

Committee, 19, 20 (July 2010),

http://www.sebi.gov.in/cms/sebi_data/attachdocs/1287826537018.pdf.

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 65

resources.

29

The RBI is more concerned with what the advances by

the banks are for, rather than what the advances are against and

therefore it obliges the banks to exercise particular care when

advances are sought against large blocks of shares. The banks should

ensure that advances against shares are not used to enable the

borrower to acquire or retain a controlling interest in a company.

30

These restrictions have been made more stringent when in 2010 the

RBI extended these restriction on grant of bank advances for

financing promoters‟ contribution towards equity capital to payments

related to such acquisitions like payment of non compete fee, etc.

Further, these restrictions would also be applicable to activities by

overseas branches/subsidiaries of Indian banks

31

Such a restriction does not only throttle leveraged buyouts of

Indian companies but also creates a huge disparity between potential

foreign acquirers who have better access to financial support from the

banks and financial institutions of their own countries as compared to

the potential domestic acquirers. And therefore we see a higher

number of foreign acquirers indulging in leveraged buyouts as

compared to Indian acquirers.

Although RBI has made certain exceptions to this restriction,

the exemption is only made with regard to acquisition finance when

the target is a foreign company and when such acquisition is of

29

Para 8, RBI Master Circular Dir.BC.90/13.07.05/98 (August 28, 1998).

30

Para 2.3.1.8, RBI Master Circular on Loans and Advances – Statutory and

Other Restrictions, DBOD.No.Dir.BC. 6/13.03.00/2011-12 (July 1, 2011).

31

Para 2, RBI circular on Bank loans for financing promoters contribution,

DBOD.No.BP.BC.42 /21.04.141/2010-11 (Sept. 27, 2010).

66 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

benefit to both the potential acquirer as well as the country on the

whole.

32

And therefore this does not in any way relax the restrictions

in the way of acquiring an Indian target by way of leveraged buyout.

Additionally, there is a blanket restriction on foreign acquirers

from borrowing from an Indian bank to buy into or acquire a

company in India.

33

(b) Restrictions against funding acquisitions from External

Commercial Borrowings:

External Commercial Borrowings refer to commercial loans

availed from non-resident lenders in the form of bank loans, buyers‟

credit, suppliers‟ credit, securitised instruments etc. These usually

have a minimum average maturity of three years. Under Indian

exchange control laws, foreign currency loans, including the proceeds

of External Commercial Borrowings (ECBs) cannot be availed of for

the purposes of leveraged buyouts of onshore Indian target

companies. This is because under the present regulations, ECB

proceeds both under the automatic and approval route have specific

end use restrictions. Therefore although ECB can utilized for

investment in new/existing projects in specified sectors in India, it

cannot be utilized for acquisition of a company or part thereof. This

restriction virtually makes external debt funding unavailable to Indian

acquirers.

34

32

Para 2-3, RBI circular on Financing of acquisition of equity in overseas

companies (June 7, 2005).

33

FIPB Press Note 9 (April 12, 1999).

34

Para I.(A)(vii) and I.(B)(ix), RBI Master Circular on External Commercial

Borrowings and Trade Credits (July 01, 2013).

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 67

(c) Underdeveloped Corporate Debt market:

The studies conducted by RBI on company finance bring out

two prominent observations, first that Indian companies do not follow

the pecking order theory (the commercial theory that profitable firms

tend to finance through internal sources and the external sources) as

they dominantly depend on external sources for their funding. And

second that bank loans dominate the source of borrowing for Indian

companies. For eg: for the period of 2006-2010, 67.4% of the total

corporate borrowings were financed through bank loans and only 7%

was financed through the corporate debt market. This trend actually

increased further in the year 2010-11 when the share of borrowings as

loan increased to 71.1% and the share of debt market was 10.7%.

This shows that bank loans continue to be the major borrowing source

for companies. The reason for such prevalence as analysed by this

study conducted by the RBI is the prevalence of the cash credit

system in the banks in which the cash management of the company is

actually done by the banks themselves.

35

The Indian corporate debt market has to go a long way despite

the fact that existing literature suggests that corporate debt market

yields would be much more efficient that bank lending rates in

reflecting the risk return trade off.

36

This underdevelopment of the

corporate debt market pushed potential issuers to foreign debt

35

Angshuman Hait, Saurabh Ghosh, Sunder Raghavan & Ashok Sahoo, A STUDY

OF CORPORATE BOND MARKET IN INDIA: THEORETICAL AND POLICY

IMPLICATIONS 4 (2014).

36

Shri Deepak Mohanty (head), REPORT OF THE WORKING GROUP ON

BENCHMARK PRIME LENDING RATE (BPLR) (Oct. 20, 2009).

68 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

markets, and this in turn will increase the inactivity in the Indian debt

market, the consequences of which will be further stagnation and

underdevelopment of the Indian corporate debt market. Hence this is a

circular problem that needs to be resolved.

1.2 Restrictions on the ability to retain a strong managerial team:

Another predominant factor that creates a barrier is

attributable to business culture in India. Most businesses are owned

by the promoter families who have a considerable say in the

management decisions and therefore the distinction between

ownership and management is diluted to a great extent.

37

This is also

the biggest reason why private equity firms are unable to enter into

hostile takeovers in India. However a bigger problem posed by such a

business environment is the relatively small pool of professional

management in corporate India.

38

1.3 Restriction to service its loan and to exit with a substantial

profit:

(a) Restrictions on the acquirer from using the assets or cash flow

from the target to service his principle obligation and interest:

Pursuant to Section 77(2) of the Companies Act 1956 and its

complementary provision in the 2013 Act (Sec 67(2)), a public

company or its subsidiary (even if it is a private company) cannot

37

Sumesh Swahney & Rishi Gautam, Investment Opportunities in India‟s M&A

market, CLIFFORD CHANCE, 3 (2010),

http://www.cliffordchance.com/content/dam/cliffordchance/Feature_topics/PD

Fs/MA_in_india_2.pdf.

38

Afra Afsharipour, NSE Working Paper on The Indian Private Equity model, 10-

11 (July, 2013),

http://www.nseindia.com/research/content/res_WorkingPaper8.pdf.

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 69

provide any financial assistance for the purpose of or in connection

with a purchase of the shares of the company itself or the holding

company. This financial assistance could be either direct or indirect, it

could be in the form of loan, guarantee, the provision of security or

otherwise.

39

Therefore, due to this provision, no company unless it‟s a

private company which is not a subsidiary of a public company which

can provide its assets as security for raising a loan to finance the buy-

out. Consequently, if an acquirer intends to acquire a public listed

company through a leveraged buy-out, the company would have to

first delist under the SEBI (Delisting of securities) Guidelines, 2003

and then convert itself into a private company under the Companies

Act 1956, which would need not only consent form shareholders but

also approval by the registrar of companies. The reason behind such a

restriction placed on public companies and their subsidiaries is

primarily to protect the interests of the general public who have

invested in the company as shareholders.

(b) Restrictions relating to exit of the acquirers:

Private equity firms restructure the companies they buy and

hope to sell them or “exit” at a much higher price, either by selling the

business to another company or private equity firm, or through an

initial public offering.

40

A lucrative option for the acquirer would be

to list the shares of the target on international capital markets through

39

Sec 77(2), Indian Companies Act 1956.

40

Kaplan, Steven N. & Per Stromberg, Leveraged Buyouts and Private Equity,

JOURNAL OF ECONOMIC PERSPECTIVES 23(1), 121-46 (2009).

70 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

the issue of Global Depository Receipts. However, until September

2013, SEBI guidelines required mandatory listing of Indian

companies on domestic stock exchange before a foreign listing.

41

Under such regulatory mechanism the acquirer company who

acquires through an Indian company through an LBO and who is

looking for exit options would have to indulge into dual listing of the

company which would cost him tremendous time and energy. This

restriction was out in place by SEBI since it believed that it would

help the development of domestic capital markets. However in light

of the relatively weak domestic capital markets with very few

successful Initial Public Offers of Indian companies in recent times

and India's increasing current account deficit,

42

this restriction has

now been removed by the Ministry of Finance through a press release

on September 27, 2013 which permits unlisted Indian companies to

list directly on offshore stock exchanges without prior or

simultaneous or subsequent listing in India on a pilot basis for the

next 2 years.

43

This change would now enable PE investors to require

their investee companies to list in jurisdictions that are favourable to

the certain sector/ industry in which the investee company operates,

thereby making IPO a potentially more viable exit option. But, the PE

41

SEBI Issue Of Foreign Currency Convertible Bonds And Ordinary Shares

(Through Depositary Receipt Mechanism) Scheme, 1993.

42

Abhinav Harlalka, Shinoj Koshy & Pratibha Jain, India: Indian Unlisted

Companies Allowed To List Internationally: Another Exit Route For Investors?

(Nov. 29, 2013),

http://www.mondaq.com/india/x/278408/Corporate+Commercial+Law/Indian+

Unlisted+Companies+Allowed+To+List+Internationally+Another+Exit+Route

+For+Investors.

43

http://finmin.nic.in/press_room/2013/lisitIndianComp_abroad27092013.pdf .

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 71

investors that would be able to benefit from this relaxation may be

limited.

Therefore the biggest limitation with regard to exit of the

acquirer is the provision regarding minimum contribution of the

promoter and the promoter share lock in when a private company

goes for an IPO under the SEBI Issue of Capital & Disclosure

Requirement regulations. These provisions provide that if a private

company undergoes an IPO, the promoters who are controlling the

company should necessarily offer 20% of the post issue capital.

Further, they are mandated to hold a minimum amount of shares in

the company even after the issue for at least a period of three years.

Therefore in India, the IPO route does not offer a clean exit to the

acquirer.

[E] ANALYSIS & CONCLUSION

Despite the growing investment into India in some form of

Leveraged buyout, there is very little discussion regarding it within

and amongst the regulators in India such as the RBI, FIPB and SEBI.

The only document closely doing this is the RBI‟s paper on

“Evolution of Global Private Equity Market” which is regarding

Private Equity players in India who majorly engage in Leveraged

Buyouts in various jurisdictions.

44

An analysis of this document

makes it clear that the regulatory authorities are not opposed to the

concept of Leveraged buyouts itself as they recognise the various

44

R. K. Jain and Indrani Manna, Evolution of Global Private Equity Market:

Lessons, Implications and Prospects for India, RESERVE BANK OF INDIA

OCCASIONAL PAPERS, Vol. 30, No. 1, (2009),

http://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=2109#1

72 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

studies have shown that Leveraged Buyouts help companies to

perform in better ways due to factors such as pressure of servicing

debts, professional governing and metering structures brought in by

the acquirer etc.

45

But, while recognising that Leveraged Buyouts are beneficial

at the micro economic level (i.e. level of a single company), RBI is

also wary of its impact in the economy as a whole. An analysis of the

financial crisis post 2012 makes clear the dangers to the financial

system of using too much leverage. Regulatory authorities‟ failure to

limit the leverage is widely understood to have contributed to the

economic crisis. And in order to avoid the mistake being repeated,

jurisdictions like US which is the most liberal economic environment

in March 2013 issued guidelines that encourage banks to refuse to

make loans that would raise the debt levels of a company beyond 6

times earnings before interest, taxes, depreciation and amortization

(Ebitda).

46

Further, in April regulators began an annual review of the

loans banks make, and this has encouraged greater compliance.

KKR‟s request for a $725 million buyout loan, for example, was

refused in May by three banks with which it had long-standing

relationships on the grounds that regulators would find the loans too

risky.

47

It is also true that it was because of the blanket cushion

45

Kaplan, S. N., The Effects of Management Buyouts on Operations and Value,

JOURNAL OF FINANCIAL ECONOMICS, Vol.24, 217-254 (1989).

46

Eileen Appelbaum, Private Equity at Work: Limit Leverage to Limit Risk,

CENTRE FOR ECONOMIC AND POLICY RESEARCH, (June, 2014),

http://www.cepr.net/index.php/blogs/cepr-blog/private-equity-at-work-limit-

leverage-to-limit-risk.

47

Greg Roumeliotis & Lauren Tara LaCapra, Banks search for loopholes in

leveraged loan guidelines, Reuters, Jun 10, 2014 at

2015 LEVERAGED BUY-OUTS: UTILITY AND LEGAL ISSUES 73

provided by the economic regulations in place in India that economic

trends affecting developed markets do not influence us directly.

Therefore the question boils down to: “How much restriction

is required and how much can be done away with?” Now this

question is not something that India is solely dealing with. As can be

seen before in this paper, even UK has been changing its policies

trying to grapple with this issue. Another example is the USA which

we recently illustrated has brought in a change in its policy. Another

example is Italy where till 2004, LBOs in themselves were considered

illegal by the Courts.

48

The restrictions that are present in the Indian legal system can

be called excessive especially when we are aiming to be an economy

growing at the GDP of 7%.

49

A better and economic way ahead would

be to relax the rigid rules that restrict Leveraged Buyouts and still

keep in place certain precautionary measures to prevent excessive

leverage in the economy. Although a deeper analysis by the regulators

is required to come up with the final policies, certain areas that they

could look at would be to remove the absolute restriction on the

ability of banks to provide acquisition finance; rather there could be

policies in place as to when and to what extent banks can provide

such leverage. Another suggestion would be providing leveraged

https://in.finance.yahoo.com/news/banks-search-loopholes-leveraged-loan-

110630583.html .

48

Bottazzi , Private Equity Regulation: Lesson from Italy, RGE, (May 2008).

49

Budget 2014: Aim for 7-8% GDP growth in 3-4 years says Arun Jaitley,

Economic Times, Jul 10, 2014 at

http://articles.economictimes.indiatimes.com/2014-07-

10/news/51301043_1_fiscal-deficit-target-finance-minister-arun-jaitley-fiscal-

prudence.

74 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

buyout as an additional fourth exception to the rule against financial

assistance and at the same time incorporate protections for the

minority shareholders and creditors. A reanalysis of these policies is

imperative for India to energize the entrepreneurial climate in India.

And to facilitate the productive use of the existing assets and

resources of companies with untapped potential by reorganizing their

operations in ways that increase their value.

LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO

ISSUE OF SECURITIES- A COMPARATIVE PERSPECTIVE

Ashwini Vaidialingam and Mannat Sabhikhi



Public issuance of securities is one of the most important ways

by which companies seek to raise capital. By its very nature,

however, there is information asymmetry between the company

and the market. It is important for this gap to be bridged to

ensure that there is investor confidence in the market, which

will lead to greater efficiency and profitability. Mandatory

disclosure regimes seek to achieve this while balancing the

interests of the company, which tend to take a myopic view by

promoting their own interests. Different jurisdictions have

devised various procedural mechanisms to this end, by

formulating rules and regulations and setting up regulatory

authorities. This focuses on making certain heads of

information available to the general public through the issue of

prospectus, which is a public document. The law in India has

undergone changes in the recent past due to the enactment of

the Companies Act, 2013. This paper adopts a comparative

perspective by analyzing these changes in light of the position

in the UK, which was also modified in the aftermath of the

2008 financial crisis. This paper examines these changes

through the lens of investor protection and its effectiveness in

achieving the same.



IV Year Students, National Law School of India University, Bangalore

76 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

[A] INTRODUCTION

The raising of capital, which is vital for financing the business

activities of a company, invariably depends on the preferences of the

directors and financial advisors, on the nature of the proposed

business activity, as well as on the vagaries of the market, resulting in

companies adopting different policies in this regard.

1

One of the most

common ways of raising capital is through the issuance of

“securities”.

2

To regulate such issuance, and ensure that the rights of

the investors and the company are balanced, most jurisdictions,

including India and UK, have mandatory disclosure regimes. One way

of ensuring such a balance is by regulating the offer document, which

is the first step a company must take in issuing securities. The

prospectus, which is the offer document in case of public issues, has

to contain all information that is necessary for an investor to make an

informed decision. Such disclosure increases market confidence, and

boosts the securities market. This is particularly important in initial

public offerings, as investors have no prior knowledge of the

securities involved. Therefore, both jurisdictions have detailed

1

For instance, a small company may not wish to bear the potentially

disproportionate costs of raising capital through a public offering, and would

prefer to take a short-term bank loan to finance its business activities. On the

other hand, a large public company may choose to raise capital through a rights

issue, or by issuing debentures/loan stock to the public.

Pennington, COMPANY LAW, 290 (7

th

edn., 1995)

2

The definition of securities given in S. 2(h) of the Securities Contracts

(Regulation) Act, 1956 [“SCRA”] is very broad in its scope. This definition has

been espoused by other statues such as in S. 2(i) of the Securities and Exchange

Board of India Act, 1992 which established the Securities and Exchange Board

of India [“SEBI”], the regulator of the Indian securities market.

