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.

UltraTech new capex plan to commence in FY23 or FY24, says brokerage

13 Jun 22

UltraTech Cement Ltd’s recently announced 22.6-mln-tonne-per-year capacity expansion is likely to be funded entirely through internal accruals and will commence in 2023-24 (Apr-Mar) or 2024-25, the company said in a recent investor conference according to a report by brokerage Jefferies India.

In 2022-23, the company will be adding 16.5 mln tonne per year capacity which was a part of capex plan announced in 2020.

On Jun 2, UltraTech Cement had announced that it would incur capital expenditure of up to 128.9 bln rupees towards increasing capacity by 22.6 mln tonne per year by way of integrated units, grinding units and bulk terminals, in a phased manner by 2024-25.

It had specified in the stock exchange filing that it would fund the capex through a mix of borrowings and internal accruals.

The brokerage report said that UltraTech specified its blended capex plan was for $76 per tonne, greenfield expansions were likely at around $100 per tonne and brownfield expansions at around $50 per tonne.

The report also stated that the company found cement demand in Apr-May to have fallen short of its expectations which led to price declines of 10-12 rupees per bag in May which followed price hikes of 30 rupees per bag in April.

The company also reportedly said that based on current petcoke prices of 250-260 rupees per tonne and international coal cost of $370 per tonne, its power and fuel costs are likely to increase by around 300 rupees per tonne as compared to the Jan-Mar quarter’s number.

Meanwhile, Fitch Ratings said today that it had raised the outlook of the ‘BBB minus’ long-term foreign currency issuer default rating of UltraTech Cement to stable from negative, following the rating agency’s recent upward revision of the outlook on India’s issuer default rating of ‘BBB minus’ to stable from negative.

The ratings agency said that UltraTech’s higher capacity expansion capex and the faster new capacity additions in the domestic cement industry will weigh on margins and lead to moderately negative free cash flow over the current and next financial year.

SEBI directs F6 Finserve to return siphoned off client funds, shares

9 Jun 2022

The Securities and Exchange Board of India today directed brokerage firms F6 Finserve and F6 Commodities and their promoter directors to return funds and securities of their client, along with annual interest of 15%, which they siphoned off in grave violation of regulatory norms.

In a final order passed against the two brokerage firms, Pankaj Goel, Meenu Goel and two other promoter directors, SEBI held that they were carrying out their broking operations with various flagrant violations and mismanaging their clients’ funds and securities.

Although the SEBI order did not specify the exact amount of client funds and securities that had to be returned, it stated separately that the claims by the clients of the broker valued 433 mln rupees.

The egregious irregularities in handling of client funds and securities were carried out for at least two years during 2016 to 2018 when an inspection by the National Stock Exchange of India brought it out in the open.

SEBI then took over the probe and carried out a detailed investigation. It found that the broker was not settling the credit balances of several clients in contravention of SEBI norms that required brokers to settle once every quarter.

Among several violations, F6 Finserve had used client securities to meet settlement obligations on its proprietary account and had transferred securities inter se between its clients.

Earlier, in April 2018, the NSE and BSE had declared F6 Finserve as a defaulter and expelled it. F6 Commodities was expelled by the commodity derivatives exchanges in May 2018.

In today’s order, SEBI also barred the two brokerage firms and the four promoter directors from all securities market activities and positions for five years.

Gulf Oil Lub’s FY22 receivables jump due to Mar sales surge, says co

9 Jun 2022

The trade receivables of Gulf Oil Lubricants India Ltd at the end of 2021-22 (Apr-Mar) represented a big increase over the year ago level but the company attributed it to the high topline growth during the financial year.

Trade receivables were up sharply by 57% to 3 bln rupees as of Mar 31, data from Informist Corporate Fundamental Database showed. The revenue from operations of the company, which is a leading private player in the domestic lubricants business, rose by 33% on year to 21.9 bln rupees in 2021-22.

Analysts tend to view any significant jump in trade receivable as an indicator of potential liquidity problem,

Manish Gangwal, chief financial officer at Gulf Oil Lubricants, said in a recent conference call with investors and analysts that the full year topline of the company grew by nearly 33% in 2021-22 which increased the receivables overall. Further, March was a “very-very high month” in terms of sales and those were all standing in the trade receivables at the end of the year.

The company’s March quarter net sales of 6.4 bln rupees was 29% of full year sales, the data showed. The revenues for Jan-Mar grew by 24% on year and 6% on quarter.

Given that trade receivables jumped up by 57% while full-year revenues grew by a lower rate of 33%, the March sales surge would have likely been significant.

The company’s clarification on the trade receivables was in response to a query from an analyst on the sudden jump in of high trade receivables. The analyst further pointed to falling cash flows.

The company said it was in control of the working capital and that the trade receivables were “only 5 to 6 days higher” than normal. It said that the buyback it effected in 2021-22 led to a total cash outflow of 1.1 bln rupees.

The company had cash and cash equivalents of 5.7 bln rupees as of March 31, higher than the year-ago level of 5 bln rupees.

