Sebi's emergency powers not unbridled

WITHOUT CONTEMPT

A recent decision of the Securities Appellate Tribunal (SAT) has brought to the fore the manner in which wide-ranging powers under Sections 11 and 11B of the SEBI Act, 1992 ought to be exercised.

Sections 11 and 11B have always been controversial since they empower Sebi to issue directions in the interests of the securities market. Sebi has constantly given these provisions the widest import, while the courts have repeatedly tried to lay down principles on when and in what manner such powers may be exercised.

The SAT has also ruled that definitive and conclusive findings ought not to be contained in ex-parte orders passed at a preliminary stage since conclusive findings recorded in ex-parte preliminary orders would mean that the regulator has made up its mind and this would leave no room for affected pers-ons to represent against such findings.

The SAT order was passed in disposal of 12 appeals filed in relation to an order passed by SEBI in August 2005, followed by another order in December 2005. DLF Commercial Developers Ltd (DLF) had bought shares of a company called Bhoruka Financial Services Ltd through a set of block deals executed on the floor of the Magadh Stock Exchange (MSE) from the erstwhile promoters of the company. The purchase of 99 per cent of the share capital had been exempted by Sebi from a formal open offer and only 26 public shareholders remained, to whom an offer at a higher price was individually made.

The shares were listed on the Bangalore Stock Exchange but were infrequently traded there. The shares were not listed on the MSE, but the exchange enabled the trade by admitting the stock to dealings in the "permitted category". Sebi objected to this on the ground that these trades violated the terms on which recognition of that stock exchange had been renewed.

SEBI used its powers under Sections 11 and 11B of the Act to pass an ex-parte ad interim order on August 19, 2005 prohibiting DLF from selling any of the shares acquired, and the sellers from parting with the sale proceeds. The sellers were asked to deposit the amount received on sale in an escrow account. A post-decisional hearing was provided to the parties. A further interim order was passed on December 5, 2005 ordering investigations into the deals, and continuing the ad interim directions until further orders.

After the SAT had ruled that the scope of the widely-used Section 11B was not penal but that it was in the nature of an emergency power, the new Section 11(4) was inserted into the Act in 2002. The new section expressly provides for issuance of directions when investigations are pending and incomplete.

Without getting into the controversy over the interpretation of Section 11B of the Act prior to the introduction of Section 11(4), the SAT has interpreted the provisions of Section 11 to mean that without investigations actually being pending, Sebi would not be able to invoke powers under Section 11(4) or 11B.

"If the matter is not so urgent and the Board (Sebi) wants to find out whether or not it is a fit case to order an inquiry or investigation, it may issue notice to those allegedly involved in the wrongdoing and make up its mind thereafter," the SAT order states. "In that event, it will not be open to it to issue interim order/directions instantaneously obviously because the matter is not urgent and investigations /inquiry is yet to be ordered."

Since no investigation or inquiry was pending when the August 2005 order was passed, SAT has ruled that the first order in this case was without jurisdiction. However, since Sebi ordered investigation in its December 2005 order, the order confirming the interim order of August 2005 was held to be within jurisdiction.

As regards the nature of findings in the interim order of December 2005, the SAT found that the orders contained firm findings holding various persons guilty of various allegations. The Sebi order had stated that DLF's defence that it merely participated in the trade at the insistence of the sellers, "can not be brooked ... in fact...acted in cahoots with the sellers, broker...exchange to execute the illegal trades...with full knowledge". The order also went on to "hold the sellers' conduct highly objectionable and one of obdurate defiance" and found that "they have failed to comply...and are liable to be punished..."

SAT has ruled that before investigations could commence (they were ordered in the same December 2005 order), it was not proper or wise for Sebi to record such conclusive findings. "Since the matter is pending investigation, it is possible that on its conclusion the Board may have sufficient material with it on the basis of which whatever has now been said in the interim order could be sustained. It is equally possible that the material which the Board may collect may not be enough to substantiate those allegations. When both the possibilities are there it was not proper for the Board to record findings at this preliminary stage. It obviously amounts to pre-judging the issues and may lead to the charge of bias."

This is the first real interpretation of the scope of Section 11(4), which was always feared to be a licence to issue directions even in mere suspicion, without a serious investigation following suit. The SAT has now laid down the rule of law by prescribing the manner in which this power is to be exercised. In the capital market, Sections 11(4) and 11B are like preventive detention powers / anti-terrorism laws, where too courts have had to lay down the manner in which such powers have to be administered.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own)

email: somasekhar@jsalaw.com