„Security‟ under English law is defined by section 3(1) of the Financial

Services and Markets Act 2000 (Regulated Activities) Order 2001.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 77

regulations on the procedure that must be followed in the issuance of

securities.

India and UK provide for both civil and criminal statutory

liability, which can be imposed on the company and all persons

involved in the issuance of the securities, including involved

intermediaries. Apart from statutory liability, all those who are

aggrieved by any deviation from the specified procedure have

recourse to common law remedies as well. In addition, regulatory

authorities in India and UK have certain powers which enable them to

enforce compliance.

The main focus of the paper is to do a comparative study of

the liability regimes in both jurisdictions. Given that there have been

significant changes with the introduction of the Companies Act, 2013,

this paper also addresses the differences between it and the

Companies Act, 1956. Part I deals with the evolution of the securities

market and the related liability regime is examined. Part II addresses

the liability that may be incurred when procedural requirements are

not fulfilled. In Part III the different liabilities arising out of untrue or

misleading statements in a prospectus in UK and India have been

examined. This includes civil, criminal and common law liability.

Finally, in Part IV, the differences in the role and liability of

intermediaries in the issuance of securities have been analysed.

[B] EVOLUTION OF STATUTORY LIABILITY

To fully understand the nature of the existing regulatory

regime for the securities market, it is important to understand how it

has evolved. This includes the formation of rules and regulations, and

78 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

the creation of regulatory bodies. In this section, this evolution in both

the UK as well as in India has been traced.

(1) United Kingdom

The current law on prospectus liability has its origins in the common

law tort of deceit. Imposing liability under the common law regime

was extremely hard.

3

In conjunction with this, due to numerous frauds

and busts, the public in nineteenth century England viewed Directors

as „predatory creatures who exploited public ignorance for personal

profit‟.

4

It was in this context that the case of Derry v. Peek

5

came

before the courts. Lord Herschell in his judgment held that first, for an

action of deceit, there must be proof of fraud and second, fraud is

proved when a false representation is made (i) knowingly or (ii)

3

GOWER AND DAVIES‟ PRINCIPLES OF MODERN COMPANY LAW, 935 (9

th

edn.,

2012). This is because to establish deceit, the plaintiff had to prove- (i) that the

maker of the statement knew that it was false or was reckless as to its truth (ii)

reliance was placed by the recipient on the statement and (iii) the maker of the

statement intended for the recipient to rely on it.

4

Michael Lobban, Nineteenth Century Frauds in Company Formation: Derry v.

Peek in Context, LAW QUARTERLY REVIEW 20 (1996).

5

Derry v Peek, (1889) 14 App.Cas. 337, HL.

The Plymouth, Devonport and District Tramways Company issued a prospectus

which stated that, “The company had the right to use steam or mechanical

power instead of horses.” However, at the time of issuance of the prospectus,

the company, in fact, did not have the right to use steampower, which was

under consideration by the Board of Trade.

The test that Lord Herschell employed in this case was whether the defendants

made a false statement knowingly or alternatively, whether they honestly

believed what they stated as a true and fair representation of facts. On the facts

of the case, Lord Herschell was of the opinion that the plaintiff has not

established fraudulent misrepresentation. This is because the defendants

believed that the consent of the Board of Trade was practically concluded.

Hence, they honestly believed what they asserted to be true. Therefore, the

charge of fraud was not made out against the defendants.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 79

without the belief in its truth or (iii) recklessly, careless whether it be

true or false.

6

The House of Lords adopted the rationale given by Stirling J.

of the Chancery Division that if any other interpretation was taken, it

would cause mercantile men to „cry out‟. However, the judgment was

seen to take a narrow view of principles such as good faith in

commercial transactions.

7

Public opinion of this judgment was that it

gave fraudsters a free reign to trick the public into buying shares in

bubbles.

8

This reaction of the public led to the passing of the

Directors‟ Liability Act, 1890.

The Directors‟ Liability Act, 1890 was the first legislation in

the United Kingdom that gave statutory backing to a claim by security

holders that they had been misled by a company‟s prospectus.

9

Section 3(1) of the Directors Liability Act, 1890 provides for the

liability of directors, promoters and persons authorizing the issue of a

prospectus to all persons who subscribe to the shares relying on the

prospectus for any damage they sustained due to an untrue

statement.

10

The defences available were reasonable ground for

believing the statement, fair representation of an expert‟s opinion, fair

representation of an official statement or document, or that the

director had withdrawn consent before the publication of the

prospectus, or that it was issued without his or her knowledge and

6

Derry v Peek, (1889) 14 App.Cas. 337, HL.

7

M. Loban, supra note 4, at 1.

8

M. Loban, supra note 4, at 22.

9

A. Alcock, Liability for Misinforming the Market, JOURNAL OF BUSINESS LAW

1 (2011).

10

Section 3(1), Directors‟ Liability Act

80 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

consent.

11

This Act did not provide for liability extending to market

purchases of shares.

These provisions were integrated into mainstream company

law legislations through the Companies (Consolidation) Act, 1908.

Section 84 of this act, which provided for the liability for statements

in the prospectus, was not substantially different from Section 3 of the

Director‟s Liability Act, 1890.

The Companies Act, 1948 made some additions to the extent

of liability. First, it made it unlawful for shares to be issued without a

prospectus, which had to carry certain mandatory provisions.

12

Second, experts were also made liable for any statement they

contributed to the prospectus, and third, shares allotted to an issuing

house with the view to ultimately sell them to the public, were

included within the ambit of offer for subscription.

13

Similar

provisions were reenacted in the Companies Act, 1985.

14

It was with the Financial Services Act, 1986 [“FSA, 1986”]

that a clear distinction was drawn between listing particulars for

shares sought to be listed on the Stock Exchange, and a prospectus for

unlisted securities.

15

The FSA, 1986 established the Securities and

Investments Board [“SIB”], which was the authority that framed

regulations.

16

The SIB was supported by self-regulatory organisations

11

Section 3(1), Directors‟ Liability Act,1890.

12

Section 28, Companies Act, 1948.

13

Section 43, Companies Act, 1948.

14

Section 56 to 71, Companies Act, 1985.

15

Chapters IV and V, The Financial Services Act, 1986.

16

Section 114, The Financial Services Act, 1986.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 81

[“SRO”] which regulated various different financial services and

participants.

17

It should be noted that with respect to the question of who can

sue for damages for a breach of a statutory duty, the FSA, 1986

provided for a remedy to all purchasers of securities i.e. it to „any

person who has acquired any of the securities in question‟.

18

Though, the FSA, 1986 was initially perceived as the first

major reform in the modern financial sector, subsequently, firms

viewed the system as too expensive and costly while stakeholders

viewed self-regulation as a mechanism for facilitating industry self-

interest.

19

It was in this context that the different regulatory bodies under

the FSA, 1986 were merged into one body called the Financial

Services Authority.

20

This body exercised statutory powers under the

Financial Services and Markets Act, 2000 [“FSMA, 2000”]. As per

the power to make rules, granted by the section 73 of the FSMA, 2000

the Financial Services Authority has framed Prospectus Rules, Listing

Rules and Disclosure and Transparency Rules. It also used to be the

17

Section 8, Financial Services Act, 1986.

18

Section 150, the Financial Services Act, 1986. Providing for a statutory remedy

to all people who bought securities and suffered loss in relation to a misleading

statement, is different from the common law position, which will be discussed

infra Part III(C).

19

L. Cox et al, United Kingdom Regulatory Reform: Emergence of the Twin

Peaks, COMPLIANCE OFFICER BULLETIN 4 (2012).

20

Id. Another reason for the formation of the Financial Services Authority was

that given by Gordon Brown, the then Chancellor of the Exchequer, to the

House of Commons that the boundaries between traditional banking, insurance

and investment business were becoming blurred. Therefore, there was a

requirement for a consolidated regulatory body that could address the

inefficiencies that a structure based on regulation by function could not.

82 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

„competent authority‟ for administering the statutory regulation of the

issue of share capital of companies on the London Stock Exchange

and associated options exchange.

21

The FSMA, 2000 tries to balance between creating a powerful

regulator, while at the same time ensuring that the regulator does not

restrict the free market in the general sense.

22

Through the Financial

Services Authority, it also sought to promote four core regulatory

objectives: market confidence, public awareness, the protection of

consumers, and the reduction of financial crime.

23

In 2010, the Financial Services and Markets Act 2000

(Liability of Issuers) Regulations 2010 introduced new aspects into

the statutory regime for issuer liability for misstatements. These

changes were incorporated in section 90A of the FSMA, 2000. Three

things need to be emphasized in context of liability for misstatements:

one, liability can be imposed for all information published by issuers

via a recognized service; two, liability can be imposed for dishonest

delay by the issuer in publishing information; and three, issuers may

be liable to buyers, sellers or holders of securities.

However, the inadequacies of the functioning of the Financial

Services Authority were exposed by the financial crisis that took

place in 2008. A report by the Conservative Party identified four

weaknesses of the system- (i) poor evaluation of and response to

emerging threats to financial stability; (ii) lack of appropriate

21

PALMER‟s COMPANY LAW VOL. 1, 5024 (25

th

edn., 2008).

22

Id, at 5025.

23

Section 2(2), Financial Services and Markets Act, 2000.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 83

instruments to mitigate emerging risks; (iii) inadequate prudential

regulation; and (iv) expertise and preparation for crisis handling.

24

In light of this, the UK government passed the Financial

Services Act, 2012 [“FSA, 2012”]. This Act did not repeal the FSMA,

2000 but just introduced some amendments. The FSA, 2012 however

did abolish the Financial Services Authority. Its responsibilities are

now exercised by two bodies: the Prudential Regulation Authority,

25

and the Financial Conduct Authority.

26

This new regime came into

effect on April 1, 2013, and it remains to be seen how effective it will

be.

(2) India

The securities market in India can be traced back to the

colonial period, when the first companies were set up. Stock

exchanges were set up in the presidency towns, with the Bombay

Stock Exchange being the most prominent of them all. However, the

securities market was largely unregulated. India, for the first 40 years

of independence, followed a model of self-reliance. Consequently,

due to high trade barriers and strict regulation of the market, the

Indian securities market was both underdeveloped and unregulated. It

could not compare with its well regulated counterparts in the

24

The Tripartite Review: a Review of the UK‟s Tripartite System of Financial

Regulation in relation to Financial Stability, as cited in supra note 21, at 7.

25

The Prudential Regulation Authority is a quasi-governmental regulator which is

responsible for the regulation and supervisions of banks, credit unions, insurers,

building societies and investment firms.

26

The Financial Conduct Authority is an independent body which regulates

financial firms providing services to consumers and focuses on regulating their

conduct.

84 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

developed world.

27

After independence, the Capital Issues (Control)

Act of 1947 and the Securities Regulation Act of 1956 had held the

field. The Securities Contracts (Regulation) Act, 1956 [“SCRA”] was

the primary legislation regulating stock exchanges in the country.

28

The year 1992, however, acted as a watershed. Among the

other financial reforms undertaken in that period, the Securities and

Exchange Board of India [“SEBI”] and the National Stock Exchange

were set up to regulate and modernize the securities market.

29

The

SEBI in particular was given the power to enforce the SCRA, the

Capital Issues (Control) Act, 1947, and to pass all necessary

regulations. In the last two decades, with the financial reforms and

positive actions taken by these new regulatory bodies, the securities

market in India has expanded considerably.

[B] ISSUE OF SECURITIES: PROCEDURE

Before a company issues securities, it must comply with a

series of complex procedures. Failure to do this leads to liability being

imposed on a number of persons, depending on the stringency of the

regulations imposed by the relevant jurisdiction. In this section, the

procedural framework in India and in the UK have been analysed and

compared.

27

S. Vattikuti, Accelerating Towards Globalization: Indian Securities Regulation

Since 1992, 23, NORTH CAROLINA JOURNAL OF INTERNATIONAL LAW AND

COMMERCIAL REGULATION, 105, 109-116 (1997).

28

Id.

29

The SEBI was set up under the Securities and Exchange Board of India Act,

1992. The NSE was incorporated in 1992, and officially recognized as a stock

exchange under the SCRA in 1993.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 85

(1) India

Offer Document: Form and Content

The first step in the process of raising capital through

securities is to issue an offer document. The nature and specifications

of this offer document depends on the law governing the issue. In the

case of a public offer, offer documents include a prospectus,

30

a shelf

prospectus,

31

a red herring prospectus,

32

or an information

memorandum.

33

In the case of a rights offer, a letter of offer is

issued.

34

30

Section 2(36), Companies Act 1956 defines prospectus as, “…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 subscription or purchase of any shares in, or

debentures of, a body corporate.” The definition contained in Section 2(70),

Companies Act, 2013 includes within its scope red-herring prospectuses and

shelf prospectuses, and excludes public deposits. It also broadens the definition

from “shares or debentures” alone to “any securities of the company”.

31

Section 60A, Companies Act, 1956. Explanation (b), Section 60A states:

““shelf prospectus" means a prospectus issued by any financial institution or

bank for one or more issues of the securities or class of securities specified in

that prospectus.” Section 31, Companies Act, 2013 defines shelf prospectus in

the Explanation as “a prospectus in respect of which the securities or class of

securities included therein are issued for subscription in one or more issues

over a certain period without the issue of a further prospectus.” Clearly, the

definition in the Companies Act, 2013, is broader as it includes all classes of

companies and not only financial institutions. It also prescribes one year

validity for a shelf prospectus commencing from the first offer of securities.

32

Section 60B, Companies Act, 1956 refers to both an information memorandum

as well as a red herring prospectus.

33

An information memorandum is defined under Section 2(19B), Companies Act,

1956 as: “…a process undertaken prior to the filing of a prospectus by which a

demand for the securities proposed to be issued by a company is elicited, and

the price and the terms of issue for such securities is assessed, by means of a

notice, circular, advertisement or document”. The concept of an information

memorandum seems to have been dispensed with in the Companies Act, 2013,

which only discusses red-herring prospectuses.

34

Section 2(x), The Securities and Exchange Board of India (Issue of Capital and

Disclosure Requirements) Regulations, 2009.

86 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

Section 56(3), Companies Act, 1956 requires every

application form for shares or debentures to be accompanied by a

memorandum that contains all the salient features of the prospectus.

Any person can ask for a copy of the whole prospectus while

subscription is still open.

35

This specifically relates to public

offerings, not amounting to an underwriting agreement.

36

Such a

prospectus must state all company-related matters as specified in Parts

I and II of Schedule II of the Companies Act, 1956. If any person

violates any of the mandatory requirements under Section 56, with

particular emphasis on the disclosure requirements, he may incur

liability extending to Rs. 50,000.

37

The contents of the offer document are very important, and

must be drafted carefully. The Companies Act, 1956 specifies the

form and contents of the prospectus in Schedule II.

38

This mandates,

among many other things, the disclosure of information about the

company, management, all proposed projects, information regarding 5

years of financial performance, and the perceived risk factors. The

company must also furnish information regarding other listed

companies which are governed by the same management.

39

In

addition to Schedule II of the Companies Act, 1956, Schedule VIII of

35

First Proviso to Section 56(3), Companies Act, 1956.

36

Second Proviso to Section 56(3), Companies Act, 1956.

37

Section 56(3), Companies Act, 1956. The prosecution powers in such cases are

exercisable by the SEBI and the DCA concurrently.

38

Schedule II of the Companies Act, 1956 was introduced by Notification No. SO

666(e) of October 3, 1991, and this replaced the erstwhile Schedule II.

39

“Same management” is defined under Section 370(1B), Companies Act, 1956

which has been repealed since October 31, 2010. However, the concept of

“same management” as laid out therein persists.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 87

The Securities and Exchange Board of India (Issue of Capital and

Disclosure Requirements) Regulations, 2009 [“ICDR Regulations”]

exhaustively lays out what must be disclosed.

40

In the event that the

company does not issue a prospectus, but only a “Memorandum

containing salient features of prospectus” i.e. an abridged prospectus,

the form and content requirements are laid out in Form 2A of the

Companies Act 1956. The main purpose of these disclosure

requirements is to enable investors to make an informed decision.

Under the 2013 Act, Schedule II has been dispensed with.

Instead, Section 26 of the Act expressly mentions what must be

disclosed,

41

with further disclosure requirements to be prescribed

under rules, which are yet to be notified.

Section 56, Companies Act 1956 also discusses the liability

for failure to fulfill the requirements laid down. In the event that any

person fails to comply with disclosure requirements in the prospectus,

they will be subject to penal liability.

