Sucheta Dalal :Sacrificing SEBI’s credibility to save NSDL
Sucheta Dalal

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Sacrificing SEBI’s credibility to save NSDL  

April 5, 2009


Members of the board of Securities and Exchange Board of India (SEBI) and the Finance Ministry have embarked on a ham-handed attempt to ensure that the National Securities Depository Limited (NSDL), that was built and headed by C B Bhave, is made to appear flawless and beyond reproach. In the process, it has suppressed a report of the two-member board committee comprising V Leeladhar (former Deputy Governor of the Reserve Bank of India) and Dr. G Mohan Gopal (the extremely highly regarded director of the National Judicial Academy) for four months since it was submitted on 4th December 2008. Now that the suppression of the report has been reported by the media and has turned controversial, SEBI and the finance ministry seem all set to discredit the committee by claiming that it “exceeded its brief.”


The background

In 2006, SEBI unearthed what it called the IPO scam or multiple-application scam. The SEBI chairman then was M Damodaran. SEBI’s investigation report was sweeping in its exposure of the negligence and bad practices of banks, depository participants as well as the two depositories – the NSDL and the Central Depository Services Limited (CDSL). Over the next couple of years, SEBI’s badly drafted report has led to mixed reactions. NSDL dragged the regulator to the Securities Appellate Tribunal (SAT) and claimed that it had not even been served a show cause notice. SEBI later issued a bizarre disgorgement order asking the two depositories and some select DPs to disgorge nearly Rs150 crore, without even bothering to establish that they were beneficiaries of ill gotten wealth due to the IPO scam.

The disgorgement order wrecked SEBI’s credibility and the entire action against NSDL was seen as a vindictive act by M Damodaran to discredit CB Bhave. What was lost in the process were pertinent issues such as the inadequate supervision of depositories, inadequate and unclear supervisory powers over its operations, its high profits earned at the cost of investors and deficiencies in its functioning. Also lost and discredited was a report by an independent IT security firm called iSec Services private limited and even prior to that a report by KPMG that had found flaws in NSDL’s operational procedures and systems. Both reports have stayed out of the public domain because of the controversy over the order against NSDL.


Ring fencing NSDL

                              Then, in February 2008, in an astonishing turn of events, C B Bhave, who was battling SEBI on many fronts, succeeded M. Damodaran as the capital market watchdog. What then happens to the many cases NSDL was fighting against SEBI, especially when Bhave was the founding chief of the depository? The finance ministry found a solution by announcing that Bhave would, at his own request, recuse himself from all NSDL issues and these would be examined by a committee comprising directors of the SEBI board. This committee would not have SEBI’s whole time directors and the finance ministry representative Dr K P Krishnan also said he would stay away. Anurag Goel, Secretary of the Ministry of Corporate Affairs said he was too busy to participate, so the committee finally comprised of Mr.Mohan Gopal and Mr Leeladhar.

Around December 2008, the SAT ruled in favour of NSDL and quashed the SEBI’s order against it. Things seemed on course for a complete clean chit to NSDL and an endorsement that its systems were beyond criticism. But it wasn’t to be. Instead, the two-member SEBI board committee found that there was some merit in SEBI’s findings about NSDL and there were also lapses on SEBI’s part in supervising the depositories. This also triggered a fire fighting exercise to suppress the report and it did remain suppressed until the Times of India reported about it a few days ago. The Times and its sister paper The Economic Times pointed out how the report was sought to be buried and quoted Mr.Mohan Gopal as saying that the two whole time SEBI directors were raising questions about the report, when they had no power to do so. He categorically said that the committee’s report was a SEBI order that could only be agitated before SAT.


Suppressing the committee report:

What then happened to SEBI’s claims about transparency if a report could be suppressed for four months? I decided to send an email to almost every SEBI board member as well as the NSDL management to get some answers.

Dr KP Krishnan, joint secretary, ministry of finance and a member of the SEBI board responded and explained that when Mr Bhave was appointed and the finance ministry decided to ring-fence NSDL-related issues, it had two choices. First, to allow TC Nair, former whole-time director of SEBI to continue the investigation and get his order vetted by a board committee; or to set up a committee with quasi-judicial authority to examine the issue afresh and pass an order. When Mohan Gopal and V Leeladhar agreed to be a part of this committee, they insisted on precise terms of reference (TOR), which were finalised after deliberations at two board meetings.

Yet, according to Dr Krishnan, their report, submitted on 4th December, “prima facie, far exceeded their terms of reference.” And, hence, the controversy or what seems like an attempt to bury it.

He also said that “because of problems with the SEBI Act” wherein the same set of issues can be adjudicated twice by two different investigation streams, almost the same set of issues that were referred to the two-member committee were also before SAT. And just around the time that SAT ruled in favour of NSDL, the SEBI committee submitted its report, and it was critical of NSDL’s systems and processes.

Is that why it was promptly buried and discredited as having exceeded its brief? And do SEBI’s whole-time members have the right to pick holes in the report without taking it to the board? Clearly, SEBI and the finance ministry are on rather thin ice on this issue.

First, Dr Krishnan says that there has been no time to take it to the board. There have been only two board meetings since V Leeladhar and Mohan Gopal submitted the report and one of these was fully occupied with discussing Satyam.


Exceeded its terms of reference?

What about the questions raised by the full-time SEBI directors and Mohan Gopal’s charge that their report can only be challenged before SAT? He told The Economic Times, “There is no provision in the law that empowers the other whole-time members of SEBI to reconsider any order issued by the panel on the completion of adjudication.”
According to Dr Krishnan, the two members were asked if they wanted to take note of SAT’s findings; they refused, saying it was a separate matter. To the ordinary person, this clearly seems like pressuring the members to fall in line with the positive order from SAT.

