‘If it ain’t broke, don’t fix it’ has a corollary: ‘if it’s badly broken, redo it, don’t fix it’. This is why the approach of the Viswanathan Committee to improve Sebi’s regulations on fraud, manipulation and insider trading falls short.
The modern origins of addressing securities and financial frauds came from the ‘new deal’ of 1933-34 in the US, where the government rewrote a vast majority of economic laws. Interestingly, the law outlawing fraud did not define the term in any new-age fashion, but relied on what we lawyers call the common law, or judge-made law.
The American parliament, supplemented by a regulatory rule, not only fully adopted this simply phrased, briefly stated and incredibly complex law, but over 80 years has not changed a single word of this definition.
Back in India, the definition does not have such a constant or consistent story.
We have tried to grab the complexity of law by explicitly trying to capture the entire world of fraud in words.
Naturally, that has not worked, and instead of going back to the origins and introducing a simple definition, we have tried to glue plastic leaves to a diseased tree with multiple amendments.
The common law and US definitions of fraud have the following five elements: intention to commit fraud, misrepresentation, materiality, causation and ill-effect (damages).
The Indian definition in the anti-fraud regulation of Sebi, by contrast, does not have even a single of the five ingredients, and specifically say that intention, deceit and damages are irrelevant.
One can mathematically show that under the Indian definition of securities fraud, walking, running and swimming are included. While one can argue that no one walking has yet been charged with securities fraud, one wonders what the point of a definition is, if it is so broad as to be meaningless.
Similarly, there is no need to define manipulation or insider trading, because they have evolved from the same definition against fraud. But in India, we have chosen to define it as broadly as possible, so as to capture either innocent conduct or unfair conduct, not just necessarily what ought to be outlawed. Income inequality is unfair but not illegal. All informational advantage may be unfair but should not be outlawed as insider trading. It is interesting to note that the Indian Parliament has, in the Sebi Act, chosen to replicate the US law on fraud, almost to the word, but the delegated regulations have been chosen unwisely.
The committee report, on the other hand, ignores this elephant in the room and applies copious bandages to the patient in coma. It starts with ‘further strengthening’ of the regulations, by which one can assume that the report further expands the already meaninglessly broad definition. It goes into territories like ‘persistent’ negligence amounting to deemed fraud. Under any definition in the world, negligence can never amount to fraud, as the required degree of intent is missing. Repeated carelessness cannot be fraud.
The other shortcoming of the committee is not looking at the second elephant in the room. This is private enforcement of securities laws by investors. Under current laws, investors are barred from approaching a court where Sebi has power to take action. As a corollary, India will never have a securities class-action lawsuit, as it is prohibited by law. This law was passed to reduce multiplicity of proceedings, but has caused untold misery to investors. In the notorious Satyam scandal, US investors have obtained money as compensation, but Indian investors have received nothing because of this law (disclosure: I was an expert witness for plaintiffs in the New York suit).
The section on improving insider trading laws similarly suffers from definitional inchoateness, which the report reaffirms. In a famous US case of Dirks, a research analyst repeatedly approached the regulator to uncover a fraud, and was rebuffed. He then circulated a newsletter telling his clients about the fraud, leading to its ultimate discovery. He was charged with the offence of tipping inside information instead of being rewarded.
The US Supreme Court came to his rescue. Dirks in today’s India would be a criminal the way the regulations are drafted.
Finally, the report recommends a disturbing recommendation to enable Sebi to tap phones of people. The privacy concerns this raises are huge and no regulator, perhaps besides North Korea’s, has such powers. The famous Rajaratnam-Rajat Gupta phone taps were uncovered in the US as their criminal enforcement agencies suspected money laundering. The US SEC and almost every other jurisdiction’s securities or other regulator has no power to tap phones.
There is merit in some of the microproposals made by the report, but that is not possible unless the big picture issues of definitions and inchoate prohibitions are addressed. And, luckily, one doesn’t need to look beyond the Sebi Act itself that captures these prohibitions of fraud, manipulation and insider trading quite well and in line with hundreds of years of wisdom.
No comments:
Post a Comment