Dave Committee on Strengthening SEBI’s Recovery Mechanism: Missed Opportunities

[Rohan Deshpande practices as a Counsel at the Bombay High Court]

On December 14, 2017, the Securities and Exchange Board of India (SEBI) formed a High Level Committee chaired by Justice Anil R. Dave, a former judge of the Supreme Court. One of the terms of reference of the Committee was to review the enforcement mechanism of SEBI, particularly the recovery mechanism under securities laws. The Committee’s report titled ‘Measures for Strengthening the Enforcement Mechanism of the Board and Incidental Issues’ was publicly notified by SEBI on June 16, 2020.

Existing provisions and the Committee’s recommendations

Before proceeding to understand the Committee’s recommendations in the context of recovery provisions (which have been previously analysed here), it is necessary to take note of the existing provisions of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”). Under section 11B, after conducting an enquiry, SEBI can issue appropriate directions in the interests of investors and the securities market, including directing disgorgement. Section 28A of the SEBI Act sets out the consequence of failure to comply with a disgorgement order issued under section 11B, or failure to pay penalty or comply with any direction for refund of monies. Under the provision, a recovery officer of SEBI is empowered to proceed against such person, being a defaulter, from whom the amount is due, by one or more modes of recovery, including attachment of the defaulter’s bank account, and attachment and sale of movable or immovable property.

For the aforesaid purpose, certain provisions of Chapter XVII, Part D of the Income Tax Act, 1961, dealing with collection and recovery of dues, along with the provisions of the Second Schedule to the Income-tax Act are stated to apply to section 28A, so far as may be applicable. Explanation 1 to section 28A of the SEBI Act further states that property transferred by a defaulter for inadequate consideration to specified relations, including spouse and minor child, on or after the amount became due under the SEBI Act, will be deemed to be the property of the defaulter, thereby enabling its recovery.

In context of these provisions, it was the view of the Committee that the recovery officer was empowered to deal with transfers made to dependent relatives referred within explanation 1 to section 28A, which, however, did not extend to corporate entities and other individuals who may have benefited. It further noted that courts or tribunals had specifically directed sale of third party assets of persons to whom monies had been allegedly siphoned off in past cases of Arrow Global and Sahara group. However, the Committee doubted if, in the absence of such directions, the recovery officer of SEBI could sell off third party assets for recovery of siphoned off monies.

Therefore, after noting the approach in the United States (“US”), where the Securities and Exchange Commission (“SEC”) disgorges unlawful gains by proceeding for recovery against ‘relief defendants’, i.e., third parties to whom unlawful proceeds have been transferred by the defaulter, and who have no legitimate claim to the funds or assets, the Committee proposed certain amendments to the recovery mechanism under the SEBI Act.

It proposed that section 11B be amended by adding an explanation clarifying that SEBI’s power to issue directions shall include and deemed to always have included “the power to direct any person to whom proceeds involved in violation, of any of the provisions of this Act, or the rules or the regulations, have been transferred to and who has no legitimate claim to such proceeds”. Another amendment to section 28A of the SEBI Act was proposed, substituting the existing explanation 1 to provide that a defaulter’s property or monies in bank accounts shall include any property or monies transferred “to any other person”, directly or indirectly, without adequate consideration, after the date when the amount become due from the defaulter.

Do the Committee’s recommendations enhance SEBI’s recovery mechanism?

The Second Schedule to the Income Tax Act is a complete code in itself, and is the backbone of recovery proceedings across various central legislation in India. The provisions of the Second Schedule are applicable to the Securities Contracts (Regulation) Act, 1956, the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, the Competition Act, 2002, and the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015. It is the view of the author that the existing provisions of the Second Schedule already provide for a legislative framework for proceeding against defaulters as well as third parties, and the recommendations of the Committee do not further strengthen the recovery mechanism of SEBI.

Rule 11 of the Second Schedule provides for investigation by the recovery officer. Where an objection to attachment or sale of property is preferred, the objector must adduce evidence to show interest in, or possession over the property. After examination, if the recovery officer finds that the objector is in possession in its own right, the officer has to release the property from attachment or sale. However, the objection shall be disallowed if it is found that the property was in possession of the objector in trust for the defaulter. The objector against whom an order is made by the recovery officer may institute a suit in a civil court to establish the right claimed over the disputed property. But, subject to the result of such suit, the order of the recovery officer is stated be conclusive. It is pertinent to note that rule 11 is not confined in its application to any specified dependant relations of the defaulter, and the same would also not be in conflict with explanation 1 to section 28A of the SEBI Act as the deeming provision under explanation 1 is merely inclusive in nature.

Rule 16(1) further provides that where a notice for payment of dues has been served on a defaulter, the defaulter or its representative in interest shall not be competent to charge or deal with any property belonging to the defaulter, except with the permission of the recovery officer. Under rule 16(2), where an attachment has been made under the Second Schedule, any private transfer or delivery of the attached property or of any interest therein is stated to be void against all claims enforceable under the attachment.

Thus, on a bare reading of the aforesaid provisions of the Second Schedule, the difficulty in effecting recovery against third parties is not attributable to the lack of an effective framework. To the contrary, the shortcoming in proceeding against third parties is attributable to the fact that proceedings under the Second Schedule have been held by the Supreme Court in Tax Recovery Officer v. Gangadhar Viswanath Ranade to be summary proceedings. Moreover, in exercise of such summary procedure, it was held that questions such as determination of title and voidability of transactions entered into by the defaulter with third parties cannot be considered by the recovery officer.

