(1) Is levy of penalty for violation of securities laws
mandatory ? Is there no discretion to the Adjudicating Officer on whether or not
to levy penalty ? Are adjudication proceedings a mere formality ? Is intention
to commit the violation a totally irrelevant factor in determining penalty ?
And, finally, are all the preceding questions answered in the affirmative
by the Supreme Court ?
(2) In the past couple of years, SEBI has repeatedly levied
stiff penalties citing certain sentences mainly from a decision of the Supreme
Court. It is claimed that the Supreme Court has held that if one does not comply
with securities laws, levy of penalty is mandatory. Good intentions and other
mitigating factors are irrelevant. And that the Supreme Court had mandated SEBI
only to find whether a particular provision is violated or not and their job
ends there. They are then left with the only choice of levying a penalty —
usually a stiff one.
(3) One of the following sentences from two Supreme Court
decisions is invariably cited :
“The Board does not have any discretion in the matter and,
thus, the adjudication proceeding is a mere formality. Imposition of penalty
upon the appellant would, thus, be a foregone conclusion.”
And, from another decision, :
“Once the violation of statutory regulations is
established, imposition of penalty becomes sine qua non of violation
and the intention of parties committing such violation becomes totally
irrelevant. Once the contravention is established, then the penalty is to
follow.”
(4) Amongst the numerous SEBI orders levying penalty citing
the above and, very often, doing nothing more, are Platinum Finvest Private
Limited – AO No. SD/AO/-46/2009, dated April 20, 2009 in which a penalty of
Rs.10 lakhs was levied for non-filing of certain reports regarding their
holdings, the order in Jayesh Waghela’s case dated June 23, 2009 where a penalty
of Rs.15 lakhs was levied and the order in Santosh Narvekar’s case levying a
penalty of Rs.25 lakhs.
(5) These Supreme Court decisions are also cited in ongoing
penalty proceedings and parties are sought to be persuaded that their
intentions, whether good or bad, are now irrelevant and adjudication proceedings
are a mere formality now. Penalty is a foregone conclusion. Considering that
typically SEBI has power to levy penalty of Rs.25 crores or even more and Rs.1
lakh per day of delay, parties find settling through consent orders a better
option rather than fight a battle that is lost to begin with since it amounts to
payment of penalty where otherwise penalty may not be warranted. Of course,
settling through consent order means that one is forced to accept a stiff
penalty.
(6) However, is it true that the above mentioned statements
are really what the Supreme Court has decided ? What was the
context in which it has said that ? What are the qualifications to such
statements ? What are the related observations ? What were the facts of these
decisions that led the Supreme Court to make these statements ? And, thus,
finally, what conclusions should one draw regarding the state of law on levy of
penalty for violation of securities laws ?
(7) To begin with, the Supreme Court has said exactly what
the SEBI orders say and what has been cited above. The Supreme Court has made
the above statements in Swedish Match AB v. SEBI, (122 Comp. Cas. 83 (SC)
(2004)) and SEBI v. Shriram Mutual Fund, [68 SCL 216 (SC)], respectively
(let us refer these decisions as Swedish Match & Shriram).
(8) It is worth reviewing these decisions briefly. However,
before we do that, let us consider the background of the issue.
(9) Violations under securities laws could be broadly and
loosely bifurcated between what are non-compliances of civil obligations and
what amounts to criminal violations. The former would typically involve civil
proceedings to levy penalty, etc., while the latter may result in prosecution.
Secu-rities Laws have numerous provisions that amount to civil obligations such
as requirements of filing of information and documents. When faced with penalty
proceedings for such non-filings, parties often argue that levy of penalty
requires that SEBI should prove that there was mens rea — i.e.,
guilty mind or intention. In other words, the argument was that a guilty state
of mind has to be proved and, further, the onus to prove it was on SEBI. If SEBI
could not establish mens rea, no penalty could be levied. As we will see
further, the decisions of Shriram and Swedish Match have settled the law by
holding that establishing of mens rea by SEBI is not a pre-condition for
levy of penalty.
(10) However, this is what the Supreme Court has said and
nothing further, if one reads the decisions as a whole, reads the same into
context and reads the qualifying and incidental statements.
