Co-authored with Mihir Deshmukh, associate at Finsec Law Advisors
The securities markets are ever-evolving and require the regulator to always be on its feet, revising and updating its regulations and practices with the changing environment. Thus, the regulator ought to rethink its policies in certain areas.
Recently, various guidance letters and directions issued by SEBI have created confusion over what services an entity may provide in the capacity of a registered intermediary. In light of the recent show-cause notice, and settlement order passed by SEBI in the Amit Jeswani matter, the scope of services that may be provided by a SEBI-registered research analyst (RA) have come under reconsideration, wherein SEBI alleged that providing model portfolio services to its clients is beyond the scope of an RA as defined under the SEBI (Research Analysts) Regulations, 2014, as it does not give investors a choice to invest in stocks other than those mentioned in the model portfolio. These findings question the present market practice based on the understanding that such model portfolios fall within the ambit of research reports as they merely provide to buy/sell/hold recommendations for certain securities, are based on a particular theme, and do not contain client-specific recommendations. While the scope of activities clearly fell within the definition of an RA, SEBI has created its own, more restrictive definition to send a show cause notice, on the assumption that while allocation of shares is permissible, the percentage allocation of a model allocation is not.
Similar confusion has been caused in relation to the ability of certain SEBI-registered intermediaries to provide advice on foreign securities due to various informal guidance letters, such as the one issued to Ask Wealth Advisors. Deviating from the prevalent market practice, SEBI stated that ‘securities’, as defined under Section 2(h) of the Securities Contracts (Regulations) Act 1956, includes only those instruments issued, listed, or to be listed by Indian companies, and Section 24 of the Companies Act 2013 only gives SEBI the power to govern matters related to securities listed on recognised stock exchanges in India.This would restrict the scope of providing the full benefit of geographical diversification to Indian investors. Given these confusions, it is imperative that the regulator provides a clear outline of the scope of services that maybe provided by a SEBI-registered intermediary to allow these entities to remain compliant at all times.
Another group of market intermediaries that have recently been affected by the regulator’s policy proposals is the ESG rating providers (ERP). With ESG investment gaining momentum in the domestic market, the demand for reliable ESG ratings is also increasing, and with an increase in the number of players in the market, certain quality control issues such as greenwashing and misallocation of assets have been highlighted and require regulatory oversight.In its consultation paper to address the need for regulated ERPs, SEBI is suggesting that only registered credit rating agencies (CRA) and RAs shall be eligible for accreditation as ERPs, excluding various other entities that also provide these services. This will also act as an entry barrier for foreign players that are presently relied upon by large Indian entities and foreign investors that generally prefer getting an ESG rating from globally-renowned ERPs. Thus, while SEBI’s initiative to have a mandatory accreditation requirement for ESG is laudable, it is recommended that it reconsiders the eligibility requirements and allows other entities such accreditation subject to fulfilment of infrastructure and technical requirements.
Another aspect where regulatory revision is needed is investigation and enforcement proceedings and the standard of proof applicable to them. The prevalent practice, especially while investigating insider trading violations, is to relyon a combination of rebuttable presumptions and circumstantial evidence. However,such practices allow SEBI to allege serious offences based on a lower standard of proof while unduly burdening the noticee with the task of proving their innocence. In its recent verdict in the matter of Balram Garg vs SEBI, the Supreme Court has held that such allegations shall be subject to a higher standard of proof, which shall be that of ‘preponderance of probabilities’ based on an evaluation of all attending facts and circumstances, which shall be of a conclusive nature and should be such as to exclude every other hypothesis but the one proposed to be proved. The SC held that the degree of remoteness and reliance on presumptions, without any concrete evidence, should be minimised.
Another key aspect of the enforcement proceedings that should be revisited is the directions for disgorgement issued by SEBI. In many orders passed by SEBI, directions for disgorgement are made on the basis of the alleged notional gains without establishing any actual gains made by such noticee that thus serve as de facto penalties to be paid by them. This contravenes not only the established principle of disgorgement but also goes beyond the scope of Section 11B of the Securities and Exchange Board of India Act, 1992 wherein, the explanation to Section 11B restricts the scope of disgorgement to the extent of actual unlawful gains made or losses averted. This principle has also been reiterated by Sebi in its order in the matter of Dhyana Finstock Limited where the adjudicating officer, while determining the quantum of disgorgement, hasheld that disgorgement of funds shall only be that of the actual gains made orlosses averted, and has accordingly set aside the quantum of disgorgement that pertained to the notional gains made by the noticees. Therefore, it is imperative that SEBI revisits not only how it conducts its investigation and enforcement proceedings but also the standard of proof applicable while alleging violations and passing disgorgement orders to provide a just andequitable treatment to the persons against whom such notices and directions areissued.
While the need for cogent regulation is always felt in the market, the regulator needs to be wary of over-regulation that inadvertently dampens the activity and growth of the stakeholders. Effectively addressing the concerns raised above will not only provide requisite clarity but will also give stakeholders the confidence to expand their operations in the markets without the fear of regulatory clampdowns. Only the crooks should tremble when SEBI knocks on the door, not every person who commits a mistake or a violation of relatively innocuous provisions of law.