India's security regulator has revealed how the promoters of Zenith Infotech Limited (ZIL) pocketed US$33 million from asset sale proceeds earmarked to pay off company debts.

fraudulent behaviour In a report released on March 25, SEBI whole time member Rajeev Kumar Agarwal detailed the findings of an investigation into the allegedlyof ZIL's six promoters. They are Rajumar Saraf (chairman cum director), Akash Kumar Saraf (managing director), Devita Saraf, Vijayrani Saraf, VU Technologies Private limited and Zenith Technologies Private Limited.

The investigation began in late 2011, after the company defaulted on US$33 million owed to creditors. It also received complaints about behaviour that could be "catastrophic" for ZIL retail investors and shareholders.

Debt crisis prompts asset sale

On December 27, 2010 ZIL notified the market that US$33 million in foreign currency convertible bonds (FCCB) were due to be redeemed in August 2011, and another US$50 million in August 2012.

An extraordinary general meeting was held a month later, when shareholders authorized the board of directors the partial or complete sale of the company's assets: cloud computing and the managed services division (MSD).

Eight months later, ZIL spun off its MSD to M/s Zenith Monitoring Services (ZMS). The "asset purchase agreement" would see ZIL promoters Rajkumar Saraf and Akash Saraf hold 60 percent, while ZIL would hold the remaining 40 percent.

Soon after, the US-based Zenith RMM LLC (ZRLC) acquired all the shares of ZMS.



On paper, these transactions delivered US$48 million cash to ZIL, and another US$6 million held in escrow. ZIL also retained a 15 percent stake in ZRLC, worth US$7.4 million. However, SEBI said ZIL received less than half this amount.





Where the money went

Of the US$48 million cash, Zenith Dubai (FZE), a Dubai-based wholly owned subsidiary of ZIL, took US$27 million as consideration for "software and intellectual property rights" of the MSD Division, of which US$21.73 million was distrbuted to other entities as follows:

US$13 million, was transferred to two Dubai-based companies related to ZIL promoters--VU Telepresence FZC (US$8 million) and Zenith Cloud Computing (US$5 million).

Another US$7.2 million was moved to the Singapore-based, wholly owned subsidiary Zenith Singapore.

US$1.53 million was paid towards the purchase of capital goods.

Overall, US$33.93million out of US$48 million was diverted for purposes not connected to the explicit purpose authorized by shareholders: repaying the debt.

"ZIL and its promoters/directors not only wantonly defaulted in redemption of FCCBs and disregarded shareholders' resolution but also adopted fraudulent device and artifice to defraud the shareholders," SEBI's Agarwal wrote.

Despite the injection of millions of dollars of cash, ZIL still defaulted on the FCCBs originally due to be redeemed in August 2011--even despite the fact the redemption date was pushed back to September 21, 2011.

The investor fallout

ZIL only disclosed these events to the market on October 13, 2011, after the Bombay Stock Exchange (BSE) began its initial queries.

Between September 23, 2011 and November 30, 2011, ZIL's share price dropped from 190 rupees to 45 rupees per share--a 77 percent decline in just 45 trading days. Half of this occurred before the disclosure on October 13.

On October 28, the trade volume in ZIL stock almost hit 300,000, which dwarfed its previous daily highs. In the last quarter of 2011, institutional investors halved their stakes in the company to 11.96 percent.

The secrets

SEBI said ZIL concealed a number of facts that should have been communicated to shareholders. It didn't disclose to the market that on October 11 and 12, 2011, the two Dubai-based companies related to the promoters--the ones which pocketed US$13 million from the asset sale--were made subsidiaries of FZE.

A week later, on October 21, the FCCB holders filed a suit against ZIL in the Bombay High Court, seeking to recover their funds. They also petitioned to wind up the company. ZIL promoters did not publicly reveal the litigation.

Despite the still falling share price, ZIL justified the secrecy by saying disclosures could affect the interests of the company. SEBI dismissed this excuse.

"The above price movements reveal that the uncertainty surrounding the event of redemption had, prima facie, substantially harmed the interest of the shareholders by the time of subsequent confirmation at BSE," SEBI said.

It would later emerge, on July 9, 2012 the Bombay High Court rejected the US$108.7 million (5.98 billion rupees) valuation of ZIL (cloud computing business) and instead nominated a range of 1.52 billion rupees to RS2.11 billion rupees.

Making an example

SEBI said the prima facie evidence indicates the ZIL directors and promoters breached section 2(1)(c) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.

Eseentially, they defrauded shareholders, SEBI said. "They diverted the monies realized from the sale of the MSD Division for the benefits/interests of promoters and/or directors and subsidiaries," Agarwal wrote in his report.

"In light of the aforesaid prima facie findings, I note that the promoters/directors of ZIL have in a devious manner attempted to take away the assets of a listed company directly and indirectly for their own benefit or for benefit of entities owned and controlled by them.

"Such conduct of promoters / directors not only defeats the whole purpose of seeking shareholders' approval for crucial decisions but also jeopardizes the integrity of the securities market."

As of December 31, 2012, the six promoters of ZIL held 64.89 percent of the company's shares.

On March 25, 2013, SEBI prevented the ZIL promoters from accessing the securities market or trading in securities, "in any manner whatsoever".

Further, it ordered that within 30 days, by April 23, they must produce a US$33 million bank guarantee, without tapping ZIL's assets or funds.

The behaviour of the promoters threatens to tarnish foreigners' perception of the Indian securities market, and SEBI believes it must act quickly to limit further damage to shareholders, the wider market, and to send a message to other future fraudsters.

"One of the basic premise that underlies the integrity of securities market is that the participants conform to standards of transparency, good governance and ethical behavior prescribed in securities laws and do not resort to fraudulent activities," Agarwal wrote.

"SEBI needs to send a stern message to prevent companies and their promoters/directors from indulging in such acts of omissions and commissions as observed in this case," he said.