42

It is submitted that this broad

phrasing expands the scope of the provision to cover all the

intermediaries who help facilitate the issue of securities. However,

there are certain specific circumstances in which directors and other

persons who were responsible for the prospectus will not be liable.

This includes situations when the person did not have knowledge of

40

Part A of The Securities and Exchange Board of India (Issue of Capital and

Disclosure Requirements) Regulations, 2009 specifies what disclosures are

required in a Prospectus, a Red Herring Prospectus and a Shelf Prospectus. Part

B and C list the non-mandatory disclosure requirements. Part D lists out the

disclosure requirements for Abridged Prospectuses. Part E lists the disclosure

requirements in Letters of Offer, and Part F on abridged letters of offer.

41

Section 26(1), Companies Act, 2013.

42

Section 56(3), Companies Act 1956.

88 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

the matters that the prospectus failed to disclose, when there was an

honest mistake made, or when this contravention or non-compliance

by the company is immaterial or can be excused by the court.

43

This

position is echoed in common law as well.

44

Under the Companies Act, 2013, while the broad scope of

Section 56, Companies Act, 1956 is retained,

45

the liability of the

company is different. Section 26(9) mandates a significantly enhanced

fine as well as imprisonment.

46

Furthermore, it does not make any

mention of defences available to persons so liable.

Companies may also issue an information memorandum prior

to issuing a prospectus. This is done for the purposes of gauging the

market. If they choose to do so, they have to issue a red-herring

prospectus as well, which together with the information

memorandum, is subject to the same mandatory regulations as a

prospectus.

47

This implies that the company, its directors and

employees, as well as all intermediaries will be as liable for

misstatements in the information memorandum as in a prospectus

issue. In the event that the final prospectus differs in any way from

this red-herring prospectus, all such variations must be intimated to

any and all invitees.

48

If there is failure on the part of the company,

43

Section 56 (4), Companies Act, 1956.

44

This is discussed below: infra Part III(C).

45

As opposed to referring specifically to directors and other persons as under

Section 56, Companies Act, 1956, Section 26, Companies Act, 2013 states that

“every person who is knowingly a party to the issue of such prospectus…” shall

be liable.

46

Section 26 (9), Companies Act, 2013.

47

Section 60B(3), Companies Act, 1956.

48

Section 60B(6), Companies Act, 1956.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 89

the underwriters or bankers to the issue, to adequately inform the

invitees, all applicants are entitled to receive a refund. The company

will also be liable to pay an interest of 15% from the date of payment

till the refund is realized.

49

In the 2013 act, the concept of information memorandums has

been done away with. The process of issuing a red-herring prospectus

has also been greatly simplified. Moreover, the requirements and

liability under Sections 60(5) to (8) that existed under the Companies

Act, 1956 have been removed.

50

Expert Statements in Prospectuses

When a company releases a prospectus, it may include within

it, expert statements. These are statements made in the prospectus by

experts in a relevant field which give authority to claims made

therein.

51

While such use of experts is permitted, and even

encouraged, no person is allowed to make a statement in the

prospectus purporting to be an expert on any matter, if he had been, or

was at the time of the issue, or at any previous time been connected

with the company.

52

Such measures ensure that the public are not

misled by any biased or personal opinions, masquerading as

49

Section 60B(8), Companies Act, 1956.

50

Section 32, Companies Act, 2013.

51

“Expert” means anyone who holds himself out to the public as specially

qualified in any line by knowledge or skill (Palmer‟s Company Precedents, 123

(16th edn.) as cited in A Ramaiyya, GUIDE TO THE COMPANIES ACT, 863 (17

th

edn., 2010).). The statutory definition as that stated in Section 59(2),

Companies Act, 1956 - “expert” includes engineer, valuer, accountant and any

other person whose profession gives authority to a statement made by him.

52

As per Section 57, Companies Act, 1956, this connection is understood in the

terms of “engaged or interested in the formation or promotion, or in the

management, of the company.”

90 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

authoritative analyses. However, such a “connection” with the

company does not include any professional engagement, but only

personal ones. For instance, a chartered accountant or a solicitor

engaged by the company in a professional capacity, for assisting in

the preparation of constitutional documents, can act as an expert.

53

Further, any such expert statement included in the prospectus

has to be with the expert‟s express consent in writing, to both the

form and the content. If he withdraws consent prior to issuance, the

company cannot use his statements.

54

This section has been adopted

from English law.

55

If there is failure to abide by these requirements

as to expert statements in the prospectus, the company and every

person who was “party to the issue thereof” are punishable with fine

up to 50,000 rupees.

56

Under the 2013 Act, however, Section 35(1)(e)

makes experts liable to pay compensation to every person who relies

on and suffers consequent loss due to any misstatements in the

prospectus. This is a departure from the position in the Companies

Act, 1956 where experts were made expressly liable only to the

statement made by them in the prospectus.

Registration of Offer Documents

53

This is because only personal or financial interests are presumed to affect any

objective assessment that may be done. Mere professional transactions are not

presumed to colour any statement that is made in the prospectus. A Ramaiyya,

supra note 60.

54

Section 58, Companies Act, 1956.

55

This provision takes inspiration from Section 40 of the 1948 English

Companies act. It is meant to be a “wholesome rule intended to protect

intending investors by making experts liable”. ¶ 59, Company Law Committee

Report, 1952, as cited in Ramaiyya, supra note 60.

56

This provision pertaining to the consent of experts has been incorporated in the

Companies Act, 2013, in Section 26(5).

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 91

Prior to issuing a prospectus, all directors or proposed

directors must sign and deliver a copy of it to the Registrar of

Companies.

57

This copy must be accompanied by the written consent

of all experts as per Section 58, as well as endorsed copies of all

existing contracts and other statements pertaining to Schedule II

disclosures.

58

Such contracts mentioned in the prospectus or other

documents cannot be varied unless the company in general meetings

grants its approval.

59

Any liability for failure to abide by this

provision does not fall within the jurisdiction of a company court, but

will be subject matter of a regular court. Ordinary civil courts will

have jurisdiction in such cases.

60

The Registrar will then register this prospectus, after ensuring

all the requirements under Sections 56-58 are complied with.

61

He

must also ensure that the consent of any person named in the

prospectus such as an auditor, attorney, solicitor, banker or broker,

have been included as a separate statement.

62

Once this prospectus is

registered, it must be issued within 90 days.

63

If it is not issued, then it

will be deemed a prospectus for which registration has not been done.

A failure to follow any of these stipulated requirements under Section.

57

Section 60, Companies Act, 1956. This requirement is retained under Section

26(4), Companies Act, 2013,, subject to a few modifications.

58

Under the Companies Act, 2013,, there is no requirement for these endorsed

copies of every contract entered into by the company and Schedule II

documents.

59

Ramaiyya, supra note 60; Section 27, Companies Act, 2013.

60

Poonam Chand Kothari v. Rajasthan Tubes Mfg. Co. Ltd., (1996) 87 Com

Cases 842 (Raj).

61

This has been incorporated in Section 26(7), Companies Act, 2013.

62

Section 60(3), Companies Act, 1956.

63

Section 60(4), Companies Act, 1956.

92 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

60 of the Companies Act, 1956 will expose the company and every

person who has knowingly authorized the issue to a fine extending to

Rs. 50,000.

64

This provision follows Section 41 of the English Companies

Act of 1948 and Sections 64-65 of the 1985 Act, which provides for

registration of the prospectus. However, the Indian law makes certain

departures. Once registered, the prospectus must be issued within 90

days. There is no similar provision in English law. The purpose

behind such a restriction on the company and all persons involved is

to ensure that the issue is not delayed for a considerable period of

time. This is because conditions may be altered and what appears in a

prospectus may not necessarily be valid at the end of that period of

time.

65

The Companies Act, 2013 incorporates these requirements in

Section 26(8). Further, under the Companies Act, 2013, if a

prospectus is issued without registration, the liability has been

enhanced: the company and any party who knowingly issued the

prospectus shall be liable to pay a fine of minimum Rs. 50,000 but

which may extend to three lakh rupees; such persons may also be

imprisoned up to 3 years.

66

Section 60, Companies Act, 1956 also mandates the written

consent of certain persons named in the prospectus.

67

While this

written consent does not expose such persons to liability,

68

it ensures

64

Section 60(5), Companies Act, 1956.

65

Ramaiyya, supra note 60 at 946.

66

Section 26(9), Companies Act, 2013.

67

Section 60(3), Companies Act, 1956.

68

This is only in so far as they are not acting as experts. If they are acting as

experts, Ss. 58 and 59, Companies Act, 1956 will apply to them.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 93

that they are circumspect in their actions. The public places

importance on the inclusion of well-known or respected names in a

prospectus, and this ensures that such professionals do not associate

themselves with dubious enterprises.

69

Interestingly, however, there is

no such requirement under the Companies Act, 2013. Only those who

have been named as a director, or proposed director, or their duly

authorized attorney need to provide such written consent.

70

(2) United Kingdom

The prospectus rules are provided in the Financial Conduct

Authority Handbook (FCA Handbook). A prospectus can either be a

single document or separate documents.

71

If the prospectus is in the

form of a single document it needs to have a registration document, a

securities note and a summary.

72

However, if the prospectus is in the

form of separate documents, it must have a registration document

which contains information of the issuer and the securities that are

going to be issued.

73

Under the FSMA, 2000 it is unlawful to deal in transferable

securities unless an approved prospectus has been published.

74

Moreover, the mere request to have securities admitted to trading on

69

¶ 60, Report of the Company Law Committee, 1952, as cited in Ramaiyya,

supra note 60, at

70

Section 26(4), Companies Act, 2013.

71

Para 2.2.1R, Prospectus Rules, Financial Conduct Authority Handbook, 2013.

72

Para 2.2.2(1)R, Prospectus Rules, Financial Conduct Authority Handbook,

2013; Further requirements are laid down in Article 25.1, Prospective

Directives Regulation.

73

Para 2.2.2(2)R, Prospectus Rules, Financial Conduct Authority Handbook,

2013; Further requirements are laid down in Article 25.2, Prospective

Directives Regulation.

74

Section 85(1), Financial Services and Markets Act, 2000.

94 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

the stock exchange is criminalized unless such an approved

prospectus has been made available to the public.

75

Copies of Form A and the prospectus are the relevant

documents for the approval by the competent authority.

76

The

competent authority cannot approve a prospectus unless the

requirements under section 87A(1) of the FSMA, 2000 are satisfied.

77

Section 87A(1)(b) contains a requirement that all „necessary

information‟, as defined in section 87A(2) of the FSMA, 2000,

78

needs to be provided. The general duty for disclosure is that the

investor needs to make an „informed assessment‟

79

i.e. while

preparing the prospectus, the people involved in the drafting must

keep in mind the level of information a prospective investor needs to

be able to assess the securities being offered. As is evident, the United

Kingdom follows a system of mandatory disclosure obligations on

issuers. This is to promote confidence in the market and protect

investors.

80

The FSMA, 2000 also permits, in certain circumstances, the

omission of required information.

81

However, this is only allowed by

application of the issuers of the prospectus. The application must

75

Section 85(2), Financial Services and Markets Act, 2000. Exemptions to the

requirement of issuing a prospectus are laid down in Section 86, Financial

Services and Markets Act, 2000.

76

Para 3.1.1R, Prospectus Rules, Financial Conduct Authority Handbook, 2013.

77

Section 87A, Financial Services and Markets Act, 2000.

78

Section 87A(2), Financial Services and Markets Act, 2000.

79

Palmer, supra note 23, at 5114.

80

Ellis Ferran, COMPANY LAW AND CORPORATE FINANCE, 582 (1999).

81

Section 87B, Financial Services and Markets Act, 2000.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 95

identify the information that is sought to be omitted, and the reasons

under Section 87B(1) for the same.

82

Additionally, Section 87G provides for a procedure if during

the relevant time period,

83

there is a “a significant new factor,

material mistake or inaccuracy relating to the information included in

a prospectus approved by the competent authority”.

84

The persons

responsible for the prospectus can then provide for the further

information in a „supplementary prospectus‟ to the FCA. The issuers

of the prospectus do not need to start the procedure for approval of

prospectus from scratch. In fact, persons responsible for the

prospectus have an obligation to give notice of any new factor,

mistake or inaccuracy.

85

The purpose of the supplementary prospectus

is to correct any incorrect impression created by the original

prospectus.

To ensure that issuers of securities comply with the above

requirements, the Financial Conduct Authority has been given certain

powers. They can be divided it two parts based on the time at which

they are exercised- ex ante controls and ex post controls:

Ex ante Controls

The methods by which the FCA can exercise ex ante control

are as follows –

82

Para 2.5.3R, Prospectus Rules, Financial Conduct Authority Handbook, 2013.

83

As per Section 87G(3), Financial Services and Markets Act, 2000, „relevant

time period‟ begins when the prospectus is approved and ends either with the

closure of the offer of the transferable securities to which the prospectus relate

or when trading in those securities on a regulated market begins.

84

Section 87G(1), Financial Services and Markets Act, 2000.

85

Section 87G(5), Financial Services and Markets Act, 2000.

96 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

1. The FCA can refuse admission to listing where the applicant

has not met the listing requirements or any other requirement

imposed in relation to application.

86

2. The FCA does not need to approve a prospectus if it does not

contain the required information or other rules are not adhered

to.

87

3. The FCA can suspend offer of securities, even after it has

approved the prospectus, if it has reasonable grounds to

suspect that Part VI of the FSMA or of the Prospectus Rules

or any other provision required by the Prospective Directives

has been infringed.

88

4. If the FCA finds that a provision has been or is likely to be

infringed it can require the offer to be withdrawn or the

securities to be prohibited from trading.

89

If there are suspension orders or instances where the FCA

refuses to give approval, notice needs to be issued to the applicant

stating the reasons for the action.

90

Moreover, of the two powers i.e.

to refuse admission to listing and not approving a prospectus, the

latter may be more viable. This is because if the FCA cancels listing

rights, after securities have been offered to the public, it will result in

shareholders holding an illiquid asset.

91

Ex Post Controls

86

Section 75(4), Financial Services and Markets Act, 2000.

87

Section 87A, Financial Services and Markets Act, 2000.

88

Section 87K, Financial Services and Markets Act, 2000.

89

Section 87L, Financial Services and Markets Act, 2000.

90

Section 87D, Financial Services and Markets Act, 2000.

91

Gower, supra note 3, at 940.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 97

The FCA can also impose penalties on individual members of

a corporation. Section 91(1A) of the FSMA, 2000 provides for

penalties to be imposed if there has been a breach of Part VI of the

FSMA, prospectus rules or listing rules. The FCA may substitute

public censure in lieu of imposing a penalty.

92

This liability can also

be imposed on individual Directors who were knowingly parties to

the contravention.

93

It is submitted that any law on the liability of issuers of

securities should have remedies arising under both general,

substantive law and financial regulation. There is a question of which

of these two systems are more efficacious.

94

However, the researchers

submit that since both laws are based on different presumptions and

are aimed at different aspects of the issuance, having both frameworks

provides for a more holistic system.

95

92

Section 91(3), Financial Services and Markets Act, 2000.

93

Section 91(2), Financial Services and Markets Act, 2000.

94

Palmer, supra note 23, at 5009-5010.

On the one hand, financial regulation is concerned with the observance of

standard market procedures with a view to support the efficiency of markets.

Palmer considers two aspects of general law that result in it being more

efficacious than financial regulation. One, is that common law and equity are in

constant flux and therefore, better able to adapt to changing situations and

second that since the general law is not created by people involved in financial

markets, it carries a latent expression of common social morality and of general

legal principles.

95

General law is based on principles of general contract law, tort and equity, and

is concerned with the good faith issuance of securities. While, financial

regulation deals with standard procedures that need to be followed in the

market to promote better efficiency in functioning. See, Palmer, supra note 23,

at 5009.

98 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

(3) Comparison between UK and India

While the broad principles relating to issue of prospectus are

the same in both jurisdictions, there are certain differences in the

liability incurred. For instance, liability incurred with respect to

registration of prospectus differs. In India, as discussed previously,

the prospectus must necessarily be registered with the Registrar of

Companies, prior to the issue. Failure to do so will attract a penalty of

Rs. 50,000 under the Companies Act, 1956.

96

Under the Companies

Act 2013, the penalty has been made harsher. The company and every

person who was knowingly a party to the issue will be liable to pay a

fine not less than Rs. 50,000, which may extend to three lakh rupees

as well. Every person, who was knowingly a party to this, may also be

punished with imprisonment for a term up to three years. With respect

to English law, a prospectus cannot be circulated without being

approved by the FCA. Failure to follow this would result in criminal

liability of a term extending to 3 months and/or fine for a summary

conviction, and up to 2 years and/or fine for a conviction.

