Supreme Court: In the appeals filed under Section 15-Z, Securities and Exchange Board of India Act, 1992 (SEBI Act) challenging the order passed by the Securities Appellate Tribunal (SAT) whereby SAT set aside the penalties imposed by the Adjudicating Officer for violation of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (PFUTP Regulations), and the Securities Contracts (Regulation) Act, 1956 (SCRA), a Division Bench of J.B. Pardiwala and K. V. Viswanathan,* JJ., set aside the impugned order and restored the order of the Adjudicating Officer dated 29 April 2020.
The Court held that the diversion of preferential allotment funds contrary to disclosed objects constitutes violation of PFUTP Regulations, the diversion amounted to fraudulent and unfair trade practice, and the subsequent ratification could not validate the illegality.
The Court observed that,
“When a company offers private placement or goes public, the legal regime mandates fair disclosure and transparency. The investors and all other stakeholders concerned with the securities market irrespective of whether they ultimately subscribe to the shares or not, adjust their affairs based on the disclosure made.”
Factual Matrix
In the instant matter, the respondent company issued notice dated 3 September 2012 for an Extraordinary General Meeting proposing preferential allotment of shares to raise funds for capital expenditure, acquisition of business, working capital, marketing, setting up offices abroad and other corporate purposes. A special resolution was passed on 1 October 2012 and preferential allotment was made between 16 October 2012 and 8 November 2012, thereby raising ₹15,87,50,000.
SEBI found that immediately after receipt of funds, the company diverted the proceeds for purchase of shares of other companies and for loans and advances to several entities. The diversion started from the very next day after funds were credited, indicating that the proceeds were never intended to be used for the stated objects.
On 4 December 2014, the Whole Time Member of SEBI passed an ad-interim order restraining the company, its promoters and directors from accessing the securities market, observing that the preferential allotment appeared to be part of a “dubious plan, device and artifice” to generate fictitious gains.
Later, the company amended its Memorandum of Association (MoA) in 2014 to include financing and investment activities. In 2017, a resolution was passed by shareholders purportedly ratifying the earlier utilisation of funds.
The Adjudicating Officer, by order dated 29 April 2020, imposed a monetary penalty of Rs.70,00,000 under Section 15-HA, SEBI Act for violation of PFUTP Regulations and Rs. 30,00,000/- under Section 23-E SCRA for violation of Section 21 SCRA and Clause 43 of the Listing Agreement. Insofar as the individual Directors were concerned, penalty of Rs.25,00,000/- each was imposed for violation of PFUTP Regulations. The SAT set aside the penalties on the ground that the shareholders had ratified the utilisation of funds. SEBI challenged the SAT order before the Supreme Court.
Moot Points
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Whether diversion of funds raised through preferential allotment, contrary to the disclosed objects, amounted to fraud under PFUTP Regulations?
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Whether such illegality could be cured by subsequent ratification by shareholders?
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Whether the SAT was justified in reversing the order of the Adjudicating Officer, and exonerating the respondents for alleged violations of PFUTP Regulations and the SCRA?
Court’s Analysis and Reasonings
The Court emphasised that the SEBI Act and the PFUTP Regulations are enacted to protect investors and to provide an environment conducive to increased participation and investment in the securities market, which is vital to the growth and development of the economy. These provisions are intended to prevent manipulative practices and ensure that investors are not misled by false disclosures.
The Court observed that the regulatory scheme is designed to create an environment of fairness and transparency, and any interpretation which protects fraud over legality must be rejected. The Court emphasised that “any practice which does not conform to the fair and transparent principles of trades in the stock market would be captured under the rubric of unfair trade practices in the securities market.”
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Disclosure of Objects of Preferential Issue
At the outset, the Court examined the statutory framework governing preferential allotment and noted that the original object for the preferential issue was that the funds raised would be utilized for capital expenditure including acquisition of companies/business, working capital requirements, marketing, setting up offices abroad, and other approved corporate purposes. Such disclosure is mandatory under Regulation 73, SEBI (ICDR) Regulations, 2009 and is intended to ensure transparency in the securities market.
The Court noted that it was undisputed that the funds were used for investments in shares and for granting loans and advances, which were not part of the disclosed objects. The only defence raised was that the shareholders later ratified the variation in utilisation. The Court observed that the entire reasoning of the SAT rested on this ratification, and therefore the validity of such ratification became the central question.
Applying the principles and objects of the SEBI Act and the PFUTP Regulations to the present case, the Court found that the proceeds of the preferential allotment were transferred to other entities immediately after receipt. The funds were credited between 16 October 2012 and 8 November 2012, and the transfers took place during the same period, showing that the proceeds were never retained for the objects stated in the notice.
The Court rejected the explanation that the funds could not be utilised due to market conditions. The Court noted that the Adjudicating Officer had correctly found that the respondents failed to explain the alleged “prevailing market conditions” which they claimed prevented them from utilizing the funds for the disclosed objects. No material was produced to demonstrate why the funds had to be diverted for loans and investments instead.
The Court further observed that there is a clear distinction between the objects stated in the MoA of a company and the specific objects disclosed in the explanatory statement accompanying the notice of the EGM. What matters in securities law is the object disclosed to investors at the time of raising funds. Once funds are raised on the basis of a particular representation, deviation from that representation without proper procedure undermines investor confidence and violates the regulatory framework.
The Court also referred to Clause 43 of the Listing Agreement which requires companies to furnish quarterly statements showing variations between projected utilization of funds and actual utilization. The existence of such provisions demonstrates the importance attached to faithful adherence to disclosed objectives.
While examining the definition of fraud under the PFUTP Regulations, the Court noted that the definition is inclusive and broader than common law fraud. Fraud includes any act, omission, concealment, or promise made without intention of performing it, even if there is no deceit in the traditional sense.
