Adani-Hindenburg Scandal: SEBI Playing for Time?

New Delhi: On July 10, the Securities and Exchange Board of India (SEBI) filed an affidavit in the Supreme Court (SC) responding to the court-appointed expert committee’s report on evaluating SEBI’s potential regulatory failure regarding allegations of manipulation of stock prices of publicly listed companies of the Adani Group.

In the report, the court-appointed committee concluded that there was no regulatory failure by the financial markets regulator and advanced a legal theory that advocated for the Adani Group’s exoneration on issues related to the public floatation of its shares, related party transactions and alleged manipulation of stock prices.

The allegations were raised in the January 24 report of the US-based short-selling firm Hindenburg Research. 

A quick recollection of facts at the outset. SEBI has investigated various allegations against the Adani Group since, at least, 2016. The regulator has looked into specific allegations, including the ones raised in the Hindenburg report since, at least, 2020. These investigations have yet to result in any public outcome.

A recent report by The Morning Context says that SEBI in recent times has appeared to be “toothless” preferring to issue multiple interim orders and leaving investigations inconclusive. 

Investigating the Origins of Funds 

The committee’s report revealed that SEBI has made some progress in investigating the origin of funds invested in Adani Group companies by entities registered in offshore tax havens but has been stymied by non-cooperation by authorities in those jurisdictions, where the “beneficial owners” of the investing entities are protected by privacy laws.

In its response, SEBI has defended itself against various positions taken by the committee. While the committee had argued that SEBI’s hands are tied in its investigation into stakes held in Adani Group companies by foreign portfolio investors (FPIs) with unidentified ownership, the regulator has pushed back, providing arguments supporting its ability to investigate.

SEBI has also disagreed with the legal theory offered by the committee and its applicability to the allegations about beneficial ownership, related party transactions and minimum public shareholding in Adani Group companies whose shares are listed. 

However, while defending its ability to investigate the ownership of the FPIs, SEBI’s submission has implicitly argued for it to be given an indefinite extension to complete the investigation. In May, the SC had given the SEBI time till August 14 to complete its investigation. 

Politically Explosive 

While it is easy to get lost in the weeds of the technical details of the issues covered by the committee report (comprising more than 170 pages) and SEBI’s response (more than 40 pages), the critical context that should not be forgotten is that the Adani-Hindenburg scandal is a politically explosive issue that has already embarrassed the Narendra Modi government before the 2024 general election. 

If SEBI can conclude its investigation expeditiously and release its findings to the public before the elections, the scandal can be a potent electoral issue for several BJP political opponents.

Should the investigation take longer, questions may arise about SEBI’s performance as a regulator and the possibility of political interference with it having reportedly been investigating FPI investment into Adani Group companies.

SEBI’s Powers to Probe 

That said, let us examine the key points made by SEBI in its response to the report and recapitulate the basic issues at hand. 

The Hindenburg report identified a set of 13 FPIs (12 of which are registered in Mauritius and one in Cyprus) that are heavily invested in Adani Group companies and presented evidence to argue that the FPIs are, in fact, linked to the group’s ownership and acted as their proxies. If this is true, it would imply three possible sets of violations.

First, if the FPIs are indeed Adani Group proxies, it would mean that the group’s promoters own more than 75% of the shares of the listed companies, violating minimum public shareholding requirements under Indian securities law.

Second, it would mean that transactions between the Group companies and the FPIs, or entities linked to them, would constitute related-party transactions, which are supposed to be disclosed by the Group. Failure to make such disclosures would violate the law relating to related party transactions.

Third, investment in Adani Group company shares by these FPIs may constitute illegal market manipulation if they are indeed proxies for the promoters instead of the disinterested third parties that they present themselves as. 

To investigate whether any law was violated on all three counts, it is first necessary for SEBI to gather information regarding the true beneficial owner of the funds invested by the 13 FPIs.

