The regulator can no longer be selective about the cases in which it would flex its muscle and those in which it would plead an absence of power
It has taken a long time coming — but after 28 years, finally it’s here. The Securities and Exchange Board of India (Sebi) has notified an amendment to regulations prohibiting fraudulent and unfair trade practices to include fudging of accounts of listed companies as a fraudulent practice relating to securities markets.
The regulations have been amended to clarify that “any act of diversion, misutilisation or siphoning off of assets or earnings of a company whose securities are listed” shall be deemed to have been considered as manipulative, fraudulent and an unfair trade practice in the securities market. Likewise, “any concealment of such an act or any device, scheme or artifice to manipulate the books of accounts or financial statement of such a company that would directly or indirectly manipulate the price of securities of that company” shall always be deemed to have been considered in the same manner.
The journey to get here has been a piquant one. The regulator of the market had long held a belief that it does not have jurisdiction over the manufacturer of products traded in the market, and only has jurisdiction over those who trade in the market. With that approach, came the practice of stating that Sebi had no power to act against companies where accounting fraud took place. This enabled a completely arbitrary pick-and-choose practice, with Sebi choosing to argue when it wanted, that it had no jurisdiction, and at other times, making the case that any malcontent in financial information and book-keeping would necessarily have an impact on trading in the securities of that issuer, enabling Sebi to act.
The Bombay High Court was once faced with a unique situation when before the same judge, Sebi swore on oath in one case that it did not have jurisdiction to act against accounting fraud, while in another case, it swore on oath that its order directing a company and its promoters to bring back monies alleged siphoned out, was fully within its jurisdiction. Indeed, even within the same case, inherent contradictions were seen — in the Satyam scandal, Sebi tested its powers to go after the statutory auditors stating that their quality of audit was actionable within its jurisdiction but did not go after the promoters and management of Satyam for accounting fraud. It only went after the promoters’ trades in securities during the period of the fraud.
Since inception, Sebi has written legislation to regulate brokers, merchant bankers, mutual funds and the like — essentially, market intermediaries that transact in securities — but has refrained from writing regulations to govern the issuer of the securities. It is not as if Sebi did not stipulate requirements to be met by issuers, but the stipulations were set out in “guidelines” as opposed to “regulations”.
Regulations are “subordinate law” — made by authority conferred by Parliament. Since Parliament, the supreme law-making body of the Republic, delegates authority to make regulations, once made, the regulations are required to be tabled in Parliament. They become an integral part of the law fusing their legal status with the parent law. As Sebi believed it does not have jurisdiction over issuers of securities, it only made “guidelines” governing “disclosure and investor protection”, to stipulate what disclosures must be made in a securities offering. Guidelines, not being provided for in law made by Parliament, are not scrutinised by Parliament, and do not carry the same weight as regulations.
While the Disclosure and Investor Protection (DIP) Guidelines governed disclosures at the time of a securities offering, ongoing disclosures were stipulated only in an instrument called the “listing agreement” executed between issuers and stock exchanges. Until 1995, the term “listing agreement” was not even referred to in any law made by Parliament. The Securities Contracts (Regulation) Act, 1956, was then amended to provide that a company listed on a stock exchange must comply with the listing agreement with that stock exchange. Different companies were governed by different terms — depending on the state of play of the agreement required to be signed at the time they got listed. What the agreement should contain when it was executed was stipulated in a model listing agreement that Sebi would stipulate, again outside of any regulatory provision.
The “DIP Guidelines” eventually were codified into regulations governing issue of capital only a decade ago. The requirements of listing agreement got codified into regulations governing listing obligations just five years ago. Even while these developments took place, it was completely open to Sebi to blow hot and cold about whether it actually had jurisdiction over accounting fraud, misstatement of financial information and siphoning off of funds from a listed company. A “forensic accounting cell” in Sebi was formed, sending letters to companies and asking audit committees to examine issues that it suspected, but without a statutory conviction that Sebi could actually act when fraud is detected, in the absence of any specific transactions in securities being on the table for consideration.
All that uncertainty has come to an end now. The regulator can no longer be selective about the cases in which it would flex its muscle and those in which it would plead an absence of power.The writer is an advocate and independent counsel