SEBI has laid down a detailed regulatory framework to govern intermediaries in the capital market and avoid the possibility of default. Various categories of intermediaries are regulated through the following SEBI rules and regulations:
- The SEBI (Stock Brokers and Sub- Brokers) Regulations, 1992;
- The SEBI (Depositories and Participants) Regulations, 1996;
- The SEBI (Bankers to an Issue) Regulations, 1994;
- The SEBI (Merchant Bankers) Regulations, 1992;
- The SEBI (Portfolio Managers) Regulations, 1993;
- The SEBI (Registrar to an Issue and Share Transfer Agents) Regulations, 1993;
- The SEBI (Underwriters) Regulations, 1993.
These regulations provide detailed requirements to make intermediaries eligible for registration along with the compliance requirements that need to be fulfilled during the entire course of functioning, the nature of registration being perpetual or subject to renewal, the required code of conduct during functioning in capital markets, guidelines for maintenance of books of accounts, the disclosure requirements, procedure for inspection of accounts and documents, investigation and inquiry process for any alleged default, the conduct of adjudication or disciplinary procedure, orders to enforce the decisions and appeal against such orders.
Even though all the regulations about a specific intermediary category are similar in terms of structure, the difference arises concerning the requirement of disclosure, eligibility for a registration certificate, disclosure of multiple interests to avoid preferential investment advice, the term for which registration is granted, the procedure for addressing grievances of investors, corporate governance practices and the code of conduct of each intermediary.
Therefore, a consolidated framework with consistency regarding standard requirements of all categories of intermediaries would help prevent the conflicting interpretation of regulations, bring administrative convenience and legal enforcement. However, the persistence of conflicts of interests by financial intermediaries is mainly unavoidable and is only likely to increase with the growth of capital markets. Despite that, regulators make efforts to keep an eye on excessive fraud to protect the investors to the maximum degree.
Some of the important regulations laid down by SEBI governing the activities performed by financial intermediaries in the capital market have been analyzed below with particular reference to essential provisions:
The SEBI (Intermediaries) Regulation, 2008.
Regulation 15 requires intermediaries and related persons such as directors, officers, employees, and key management personnel to make clear disclosure regarding all direct or indirect interests that they have in a security for which they give investment advice. Additionally, it prohibits rendering such advice without reasonable cause of making such a recommendation. However, what amounts to “reasonable grounds” has not been defined by SEBI, thus left to the interpretation by intermediaries.
Regulation 16 read with the Code of Conduct (CoC) provided in Schedule III of the Intermediary regulations, ensures continuous adherence to the CoC to avoid conflict of interest, such as,
- Article 4 deals with conduct to avoid conflict of interests and makes it mandatory for intermediaries to make adequate disclosures to the public regarding their interests and potential area of conflict to resolve conflicts that may arise.
- Article 1 lays down ways in which intermediaries should conduct themselves to protect the interest of investors by prioritizing the needs of the client and maintaining their professional skills. It necessitates high standards of service by professionalism, integrity, and ethics while conducting business.
- Concerning disbursal of the information under Article 3, there must be no misrepresentation in statements made to clients and the quality of disclosures must help clients make a well-informed decision.
- Article 5 deals with corporate governance issues of avoiding indulgence in unfair competitive or corrupt practices hampering the investor’s interest or distorting market equilibrium.
Regulation 17 Read with Article 6 of the CoC, requires intermediaries to maintain adequate systems of internal control and additional safeguards.
Regulation 12 when read with Article 5 of the CoC requires intermediaries to maintain records and data that is continuously backed up to trace possible default and malpractices.
Regulation 3 read with Schedule I necessitates intermediaries to disclose the structure of ownership and information of promoters during the registration process to assist in the supervision of intermediaries and avoid conflicts of interests due to the diversity in intermediary services provided by entities owned by the same proprietors.
SEBI (Investment Advisors) Regulations, 2012.
The purpose of this regulation is to ensure that investment advisors should perform their duties towards their clients in a fiduciary capacity and distinctly perform advisory functions from other activities they undertake. Full disclosure should be made regarding commission or remuneration from other activities.
When intermediaries render advisory services for a commission, then regulating such entities can be done to avoid exploitation of investors by investment advice that is biased or ignorant. However, the advice that given free of cost cannot be brought within the purview of the regulations
The regulations provide for different categories of investment advisers rendering their services to private equity funds, venture capitalists, hedge funds, and other corporates. Based on these categories they are required to obtain certification.
