Securities Law Series: SEBI and The Basic Structure of Securities Enforcement in India

There is considerable literature today on the powers of Securities and Exchange Board of India (SEBI), SEBI and its multi-faceted role as an administrative body, rule-maker and enforcement agency. But as we start this series on securities regulation with Bar and Bench, a quick baptism ritual into the workings of SEBI is important before we foray into more nuanced areas, in the coming months.

SEBI was established in 1992, in accordance with the provisions of the SEBI Act, 1992 (SEBI Act), with a twofold objective of (a) protecting the interests of investors in securities and (b) promoting the development of and to regulate the securities market.

Even within the universe of its enforcement powers, SEBI has the ability to trigger three distinct provisions of law

- Issuing directions and levying penalties under Sections 11(4) and 11B of the SEBI Act (Section 11 & Section 11B),

- Adjudicatory powers under Sections 15A-15J of the SEBI Act (Section 15) and

- Enquiry proceedings in terms of the Section 12(3) of the SEBI Act (Section 12(3))

In addition to this, SEBI can initiate criminal proceedings under Section 24 of the SEBI Act (Section 24). However, this provision is more-often-than-not used as a predicate power – to punish instances of contravention where action in terms of the quasi-judicial processes within the organisation have not been sufficient or fruitful.

SEBI also has powers in terms of the Securities Contracts (Regulation) Act, 1956 (SCRA) to regulate the affairs of stock exchanges and clearing corporations, i.e., market infrastructure intermediaries, and take necessary punitive and restorative action, when so required. The punitive provisions of the SCRA can also be brought to bear against intermediaries as well as errant listed entities.

SEBI is also tasked with regulating the issue and transfer of securities by listed companies or intending-to-be-listed companies in terms of the Companies Act, 2013 (Section 24 of Companies Act), and routinely passes orders with respect to governance, disclosure and financial proprietary issues of such companies.

A step prior to initiating proceedings under any of the provisions outlined above would be to do an inquiry or investigation (as the case may be) and follow that up with an investigation report. Basis this, the regulator forms a ‘action matrix’ recommending the ideal course of action.

In certain cases, where SEBI believes that urgent directions are required to be passed in the interest of securities market, it may pass an ad-interim order against the relevant persons and then subsequently proceed to undertake a detailed investigation and thereafter pass the final order under Section 11B of the SEBI Act.

Perhaps the most well-known section in the SEBI Act, this equips SEBI with a wide range of corrective, restorative and equitable powers. These directions can range from mere warnings to suspension/cancellation of licences of regulated intermediaries, debarment of officers of intermediaries and listed companies, directing monetary compensations, restricting companies from raising capital in the public markets, disgorging illegal gains made by violators, directing restitution to wronged investors etc. It is also well-established that Section 11B empowers SEBI to pass directions on an ad interim ex parte basis, as well, when the facts so demand. The exercise of these powers has been a subject matter of much debate recently, especially around the degree of egregiousness which would merit such exacting measures being taken by the regulator, without affording an opportunity of defence at the first instance.

Given that the powers under Section 11B (and the concurrent provisions of Sections 11, 11(1) and 11(4) are of a wide amplitude and offer significant elbow room for the regulator to innovate more dynamic and fact-fitting remedies, this has served as the ideal tool to test the remit of its jurisdiction. For instance, in a matter concerning cross-border issuance and transactions concerning securities, when SEBI had exercised its jurisdiction with respect to entities which were housed outside India, the Apex Court upheld the same to the extent the securities in question had an “impact on or nexus with India” – essentially applying the Effects Doctrine. Even earlier, prior to an amendment of Section 11B in 2014 (which expressly allowed it), SEBI had used this very provision to order disgorgements on several occasions (and successfully in some).  This provision has also been used to take action against entities like chartered accountancy firms which are ancillary but integral features of the securities market, with both the Bombay High Court and SAT confirming that remedial action can be taken under Section 11B in such cases, but in the absence of evidence to prove fraud/mens rea, it was held that SEBI cannot assume the role of penalising them for not duly discharging their audit duties.

On the other hand, while it is no longer res integra that the powers under Section 11B(1) cannot be used to punish delinquents, the newer sub-section (2) empowers the regulator to also impose monetary penalties within this process.

Under Section 15, SEBI begins the formal enforcement process by appointing an Adjudicating Officer (AO). The AO investigates the facts and reports his/ her findings to the SEBI board. If the findings are adverse, a show cause notice is issued to the noticee by the AO to explain why a monetary penalty should not be levied on such person. Thereafter, the noticee is given an opportunity to file written submissions, as well as appear personally before the AO to explain their case, before a final order is passed.

