IL&FS case: Sebi may inflict more wounds on raters, increase penalty

Rating agencies CARE, ICRA and India Ratings may have got away lightly for their lapses in assigning ratings to the non-convertible debentures (NCDs) of Infrastructure Leasing and Financial Services (IL&FS), feels the Securities and Exchange Board of India (Sebi).

In an unprecedented move, the market regulator is planning to review the Rs 25-lakh penalty, which had been imposed by its adjudicating officer on the three rating firms last month. 

Sources said the settlement amount could be revised up to four times upwards.

“The Sebi board is not convinced with the quantum of penalty levied on these rating firms as it believes that it is quite less, considering the magnitude of the violation, said a regulatory source in know. He added that the department which handles the concerned division (rating agencies) has been instructed to initiate the process of review as envisaged in the regulation.

The crisis at IL&FS, whose board was superseded by the government, has come to the spotlight in September 2018. Since then, the company as well as related entities have come under regulatory glare.

In three separate but similarly worded orders, Sebi had said the default by IL&FS occurred due to lethargic indifference and needless procrastination as well as laxity of the rating agencies.

The market regulator is of the view that exposure to IL&FS, during relevant times was critical to the financial stability as its share in total exposure of banks to non-banking financial companies sector was fairly high. 

There was substantial public interest involved in the affairs of the beleaguered infra firm, considering its importance for financial stability.  

This review of adjudication order was enabled under new power the regulator received through the securities law amendment in 2014. Section 15-I(3) introduced in the Sebi Act states that the regulator can call for and examine an order passed by an adjudicating officer if it considers the order to be “erroneous” to the extent that it is not in the interest of the securities market. In such cases, the regulator can make a fresh inquiry and enhance the quantum of penalty levied by the adjudicating officer.

Experts say that the violation of rating regulation, however, allows a penal provision of maximum Rs 1 crore penalty unless Sebi adds some other provisions of the Securities Act to enhance the penalty. But, other provisions could be imposed, if it launches a fresh adjudication proceedings in the matter, said a legal expert tracking the development.  

In the last six years, the market regulator has reviewed only 10 adjudicating orders and levied maximum penalty of Rs 5 lakh. In one of the orders, whole-time member feels that this power (to review) cannot be used to reverse an acquittal into conviction,” said Suresh Gupta, a former senior officer at Sebi.

The case pertains to the default committed by the IL&FS and its subsidiary IL&FS Financial Services on their obligations in respect of commercial papers (CP), inter –corporate deposits as well as on interest payments related to NCDs.

The Sebi examined the role of the three rating firms in assigning ratings to various NCDs of the IL&FS.

While assigning credit ratings to the NCDs of IL&FS, the three entities “failed to exercise proper skill, care and due diligence while discharging its responsibilities as a credit rating agency. It violated the provisions of the code of conduct of the credit taring agencies,” the adjudication order had said.

They also “failed to exercise independent professional judgment in order to achieve and maintain objectivity and independence while rating IL&FS and its instruments,” it added. 

Though there is no allegation of any mala fide intention on part of these rating agencies, Sebi had said the failure by them is blameworthy.