Does the person against whom investigation is directed must be identified?

SEBI is not required to direct investigation against a particular or identified person. SEBI can investigate into a transaction^[1] and during such investigation determine the persons/intermediaries against whom it wishes to commence proceedings. Further, SEBI can commence investigation if it believes that a transaction has been carried out or dealt with in a manner detrimental to investors or the securities market or if it believes that a statutory or regulatory provision under the SEBI Act has been violated by any person associated with the securities market. This demonstrates the wide ambit of SEBI’s powers to investigate.

What can SEBI do as part of investigation?

SEBI has the power to issue a wide variety of directions as part of its power to investigate under Section 11-C of the SEBI Act. Under Section 11-C, SEBI can:

• call upon any intermediary or any person associated with securities market to furnish information, or produce books, or registers, or other documents, or records;
• keep in its custody any books, registers, other documents or record produced;
• examine on oath any manager, managing director officer or other employee of any intermediary or any person associated with securities market and may require such persons to appear before him personally (Section 11-C also empowers the investigating officer to take down in writing the notes of examination, read it over to the person examined and obtain his signature. The notes of examination can be used by the investigating authority in evidence against such person); and
• make an application to the Magistrate or Judge of a designated court in Mumbai for an order for seizure of books, registers, other documents and record if the investigating authority has reasonable ground to believe that they may be destroyed, mutilated, altered, falsified or secreted. Police assistance, in this regard, can also be availed by the investigating officer.

Who can be the investigating authority?

Further, under Section 11-C “any person” can be directed to investigate the affairs of the intermediary or persons associated with the securities market and to make a report of their investigation. Section 11-C does not prescribe the criteria or qualifications of such investigating authority. The usage of words “any person” in Section 11-C(1) signifies that SEBI is empowered to appoint any person, who it may deem fit, to conduct the investigation. Such person can also be an external agency. Importantly, even the Securities and Exchange Board of India (Delegation of Statutory and Financial Powers) Order, 2019(DOP Order) does not prescribe the rank of the individual to be appointed to conduct an investigation. The DOP Order however specifies that an order for investigation and appointment of the investigating authority under Section 11-C can be passed by an executive director of SEBI. Under Order 3(2) of the DOP, the said power may be exercised by any officer or authority, higher in grade or rank or position to the executive director.

What happens on failure to comply with SEBI’s directions under Section 11-C?

Section 11-C(6) provides penal consequences for failure, without reasonable cause, or for refusal to comply with the directions of the investigating authority. The section provides that if any person fails to

(i) produce any book, register, other document and record; (ii) furnish any information sought; (iii) appear before the investigating authority; (iv) answer any question which is put to him; or (v) sign the notes of any examination, then such person shall be punishable with imprisonment for up to one year or with fine up to one crore rupees or with both. It is also provided that further fine of up to five lakh rupees can also be imposed for every day after the first day during which the failure or refusal continues.

SEBI’s role while discharging its function under Section 11-C

Investigation is a fact finding and evidence collecting exercise. It typically consists of examination of persons, search and seizure of materials and documents for the purpose of determining whether the transaction in question or the persons being investigated have violated any provisions of the applicable law. As stated above, SEBI has been empowered by the Act to carry out investigations for the purpose of identifying any violations of the Act or of rules and regulations framed thereunder and for identifying any transactions in securities which have adverse effects on investors in the market. Section 11-C(1) provides that SEBI may, at any time by an order in writing, direct any person to investigate the affairs of an intermediary or persons associated with securities market and to report to SEBI thereon.

In DLF Ltd. v. SEBI^[2], a learned Single Judge of the Delhi High Court considered Section 11-C of the Act and held that the powers conferred by the said section on SEBI are in the nature of “inquisitorial powers” and not “quasi-judicial powers”. The High Court further held that an investigating authority is extensively empowered to unearth facts and cause a detailed investigation into the matter; and once the investigation has been ordered under Section 11-C and an investigation report is made, SEBI, while examining said report and acting on it, functions in its quasi-judicial capacity. The relevant extract is as under:

58. Similarly, SEBI has also been invested with powers and responsibilities to function in a dual capacity. It functions in an inquisitorial capacity while examining the issue, whether reasonable grounds exist to believe that the transactions in securities marketare being dealt with in a manner detrimental to the investors or the securities market, or whether any intermediary or any person associated with the securities market has violated any of the provisions of the SEBI Act or the rules & regulations made thereunder, or directions issued by the Board. If it finds that reasonable grounds exist to believe the existence of the aforesaid state of affairs, it can direct an investigation by an investigating authority under Section 11-C of the Act. Once the investigation has been ordered under Section 11-C and an investigation report made, the SEBI while examining the said report and acting upon it, functions in its quasi-judicial capacity.3^[3]

Thus, while SEBI dons many hats, for example, that of a regulatory body framing rules and regulations, of a quasi-judicial body, etc., under Section 11-C, SEBI acts as an inquisitorial body engaged in the exercise of fact finding. This nature of power being exercised by SEBI under Section 11-C also has some bearing on the limitations imposed upon it by courts, as will be discussed below.

Scope of judicial intervention at the stage of investigation

What is “reasonable grounds” as contemplated under Section 11-C?

SEBI can commence investigation if it has “reasonable grounds” to do so. The existence of “reasonable grounds” is therefore a sine qua non for ordering an investigation under Section 11-C of the Act. The term “reasonable grounds” has not been defined in the Act.

Can investigation be challenged on the ground of non-existence of “reasonable grounds”?

