Adani-Hindenburg : Did The Supreme Court Panel Ask The Right Questions?

To get the right answers, one needs to ask the right questions.

The expert committee constituted by the Supreme Court in the Adani-Hindenburg case has made a prima facie finding that there is no regulatory failure on the part of the Securities and Exchange Board of India (SEBI) in relation to the Adani group of companies. However, a reading of the 173-page report leaves an impression that the committee has omitted to ask certain right questions. At some places, it seems that the committee has exceeded the remit set by the Supreme Court by making certain observations on the merits of the matter, which is under the investigation of the SEBI.

Brief Background

On March 2, the Supreme Court directed the SEBI to investigate the allegations levelled by US-based short seller firm Hindenburg Research against Adani group companies. Three issues were specifically mentioned by the Court for investigation :

1. Violation of norms relating to minimum public shareholding [Rule 19A of the Securities Contracts (Regulation) Rules 1957];

2. Non-disclosure of related party transactions.

3. Stock price manipulation.

The Court also constituted a 6-member expert committee “for the assessment of the extant regulatory framework and for making recommendations to strengthen it”. The committee was to be headed by former SC judge Justice AM Sapre. The other members of the committee were :

1. OP Bhatt (former SBI Chairman)
2. Justice JP Devadhar (former Bombay HC Judge)
3. KV Kamat (former Chief of the New Development Bank of BRICS countries)
4. Nandan Nilakeni (co-founder of Infosys, former Chairman of UIDAI)
5. Somasekaran Sundaresan ( Advocate, whose name was reiterated by the Supreme Court collegium in January 2023 for elevation as a judge of the Bombay HC)

The Court asked the panel to “investigate whether there has been regulatory failure in dealing with the alleged contravention of laws pertaining to the securities market in relation to the Adani Group or other companies''.

Let us analyze how the committee has examined the issues.

Minimum Public Shareholding

As a general rule, SEBI rules mandate that listed public companies should have at least 25% public shareholding. This is to ensure a minimum free float of shares which are not under the control of promoters. This mandate is based on a public interest requirement that the market should be able to freely and fairly determine the stock prices, without interference or manipulations by the promoters.

In relation to Adani group companies, SEBI had suspicions about 13 overseas entities (12 foreign portfolio investors and one financial institution) which have made substantial investments in Adani group companies. Since 2020 (that is even before the release of the Hindenburg report), SEBI has been examining if these offshore entities (which are based in countries known to be tax havens) are proxies of Adani group promoters..

The expert committee finds that the investigation in this regard “hit the wall” and “drew a blank” due to some changes in the rules made by the SEBI itself.

Why did SEBI make regulatory changes? Panel does not ask

The regulations framed by SEBI in 2014 - SEBI (Foreign Portfolio Investors) Regulations- mandated that the FPIs should not have an “opaque structure” and that they should declare their “ultimate beneficial owner”. This was intended to discover the natural person at the end of the chain who is deriving the ultimate economic gain out of the investment. Many investment companies were being controlled by a web of companies registered in multiple countries and tax havens and it was a practice that the real brain or beneficiary for whom such a complex legal structure is created remained behind the shadows.  So it was difficult for market regulators and investigating agencies to identify the real beneficiary or the source of funds.

However, in 2018, this rule [Regulation 32(1)(f)] was amended to state that “ultimate beneficial owner” will have the same meaning as the term “beneficial owner” as defined under Rule 9 of the Prevention of Money Laundering (Maintenance of Records) Rules. In 2019, the SEBI altogether deleted the mandate that FPIs should not have “opaque structure”.

The point to be noted is that the PMLA rule is a relaxed version. For example, if the natural person having the controlling ownership interest in the FPI is not identified, the natural person who holds the position as a senior managerial official will be regarded as the “beneficial owner”. Thus, an employee of the company could be declared as the “beneficial owner” if the real controlling person hides behind a veil.

As regards the 12 FPIs under scanner, all of them had declared their “beneficial owners” in compliance with the PMLA rules. Their names are mentioned in the report (page 99). They are individuals or companies based in foreign nations like Mauritius, Switzerland, UAE, UK etc.

The committee notes that these entities have made declarations as per the PMLA Rules and hence they become automatically compliant with the SEBI regulations as well. The “beneficial owners” declared by them under PMLA rules are regarded as the “ultimate beneficial owners” as per the SEBI regulations. The SEBI has been attempting to ascertain if these persons are in fact really the “ultimate beneficial owners”. The committee opines that this is a futile exercise by the SEBI, as the entities have fulfilled the requirement of the law as it exists today by making the declaration as per the PMLA Rules. It also notes that the ED does not seem to be having a position that the declarations made under the PMLA rules are false.

However, the committee also acknowledges the possibility that the named persons are not the real beneficial owners. The FPIs here are collective investment pools such as mutual funds. So, there could be participatory shareholders (contributors) and controlling shareholders(fund managers. The committee does not rule out the possibility of promoters making indirect control by funding the visible contributors to the funds (see para 35 and 36, page 96). The key aspect to be examined is if the person funding the contributors has the power to control decisions on behalf of the investment pool. In paragraph 50, the panel says that even if SEBI is able to get behind one contributor, the reaching the final result will be arduous as there could be further layers of companies or body corporates. Hence, substituting the “ultimate beneficial owner” requirement with the “beneficial owner” requirement has made the job of the regulator difficult.

