[2021] 

127 taxmann.com 19 (Article)
Date of Publishing: April 28, 2021

SEBI's Order in the matter of YES Bank-AT-1 Bond Fiasco: An Analysis

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ADARSH VIJAYAKUMARAN
Financial institutions in India have always surprised both the investors as well as customers. From
surmounting debts gone bad, to erosion of capital to level zero, the stories are many for the banking
sector tell but the blame has always been on the futile regulations with tiny little teeth that can hardly
grip the banking wild nuts. The present article will analyze the recent adjudication order of the
Securities and Exchange Board of India (SEBI) dated April 12, 2021 where the market regulator
penalized YES Bank Limited and three of its former officials (Collectively Noticees) for the alleged AT1
Bond mis-selling. While the cumulative penalty in this decision was less than 27 crores, the case brings
into light some of the major issues within the banking sector as well as the increasing need for the
market regulators to keep these high risk bonds as far away the individual investors as possible. The
article will also shed some light into the regulatory lacunae surrounding the AT1 bond issuance and
SEBI's perplexing boundaries of justification for fraud related economic offences.

The Matrix

SEBI received multiple complaints in 2020, from various investors of Basel III compliant Additional
Tier 1 Bonds (AT1) issued by the YBL. The AT1 bonds are high risk unsecured perpetual bonds that have
no maturity period. However, these bonds can have a call option which can be used by the banks to buy
it back from the investors. It was alleged by various complainers that these bonds were sold to them
without apprising them of its risky nature. Based on the complaints received, SEBI conducted an
investigation in the matter to ascerta in if there was any violation of the provisions of SEBI (Prohibition
of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (PFUTP
Regulations) and SEBI Act, 1992 in respect of selling of these bonds to individual investors. SEBI
alleged that YBL and its former officials have sold these bonds to the retail investors in violation of
Sections 12A(b) and 12A(c) of the SEBI Act and 3(a), 3(c), 3(d), 4(1) and 4(2)(s) of PFUTP Regulations
read with Explanation (1) to Regulation 4(2) of the PFUTP Regulations.

It was contented by the Noticees that extending a primary market disclosure requirement onto the
secondary market transaction and holding YBL and its former officials responsible for such process
with retrospective effect in the name of fiduciary responsibility was unjustified without any
legal/regulatory basis. However, SEBI found out based on the facts and circumstances of the case that
in order to make the institutional investors subscribe to more capital of YES Bank Limited (YBL) the
Noticees had devised the plan to down sell the AT1 bonds, held by the institutional investors to
customers (individual investors). To do that, the Noticees have suppressed material facts to create a
misleading appearance of the AT1 bonds so that the investors / customers can be lured to invest in these
bonds.

Bail Out Story

The decision in the present case comes in the background of the YBL's reconstruction scheme nudged
by the Reserve Bank of India in 2020. YBL was the poster child of India's $200 billion-plus bad-loan
malaise. YBL had massive exposure from troubled borrowers such as DHFL, IL & FS etc. that led to its
gradual downgrade in reviews from various credit rating agencies as wells as the central bank. The
sharp increase in its impaired loans ratio and significant governance lapses made it necessary for the
RBI to step in for YBL's reconstruction which was made possible through capital infusion by a SBI led
consortium. However, the scariest part of YBL bailout story was what happened to AT1 Bond holders of
the bank when the reconstruction scheme came into effect in March, 2020. Rs 8,415 crores worth AT1
Bonds were written off by Yes Bank invoking a rule that is permitted under Basel guidelines. Basel III is
a 2009 international regulatory accord that was introduced as a set of reforms designed to mitigate risk
within the international banking sector, by requiring banks to maintain proper leverage ratios and keep
certain levels of reserve capital on hand. In India, Basel III regulations were introduced by RBI in 2015
and hence have a statutory force. According to AT 1 Rules, Basel III bonds are required to absorb losses
as per specified trigger and at the point of non viability. Moreover, the banks issuing these bonds have a
discretion to skip payment of coupon when the capital falls below a specified trigger. In the present
scenario, the reconstitution by the RBI itself triggered the point of non viability under section 45 of the
Banking Regulation Act. Hence, the writing off was defended on these ground and was further given
constitutional validity in the case of Piyush Bokaria v. Reserve Bank of India [2020] 120 taxmann.com
81 (Mad.).

What Does The Order Mean?

