SEBI must fortify surveillance, investigation depts: Sinha

On the occasions of Securities and Exchanges Board of India truning 25, Chairman UK Sinha recognised the need to strengthen its enforcement, surveillance and investigation division so that investors can be protected with even more rigor.

However insufficient financial resources have always been hampering the market regulator from achieving this goal. Even while its grappling with constant financial constraints, Sebi is not looking towards the government for a helping hand, Sinha said.

"In the long run, for the health of the market and health of Sebi, it is better that Sebi find resources of its own," he says. Sinha said that fortification of its investigative capabilities becomes even more important in the times when the country is facing several chit fund scams which are affecting several small uninformed investors.

Commenting on the Sebi Act, Sinha says, the regulator has taken up the difficulties faced by it with the government. "If Sebi passes an order against an intermediary who has to do business and be here in the market he is likely to respond to our orders and pay up. But if somebody is not directly connected with the market, he is not obliged to pay because the mechanism for me to recover that money is very cumbersome," he explains.

He says CCI and IT regulations have better recovery mechanisms, whereas Sebi still does not have the power to demand documents. Also, the accountability of the regulator is not properly addressed in the Act. "The Sebi Act has many exemptions for chit funds, Nidhis," he says adding, "facing severe challenges in case of CIS Acts in North East and Bengal."

Sebi has been taking action against collective investment scheme (CIS) but Sinha says he cannot say at this point in time whether the regulator can regulate all such schemes. "There should be one regulator dealing with all deposit-taking activities," he says. And in case Sebi is asked to regulate, Sinha wants more financial resources and manpower to deal with CIS sector.

Sebi has been seeking an overhaul of regulations governing its powers and mandate for a long time, given the changing nature of the securities market in general, and newer tools being used by manipulators to take gullible investors for a ride, in particular.

The government has decided to accept most of the proposals made by Sebi in this regard and the amendments would be carried out after the Cabinet approves the move and the required amendment bill is passed by the Parliament. The proposed amendment seeks to bring all kinds of ponzi schemes, which are thriving in various semi urban and rural areas at the expense of gullible investors, are brought under Sebi's oversight, which itself would be made much more effective to safeguard investors from being defrauded.

Sinha says the regulator is undertaking massive campaign for investor education.

Meanwhile, Sinha says the mandatory safety net mechanism has received "very strong opposition" and is yet to go to Sebi board.  A safety net is a scheme where the company promoters assure that they will buy back shares from the retail applicants at the IPO price, if its stock falls sharply during the first six months after listing.

The Sebi chairman is also looking at one route for foreign portfolio investors and simplifying the KYC requirements as well. "The KYC will be based on type of investor and it will be done by Sebi-regulated agencies," he told the channel.

Interview on page 2

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Below is the verbatim transcript of his interview on CNBC-TV18

Q: 25 years is a long commendable set of achievements for Securities and Exchange Board of India (Sebi). I would like to hear it from you itself on how you think Sebi as a regulator of markets in an emerging country has been able to distinguish itself from its peer group and been able to make a mark for the kind of work that it has done?

A: When we were created in 1988, our immediate challenge was to get our credibility with the intermediaries. There were several protests about who is Sebi? What is Sebi? What are they going to achieve? What are their powers? We faced lot of judicial actions which we fought upto the Supreme Court. From that level, now we have come to a level where we are now agitating and talking about how we protect the interest of the small investors. So, we have covered a long distance.

If you look at the way Sebi has evolved, I would like to categorize it into three distinct phases. The first phase was from 1988 or 1992 when the act was passed, and around 2000 a lot of changes in the architecture and infrastructure were made. From 2000 to 2008-2009 derivatives were allowed. The focus came on enforcement, the focus came on surveillance and starting a few new products. Last four-five years our focus has been how to reach out to these small investors, how to provide protection and a feeling of a good will in their minds. This is a task in which if you look at many other parts of the world, we are recognized today as an organisation which has done a reasonably good job.

Q: Let me offer my congratulations on everything that Sebi has achieved over the last 25 years, you along with the several past Chairman and the entire staff of Sebi. But as regulators would want - you would rather look ahead than look behind, as you look ahead than look behind and as you look ahead I think the first key thing that strikes me as an important issue that needs to be resolved is whether Sebi is equipped with the resources monetary and otherwise to deal with the challenges that a fast-moving, innovating marketplace will throw up in the years to come.

Slightly long question, but I will put some points there to you, for instance from the resource front, unfair to draw a parallel with the Securities Exchange Commission (SEC), but I will still do that – the SEC in FY14 budget that it has put to its government has put in a proposal to add 670 odd people – that’s the full strength of Sebi. SEC is intending to add A Sebi in one year to itself as oppose to our size. If you look at the budgets they have put out a USD 1.6 billion request for a budget. Our budgets are about Rs 400 crore and I think that number is also slightly inflated because of the recent capital expenditure. On that front we desperately need more resources if the government wants the regulator to do an effective job of protecting investors is your first mandate.

