SEBI & Consent: Ahead Of the Curve Or Boxed In?
Consent or settlement is widely used by regulators across the world - the reasons are common - immediacy of sanctions and hence more effective deterrence, faster return of funds to harmed investors and saving regulatory time & costs by avoiding long drawn out litigation; also thereby allowing the regulator to focus on more important cases. Of course the reduced burden on the judicial system is a collateral benefit. Broadly speaking, till now, courts too have approved consent orders and acknowledged the right of regulators to settle. The process seems to have had all round acceptances. But not in the recent past. After the global financial crisis, the occupy protests, the anti- big business sentiment... some settlements have drawn a negative vibe. US District Court judge - Judge Rakoff, when examining the SEC- Citi consent order last year called consent orders a 'cost of doing business rather than as any indication of where the real truth lies'. In India too, the 50 crore rupee Anil Ambani consent case drew flak for an order short on detail. SEBI Chairman UK Sinha alluded to these new pressures on regulators when he spoke at the IBA conference in March this year.
SEBI Chairman UK Sinha on 9th March, 2012
“There are now changing expectations of the society from the regulators”
“Globally we are seeing more and more examples of a feeling of anger, a feeling of distrust. The legitimacy of institutions is being challenged and being challenged much more openly than it ever has been in the history of mankind”
“The failure of institutions to protect the ordinary person has come out more and more openly now.”
“Terms like regulatory capture are no longer being used in hush tones. They are being now made part of mainframe economic literature.”
“In a very famous case when the SEC of the USA went for a consent order and it was filed in a district federal court - the comments and judgment of that particular court were extremely severe. What is the public purpose being served? Where is the transparency? Whether there was enough knowledge of what was the unlawful gain made? 99% of the people now feel that 1% have been getting all the money, the advantages. Please remember these developments put pressure on the thinking of the regulator not only in India but across the world.”
It may be that pressure that prompted SEBI to change its consent guidelines and disallow some offences from being settled. The question is- do SEBI's new consent guidelines put the regulator ahead of the curve? Or has it boxed itself in? I am joined today by two former regulators - former SEC Chairman Harvey Pitt and former SEBI Chairman M Damodaran.
Doshi: If I may start first by asking you to assess the changes to SEBI’s new consent guidelines and give us a view from the outside-in of what you make of the regulator’s attempt to disallow certain kinds of offenses from being settled?
Pitt: I think this is an innovative approach and one that will have to await final evaluation after seeing how it is implemented. If SEBI’s guidelines are truly guidelines and the regulator has the ability to accept settlements if things are positive, then I think this will be a very interesting and potentially very valuable experiment. But if in fact the guidelines wind up constructing what the regulator can’t do- that is when there are cases where settlements immediately and producing huge benefit from investors have to await either guilty admissions or trial- then I think it will prove to be a burden and one that will need to be revised.
Doshi: If I may follow that up with a question on the phrase that you used- interesting and valuable experiment- why do you think this could be a valuable experiment?
Pitt: I think whatever problems that people have when they assess the way regulators approach violations; there is always a second-guessing element that goes on. When I served as Chairman of the US SEC, I tried not to second-guess the staff in terms of settlements they presented but rather to look at the broad policy implications of the settlement. If the agency gets the benefit of settling and settling quickly, then it seems to me the fact that it could have been a little more stringent or it could have extracted a little more money maybe irrelevant- if you are getting immediate and beneficial results for the ordinary person as the current chairman of SEBI indicated. So I think it could be interesting because this will give the Indian regulators a real world opportunity to see how requiring admissions and so on will impact the ability of the agency to effect benefits for investors through the settlement process.
Doshi: Mr. Damodaran, do you agree with Harvey Pitt's assessment that this could be an interesting and valuable experiment or do you believe that SEBI may have boxed itself in one of the pitfalls that Mr. Pitt pointed out as well?