In the present case, an amount of 25 crores was imposed on YBL and a total amount of 2 crores on
other noticees. While the amount that the SEBI has imposed in this case was the maximum statutorily
available under section 15H of the SEBI Act for violations of the PFUTP Regulations and SEBI Act, the
total defrauded amount sums up to not less than 300 crores for the complainers. This is a case of slap
on the wrist where the gullible investor was made a prey to the YBL's tactical governance with little to
no recourse for recouping the amount that the investors were defrauded of, even after catching the
wrong doer red handed. While this decision does not bring any relief to the investors, the SEBI's
rationale in imposing the fine and the arguments raised by the Noticee's is a premonition of two sides of
justification in fraud related economic offence cases for the days to come.

The Noticees in the present case has argued that their roles were limited to facilitation of AT1 bonds
from the institutional investors to the individual investors and that risk profiling of investors in
secondary market is not a statutory requirement. The arguments raised by the notices hold water
especially at time when the AT1 bonds are still being traded in the secondary market. Furthermore, the
Reserve Bank of India's Master Circular dated July 1, 2015 allows banks to issue AT1 bonds to the retail
investors subject to the approval of the Bank's Board. However, not relying on this regulatory lacuna
that fails to address if risk profiling should have been done in cases where the retail investors are buying
high risk bonds at a reduced lot size from the Secondary market players, SEBI's decision relied on the
Apex court's judgment in SEBI v. Kishore Ajmere [2016] 66 taxmann.com 288/134 SCL 481 (SC) SAT
decision in Brook Laboratories Ltd. [Appeal No 246/2015, dated 1-3-2017] to observe that proof
regarding the allegations leveled against an individual may be inferred by a logical process of reasoning
from the totality of the attending facts and circumstances. SEBI observed that based on the facts of the
case, the officials of the bank and its officials have mis-sold the bond to retail investors by making them
believe that it's a super FD and not letting them know abou the risks involved. The YES bank's fall in
light of lack of capital base, and the many allegations leveled against Rana Kapoor (the former CEO)
and the pending cases in the Apex court and various other high court's regarding the fallen bank and its
officials further conveniently supports SEBI's inference.

The way forward

As noted in the previous paragraphs, the SEBI's order in YBL case points to the regulatory lacunae in
the compliance related aspect of selling of AT1 bonds to the buyers in secondary markets. While the
present law on the same does not extend risk profiling for buyers, the need has arisen for the law
makers to create efficient system in place to assess if the buyers will be able to take the hit if something
unanticipated happens like the fall of a billion dollar bank. The current law mandates that banks can
sell additional AT1 bonds to only the Qualified Institutional Buyers for a lot size not less than 1 crore.
However, there is nothing that prevents selling of the existing bonds in parts at a reduced lot size in the
secondary market places. Moreover, the high interest rate that these unsecured bonds offer especially
when they are being advertised as the super FD by prominent banks is one of the major reasons why
individual investors enters these unsteady markets. Nevertheless, what happens when these type of
bonds are being facilitated by other banks that does not in background has a YES bank zombie story.
What will happen to the retail investors when these banks default on their unsecured perpetual bonds
especially when it was sold to individual investors without proper risk profiling? While SEBI's
jurisprudence on these aspects of issuing AT1 bonds in the secondary market places is silent, one thing
that can be ascertained for the individual investors is to keep afar as possible from these type of
financial creatures and make it a habit to read Information memorandum and term sheet before
making a hasty investment by throwing themselves out on the luring interest rates. Because, though in
the present case, SEBI has come as a messiah widening its wings in inferring the mis-selling of AT1
Bonds, the same may not be true with other cases with different facts and circumstances. Moreover,
messiah's power to order compensation are limited to bring little to no relief to the investors.

Conclusion

AT1 bonds are high risk instruments with no maturity period and any underlying assets. While these
bonds are still being traded in the secondary markets, great caution must be taken while availing the
same. The YBL fallout is a lesson for the investors on why not to go behind the lure of these high risk
instruments and loose their hard earned money. Further, the SEBI in the present case may have
achieved in acknowledging the rot that was in the YBL. However, much of the story is yet to unfold. The
allegations against the former CEO Rana Kapoor and the tandem of cases that followed his reputation
are all still to be decided. Nevertheless, it will be interesting to see how the YBL melodrama will play out
in the coming years.

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