Criminal Liability, Fraudulent Inducement and Personation

"Every person who authorises the issue" identifies the defendant. It is not limited to directors, promoters or officers.

The proviso gives the defence:

nothing in this section shall apply to a person if he proves that such statement or omission was immaterial or that he had reasonable grounds to believe, and did up to the time of issue of the prospectus believe, that the statement was true or the inclusion or omission was necessary.

Two routes out, and the burden is on the accused. Immateriality, which is an objective question. Or honest belief on reasonable grounds, held up to the time of issue. A belief formed carelessly will not do, and a belief abandoned before issue will not do either.

Section 36: fraudulently inducing persons to invest money

Any person who, either knowingly or recklessly makes any statement, promise or forecast which is false, deceptive or misleading, or deliberately conceals any material facts, to induce another person to enter into, or to offer to enter into,

(a) any agreement for, or with a view to, acquiring, disposing of, subscribing for, or underwriting securities; or

(b) any agreement, the purpose or the pretended purpose of which is to secure a profit to any of the parties from the yield of securities or by reference to fluctuations in the value of securities; or

(c) any agreement for, or with a view to obtaining credit facilities from any bank or financial institution,

shall be liable for action under section 447.

Section 36 is much wider than section 34 and the differences are the marks.

No prospectus is needed. Section 36 catches a statement made in a telephone call, an advertisement, a message or a meeting.

The mental element is spelled out: knowingly or recklessly. Recklessness is enough, so a person who makes a confident forecast without caring whether it is true is within the section.

The conduct includes forecasts and promises, not merely statements of existing fact, and includes deliberate concealment of material facts.

Clause (c) is not about securities at all. An agreement for obtaining credit facilities from any bank or financial institution is covered, so a person who lies to get a company loan is caught by a section that sits in the prospectus chapter. Students consistently miss this.

Section 38: personation for acquisition of securities

Section 38(1). Any person who:

• (a) makes or abets making of an application in a fictitious name to a company for acquiring or subscribing for its securities; or
• (b) makes or abets making of multiple applications to a company in different names or in different combinations of his name or surname for acquiring or subscribing for its securities; or
• (c) otherwise induces directly or indirectly a company to allot, or register any transfer of, securities to him, or to any other person in a fictitious name,

shall be liable for action under section 447.

Clause (b) is the one to read twice. It catches not only different names but different combinations of his own name or surname. So "R. K. Sharma", "Rajesh Sharma" and "Rajesh Kumar Sharma", all the same man, are multiple applications.

And note "makes or abets making" in both (a) and (b): the person who arranges the applications is as liable as the person who signs them.

Section 38(2): a warning that must be printed. The provisions of sub-section (1) shall be prominently reproduced in every prospectus issued by a company and in every form of application for securities. This is why the warning appears on application forms, and it makes ignorance of the offence very hard to plead.

Section 38(3): disgorgement and seizure. Where a person has been convicted under the section, the Court may also order:

• disgorgement of gain, if any, made by such person; and
• seizure and disposal of the securities in his possession.

Section 38(4): where the money goes. The amount received through disgorgement or disposal shall be credited to the Investor Education and Protection Fund, which is constituted under section 125. So it does not go to the company; it goes to a fund that exists for investors generally.

Section 447: the punishment all three lead to

Since sections 34, 36 and 38 all say "shall be liable for action under section 447", the punishment is in that section and it must be learned.

The main punishment. Without prejudice to any liability including repayment of any debt, any person found guilty of fraud involving an amount of at least ten lakh rupees or one per cent of the turnover of the company, whichever is lower, shall be punishable with:

• imprisonment for not less than six months and up to ten years; and
• a fine not less than the amount involved in the fraud and up to three times that amount.

First proviso: public interest. Where the fraud involves public interest, the term of imprisonment shall not be less than three years.

Second proviso: small frauds. Where the fraud involves an amount less than ten lakh rupees or one per cent of turnover, whichever is lower, and does not involve public interest, the punishment is imprisonment up to five years, or a fine up to fifty lakh rupees, or both. Note that here there is no minimum imprisonment and imprisonment is not compulsory.

The Explanation defines fraud, and it is worth quoting because it is unusually wide:

"fraud", in relation to affairs of a company or any body corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss.

The closing words are the point: "whether or not there is any wrongful gain or wrongful loss". Fraud under this Act does not require anybody to have gained or lost. The intent to deceive is enough. The Explanation goes on to define wrongful gain as gain by unlawful means of property to which the person is not legally entitled, and wrongful loss as loss by unlawful means of property to which the person losing is legally entitled.

A worked example

Nagothane Chemicals Limited issues a prospectus. It states that the company holds environmental clearance for a new plant. The clearance application was in fact rejected.

Section 34. The statement is untrue. Every person who authorised the issue of the prospectus is liable under section 447. A director who can prove the matter was immaterial, or that he had reasonable grounds to believe, and did believe up to the time of issue, that the clearance had been granted, escapes under the proviso.

