Enforcement of the regulatory framework in relation to Collective Investment Scheme (CIS).
Facts of the Collective Investment Scheme case
The Respondents in the instant matter, Mr. Gaurav Varshney and Vinod Kumar Varshney incorporated a company, i.e. M/s. Gaurav Agrigenetics Ltd., a company registered under the provisions of the Companies Act. The two respondents are the directors of the M/s. Gaurav Agrigenetics Ltd. The company was operating collective investment schemes and had raised an amount of Rs.14,63,279/- (Rupees fourteen lakhs sixty-three thousand two hundred seventy-nine only) from the general public.
Collective Investment Scheme or CIS is a mechanism where investors invest their funds to derive some return on investment. The funds, in turn, are used for purposes of the scheme. The arrangement is regulated by the Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999 (“CIS Regulations”) and Securities and Exchange Board of India Act, 1992 (“SEBI Act”).
The matter in dispute in the instant case is in the context of section 12(1B) of the Securities and Exchange Board of India Act, 1992 (the “SEBI Act”). The provision states that no person shall carry out a Collective Investment Scheme (CIS) unless he or she obtains a certificate of registration from the Securities and Exchange Board of India (“SEBI”) as provided in the regulations. The regulations which were provided as a method of obtaining the registration certificate came into effect from October 15, 1999, in the form of the SEBI (Collective Investment Schemes) Regulations, 1999 (the “CIS Regulations”).
Issues Involved In Collective Investment Scheme Case
The legal issue involved was whether by carrying out CIS activity during the period when section 12(1B) which restrains such activity without registration was in existence but not the CIS Regulations that deals with the procedure to obtain the registration certificate, the directors can be held liable for breach and can be subjected to criminal activity or not.
Contention of the Appellant
The primary contention of SEBI, i.e. the appellant was that the High Court while quashing the criminal complaint against the Varshney’ erred in interpreting the bar created by Section 12(1B) of the SEBI Act. It was submitted on behalf of the appellant, that the bar is in existence from the date the main provision, i.e. the date section 12(1B) came into effect (25.1.1995). It was contended, that the bar put a restriction on everyone, from sponsoring or carrying on any collective investment activity, without a certificate of registration from ‘the Board’ and any such act which is done in violation of the provision stands forbidden. The appellant submitted that the collective investment schemes without the registration certificate were permissible to be conducted by only those who started it prior to the commencement of the Securities Law (Amendment) Act, 1995. Only such schemes can be allowed to operate under the proviso of section 12(1B).
Contention of the Respondents
The simple contention advanced at the hands of the Respondents was that the bar of obtaining a registration certificate for the purposes of collective investment schemes that operate post-January 25, 1995 could come into existence only after the Collective Investment Regulations are brought into force, i.e. from October 15, 1999. It was also submitted on their behalf that both the directors severed their relationship from the companies in 1998 by submitting Form-32 with the Registrar of Companies. Hence, they cannot be subjected to the criminal complaint initiated by SEBI.
The Supreme Court interpreted section 12(1B) of the SEBI Act, which reads as:
“No person shall sponsor or cause to be sponsored or carry on or cause to be carried on any venture capital funds or collective investment scheme including mutual funds unless he obtains a certificate of registration from the Board in accordance with the regulations.
Provided that any person sponsoring or cause to be sponsored, carrying or causing to be carried on any venture capital funds or collective investment scheme operating in the securities market immediately before the commencement of the Securities Laws (Amendment) Act, 1995 for which no certificate of registration was required prior to such commencement, may continue to operate till such time regulations are made under clause (d) of sub-section (2) of section 30.”
The Supreme Court while analysing the provision bifurcated the provision into two parts. Firstly, the main provision that deals with the non-proviso category of persons who did not commence their activity before January 25, 1995. The provision mandated the presence of registration certificate if any activity pertaining to CIS is started after January 25, 1995. The second part of the provision that is the proviso deals with the persons who started the Collective Investment Scheme (CIS) activity before January 25, 1995, and hence, it establishes the regulations for any kind of existing activity.
While deciding on the legal question about the bar imposed by section 12(1B), the court held that the bar against commencing CIS activity without registration would operate with effect from the date that the statutory provision, i.e. section 12(1B) came into force and not only when the regulations were notified. The Court observed that operating any kind of Collective Investment Scheme (CIS) activity after January 25, 1995, without the registration certificate is completely forbidden by virtue of section 12(1B).
Therefore, the legal question was answered in favour of the appellant; but the Supreme Court upheld the decision of the High Court of quashing the criminal complaint against Varshney’ on procedural grounds. This is because of the fact that SEBI’s complaint was made under the proviso category which deals with the persons who are already operating a CIS activity prior to 25.01.1995. However, the case of the Varshney’ falls under the purview of the main provision because they commenced the Collective Investment Scheme (CIS) activity after 25.01.1995. The procedural question was therefore held in favour of the Respondents because SEBI prosecuted the Respondents under the wrong category.
Analysis: The Way Forward
With regard to the substantive question of law involved, the decision affects the class of persons on whom a restriction is imposed in the perusal of any kind of commercial activity by virtue of licensing or registration requirements. Since these licensing and registration requirements are also to be provided by the regulatory bodies, it was incumbent on them to enact the procedural requirements because conducting any kind of commercial activity stands forbidden by the prescribed legislation even in the absence of the requirements.
Like in the instant matter, it took three years for SEBI to come up with the procedure of obtaining the registration certificate; in such scenarios, the parties are at a gross disadvantage because they are required to abstain from engaging in any kind of Collective Investment Scheme (CIS) activity in the interim period. In the context of the procedural requirement, it mandates the regulators to be specific and correct with the category under which they file a case and against which they allege the violation to have taken place. The entire case of the prosecution can be subjected to dismissal on account of proceeding against the wrong legal provision.