The committee had argued that SEBI lacks the powers to investigate to find out the beneficial ownership of the FPIs. This, the committee argued, is because SEBI had, over the years, diluted the disclosure requirements imposed on FPIs regarding their beneficial ownership and led to a situation wherein it lacks the powers to now seek to lift the corporate veil and find out who ultimately controls the funds invested by the FPIs. 

Disclosure Norms

SEBI’s response effectively argues that the committee has misunderstood the progression of disclosure requirements relating to beneficial ownership.

Contrary to what the committee contended, SEBI states that, in fact, disclosure requirements were strengthened, not diluted. The regulator argued that prior to changes made in 2018, FPIs were only required to provide an undertaking committing themselves to providing information about beneficial ownership when asked for it.

In 2018, the changes in SEBI’s rules for FPIs mandated that such investors must declare beneficial ownership upfront at the time of registration. Then, in 2019, a clause defining “opaque structures” was removed from the rules, it says, because this clause would form a loophole allowing a higher disclosure threshold. 

The committee had pointed to the removal of this clause as constituting a dilution of the disclosure rules. “Thus, the changes made in FPI Regulations in 2018 and 2019 effectively tightened the disclosure requirement related to BOs (beneficial owners),” SEBI’s response says. 

SEBI further argues that the committee is incorrect in its assessment that this progression in the FPI rules has stymied its efforts to identify the beneficial owners of the 13 FPIs.

Here is a short extract from SEBI’s response: “…the challenges with respect to the identification of natural person economic interest holders in FPIs are in no way a consequence of the 2018 Circular or the 2019 FPI Regulations… On the contrary, the regulatory framework was tightened during this period rather than relaxed. Even if [the] 2014 Regulations were extant, nothing would have changed with respect to the challenges faced vis-a-vis identifying natural persons with [an] economic interest in FPIs. To address the challenges, SEBI Board has approved a new proposal which, for the first time, would mandate granular disclosures to the last mile (without any thresholds) by certain categories of FPI.”

This part of SEBI’s response also directly takes on the legal theory propounded by the committee: “…the Expert Committee has expressed certain interpretations of facts and law in the report which has bearing on the ongoing investigation and other matters. The submissions made before the Expert Committee were based on the prima facie facts available to SEBI as on the date of submission and not based on the application of law on facts found out on completed examination.”

Rules on Related Party Transactions

SEBI then addresses the issue of related party transactions. Here too, the regulator strikes at the committee’s legal interpretation of the development of its regulatory approach to classifying transactions as between related-parties.

In its report, the committee argued that SEBI had over the years narrowed the definition of “related party”. It pointed out that the SEBI Act had outlawed “contrivances and devices that are structured to circumvent the law” and that SEBI’s Listing Obligations and Disclosure Requirements (LODR) Regulations “prevents ‘schemes’ and ‘artifices’ to circumvent the regulations”.

The committee said that SEBI subsequently provided a specific definition of a “related party” which was amended and added to from time to time—leading to a narrowing of the term’s meaning to only those instances covered by the definition. This, the committee argued, meant that the more expansive test of structures designed to circumvent the law could no longer be used to determine who constitutes a “related party” if it was not covered by the specific definition.

In response, SEBI bluntly disagreed: “It is submitted that of the multiple regulatory approaches to deal with violation of securities laws, one is to expand the definition of a particular clause to address the circumvention.”

SEBI continued: “The other approach to deal with circumvention is to apply the pre-existing provision which prevents ‘schemes’ and ‘artifices’ to circumvent the regulations. It is submitted that once the definition is refined to address the circumvention, the approach of applying the provisions of ‘schemes’ and ‘artifices’ to the situation when the definition was narrow and test whether there was any circumvention at that point of time is fully legally justified.”

Effectively, what SEBI is saying is that it has every right to investigate whether the FPIs or entities linked to them constitute related parties to the Adani Group even if its specific definition of related parties did not require the group to declare them as such. If the FPIs’ beneficial ownership information shows that the funds invested by them in Adani Group companies are, in fact, the group’s own funds, then the SEBI’s investigation can charge them as being structures designed to circumvent the law.

