SEBI feuds with SAT in the Supreme Court

Or how petty conflicts are good business for lawyers

SEBI and SAT being two petty cats

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A company that’s going public really wants two things. First, it wants to raise money by selling its shares to the public. Second, it wants its shares listed on an exchange so that these investors can buy and sell its shares whenever they like.

When a company is raising money from investors, it’s usually at its best behaviour. It releases its detailed financial statements, informs investors of the risks it faces, tells them about its competitors and how it compares with them, and generally complies with a thousand other regulations. It’s a happy but also sensitive time for the company. If things go wrong, you’d potentially lose a lot of money. So you’re going to be good!

After a company has raised money, things aren’t so sensitive. As a listed company, its share price will go up and down depending on a lot of factors, and the company’s general behaviour is just one of those factors. One of the goals of SEBI—that regulates buying and selling of shares—is to ensure that companies that are public sustain their good behaviour. SEBI does this by mandating that companies file disclosures if there is any information that can affect their stock prices. If there's a workers’ strike at the company’s factories, for instance. Or maybe a large contract has been cancelled. There is some subjectivity here, but a company that’s nice will file a disclosure, just in case.

These “good behaviour” regulations are part of a listing agreement that a company signs right before its shares are listed on an exchange. A company that wants to go public has to sign this agreement, it’s not an option. The nuance though is that, on a dumb technical level, the company doesn’t sign this agreement for the first part of its going public process, which is, while selling shares to investors. It signs this for the second part—to allow public investors to trade the shares they just bought.

This is a dumb and meaningless distinction! A company can’t go public without signing its listing agreement. There isn’t a real option for it to sell its shares to the public and then refuse to sign the listing agreement to list them on an exchange. And yet, here we are. Earlier this month from Mint:

The stalemate between the Securities and Exchange Board of India (Sebi) and the Securities Appellate Tribunal (SAT) over the interpretation of a specific provision of the securities law has now reached the Supreme Court. SAT has overturned more than half a dozen Sebi orders related to listing-agreement violations, and Sebi has now appealed these judgements in the Supreme Court.

Provision 23(E) of the Securities Contracts (Regulations) Act (SCRA) is at the heart of the impasse. The provision says any company violating listing conditions could attract a penalty of up to ₹25 crore. Sebi has been taking the view that “listing conditions" specified in the Act mean a violation of listing rules.

SAT, however, has rejected this interpretation taken by Sebi and said the law only applies if listing conditions are not met. It overturned all Sebi orders related to the matter.

SEBI passed some orders against some companies which apparently violated their listing agreements. The companies appealed against this and went to the Securities Appellate Tribunal (SAT), which is the court that hears appeals. SAT overturned these orders. So SEBI appealed against this in the Supreme Court.

SEBI says that these companies violated their listing agreement, the good behaviour agreement that they signed right before their shares went up on the exchange. So it charged them under a certain section of the securities law, which applies when “listing conditions” are violated. But SAT disagreed that this particular section applied for listing agreement violations.

Yeah, this conflict is about the stupid distinction I spoke about earlier. A company has to meet its listing conditions before it sells shares to the public, but it signs the listing agreement only before its shares go up on the exchange.

Suzlon is where it started

In 2018, SEBI released an enforcement order penalising Suzlon Energy, a wind energy company, for failing to make certain disclosures back in 2007-2008.¹ Honestly, this entire episode is so old now that the finer details aren’t important anymore. The gist of the order was:

1. Suzlon failed to inform the stock exchanges immediately after multiple large orders were cancelled by customers. These orders were the basis of Suzlon’s valuation at the time

2. SEBI decided that Suzlon had broken its listing agreement

3. So it fined Suzlon

Suzlon appealed SEBI’s decision and went to SAT. In 2021, SAT released its order.. agreeing with pretty much everything SEBI did? The only disagreement was the specific section of the law which applied to Suzlon, and consequently the penalty amount that came with it. SEBI had imposed a small fine (₹5 lakh/$6000) and a large fine (₹1 crore/$120k) on Suzlon under two different sections. SAT decided that only the lesser section applied.

Here are the two sections:

23A (the lesser penalty)

Any person, who is required under this Act or any rules made there under,—

(a) to furnish any information, document, books, returns or report to a recognised stock exchange, fails to furnish the same within the time specified therefore in the listing agreement or conditions or bye-laws of the recognised stock exchange, shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore rupees, whichever is less for each such failure;

23E (the higher penalty)²

If a company or any person managing collective investment scheme or mutual fund, fails to comply with the listing conditions or delisting conditions or grounds or commits a breach thereof, it or he shall be liable to a penalty not exceeding twenty-five crore rupees.

