Jayant Thakur: Do extreme penalties work?

Sebi has dramatically upped its penalties, but it is not certain they will work.

Does giving powers to inflict greater punishment lead to prevention of offences? Does actual levy of strong "" almost extreme "" punishment act as an effective deterrent to offenders in securities markets? Importantly, the question is whether and when would such severe punishment be upheld by appellate authorities and if not, will the purpose of granting more powers be defeated? If numerous recent orders of Sebi are taken together, this is what Sebi seems to be grappling with, in its attempts to prevent, punish and remedy offences in the capital markets.

Until just four years ago, serious capital market offences were punishable by fines in just thousands of rupees. Imprisonment was possible upto a maximum of one year and even that was virtually unheard of. I remember a case where a leading company was said to have come to the hearing for penalty with a cheque for the maximum penalty of Rs 5 lakh. Sheer arrogance, one might say, but it made practical sense, too, since otherwise, the legal costs themselves would have cost much more. The irony was that later, the company actually appealed, won and got the Rs 5 lakh back!

Since 2002, Sebi has powers to levy penalties in crores and offenders look at a higher prison term of 10 years. One has seen this power being used in numerous cases and penalty proportionate either to the loss caused or benefit gained. There are also some interesting examples where these new powers have been innovatively used.

For instance, it was often found that people accused of major frauds, or who are believed to have information regarding such offences, simply failed to turn up, attend the hearing or provide the information demanded. The intention may be that if one does not turn up, Sebi may not be able to establish the case and, hence, while they may be penalised for the smaller crime of defying the summons, they may escape punishment for the real and greater offence. Take the examples of the order against MS Consultancy, on whom a penalty of Rs 25,000 was levied, Rs 1 lakh against Shonkh Technologies, Rs 20,000 against Gautam Patel and numerous others. Sebi, perhaps, realised this trend and came out with an innovative way to deal with it and, in some cases, recently, it straightaway levied penalty of the full amount involved in the offence. This amount may be, for example, the whole of the gain that the offender may have made. In case of Nokia Finance International Pvt Ltd. (dated May 20, 2005), where there was an allegation that shares more than even the authorised capital of a listed company were held by a person, Sebi served summons but these were allegedly not fully complied with. Sebi then levied a penalty of the full possible gain at the minimum level that could have been made out of the alleged fraud for which the company did not fully respond.

In a strange and, in my opinion, arbitrary variant of this, recently (in Kerry Jost matter), an alleged offender was penalised for not having made an open offer. The amount of the open offer consideration for acquiring 20 per cent of the shares was worked out and three times this amount was levied as a penalty.

Such huge monetary penalties can obviously act as a deterrent and, in some cases, even take away the profits that may have been made. For those accused who are innocent or less guilty than charged, there is an incentive also to come forward and co-operate.

However, one will have to see whether this well meant "" though some may call arbitrary "" methods are upheld in appeals. Appellate authorities have repeatedly reduced the huge penalties in crores to just thousands. The Securities Appellate Tribunal held in the Bonanza's case that increased powers granted does not mean that Sebi can levy sky-high penalties.

There are also limitations and inadequacies in the law. For example, the law provides for three considerations for levy of penalty and none of these justify levy of the highest of penalty. Further, if the accusation is of an offence such as a fraud, then the onus to prove it would lie more on Sebi, and just because the accused did not co-operate would not justify assumption of guilt and, therefore, levying maximum penalty. In the example of Kerry Jost, where three times the open offer consideration was levied as penalty, there appears to be an anomaly since if the accused had made an open offer, he would have got valuable shares. Also, the penalty would go to the coffers of the government and would not compensate those who are entitled to, that is, the shareholders.

Levy of maximum penalty is not found to be necessarily effective by legal philosophers even centuries ago. As Salmond has said, "Were human nature so constituted that a threat of burning all offenders alive would with certainty prevent all breaches of the law, then this would be effective penalty for all offences from high treason to petty larceny". He then advised that the quantum of penalty should be judged with regard to factors such as motive for the offence, the magnitude for the offence and the character of the offender. Thus, penalty would have to be levied and be proportionate to factors acceptable in law and as the Supreme Court has observed in Hindustan Steel's case, "Penalty will not be imposed merely because it is lawful to do so".

To conclude, the huge penal powers granted are not an open-all-locks-key to be used identically and indiscriminately. Rather, these powers are similar to a Swiss army knife with tools that should be used discreetly and appropriately and, more importantly, used along with and supported by adequate homework and evidence. At the same time, such greater powers also cause potential offenders to pause and reflect on the consequences of the acts they contemplate. It will be a while, though, both of these will happen.

The writer is a chartered accountant