97

Moreover, under English law, any liability that the company

may incur with respect to the prospectus extends to supplementary

prospectuses as well.

98

In contrast, the Companies Act, 1956, and

other related legislations do not allow for such supplementary

prospectuses. If any change has to be made to a prospectus, the entire

issuance process must be started de novo.

96

Section 60, Companies Act, 1956.

97

Section 8(3), Financial Services and Markets Act, 2000.

98

Section 90(10), Financial Services and Markets Act, 2000.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 99

Finally, under the Companies Act, 1956, if there is failure to

comply with the requirements under Section 60, such as attaching a

copy of written consent by an expert, the company and every person

who is knowingly a party to the issue, may be liable to pay fine up to

Rs. 50,000. A similar, but more enhanced liability exists under

Section 26(9) of the Companies Act, 2013 as well. There is no such

corresponding provision in the UK under the FSMA.

[C] LIABILITY – CIVIL, CRIMINAL AND COMMON LAW

In addition to imposing sanctions for violations of the rules for

the publication of a prospectus, liability also arises in both

jurisdictions with respect to false or misleading statements made by

persons responsible for the prospectus. This is with a view to protect

investors from suffering loss due to misinformation of an investment.

This section will examine the liability arising in connection with the

issuance of securities in both UK and India, under three heads- civil

liability [A], criminal liability [B] and common law [C]. The

researchers have also distinguished the liability regimes in India and

the UK under the heads of civil liability and criminal liability. Finally,

the researchers will also look at certain specific liabilities that are

imposed on intermediaries [D].

100 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

(1) Civil Liability

India

Liability on the part of companies and other persons is not

limited to that imposed under Section 56.

99

If the prospectus contains

any untrue statements, or is fraudulent or engages in

misrepresentation, liability may still be imposed. This involves paying

compensation to every person who subscribes for shares or debentures

based on the strength of these untrue statements contained in the

prospectus, who have suffered any loss or damage.

100

There are four categories of persons who may be so liable:

101

1. Every director at time of the issue

2. Anyone is named or has authorized himself to be named in the

prospectus as a director or has agreed to become a director of

the company immediately or after an interval of time.

3. All promoters of the company

4. Anyone else who has authorized the issue of the prospectus

The fourth category is subject to exceptions. It does not

include any expert who has given consent under Section 58. It also

excludes any “auditor, legal adviser, attorney, solicitor, banker or

broker of the company or intended company” who has consented

99

In fact, Section 56(6), Companies Act, 1956 specifically states: “Nothing in this

section shall limit or diminish any liability which any person may incur under

the general law or under this Act apart from this section.”

100

Section 62, Companies Act, 1956.

101

Section 62(1), Companies Act, 1956.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 101

under Section 60(3).

102

Such persons will only be liable to the extent

of their own statement in the prospectus.

103

This liability that is imposed is not absolute in nature. It is

subject to certain exceptions. First, any person so liable will be

exempt if he shows that he withdrew consent to the impugned

statement, before the prospectus was issued, and that this issuance

was undertaken in without his authority or consent.

104

Secondly,

liability may also be avoided if the prospectus was issued without that

persons‟ knowledge or consent, and upon becoming aware of the

same, he gave reasonable public notice of this absence of knowledge

or consent.

105

Thirdly, if this person becomes aware of an untrue

statement after the prospectus has been issued but before the

allotment has occurred, he can withdraw his consent. He must also

give reasonable public notice of and reasons for the same.

106

Finally,

there is no liability if as regards the untrue statement, that person had

reasonable ground to believe and did in fact, believe that the

statement was true. If this statement was made by an expert or was of

official nature, it should have been a fair and correct representation of

an extract of, or of the statement itself. In the case of an expert, the

person must also have had reasonable ground to believe, and should

102

Section 60(3), Companies Act, 1956.

103

Proviso to Section 62(1)(d), Companies Act, 1956.

104

Section 62(1)(a), Companies Act, 1956.

105

Section 62(1)(b), Companies Act, 1956.

106

Section 62(1)(c), Companies Act, 1956.

102 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

have believed that the expert had competence to, and did consent to,

the statement.

107

Experts making statements in a prospectus may also be held

liable if the statement made by them authorizing the issue of the

prospectus is untrue. However, he may be exempt from liability if:

108

1. He withdraws consent in writing before delivery of the copy

of the prospectus

2. After delivery of the copy of the prospectus for registration

and prior to allotment, he becomes aware of the untruth, then

withdraws consent in writing and gives reasonable public

notice with reasons for the withdrawal.

3. He was both competent to make the statement and had

reasonable grounds to believe, and did believe that the

statement was true

Liability may be imposed upon other directors and other

persons authorizing the issue of the prospectus, if the prospectus

names people as directors, even though they are not directors; or if the

named persons have withdrawn consent from the prospectus; or if the

named persons have not authorized or consented to the issue of the

prospectus; or where consent is required under Section 58, such

consent has either not been given, or has been withdrawn prior to the

issue of the prospectus.

109

In such a case, they will be required to

indemnify such persons named consequently for all damages, costs

107

Section 62(1)(d), Companies Act, 1956.

108

Section 62(2), Companies Act, 1956.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 103

and expenses that they may incur, as well as any costs arising out

legal proceedings instituted against them.

110

The 2013 Act has made several changes with respect to this

civil liability. It retains the broad scope under Section 62, including

all four categories previously mentioned.

111

However, significantly, it

adds experts as a fifth category to the list of persons who are liable.

Further, unlike Section 62 of the Companies Act, 1956, Section 35 of

the Companies Act, 2013 makes a distinction between innocent and

fraudulent misstatements. If the statement made is fraudulent, under

Section 35(3), all such persons shall be personally responsible, with

unlimited liability, to all those incurring loss or damage due to the

untrue statements made. This imposition of unlimited personal

liability is not there under Section 62 of the Companies Act, 1956.

Further, Section 35 of the 2013 Act simplifies Section 62 of

the Companies Act, 1956 to a large extent. Under sub-section (2), in

the case of directors, the director has to prove that he withdrew his

consent before the prospectus was issued; in the case of all other

persons who may be liable, they have to show that the prospectus was

issued without their knowledge or consent, and that on becoming

aware, they immediately gave reasonable public notice indicating the

same. This is vastly different from Section 62 which provides very

similar defences, in a complicated yet repetitive manner, for the

different categories of persons who may be liable. This is particularly

110

Id.

111

By retaining persons who have “authorized the issue of the prospectus”, it

continues to cover intermediaries. Section 35(1)(d), Companies Act, 2013.

104 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

true with respect to the liability of “experts”, which has a much more

detailed definition under Section 26(5) of the Companies Act, 2013

that that under Section 59(2) of the Companies Act, 1956.

112

By

proceeding on the basis of the definition of an expert as someone

unconnected to the company, who has consented in writing and has

not withdrawn his consent prior to the issue of the prospectus, the

legislature has avoided the complicated approach under Section 62 of

the Companies Act, 1956.

113

A similar approach, simplifying matters,

can be seen with respect to directors‟ liability as well.

However, there are certain drawbacks as well to this

simplification. Under the Companies Act, 1956, as previously

discussed, there were defences available to persons under certain

specific circumstances, which have been dispensed with under the

Companies Act, 2013.

114

Finally, the Companies Act, 2013 also allows for class action

by virtue of Section 37. A suit may be filed under Section 35,

Companies Act, 2013 by any person, group of persons or any

112

Experts have been defined in Section 26(5), Companies Act, 2013, as someone

“who is not, and has not been, engaged or interested in the formation or

promotion or management, of the company and has given his written consent to

the issue of the prospectus and has not withdrawn such consent before the

delivery of a copy of the prospectus to the Registrar for registration and a

statement to that effect shall be included in the prospectus”.

113

Under Section 62, Companies Act, 1956, experts who have not given consent,

or who have withdrawn consent have been repeatedly exempted in sub-sections

(2), (3) and (4). The approach under the Companies Act, 2013, is evidently

briefer and less confusing.

114

These defences included whether the untrue statement was a correct and fair

representation, whether there was reasonable ground to believe and the person

did believe that the statement made by an expert or an official document was

true. These defences, exempting persons from liability have been done away

with under the Companies Act, 2013.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 105

association of persons who have been affected by a misleading

statement or the inclusion or omission of any matter in the prospectus.

Affected shareholders can thus, take joint action.

United Kingdom

Section 90 of the FSMA, 2000 provides for a parallel remedy

to those provided for in common law. A statutory remedy for loss

suffered due to a misleading statement was necessary because under

common law, it was difficult to establish proximity between the

maker of the statement and the investor.

115

Moreover, as illustrated in

Part I of this paper, the burden was on the plaintiff to establish that the

maker of the statement had fraudulent intent. The current statute

providing a remedy for false or misleading particulars is the FSMA,

2000. It needs to be emphasized that the FSMA, 2000 is a supplement

to the common law remedies.

116

This section will examine the

nuances of the civil liability as provided for in sections 90 and 118 of

the FSMA, 2000.

Three heads of liability arise from section 90 of the FSMA,

2000: (i) untrue or misleading statements;

117

(ii) omission of material

which would otherwise be required by section 80 or 81;

118

and (iii)

omission of information about the absence of a particular matter

115

See Part IIID(2)(ii).

116

Section 90(6), Financial Services and Markets Act, 2000.

117

Section 90(1)(b)(i), Financial Services and Markets Act, 2000.

118

Section 90(1)(b)(ii), Financial Services and Markets Act, 2000.

The heads of liability in relation to false or misleading statements or omissions

in listing particulars were extended to apply to prospectuses in the same manner

by Prospectus Regulations (SI 2005/1433) 2005.

106 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

required by the listing particulars.

119

The amount of compensation

payable will be determined in the same manner as a claim in tort.

120

Moreover, in 2010, section 90A was introduced by way of

amendment.

121

This section makes issuers of securities liable to pay

compensation for a misleading statement or a dishonest omission in

certain published information relating to the securities and a dishonest

delay in publishing such information. With respect to the former,

Section 90A extends liability to any information that has been

published by a quoted company, through a recognized information

services, whether the information is required to be published or not.

122

Additionally, the liability for delay in context of issuance of securities

will arise in the situation where bad news is dishonestly delayed, and

the claimant purchased the securities in that delay.

123

To bring a claim under section 90, two things need to be

proved by the plaintiff: first that some loss has been suffered by them

and second, that the loss was a result of the untrue or misleading

statement or omission.

124

The plaintiff does not necessarily need to be

a subscriber; they can also be a purchaser in the secondary market.

125

119

Section 90(3), Financial Services and Markets Act, 2000.

120

Palmer, supra note 23, at 5218.

121

By the Financial Services and Markets Act 2000 (Liability of Issuers)

Regulation, 2010.

122

Alcock, supra note 8, at 7.

123

Alcock, supra note 8, at 7.

124

Alcock, supra note 8, at 7.

125

Section 90(1)(a), Financial Services and Markets Act, 2000 states that a remedy

exists for „a person who has acquired securities to which the particulars

apply‟. „Acquire‟ has been defined in Section 90(7) as contracting to acquire

securities or having an interest in them.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 107

Persons who can be held liable under section 90 are provided

for in Para 5.5, Prospectus Rules.

126

The people responsible in an

offer of equity shares are-

1. The issuer

2. The directors of the issuer

3. Each person who has authorized themselves to be named in

the prospectus

4. Each person who has accepted responsibility, and is stated to

have accepted responsibility, for any part of the prospectus

5. Each person who has authorized the contents of the prospectus

or any part of it, and

6. The offerer of the securities or the company seeking admission

and its directors where it is not the issuer.

127

The above liability is subjected to the exceptions under

Schedule 10 of the FSMA, 2000.

128

There are four defences that can

be availed of -

1. Defendant‟s belief

129

– there are two limbs to this defence.

The first is that the defendant should have believed the

statement at the time when the listing particulars, prospectus,

supplementary prospectus were submitted for approval.

126

Para 5.5, Prospectus Rules, Financial Conduct Authority Handbook, 2013

makes a classification between „equity shares‟ and „all other securities‟.

127

Gower states that this is for secondary offers. However, the offeror will not be

liable if the offeror was made in association with the issuer and the issuer took

the lead in drawing up the prospectus. Gower, supra note 3, at 933.

128

Section 90(2), Financial Services and Markets Act, 2000.

129

Para 1, Schedule 10, Financial Services and Markets Act, 2000.

108 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

The second is in relation to the time when the securities were

acquired by the plaintiff. One of the four alternatives needs to

be present-

a. That the defendant continued in their belief

b. Securities were acquired before it was reasonably

practicable to bring to the notice of person the

correction

c. Before the acquisition of the securities, the defendant

had done all that is reasonable for him to ensure that

the correction had been brought to the notice of

interested persons.

d. Substantial lapse of time between commencement of

business and the claimant‟s acquisition of securities.

2. Statement by an expert

130

– this defence is not available to the

expert but to the person who is incurring liability under

section 90(1). This defence is similar to the first one i.e. there

are two limbs- first, at the time of submitting documents for

approval, the defendant‟s belief should have existed and

second, subject to the time when the securities are acquired by

the plaintiff. The four alternatives in the second limb are also

the same as those mentioned above, under (1).

3. Correction

131

– this defence is based upon publication, or the

taking of reasonable steps to secure publication of a

correction. The defendant needs to establish that before the

130

Para 2(1), Schedule 10, Financial Services and Markets Act, 2000.

131

Para 3, Schedule 10, Financial Services and Markets Act, 2000.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 109

securities were acquired, a correction of the fact had been

published. Or, the defendant needs to establish that they took

all reasonable steps to bring it to the notice of the claimant,

and they actually believed that this had taken place before the

acquisition of securities.

4. Official Statement or Document

132

– the defendant only needs

to establish that such statement or document was fairly and

accurately reproduced.

5. Claimant‟s Knowledge- the defendant has to prove that the

person claiming compensation had knowledge of the false or

misleading particular or omission in the document. The test

for „knowledge‟ is whether the claimant would have known if

reasonable enquiries had been made.

133

Market Abuse

Civil liability can also arise under Section 118 of the FSMA,

2000 which defines market abuse generally, which is when persons

use „insider information‟

134

in relation to qualifying investments

admitted to trading, or where a request has been made for permission

to trade. Section 123 of the FSMA provides that if a person has

engaged in market abuse, it can either impose an appropriate

penalty

135

or publicly censure the person.

136

132

Para 2(3) & 4, Schedule 10, Financial Services and Markets Act, 2000.

133

Palmer, supra note 23, at 5221.

134

Section 118C(2) of the FMSA, 2000.

135

Section 123(1), Financial Services and Markets Act, 2000.

136

Section 123(3), Financial Services and Markets Act, 2000.

110 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

Included in the definition of market abuse is acting on

information which is generally not available to the general public, but

which would affect the decision of a regular investor;

137

transactions

that are conducted which are likely to give a false or misleading

impression as to the supply or demand of the qualifying

investment;

138

or the dissemination of information by means which

gives or is likely to give a false or misleading impression.

139

Comparison between India and the UK

In India, as discussed previously, there are 4 categories of

persons who will liable under the Companies Act, 1956. The

Companies Act, 2013 has introduced a fifth category – experts

making statements in the prospectus. In English law, on the other

hand, civil liability does not extend to experts, but only to persons

liable under Section 90, as discussed in the previous sub-section. Such

persons also will not be liable for expert statements if they satisfy the

exceptions under Schedule 10. Further, the categories of persons

liable under Indian law, in both the Companies Act, 1956 and the

Companies Act, 2013, do not include the company which is issuing

the prospectus. In the UK, on the other hand the issuer of the

prospectus is also liable. According to Professor Gower, this “issuer”

means the company itself.

140

UK and Indian law also differ on the question of who can sue. A plain

reading of Section 56 indicates that only subscribers to securities have

137

Section 118(4), Financial Services and Markets Act, 2000.

138

Section 118(5), Financial Services and Markets Act, 2000.

139

Section 118(7), Financial Services and Markets Act, 2000.

140

Gower, supra note 3, at 933.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 111

a remedy. In contrast, UK law not only provides remedies for

subscribers, but also for purchasers in the secondary market.

141

Moreover, in UK law, if the claimant had knowledge of the

error or misstatement in the prospectus, he cannot claim

compensation under Section 90, FSMA, 2000. In India, there is no

such statutory defence provided to persons who may otherwise be

liable. Additionally, in Indian law, a person will be exempted from

liability if he is named in the prospectus as a director, but is not

actually a director.

