Smoke without fire?

The market regulator faces misguided flak for consent orders

The US securities regulator, the Securities and Exchange Commission,  or the SEC as it is popularly known, was reprimanded by a US district court in November for settling a case rather blindly. To give the context in which this happened, the SEC settles over 90% of all cases that it brings against securities market participants who it believes have violated securities laws. Most of them are brought before the court for a settled ruling to be passed by the court. These rulings by the court would typically have a monetary penalty, disgorgement and, also, an injunction.

An injunction is a court order asking a person not to commit a violation in the future and comes with a threat that a future violation would invite a contempt of court action, and some jail time as well. In the case, US SEC vs. Citigroup, the SEC not only brought charges, but also simultaneously filed a draft order in terms of a settlement that it proposed to the court. The draft order that it filed proposed payment by the Citigroup of $285 million towards penalty, disgorgement and interest. The judge set aside the proposed consent and gave a date for a full trial. While the comments were specific to the case, the judge pointed out various issues that were more general and applied to at least some cases that came before courts.

Rewind a few months to India, and a public interest litigation has been filed in a high court challenging the entire consent process and all rulings passed by Sebi since 2007. However, there are various reasons to be hopeful about the survival of the Indian consent system.

First, the Indian statute specifically, though implicitly, permits consent orders. Specifically, Section 15T (2) of the Sebi Act states that there can be no appeal from an order passed with the consent of the parties. Thus, Parliament in its wisdom had envisaged that the regulator has the power to consent, though it has not explicitly provided for them. By contrast, the US consent mechanism has no legislative mandate, and the same is justified based on historical use of the power.

Second, the specific ruling in SEC vs. Citigroup was set aside because sufficient evidence of the background was not provided. It said, “the court, and the public, need some knowledge of what the underlying facts are,” and, “for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.” In India, the framework prohibits settling a case unless a full investigation is carried out. A formal investigation by Sebi is supposed to extricate all relevant facts. Thus, the Indian mechanism does not permit a blind settling of charges without knowing all the facts (unless there is a technical or such violation where the facts speak for themselves, e.g., disclosure violation under takeover regulations).

Third, the Indian process takes place mainly outside the regulatory system and thus has objectivity built into the settlement process. An independent committee headed by a retired judge of the high court looks at the charges, evidence and other factors. Based on the facts and 15 factors (See: Under the microscope), the committee recommends action against the entity. Based on the recommendation, the file goes to a table comprising two whole-time members, who must approve the case (or to an adjudication officer).

 The case can be returned as not being worthy of settlement or because the penalty agreed to was too low. Nearly half of all cases that go for settlement, in fact, do not get settled. The US system, by contrast, is secretive and completely in-house. This reduces or eliminates the problem of fairness and objectivity. There is a case for the US regulator to learn from the Indian system, given that there has been an outcry against Wall Street and its ways over the past several months of ‘Occupy Wall Street’ protests. 

Often the problem is not that violators get away too easily, but that they are dealt with too harshly. In view of criticism about violators getting away too easily, there is a danger that the regulator becomes overly harsh. This is already an issue. The other problem relates to the need for more transparency in the consent process. Sebi could make several improvements here. The key change that Sebi needs to make is making consent orders more detailed. This will ensure that everyone knows in detail what  was the charge levelled against the alleged violator.

Second, and equally important, is that the process needs to be opened up to scrutiny. This can be done by permitting Right to Information queries for already settled cases. Today, Sebi does not part with consent papers on the grounds that it hold them in a fiduciary capacity, and the Chief Information Commission has upheld this argument of Sebi. It is time Sebi gives up this right voluntarily. 

Given the above safeguards, I think India should continue to have a consent process. The process provides substantial, certain and immediate benefits and the Securities Appellate Tribunal (SAT) is perhaps the only tribunal in India with close to zero pendency. Sebi orders, which typically lagged a violation by eight to 10 years, have come down dramatically. Similarly, even when Sebi won a case, it was often bogged down by years, if not decades, of appeals and delays in the courts. 

In fact, other government agencies and regulators need to introduce the system to improve on India’s judicial delays. Over 50% of court cases in India have one side as the government, and if a substantial number of these cases unclog the judicial system, we could see a substantial improvement in the rule of law and administration of justice.

I strongly believe in the consent process in the Indian securities market. At the same time, I  believe that more transparency in both the process and the final order is necessary.