The dented credibility of the Securities and Exchange Board of India

In recent times, the Securities and Exchange Board of India (SEBI), the capital markets regulator in India, has been facing an unprecedented crisis in terms of its credibility, especially as an investigative body. This has in turn left many to question the SEBI’s ability to carry out time-bound investigations and to effectively regulate the securities market in India.

It has faced multiple scathing comments and observations from various judicial fora including the Securities Appellate Tribunal (SAT), a statutory body established to hear and dispose of appeals against orders passed by the SEBI.

The latest of such observations was made by the Bombay High Court, which castigated the regulator for failing to comply with an order passed by the Court in respect of a writ petition filed by certain minority shareholders of Bharat Nidhi Limited (BNL). Noting that there has been “persistent non-compliance” of the orders passed by it, the Bombay High Court observed that the SEBI has “resorted to all possible efforts, not to comply with the order” and that such an approach in not furnishing certain documents to the petitioners despite specific directions would “cause a dent to the confidence, the investors would repose in the SEBI.” This interim order of the Bombay High Court was recently upheld by the Supreme Court, which chose not to interfere with the observations of the Division Bench.

Strikingly, this is not the first instance of a judicial forum passing strictures against the SEBI in relation to complaints of minority shareholders in the affairs of BNL and related entities. In 2019, the SEBI was forced to move the Supreme Court against an order of the SAT which had labelled the SEBI’s approach as being “a strange one” and which concluded that the regulator had “lost sight of the mandate provided to them under Section 11 of the SEBI Act which mandates SEBI to safeguard the interest of the investors.” The SAT had gone on to observe that,

“...the SEBI as a regulator in the instance case has not performed its duties and has kept the complaint pending for more than six years which speaks volumes by itself. The Tribunal fails to fathom as to why the complaint could not have been decided unless SEBI officials have vested interest in not deciding the matter.”

While the Supreme Court held that these observations were not warranted and, consequently, “diluted” the order of the SAT, the order was otherwise affirmed.

The SEBI has also come under severe criticism of the SAT for its failure to comply with the latter’s order in other matters. In an appeal against the order of the SEBI imposing a six-month prohibition on market access for the promoters of Kirloskar Brothers Limited, the SAT had overturned the order, thereby removing all limitations imposed. However, the promoters’ ownership of the shares remained immobilized for several months. On approaching the SAT again, the SEBI’s failure to take appropriate action despite communications from the National Securities Depository Limited (NSDL) and the promoters was taken note by the SAT, which apart from criticizing the SEBI for inaction, imposed costs of ₹5 lakh on the regulator.

Delays and more delays

The observations of the Bombay High Court and the SAT in the above matters come mere weeks after an order of the SAT in an appeal filed by the promoters of Zee Entertainment Enterprises Limited (ZEEL) against a confirmatory order passed by the SEBI barring them occupying key managerial positions in the company boards of four Zee entities. During the course of that appeal, the SAT had raised concerns over the eight-month investigation period dedicated by SEBI to look into the alleged fund diversion by Punit Goenka and Subhash Chandra of ZEEL and went on to comment that the confirmatory order “says eight months. Now, where do you get these eight months, and what’s the certainty that you won’t extend this beyond eight months?” Even in its final order passed in the above appeal, SAT had made the following remarks pertaining to SEBI’s proclivity in seeking repeated extensions of time,

“We have seen that on numerous occasions whenever this Tribunal or the superior Court has directed SEBI to complete the investigation within a stipulated period, the same has not been done and applications after applications are being filed by SEBI seeking.”

To further add to its woes, these observations arrive at a time when the SEBI has been reeling under pressure due to its inability to investigate the serious charges of round tripping involving the Adani Group. A panel appointed by the Supreme Court of India to review the existing framework of the stock market's regulatory mechanism, as a result of the precipitous decline in shares of listed Adani Group companies following a report by US short-seller Hindenburg Research, went on to label that the SEBI’s investigation into the alleged round tripping as an exercise that “could be a voluminous one but potentially a journey without a destination”. News reports even suggest that the ongoing Financial Action Task Force (FATF) review of India is likely to take a dim view of the lenient treatment of the Adani Group by various investigative agencies including SEBI. As noted above, SEBI has had the tendency to seek for repeated deadline extensions for carrying out investigations. In addition to SAT’s rebuke against SEBI in the promoter’s appeal in the ZEEL dispute, SAT had also questioned the SEBI’s “credibility to complete an investigation within the stipulated time” in the Adani investigation.

Differing yardsticks

In 2018, the SEBI had received severe criticisms from the SAT for its ruling regarding Reliance Industries’ (RIL) non-disclosure in its acquisition of the Network18 (NW18) group. In RIL’s case, the SEBI had ruled that no disclosure was required as the entity through which indirect control was acquired by RIL, Independent Media Trust (IMT), was not its subsidiary but a “trust”. According to Clause 36 of the Listing Agreement, a listed entity is obligated to disclose ‘material’ information which will have a bearing on the performance/operations of the company. The SAT, in overturning SEBI’s decision, was critical of the decision made by SEBI to dismiss the complaint against RIL, observing that the reason for dismissal, which was the non-subsidiary status of IMT, was not justified. While directing SEBI to investigate the issue pertaining RIL’s violation of Clause 36 of the Listing Agreement, the SAT observed that sustaining “such patently erroneous decision of SEBI” would have negative consequences for investors in the securities market and would potentially incentivize listed companies to gain indirect control over other entities, such as through a rust or a similar entity, without fulfilling the disclosure requirements outlined in Clause 36 of the Listing Agreement.

