Financial Sector Regulation Heats up in India amid Sahara Case

Financial sector regulations protect consumers of financial services, provide institutional safety and soundness, and uphold market integrity. Rules and laws are necessary to maintain investor confidence and to enable the market to function efficiently and effectively. If these conditions are not met, activities such as mis-selling may take place. (For more insight on mis-selling, read the CFA Institute discussion paper, “Mis-selling of financial products: How are investors protected in today’s marketplace?”)

An interesting case in India involving the sale of an investment product based on one company’s interpretation of law and regulations, which conflicts with that of the Supreme Court of India, is currently the subject of legal proceedings, and it highlights potentially wide-reaching issues for investors.

On 31 August, news broke that the Supreme Court of India ordered Sahara Commodity Services Corporation (formerly known as Sahara India Real Estate Corporation Limited) and Sahara Investment Corporation, two unlisted companies belonging to the same group, to return 174 billion rupees (approximately US$3.1 billion) along with 15% interest to 23 million investors in a convertible debenture scheme within three months. The Supreme Court of India judged (Sahara India Real Estate Corp. Ltd. & Ors. vs. Securities & Exchange Board of India & Anr.) that on 31 August, Sahara India Real Estate violated India’s Companies Act.

The Sahara group invited more than 30 million potential investors to invest in the convertible debentures they offered. However, Sahara India Real Estate did not file this issue with the country’s regulator, the Securities and Exchange Board of India (SEBI), and did not list the issue, despite being obliged to do so as more than 49 investors had been targeted. Contrary to the Supreme Court’s judgment, Sahara India Real Estate openly claimed that listing the debenture offering was not legally mandatory because the convertible debenture on offer was a security. The company went on to argue that the placement of debentures had been a private placement rather than a public placement since the debenture was offered to friends, associates, group companies, workers/employees, and other individuals associated, affiliated, or connected with the Sahara group.

According to Section 73(1) of the Companies Act in India, a company intending to offer shares or debentures to the public has to do so by issue of a prospectus, and before that is issued it must make an application to one or more recognized stock exchange(s) for permission for the shares and debentures to be dealt with in the stock exchange(s). As explicitly noted by the Securities Appellate Tribunal Mumbai in an earlier judgment, Sahara India Real Estate, among others, breached every requirement of this sub-section.

It is obvious that there may be wide-reaching implications for the protection of investors in the case of the Sahara India Real Estate debenture. It remains unclear, for example, which approach Sahara India Real Estate’s agents take when selling the debentures. As opposed to registered investment advisers, individuals offering Sahara India Real Estate’s debentures are relatively free in their soliciting approach. On the other hand, registered investment advisers in India are generally expected to obey regulations relating to code of conduct, fiduciary duties, record keeping, risk profiling of clients, and  suitability and appropriateness of advice.

SEBI is continuing its financial markets reform efforts. Just last month SEBI announced revised regulations on investment advisers in addition to introducing a number of other financial market reforms; earlier this year it improved alternative investment funds regulation following a public consultation to which the Indian Association of Investment Professionals (IAIP), a member society of CFA Institute, and CFA Institute replied.

By taking legal steps to enforce law and regulations, as evidenced in the case of Sahara India Real Estate, SEBI shows that it is serious about creating an environment where investor protection is not just an expressed goal but where a high level of market integrity is a reality.