Preferential Allotment Misused for Fictitious LTCG Attracts PFUTP Penalty

The appeals arose from a SAT order dated 02.06.2022 which had set aside the Adjudicating Officer's order of 29.04.2020 imposing monetary penalties on Terrascope Ventures Limited (formerly Moryo Industries Limited), its Managing Director Mr. Manoharlal Saraf, and Director Mrs. Geeta Manoharlal Saraf for violations of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 and the Securities Contracts (Regulation) Act, 1956.

On 03.09.2012, the company issued an EoGM notice proposing preferential allotment of up to 74,50,000 equity shares to 49 non-promoter allottees. The stated objects included capital expenditure, acquisitions, long-term working capital, marketing, setting up offices abroad and other approved corporate purposes. A Special Resolution was passed on 01.10.2012 and between 16.10.2012 and 08.11.2012, allotments were made to 42 entities raising Rs. 15,87,50,000.

Diversion of Proceeds

From 17.10.2012 itself, the proceeds were deployed to purchase shares of other listed and unlisted companies and to grant loans and advances to a group of related entities, many sharing a common promoter. SEBI's case was that the funds were never intended to be used for the disclosed objects, and the preferential allotment route was a device to expand share capital sufficiently to accommodate fictitious LTCG of around Rs. 141 crore through subsequent volume and price manipulation.

WTM Findings

The Whole Time Member, by ad-interim order dated 04.12.2014 under Section 19 read with Sections 11(1), 11(4)(b) and 11B of the SEBI Act, recorded that the preferential allotment was used as a tool for implementing a dubious plan, device and artifice. The WTM observed that the pre-allotment share capital was too small to accommodate the planned fictitious LTCG, and the capital expansion through preferential allotment and stock split provided a larger base for volume and price manipulation.

Issues Before the Court

The appeals under Section 15Z of the SEBI Act required the Court to consider whether SAT was justified in setting aside the Adjudicating Officer's monetary penalty, and whether earlier WTM orders on the same facts barred subsequent adjudicatory action. The Court also examined the proportionality of the penalty.

Holding

Justice K. V. Viswanathan, writing for the Bench comprising Justice J. B. Pardiwala, held that the impugned SAT order could not be sustained. The Court distinguished the precedents relied upon by the respondents. It noted that Ram Kishori Gupta turned on a prior WTM order attaining finality on the same cause of action, which was not the position here. The Court also clarified that observations on Nirmal N. Kotecha, pending before it, should not be read as commenting on that appeal. The penalty imposed was held not to be disproportionate.

Accordingly, the SAT order in Appeal Nos. 116, 114 and 115 of 2021 was set aside and the Adjudicating Officer's order dated 29.04.2020 was restored.

Takeaway

Using a preferential allotment to expand capital for facilitating fictitious LTCG and price manipulation is a fraudulent and unfair trade practice under the PFUTP Regulations, and earlier interim WTM directions do not foreclose a subsequent adjudicatory penalty on the same facts.