On the second front - more powers for Sebi, recent instances whether it is the Sahara case where Sebi has had to repeatedly go back to the Supreme Court to be able to get directions to do what the Supreme Court order itself ask Sebi to do, which is to attach assets etc. the restricted powers that you have to attach assets or there is Sharda chit fund matter, where it is taking you three years to be able to go ahead and take any action. I am sure that frustrates you as a regulator as well. What needs to be done to equip Sebi for the next 25 years?

A: Every country has its own cultural and historical perspective. You were talking about the US SEC, but one major positive, which Sebi in India has compared to SEC is that we are financially independent. I had a discussion with the previous SEC chairperson and she had a problem in getting her budget approved by the US Senate. Even the requirements of the Dodd–Frank Act and the amount of subordinate legislation that they had to do they didn’t get the manpower for pretty long time and they were not able to meet the timeline.

So, we are happy that we are financially independent. The parliament of India has given us power to raise our own resources. We are not dependent on the government for that purpose.

I am also very happy to note that you and many friends in the media are raising the question of our resource constraints. We are a small organisation, we need to strengthen some of our divisions especially the enforcement division, the investigation and surveillance division. I would like to assure you that finances will not be a constrain.

Q: But you are dipping into reserves this year for instance to make up for the deficit in your numbers, right? I don’t mean this as a criticism, I just mean this as a being able to equip yourself because markets are getting more technology oriented, surveillance therefore needs large IT budgets, all of this needs money – effective regulation in that sense. So, while you are independent is great credit to you but don’t you need more money?

A: I need more money but I do not want money from the government.

Q: How do you hope to raise it on your own?

A: I will have to raise it on my own when the markets improve, hopefully the activities will improve. So far as our enforcement action is concerned, surveillance is concerned we will not be found lacking. Although I do appreciate your concern and I have seen many news articles saying that Sebi does not have the wherewithal. At the same time I must make it very clear that I do not want any grant or loan from the government. In the long run it is for the health of the market and health of Sebi that Sebi should be able to find resources of its own.

Q: I understand that from an independence of the regulator point of view. What about strengthening the act?

A: About the act, we have some very serious difficulties. All I can inform you is that we have taken up the matter with the government. We have been assured by the government that government is taking it up very seriously. For example if Sebi passes an order against an intermediary who has to do business and be here in the market, he is likely to respond to our orders and pay up. But if somebody is not directly connected with the market, he is not obliged to pay because the mechanism for me to recover that money is very cumbersome.

Recently new legislations have come. For example the competition commission of India (CCI) which has come or the income tax law there the recovery mechanism is much more stronger. More than Rs 150 crore worth of penalties, which we have enforced, which we have imposed but they have not been recovered.

Q: That is a small amount as opposed to what in one case where the SC has asked you to recover tens of thousands of crore rupees and you have been able to recover only a fifth of the amount?

Similarly, we do not have right and power to demand for documents. We have to go to a different court for that purpose whereas many other regulators even in India have now got those powers.

My feeling is that government is cognisant of these deficiencies in the Sebi system. For some time – I am talking about last one year or so, government was also toying with the idea that they would like to wait for the Financial Sector Legislative Reforms Commission (FSLRC) report to come and then take a comprehensive view.

I am now informed by the government that they are not going to wait for FSLRC, they realise that Sebi act has to be strengthened without waiting for FSLRC and they are working on that direction.

We had several meetings on this with the government. 

Q: What is your view on the FSLRC report? Your broad view on what that report has suggested in terms of unification of certain regulatory activities. Secondly I also want to come to regulatory overlap with the Financial Stability and Development Council (FSDC) because I think that is where one of your key issues with chit funds the problem with that lies. Is the FSDC effective when it comes to areas which are regulated by more than one regulator?

A: Coming to FSLRC I would like to make only one comment at this stage, is that this country has a problem of multiplicity of regulators and their areas are not well defined, not well demarcated. At times it leads to problems and these Collective Investment Schemes (CISs) are one such major example.

So, whatever view government or parliament has to take about FSLRC recommendation about combining various regulators, they have to keep two contrasting things in mind. One is how to ensure that a particular set of activity is assigned to a particular regulator on the one hand and secondly, how to ensure that the accountability of that regulator is also ensured.

In this country I honestly feel that the question of accountability of regulator has not been properly addressed, that also needs to be addressed.

Q: You are saying many different things in one answer, right?

A: Yes.