Analysts look at trade receivables to turnover ratio of companies to gauge the liquidity position. A rise in the ratio is generally considered as problematic.

In case of Gulf Oil Lubricants, the data showed that that average trade receivables in 2021-22 were nearly 12% of full year revenues and it was significantly up compared to the previous year ratio of 10.1%. The average was calculated as a mean of the Sep 30 and Mar 31 figures provided in the balance sheets as of those two dates.

A rise in operating costs had reined in the company’s growth in earnings before interest, tax, depreciation and amortisation to 3.3 bln rupees in 2021-22 from 3.2 bln rupees in the previous year, while the EBITDA margin contracted sharply to 14.8% from 18.6%.

Price cuts, input cost rise in May to hit cement cos, say brokerages

7 Jun 2022

A slack in demand last month led to cement companies partially rolling back the price hikes they had taken in April in key regions.

Further, spikes in petcoke and coal prices, a key input cost for the cement industry, continued in May and analysts expect this, along with subdued net price hike in Apr-May, to hit the operating margins of cement companies.

The average domestic selling price of cement declined 3% on month In May, with multiple markets seeing declines, on the back of weak demand, said brokerage Jefferies India in a report.

Average cement prices witnessed 3% on-month decline in May on account of a sharp 7% decline in the major region of North, followed by 3% on-month decline each in central and southern regions, according to brokerage JM Financial.

“Volumes in May slipped on MoM (month-on-month) basis by mid-to-high single digit, while remaining higher YoY (year-on-year) on soft base,” said Jefferies. The brokerage estimates cement industry demand for 2022-23 (Apr-Mar) to be in high-single digits, compared to around 8% increase in demand in 2021-22.

The key input costs were inching up materially, said JM Financial, with coal prices rising sequentially in May and average petcoke prices rising to around $390 per tonne in May from $360 per tonne level in the previous month and around $320 in March.

According to broker Motilal Oswal Financial Services the impact of sustained increase in energy costs will be felt by cement companies in Apr-Sep. Based on its channel checks, the brokerage estimated the Apr-Jun volumes to decline around 15% on quarter as against a historical on-quarter decline of 8-9% in the June quarter.

Jefferies India said that the price hikes announced by cement companies for June were limited to “very few” markets. As a result of price hikes not sustaining and input costs remaining elevated the brokerage said the downward risk on earnings estimates had resurfaced.

Analysts expect that the on-year volume growth in Apr-Jun to be high due to a low base and were, therefore, watchful of on-quarter trends which showed weakness.

Analysts are watching closely whether the Apr-May trends in prices, volumes and input costs will continue to worsen in the current month and result in a larger hit on the operating margins of cement companies.

UltraTech to incur 129-bln-rupee capex to raise capacity by 23 mln tn

2 Jun 2022

UltraTech Cement Ltd has decided to incur capital expenditure of up to 128.9 bln rupees towards increasing capacity by 22.6 mln tonne per year by way of integrated units, grinding units and bulk terminals, in a phased manner by 2024-25 (Apr-Mar).

The capacity expansion will be done through the brown field and green field routes, the company said in a stock exchange filing today.

The Aditya Birla Group company will fund the capex through a mix of borrowings and internal accruals.

UltraTech’s existing grey cement capacity is nearly 120 mln tonne per annum with a current capacity utilisation of 77%.

Kumar Mangalam Birla, Chairman, Aditya Birla Group said that the “ambitious capacity expansion plan is a significant milestone in the ongoing transformational growth journey of UltraTech.”

The company said the commercial production from the new capacities is expected to go on stream in a phased manner by 2024-25.

It said that the current expansion program was on track and estimated to be completed by the end of 2022-23 (Apr-Mar).

SEBI Watch: Client collateral safeguards in place, monitoring now key

2 Jun 2022

From May 2, a major gap in the client margin mechanism that enabled brokers to use excess funds or securities balance in one client to fund a shortfall in the account of another client was plugged. This is a substantial change.

Securities and Exchange Board of India announced this change along with others in a circular in July last year on client level collateral segregation and monitoring by brokers, clearing members and clearing corporations. It was initially scheduled to take effect from Dec 1 but market participants have got SEBI to postpone it.

After the Karvy Stock Broking fraud case came to light in 2019, the issue of client funds and securities misuse has become paramount for the regulators and market participants. The problem in the system was acute as many other cases of broker misappropriating client funds and securities came out in the open.

The underlying weakness in the mechanism of handling of client funds and securities by brokers and clearing corporations for margins and trade settlement purposes came as a shock to many.

But since then the capital market regulator has moved deftly and effected changes aimed at safeguarding client funds and shares.

The most important safeguard to have was that of one client’s funds and shares not getting misused to fund the shortfall in another client or the broker’s proprietary account.

At the same time, since mid-2020, the retail investor participation in cash and derivative markets has gone up exponentially and the need for changes became urgent.

