Shareholder Ratification Cannot Cure Fraud Under SEBI's PFUTP Regulations: Supreme Court Restores Rs. 70 Lakh Penalty on Company

"Illegality Cannot Be Ratified; Only an Irregularity Can Be", Supreme Court has held that a company which diverts preferential allotment proceeds from their disclosed objects cannot escape regulatory liability by passing a subsequent shareholder resolution purporting to ratify the diversion.

A bench of Justice J.B. Pardiwala and Justice K.V. Viswanathan set aside the order of the Securities Appellate Tribunal and restored penalties of Rs. 70 lakhs on Terrascope Ventures Limited (formerly Moryo Industries Limited) and Rs. 25 lakhs each on its Managing Director and Director for violating SEBI's Prohibition of Fraudulent and Unfair Trade Practices Regulations, 2003.

Background

On 03.09.2012, Moryo Industries Limited issued notice for an Extraordinary General Meeting disclosing that funds raised through preferential allotment would be used for capital expenditure, working capital, marketing and setting up offices abroad.

Between 16.10.2012 and 08.11.2012, the company raised Rs. 15,87,50,000/- from 42 entities through preferential allotment. From the very next day — 17.10.2012 — the funds were diverted to purchase shares of other companies and to extend loans and advances to various entities connected to a common promoter, Mr. Giriraj Kishore Agarwal.

SEBI's Whole Time Member passed an ad-interim order on 04.12.2014 restraining the company, its promoters, directors and preferential allottees from accessing the securities markets. The WTM confirmed the order in 2016. A separate show cause notice was issued by the Adjudicating Officer in 2018.

Crucially, in 2017 — after the WTM's order and after the entire amount had already been diverted — the company passed a shareholder resolution purporting to ratify the variation in utilisation of proceeds. The SAT accepted this ratification and set aside the penalties. SEBI appealed to the Supreme Court.

Diversion from Day One Proves Fraudulent Intent

The Court found no difficulty in concluding that the respondents had violated Regulations 3 and 4 of the PFUTP Regulations.

The Court noted the speed with which the diversion occurred. "It is very clear from the facts that the respondents had from the very inception had no intention to use the funds for the stated objects and their only object was to somehow raise the funds and divert it for the purpose they ultimately did," the bench observed.

The Court pointed out that the PFUTP Regulations define fraud broadly — going well beyond its ordinary meaning. "Under the PFUTP Regulations, fraud is broadly defined and is not confined to the meaning as normally understood. There could be fraud under the PFUTP Regulations even without deceit," the Court held, relying on SEBI v. Kanaiyalal Baldevbhai Patel, (2017) 15 SCC 1.

The definition includes "a promise made without any intention of performing it" — squarely applicable to a company that raised funds against stated objects and diverted them from the very next day without any genuine attempt at compliance.

Objects of Preferential Issue Are Not a Formality

The Court emphasised that disclosure of objects in the explanatory statement to the EoGM notice is a statutory mandate under Regulation 73 of the SEBI ICDR Regulations, 2009 — not a mere technicality.

"Investors and all other stakeholders concerned with the securities market, irrespective of whether they ultimately subscribe to the shares or not, adjust their affairs based on the disclosure made," the Court said.

An investor holding shares may decide to retain them based on stated objects. Another may buy shares in the open market after finding the objects genuine. Yet another may offload his holdings if the object appears detrimental. All these decisions are influenced by the stated objects of the preferential issue.

"A conspectus of the SEBI Act, PFUTP Regulations, the SCRA, ICDR Regulations and the Listing Agreement all point in one direction — objects set out in the explanatory note are of utmost significance and have a large say in influencing and impacting the conduct of stakeholders," the Court held. "It is not to be taken casually since the consequences to public interest could be grave."

Shareholder Ratification Cannot Cure Regulatory Fraud

The SAT had set aside the penalties solely on the ground that the shareholders had ratified the diversion through a resolution dated 29.09.2017. The Supreme Court rejected this reasoning comprehensively.

First, the Court held that Section 27 of the Companies Act — which provides a mechanism for varying objects of a prospectus — has no application whatsoever to preferential allotments made through private placement. Private placement is governed by Section 42 of the Companies Act, not by Section 27. The reliance placed by the SAT and the amicus curiae on Section 27 read with Section 62(1)(c) was held to be completely misplaced.

Second, and more fundamentally, the Court held that even if Section 27 were applicable, it requires unutilised funds to exist at the time of variation. Here, the entire amount had already been diverted before any ratification was sought. There was nothing left to vary.

Third, and most decisively, the Court held that SEBI's regulations protect multiple stakeholders and carry public law dimensions. A liability crystallised under such regulations cannot be extinguished by a private shareholder resolution.

"By a private resolution, a liability which is crystallised cannot be wiped off by contending that the shareholders have condoned the action. When rights of multiple stakeholders are involved and certain Regulations proscribe a particular course of action, any breach of the Regulation has to face its consequences," the Court declared.

Relying on Government of Andhra Pradesh v. K. Brahmanandam, (2008) 5 SCC 241, the Court reiterated the settled principle: "Illegality cannot be ratified. Illegality cannot be regularised, only an irregularity can be."

The Court further held that matters involving public interest cannot be treated as private waivable rights. "No condonation or ratification on aspects opposed to public policy can be made, as it will seriously jeopardize public interest," it said.

WTM and Adjudicating Officer Can Act on Same Facts

The amicus curiae had also argued that once the WTM had adjudicated the matter, the Adjudicating Officer could not initiate separate proceedings on the same facts. The Court rejected this contention as well.

The Court drew a clear line between the two authorities. The WTM exercises powers under Sections 11(1), 11(4)(b) and 11B of the SEBI Act — limited to restraining market access and ordering disgorgement. The Adjudicating Officer exercises a separate power under Section 15(I) to impose monetary penalties under Section 15HA.

Prior to the Finance Act 2018, the WTM had no power to levy penalty under Section 15HA. Having imposed only a market restraint, the WTM left the field of monetary penalty entirely open for the Adjudicating Officer.

"It is only that two authorities vested with different powers operating in separate fields have exercised jurisdiction during the period in question. We find nothing wrong in the course of action adopted," the Court held.

The judgments relied upon by the amicus — Ram Kishori Gupta and Nirmal N. Kotecha — were distinguished on facts.

The Supreme Court allowed SEBI's appeals, set aside the SAT order, and restored the Adjudicating Officer's order dated 29.04.2020 imposing penalties of Rs. 70 lakhs on the company and Rs. 25 lakhs each on the Managing Director and Director. The Court also found the penalties not to be disproportionate.

Date of Decision: March 17, 2026