Supreme Court Clarifies Collective Investment Scheme Regulations for Trusts: OSIANS CONNOISSEURS OF ART PVT. LTD. vs. SEBI (2020)

Introduction

Date of the Judgment: 12 February 2020
Citation: 2020 INSC 169
Judges: R. F. Nariman, J., S. Ravindra Bhat, J., V. Ramasubramanian, J.

Can a private trust operate a collective investment scheme without registering with the Securities and Exchange Board of India (SEBI)? The Supreme Court of India addressed this critical question in a case involving art investment funds. The core issue was whether the appellant’s art funds, structured as trusts, qualified as Collective Investment Schemes (CIS) under the SEBI Act, 1992 and the SEBI (Collective Investment Scheme) Regulations, 1999, and therefore, required registration. This judgment clarifies the regulatory landscape for such schemes, emphasizing that the form of the entity (trust vs. company) does not exempt it from CIS regulations. The judgment was delivered by a three-judge bench comprising Justices R. F. Nariman, S. Ravindra Bhat, and V. Ramasubramanian, with the opinion authored by Justice R.F. Nariman.

Case Background

The case revolves around two trusts, Yatra Art Fund Trust (Fund I) and Yatra Art Fund II (Fund II), established under the Indian Trusts Act, 1882. These trusts were created to allow investors to invest in works of art. Fund I was created on 15.06.2005 and Fund II was created on 01.12.2006. The trusts were initially set up for a period of 4 to 4.5 years, with Fund I ending on 15.09.2011 after an extension, and Fund II ending on 31.01.2012, also after an extension. The investment strategy was communicated to investors through a Confidential Information Memorandum, which highlighted the high risks involved. Fund I collected Rs. 10.95 crores from 50 investors, while Fund II collected Rs. 21.92 crores from 132 investors.

On 18.06.2007, SEBI notified the trustees that these funds were considered Collective Investment Schemes (CIS) and required registration. The trustees of Fund I responded on 16.07.2007, denying that their activities constituted a CIS. On 12.10.2007, SEBI issued a show cause notice, directing the Yatra Art Fund to register as a company and refund all collected amounts within 30 days. The trustees responded on 05.11.2007, arguing that they were not in violation of Section 12(1B) of the SEBI Act, 1992, read with Regulation 3 of the SEBI (Collective Investment Scheme) Regulations, 1999, and that the regulations did not apply to them as they were not a company. They further argued that their schemes were not collective investment schemes. A joint representation was made to SEBI on 03.11.2008, reiterating these points.

In 2013, the matter was revived after complaints from nine investors of Fund II. After a hearing, SEBI issued an order on 06.11.2015, directing the funds to cease operations as a CIS, refund all monies with 10% interest within three months, and submit a winding-up report. The order also restrained the funds from accessing the securities market for four years and threatened further action for non-compliance.

Timeline

Course of Proceedings

The appellants appealed SEBI’s order to the Securities Appellate Tribunal, which disposed of the appeal on 21.08.2017, following its earlier judgment in Osian’s – Connoisseurs of Art Private Limited v. Securities and Exchange Board of India & Anr. The Tribunal set aside the portions of SEBI’s order that directed the State Government to initiate criminal cases and attachment proceedings. However, it upheld the order to refund the investors’ money, remanding the matter back to SEBI for re-evaluation of the refund process. The Tribunal adopted the reasoning of the earlier judgment of 13.10.2015. The Supreme Court heard the matter, and after considering the arguments, found it difficult to interfere with the concurrent findings of SEBI and the Appellate Tribunal that the schemes were indeed Collective Investment Schemes.

Legal Framework

The Supreme Court examined the relevant provisions of the Securities and Exchange Board of India Act, 1992 (SEBI Act) and the SEBI (Collective Investment Scheme) Regulations, 1999 (CIS Regulations). Section 11(2)(c) of the SEBI Act empowers SEBI to regulate collective investment schemes. Section 12(1B) of the SEBI Act states that no person can sponsor or carry on any collective investment scheme without obtaining a certificate of registration from the Board.

Section 11AA of the SEBI Act defines a Collective Investment Scheme. As per Section 11AA (2), a scheme is a CIS if:

• (i) the contributions, or payment made by the investors, by whatever name called, are pooled and utilized for the purposes of the scheme or arrangement;
• (ii) the contributions or payments are made to such scheme or arrangement by the investors with a view to receive profits, income, produce or property, whether movable or immovable, from such scheme or arrangement;
• (iii) the property, contribution or investment forming part of scheme or arrangement, whether identifiable or not, is managed on behalf of the investors;
• (iv) the investors do not have day-to-day control over the management and operation of the scheme or arrangement.

Regulation 2(h) of the CIS Regulations defines a “Collective Investment Management Company” as a company incorporated under the Companies Act, 1956, and registered with the Board, whose object is to organize, operate, and manage a collective investment scheme. Regulation 3 of the CIS Regulations states that no person other than a Collective Investment Management Company can carry on or sponsor a collective investment scheme without a certificate.

Arguments

The appellant argued that Section 11AA of the SEBI Act uses the word “company” and not “person,” and since their business was carried out as a trust, the SEBI Act’s provisions would not apply to them. They contended that the schemes floated by them were not collective investment schemes. The appellants also argued that since they were not registered as a company, the CIS regulations would not apply to them.

The respondent, SEBI, argued that the schemes operated by the appellant met the criteria of a Collective Investment Scheme under Section 11AA of the SEBI Act. SEBI contended that Section 12(1B) of the SEBI Act uses the term “person,” which includes a trust, and that the CIS Regulations mandate that a CIS can only be operated by a Collective Investment Management Company, which must be a company registered under the Companies Act, 1956. SEBI argued that the appellants were in violation of the SEBI Act and CIS regulations by operating a CIS through a private trust.

