The Hindu Business Line : The SEBI missile that failed SAT test

IS REGULATION of the securities market really a Sisyphean task, or does the problem lie in SEBI's inability, even after a decade of experience, to pursue investigations into market manipulations thoroughly to their logical conclusion and pass orders which are logical, realistic, equitable and foolproof?

The case of Samir Arora, a professional market intermediary after whom SEBI seems to have gone hammer and tongs, may serve to highlight not only the deficiencies of the existing system for market supervision and regulation but also SEBI's own shortcomings.

The charges

Arora is a fund manager, managing equity funds of several affiliates of Alliance Capital Management LP (ACM), USA, including Alliance Capital Mutual Fund (ACMF), a mutual fund registered with SEBI. He is the head of the Asian Emerging Markets with Alliance, Singapore, an affiliate of ACM. It appears that ACM intended to sell the Alliance Capital Asset Management Co. Ltd (ACAML) which is the asset management company of ACMF. Arora made a bid for the Indian fund along with Henderson Global Investors.

The allegation is that he induced redemption pressure on the mutual fund which brought down its assets under management (AUM). Eventually, ACM gave up the idea of selling its India business, because most of the bidders backed out and the bids that were maintained did not match ACM's expectations. One of the charges accordingly is that the conduct of Arora was not in accordance with the standards of integrity, fairness and professionalism expected of a fund manager.

The Special Appellate Tribunal (SAT) has rubbished this charge by pointing out that there is no bar in any rule, regulation or statute, to an employee bidding for an undertaking sold by his employer-company, and strictly, on facts, nobody's interests were prejudiced because there was no actual diminution in the aggregate net asset value (NAV).

It is difficult to disagree with SAT on this point for several reasons. One, if anyone had reason to be unhappy with Arora's bid it was ACM but Arora does not seem to have had a bad equation with ACM at any time. And, there was no conflict of interests in the case. He was not a competitor but a faithful ally, who volunteered to take over what ACM wanted to part with. To run him down on the ground that in the process he subjected Indian unit holders to any loss was hitting him below the belt, particularly if he was in no way personally responsible or accountable for market reactions and behaviour or their consequences.

The joint shareholdings of ACMF and ACM along with FII sub-accounts in the equity structure of some Indian companies taken together were beyond the threshold limits prescribed in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 calling for proper disclosures. Since such disclosures had not been made, ACM and ACMF were considered guilty of violating the Takeover Regulations and Arora was arraigned for unprofessional conduct since he was in charge of investments of both ACM and ACMF.

Arora cannot be totally absolved of his responsibility in the matter but the wisdom and legal propriety of not sending show-cause notices for appropriate action against the `acquirers' directly concerned would be open to doubt. SAT's disregarding his responsibility in the matter does not appear justified.

SAT's observation in para 19 of its order that SEBI could have asked Arora to withdraw his bid or directed ACM to ignore Arora's bid instead of merely stating that he should have resigned as fund manager before proceeding to make a bid for buying the stake in ACAML seems inappropriate. This would be an unorthodox way of dealing with any action which a regulator believes to be of the nature of an offence.

There is no provision in the Securities and Exchange Board of India, 1992 (SEBI Act), enabling prevention of crime by persuasion or an advance ruling. If this method is adopted, there will be two risks. One is exposure of the regulatory authority to litigation on the ground that what was frustrated or prevented was not an offence under the law but a legitimate business decision and there was no scope for interference with such activity.

Such foiling of a business initiative would be subject to compensation claims if the regulator's advice or direction is found defective entailing `loss of profit' or deprival of any business advantage in the absence of any provision for issue of directions before the occurrence of an offence.

SEBI gives one the impression of being more concerned about the India business of ACM than ACM itself. It is significant that ACM did not think it necessary to distance itself from Arora or make a statement about his position in regard to ACMF or/and ACAML just as SEBI did not take any action against them for contravention of its Takeover Regulations.

There was neither consistency nor realism in expecting Arora to make a statement himself or attribute the fall in AUM exclusively to his omissions or conduct. On the facts of the case, the charge of misconduct against him was unsustainable as held by the SAT.

Unit-holders' interests compromised?