Even in the case of Somani Cement Company, which related to an alleged fraudulent share sale, the SAT had reprimanded SEBI’s adoption of a discriminatory treatment of the appellant by making the following observations, “[i]ssuing shares in excess of authorised share capital and further dematting those unauthorized excess shares and allowing those shares to be sold on-market to innocent investors is a serious fraud on the securities market. In such a case, SEBI is unjust.” Stopping short of imposing costs on the SEBI, the SAT had directed SEBI to take appropriate remedial measures to ensure that its credibility as a market regulator is not affected.

Journey without a destination

The Expert Committee, in its report submitted before the Supreme Court of India regarding the investigation of the alleged stock manipulation of the Adani Group, suggested that the SEBI’s investigation into “whether one could make a case that the FPIs (Foreign Portfolio Investors) are in fact investing funds of the promoters of Adani Group and therefore could be regarded as a front for the promoters,” may have hit a wall due to an amendment to the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014 (FPI Regulations). The Committee went on to label that the SEBI’s investigation into the alleged round tripping as an exercise that “could be a voluminous one but potentially a journey without a destination”.

Through an amendment to regulation 23 of the FPI Regulations, the term “beneficial ownership” was substituted with the words “common ownership or control” in sub-regulation (4), which originally required FPIs to disclose any direct or indirect change in structure or beneficial ownership of the FPI. As a consequence, “the provision of dealing with an ‘opaque structure’ and requiring an FPI to disclose every ultimate natural person at the end of the chain of every owner of economic interest with the FPI was done away with” on the premise that declarations of the beneficial owner flows from Rule 9 of the Prevention of Money Laundering Act Rules (PMLA Rules), and that such a stipulation is sufficient for its regulatory purposes. The said amendment is also of particular significance as Rule 19(A) of the Securities Contracts (Regulation) Rules, 1957 requires every listed company to maintain public shareholding of at least 25% of shares.

As the Morning Context had reported, “if you remove these [FPI] funds, the effective [public] shareholding in Adani Enterprises comes down to only 10%,” and in Adani Transmission, the “effective public float is about 7-8%,” meaning that both the entities would be in clear violation of Rule 19(A). The SEBI, in response to the report of the Expert Committee, has inter alia stated that “[i]n such a case, the law as applicable at the relevant point of time is applied and no retrospective application of refined or explicit stipulation is applied retrospectively.”

Conclusion

The aforementioned issues stand to warn us against institutional complacency. It is rather unfortunate to witness the SAT criticize the SEBI for its many shortcomings. While the judicial impartiality of the SAT needs to be lauded, the sharp criticisms levelled against SEBI completely erodes the investors’ confidence in SEBI functioning as an efficient market regulator. Recently, the SEBI has sought to address the issue of certain FPIs holding a significant portion of their equity portfolio in a single investee company or corporate group. The concentrated nature of FPI investments has sparked concerns regarding the potential for promoters of the investee companies to exploit FPIs as a means to bypass regulatory obligations, such as those pertaining to the maintenance of minimum public shareholding in the listed company.

The SEBI released a consultation paper on May 31, 2023, which outlines a proposal to enhance disclosure obligations for FPIs with the objective of mitigating the potential for misuse by evading the minimum public shareholding norms. In order to address such concerns, it was deemed necessary to acquire detailed information regarding individuals who possess ownership, economic interest, or control in specifically identified FPIs. To achieve this objective, the FPI Regulations have been amended through the insertion of Regulations 22 (6) and 22 (7) vide the SEBI (Foreign Portfolio Investors) (Second Amendment) Regulations, 2023, which were officially notified on August 10, 2023.

In terms of Regulations 22(6) and 22(7) of the FPI Regulations, granular details of all entities holding any ownership, economic interest, or exercising control in the FPIs, on a full look through basis, up to the level of all natural persons, without any threshold, must be provided by FPIs, if they:

(i) hold more than 50% of their Indian equity Assets Under Management (AUM) in a single Indian corporate group, or

(ii) individually, or along with their investor group (in terms of Regulation 22(3) of the FPI Regulations), hold more than ₹25,000 crore of equity AUM in the Indian markets.

These Regulations also provide certain exemptions to certain categories of FPIs from the requirement to make the above disclosures.

While the above amendment could be a step in the right direction, the threshold limits set for making such disclosures appear to be too high; thereby making it convenient for an FPI to escape such disclosure requirement by consciously reducing its holdings to just below the threshold limit. This could once again result in SEBI’s action/investigation being labelled ‘journey without a destination’. Clearly, there is an impending need for SEBI to consciously embrace efficiency, transparency, and introduce significantly more stringent governance regulations.

Sriram Venkatavaradan and Saai Sudharsan Sathiyamoorthy are Advocates practicing at the Madras High Court and can be reached at sriramv21@gmail.com and saaisudharsans@gmail.com respectively.