Implications of SEBI (Intermediaries) (Amendment) Regulations, 2017

[Rishabh Chawla is a 5th year B.A., LL.B.(Hons.) Student, National Law Institute University in Bhopal]

Introduction

On May 26, 2008, the Securities and Exchange Board of India (SEBI) notified the SEBI (Intermediaries) Regulations, 2008 (Regulations). They provide for a comprehensive regulation over all intermediaries on various requirements such as registration, code of conduct, procedure for action in case of default, etc.

These Regulations empower SEBI to conduct inspections of registered intermediaries. This inspection can be initiated either to ensure compliance with the provisions of law, or on the basis of investor complaints, or as a matter of routine. Although different regulations may be applicable to different intermediaries, the procedure in case of inspection and investigation is almost the same. These regulations empower a ‘Designated Member’, who is a Whole Time Member (WTM) on the board of SEBI, to authorize such inspections. Such a Designated Member is authorized to initiate the investigations and then further appoint a ‘Designated Authority’, which is responsible to conduct such investigations and provide recommendations to the Designated Member. On November 21, 2017, these regulations were amended in order to usher in certain changes with regard to the person authorized to appoint such Designated Authority.

Highlights of the Amendment

The SEBI (Intermediaries) (Amendment) Regulations, 2017 have introduced the role of an Executive Director in the pre-investigation process. The Designated Member of SEBI is now only authorized to approve the initiation of proceedings against a defaulter with regard to the certificate of registration[1] Thereafter the Executive Director is empowered to appoint the Designated Authority.[2] The other remaining regulations regarding the appointment of the Designated Authority continue to be the same.

Background

On July 15, 2016, the Securities Appellate Tribunal (Tribunal), in the case of Adventz Finance Pvt. Ltd. v. SEBI ,[3] held a WTM of the SEBI responsible for misleading the Tribunal. In this case, the Tribunal gave seven weeks’ time to SEBI for hearing and disposing off the matter. A letter was the issued by the Chief General Manager (CGM) of SEBI claiming that the order has been passed by the WTM. Later it was discovered that no such order has been passed by the WTM and the alleged order was merely an endorsement on the office-note put up by a junior member, which was later signed by the WTM.

This case was marked by the Tribunal as a serious case of misconduct on the part of the concerned officials of SEBI. The order was supposed to require the application of judicial mind by the WTM, but it turned out to be a letter drafted by the junior staff. The possible reason behind such an incident is the absence of a separate adjudication wing within SEBI. In this case, there was a direct influence of the adjudicating officer (WTM) over an executive officer (CGM), to issue a misleading communication.

This case points to a fundamental error in the regulatory structure of SEBI, where there is no provision for a separate internal adjudication unit. The consequence of this type of a structure results in handling of both the adjudicatory as well as the executive functions by the same individual. By various SEBI regulations, a WTM is vested with responsibilities like furnishing statements or returns, approval of Memoranda to the Board for subordinate legislations, etc. It is thus clear that there is no shield between the adjudicatory and the executive functions of a WTM.

Position in Foreign Jurisdictions

Considering the case of United Kingdom, the regulator, i.e. the Financial Conduct Authority, provides for a board committee called Regulatory Decisions Committee. This committee is independent of the rest of the authority and performs the role of an adjudicator. Similarly, in the United States, the regulatory architecture is such that it provides for an internal separate team vested with adjudicatory functions. In the US Securities and Exchange Commission, the adjudication role is performed by independent adjudicators known as Administrative Law Judges. The basic philosophy behind such a separation of operations is the same as that which provides for an independent judiciary, which cannot be influenced by or which cannot influence the executive.

Recommendations of the Financial Sector Legislative Reforms Commission

The Financial Sector Legislative Reforms Commission was set up on 24 March 2011, by the Government of India, Ministry of Finance. This body was set up to scrutinize the legal-institutional architecture of the Indian financial sector and provide recommendations for upgrading the process. Justice B. N. Srikrishna, a former Judge of the Supreme Court of India was the Chairman of this commission.

The recommendation which concerns the instant issue was to create a separate administrative law wing, which is independent from the rest of the regulator. The crucial point was that the members of this wing should not be assigned any executive functions. These recommendations of the Commission have received both appreciation as well as criticism from the various corners of the industry.

Way Forward

The Tribunal in the above decision also issued an order to send a copy of the same to the Finance Minister as well as the Chairman of SEBI. This copy was sent to highlight the seriousness of this issue and to point out the need to take appropriate measures. The abovementioned Amendment in which the authority of a Designated Member to appoint the Designated Authority has been transferred to the Executive Director is a welcome step in the light of the issues being raised regarding the separation of functions. The Designated Member is still authorized to pass the order to initiate the proceedings under the Regulations and to act after the receipt of the recommendations from the Designated Authority. The executive function of appointing of the Designated Member, which was previously performed by the WTM, was deemed to create a burden on the official. Therefore, this amendment shall be a positive step in this regard. Also, the structural change requires substantial compliance on the part of SEBI; hence, making such small but notable changes in the current system will act as a catalyst in improving the overall regulatory structure.

– Rishabh Chawla

[1] Regulation 24(1), SEBI (Intermediaries) Regulation, 2008.

[2] Regulation 24(2), SEBI (Intermediaries) Regulation, 2008.

[3] Adventz Finance Pvt. Ltd. v. SEBI, Appeal No. 206 of 2016, Securities Appellate Tribunal, Mumbai.

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