This week a SEBI order prompted a 30% fall in DLF’s stock price – wiping out over Rs 7000 crores in market capitalisation and reducing the company’s value to below its outstanding debt. The SEBI order finds DLF guilty of active and deliberate suppression of material information so as to mislead and defraud the investors in the securities market in connection with the issue of shares of DLF in its IPO, thereby violating the SEBI Act, Disclosure & Investor Protection (DIP) Guidelines, ICDR Regulations and the Prohibition of Fraudulent & Unfair Trade Practices Regulations. It’s a fascinating story of how a Rs 34 crore litigation has brought this giant company to its knees. It’s the story of DLF & its housewives.
DLF & THE HOUSEWIVES!
SEBI Order
‘I find that the case of active and deliberate suppression of any material information so as to mislead and defraud the investors in the securities market in connection with the issue of shares of DLF in its IPO is clearly made out in this case’
In June 2007, just days before the DLF Rs 9000 crore IPO opened, Kimsuk Krishna Sinha filed a complaint with SEBI. He alleged that a DLF subsidiary – Sudipti Estates and others had duped him of Rs 34 crore. DLF denied that Sudipti was its subsidiary. The matter ended up in the Delhi High Court, the court directed SEBI to investigate and here’s what SEBI found.
DLF & THE HOUSEWIVES!
SEBI Order
4th June 2007: Kimsuk Krishna Sinha filed 1st complaint with SEBI Stated that Sudipti Estates & others duped him of Rs 34 cr
11th June 2007: DLF IPO opens
11th July 2007: DLF denied Sudipti was a subsidiary
9th April 2010: Delhi HC orders SEBI to investigate Sinha’s complaint
That in March 2006 Sudipti, Shalika & Felecite were incorporated. They were second tier subsidiaries of DLF. In November 2006 Felicite was sold to 3 women – wives of key managerial personnel at DLF. The 3 were housewives, with no individual income of theirs, operating joint bank accounts with their husbands, who funded their purchase of shares of Felicite - a day later Shalika was sold to Felicite and Sudipti to Shalika.
DLF & THE HOUSEWIVES!
SEBI Order
Sudipti Estates, Shalika Estate, Felicite Builders
- Incorporated on 26th March 2006
- Owned by DHDL, DEDL & DRDL…all 100% subsidiaries of DLF
DLF & THE HOUSEWIVES!
SEBI Order
29th November, 2006
Madhulika Basak, wife of DLF KMP
Felicite sold to Niti Saxena, wife of DLF KMP
Padmaja Sanka, wife of DLF KMP
30th November, 2006
Shalika sold to Felicite
Sudipti sold to Shalika
SEBI says the sale of Felicite to the housewives is a sham transaction, that DLF was in control of Felicite even after its sale to the housewives and hence also in control of Shalika & Sudipti. It should have disclosed these subsidiaries and the related party transactions with the housewives in its prospectus. It should have also disclosed Kimsuk Sinha’s FIR & pending litigation against Sudipti. Guilty of all of this active and deliberate suppression of any material information, SEBI has barred DLF, its promoters & some executives from accessing the capital markets for 3 years.
DLF & THE HOUSEWIVES!
SEBI Order
‘…find that the purported transfers of shareholding in the said three companies were sham transactions devised as a plan, scheme, design and device to camouflage the association of DLF with these three companies as holding –subsidiary’
DLF & THE HOUSEWIVES!
SEBI Order
‘DLF failed to make disclosures (about Sudipti, Shalika & Felicite) in its RHP/Prospectus’
‘DLF was required to disclose the 'related party transactions' pertaining to these three companies’
‘..the fact of filing of aforesaid FIR that was subsisting on the date of issuance of RHP/Prospectus, should have been disclosed’
DLF & THE HOUSEWIVES!
