Hindenburg vs SEBI: In the Interest of Reinforcing Credibility of the Regulator

SEBI chairperson Madhabi Puri Buch has strongly denied the allegations of conflict of interest raised by Hindenburg Research in its latest volley. Innocent till proven guilty is not the only principle at stake here.

If it is established that it suffices to raise allegations of impropriety against a regulator to erode that regulator’s credibility and weaken regulation itself, even if only for a short interval, we will have to add engineered discrediting to the list of ills associated with regulation per se: regulatory capture, regulatory caprice, regulatory opacity, inefficient or ill-informed regulation. Therefore, it is vital to hold off damning the regulator just because a short seller makes allegations that could tank specific securities or the index itself.

Outside the island of Robinson Crusoe, wherever people live together, they need norms of conduct to ensure that one person’s freedom to swing his fist does not violate another’s right to live without being punched. These norms are codified into laws, and institutions are created to enforce the laws.

Laws govern every field of life, including the economy. However, certain sectors of the economy call for active regulation, that is, enforcement of the rules of conduct on a real-time basis, and not just enforcement of laws, which could take time, and restitution, in case of violation, could lag, as the due process is gone through.

Capital markets call for regulation. The regulator should be credible to be effective. Therefore, it is vital to not let mere accusations of fault dilute credibility, and to also dispose of challenges to the regulator’s integrity with credible evidence and speed.

Hindenburg has raised essentially three charges against SEBI Chairperson Madhabi Puri Buch.

One, she, along with her husband, made investments in the offshore fund that, according to Hindenburg, had been used by the Adanis to manipulate the stock price. While she liquidated her holdings, after joining SEBI, it is alleged that her past association with the fund taints her ability to be impartial while investigating the charge of manipulating stock prices.

This charge lacks credence. The investigation into the charge of stock price manipulation is based on evidence, gathered and analysed by professionals, and unless all of them could be suborned, somehow, by the SEBI chairperson, and any unfavourable evidence suppressed, Buch’s past investment choices could not have influenced the outcome of the investigation.

Further, merely investing in a fund or a company does not make the investor a party to the fund’s doings. LIC, HDFC, SBI and Central Bank were major investors in IL&FS. Should they be held responsible for what IL&FS did? Any charge of misconduct must be backed up with direct evidence, not by a circumstance of association.

However, there is a lacuna in SEBI's regulation of employee conduct with regard to investments in securities. It seeks employees to report asset ownership at the time of joining and to file an annual report of asset ownership by the end of July. It prohibits investment in equity except through mutual funds. In the case of immovable property, it calls for prior sanction of the competent authority designated by the board, but in the case of movable property, and that would include shares, such prior sanction is required only if the sale is to someone with whom the employee has official dealings. Otherwise, the transaction has to be reported within 30 days.

The US securities regulator, SEC, requires employees to obtain prior sanction of a Designated Agency Ethics Official before any transaction in securities, with some exemptions. It would make sense for SEBI also to mandate prior sanction for securities transactions by its employees, and to institute holding periods and post-transaction disclosures to the board.

Charge number two is that SEBI, with Buch as chairperson, created a policy that facilitated the growth of Real Estate Investment Trusts (REITs), to benefit, among others, one in which Blackstone had a major interest, while Buch’s husband Dhaval Buch was an advisor to Blackstone.

All Indian cities put together do not have the office space that Singapore has, according to a real estate consultant. India certainly needs more workspace, rental housing and other real estate, and REITs are a healthy way of growing the supply of this vital infrastructure. Regardless of Buch’s interests, SEBI would have been remiss, if it had not created policy to boost REITs.

Rather than wonder if Dhaval Buch’s advisory role helped REIT-friendly policy evolve at SEBI, it would make more sense to ask if he should have taken up a position as an advisor to an entity regulated by SEBI, while the regulator was headed by his wife.

Of course, if Mr Buch were a tinker, tailor, soldier or spy, this kind of problem would not arise. But he is a corporate executive. Any job he does can be construed as being potentially in conflict with his spouse’s regulatory function.

What Section 56 of SEBI's Service Regulations on the employment of SEBI employees’ relatives says is this: one, no influence would be peddled to procure jobs for relatives, two, “Every employee shall report to the competent authority in case his son/daughter or any other member of his family accepts employment in any intermediary registered with the Board with which he has official dealings or in any undertaking having official dealings with the Board.”

A REIT is an intermediary registered with the Board. Here, the burden of compliance is for Madhabi Buch to report her husband’s occupation to the board. It is hard to imagine that she would have kept this a secret.

The third charge is with regard to Madhabi Buch’s ownership of a consultancy. If the clients of the consultancy are regulated entities, and it earns significant income, there would be a conflict of interest. It is conceivable that she has declared this asset, too, to the Board, and the consultancy’s clientele. But that would not erase the potential conflict of interest.

A defect of the Indian regulatory system is that there is no institutional system for holding the different regulators to account. This leaves the regulatory apparatus open to trial by the media and partisan debate among political parties.

Regulators should be autonomous from the executive, not accountable to it. Courts can determine whether regulatory conduct adheres to or violates the law. Their job is not to hold them to account. If not the government or the judiciary, who, then? It should be the legislature.

Regulators should testify before a committee of the legislature regularly, and the people’s representatives must satisfy themselves that the regulators do a good job. Once they are given this responsibility, MPs would see in it an opportunity to make a mark, just as American senators do, in a similar capacity.

In the interest of reinforcing the credibility of the regulator and in fairness to Madhabi Buch, she must be given the opportunity to appear before a committee of the legislature, offer her testimony and answer questions, so that the committee could finish its work with dispatch.

Should she step aside during this process? If the Board, which has access to information on her consultancy business, does not find it a source of conflict, there is no reason for her to not continue with her work, while the committee goes about it.

(The author is a senior journalist and formerly the Editor of Opinions at the Economic Times. This is an opinion article and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)