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For Whom the Bell Tolls: SEBI’s Concept of Promoter

Ansh Chaurasia

[Ansh is a student at Dr Ram Manohar Lohiya National Law University.]


John Donne used the phrase “for whom the bell tolls” for his poem to paint a picture of human lives bound together. If we figuratively borrow this concept of interconnectedness to situate this for a company to ask: If the bell tolls for a company, does it also toll for the purported promoter of the company?. The Securities and Exchange Board of India (SEBI) would answer this in the affirmative, even in cases where the purported promoter is not the person in control of the company.


On 26 August 2024, a division bench of the Bombay High Court (HC) in the matter of Dr Pradeep Mehta v. Union of India and Others delivered a significant, yet short-lived, judgment with broad implications for the securities regulatory regime. This judgment ceases to have any value as a precedent after the stay ordered by Supreme Court (SC). However, this stay is made purely on procedural grounds because the HC reserved the case for interim relief but proceeded to deal with the matter in a manner that warrants the final disposal of the writ petition. 


The issue was centered around the petitioner’s alleged status as a promoter of Shrenuj & Co (Shrenuj), that he promoted in 1989 by subscribing to two-thousand shares of the. The petitioner’s shareholding was 0.01% of the total paid-up share capital as of 2016. Hitherto, he was never involved in the company’s affairs or decision-making. He was only named as an investor promoter of Shrenuj at the time of incorporation in 1989. In 2016, Shrenuj failed to file the financial results as per Regulation 33 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations 2015 (LODR), which led the regulator to freeze the demat account of the people involved with the company including the petitioner, as per Regulation 99 of the LODR. 


The petitioner challenged – the legality of the regulator’s action that regarded him as the promoter, the law allowing freezing of the entire demat account, and procedural fairness in the proceedings dealing with alleged violation of the law. The analysis of this blog will be centred on the challenge against the regulator’s action that envisaged the petitioner as the promoter of Shrenuj. This piece highlights the departure from settled concept of promoter that has characterised the previous proceedings initiated by SEBI. Therefore, though a short-lived judgment, it serves well to its clarificatory role.


Promoter and Company: Substance over Form


The liability qua promoter


Regulation 33 of the LODR mandates listed companies to submit quarterly and annual financial results to the stock exchange. Regulation 98 of Chapter XI of LODR allows the stock exchange to impose fines, suspend trading, freeze promoter or promoter group holding of designated securities, and take any action as specified by the SEBI through circulars and guidelines.

 

After Shrenuj’s default, it received communication that directed the freezing of the petitioner’s demat account as per circular dated 26 October 2016. Further, Shrenuj was delisted by the stock exchange for non-compliance with LODR as per Rule 21 of the Securities Contracts (Regulation) Rules 1957. As a consequence, the petitioner was barred from accessing the stock market as per Regulation 34 of the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations 2021 (Delisting Regulations). Upon delisting, the company’s promoters are obligated to acquire the delisted equity shares from the public as per Regulation 33 of the Delisting Regulations (also called exit option). The proceedings initiated by the SEBI and stock exchange were premised on the petitioner’s obligation as the promoter of the company. The rationale was that he promoted Shrenuj in 1989 and has remained a shareholder.


Promoter with a notion of actual ‘control’


The promoter’s role, as envisaged by different legislations, has a broader connotation than merely having the name in the company’s memorandum. Two aspects of a ‘promoter’ of the company are relevant for our analysis as provided in Section 2(69) of the Companies Act 2013: the person has been named as a promoter in the prospectus or in annual return, or a person having direct or indirect control over the affairs of the company as shareholder, director or otherwise. As per Regulation 2(1)(oo) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations 2018, a promoter includes a person in control of the issuer, instrumental in the formulation of a plan or programme pursuant to which specified securities are offered to the public, or person named in the offer document as the promoter. 

 

The HC accorded wide meaning to the term ‘promoter’, it referred to foreign and Indian precedents to conclude that the categorisation of any person as ‘promoter’ requires substantive analysis. Such substantive analysis must be focused on- the person’s active involvement in the promotion of the company, the obligations and fiduciary duty of the promoter after the board of directors took over the affairs of the company, and whether any active role of the promoter exists in relation to the company or shareholder (paragraph 63). The HC stated that these principles were to be read in the SEBI Act and any other delegated legislation framed therein. 


To regard a person in control of a company as promoter is something that SEBI itself has advocated in a consultation paper of 2021, and it also emphasised on the ‘necessity of reorientation of enforcement strategy’ given this has direct implication on one of its important tool of enforcement that is freezing of demat account. Subsequently, the notion of person-in-control underlying the concept of promoter was approved by SEBI.


The respondents did not argue on the legality of the categorisation of the petitioner as the promoter rather petitioner’s role as promoter served the foundation for all arguments that justified freezing of the demat account and imposition of a fine. They failed to prove any of the ‘substantive requirements’ that warranted the categorisation of the petitioner as a promoter of the company. Their arguments were centered only around the fact that petitioner promoted the company once, and no submission was done to establish that petitioner qualifies to be categorised as promoter.


The Departure at SAT


This is not a one-off instance where SEBI or Securities Appellate Tribunal (SAT) faced this issue for the first time; there have been cases where erstwhile promoters who were not involved in the affairs of the company were subjected to regulatory proceedings. 


In Kashyap K Mehta v. BSE, the issue before SAT was to decide the legality of the action taken by SEBI to freeze the promoter’s account for violation of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 1997. The appellant was not actively involved in controlling and managing the company, and this time, the appellant’s limited role was present on record (paragraph 16). 


In Aditi Asim Dalal v. SEBI, the promoter whose demat account was frozen contended against their role as promoter. Because of the newly issued circular that incorporated standard operating procedures for freezing the account of promoters, SAT directed to de-freeze, the question of law remained open (paragraph 10). From these cases, it is adequately clear that this has remained an issue for long before the SAT.


In the present case, the petitioner approached SAT in two instances, and on both occasions, SAT directed the stock exchanges to reply to the representations made by the petitioner (paragraphs 10 and 14). The position of law left no choice with the petitioner but to approach the HC. The statute provides for an appeal to SAT against decisions of the stock exchange under Section 23L of the Securities Contracts (Regulation) Act 1956. Where the nature of grievance is such that it includes a challenge to the basis of law itself, neither the stock exchange nor SAT can do anything. It was evident in the present case that neither the stock exchange nor the SAT could have determined the interpretation of the term ‘promoter’ under the challenged regulations and circular.


Conclusion


Promoter of a company plays a crucial role in formation and operation of the company, a great chunk of liability arising from a violation of law on part of company is fastened upon promoter . In this regard, this judgment clarifies the basic considerations to determine the promoter who is actually in control of the company. The SC has directed for disposal of the petition after hearing final arguments. In meantime, the earlier judgment may not be a legal precedent, yet the underlying reasoning will have significant bearing on respondents’ defence when the case will be re-heard. Such cases are frequently defended by SEBI or stock exchanges before SAT, as stated earlier. Even the HC itself recognised this to be a ‘classic case’ (paragraph 45). It would not happen in every instance that an aggrieved person has the resources to litigate against SEBI or stock exchanges who are well-equipped to defend till any stage of litigation.


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©2025 by The Indian Review of Corporate and Commercial Laws.

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