Sucheta Dalal :The Curious Case of Suppressed Orders
Sucheta Dalal

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The Curious Case of Suppressed Orders  

November 20, 2009

The machinations of the venerable directors of the Securities and Exchange Board of India (SEBI) to protect its ring-fenced chairman, CB Bhave, is threatening to ruin the credibility of the regulatory process altogether. In a system where nobody dares to criticise a powerful regulator, the story needs to be told.

When Mr Bhave took over as chairman, he was locked in litigation with SEBI over what was called the IPO scam of 2006. This involved a cabal of individuals who had colluded with some banks and depository participants (DPs) to open hundreds of fake demat accounts in order to corner big chunks of the retail investor quota in initial public offerings (IPO). SEBI passed orders against scores of individuals, DPs and the two depositories and the Reserve Bank of India (RBI) meted out crippling punishment to a dozen-odd banks (in fact, the biggest and the best ones) for lax implementation of Know Your Customer (KYC) rules. They were stopped from opening new branches for well over a year, in the middle of arguably the biggest economic boom in independent India. And they accepted the punishment without rushing off to court.

Not so the NSDL. It took the stand that its actions, its systems and its interpretation of its supervisory role and duties were so impeccable as to be beyond criticism. NSDL almost routinely rushed to the appellate tribunal against SEBI orders, because of a personality clash between Mr Bhave and M Damodaran, the previous SEBI chairman.

When Mr Bhave became SEBI chairman, the finance ministry ring-fenced him by asking a committee of the board to examine and dispose of all investigations pertaining to NSDL. It comprised Dr Mohan Gopal, a legal luminary who heads the National Judicial Academy and V Leeladhar, deputy governor of the RBI. Unfortunately, this bench did not play the role envisaged by the finance ministry and Mr Bhave. Instead of dismissing all SEBI charges, it dared to uphold a few and so the SEBI board worked hard to suppress the order for almost a year.

It was only a public interest litigation filed in the Andhra Pradesh High Court that finally forced the SEBI board to publish the order on 9th November, but with a catch. Two of the orders were declared null and void. There was also another surprise. We, the people, learnt that there were three suppressed orders, not one. One pertained to NSDL’s role in the IPO scam; the second to lapses in the dematerialisation of DSQ Software shares (it predates the IPO scam); and the third to a DP called Rajnarayan Capital Market Services Limited (RCMSL) which NSDL was apparently very reluctant to discipline.

According to the SEBI release, it had obtained a legal opinion (from C Achuthan, former presiding officer at the Securities Appellate Tribunal who now heads a SEBI committee to examine the revamped takeover regulations) to back its view that the Gopal-Leeladhar bench’s order had exceeded its terms of reference. So the orders against NSDL and DSQ Software were declared ‘null and void’ or ‘non est’ and only the one on RCMSL would be served on the parties concerned.

In effect, the SEBI board could not fault the reasoning of the Gopal-Leeladhar bench; so in order to shield Mr Bhave, it clutched on to the fig leaf that SEBI had been criticised. Does the SEBI board even have the powers to declare an order by two of its colleagues null and void? All that the order says about SEBI is that it failed to carry out its regulatory role adequately and must be proactive and not passive in order to prevent scams. It also asks SEBI to frame a code of conduct for depositories and assess the adequacy of institutional arrangements for depositories through independent experts and initiate remedial action immediately. Is this reason enough to declare the order null and void? Is the regulator beyond criticism even by its own board members? Surely this goes against the concept of good governance, irrespective of whether or not the criticism was documented in a quasi-judicial order.

As for the NSDL issues, it was decided that the “board as a whole (excluding chairman Mr Bhave) would dispose of these two matters afresh.” This ensures that with three whole-time members reporting to the chairman or the finance ministry and outside directors who are subject to their regulation, the issue will be buried. The board has fixed no timeframe to dispose of the issue.

SEBI seems to have lost sight of the fact that the orders uphold themselves. Everyone connected with the capital market is bound to read them and realise that the criticism of SEBI as well as NSDL is well-reasoned and balanced. In fact, we are at a loss to understand the elaborate machinations by SEBI to suppress the order. Has this misguided attempt to project NSDL as a flawless organisation ended up damaging it more? One thing is sure: the action has allowed its competitor, the Central Depository of Securities Limited, to go scot free.

What exactly has the Gopal-Leeladhar bench said about NSDL, DSQ Software and RCMSL? In a nutshell, NSDL is indicted for failing to detect hundreds of accounts opened by the same entity to corner the retail quota of public issues. The DSQ Software case is more dubious. NSDL dematerialised 1.3 crore shares allotted on preferential basis to four entities and allowed them to be delivered in settlement without verifying if they had obtained listing permission. It also dematerialised 30 lakh shares issued as employee stock options without the mandatory lock-in. The preferential allotment was a big scam engineered by Dinesh Dalmia who is languishing in jail for the past three years. The case pertaining to RCMSL dates back to 2003. NSDL renewed its registration although it did not meet the networth criteria, then took 30 months to terminate its DP licence and, even after this, failed to prevent unauthorised transfer of investors’ securities to a pool account because it did not deactivate the depository pool module terminal for one-and-a-half years after termination.

The Gopal-Leeladhar order in all the three cases has directed NSDL to conduct an internal inquiry and fix individual responsibility for failure to put in place appropriate systems. It also asks NSDL to conduct an independent audit of its systems and operations in different aspects of its functioning. In fact, it specifies that the directives issued to NSDL are not punitive but aimed at strengthening the regulatory framework to prevent the recurrence of large-scale fraud.

But NSDL refuses to admit any problem whatsoever; it invariably argues that everything that went wrong is due to criminal activity rather than any operational or systemic failure. But the bench has refused to accept NSDL’s “erroneous and excessively narrow view” that it is a mere operator of the depository system and a record-keeping agency. 

Quite frankly, if RBI can deliver such crippling punishment to banks for slipping up on KYC norms, it is hard to accept NSDL’s stand that it will accept no blame for failing to detect or prevent the IPO scam. In fact, one fails to understand why chairman Bhave has staked his personal reputation on the issue and ended up damaging his credibility and that of SEBI by all the manoeuvres to suppress the report.

-- Sucheta Dalal