A Stinging Repost 

So far, on the legal issues concerned, SEBI’s position is that it is empowered to conduct the investigation into the FPIs and determine, based on what it finds regarding their beneficial ownership, whether rules and laws relating to minimum public shareholding and disclosure of related party transactions were violated. This assumes the appearance of a stinging repost to the committee’s legal theory that undermined the SEBI’s ability and authority to carry out such an investigation in the first place.

Timelines for Investigation

However, a different part of SEBI’s response is of significant political and practical import to the Adani-Hindenburg scandal, concerning the time it is allowed to take to complete the investigation. 

When the apex court ordered SEBI to investigate whether the Adani Group could indeed be charged with the violations and illegalities alleged in the Hindenburg report, it had given it a deadline of two months, ending early-May. In mid-May, SEBI requested an extension of six months. The court ended up granting an extension of three months, i.e., till August 14.

The issue of the time taken to investigate was also raised by the committee, which recommended that “there should be timelines stipulated for initiation of investigations, completion of investigations, initiation of proceedings, disposal of settlement, and disposal of proceedings. Some elements of (the) timeline may be directory and other elements may be mandatory.”.

In its response, however, SEBI argues forcefully against any timelines being imposed on it. While its arguments are lengthy and detailed, the key points it makes is that imposing a timeline may “compromise the quality of investigation”.

While this is a question open to debate by stakeholders, the implicit signal being sent by SEBI regarding the Hindenburg-Adani investigation is that the SC should not expect the regulator to adhere to its deadline, and that the investigation may go on indefinitely.

Indeed, it is already a matter of public record that the FPI issue with the Adani Group has been under investigation by SEBI since, at least, 2020 and that it has investigated the group on other grounds since, at least, 2016.

This position may undermine the robustness of SEBI’s defence of its investigation. By its own argument in its response to the committee, its role as the regulator is to safeguard the integrity both of the Indian securities market and the interests of investors.

Surely, timely investigation of allegations of malpractices by one of the largest listed conglomerates is crucial to carrying out this function. Yet the regulator has sought more time from the SC twice—once directly and now again implicitly in its response.

The issue of timelines brings SEBI’s efforts to investigate the Hindenburg allegations into the larger political context surrounding the scandal. The Adani scandal has invigorated the Opposition and put the Modi government in a tight spot. The conclusion of SEBI’s investigation and the release of its results to the public may be a crucial turning point in the run-up to the 2024 elections. 

Can SEBI Rake Up Muck On Its Own?

SEBI told the committee that its investigation has revealed the names of 42 investors in the 13 FPIs so far, and that all these companies are registered in several tax havens—the Cayman Islands, the British Virgin Islands, Malta, Curacao and Bermuda. Further, SEBI has obtained information on the controlling stakeholders and investors of 24 among the 42 investors but has been struggling to obtain the rest. 

The Enforcement Directorate and the Central Board of Direct Taxation have apparently declined to support SEBI’s requests to join the investigation, and international coordination mechanisms to obtain information from the market regulators in the offshore jurisdictions have also failed. 

Even if SEBI is able to obtain enough information to attribute the funds invested by the FPIs to specific persons, and it turns out that they are indeed acting on behalf of or are linked to the Adani Group’s promoters, the question remains whether and how SEBI will act on this information.

Will the regulator initiate legal proceedings, which would necessitate placing the information in the public domain? Or will it remain toothless preferring to issue interim orders without bringing the matter to closure? 

Ever since the Modi government rejected the Opposition’s demand to constitute a Joint Parliamentary Committee to investigate the allegations against the Adani Group—whether in the Hindenburg report or made by others—doubts have been raised over whether proceedings before the SC on a subset of Hindenburg’s allegations will result in a ‘clean chit’ for the Adani Group even as issues outside the remit of the court case remain unaddressed. 

(Research and editing support from Ravi Nair and Paranjoy Guha Thakurta.)

The author is an independent journalist.