Damodaran: I think, based on the way the scheme has played out over the last five years, SEBI might have felt it necessary to exclude a number of categories from the scope of the consent scheme. It is likely that based on some of the criticism that has recently come up, SEBI might have felt that there are categories where a settlement might not send the desired message to the person who has committed the offence or even to the market by way of kind of a disincentive to those that might contemplate similar action later. That said, I think it's useful to remember the context in which the 2007 scheme was introduced. If you look back at the situation that prevailed before that scheme came in, there were thousands of cases, some were serious, a large number were technical violations not arising out of malafied intent and given the atmosphere that prevails relatively in most organizations in the government or quasi government, no one really wants to drop an investigation once taken up and therefore a number of small cases tended to queue up before the systemically important large cases. The 2007 scheme was principally aimed at taking out a lot of these small cases so that the limited enforcement staff, the limited investigation teams available with SEBI could focus on the systemically important cases. That was the broad objective. Also I think and I think Mr. Pitt referred to this that if you go the normal way in the absence of a consent scheme, it could take a very long time and you might not be able to give any benefits to those who have been adversely impacted by the actions of some market participant. That clearly was another thing and I don't want to get into specifics but in the context of insider trading where SEBI is often criticized not having done enough, there is a case that was decided by the then SEBI Chairman in mid 90s which was overturned in appeal by two government officers then exercising appellate powers and that is pending I think in the high court even as we speak today.
Doshi: Mr. Damodaran, apologies for interrupting, but you seem to be making the point that while its valid to have some technical infractions settled by consent orders and that you agree that SEBI can carve out serious offences and not allow for them to be settled- it might be a counter productive move because for offences like insider trading which are difficult to prove in a court of law, the litigation may go on for several years as it goes into appeal. So in a sense SEBI has closed the door in being able to settle those offences and dispense speedy justice because it has now moved that offence off the list?
Damodaran: That really is what I was getting at after setting the context because if you look at the recent circular, it sets out a large number of exclusions and then goes onto say- however, based on the facts and circumstances of a case, it is possible that the high powered advisory committee or the whole time members could decide to bring that scheme, that particular matter under the consent scheme. Now in the climate that is all pervasive today of suspicion, distrust, of institutions not being looked up to and things of that kind and I don't want to mince words on that- I don't see too many cases where high power red advisory committee or the whole time members are likely to use that particular provision to deal with the case. So for all practical purposes, I think those cases will constitute exclusions and the consent orders will really be focusing on the relatively minor issues that are not listed.
Pitt: My concern is this- if the world at large understands that the only cases where, predominantly the only cases that will be settled are cases that are either inconsequential or small or where there maybe difficulties of proof, the fact that settlements occur may well demean the quality and the benefits of the settlements that are allowed to take place. In addition, I worry that if regulators are forced to litigate every single case, the difficulty may well be that they will bring far fewer cases. Think about how much longer it will take to bring cases to court; so I think what is required in all respects is a balancing.
Doshi: Where do you suggest Mr. Pitt that balancing point may lie because on the one hand you have Judge Rakoff in the US itself make a comment saying “a consent judgment that does not involve any admissions and that results in modest penalties” appears to be simply “a cost of doing business imposed by having to maintain a working relationship with a regulatory agency, rather than any indication of where the real truth lies.” On the other hand, regulators run the risk of having to litigate forever to bring anyone to justice. Where does the middle path or the balance point lie in this?
Pitt: I think ultimately the balance point has to lie in discretion of regulators and those who are going to have to try cases. When our staff, when I was at the SEC, would recommend certain cases and recommend settlements that we thought were weak or not acceptable, we also took into account and asked our staff to tell us what they thought about their chances if they litigated. What's important really is to provide the maximum amount of protection to the maximum number of investors and that really can't be done by formula and it can't really be done by governmental edict. It really requires a case by case assessment and that's the way today all regulators approach the cases that they will accept the settlement and those that will require to be litigated.