In this context, one would reasonably expect the committee to ask why the regulations were changed in 2018 and 2019 to substantially dilute the mandate regarding declaration of ultimate beneficial ownership in relation to FPIs. Why was a relaxed definition of “beneficial owner” as per the PMLA rules, which are framed for an altogether different purpose, adopted in relation to the securities market? What was the purpose behind doing away with the mandate that FPIs should not have “opaque structure”? Was there any link between these regulatory changes and the investments made by these FPIs in Adani group companies? These questions have nexus with the issue regarding regulatory failure of SEBI. Without raising these questions, the panel returns a favorable finding to the SEBI by essentially saying that its hands are tied due to the regulatory changes (which are made by the SEBI itself). The panel adopts a superficial and technical approach on this issue, without attempting to make a deeper examination into the root of the matter.

It frames the question as “the key issue, is whether as the law stands, one could draw a conclusion that the FPIs are fronts for the promoters of the Adani Group”. In fact, this is a question for the SEBI to answer as part of its ongoing investigation. The panel ought to have perhaps asked why the regulator has left loopholes in the present legal framework which can be possibly exploited to circumvent the minimum public shareholding norms. This question has a direct nexus with the issue of regulatory failure, which the panel was supposed to examine.

The panel also notes that the SEBI had sought the help of the Central Board of Direct Taxes and the Directorate of Enforcement to ascertain if there was any money trail linking the overseas entities and Adani promoters. However, CBDT and the ED turned down SEBI's request for cooperation. The CBDT stated that SEBI’s queries were generic which cannot be used to seek information regarding possible tax evasion from foreign countries. ED expressed helplessness by citing that no case for scheduled offense has been registered so as to invoke the PMLA. Interestingly, ED in turn told the SEBI that it should be investigating intelligence inputs regarding concerted selling ahead of the publication of the Hindenburg report.

The notable aspect is that the panel does not make any attempt to put questions to the ED or CBDT or to seek any further clarifications from them. The panel possessed the power to do so as the Supreme Court had directed all central agencies to cooperate with it. Without making such efforts, the committee speculates that the SEBI’s probe is a “journey without a destination”. Going one step ahead, the committee makes a conclusive finding that SEBI “has not been able to prove that its suspicion can be translated into a firm case of prosecuting an allegation of violation”. What was the need to make such findings when the SEBI investigation is ongoing?

Related party transactions

While reading the committee’s discussions on this issue, one might get the impression that it is exceeding its mandate and is arguing a case.

Here, the committee notes that the SEBI had amended the rules in 2019 to expand the scope of related party transactions. However, the implementation of these amendments were deferred till April 2022; some provisions were deferred till April 2023.

The SEBI suspects certain transactions to be running foul of the regulations. In this regard, it seeks to invoke Section 12A of the SEBI Act which prohibits “any manipulative or deceptive device or contrivance” to circumvent the securities law.

Astonishingly, one finds the panel labouring to make legal arguments to establish that SEBI cannot invoke Section 12A when it has deferred the implementation of amendments relating to related party transactions. The panel repeatedly employs the “letter of law” argument to counter SEBI’s “spirit of law” argument. The obvious question which comes to one’s mind is - why is the panel arguing a case?

“A key question that would then emerge is whether a commercial business can be accused of violating the law when the law at the relevant time did not not exist or did exist but in a manner and form materially different from how it is formulated later” - this is what the committee asks(para 96). Did the Supreme Court ask the committee to decide the liability of Adani group?

Whether the market regulator can invoke a general statutory provision (Section 12A) to deal with a mischief when a specific regulation dealing with the very same mischief (related party transaction) has been deferred is a matter for legal interpretation and adjudication by the Court. However, the Committee here not only assumes the role of adjudicating the tenability of the SEBI’s approach but also passes a judgment that it is not legally feasible.

For example, it says, “it would be legally infeasible to attack past transactions on the standards that have later been made applicable with prospective effect” (Para 33, page 12). At another place, the report states that as per Indian Constitution, all human activities are permitted unless expressly prohibited by law. The tenor of the panel’s argument is that Adani group transactions, even if assumed to be contrary to the standards of propriety, cannot be termed as illegal. It even goes to the extent of saying that the Adani group has paid its price in the market for its acts, but that cannot give rise to any presumption of illegality (“If the market feels the actions taken in the past were not entirely desirable, it would reprice the stocks, but that by no means can be extrapolated to inexorably conclude that a violation of law has been made out", para 103).

Paragraph 94(page 127) of the report is jaw-dropping. There, the committee refutes the SEBI’s arguments point-by-point and makes conclusive findings like “the allegation of non-disclosure is not sustainable since by the application of the legal definition of "related party" none of the counter-parties were related parties in the eyes of the law at the time of the transactions”.

It further says : “SEBI's pursuit of investigations is based on the premise that it is pursuing the "spirit of the law" which flies in the teeth of the prospective amendments with deferred effect that SEBI has made on the legislative side”.

Incidentally, certain sections interpreted the panel’s observations as a “clean chit” to Adani group and its stock prices reportedly rose after the report came into public domain. 

Such sweeping findings are beyond the committee’s remit, which was to examine if there was any regulatory failure. The committee had no mandate to rule on the legality or the effectiveness of the pending investigation or to make any finding regarding allegations against Adani group. After making such elaborate comments which have the potential of prejudicing the ongoing investigation, the report states elsewhere that it is not commenting on the merits of the ongoing probe against Adani group! The other befuddling aspect is that the panel reaches a finding of no regulatory failure despite making critical comments against SEBI’s investigative approach. Indeed the committee makes certain valuable suggestions for strengthening the regulatory framework and increasing investor awareness. However, on the specific issue of Adani-Hindenburg, it would have been ideal had the committee stuck to its mandate and asked the right questions.

Click here to read the committee's report.

(Manu Sebastian is the Managing Editor of LiveLaw. He tweets @manuvichar. He may be reached at manu@livelaw.in)