Introduction

A few centuries ago, U.K. had a legislation called the Bubble Act 1720. As interesting as the name sounds, the history behind it is equally interesting. The Bubble Act prohibited companies to raise funds unless such fund raising was approved by the royal charter (official government order). What preceded the notification of this law, was that at the time, in the U.K. several companies would raise money from the public and immediately after such fund raise, these companies would vanish-- just like a bubble! Investors who invested in the stocks of such companies, would suffer heavy losses with no recourse. While that was a legal history trivia – the underlying rationale and history of the Bubble Act of the U.K. is still the primary reason why raising capital by companies is a compliance heavy procedure and also why public listed companies that raise capital from common public, are so heavily regulated across jurisdictions – India being no different.

Recently, in India, there has been a spurt of equity crowdfunding platforms which allow start-ups to raise funds from a dispersed group of retail investors and individuals with high-risk investment appetite. Investors using these platforms can invest in start-up companies listed on these platforms. This has become a growing concern for regulators like Securities and Exchange Board of India ("SEBI") and Registrar of Companies ("ROC"), firstly because the retail investors using these platform are usually not seasoned investors and are unprepared to bear potential losses associated with high risk ventures like start-ups, and secondly because such start-up companies operating as private companies are neither heavily regulated nor the commercial viability of their product/business is tested sufficiently. These companies are early-stage companies and do not have sufficient track record to justify raising of capital from common public.

A Dissection of the Tyke Technologies Case

Recently, the ROC (NCT of Delhi and Haryana) arraigned 2 companies i.e., Anbronica Technologies Private Limited ("Anbronica") and Septanove Technologies Private Limited ("Septanove") for raising funds through an online equity crowdfunding platform named tykeinvest.com ("Tyke Platform") run by Tyke Technologies Private Limited ("Tyke Technologies"). The ROC held Anbronica and Septanove to be in violation of private placement related provisions of the Indian Companies Act 2013 ("Companies Act"). Private placement means issue of securities to a selected private group of people (which cannot exceed 200, as per Companies Act) identified by the board of the company for issuing the securities. Although not specifically spelt out in the orders dated 1 March 2023 ("Orders"), the ROC's concern was quite clear i.e., these crowdfunding platforms are being used like a 'pseudo stock-exchange' for raising funds from the public at large in the guise of private placement.1

Through the Tyke Platform, the investee companies pay an on-boarding fee and submit basic corporate documents like the certificate of incorporation, charter documents and audit reports. Thereafter, the company is allowed to display its pitch information and enter into a question and answer session with 1,50,000 potential investors listed on the Tyke Platform. The potential investors express their intent to invest in these investee companies and park the requisite amounts they wish to invest in an escrow account. The investee company can access the list of interested investors (which can at times be more than the statutory limit of 200 persons) and basis this list the investee company can finalize the names of the investors for passing a board resolution and circulating the private placement offer letter. Sometimes there can be an over-subscription where the number of investors can exceed 200. Once the private placement procedures are completed, the money is released by the escrow bank account and the shares are issued by the investee companies and relevant forms are filed with the ROC.

The ROC in its Order noted that, Anbronica and Septanove (acting through the Tyke Platform) were at fault at 2 critical aspects: (i) the number of actual subscribers may sometimes exceed 200, which is a violation of Section 42(2) and 42 (3) of the Companies Act, which says that an offer or an invitation to subscribe should be circulated with a select group of person which cannot exceed 200. This was just an observation as in the present case the number of subscriber did not exceed 200; and (ii) Anbronica and Septanove have used the Tyke Platform to release its public advertisement (i.e., the pitch information) and used the Tyke Platform as a media, marketing and distribution channel to inform the public at large (i.e., the 1,50,000 potential investors) regarding their proposed issuance, which is in violation of Section 42 (7) of the Companies Act. Although Tyke Technologies is the key facilitator of these violations, Section 42 of the Companies Act does not allow the ROC to take direct action against and impose a penalty on Tyke Technologies. Therefore, ROC took a commercial approach by initiating proceedings directly against the investee entities, thereby also hindering the revenue stream of Tyke Technologies.

