Misreading ex-parte SC order dangerous

WITHOUT CONTEMPT

The media has recently been agog with reports on a recent ex-parte decision of the Supreme Court overturning a decision of the Securities Appellate Tribunal (SAT) in case of a mutual fund and its asset management company (AMC), each of which have been penalised by the Securities and Exchange Board of India (Sebi).

The Court reiterated the settled legal position that mens rea (conscious guilty mind) was not necessary for a market intermediary to be liable for civil monetary penalties.

Although the order has only reiterated the earlier Supreme Court decisions on the subject, the strong language used has already led to overzealous misreading of the law.

This column strikes a contrarian note of caution. The Supreme Court order ought not to be interpreted in a sweeping manner to the detriment of all market intermediaries that may commit bona fide errors in their day-to-day operations.

The AMC in question had admittedly breached the limits imposed by Sebi on the size of business that could be given by a mutual fund to an individual stock broker firm. The mutual fund had its explanations and reasons, which did not impress Sebi's adjudicating officer. A penalty of Rs 5 lakh was imposed on the AMC and Rs 2 lakh on the mutual fund.

In other words, the unit holders whose interests are sought to be protected have also been penalised since the resources of a mutual fund are the resources ultimately beneficially owned by the unit holders.

The SAT set aside the penalty not only on the ground that was there proof of mens rea on the part of the mutual fund and the AMC but also on the ground that merely because a penalty may be levied in law, the penalty need not be mandatorily imposed.

The SAT, satisfied with the reasons provided by the mutual fund and the AMC, ruled that in terms of Section 15J of the Sebi Act, which lays down the criteria for determining the quantum of penalty, no penalty is to be imposed.

Interestingly, the mutual fund went unrepresented before the Supreme Court. Perhaps it was reluctant to incur an expense in excess of the penalty in question.

However, the absence of assistance from the mutual fund's counsel seems to have resulted in a very narrow issue being framed for consideration by the court.

The Supreme Court order has only considered whether a breach automatically justifies imposition of a penalty and whether mens rea is a necessary ingredient for imposing penalty.

The order records that the quantum of penalty is discretionary, but neither deals with how this discretion is to be exercised nor prescribes the principles to be followed for ensuring reasonable computation of penalty. The element of whether unit holders (who had no role in the AMC's choice of brokers) could be forced to suffer a no-fault liability for the AMC's wrongs has not been considered.

The criteria in Section 15J of the Sebi Act require an assessment of the extent of gain made due to the default, the extent of loss caused due to the default, and of course, whether the default is repetitive in nature.

These do point to the state of the human mind that was responsible"�whether the default was calculated to make a gain or to inflict a loss and whether the default was repetitive in nature, that is, a willful default or a gross negligence.

The order, which only reiterates the well-settled principle that mens rea is not a necessary ingredient for a civil penalty, is of no assistance to either Sebi or to market intermediaries in other cases. Neither Sebi nor the market intermediaries are any wiser in terms of the principles to be applied to determine the quantum of penalty.

Expectedly, Sebi's counsel would not have urged the unit holders' point of view before the court, particularly when the mutual fund was in Sebi's line of attack and such a point of view would run counter to his mandate. There were no amicus curiae assisting the court either.

Any blanket application of this order would have dangerous and unintended consequences. For instance, the law provides for a penalty of Rs 1 lakh per day for failure to file a document or a return. A bona fide error in meeting the deadline by a quarter would mean a penalty of Rs 90 lakh.

Now, unless the criteria specified in Section 15J are applied (which, in turn, would necessarily lead to considering the state of the human mind involved), a penalty would not be fair, just or equitable.

No human mind is infallible, whether at work in a market intermediary, or in a regulatory organisation. Blanket imposition of penalty, ignoring reasonable factors, would be fatal to the morale of even the most conscientious compliance officer in a market intermediary.

Both the adjudicating officer, and the SAT, which is charged with overseeing the conduct of the regulator, would necessarily have to consider whether the quantum of penalty is justified. This is why Parliament has wisely introduced Section 15J to ensure that the law is not blind.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)

somasekhar@jsalaw.com