While evaluating whether or not there exist any “reasonable grounds”, courts typically do not go into the sufficiency of the reasons. It is, however, open to courts to examine whether the reasons for SEBI’s belief have a rational connection or a relevant bearing to the formation of the belief and are not extraneous or irrelevant^[4]. The expression “has reasonable ground to believe” would have to be understood to be the state of mind as regards the existence of something as likely or relatively certain and would have to be backed by some reasonable grounds. Reasonable grounds are understood to mean the information that establishes sufficient articulable fact that gives a reasonable basis to believe^[5].

Research shows that courts are generally reluctant to interfere with orders of investigation^[6]. Investigation by SEBI would typically lead to issuance of a show-cause notice to the person concerned. Although not in the context of a show-cause notice under the SEBI Act, the Supreme Court^[7] in a writ petition seeking quashing of a show-cause notice issued under the provisions of the Foreign Exchange Management Act, 1999 stated that “This Court in a large number of cases has deprecated the practice of the High Courts entertaining writ petitions questioning legality of the show-cause notices stalling enquiries as proposed and retarding investigative process to find actual facts with the participation and in the presence of the parties….” A similar approach was adopted by the Supreme Court in Vishal Tiwari v. Union of India^[8] dealing with the fall in share prices of the Adani Group of Companies pursuant to the report of Hindenburg Research. One of the reliefs sought was transfer of the investigation from SEBI to the Central Bureau of Investigation (CBI) or a special investigation team (SIT). The basis of seeking such transfer was that SEBI allegedly portrayed glaring, wilful and deliberate inaction in carrying out the investigation. The Court noted that while it has powers under Articles 32 and 142 of the Constitution to transfer the investigation, however, such power must be exercised sparingly and in extraordinary circumstances. While refusing to grant this relief, the Court noted that no apparent regulatory failure can be attributed to SEBI, nor is there any deliberate inaction or inadequacy which would warrant transfer of investigation from SEBI to CBI or a SIT.

Does a person have a right to be heard before investigation commences?

Section 11-C of the Act does not envisage any opportunity of being heard before an investigation is ordered. This is confirmed by the Securities Appellate Tribunal (SAT) in Bhoruka Financial Services Ltd. v. SEBI^[9]. The view taken by SAT has also been affirmed by the Delhi High Court in DLF Ltd. v. SEBI^[10]. In the said case the Division Bench of the Delhi High Court also stated that “An investigation by itself does not adversely affect any person or intermediary and no civil consequences flow from such an order directing investigation.”

Thus, it can be concluded that the scope of judicial intervention based on alleged non-existence of “reasonable grounds” or otherwise, at the stage of investigation, is narrow. A party challenging investigation by SEBI would therefore have a high burden to discharge.

Whether a person being investigated by SEBI has a right against self-incrimination?

In Multibagger Securities Research & Advisory (P) Ltd. v. SEBI^[11], the petitioners challenged Sections 11-C(3), (5), (6) and (7) of the SEBI Act. The petitioners’ contention was that these provisions inter alia curtailed their fundamental right of protection against self-incrimination and of life and liberty. It was also contended that Section 11-C(7) violates Article 20(3) of the Constitution of India. Section 11-C(7) inter alia provides that notes of any examination taken down in writing during examination of a person may be used in evidence against him after the same have been read over to and signed by the said person. Dismissing the petition, the Punjab and Haryana High Court held that:

34. If it is not made obligatory for the persons proceeded against by SEBI to cooperate with the investigation by furnishing information in person or producing documents in their possession [by enacting provisions like Sections 11(3), (5) and (6)] the whole purpose of empowering the SEBI to investigate, would come to a nought. Such powers are necessary to ensure that the complaint is investigated thoroughly and if after such investigation, it is thought prudent, then an adjudication under Section 15-I of the Act will happen.^[12].

It also held that:

35. The penalty of imprisonment of a term which would extends to one year or fine which would extend to Rs 1 crore become leviable under sub-section (6) of Section 11-C only if without reasonable cause a person were to refuse to produce before the investigating authority the books, registers and other documents or furnish information which is his duty to furnish or refuses to appear before the investigating authority personally or to answer any question which is put to him by the investigating authority or to sign the notes of any examination referred to in sub-section (7).^[13]

While it appears that the Court has not directly addressed the issue, it appears that the Court has taken a view that the Act contains adequate safeguards provided in the enactment itself against any misuse of power.

The above analysis makes it clear that SEBI’s powers to investigate are vast. This appears to be intended to allow SEBI to thoroughly and freely investigate transactions affecting the interests of investors and securities market and possible violations of SEBI Act and the rules and regulations.

Footnote

[1] Rajan Vasudevbhai Dapki v. SEBI, 2006 SCC OnLine Guj 259; Sunita Agarwal v. SEBI, 2022 SCC OnLine Gau 2325.

[2] 2012 SCC OnLine Del 46.

[3] DLF Ltd. case, 2012 SCC OnLine Del 46.

[4] S. Narayanappa v. CIT, 1966 SCC OnLine SC 173; CIT v. M.R. Shah Logistics (P) Ltd., (2022) 14 SCC 101.

[5] Sunita Agarwal v. SEBI, 2022 SCC OnLine Gau 2325.

[6] Panther Fincap and Management Services Ltd. v. Union of India, 2005 SCC OnLine Bom 386.

[7] Special Director v. Mohd. Ghulam Ghouse, (2004) 3 SCC 440.

[8] (2024) 4 SCC 115.

[9] 2006 SCC OnLine SAT 163.

[10] 2012 SCC OnLine Del 5765.

[11] 2022 SCC OnLine P&H 4243.

[12] Multibagger case, 2022 SCC OnLine P&H 4243.

[13] Multibagger case, 2022 SCC OnLine P&H 4243.

This article was originally published in SCC Online on 22 July 2024 Co-written by: Vaibhav Singh, Partner; Radhika Indapurkar, Principal Associate; Manas Kotak, Associate. Click here for original article

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