(11) Since Shriram is the decision consistently cited, let us
review this decision. In that case, Shriram Mutual Fund was alleged (all
statements made in this article are allegations of SEBI and not necessarily
established to be true) to have repeatedly exceeded the trading limits placed on
mutual funds for dealings through associated brokers. Penalties were levied on
the mutual fund and the matter went finally to the Supreme Court. The Supreme
Court observed (incidentally the decision was ex parte) that this
violation was conclusively established. The question then was, when such
violation is conclusively established, does “imposition of penalty becomes a
sine qua non of the violation” ?
(12) The Supreme Court described the scheme of the Act and
particularly the framework for levy of penalty. It pointed out that various
factors were specifically laid down as relevant for consideration for
determination of the quantum of penalty, and that “The Legislature in its wisdom
had not included mens rea or deliberate or wilful nature of default as a
factor to be considered by the Adjudicating Officer in determining the quantum
of liability to be imposed on the defaulter”.
(13) It also pointed out that the provisions relating to
penalty contained in S. 15A to S. 15H, etc. provide that the violator ‘shall be
liable’ to penalty and therefore, it held that penalty is mandatory.
Incidentally, it was not brought before the Court that S. 15I which provides for
levy of penalty by the Adjudicating Officer specifically uses the words ‘he
may impose such penalty’ as he deems fit.
14) It further held that the provisions relating to penalty under the aforesaid Sections were ‘neither criminal nor quasi-criminal’ and were actually breaches of civil obligations. Thus, it held that “Therefore, there is no question of proof of intention or any mens rea by the appellants and it is not essential element for imposing penalty under SEBI Act and the Regulations.” This issue is thus well settled now.
15) The issue, however, is not whether mens rea has to be proved by SEBI or not. The issue is whether mens rea is wholly irrelevant as SEBI claims. Or that even absence of mens rea is irrelevant. Or that mens rea does not appear into the picture at all.
16) I repeat and submit that the only thing the Supreme Court has laid down is that there is no onus on SEBI to prove mens rea as a pre-condition to levy penalty. Violation is by itself sufficient to attract penalty. However, mens rea is certainly a factor to determine the quantum of penalty, when the penalty provided is within a range of amount. Further, I would even submit that absence of mens rea and presence of other mitigating factors should actually mean that SEBI should use its discretion not to levy any penalty at all. As one reads the decision further, this is actually what the Supreme Court has laid down.
17) One should also note the peculiar facts of the case which the Supreme Court specifically listed. Firstly, the offender was a mutual fund which is expected to know the law. Secondly, the facts showed that the mutual fund had repeatedly violated the law – as many as 12 times. The nature of the violation that was violated is also of interest. The mutual violated the restriction on not dealing through associated brokers beyond 5% – the intention of the restriction is obvious – the mutual fund should not farm out business of brokerage to group concerns beyond a specified limit. In fact, the mutual fund farmed out business even to the extent of 91% and 52% in a couple of cases.
18) It was also felt that when a knowledgeable mutual fund violates the limit, then ex facie, the violation was intentional.
19) Importantly, the Supreme Court emphasised that the discretion of the Adjudicating Officer in levy of penalty and held that “the quantum of penalty is discretionary”.
20) It also held that “the respondents have wil-fully violated statutory provisions with impunity and hence the imposition of penalty was fully justified”. In other words, far from holding that intention or mens rea is irrelevant, it has actually given weight to the fact that the violation was wilful, made with impunity and this factor made the levy of penalty justified.
21) The Supreme Court further observed, “it has been established by the Adjudicating Officer as well as admitted by the respondents that there has been a conscious disregard of the obligation inas-much as the respondents were aware that they were acting in violation of the provisions of Regulations.”. In other words, while, to begin with, there was no onus on SEBI to establish mens rea as a pre-condition to levy penalty, the Court itself gave full weight to the fact that the violation was a conscious one, that the mutual fund was aware that they were acting in violation and, finally, the mutual fund itself admitted that they were so conscious and aware. Thus, mens rea was given its full and due weight as regards the quantum of the penalty and also as regards whether the discretion to waive penalty should be exercised or not. In the face of such words, it does not at all lie on SEBI to contend that mens rea is irrelevant.