142

There is no corresponding express statutory

defence in UK law. This defence is not expressly mentioned in the

Companies Act, 2013 either.

(2) Criminal Liability

India

Liability imposed, under the Companies Act, 1956 and the

Companies Act, 2013 in the case of untrue statements in prospectuses

may also be of penal nature. This is over and above penal sanctions

that may be imposed under other statutes, such as the Indian Penal

Code, 1872. However, all offences under the companies act may not

be taken cognizance of by any court unless the Registrar, shareholder

or any person authorized by the Central Government makes a

complaint in writing.

143

Under Section 63 of the Companies Act, 1956, any person

authorizing the issue may be subject to two years imprisonment or a

141

Section 90, Financial Services and Markets Act, 2000.

142

Section 62, Companies Act, 1956.

143

Section 621, Companies Act, 1956.

112 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

fine extending to Rs. 50,000, or both. However, in the event that the

person did have reasonable ground to believe and did believe that the

statement was true up to the time of issue, or if the statement was

immaterial, there is no liability.

144

Echoing the other related

provisions in the Companies Act, 1956, this criminal liability does not

extend to persons merely because they have consented under Section

58 or Section 60 (3).

145

Criminal liability also exists under Section 68,

when a person fraudulently induces others to invest in the company

though shares or debentures.

146

The company is not permitted to allot shares in its first

allotment, unless a minimum subscription, as stated in the prospectus,

is received. There are strict regulations as to the procedure to be

followed in such cases. For instance, the money collected must be

accounted for and deposited in a very specific manner. Moreover, if

the minimum subscription is not received within 120 days, all the

money received must be returned to the applicants.

147

If this process is

not adhered to, every promoter, director and other person responsible

for the contravention is liable for fine up to Rs. 50,000.

148

In the

specific event that there is failure to return all the monies within 130

days from issue, all directors shall be jointly and severally liable to

repay the money at 6% interest from then on.

149

144

Section 63(1), Companies Act, 1956.

145

Sections 58, 63(2), Companies Act, 1956.

146

Section 68. Companies Act, 1956.

147

Section 69(5), Companies Act, 1956.

148

Section 69(4)(b), Companies Act, 1956.

149

This liability is on the condition that this default is not because of misconduct

or negligence on his part. Proviso to Section 69(5), Companies Act, 1956.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 113

Section 70 of the Companies Act, 1956, also imposes criminal

liability. A company that has a share capital but has not issued a

prospectus, or which has not yet allotted shares after issuing a

prospectus, cannot make a first allotment without registering a

statement in lieu of a prospectus 3 days before such allotment. Such a

written statement must also comply with disclosure requirements

under Schedule II.

150

If this provision is contravened, the company,

and every director of the company who willfully authorizes or permits

the contravention, shall be punishable with fine which may extend to

Rs. 10,000.

151

If this statement contains anything untrue, any person

authorizing this statement will be punished with imprisonment

extending to two years or with fine up to Rs. 50,000.

152

All transactions in violation of Sections 69 and 70 are

voidable at the option of the applicant.

153

Any willful contravention

by a director of Section 69 and 70 exposes him to liability to the

extent of the loss, damages or costs that the company or the allottee

suffered. When the company allots shares, subsequent to registration

of prospectus, it is necessary for it to do so only 5 days after

issuance.

154

The purpose behind such a measure is to ensure that all

potential shareholders have adequate notice of the issue, and time to

seek independent financial advice. Section 72(3) makes any

150

Section 70(1), Companies Act, 1956.

151

Section 70(4), Companies Act, 1956.

152

Section 70(5), Companies Act, 1956.

153

Section 71, Companies Act, 1956.

154

In the event that any person liable under Section 62 issues a public notice

excluding, limiting or diminishing his responsibility, the five days begins from

the date of the public notice.

114 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

transaction in violation of this requirement valid, but exposes the

company and every officer of the company who is part of the issuance

to a fine extending to Rs. 50,000.

Similar to changes to civil liability, significant changes have

been made to the criminal liability imposed on persons under the 2013

Act. Section 34 of the 2013 Act does not incorporate sub-section (2)

of Section 63, Companies Act, 1956. That is, although previously

experts and other persons named in the prospectus, covered under

Section 60(3), Companies Act, 1956, were exempted, they are now

criminally liable under the 2013 Act. The defence provided under

sub-section (1) of Section 60, Companies Act, 1956 is still

available.

155

Additionally, Section 63, Companies Act, 2013, adds a

phrase “or the inclusion or omission was necessary”. This acts as an

additional ground of defence to penal liability. Sections 36 to 39 of

the Companies Act, 2013 also impose criminal liability.

United Kingdom

a. FSMA

The FSMA, 2000 also imposes criminal liability when

securities are offered to the public without a prospectus approved by

the competent authority first being circulated.

156

A mere request to

trade in securities where an approved prospectus has not been made

available is also an offence.

157

155

That is, the person may prove that the statement or omission was immaterial or

that he had reasonable grounds to believe and did believe up to the issuance of

the prospectus that the statement was true.

156

Section 85(1), Financial Services and Markets Act, 2000.

157

Section 85(2), Financial Services and Markets Act, 2000.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 115

If the above two offences are committed, the penalty that can

be imposed in a summary conviction is imprisonment not exceeding 3

months and/or a fine.

158

While, if the person is convicted on

indictment, the penalty imposed is a term not exceeding 2 years

and/or a fine.

159

However, liability will not be imposed if the offer is made to

qualified investors only;

160

where the offer is made to fewer than 150

persons;

161

where the minimum consideration which may be paid by

any person for transferable securities offered is at least 50,000

euros;

162

when the transferable securities are denominated in amounts

of at least 50,000 euros;

163

or when the total consideration for the

securities cannot exceed 100,000 euros.

164

It can be inferred that a

person will be exempted from criminal liability when either the offer

is made to a small group of targeted investors or they are of such a

size that they are beyond the reach of small investors.

165

The FSMA, 2000 also provides for criminal liability under

section 397,

166

for misleading statements and practices. However, the

standards of proof required for imposing liability under this section

remains vague.

167

For example, it is uncertain what would constitute

„knowledge‟ in section 397(1)(a) i.e. it is unclear whether this is actual

158

Section 85(3)(a), Financial Services and Markets Act, 2000.

159

Section 85(3)(b), Financial Services and Markets Act, 2000.

160

Section 86(1)(a), Financial Services and Markets Act, 2000.

161

Section 86(1)(b), Financial Services and Markets Act, 2000.

162

Section 86(1)(c), Financial Services and Markets Act, 2000.

163

Section 86(1)(d), Financial Services and Markets Act, 2000.

164

Section 86(1)(e), Financial Services and Markets Act, 2000.

165

Palmer, supra note 23, at 5261.

166

Section 397 of the Financial Services and Markets Act, 2000.

167

Palmer, supra note 3, at 5266.

116 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

or constructive knowledge. Similarly, under section 397(1)(b), the test

for „dishonesty‟ or actual fraud, on the basis of which liability will be

imposed, is if a person failed to operate as an honest person.

Contravention of this section will result in summary conviction with

imprisonment up to six months and/or a fine; whereas if convicted on

indictment, imprisonment will extend up to seven years and/or fine.

168

b. Theft Act

Since the FSMA, 2000 does not exclude liability under other

statutes, the Theft Act, 1968 can also be applied. Section 19 of the

Theft Act makes it illegal for an officer of the company to make any

statement with the intention of misleading investors or creditors.

169

Under this Act, the prosecution bears the burden of proving

that the officer of the court fraudulently made the statement.

170

The

defendant only needs to establish that he was negligent to escape

liability. However, judicial interpretation has eased the burden on the

prosecution by holding that even if a statement is literally correct, if it

creates a misleading impression, it would constitute a false

statement.

171

Comparison between UK Law and Indian Law

UK law provides for summary conviction as well as

conviction by indictment, for offences pertaining to issue of

securities. With respect to the former, liability extends up to 3 months

imprisonment and/or fine; whereas, in the latter, liability extends up

168

Section 397(8), Financial Services and Markets Act, 2000.

169

Section 19, Theft Act, 1968.

170

Palmer, supra note 23, at 5262.

171

R v. Kyslani, [1932] 1 K.B (Court of Criminal Appeal).

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 117

to 2 years imprisonment and/or fine.

172

In Indian law, on the other

hand, no such distinction is made.

Additionally, UK law exempts criminal liability when either

the offer is made to a small group of targeted investors or they are of

such a size that they are beyond the reach of small investors.

173

In

contrast, criminal liability is exempted in India when there is

reasonable grounds for believing the same or if the statement is

immaterial.

174

Apart from these specific distinctions, both jurisdictions preserve

criminal liability under multiple other statutes.

(3) Common law

The liability under common law is same for both jurisdictions,

as both India and UK are common law countries. Under common law,

the liability of persons who have authorized the issue of an offer

document is based on the “golden rule” as laid down by Kindersley

V.C. in New Brunswick, etc. Co. v. Muggeridge.

175

This rule

172

Section 96, Financial Services and Markets Act, 2000.

173

Section 86(1), Financial Services and Markets Act, 2000.

174

Section 63(1), Companies Act, 1956.

175

Kindersley V.C. in New Brunswick, etc. Co. v. Muggeridge, (1860) 30 LJ Ch

242 stated: “Those who issue a prospectus, holding out to the public the great

advantages which will accrue to persons who will take shares in a prosposed

undertaking, and inviting them to take shares on the faith of the representations

therein contained, are bound to state everything with strict and scrupulous

accuracy, and not only to abstain from stating as facts that which is not so, but

to omit no one fact within their knowledge the existence of which might in any

degree affect the nature, or extent, or quality of the privileges and advantages

which the prospectus holds out as inducements to take shares”.

This was subsequently expanded upon by Lord Halsbury in Aaron‟s Reefs v.

Twiss, 1896 AC 273 (HL) who said: “I do not care by what means it is

conveyed, by what trick or device or ambiguous language; all those are

expedients by which fraudulent people seem to think they can escape the real

118 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

governing the issue of a prospectus, specifically with respect to its

content and consequent effect on the public, was upheld in Henderson

v. Lacon.

176

This has been accepted by the Indian Supreme Court.

177

The principles embodied in the “golden rule” have been

incorporated in the respective statutes in India and in the UK.

178

Under common law, in the event that the prospectus fails the “golden

rule” test and there are false or misleading statements present in the

prospectus, liability will arise under both tort and contract law.

179

In

this regard, three interrelated questions need to be answered: who is

liable; who can sue; and what remedies do they have? The researchers

have sought to answer these questions in this section by discussing the

two main remedies available to aggrieved persons – [1] Recission and

[2] Damages

Rescission

Rescission is considered a good supplement to the right to

claim damages because the investor may often merely wish to return

substance of the transaction. If by a number of statements you intentionally give

a false impression and induce a person to act upon it, it is not the less false

although if one takes each statement by itself there may be a difficulty in

showing that any statement is untrue.”

176

Henderson v. Lacon, (1867) LR Ew 249.

177

N Parthasarathy v. Controller of Capital Issues, (1991) 72 Com Cases 651.

178

For instance, the particulars laid out in Schedule II of the Companies Act, 1956

and Section 26 of the Companies Act, 2013 read with the rules that are

expected to be issued regarding the same (see infra Part II(A) ) are supposed to

ensure that the disclosures in the prospectus give investors a reasonably fair and

clear picture as to the company‟s financial and other affairs. In the UK, similar

disclosure requirements are laid out in the Prospectus Rules.

179

S. Gleeson and H.S. Bloomenthal, The Public Offer of Securities in the United

Kingdom, 27(3), DENVER JOURNAL OF INTERNATIONAL LAW AND POLICY, 359,

443 (1999).

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 119

to the position he had originally occupied.

180

For the purchaser of

securities to be entitled to rescission, he will have to prove that the

misrepresentation was one of fact, that it was a material

representation, and that he had acted upon it.

181

Not only is this burdensome on the purchaser of securities, this

remedy has other shortcomings as well. First, under the

Misrepresentation Act, 1967, the court has the discretion to substitute

a suit for rescission and replace it with an award for damages.

182

Secondly, rescission is available only against a contracting party. This

implies that if a person purchases shares from a shareholder in the

market, or from an issuing house, they would subsequently not be

allowed to rescind that contract against the company, because the

company was not a contracting party. Thirdly, a failure to give

information i.e. an omission, will not give rise to a right to rescission.

Fourthly, the right to rescind expires more quickly than the right to

damages. That is, if after the truth is discovered, an investor performs

certain acts such as accepting dividends, or attending and voting at

meetings, the contract will be understood as ratified.

183

Finally, a

rescission claim is defeated by the liquidation of the company.

184

Damages

a. Tort of Deceit

180

Gower, supra note 3, at 937.

181

Palmer, supra note 23, at 5209.

182

Section 2(2), Misrepresentation Act, 1967.

183

Gower states that this is with the view to protect the interests of creditors i.e.

the company may have raised credit from third parties who would have acted

on the basis of capital already raised by the company, which rescission of the

shareholder‟s contract would undermine. Gower, supra note 3, at 938.

184

Gower, supra note 3, at 938.

120 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

Actions against misrepresentations made in prospectuses

originally developed out of actions for the tort of deceit. For the tort

of deceit to be established, the requirements are:

185

1. The maker of the statement should have knowingly known it

to be false, or should have at least been reckless of the truth,

2. The recipient of the statement should have relied on the false

statement, and

3. The maker of the statement should have intended that the

other person rely on the statement.

This implies that the maker of the statement can escape

liability if he can prove that there was no fraudulent intention, and

that they honestly believed in the veracity of the statement made.

186

Persons who can potentially be held liable are the company, directors,

experts and agents of the company.

187

The measure of damages that

185

Palmer, supra note 23, at 5224.

186

The test for deceit has been held to be a subjective one. In Akerhielm v. De

Mare (1959) 3 All ER 485, it was held that the defendant can escape liability if

he honestly believed the representation made to be true in the sense that he

made it. The court specifically stated–

“The question is not whether the defendant in any given case honestly believed

the representation to be true in the sense assigned to it by the court on an

objective consideration of its truth or falsity, but whether he honestly believed

the representation to be true in the sense in which he understood it, albeit

erroneously when it was made. This general proposition is no doubt subject to

limitations. For instance, the meaning placed by the defendant on the

representation made may be so far removed from the sense in which it would be

understood by any reasonable person as to make it impossible to hold that the

defendant honestly understood the representation to bear the meaning claimed

by him and honestly believed it in that sense to be true.”

187

Palmer, supra note 23, at 5224.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 121

can be claimed by any person is appropriate to a claim in tort.

188

The

aim is to place the plaintiff in the position they would have been had

it not been for the misrepresentation. Therefore, the actual value of

the shares is subtracted from the price paid.

189

b. Tort of Negligent Misrepresentation

A claim for negligence can be made only when the maker of

the statement owed some duty of care to the plaintiff. The test for

imposing such a duty of care is proximity of relationship,

foreseeability of damage, and reasonableness.

190

An interesting question that arises is to what extent the

proximity condition can be stretched. That is, should proximity be

188

Lord Browne-Wilkinson laid down seven principles to assess the damages that

can be claimed in Smith New Court Securities Ltd. v. Scrimgeour Vickers

(Asset Management) Ltd., [1996] 4 All E.R. 769:

“1. The defendant is bound to make reparation for all the damage directly

flowing from the transaction;

2. Although such damage need not have been foreseeable, it must have been

directly caused by the transaction;

3. In assessing such damage, the plaintiff is entitled to recover by way of

damages the full price paid by him, but he must give credit for any benefits

which he has received as a result of the transaction;

4. As a general rule, the benefits received by him include the market value of

the property acquired as at the date of acquisition; but such general rule is not

to be inflexibly applied where to do so would prevent him obtaining full

compensation for the wrong suffered;

5. Although the circumstances in which the general rule should not apply

cannot be comprehensively stated, it will normally not apply where either (a)

the misrepresentation has continued to operate after the date of the acquisition

of the asset so as to induce the plaintiff to retain the asset or (b) the

circumstances of the case are such that the plaintiff is, by reason of the fraud,

locked into the property.

6. In addition, the plaintiff is entitled to recover consequential losses caused by

the transaction;

7. The plaintiff must take all reasonable steps to mitigate his loss once he has

discovered the fraud.”

189

McConnel v. Wright [1903] 1 Ch. 546.

190

Caparo Industries Plc v. Dickman, [1990] 2 A.C. 605.

