Can shareholder ratification validate the diversion of funds raised through a preferential issue if the diversion was contrary to the disclosed objects?

No. The Supreme Court held that ratification cannot legitimize an act that is fraudulent or illegal from inception. Under the PFUTP Regulations, diversion of funds for undisclosed purposes constitutes fraud, and such acts are void ab initio and cannot be ratified, even by unanimous shareholder approval.

Does Section 27 of the Companies Act apply to private placements under Section 42?

No. Section 27 applies only to prospectuses for public issues. Private placements under Section 42 are governed by different procedural requirements under Chapter III and the Companies (Prospectus and Allotment of Securities) Rules, 2014, and do not incorporate Section 27’s safeguards for variation of objects.

Can SEBI initiate both an interim restraining order under Section 11B and a penalty proceeding under Section 15HA for the same conduct?

Yes. The Supreme Court held that the WTM’s order under Section 11B (for investor protection via market restraint) and the AO’s penalty proceeding under Section 15HA (for punishing fraud) serve distinct statutory purposes and are not mutually exclusive. Parallel proceedings are permissible when they address different regulatory objectives.

Is the mere fact that no investor complained sufficient to negate a finding of fraud under PFUTP Regulations?

No. The Court held that the test for fraud under PFUTP Regulations is not based on investor complaints but on the nature of the conduct-specifically, whether the act was misleading, deceptive, or induced securities trading contrary to disclosed information. Public interest and market integrity override individual complaints.

Fraudulent diversion of preferential issue funds SC ruling

The Supreme Court has unequivocally held that the fraudulent diversion of funds raised through a preferential issue, contrary to disclosed objects, cannot be legitimized by subsequent shareholder ratification. This landmark ruling reinforces the primacy of investor protection and transparency in securities markets under the PFUTP Regulations and the SEBI Act.

Background & Facts

The Dispute

The dispute arose from the preferential allotment of 63,50,000 equity shares by Terrascope Ventures Limited (then Moryo Industries Limited) in October-November 2012, raising Rs. 15,87,50,000. The company disclosed in its explanatory statement, pursuant to Section 173(2) of the Companies Act, 1956 and Regulation 73(1) of the SEBI (ICDR) Regulations, 2009, that the proceeds would be used for: (a) capital expenditure including acquisition of companies/business; (b) funding long-term working capital requirements; (c) marketing; (d) setting up offices abroad; and (e) other approved corporate purposes.

Key Facts

The Extraordinary General Meeting (EoGM) notice was issued on 03.09.2012.
A Special Resolution approving the preferential issue was passed on 01.10.2012.
Funds were credited to the company’s account between 16.10.2012 and 08.11.2012.
From 17.10.2012 onwards, the proceeds were immediately diverted to purchase shares of unlisted and listed companies and to grant loans and advances to entities connected to Mr. Giriraj Kishore Agarwal.
The total amount diverted was Rs. 10,33,37,467 for investments and Rs. 5,04,31,000 for loans and advances.
The company had no active business operations during the relevant period.
On 12.03.2014, the company amended its Memorandum of Association to include financing, investment, and lending as objects.
On 29.09.2017, the company passed a Special Resolution purporting to ratify the diversion of funds.
No complaints were received from investors who subscribed to the preferential issue.
The company had disclosed the utilization of funds in its balance sheets and on its website.

