SEBI v/s Zenith Infotech

Last month SEBI barred the promoters of Zenith Infotech from accessing the capital markets on grounds of fraud, misleading and inadequate disclosures and violation of corporate governance principles. But more importantly and in a first for India – the regulator has also held the Board Of Directors accountable, asking them to provide a bank guarantee for the funds misused.  It’s an interim order, one that may also throw up some jurisdiction challenges as Payaswini Upadhyay reports.

Jan 29th 2011
Zenith Infotech’s shareholders approved a BOARD proposal to raise up to Rs 1500 cr – $333.4 mn - to redeem FCCBs maturing that year and next. According to the shareholders approval Zenith could either borrow the money or raise it via the sale or lease of business divisions  On Sep 26, 2011
Zenith Infotech informed BSE that the company has spun off one of its 2 BUSINESS divisions to Zenith Monitoring Services- a company in which ZIL was a majority shareholder. Despite realizing money from the sale of this business division the company defaulted on its FCCB repayment obligation – yet made no mention of this to the exchanges. The default came to light only when the BSE, on October 13, 2011, raised the matter with ZIL - at which point ZIL informed the exchanges that it had defaulted on its payment of $33mn of FCCBs that were due in September. The default and its delayed disclosure made media headlines, then followed investor complaints and a SEBI investigation. SEBI found that between Sep 23rd and October 13th –, the period in which the default took place but was not disclosed – that Zenith’s share price fell from Rs 190 to Rs 93 and further halved to Rs 45 by Nov 30th  that year- causing considerable loss to shareholders. Last month, the market regulator passed an ex parte interim order against the promoters and directors of Zenith Infotech. The first violation- non-disclosure of material and price sensitive information. SEBI noted that the two series of FCCBs due for redemption in 2011 and 2012 had terms of cross defaulting- that is, default in the redemption of the first series would trigger default in the second. Zenith and its promoters and directors were aware of this, chose to default and made no disclosure of that to the exchanges. Besides inadequate disclosures, SEBI has charged the promoters and other directors with misleading disclosures as well. In its letters to the exchanges and SEBI, Zenith had claimed that it was negotiating the terms of repayment with its FCCB holders and hence didn’t make the disclosures. But SEBI noted that at the time of making this claim, the FCCB holders of Zenith had already filed a suit against the company and a separate winding up petition as well. SEBI concluded that disclosure by Zenith was on the face of it false and misleading. M Prasanna
Corporate Consultant
“If you're talking about a situation where a company has defaulted on loan repayment- very simplistically put, let’s not worry about raising money to repay etc- that's a matter of disclosure under corporate governance and under the Listing Agreement. You need to make that disclosure so that people know that you have defaulted - that is a very vital information for a person to determine whether you want to invest or stay invested. So that's a matter of disclosure even on a plain vanilla basis.” Zenith Infotech’s alleged violations are not limited to disclosure issues. SEBI has also accused the promoters and directors of fraud. It noted that while Zenith sold its MSD business division to raise $48mn towards FCCB redemption, $33.93 mn of that amount was instead diverted to several unrelated purposes - beyond the authorization of shareholders. For instance 13 million dollars were transferred to promoter related entities, another 11 million to a Singapore subsidiary of Zeneith- transactions that the SEBI order referred to as ‘asset stripping’ in a ‘fraudulent and deceitful manner’ – charging Zenith and its promoters and directors with fraud and FUTP violations. Umakanth Varottil
Associate Professor, NUS
“If there was a condition for X and it was used for Y, then it is clearly a violation of the shareholder approval that was obtained under Sec 293 of the Companies Act. And there is no doubt the company could face consequences for that but whether SEBI has jurisdiction- that is a question. Shareholders can bring an action through the company for breach of Directors’ duties and potentially an oppression and mismanagement action against the promoters but whether it’s a matter for SEBI to implement a decision under Sec 293 – there could be jurisdictional issues.” Sandeep Parekh
Founder, Finsec Law Advisors
“It’s not so much oppression and mismanagement; though you could call it that; but it’s much more serious- its plain and simple fraud. So I will hesitate to call it oppression and mismanagement which can happen even in situations where you have related party transactions which are not completely kosher but they are not illegal either. This is a simple case of fraud and SEBI has jurisdiction over listed companies and fraud that happens in listed companies.” M Prasanna
Corporate Consultant
“If you see the order, there is absolutely no specific finding that there is a prima facie case of fraud having been perpetrated- its a question of impropriety at this point in time-  and I think there is a lot more evidence required to actually show that there was indeed a fraud committed on the shareholders or the FCCB people. The facts, according to me, are not adequate to come to that iron clad conclusion.”
 
But SEBI concluded otherwise - and has banned 4 promoters of Zenith Infotech from accessing the securities market. In a first for India the regulator has also held Zenith’S Board of directors accountable. Zenith’s directors, 2 promoter & 2 independent, have to furnish a bank guarantee of $33.93mn - the amount that was raised to redeem FCCBs but was diverted elsewhere instead. And SEBI has specified that the board cannot use Zenith funds or assets to raise this guarantee Umakanth Varottil
Associate Professor, NUS
“This certainly seems to be something peculiar – I have not come across any previous instance where the Board has been asked by SEBI to compensate the company. However, SEBI does have fairly extensive powers under the SEBI Act and one of the powers which has been constantly exercised is to disgorge illegally gotten profits. And in this case, there could be an argument that SEBI is simply seeking to recover monies which otherwise belonged to the company.” M Prasanna
Corporate Consultant
“When SEBI comes to the conclusion that Board of Directors should give a guarantee, I would've expected certain amount of discussion as to the role that the Directors played- some kind of culpability- but I could not see any of those discussions. I thought the conclusion that SEBI came in asking the Board of Directors to give a bank guarantee is something very abrupt according to me - so whether SEBI has power to do this and second, SEBI could have found out the role played by non-promoter directors.” Sandeep Parekh
Founder, Finsec Law Advisors
“I think the answer is somewhat logical. It seems to be premised on some level of liability and duty on the Board of Directors. Assuming that the Independent Directors are completely faultless, they will ask the promoters to pay up the premium, which is required to get the bank guarantee. So ultimately it may not be as unfair as it sounds because the promoters will cough up that premium. Once the final investigations are over, I am sure if in the final investigations SEBI finds the non-promoter directors not guilty, they will not impose the standard in the entire round.” SEBI’s order is interim, the accused will now get a hearing after which the final order will be passed. But before that happens, Zenith, its promoters and directors have already moved the S..A..T.. against this interim order. It will be interesting to watch how Zenith’s Independent Directors fare in this battle. Lawyers representing them say not only do they deny misuse of funds but also question the passing of an ex-parte order in a 2011 matter! There was enough time to have given the directors a hearing. Besides how can SEBI ask directors to provide a dollar based guarantee. Answers to all these questions should come up over the next few weeks. In Mumbai, Payaswini  Upadhyay