Fit-and-proper decisions: Regulators need clear, predictable rules

Regulators need discretion, but that discretion must be structured, transparent and predictable

In the quarter ended June 2026, the Insolvency and Bankruptcy Board of India (IBBI) cancelled the registrations of 207 insolvency professionals (IPs) “on failing to fulfil the requirement of fit and proper person status”, roughly 5 per cent of registered IPs. No order explaining these cancellations is publicly available. The profession, and the creditors and courts who rely on it, cannot know what made these IPs unfit, or what might make the next one so.

 

In the same quarter, the Securities and Exchange Board of India (Sebi) moved in the opposite direction. It amended its regulations to mandate that a person be given a reasonable opportunity of being heard before being declared not a “fit and proper person”. It also removed two triggers that, since November 2021, had automatically rendered a person unfit: A pending criminal complaint or FIR filed by Sebi, and a pending chargesheet filed by any enforcement agency in a matter concerning economic offences. Sebi noted that there is no judicial application of mind at the FIR or complaint stage, and, even at the chargesheet stage, the allegation has not been adjudicated. The change followed public consultation and despite some comments favouring retention of the provisions. Sebi also approved administrative steps to withdraw pending show-cause notices that would not survive the amended test. This is a welcome instance of regulation correcting itself through consultation.

 

That correction settles one question: An allegation should not operate as a verdict. It does not, however, eliminate wide regulatory discretion. Some elements of the fit and proper test are objective and readily verifiable: Whether a person has been convicted of specified offences, debarred by a regulatory authority, or classified as a fugitive economic offender. Others are inherently subjective, requiring an assessment of integrity, honesty, ethical conduct, reputation, fairness and character. More significantly, these criteria are expressly illustrative, not exhaustive. The regulations permit Sebi to consider “any criteria as it deems fit” and to specify “any other disqualification” from time to time. This gives the regulator considerable latitude to assess unspecified considerations against open-ended standards.

 

Such discretion may be justified by the need to protect market integrity and investors, but it also increases regulatory uncertainty, reduces the predictability of market entry and creates scope for inconsistent decision-making. Importantly, the regulatory framework enables Sebi not merely to apply prescribed eligibility norms but, in effect, to supplement and shape them. The boundary between its quasi-legislative function of prescribing eligibility standards and its executive function of applying those standards consequently becomes blurred. This raises questions of transparency, accountability and institutional design, particularly where executive discretion can effectively determine the content of the eligibility standards themselves.

 

The omitted triggers have not left the room. Sebi has said that pending criminal proceedings of a severe nature remain relevant under the principle-based criteria, to be weighed case by case. That is defensible in principle. But “severe” is undefined. So is “economic offence”, which Sebi did not define on the grounds that the category keeps evolving. Sebi has left open the possibility of guidelines on when pending proceedings may be egregious enough to disqualify a person. In the public consultation, concerns were expressed that the omitted clauses should not simply migrate into guidelines. The concern is legitimate: A regulator can reach through the principles door the very outcome that the rules door had produced.

 

The choice between rules and principles is old. Rules are relatively cheap to administer and predictable, but can be over-inclusive: They place the cost of a crude boundary on whoever lands on its wrong side, as the 2021 triggers did. Principles fit the facts better, but are costlier to apply and create scope for inconsistency and selective enforcement. The answer is not to swing from one to the other, but to discipline judgement so that it delivers the predictability that rules provide. Five elements could help.

 

First, publish the factors in advance. Where pending proceedings are relevant, the regulator should specify, after consultation, what it will weigh: The nature and gravity of the allegation, its nexus to the regulated activity, the stage reached (FIR, chargesheet, framing of charges, conviction under appeal), the passage of time, and the person’s conduct since.

 

Second, reason and publish every order. A declaration of unfitness should be a speaking order, published with suitable redaction, so that individual decisions accumulate into a body of precedent. The 207 cancellations would then instruct the profession rather than unsettle it.

 

Third, calibrate the consequences. Between fit and unfit lie conditions, enhanced disclosure, monitoring and exclusion from particular functions. A binary test can push a regulator towards either overreach or inaction.

 

Fourth, build in reversibility. A finding resting on pending proceedings should carry a review date and be revisited on discharge, quashing or acquittal, with rights restored on final exoneration. Sebi has declined automatic restoration on a stay; restoration on an outcome should at least be expressly provided for.

 

Fifth, create new disqualifications only through regulations. The residual power to specify “any other disqualification” should be exercised through regulations backed by consultation and a regulatory impact assessment, not through subsidiary instructions.

 

These are not Sebi's questions alone. The IBBI’s regulations likewise allow it to take into account any consideration it deems fit. The Reserve Bank of India, the Insurance Regulatory and Development Authority of India, and the International Financial Services Centres Authority all run versions of the same test. A common minimum standard of structured discretion, rather than a separate experiment by each regulator, would serve markets and professionals alike.

 

Sebi has shown that a regulator can recognise that a rule has gone too far and correct it through consultation. The harder task is to demonstrate that judgement, once freed from a rigid checklist, can be exercised in the open. A fit and proper test earns trust only when those subject to it can understand, from published criteria and reasons, what makes a person fit, and what does not.

 

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 The writers are, respectively, former chairperson of IBBI; and  managing partner, Regstreet Law Advisors, and a former Sebi officer