Sebi consent order copout may be linked to RIL, Sahara hot potatoes

Sometimes, what is intended to make things more transparent may end up achieving something quite unintended: creating scope for arbitrary decisions even while avoiding responsibility for the same. A case in point is the Securities and Exchange Board of India’s (Sebi’s) amendments to its consent orders regime (read here ).

On Friday (25 May), Sebi announced that it would not consider requests for compounding offences and passing consent orders in cases involving insider trading, serious fraudulent and unfair trade practices which cause losses to investors, failure to make open offers , or front-running (buying or selling shares in advance of expected larger buy or sell orders), among other things. This means the market regulator will “not seek to settle” these defaults, and instead impose its own order final order, and, if necessary, prosecute the guilty.

Sebi’s move may not be unconnected to two big regulatory orders involving Reliance and Sahara group that may come up for consent orders or settlement in the near future. The fact that Reliance has already moved the Bombay High Court to seek consent under the old regime indicates that that two are linked.

In a consent order, companies accused by the regulator of breaching any of its laws can seek to compound their offences, offer to pay agreed penalties, and seek to avoid prosecution or explicit admissions of guilt. If Sebi agrees.

For companies, consent orders save time and effort in trying to prove themselves innocent of white collar crimes (of course, it also helps them avoid pleading guilty). For Sebi, such orders ensure compliance with the law without having to go through a tortuous legal process of proving intentional wrongdoing and wrongful gain at the cost of investors.

While the broad thrust of Sebi’s new rules on consent orders are procedural and probably an improvement on the current regime, the regulator has shot itself in the foot by announcing two contradictory ideas: that it will not “settle” cases like insider trading or unfair trade practices and front-running, but that may still settle cases by consent with the help of a high-powered advisory committee (HPAC) that will be headed by a retired high court judge.

Here’s what the new rules say: “Notwithstanding anything contained in this circular, based on the facts and circumstances of the case, the HPAC/panel of WTMs (whole-time members of Sebi) may settle any of the defaults listed above.” The defaults include insider trading, et al.

In other words, Sebi first says it won’t settle some kinds of cases, and then goes on to say it will, with some outside help and some of its own whole-time board members, if it thinks fit.

There can be three problems with this kind of formulation.

One, it introduces an element of discretion and uncertainty in consent orders. Two, by lobbing the decision to an outside panel, it is probably seeking to spread the guilt on consent orders that look politically inconvenient, since it can say it took the advice of HPAC.

However, one wonders how this makes any difference since the procedure currently followed is almost the same: First, a company seeks a consent order and sends in its proposals to Sebi. This offer is debated by an internal Sebi committee, which then sends in its final view to HPAC. HPAC’s decision to accept, reject or modify the consent order come back to two wholetime Sebi members for a final decision.

The only difference is that Sebi says it will not “settle”. How’s that for clarity?

But the most important argument against this new consent circular is this: it will make an already difficult job (of policing stock market sins like insider trading and front-running) impossible to bring to book.

Consider the nature of the beast.

In a country with thousands of listed companies and millions of employees, insider trading based on sensitive inside information can theoretically be committed by at least lakhs of people. Given this reality, it is possible for Sebi to track down the more egregious cases by monitoring unusual spikes and falls in share prices, and try and see which ones are more likely to be the result of insider trading and which ones are merely incidental.

However, Sebi’s insider trading definitions are now so wide as to include not only senior management (like directors and senior executives), but anyone “who has received or has had access to price-sensitive information”. This could include the canteen boy who may have overheard something while serving tea at a board meeting or a sweeper who retrieved something from the wastebasket.

Sebi does not have thousands of sleuths to investigate such white collar crimes. Nor does our legal system have the necessary finesse to speed decisions on such crimes.

So one wonders what Sebi is trying to achieve by its will-not-settle-but-will-occasionally-settle approach to consent orders. Saying no and yes at the same time is not the ideal way to achieve transparency.

In January last year, Sebi’s decision to impose a Rs 50 crore fine on Anil Ambani and four of his group officials - Satish Seth, SC Gupta, JP Chalasani and Lalit Jalan - for alleged use of borrowed funds to invest in stocks sent shockwaves through the markets. The consent order followed Sebi’s probe into Reliance Natural Resources and Reliance Infrastructure which allegedly found instances of funds borrowed overseas being used to invest in the markets, including other group company shares.

Anil Ambani not only paid the fine, but his shares were hammered in the markets once the news was out since it raised concerns about group practices.

The consent order involving Anil Ambani set tongues wagging on whether his brother Mukesh Ambani would also be given a consent order in another case involving alleged insider trading in Reliance Petroleum shares before the company was merged with the flagship. In this case, former Sebi whole-time director KM Abraham had alleged that there was even pressure from the finance ministry to settle , which could have involved a fine going upto Rs 1,500 crore.

According to a report in The Economic Times , Reliance has now moved the Bombay High Court to ask Sebi to consider a consent order in line with the earlier policy.

The moot point is: why is Sebi shying away from consent orders? As Somasekhar Sundaresan argues in Business Standard , “such norms are a product of playing to the gallery in the current national environment, where any alleged infraction of a regulatory requirement is seen as morally reprehensible. "

Sundaresan concludes: “The universal reality is that every type of alleged violation should be capable of being settled - it is only the terms of settlement that would make the decision appropriate or inappropriate. Insecurity about the quality of governance, should not lead to implementing a system where one need not govern at all.”

Quite clearly, Sebi’s new consent order decision is a regulatory copout- where Sebi is trying to avoid tough or unpopular decisions to settle cases where it may be accused or favouring some party or the other where it agrees to consent order.

By making consent orders the norm, it can go after the big fish, extract penalties and indirect admissions of guilt, and not waste years in courts and legal expenses.

It is worth recalling that in the US, both the Satyam case and that of its auditors - PriceWaterhouse - were decided by mutual agreement and settlement.

Sebi’s new consent order circular will make life difficult for everybody with no one - including the investor - being the gainer. It’s a lose-lose game.

(Disclosure: The authors and/or his family own shares in Reliance Industries, and the publisher of Firstpost, the Network18 Group, is in the process of seeking investments from the Reliance Group).