Q: Are you saying then that ideally you should have been empowered which is Sebi should have been empowered with full powers to be able to regulate chit funds activity in this country under the CIS umbrella regulation if I may put it that way, are you also saying when you say accountability, that other regulators that was supposed to look at chit funds whether they are central or state have not done the job they were mandated to do?

A: I leave this last interpretation to your wisdom. But regarding CIS and chit funds, Section 11AA of the Sebi Act has several exemptions — chit funds, cooperatives and nidhis are exempted. With these exemptions, there is the responsibility of the state governments. In case of CIS activities in Bengal and in the Northeast, Sebi has been taking action very seriously for last two years.

But the problems encountered are varied. In one case, district courts passed injunction orders against Sebi’s orders. Under the Sebi Act, the power of appeal against any court direction lies with the Securities Appellate Tribunal and the Supreme Court and not district courts.

Q: Is that not allowed under the Sebi Act?

A: It is illegal. But what can you do at Sebi? If there has been an injunction, you go to the High Court and you request for that to be vacated — it takes months. In one case, we got it vacated. The High Court was so peeved that they also awarded a monetary penalty. But immediately they went to another district and were able to get stay orders. We have been able to vacate six or seven of them.

Q: But isn't that a long-drawn process?

A: It is a long drawn process and I think Sebi Act has to be strengthened to deal with these situations.

Q: You are saying a couple of things, Sebi act has to be strengthened for you to get more powers, in the regular regulation that you do, right?

A: Correct.

Q: The second part you are saying is that maybe the entire way you look at CIS needs to be expanded to include chit funds because state governments and other regulators have not done a good job and it is best to locate the regulation of these kinds of entities with one regulator than Sebi?

A: You might be hearing the word financial innovation and the people who are proponents of them always say that regulators are the spoil sports, they do not allow financial innovation. People in this country and maybe in other parts of the world also are very creative in their innovations. So in a situation like this, somebody has to be responsible for taking into account all the so-called innovations that can come through. For example, the multi-level marketing companies. If you ask for my opinion, I have written to government, I have suggested them to create one regulator for all the activities like this. According to me, the ideal situation would be that you create one regulator, which is dealing with all these deposit taking activities.

Q: That should be Sebi?

A: I cannot say that should be Sebi because I will now then come back to your first question, because then I will have to be very strong in manpower or resources because if I ask for this I need huge amount of resources in Sebi, I also do not have the financial resources for that purpose. So whosoever it is, create an institution or give it to one of the existing institutions with the required resources. 

Q: But there will be then either overlaps or gaps if it is not with Sebi because you are looking at certain kinds of collective investment schemes, these definitions are like you said innovation gets the better of almost any definition – isn’t the best thing to empower Sebi to look at all of this and give Sebi the resources to do all of this and maybe independent resources so that the independence is maintained?

A: I leave that decision on the wisdom of the government and the parliament.

Q: 62 percent of the IPOs between 2008 and 2011 traded below their issue price within 6 months of listing. Of the 72 issues which witnessed a fall in price 55 fell more than 20 percent below their issue price. Perturbed by the dismal post-listing price performance of IPOs, Sebi in September last year proposed an IPO safety net mechanism for retail investors. If within three months of listing, the share price drops from the issue price by at least 20 percent over and above the broader market, the company would have to buyback 5 percent of the issue from retail investors. This proposal has been met with severe criticism and Sebi is yet to mandate it. Though it is currently voluntary, word has it the regulator has been asking some IPOs to include the safety net.

Sebi's primary mandate is the protection of investors. A key initiative has been the implementation of a safety net mechanism for the IPO market. However, you have not notified the safety net mechanism. It is has not been made mandatory, yet some companies are being asked to provide for a safety net mechanism. What do you intend to do with this mechanism? Will you mandate it or will you continue to implement it on a case-by-case basis?

A: The mandatory safety net mechanism received very strong opposition from various segments of the business and financial community. Our current regulations do provide for a voluntary safety net.

Q: So Sebi has not asked these IPOs to provide for a safety net?

A: Those are subjective case. I do not think I can answer that.

Q: Have you nudged these IPOs towards providing for a safety net?

A: We have come out with a mechanism wherein if a draft red herring prospectus (DRHP) or an IPO application is not in conformity with our requirements or certain details are not disclosed, then we reject the offer document. The fear of rejection is perhaps bringing some of the corporates, expecting very high valuation, to come forward.

Q: What is the connection? If a draft offer document does not meet your requirements, you reject the draft offer document. It cannot be that if they are willing to put in a safety net mechanism into the IPO that you will accept the draft offer document that otherwise does not meet your requirements. So what is your plan with the safety net mechanism? Do you intend to mandate it? Are you going to case by case nudge people towards it or have you changed your mind and said, no too much criticism?