In the seminal case of SEBI v. Bhavesh Pabari, after a series of judicial pronouncements which offered different views on the subject, a full bench of the Hon’ble Supreme Court held that an AO has the right and discretion to determine the quantum of fine when any provisions specified in the SEBI Act or SCRA are not complied with. The decision broadened the application of Section 15J of the SEBI Act and highlighted that the three reasons[1] listed therein must only be regarded as illustrative and not exhaustive in nature, hence allowing the AO to assess the punishment after a consideration of all aggravating and mitigating factors. This decision has evolved considerably over the years, to now recognise the ability of AOs to not impose penalties at all, even in cases where a non-compliance is identified, but is not significant enough to merit a penalty.

[1] Under Section 15J of the SEBI Act, while adjudging the amount of penalty, the AO is required to consider the, (i) amount of disproportionate gain made; (ii) amount of loss caused to the investors; and (iii) repetitive nature of the default.

Depending on the nature of violation (such as failure to furnish information, failure to enter into agreements with clients or failure to redress investors’ grievances) and/or the nature of intermediary to whom show cause notice is issued (such as mutual funds, investment advisers or stock-brokers), the quantum of penalty is provided in Sections 15A to 15J. Whereas penalties typically range from INR 1 lakh to INR 1 crore for such violations, in case of more serious charges such as insider trading and fraudulent trading, the maximum penalty imposed that can be imposed is INR 25 crores or three times the amount of profits made, whichever is higher.

Although the law has expanded SEBI's enforcement authority over a period of time, it neither specifies which violations would result in which enforcement consequence nor does it establish the requirements for proportionality for various offences or offenders. This leads to ambiguity in the quantum of penalties awarded by SEBI and almost mechanical application of fines in some cases.

In this context, it is interesting to note that despite the SEBI Act having been amended more than a dozen times since 1992, the cap on penalties under these sections has remained more or less unchanged and at INR 1 crore (except in cases of insider trading or fraudulent trading) – something with places SEBI at a significant disadvantage to its regulatory peer group (for example, the Competition Commission).

Section 12 of the SEBI Act sets out the procedure with respect to the registration of market intermediaries. As a corollary to that, sub-section (3) lays down the powers of SEBI to suspend or cancel the registration of these intermediaries. This provision, read with the provisions of Chapter V (or VA) of the SEBI (Intermediaries) Regulations, 2008 set out the circumstances and manner in which these powers are exercised by the regulator.

A stockbroker, sub-broker, share transfer agent, banker to an issue, trustee of trust deed, registrar to an issue, merchant banker, underwriter, portfolio manager, investment adviser etc. are some categories of intermediaries which are registered with SEBI.

When SEBI observes that there have been non-compliances on part of a registered intermediary, it appoints a Designated Authority, who issues a show cause notice to the intermediary and, basis the responses received, recommends the next course of action. These actions can include suspension or cancellation of a certificate of registration, prohibiting the noticee to take up any new business, debarring a branch from operating for a certain time or disqualifying the principal officer from associating with a registered intermediary for a given period, or even a warning. These recommendations are put to a Designated Member, i.e., one the WTMs of SEBI, when the same are either confirmed or modified and issued as an order, after complying with the requirements of natural justice. According to the annual report of 2021-22, as many as 24 certifications of registration of various intermediaries were cancelled by SEBI over the course of the year. This provision was recently invoked by SEBI to withdraw the license issued to Brickworks Ratings, a credit rating agency and the matter is currently under appeal before SAT.

SEBI is entitled to initiate parallel proceedings and issue orders under Section 11B as well as initiating adjudication proceedings to impose fines under Section 15. However, in order to avoid multiplicity of proceedings, vide an amendment w.e.f. March 8, 2019, powers under Section 11B were broadened to include levy of monetary penalty under relevant sections under Section 15. Although theoretically, SEBI still has the power to initiate multiple proceedings against the same entity/person, the need for the same has diminished pursuant to this amendment. However, it remains almost a matter of intrigue as to when and in what situations which action by SEBI would be taken – while empirically it may be true that SEBI adopts both penal and directive proceedings in matters of greater significance (and only adjudication in more business-as-usual matters), there is no scientific approach nor any statutory prescriptions guiding the regulator when it devises its ‘action matrix’.

Over and above the powers mentioned above, if a person contravenes or violates any provision of the SEBI Act or rules or regulations made thereunder, as also the concerned provisions of the Companies Act, 1956/2013, Depositories Act, 1996 or the SCRA, they can be punished with imprisonment which may extend to 10 years and/or with fine which may extend to INR 25 crores. Courts will take cognizance of an offence when a complaint is made by SEBI itself.

As on March 31, 2022, the Courts have disposed of 785 of the 1,930 prosecution cases filed by SEBI out of which 243 cases resulted in convictions, 248 in acquittals and 294 cases were compounded. Of late, there have also been policy-level discussions with respect to the possibility of enhancing SEBI’s powers with respect to taking actions under criminal law, including where the regulator may be equipped to pass such orders.

