By Jayant M. Thakur
Chartered Accountant
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SEBI has recently, on 25th May 2012, made significant amendments to its guidelines for settlement of violations. In the process, they have made them so complex that, from the initial do-it-yourself simple scheme, now the new Scheme has made involving lawyers and accountants almost inevitable. There are several positive changes though and particularly some of the major criticisms of the earlier scheme have been addressed.
To recollect, in 2007, SEBI had introduced guidelines for settlement of alleged violations through consent orders and, in case of prosecution, through compounding. The Scheme was very simple and widely framed in its drafting and implementation. Any violation at any stage of punitive proceedings (or, even without proceedings) could be settled. The arbiter of what should be the agreed terms of settlement was an independent Committee (called High-Powered Advisory Committee or HPAC) though, being a voluntary settlement, obviously both sides had to agree. The settlement was usually very swift in practice, the procedures being so simple that even an educated layman could apply for it — and many did. Even the HPAC was co-operative in this regard and, in fact, as an unwritten rule, legal arguments and submissions were neither required, nor generally entertained though a fair and patient hearing was granted. Simple and brief orders were passed so that the spirit of the Settlement Scheme was upheld and a person who has not been held guilty was not seemed to be held guilty by the settlement order.
But, as was almost inevitable, the seeds of malaise were in the simplicity of the Scheme itself and serious concerns were raised. A major concern was that serious violations got settled and the stringent and exemplary punishment required in some cases was avoided through monetary penalties, even if those that appeared to be large. The settlement process was also felt to be opaque. Wide differences in settlement amounts were observed with no reason expressed explaining this and the brief orders giving no further clues. Settlement proceedings were sometimes felt to be used for delaying the regular proceedings. Inevitably, allegations — though unsubstantiated — of corruption were also made.
SEBI has taken the experience and criticism both of 5 years seriously — perhaps too seriously. Several types of serious violations have been put on the negative list though a small window of discretion even for such violations has been kept open. Many of the actual procedural details of the internal process of settlement have been formalised and made transparent. The time limits of making the application — both the earliest and the last dates — have been specified. A significant amendment is the introduction of a very detailed and fairly complicated method of determining what would be the amount at which a particular type of violation having the specified features would be settled. This is obviously to partly remove the discretion involved. On the other hand, it makes the settlement process complex requiring professional help unavoidable. The process itself becomes mechanical which to some extent is antithesis of a settlement process.
Let us consider some important amendments proposed.
First is the
negative list of those violations for which
settlement is not permitted. But before we examine some of important items in this list, some thoughts on what is the purpose of the settlement process. The objective of settlement is quite obviously to shorten the proceedings for investigating and punishing violations of securities laws. SEBI is benefitted as it saves time and costs, has the benefit of not having to prove the violation in accordance with due process of law and often also has the benefit of the party’s cooperation. Importantly, a punishment — even if lower than what could have been levied if the allegation had been proved — is also meted out. The party accused also saves on time and costs, gets benefit of a lower penalty and also does not have a stigma of a past violation attached, at least on record. Thus, the settlement process is — or, I think, ought to be — a consideration of how the inter- ests of justice and capital markets would be achieved on the facts of the case — a careful balance between the benefit of further proceedings with attached costs and delays and the likelihood of the accused going scot-free.
The offence of Insider trading is now prohibited from being settled. There was strong criticism that inside traders were getting away by settling their cases. Insider trading is in many ways an evil of capital markets. The perpetrator takes advantage of the trust reposed on him as an insider. He makes profits illegitimately by this trust. While some argue that it is a victimless crime, I believe that other shareholders usually do pay the cost. The need to punish such perpetrators is justifiable. However, the fair criticism of disallowing settlement is that insider trading is rather difficult to investigate and prove on facts though SEBI has put in a series of deeming provisions to make up. Prohibiting settlement of allegation of insider trading means that the long process of establishing it will have to be followed in all cases. It would have made better sense to put a higher settlement amount in such cases than an absolute ban. To clarify, though, violation of insider trading cannot be settled, other violations of the insider trading Regulations such as delay/default in disclosures, etc. can be settled.
Serious fraudulent and unfair trade practices causing substantial losses to investors and/or affecting their rights cannot be settled. However, if the person makes good the losses to the investors, the case can be settled. These perhaps constitute the single largest of violations, but a more detailed analysis would be beyond the scope of this article. But suffice is to say that words such as ‘serious’, ‘substantial’, etc. are not defined and may lead to discretion.
Failure to make an open offer under the Takeover Regulations cannot be settled except where (i) the entity is willing to make an offer unless, in the opinion of SEBI, the open offer will not be in interest of shareholders or (ii) where SEBI has decided to refer the matter to adjudication.