As SAT puts it, the gravamen of the second charge of SEBI against Arora is that being entrusted with equity funds of ACMF as well as of ACM through the FII route he compromised the interests of Indian unit-holders for benefiting the parent company ACM by just depressing the value of stock of some specified companies by massive selling of ACMF holdings therein and subsequently purchasing the same at depressed prices on behalf of ACM, thereby benefiting the ACM at the cost of ACMF and harming the interest of Indian unit-holders.

SAT's findings are that the transactions specified by SEBI are the only ones that SEBI had been able to locate and identify in support of the charge. SAT has pointed out that a transaction could not be taken to be violative of regulation 4, unless it was artificial or unfair or misleading. SAT is satisfied that there is a perfectly rational and plausible explanation underlying each of the transactions impugned by SEBI, "and that is saying a lot for a market that is by definition speculative". SAT has, therefore, no hesitation in holding that SEBI's charge is not established against Arora.

There is another component in this charge on which Arora's action may not be free from controversy. That hinges on the way in which one looks at a press interview during the crucial period in which Digital Globalsoft (DGL) was praised by Arora before the funds/companies with which he was associated unloaded their holdings of that company at a good profit whereafter the price of the shares in question dipped in the market. The issue is whether Arora's observations about the company were wrong or misleading in any `material particular' within the meaning of regulation 5. "In fact the overall tenor of the statement is more like a defence of his investment in these technology stocks rather than on inducing investors to buy or sell any these securities. This defence of his portfolio he owed to his unit holders. There is not a single word or phrase that can be considered even remotely misleading in any material particular.

In fact he attributes very carefully the likely merger of DGL and HPISO to market rumours. It is conceded at so many places in the impugned orders (of SEBI) that merger had been under discussion since October 2002 and that this information was in public domain." In view of SAT's conclusion, SEBI's charge of violation of clauses (a) to (d) of regulation 4 and regulation 5 fails in its entirety. There is another aspect of Arora's press interview and subsequent conduct which needs scrutiny from a different angle under regulation 3 of the SEBI (Prohibition of Insider Trading) Regulations, 1992 .

It remains to be seen whether what escapes from the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 1995 will come within the mischief of regulation 3 of the Insider Trading Regulations.

Neither insider nor trader

The SAT apparently felt that Arora was more sinned against than sinning. Its conclusion seems to be that he deserved a compliment for his ability and his care for the unit holders' interests instead of being punished by SEBI. The SAT reproduced extracts from SEBI's order exonerating Reliance Industries Ltd. of the charge of insider trading, expressing its appreciation of the `fine distinction' made by SEBI between directors of L&T who could not be taken to be its `directing mind and will' and other directors, and suggested that SEBI should apply the same ratio to all other cases handled by it in respect of insider trading.

Need to remove loopholes

As the UK experience shows, SEBI's task is not easy. In the UK also, civil sanctions supplement criminal proceedings. The European Community Directive on Insider Trading has explained that the objective of the legislation on insider trading is the protection of public confidence in the stock exchanges. However, according to expert opinion, the stock exchange and the Department of Trade and Industry in the UK are yet to come to grips with the problem of detection and prosecution of those engaged in insider trading. Among the issues to which the Government may have to apply its mind in any amendment to the existing law are the following:

The range of situations in which one comes to possess valuable information is extensive. Any amendment that is made should cover as many typical situations as practicable. Information which has been gathered by sheer skill and effort should not be hit by the law.

If any company or other person has been the beneficiary of the insider's trading, action should be initiated not only against the insider but also the beneficiary concerned. If no benefit has resulted or if the effort to utilise the price sensitive information has been frustrated, the punishment must be nominal.

The possibility of not merely depriving the insider of the profit from his dealings but compensating the others who suffer from the contravention of the law should be examined.

The scope of Section 11B of the SEBI Act should be made clearer so that there is no avoidable litigation on its overlapping with the separate provisions that are made for levy of penalties or for criminal prosecution in respect of the same offence.

There should be a continuous monitoring of all unusual transactions by the stock exchanges under specific statutory provisions. What will be taken to be unusual should be indicated in the Regulations.

(By arrangement with Corporate Law Adviser, New Delhi.)

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