In re Target People Social Security Scheme Micro Finance Limited.

The author here discusses the violation of SEBI norms for issuance of Equity shares by Non Banking Financial Companies with the help of a case law.
Estimated Reading Time: 9 minutes

Introduction

Non-banking financial companies (Hereinafter “NBFC”) are companies that do not have the license to offer the full range of banking services. They cater to particular groups in need of a smaller set of financial services. To provide credit for this purpose, NBFCs need to raise capital at frequent intervals. Hence, raising capital is essential to the growth of NBFCs. The non-banking sector was unregulated until the introduction of Chapter IIIB in the Reserve Bank of India (Hereinafter “RBI”) Act.[1]Simplified norms, flexibility, and speed in fulfilling credit needs as well as the low cost of operations enabled NBFCs to get an edge over banking institutions in funding. Non-banking institutions have been pioneering at lending and dealing with asset-backed securities and microfinancing. However, in many cases, mismanagement and non-adherence to regulations and legal provisions have been observed. Being the market regulator, the Securities Exchange Board of India (Hereinafter “SEBI”) has the duty to safeguard the interest of investors for which it has enforced a comprehensive mechanism. Let us discuss the case of Target people social security.

Under Sections 11(1)[2], 11(4)[3], 11A[4] and 11B[5] of the SEBI Act, 1992along with Regulation 107[6] of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, the Board scrutinized Target People Social Security Scheme Micro Finance Limited and its directors, Mariaponnusamy Moyeeson, Joseph Johnson Savarimuthu and Arockiasamy Judi Gerald Paulrajfor issuance of equity shares.

Factual Background

The Securities and Exchange Board of India (SEBI) received a reference dated 24thJuly, 2014 from the Reserve Bank of India regarding the issuance of equity shares made by Target People Social Security Scheme Micro Finance Limited (TPSSSMFL). It was stated that TPSSSMFL had applied for the certificate of registration under Section 45-I of RBI Act, 1934 for commencing operations as a Non-banking Finance Company – Micro Finance Institution (NBFC-MFI). In addition, it was stated that while processing the application, RBI had observed that TPSSSMFL made the issuance of shares to more than 50 persons. Along with the reference, RBI enclosed copies of the share allotment forms and letters issued by TPSSSMFL to the allottees.

It was alleged that the Noticees hadcontravenedSections 56(1)[7], 56(3)[8], 60[9] and 73[10] of the Companies Act, 1956 and Regulations 4[11], 5[12], 6[13], 7[14], 8[15], 9[16], 26[17], 32[18], 36[19], 37[20], 46[21], 47[22], 49[23], 57[24], 58[25] and 63[26] of Issue of Capital and Disclosure Requirements (Hereinafter “ICDR”) Regulations.

Issues

  1. Whether TPSSSMFL can be recognized as an NBFC?[27]
  2. Whether TPSSSMFL has violated Section 56(1), 56(3) and 60 of the Companies Act?[28]
  3. Whether TPSSSMFL has contravened the provisions of Section 73 of the Act for not applying for listing of its shares on any recognized stock exchange?[29]
  4. Whether Regulations 4, 5, 6, 7, 8, 9, 26, 32, 36, 37, 46, 47, 49, 57, 58 and 63 of ICDR Regulations were violated?[30]

Summary of the decision and judgement

TPSSSMFL had made a series of allotments of equity shares between 29thJune, 2013 and 21stAugust, 2013 to 10,043 persons amounting toa total of Rs. 5.19 crores. The question of law regarding the allotment of shares to allottees exceeding 49 allottees was previously dealt with in the case ofSahara India Real Estate Corporations Limited &Ors. v. SEBI &Anr.[31]It was held that the issue of securities made to fifty or more persons would be considered as a public issue underSection 67(3) of the Companies Act, 1956.[32]

The Noticees contended that TPSSSMFL is an NBFCwith the sole purpose of lending or providing credit within the parameters laid down by RBI and in light of this, they had applied for the license to function as anNBFC to carry on business. While NBFCs are exempted from the first proviso to Section 67(3), as on the dates of allotments, TPSSSMFL was not registered with RBI as an NBFC. In fact, as on the dates of these allotments, it had not even made an application for obtaining the certificate of registration from RBI, which was later done on October 7, 2013.[33] As per Section 45-IA of the RBI Act, an NBFC cannot commence or carry on its business without obtaining a certificate of registration from RBI.[34] Therefore, TPSSSMFL could not operate as anNBFC as it had not obtained the certificate of registration from RBI and failed to come within the ambit of thesecond proviso to Section 67(3). In light of this, the Court found issuances of shares by TPSSSMFL to 10,043 persons as public issues.

