Is levy of penalty mandatory for Securities Laws’ violations?

– Decoding the decision of the Supreme Court in Shriram’s case

1. Is levy of penalty for violation of securities laws mandatory? Is there no discretion to the Adjudicating Officer on whether or not to levy penalty? Are adjudication proceedings a mere formality? Is intention to commit the violation totally irrelevant? And, finally, are all the preceding questions answered in the affirmative by the Supreme Court of India?

2. In the last couple of years, SEBI has repeatedly levied penalties citing certain sentences from mainly one decision of the Supreme Court. It is claimed that Supreme Court has held that if one does not comply with securities laws, levy of penalty is mandatory. Good intentions (or absence of malafide intentions) and other mitigating factors are irrelevant. It is often claimed or implied that Supreme Court had mandated Adjudicating Officers now only to find whether a particular provision is violated or not and the matter more or less ends there. They are then left with the only choice of levying a penalty – often a stiff one.

3. One of the following sentences from two decisions (listed subsequently in this post) are invariably cited.

“once the violation of statutory regulations is established, imposition of penalty becomes sine qua non of violation and the intention of parties committing such violation becomes totally irrelevant. Once the contravention is established then the penalty is to follow”

By implication particularly, the following devastating sounding sentence:-

“The Board does not have any discretion in the matter and, thus, the adjudication proceeding is a mere formality. Imposition of penalty upon the appellant would, thus, be a forgone conclusion.”

4. Amongst the numerous SEBI decisions levying penalty citing the above and, very often, doing nothing more, are the case of Platinum Finvest Private Limited – AO No. SD/AO/-46/2009 dated April 20, 2009 in which a penalty of Rs. 10 lakhs was levied for non-filing of certain reports regarding their holdings, the order in Jayesh Waghela’s case dated June 23, 2009 where a penalty of Rs. 15 lakhs was levied and the order in Santosh Narvekar’s case levying a penalty of Rs. 25 lakhs.

5. To be fair, in a few decisions, rare though, penalty proceedings have actually been dropped even if there was a violation. There are also decisions where some other factors – particularly Section 15J – are considered but the shadow of the aforesaid citations looms heavy and large. In any case, none of the decisions I came across place the aforesaid citations in context of the facts and ratio of the decisions and the other observations. The focus of discussion here is thus the fact that these citations have been given considerable weight – highly disproportionate, I feel – and quite heavy penalties levied.

6. These Supreme Court decisions are also cited in ongoing penalty proceedings and parties may thus be persuaded that their intentions, whether good or bad, are now irrelevant and adjudication proceedings are a mere formality now. Penalty is a foregone conclusion. Considering that typically SEBI has power to levy penalty of Rs. 25 crores or even more and Rs. 1 lakh per day of delay, parties may find settling through consent orders a better option rather than fight a battle that is lost to begin with since it amounts to payment of penalty where otherwise penalty may not be warranted. Of course, settling through consent order means that one is forced to accept a stiff penalty.

7. However, is it true that the above mentioned statements are really what the Hon’ble Supreme Court has decided? What was the context in which it has said that? What are the qualifications to such statements? What are the related observations? What were the facts of these decisions that led the Hon’ble Supreme Court to make these statements? And, thus, finally, what conclusions should one draw regarding the state of law on levy of penalty for violation of securities laws?

8. To begin with, the Supreme Court has said exactly what the SEBI orders say and what has been cited above. The Supreme Court has made the above statements in SEBI v. Shriram Mutual Fund (68 SCL 216 (SC)) and Swedish Match AB v. SEBI (122 Comp. Cas. 83 (SC) (2004)) respectively (Shriram and Swedish Match).

9. It is worth reviewing these decisions briefly. However, before one does that, let us consider the background of the issue.

10. Violations under securities laws could be broadly and loosely categorized between what are non-compliances of civil obligations and what amount to criminal violations. The former would typically involve civil proceedings to levy penalty, etc. while the later may result in prosecution. Securities laws have numerous provisions that amount to civil obligations such as requirements of filing of information and documents. When faced with penalty proceedings for such non-filings, parties often argue that levy of penalty requires that SEBI should prove that there was mens rea – i.e., guilty mind or intention. Furthermore, it was argued that the onus to prove the guilty state of mind was on SEBI. If SEBI could not establish mens rea, no penalty could be levied. As we will see further, the decisions of Shriram and Swedish Match have settled the law by holding that establishing of mens rea by SEBI is not an absolute pre-condition for levy of penalty.