SEBI Order
‘ restrain the following entities from accessing the securities market and prohibit them from buying, selling or otherwise dealing in securities, directly or indirectly, in any manner, whatsoever, for the period of three years…’
DLF Limited
Rajiv Singh
Pia Singh
Kameshwar Swarup
Ramesh Sanka
To discuss this headline grabbing case, CNBC-TV18’s Menaka Doshi talks to Sandip Bhagat, Partner, S&R Associates; Sanjay Asher, Partner, Crawford Bailey; & J N Gupta, Founder, SES
At the heart of this case lies the question as to whether those three subsidiaries that we have spoken about continue to be in control of DLF and hence subsidiaries of DLF even after DLF allegedly sold them to the housewives. Now SEBI has used several arguments to conclude that DLF continued to have control of these companies and therefore they continue to be subsidiaries of DLF.
These arguments are namely, that the three housewives were wives of the key management personnel (KMPs) of DLF; that is point one. That the Directors of the three companies were employees of DLF and that they continue to be Directors even after these companies were sold to the housewives. That there was no change in the registered office, statutory auditor and authorized signatory even after the sale of these companies to the housewives. SEBI has also established funding lines that connect the wives, the husbands, loans, DLF and these subsidiaries and therefore concluded that control of DLF through its KMPs existed over Felicite.
DLF & THE HOUSEWIVES!
SEBI Order
DLF employees were directors of Sudipti, Shalika & Felicite before & after the sale
No change in the registered office, statutory auditor, authorized signatory etc.
Incurring/absorbing costs of Sudipti and Shalika by some other entity
DLF subsidiaries sold Sudipti to Shalika & funded Shalika to pay for the purchase
Doshi: Would you agree after hearing SEBI’s analysis of this matter that these three companies, but mainly Felicite- because that was the most important subsidiary- continue to be in the control of DLF and therefore should have been disclosed as a subsidiary of DLF?
Bhagat: It is a question of the analysis of do you control the board of the company. SEBI has gone into other aspects of control here which is again coming out to our favorite question of what is control but the key question here, specially under the Companies Act, is does DLF continue to have the ability to control the board and the companies act has a specific provision. They have no shareholding in these companies, the only inference of control is that these entities, these Board of directors are employees of ours and therefore we control.
DLF & THE HOUSEWIVES!
Companies Act, 1956 Sec 4: Meaning of HOLDING COMPANY and SUBSIDIARY
a company shall… be deemed to be a subsidiary of another if, but only if
(a) that other controls the composition of its Board of directors ; or
(b) …the composition of a company's Board of directors shall be deemed to be controlled by another company if, but only if, that other company by the exercise of some power exercisable by it at its discretion without the consent or concurrence of any other person, can appoint or remove the holders of all or a majority of the directorships
Looking at fact specific, I wasn’t entirely convinced based on these arguments, based on just that technical definition that there was control. There were other aspects which you could look at for definition of control but for this purpose the key question is, is it a subsidiary? The question for a subsidiary is- is it controlled under the Companies Act and it is kind of debatable out there based on this.
Gupta: As the order very clearly establishes that control is to be defined not only on the legal language basis but on the practical aspect and what is the fact on the ground. Now if you see all these things, none of the ingredients of the transaction make this transaction independent of DLF. All the aspects lead somehow to DLF.
The biggest thing is this although DLF or a subsidiary did not continue to be the shareholders of those companies but DLF had appointed ABC as directors and those directors continued even after that. Now, you see in practical life even if two brothers split, the first thing that they do is they change the Board of Directors. The second thing of which I am very much worried is this company Felicite eventually held 281 subsidiaries which were erstwhile subsidiaries of DLF.
Now I am running a big conglomerate, a big company, I have 350 subsidiaries- why the hell one day I decide that three of you are my good employees, or your wives are very good and I will give 281 of my subsidiaries to them. I don’t understand this.
DLF & THE HOUSEWIVES!
SEBI Order
‘…it cannot be just a coincidence that Felicite is incorporated on March 26, 2006 with its 100% shareholding held by the wholly owned subsidiaries of DLF, those wholly owned subsidiaries subsequently sold their entire shareholding in Felicite to the 'Housewives' of three KMPs who made payments for the purchases made by their respective wives and subsequently, they transfer their entire shareholding to the DHDL (one of the three initial shareholders), wholly owned subsidiary of DLF and the 'Housewives' of other KMPs’
Doshi: Are the grounds good enough for you?
Asher: To my mind, no.
Doshi: Why?
