SEBI Order and Satyam Scandal: Much Needed Impetus

SEBI Order and Satyam Scandal: Much Needed Impetus GAURAV ARORA M. SUPRITHA PRODATURI INTRODUCTION 1. More than five years ago Corporate India was taken aback when the founder of Satyam Computer Services Limited ( the Company ) (now known as TechMahindra Limited) admitted that one of India s most renowned companies had been lying to the whole world about its earnings for years together. The Satyam scam changed the way legislators thought about framing laws in relation to corporate governance, which was also clearly reflected in the provisions of the newly enacted Companies Act of 2013. Five years down the line, when the CBI is awaiting the trial Court s decision, market regulator - the Securities and Exchange Board of India( SEBI ) passed its order B. Ramalinga Raju, In re [2014] 47 taxmann.com 47 (SEBI) against Mr. B Ramalinga Raju, Ex-Chairman; Mr. B Rama Raju, Ex-Managing Director; Mr. Vadlamani Srinivas, Ex-Chief Financial Officer; Mr. G Ramakrishna, Ex-Vice President; and Mr. V. S. Prabhakara Gupta, Ex-Internal Audit Head. One could ponder over whether this order delivered after five long years is too late but at the same time, one must acknowledge that this is the first official and comprehensive account in the public domain of what allegedly happened in that scam. BRIEF BACKGROUND OF THE CASE AND SEBI S INITIATIVE 2. SEBI received an e-mail, dated January 7, 2009 from Mr. B. Ramalinga Raju admitting and confessing the fraud done along with details of manipulated accounts. In response to this e-mail, SEBI initiated an investigation into the affairs of the Company to ascertain, particularly whether the provisions of the AUGUST 16 TO 31, 2014 Taxmann s Corporate Professionals Today Vol. 30 51

Securities and Exchange Board of India Act, 1992 ( SEBI Act ) and rules and regulations framed thereunder had been violated? Several opportunities were provided by SEBI to all the accused while adhering to principle of natural justice, which none of the parties availed and eventually SEBI proceeded with the case on the basis of material available on record by noting that the pendency of CBI trial could not be accepted as a justifiable reason for their non-attendance on the dates fixed for personal hearings and they could appear for personal hearing through authorised representative/s. RELEVANT PROVISIONS ALLEGED TO HAVE BEEN VIOLATED IN THE CASE 3. The relevant provisions of the SEBI Act; SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to the Securities Market) Regulations, 2003 ( the PFUTP Regulations ) and SEBI (Prohibition of Insider Trading) Regulations, 1992 ( the PIT Regulations )which are alleged to be violated are reproduced below: 3.1 SEBI Act 3.1.1 Prohibition of manipulative and deceptive devices, insider trading and substantial acquisition of securities or control 12A. No person shall directly or indirectly (a) use or employ, in connection with the issue, purchase or sale of any securities listed or proposed to be listed on a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of this Act or the rules or the regulations made thereunder; (b) employ any device, scheme or artifice to defraud in connection with issue or dealing in securities which are listed or proposed to be listed on a recognised stock exchange; (c) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person, in connection with the issue, dealing in securities which are listed or proposed to be listed on a recognised stock exchange, in contravention of the provisions of this Act or the rules or the regulations made thereunder; (d) engage in insider trading; (e) deal in securities while in possession of material or non-public information or communicate such material or non-public information to any other person, in a manner which is in contravention of the provisions of this Act or the rules or the regulations made thereunder. 3.2 PFUTP Regulations 3.2.1 Prohibition of certain dealings in securities 3. No person shall directly or indirectly - (b) use or employ, in connection with issue, purchase or sale of any securities listed or proposed to be listed in a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of the Act or the rules or the regulations made thereunder; (c) employ any device, scheme or artifice to defraud in connection with dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange; (d) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person in connection with any dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange in contravention of the provisions of the Act or the rules and the regulations made thereunder. AUGUST 16 TO 31, 2014 Taxmann s Corporate Professionals Today Vol. 30 52

4. Prohibition of manipulative, fraudulent and unfair trade practices - (1) Without prejudice to the provisions of regulation 3, no person shall indulge in a fraudulent or an unfair trade practice in securities. (2) Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice it involves fraud and may include all or any of the following, namely:- (a) indulging in an act which creates false or misleading appearance of trading in the securities market; (e) any act or omission amounting to manipulation of the price of a security; (f) publishing or causing to publish or reporting or causing to report by a person dealing in securities any information which is not true or which he does not believe to be true prior to or in the course of dealing in securities; (k) an advertisement that is misleading or that contains information in a distorted manner and which may influence the decision of the investors; (r) planting false or misleading news which may induce sale or purchase of securities. 3.3 PIT Regulations 3.3.1 Prohibition on dealing, communicating or counselling on matters relating to insider trading 3. No insider shall (i) either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange when in possession of any unpublished price sensitive information; or (ii) communicate or counsel or procure directly or indirectly any unpublished price sensitive information to any person who while in possession of such unpublished price sensitive information shall not deal insecurities: Provided that nothing contained above shall be applicable to any communication required in the ordinary course of business or profession or employment or under any law. 3.3.2 Violation of provisions relating to insider trading 4. Any insider who deals in securities in contravention of the provisions of regulation 3 or 3A shall be guilty of insider trading. FINDINGS OF SEBI 4. After a careful analysis of records available, SEBI gave a detailed description of the accounts fraudulently maintained by the Company by comparing it with the actuals and determining the unlawful gains and, accordingly, laid down penalties. 4.1 From where did the inflated money come?- Inflated money was the result of combination of many factors which were induced fraudulently by the erstwhile top management. In relation to Fixed Deposit Receipts ( FDRs ), it was observed that the balances of FDRs stated in the letters of confirmation provided to the auditors were substantially higher than the actual FDR balances and some were even non-existent. It was further observed by SEBI that the sales revenues were inflated and shown in the books through insertion of a large number of fictitious invoices raised in respect of fake customers and/or transactions. There were more than 7,500 fake invoices created in the period from April, 2003 to September, 2008. Fake invoices were introduced into the system through the Invoicing Management System ( IMS ). SEBI gave a detailed description of how IMS was misused. Over-statement of AUGUST 16 TO 31, 2014 Taxmann s Corporate Professionals Today Vol. 30 53

