Sebi Proposes Major Revamp of 'Fit and Proper' Framework for Market Intermediaries
The Securities and Exchange Board of India (Sebi) is planning a comprehensive overhaul of its 'fit and proper' framework for market intermediaries, acknowledging that some existing rules may be excessively rigid and could unfairly penalize individuals and firms before any wrongdoing is conclusively established. In a significant consultation paper released on Wednesday, the markets regulator highlighted that insights gained from five years of enforcing these regulations, coupled with global best practices, necessitate a thorough review of Schedule II of the Intermediaries Regulations.
Addressing Rigid Compliance and Premature Disqualifications
This initiative follows persistent representations from various market participants, who have raised concerns about onerous compliance requirements and the potential for irreparable harm resulting from premature disqualifications. The draft paper specifically calls for a reconsideration of provisions that trigger disqualification at an early stage of legal proceedings. Under the current framework, an applicant or intermediary can fail the 'fit and proper' test merely if they are the subject of a pending criminal complaint filed by Sebi or a charge sheet issued by an enforcement agency for an economic offence.
Sebi has pointed out that such rule-based triggers, which operate at a preliminary stage of the criminal process, may fundamentally contradict the legal principle that an individual is presumed innocent until proven guilty. The regulator emphasized that its other regulations, including those governing stock exchanges and depositories, do not impose disqualification solely based on the filing of a complaint or charge sheet. Furthermore, international standards, such as those established by the International Organization of Securities Commissions, primarily focus on convictions rather than pending cases.
Aligning with Domestic and Global Practices
Domestic regulators like the Reserve Bank of India follow a similar approach, relying on convictions under a rule-based test while considering pending proceedings as a factor within broader, principle-based assessments. In response, Sebi has proposed eliminating automatic disqualifications linked to pending criminal complaints and charge sheets. Instead, the regulator aims to adopt principle-based criteria that evaluate factors such as integrity, reputation, and overall conduct. Sebi clarified that it would retain the discretion to take action in serious or egregious cases, potentially through specific guidelines that identify when pending proceedings are severe enough to warrant regulatory intervention.
Broadening Disqualification Criteria and Refining Insolvency Rules
While easing rules for those facing pending charges, Sebi has proposed broadening its disqualification criteria to include anyone convicted of economic crimes or stock market violations. This adjustment aims to bring these rules in line with its other major regulations, ensuring consistency across the regulatory landscape. The consultation paper also addresses concerns related to insolvency-related disqualifications. Currently, a legal entity can be disqualified as soon as winding-up proceedings are initiated.
Sebi noted that this threshold might be too low, especially since proceedings under the Insolvency and Bankruptcy Code can often result in a successful resolution rather than liquidation. Consequently, the regulator has proposed limiting disqualification to cases where a winding-up order has actually been passed, providing a more nuanced approach to insolvency scenarios.
Revisiting Default Prohibitions and Enhancing Procedural Clarity
Another critical area under review is the default five-year prohibition that applies when Sebi declares a person not 'fit and proper' without specifying the duration of the ban. Sebi argued that this automatic consequence can function as a one-size-fits-all penalty, potentially failing to reflect the gravity of the violation or the regulator's intent. To address this, the regulator has proposed removing the default period, with prohibitions applying only when explicitly specified in the regulatory order.
Sebi has also suggested several procedural changes to reduce ambiguity and enhance transparency. These include explicitly stating that a reasonable opportunity of hearing will be provided before declaring a person not 'fit and proper'. Additionally, intermediaries will be required to promptly disclose events that could trigger disqualification for key management personnel or persons in control, ensuring timely and accurate reporting.
Streamlining Registration and Show-Cause Notice Processes
Finally, the regulator proposed narrowing and shortening the restriction that applies when a show-cause notice is issued at the time of registration. Sebi plans to limit the freeze to cases involving serious regulatory directions and reduce the waiting period from one year to six months. This change aims to streamline the registration process while maintaining regulatory oversight where necessary.
Overall, Sebi's proposed revamp of the 'fit and proper' framework represents a significant shift towards a more balanced and principle-based regulatory approach. By aligning with global best practices and addressing industry concerns, the regulator seeks to foster a fairer and more efficient market environment for all intermediaries.
