The Sharepro share transfer fraud was uncovered when a complaint was filed with the Securities Exchange Board of India (SEBI) pursuant to which the market regulator initiated an investigation. Upon discovering the fraudulent transfer of shares and unclaimed dividend, SEBI, and many of the companies for which Sharepro acted as a registrar and share transfer agent, filed a compliant with the Economic Offences Wing (EOW).
Registrars and share transfer agents have been familiar with controversy. Last year, SEBI recognized the failure of TSR Darashaw Ltd to act with due skill, diligence and its violation of the code of conduct specified in the Securities and Exchange Board of India (Registrars to an Issue and Share Transfer Agents) Regulations, 1993, which resulted in a fraudulent transfer of shares, however it did not go so far as to impose a penalty vide its order. Shortly thereafter, in June, 2015 SEBI cancelled the certificate of registration granted to Knack Corporate Services Ltd due to their lack of even basic infrastructure and adequate office space, equipment and man-power to effectively carry out its activities.
Although any move towards higher supervisory oversight and tighter regulation is often faced with fierce resistance, mandating higher supervisory oversight often has the unintended effect of increasing accountability of the regulator itself. The converse is true in the case of supervision of registrars and share transfer agents by The Registrars Association of India (RAI), a self-regulatory organisation for registrars to an issue and share transfer agents. Consequently, in the event of a fraud, by virtue of registrars and share transfer agents being inherently self-regulatory, SEBI’s lack of regulatory oversight is obviously not called into question.
SEBI, however, is equipped by virtue of Regulation 16 of the SEBI (Registrar to an Issue and Share Transfer Agents) Regulations, 1993 to undertake an inspection of any registrar or share transfer agent. A fetter imposed on the powers of SEBI is the requirement under Regulation 17 for SEBI to provide a reasonable notice to the registrar to an issue or share transfer agent before carrying out inspections, which does not permit the market regulator to conduct a dawn raid. This fetter, although reasonable, may need to be revisited and perhaps diluted in light of the recent spate of share transfer frauds.
Inevitably investors are the worst affected by frauds perpetuated by registrars and share transfer agents, being placed in a lopsided battle against a systemic issue wherein ludicrously the easiest recourse is to approach SEBI. It would therefore be in the interest of investors if SEBI were to institute a stronger framework for monitoring the activities of registrars and share transfer agents and institute controls to prevent fraud. This could include yearly, or quarterly filings and/ or compliance reports along with the constitution of a specific ombudsman entrusted with the task of resolving the residual disputes not redressed by the registrar or share transfer agent.
To address the larger question of whether SEBI should adopt a more proactive approach, it may help if SEBI take a proactive approach rather than act reactively upon the occurrence of a fraud. Allowing SEBI to monitor electronic matching of share transfers through access to servers and computer systems, algorithmic suspicious transaction identification and strict record keeping for physical share transfers may appear to be ostensibly onerous and perhaps stifling regulatory measures, but they may go a long way in reducing, if not eliminating instances of fraud.
Another challenge with accountability for fraud prevention and control is that owing to the requirement to establish criminal intention or ‘mens rea’ involved' in fraud, it would be unfair to attach liability to directors of a company for fraudulent conduct of employees when they are neither privy to, nor complicit in such fraudulent activity. Needless to say, this principle cannot be diluted as it would be ridiculous to hold someone liable for a criminal offence if he lacked any intent to commit it. Negligence in ensuring minimum standards of fraud prevention however, is an entirely different matter.
Setting minimum standards of fraud control measures may allow SEBI to hold directors liable if their companies fail to implement such fraud control measures. Establishing these minimum standards of fraud prevention and control for registrars and share transfer agents has become imperative given that the last decade has been peppered with instances of share transfer fraud. These measures could include logging of order matching, dividend distribution and share transfer activities on a system which shares these logs with SEBI on demand and also allows for algorithmic risk identification so that the large volumes of data can be analysed by software, rather than having any unrealistic expectations of manual identification of suspicious transactions. The prevalent SCORES, grievance redressal platform could be augmented with a specific ombudsman for grievances relating to registrars and share transfer agents accordingly focus the attention of SEBI where adequate fraud control measures are lacking.
Allowing self-regulation without randomised inspections, or at a minimum, compliance and audit requirements, in an industry rife with instances of fraud, would tantamount to deliberately neglecting reasonable investor protection measures.
(Akash Karmakar is an associate at AZB & Partners. Opinions expressed in this article are personal.)