All these quasi-judicial orders of SEBI are subject to the appellate jurisdiction of Hon’ble Securities Appellate Tribunal (SAT). The SAT is headed by a Presiding Officer, who is required to be a Judge of the Supreme Court or a Chief Justice of a High Court or a Judge of High Court for at least seven years, and such number of Judicial Members and Technical Members as may be prescribed. Any Bench of the SAT is required to be a Division Bench. An aggrieved person must file the appeal within 45 days of receipt of the order by SEBI. Any person (including SEBI) aggrieved by order of SAT may file an appeal before the Hon’ble Supreme Court.

In a landmark judgment, the Hon’ble Supreme Court held that only "quasi-judicial" orders of SEBI under Section 11B and Section 15 are subject to appellate jurisdiction of Securities Appellate Tribunal (SAT). Administrative orders such as circulars/notifications issued under the SEBI Act and rules/regulations made thereunder are outside the appellate jurisdiction of SAT. Such orders will only be subject to review by the High Court or the Supreme Court under Article 226 and 32 of the Constitution respectively, vide a writ petition.

The discretionary and wide-ranging powers granted to SEBI have sometime resulted in inconsistent and disproportional decision, leading to ambiguities. Given that the standard is often one of individual satisfaction, in the absence of clear-cut standard-operating-procedures, similarly placed entities often see disparate outcomes. Yet, in an ever-evolving market and with hydra-headed violations and violators, it may be in the interest of the integrity of the securities market that the regulator be equipped with not only a sword and a shield, but also a forge a tool which fits the trade. While structurally sound, for the scale at which securities enforcement operates and the increasing space it is occupying in the room, there are several key reforms to consider:  

1. While there have been judicial pronouncements which have affirmed that there is no statutorily prescribed limitation period for SEBI to initiate (or, for that matter, complete) enforcement proceedings, the courts have time and again expressed that SEBI must act in a timely fashion. While processes have been streamlined in the recent past, powers which are so wide as those of SEBI are squandered if not used expeditiously. Without any certainty about when certain acts or omissions may come under the scanner of SEBI, and whether it would be near-enough in the past to put up any cogent defence, securities market participants, intermediaries and institutions often have to carry on their businesses. It is time that a period of limitation (even with reasonable exceptions) be built into SEBI’s powers, both for closure of investigations and proceedings.  

2. As we have discussed above, as the years go by and we move further and further away from 1992, the teeth of the SEBI’s penal provisions need a sharpening. Given the current rates of inflation, even the steeper penalties imposed by SEBI are likely to lose their efficacy and deterrent effect soon.

3. Without clear policy guidance on what kinds of measures SEBI intends to take in case of a given violation, a potential noticee is handicapped in planning and coordinating his defence. While the principles of res judicata should ideally govern SEBI’s ability to take multifarious action for the same set of violations, the lack of statutory clarity insofar as what would be SEBI’s reaction to a non-compliance impairs a person seeking to bring herself within the four corners of the law. A greater degree of certainty when it comes to possible actions would be a welcome move for both the regulator and the regulated.

4. Two concepts from the US SEC are worth an import:- Administrative law judges and the  ‘Wells Notice’. A Wells Notice is a letter which the US SEC issues to persons on the completion of its investigation indicating the charges which it proposes to bring against them and the probable recommendations for the nature of action proposed to be initiated. Not only will this make efficient the processes at enforcement wing of the regulator, but it will also afford the entity to clear the air before formal charges are brought. In fact, conceptually this is not alien to SEBI – it routinely issues ‘observation letters’ on the completion of an inspection of intermediaries – the same needs only to be tweaked and replicated in investigations/inquiries. Administrative law judges are the equivalent of the current adjudication officers and differ from the Indian structure in that they are external third parties, and not employees of the regulatory agency themselves. Such a distinction enables quicker, more efficient decision making while also respecting the separation of powers.

5. In 2021-22, SEBI disposed of 226 proceedings under Section 11 and 11B. Parallelly, SEBI completed adjudication proceedings against 2,369 entities involving 546 cases, amounting to around 919 orders – this amounts to more than 1100 orders. As against this, around 1,000 appeals were filed before the Hon’ble Tribunal, which stretch the capacity of the bench and take workload of the single bench to unmanageable levels. Since multiple cases across different arms of SEBI upstream to one bench at SAT, it is time to consider setting up different benches in a manner that does justice to both the judges and the litigants.

6. Of late, while on one hand SEBI has come out with several schemes which offer one-time en mass settlement in case of violations involving numerous entities, there have been logistical and technical issues while dealing with settlements of ‘business-as-usual’ contraventions, which would have the tendency of pushing a person down the road of protracted and laborious (and expensive) litigation. If the settlement proceedings can be automated, even AI driven, the regulator and the courts would be so much more equipped to deal with larger, more significant and more circuitous problems. Not only is this possible, given the size of the beast and the tools available today, it may just be inevitable.

Shruti Rajan is a Partner, Anubhav Ghosh is a Counsel and Anurag Gupta is an Asoociate at Trilegal. Trupti Jain assisted in the writing of this article.

This is the first article in the Securities Law series by Trilegal