Mr.Gopal responded to these charges. He agrees that the terms of reference were detailed, although they did not take “two entire board meetings” to finalise.

Dr Krishnan says that, ordinarily, a report of such a committee would not go to the full SEBI board for discussion; but, in extraordinary circumstances, the board has the right to examine the order of a committee that has been delegated adjudication powers. So a board meeting will be held in the next few weeks and the order of the committee will be put in the public domain.


Arm twisting the committee:

Creating an ‘extraordinary’ situation out of the committee’s findings, delaying a discussion and having SEBI’s whole-time members pick holes about whether the terms of reference have been exceeded makes a mockery of the entire exercise of ring-fencing NSDL. In fact, it seems like the entire process is being twisted to ensure a clean chit for the depository, even if it questions the credibility of the committee.

Clearly, there are only two issues here. First, the bizarre SEBI Act that allows the same matter to be adjudicated through multiple streams. Another SAT order has already criticised this lacuna in the statute. Since SEBI’s board comprises the senior-most policymakers from RBI, Ministry of Finance and Ministry of Corporate Affairs, isn’t it extraordinary that no action has been taken to amend the statute as yet?

Secondly, instead of worrying about whether the terms of reference have been exceeded, shouldn’t SEBI be more concerned about deficiencies and lapses in the operations of the depositories and how these can be set right? After all, V Leeladhar and Mohan Gopal, iSec Services and KPMG cannot all be part of an anti-NSDL nexus.

Now that the issue is in the public domain, any ham-handed attempt to discredit its own committee, comprising eminent members, will seriously erode SEBI’s credibility as well as that of its chairman CB Bhave.

Dr. Mohan Gopal, tells us that as part of the ring-fencing of NSDL issues and to ensure an independent inquiry, it was decided that the finance ministry representative, as well as the two whole time members and Chairman Bhave would recuse themselves from the committee. That left just him, Mr.Leeladhar, Mr Goel (Anurag Goell from the Ministry of Corporate Affairs) and Mohandas Pai of Infosys.

The entire board also agreed that once an order is issued, it cannot be open to review. The board has vested the authority in the committee, or more appropriately a bench comprising Mr.Leeladhar and Mr.Gopal to dispose off all matters related to NSDL. 


Vitiating procedure to protect NSDL

Gopal further says, although there are many loopholes in the capital market regulatory system, one thing that is clearly laid down is the inquiry procedure. It says very clearly that “once a member’s order is processed, it has to be issued and served on the entity involved and published. There can be no deviation from this process.”.

According to Mr.Gopal, “Whatever the view of the board may have come up with, it cannot link it to the delivery and implementation of the order or making the report public. Instead of doing that, they want to discredit the report by getting the board to take a view on it by calling it an extraordinary situation”. He has, in several emails to SEBI and the board members, stressed on only one point -- “you must respect the process and the law; if you make an exception in this case and vitiate the rule of the law, then what will be the credibility of our regulatory processes? In a market economy we only have the law to protect us – my simple plea is, follow the law and let it take its course – that is in the long term interest of the securities market.” But, the finance ministry and SEBI are so bent on protecting NSDL and indirectly the SEBI chairman from any hint of criticism that they are in no mood to listen.

Why did Dr. Krishnan, who takes credit for Mr.Bhave’s appointment as SEBI chief, not anticipate the possibility that NSDL may not emerge lily white from an inquiry? Isn’t he responsible for rushing through the appointment and leaving the watchdog body open to embarrassment? It is not as though there were no candidates for the post either. In fact, Jaimini Bhagwati, now India’s ambassador at Brussels, was far more technically qualified to regulate the capital market and is also an upright and no-nonsense government official.

Mr.Gopal stresses that the report has criticized NSDL as well as SEBI for failing to “put in place a code of conduct for depositories and other issues”. The board is using this as an excuse to claim that “you have taken a view on SEBI and that is beyond your mandate”. However, he does not accept this contention and says that the committee only made observations about SEBI in the context of NSDL’s claim that it had specific approval from SEBI for everything it did. It also pointed out that there was no code of conduct for depositories, although there was a code for Depository Participants.


A fake ring fence?

There is also another issue. It is that the alleged ‘ring-fence’ around the chairman is not really working? After the board committee submitted its report, the whole time SEBI directors have apparently noted that the “Chairman will take a view on the report”. How is that possible? How can the chairman who is the conflicted party take a decision on the issue, especially when he has publicly claimed that he is staying away from all NSDL related issues and that was the whole purpose of setting up this bench of board members, asks Mr.Gopal.

If it is, then the Chairman ought to have no access to the report. But our information collated from multiple sources indicates that every board member has a copy of the report, including the chairman; they are also discussing it furiously with each other. The only thing that had been avoided so far is a board meeting; but that too has changed since the issue has snowballed into a public controversy. Dr K P Krishnan is now using his clout as a representative of the finance ministry to force a board discussion on the issue

A board meeting has been called on 13th April to take a view on the issue. It is clear that Mr.Gopal will be isolated at the meeting, since the other committee member, Mr.Leeladhar has completed his terms and the rest are either SEBI members, government officials or regulated entities. 

If the SEBI board discredits the committee report and vitiates the regulatory process, it will be very evident that the idea of the ring-fence was only to whitewash NSDL and wind up the IPO scam investigation. Already, most of the other orders against the smaller intermediaries have been disposed off through the consent route. The regulator will then limp along at the orders of the finance ministry with very little credibility.

Email: [email protected]



-- Sucheta Dalal