Asher: For a simple reason that DLF did not have any shareholding - directly or indirectly. Merely because the employees’ wives or spouses are holding the shares would not mean that DLF has complete control over those shares. Because now for example if those three individuals continued to be the directors and they are the employees of DLF as well but in law these three individuals have fiduciary duties towards the shareholders and in law they cannot act on the whims and fancies or on the directions of the employer.
Bhagat: There is no agreement which DLF has with these to control them, there is no shareholding.
Doshi: No agreement in this order.
Gupta: Even if there is no agreement, it doesn’t matter; the matter is that what is the factual position.
Doshi: Before we get into that which definition of control applies here, because there are 2-3 definitions of control that populate this order. There is a Takeover definition of control from that time- the 1997 regs; the Accounting Standard, the Companies Act of 1956 - which definition of control should apply here?
Bhagat: So the concept is, are you a subsidiary or not.
Asher: That is number one.
Bhagat: There are just two definitions there. One is under the old 1956 Act of what is a subsidiary- Section 4. Second is under Accounting Standard 21. These are the two ones. Bringing in this Takeover Code definition of control is confusing.
Doshi: So if you look at 1956 holding company and subsidiary definition, it simply says that a company is deemed to be a subsidiary of another if, but only if, that other controls the composition of its board of directors. Now did DLF control the composition of the board of directors of these three subsidiaries - Feleicite, Shalika and Sudipti - even after they were sold to the housewives? That is the question here, did they control the board or did they not control the board. Would you agree that by having their own employees stay on even after the transfer they were in fact controlling the board?
DLF & THE HOUSEWIVES!
Companies Act, 1956 Sec 4: Meaning of HOLDING COMPANY and SUBSIDIARY
a company shall… be deemed to be a subsidiary of another if, but only if
(a) that other controls the composition of its Board of directors ; or
(b) …the composition of a company's Board of directors shall be deemed to be controlled by another company if, but only if, that other company by the exercise of some power exercisable by it at its discretion without the consent or concurrence of any other person, can appoint or remove the holders of all or a majority of the directorships
Asher: No, to my mind no. Because if you have 50 percent plus one share you can remove a director in a split second. DLF did not have directly or indirectly 50 percent plus one share.
Doshi: It had nothing after they sold it to the women.
Asher: Nothing at all. Now the only issue which is there is they had their employees who were on the board and their wives had the shareholding. Merely because their wives had the shareholding would not mean that DLF has control over their particular shares.
Gupta: I totally disagree.
Doshi: No, because it is fair to say that if those three wives who were owners of Felecite and therefore the other two as well wanted to appoint other directors on board they had the full powers to do so at least based on the information we have in this order. They had all the shareholding, all 100 percent of it. They could have appointed a different set of directors.
Gupta: Yes, I totally agree with you.
Doshi: They didn’t because that was their choice, not DLF’s.
Asher: I would just say one thing. At best DLF could have terminated their employment agreements in which event there was no control. The control was definitely with the wives of those three employees.
Gupta: I would say very clearly that go back to the position which was existing pre transfer of shares to housewives. At the time I was under control of those subsidiaries- I as DLF was under control - and I appointed three of you and then the shareholding was transferred to each of yours relative, and they did not bother, they were very happy with the people appointed by me. The question is very simply is - if it was a transaction which was totally isolated from DLF, it had nothing to do with DLF, the transaction was independent, then it must be one in a million of case where that directorship would not change upon total 100 percent divestment of equity. To me it is indigestible.
Doshi: It looks terribly suspicious when you sell a company that owns certain land development rights that are crucial to your company, when you sell that subsidiary to three housewives of your key managerial personnel who have no independent income of their own or any other business experience and it's not just that one transaction. Subsequently there were other housewives; how were wives of other key managerial personnel of DLF that became shareholders of these companies. We could technically argue this to death and say well there is no control but this smells bad, it looks bad and therefore probably must be bad.
Gupta: And you don't bother to recover the money that you have lent to them. See, if I had a subsidiary, I had lent Rs 40-50 crore to that company, I have divested that subsidiary, the first thing I would say- now this company doesn't belong to me, get my money back. And for 3 to 6 years you are not even bothered about that money. That means some umbilical cord still is connected and that umbilical cord where it is getting connected is not appearing anywhere on the papers.
