prpri Report on Measures for Strengthening Enforcement Mechanism of SEBI & Incidental Issues Report on Measures for Strengthening Enforcement Mechanism of SEBI & Incidental Issues




The Securities and Exchange Board of India was set-up with the following mandates, –

(i) to protect the interest of investors in securities;

(ii) to promote the development of the securities market; and

(iii) to regulate the securities market.

Protection of investors’ interest is the primary and one of the most important responsibilities of the Board. The Board regulates the manner of raising monies from the public and in case of any default, it protects the investors’ interest by initiating several measures including suspending and cancelling the certificate of registration, debarring, penalizing, prosecuting defaulters, ordering recovery and directing disgorgement and refund to identifiable investors. The Board also regulates trading of securities and ensures that the same is carried out in tune with investors’ interest. The Committee has considered various issues pertaining to the enforcement mechanism of the Board and made recommendations thereon to make it more robust and efficient. These recommendations
seek to introduce tactical, strategic and systemic changes in the enforcement process spread over a period of few years, to enhance and improve the capabilities of the Board in protecting the investors and indicting the defaulters.

Part-A: Review of Intermediaries Regulations:

The securities market is largely built on the infrastructure and services provided by the intermediaries. A deficiency in the functioning of an intermediary may possibly impact the functioning of the securities markets and erode investors’ trust. The Board regulates intermediaries through:

(i) substantive Regulations which are entity specific and which specify the eligibility criteria for obtaining the certificate of registration and lay down the operating standards for providing financial services to clients, and

(ii) the SEBI (Intermediaries) Regulations, 2008 which regulate the manner of holding enquiry against them in case they violate the substantive regulations.

In order to protect the interests of the investors, the Board should be able to initiate remedial and punitive action against the delinquent intermediaries efficiently and in a timely manner for the effective regulation of the securities market. On the basis of experience gained in the enforcement proceedings against the intermediaries so far, it is felt that the current process under the SEBI (Intermediaries) Regulations, 2008 is unjustifiably drawn-out and hence needs to be reviewed. The fact that intermediaries owe a fiduciary duty to the investors unlike other market participants, underscores the need for proceedings against the intermediaries to be conducted and concluded in a timely fashion.

Hence, to enable efficient regulation of intermediaries, the Committee has proposed rationalization of processes in the SEBI (Intermediaries) Regulations, 2008 to avoid duplicity of proceedings before the Designated Authority and the Designated Member. SEBI is required to adhere to the principles of natural justice in the course of its proceedings against an intermediary but such adherence cannot be meant to extend the application to such an extent that permits holding the system hostage at the cost of compromising the very interest of the investors. It is thus proposed that once the Designated Authority has provided personal hearing to the intermediary and submitted the report to the Designated Member, in the second stage of enquiry, the Designated Member shall, after issuing a notice to show cause and granting an opportunity of written submission to the noticee, proceed to pass an appropriate order in the matter in the interest of justice, equity and good conscience.

Part-B: Recovery of monies due under the securities laws :

Prior to July 2013, the Board was not empowered to recover amounts such as fees, penalty, disgorgement amounts or monies ordered to be refunded. Initiation of criminal proceedings for default in the payment of penalty levied by the adjudicating officer was the only action available to the Board. The results were not satisfactory, since the said proceedings were stalled for a considerable period of time due to the absence of Special Courts. Nor did they ensure actual recovery. In any case, this power did not extend to instances where the dues were not in the nature of penalties (amount due as refunds to investors, monies ordered to be disgorged and unpaid fees).

After the promulgation of two Ordinances and the Securities Laws (Amendment) Act, 2014, the Board has been vested with the power to recover the monies due under securities laws. The mechanism relating to the ‘Recovery Officer’ under the Income Tax Act, 1961 and the Rules made thereunder were made applicable with ‘necessary modifications as if the said provisions and the rules made thereunder were provisions of’ securities laws. However, the ‘necessary modifications’ are not clarified anywhere, even in the Rules made by the Central Government. Over a period of time, on the basis of experience gained, it is noted that the mechanism of Recovery Officer needs several
modifications considering that, –

(i) monies due under securities laws may be due to several persons and not just to the Central Government as is the case under the Income Tax Act, 1961;

(ii) some of the provisions of recovery inserted in the securities laws enactments are more suited for recovery in case of ‘clubbing of income’  which are not applicable in securities laws.;

(iii) the existing provisions do not take into account positive developments in law such as ‘e-auction’ which has been recognized by the Punjab and Haryana High Court in Dr. Mandeep Sethi v Union Bank of India & Ors (AIR 2013 P&H 82) and other courts subsequently.

Securities laws empower the Board to frame ‘regulations’ which are consistent with the securities laws and the Rules made thereunder and to carry out the purpose of the securities laws. Since the relevant provisions of the Income Tax Act, 1961 and the Rules thereunder have been incorporated as part of the securities laws enactments itself, the Committee is of the view that in so far as the modifications may be provisioned by way of subordinate legislation, the Board is competent to frame regulations relating to recovery while certain other modifications may be carried out by way of amendments in the securities laws enactments. Accordingly, the Committee has recommended the issuance
of comprehensive Regulations for Recovery, to clarify issues relating to recovery in the context of the securities laws. The Committee is also of the view that amending the securities laws enactments to clarify the power of the Board to make regulations relating to recovery would also obviate any unnecessary challenges in this regard.

Part-C: Quantification of profit and loss and related issues:

In the Report on the Settlement mechanism of the Board, this Committee has dealt with the factor relating to the ‘repetitive nature of the default’. In the present report, the Committee shall deal with the factors relating to disproportionate gains made and losses caused to investors by a defaulter and attempt to lay a roadmap to enable quantification of gains and losses and other incidental aspects, which are of material significance to the enforcement processes of the Board, including the settlement mechanism. The Committee had inter alia recommended that broad list of defaults which could not be settled under the previous 2014 settlement regulations could be made principle based in view of the Committee’s impending report on quantification which would enable the Board to arrive at a fair settlement. As the 2018 settlement regulations is in line with the recommendations of the Committee, this Report deals with the quantification of profit and loss due to various defaults, to the extent possible. Further, the Committee has taken note of the present non-public guidelines for quantification of profit (which do not pertain to quantification of loss to investors) used by SEBI and appear to be applicable to a limited number of ‘simple’ scenarios and do not capture the full capabilities of the technical resources available with the Board.

The Committee notes that over a period of time, securities laws violations have become complex. The Board should therefore prepare in advance for the challenges of the future and in order to do so, must also develop its technical resources to adequately assess and punish defaulters. In view of the same, the Committee advocates the use of financial economics as used in other securities jurisdictions and has re-worked the manner of quantification of profit and also provided for quantification of loss caused to the investors along those lines.

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July 2021