Regulating unlisted firms: One too many for Sebi?

Experts say the market regulator doesn't have the capacity to take on more responsibilities

The Securities and Exchange Board of India (Sebi) seems to be emerging as the poster boy for effective enforcement in matters related to capital markets, with the government and courts increasingly relying on the regulator to look into several existing grey areas. 

The abuzz in the streets is that the government will soon amend the Companies Act, to give Sebi powers to regulate an unlisted company in the cases where it is a subsidiary of a listed player. The possible move comes in the wake of the Uday Kotak-headed corporate governance committee’s recommendations.

This is not the first time the markets regulator will be bestowed with additional responsibilities. After the infamous Sahara scam, the government brought all the collective investment schemes (CIS) under Sebi's jurisdiction. Similarly, Sebi was mandated to regulate the commodity space as the erstwhile commodity markets regulator, Forward Markets Commission, was merged with it. Also, discussions are on about bringing crypto currencies, or bitcoin, under its ambit. 

So, the question is whether Sebi is prepared to take additional responsibilities amid complex challenges in regulating commodity markets, corporate governance issues, CIS-related matters, and so on. Experts feel that such a move would encroach the space and power being provided to the Ministry of Corporate Affairs (MCA) to regulate unlisted entities. 

“Given the regulatory capacity and historical legal architecture, it will be courageous to seek regulation of all the unlisted subsidiaries of listed companies,” says Sumit Agrawal, founder, Suvan Law Advisors. In 1956, it was envisaged that the Companies Act will regulate unlisted companies, while the Securities Contracts (Regulation) Act will deal with publicly held listed companies, Agrawal points out. “Gradually, the regulatory lines are getting blurred, and any change must outline the principles of judging the conduct of unlisted company with effect on listed company or securities market,” he adds.

To make the idea effective, specific sections of the Companies Act need to be amended to empower Sebi to regulate or take penal action against an unlisted entity and its promoters for violating the insider trading and other securities norms. At present, securities laws are silent on the unlisted subsidiaries. Official data suggests about 80 per cent of the listed firms’ businesses come from its subsidiary account. There are several instances where listed firms diverted or siphoned-off money by using its unlisted arms to evade taxes, notes a regulatory official. 

“Nobody is presently watching that space, and since what is happening in such unlisted companies affects the listed companies, necessary oversight is essential,” says Prithvi Haldea, founder, Prime database. 

“From a regulatory perspective, the idea is to ensure that, what is being done directly could also be done indirectly via the subsidiaries. Thus, it is the regulator’s duty to ensure the interest of the public shareholders in the listed companies is taken care of, since they have an indirect exposure on the businesses of these subsidiaries,” says Yogesh Chande, partner, Shardul Amarchand Mangaldas.  “Companies often do the public fundraising exercise for capitalising their subsidiaries and it is fair for Sebi to have jurisdiction over them as well,” he adds. 

However, some experts feel the classification of Acts, particularly in terms of insider trading, is required, as both the Securities Contract (Regulation) Act and the Companies Act have different provisions. The lack of correlations between the two makes it difficult to take appropriate action against fraudsters. “Currently unlisted companies get away because of the regulatory structure as the MCA isn’t a regulator, like Sebi,” says Shriram Subramanian, managing director, Ingovern research services. 

While in most cases giving Sebi the regulatory control makes sense, one must also consider the constraints under which the market regulator functions.  Sebi needs more resources, especially manpower and technology, to deliver on its charter.

Manpower conundrum: How Sebi stacks up against SEC

The Kotak committee points out that there is a severe shortage of manpower in Sebi. The panel notes that the United States’ SEC has one employee for each listed company. In comparison, Sebi has just one employee for six listed firms. Further, in the corporate finance department — which handles key functions — the SEC has 15 times more employees than Sebi. The total staff strength of the SEC is 4,554, against Sebi’s 780. Besides, the market regulator also lacks the cutting-edge technology to stay ahead in the curve with offenders.

Besides improving staff strength, the panel also notes there was a greater need for collaboration between Sebi and other agencies, particularly the MCA, which oversees the compliance of the Companies Act. Cross-regulator coordination would help ensure effective enforcement, it said. 

According to the Kotak panel, Sebi needed to develop teams comprising data scientists, accountants, lawyers specialised in corporate law, software engineers, and academicians. The members of such teams need to have depth of knowledge within their respective areas, as also possess broad expertise across functional areas. Additionally, Sebi should build its market intelligence through regular review of market research and reports of proxy advisors, the panel said.