SEBI-Sahara OFCD case: Optionally fully-convertible debentures- Meaning explained

What is Debenture?

From the earlier Debt vs. Equity article, you know there are two (legit) ways to arrange money for starting or expanding a company

DebtBorrow money from someone. Offer him interest rate and guarantee to repay the principal after xyz date.Bank loansBorrowing from friends, relatives, moneylendersBondsDebentures
EquityTake money from someone and offer him part ownership of the company.IPO-> Share.Venture CapitalistAngel Investor
  • Suppose a Telefilm company is producing a new bogus saas-bahu series.
  • The company needs additional finance of 100 Crore rupees just for the make-up, jewelry and expensive sarees of those actresses.
  • Company can approach the bank for a loan, but problems: 1) terms and conditions are heavy 2) the SARFAESI act (with its new amendments)
  • So, it’s better just to borrow from public.
  • Whoever gives you Rs.100, you give him a piece of paper titled “blah blah blah..these are the terms and conditions, repayment dates, interest rates etc.”
  • This piece of paper is called Debenture.
  • In this case, you need 100 crores, meaning print 1 crore papers (debentures) each worth Rs.100.
  • Whoever holds such paper units is called Debenture holder.
  • The cash thus collected is a loan for the company. (=debt)

Difference between Bonds and Debentures?

Overall, the principle behind Bonds and Debentures is same: They offer fixed interest rate + principal repaid at the specified date.

Issued byUnion GovernmentState GovernmentPSUsIssued by companies.
  • Second difference: the different rates of Stamp Duty applied on each of them.
  • Third difference:  The interest rate offered by Debenture is (usually) higher than Government Bonds. Because Government more likely to repay = no need to seduce customers with higher interest rate.

Types of Debentures

Based on ‘convertibility’ the Debentures are of two types

1.Convertible debenturesThey can be converted into shares of the company on the expiry of xyz date.
2.Non-Convertible DebenturesThey cannot be converted into shares.
  • When debenture is converted into shares, it means debt holder becomes an equity holder.
  • Both debt vs equity have their own advantages and disadvantages. We’ve discussed it in the earlier article (click ME)
  • But by and large, from the investor’s point of view, Debt is safer than Equity.

What is Optionally fully-convertible debentures (OFCD)?

  • These debentures can be converted into shares, when debt holder (investor) wishes (after expiry of xyz pre-decided date).
  • But the “rate”, will be decided by the company e.g. 20 debentures =>1 share.

From investor’s view, this “option” to convert Debenture into Shares is good ONLY IF

  1. Company is likely to make huge profit (so you, the shareholder can earn more dividend.) OR
  2. Company’s share-price is likely to rise in the share market (then you can sell shares to third-party and make profit).

BUT if the Company is going bankrupt, then it is better to avoid converting the Debenture into shares.  Because when a company is liquidated (i.e. its assets sold off),  the Debenture holders get the money before the shareholders.

It means Sahara OFCD is a bit tricky game. Investors should have some knowledge and understanding of share prices, company performance etc. else they could lose money. (or end up not getting maximum profit out of their investment). Now let’s move to the SEBI-SAHARA case.

2008-09: The game begins

Two firms of Sahara Conglomerate:

  1. Sahara Housing Investment Corporation
  2. Sahara India Real Estate Corporation. (aka Sahara Commodities)

These ^two companies Issued OFCD to collect money from investors.

~23 million people, mostly from villages and small towns subscribed to this scheme. They invested ~24,000 crores rupees in these OFCDs of SAHARA.

SEBIYou (SAHARA) have violated rules. If OFCDs are issued then whole process should be completed within 10 working days, but here you continue collecting money from people for more than two years!
SAHARAThis fund-raising was in the form of a private placement. I.e. we offered the schemes only to our select clients, this wasn’t meant a “Public Offer”! So what’s your problem?
SEBIDude if this is private placement, then maximum only 50 people can invest money in it.Here ~23 million people have parked their hard earned cash! Hell the number of investors in this case, is even more than the total number of people investing in the conventional stock-exchanges of India!India’s biggest IPO till date was of Coal India worth Rs.15000+ crores, and you’ve made 24,000 crores out of these OFCDs! It is my responsibility to protect the investors’ in Capital market.Hence, By the powers given to me under SEBI Act, I hereby order you to stop collecting money and refund all the money to those investors with 15% interest rate.
SAHARAThis is not right!
SEBIWell, if you’re unhappy with my order you can go to the Securities Appellate Tribunal (SAT)
SAHARAPleads before SAT.
SATSEBI is right. You refund money to those people.
SAHARANow, I’ll appeal in Supreme Court.

2012: Supreme Court hearing

SCWhat are your arguments?
SAHARAThose two companies are unlisted. Meaning, their shares are not listed on any Stock Exchange of India.Therefore, their conduct is outside the jurisdiction of SEBI. Because SEBI is regulator for listed firms only.Our matter falls under Union Corporate Affairs Ministry and not under SEBI.
SEBINope, this matter comes under my jurisdiction, becauseOFCD is a “security” under the Securities Act= it comes under the Sebi Act= I’ve the jurisdiction= Hence I can pass a special order to regulate unlisted companies!

Order of Supreme Court

Saare sabuto aur gawaaho ko madde nazar rakhte hue (in the light of all evidence and witnesses)

We are unconvinced with your logic that OFCD schemes don’t come under the scope of  SEBI.Mostly rural people have Invested money in your schemes and they’re not aware of OFCD.At the end of day, they would come and say that they were cheated. You know Harshad Mehta’s case, same modus operandi was there. Investors were not aware of the scheme.It seems you have no intention of returning the investors’ money. Your intentions are shady.We order you to refund the money.If those two companies of SAHARA donot refund money, you’re free to attach their properties and freeze their bank accounts.Also conduct a probe against those two Sahara companies to find out their actual subscriber base. (to make sure some funny game or money laundering isnot going on.)Check the genuineness of the investors and if the investors are not traceable, the amount will go to the government.

Government’s response

  • As you’ve seen in ^this case, SAHARA’s main argument is “SEBI doesn’t have jurisdiction over our OFCD investment scheme, because this money was meant for our “unlisted” companies.”
  • Government has decided to fix this ambiguity in the new Companies Act.
  • According to Companies Bill 2012 (passed in Lok Sabha): SEBI will have undisputed jurisdiction over any investment scheme involving more than 50 investors-It doesn’t matter whether you’re a listed company or an unlisted company.

SEBI ordinance

  • In 2013, Government had introduced Securities Laws (amendment) Bill, 2013. This was to empower SEBI against Sahara like litigations.
  • although it couldn’t be passed, but since the matter was of urgent importance, government decided to implement the provisions as an ordinance.
  • In March 2014, For the third time, Government extended this ordinance.

The silent features of the bill/ordinance:

  1. Empowers SEBI to investigate, raid and attach bank account and properties.
  2. If a person doesn’t comply with SEBI order, SEBI can arrest him without approaching the court.
  3. If any entity gathers funds of 100 crore OR above from juntaa, it’ll be called Collective investment scheme. (=indirectly it means company will fall under jurisdiction of SEBI, because SEBI regulates after Collective investment schemes.) This is necessary because Sahara says, “our scheme was above 100 crore but we are not a CIS, hence SEBI doesn’t have jurisdiction over us”
  4. SEBI can further expand the definition of Collective Investment funds through regulations.
  5. SEBI can sign agreements with foreign financial regulators for exchange of information.
  6. Fast track courts for speedy trials of pending SEBI cases.

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