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The author is Ritesh Raj, a student at National Law School of India University, Bangalore.
Introduction
On 27 June 2024, the Securities and Exchange Board of India (“SEBI”) introduced Chapter IV A in the Securities and Exchange Board of India (Stock Brokers) Regulations 1992. The chapter requires all stock brokers to establish a self-regulatory mechanism for the prevention and detection of fraud or market abuse. It mandates three mechanisms to do so. First, a system for surveillance of trading activities and internal controls (Regulation 18F). Second, a system for escalation and reporting (Regulation 18H). Third, an internal whistleblower policy (“IWB policy”), which mandates each stockbroker to develop its own IWB policy (Regulation 18I). This regulation is vague and does not establish proper standards. It merely mentions that the complaining mechanism needs to be confidential and should adequately protect whistleblowers. The Broker’s Industry Standards Forum (“ISF”) is responsible for developing standards for the IWB policy, drawing on industry feedback and stakeholder consultation.
However, the ISF has certain problems that will be discussed below. This article argues that without statutory protection for private WBs, the mandatory IWB policy for stockbrokers lacks effectiveness. The scope of the Whistle Blowers Protection Act 2014 (“WB Act”) is currently limited to public officials. It is necessary to either expand the act's scope or enact a new law specifically for private entities.
To that end, the next part of this article demonstrates the issues in SEBI’s IWB policy framework. The third part advocates for certain changes in the WB Act to ensure protection for even private WBs.
Shortfalls in SEBI’s IWB Policy Framework
The amended regulation does not provide specific guidelines for the IWB policy. While it mentions that a policy should ensure the protection of the WBs, it does not specify the extent to which protection should be provided. This vagueness leaves the provision without clear guidelines for stockbrokers to follow, which may result in the stockbrokers having an IWB policy that remains unimplemented (for a comprehensive understanding of how inadequate guidelines fail IWB policies, see here). While the ISF has been tasked with the development of standards for implementing the IWB policy, it lacks effectiveness for two reasons. First, there are significant deficiencies in the ISF and its implementation. Second, self-regulatory mechanisms (the regulation mandating an IWB policy is a self-regulatory mechanism) are prone to failure without statutory protection.
Shortfalls in the ISF
The ISF was established to develop standards for the effective implementation of SEBI’s general regulations and circulars. However, because it largely comprises stockbrokers and other industry players, individuals’ (investors and employees) interests may be neglected. The ISF could have included the major investor associations to avoid bias in its recommendations.
Further, there are areas where SEBI has mandated these vague IWB policies, without prescribing an implementing agency. One of the regulations, whilst providing proper communication of the policy to all the employees as a guideline, fails to protect WBs against victimisation. Another regulation, whilst protecting WBs, fails to ensure adequate communication and easy access to the policy. Yet another doesn’t provide any guidelines at all. While these are limited to some specific areas, Section 177(9) of the Companies Act 2013 mandates every listed company to establish a reporting mechanism. Clause 10 of the section provides that the mechanism shall adequately protect the complainant and be properly disclosed to the employees. However, despite this mandatory requirement, the IWBs have failed due to a lack of proper legislation on it.
Thus, even the few regulations mandating IWB policy lack uniformity. This is exacerbated by the variations in the IWB policies adopted by different companies. These variations are evident in their reporting structures, ranging from direct access to the Audit Committee to the Ombuds process. The policies also diverge in their approach to anonymity and confidentiality, with some explicitly ensuring it, and others making it optional.
Shortfalls in a Self-Regulatory Mechanism
Even if one says that these IWB policies can be standardised by an ISF-like body, the inherent problems in a self-regulating mechanism make statutory protection necessary for IWBs. The SC, in Indirect Tax Practitioners Assn v RK Jain, has held that without ensuring near absolute confidentiality for the IWBs, people are less likely to blow the whistle. Experience in the USA has also demonstrated that voluntary IWB policies are ineffective in preventing corporate fraud. Moreover, IWB policies may not be sophisticated enough to protect the identity of the whistleblower. Thus, an IWB policy (without statutory backing) is ineffective in ensuring absolute confidentiality.