revenues and under-statement of liabilities also led to inflating the bank balances. 4.2 How it impacted the investors? - SEBI stated that the falsified financials of the company showed grossly inflated earnings, which, in turn, resulted in an inflated earnings per share ( EPS ) that had a direct bearing on the investment decision of an investor. Also, the other financial ratios, such as price to earnings ( P/E ) also portrayed an incorrect picture. Millions of investors who invested in the scrip of the Company were clearly misled by the wrong projections given in the financial indicators such as EPS, P/E, etc. 4.3 Fraudulent announcements by the company - In October, 2006, the company made a bonus issue of 32,76,94,738 equity shares in the ratio of 1:1 to the shareholders on the basis of the false financial position disclosed in the books of account. Immediately upon the announcement being made by the Company on April 10, 2006 that it was considering the issue of bonus shares, there was a rally in the scrip of Satyam Computers on the NSE, the price rising from the previous closing price of ` 816.3 to a high of ` 844.5 (about 3.5%). Similar upward movement was also noticed in the scrip at BSE 1. Thus, the bonus issue was declared with a view to mislead investors and to maintain an artificial price of the company in the market. Similarly, announcements in relation to American Depository Share (2005) and Buy-back (2008) were made by the company with a view to portray a false picture in the market and to mislead the investors. 4.4 Violations of PFUTP Regulations and PIT Regulations - Based on factual records, such as creating manipulated accounts and knowledge of such manipulations by others with possession of unpublished price sensitive information ; fixed deposits, monthly statements, banking arrangement and fake renewal letters; false CEO certification under clause 49 of the Listing Agreement; fraudulent announcements such as Bonus and American Depository Share Issues, Buy-back of shares by the Company; etc., charges under PFUTP Regulations and PIT Regulations were established by SEBI against all the five erstwhile top management personnel. SEBI also presented a detailed account of charges against each individual by drawing an analogy with facts in the order. 4.5 SEBI acted on Supreme Court s directions - Before pronouncing a verdict on penalty, SEBI gave a reference of one of the recent judgments of the Hon ble Supreme Court in the case of N. Narayanan v. Adjudicating Officer, SEBI 2, wherein the Court made the following observations: word of caution: SEBI, the market regulator, has to deal sternly with companies and their Directors indulging in manipulative and deceptive devices, insider trading etc. or else they will be failing in their duty to promote orderly and healthy growth of the Securities market. Economic offence, people of this country should know, is a serious crime which, if not properly dealt with, as it should be, will affect not only country s economic growth, but also slow the inflow of foreign investment by genuine investors and also casts a slur on India s securities market. Message should go that our country will not tolerate market abuse and that we are governed by the Rule of Law. Fraud, deceit, artificiality, SEBI should ensure, have no place in the securities market of this country and market security is our motto. People with power and money and in management of the companies, unfortunately often command more respect in our society than the subscribers and investors in their companies. Companies are thriving with investors contributions but they are a divided lot. SEBI has, therefore, a duty to protect investors, individual and collective, against opportunistic behaviour of Directors AUGUST 16 TO 31, 2014 Taxmann s Corporate Professionals Today Vol. 30 54

and Insiders of the listed companies so as to safeguard market s integrity. 4.6 Penalty Imposed - The true, fair, adequate and timely disclosures of the financial position of a company form one of the basic tenets of governance in listed companies and are essential for maintaining the integrity of the securities market 3, SEBI noted. Based on aforementioned principle and in exercise of the powers conferred under section 19 of the SEBI Act, 1992, read with sections 11, 11(4) and 11B of the SEBI Act, and regulation 11 of the PFUTP Regulations, and regulation 11 of the PIT regulations, SEBI restrained all the five charged personnel from accessing the securities market and further prohibited them from buying, selling or otherwise dealing in securities, directly or indirectly, or being associated with the securities market in any manner, whatsoever, for a period of 14 years. Further, regulator observed that no person could be allowed unjust enrichment by way of wrongful gain made on account of fraudulent, manipulative and unfair activities and/or insider trading and, therefore, imposed a penalty of ` 1,849 crore on all the charged persons with simple interest at the rate of 12% per annum from January 7, 2009 till the date of payment. Directions were issued to pay the said amount within 45 days from the date of the passing of the order. CONCLUDING REMARKS 5. There is no doubt in the fact that this order of SEBI has provided much needed impetus towards realization of our goals of corporate governance. At the same time, regulator should be ready to face challenges related to implementational aspects of this order. First challenge - how SEBI is proposing to collect this penalty amount and when the amount is realised, next challenge before the regulator will be to figure out all the investors who had suffered losses out of the fraudulently conducted activities by the Company and their respective loss amounts. - The views expressed are personal views of the authors. 1. Please refer to paragraph 66 of the SEBI s order. 2. [2013] 32 taxmann.com 302. 3. Please refer to paragraph 142 of the SEBI s order. AUGUST 16 TO 31, 2014 Taxmann s Corporate Professionals Today Vol. 30 55