Procedural History

16.10.2012 to 08.11.2012: Preferential allotment completed; proceeds diverted.
04.12.2014: Whole Time Member (WTM), SEBI, passed ad-interim order restraining respondents from dealing in securities under Section 19 read with Sections 11(1), 11(4)(b), and 11B of the SEBI Act.
22.08.2016: WTM confirmed the ad-interim order.
05.12.2017: SEBI issued a show cause notice under Sections 11B, 11(4), and 11(1) alleging violations of PFUTP Regulations.
19.03.2019: WTM concluded proceedings, noting the respondents had already been under market access restriction for over four years and imposed no further penalty.
27.04.2018: Adjudicating Officer (AO) issued a separate show cause notice under PFUTP Regulations and Section 21 of the SCRA.
24.04.2019 and 24.07.2019: Personal hearings scheduled; notices returned unclaimed; service effected by affixation on 15.07.2019.
22.07.2019: Respondents submitted reply to AO’s notice.
29.04.2020: AO imposed penalties: Rs. 70,00,000 on the company for PFUTP violations and Rs. 30,00,000 for breach of Section 21 of SCRA and Clause 43 of Listing Agreement; Rs. 25,00,000 each on the Managing Director and Director.
02.06.2022: Securities Appellate Tribunal (SAT) set aside the AO’s order, holding that the 29.09.2017 ratification validated the diversion.
05.05.2022: SEBI filed Civil Appeals Nos. 5209-5211 of 2022 before the Supreme Court.
22.08.2025: Supreme Court appointed Mr. Mahfooz A. Nazki as amicus curiae.
17.03.2026: Supreme Court delivered judgment.

The Parties' Positions

The appellant, SEBI, contended that the diversion of funds immediately after receipt constituted fraud under PFUTP Regulations and violated disclosure norms under the SCRA and Listing Agreement. It argued that ratification cannot cure a fraud committed at inception.

The respondents, through amicus curiae, argued that the 29.09.2017 ratification by shareholders validated the diversion, that the amended Memorandum of Association permitted lending and investment, and that no investor complained. They further contended that parallel proceedings by WTM and AO were impermissible.

Relief Sought

SEBI sought setting aside of the SAT order dated 02.06.2022 and restoration of the AO’s order dated 29.04.2020, including the imposition of penalties: Rs. 70,00,000 on the company, Rs. 30,00,000 for breach of SCRA, and Rs. 25,00,000 each on the two directors.

The Legal Issue

Can shareholder ratification of a diversion of funds raised through a preferential issue, which was contrary to the disclosed objects and occurred immediately after receipt, legitimize a fraudulent act under the PFUTP Regulations and the SEBI Act?

Arguments Presented

For the Appellant

SEBI, through Senior Advocate Mr. Naveen Pahwa, argued that the diversion of funds from 17.10.2012 onwards, mere days after receipt, demonstrated fraudulent intent from inception. The disclosure under Regulation 73 of the ICDR Regulations and Clause 43 of the Listing Agreement was material to investor decision-making. Ratification under Section 27 of the Companies Act applies only to prospectus-based public issues, not private placements under Section 42. The PFUTP Regulations define fraud expansively to include active concealment and promises made without intent to perform. The act was void ab initio and could not be ratified. Parallel proceedings by WTM and AO were distinct: WTM acted under Section 11B for investor protection via restraint, while AO acted under Section 15HA to impose penalties for fraud.

For the Respondent

The amicus curiae, Mr. Mahfooz A. Nazki, contended that Section 62(1)(c) of the Companies Act, read with Chapter III, allows analogical application of Section 27 principles to private placements. Shareholders, as principal stakeholders, have the implied power to ratify acts not expressly prohibited by law. The amendment to the Memorandum of Association on 12.03.2014 brought the diversion within the company’s objects. No investor complained, and the company disclosed the utilization in financial statements. The WTM’s prior order on the same facts barred the AO from initiating a penalty proceeding under the doctrine of res judicata and regulatory consistency.

The Court's Analysis

The Court began by affirming that the PFUTP Regulations are designed to protect investors by ensuring transparency and preventing manipulative or deceptive conduct. Fraud under Regulation 3 and 4 is defined broadly to include acts committed without deceit, if they induce securities trading. The definition encompasses active concealment and promises made without intent to perform.

"Fraud would also include an active concealment of a fact by a person having knowledge or belief of the fact and making of a promise without any intention of performing it."

The Court emphasized that the objects disclosed in the EoGM notice are not mere formalities but statutory disclosures under Regulation 73 of the ICDR Regulations and Clause 43 of the Listing Agreement. Investors rely on these disclosures to make informed decisions. The immediate diversion of funds - beginning on 17.10.2012, the very next day after the first credit - established that the company had no intention to use the funds for the stated purposes.

