SEBI Watch: Plug loopholes allowing misuse of preferential share issue funds

13 Jun 2022

A recent ruling by the Securities Appellate Tribunal has put a spanner in the works of the Securities and Exchange Board of India with regard to the latter’s regulatory and enforcement rigours in the rules governing preferential issue of shares by listed companies.

Early this month, SAT ruled against a SEBI order of April that had fined a company, Terrascope Ventures, for a significant deviation from the stated use of funds garnered in a preferential issues of equity shares in 2012.

The sole ground on which SAT allowed the appeal was that the deviation in funds use was ratified by shareholders in an annual general meeting in 2017 by a majority vote.

This ruling by SAT may have adverse ramifications for shareholders if companies manage to get majority votes for ratifying earlier use of funds that was not in line with the stated purposes at the time of a preferential issue.

It opens a pandora’s box which SEBI would find it hard to grapple with. A majority approval is easy for companies where promoters hold stakes of 25-30% or more.

At present, the issue of capital regulations require companies raising funds through preferential issue of shares to specifically state the various purposes for which the funds proposed to be raised by them and get shareholder approval prior to giving effect to the preferential allotment of shares.

SEBI had rightly contended in its order against Terrascope Ventures that the company’s use of funds for other purposes would render the information provided prior to the preferential issue as untrue, misleading and distorted.

This violated the listing regulations, the issue of capital norms and the regulations on prohibition of fraudulent and unfair trade practices in the securities market. It was, therefore, appropriate that SEBI impose penalties on the company, its managing director and another director in the case.

But, given the negative implications for investor rights from SAT’s order, SEBI must appeal the ruling in higher courts.

SEBI also has the option to tweak its regulations on issue of capital and listing obligations to specifically prohibit retrospective shareholder approval of deviation in use of funds raised through preferential issues.

Any misuse of funds raised from issue of shares, even if it is within the ambit of court rulings, will hurt the interests of investors. Existing loopholes in the norms that get exploited by companies in the court appeals must get removed.