It was leading to demand by some recalcitrant clients on brokers to take care of margin or other shortfalls in their accounts by any means possible. If the broker was not funding these shortfalls from its own funds or securities then it was dipping into funds or securities of other clients.

Broker proprietary account shortfalls also posed similar problems for the client funds and securities.

The changes that SEBI announced in July laid out in great detail on how the fund and securities collateral, including the recently introduced securities pledge and re-pledge for margins directly with the clearing corporation, will be handled at all stages from the client to the clearing corporation.

There is, since May, a strict bar o the broker from co-mingling client funds and securities with each other or with its proprietary account.

Now, if there is a margin or other shortfall in one client’s account, the broker will only be able to fund it from its own account and not accounts of other clients.

These much-needed safeguards are now in place, and credit goes to SEBI on persisting with the change.

But continuous monitoring by clearing corporations and SEBI will still be needed. They will have to be on guard against false allocation of client level margins provided by brokers to clearing corporation, and undue withdrawal of client allocation by brokers without intimation to the clients.

The markets will be safer only if adequate monitoring and enforcement happens.

Even before the Karvy scam took place, the principle of client funds and securities not getting misused by the broker was enshrined in the rules. But the underlying mechanisms were not foolproof to ensure that it was followed all the time.

Religare Ent, Religare Finvest settle with SEBI in funds fraud case

1 Jun 2022

Religare Enterprises Ltd and its subsidiary, Religare Finvest, have paid settlement amounts of 54.2 mln rupees and 50.9 mln rupees respectively to settle a probe by the Securities Exchange Board of India into their alleged breaches of listing and prohibition of fraudulent practice regulations.

In a settlement order on Tuesday, SEBI said that it had issued a show-cause notice to Religare Finvest for allegedly being a part of a fraudulent and deceptive scheme to divert 24.74 bln rupees from Religare Enterprises to the promoter group entities. Shivinder Singh and Malvinder Singh were the ultimate promoters of Religare Enterprises when the alleged fraud took place.

SEBI was also probing Religare Enterprises for falsifying its consolidated financials and not disclosing on time Reserve Bank of India’s repeated adverse observations on Religare Finvest’s corporate loan book.

SEBI passed another settlement order on Tuesday in the same case against Pankaj Sharma, chief executive officer of Religare Finvest.

Sharma has paid 4.4 mln rupees to settle SEBI’s probe into his alleged failure to carry out adequate due diligence and exercise independent judgement with respect to grant of loans by Religare Enterprises during the period in question.

Religare Finvest had, in January, settled a similar case involving its alleged role in aiding and abetting the routing of funds from Fortis Healthcare to RHC Holdings and consequently to Malvinder Singh and Shivinder Singh, who were part of the promoter group of the Fortis Healthcare when the funds diversion took place.

It paid a settlement amount of 18.2 mln rupees to SEBI in that case.

SEBI fines six entities for front running Sterling Group trades

1 Jun 2022

The Securities and Exchange Board of India, on Tuesday, levied a fine of 3 mln rupees against an employee of Sterling Group and two of his family members in a front running case pertaining to trades carried out by them during 2010-2011.

SEBI held that Manish Chaturvedi and his family members made an unlawful profit 81.9 mln rupees by orchestrating the front running in trades Sterling Group trades by getting a few traders to execute trades ahead of the corporate group.

SEBI had, in December 2020, ordered Chaturvedi and his family members to disgorge 189.9 mln rupees, including interest of 105.7 mln rupees, towards the illegal gains made from the front running operation.

In the same matter, SEBI, on Tuesday, also fined Madhu Chanda, a dealer who was associated with brokerage firm, Sharekhan, during the period in question, and her two family entities 2.5 mln rupees. SEBI said they made unlawful gains of nearly 4 mln rupees from their front running trades.

Chanda and her family members were, in December 2020, directed by SEBI to disgorge 9.1 mln rupees, including interest of 5.1 mln rupees.

SEBI’s enforcement in front running cases is based on the premise that it is a fraud against the securities market as a whole and not only against the specific entity whose trades have been front run.

Front running is specifically barred under SEBI’s prohibition of fraudulent and unfair trade practices.

Former SBI MD Ashwani Bhatia joins SEBI as a whole-time member

1 Jun 2022

Ashwani Bhatia, who was a Managing Director in State Bank of India till last month, has joined the Securities and Exchange Board of India as a whole-time member.

In a statement, SEBI said that Bhatia took charge of his position today.

A whole-time member at SEBI occupies a seat on the market regulator’s board, which currently has Madhabi Puri Buch as the chairperson, three whole-time members including Bhatia, and four part-time members.

At SEBI, Bhatia will be required to handle all regulatory matters pertaining to foreign portfolio investors, market intermediaries, debt and hybrid securities, alternative investment funds, corporation finance and investor assistance and education.

Apart from Bhatia, S K Mohanty and Ananta Barua are the current whole-time members of SEBI.

The position of a whole-time member had fallen vacant after G Mahalingam’s 5-year tenure got over in November.

Mohanty became a whole-time member in June 2018 and Barua took over his position in August 2018.