Delhi High Court Circumscribes SEBI’s Power to Initiate Adjudication Proceedings

Independent regulators must demonstrate their independence and fairness in their actions in order to maintain credibility. For this, the process by which they carry out their actions must be robust. This applies equally to India’s securities regulator, SEBI, which is the earliest independent regulator in the post-liberalisation era and one that heralded the advent of an array of similar regulators in other sectors.

In a decision that is likely to have wide-ranging ramifications on SEBI’s functioning, the Delhi High Court earlier this month set aside adjudication proceedings in Amit Jain v. Securities and Exchange Board of India. The Court found that SEBI had failed to follow the requisite procedures for initiating adjudication proceedings. This is likely to affect nearly 1,500 adjudication proceedings pending before SEBI, requiring it to introspect on the manner in which it carries out such actions.

In the Amit Jain case, SEBI had initiated adjudication proceedings on the ground that Mr. Jain had acquired more than 5% shares in a listed company and failed to disclose the same as required under the erstwhile SEBI (Prohibition of Insider Trading) Regulations, 1992 (the “PIT Regulations”). A meeting of the Group of Assistant General Managers of SEBI recommended that the regulator take action against him and certain other persons. A Whole Time Member (“WTM”) of SEBI received recommendations and noted in the file that an adjudicating officer be appointed in the case. When the adjudicating officer so appointed issued a notice and initiated proceedings, the petitioner mounted a challenge before the Delhi High Court in a writ petition under Article 226 of the Constitution.

Two legal questions of importance arose before the Delhi High Court. The first was whether the WTM “had formed an opinion that there were grounds for adjudging penalty” under section 15A(b) of the SEBI Act, 1992, namely the statutory provision that prescribes penalty for failure to furnish information. The second was whether the WTM was required to pass an order under regulation 14 of the PIT Regulations before initiating adjudication proceedings. In other words, the issue is whether the proceedings for finding of a violation on the one hand and adjudication proceedings for imposition of penalties are sequential or whether they can go on in parallel.

On the first question, the crux of the case is whether the adjudication proceedings are without jurisdiction because the WTM (which is delegated powers from the SEBI Board for this purpose) had not “formed any opinion that there are grounds for adjudging” under the relevant provisions of the SEBI Act. Based on an interpretation of rule 3 of the SEBI (Procedure for Holding Enquiry and Imposing Penalties by Adjudicating Officers) Rules, 1995, the Court held:

33. It is apparent from the above that the formation of an opinion by the Board that there are grounds for adjudging under any of the provisions of Chapter VIA of the Act is a pre condition for appointment of an Adjudicating Officer. It follows that in absence of such an opinion, an Adjudicating Officer cannot be appointed and any such appointment would be without jurisdiction.

On the facts of the case, the issue arose whether the WTM can merely note the appointment of an adjudication officer as evidence of application of mind, or whether something more was required. Here, the Court expanded its analysis:

35. This Court is of the view that the noting made by the Whole Time Member cannot be read as an expression of his opinion that there are grounds for adjudging under Chapter VIA of the Act, which is a pre condition for appointment of an Adjudicating officer. The contention that the Whole Time Member was required to give reasons and pass an order is unmerited. There is no such requirement under the Rules. Further, an opinion to be formed is also not a judicial or quasi judicial order, which would require the Whole Time Member to articulate his reasons in detail. However, he as a delegate of the Board is required to examine the allegations made and independently form and express an opinion that there are grounds for adjudging under Chapter VIA of the Act.

36. The formation of an opinion that there are grounds for adjudging under Chapter VIA of the Act is the necessary pre-requisite for the Board to exercise its jurisdiction. Absent such opinion, the Board would have no jurisdiction to appoint an Adjudicating Officer. There is no dispute as to the above proposition. The only controversy is whether the fact that the Board (Whole Time Member) had formed such opinion can be inferred from appointment of the Adjudicating Authority. Plainly, there is no scope for inferring formation of such opinion merely for the reason that an Adjudicating Officer has been appointed and other officers have forwarded their recommendations for such an action. As stated above, the Board has to form an independent opinion that there are grounds for adjudging under Chapter VIA of the Act. It is not necessary for the Board to elaborate its opinion or to provide reasons for the same. However, the least that is required for the Board is to state in unequivocal terms that in its opinion, there are grounds for adjudging under Chapter VIA of the Act before proceeding to appoint an Adjudicating Officer. It is necessary that the record clearly bears out that there is an application of mind on the part of the Board. The power to appoint an Adjudicating Officer has been delegated to the Whole Time Member. Therefore, it was necessary for him to have formed such opinion before proceeding further.

By this, the Court has sought to set out a precarious balance among various factors to determine the WTM’s application of mind. The mere appointment of an adjudicating officer is insufficient. At the other extreme, it is not necessary for the WTM to set out reasons for arriving at a conclusion. The truth lies somewhere in between. Although the Court does not clarify the circumstances that indicate the WTM’s application of mind or provide concrete guidance in this regard, the matter would depend upon the facts and circumstances of each case based on the actions taken by the WTM. This is because the Court only identifies instances (such as the ones that occurred in this case) that are impermissible, but does not clearly lay out those that are desirable. This will require SEBI to review its internal processes and establish proper procedures to ensure they do not transgress into the types of situations the Court has identified.

On the second issue, the Court adopted a more measured approach. It rejected the petitioner’s contention that SEBI must first exhaust the procedure under the PIT Regulation to determine a violation therefore before turning to adjudication proceedings. The Court noted:

30. … It is clear from the scheme of PIT Regulations that the Board is duly empowered to conduct investigations and pass orders under PIT Regulations and issue directions as specified under Regulation 11 of the PIT Regulations. However, the said procedure does not impinge or any way dilute the powers of the Board to otherwise take action under the provisions of Chapter VIA of the Act. In view of the above, the contention that the Board was first required to determine whether the petitioner had violated the PIT Regulations before appointing an Adjudicating Officer under Section 15-I of the Act is unmerited. …

In that sense, SEBI is entitled to initiate parallel proceedings under the relevant regulations or even the SEBI Act for determining violations or to pass other orders (such as debarring persons from accessing the stock market) as well as adjudication proceedings for levying penalties. These are not sequential in nature.

Although vindicated by the Court, SEBI’s approach of initiating parallel proceedings has come under some criticism. For instance, in a paper titled “Improving the legal process in enforcement at SEBI”, Ms. Dharmishta Raval notes:

The procedure followed for issuing directions under Section 11 and 11(B) of the SEBI Act, 1992, passing punitive orders against [an] intermediary, and imposing monetary penalty are different under the Act. Three different procedures are prescribed under the Act, rules and regulations when taking disciplinary proceedings. This often becomes a cause for confusion to investors and noticees as to what procedure which will be followed by SEBI to pass orders under the SEBI Act, 1992.

For example, when enquiry proceedings are initiated and an enquiry officer is appointed, the noticees are not aware that the enquiry officer is only a fact finding authority and will only recommend the penalty. Or that the final orders will be passed by the WTM only after issuing a second show-cause notice which officers an opportunity of hearing. While for the purpose of issuing directions under Sec 11 or Sec 11B, there is only one stage proceedings wherein the WTM is a fact finding authority and also the final authority issuing directions like directing the notice not to access the securities market, not to buy or sell any securities, etc.

Any review of SEBI’s processes will have to include these aspects as well.

Update – 11 August 2017: A Division Bench of the High Court in Securities and Exchange Board of India v. Amit Jain (on 31 July 2017) has temporarily stayed the aforesaid judgment of the single judge, noting:

Hat-tip: Sumit Agrawal