1. What is Conflict?

Disclosure Documents: Prospectus / Red Herring Prospectus / Placement Memorandum / Quarterly Results / Annual Report / RHP - filed with SEBI / ROC, contains audited financials, risk factors, use of proceeds.

Actual Financial Position: Real cash flows, hidden loans, fictitious sales, diverted funds, undisclosed defaults.

Conflict arises when:

• Prospectus shows profit, actual books have loss
• Disclosure says funds for expansion, actual used to repay promoter loan
• Balance sheet shows inventory, actual godown empty

SEBI: Interest of investors who take decision on basis of financial position and disclosures made in financial statements have been, prima facie, affected adversely due to fraudulent misstatements in financial statements and have violated Sec 12A(a)(b)(c) SEBI Act, Regulation 3(b)(c)(d) PFUTP

2. Legal Framework

A. Companies Act 2013 - Sec 34, 35, 447:

• Sec 34: Prospectus must contain true statements
• Sec 35: Civil liability for misstatement - every person who authorised issue liable to compensate
• Sec 447: Fraud - imprisonment up to 10 years

B. SEBI (ICDR) Regulations: Draft Red Herring Prospectus must contain audited financials, litigation, use of proceeds, material facts.

C. SEBI PFUTP Reg 4(2): Fraudulent misstatements in financial statements will amount to misrepresentation / unfair trade practice

3. Landmark Case Laws

Case 1: Shiromani Sugar Mills Ltd. v. Debi Prasad (1950) - Supreme Court - First Indian case

Company released prospectus containing inflated projections about its profit and financial standing.

Held: Any false representation of fact made by company either intentionally or by negligence in prospectus makes company and its directors liable for investor losses.

Principle: Even negligence, not just intent, is enough. This is still cited in all SEBI orders.

Case 2: DLF Ltd. vs SEBI - 3 Year Ban - Suppression in RHP

Facts: Real estate major DLF in its Red Herring Prospectus suppressed material information about subsidiaries and pending FIRs to mislead investors.

SEBI restrained DLF and its 5 directors and CFO from accessing securities market for 3 years for suppression of material information in RHP so as to mislead.

Later SAT reduced ban but principle upheld: Omission = Misstatement.

A well-known Indian example of golden rule being tested - SEBI now requires Draft RHP with audited financials, risk factors, litigation before public sees final offer.

Case 3: Sahara vs SEBI (2012) - Supreme Court - Rs 24,000 cr fraud

Supreme Court unravelled one of India's largest financial frauds. Sahara's OFCDs were public offerings, contrary to claim of being private placements, as they had amassed Rs 24,000 cr from over 3 crore investors without adhering to SEBI regulations.

Sahara filed disclosure documents claiming private placement, actual financial position was public money collection without approval. Stunt of 127-convoy trucks with fake documents to show innocence failed.

Principle: Form of disclosure cannot override substance of financial position. If you collect from public, ICDR applies.

Case 4: Varanium Cloud Ltd - SEBI 2023-24 - Rs 62.51 Cr IPO Fraud

SEBI uncovers massive Rs 62.51 cr fraud in IPO, issues SCN for fund diversion and fictitious transactions. Serious violations relating to diversion of public issue proceeds, fictitious sales and purchases, misleading disclosures, and misrepresentations of financial statements.

Company raised funds stating different objectives in prospectus and did different things when money actually raised. Management showed fictitious sales to inflate revenue.

Held guilty under securities laws - SEBI PFUTP.

Case 5: Ujaas Energy / Similar - Wrong Disclosure under RHP regarding loans

SEBI order:

Making wrong disclosure under RHP regarding loans - Rs 12.70 crores in prospectus out of which loans worth Rs 1.50 crores taken before prospectus submitted i.e. before Aug 30, 2011 and loans worth Rs 11.20 crores belong to period after submission and before allotment.

Violation of Sec 12(a)(b)(c) SEBI Act + 3(b)(c)(d), 4(1) and 4(2)(f) PFUTP.

Case 6: SEBI vs Kalahridhaan Trendz, SAR Televenture, Suzlon - Disclosure vs Actual Defaults

KTL: False and misleading corporate disclosures, failing to disclose loan defaults and other governance lapses - Rs 1 crore penalty.

Suzlon: Rs 28.95 cr penalty on Suzlon, promoters over deceptive monetary disclosure - price, leverage, monetary publicity and danger profile - imposed Rs 15.95 cr on company.

SAR Televenture: Misleading announcements, incorrect disclosures and delayed filings - guilty under Sec 15HB.

Principle: Hiding loan default while showing healthy balance sheet = fraudulent misstatement.

Case 7: Ritesh Polysters / Ritesh Agarwal vs SEBI (2008) - Minor as Promoter

Question: If minor represented as promoters in prospectus, could be held liable for misrepresentation?

Supreme Court in Ritesh Agarwal and Anr v SEBI held minors having regard to Indian Contract Act could not be proceeded against strictly under Companies Act. But company and major promoters liable.

Shows even who is shown as promoter must reflect actual financial capacity.

4. How Courts Resolve Conflict

1. True and Fair View Test: Prospectus must give true and fair view. Any untrue statement - every person who authorised issue punishable with imprisonment up to 2 years or fine Rs 50k or both, unless proves statement immaterial or had reasonable ground to believe true up to time of issue.

2. Investor Reliance Test: SC: Interest of investors who take decision on basis of financial position affected adversely due to transactions and consequent fraudulent misstatements.

3. No Shareholder Approval Can Legalise Diversion:

Supreme Court bench Justices Pardiwala and Viswanathan - "Any diversion of funds without proper disclosure to investors amounts to fraudulent activity under PFUTP Regulations. Shareholder approval cannot legalise fund diversion."

4. Criminal + Civil Liability: ROC can file complaint u/s 63 and 628 Companies Act 1956 (now 447) for misstatement in prospectus - e.g., Cilson Finance case 1995 public issue of 10 lakh equity shares.

5. Consequence

• SEBI can bar access to capital market 3-10 years
• Refund with 15% interest (Sahara ordered to refund Rs 24,000 cr)
• Penalty up to 25 cr or 3x profits
• SFIO prosecution under Sec 447 Companies Act
• Class action under Sec 245

Best Practice:

• File DRHP first, get SEBI observations, then file RHP
• Reconcile utilization of issue proceeds quarterly - submit to audit committee
• Disclose all pending litigations, defaults, even if you think immaterial - let investor decide