The fate of Brickwork Ratings and its employees rests on the outcome of a likely legal battle with the Securities and Exchange Board of India (SEBI), which on October 6 asked the credit assessor to cease operations within six months, citing multiple lapses.
A legal battle may last for years, with no guarantee that the rating agency’s business would restart. Employees, meanwhile, will likely have to go through a temporary setback and face job losses, industry veterans and experts said.
“Most likely, Brickwork will appeal and ask for a stay in SAT (Securities and Appellate Tribunal) because its business is at stake here. The case is likely to be taken to the Supreme Court as well if the SAT order goes against Brickwork,” said JN Gupta, founder and managing director of Stakeholders Empowerment Services (SEES) and a former executive director of SEBI.
If the case drags on for the next 3-4 years and assuming Brickwork is not allowed to resume operations, it could be the end of the road for the Brickwork, Gupta said.
Brickwork versus SEBI
Brickwork is a full-service rating agency that assigns ratings to financial products such as non-convertible debentures, bonds, bank loans, commercial paper, and fixed deposits, among others.
The agency was founded by bankers, credit rating professionals, former regulators, and academics. Canara Bank is its promoter and strategic partner.
According to the rating agency’s website, Brickwork has rated debt instruments/bonds/bank loans, and securitized paper of more than Rs 19 lakh crore.
It has also rated fixed deposits and commercial paper worth over Rs 83,500 crore. Some of its notable clients are the Bank of Baroda, Bank of India, Central Bank of India, and Union Bank of India, Brickwork’s website shows.
Matters took a turn for the worse, when SEBI, in a rare action on October 6, issued a winding-up order against Brickwork Ratings, citing major lapses in its operations including in the case of Bhushan Steel.
The action followed probes by the capital market watchdog and the banking regulator, the Reserve Bank of India (RBI).
In its order, Sebi cited failure on the part of the rating agency to "exercise proper skill, care, and diligence, while discharging its duties as a credit rating agency.”
In the past, the regulator has imposed a monetary penalty on credit rating agencies, but the revocation of a permit is unprecedented. The market regulator ordered Brickwork Ratings to cease operations within six months.
Brickwork has already begun mulling a “legal recourse” after SEBI’s order.
“The regulator has clearly demonstrated that they are ready to take stringent punitive action on any repetitive violations in regulations. The regulator’s unprecedented action has created a shock wave in the rating industry as a whole,” said Venkatakrishnan Srinivasan, founder, and managing partner at Rockfort Fincap, a Mumbai-based debt advisory firm.
Most investors always insist on a dual credit rating for debt instruments to avoid such a scenario. There could be an immediate opportunity for fresh mandates for other rating agencies, especially in bank loan rating and asset reconstruction companies’ rating segments, added Srinivasan.
Harsh punishment or firm precedent?
Experts are divided on SEBI’s order. Some hailed the order, terming it as a harsh precedent for other rating agencies. And some said the regulator could have imposed a heavy penalty or even a temporary ban, considering the larger impact.
“SEBI’s order of cancelling the certificate of registration of Brickworks seems to be an extremely harsh action,” said Prashant Pakhiddey, partner at DSK Legal. “SEBI has been taking actions against rating agencies by imposition of penalty and in some cases, highest possible penalty. In a couple of appeals, SAT had interfered and reduced the quantum of penalty payable.”
Gupta, the former SEBI ED, has a contrasting view. Any penalty or action, according to Gupta, has to be a deterrent on a larger level. Soft penalties, he said, are mostly ineffective and do not send out a stern enough regulatory message.
“I am a votary of harsh regulatory decisions,” said Gupta. “In the Brickwork case, too, SEBI would have provided ample opportunities to the rating agency to defend itself. While one could argue that the punishment could have been less harsh, it is likely that this step has been taken as a last resort in the larger interest of market integrity.”
According to Shriram Subramanian, founder and managing director of InGovern Research Services, a corporate governance advisory firm, the message from the regulator is pretty clear -- that rating agencies should work for investors’ benefit and not become flexible for companies’ sake.
“Clearly, it is a message that there is no scope for going ‘rate shopping’ and could probably set a good precedent in the future,” added Subramanian.
Rate shopping is said to be the case when a company solicits additional ratings from other agencies in the hope of procuring a more favorable rating.
Also read: Banking Central | SEBI sends a strong message to rating industry with Brickwork ban
What next for Brickwork?
Experts said the only option left with Brickwork was to challenge the SEBI order in SAT and seek a stay. It remains to be seen how SAT will react to such a move.
“The rational course of action for the company would be to analyse their assets and liabilities if they are in deliberations for finding a new buyer,” said Sameer Jain, managing partner at PSL Advocates & Solicitors. “Meanwhile, the company must implement improved procedures and systems.”
DSK Legal’s Pakhiddey concurred with Jain’s view.
“Brickworks can challenge the order before SAT and seek a stay on the operation of the order. It remains to be seen how SAT will react, especially since SEBI’s order seems to be in the nature of a strong signal to the market and on the other hand the scope of SEBI regulations (credit rating agencies) and its implementation by the rating agencies also needs to be understood.”
Job losses likely
The wider implications of the legal battle pertain to employees, who are invariably dragged into the picture, said, experts. Moneycontrol tried to contact some of Brickwork’s employees for this story, but none of them wished to comment, given the legal complexities. Brickwork has employed over 350 credit analysts and credit market professionals across nine offices in India.
However, a former employee at Brickwork maintained that the rating agency always adhered to SEBI norms and any lapses “may not have been deliberate.” Hence, SEBI could have also taken into consideration the interest of employees, the former employee said.
According to Gupta, in such cases, there are generally two types of employees – those who were a part of the wrongdoing and for whom the order has been announced.
Second, are those who are not aware of inefficiencies within the organisation or are simply following the policies laid out by the top brass, he said.
“In any case, for the regulator, maintaining the integrity and security of the market is of paramount importance,” said Gupta. “The larger interest of the market is more important than the interests of a few employees. Hence, there is likely to be a temporary setback for employees in terms of job prospects but the order is for a larger good.”
InGovern’s Subramanian had similar views.
“There could be a short-term panic among the employees where they face a personal setback,” said Subramanian. “But looking at the nuances of the business, this impact may not be long-lasting as the number of employees getting impacted could be relatively low.”
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