1ST GNLU MOOT ON SECURITIES

AND INVESTMENT LAW

11TH 13TH SEPTEMBER, 2015

MOOT PROBLEM

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BEFORE THE SECURITIES APPELLATE TRIBUNAL, MUMBAI
TradExchange Limited
Mr. Robin Kanwar
FinLine Financial Services Limited

High Networth Fund, LP

Appellants

v.
Securities and Exchange Board of India

1.

Respondents

After a successful career in Silicon Valley for over a decade, Mr. Robin Kanwar was
looking for business prospects in his home country India. Upon his return in 2002, he
found an upsurge in Internet penetration in India, and decided to cash in on the online
boom. At the time, he witnessed a perceptible change in shopping habits of wealthy
individuals as well as the steadily rising middle class. Brick-and-mortar shopping was
gradually giving way to online shopping, as more people were not only getting
comfortable with the idea of buying on the click of the mouse, but they were also
enjoying the efficiency of online shopping.

2.

Buoyed by this phenomenon, Mr. Kanwar decided to establish an online marketplace for
luxury goods such as shoes, bags, watches and similar accessories. He established contact
with leading international and domestic brands who agreed to list their products on his
marketplace. Through his newly incorporated company, TradExchange Limited, he set up
an online marketplace by the name TradEx. Under this business model, TradExchange
would provide an online platform in the form of a website on which its clients can display
and sell their products. TradExchange (together with some of its affiliates) also provides
additional services such as handling the payment mechanisms, ensuring delivery and also
accepting returns of goods. However, TradExchange did not itself obtain title over the
goods, which were transferred directly from the sellers to the buyers. Despite the
bifurcation of the legal aspects of the transaction as set out above, the customers trading
on the TradExchange portal are unaffected by them as they enjoyed a seamless
experience of buying the luxury goods on the TradEx web portal.

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3.

TradExchanges business expanded significantly, and in the first few years of its
establishment it also received equity investments from three different venture capital and
private equity funds. In 2006, Mr. Kanwar decided that it was time for massive
expansion, which required additional capital investments. Since the existing investors
were looking for valuable exit opportunities as well, TradExchange decided to approach
the capital markets, and following an initial public offering (IPO) the companys shares
were listed on the National Stock Exchange (NSE).Subsequently, in 2007, TradExchange
carried out a sponsored offering of American Depository Receipts (ADRs) that were then
listed on the NASDAQ. Following these listings, Mr. Kanwar held 32% shares in
TradExchange through an investment company. The remaining shares were held among
institutional and retail investors. Mr. Kanwar was the chairman and managing director
(CMD) of the company.

4.

By 2014, TradExchange had become the largest online retailer in India, leaving the
competition far behind. Being a man of lofty ambitions, Mr. Kanwar set himself up to
achieve greater heights and sought a global presence. For this purpose, he decided that
TradExchange

required

further

capital.

Accordingly,

in

consultation

with

TradExchanges lead investment bank, FinLine Financial Services Limited, Mr. Kanwar
decided that it would be preferable for TradExchange to offer fresh shares to the public
by way of a follow-on public offering (FPO). Accordingly, on April 15, 2014,
TradExchange filed a draft red-herring prospectus (DRHP) with the Securities and
Exchange Board of India (SEBI).
5.

The news of TradExchanges further capital raising plan triggered a flurry of

developments. An employee of TradExchange immediately wrote an anonymous letter to
SEBI indicating the prevalence of counterfeit products being sold on TradEx, which
would be severely damaging to the genuine traders who are marketing their products
through the portal. The letter also indicated that TradExchanges senior management was
aware of counterfeiting being perpetuated on TradEx, but that they did not take any steps
to prevent the same as such activities only boosted sales on the website and enhanced
TradExchanges revenues. When SEBI communicated its comments on the DRHP to
TradExchange through the investment banks, it specifically asked the company to make
appropriate disclosures regarding any counterfeit products being sold on its portal. In

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response to SEBIs comments on this point, TradExchange included an additional risk
factor in the DRHP as follows:
We may be subject to allegations claiming that items listed on our marketplaces
are pirated, counterfeit or illegal.
It is possible that items offered or sold through our online marketplace by third
parties infringe third-party copyrights, trademarks and patents or other intellectual
property rights. Although we have adopted measures to verify the authenticity of
products sold on our marketplace and minimize potential infringement of thirdparty intellectual property rights through our intellectual property infringement
complaint and take-down procedures, these measures may not always be
successful.
Thereafter, TradExchange proceeded with the FPO, which concluded successfully.
6.

