By M Muneer,

The latest Hindenburg report against Securities Exchange Board of India (Sebi) chairperson Madhabi Puri Buch and the response of the regulator and the government of India beg the question as to whether a regulator is beyond regulation. Will that augur well for a country that is aiming to become a developed nation, especially when stock markets are considered the lifeblood of a nation’s economy, facilitating the flow of capital and driving economic growth?

The integrity and efficiency of the markets depend heavily on the regulators who oversee them. Regulatory bodies such as the Securities and Exchange Commission (SEC) or Sebi are entrusted with the responsibility of maintaining order, preventing fraud, and protecting minority investors. But who regulates the regulators? Shouldn’t there be an oversight to ensure accountability and transparency?

Stock market regulators are responsible for enforcing laws, setting rules, and monitoring market activities to ensure fair trading practices. Regulators also play a critical role in overseeing the activities of brokerage firms, stock exchanges, and other financial institutions. However, the immense power and responsibility vested in regulators make it essential that their actions are subject to oversight. Without proper checks and balances, there is a risk that they may become complacent, corrupt, or even act in ways that are detrimental to the markets they are supposed to protect.

The idea of regulating the regulators is rooted in the principle of accountability. Just as companies and market participants are held accountable for their actions, regulators too must be accountable for their decisions and actions. This is particularly important because regulators have the authority to impose penalties, ban trading activities, and make decisions that can greatly impact market dynamics.

Moreover, financial markets have become increasingly complex with the advent of high-frequency trading, complex financial instruments, and global interconnectedness. This requires regulators to be vigilant and well-equipped to understand and manage emerging risks. Their oversight ensures that they are not only performing the duties effectively but also adapting to new market challenges. That also means accusations are dealt with appropriately and records are set straight for upholding their credibility.

One of the most notorious examples of regulatory failure is the Bernie Madoff Ponzi scheme, which collapsed in 2008. Madoff, a former chairman of the NASDAQ stock exchange, ran a Ponzi scheme that defrauded investors of $65 billion. Despite multiple warnings and red flags, the SEC failed to uncover the fraud for years. In fact, the regulator had been informed by a whistle-blower, but failed to take adequate action — potentially similar to the whistle-blower account on Buch’s non-disclosures.

This case highlights the need for regulating the regulators. The SEC’s failure to act on credible information led to massive financial losses for investors and eroded public trust in regulatory bodies. After the scandal, the regulator faced significant criticism, leading to internal reforms for improving its oversight functions and responsiveness to whistle-blower reports.

The Libor (London Interbank Offered Rate) scandal is another such example. Libor, a benchmark interest rate used in financial markets, was manipulated by several major banks for financial gain. The scandal, which came to light in 2012, revealed that regulators in multiple countries, including the UK’s Financial Services Authority, had been aware of irregularities but failed to take timely action. This exposed the weaknesses in global regulatory frameworks and also underscored the need for better coordination among regulators. In response, reforms were implemented to enhance transparency and governance of benchmark rates, and regulatory bodies underwent significant restructuring to improve oversight capabilities.

It is not that Sebi hasn’t had similar bad exposures before (remember the Satyam saga of 2009?). Satyam was found to have falsified its accounts, inflating profits and assets to the tune of $1.5 billion. The scandal was a blow to investor confidence and questioned Sebi’s role. It prompted the regulator to take steps to strengthen its framework, including enhancing corporate governance norms, improving the quality of financial disclosures, and tightening oversight of auditors.

To ensure regulatory bodies are held accountable, here are some suggestions:

Independent oversight bodies: One of the most effective ways to regulate regulators is through independent oversight bodies — often composed of experts from various fields, and tasked with reviewing the actions and decisions of regulatory agencies. For example, in the US, the Government Accountability Office audits and investigates the operations of federal agencies, including the SEC, to ensure they perform their duties effectively. Can the Comptroller and Auditor General here get a mandate for a Sebi audit?

Regular audits and evaluations: This will help identify areas where they may be falling short. These audits shall be conducted by independent third parties or government agencies to assess the efficiency and transparency of the regulator’s operations, including their chairpersons’. In some cases, peer reviews by other regulatory agencies can provide valuable insights and recommendations for improvement.

Whistle-blower protections: Such protections are critical for identifying and addressing regulatory failures. Encourage employees and market participants to report misconduct without fear of retaliation. This will help regulators uncover issues that might otherwise go unnoticed. In the wake of the Hindenburg report, Sebi has an opportunity to strengthen its whistle-blower programme by offering financial incentives and legal protection to those who can offer valuable information on Adani group’s dealings.

Public accountability and transparency: Transparency is a cornerstone of good governance. Regulatory agencies and their leaders should be required to publicly disclose their decisions, enforcement actions, and the rationale behind them. Many regulatory agencies now publish detailed annual reports, enforcement statistics, and public consultations to engage with stakeholders for transparency.

Judicial review: In some cases, the actions of regulatory bodies can be challenged through judicial review as in the earlier Supreme Court intervention via a public interest litigation. This allows courts to assess whether a regulator has acted within its legal authority and followed due process. Judicial review serves as an important check on the power of regulators.

Will Buch take some steps in the right direction beyond mere denials in an increasingly meek media?

The author is a Fortune-500 advisor, start-up investor and co-founder, Medici Institute for Innovation.

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