When Policy-makers and Judiciary Fail To Understand Basics of Regulation and Accountability
The more you look for change, the more hopeless it makes you feel. If two court orders, discussed in my previous column (Videocon and Supertech Orders: Blip in a Bleak Landscape or Harbinger of Change?) held out a ray of hope last week, we are back to staring at the abyss this week. 
 
What is the way forward when a new accounting regulator, doing a credible job, is at war with ministry of corporate affairs (MCA) that is working to undermine it along with a body of chartered accountants (CAs) with a poor track record? 
 
What do you do if the Supreme Court also fails to understand the concept of exemplary penalty imposed on rating agencies, whose repeated failures have inflicted crippling losses on retail and institutional investors?  
 
Let’s look at the two episodes that explain why regulators may be reluctant to initiate decisive action because inaction is likely to find more favour with the government and courts. 
 
NFRA at Loggerheads with MCA
The National Financial Reporting Authority (NFRA), a brand new regulator, is at loggerheads with its administrative ministry, the ministry of corporate affairs  as well as the Institute of Chartered Accountants of India (ICAI). NFRA has already established a good track record with its investigation report on Infrastructure Leasing & Financial Services (IL&FS) and several auditors involved with the group. 
 
A major bone of contention today is a consultation paper issued in March 2021 by NFRA’s technical advisory committee (TAC) titled “Enhancing Engagement with Stakeholders Report”. Two paragraphs in the Report explain why ICAI is up in arms; but those very paragraphs explain why NFRA came into existence and needs public support, especially at a time when India’s investor population has nearly doubled and over 15 million investors are new to the market and its ways. 
 
 
ICAI, which regulated the auditors, has a reputation of poor or negligible action against its members and has been opposed to the formation of NFRA – just as brokers used to be against the formation of the capital market regulator. Finance minister (FM) Nirmala Sitharaman has the charge of MCA, under which comes NFRA. Investors, as key savers and major stakeholders, should expect her to step in put an end to an unseemly war that has been extensively reported by N Sundaresha Subramanian in The Economic Times. Instead of reading the riot act to the warring parties and putting public interest first, the government appears unconcerned, even supportive, of those trying to destabilise the new regulator. 
 
For instance, Mr Subramanian narrates how NFRA, on 29th June, had to write to MCA not to appoint CAs, even as part-time members on the regulatory body, since they are ‘regulated entities’. The NFRA letter that he obtained under Right to Information (RTI) minces no words. It says, “In our considered opinion, it is travesty of independent audit regulation, and a mockery of the basic principles underlying the same, to have practising CAs even as part-time members of the authority. Apart from substantive objections to such membership, this also results in appearing to cut at the independence of the regulator.”
 
This is not about a turf war alone, but a glaring example of how ignorant our bureaucrats and policy-makers are of the basic concepts of regulation, supervision, oversight and regulatory independence. When these fundamental tenets are compromised, we get crony capitalism, corruption and collusion, all of which leads to frequent corporate failures, affecting ordinary savers. 
 
Over the past 30 years, we have watched every independent regulator being systematically compromised and defanged. Loyalty to the administrative ministry or minister in charge is the key consideration for appointments to top positions and repeated tenure extensions. It is ironical that many of those who tacitly supported or went along with this system are now calling for reform in regulatory bodies to make them truly independent, without calling for specific wrongs to be corrected. 
 
Credit Rating Failure? No Consequences
We have often criticised the Securities and Exchange Board of India (SEBI) for not acting quickly enough, or severely enough, against wrongdoers. While that is largely true, most glaringly in the co-location scam at the National Stock Exchange (NSE), the penalty imposed on CARE Ratings in the Reliance Communications (RCom) ratings fiasco shows us what the regulator is up against. Or why SEBI would feel that it is futile to get tough with influential intermediaries or corporate houses. 
 
