01 June 2012

Consent order - incorrect arguments

I read a piece by Mr. Virendra K Jain, of Midas Touch Investor Association on consent orders and the new law which was introduced by SEBI. While Mr. Jain is entitled to have his own view and vision of SEBI's regulatory role, it get most facts incorrect, so I have reproduced the article below along with my comments on the previous para in bold.

The rapid developments with regard to the Consent Order” mechanism to settle regulatory action initiated by the Securities & Exchange Board of India are rather intriguing – Virendra K Jain

On Friday, 25 May the Securities and Exchange Board of India (SEBI) released revised consent rules by amending its Consent Circular of 20 April 2007. It did this even as proceedings related to a Public Interest Litigation (PIL) challenging the very legality of the Consent Circular were underway at the Delhi High Court.
Meanwhile, The Economic Times reported today that Reliance Industries (RIL), India’s largest private sector group has moved the Bombay High Court urging that action initiated against it in a massive insider trading case should be allowed to be settled under the now-discarded consent regulations.
Wrong news – ET has retracted  this news.

RIL’s action comes after SEBI has apparently rejected its consent application twice before. However, it is not clear why SEBI has not initiated regulatory proceedings against the group for so many years. The RIL case suggests that there is no clear process for initiating punitive action once the regulator rejects a consent request. It is also unclear under what rules and circumstances it does this, since there is apparently a very long window available to some entities to keep revising their settlement offers.

The PIL in Delhi HC has prayed, amongst others, for quashing of the 2007 circular and all consent orders passed by SEBI pursuant to it. It has argued that SEBI’s circular does not have clear legal basis.
S. 15(T)(2) of the SEBI Act, 1992 is the basis of the consent process

SEBI’s recent amendment to the consent rules states that it will not settle charges such as insider trading, fraudulent and unfair trade practices, failure to make the open offer, front-running, manipulation of net asset value or othermutual funds defaults, failure to redress investor grievances and failure to make  disclosures under the ICDR. But, having said that, it still keeps a window open for by arming itself with discretionary powers to settle any case even in these defaults!

The original SEBI consent mechanism was obliquely justified on the grounds that it was modelled on the lines of the settlement procedure followed by the US Securities and Exchange Commission (SEC). This is factually incorrect.

Unlike the SEBI Act, the SEC has specific provisions in its statues to govern the settlement procedure (and not consent) with clear objectives of investor protection and fairness.
It doesn’t – they just have a two liner administrative rule and no statutory backing to consent.

They focus on disgorgement of illegal gains and compensation to affected investors from the money disgorged and fines collected. The SEBI Act has no provision for awarding compensation or damages for the losses suffered due to fraud or unfair practices. The fines imposed by SEBI are deposited in consolidated fund of the Government of India.
Incorrect. SEBI has collected well over 100 crores in disgorgement – this does not to the Consolidated Fund of India. Only penalties go to the CFI. SEBI typically collects both penalties and disgorgement beside other actions (like consent bar from the market).

Further, settlement terms of the SEC require the approval of a court (which can also reject the settlement). SEBI’s consent orders are entirely negotiated by its staff and ratified by its own chosen committee, headed by a retired judge. There is no known case where this committee has objected to the consent terms or sought their modification. 
Wrong on both. Court approval is necessary only where a case has been filed in court – in both cases SEC and SEBI. In fact the SEC  has no external objective body which looks at the consent mechanism – the staff  alone decides the amount. The HPAC rejects well  over 60% of all cases – these are contained  in SEBI’s annual report – so there are hundreds if not thousands of known cases.

This means that even after the latest amendment, the fundamental issue of whether SEBI’s consent rules are legally valid has still to be decided by the courts.  Does SEBI have the powers to settle all type of defaults? In my view, it does not. In fact, once it is satisfied that a violation or transgression of rules has occurred, SEBI is mandatorily required to impose the penalty prescribed for that particular offence under the Act. It has no discretion in the matter. For instance, “a penalty of Rs25 crore or three times the amount of profits made out of insider trading, whichever is higher,” is to be levied for insider trading or non-disclosure of acquisition of shares and takeovers or fraudulent and unfair trade practices.
If it had no discretion, why would Parliament have inserted S. 15(T) (2).

Both SEBI circulars on consent proceedings—dated 20 April 2007 and 25 May 2012—turn the intent of the legislature as well as the letter and spirit of the legislation on its head. The legislation provides for mandatory and specific (in most of the violations) penalties whereas SEBI’s circulars over-ride this and empowers itself to decide matters on a case-by-case basis. A close reading of the latest amendment makes it obvious that it is another exercise in self-empowerment and SEBI’s sympathies lies with the violators rather than in protecting investors’ interest and safeguarding market integrity.
In consent cases, SEBI normally imposes a higher penalty,  and disgorgement rather than dilute the law. In other words, the penalties are not subverted but enhanced. Of course this is done with an order "without admitting or denying guilt in return".

The new regulations are strange in another respect. They in fact formalize the process for those who commit an offence or violate a rule to walk through the consent door every two years (from the date of the previous consent order or even earlier “if the default is minor in nature”). Only those who have already received two consent orders (or pardons) already have to wait for three years before applying for consent again.

SEBI’s consent rulings so far have been extremely opaque and arbitrary, so one can only draw inferences from the amendments. One such amendment says that a consent application cannot be filed until the investigation is complete. 

Does this mean that in the past, under a more lawless regime, SEBI has allowed entities to file consent applications even before it had completed its investigations and figured the extent of wrongdoing?
No, even in the previous circular, investigation had to be completed before consent could be done – except in cases where the violation is technical and obvious i.e. where investigation is not necessary.

Clearly, the new consent regulations are also grossly inadequate. SEBI is India’s capital market regulator, it would do well to regulate, strictly within the parameters set by the legislature and leave legislation to parliament.  
It has – see above.

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