Is excessive governance good governance? A case study on constitutionality of SEBI’s recent directives

The Indian stock market regulator, the Securities and Exchange Board of India (“SEBI”), among others has been entrusted with delegated legislative powers to frame laws to protect the interests of investors in securities market, to promote the development of, and to regulate, the securities market. While SEBI has promulgated laws through the enactment of regulations, notifications or guidelines, it has recently been adopting several informal avenues of communication with a select group of stakeholders, to lay out intentions and expectations from a niche community of stakeholders in the securities market.

A case in point to be considered is the recent SEBI’s interaction with merchant bankers through email communication dated May 29,2024 to a select group of merchant bankers with an expectation of such communication be treated as a legal diktat. As a common commercial practice, Indian merchant bankers, often being at the mercy of SEBI, have always followed such communication as binding diktat hitherto, without questioning the legal sanctity of such communications.

It is integral for legislative and regulatory institutions to follow principles of natural justice, rule of law and constitutionalism while discharging their duties. While ignorance of law not being an excuse is an established principle of law, adherence to and compliance of law requires the law to be made known.

In this regard, one needs to evaluate whether the email dated May 29, 2024, received from the SEBI follows the principle of rule of law and consequently, whether the directives should be considered binding or applicable ‘law’, considering the nature, method and the reach of communication.

Salient Features of the Communication

Before evaluation though, it is essential to understand the salient features of the foregoing communication:

1. SEBI, through the email address of an officer, communicated a set of instructions via email that contained a PDF file stipulating ‘Additional Confirmations and Disclosures’ sought from lead managers in the draft offer document/draft letter of offer to be filed by Companies proposing to raise capital from public;
2. The email was addressed to approximately 175 parties, including the Indian stock exchanges;
3. The email stated that the offer documents which are not in conformity with the directives in the email shall be dealt in terms of (i) the SEBI Circular that inter alia prescribes the conditions for returning of offer documents,  and (ii) SEBI general orders, thereby imposing sanctions for non-compliance of the directives.
4. It is pertinent to note that after a draft offer document is filed with SEBI by an issuer company and the merchant banker, SEBI, after its perusal of the draft offer document, issues observations that must be carried out in the final offer document, before an issue can open for public. This mail asks the merchant bankers to incorporate all observations SEBI may have issued on any previous filing of a draft offer document where a merchant banker is acting as one of the lead managers, in all future filings by such lead manager where it is acting as a lead manager.
5. The PDF file does not contain any name of the notifying authority, date or time by way of a time stamp, signature and designation of authorised signatory, notification number, etc. It is merely a write up of directives to be followed. It has, to this date, not been published in the official gazette as mandated under the parent act through which the Parliament of India established SEBI in 1992. Further, it has not been communicated to the larger public through any other means.

The question that arises is whether this communication by email can be considered notification or publication of law and whether it is sufficient to deem it ‘law’ or ‘regulation’.

Compliance with the Principle “The Law Must be Made Known to the Public

In 2020, the Supreme Court of India (“SCI”) in the Union of India v. G.S. Chatha Rice Mills noted that a notification, which is made by the executive wing of the government, must indeed be made known. Ordinarily this is made known by being published in the gazette.

The SCI has also recorded in many cases that there can be no doubt about the proposition that where a law, whether parliamentary or subordinate, demands compliance, those that are governed must be notified directly and reliably of the law and all changes and additions made to it by various processes.

In B.K. Srinivasan v. State of Karnataka it stated that law must be known, that is to say, it must be so made that it can be known. But unlike parliamentary legislation, which is publicly made, delegated or subordinate legislation is often made in the chambers of a minister, a secretary to the Government or other official dignitaries, shrouding it with a layer of relative secrecy. It is, therefore, necessary that subordinate legislation, in order to take effect, must be published or promulgated in some suitable manner, whether such publication or promulgation is prescribed by the parent statute or not. If the parent act does not prescribe the mode of publication or if it prescribes a plainly unreasonable mode of publication, it will take effect only when it is published through the customarily recognised official channel, namely, the official gazette or some other reasonable mode of publication.

It has also been noted by the SCI, in several cases including Harla v. State of Rajasthan¹, on the necessity of notification of laws noted that natural justice requires that before a law can become operative it must be promulgated or published. It must be broadcast in some recognisable way so that all men may know what it is; or, at the very least, there must be some special rule or regulation or customary channel by or through which such knowledge can be acquired with the exercise of due and reasonable diligence.

Doctrine of ‘Rule of Law’

The principle at the root of this issue is the doctrine of ‘Rule of Law’ which requires regularity, predictability and certainty in instances of the governments dealing with the public. Further, the principles of Rule of Law envisage absence of arbitrariness and unreasonableness, and state that law requires publicity, consistency and equality. There cannot be unreasonable exercise of discretionary power. While executive authorities may have such powers, the discretion must be exercised reasonably in furtherance of public policy, public good and for the public cause. A reasonable and non-arbitrary exercise of discretion is an inbuilt requirement of the law and any unreasonable or arbitrary exercise of it violates Article 14 of the Constitution of India.

However, in the present case, none of the inbuilt requirements seem to be fulfilled. Any notifications on regulatory compliance required by SEBI must come directly from SEBI, notified publicly and accessible to all stakeholders, as has been the case so far.

Analysing SEBI’s Actions in light of the above Principles

Knowledge of existence of law is a condition precedent to the functionality and applicability of the directives.  This knowledge should flow from a sufficiently legally recognised reasonable source. In this context, the email from SEBI raises several questions – Does it reach all stakeholders? Is it publicly accessible? Is the document reliable? Under what authority is it made? Is the communication sufficient or reasonable? Whether SEBI is within its powers to return the offer documents or take other penal measures for compliance of such informal directives? The current situation of the May 29, 2024, email makes SEBI subject to criticism for not following principles of natural justice, rule of law and constitutional principles in their functioning, urging us to contemplate upon the jurisprudential validity of this act of the regulatory body.

Furthermore, in some other unprecedented moves on excessive governance, SEBI has in the last week of July returned offer documents of several companies that were seeking to get listed on mere technical grounds. Such actions by SEBI over the past couple of months has left the securities market and the Indian merchant banking fraternity in a frenzy.

Therefore, on one hand while the stand of the Indian Government over the past decade has been to facilitate ease of doing business, on the other hand the fear of who will bell the cat has given birth to a system of unchecked measures by regulators like SEBI, who in the garb of protecting interests of investors have been failing the tests of constitutionality and the very principles they were established to protect.

¹ Harla v. State of Rajasthan 1951 AIR 467

This blog is written by Ankesh Kumar, A Practicing Captial Market Lawyer.