In arguendo, if TPSSSMFL was an NBFC, it could not have made the allotment of shares to more than 49 persons as per the guidelines issued for NBFCs.[35] RBI had issued a circular on ‘Raising Money through Private Placement by NBFCs-Debentures etc.’which implemented guidelines on private placement by NBFCs and the same was in operation on the date of allotments.[36] Clause 2(iv)[37] of these Guidelines stated that private placement by NBFCs shall be restricted to not more than 49 investors identified by the NBFC. Therefore, even if the companywas treated as an NBFC, it was not permitted toallot shares to more than 49 persons as per theguidelines.

It was noted that TPSSSMFL did not issue a prospectus registered with the Registrar before the issuance of shares as stipulated under Section 56(1)[38] and 60[39] of the Companies Act. Moreover, the application form circulated was not accompanied by a memorandum as prescribed under Section 56(3) of the Companies Act.[40]

Companies offering shares have to ensure that the securities are mandatorily listed on a recognized stock exchange under Section 73 of the Companies Act.[41] Since TPSSSMFL did not apply for listing of its shares on any recognized stock exchange, it had contravened this Section as well.

Lastly, TPSSSMFL violated numerous regulations notified by SEBI for safeguarding investors. All public issues are to adhere to these regulations as they lay down norms for eligibility and disclosure as well as other procedural requirements.  It was held that ICDR Regulations 4[42], 5[43],6[44], 7[45], 8[46], 9[47], 26[48], 32[49], 36[50], 37[51], 46[52], 47[53], 49[54], 57[55], 58[56] and 63[57] were violated by TPSSSMFL.

The following directions were issued: Target People Social Security Scheme Micro Finance Limited and its directors,MariaponnusamyMoyeeson, Joseph Johnson Savarimuthu and Arockiasamy Judi Gerald Paulraj were to refund the money collected through allotment of shares within three months from the date of the order, jointly and severally with interest at the rate of 15% per annum from the date of receipt of money till the date of refund through a Demand Draft or Pay Order. A public notice was to be issued detailing the modalities for refund within fifteen days of the order. Within seven days after the refund, the company was required to file a certificate of completion with SEBI received from two independent peer-reviewed Chartered Accountants in the panel of any public authority or institution. Moreover, the directors mentioned above were directed not to access the capital market by issuing prospectus, offer document or advertisement soliciting money from the public and were prohibited from dealing in securities till the refund was made to the allottees.[58]

Analysis

Non-Banking Financial Companies (NBFCs) essentially deal with loans, advances and acquisition of shares, debentures, stocks and securities. In this case, TPSSSMFL, an NBFC, allotted shares without obtaining a certificate of registration. Recognizing an unregistered company as an NBFC for the purposes of the RBI Act and the Companies Act, 1956, merely on the basis that its purposewas to carry out activities of an NBFC, would defeat the need for registration and regulation of NBFCs under the law. As a consequence, the issuance of shares violated numerous provisions. Each contravention was clearly dealt with and decided in this case.

Although the case was decided in 2015, the provisions of Section 42[59] and 23(1)(b)[60] of the Companies Act, 2013 were applicable only from April 01, 2014. Therefore, the allotments were governed by Section 67 of the Companies Act, 1956.[61] The difference in the language of the provisions is that under Section 67,[62]the offer or invitation through private placement to more than 50 persons does not constitute a public offer. On the other hand, under Section 42[63] of the Companies Act, 2013 read with the Rules, to avail the benefit of exemption, the NBFC should be registered with RBI.

