Thursday, November 19, 2009

The SEBI-NSDL Controversy

The recent decision of the SEBI to set aside as ultra vires two orders passed by a Special Committee set up by it has led to a huge furore in commercial and legal circles. The origin of the controversy was the appointment of CB Bhave as the Chairperson of the SEBI at a time when SEBI was investigating the propriety of the actions of the National Securities Depositary Limited (“NSDL”), in relation to several past events. The fact that CB Bhave had been the CMD of NSDL prior to his appointment as Chairman of SEBI, lead to an obvious conflict of interest. In order to avoid this conflict, it was decided that the investigation be carried out by an independent Committee. The investigation was completed and an order delivered in December 2008. In a departure from usual practice, the SEBI did not disclose the findings till November this year, when it also declared that the two orders were ultra vires and hence void. The basis of this conclusion was that

a. The Board had delegated its authority to the committee to dispose of three quasi-judicial proceedings pending against NSDL.

b. The committee, however, entered findings that the Board failed as a regulator, while disposing of two matters relating to IPO Irregularities and DSQ Software Ltd.

c. These findings against the Board are outside the confines of delegation and therefore, these are without the authority of law.

d. These findings, which have vitiated these two orders, cannot be severed from the rest of the orders. Hence these orders are null and void and are non est.

e. The third order (in the matter of Rajnarayan Capital Market Services Limited) is in order since it does not have similar findings.

Much has been said about the effect of such a decision on the accountability of the SEBI, and the real suspicion that the decision is in bad faith. However, there are also two important legal issues that arise from this decision of the SEBI, which is what I focus on here. These are:

First, does the SEBI have the power to declare an order of the Special Committee as ultra vires? Secondly, even if it has this power, was the order here in fact ultra vires and liable to be declared void?

On the first issue of the powers of the SEBI, they are comprehensively covered by Chapter IV of the SEBI Act (these powers have also been discussed earlier). The structure of the Act broadly envisages action of two types- taken by the SEBI itself (ss. 11, 11A and 11B), or by an Investigating Authority appointed by the SEBI (s. 11C). The decisions taken by either of these are appealable only to the Securities Appellate Tribunal (ss. 15T, 15Y and 20A). Besides this appeal mechanism, the Central Government can also be appealed to (s. 20), and it can also take other action against the decision of the Board or the Investigating Authority (ss. 16 and 17). This schema suggests that the SEBI has no review power over the actions of the Investigating Authority, which is what has led some to argue that the decision in the NSDL case was also incorrect. However, it is important to appreciate that the nature of the Committee and the Investigating Authority is fundamentally different. The Committee was exercising the powers of the SEBI under ss. 11 and 11B, which were delegated to it under section 19. There is nothing in the Act to suggest how the exercise of this delegated power can be controlled. Admittedly, such a power has arguably never before been exercised by SEBI (there is a dispute over whether it was exercised on 2006). However, given that the Special Committee was the first body of its sort under the SEBI framework, there is limited value that can be garnered from past precedent. This necessitates reliance on general administrative law principles on sub-delegation. Usually, the controversy over sub-delegation is focussed on whether the delegate has the power to sub-delegate. Given section 19, this isn’t in issue here. The other issue is the extent to which the delegate can exercise control over the sub-delegate. While this has been a point of serious contention, the more supported view seems to be that the delegate continues to retain authority over the matter that has been sub-delegated. Though some decisions like the UK Court of Appeals in Blackpool Corporation v. Locker, [1948] 1 KB 349) and the Employment Appeal Tribunal in Department For Environment Food & Rural Affairs v. Robertson, [2004] ICR 1289 (affirmed on a different point in Robertson v. Department For Environment Food & Rural Affairs, [2005] EWCA Civ. 138, para. 41), have departed from this view, they have been criticised as proceeding on a mistaken understanding of ‘sub-delegation’ (Jackson, 66 LQR 363, 376). In any event, these decisions also only restrict the rights of the delegate during the delegation, and do not prevent it from revoking the delegation. Thus, there seems to be nothing to prevent SEBI from reviewing the exercise of the delegated powers by the Special Committee, especially when what it purported to review was not the decision per se, but the scope of the decision.

This is not to say that the exercise of this power was appropriate on the circumstances here. In fact, while I believe that SEBI has the power to revoke the authority granted to the Special Committee or to declare it void, there is no doubt that the power was incorrectly used here, for two reasons-

First, the very reason for the constitution of the Special Committee was to avoid all conflicts of interest resulting from Mr. CB Bhave’s previous position on NSDL. The fact that independent and not existing members were chosen for the Committee clearly shows that the mere recusal by Mr. Bhave was considered insufficient to counter the conflict of interest. Subjecting the decision of this independent body to the review of the very body that may be influenced by a conflict of interest seems incorrect and undesirable. In these special circumstances, I think the review by the SEBI was inappropriate, and could not be remedied only by Mr. Bhave’s recusal.

Secondly, the SEBI declared the orders of the Special Committee ultra vires because they consider the role of the SEBI instead of focussing only on NSDL. Further, these observations on the functioning of the SEBI are considered to be so fundamental as to constitute an integral part of the decision. However, a reading of the orders suggests nothing of the sort. In fact, after a few passing mentions during the text of the order dealing with the IPO scam, in the penultimate paragraph 94, the members specifically state, “It would not be appropriate for us to leave this matter without expressing our concern about the failure of SEBI to carry out its regulatory role adequately”. This shows that the observations were ancillary to the other findings of the members, far from being integral and inseparable from their other findings. Further, of the three orders, only the ones pertaining to the IPO scam and DSQ Software were annulled. The third order regarding Rajnarayan Capital Market Services Ltd. was affirmed on the basis that the Committee had made no such observations outside the scope of its mandate. However, as rightly pointed by one of the several discussions of this issue, this distinction is incorrect. Even the RCMSL order contains a recommendation to the SEBI, in paragraph 35. The only difference is that there are no general observations or strictures against the SEBI. This lends force to the argument that the other orders were held ultra vires not due to the consideration of SEBI’s conduct, but because of what they said about SEBI’s conduct. This conclusion also finds support in the fact that the SEBI refused to disclose the orders for about 11 months.

In sum, SEBI’s decision to declare ultra vires the decisions of the Special Committee appointed to look into the NSDL matter is incorrect. However, the problem with the decision is less the lack of competence of the SEBI to take the decision, but more the propriety of the decision on its merits. Hence, while the apprehension over the decision and its implications is justified, doubting the competence of the SEBI to make such a determination would be directing the disapprobation at the wrong target.

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