(Note:- This article is my latest contribution to my monthly column on Securities Laws in Bombay Chartered Accountants' Journal)
Penalty is mandatory because Supreme Court says so, SEBI consistently and incorrectly holds
Almost each and every SEBI order levying penalty relies on a Supreme Court decision in Shriram’s case (SEBI vs. Shri Ram Mutual Fund (2006) 68 SCL 216). The reliance is for, it is submitted, an incorrect justification that since there is a violation, then penalty has to follow. Not only is mens rea (guilty intent) irrelevant, it is stated, but the penalty has to mandatorily follow any violation. Further, mitigating factors are irrelevant. In short, it is put forth, in the name and finality of a Supreme Court decision, that in case of proceedings for levy of penalty, penalty is mandatory and the Adjudicating Officer has no discretion in the matter. How far a correct conclusion is this? How far should a person who has not filed a document late, or made some errors in some filings, etc. resign himself to a penalty in all circumstances?
As stated, for this purpose, SEBI almost always cites a single sentence from the Shri Ram case as if by mindless rote. Here is one example from a recent SEBI Order (in matter of M/s. Vizwise Commerce Private Limited, Order No. JJ/AM/AO-117/2014, dated 28th August 2014).
“In the matter of SEBI Vs. Shri Ram Mutual Fund (2006) 68 SCL 216 (SC), the Hon’ble Supreme Court of India has held that “In our considered opinion, penalty is attracted as soon as the contravention of the statutory obligation as contemplated by the Act and the regulation is established and hence the intention of the parties committing such violation becomes wholly irrelevant”. (emphasis supplied)
With such words, it would appear inevitable that even in cases of mere clerical violations, liability is strict and absolute and there is no escape to levy penalty. However, the matter does not end there. Next cited are the powers of SEBI to levy huge penalties. Most provisions allow levy of penalty of upto Rs. 25 crores or a Rs. 1 lakh per day. Citing the decision and such penal provisions, large penalties running into several lakhs are levied, which, if one compares with huge and absolute powers SEBI has, would sound almost lenient.
The mitigating factors, even if pleaded by the party, are usually brushed aside, as if the hands of SEBI are tied in view of the clear mandate of the Supreme Court.
The alleged defaulter, in the face of such words of the Supreme Court, is demoralized and believes that there is no point in filing an appeal before the Securities Appellate Tribunal. It also so happens that the SAT in recent times rarely reduces or reverses such penalty. Thus, it is common to see scores of orders passed every week with relatively large amount of penalties. To be sure, SEBI does consider the facts of the case, and applies (as we will discuss) the provisions of Section 15J. But the quote in Shriram looms fairly large and heavy and, to many, would appear to shut out further consideration.
Is penalty inevitable? What did Supreme Court really say?
However, is levy of penalty so inevitable? Has the Supreme Court made the issue so absolute? Or are the words of the Court cited out of context? It is submitted that Supreme Court has really held something different. Moreover, it has itself considered mitigating factors and has not wholly ruled out bonafide intention. The Court has also not relieved SEBI/Adjudicating Officer from exercising judicial discretion and stated that he may choose not to levy penalty in appropriate cases.
Let us review very briefly the reported facts of Shriram’s case. Shriram was a mutual fund. Provisions made by SEBI prohibited a mutual fund from dealing with stock brokers beyond 5% of its aggregate sales/purchases. It was an admitted fact that in 12 instances Shriram violated this limit. Penalty was levied. Shriram pleaded (before the SAT, the appellant did not appear before the Supreme Court) that the violation was not intentional and there were certain genuine circumstances that required them to deal with such brokers beyond the maximum limits. The SAT set aside the order of penalty “on the purported ground that the penalty to be imposed for failure to perform a statutory obligation is a matter of discretion. The Tribunal has held that the penalty is warranted by the quantum which has to be decided by taking into consideration the factors stated in section 15J” (in the words of the Supreme Court).
Question of law
The Supreme Court phrased the “question of law” before it in the following words:-
“The important question of law which arises for consideration in the present appeal is whether the Tribunal was justified in allowing the appeals of the respondent herein and that whether once it is conclusively established that the Mutual Fund has violated the terms of the Certificate of Registration and the Statutory Regulations, i.e., the SEBI (Mutual Funds) Regulation, 1996, the imposition of penalty becomes a sine qua non of the violation. In other words, the breach of a civil obligation which attracts penalty in the nature of fine under the provisions of the Act and the regulations would immediately attract the levy of penalty irrespective of the fact whether the contravention was made by the defaulter with any guilty intention or not.” (emphasis supplied).
