Regulation by circulars is illegal

WITHOUT CONTEMPT

A material legal threat looms large over financial sector regulation in India. It is a threat caused by the approach the financial regulators themselves "� specifically, the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI), have adopted.

The RBI and SEBI have been empowered by statutes made by Parliament to make regulations to discharge the functions and duties cast on them.

For instance, all exchange controls applicable in India source their authority from the Foreign Exchange Management Act (FEMA) and the power entrusted with the RBI to make regulations consistent with FEMA. Similarly, most securities laws flow from the SEBI Act, or the Securities Contracts (Regulation) Act (SCRA), which empower SEBI to make regulations.

In short, the relevant financial regulator can make regulations on subjects on which specific authority has been delegated by Parliament. The procedure for making such regulations has also been formally laid down in these statutes. Any regulations made by these regulators have to be within the scope of such power, and ought to be made, both in substance and in form, only in compliance with the requirements of these statutes.

Initially, the SEBI Act required regulations drafted by SEBI to first be approved by Government of India. There was also a period for which the regulations had to be tabled in Parliament.

As the law evolved, SEBI was empowered to directly cause its regulations to be notified in the Official Gazette without prior approval of Government of India. However, such regulations still have to be tabled in Parliament. FEMA has similar provisions requiring regulations made by the RBI to be tabled in Parliament. This is a very crucial requirement since it ensures a check and balance in the law-making system.

The making of the law would be by SEBI under the SEBI Act and the SCRA, and by the RBI under FEMA, but the check on such law takes the form of tabling it in Parliament so that the law-makers who delegated the power to make regulations get to review how the authority is being discharged.

This system of check and balance gains further importance since under the Indian Constitution, not only can the regulations be struck down by courts for being inconsistent with the main statute or the Constitution, but the main statute itself can be struck down for being inconsistent with the Constitution, or for the role of Parliament in the form of excessive and arbitrary delegation.

Over time, an unhealthy approach to exercising these delegated powers has gained ground. Exchange controls and securities laws are replete with "circulars", "guidelines" and even "press releases", each purporting to prescribe legal requirements, often even having the effect of amending the regulations.

On some rare occasions, the regulations eventually get amended to reflect the provisions of such circulars, but many a time, the regulations remain un-amended, with such circulars, guidelines and press releases masquerading as valid law.

It is a well-settled proposition in any sensible law-making jurisdiction that should there arise a conflict between regulations and the main statute, the main statute would prevail.

Similarly, when there is a conflict between regulations and the conduct of a regulator (whether evidenced by its circulars, guidelines and press releases, or by its own actual actions), the regulations have to prevail. This is because the subordinate legislation made by a regulator cannot overstep the very statute that conferred the regulation-making authority.

Similarly, once the regulations state to the world that they represent the applicable law, even the regulator, along with the world at large, becomes bound by it. This is very logical because if a regulator seeks change in course, all it has to do is amend the regulations.

However, our financial regulators have often taken the short-cut of issuing circulars, even purporting to amend the regulations already notified. If a circular, guideline or a press release issued by the regulator, announcing the regulator's view of the law, has the objective of amending the regulations, or creating new regulations, they can never be legal, constitutional and valid. The only way to do such things is to use the powers to notify regulations or amend the regulations.

The Kania Committee Report containing recommendations on amending the SEBI Act expressly acknowledged that the SEBI Act has no power to issue circulars.

Even if a power to issue circulars gets conferred on SEBI by statute, the statute can never empower SEBI to make circulars that constitute regulations, or have the effect of amending existing regulations. Such a provision would stultify the basic check and balance of law-making that is necessary to keep any statute compliant with the Indian Constitution.

Of course, clarificatory circulars may be issued when the regulations require to be clarified. There will never be any dearth of the need for clarity from the regulator.

But circulars that purport to constitute substantive legal requirements, or circulars that conflict with the regulations (regardless of whether to the detriment or benefit of their subjects) would be bad in law. The only course available in any credible legal system would be the actual formulation of specific regulations, or the actual amendment of existing regulations.

Perhaps, it is only when a court draws the line some day that the system will sit up and take note.

somasekhar@jsalaw.com