The Supreme Court, on March 2, appointed a committee led by retired Judge Abhay Manohar Sapre to investigate the allegations made by Hindenburg Research against the Adani group. The committee's objective was to examine any potential "regulatory failures" and propose improvements to the system.
The committee, consisting of retired Judge JP Devdhar, former bankers OP Bhatt and KV Kamath, corporate expert Nandan Nilekani, and senior securities lawyer Somsekhar Sundaresan, submitted a comprehensive report earlier this month.
One of the committee's specific mandates was to investigate whether there were any instances of "regulatory failure" in dealing with alleged violations of securities market laws by the Adani group or other companies.
While the committee did not find conclusive evidence of regulatory failure, the report highlighted various instances where the Securities and Exchange Board of India (SEBI) faced challenges in performing optimally. These challenges were attributed to internal process deficiencies as well as inconsistencies in policy-making. The report also proposed several measures to make it harder for white-collar criminals who operate across multiple regulatory domains.
The report provides unprecedented insights into how SEBI conducted its investigation into the Adani group's affairs, particularly concerning the 13 overseas entities.
The following are the committee's observations regarding the foreign entities.
Controlling vs. participating shareholders
The Adani group comprises six listed companies: Adani Enterprises, Adani Transmission, Adani Total Gas, Adani Green Energy, Adani Ports and Special Economic Zone, and Adani Power.
Among the 13 overseas entities, one is a financial institution, and the remaining 12 are foreign portfolio investors (FPIs). These entities have held a significant portion of the free float of Adani group stocks. From March 2017 to March 2020, these 13 entities collectively controlled between 6% and 21% of various Adani companies.
According to the minimum public shareholding regulations, each listed company must have a minimum of 25% of its shareholding with public shareholders. The opaque ownership structure of these overseas entities raised suspicions at the Securities and Exchange Board of India (SEBI) that they might be acting as fronts for Adani group promoters, thereby violating the public shareholding norms.
As of March 2020, Adani Green Energy had the highest holding of 20.39% by these suspected entities, followed by Adani Transmission (18.05%), Adani Total Gas (17.91%), Adani Enterprises (15.56%), and Adani Power (14.11%). The entities did not hold any exposure to Adani Ports as of March 2020.
Typically, these overseas entities have two types of shareholders. The first group consists of controlling shareholders who own the equity and control the raised funds. They are referred to as fund managers or general partners. The second group includes shareholders who contribute funds and participate in the returns generated by the controlling shareholders. SEBI refers to these shareholders as participating shareholders or economic-interest shareholders.
The countries where the participating shareholders (PR shareholders) of these 12 FPIs are based include Cayman Islands, Malta, Curacao, British Virgin Islands, Bermuda, Ireland, and the United Kingdom.
These country names may sound familiar in the context of the suspected entities and their shareholders.
The fight against black money
The report on Black Money had previously identified certain jurisdictions, including the Cayman Islands, Bermuda, and the UK. The Securities and Exchange Board of India (SEBI) had informed a special investigation team (SIT), formed by a Supreme Court order, that investments through overseas derivative instruments (ODIs) were largely originating from these jurisdictions. In 2009, former law minister Ram Jethmalani had filed a public interest litigation to address the black money issue. In 2011, the Supreme Court directed the central government to establish the SIT, which has since filed multiple status reports on various aspects of the issue and the progress made.
In the SIT's third status report released in July 2015, it highlighted that a significant portion of outstanding ODIs invested in India came from the Cayman Islands, accounting for approximately INR 85,006 crore. Considering the small population of the Cayman Islands, it seemed implausible for a jurisdiction with fewer than 55,000 residents to invest such a substantial amount in one country. The SIT recommended that SEBI should have access to information on the beneficial owners of these investments, specifically in the form of individuals whose KYC information is known to SEBI. It emphasized that KYC information should not stop at the name of a company.
After eight years since the SIT's clear recommendation, what does SEBI have? It still harbors suspicions and struggles to identify the beneficial owners of 42 companies despite years of investigation. SEBI is reaching out to uncooperative individuals.
SEBI informed the Sapre panel that each of the 42 participating shareholders is incorporated as a company in one of the seven tax havens mentioned earlier. These companies have dual shareholding, with controlling shareholders and participating shareholders based in different jurisdictions.
According to SEBI, beneficiary owner details have only been determined for the controlling shareholders of 24 out of the 42 companies. The participating shareholders of these 42 companies remain unknown. Considering that there may be three or four shareholders in each of these companies, the total number of companies and shareholders involved reaches approximately 150.