122 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

recognized only between the maker of the statement and the persons

to whom the document is specifically directed to? Or can it be

extended to exist between the makers of the statement and the people

who relied on the document to purchase shares, but to whom the

document was not specifically directed? The courts have been

grappling with this question. In Al-Nakib Investments (Jersey) Ltd.

and Another v. Longcroft and Others it was held that this proximity

could be established only between the maker of the statement and

people to whom shares are allotted.

191

The rationale for this was that

191

Al-Nakib Investments (Jersey) Ltd. and Another v. Longcroft and Others,

[1990] 1W.L.R. 1390.

Judge Mervyn Davies applied the ratio of Caparo Industries Plc. v. Dickman to

the facts of the case before him. In Caparo Industries Plc. v. Dickman, the court

looked into the extent a person is liable for a negligent statement made by them.

It was held in Caparo Industries that the auditors of a company would be liable

for their reports only to shareholders of the particular company and not outside

investors. Lord Jauncey was of the opinion that-

“If the statutory accounts are prepared and distributed for certain limited

purposes, can there nevertheless be imposed upon auditors an additional

common law duty to individual shareholders who choose to use them for

another purpose without the prior knowledge of the auditors? The answer must

be no. Use for that other purpose would no longer be use for the „very

transaction‟ which Denning L.J. in the Candler case [1951] 2 K.B. 164, 183

regarded as determinative of the scope of any duty of care. Only where the

auditor was aware that the individual shareholder was likely to rely on the

accounts for a particular purpose such as his present or future investment in or

lending to the company would a duty of care arise. Such a situation does not

obtain in the present case.”

Judge Davies agreed with the ratio of Caparo Industries as he stated that duty of

care could not be fastened on a situation when a statement has been made for a

particular purpose and that statement is used for another purpose. He held ,

therefore, that the defendants did not owe the plaintiffs a duty of care for shares

bought in the market. This is because the prospectus and the interim reports

were addressed to the first plaintiff i.e. Al-Nakib Investments (Jersey) Ltd. with

the purpose of convincing the first plaintiff to take up the rights issue. It was

not with the purpose for buying shares in the market. Hence, applying the test

of proximity between the plaintiff and defendant, the court did not extend

prospectus liability to transactions that took place in the secondary market.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 123

the purpose of the prospectus was only to induce people to subscribe

to shares, and they would not have considered the trade of shares in

the secondary market.

In Andrews v. Mockford, however, it was held that liability

could be extended to the secondary market also since there was a

„continuous fraud‟ beginning with the issue of prospectus.

192

Such a

similar view was taken by the court in Possfund Custodian Trustee

Ltd. and Another v. Diamond and Others Parr and Others v Diamond

and Others.

193

The court recognized the proximity between the people

192

Andrews v. Mockford, [1896] 1 Q.B. 372.

The defendants contended that even assuming that the statements made in the

prospectus were false, the plaintiff bought shares in the market and not at the

time of subscription. Therefore, the damage sustained by the plaintiff did not

arise from the prospectus. They cited Peek v. Gurney, which held that the

purpose of the prospectus was to induce people to whom it is sent to become

allottees and after this its effect is exhausted, to argue that the plaintiff had not

bought shares relying on the statements made in the prospectus.

However, the court held that there was a „continuous fraud‟ by the defendants

i.e. the prospectus‟ function was not exhausted and it continued to play a role in

conjunction with the false telegram. Lord Justice Smith was of the opinion that-

“There was proof against the defendants a continuous fraud on their part,

commencing with the sending of the prospectus to the plaintiff, and culminating

in the direct lie told in the telegram, which was intended by the defendants to

operate upon the plaintiff's mind as well as on the minds of others, and did so

operate to his prejudice, and to the advantage of the defendants.”

Therefore, the court imposed liability on the defendants even though the

plaintiff had bought these shares in the secondary market. However, liability

was imposed not because liability extends to market transactions but because

there was a „continuous fraud‟ which began with the misleading statements in

the prospectus. In effect, the court still applied the test that the plaintiff should

have relied on the misleading statements in the prospectus to buy shares.

193

Possfund Custodian Trustee Ltd. and Another v. Diamond and Others Parr and

Others v Diamond and Others, [1996] 1 W.L.R. 135.

In relation to the second aspect i.e. proximity, the court examined whether the

plaintiff‟s contention that the prospectus must be examined after taking into

account the changed market practice on the date of preparation and circulation

can be accepted. The plaintiff contended that an additional purpose had evolved

124 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

responsible for the contents of the public and the general public, if the

prospectus was prepared with the intention of inducing the public to

invest in the companies‟ securities.

Palmer is of the opinion that the decision in Possfund

Custodian Trustee Ltd. is in line with the principles that the FSMA,

2000 and the listing rules are based on.

194

Section 90 of the FSMA,

2000, for instance, provides a remedy for people who bought

securities in the secondary market. In Possfund Custodian Trustees

Ltd., the court also recognized that prospectuses are intended to be

relied on by the public at large. The researchers submit that since the

statutory law has already extended liability to the secondary market,

the decision in Possfund Custodian Trustees Ltd. is correct. There is

no rationale today for common law to limit liability to only the initial

allotment of shares.

195

c. Breach of Contract

The principle is that the misrepresentation present in the

prospectus can be incorporated in the subsequent contract of allotment

for the publication of the prospectus by the issuer i.e. to „inform and encourage

aftermarket purchases‟.

Judge Lightman examined case law and observed that courts have since 1873

recognised a duty of care in relation to prospectuses, when there is a direct

connection between those who issue the prospectus and those who rely on it.

He cited Lord Chelmsford

and Lord Cairns

judgments in Peek v. Gurney for the

proposition that necessary direct connection between issuers and aftermarket

purchasers can be found if there was intention that the aftermarket purchasers

continue to rely on the prospectus. This intention the Judge felt could be

manifested in whatever manner i.e. by the sale of the prospectus to possible

aftermarket purchasers (Scott v. Dixon) or by other means (Andrews v.

Mockford). It was held therefore, that the claim could not be struck off and the

merits of this matter need to be determined in trial.

194

Palmer, supra note 23, at 5238.

195

Palmer, supra note 23, at 5238.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 125

between the company and the subscriber. However, whether

statements made in a prospectus amount to a term of a contract is a

contested point of law, as courts are unwilling to regard it as more

than mere misrepresentations.

196

Yet, there are certain advantages to

viewing this as a contract, as damages can be claimed in a contractual

manner.

197

Moreover, applying the doctrine of privity of contract, it

would follow that the vendor of the shares can be held liable only to

those he entered into the contract with.

198

Therefore, any damages

sought for breach of contract will necessarily be available only to the

allottees of shares.

[D] LIABILITY OF INTERMEDIARIES

(1) India: Regulation by SEBI

As discussed in the previous sections, the Companies Act,

1956 details the liability of the company, the directors and other

persons authorizing the issue of the securities. It is submitted that this

includes employees and other officers of the company, as well as

intermediaries to an issue. In addition to those provisions, the SEBI,

which is the primary regulator of the securities market, lays out the

function and duties of such intermediaries to an issue.

„Intermediary‟ has been defined in the SEBI (Intermediaries)

Regulations, 2008,

199

which defines its scope by referring to the

various categories contained in Sections 11 and 12 of the SEBI Act.

200

196

S. Gleeson and H.S. Bloomenthal, supra note 187, at 444.

197

Jacobs v. Batavia [1924] 2 Ch. 329.

198

Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co Ltd., [1915] UKHL 1.

199

The SEBI (Intermediaries) Regulations, 2008 primarily relates to the

registration by these intermediaries with the SEBI

200

Regulation 2(g) of the SEBI (Intermediaries) Regulations, 2008.

126 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

These two provisions discuss several intermediaries including stock

brokers, sub-brokers, share transfer agents, bankers to an issue,

trustees of trust deeds, registrars to an issue, merchant bankers,

underwriters, portfolio managers, investment advisers, and others.

201

While some of these intermediaries are involved only in the

secondary market, many of them perform essential functions in the

primary market, particularly in IPOs. The most important of these

intermediaries in the issuance of securities is the lead merchant

banker.

202

Under Regulation 5 of the ICDR Regulations, it is mandatory

for any issuer of securities to appoint a lead merchant banker to carry

out all the obligations relating to the issue. Further, in consultation

with this lead merchant banker, other intermediaries may be

appointed.

203

Such intermediaries have several obligations imposed

on them under the ICDR Regulations, above and beyond the

Companies Acts and applicable delegated legislations.

204

201

Section 11, SEBI Act, 1992.

202

Merchant banker is defined under Regulation 2 (cb) of the SEBI (Merchant

Bankers) Regulations, 1992 as“…any person who is engaged in the business of

issue management either by making arrangements regarding selling, buying or

subscribing to securities or acting as manager, consultant, adviser or

rendering corporate advisory service in relation to such issue management.”

203

These intermediaries must necessarily be registered with the SEBI. The SEBI

has issued guidelines pertaining to the registration and regulation of each of

these kinds of intermediaries. This includes the SEBI (Merchant Bankers)

Regulations, 1992; SEBI (Registrars to an Issue and Share Transfer Agents)

Regulations, 1993; SEBI (Portfolio Managers) Regulations, 1993; SEBI

(Registrars to an Issue and Share Transfer A gents) Regulations, 1993; The

SEBI India (Underwriters) Rules, 1993; the SEBI (Bankers to an Issue)

Regulations, 1994; and The SEBI (Investment Advisers) Regulations, 2013.

204

Under Section 11A of the SEBI Act, 1992, the Board has the power to issue

regulations, general orders and special orders pertaining to the issue of

securities, without prejudice to the Companies Act, 1956. For instance, prior to

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 127

In addition to the provisions in the Companies Act against

untrue statements or fraudulent inducement of investment, there are

additional provisions imposing liability on persons under the SEBI

Act as well. Section 12A prohibits “manipulative and deceptive

devices, insider trading and substantial acquisition of securities or

control”, in relation to securities that are listed or proposed to be

listed. The penalties are listed in Chapter VIA of the SEBI Act.

Among the provisions relevant to this paper is Section 15HA,

205

which penalizes fraudulent and unfair trade practices, and Section

15HB,

206

which is a penalty for contravening provisions for which

separate penalties have not specifically been provided. Section 27,

which discusses offences by companies, makes the company and all

persons in charge of, and responsible for, the conduct of the business

activities of the company, liable for these offences. If any officer of

the company was also a party to the offence, he too shall be

prosecuted for it. The use of “every person who was responsible to the

the registration of any offer document with the registrar such as a prospectus,

red-herring prospectus or a shelf prospectus, the lead merchant banker must

submit a draft to the SEBI, which will suggest changes or make observations.

Regulation 6(2), The Securities and Exchange Board of India (Issue of Capital

and Disclosure Requirements) Regulations, 2009.

205

Section 15HA, SEBI Act, 1992: “If any person indulges in fraudulent and

unfair trade practices relating to securities, he shall be liable to a penalty of

twenty-five crore rupees or three times the amount of profits made out of such

practices, whichever is higher.”

206

Section 15HB, SEBI Act, 1992: “Whoever fails to comply with any provision of

this Act, the rules or the regulations made or directions issued by the Board

thereunder for which no separate penalty has been provided, shall be liable to

a penalty which may extend to one crore rupees.”

128 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

company for the conduct of business” in Section 27 may be broad

enough to include intermediaries.

207

(2) United Kingdom

Under the Listing Rules, it is a requirement for a company

seeking admission to the Official List to have a sponsor.

208

The

sponsor is appointed by the FCA,

209

which maintains a list

professionals and bodies who are authorized sponsors.

210

The FCA

also determines the functions of the sponsor.

211

With respect to issuance of new securities, the sponsor must,

before submitting an application to the FCA on behalf of the

applicant, have a „reasonable opinion‟ that the applicant has satisfied

all the requirements of the Listing Rules, Prospectus Rules, and that

the directors have established procedures which enable the applicant

to comply with the listing, disclosure and transparency rules.

212

207

Section 27, SEBI Act, 1992.

208

Para 8.2.1R, Listing Rules, Financial Conduct Authority Handbook, 2013.

209

Section 88(2), Financial Services and Markets Act, 2000.

210

Section 88(3)(a), Financial Services and Markets Act, 2000.

211

Section 88(3)(b), Financial Services and Markets Act, 2000.

212

Para 8.4.2, Listing Rules, Financial Conduct Authority Handbook, 2013-

“A sponsor must not submit to the FCA an application on behalf of an

applicant, in accordance with LR 3, unless it has come to a reasonable opinion,

after having made due and careful enquiry, that:

(1) the applicant has satisfied all requirements of the listing rules relevant to an

application for admission to listing;

(2) the applicant has satisfied all applicable requirements set out in the

prospectus rules unless the home Member State of the applicant is not, or will

not be, the United Kingdom;

(3) the directors of the applicant have established procedures which enable the

applicant to comply with the listing rules and the disclosure rules and

transparency rules on an ongoing basis;

(4) the directors of the applicant have established procedures which provide a

reasonable basis for them to make proper judgments on an ongoing basis as to

the financial position and prospects of the applicant and its group; and

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 129

Additionally, the sponsor should also submit documents such

as the Sponsor‟s Declaration on an Application for Listing, a

Shareholder Statement or Pricing Statement and should ensure that

the prospectus discloses prominently any matters which the FCA

would take into account in the application for listing.

213

With respect to liability, a sponsor is not liable to investors

directly. This is because professional advisers who provide assistance

on the contents of the listing documents are not regarded as people

(5) the directors of the applicant have a reasonable basis on which to make the

working capital statement required by LR 6.1.16R.”

213

Para 8.4.3, Listing Rules, Financial Conduct Authority Handbook, 2013-

“A sponsor must:

(1) submit a completed Sponsor's Declaration on an Application for Listing to

the FCA either:

(a) on the day the FCA is to consider the application for approval of the

prospectus and prior to the time the prospectus is approved; or

(b) at a time agreed with the FCA, if the FCA is not approving the

prospectus or if it is determining whether a document is an equivalent

document ;

(2) submit a completed Shareholder Statement or Pricing Statement, as

applicable, to the FCA by 9 a.m. on the day the FCA is to consider the

application;

(3) ensure that all matters known to it which, in its reasonable opinion, should

be taken into account by the FCA in considering:

(a) the application for listing; and

(b) whether the admission of the equity shares would be detrimental to

investors' interests; have been disclosed with sufficient prominence in the

prospectus or equivalent document or otherwise in writing to the FCA; and

(4) submit a letter to the FCA setting out how the applicant satisfies the criteria

in LR 2 (Requirements for listing - all securities), LR 6 (Additional

requirements for premium listing (commercial company)) and, if applicable, LR

15 or LR 16, no later than when the first draft of the prospectus or listing

particulars is submitted (or, if the FCA is not approving a prospectus or if it is

determining whether a document is an equivalent document, at a time to be

agreed with the FCA ).”

130 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

who are responsible for the prospectus under Para 5.5 of the

Prospectus Rules.

214

However, even though investors may not have a remedy

against the sponsors, the FCA has various modes of monitoring the

functioning of the sponsors. Other than regulating the list of sponsors,

the FCA can also impose the following sanctions

215

–

1. Public Censure of the sponsor- If the sponsor contravenes any

of their obligations as per section 88(3)(c) of the FSMA, 2000,

the FCA can publish a statement to that effect.

216

2. Financial Penalty

217

3. Suspension, limitation or other restriction

218

The second and third categories i.e. financial penalty and

suspension of sponsors, are newly introduced powers that came into

effect only on 1 April, 2013.

(3) Comparison between Indian Law and UK Law

The primary difference between Indian law and UK law with

respect to the functioning and regulation of intermediaries is that

Indian law discusses intermediaries in great detail, in different statutes

and applicable delegated legislations. The FSMA, 2000 and the

214

Footnote 14, Wai Yee Wan, Recent Changes to, and Proposals to Enhance

Effectiveness of, the Listing Regime in the United Kingdom, COMPANY LAWYER

(2013).

215

As per para 8.7.20, Listing Rules the Enforcement Guide sets out the FCA‟s

policy on when and how it will use its disciplinary powers in relation to a

sponsor. A statutory notice may be required under section 88B of the FSMA,

2000.

216

Section 89(1), Financial Services and Markets Act, 2000.

217

Section 88A, Financial Services and Markets Act, 2000.

218

Section 88A, Financial Services and Markets Act, 2000.

2015 LIABILITY OF COMPANY AND INTERMEDIARIES IN RELATION TO ISSUE OF SECURITIES 131

delegated legislation passed under it, on the other hand, specifically

provides only for sponsors.