Let’s begin with the fact that three of the top four rating agencies have been badly exposed by big corporate defaults such as IL&FS, Altico Capital, Dewan Housing Finance Ltd (DHFL), Cox & Kings, a slew of Anil Ambani companies and others. SEBI, too, has been acting after the fact and imposing penalties on the rating agencies. This is cold comfort to investors who have lost money; but at least it showed the regulator’s willingness to punish wrongdoing. In September 2020, SEBI raised the penalty imposed on CARE Ratings (CARE), ICRA Ltd and Indian Ratings from Rs25 lakh to Rs1 crore for lapses in the IL&FS group entities. 
 
In June 2020, SEBI imposed a penalty of Rs1 crore on CARE for taking its time to downgrade the rating of RCom, even while two other raters had downgraded it six months earlier, after RCom’s struggle to meet interest payments became evident. RCom had issued Rs2,000 crore of non-convertible debentures (NCDs) which were to mature in 2019; but it began to default on interest and payment of principal in 2016 and CARE had maintained a higher rating until November 2017—many months after Moody’s Investor Services and Fitch Ratings had announced a downgrade. 
 
CARE contested the order and managed to persuade the Securities Appellate Tribunal (SAT) to slash the penalty to a mere Rs10 lakh – not even a slap on the wrist really. SAT’s stunning failure to grasp a rating agency’s responsibilities or understand how thousands of crores of rupees of public money is invested on the basis the credit rating is encapsulated in this sentence: “The charge is one of lack of due diligence and it is not a case where ratings were not downgraded. The ratings were downgraded by the appellants but not in a timely manner. There could be a case of carelessness or sluggishness or laxity in the manner in which the downgrading was done by the appellant but it is not a case of oversight.”
 
SEBI appealed the order and one expected the apex court to do better. Shockingly, the Supreme Court (SC) dismissed SEBI’s special leave petition  against the order allowing the reduced penalty to stand. The two-judge bench reportedly clarified that this reduction cannot be a precedent in all cases, but that is hardly of any consequence. The judgement sends out a chilling message that you should rely on ratings at your own peril and the rater will face no significant damage for breach of fiduciary duties. 
 
The standing committee of Parliament on finance had taken note of the need for a fresh evaluation of the credit rating framework in India. The committee is headed by Jayant Sinha, who, unlike past convention, is from the ruling coalition and would have no real incentive to rake up issues that don't show the government in good light, especially after the latest SC ruling. 
 
Over the past few years, the failure of several banks, non-banking finance companies (NBFCs), stock brokers and corporate bankruptcies, have inflicted crippling losses on millions of investors and savers. These losses, if tabulated, would be significantly more than Rs25,000 crore in the past four years alone, including equity and fixed deposits written off. The unseemly move to undermine NFRA and the strange SC order to prevent SEBI from inflicting even small amounts of penalty on a rating agency which failed to do its job, explains why scams continue to happen regularly. Investors are really on their own; don't expect much help from the government, regulators and courts.
 

Comments
adityag
2 weeks ago
Everything goes to SC one way or other. That's the reality of regulation here. It's a joke.
aparpasricha
2 weeks ago
Excellent reporting as always! This is the reason why Moneylife is the only weekly publication I read. Slight disagreement on the CARE Ratings case though. RCom, for its non-cooperation with CRAs and debenture trustees, settled with SEBI for 60 lakhs. The penalty imposed on a CRA can't be higher than the penalty imposed on the actual defaulting entity.
anant.9196
2 weeks ago
Keep it coming!
anant.9196
2 weeks ago
Requesting ML to make it easier to share such articles through WA..
Step one is to enable wider awareness of such wrongdoings !

