One of the tricky issues that chairman M Damodaran has to grapple with at the Securities and Exchange Board of India (Sebi) is the role of his own officials in issuing weak orders or showcause notices. Sebi’s entire investigation team is certainly not venal or incompetent, but a couple of bad eggs are enough to give the organisation a bad name and to cause long-term damage by turning bad decisions into a precedent for future cases.
The latest in a list of such issues is a case where Sebi’s own adjudication officer has ruled, after a lengthy discussion, that the filing of false and misleading information under section 15A of the Sebi Act is not a punishable offence. The order arrives at this outrageous conclusion on the grounds that the Act does not have any specific provision for imposing monetary penalty where the information filed by a person is wrong or misleading. On the other hand, not filing information under the relevant section is, indeed, punishable under the Sebi Act, with a heavy penalty starting at Rs 1 lakh a day, going up to a Rs 1 crore.
In a disclosure-based regulatory environment, this means that dubious companies and market intermediaries can now have a field day. And, investors can no longer rely on the accuracy of information filed in IPO offer documents or under the takeover rules, because the information could well be false. The only thing to stop a company or market intermediary filing untrue or disingenuous information is its own ethical constraint.
Consider how peculiarly this would work. Sebi itself takes no responsibility for the accuracy of information filed in IPO documents. Although it offers its comments, it actually holds the investment bankers responsible for ensuring factual accuracy. Sebi’s ruling now suggests it can do little to punish them under its adjudication proceedings. These proceedings allow Sebi to levy stiff penalties, while an inquiry proceeding should lead to a reprimand, suspension or a cancellation of registration. Since Sebi apparently has no specific powers to punish the filing of false information, such mischief may not have fetched even a reprim-and under the inquiry process.
Interestingly, the order has caused plenty of outrage and consternation within the regulatory body. Any adjudication official would have realised that his unusual conclusion, although logically argued, would have far-reaching consequences. That alone should have prompted him to discuss the issue with his seniors before issuing the order. A smart regulator would then have relied on other powers to deal with the problem differently, in order to avoid bizarre conclusions and consequences. Chairman Damodaran immediately moved the officer out of the adjudication function, without assigning him a new portfolio. But the damage is already done.
• Filing false information isn’t punishable, a Sebi official has ruled
• Sebi is preparing the case for rule changes to check such damage
• Yet, it also needs to clearly show it holds its people to strict standards
Clearly, this lacuna in the Sebi Act (the order has relied on the Justice Kania committee report, which notes that Sebi has no specific powers to punish filing of false and misleading information) will have to be urgently rectified through a suitable amendment.
There are many other cases where Sebi has discovered that the actions of its officials are a cause of serious embarrassment. For instance, market sources say one investigation official is known for her benevolence towards wrongdoers and often recommends just a one-day suspension for even fairly serious offences. The chairman will have to examine such allegations by studying several orders by the individual and act on the conclusions.
The investigation into JM Morgan Stanley in connection with the crash in stock prices on May 17, 2004, is another curious example. A showcause notice was issued, but the company was ultimately let off on the grounds of impossibility of enforcing the Sebi orders. In this case, Morgan Stanley was asked to produce telephone records of dealing room conversation a month after the debacle. Sebi rules do not mandate this and JM does not maintain records for more than a month. In that case, why was a notice issued to the company when Sebi clearly didn't have a case?
In the Alka Synthetics/Magan Industries case, a senior Sebi official (who is no longer with the organisation) allegedly issued two contradictory orders. One was in favour of the accused and the other was against the entity. Naturally, the accused chose to follow the order that favoured its actions. The official responsible for this dubious behaviour got away unpunished. During that phase, files pertaining to several important investigations are also understood to have gone missing from Sebi.
Mr Damodaran is hoping to persuade the government to consider a series of measures to mitigate this damage and to give it some operational manoeuvrability. This includes a two-stage adjudication procedure, whereby there is some room for appeal and revision of orders within the organisation itself, before going to the Securities Appellate Tribunal (Sat). Sebi is also pushing for the introduction of plea bargaining, to ensure swifter action against wrongdoers without cluttering court time. Fortunately for Sebi, the Sat presiding officer’s controversial suggestion that the former consider a plea bargain in the UBS Securities case (again in connection with its May 17, 2004 trades) will strengthen Sebi’s case for specific powers to enter into plea bargains in order to catch the bigger culprit or avoid lengthy and expensive adjudication and appellate proceedings.
This still leaves the question of integrity and competence of Sebi’s own officials. The regulator can discipline market intermediaries only if its own officials are strictly accountable. This means hiring the right people and sacking the occasional mischief maker to signal its seriousness.