Prosecution for Securities Law Violations and SEBI’s Powers

In the previous article of this series last month, we discussed the nature of SEBI’s enforcement powers and the various routes available for the securities market regulator to take action against market participants and intermediaries. This month’s column delves into one such aspect in more detail and examines the powers of the market regulator to initiate criminal action and the legislative framework for SEBI to initiate and participate in the prosecutorial process.

Although the following sections recognise SEBI’s rights to flag off process under the criminal justice architecture, it is important to note that SEBI remains reliant on the overall criminal procedure framework under the CrPC and does not have a parallel regime for criminal action. To understand the breadth of its reach, the following provisions of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”) as well as the Securities Contract (Regulation) Act, 1956 (“SCR Act”) and the Depositories Act, 1996 (“Depositories Act”), are relevant.

1. Section 24 envisages two key powers of criminal sanction, which can be initiated only upon the filing of a complaint by SEBI in terms of Section 26(1) :

   (i) Where a person can be punished with imprisonment for a term which may extend to ten years, or with fine, which may extend to twenty-five crore rupees or with both, for any violation of the SEBI act, its rules and regulations. This is without prejudice to any other action initiated by SEBI under the adjudicatory or 11B mechanism.

   (ii) A similar action is contemplated under Section 24(2) for failing to pay the penalty imposed by SEBI in exercise of its quasi-judicial powers, or to comply with its directions/orders.

2. Section 23 of the SCR Act primarily contemplates criminal action in two scenarios – first, under Sections 23 (1) and (2) which criminalises violations such as entering into prohibited contracts, entering into securities contracts outside of a recognised stock exchange, etc., and secondly, under Section 23M which covers those violations for which no other punishment has been specified and for failing to comply with penal or directory orders of SEBI. In both these instances, punishment can extend to imprisonment up to ten years, and/or a maximum fine of ₹25 crores.

3. Similar to the criminal powers contemplated under the SEBI Act and the SCR Act, Section 20 of the Depositories Act lays down two similar powers for contravention/abetting such contravention of any of the provisions of the Act/regulations/bye-laws as also for failing to remit a penalty, or comply with any directions/orders of SEBI.

These provisions have been amended over the years and been statutorily assembled through a slew of amendments over the years, to keep them current and relevant.

The Securities Laws (Amendment) Act, 2014 (“2014 Amendment”) introduced amendments that prescribed for the Central Government to designate a special court for speedy trial of such alleged criminal offences and prescribed such special court to consist of a single judge appointed by the Central Government in consultation with the Chief Justice of the jurisdictional High Court and must be holding the office of a Sessions Judge or Additional Sessions Judge. It additionally prescribed that all criminal offences conducted in terms of these statutes shall be mandatorily tried by the jurisdictionally relevant special court – however, in the absence of a court designated as such, it may be tried by Sessions Court. It additionally specified that the High Court can exercise its powers over the special court as if it were a Sessions Court, and that the Code of Criminal Procedure, 1973 was applicable to such proceedings.

In terms of a notification dated April 21, 2015, the Central Government designated the 39^th Sessions Court, City Civil Court, Greater Mumbai as the Special Court for the purposes of prosecution under Section 26A of the SEBI Act and SCR Act as well as Section 22C of the Depositories Act.

As an aside, it is also interesting to note that the forum for conducting such prosecution cases has also been a vexed question, especially prior to the 2014 Amendment. In the matter of SEBI vs. Classic Credit, the Hon’ble Supreme Court had clarified that the forum for trial post the 2014 Amendment would be the Special Court. Consequently, while matters pending before the jurisdictional Sessions Courts were transferred to the Special Court, the Special Court also started to directly take cognizance in these matters, without there being a committal by the Magistrate’s Court. In these prosecution matters, cognizance is taken only on a written complaint made by SEBI, the State or Central Government, a recognised stock exchange or any other ‘person’ but not the police authorities.

It has been argued that this position is antithetical to the correct position in criminal law whereby a Magistrate’s Court is where the matter is instituted and which can commit the matter for taking cognizance and trial to a higher court, in terms of Dharam Pal & Ors. vs. State of Haryana & Anr.

Section 27 also empowers SEBI to pierce the veil and attribute liability to persons within the company or juristic organization, and attribute liability to individuals for contraventions by the entity.

The SEBI (Amendment) Act, 2002 (“2002 Amendment”) amended the erstwhile Section 26(2) of the SEBI Act to specify that no court below a Sessions court could try a criminal proceeding initiated under the SEBI Act. It had also increased the punishment contemplated under Section 24 to the present thresholds; prior to the 2002 Amendment, the punishment contemplated was one year and/or a discretionary fine. The amendment also introduced compounding of offences under Section 26A, which was not contemplated in terms of the erstwhile framework.