Further, sponsors in the UK are analogous to lead merchant bankers

in India. The type of liability that the respective regulatory bodies

impose upon these two categories of intermediaries is different in

both jurisdictions. For instance, while public censure is one form of

punishment imposed on sponsors, there is no such corresponding

power granted to the SEBI or any other body in India. Other

punishments such as penalties and suspension are common to both

jurisdictions.

[E] CONCLUSION

This paper has sought to examine the liabilities that may be

incurred in the issuance of securities by companies and

intermediaries. As discussed, in public issues, the role of the

prospectus is paramount. The regulatory structures prevailing in both

countries lay down elaborate and comprehensive guidelines to ensure

that all necessary information is passed on to potential investors. This

is done to prevent investor right violations and to promote market

confidence, which will facilitate the further development of the

securities market and the economy in general.

The focus of the paper was on comparing the liability regimes

in India and in UK. Largely, both jurisdictions impose the same kind

of liabilities in that they regulate the issue of prospectus, and in case

this prospectus carries untrue or misleading statements, they impose

civil and criminal liabilities. Since both India and UK are common

law countries, affected parties can avail of common law remedies.

132 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

However, there are certain limitations under common law, and there

has been a difference in the statutory response of both countries to

these limitations. For instance, purchasers in the secondary market

have no remedy under common law. While UK has provided a

remedy for them under the FSMA against all liable persons, India

only recognizes the rights of subscribers. In addition, in India, SEBI

has detailed provisions regulating the functioning of intermediaries. In

UK, attention has been devoted only to the role and regulation of

sponsors. Other differences, as highlighted in the paper, also exist.

The researchers submit that these nuanced differences arise due to the

indigenous factors present in the respective political economies.

It is also extremely evident that both securities markets are

dynamic in nature. In the UK, after the 2008 financial crisis, the

regulatory framework for the securities market was extensively

revamped. The latest regime came into effect in April, 2013. In India

also, after the economic crisis in the 1990s, significant changes were

made to the regulatory structure. The securities market was

modernized, and regulatory bodies were set up to better monitor it.

More recently, the Companies Act, 2013 has been enacted, which has

also changed the liability regime that previously existed in light of the

vastly changed Indian economy. Clearly, both countries are

responding to the changing times.

In conclusion, while there are certain differences in the

liability regimes, these are not fundamental in nature. They both

appear to be driven by the same principles of equitably balancing

market efficiency with the rights of the investor.

SEBI ON TRACK? – AN ANALYSIS OF THE SEBI

(RESEARCH ANALYST) REGULATIONS, 2014

Sindoori Sriram



and Srijan Sahay



The threat of research analysts exploiting loopholes in the

legal framework and misrepresenting reports and

recommendations in order to make illegal profits for

themselves is a very real one. Given the importance placed on

these reports by investors in order to make investment

decisions, such acts by research analysts can cause a severe

information asymmetry in the markets. It was to tackle this

problem that SEBI, in 2014 came out with the SEBI (Research

Analyst) Regulations. However, inspite being hailed as a

godsend by many investors, the regulations do come with their

own set of problems which might hamper their effective

implementation. The present paper is an analysis of the same.

[A] INTRODUCTION

The Indian securities market has gone through a series of

continual changes since its inception to keep pace with the

requirements of an unremittingly developing global market. To assist

the Indian economy keep abreast with the ever-changing global

economy, the Securities and Exchange Board of India (SEBI) was

incorporated in 1992 and authorized with statutory powers to

undertake the role of becoming the Indian securities market

watchdog. Ever since, SEBI has strived to introduce reforms that

ensure efficient, fair and transparent market practices; that safeguard



V Year Student, NALSAR University of Law



IV Year Student, NALSAR University of Law

134 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

the interests of investors; and which reduce the incidents of fraud and

corruption in the Indian securities arena. A recent development in this

area was introduced by SEBI on 1

st

September, 2014 in the form of a

new regulatory framework that proposes to capture research analysts,

intermediaries as well as independent entities who are involved in

securities research activities that include the formulation of research

reports, recommendations, suggestions and opinions regarding

securities.

1

The proposed SEBI (Research Analyst) Regulations, 2014

are an effort to ensure that research analysts and entities do not have

any leeway to exploit conflicts of interest, thereby resulting in biased

research reports that might be used to manipulate market trends.

2

In

light of SEBI‟s recent efforts to protect the Indian securities market

from analyst scandals, this essay seeks to evaluate the practicality and

efficacy of the proposed SEBI (Research Analyst) Regulations, 2014.

The historical importance of implementing research analyst

regulations can be traced all the way back to the 1990‟s stock market

boom.

3

Although it initially caused a surge in the stock market, the

boom was short-lived and resulted in the collapse of several large

public companies, consequently leading to the complete breakdown of

1

Sachin P. Mampatta, SEBI‟s New Regime for Research Analysts, BUSINESS

STANDARD, (September 11, 2014), http://www.business-

standard.com/article/markets/bs-primer-sebi-s-new-regime-for-research-

analysts-114091100845_1.html.

2

Id.

3

Urban J. Jermann & Vincenzo Quadrini, Stock Market Boom and the

Productivity Gains of the 1990‟s, THE WHARTON SCHOOL OF THE UNIVERSITY

OF PENNSYLVANIA, available at:

http://finance.wharton.upenn.edu/~jermann/FinalPapOct6.pdf (last updated

November 20, 2014).

2015 SEBI ON TRACK 135

the stock market itself.

4

In an attempt to identify the cause of the stock

market fiasco and rectify regulatory failures, the U.S. Securities and

Exchange Commission

5

scrutinized market players, only to discover

rampant incidents of corruption, accounting discrepancies and

instances of corporate delinquency. The SEC further found that

several intermediaries, particularly research analysts, had exploited an

array of grey areas in the regulatory framework to quickly cut deals

for themselves and make money by misrepresenting research reports

and recommendations, providing unreliable information, lying about

the nature of securities to investors, touting extremely average

securities by giving them high ratings and providing biased

investment advice to naïve investors.

6

Upon finding evidence of such

widespread analyst misdemeanour that was resulting in the

dissemination of skewed information on market trends, the US

regulators decided to introduce stronger legislations that would

effectively address the problem of conflicts of interest and capture all

analysts and research-entities that were engaged in unfair securities

related activities.

7

[B] THE ROLE OF RESEARCH ANALYSTS AND THE NEED FOR

REGULATIONS

In today‟s global economy, information is the most vital

component of any decision-making process. This is especially true in

the case of investment-decisions, for which, there is a significant need

4

Id.

5

Hereinafter referred to as “SEC”.

6

Jill E. Fisch, Fiduciary Duties and the Analyst Scandals, 55 ALABAMA LAW

REVIEW 1083, 1083 – 1085 (2007).

7

Id.

136 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

for investors to rely upon accurate and timely information about the

investment products and the company offering the investment

products. However, it is also an arduous task for an investor to

understand and decipher the complex and voluminous material

available to him before he can come to a conclusion and make an

investment decision. In this context, Research Analysts play a vital

role in bridging the gap between the investors and the companies

offering the investment products. Research analysts are, in essence,

the sentinel for the securities market – they study the information that

is available on companies, industries, the different types of shares and

investment products that are offered, and prepare reports and

recommendations that they subsequently deliver to the investors and

the public, thereby enabling them to make informed investment

decisions.

8

Their role, however, is not limited to merely compiling

reports. Research analysts have to go about their duties in an

extremely systematic manner – they have to first, collect information

on the subject-matter upon which they seek to base their reports on.

Second, they have to study and process the information that has been

collected – this requires the research analysts to use their own

research as well as publicly available information to explain what the

company does and what its prospects are.

9

They are expected to give a

8

Id.

9

Jill Fisch, Regulatory Responses to Investor Irrationality: The Case of the

Research Analyst, UNIVERSITY OF PENNSYLVANIA LAW SCHOOL, PENN LAW:

LEGAL SCHOLARSHIP REPOSITORY 2006,

http://scholarship.law.upenn.edu/cgi/viewcontent.cgi?article=2055&context=fa

culty_scholarship (last updated November 28, 2014).

2015 SEBI ON TRACK 137

thorough analysis of not only the shares and securities of the

company, but also the market within which it operates, the products of

its competitors and a general evaluation of the merits and demerits of

investing in the company.

10

Third, research analysts are required to

give their own opinion about the company, the industry, and the

investment products, and are further required to use statistical

techniques to provide predictive analysis about the company‟s

performance in the future, especially with respect to its earnings.

11

There are three different types of research analysts - buy-side

analysts, sell-side analysts and independent analysts.

12

Buy-side

analysts are typically employed by money managers such as mutual

funds, hedge funds, portfolio managers etc. Research reports prepared

by these analysts are generally circulated amongst the top

management of the employer firms and may contain information as to

which securities to buy, sell, or hold. There is a potential for conflict

of interest in such a case because the views taken by these research

analysts may be influenced by the views of the money manager and

the clients that they work for.

13

Sell-side analysts are analysts who

usually publish reports in the industries and companies that they cover

which contain advice as to holding, selling or buying the securities in

question. These reports typically include forecasts made by the sell-

10

Id.

11

Id.

12

Jermann & Quadrini, Supra n.5.

13

Report on Analyst Conflicts of Interest, A Report of the Technical Committee of

the International Organization of Securities Commissions, IOSCO,

http://www.iosco.org/library/pubdocs/pdf/IOSCOPD152.pdf (last updated

28November 2014).

138 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

side analyst as to the future performance of the securities in

question.

14

Hence there is a large potential for conflict of interest in

such a scenario as many analysts who publish these reports often

work for investment banking firms whose clients are those that the

research analyst cover in their reports. Finally, independent analysts

are those analysts who are usually employed by research

organisations and boutique firms that are separate from full service

investment banks.

15

These analysts sell their research reports on a

subscription basis. Here, a potential conflict of interest may arise

when companies that these research analysts are covering pay a

substantial subscription fee for the research report.

16

A major concern of regulatory authorities with respect to

research analysts is the credibility of the research reports and

recommendations that they issue to the investors. Sometimes,

research reports are made to artificially inflate the price of the

securities, thereby causing a negative impact on the market as a

whole.

17

This problem arises because, oftentimes, the investment

analysis made by a research analyst is highly susceptible to conflicts

of interest that may prevent them from providing a neutral opinion on

14

Id.

15

Id.

16

Anup Agarwal & Mark A. Chen, Do Analyst Conflicts Matter? – Evidence

From Stock Recommendations, UNIVERSITY OF ALABAMA AND GEORGIA STATE

UNIVERSITY, http://bama.ua.edu/~aagrawal/reco.pdf (last updated November

28, 2014).

17

Id.

2015 SEBI ON TRACK 139

the securities in question.

18

These conflicts of interest may interfere

with the neutrality of the research report, which subsequently will

affect the decisions made by investors.

19

The primary objective of all

regulatory authorities in the securities market is investor protection,

and in this regard, many regulatory authorities have failed because the

degree of their governance over research analysts has proven to be

grossly insufficient.

20

However, after having learnt from regulatory

failures, most developed economies today have implemented strict

norms for research analysts, to avoid the spread of tainted research

reports that are detrimental to the interests of investors.

21

[C] RESEARCH ANALYST REGULATIONS – THE USA

APPROACH

Since the 1990‟s stock market scandal, there has been a global

effort to identify and address the potential conflicts of interest arising

from the production of securities-related research reports, with many

developed market economies, such as the USA, the UK and Hong

Kong, having proposed or implemented extremely precise legislations

that provide no scope for exploitation or circumvention.

22

Learning

from previous regulatory mistakes with respect to research analysts

and issues of conflicts of interest, the SEC, in conjunction with the

18

Roni Michaely & Kent L. Womack, Conflict of Interest and the Credibility of

Underwriter Analyst Recommendations, 12(4) THE REVIEW OF FINANCIAL

STUDIES 654, 654 (1999).

19

Id.

20

Id.

21

Fisch, Supra n. 8.

22

Anup Agarwal & Mark A. Chen, Analyst Conflicts and Research Quality, 2(2)

QUARTERLY JOURNAL OF FINANCE (2012),

http://www.bama.ua.edu/~aagrawal/analysts.pdf (last updated on 27 November

2014).

140 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

Financial Industrial Regulatory Authority (FINRA) and the New York

Stock Exchange (NYSE), negotiated the Global Research Settlement

in 2003, an enforcement agreement that sought to completely

eradicate issues of conflicts of interest between the investment

banking and the research analytics departments of all the investment

firms in the United States.

23

The primary objective of this Global

Settlement was to stop the flow of information between the research

department and the investment banking departments of all firms to

ensure that stock recommendations and research reports were not

tainted by conflicts of interest.

24

Further, the Global Settlement also

prohibited research analysts from receiving compensation for

investment banking activities and prevented the investment banking

departments from partaking in research activities thereby mandating a

complete severing of any nexus between the investment banking and

research divisions to guarantee the reliability of research reports and

recommendations.

25

Another regulatory reform that the US adopted to curb

unethical research analyst practices was the Sarbanes-Oxley Act of

2002. Although the foremost objective of the Sarbanes-Oxley Act,

2002 was to tackle widespread corporate and accounting scandals, an

23

John Heine, Ten of Nation‟s Top Investment Firms Settle Enforcement Actions

Involving Conflicts of Interest Between Research and Investment Banking,

SECURITIES AND EXCHANGE COMMISSION (April 28, 2003),

http://www.sec.gov/news/press/2003-54.htm.

24

Id.

25

Ohad Kadan, Rong Wang, Leonardo Madureira & Tzachi Zach, Conflicts of

Interest and Stock Recommendations: The Effects of the Global Settlement and

Related Recommendations, 22(10) REVIEW OF FINANCIAL STUDIES 4189, 4191

(2009).

2015 SEBI ON TRACK 141

entire section in the Act was dedicated towards tightening the norms

surrounding research analysts as well.

26

A salient feature of the

Sarbanes-Oxley Act, 2002 is the provision under Section 501 that

mandates the certification and registration of all research analysts and

further requires disclosures to be made in special circumstances.

27

This two-pronged regulatory move of mandating registration and

disclosure by the Sarbanes-Oxley Act has helped solve several issues

of analyst conflicts of interest and capture defaulters in a methodical

manner.

28

The Sarbanes Oxley Act, 2002 and Global Settlement aside,

the US regulatory authorities frequently update their regulatory

framework with the objective of ensuring that retail investors are

aware of the potential for conflict of interest in the preparation of

research reports through enhanced disclosure requirements.

29

Measures such as enhancing and strengthening existing 'Chinese

walls' between research and business units in a full service investment

firm,

30

regulating the ability of the analyst to own and trade securities

of the firm they cover as well as regulating the incentive mechanism

of research analysts in a full service investment firm have been

implemented so as to reduce the likelihood of the production of biased

research.

31

The American model of research analyst regulations has,

26

Id.

27

SARBANES- OXLEY ACT, 2002, § 501.

28

John C. Coates, The Goals and Promise of the Sarbanes-Oxley Act, 21(1)

JOURNAL OF ECONOMIC PERSPECTIVES 91, 97 (2007).

29

Id.

30

Fisch, Supra n. 11.

31

Jill E. Fisch & Hillary A. Sale, The Securities Analyst as Agent: Rethinking the

Regulation of Analysts, 88 IOWA LAW REVIEW 1035 (2003).

142 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

thus far, been a great success in preventing analyst scandals and

improving investor confidence by ensuring the dependability of

research reports and recommendations.

32

[D] THE RESEARCH ANALYST REGIME IN INDIA – THE NEED FOR

CHANGE

Prior to 2014, there were no specific regulations regarding

research analysts in India. However, there were certain mechanisms in

place that sought to address potential conflicts of interest, such as the

one enshrined in the SEBI (Prohibition of Insider Trading)

Regulations, 1992, (hereinafter „Insider Trading Regulations) which

mandated that analysts who were involved in the preparation of

research reports for clients must disclose their shareholding in the

client's company.

33

The Insider Trading Regulations further

prevented analysts from trading in the securities of the company 30

days post the publication of the research report.

34

Another mechanism

that sought to address issues of conflicts of interest in the securities

market of India was the Code of Corporate Disclosure Practices for

the Prevention of Insider Trading, which laid down a series of

disclosure requirements.

35

The Code stipulates certain disclosures that

companies have to make while dealing with analysts or institutional

investors, including the following:

32

Id.

33

Suchismita Bose, Securities Market Regulations: Lessons from US and Indian

Experience, THE ICRA BULLETIN, MONEY & FINANCE, Vol. 2, No. 20-21,

(January 2005), http://icra.in/Files/MoneyFinance/2005-jan-june-

suchismita%20bose.pdf.

34

Id.

