The article is written by Anumeha Agrawal pursuing BA.LLB (Hons.) from Symbiosis Law School, Pune. On June 16, 2020, the Report of the High-Level Committee under the Chairmanship of Justice (Retd.) Anil R. Dave was published, the report provides Measures for Strengthening the Enforcement Mechanism of the Board and Incidental Issues. The report is divided into four parts the current article summarises the first part of the Report- Review of the Intermediaries Regulations.

Introduction

Intermediaries have been defined under regulation 2(1)(g) of the Regulations as: 

“Intermediary” means a person mentioned in clause (b) and (ba) of subsection 2 of section 11 and sub-section (1) and (1A) of section 12 of SEBI Act and includes an asset management company in relation to the SEBI (Mutual Funds) Regulations, 1996, a clearing member of a clearing corporation or clearinghouse suspends, foreign portfolio investors and a trading member of a derivate segment or currency derivatives segment of a stock r=exchange but does not include foreign venture capital investor, mutual fund, collective investment scheme and venture capital fund”.

However, the section is not in force as only Chaptres V, VA and VI of SEBI (intermediaries ) Regulations, 2009 have been notified but the committee looks at it to understand the regulatory perspective.

This definition includes “intermediary” as defined under Intermediaries Regulations and specifically includes and excludes specific market entities, thus this is not an exhaustive definition and even entities providing similar services as intermediaries but not mentioned in the definition will be within the Regulations’ purview.

Legislative History 

From 1992 to 2002 separate regulations were enacted to provide the separate legislative framework for each intermediary providing for registration, obligation and responsibilities and procedure for inspection and action in case of default.

During the last three decades, SEBI more than a dozen regulations have been passed with the objective of regulative an individual category of an intermediary. Some of such regulations are:

1. The Securities and Exchange Board of India (Mutual Funds) Regulations, 1996.
2. The Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999.
3. The Securities and Exchange Board of India (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008.
4. The Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012.
5. The Securities and Exchange Board of India (Infrastructure Investment Trusts) Regulations, 2014.
6. The Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014.

In 2002 the SEBI (Procedure of Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations,2002 were passed to consolidate and unify the inspection procedure and action in case of default for all intermediaries.

Currently, there is a two-tier enquiry proceeding, the first tier of enquiry is conducted by the Designated Authority. Firstly, u/r 24(1) Intermediaries Regulations the Designated Member is satisfied that an intermediary has failed to comply with conditions of registration and various SEBI regulations it appoints an officer as DA.

Then DA issues show-cause notice to the concerned intermediary as to why its registration certificate shall not be suspended. After concluding the enquiry DA submits the material findings and requirements to the DM.

If the finding is that the intermediary has violated some provisions the DM further issues show-cause notice to the intermediary as to why appropriate action should not be taken against the intermediary. After providing the intermediary with an opportunity to be heard DM passes its final order.

Need for Revision

Six years after passing the Enquiry Regulations in 2002 it was decided there is considerable overlap in the regulations pertaining to intermediaries thus there should be one consolidated, thus SEBI Intermediaries Regulation 2008 was enacted. But due to various practical issues only process of holding enquiry was notified.

According to the data available with the Committee 408 inquiry, the proceeding was pending with the Board. This high rate of pendency is due to the two-tier process, first the fact-finding process by the DA and then the quasi-judicial process by DM. This two-tier process was first enacted in SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992, before 2002 investigation reports were not mandatorily the basis of initiating action in case of default which results into the requirement of the two-tier process. The same process was adopted in the Enquiry Regulations and was once again adopted in the Intermediaries Regulations.

The current mechanism requires duplication of the entire procedure, it does not add much value to the proceedings rather delays the completion of enquiry. These exhaustive proceedings result in prolongment of the process which leads to a reduction in regulatory effectiveness and expeditiousness.

The process is similar to internal employment matters where the employer opts to provide the employee with ample opportunity to explain the alleged misconduct. The intermediaries are market participants acting in direct contact and on the fees and commissions from the investors and even operates from the payments and fees paid to them by the investors thus a direct and expeditious manner of proceedings against the intermediaries is required for the benefit of the investors.

Therefore, there is a clear need to revise the current process to reduce the excessive and unnecessary burden on the Regulator. 

Global Regulations of Intermediaries

The United States of America

The United States- Securities and Exchange Commission is their market regulator. Under section 15 of the Securities Exchange Act, 1934 it is required to register broker-dealers. The primary regulatory tasks are performed by the Financial Industry Regulation Authority, which is a private corporation and a self-regulatory organisation for intermediaries. Other intermediaries are registered with SEC under other legislations like Investment Advisers under Investment advisers Act, 1940 and Investment Companies under Investment Companies Act, 1940.

FINRA regulates the firms and professionals selling securities alike. It both writes and enforces its own rules and it also has the authority to fine, suspend or ban brokers from the market. FINRA takes disciplinary action either as a settlement or a formal complaint. When FINRA finds a violation has occurred a formal disciplinary action is vital and the Enforcement Directorate or Markt Regulation Department files a complaint with the Office of Hearing Officers.

OHO is independent of FINRA and has impartial adjudicators. The hearing is before 3 member Panels with the chairperson an employee of OHO and the other two members are industry panellists.

The decision can be appealed before the National Adjudicatory Council.

United Kingdom

The Financial Conduct Authority (“FCA”) is the regulator of investment in the United Kingdom. It is independent of the Government of UK and draws its finances from the fees charged to the members of the financial services industry. 

