12 June 2012

Consent orders - is it DoA?

I had a face-off in the Business Standard last week on consent orders. Here is the piece. Click on the link to see the opposite view as well - by Shriram Subramanian, Founder and Managing Director, InGovern Research Services.

The Securities and Exchange Board of India (Sebi) should have allowed all kinds of serious and non-serious violations to be settled through the consent route. Indeed, moral arguments can be made on how a serious violation can be settled. But the settlement process has many benefits, many of which are not fully appreciated.

First, instead of decades of litigation and disputes, amounts can be disgorged from a person. To take just two examples from the arena of fraud, have any investors been compensated for the Harshad Mehta scam or the Satyam scam till today? Contrast the lack of compensation to Satyam investors in India, where nothing substantial has even been initiated, with the partial settlement in the US where Satyam securities holders (American depository receipt holders) have settled the case with several of the accused and received compensation. While we have earned a moral victory, the US investors have got real compensation.

Second, litigation in India is particularly long and tortuous. This means few civil litigants see results within a decade or more. This was equally true of Sebi enforcement actions. Weighing complex financial data; gathering oral testimonies, written records and so on from exchanges; and giving a hearing to all parties and often a right to cross-examine can take substantial time. Add to that two appeals and the process is indeed long.

Third, even the guilty party in litigation may get away because a court of law may find the evidence less than watertight. In particular, a situation in which a person is charged with fraud, the burden of proof is extremely high and the guilty party can be set free either on a technicality or on lack of substantial evidence. To take an example, a person accused of insider trading would more likely than not get off scot-free because there is rarely more than circumstantial evidence available. One can rarely prove the conversation that took place inside a closed room with only two people present, particularly when it is in their interest to not disclose the illegality.

Fourth, criminal trials are even worse with a three per cent conviction rate. Most convictions in economic offences don’t even invite a jail sentence. Many invite a penalty of Rs 5,000 on conviction. Compare that against a multi-crore scam and the moral victory doesn’t look like much of a victory.

Fifth, the judicial system can work more efficiently since it gets unclogged owing to settlements. The securities appellate tribunal is perhaps India’s only court or tribunal that has close to zero backlog — this was made possible after the consent mechanism was introduced. The court, with more time, can better appreciate evidence and dispense justice in a time-bound fashion.

Sixth, contrary to public perception, consent penalties and consent remedies are, in fact, higher than in cases that go through the usual process of enforcement. Here an alleged violator gets something and gives up something else. He gets an order that finds him neither guilty nor innocent. And, in return, he must pay a higher penalty.

Seventh, there is no question of lack of guilt. In fact, the condition of settling the case is that a person neither admits nor denies the violation. There have been cases in the US in which people who made a press statement saying they are not guilty had the whole enforcement re-opened against them. Given that the consent orders are in the public domain, and that these need to be disclosed in public documents, there is a sufficient disincentive to commit violations in the future.

Finally, none of this would be possible if serious cases are taken outside the purview of consent. Petty and technical cases are anyway not disputed and don’t clog the system. A broker who sends a contract note a day late will end up paying a small fine, which he will not contest since it is impossible to argue against the violation. I, therefore, believe that serious offences like insider trading should be consentable though they should invite a higher penalty.

1 comment:

Anonymous said...

Oops! I posted this comment under AIF post. It actually belongs here.

“Contrast the lack of compensation to Satyam investors in India, where nothing substantial has even been initiated, with the partial settlement in the US where Satyam securities holders (American depository receipt holders) have settled the case with several of the accused and received compensation.” This difference has nothing per se to do withthe availability or lack of consent mechanism to the regulator. US investors could settle the case directly with the defendants because the US Supreme Court at least since “J. I Case Co. v. Borak - 377 U.S. 426 (1964)” read into Section 27 of the Securities Exchange Act, 1934 a private right of action. On the other hand, Sections 15Y and 20A of the SEBI Act, as interpreted by the Mumbai HC in “Kesha Appliances v. Royal Holdings Services Ltd. 2006 65 SCL 293 (Bombay)” have been marshalled to argue that no such private right of action exists in India. In fact, you, along with Prof. Vikramaditya Khanna successfully convinced the federal district court for SDNY that this is the legal position and so the motion to dismiss for forum non conveniens is meritless! (Let me add that there are people who believe that the judgment in Kesha Appliances should be read restrictively as it involved a matter solely arising out of SEBI Act and Regulations whereas the Satyam case is distinguishable as in this case the common law tort of deceit remains available).

An afterthought : If SEBI enters a consent order, without the other party admitting or denying guilt, would it mean that SEBI declined to `determine’ (within the meaning of 15Y) the relevant matter? In that case, neither SEBI would determine that particular matter, nor any other forum would have the power to do so. Where does it leave the harmed investors?

-Mangesh Patwardhan