35

Id.

2015 SEBI ON TRACK 143

i. To prevent misquoting or misrepresentation, at least two

authorised company representatives or brokers must be present

at meetings with analysts.

ii. Only publicly available information is to be provided to

institutional investors and analysts. Alternatively, information

given to research analysts must be made public as soon as

possible.

iii. Issues raised by analysts during discussions, whose answers

may include unpublished price sensitive information, are

required to be disclosed to the public before the response is

recorded with the analyst.

iv. A company must issue a press release or post relevant

information after every meeting with a research analyst.

36

Even though potential issues of conflicts of interest were being

dealt with by SEBI‟s prescribed code of conduct and the regulations

on fraudulent and unfair trade practices and insider trading, there were

no self-sufficient set of guidelines or regulations to deal with the

conflicts of interest by research analysts and entities that were not

captured by SEBI. This absence of a comprehensive and exclusive

regulation to deal with the potential conflicts of interest that may arise

as a consequence of the work done by research analysts was recently

answered by the introduction of the new SEBI (Research Analyst)

Regulations, 2014

37

(hereinafter „Research Analyst Regulations‟).

36

Id.

37

Anuradha Verma, SEBI Notifies Norms For Research Analysts, VC CIRCLE,

(September 2, 2014), http://www.vccircle.com/news/finance/2014/09/02/sebi-

notifies-norms-research-analysts

144 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

[E] ANALYSIS OF THE SEBI (RESEARCH ANALYST) REGULATIONS,

2014

The new Research Analyst Regulations are a much needed

change in the realm of Indian securities law and governance. They

are to come into effect by 1

st

December, 2014 and from their

commencement, all research analysts and research entities in India

have to obtain a certificate of registration in accordance with these

regulations to be able to discharge the activities of a research analyst.

(1) Taxonomy of Research Units

The regulations have defined three different units that can be

engaged in the preparation and dissemination of securities-related

research reports: research analyst, research entity and independent

research analyst. A research analyst is any person who is primarily

responsible for the preparation and publication of the contents of a

research report; for making buy/sell/hold recommendations; for

giving price targets and for offering opinions.

38

A research entity, on

the other hand, is an intermediary that is registered with SEBI which

is also engaged in merchant banking or investment banking or

brokerage or underwriting services and simultaneously also issues

research reports or research analysis in its own name or through

individuals employed by it.

39

Finally, an independent research analyst

is a person whose only business activity is research analysis or

preparation and/or publication of research report.

40

38

SEBI (Research Analyst) Regulations, 2014, § 2(1)(u).

39

Id., § 2(1)(v).

40

Id., §2(1)(h).

2015 SEBI ON TRACK 145

SEBI has created this distinction between the three types of

entities that are involved in research activities in order to identify the

different types of conflicts of interests and lay down suitable

regulations for each entity to ensure the prevention of biased research

reports. Apart from the three abovementioned research units, SEBI

has also attempted to capture other intermediaries, including

investment advisers, credit rating agencies, asset management

companies and fund managers by requiring that they strictly comply

with the provisions pertaining to management and disclosures under

Chapter III of the Regulations in order to be able to issue or circulate

research reports in India. However, registration under the Regulations

per se, is not required for investment advisers, credit rating agencies,

asset management companies and fund managers as long as they

comply with Chapter III. Furthermore, SEBI has also brought within

its ambit, those persons or entities located outside India which are

engaged in the issuance of research reports or research analysis (of

securities that are listed or proposed to be listed in India), by

mandating that they enter into agreements with a research analyst or a

research entity who is already registered under the SEBI (Research

Analyst) Regulations, 2014.

41

However, this regulation poses a

glaring ambiguity as neither does it provide any clarifications on the

nature of such an agreement, nor does it provide any explanation as to

its scope.

41

Id., § 4.

146 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

(2) Eligibility Requirements for Registration

The Research Analyst Regulations have laid down certain

eligibility criteria that research analysts and entities must observe in

order to be eligible to apply and obtain certification under Section 3

of the said Regulations. Certain qualifications and capital adequacy

requirements have been prescribed, which need to be adhered to by all

applicants. The qualification requirements include the applicant being

a fit and proper person based on the criteria specified in Schedule II of

the SEBI (Intermediaries) Regulations, 2008 (hereinafter, „SEBI

Intermediaries Regulations‟); professional qualification from a

recognized university specified under the regulations; and

certification from the National Institute of Securities Market (NISM).

Further, before granting a certificate of registration, SEBI also takes

note of whether the applicant has the necessary infrastructure to

effectively carry out the activities of a research analyst and whether

the applicant has had any disciplinary action taken against him or

against any person directly or indirectly connected to the applicant by

the Board or by any other regulatory authority. Although it has tried

to maximize precautions with respect to the granting of certification

to research analysts and entities, SEBI has neglected to mention the

scope of “any person directly or indirectly connected with the

applicant”. This could pose another significant grey area in terms of

its implementation.

The general eligibility criteria aside, SEBI has also prescribed

certain capital adequacy requirements that all applicants have to

comply with. Section 8 of the regulations require that a research

2015 SEBI ON TRACK 147

analyst who is an individual or a partnership firm must have net

tangible assets of value not less than one lakh rupees; and that a

research analyst who is a body corporate or a limited liability

partnership firm must have a net worth of not less than twenty five

lakh rupees. With respect to this requirement, SEBI has not yet given

an explanation on whether there is any separate capital adequacy/ net

worth requirement for a research analyst who works in an entity that

undertakes other activities as well, and if so, whether the net worth is

to be computed separately for each of such activities. Although

instructions on how to calculate the net worth for a body corporate or

a limited liability partnership firm have been given by SEBI, no

clarification has been provided on how an individual‟s net tangible

assets of value are to be calculated. This is another ambiguity that

SEBI needs to provide more information for.

(3) Parameters for Research Reports

The regulations provide an extremely wide, albeit concise

definition of what constitutes a “research report”. It is wide enough to

cover all written and electronic communications which include

research analysis, recommendations or opinions concerning any

securities or public offer. The definition also includes within its

ambit, any comments on general trends in the securities market;

discussions on broad-based indices; commentaries on economic,

political or market conditions; periodic reports or other

communications prepared for the unit holders of mutual funds,

alternative investment funds or clients of portfolio managers and

investment advisers; statistical summaries of financial data of

148 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

companies and technical analysis relating to the demand and supply in

a particular sector.

42

The regulations have also specified certain guidelines

regarding the contents of the research report, and have laid down

extra requirements for disclosures to be made in it.

43

Section 19 of the

regulation mandates that the research analyst or entity disclose all

material information about itself including:

i. its business activity

ii. its disciplinary history

iii. complete details of the associates

iv. the terms and conditions on which it offers such report

v. any financial interest it may have in the subject company

vi. any beneficial or actual ownership it may have in the securities

of the subject company

vii. any other conflicts of interest it may have at the time of

publication of the research report or at the time of public

appearance.

44

Although SEBI has taken a well-calculated move by

mandating the disclosure of any financial interest along with the

nature of such interest that a research analyst or entity may have in the

subject company, it has failed to provide a materiality threshold for

42

Id., § 2(1)(w).

43

Guidelines Issued by Securities and Exchange Board of India for Regulating

Research Analysts, ERNST & YOUNG REGULATORY ALERT, (September 9,

2014),

http://www.ey.com/Publication/vwLUAssets/EY_Alert_SEBI_Research_Analy

sts_Regulations/$FILE/EY_Alert_SEBI_Research_Analysts_Regulations.pdf

44

Supra n. 40, § 19.

2015 SEBI ON TRACK 149

the determination of such financial interest. This provision requires

further clarity and explanation to ensure appropriate compliance by

research analysts and entities, and to avoid future instances of

circumvention.

In addition to the abovementioned disclosures, a research

analyst or a research entity is also required to make certain other

disclosures with respect to the receipt of compensation. The core

concept behind the requirement to mandate compensation-related

disclosures is to ensure that there are no side deals or hidden

transactions that benefit research analysts to the detriment of the

neutrality of research reports and recommendations. Section 19 (ii)

requires a research analyst and a research entity to disclose the

following:

i. whether it or its associates have received any compensation

from the subject company in the past 12 months;

45

ii. whether it or its associates have managed or co-managed public

offering of securities for the subject company in the past 12

months;

46

iii. whether it or its associates have received any compensation for

investment banking or merchant banking or brokerage services

from the subject company in the past 12 months;

47

iv. whether it or its associates have received any compensation for

products or services other than investment banking or merchant

45

Supra n. 40, § 19(ii)(a).

46

Id., § 19(ii)(b).

47

Id., § 19(ii)(c).

150 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

banking or brokerage services from the subject company in the

past 12 months;

48

v. whether it or its associates have received any compensation or

other benefits from the subject company or third party in

connection with the research report.

49

(4) Separation of Research Analysts from other Divisions

In a bid to prevent instances of conflicts of interest, SEBI has

adopted the US model of research analyst regulations by prohibiting

research analysts from participating in business activities that are

designed to solicit investment banking, merchant banking or

brokerage service businesses. Further precautions in this regard have

been taken in the form of a requirement, under Section 18, that the

personnel from the investment banking, merchant banking or

brokerage services divisions not be permitted to direct the individuals

employed as research analysts to engage in sales or marketing

activities, or to engage in any communication with current or

prospective clients.

50

Moreover, Section 18(8) specifically provides

that no research analyst or entity can provide any promise or

assurance of a favourable review in its research report to a company

or industry or sector or group of companies or business group as

consideration to commence or influence a business relationship or for

the receipt of compensation or other benefits.

51

The insertion of

Section 18(10) has sought to effectively compound the same

48

Id., § 19(ii)(d).

49

Id., § 19(ii)(e).

50

Supra n. 45.

51

Supra n. 40, 18(8).

2015 SEBI ON TRACK 151

precautions by requiring that the individuals employed as research

analysts are separate from other employees who are performing sales

trading, dealing, corporate finance advisory or any other activity that

may affect the independence of its research report.

52

SEBI, having realized that conflict of interest with respect to

research analysts have to be kept at bay, has installed an additional

regulatory restriction on personal trading by analysts. Section 16 has

laid down a mechanism that monitors, oversees and records all

personal trading activities of individuals employed as research

analysts and seeks to put all research analyst trading activities through

a formal approval process. Section 16(2) has established that no

research analyst or entity shall deal or trade in securities which are the

subject of the recommendation or report within 30 days before and 5

days after the publication of the research report.

53

Moreover, section

16(3) requires that research analysts or entities do not deal or trade in

any securities that they review in a manner contrary to their given

recommendation,

54

while section 16(4) further requires that they do

not purchase or receive securities of the issuer before the issuer's

initial public offering, if the issuer is principally engaged in the same

types of business as companies that they follow or recommend.

55

Therefore, by inserting the requirements under section 16, SEBI has

successfully filled any void that research analysts and entities could

52

Id., § 18(10).

53

Id., § 16(2).

54

Id., § 16(3).

55

Id., § 16(4).

152 JOURNAL OF CORPORATE AFFAIRS AND CORPORATE CRIMES VOL.3

have used to benefit from the research reports or recommendations

that they make for investors.

SEBI (RESEARCH ANALYST) REGULATIONS, 2014 – THE ROAD AHEAD

Having understood the importance of credible and

unadulterated research reports being available to the investing public,

most developed economies today have attempted to permanently

solve issues of conflicts of interests by way of narrowly tailored laws

that leave no lacuna for research analysts, entities and other

intermediaries to exploit. SEBI’s adoption of the principles enshrined

in the US Global Settlement of 2003 has been an excellent move to

keep research reports and recommendations pure and free from the

blemish of investment banking-influenced conflicts of interest. Its

chief objective in implementing the Research Analyst regulations is

two-fold: to ensure the credibility of research reports and

recommendations, and to reinstate the research analyst’s eminence as

the gatekeeper of the securities market. It has, in this regard, once

again put forward a set of comprehensive regulatory reforms that seek

to uphold investor interests as well as maintain the stability of the

Indian securities market. Although its efforts are commendable, there

are plenty of difficulties on the implementational front, along with the

existence of gaping grey areas in the regulations, that it has yet to

close. However, given the nascent stage of the regulations, there is

plenty of optimism that SEBI will as always continue to devise

amendments to tighten the norms and close any void that the 2014

regulations might have.

2015 SEBI ON TRACK 153

Although the costs of complying with the new regulations will

be high for most research entities, analysts and intermediaries, the

regulations offer a new degree of transparency and availability of

credible information on market trends that will provide the investing

public with confidence to make the right investment decisions, which

will further help the Indian securities market flourish. While it is too

early to tell what kind of impact the new SEBI (Research Analyst)

Regulations 2014 will have on the Indian securities market, it can be

assumed from SEBI’s focused effort of mandating independence of

research analysis that the above will most definitely help in

addressing issues of conflicts of interest and recuperate corporate

governance standards in India.

V

NOTE TO CONTRIBUTORS

The JCACC publishes articles, essays, notes, comments and book

reviews. All students, practitioners and scholars of corporate law are

encouraged to contribute under any of the above heads. However,

undergraduate students may not submit book reviews.

The JCACC promotes original scholarship. Therefore, all

manuscripts sent to it must consist of original thought and research. Further,

the manuscripts submitted must neither be previously published nor under

consideration for publication elsewhere whilst being considered for

publication in the JCACC. No manuscript containing any form of plagiarism

shall be considered for publication. The decision of the Editorial Board in

this matter shall be final. The Editorial Board of the Journal shall not be

responsible for any libelous or scandalous matter and the author shall be

deemed to have obtained the permission of the referred author in case the

work is unpublished.

Submissions as e-mail attachments are encouraged in Microsoft

Word Document or Rich Text format to submissions.jcacc@gmail.com.

However, hard copies that are word-processed, double-spaced and

numbered on A4 paper may be submitted to:

The Editorial Board,

The Journal of Corporate Affairs and Corporate Crimes,

NALSAR University of Law,

Jusitice city, Shameerpet, R.R. district,

Hyderabad - 500101, Telangana.

Each submission must include, in one single document:

 Title page with word count mentioned.

 Abstract (not exceeding 500 words)

 Contribution which should not exceed 4500-5000 words for

Articles, and 2000-2500 words for Case notes, Case Comments and

Book Reviews.

A separate document with biographical information must also be

attached including the following details (if submitting in the form of a hard

copy, this page is to be sent as a separate removable page):

 Name

 Email address

 Name and Address of college/university

Notes to Contributors

VI

 Course

 Student identification number/ Roll No and academic year.

The Editorial Board reserves the right to reject without review

manuscripts that exceed the word limit substantially. The citation style

followed should be that prescribed by the eighteenth edition of The

Bluebook: A Uniform System of Citation. For more details, consult the

reference guidelines.

All contributors by submitting a work, agree to indemnify NALSAR

University of Law, The Journal of Corporate Affairs and Corporate Crimes,

from and against all claims, suits, and damages based on any claim of

copyright infringement or plagiarism or unauthorized use.

For permission to reprint the articles and comments published in the

Journal of Corporate Affairs and Corporate Crimes, please contact:

The Editor-in-Chief,

The Journal of Corporate Affairs and Corporate Crimes,

NALSAR University of Law,

Justice City, Shameerpet, R.R. District,

Hyderabad- 500101, Telangana

In order to obtain copies of the Journal and other queries, please contact:

The Assistant Registrar,

NALSAR University of Law,

Justice City, Shameerpet, R.R. District,

Hyderabad- 500101, Telangana

Ph. No. 040 – 23498105 / 108.

VII

FORM IV

AS PER RULE 8 OF THE NEWSPAPERS (CENTRAL) RULES, 1956

Statement about ownership and other particulars about the Journal

Of Corporate Affairs And Corporate Crimes

Place Of Publication

Nalsar University Of Law,

Hyderabad

Printer‟s Name

NY Creations

Nationality

Indian

Address

31/A, Vengal Rao Nagar, Hyd.

Publisher‟s Name

The Registrar,

Nalsar University Of Law

Nationality

Indian

Address

3-5-874/18, Hyderguda,

Hyderabad – 500029

Editor‟s Name

Prof. KVS Sarma

Nationality

Indian

Address

3-5-874/18, Hyderguda,

Hyderabad – 500029

Names and addresses of individuals

who own the newspaper and partners

or shareholders holding more than

one percent of the total capital

The Registrar,

Nalsar University of Law,

3-5-874/18, Hyderguda,

Hyderabad – 500029

I, Registrar, NALSAR University of Law, Hyderabad, hereby declare

that the particulars given above are true to the best of my knowledge

and belief.

SD/-

DATE : REGISTRAR