Has this happened before?

Back in 2014, SEBI issued a Consultation Paper2 wherein it stated the risks associated with such equity crowdfunding platforms. Some of the risks highlighted by SEBI are: (i) retail/non-institutional investors will not be able to understand the risk and bear the heavy losses, as compared to an informed institutional investor; (ii) investors will not be able to negotiate better pricing and deals; (iii) lack of recourse in case of fraud or defaults by the investee companies; (iv) lack of proper due-diligence and the volatile nature of the platform itself; etc.

Again in 2016, SEBI issued a Press Release3 whereby it cautioned investors and requested them to refrain themselves from investing through these crowdfunding platforms. As per SEBI, these platforms are performing activities similar to that of a stock-exchange but are not recognised by SEBI, and are therefore unauthorized, illegal and in contravention of the Securities Contract (Regulation) Act 1956 and the Companies Act. This, for a certain period of time, had chilling effect on platforms like Grex, LetsVenture, Termsheet and Equity Crest.

Going further back in time 2 companies of Sahara Group tried to do a similar thing offline and issued securities to approximately 3 crore people in the guise of private placement. In the earlier regime of Companies Act 1956, a private company could issue securities to a maximum of 50 persons. SEBI (and later on the Supreme Court) called out the actions of Sahara Group as violative of this limit of private placement by companies. The Supreme Court held that when a company issues shares to such number of people which is way beyond the statutory limit, it should be treated akin to a public issue.4

Conclusion

One cannot also entirely lose sight that platforms like Tyke are also an innovative way to help early-stage companies and budding entrepreneurs to connect with potential investors easily. But to be within the framework of law - could the Tyke Platform operate differently? the answer is 'yes.' The Tyke Platform could have kept basic information about the investee companies on the open platform for the potential investors to view (after login) and released the pitching information to only selected group of 200 investors (selected using any criteria suitable to the investee company and the Tyke Platform). Thereafter, the investee company could be allowed to pitch only to these select group of 200 persons and circulate the subscription offer letter to only those who amongst these 200 persons agree to subscribe. However, these recourses are only a temporary fix. The larger concern of investments in start-ups being high-risk investments for retail investors, and minimal oversight of financial regulators on such companies remains as is.

As we have seen historically, from time to time, regulators have been taking action against crowdfunding platforms and companies violating provisions of private placement, however a strict regulatory regime governing such platforms is not in place so far. If the scale and operations of these platforms does not change in the near future, it will not be long before a regulator will use an extant or new law to enforce strictures against such platforms (instead of the investor/investee). For example, the Ministry of Electronics and Information Technology ("MEITY") has been highly active in regulating the types of intermediaries which were unregulated until recently. The Government, using its powers under the Information Technology Act 2000, has been rampantly enforcing blocking orders against different platforms in the interest of public order. It may not be long before equity crowdfunding platforms will also be under the direct radar of regulators like MEITY and SEBI, and ultimately be subject to similar enforcement actions from the Government; unless they find a way their operations are strictly in accordance with the current legal and regulatory framework.

Footnotes

1. Order under Section 42 of the Companies Act issued by Adjudicating Officer, ROC (NCT of Delhi and Haryana) dated 1 March 2023, No. ROC/D/ADJ/Section 42/ ANBRONICA/964-67; and

Order under Section 42 of the Companies Act issued by Adjudicating Officer, ROC (NCT of Delhi and Haryana) dated 1 March 2023, No. ROC/D/ADJ/Section 42/ SEPTANOVE/974-77

2. The full text of the Consultation Paper can be accessed at https://www.sebi.gov.in/sebi_data/attachdocs/1403005615257.pdf (last accessed on 21 March 2023)

3. SEBI Press Release No. 137/2016 issued on 30 August 2016.

4. Sahara India Real Estate Corporation Limited & others v Securities and Exchange Board of India & another, (2013) 1 SCC 1

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