The Court rejected the amicus’s reliance on Section 27 of the Companies Act, noting that it applies only to prospectuses for public issues, not private placements under Section 42. Section 62(1)(c) does not incorporate Section 27’s procedural safeguards, including the requirement to disclose unutilized amounts and obtain shareholder approval via postal ballot. The diversion occurred before any amendment to the Memorandum of Association and before ratification.

"The funds were not utilized for those disclosed objects. To make the matters worse for the respondents here the diversions were made soon after the amounts were raised between 16.10.2012 and 08.11.2012."

The Court held that ratification cannot validate an act that is illegal, fraudulent, or ultra vires. Citing Shri Lachoo Mal v. Shri Radhey Shyam, Government of Andhra Pradesh v. K. Brahmanandam, and Pramod Kumar v. U.P. Secondary Education Services Commission, the Court reiterated that illegality cannot be regularized - only irregularities can be. The act of diverting funds for undisclosed purposes was not merely an irregularity but a fraud impacting public interest and multiple stakeholders beyond shareholders.

"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. They are not in the realm of private rights which can be waived off as ratified."

Regarding parallel proceedings, the Court distinguished SEBI v. Ram Kishori Gupta and Nirmal N. Kotecha. The WTM’s order under Section 11B was an interim protective measure to restrain market access. The AO’s proceeding under Section 15HA was a separate, statutory penalty proceeding initiated after investigation. The two authorities exercised distinct powers at different times and for different purposes. The AO’s jurisdiction was not barred.

The Court found the penalties imposed - Rs. 70,00,000 on the company, Rs. 30,00,000 for SCRA breach, and Rs. 25,00,000 each on the directors - were proportionate and justified given the scale of the fraud and the need for deterrence.

The Verdict

The Supreme Court allowed the appeals and set aside the SAT order dated 02.06.2022. The Adjudicating Officer’s order dated 29.04.2020 is restored. A monetary penalty of Rs. 70,00,000 is imposed on Terrascope Ventures Limited for violation of PFUTP Regulations, Rs. 30,00,000 for breach of Section 21 of the SCRA and Clause 43 of the Listing Agreement, and Rs. 25,00,000 each on Mr. Manoharlal Saraf and Mrs. Geeta Manoharlal Saraf. The Court upheld that ratification cannot cure fraud and that parallel proceedings by WTM and AO are permissible when they serve distinct regulatory objectives.

What This Means For Similar Cases

Ratification Cannot Cure Fraudulent Conduct

Practitioners must advise clients that shareholder ratification of fund diversion contrary to disclosed objects is legally ineffective if the act constitutes fraud under PFUTP Regulations.
Any attempt to justify diversion by citing post-facto amendments to the Memorandum of Association will fail if the diversion occurred before the amendment.
The timing of diversion - especially if immediate after receipt - is a critical factor in inferring fraudulent intent.

Disclosure Compliance Is Non-Negotiable

Companies must ensure that explanatory statements for preferential issues strictly comply with Regulation 73 of the ICDR Regulations and Clause 43 of the Listing Agreement.
Quarterly disclosures under LODR Regulations 32 and 35 must be accurate and timely; failure to disclose deviations may attract additional penalties.
Public disclosures on websites and in financial statements do not substitute for statutory disclosures made at the time of issue.

Parallel Regulatory Proceedings Are Permissible

SEBI’s WTM may issue restraining orders under Section 11B for investor protection without precluding the AO from initiating penalty proceedings under Section 15HA.
The nature of the relief sought (restraint vs. penalty) determines the forum; concurrent proceedings are lawful if they serve distinct statutory purposes.
Practitioners must prepare for dual-track enforcement: interim protective measures and subsequent penalty proceedings.

Fraudulent Diversion of Preferential Issue Proceeds | Shareholder Ratification Under PFUTP Regulations Void : SC