This amendment was deliberated over at length in Videocon International & Ors. vs. SEBI & Ors., where the Bombay High Court differed from the view of the Delhi High Court to opine that the change to Section 26(2) could not be read in isolation of Section 24, as they are complimentary sections that do not operate in a mutually exclusive fashion. It held that the 2002 Amendment was prospective in nature. 

This framework is broadly in line with the powers of regulators in other jurisdictions. In the US, the SEC is responsible only for civil enforcement and works with the department of justice to effect appropriate criminal enforcement and punishment for securities law violations. Criminal violations of securities laws can result from ‘willful violations’ or from ‘process offenses’ related to the investigatory process, such as perjury, false statements, or obstruction of justice during an investigation, which are prosecuted by the Fraud Section of the Criminal Division of the DOJ. The DOJ prosecutors may either take suo moto cognizance of a case, or act once they are in receipt of a formal referral – a criminal reference report – from the SEC, which includes the latter’s findings and recommendations. In Hong Kong as well, Secretary of Justice is typically responsible for the prosecution of securities offences, either through summary or indictable proceedings and the SFC is empowered to prosecute such cases summarily through the Magistrate’s Court.

While the prosecution powers of SEBI have typically been used, in cases where a person or an entity fails to comply with a SEBI order imposing penalty or passing directions, there have also been instances where such criminal proceedings have been adopted by SEBI in what the regulator perceives to be ‘serious’ cases. In 2021-22, over 86 prosecution cases were filed against 211 assorted entities, and 18 convictions had been secured by the regulator. This represents a steep hike from the previous year, which recorded a mere 20 prosecution cases. A large bulk of these cases were in exercise of the powers of SEBI under Section 24(2) of the SEBI Act, i.e. non-payment of penalty imposed in quasi-judicial proceedings by the Adjudicating Officer. An application for compounding was filed in 2 of these 86 cases. As of March 2022, 243 cases filed by SEBI have resulted in convictions, and 294 cases have been compounded. 

The discretion to initiate prosecution remains with the regulator entirely and there is no mandatory initiation of criminal prosecution under the SEBI framework. In an order in the matter of BPL Ltd. vs. Securities and Exchange Board of India, it was held by the SAT that prosecution in terms of section 24 of the SEBI Act was a totally independent course of action left to the discretion of SEBI and is entirely independent of the adjudication process.

In a recent judgment, the Hon’ble Supreme Court in Reliance Industries vs. SEBI took note of the delay on the regulator’s part to initiate criminal proceedings, especially in light of the lack of procedural propriety displayed in not furnishing the requisite documents and other material on the basis of which the charges were drawn up. This case involved SEBI filing a criminal complaint against the appellant in the special court, alleging violations of the applicable regulations. However, the complaint was dismissed as being barred by limitation. The Court cautioned that entertaining frivolous criminal actions against corporations would have adverse economic consequences on the country in the long run and opined that the regulator had a duty to carefully weigh all applicable factors, to come to a reasoned decision as to whether to initiate criminal action under Section 24 of the SEBI Act.

Section 24 is also referred to in the Schedule to the Prevention of Money Laundering Act, 2002 (“PMLA”), where it is deemed as a scheduled offence along with market conduct and takeover code violations. The issue of how this must be interpreted came up before the Supreme Court in 2016 (Gautam Kundu vs. Assistant Director, Directorate of Enforcement), where it was argued that Section 24 cannot be a separate offence under the PMLA and has to be read along with the identified substantive violations.

For instance, in the matters of the funds collected by the Sahara group entities (viz., Sahara Housing Investment Corporation Limited and Sahara India Real Estate Corporation Limited), SEBI had opted to adopt criminal proceedings against the entities and its founder Subrata Roy along with passing other enforcement orders against them. More recently, in the matter of Anugrah Stock & Broking Private Limited, where there were allegations of running an illegal portfolio management scheme which led to the erosion of wealth of the investors to the tune to ₹1,200 crores, (over-and-above taking other enforcement actions through its resident powers) SEBI initiated criminal prosecution against the broker, its promoters and associated entities.

Non compliance with SEBI’s orders: SEBI largely prefers to initiate prosecution proceedings under Section 24(2), upon the non-receipt of penalty imposed. These proceedings are normally preceded with a show-cause notice intimating the concerned parties of SEBI’s intention to initiate criminal action. In Sterling Investment Corporation v. SEBI, the Securities Appellate Tribunal deprecated the initiation of adjudication proceedings without an element of willful disobedience, highlighting that adjudication proceedings is accompanied with the possibility of prosecution under Section 24 of SEBI Act. Similarly, in a clutch of cases –SEBI v. Prashant Narvekar, SEBI v. Jatin Manubhai Shah, SEBI v. Kartik Parekh & Ors.– the Special Court, acting on the complaint of SEBI under Section 24(2), convicted on the basis of non-payment of the penalty as quantified by the Adjudicating Officer. It is noteworthy that criminal complaints were lodged by SEBI only after a show-cause notice had been duly issued, notifying the defaulter of potential criminal sanctions under the the SEBI Act.

