It is raining ex parte orders again in the Indian securities market. Essentially, orders that are passed without hearing the person against whom it is passed, the practice is justified in the eyes of the law if the circumstances demonstrate grave urgency and warrant action.
Yet, when an ex parte action is taken, the authority taking the action is expected to do its homework to demonstrate the urgency and get its facts right to defend the action when challenged. Take the case of the 331 listed companies, which the capital market regulator was told — by none less than the Ministry of Company Affairs — were “shell companies”.
A shell company is one that is merely a shell — without substance in its operations and functions. The Securities and Exchange Board of India appears to have blindly taken the list it received and declared all these companies to be shell companies. Media reports suggest that some noteworthy names have been declared in one sweep to be “shells”. Declaring them to be shell companies, suggesting forensic audit of their existence and giving them pariah status on the stock market, where trades in them would be permitted only once a month, would cause serious injury to every holder of securities in these companies.
Some investors would have pledged their shares to lenders, who would determine such an event to be one of default. The underlying asset over which they had security would suddenly become illiquid. Others would have taken trading positions in these securities with a certain assessment of facts in; if they were suddenly told that regardless of facts, these companies deserved to be shunted to the periphery of the stock market, it would cause them serious losses.
Such a drastic action would, therefore, warrant giving notice to the parties concerned, giving them a chance to explain themselves. At the least, one would expect basic due diligence to be carried out before action were taken so that the (well-intentioned) objective of investor protection, far from being met, is not undermined. If a basic internet check would have shown that some of these are well-functioning, profit-making, loan-taking operating companies, the embarrassment of terming them “shells” could have been avoided.
The history of financial markets is replete with examples of such decisions. Ex parte orders purporting to be interim measures get passed and routinely become permanent measures. They are often known to continue for as long as five years.
Examples of every kind of sudden shock and surprise are now easily available. We have had securities being introduced into the derivatives segment in the middle of a month. We have had securities removed from derivatives in the middle of a month. Issuers of securities with derivatives riding on them, declaring record dates in the middle of a derivatives trading cycle, too have been seen.
Abnormal or extraordinary decisions invariably also point to the need to check if there was any abnormal pattern of trading just before they were announced. Often, that leads to probes and allegations of insider trading. In fact, a recent ex parte order froze every bank account of every individual named in it overnight, rendering them penniless. The suspicion in that order was that publicly known regulatory proceedings against a company had been the motive for every sale in listed securities of affiliates of that company.
Another type of development is in the risk of being repeated so often that it would become a trend. Relying on private “forensic reports” (often conducted by accounting and audit firms with little training in the rigours of investigative discipline), regulators take ex parte actions. Typically, these reports are riddled with disclaimers that render them poor evidence in law. However, in the post-truth world, by the time it can be demonstrated that there is no real legal evidence, the damage is done, and destruction of individuals and institutions is complete.
Is there a better way to handle this? Surely, if one asks oneself multiple times if the use of emergency powers to pass ex parte orders is warranted, the reckless usage of such a blunt weapon would get tempered. The value one attaches to the concept of the “rule of law” is best tested when the most provocative circumstances present themselves.
It is easy to adhere to the rule of law if one’s patience is not being tested to the brink. If one loses all vestiges of being circumspect and stops checking and regulating oneself, the rule of law would be replaced by the rule of men, risking the very credibility and majesty of law enforcement.
(This was published as a column titled Without Contempt in the Business Standard editions dated August 10, 2017. Disclosure: The author represents (after publication) for some companies affected by it.)