A self-regulating mechanism is one in which regulations are defined and enforced from within instead of an external authority. IWB policies, though mandated by SEBI in some instances (a statutory body), are neither defined nor administered by it. They are enforced and specified by each entity on its own. Thus, they largely fall within the scope of self-regulation. To ensure effective implementation, what is required is co-regulation. Defined as a mechanism where regulations are a combination of self and statutory elements, they ensure uniformity in the IWB policies adopted. An example of co-regulation can be seen in Australia. It mandates certain requirements that must be addressed in an IWB policy (including WB protection, disclosure procedures, and investigation process) while allowing companies flexibility in their implementation (since the implementation standards are developed by the Australian Securities and Investments Commission (ASIC) in consultation with important stakeholders, see here).
Certain limitations of an IWB policy can only be cured by official legislation. Ensuring proper protection against victimisation and confidentiality of WBs is one such limitation. As per a survey done on the top 100 listed Indian companies, only 35% of them communicated with their employees about the WB policy. Additionally, about 50% did not clearly lay down the WB policy.
It can be concluded that without a proper statute, IWB policies fail to provide comprehensive protection and an effective channel for whistleblowers. Thus, what is needed is a proper statute and an unbiased statutory body to develop implementation standards.
Remedying the Shortfalls
While proper standards for whistleblowing can only be developed as a change in corporate culture, it is crucial to note that protection against victimisation and confidentiality of the whistleblowers are non-negotiable and require statutory backing. Thus, the WB Act’s scope must be expanded to encompass even the IWBs. While this was suggested by the second Administrative Reforms Commission, the legislature did not adopt the same. Moreover, the WB Act has still not been operationalised. Currently, therefore, there is no statute governing whistleblowers. The Central Vigilance Commission, authorised as an interim body for handling whistleblower cases in 2004, is the only mechanism available. However, this is again limited to public servants.
Whenever operationalised, it is necessary to change the WB Act in two aspects (The WB Act has other issues that need attention, such as the lack of a definition for 'victimisation' and the authority to disclose the complainant's identity under Section 13 going beyond Section 5(4) which limits it to the extent that the disclosure is with the complainant’s consent. However, this paper is limited to the protection of IWBs). First, the protection awarded against confidentiality and victimisation needs to be expanded to the IWBs. Second, if internal whistleblowing fails, an external whistleblowing mechanism needs to be established.
A similar model is also followed in Australia. While IWB policies are required to make provisions for the protection of IWBs, the statute itself also provides them protection. At the same time, it also follows a two-tiered approach. If internal whistleblowing fails, one can complain to external authorities as well. This tiered approach is also followed in New Zealand and the UK. A similar approach can be adopted in India as well. If internal whistleblowing fails, the statute should provide an option to file a complaint with SEBI. For this, the competent authority under Section 3(b) of the WB Act can be broadened to include SEBI with respect to security market complaints.
Without a way to complain about the IWB, it would be difficult to gauge its effectiveness. Consider N Narayanan v Adjudicating Officer, SEBI, where the director had himself committed fraud. Such a scenario is scarcely contemplated in an IWB policy. Thus, an external whistleblowing mechanism is required to better prevent such fraud. This also achieves the balanced approach envisioned by the SC in Securities and Exchange Board of India v Rakhi Trading Private Ltd. The court held that SEBI’s regulations should strike a balance between fostering market creativity and preventing market abuse. Having an IWB-first policy backed by statutory protection for IWBs and an external whistleblowing mechanism fulfils this objective.
Conclusion
The urgency for whistleblower protection in India is evident from Parveen v Director General, Indian Council of Forestry Research & Education, where the HC invoked the WB Act despite it not being operationalized. This highlights the crucial need for effective whistleblower legislation. When the Act is finally operationalised, it is imperative that the changes suggested in this paper be incorporated, particularly the expansion of its scope to include IWBs.
While this paper has primarily focused on stockbrokers and other private entities in the securities market, the case for expanding the scope of the WB Act to protect IWBs applies to all private entities. This broader application would result in a more robust framework for corporate accountability across various sectors of the Indian economy, not just the financial markets.
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