Enabling private individuals to enforce securities laws

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There is no gainsaying to the fact that better securities regulations lead to an effective capital market, and the current SEBI chairman has done well to begin an overhaul of securities laws. However, a legal right holds meaning only to the extent of its enforceability, which can be regulated by restricting the right to enforce such a right. For instance, do rights under the SEBI Act hold water if the right to enforce it is not vested in the investors that SEBI aims to protect. Or in other words, who should enforce a statute to achieve its objectives and why does it matter?

Whether a right is to be privately (individual party) or publicly (by the state) enforced is not always a binary choice. Classically, contract law is privately enforced because it is essentially a dispute between two private parties, who have informational advantage of its contents and breach, and are in the best position to exercise discretion upon its enforcement. Criminal laws on the other hand deal with non-consensual harm, which are graver in nature, and in violation of community standards. They are publicly enforced because public enforcers have an informational advantage, and are better placed in weighing enforcement cost vis-a-vis harm to the society. But securities law-controversially classified as “civil obligations”, fall somewhere in between.

The choice then for regulating the capital market participants is to be made between the extremes of private ordering and competition on one end, and an all-pervasive state regulator on the other end, with increasing control of the state and decreasing disorder as one chooses from the former to the latter. A common argument against leaving the market to be regulated by market forces has been the inequality of weapons between the private parties before courts (say between the company and its retail investors) and the case is made in favor of the regulator which is an expert and motivated to pursue social objectives.

However, an even more efficient intermediate strategy suggested is the private enforcement of public statutes through private litigation in courts. For instance, the Companies Act, 2013 statutorily provides that the issuer of securities can be sued by the subscriber for misstatement in prospectus, instead of the subscriber having to prove negligence of the issuer in making the statement under common law principles or contract.      

If we are to borrow precedents, advanced markets have adjusted to this mix of enforcement style to suit their evolving needs. For instance, the judiciary in USA has long recognized, that though there are no express terms of remedy for a private individual under its securities law; in order to achieve the purpose of ‘protection of investors’, such a remedy must be implied under general principles of law. The regulator has aided by agreeing that constraints of manpower limits enforcement, and private actions based on securities laws are an important supplement to enforcement by the regulator.

On the other hand, precedence of public enforcement over private enforcement in the UK has proven efficient because of a resourceful regulator and a strong takeover panel. So while there is a debate over what enforcement medium leads to a better financial market, one cannot argue for public enforcement by an under-staffed regulator like SEBI.

India however, by restricting a civil court from entertaining any claims by individual parties under SEBI laws has chosen to vest an exclusive and wide discretion of enforcement upon SEBI with almost nil private participation. The complaints by private parties to SEBI that do result in penalty-which is distinct from damages-is difficult to be traced back to the victimized investor, as all penalties are credited to the Investor Protection and Education Fund and the Consolidated Fund of India.

Compensation for losses in the form of damages is a great incentive for the participating investors and disincentive for the company to resort to fraud or unfairness. Heeding to this the Companies Act, 2013 seeks to provide the right to sue for damages to members of a company against the company or its management for fraudulent, unlawful or wrongful act, but in effect only adds to the list of unenforceable rights by requiring a minimum of 100 members to initiate the class action. This requirement of 100 members was added in the Companies Bill, 2010 for fear of abuse, overlooking the fact that rarely has an investor claimed civil damages under the provision for damages for misstatement in prospectus over the last 100 years, but the Registrar of Companies has in some cases initiated criminal action for similar misstatements.

The Companies Act, 2013 provides for additional safeguards in the form of strict scrutiny by the tribunal for prevention of abuse of class action provision, including imposition of heavy costs on frivolous or vexatious litigants, but fails to address the problem faced by a member in gathering a class of anonymous members holding fungible security. It is no surprise that despite several cases of mismanagement by listed companies since 2016, a class action is yet to see the light of day. While contingency fee restrictions in class actions are a debate for another day, the provision for claiming damages by investors against errant management would only be meaningful if the numerosity provision is watered down. This would be a step in addressing the larger question: is it time that pubic statutes should in effect be allowed to be privately enforced before the newly formed specialized company tribunals.

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