This structure qualifies as an "opaque structure" in regulatory terms, as described by the Sapre panel. SEBI has encountered a significant hurdle in identifying contributors with an economic interest in these foreign portfolio investors (FPIs). The investigation has reached a dead end, and the publication of the Hindenburg Report has renewed SEBI's efforts to determine the economic interest in FPIs that have invested in listed Adani stocks.
Hindenburg's research has linked some of these entities to the Mauritius-based Monterosa group and its chairman and CEO, Alastair Guggenbul-Even. Hindenburg has made these connections based on publicly available information and raised suspicions. SEBI has relied on other agencies such as the Enforcement Directorate (ED), Central Board of Direct Taxes (CBDT), and foreign regulators to obtain concrete details. It is crucial for SEBI to establish that these entities received funds from the Adani group, as both the group and the FPI entities have denied any movement of funds from the group to these entities.
It is not a complex task to establish multiple layers of companies with one another as shareholders, creating a convoluted web that obscures the origin and flow of funds. It is widely known that tax havens, which profit from facilitating money laundering, will go to great lengths to safeguard the identities of their lucrative clients.
The question arises: why did the knowledgeable individuals in charge of the market regulator allow this loophole to exist, despite a clear directive from the SIT on black money that the ultimate beneficial owner should never be a company?
Why did they lower their guard without implementing sufficient alternatives?
The Sapre panel is forthright in highlighting this dichotomy. It even suggests that this loophole may have been deliberately created as recently as 2019, just a year before SEBI started harboring suspicions about the Adani group. However, the panel downplays it as a "legislative policy choice."
The committee states, "It appears that the legislative policy stance of SEBI on the ownership structure of FPIs has moved in one direction while SEBI's enforcement is moving in the opposite direction."
The report provides detailed insights into a policy change that took place.
Since the implementation of the Foreign Portfolio Investor (FPI) regime in 2014, it was the responsibility of depository participants to ensure that FPIs did not have an "opaque structure."
However, in 2018, SEBI formed a committee led by former RBI deputy governor HR Khan to propose measures to "rationalize and simplify" the FPI regime. The committee included three SEBI officials and two representatives from Citibank and Deutsche Bank as members. Numerous international banks and securities firms willingly shared their perspectives with the Khan committee in 2018-19. In stark contrast, the Sapre committee observed that none of these entities were willing to engage. Goldman Sachs, for example, redirected the request to the FPI lobby Asia Securities Industry and Financial Markets Association (Asifma), which promptly expressed its inability to contribute.
Khan panel suggestions and rationale:
The Khan panel made suggestions and provided a rationale for the removal of the opaque structure rule. Regulation 32(1)(f) of SEBI (FPI) Regulations mandated that designated depository participants ensure FPIs do not have an opaque structure, with the aim of prohibiting entities where beneficial owner (BO) information is not available or accessible.
In September 2018, a SEBI circular required all Category II and III FPIs to provide BO information, including details of intermediate investors, in the prescribed format. The Khan committee justified the removal of the opaque structure rule by referring to a practice called ringfencing.
The committee argued that structures where BOs are known but are ringfenced against each other, either due to regulatory requirements or contractual arrangements, should not be considered "opaque." They claimed that ringfencing is common among funds in various jurisdictions, citing examples such as the ringfencing of assets and liabilities within mutual funds and alternative investment funds in India.
The committee recommended that the opaque structure clause be removed from FPI regulations, stating that all FPIs must provide BO details. Those FPIs that fail to provide BO details, including due to bearer shares, would be prohibited from dealing in the Indian securities market.
The Sapre panel found it intriguing that SEBI decided to delete the regulatory stipulation altogether on August 21, 2019. They noted that this decision was made just months before SEBI's suspicion regarding Adani FPIs emerged in 2020. However, the Sapre committee did not view this sequence of events and the weak justification as regulatory failure.
The Sapre panel questioned why SEBI couldn't ask the 13 entities and their intermediaries to identify their lineage. They suggested that the regulator should require them to provide the names of all shareholders leading up to the natural person within 45 days or sell their shares and exit the market. The panel found it puzzling that SEBI had to write to unresponsive regulators from other jurisdictions, creating a sorry figure.
The panel raised concerns about whether SEBI would address this issue as a regulatory failure and make amendments by the deadline to file the final report to the Supreme Court on August 14.
The Sapre panel found the entire situation to be "piquant," expressing their bewilderment and raising important questions about the regulatory decision-making process.
Comments