Relying on SEBI v. Kanaiyalal Baldevbhai Patel, (2017) 15 SCC 1, the Court noted that fraud in securities markets is difficult to define exhaustively because “human ingenuity would invent ways to bypass such behaviour.” The emphasis, therefore, is on the effect of the conduct rather than the form in which it appears.
The Court further stated that Court must weigh against any interpretation which would protect unjust claims over just, fraud over legality and expediency over principle and once this Rule is established, individual cases should not pose any problem.
The Court further attached significance to the timing of the diversion and noted that the funds started coming in after the EGM resolution, and from the very next day they were transferred to other entities. The ratification resolution was passed only in 2017, long after the diversion and after SEBI had already passed interim orders. It stated that the conduct indicated that the company never intended to utilise the funds for the stated objects. The Court held that violation of PFUTP Regulations can be inferred from the totality of circumstances, and in the present case the speed of diversion clearly showed the true intention of the respondents.
The Court further stated that breach of Regulation 3 and 4 would be attracted if any person sells or otherwise deals in the security in a fraudulent manner and also “if any person uses or employs in connection with issue of any security, any manipulative or deceptive device in contravention of provisions of the Act; knowingly publishes or causes to publish any information which is not true or which he does not believe to be true prior to or in the course of dealing with securities; disseminates information which he knows to be false or misleading and which is designed to influence the decision of the investor dealing in securities and knowingly plants false or misleading news which may induce sale or purchase of securities.”
The Court held that in the present case, the funds were raised on the representation that they would be used for specific purposes but were diverted almost immediately. This, according to the Court, clearly attracted Regulations 3 and 4 of the PFUTP Regulations.
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Could illegality be ratified?
The Court rejected the reasoning adopted by the SAT that since the shareholders have ratified the Acts and Deeds done by the company, they become valid and authorised and therefore there was no variation in the utilisation of the proceeds.
The Court held that Section 27, Companies Act, 2013 (Companies Act) applies only to variation of objects mentioned in a prospectus and does not apply to preferential allotment made through private placement. Even otherwise, the provision requires prior approval and cannot validate completed illegal acts.
The Court noted that, in the present case, the entire amount raised was utilided for a different object than the one set out in the EoGM notice before the sought the resolution of ratification was sought, therefore, the reliance on Section 27 read with Section 62(1)(c) was completely misplaced.
The Court further recognised that violations of SEBI regulations are not merely matters between the company and its shareholders as “SEBI’s Regulations including the PFUTP is to protect the rights of several stakeholders and as such has public law dimensions.” A private resolution cannot extinguish liability arising from breach of statutory obligations that affect the public and the securities market as a whole.
“When rights of multiple stakeholders are involved and certain Regulations proscribe a particular course of action any breach of the Regulation has to face its consequences. They are not in the realm of private rights which can be waived off as ratified.”
The Court referred to Govt. of A.P. v. K. Brahmanandam, (2008) 5 SCC 241, where it was held that “illegality cannot be ratified. Illegality cannot be regularised, only an irregularity can be.” It referred to established principles of law and stated that while irregularities may sometimes be regularised, acts that are illegal or ultra vires cannot be validated retrospectively. It stated that “no condonation or ratification on aspects opposed to public policy can be made, as it will seriously jeopardize public interest.”
The Court held that diversion of funds contrary to statutory disclosure requirements constituted an illegality and therefore could not be validated by a later resolution of shareholders.
“Being a plainly illegal act impacting a vast array of stakeholders other than the shareholders of the company, the question of ratification cannot arise at all.”
The Court rejected the respondent’s argument that the MoA was amended in 2014 to permit financing and investment activities. The Court held that this amendment was irrelevant, because the legality of the act must be judged with reference to the objects disclosed at the time of the preferential issue. The diversion took place before the amendment and in violation of the disclosure made to shareholders. Therefore, the amendment of the MoA could not justify the earlier diversion of funds.
“When matter involves public interest it cannot be deemed as private waivable right. What applied to waiver will also apply to ratification. No condonation or ratification on aspects opposed to public policy can be made, as it will seriously jeopardize public interest.”
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Validity of Parallel Proceedings by SEBI Authorities
The Court rejected the contention that once the Whole Time Member had passed an order, the Adjudicating Officer could not initiate proceedings on the same facts. It observed that the powers exercised by the Whole Time Member under Sections 11 and 11-B, SEBI Act are preventive and regulatory in nature, aimed at protecting the interests of investors and maintaining market integrity. On the other hand, proceedings before the Adjudicating Officer are penal in nature and intended to impose monetary penalties for statutory violations.
The Court held that since the objectives and statutory provisions governing the two proceedings are different, both actions can coexist without conflict.
Ultimately, the Court held that the diversion of funds raised through preferential allotment for purposes not disclosed to shareholders constituted a clear violation of the PFUTP Regulations and disclosure requirements under securities law. The subsequent ratification by shareholders could not cure the illegality, particularly when the conduct affected the integrity of the securities market and the interests of investors at large.
Court’s Decision
The Court did not find the penalty imposed by the Adjudicating Officer disproportionate. The Court held that the SAT erred in setting aside the order of the Adjudicating Officer and therefore the same cannot be sustained. Accordingly, the Court set aside the SAT’s order and restored the order of the Adjudicating Officer.
[SEBI v. Terrascope Ventures Ltd., Civil Appeal Nos. 5209-5211 of 2022, decided on 17-3-2026]
*Judgment by Justice K. V. Viswanathan
Advocates who appeared in this case:
Mr. Naveen Pahwa, Sr. Adv., Counsel for the Appellant
Mr. Mahfooz A. Nazki, the Amicus Curiae