Section 36, and note that no prospectus is needed. The company's marketing head telephones two hundred wealthy individuals and tells them, recklessly, that the plant will be commissioned in six months and will triple the share price. That is a statement, promise or forecast which is false, deceptive or misleading, made recklessly, to induce them to enter into an agreement for subscribing for securities. He is liable under section 447, whatever happens to the prospectus.

And clause (c). The same man tells a bank that the clearance exists, to obtain a term loan. That is an agreement for, or with a view to obtaining credit facilities from a bank, and section 36(c) catches it even though no securities are involved.

Section 38. An applicant, Mr Salvi, wants a larger allotment. He applies as "P. Salvi", "Prakash Salvi" and "Prakash D. Salvi", and gets his driver to apply in a name that belongs to nobody. He is caught by clause (b) for the multiple applications in different combinations of his own name, and by clause (a), as an abettor, for the application in a fictitious name. On conviction the Court may order disgorgement of his gain and seizure and disposal of the securities in his possession, and the proceeds go to the Investor Education and Protection Fund.

And note where the warning was. The text of section 38(1) was prominently reproduced in the prospectus and on the application form, as section 38(2) requires.

Punishment. If the amounts involved are ten lakh rupees or more, or one per cent of turnover, whichever is lower, section 447 gives six months to ten years' imprisonment and a fine of one to three times the amount, with a minimum of three years if public interest is involved. If the amount is below that threshold and there is no public interest, the second proviso applies: up to five years, or a fine up to fifty lakh rupees, or both.

Distinctions that carry marks

What this does NOT mean

It does not mean somebody must actually have been misled under section 34. The section applies where the inclusion or omission is likely to mislead.

It does not mean section 36 is confined to securities. Clause (c) covers agreements for obtaining credit facilities from any bank or financial institution.

It does not mean fraud under section 447 requires a gain or a loss. The Explanation says "whether or not there is any wrongful gain or wrongful loss".

It does not mean multiple applications are only in other people's names. Section 38(1)(b) catches different combinations of the applicant's own name or surname.

Quick revision

• Section 34: a prospectus issued, circulated or distributed with a statement untrue or misleading in form or context, or an inclusion or omission likely to mislead, makes every person who authorises the issue liable under section 447. Proviso: immateriality, or reasonable grounds for belief held up to the time of issue.
• Section 36: any person who knowingly or recklessly makes a false, deceptive or misleading statement, promise or forecast, or deliberately conceals material facts, to induce another to enter into (a) an agreement for acquiring, disposing of, subscribing for or underwriting securities, (b) an agreement to secure a profit from the yield of securities or from fluctuations in their value, or (c) an agreement for obtaining credit facilities from a bank or financial institution, is liable under section 447.
• Section 38: (a) application in a fictitious name; (b) multiple applications in different names or different combinations of his own name or surname; (c) otherwise inducing allotment or transfer to himself or another in a fictitious name. Making or abetting both caught. 38(2): the sub-section must be prominently reproduced in every prospectus and application form. 38(3): on conviction the Court may order disgorgement and seizure and disposal. 38(4): proceeds to the Investor Education and Protection Fund.
• Section 447: fraud of at least ten lakh rupees or one per cent of turnover, whichever is lower: six months to ten years and a fine of one to three times the amount. Public interest: minimum three years. Below the threshold and no public interest: up to five years, or fine up to fifty lakh rupees, or both. Fraud is defined to include act, omission, concealment or abuse of position with intent to deceive, whether or not there is any wrongful gain or wrongful loss.

Test yourself

1. Who is criminally liable for a misleading prospectus, and what must be shown? Every person who authorises the issue of the prospectus, where it includes a statement untrue or misleading in the form or context in which it is included, or where an inclusion or omission is likely to mislead: section 34. Nobody need actually have been misled.

2. What defences does section 34 give? That the statement or omission was immaterial, or that the accused had reasonable grounds to believe, and did up to the time of issue of the prospectus believe, that the statement was true or that the inclusion or omission was necessary.

3. Does section 36 require a prospectus? No. It applies to any person who knowingly or recklessly makes a false, deceptive or misleading statement, promise or forecast, or deliberately conceals material facts, to induce another into the agreements listed in clauses (a) to (c), which include an agreement for obtaining credit facilities from a bank or financial institution.

4. A man applies for shares as "S. Kulkarni", "Sanjay Kulkarni" and "Sanjay R. Kulkarni". Which provision does that offend? Section 38(1)(b), which covers multiple applications in different names or in different combinations of his name or surname. He is liable for action under section 447.

5. What may a Court order on conviction under section 38, and where does the money go? Disgorgement of any gain made, and seizure and disposal of the securities in the convict's possession: section 38(3). The amount received is credited to the Investor Education and Protection Fund: section 38(4).

6. Define fraud under section 447 and state the punishment for a fraud of fifty lakh rupees not involving public interest. Fraud includes any act, omission, concealment of any fact or abuse of position committed with intent to deceive, to gain undue advantage from, or to injure the interests of the company, its shareholders, its creditors or any other person, whether or not there is any wrongful gain or wrongful loss. Fifty lakh rupees exceeds the ten lakh threshold, so the punishment is imprisonment of not less than six months and up to ten years, and a fine of not less than the amount involved and up to three times it.