Financial sector regulation has been in the news for at least three reasons. First, the Supreme Court judgment in the Sahara case is a landmark ruling, demystifying the relatively technical aspects of corporate and securities law and the Securities and Exchange Board of India (SEBI) Act with effortless ease. It considerably strengthened the hands of the SEBI which appeared to be waging an unequal battle with a politically well-connected group and the top lawyers engaged by it. Second, in Tamil Nadu, a series of scams involving emu birds had drawn attention to the limited reach of financial regulation. Third, a high-level committee headed by Justice Srikrishna has recommended a unified regulatory authority for the financial sector.

It would be useful to enumerate the salient features of the Supreme Court judgment on Sahara even as the group has filed for a review. Incredibly, just a few days earlier, Sahara’s senior counsel had assured the Court that it will have no problems repaying the depositors, as ordered.

(1) The Supreme Court plugged the apparent loopholes in existing laws that had emboldened the group to justify its massive fund raising efforts without submitting to the regulatory jurisdiction of the SEBI. Even after losing the legal battle at different stages — the Allahabad High Court and the Securities Appellate Tribunal (SAT) — the group thought it fit to approach the Supreme Court.

In the event, the Sahara group not only lost comprehensively but also received much more than the customary rap on the knuckles from the Court. The stringent criticism of the conduct of appellants is one of the highlights of the judgement.

(2) The Supreme Court has clarified the issues succinctly. Even a novice would know that the group’s stand was basically untenable and that, even in terms of common sense, it should have been dropped right at the beginning.

The Sahara group companies, both unlisted, were mobilising huge sums of money through “optionally convertible debentures”, little known opaque instruments, which, they claimed, will not come under the SEBI jurisdiction as they are “privately-placed” and, in any case, will not be listed on any exchange.

(3) Private placement is a legitimate route, but is applicable only when securities are offered to not more than 50 persons, who should be associates, friends, relatives, employees and others who are within the close circle of promoters or top management. Further, the offer will be restricted to those to whom the offer is being made. Implicit in that description is the fact that amounts of money so mobilised cannot be very large. It was, therefore, preposterous for the Sahara companies to call their massive Rs.20,000 crore plus mobilisation from over 2.2 crore investors, employing 10 lakh agents, as private placement.

Beyond Sahara

Obviously, a landmark judgment such as this one has implications for the financial sector as a whole. Sahara was seeking to be regulated by the Ministry of Corporate Affairs even while it was resisting SEBI. Can an issuer of securities choose his own regulator? Sahara’s strategy does not reflect favourably on the Ministry. It is seen to be more pliable than the SEBI.

For many other entities in the financial sector, it is not so much a question of choosing a regulator but having one at all. Or so it seems judging by the reports of recent scams involving emu birds in Salem and Erode districts of Tamil Nadu. As has been the case with many such schemes, a slightest rumour is sufficient to bring the whole edifice down. So fickle has been the level of investor confidence in these unregulated schemes. That it does not matter that a few promoters might probably have delivered given continued investor support. This has happened in the case of teak farms and other “collective investment schemes” that SEBI has tried, with a lot of difficulty, to bring under regulatory scanner.There is only one way forward: extend regulation to all these under various heads. But the task is onerous. It might involve banning some activities: obviously some of these will be too small or localised to be meaningfully regulated. A second obstacle arises out of the need of the regulator to have ‘domain’ knowledge of some of these activities.

Regulation can be painful. When the Reserve Bank of India (RBI) asked non-banking finance companies (NBFCs) to get an investment grade rating in the late 1990s, there was a shake-out. Barring the soundest, many NBFCs had serious adjustment problems with the new regulatory regime. Again, when the government came down heavily on unincorporated entities — partnerships, sole traders — offering sky-high interest rates on deposits, it brought to a halt not only some unscrupulous deposit takers but even some businesses that have been in existence for long and served a useful purpose. There can be many, many more examples. Two relevant points need to be emphasised. Despite the apparent pain regulation might cause, the regulated entity will be better of with it rather than defying its imposition. Regulation will give the stature which it might have lacked. Second, as important as regulation is, there is no substitute for investor education to evaluate the risks in any investment.

An important message from the recent Sahara judgment concerns unified regulation. Sahara was involved in a regulatory spat with the RBI earlier. A unified regulator will, most probably, pre-empt legal challenges of the type mounted by Sahara. That is where the suggestions of the Justice Srikrishna panel to set up a unified financial agency become important. The recently-released discussion paper will, after a wide discussion, form the basis of new legislation, which will integrate the regulatory functions now undertaken by different regulators.

narasimhan.crl@thehindu.co.in