Watchdog Or Lapdog?

The Securities and Exchange Board of India (SEBI), the regulator of the country's 24 stock exchanges is often described as the watchdog of the capital markets. Some would, however, argue that the analogy is quite inappropriate given the inadequate powers that have been conferred on SEBI. If at all a comparison can be made with a member of the canine species, cynics contend the body should be described as a lapdog, a gentle pet whose bark is usually much worse than its bite.

Those not so favourably disposed towards SEBI -- for instance stock market players and financial intermediaries -- argue that the organisation has sufficient powers but, like most bureaucratic bodies, tends to be lethargic and wakes up only after the burglars have committed a theft.

The management of SEBI, on the other hand, claims that it is inadequately empowered to initiate punitive action against offenders and that its clout is akin to that of a toothless tiger.

It is said that the regulator of the most advanced of capital markets in the world, namely the Securities and Exchange Commission of the US has far more wide-ranging punitive powers than SEBI.

Here is a list of the powers that SEBI does 'not' possess that was recently provided to members of the Joint Parliamentary Committee (JPC) investigating the stock market scandal involving brokers like Ketan Parekh. SEBI does not have the power to search and seize premises to gather evidence. It also does not have the power to impound documents that could serve as evidence during prosecution.

In this respect, SEBI officials are clearly handicapped vis-a-vis their counterparts in the income tax department as well as officials dealing with customs and central excise duties, besides those working for the Enforcement Directorate which oversees foreign currency transactions.

In a note presented to the Union Cabinet that was considering issuing an ordinance to empower SEBI, the Home Ministry opposed any move to grant SEBI officials the power to conduct search-and-seizure raids.

This is perceived to be an instance of traditional intra-governmental rivalry, a turf battle between two wings of the government -- the Ministry of Finance and the Ministry of Home Affairs -- both of which are headquartered in the North Block.

SEBI officials cannot at present summon witnesses who are not directly connected with the securities market-- like the banker of an investor-- but who could be in possession of crucial evidence. In addition, despite being a quasi-judicial body, SEBI does not have the power to impose penalties against any individual who fails to appear before it, that is, not comply with a summons issued against the concerned individual.

SEBI can under such circumstances start proceedings for prosecution but the judicial system is rather time-consuming. Besides the SEBI Act, the legal framework available to the regulatory body includes various enabling regulations and other legislation like the Securities Contract (Regulations) Act and the Depositories Act.

Under the SEBI Act, the board has powers vested in a civil court while trying a suit only with respect to the following: (a) the discovery and production of books of account and other documents, (b) summoning for the attendance of persons and examining them on oath, and (c) inspection of any documents of any person.

Under Section 11 of the SEBI Act, the body can call for information, conduct an inquiry, an audit or an inspection of the stock exchanges, mutual funds (barring, of course, the biggest one of them all, namely, US-64 or the Unit Scheme of 1964 of the Unit Trust of India that was established under a separate Act of Parliament) and other persons associated with the securities market.

This is where SEBI's powers end. Since it does not have the power to force a person to comply with its summons, investigations invariably tend to get delayed.

According to SEBI, after it completes its investigations, it cannot effectively enforce punitive action because of 'inadequacies in enforcement powers'. For instance, it is pointed out that the current legal framework in India does not provide SEBI the power to impound or 'disgorge' ill-gotten gains or profits that arise out of market manipulation or insider trading. Whenever SEBI has attempted to do so, its actions have been successfully challenged in courts of law and stalled.

SEBI also does not possess powers to impose monetary penalties on violators. 'Even when there are provisions for penalties, such as in the cases of insider trading, the penalties provided are very meagre and are not commensurate with the gains made or losses avoided,' the regulatory body has lamented while replying to a JPC member's question.

SEBI cannot collect penalties nor can it issue interlocutory directions while proceedings are pending.

Conversely, it cannot also grant immunity from prosecution. Moreover, SEBI does not have the power to compound offences. Most capital market regulators the world over, especially in the US, have such powers and use these effectively because of their 'immediate impact' since the process of prosecution takes time.

Thus, the regulator of India's bourses claims that it is 'unable to take adequate action even after an investigation establishes violation of SEBI regulations' in its statement to the JPC. Whereas SEBI has been issuing what it calls 'general directions' under Section 11 of the Act, its powers in this regard have been challenged in a number of courts of law.

SEBI was constituted in April 1988 as a body to protect the interest of investors and promote the orderly and healthy growth of the country's capital markets. It was not until four years later that SEBI was formally converted into a 'statutory' body. SEBI was initially constituted by persons who were on deputation from the Reserve Bank of India and the Industrial Development Bank of India. The body has currently over 330 employees located at its offices at Mumbai, Delhi, Kolkata and Chennai.

Even after it was converted into a statutory body in 1992, the Union government took its own sweet time empowering SEBI. During the proceedings of the earlier JPC which had inquired into the 1992 stock market scandal, committee members were provided a series of letters written by the then SEBI Chairman G.V. Ramakrishna to the then Finance Secretary Montek Singh Ahluwalia complaining about how the Ministry of Finance had dragged its feet about granting powers to the regulator.

Regulations governing the activities of brokers and sub-brokers were issued in 1992, rules relating to insider trading came the following year while regulations prohibiting fraudulent and unfair trade practices were put in place in 1995. The same year, SEBI acquired powers to issue summons to individuals.

But, as already stated, these powers were insufficient because these did not cover bankers. Besides, the regulator could not conduct search and seizure operations to obtain evidence documents nor could it impound documents.

SEBI had appointed the Justice Dhanuka committee to identify deficiencies in the existing laws. The panel has made a number of suggestions that include the following: the SEBI Act should be applicable to overseas entities dealing in securities in India; SEBI should have powers to compensate investors to redress grievances; it should be allowed to impound profits made by market manipulation and price rigging; it should be allowed to attach properties, and; it should levy penalties to for failure to obey summons and directions.

The Dhanuka committee has also suggested that the Securities Appellate Tribunal be enlarged to comprise at least two members and that the Securities Contract (Regulations) Act be repealed and its provisions suitably incorporated into the SEBI Act together with specific provisions of the Companies Act relating to securities transactions.

Another study conducted at the behest of the Finance Ministry by N.L. Mitra, former principal of the National Law School, has suggested the enactment of separate legislation for investor protection. It has also concurred with particular recommendations of the Dhanuka committee like the granting of powers to SEBI to award compensation to aggrieved investors and said promoters and directors should be held personally liable in this respect. Mitra has suggested that special courts be set up to deal with financial frauds.

India's capital markets are bound to expand over time. At present, the shares of over 9,800 companies are listed on 24 stock exchanges. Between one million and two million transactions take place each working day through over 10,000 registered domestic brokers and sub-brokers. In addition, players in the stock markets include more than 500 foreign institutional investors with over 1,300 sub-accounts, besides large numbers of corporate bodies (registered in the country and overseas), banks, mutual funds and financial institutions. Currently, there are online trading terminals in more than 450 cities and small towns spread all over the country.

A suitably empowered regulator is a crying necessity not merely to check scams that have been periodically breaking out, but also to protect the interests of small investors.

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