Asher: But there are no facts which say there is something which is connecting DLF with the subsidiaries.
Gupta: I agree, but that means something is hidden
Bhagat: That's the question here - what's the motive. I actually haven't been able to figure out from this order - is there any motive? If you are saying that DLF conceals these subsidiaries, what is the purpose of it - surely can't be because of a Rs 34 crore litigation.
Doshi: Forget motive, we don't need a motive. If you have violated the regulations, you have violated the regulations. Whatever your motive is, it’s in your head; it is not publicly available- that's your problem. So let's overcome the confusion over what the motive was and why DLF would do something like this just months before its Rs 9,000 crore IPO. Why a company would take such a risk is confounding.
Bhagat: It's probably very important to understand that because you have taken a very serious action against a company today based on a transfer of shares of whether it's 2 subsidiaries or 200. It is a real estate company; a real estate company in its business does acquire land development rights from various companies including whether they are subsidiaries or not. Maybe it was a part of a business model.
Doshi: In your history as a lawyer to thousands of issues, you must have seen all kinds of structuring. Have you ever seen the housewives of key managerial personnel including the CFO of the company get involved in such a situation? Just give me a yes or no answer?
Bhagat: If a direct yes or no, probably not.
Asher: One may not have seen it but as long as it is within four corners of law, it’s ok. We need to see whether it is within the four corners of law; that is number one. Two, what are the investors investing on, on the basis of my current business model.
Doshi: You mean the IPO investors?
Asher: Yes, whatever they have disclosed what my business model is, what my track history is. Now whether I have sold off my subsidiaries to anybody is completely irrelevant to my mind.
Gupta: Sanjay said that the investors have invested, they have no business to know whether I have transferred 255 companies to the wife or to someone. Investors have every right to know what is your business model, they do not want to know what is your technical secret or what is the formula for making this drug but they certainly want to know how you perform your business.
Doshi: Second point
Gupta: The second point is this; the governance is much beyond law. Disclosures are not only related to law.
Doshi: You say that there is no violation of regulation or law, DLF did not do anything legally incorrect?
Asher: Absolutely, because they were not the subsidiaries and they are not even covered under your AS 18.
Doshi: Which corner are you in?
Bhagat: I don’t think there are enough facts to say that DLF had control over the subsidiaries.
Doshi: I was wondering when I was reading this order saying how their lawyers allowed them to do this. Now I have a fairly good idea why the lawyers thought that there was nothing wrong with what went on.
Bhagat: In defence of any advisor working on this, I do not - if ultimately as an advisor working on a transaction whether as a lawyer or whether as a merchant banker on this- whether you would have a set of these facts in front of you. You would likely be told these entities have been sold and may you have looked at something.
Doshi: And wouldn't you check because you have to sign a certificate saying that this information is correct?
Bhagat: As either a lawyer or a merchant banker, you are not a forensic investigator where you are doing this kind of investigation. You are doing reasonable investigation.
Doshi: But don’t merchant bankers sign a certificate of due diligence?
Bhagat: Merchant bankers sign a certificate of due diligence. You have lawyers who assist them with due diligence.
Doshi: So in their due diligence if they saw over the course of 6-8 months that over 300 subsidiaries have been sold, you don’t think that the merchant banker would ask the question who brought these 300 subsidiaries. If DLF answered that these three women bought them, you don’t think the merchant banker would have asked the question who are these three women, don’t think that the merchant banker would ask the question Padmaja Sanka is the wife of the CFO of your company, how is it that she has bought one of these subsidiaries which controls the other 200. You don’t think that the merchant banker would have even queried any of this, don’t merchant bankers do this?
Bhagat: You are expected to do reasonable diligence.
Doshi: This is not part of reasonable diligence?
Bhagat: If the merchant banker had details about all this and had been told by the way, this is the source of funding by X&Y, this is how it is happening, maybe.
Doshi: So what due diligence do merchant bankers do if they don’t query anything, they only accept the facts that are given to them by the company- then that is not due diligence.