The appellant’s argument was based on a literal interpretation of Section 11AA, focusing on the use of the word “company.” The appellant contended that the definition of CIS under Section 11AA(2) applies only to schemes made or offered by a “company,” and since the appellant was a trust, it was not covered by this provision. The appellant also contended that since the CIS regulations require a collective investment scheme to be floated by a “Collective Investment Management Company” which is defined as a company, the regulations would not apply to a trust.

SEBI’s argument focused on the overall regulatory intent of the SEBI Act and CIS Regulations, which is to protect investors in collective investment schemes. SEBI argued that the substance of the scheme, rather than the form of the entity operating it, should determine whether it is a CIS. SEBI highlighted that Section 12(1B) of the SEBI Act uses the term “person” and not “company,” and that the CIS Regulations were designed to ensure that all collective investment schemes are operated by a registered Collective Investment Management Company.

The innovativeness of the argument by the appellant lies in the literal interpretation of the term “company” in Section 11AA(2) to exclude trusts from the ambit of CIS regulations. However, the court rejected this argument, holding that the overall regulatory intent was to cover all collective investment schemes irrespective of the entity operating it.

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame specific issues in a separate section. However, the primary issue the Court addressed was:

1. Whether the schemes operated by the appellants qualified as Collective Investment Schemes under Section 11AA of the SEBI Act, 1992, and the SEBI (Collective Investment Scheme) Regulations, 1999, and therefore, required registration with SEBI.

The sub-issue that the court dealt with was, whether the definition of “company” under Section 11AA(2) of the SEBI Act would exclude the schemes run by a trust from the ambit of CIS regulations.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Court considered the following authorities:

Judgment

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need to ensure that all collective investment schemes are regulated to protect investors, regardless of the legal structure of the entity operating the scheme. The Court emphasized the following points:

• The Court focused on the substance of the scheme rather than the form of the entity operating it.
• The Court emphasized that the intent of the SEBI Act and CIS Regulations was to cover all collective investment schemes irrespective of the entity operating it.
• The Court emphasized the importance of investor protection and regulatory compliance.
• The Court noted that the CIS Regulations were designed to ensure that all collective investment schemes are operated by a registered Collective Investment Management Company.

The court rejected the appellant’s argument that the use of the word “company” in Section 11AA(2) of the SEBI Act would exclude their schemes from the ambit of CIS regulations. The court reasoned that the CIS Regulations of 1999 had come into force before Section 11AA was enacted. The court also emphasized that the statutory scheme is that if a collective investment scheme, as defined, is to be floated by a person, it could only be done in the form of a collective investment management company.

The Court’s reasoning was based on the principle that the substance of the scheme should prevail over its form. The court also emphasized the need to protect investors and ensure that all collective investment schemes are regulated. The Court stated:

“The statutory scheme, therefore, is that, if a collective investment scheme, as defined, is to be floated by a person, it could only be done in the form of a collective investment management company and in no other form.”

“Once the statutory scheme becomes clear, it is clear that the collective investment scheme that was being carried on by the appellants in the form of a private Trust would be in the teeth of the Statute read with the CIS Regulations and would thus be illegal.”

“It is difficult, therefore, to interfere with the concurrent findings made in this behalf by both SEBI and the Appellate Tribunal.”

The Court did not have any minority opinion.

Key Takeaways

• Trusts operating collective investment schemes must register as Collective Investment Management Companies under the Companies Act, 1956.
• The form of the entity (trust vs. company) does not exempt it from the regulations governing Collective Investment Schemes.
• The substance of the scheme, rather than its form, determines whether it is a Collective Investment Scheme.
• The judgment reinforces the importance of investor protection and regulatory compliance in the securities market.

Directions

The Supreme Court directed the following:

• The principal amount repayable to each investor of both the Schemes shall be paid back within a period of six months from the date of the judgment.
• The balance owing to the 50 investors of Fund No. 1 and to the 132 investors of Fund No. 2 shall be repaid within six months from the date of the judgment.
• Interest at the rate of 10% per annum will be paid on the principal outstanding amount from the date on which it became due to each such member, till the date on which each Fund came to an end.
• The interest shall be paid within nine months from the date of the judgment.
• A compliance report must be filed with SEBI once the amounts are paid within the specified time period.

Development of Law

The ratio decidendi of this case is that any scheme that meets the definition of a Collective Investment Scheme under Section 11AA of the SEBI Act, 1992, and the SEBI (Collective Investment Scheme) Regulations, 1999, must be registered as a Collective Investment Management Company, irrespective of whether the entity operating the scheme is a company or a trust.

This judgment clarifies that the form of the entity does not exempt it from the regulations governing Collective Investment Schemes. It emphasizes that the substance of the scheme, rather than its form, determines whether it is a Collective Investment Scheme. This is a change from the previous position where entities may have tried to circumvent the regulations by operating as a trust.

Conclusion

The Supreme Court’s judgment in OSIANS CONNOISSEURS OF ART PVT. LTD. vs. SECURITIES AND EXCHANGE BOARD OF INDIA & ANR. clarifies that trusts operating collective investment schemes are subject to the regulations of the Securities and Exchange Board of India (SEBI). The Court held that the schemes in question were indeed Collective Investment Schemes and that the appellants were in violation of the SEBI Act and CIS regulations. The Court directed the appellants to refund the investors’ money with interest. This judgment reinforces the importance of investor protection and regulatory compliance in the securities market, ensuring that all collective investment schemes are regulated irrespective of the legal structure of the entity operating them.