11. However, this is what the Supreme Court has said and nothing further, if one reads the decisions as a whole, reads the same into context and reads the qualifying and incidental statements.

12. Since Shriram is the decision consistently cited, let us review this decision. In that case, Shriram Mutual Fund was alleged (all statements made in this article are allegations of SEBI and not necessarily established to be true) to have repeatedly exceeded the trading limits placed on mutual funds for dealings through associated brokers. Penalties were levied on the mutual fund and the matter went finally to the Supreme Court. The Supreme Court observed (incidentally the decision was ex parte) that this violation was conclusively established. The question then was, when such violation is conclusively established, does “imposition of penalty becomes a sine qua non of the violation”?

13. The Supreme Court described the scheme of the Act and particularly the framework for levy of penalty. It pointed out that various factors were specifically laid down as relevant for consideration for determination of the quantum of penalty, “The legislature in its wisdom had not included mens rea or deliberate or wilful nature of default as a factor to be considered by the Adjudicating Officer in determining the quantum of liability to be imposed on the defaulter”.

14. It also pointed out that the provisions that relating to penalty contained in sections 15A to 15H, etc. of the SEBI Act, 1992 provide that the violator “shall be liable” to penalty and therefore, it held that penalty is mandatory. Incidentally, it was not brought before the Court that section 15I which provides for levy of penalty by the Adjudicating Officer specifically uses the words “he may impose such penalty” as he deems fit.

15. It further held that the provisions relating to penalty under the aforesaid sections were “neither criminal nor quasi-criminal” and were actually breaches of civil obligations. Thus, it held that “Therefore, there is no question of proof of intention or any mens rea by the appellants and it is not essential element for imposing penalty under SEBI Act and the Regulations.”. This matter is perhaps well settled now.

16. The issue, however, is not whether mens rea has to be proved by SEBI or not. The issue is whether mens rea is wholly irrelevant as is claimed. Or that even absence of mens rea is irrelevant. Or that mens rea does not appear into the picture at all.

17. I submit that the only thing the Supreme Court has laid down is that there is no onus on SEBI to prove mens rea and therefore violation is sufficient by itself to attract penalty. However, mens rea is certainly a factor to determine the quantum of penalty, when the penalty provided is within a range of amount. Further, I would even submit that absence of mens rea and other mitigating factors could actually mean that SEBI should use its discretion not to levy any penalty at all. As one reads the decision further, this is also what the Hon’ble Supreme Court, I respectfully submit, has laid down.

18. One should also note the peculiar facts of the case which the Supreme Court specifically listed. Firstly, the offender was a mutual fund which can validly be expected to know the law. Secondly, the facts showed that the mutual fund had repeatedly violated the law – as many as 12 times. The nature of the restriction that was violated is also of interest. The restriction was on dealing through associated brokers beyond 5% – the intention is obvious – the mutual fund should not farm out business of brokerage to group concerns beyond a specified limit. In fact, Shriram farmed out such business to associated brokers even to the extent of 91% and 52%.

19. It was also felt that when a knowledgeable mutual fund violates the limit then, ex facie, the violation was intentional.

20. Importantly, the Supreme Court emphasized the discretion of the Adjudicating Officer in levy of penalty and held that “the quantum of penalty is discretionary”.

21. It also observed that “the respondents have wilfully violated statutory provisions with impunity and hence the imposition of penalty was fully justified”. In other words, far from holding that intention or mens rea is irrelevant, it has actually given weight to the fact that the violation was willful and this factor made the levy of penalty justified.

22. The Supreme Court further observed, “it has been established by the Adjudicating Officer as well as admitted by the respondents that there has been a conscious disregard of the obligation inasmuch as the respondents were aware that they were acting in violation of the provisions of Regulations.”. In other words, while, to begin with, there was no onus on SEBI to establish mens rea as a pre-condition to levy penalty, it itself gave full weight to the fact that the violation was a conscious one, that the mutual fund was aware that they were acting in violation and, finally, the mutual fund itself admitted that they were so conscious and aware. Thus, mens rea was given its full and due weight. In the face of such words, it cannot be contended that mens rea is irrelevant.