Section 42 of the Financial Services and Markets Act, 2000 states that FCA may grant permission to an applicant to carry on regulated activities- it is similar to granting registration.

Section 40 the Financial Services and Markets Act states the following entities can be an applicant for the said permission, an individual, a body corporate, a partnership and an unincorporated association.

Section 45 of the Financial Services and Markets Act states when an authorised fails or is likely to fail in meeting the conditions of granting the permission the FTC can cancel the permission.

Section 56 of the Financial Services and Markets Act specifies where an authorised person is not a fit and proper person to perform regulated functions FTC may prohibit any individual from performing as a specified function.

The order passed by the Authority can be referred to the Financial Service and Markets Tribunal. A further appeal lies to the order of the Tribunal to the Court of Appeal or the Court of Sessions. 

Key Recommendations and Rationale 

Enquiry Proceedings

The Committee examined the viability of allowing the two-tier enquiry for the intermediaries which do not handle funds of clients however this would require division of intermediaries under various categories. But this would not solve the problem of extra burden on the Regulator, even if only w.r.t specific intermediaries.

Another anomaly in the proposal was the potential confusion in the categorization of some intermediaries which although do not directly handle the funds of clients but their acts necessarily affect the client funds and its security like credit rating agencies.

The Committee recommended the opportunity of personal hearing, an inspection of documents, cross-examination etc., shall be granted by the Designated Authority and not by the Designated Member.

The issues of inspection of documents and /or cross-examination arise at this stage thus it seems more viable that Designated Authority grants a personal hearing. Also, only the Whole-time Members function as Designated Members which are only four resulting in further delay as the long process is to carry out before authorities which are fewer in number. Since there is no restriction on the number of Designated Authorities the Board can appoint the personal hearing before Designated Authorities is a more viable option.

The Report also clarifies by quoting several precedences like Travancore Rayons v. India and Gullapalli Nagewara Rao v AP State Road Transport Corporation stating the natural right of audi alteram partem doesn’t necessarily grant the right of an oral hearing it can also be sufficed by granting an opportunity to submit written reply. Therefore this requirement will be fulfilled in the proposed process as well, where DA will grant an opportunity to submit written statement, as well as an oral hearing and the DM, will allow a written statement submission.

Factors to be considered by DA

In present the Section 15J of the SEBI Act to provide relevant factors which are to be considered while granting a penalty under Section 15 I of the SEBI Act, but the INtermediaries Regulation lack such a provision. 

The Committee recommends incorporation of a similar provision under Intermediaries Regulation and the following factors must be given regard by the DA and DM while passing an order:

• The amount of disproportionate gain or unfair advantage, wherever quantifiable, made as a result of the default;
• The amount of loss caused to an investor/ group of investors as a result of the default;
• The repetitive nature of the default; and
• Any other relevant factor. 

Draft Regulations 

Regulation 25-28

The Committee has provided draft regulations for regulation 25, 26, 27 and 28 of Chapter V of Intermediaries Regulations incorporating the proposed recommendations.

Draft Regulation 25: Provides a procedure for holding an enquiry by DA including allowing an oral hearing.

Draft Regulation 26: Provides recommendation of action by the DA in its report.

Draft Regulation 27: Provides the procedure of passing an order by DM and explicitly states no Noticee shall have a right to seek an oral hearing.

Draft Regulation 28: Provides the factors to be taken into account by the DA or DM while passing an order.

Intermediaries Regulation solely for default

The committee has further recommended that the Intermediaries Regulations ought to be replaced by regulations which only have provisions w.r.t manner of actions in case of a default by an Intermediary, as till date only Chapter V, V-A and VI of the Intermediaries Regulations have been notified. The Committee has provided draft regulations for the same.

Conclusion

The two-tier process is an excessively time-consuming process particularly in terms of a quasi-judicial adjudication. The clogging of the matters before the Designated Members is inevitable in the current scenario as there are only four of them and the thousands of cases resulting in a disproportionate workload. Therefore the omission of an oral hearing before the Designated Members is a welcome step and will prove beneficial in reducing the dependency and the time required to dispose of one proceeding. 

However, the entire two-tier process has more demerits than merits. I recommend conversion of this process to a procedure similar to that practised by Competition Commission of India. It can be done by the incorporation of an independent investigation wing-like Directorate General and residing the adjudicating powers on the Designated Authority and Designated Member to maintain the impartiality in the adjudication process. This would serve the purpose of the two-tier process without prolonging it.

The impugned report has four parts, this was the first part to read the second part follow the link – https://blog.ipleaders.in/part-ii-sebi-high-level-committee-report-of-2020-attachment-and-recovery-proceedings/

References

• https://www.sebi.gov.in/reports-and-statistics/reports/jun-2020/report-of-high-level-committee-under-the-chairmanship-of-justice-retd-anil-r-dave-on-the-measures-for-strengthening-the-enforcement-mechanism-of-the-board-and-incidental-issues_46863.html

• https://indiankanoon.org/doc/1964183/

• https://indiankanoon.org/doc/948743/ 

• https://www.legislation.gov.uk/ukpga/2000/8/contents

• https://taxguru.in/sebi/report-measures-strengthening-enforcement-mechanism-sebi-incidental-issues.html
• https://indiacorplaw.in/2020/07/dave-committee-on-strengthening-sebis-recovery-mechanism-missed-opportunities.html#:~:text=On%20December%2014%2C%202017%2C%20the,chaired%20by%20Justice%20Anil%20R.&text=One%20of%20the%20terms%20of,recovery%20mechanism%20under%20securities%20laws.

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