22) I submit that discretion to levy penalty is actually discretion not to levy any penalty and the Supreme Court made observations confirming this position of law. The Supreme Court observed,” The facts and circumstances of the present case in no way indicate the existence of special circumstances so as to waive the penalty imposed by the Adjudicating Officer.” In other words, it, firstly, recognized that penalty can be waived, and that under special circumstances, it, should be waived. It then proceeded to discuss the various factors in that case that, on one hand justified a lesser penalty and on the other hand justified a higher penalty. An important adverse factor was whether the violation was made for benefit by the mutual fund.
23) The summary and essence of the decision – which strangely none of the SEBI decisions ever cite is beautifully and succinctly laid down in the following observation – “On particular facts and circumstances of the case, proper exercise or judicial discretion is a must, but not on a foundation that mens rea is an essential to impose penalty in each and every breach of provisions of the SEBI Act.”
24) It is in the above light, then, the words of the Supreme Court cited at the start of this article need to be reread. To repeat, the Supreme Court observed, “In our considered opinion, penalty is attracted as soon as the contravention of the statutory obligation as contemplated by the Act and the Regulation is established and hence the intention of the parties committing such violation becomes wholly irrelevant.” Thus, it is only for deciding the question whether penalty is to be levied or not that the intention is wholly irrelevant. However, for determining the quantum of penalty – from zero to Rs.25 crores – indeed for even waiving the penalty intention and mens rea are very much relevant. Indeed, the Supreme Court itself, in this very decision, repeatedly relied on the intention and mens rea.
25) Then let us consider the apparently even more drastic words of the Supreme Court that in Swedish Match’s case that, “The Board does not have any discretion in the matter and, thus, the adjudication proceeding is a mere formality. Imposition of penalty upon the appellant would, thus, be a forgone conclusion.”
26) Let us first consider the facts of this second case. To summarise them very briefly, in this case, the appellant was held to have violated the requirements of open offer and thus was required to make an open offer and also pay interest for the period of delay. The appellant, however, expressed concern that SEBI may levy penalty on them. The Supreme Court noted that the appellant was by the decision required to comply with all its obligations and, in fact, taking into account also the interest, the appellant was being made to pay a large amount. The Supreme Court had already decided the dispute of law before it as to whether the open offer was required to be made or not. The issue of penalty was not at all a matter of appeal. There was no order or even Notice of SEBI relating to penalty.
27) However, the concern arose on whether, after the appellant makes the open offer, SEBI may initiate penalty proceedings and even levy a penalty of Rs.25 crores. The appellant argued that SEBI cannot initiate such proceedings. SEBI rightly pointed out that this matter was not at all the subject matter of proceedings before the Supreme Court and therefore should not be discussed or decided.
28) It is in this light that the Supreme Court raised the concern that since the appellant is complying with its obligations and also even paying interest, should it also face penalty the levy of which is a matter of course. It also apparently referred to a peculiar wording of the law where the penalty leviable is exactly Rs.25 crores and not upto Rs.25 crores. It observed that in such a case, levy of penalty of Rs.25 crores would be ‘a foregone conclusion’ and the adjudication proceedings being reduced to a mere formality.
29) The Supreme Court thus directed that SEBI should not initiate penalty proceedings. It gave this direction by exercising its jurisdiction under Article 142 of the Constitution of India. In fact, it even stated specifically that “This may not, however, be treated to be a precedent”.
30) I submit that the issue as to whether levy of maximum penalty is automatic or not, and whether adjudication proceedings are required or not were not matters for consideration before the Supreme Court. Hence, at best, these were mere obiter dicta and not a considered decision on issues raised. With great respect, I would also state that the view that adjudication proceedings are now a mere formality is not correct. In any case, this decision was followed by Shriram which in fact laid down the objective factors for levy of penalty.
32) To conclude, unfortunately for SEBI, the Supreme Court has not made its job easy so that it needs only to establish the default to levy the maximum penalty. Adjudication proceedings are not a formality – at least not in the manner which SEBI would like us to believe. Far from ignoring the intentions of parties, SEBI will have to consider them. If it wants to levy very high penalties, it may even have to establish mens rea. It will have to consider other factors such as disproportionate gain, loss caused to investors and repetitive nature of the default. It will have to consider mitigating factors. Of course, all these will have to be put forth by the party – obviously SEBI may not go out of its way to help the party. And, in the right and special facts, SEBI will even have to exercise its judicious discretion to waive the penalty.
32) In other words, the presumption that has been invalidated is ‘no mens rea, no penalty’. But, there is no new rule that ‘mere violation = maximum penalty’.