Gupta: I would say if it was not in the history of DLF to keep on removing subsidiaries, creating subsidiaries in dozens and hundreds, if it had happened in the history of DLF for the first time merchant bankers certainly would have asked the question. And if they were given this response that yes, we have sold the subsidiary to XYZ’s wife or something then they would have certainly questioned. But in all probability, as everybody says that they would not have been given the information because any merchant banker having got the information would have certainly probed it.
Doshi: I am going to give the benefit of the doubt to merchant bankers. One of the names, and I will take a name here, Kotak, a very well respected institution was the co lead manager to the issue. On the other hand, you have this SEBI order also lay out how those three housewives, their husband’s actually, who were key managerial personnel of DLF, got these Rs 20 lakh worth of loans each which were unsecured loans from Kotak. Now is it your argument that Kotak investment banking and Kotak commercial banking work with a Chinese walls in between and so therefore Kotak investment banking who would be looking at this transferring out of subsidiaries would have no idea that some of the funding is being done by Kotak commercial banking?
DLF IPO
Lead Managers: Kotak Investment Banking, DSP Merrill Lynch Senior Lead Manager: Lehman Brothers Lead Managers: Citi, Deutsche Equities, ICICI Securities, UBS Securities, SBI Caps
Asher: Exactly, they would not know and why there is no reason as to why they should know as to who has funded it. How is it relevant at all whether Kotak bank has funded it or some other bank has funded it? As long as DLF has got the sale proceeds of these subsidiaries - which are the fair market value of the shares- then the merchant banker’s due diligence comes to an end. Whether it has been sold to the housewives, whether it has been sold to the wives of the employee is completely irrelevant to my mind as long as DLF has got its due share of money.
Doshi: Now having seen this order, do you think that I am still sort of laying out a harsh requirement or do you think that now all advisors to issues will up their diligence?
Bhagat: This order is a little unfortunate in terms of where it has gone with these facts and where it has ultimately ended up in terms of the penalty. It does make my life a bit more difficult if I am looking at it practically when I am looking at a company. The problem I have with this order is that the regulator has looked at a certain set of facts and concluded this is a material omission in the document and has concluded it based on these facts which I have a problem with because this is not giving me clarity on what is material from now on. It doesn’t help me to say, okay, this we can exclude, or this we should include.
Doshi: If they are your subsidiaries, you are required by law and regulation to disclose them- whether they are material subsidiaries or not. So where is the confusion?
Bhagat: There is no confusion. If these set sets of facts were given to me again presented with this order I would go and talk to the issuer again, I would go and have a discussion with the auditors. I would say that, listen here are the facts, do we still control these entities or not. That is a factual determination which you will have to do and if you do, then let’s put them in the document as subsidiaries and then you take the next step.
Doshi: DLF’s defence is that even the auditor report or the annual report of that year, the auditors also agree that these were not subsidiaries.
Asher: True, because I have in my register of members have transferred the shares; my shares are not in my name. I have no direct or indirect mechanism to control because of this.
Doshi: What impact will this order have?
Bhagat: More confusion.
Doshi: More confusion?
Asher: Yes, more confusion.
Bhagat: Because I have no idea based on this order now if a client is asking and this is a constant day to day interaction when you are doing an IPO. Should I disclose this, should I not, is this material, is this not.
Doshi: But there is no question of materiality here. There is only a question of whether these are subsidiaries or not. Where is the materiality of the subsidiary?
Bhagat: Fair enough. Let’s just say that they were wrong, they should have disclosed this. Is this material at the end of the day that they did not disclose?
Doshi: That is interesting and that comes to my last point. How material is this disclosure and is it material enough to deserve the punishment that has been meted out, not just to the promoters and the executives involved but the company as well who has now been barred from the security markets for three years; thereby putting to a disadvantage all its other shareholders which includes the public?
Gupta: Your question is very valid and I would say that the issue that it is affecting the shareholder is a big issue but one has to look into this that some day or other, you have to take an action which gives signal to the market that look- enough is enough, integrity of the market is very important and integrity of the market will come back only when promoter, merchant bankers, legal advisors play their role today.
I agree with Mr Bhagat that yes, it will make their life difficult but regulator is not bothered whether your life is difficult or his life is difficult. Regulator is bothered whether there market place is safe and integrity is intact for the investors or not and I would see it that way.
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