23. Discretion to levy penalty is actually discretion not to levy any penalty and the Supreme Court made observations which confirm this position of law. The Supreme Court observed, “The facts and circumstances of the present case in no way indicate the existence of special circumstances so as to waive the penalty imposed by the Adjudicating Officer.” In other words, it, firstly, recognized that penalty can be waived, and that under special circumstances, it should be waived. It then proceeded to discuss the various factors in that case that, on one hand justified a lesser penalty and on the other hand justified a higher penalty. An important adverse factor was whether the violation was made for benefit by the mutual fund.

24. The summary and essence of the case – which strangely none of the SEBI decisions ever cite – is beautifully and succinctly laid down in the following observation – “On particular facts and circumstances of the case, proper exercise or judicial discretion is a must, but not on a foundation that mens rea is an essential to impose penalty in each and every breach of provisions of the SEBI Act.”.

25. It is in the above light, then, the words of the Supreme Court cited at the start of this article need to be considered. To repeat, the Supreme Court observed, “In our considered opinion, penalty is attracted as soon as the contravention of the statutory obligation as contemplated by the Act and the Regulation is established and hence the intention of the parties committing such violation becomes wholly irrelevant.”. Thus, it is only for deciding the question whether penalty is to be levied or not that the intention is wholly irrelevant. However, for determining the quantum of penalty – from Re 1 to Rs. 25 crores – indeed for even waiving the penalty – intention and mens rea are very much relevant. Indeed, the Supreme Court itself in this very decision, repeatedly relied on the intention and mens rea.

26. Then let us consider the apparently even more devastating sounding words of the Supreme Court in Swedish Match that:-

“The Board does not have any discretion in the matter and, thus, the adjudication proceeding is a mere formality. Imposition of penalty upon the appellant would, thus, be a forgone conclusion.”

27. Let us first consider the facts of the case. To summarise them very briefly, in this case, the appellant was held to have violated the requirements of open offer and thus was required to make an open offer and also pay interest for the period of delay. The appellant, however, expressed concern that SEBI may levy penalty on them. The Supreme Court noted that the appellant was by the decision required to comply all with its obligations and, in fact, taking into account also the interest, the appellant was being made to pay a large amount. The question of law before the Supreme Court related to whether the open offer was required to be made or not. The issue of penalty was not at all a matter of appeal. There was no order or even Notice of SEBI relating to penalty.

28. However, the concern arose on whether, after the appellant makes the open offer, SEBI initiates penalty proceedings. The Appellant argued that SEBI cannot initiate such proceedings. SEBI’s counsel rightly pointed out that this matter was not there at all the subject matter of proceedings before the Supreme Court.

29. It is in this light the Hon’ble Supreme Court observed that since the appellant is complying with its obligations and also even paying interest, should it also face penalty the levy of which is a matter of course? It also apparently referred to a peculiar wording of the law where the penalty leviable is exactly Rs. 25 crores and not upto Rs. 25 crores. It was then it observed that in such a case, levy of penalty of Rs. 25 crores would be “a foregone conclusion” and the adjudication proceedings being reduced to a mere formality.

30. The Supreme Court then thus directed that SEBI should not initiate penalty proceedings. It gave this direction by exercising its jurisdiction under article 142 of the Constitution of India. In fact, it even stated specifically that “This may not, however, be treated to be a precedent”.

31. I submit that the issue as to whether levy of maximum penalty is automatic or not and whether adjudication proceedings are required or not were not matters for consideration before the Supreme Court. Hence, I respectfully submit these were mere obiter dicta and not considered decision on issues raised. With great respect, I would also state that that the view adjudication proceedings are now a mere formality is not correct. In any case, this decision was followed by Shriram which in fact laid down the objective factors for levy of penalty.

32. To conclude, the Supreme Court has not made job of penalty very easy such that SEBI needs only to establish the default and thereby automatically levy the maximum or even a stiff penalty. Adjudication proceedings are not a formality – at least not in the manner which the out-of-context cited statements of the Supreme Court may imply. Far from ignoring the intentions of parties, these are to be given due consideration. If very high penalties are to be levied, even mens rea or other serious aspects of the case may have to be established. It will of course also have to consider other factors such as disproportionate gain, loss caused to investors and repetitive nature of the default as mandated by Section 15J. It will have to consider mitigating factors. Of course, all these will have to be put forth by the party – obviously SEBI may not go out of its way to help the party. And, in the right and special facts, SEBI will even have to exercise its judicious discretion to waive the penalty.

33. In other words, the presumption that has been struck down is “no mens rea, no penalty”. But, there is no new rule that “violation = maximum penalty”.

– Jayant Thakur