Mon, 28 Mar 2016
When a serious breach of market integrity is suspected, what should the regulators’ priorities be: should it try to punish the guilty, or should it seek to deter other wrong doers or should it focus on protecting the victims? Both bureaucratic and political incentives may be tilted towards the first and perhaps the second, but in fact it is the last that is most important. I have been thinking about these issues in the context of the order of the Securities and Exchange Board of India in the matter of Sharepro Services, a Registrar and Share Transfer Agent regulated by SEBI. The order which is based on six months of investigation and runs into 98 pages finds that:
Shares and dividends have been transferred from the accounts of the genuine investors to entities linked with the top management of Sharepro without any supporting documents
Records have been deliberately falsiﬁed avoid the audit trails.
Sharepro and its top management have authorized issuances of new certiﬁcates without any request or authorisation from shareholders.
The management of Sharepro has not cooperated with the investigation which being carried out by SEBI and on several occasions, it has attempted to mislead the investigation in the matter.
If one assumes that these findings are correct, then the key regulatory priority must be to take operational control of Sharepro and thereby protect the interests of investors who might have been harmed. A Registrar and Share Transfer Agent is a critical intermediary whose honest functioning is essential to ensure market integrity and maintain the faith of investors in the capital markets. I think that SEBI’s powers under section 11B of the SEBI Act would be adequate to achieve this objective, but in case of need, resort could also be had to section 242 of the Companies Act 2013.
The SEBI order does take some steps to punish the top management of Sharepro but does too little to protect the investors who appear to have lost money. It does not even cancel or suspend the registration of Sharepro as a Registrar and Share Transfer Agent, but merely advises companies who are clients of Sharepro switchover to another Registrar and Share Transfer Agent or to carry out these activities in-house. The only investor protection step in the order is the direction to companies who are clients of Sharepro to audit the records and systems of Sharepro. But if the records have been falsiﬁed, then only a regulator or other agency with statutory powers can carry out a meaningful audit by obtaining third party records.
A decade ago, when the Satyam fraud occurred, I was among the earliest to write that the government should simply take control of the company. I would argue the same in the case of Sharepro as well assuming that the SEBI findings are correct.
Pratik Datta wrote on Tue, 29 Mar 2016 19:35
Re: Regulatory priority: punish, deter or protect?
Sir, without going into whether nationalisation is the appropriate remedy or not in this case, I would argue that SEBI does not have the legal power to do what you are suggesting.
First, section 11B can be used to debar a person from accessing the capital markets. But taking over a company by SEBI is clearly not within the scope of this section. If you see nationalisation statutes, they are clearly worded to empower the appropriate authority to take over enterprises. The wording of section 11B is not the same. Therefore, any such attempted takeover would be struck down as ultra vires (beyond the scope of) the SEBI Act.
Second, s. 242 powers can be used by the Tribunal only after an application under s. 241 has been filed. A s. 241 application can be filed only by a member of the company. SEBI is not a "member" of Sharepo.
Therefore, your suggestion is legally untenable.
Prof. Jayanth R Varma wrote on Wed, 30 Mar 2016 11:08
Re: Re: Regulatory priority: punish, deter or protect?
1. The government can make an application under S241 of Co Act 2013.
2. Changing management is not the same as nationalization. 11B can certainly be used to debar existing management from holding office in any regulated entity; Sharepro would then need to find new management. Putting a SEBI nominee in charge of management is harder, but one should not underestimate the regulator's powers to do such things even without formal powers. My favourite example is what the Douglas SEC did to the NYSE in the late 1930 when the New Deal was already in full retreat.
Pratik Datta wrote on Wed, 30 Mar 2016 15:40
Re: Re: Re: Regulatory priority: punish, deter or protect?
1. Your blog reads: "the key _regulatory_ priority must be to take operational control of Sharepro and thereby protect the interests of investors who might have been harmed." I thought by "regulatory" you meant SEBI (the regulator) should take over operational control - not the Government (Ministry of Finance). Therefore, I argued why SEBI can't take over operational control.
2. Sharepro finding new management is not the same as regulator or government taking over operational control in the formal sense. This is very different from your original suggestion as I quoted earlier. But this now seems more reasonable and practical.
3. Thanks for sharing the Douglas SEC anecdote. Will look that up. I am guessing you are referring to the McKesson & Robbins case.
Prof. Jayanth R Varma wrote on Thu, 31 Mar 2016 17:00
Re: Re: Re: Re: Regulatory priority: punish, deter or protect?
1. First, government for S241 is not MOF but MCA which is a regulator (of all companies). Second, regulators can and do take help from arms of the government (police for example) in pursuit of regulatory priorities. Third, the last sentence of my post was in fact a call for government action.
2. Once regulators have forced out existing management, it is hard to imagine any new management willing to step forward without the regulators' blessing. In practice, regulators would have operational control.
Another (more recent than Douglas) episode is of Salomon Brothers treasury auction scandal in the early 1990s. When the regulators threatened cancellation of Salomon's primary dealer licence, Warren Buffet took over as Chairman and did whatever the regulators wanted.
Re: Re: Re: Re: Re: Regulatory priority: punish, deter or protect?
1. You are right on MCA. My mistake.
2. Still I would request you to be clear on usage of terms like regulator and government. They are very different entities when you are talking policy.
2. Using s. 11B for replacing existing management is an interesting proposition. Can't recollect any precedent. Usually it is used to bar access to capital markets.
3. Thanks again for sharing this scandal story. Will look it up. Financial laws seem to have been shaped more by scandals and scams than by rational policy thinking. I have always felt the lack of any one single book or article that explains how different scams in the Indian financial market have shaped Indian laws. Eg. The SEBI Amendment Act of 1995, the FMC-SEBI merger etc. May be you should take sometime out and write on this. It would help us lawyers understand the laws better! :-)