Adani-Hindenburg Report | Prima Facie ‘No Regulatory Failure,’ Says Supreme Court Expert Committee About SEBI Probe

The three areas of investigation that have been spelt out by the Committee are: first, whether there has been a violation of Rule 19A of the Securities Contracts (Regulation) Rules, 1957 (relating to maintaining public shareholding of at least 25%); second, whether there has been a failure to disclose transactions with related parties and other relevant information which concerns related parties to SEBI, in accordance with law; and third, whether there was any manipulation of stock prices in contravention of existing laws.

The conclusions of the expert committee with respect to each of these areas of investigation are given below.

Question – Was there a violation of Rule 19A of the Securities Contracts (Regulation) Rules 1957?

Expert Committee’s Answer –

The issue of minimum public shareholding is dependent on whether 13 overseas entities including 12 foreign portfolio investors are compliant with disclosure of their beneficial owners, as stipulated by law.

According to SEBI, there is no demonstration that the persons declared to be beneficial owners are not ‘beneficial owners’ for purposes of Rule 9 of the Prevention of Money Laundering Rules (from which the meaning of ‘ultimate beneficial owners’ in the SEBI (Foreign Portfolio Investors) Regulations, 2014 has been imported). The Committee report states:

“SEBI has been suspecting 13 overseas entities of having links to the promoters of the Adani Group and thereby suspecting that the shareholding in the listed Adani stocks in the hands of these 13 overseas entities need not qualify as public shareholding; If such holding is not public shareholding, the listed Adani companies would have violated Rule 19A of the SCRR; At this stage, each of the 13 overseas entities have provided the details of the beneficial owners to the respective reporting entities and to SEBI in compliance with Rule 9 of the PMLA Rules.”

The expert committee has also said that it appeared that prima facie SEBI has not been able to make out a case. This prima facie position cannot be confirmed unless more investigation is done.

“In any prosecution of proceedings, whether civil or criminal, the presentation of a ‘prima facie’ case is the responsibility of the plaintiff or the prosecutor. Once a prima facie case is made out, the burden shifts to the accused: The inversion of the process of proving a charge, leaves the matter in the realm of suspicion. It is trite law that suspicion, however strong, cannot replace proof.”

However, the committee has added that the publication of the Hindenburg Report reinforced SEBI’s suspicion that “perhaps there is something amiss and it desires to probe this further and is seeking time”. The report states:

“Even the fundamental rules of evidence require a conclusion of whether an allegation is ‘proved’, ‘disproved’, or ‘not proved’. At this stage, the factual matrix appears to place the matter in the realm of ‘not proved’ — the regulator has not been able to prove that its suspicion can be translated into a firm case of prosecuting an allegation of violation.”

Question – Was there a failure to disclose transactions with related parties and other relevant information which concerns related parties to SEBI, in accordance with law?

Expert Committee’s Answer –

The committee noted that SEBI substantially amended the definition of terms "related party" and "related party transactions" with a deferred prospective effect providing time to entities to re-arrange their affairs to become compliant with law. The committee said it is a good practice in economic legislation and SEBI's prerogative in this regard cannot be said regulatory failure.

The report states:

“Therefore, it would be difficult to arrive at a finding of a regulatory failure on the legislative side, when SEBI has been intervening to regularly raise the bar in its stipulation of desirable conduct.”

“However,” the report adds, “While the legislative policy has proceeded in one direction, enforcement policy cannot move in a diametrically opposite direction.” The committee has highlighted the need for an effective enforcement policy that is coherent and consistent with the legislative position adopted by SEBI. This would ensure that “precious regulatory resources are not expended on regulatory action that is infirm on the ground of applying the law retrospectively”. The report explains:

“Once SEBI has taken the legislative position (in November 2021) that transactions between related parties and subsidiaries of listed companies would come within the coverage of related party transactions only with a deferred prospective effect (with effect from April 1 , 2022), it cannot assail past transactions effected even before November 2021 as being violative of law that has been stated by it as not being in force when the transactions were effected. Likewise, once SEBI has made a legislative stipulation (in November 2021) that transactions with unrelated parties would fall within the scope of related party transactions if it can be shown that the intent and purpose of the transaction is to benefit a related party, with deferred prospective effect (with effect from April 1, 2023), it cannot assail transactions effected in the past as being in violation of law that has been stated by it as not being in force when the transactions were effected.”

“Invoking the spirit of the law would not suffice to pursue a credible means of investigation into the matter, keeping a cloud over the transactions,” the committee has said. The report also states:

“Assuming the law to have been applicable when the transactions were effected, it must be noted that the Supreme Court has repeatedly held in matters relating to securities law that enforcement must be taken up with promptitude and reasonable proximity of time with the occurrence of the events suspected to be violative.”

Question – Was there was any manipulation of stock prices in contravention of existing laws?

Expert Committee’s Answer –

Committee noted that SEBI has an active and working surveillance framework to take notice of high price and volume movements and has applied itself to the data generated by such surveillance, applying objective criteria, to consider if the integrity of the natural price discovery process has been manipulated.

In the case of the Adani stocks, 849 automated alerts for potential market abuse and price or volume manipulation were generated. Based on the reports received from various stock exchanges, SEBI undertook an analysis and found no pattern of artificial trading. SEBI also found that some entities have taken short positions prior to the publication of the Hindenburg Report and have profited from squaring off their positions after the price crashed upon publication of the report.

"All of these are still under investigation and the Committee therefore does not express any opinion on merits. Suffice it to say, it would not be possible to return a finding of regulatory failure on this count since SEBI has an active and working surveillance framework to take notice of high price and volume movements and has applied itself to the data generated by such surveillance, applying objective criteria, to consider if the integrity of the natural price discovery process has been manipulated," the Committee concluded.

It was on January 24 that US-based Hindenburg published its report accusing Adani group of widespread manipulations and malpractices to inflate its stock prices. Adani Group refuted the allegations by publishing a 413-page reply.

On March 2, 2023, the court constituted a committee and appointed the following persons as the members of the committee – Mr OP Bhat (former Chairman of SBI), retired Justice JP Devadhar, Mr KV Kamath, Mr Nandan Nilakeni, Mr. Somasekharan Sundaresan. The Committee was held to be under the head of former Supreme Court judge Justice AM Sapre. The court directed the committee to submit its report in a sealed cover before this court within 2 months. However, the court remarked that the constitution of the expert committee did not divest SEBI of its powers or responsibilities in continuing with its investigation into the volatility in the securities market in India. SEBI was also directed to submit a status report within a period of two months.

Later, the SEBI filed an application in the Supreme Court seeking a six-month extension to complete its probe into allegations. The regulatory body said that examinations/investigations for which further time would be required would fall into three broad categories:

1. Those where prima facie violations have been found and a period of 6 months would be required to arrive at conclusive finding; 
2. Those where prima facie violations have not been found, a period of 6 months would be required to revalidate the analysis and arrive at conclusive finding;
3. In cases where, further examination/investigation is required and most of the data that is required for this purpose is expected to be reasonably accessible, a conclusive finding is expected to be arrived at in 6 months.

Earlier this month, while hearing an application filed by SEBI to grant an extension of six months to complete the probe, a bench comprising Chief Justice DY Chandrachud, and Justices PS Narasimha and JB Pardiwala indicated that it could not allow more than three months to finish the entire exercise. The two months’ time originally allowed by the apex court as per its March 2 order ended on the day of the last hearing, i.e., May 2.