A: Safety net mechanism is yet to go to our board. We have received very strong opposition on this, so I am not in a position to tell you that it will be implemented. The board will be briefed about all the opposition which we have received, but corporates and merchant bankers being aware of the fact that offer documents can be received are offering new and new bargains to the investor.

Q: How can you bargain away a bad offer document or one that is unacceptable?

A: It is very difficult to say what is good or bad. Everything is bad at a particular price and good at a particular price.

Q: You are saying that if your offer document is not acceptable to me in some ways, but you put in a safety net mechanism I will accept it?

A: It is not that Sebi will decide the price, but merchant bankers and corporates are now realising that they run the risk of an offer document being rejected and they will be debarred for next 12 months. That is acting in their minds. That is all I can say.

Q: You are not going to mandate the safety net mechanism?

A: That is for the board to decide. We will go to our board. Right now it is not mandated.

Q: You have mandated a committee to look into the combining different portfolio routes. In parallel, you have introduced a segment for QFIs (Qualified Foreign Investors) over the last year-and-a-half and it has not done well. Do you agree that there should be one foreign portfolio investor route?

A: Yes, this was part of the Budget announcement as well. So there will be one route now. Coming to QFIs, one of the reasons the QFI route has not been so successful is because of the KYC (Know Your Customer) requirements.

So we are working not only at creating one route, we are also trying to simplify KYC requirements for foreign investors. We will for a risk-based KYC rather than a rule-based KYC.

Q: Which means?

A: Which means that depending upon the vulnerability of a particular investor, the type of questions which will be asked to him, if you are a sovereign wealth fund or a foreign government agency who is investing versus somebody who has no track record, who is not regulated, not registered with any entity in his own country maybe more questions will be asked.

Q: Is that already happening or is that about to happen over time?

A: Committee is likely to meet sometimes next month and they will be submitting their report, then it will be implemented. 

Q: I want to look at governance and the reason why I am asking you about it is you have been fairly aggressive on that part in the last year and half. I must say that with clause 49 Sebi set a bar that many other regulators even in developed market have yet to reach with the focus on independent directors etc. We do not know how effective it has been. There are criticisms around that, but let us not get into it.

In the last year and half you have introduced new requirements and schemes of arrangement which give minority shareholders a bigger say. You have cracked down on qualified accounts and you have put out a very aggressive set of corporate governance guidance as a discussion paper. It is a fairly mind-blowing paper. You have suggested things like relationship agreements. I do not know if the country is ready for it, but the ideas in that are fairly revolutionary for India. What is your forward looking governance agenda and will those guidelines you put out likely to become mandatory?

A: That is the dilemma of a regulator. If you like something you want it to be done in a hurry, at the same time you are criticised that you did not effective consultation. Today I read an editorial and there are also recommendations of FSLRC that every clause of every regulation should have an explanatory note and there should be wider consultation. Sebi does a consultation, but it is not good enough. I would like to err on corporate governance side on a wider, more detailed consultation.

Q: It has been out there in the public domain for several months now.

A: Several months, but it will take time. We will have mechanism for consultations and coming through. What I would like to tell you is we are very keen to improve, but we are not keen to do something which will be accounted as disruptive. So we will do it in a manner like you said that it is far-reaching and many other countries have not done it. So we will go in a graded manner rather than do something which will be criticised as being very, very disruptive.

Q: How you perceive when some of those suggestions in those guidelines will become effective?

A: In my silver jubilee year you will see a lot of things happening.

Q: Call and Put Options. The last time we spoke you said it will happen in a month, that was a year ago. Finally it is going to become a reality. What is it that you would like see done in that note that finally comes out of the government. Will there have to be a change in the Securities Contracts Regulation Rules (SCRR) or will it just be a Sebi circular that will be required?

A: It will be a change in the SCRR which we are now empowered to promulgate. I also hear media reports that government has now...

Q: Do you mean there are only just media reports, government has not reached out to you?

A: I have not received any formal communication. I am waiting for that.

Q: What about two areas that we are still waiting to hear from you? You did a big expose on Global Depository Receipts (GDRs), cracked down on it in a big way. We do not know if you are relooking at that route or looking to put in any new safeguards, so that is one part. The second part which continues to confuse the markets a little bit is Sebi’s position on both affirmative as well as negative control?

A: On GDR there is consultation going on between government and RBI and Sebi. Hopefully, government will be able to announce something very quickly. On affirmative and negative bias basically we are looking at what is control and I would agree that control has to be defined in a sharper way, although it is not very easy to do that, we are working on that.

Q: Would mean what, like maybe a guideline note or something like that?

A: Some guideline.

Q: All of this in your silver jubilee year?

A: You should expect a lot in the silver jubilee year.