For the Securities and Exchange Board of India (Sebi), it is one step forward and another back.
Only a week ago its decision to scrap discretionary allotment for institutional investors and end their mischief in Initial Public Offerings (IPOs) was appreciated by the global community of regulators. Sebi had done what the most powerful regulators in the world have hesitated to do, in order to ensure that Indian retail investors are not duped by trumped-up subscription numbers trumpeted in the first few minutes after the subscription books are thrown open.
But its reputation took another severe blow last week when the Securities Appellate Tribunal (SAT) set aside its case against UBS Securities Asia on almost all counts.
To recap, the investigation pertains to the stock market meltdown of May 17, 2004, when UBS Securities Asia emerged as one of the biggest sellers in the early minutes of trading. Sebi was unable to establish any price manipulation but UBS’s persistent obfuscation and delays in parting with details about four of its investors had led to action under Sebi’s Know Your Client (KYC) rules. Sebi punished UBS by barring it from issuing offshore derivatives instruments (ODIs) including participatory notes (PNs) for a year. UBS appealed against the decision questioning the applicability of Sebi’s disclosure rules.
Sebi’s initial order had attracted a volley of criticism. To my mind, the flak is indicative of FIIs’ resentment at one of their ilk being punished by an emerging market regulator.
Much of the criticism was silenced after the case took a bizarre twist and the SAT Presiding Officer stunned the market by suggesting that Sebi should consider a ‘‘form of plea bargain’’ as an innovation and mull over the possibility of accepting a penalty of Rs 50 crore in lieu of further proceedings.
SAT also demanded clarity from Sebi on the applicability of its KYC for FIIs. Within days of this suggestion, the SAT Presiding Officer Justice K. Rajarathinam recused himself from the case, claiming to be upset over the Sebi counsel’s press statements. He even tendered his resignation, but was apparently persuaded by the Finance Minister to continue in office. He has since resumed hearings. The reasons for his various decisions remain shrouded in mystery and UBS has never reacted to the plea bargain suggestion.
The upshot was that the UBS’s appeal against the Sebi order was heard by the other two SAT Members — C. Bhattacharya, a former managing director of the State Bank of India, and R.N. Bharadwaj, a former chairman of the Life Insurance Corporation (LIC).
Although the full order was not available when this column was written, the SAT members reportedly ruled, ‘‘We do not find any reason to uphold the orders under Section 11 B and Section 11 (4) of the Sebi Act. We set aside the impugned order and uphold the appeal on basis of the fact and circumstances of the case.’’
However, they did not accept UBS’ claim for compensation and recommended that the regulator was ‘‘free to take any action if it so desires and if there is a prima facie case under any of the provisions of the Sebi Act, 1992 and FII regulations thereunder.’’
Essentially, SAT has objected to the use of Sebi’s powers under section 11 (4) and 11B, which allow the regulator to intervene in order to safeguard the market. The tribunal has ruled that these powers cannot be used to penalise violation in the absence of any emergency.
If the issue were really as clear as that, wasn’t SAT being unfair to UBS Securities by suggesting a ‘plea bargain’ and a payment of Rs 50 crore? In retrospect, Sebi should have grabbed the plea bargain deal with alacrity.
We learn that there is some issue over whether the ‘plea bargain’ proposal had come from the Presiding Officer alone or was worded as a suggestion from the SAT bench. If it is the latter, this detail is bound to come up in Sebi’s appeal against the ruling before the Supreme Court.
Sebi ources say there are many issues of law that have been raised or left unanswered by the SAT findings. Specifically, the regulator would seek clarity on its use of powers available under Section 11B of the Act. Especially since the apex court has, in one interim order, stayed a SAT ruling that ‘‘direction under section 11B of the Sebi Act could only be a remedial measure and not a punitive one.’’
Another area that needs clarification is how precise should Sebi’s KYC norms be in the context of global capital flows, where hedge funds and investors operate through various tax havens. The Joint Parliamentary Committee investigating Scam 2000 had said: ‘‘It should also be ensured that this instrument (PN) is not misused in any way to manipulate the Indian securities market.’’
This led to the market regulator’s KYC rules mandating the disclosure of ultimate beneficial ownership of PNs. Can the norms be made any more precise than they already are without damaging the FII investment climate? And if not, are these rules meaningless?
Technically, the SAT ruling allows the regulator to continue its investigation into UBS’s dealings. But that may be unwise. A preliminary investigation report into Manic Monday, available with this writer shows that the investigation was badly handled and remains shrouded in secrecy. Officers, in charge of the investigation have been changed and there is no clarity about the status of many showcause notices issued after the stock crash, including investigation of dubious domestic investors and brokerage firms.
Instead of raking up the quality of past investigation, this may be a good time for Sebi Chairman M. Damodaran to commission an independent inquiry by legal experts on SAT orders issued in favour of, or against the regulator. The inquiry should provide the regulator a true and objective assessment of the quality of its investigation, drafting of its orders as well as the presentation and handling of its appeals before SAT.
This must, once and for all, settle the issue of whether SAT is being unduly harsh on Sebi or does the regulator need to clean up its act and dramatically improve its supervision and legal functions.