Front running transactions also now cannot be settled. As is known, front running transactions involve trading in anticipation of information about impending large orders. As held in some earlier cases, persons connected with mutual funds, who came to know the impending large orders of the mutual funds, traded ahead (or shared such information) and the mutual fund’s investors thus had to buy/sell at a little adverse price because of the earlier orders so placed. Strangely, SEBI defines front running here — which is inappropriate since the law does not define this term — as placing or using non-public information on an impending transaction of substantial quantity. Generally, front running is understood to be a situation where a person in a position of trust having access to non-public information uses this information to carry out front running. The analogy is of an insider. And just as having unpublished information and trading on it does not necessarily make a person guilty of insider trading, the same way a person not connected with such an institution but who still in some way has information of impending large transactions cannot necessarily be held to be guilty of front running.
Other violations on the negative list include net asset value manipulation by mutual funds, failure to redress investor grievances, failure to comply with orders of specified SEBI officers, failure to comply with orders of summons, etc.
However, interestingly, discretion has been retained to settle cases even amongst the negative list, though no criteria has been laid down how such discretion will be exercised.
Another important amendment is that now time limits are specified for making the application.
First time limit is how early can the consent application be made. It is now provided that an application cannot be made before the investigation/inspection of the alleged default is complete. Earlier, the Guidelines provided that that the application could be made at any stage, but in case of serious and intentional violation, the settlement would not be made till the fact-finding process was complete. This was a sensible provision. If a person is coming forward voluntarily, then unless SEBI had indication that more violations could be detected, the matter should be taken up. An important purpose of settlement is to shorten the proceedings.
Second time limit is specification of the last date the application for settlement should be made. The earlier Guidelines had no last date. It is now provided that the application cannot be made more than sixty days from the date of serving the show-cause notice. This would sound fair. Sixty days for examining the show-cause notice, which is expected to be comprehensive, are sufficient to decide whether one wants to fight further or come forward and settle. A concern is whether the time taken for obtaining information and documents relied on in the notice but not provided upfront should be taken (though the law requires such information/documents be provided upfront, some times this is not done). However, there is discretion for extending this last date, if the delay is beyond the control of the applicant.
Repetitive consent applications are now restricted. If an alleged default takes place within two years of the last consent order, then that default cannot be settled through these Guidelines. Further, if two consent orders are already obtained, then no further applications can be made for a period of three years from the date of the last consent order. Strangely, a consent application/order once made for a certain violation, will bar consent order in the above manner for even any other type of violation. This is unlike, say, the Reserve Bank of India Regulations for compounding where restrictions are placed for repetitive compounding of ‘similar’ contraventions. Thus, one would have to be very careful in making a consent application.
A lump-sum non-refundable fee of Rs.5000 is now provided to be paid. This amount is irrespective of the amount involved in the alleged violation or its gravity.
The process of settlement has been changed. The applicant has to first appear before an internal committee of SEBI who will work out the terms of consent in accordance with the formula. These terms will then be forward to the HPAC for its recommendation. Finally, these recommendations of the HPAC will be sent to a Panel of two Whole-time Members of SEBI who will take a final decision and if they deem fit, increase or decrease the terms or reject the application. However, it is provided that this whole process should be ‘preferably’ completed within six months of registration of the consent application. While this period of six months may sound short, it may be recollected that in actual practice, earlier, the process used to be completed much earlier in many cases.
There is an elaborate and complex formula provided for determining the settlement amount. The formula is too detailed to be within the scope of this short article. Suffice is to say that the formula considers the stage at which the application is made, the nature of the violation, etc. and provides for quantitative parameters to determine the settlement amount. Clearly, this is to make the settlement more transparent and remove discretion and discrimination. Minimum amounts have also been provided depending upon the nature of the violation or the alleged perpetrator.
It has been stated — though with some ambiguity — that the minimum settlement amount for first-time applicants will be Rs.5 lac and in case of ‘name-lenders’, this minimum will be Rs.2 lac. Curiously, the minimum amount for second-time applicants is not specified. This minimum limit is strange and perhaps even inequitable. Firstly, even orders passed with due process by SEBI for minor offences have fine far less than Rs.5 lac. Secondly, this would obviously hit persons having made less serious violation. Serious violations even otherwise would be settled for, or punished with, higher amount.
Another common complaint was that the formal orders published do not bring out the facts properly and were too brief and opaque. Thus, one could not know what were the merits of the case and whether the case was fairly settled. To meet this criticism, on the one hand, as explained above, to a large extent, the discretion is diluted. On the other hand, it is now provided that the order shall be more detailed in specific matters including the facts and circumstances of the case. It will have to be seen though how much detailed the orders are in actual practice.
In conclusion, the experience of five years is brought out well in the amendments. While one will miss the simplicity of the earlier provisions and lament the complex new law requiring the need of professional help, it will be also fair to say that the earlier provisions were too simplistic. Where the basic matter itself is complex, the settlement has to be complex. A professional analysis of a complex matter is a must for fair and transparent dealing on both sides. One hopes though that in practice, the amendments are implemented in their true spirit, since the earlier Scheme, despite its short-comings, did set an enviable benchmark to settlement proceedings in India.