Use in collective investment schemes: SEBI has invoked these provisions multiple times in the context of collective investment schemes. In most such cases of unlicensed entities collecting funds, SEBI passed orders directing refunds to be made to investors, failing which, prosecution proceedings under section 24 against the Company and its directors would be initiated and references made to the local police to register a case against the company, its promoters and managers for fraud, cheating, criminal breach of trust and misappropriation of the public’s funds, indicatively in the matters of Alchemist Holdings Limited and Osian's-Connoisseurs of Art Private Limited.

Use in market conduct violations: Famously used in the Rakesh Agarwal case where SEBI, in its 2001 order made a finding of insider trading and directed the initiation of adjudication proceedings under the SEBI Act, opining that it was a fit case for invoking the provisions of Section 24 of the SEBI Act. The Securities Appellate Tribunal subsequently held that it was beyond its jurisdiction to set aside SEBI’s direction to initiate prosecution proceedings, and that SEBI was well within its discretion to invoke Section 24 for a serious offence such as insider trading.

In addition to the above, the SEBI Act, SCR Act and the Depositories Act all recognise the right of parties to compound such offences. Section 24A of the SEBI Act, Section 23N of the SCR Act and Section 22A of the Depositories Act permit the special court to compound offences brought before it notwithstanding any provision to the contrary in the Code of Criminal Procedure, 1973, provided they are not offences punishable with imprisonment, or with fine and imprisonment.

The FAQs on Consent Orders and Compounding of Offences issued by SEBI details the process for compounding offences. (“FAQs”) The FAQs note that ‘prosecution’ within the terms of the SEBI Act, involves “...filing of criminal complaints by SEBI for violation of securities laws, which may result in imprisonment and/or fines.” Similarly, compounding of offence involves “…an accused pays compounding charges in lieu of undergoing consequences of prosecution.” The FAQs also list down an indicative list of factors that would be considered for determining an application of compounding, such as whether the violation was intentional, amount lost by the investors, gravity of charge inter alia. The FAQs strongly suggest that grave offences, involving fraud, market manipulation and insider trading, cannot be compounded. The compounding application can be filed by the party at any juncture post the filing of the criminal complaint by SEBI.

The issue of whether SEBI’s consent is required for compounding under this section has been an interesting one and has evolved significantly over the years. Until recently, it was a settled position that courts cannot entertain compounding applications without SEBI’s consent and as the regulator in charge of overseeing public interest, SEBI cannot be required to compulsorily assent to a compounding application so filed.

Recently, the Supreme Court had weighed in on the role accorded to SEBI in compounding application within the terms of Section 24A, where the facts were as follows. In 1996, SEBI received a complaint on the Initial Public Offer made by Ideal Hotels & Industries Ltd. (“Ideal Group”) regarding market misconduct, including price rigging and insider trading, to artificially inflate the share price. Post an exhaustive investigation, SEBI launched parallel proceedings against the Ideal Group director Prakash Gupta – it filed a criminal complaint, and initiated adjudication proceedings before an Adjudication Officer. It subsequently recommended to the special court that the offence not be compounded.

The Hon’ble Court held that one could not read a requirement for the market regulator’s consent for compounding into the section – however, the Court opined that the section must be constructed in light of SEBI’s mandate as an expert regulator, entrusted by the legislature with the powers to regulate and govern the securities market. It thus imposed upon the SAT/special court a requirement to solicit SEBI’s views on compounding of an offence, which must be treated with ‘high deference’ unless the same is mala fide or manifestly arbitrary. The Court also sets out guidelines to adjudge a compounding application under Section 24A. This position mirrors the ratio in an earlier judgment of the Hon’ble Bombay High Court in the matter of Shilpa Stock Broker (P) Ltd.(interestingly, with the present Hon’ble Chief Justice of India having authored both the judgments).

As detailed above, SEBI invokes its powers of criminal sanction sparingly – less than 20% of the enforcement actions it levied across 2021-22  pertained to criminal proceedings. However, this could soon be changing – the Central Government is contemplating amending the SEBI Act to make certain offences mandatorily subject to prosecution. SEBI would thus not have full discretionary powers to elect civil and/or criminal proceedings – the regulator would have to pursue criminal action against the violators. This is in line with the philosophy of the Companies Act, 2013, under which certain violations – for example, those involving fraud – cannot be resolved by mere payment of penalties. While there is no official word on which kind of offences would be classified as mandatorily prosecutable, it is likely to include offences that cause significant losses to investors’ confidence or have a macro impact on the market as a whole. 

Shruti Rajan is a Partner, Anubhav Ghosh is a Counsel and Anurag Gupta is an Asoociate at Trilegal.

This is the second article in the Securities Law series by Trilegal.