Conclusion

NBFCs have been engines of financial growth and form an integral part of the Indian financial system. They have enhanced competition and diversification in the sector, particularly at times of distress. The need to borrow is juxtaposed to man’s greed for money. Due to the complexity of operations, there was a need for a regulatory mechanism to efficiently regulate the business of these financial institutions which were now being called as NBFCs. Therefore, the Reserve Bank of India Act assigned authorities to the Bank to regulate deposit-taking companies. Since then, the RBI has implemented measures to bring the NBFC sector within the sphere of its regulation. Contravention of the provisions pertaining to NBFCs is strictly dealt with as was observed in this case. In subsequent orders of the SEBI, it can be observed that this trend has been maintained.

Moreover, liberalization of private placement of securities by NBFCs has led to ease in raising capital. The RBI issued guidelines[64] after reviewing the provisions of Companies Act, 2013. The minimum number of subcribers for a maximum subscription of less than Rs. 1 crore per investor is 200, while there is no limit for a minimum subscription of Rs. 1 crore and above per investor.

Also read Statutory Company under the Companies Act, 2013


[1] The Reserve Bank of India Act, 1934, No.2, Imperial Acts, 1934, Chapter IIIB.

[2] The Securities and Exchange Board of India Act, 1992, No.15, Acts of Parliament, 1992, Section 11(1).

[3]Id. at Section 11(4).

[4]Id. at Section 11A.

[5]Id. at Section 11B.

[6] SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, LAD-NRO/GN/2009- 10/15/174471, Regulation 107.

[7] The Companies Act, 1956, No. 1, Acts of Parliament, 1956,  Section 56(1).

[8]Id. at Section 56(3).

[9]Id. at Section 60.

[10]Id. at Section 73.

[11] SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, Regulation 4.

[12]Id. at Regulation 5.

[13]Id. at Regulation 6.

[14]Id. at Regulation 7.

[15]Id. at Regulation 8.

[16]Id. at Regulation 9.

[17] SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, Regulation 26.

[18]Id. at Regulation 32.

[19]Id. at Regulation 36.

[20]Id. at Regulation 37.

[21]Id. at Regulation 46.

[22]Id. at Regulation 47.

[23] SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, Regulation 49.

[24]Id. at Regulation 57.

[25]Id. at Regulation 58.

[26]Id. at Regulation 63.

[27] In re Target People Social Security Scheme Micro Finance Limited, 2015 SCC OnLine SEBI 75, para. 11.

[28]Id. at para. 14-15.

[29]Id. at para 17.

[30]Id. at para 18.

[31]Sahara India Real Estate Corporations Limited &Ors. v. SEBI &Anr., (2013) 1 SCC 1.

[32]The Companies Act, 1956, Section 67(3).

[33] In re Target People Social Security Scheme Micro Finance Limited, 2015 SCC OnLine SEBI 75, para. 11.

[34]The Reserve Bank of India Act, 1934, Section 45-IA.

[35] In re Target People Social Security Scheme Micro Finance Limited, 2015 SCC OnLine SEBI 75, para. 12.

[36]Guidelines on Raising Money through Private Placement by NBFCs-Debentures etc., RBI/2012-13/560 (Jun. 27, 2013)

[37]Id. at Clause 2(iv)

[38]The Companies Act, 1956, Section 56(1).

[39]Id. at Section 60.

[40]Id. at Section 56(3).

[41]Id. at Section 73.

[42]SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, Regulation 4.

[43]Id. at Regulation 5.

[44]Id. at Regulation 6.

[45]Id. at Regulation 7.

[46]Id. at Regulation 8.

[47]Id. at Regulation 9.

[48]Id. at Regulation 26.

[49]Id. at Regulation 32.

[50]SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, Regulation 36.

[51]Id. at Regulation 37.

[52]Id. at Regulation 46.

[53]Id. at Regulation 47.

[54]Id. at Regulation 49.

[55]Id. at Regulation 57.

[56]SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, Regulation 58.

[57]Id. at Regulation 63.

[58] In re Target People Social Security Scheme Micro Finance Limited, 2015 SCC OnLine SEBI 75, para. 22.

[59]The Companies Act, 2013, No. 18, Acts of Parliament, 2013, Section 42.

[60]Id. at Section 23(1)(b).

[61]The Companies Act, 1956, Section 67.

[62]Id.

[63]The Companies Act, 2013, Section 42.

[64] Revised Guidelines on Raising Money through Private Placement by NBFCs-Debentures etc., RBI/2014-15/475 (Feb. 20 2015)

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