On July 17, 2014, a few weeks after the conclusion of the FPO, TradExchange was
notified of a suit filed by Cranberry Fashion Inc., a leading American luxury retailer, in
the Delhi High Court for infringement of its intellectual property rights on account of
alleged counterfeit products being sold through TradEx. Cranberry itself had been a key
client of TradExchange as it sold its products through TradEx for a number of years.
However, that relationship came to an end in 2013 when Cranberry began doubting the
authenticity of the products being marketed on TradEx. As of the date of filing of the suit
in the Delhi High Court, Cranberry was no longer a client of TradeEx.

7.

Mr. Kanwar was taken aback by this development. It had been the case that he and Mr.
Sprine, the flamboyant CEO of Cranberry had a strained relationship. Furthermore, there
was speculation that the termination of the contractual arrangements between
TradExchange and Cranberry was the result of payment disputes and not merely due to
the alleged suspicion on the part of Cranberry regarding the counterfeiting of products on
TradEx. In any event, Mr. Kanwar was shocked to find that the suit was filed for an
injunction restraining TradExchange from selling any products that are deceptively
similar to that of Cranberrys products and also for damages amounting to Rs. 100 crores
for sales of counterfeit products that had already occurred over the previous years
(including during the period when Cranberry had been TradExchanges customer).
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8.

Although TradExchange was notified of the suit on July 17, 2014, it immediately began
consultation with the lawyers and decided to make any public announcement of the same
only after initial advice from the lawyers. Hence, it notified the stock exchange of such
suit only on July 24, 2014. This announcement sent ripples through the stock market.
Overnight, the price of TradExchanges ADRs fell 20% on the NASDAQ. There was a
precipitous slide on the NSE as well where the stock took a beating in the following days
to come. This also sent shockwaves through the market in general where the stocks of
other listed companies in the business of operating online marketplaces took a beating
since investors demonstrated their apprehension that counterfeiting had become an
industry-wide phenomenon.

9.

In addition to notifying TradExchange of the suit, Cranberry lodged a complaint with

SEBI alleging misstatements in the prospectus for the FPO. It also requested SEBI to
launch an investigation. Specifically, Cranberry alleged that it had served a legal notice
on TradExchange regarding the counterfeiting claims. This legal notice was served on
April 25, 2014, and it is Cranberrys case that this legal notice was suppressed and that it
was neither brought to SEBIs attention nor was there any disclosure thereof in the FPO
prospectus.

10.

Based on the complaint of Cranberry (which incidentally held 1000 shares in

TradExchange), SEBI initiated investigations. In an interim order passed on August 16,
2014, SEBI barred TradExchange and Mr. Kanwar from accessing the capital markets or
from otherwise trading in securities on a stock exchange, pending further investigation.
By way of this order, it also debarred FinLine from providing any investment banking
services to its clients, again pending further investigation.

11.

In the meanwhile, the Enforcement Directorate, Government of India, initiated

investigations against TradExchange on account of potential violation of the Foreign
Exchange Management Act, 1999 read with the Governments policy on foreign
investment. The Government was particularly concerned that TradExchange was carrying
on its business without complying with the legal requirements on foreign direct
investment (FDI). Specially, the investigation was premised on the basis that
TradExchange was in breach of the spirit of the law, if not the letter of the law relating
to foreign investments in the relevant sector. A total of 37% shares in TradExchange
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were held by foreign investors, including shares in respect of ADRs. The prospectus did
not contain any specific reference to compliance with foreign investment policies, which
was based on legal advice received by TradExchange.
12.

Thereafter, SEBI heard the parties in detail on the merits of the case and passed its final
order on December 21, 2014. In this order, SEBI found inadequate disclosures in
TradExchanges offer document for the FPO due to which it confirmed its orders against
TradExchange, Mr. Kanwar and FinLine respectively, which would operate for a period
of three years from the date of the order. Furthermore, SEBI found that there was an
inexcusable delay on the part of TradExchange in disclosing the filing of Cranberrys
lawsuit to the stock exchanges. SEBI also passed an order requiring TradExchange to
disgorge its ill-gotten gains that were computed to be Rs. 37 crores. This was arrived at
on the basis of the additional gains made by TradExchange on account of the nondisclosure of the counterfeiting, and particularly the potential legal action by Cranberry
and its impact on the stock price of TradExchange. Separately, SEBI also imposed a
penalty of Rs. 5 crores on TradExchange for violation of the SEBI Act and the relevant
regulations thereunder. Aggrieved by SEBIs order, the parties preferred an appeal to the
Securities Appellate Tribunal (SAT).

13.

