SAT’s Ruling Interpreting SEBI’s Powers to Issue Ex-parte Interim Orders – An Analysis!

Ex-parte interim orders are made by regulatory authorities when there is urgency. In Liberty Oil Mills & Ors. vs. Union of India & Ors. [AIR (1984) SC 1271], the Supreme Court had observed that the urgency must be infused by a host of circumstances, viz. large scale misuse and attempts to monopolise or corner the market. Supreme Court further held that the regulatory agency must move quickly in order to curb further mischief and to take action immediately in order to instill and restore confidence in the capital market.

Powers of SEBI: It is no more res integra that SEBI has power to pass ex-parte interim orders, pending investigation. SEBI has adequate powers to pass ex-parte interim orders under section 11 and section 11B of the SEBI Act. Let’s discuss the powers of SEBI:

Subject to the provisions of SEBI Act, it shall be the duty of SEBI to protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit. [section 11(1) of SEBI Act].

Section 11B of the SEBI Act relates to ‘Powers to issue directions and levy penalty’. According to the said provisions, save as otherwise provided in section 11 of SEBI Act (i.e. except, but, other than), if after making or causing to be made an enquiry, SEBI is satisfied that it is necessary:

(i) In the interest of investors, or orderly development of securities market; or (ii) To prevent the affairs of any intermediary or other persons (as referred to in section 12 of SEBI Act) being conducted in a manner detrimental to the interest of investors or securities market; or (iii) To secure the proper management of any such intermediary or person, SEBI may issue such directions:

a)      To any person or class of persons (as referred to in section 12 of SEBI Act), or associated with the securities market; or

b)      To any company in respect of matters specified in section 11A of SEBI Act, as may be appropriate in the interests of investors in securities and the securities market.

SEBI’s power to pass ex-parte orders: SEBI has power to pass interim orders and such interim orders can also be passed ex-parte. Interim orders are passed in order to prevent further possible mischief of tampering with the securities market. If during a preliminary enquiry, it is found prima-facie, that the person is indulging in manipulation of the securities market, it would be obligatory for SEBI to pass an interim order or for that matter an ex parte interim order in order to safeguard the interests of the investors and to maintain the integrity of the market. Normally, while passing an interim order, the principles of natural justice have to be adhered to, namely, that an opportunity of hearing is required to be given. Procedural fairness embodying natural justice is to be applied whenever action is taken affecting the rights of the parties. At times, an opportunity of hearing may not be pre-decisional and may necessarily have to be post-decisional especially where the act to be prevented is imminent or where action to be taken brooks no delay. Thus, pre-decisional hearing is not always necessary when ex-parte ad-interim orders are made pending investigation or enquiry unless provided by the statute. In such cases, rules of natural justice would be satisfied, if the affected party is given a post-decisional hearing.

However, an ex-parte interim order should be passed on the pretext that it was imminent to pass such interim order in order to protect the interest of the investor or the securities market. An interim order, however temporary it may be, restraining an entity/person from pursuing his profession/trade may have substantial and serious consequences which cannot be compensated in terms of money.

Factual Matrix in North End Foods Marketing Pvt. Ltd. Vs SEBI: The issue – in which cases can SEBI pass an ex-parte interim order – was in decided by Securities Appellate Tribunal (‘SAT’) in North End Foods Marketing Pvt. Ltd. Vs SEBI [LSI-171-SAT-2019(MUM)]. In this case, SEBI had received an e-mail from Multi Commodity Exchange of India Ltd. (‘MCX’) intimating that 3 entities were holding more than 75% of the total exchange deliverable stock of Mentha Oil. MCX further informed that the 3 entities were clubbed in accordance with MCX’s circular dated August 23, 2017 with regard to monitoring of position limits as it was found to be receiving funds from the appellant, i.e. North End Foods Marketing Pvt. Ltd. (‘NEFM’). SEBI noted that the 3 entities acquired Mentha Oil through transactions in Mentha Oil futures contracts on the exchange platform as well as by way of ‘off-market’ transfers. During investigation, SEBI observed that all the entities were funded by one entity – NEFM.

Prima facie, SEBI’s investigation revealed that NEFM was the beneficial owner of the Mentha Oil stock and the entities were acting as front entities of NEFM to hold the stock in their names and were thus, proxy entities assisting in the entire process.

SEBI’s prima-facie conclusion: SEBI’s prima-facie conclusion was drawn that such cornering of substantial percentage or specified stocks of Mentha Oil was fraudulent within the meaning of the term ‘fraud’ as defined under Regulation 2(1)(c) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market) Regulations, 2003 (‘PFUTP Regulations’) and was also in violation of Section 12A of the SEBI Act read with Regulations 3 and 4 of PFUTP Regulations. A presumption was drawn that this accumulation / cornering of stocks of Mentha Oil was predominantly done with the purpose of manipulating the Mentha Oil market on the exchange platform and on the physical stocks of Mentha Oil through entities.

SEBI formed a prima-facie opinion that concentration of large stocks with a single entity was detrimental to the price discovery and that single entity was in a position to dictate the Mentha Oil Future Contracts on exchange platform during lean season. On this bonafide apprehension, SEBI adopted urgent measures by passing an ex-parte interim order.

SAT termed SEBI’s order as ‘harsh’ and ‘unwarranted’: On appeal, SAT opined that SEBI’s ex-parte interim order was harsh and unwarranted. SAT opined that there was no real urgency at this late stage in passing an ex-parte restraint order which virtually amounted to passing a final order. SAT observed that there is nothing on record to indicate that the sales made by the 3 entities was on a higher side indicating manipulation in the price nor there is any prima-facie, finding that by accumulating large stocks of Mentha Oil, the 3 entities had dominated the market without making any comparison with the total volume of trades in the physical market.

SAT opined that “Basis of urgency was purely on account of presumption and was not based on any piece of evidence. There should be some shred of evidence to come to a prima-facie conclusion that the appellants are indulging in unfair trade practices in cornering the market with a manipulative intent to manipulate the price. Passing a restraint order which virtually puts a stoppage on the appellants right to trade based on a needle of suspicion, in our opinion, is harsh and unwarranted”. SAT concluded that SEBI’s order was not sustainable in the eyes of law as it has been passed in gross violation of the principles of natural justice as embodied in Article 14 of the Constitution of India.

Lessons for SEBI and concluding remarks: As discussed above, without any further doubt, SEBI has powers to issue an ex-parte interim order. However, such orders can be passed only in case of urgency along with circumstances like large scale misuse and attempts to monopolise or corner the market. Timing of such ex-parte interim order is the crux. At the same time, SEBI’s objective of protecting interest of investors and regulating the securities market is achieved when the ‘timing’ of ex-parte interim order is met. Ultimately, the objective of passing such orders is curbing further mischief and restoring the confidence in capital market. SEBI’s enforcement mechanism and monitoring of trades in securities market plays a very important role in taking actions.

In most of the cases, SEBI in its ex-parte interim order freezes the bank account and demat account of company. In addition to this, SEBI also freezes the bank account and demat account of the promoters / directors of the company or intermediaries. Does this mean that SEBI has lifted the corporate veil at an interim stage? In my view – yes. However, there should be an opportunity of hearing to the parties as such decision directly affects the operations of the company and its fund raising activity. Therefore, not just ‘timing’ but also ‘reasonable justification’ is an important aspect when SEBI passes ex-parte interim order. SEBI is empowered to pass ex-parte interim orders only in extreme urgent cases and such power should be exercised sparingly.