The SEBI (Prohibition of Insider Trading) Regulations, 1992.
The Any Insider Trading Regulations prohibit insiders from dealing with securities of which they possess unpublished information. Therefore, the regulations don’t particularly deal with intermediaries but prohibit trading securities where an intermediary may possess information, for instance, from underwriting an issue.
The regulations mandate the distinction of departments to ensure that access to price-sensitive information is not widely available. This is necessary to make sure confidential information is not exploited within the same entity rendering varied intermediary services in different capacities. For instance, the analysts making the reports of a company cannot trade in its securities for at least thirty days after making the report and they have to disclose their interest in the company.
The SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.
Regulation 4(2) prohibits fraudulent activities, unfair practices, unintended promises to perform acts, and concealment of information or making false statements. The regulations specifically prohibit certain activities of particular intermediaries such as inflating the accounts of the client to gain higher commission, circular trading of securities by various intermediaries to create false pricing, advanced trading of securities by intermediaries of a big client order, and so on.
However, one of the drawbacks of these provisions is that while fixing accountability, the “knowledge test” is undertaken where it is necessary to prove that the intermediary possessed knowledge of the malpractice to be held liable.
Jargons like circular trading and front-running have been used by the PFUTP Regulations to indicate certain malpractices, however, these terms have nowhere been defined by the regulations and have been left to the determination by courts. For instance, in the case of Vibha Sharma v. SEBI (2013), the Securities Appellate Tribunal gave a liberal interpretation to the term “front running” making it punishable regardless of whether the person is an intermediary or not. Additionally, in the case of SEBI v. Shri Kanhaiyalal Baldevbhai Patel (2017), the Supreme Court had to clarify the meaning of “non-intermediary front-running”.
Regulatory authorities have taken commendable steps towards regulating the securities market by monitoring intermediaries through SEBI rules and regulations, code of conduct, and RBI guidelines. These regulators are crucial to curb the action of intermediaries who play a prominent role in the capital market. When there are proper disclosures made by intermediaries, the interest of the investors is protected. However, proper implementation of these provisions is lacking. The norms regarding the functioning of financial intermediaries need to be more stringent to fairly redress investor’s grievances.
The fundamentals of corporate governance are absent when it comes to the Indian intermediaries rendering varied services in the market. The securities market in India is still undergoing dynamic changes. During these changes, the role of intermediaries has become so imperative, that retail investors find themselves heavily dependent on the skills and expertise of intermediaries to make investments to fulfill their requirements. Due to such dependence in the process of investment, intermediaries often are in a position to take advantage of naïve investors. The varied services that intermediaries render often give them capacities that come in conflict of interests, thereby giving their clients biased investment advice. Such practices are not only detrimental to the interest of clients but also impact the market equilibrium.
The following recommendations are made in light of the finds and conclusions regarding the functioning of capital market intermediaries:
- Despite the existence of detailed regulations to monitor the intermediaries in capital markets, the regulations governing specific intermediaries lack uniformity in terms of disclosure requirements, malpractices, tenure of registration, corporate governance practices, and the code of conduct. Since intermediaries provided a varied nature of services in different capacities, a more consistent and comprehensive regulatory framework would ease their administration and supervision.
- Regulations should try to encompass rules and norms that are binding on all market participants who render intermediary services regardless of the status of their registration. Since the majority of malpractices and defaults in capital markets take place when the unregistered service provides the undue advantage of naïve investors. Therefore, limiting the unregulated market is crucial.
- Improving disclosure requirements of intermediaries to keep the investors informed with the right information and thereby protecting the interest of investors.
- The regulatory norms should be stringent and clear in terms of interpretation. The current regulation lacks clarity in the interpretation of jargon and offers loopholes to aid defaulters to escape liability and accountability.
- To include the legal perspective by way of consulting legal experts.
- Regulators should take efforts to filter information available to investors and increase the level of awareness. Additionally, a more accessible grievance redressal mechanism must be present to protect investor interest and reduce abuse of power by intermediaries.
- Regular inspections and vigilance by regulators must take place to ensure that intermediaries are making disclosures as mandated. Information on registered intermediaries must also be available through print and electronic media.