anant.9196
2 weeks ago
Strong investor response is the only way to get justice finally. ML is playing it's part remarkably well in connecting the dots and putting the facts on public domain. Now if investors don't rise up to protect and recover their losses strongly such rip offs will continue!
rajiv.pec
2 weeks ago
The bureaucracy very well understands how to perpetuate corruption & best at managing it. They know how to network & throw a ray of hope once in a while. However, they know that in the end nothing will happen because there are enough of loopholes to absolve even the murderers. This art is practiced with such perfection that you end up finally with a surprise I.e. no one is responsible & therefore no one gets punished. The regulators are namesake regulators & would refrain from taking action just because nobody really cares.
vaibhavdhoka
2 weeks ago
The above case show that why in India the judicial system has badly failed towards ordinary population.Case or dispute management is best profession with handsome gain as one regulator will levy penalty and appellate authority will set aside or reduce to minimal level.If this fails Supreme court will definately come to their rescue.This is how show is orchestrated and public is fooled.
ak0887471
2 weeks ago
Loss of investor is duly managed by well connected corrupted team. Investor can not correct them nor expect any hands to hold them .
shaileshgan
2 weeks ago
Amazing statement by SAT: "There could be a case of carelessness or sluggishness or laxity in the manner in which the downgrading was done by the appellant but it is not a case of oversight.”
Unfortunate that apex court did not see this. It should have upheld the SEBI order.
david.rasquinha
2 weeks ago
Judiciary : One understands the desire of the judiciary to keep executive interference away. However the Collegium was a flawed solution. Citing the basic structure doctrine to preserve the separation of powers, the judiciary managed to keep the executive away, but in so doing, itself shattered the basic structure. Now we have a mess. The collegium means there is no independence in selection and judges expertise is subordinated to parameters like state representation, gender etc. But absent the collegium, the executive would dominate completely. In chess, this is Zugzwang.

Regulators : Every regulator has been captured by the IAS. Be is the RBI, SEBI, IDRAI, NFRA, PFRDA. While any senior position calls for domain expertise and experience, the IAS has managed to create the myth that its generalist training permits them to handle any problem. The resultant mess is clear. And parent ministries always tend to resist loss of control.
parimalshah1
2 weeks ago
The judicial system is such; and the lawyers ignore the spirit of the law in most of the cases. The laws enacted b britishers need a complete overhaul including a limit on number of dates that litigants can request.
crusader1
2 weeks ago
When I voted for Modiji in 2014 one of my expectation was that he would teach a lifetime lesson to corrupt babus, CAs etc. But, after 7 years I've realised that its simply not possible in our country . In India, some companies and Institutions have become more powerful than government itself and it seems ICAI is one of them. In USA, one Enron debacle took place and Arthur Anderson was gone. In India, every couple of years new scam unveiled, but no strong action against CAs. Not even for their negligence. The patent reply of ICAI to these scams is "Auditor is watchdog and not a bloodhound". Here, ICAI fails to understand that watchdog is supposed to bark when he sees something unusual and not to look at other direction by accepting biscuits. It was also in the news that some CA's played pivotal role during Demonitisation by helping people to whiten their black money, which ultimately led to failure of demonitisation (pet project of Modiji). Still, no major action against accountants. It shows how powerful they are.
Introduction of NFRA was a good move. This was evident from the fact that hundreds of CA's left their audit assignment in between citing personal reasons, which was quite unusual. However, I don't think they will allow NFRA to work freely.
I was wondering how come they became so powerful to take on govt? Then I realised that their strength came from the monopoly power given to them. Monopoly in Tax Audit and financial audit. so, if govt wants to keep ICAI in check they take away anyone or both powers from them.
Govt should take any one of the following action
1) Remove monopoly in Tax Audit = Under IT act, only chartered accountant is allowed to carry tax audit. Remove this monopoly power and allow other professionals like Cost accountants to do Income tax audit.
2) More than One accounting bodies= Why only one accounting body (ICAI) for entire country. In a country like Australia there are three accounting bodies. Having, more than one accounting body in India will increases competition and reduce dominance of ICAI.
If Govt takes any one of this action I think it will be a stepping stone in Corporate history of India and will definitely result in better quality of financial reporting and less number of frauds.
bhaskar.jain
2 weeks ago
SAT seems to go against or dilute each and every major SEBI orders. Why is it so? Time is of the essence in case of credit rating. The justification given by CARE that it was waiting for the Brookfield tower deal to happen is ridiculous. There should be investigation done on CARE - whether they received kickback / more fees etc from ADAG. CARE ratings was always treated with suspicion in the industry.
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