Lawmaking Through SEBI’s Settlement Orders

While traditionally, lawmaking has been confined to legislative, administrative, and judicial processes, the securities market in recent times, has seen some unique precedent creation, in the form of informal guidances, frequently-asked questions or FAQs, and now, settlement orders.

A form of statutory regulation that derives legitimacy from Section 15JB of the SEBI Act, The SEBI Settlement Regulations 2018 permit settlement orders to be issued, to close matters without admission or denial of guilt and without a pronouncement on the legal issues at hand. Since the inception of this compounding process in 2007, consent orders (as they were called until 2014), are a mechanism to close out securities law violations. It is standard fare for parties to settle a matter in the interest of avoiding protracted litigation and not always to side-step findings on their conduct. There are examples abound of many who are convinced of their bona fides and merits, but find the enforcement process too daunting and long-drawn, especially when wrestling their own regulator, and prefer to file for closure by paying a settlement fee.

Settlement orders are made public by SEBI and contain a broad outline of allegations, placing on record the settlement fee and conditions, without venturing into a reasoned order on the facts of the case. The settlement regulations also make it clear that such orders are not admissible as evidence. While applying to settle a matter, parties file a specific form and some waivers too, in terms of which they agree “not take any action” or “make or permit to be made any public statement denying, directly or indirectly, any finding of SEBI including that recorded in the settlement order or creating impression that the settlement order is without factual basis”.

Anecdotally, this non-disparagement undertaking is almost identical in form to the U.S. Securities and Exchange Commission settlement undertaking currently being contested as being violative of free speech in the U.S. Supreme Court by former Xerox CFO Barry Romeril, Elon Musk, and others.

Stallion Order Prompts Confusion

By design, settlement orders are sparsely worded and non-speaking in nature and not meant to create a precedent or operate as law. But late last week, a settlement order by SEBI in relation to Stallion Asset Management caused quite a stir in the market. The allegations settled in this case mainly pertain to a research analyst providing model portfolios to its clients, without having an investment advisory license, the regulatory subtext here being that only advisers (and not analysts) can make model portfolios available. Perhaps there is more to these facts, but all is not evident from reading a two-page order that was understandably not drafted to tackle all the confusion that has ensued thereon. The order imposed a fine and brought closure to Stallion’s outstanding legal issues with SEBI, and in doing so made some fleeting observations that threw up legal questions with wide ramifications.

1. Can research analysts publish model portfolios?

2. What is the responsibility, by extension, of platforms which are a marketplace to monetise such ideas?

Research Analysis Vs Investment Advisory

Model portfolios are a set of recommended stocks (or other assets), which allow the user to deploy a particular investment approach based on his own risk appetite and investment objective. Much like what research reports do, model portfolios help consumers track sectors and companies with the help of a qualified analyst’s views. Such portfolios also accord weightage to the stack of stock recommendations based on the overall strategy, which are periodically rebalanced to stay true to the stated objective of the portfolio itself. The idea of model portfolios is to help individuals take niftier, data-driven, efficient investment decisions with technology playing a phenomenal role in increasing both the depth and the breadth of such services.

Is this very different from a research report? Not really. Research reports are traditionally defined as a written analysis of securities which includes buy/sell/hold recommendations and SEBI has a similar definition for research reports under a specific set of guidelines that regulate such reports and the analysts who issue them. The conventional methods of dispensing research reports and recommendations are being speedily replaced by quicker and simpler ways to reach out to investors, including through model portfolios.

A research report is user-agnostic to the extent that it analyses data to provide an independent analysis of what a company or a stock is worth and where it should feature in the investment decisions one makes (that is, a buy/sell or hold recommendation). If research is used to guide passive investment models, that in itself does not elevate the product to personalised advice. Investment advice is bespoke and tailored to meet the objectives of a particular individual who pays you a fee to help plan her finances based on pre-determined goals. Another important differentiator is who helps the consumer measure his risk appetite or objective – an analyst does not do this, but an advisor does. An analyst or model portfolio platform interacts with an audience that knows and decides where to categorise itself across the options made available. In fact, SEBI’s regulations for investment advisors are yet to expressly accommodate robo-advisory and other automated services that reduce human interaction between the service provider and the consumer.

Passive Investing Met By Passive Regulation

The Stallion order is being dissected not only for its short-termism but also for not anticipating the confusion that such unexpected observations can unleash on a flourishing industry. It is no doubt unfair to critique an order that SEBI is structurally constrained from to reasoning out or clarifying, but caution is clearly required on multiple fronts.

Predictive and proactive lawmaking is the only way to accommodate innovation in the financial services sector. Technology’s biggest achievement in the Indian securities market has been to democratise market access and empower investors through information and it will disappointing if such gating items, multiple licenses, retrofitting new businesses and ideas into fixed legislation designed to regulate traditional businesses make us turn our backs to the future.

Shruti Rajan is a Partner in the Mumbai office of Trilegal, and a regulatory and enforcement lawyer in the financial services space.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.