Thus, as will seen later, the question before the Court was whether, once a violation is established, does penalty have to follow or does it would also have to be established that the defaulter had a guilty intention?
What Supreme Court held
It is in this light that the Court reviewed the framework of the Act. It pointed out that broadly there were two sets of proceedings under the Act – one under which penalty is levied in civil proceedings and others which are criminal proceedings. For imposing penalty in civil proceedings, proof of a guilty intention is not required, while it is mandatory in case of criminal proceedings.
Since in the present case, the proceedings were for levy of penalty under civil proceedings, there was no need to prove that Shriram had a guilty intention. It was sufficient to show that the violation was established. Since this was done, penalty was leviable. However, is this the end of the matter? Is “intention” wholly irrelevant? Are other factors including mitigating factors wholly irrelevant? It is submitted this is not so and not only does the Act provide otherwise, but even the Supreme Court does not say so, as is implied in SEBI orders.
Factors to be considered for deciding quantum of penalty or waiving it
That penalty is not so inevitable is apparent from the SEBI Act itself. Section 15J makes it clear that, in adjudication proceedings, the Officer shall have due regard to certain factors. The section reads as under (emphasis supplied):-
While adjudging quantum of penalty under section 15-I, the Adjudicating Officer shall have the due regard to the following factors, namely :-
(a )the amount of disproportionate gain or unfair advantage, wherever quantifiable, made as a result of the default;
(b)the amount of loss caused to an investor or group of investors as a result of the default;
(c )the repetitive nature of the default."
Thus, the Act itself mandates the Adjudicating Officer to consider these three factors. This was recognized in Shriram too.
It is also submitted that in appropriate cases levy of zero penalty is also appropriate. It is also submitted that other factors, apart from these three statutory factors, would also be relevant, depending on facts of each case. This is also evident from decision of Supreme Court in Shriram itself.
For example, the Supreme Court noted that “there has been a clear violation of the statutory regulations and provisions repetitively, covering a period of 6 quarters”. In other words, the fact that the violations were repetitive over 6 quarters was highlighted.
The Supreme Court also reviewed the circumstances in the case to show that there were no extraordinary circumstances mitigating the violation. The Court observed, “The facts and circumstances of the present case in no way indicate the existence of special circumstances so as to waive the penalty imposed by the adjudicating officer”. Again, this shows two things. Had there been special facts/circumstances shown, they, firstly, would have to be considered. Secondly, appropriate circumstances would justify waiver of the penalty too. Indeed, the Court went ahead and observed that the Officer had indeed considered all the circumstances before levy of penalty which too was below the maximum amount.
Curiously, the Court even noted that the violation was wilful. The Court observed, “Hence, we hold that the respondents have wilfully violated statutory provisions with impunity and, hence, the imposition of penalty was fully justified.” One wonders, if it was so clear that wilful intent is totally irrelevant, why was such factor needed to be considered? If it can be clearly established in a particular case that there was no wilful violation, would penalty not be leviable? Or at least penalty would be reduced? In other words, absence of mens rea is not wholly irrelevant, as SEBI orders suggest.
In light of this, it is submitted that the consistent stand of SEBI that violation has to result in penalty is wrong in law and its reliance on Shriram, far from being correct, is actually wrong and goes against what the Court held in that case. It is submitted that SEBI has to consider all mitigating factors before levy of penalty. If the appellant demonstrates that he did not have guilty intention, that too has to be judicially considered. Further, SEBI has full discretion to levy a nominal penalty or even waive penalty altogether. SEBI also has to consider the three factors that Section 15J prescribes. The defaulter would also be right in questioning an order of penalty on grounds that there were mitigating circumstances or that such circumstances were not appreciated by SEBI. It is thus high time that the ghost of Shriram that haunts adjudication proceedings is exorcised, either by SEBI itself, or through a strong appeal before SAT/Supreme Court. And justice, sense of fair play and absence of arbitrariness be restored in adjudication proceedings.
Endnote:- It is worth drawing attention to a recent amendment to penalty provisions made by the Securities Laws Amendment Act 2014, notified on 25th August 2014. By this, most provisions relating to penalties now provide that a minimum penalty of Rs. 1 lakh would be leviable. It is submitted that even despite such provision, the ratio of Shriram continues to be valid. SEBI has to consider all circumstances even for levy of minimum penalty. And that SEBI continues to have power to waive penalty altogether.