The Supreme Court held in Gangadhar Ranade that the provisions of rule 11 were analogous to rules 58 to 61 and 63 of order XXI, Code of Civil Procedure, 1908 (prior to the 1976 amendment). These rules provide for a summary investigation into possession, as distinct from a thorough trial of ultimate rights. If the attached property is claimed by a third party who adduces evidence to show that it was possessed of the property under some kind of a title, the said property will have to be released from attachment as the summary procedure under the provisions is not meant to decide intricate questions of law as to title over the property.

Further, the Supreme Court referred to its previous decision in C. Abdul Shukoor Saheb v. Arji Papa Rao, wherein it held that when a transfer is real and the transferee has entered possession, even if such transfer is liable to be set aside under section 53(1) of the Transfer of Property Act, 1882 on the ground of being a fraud on creditors, the transferee is bound to succeed in the summary proceedings. It would then be incumbent upon the unsuccessful attaching creditor to initiate a suit in the capacity of a plaintiff.

The conclusion in Gangadhar Ranade was, thus, that under rule 11 the recovery officer can examine who is in possession of the property and in what capacity. Only such property in possession of the defaulter in its own right, or in possession of a tenant or a third party on behalf or for the benefit of the defaulter can be attached. The recovery officer cannot declare any transfer made by the defaulter in favour of a third party as void and, if it is found that a property has been transferred to a third party with an intention to defraud the income tax department, a suit will have to be filed to have the transfer declared void. Even though the provisions of rule 16 were not considered by the Supreme Court in Gangadhar Ranade, it did come to the aforesaid conclusion in context of section 281 of the Income Tax Act, which is similar to rule 16.

Therefore, when the Supreme Court has conclusively pronounced in context of the Second Schedule that the recovery officer cannot determine questions of title as claimed by transferees, and deem transactions entered into by the defaulter with third parties to be void, the recommended amendments to sections 11B and 28A of the SEBI Act would, in no manner, come to the rescue of SEBI and enhance its recovery mechanism against third parties.

Suggestions for overcoming limitations on third party recovery

Present day limitations in proceeding against a third party transferee would continue to exist even if suitable amendments are introduced providing for the proceedings before the recovery officer to be substantive in nature, or as a complete alternative to jurisdiction normally exercised by civil courts. A recovery officer of SEBI would never be an impartial adjudicator vis-à-vis third parties when being called upon to determine questions concerning property which is under attachment by SEBI itself. This would violate the principle of natural justice, nemo judex in causa sua, viz., that a person cannot be a judge in his own cause. The remedy would be to seek appropriate orders (including protective orders such as provisional attachment during pendency of proceedings) from a civil court or an independent judicial body exercising all powers of a civil court.

In the past, a suitably empowered independent judicial body, albeit of an ad-hoc nature, has been created by the legislature under the Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992 (“Special Court Act”). The Special Court (constituted after the Harshad Mehta securities scam) is specifically empowered under section 9A(1) of the Special Court Act to exercise all such jurisdiction, powers and authority which were exercisable by any civil court, including “in relation to any matter or claim … relating to any property standing attached” under the Special Court Act.

Additionally, and without prejudice to other powers conferred under the Special Court Act, it is stated under section 9A(5) that the Special Court shall have the same powers as are vested in a civil court under the Code of Civil Procedure, 1908, while trying a suit in respect of the matters enumerated therein. These include the power to requisition any public record or document and to issue commissions for examination of witnesses or documents.

In context of the SEBI Act, so as to facilitate recovery against third party property, filing of suits by the recovery officer before already-burdened civil courts or creation of another judicial body may not even be required. The Securities Appellate Tribunal (“SAT”) is a functional independent tribunal with all trappings of a civil court under section 15U of the SEBI Act. It is suggested that the jurisdiction to determine the validity of third party claims against property attached by the recovery officer of SEBI may be vested with the SAT in exercise of original, and not appellate, jurisdiction. This will entail the SEBI Act being amended for this purpose, including conferring specific power upon the SAT to adjudicate upon claims over attached property similar to that of the Special Court.

Conclusion

The concept of ‘relief defendants’ in the US, as the name itself suggests, is applicable to suits where the SEC is the plaintiff, and third party transferees, from whom relief is sought, are arrayed as defendants. The onus is on the SEC to suitably demonstrate before the district court that it is entitled to seek remedies against third party transferees of the defaulter’s property.

There are various substantive defences available in law to be set up by a third party transferee in such proceedings (which are to be of a non-summary nature), including possession of legitimate title or ownership interest, adequacy of consideration, or being a bona fide transferee without notice of the impending proceedings against the defaulter or attachment of the property.

As is the case in the US, these issues require independent judicial determination, and merely enabling the recovery officer of SEBI to deal with third party claims, by way of amendments proposed by the Committee, cannot be a solution to enhancing SEBI’s recovery mechanism. In the Indian context, as suggested above, a preferable way out would be to appropriately empower the SAT to deal with claims arising against third party transferees of the defaulter’s property.

Rohan Deshpande

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