Doshi: In that case Mr Damodaran, that maybe the reason why SEBI has left that small window of hope or discretion open whereby disallowing certain kinds of offences and yet saying that in the rarest of rare cases, we may consider settling in such an offense, they have gone further in these new guidelines to lay down formulae for penalty. So that the allegations of arbitrariness when deciding upon penalties is, in a sense countered. They have gone ahead to lay down eligibility criteria for those parties or companies or offenders that may in fact apply to them through consent orders. If you were in the shoes of a SEBI chairman today, considering the public pressure and the environment outside, would you believe that you have struck the middle path or the balancing point by having done what they have done in these guidelines?
Damodaran: It is not the penalty; it is the settlement amounts and whatever non-monetary implications there are in a consent order, they ought to be severe enough to serve as a deterrent and be much more than the cost of doing business.
Doshi: Do you believe that this new penalty structure is in fact good enough to allow for such server penalties and not just the cost of doing business?
Damodaran: I am not in favor of any formula or structure. I think we need to trust those that have been given the responsibility in the system to deal with even much more important matters and leave it to them to decide what kind of settlement would be a disincentive to those intending to misconduct themselves in the market place thereafter.
Trying to put down a formula to my mind is not the answer. It just complicates matters maybe it does give the protection to those that pass orders saying that we have lived within the formula but it might fall short of the specifics of a particular case.
The real point that we should not be missing in all of this is that if you take advantage of the consent scheme to clear out all the small and the technical violations, it is entirely possible that your staff will be able to focus little more than they are able to do, at present, on the more serious violations. But that said, I don’t know whether if you keep so many categories of cases out, you will have the bandwidth to continue to fight these cases effectively in courts of law because every setback that you suffer in a court of law tends to somehow encourage people to take liberties with laws, rules and regulations to do things which are not in the interest of the market or in the interest of the community.
It is entirely possible to use your words that they might have boxed themselves in because I do not see too many serious cases being decided by the whole time members (WTMs) or being recommended by the high powered advisory committee (HPAC) on the basis of this circular. There would be far more safety for them if they decided not to do that and therefore in a sense the consent scheme could be considerably diluted and not be able to deliver what it needs to deliver to those who have suffered – disgorgement, for example, will get delayed. There will be a whole lot of other negative fallout unless people summon the courage and say yes, under the facts and circumstances of this case, I believe we need to go through the consent process. I will wait and watch. I want to see how that works out.
Doshi: Is that your conclusion as well of what you make of this new set of guidelines that while the regulator may have been right to give in the public pressure and the external environment, he has diluted his ability or his regulator’s ability to go ahead and bring many of these cases to some sort of conclusive event?
Pitt: I think that is a very possible result from this and the pressure that regulators are currently feeling may change when people look at the number of cases brought, the number of resolutions brought, the amount of fees and penalties extracted and so on. If all of those go down because the settlement process has been diluted and is less useful, then I think there will be a new kind of pressure on regulators and that is why ultimately my view is one has to trust to the judgment and sensitivity and sensibilities of the regulators to be able to assess when settlement makes sense and when it ought not to be utilized as a mechanism.
Damodaran: I want to state one other fact- who is in charge of the process- a high power advisory committee chaired by a retired high court judge? We had in the past, I don’t know what the present composition is, you had a retired bank chairman who was respected in the industry, you had a very senior chartered accountant so you brought in the legal expertise, you brought in the accountancy expertise, you brought in experience of settlement from the banking system and then you had two whole-time members looking at that. Now if these five gentlemen exercising their minds on this matter does not provide the kind of safety that you are seeking to ensure- that the right cases get considered and the wrong cases do not get considered- I think any prescription that you put in place and then allowing these small little windows to remain not open but ajar, nobody is going to open those windows, they will remain ajar and you will be in a situation in which nothing will get decided in a hurry and as Mr Pitt observed rightly, there could come a time when you realize that the disgorgements are less, the benefits to the investors are less. At the end of the day, let us remember, all of these are means to an end. What is end? The end is to protect the interest of the person who invests his or her money in the securities market and if you are not able to compensate those people in some manner for the crimes and misdemeanors of some others and if you have a long torturous process, which leads you nowhere, I don’t think you are serving that and even though your means might look like they are better than they were before. So that is my worry, I hope it works for the sake of the system, I am not sure it will work.