Separately, in March 2015, High Networth Fund, LP (HNF), a private equity enterprise
based in Singapore and managing funds belonging to wealthy individuals and business
families, wanted to acquire a significant stake in TradEx. HNF approached Mr. Kanwar
for negotiations. Although Mr. Kanwar was not keen on the transaction, he was
persuaded by his advisors that the deal may be beneficial to the company as it would
increase the profile of the business and also provide access to HNFs network which
extended to a large body of persons whom TradExchange could tap as potential suppliers
and customers. After some discussions, it was agreed that HNF would subscribe to 2.5%
shares in TradExchange through a preferential allotment, and that it would purchase
another 2.4% shares from Mr. Kanwar. In April 2015, necessary approvals were obtained
from the shareholders of TradExchange.

14.

In the meanwhile, HNF also conducted extensive due diligence on the business affairs of
TradExchange. During the due diligence, it was given access to management accounts,
and it was also privy to the unaudited accounts of the company for the financial year
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2014-2015. In the process, HNF discovered that on March 15, 2015 Waltenberg, a
significant supplier of TradExchange, whose sales provided nearly 22% revenues for
TradExchange, had issued a notice of termination of its relationship with TradExchange.
Upon discovery of this information, the team advising HNF went into a huddle, but they
finally decided to proceed with the deal without any change in the terms (including price)
as they were confident that this would not affect the overall long-term prospects of
TradExchange. It is a different matter, however, that when the accounts of the
TradExchange for the last quarter of the financial year 2014-2015 were approved by the
board on April 30, 2015 and announced to the stock markets, the price of the companys
shares fell 2%. The boards report contained a disclosure regarding Waltenbergs
potential withdrawal. It is only possible to surmise whether the fall in the share price was
on account of any specific fact (such as the withdrawal of Waltenberg) disclosed in the
companys reports and financial statements or due to other reasons attributable to the
performance of the company, the online retail sector as a whole or even other economic
factors.
15.

HNFs carefree attitude towards the Waltenberg withdrawal may have had something to
do with its optimism on a potential new client of TradExchange. During the time that
HNF was conducting due diligence, TradExchange was negotiating a new contract with
HiSketch, a world renowned maker of luxury bags. At the relevant time of due diligence,
TradExchange and HiSketch had entered into a non-binding memorandum of
understanding (MOU), which was valid until May 31, 2015. TradExchange revealed this
information to HNF during due diligence, upon which HNF asked to review a copy of the
MOU. Due to the sensitivity in the negotiations, TradExchange refused to share a copy of
the MOU. However, after protracted discussions, TradExchange revealed a redacted copy
of the MOU (with the key commercial terms of the deal concealed) only to the top three
officers of HNF. Despite all the brouhaha surrounding the HiSketch transaction, the
parties failed to arrive at a negotiated position, and hence the MOU expired on May 31,
2015 without a definitive deal having been struck.

16.

As far as the HNF transaction is concerned, it took place in parts. On May 5, 2015,
TradExchange issued new shares to HNF representing 2.5% of the equity share capital of
the company. During various periods of time between May 10, 2015 and May 20, 2015,
there were several block trades executed on the NSE between Mr. Kanwar and HNF by
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which Mr. Kanwar sold 2.4% shares to HNF. HNF decided that its shareholding in the
company should be no less than 5% in the company. Hence, during the same period
between May 10, 2015 and May 20, 2015, it acquired another 0.2% shares of
TradExchange on the stock market.
17.

Following all the transactions described above, the share price of TradExchange rose by
about 5% by the end of May 2015 as compared to the end of April 2015. Taking
advantage of this rise in share price, Mr. Kanwar decided to liquidate some of his
shareholdings in TradExchange. Hence, he sold an additional 2% shares in the market on
June 5, 2015. Although he had an inkling at the beginning of May 2015 that the share
price of TradExchange might likely rise given the nature of the transactions, but he could
not be sure. In an email to his chartered accountant on April 29, 2015, he indicated that
he will sell an additional 2% shares in June 2015 to raise liquidity to meet some debts
belonging to SharePrise Limited (an online broking company in which Mr. Kanwar had
a substantial financial stake).

18.

Given some abnormalities in the share price of TradExchange during April and May
2015, SEBI launched an investigation into the various transactions carried out in respect
of TradExchange. It accordingly issued notice and conducted hearing, following which it
passed an order finding TradExchange, Mr. Kanwar and HNF in violation of the SEBI
Act and the various regulations thereunder. Consequently, SEBI debarred all the three
persons from accessing the capital markets or buying and selling shares of a listed
company for a period of five years from the date of the order. Additionally, SEBI
imposed an aggregate monetary penalty of Rs. 3 crores on the parties. Against this order,
the parties have preferred an appeal to the SAT.

19.

The SAT has agreed to hear the relevant appeals together.

*****

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