SAT agreed that Suzlon was late with its disclosures and allowed 23A—which is specifically about disclosures—to apply. But it disagreed that 23E applied for being late with disclosures—which is a more general section about violation of listing conditions. Instead, according to the SAT order, the only listing condition a company could possibly violate was one of having at least 25% of the company’s shares owned by the public.

Okay, listen, listen, listen. This 25% minimum public shareholding requirement is super important. If a company is selling stock to the public, it has to make sure it sells enough of it so that the owners can’t easily manipulate the stock price.³ But is it really the only condition that matters? I mean, I don’t know. SAT seems to think so. SEBI thinks otherwise.

SEBI just wants some leeway

Since SAT’s order on Suzlon in 2021, there have been at least 6 other instances of SEBI using the same 23E provision to penalise companies, only for SAT to later overturn all of them. As one might expect, SAT isn’t too happy about having to issue the same order again and again. Here’s a 2-page order by SAT from March this year overturning a ₹5 lakh ($6000) penalty on CG Power, an electrical products company. Here’s what SAT says:

The learned counsel for the respondent has fairly conceded that the matter is squarely covered by a decision of this Tribunal in Suzlon Energy Ltd. & Anr. vs. SEBI in Appeal No. 201 of 2018 dated May 03, 2021.

That’s it! “We’ve already ruled against this exact thing, so yeah let’s not waste any more time on it and overturn this right away.”

One way to think about the conflict between SEBI and SAT is that they’re not really squabbling about which is the correct section to apply. Sure, that’s what they’re going to Court for. But what SEBI really wants is more leeway to penalise companies that miss filing disclosures on time. Section 23A, the lesser section that both SEBI and SAT agree applies, allows a flat fine of ₹1 lakh ($1200) per day of delay for a particular disclosure. But, surely, not all disclosures are the same?

Maybe there’s a hotel company that decides that it doesn’t like the hotel business anymore, and would like to instead convert their hotels into hospitals. If the company makes this decision today, informs its employees about it, maybe even hires a few doctors, but does not file a disclosure about it for a week, investors that buy its shares in that time period are expecting to buy into a hotel business, but are actually buying a hospital business. On the flip side, investors that sell their shares in that period would be expecting to sell a hotel business but would actually be selling shares of a hospital company. Maybe they would rather have held onto them? A ₹1 lakh/day fine might be okay for delays in minor disclosures, but for something like this it would just be a get-out-of-jail free card.

On the other hand, section 23E, which SAT doesn’t like being used for disclosures, allows SEBI the leeway to penalise the company up to ₹25 crore ($3 million). That’s nice! It can then evaluate just how harmful the delay of a particular disclosure was for investors and fine the company accordingly. SEBI fined Suzlon ₹1 crore ($120k), but CG Power just ₹5 lakh ($6000). Seems like the flexibility was working as intended.

One solution to this feud is that SEBI could just get more leeway with the penalty within 23A. But that would require a change of law, which would need an approval in Parliament and the Parliament doesn’t normally care about niche securities law. Another solution would be, of course, that the Supreme Court allows 23E to apply. But the Supreme Court is busy, slow and inefficient and might not care about prioritising this soon enough. I guess we’ll just be seeing SEBI issue dead-on-arrival orders against companies until then. At least the lawyers can have a good time.⁴

1. Most of the other orders that I’ve written about were interim orders by SEBI. The first order that SEBI issued against a company. This particular order was by SEBI’s adjudicating officer, who evaluates SEBI’s own arguments as well as the company’s, and releases their order after taking the merit of both into account.

2. Suzlon funnily tried to argue here that this particular section applied only to mutual fund companies or other companies that manage investor money. I’ll admit that the wording in the law is a bit odd. Thankfully SAT didn’t allow this argument to go through. If it had, it would mean that regular companies couldn’t be penalised for violating their listing conditions at all!

3. Boring Money’s first post, Adani stocks only go up, elaborates on how a company’s stock price can be manipulated if not enough of the stock is owned by the public.

4. While this listing conditions conflict seems to be petty, even if important, I have a feeling that there’s more going on between SEBI and SAT behind the scenes. There are quite a few SEBI orders that SAT has reversed, sometimes even while agreeing with SEBI’s findings. If you’re a journalist reading this, please try finding out what’s happening!