Fit and proper person criteria

A registration is not a one-off exam that a firm passes and forgets. The SEBI (Intermediaries) Regulations, 2008 require an applicant or intermediary to be a fit and proper person — and the certificate of the compliance officer filed every 1 April certifies fulfilment of the eligibility criteria on a continuous basis.

The test has two positive limbs and a long negative one. Positively, the firm must show competence and capability in terms of infrastructure and manpower, and financial soundness, which includes meeting the net worth requirements. Negatively, neither it nor a specified circle of people around it may incur any of eleven disqualifications.

Who is tested. The criteria apply to:

1. the applicant or the intermediary itself;
2. the principal officer, the directors or managing partners, the compliance officer and the key management persons by whatever name called; and
3. the promoters, or persons holding controlling interest, or persons exercising control over the applicant or intermediary, directly or indirectly.

And there is a bright line for unlisted firms: in the case of an unlisted applicant or intermediary, any person holding 20% or more voting rights must satisfy the criteria, irrespective of whether they hold controlling interest or exercise control.

What SEBI may consider. Any criteria it deems fit, including the integrity, honesty, ethical behaviour, reputation, fairness and character of the person — and whether the person incurs any of the eleven disqualifications:

1. a criminal complaint or information under section 154 of the Code of Criminal Procedure, 1973 filed against the person by SEBI and pending;
2. a charge sheet filed by any enforcement agency in matters concerning economic offences and pending;
3. an order of restraint, prohibition or debarment by SEBI or any other regulatory authority or enforcement agency in a matter concerning securities laws or financial markets, in force;
4. recovery proceedings initiated by SEBI and pending;
5. an order of conviction by a court for an offence involving moral turpitude;
6. winding up proceedings initiated, or an order for winding up passed;
7. declared insolvent and not discharged;
8. found to be of unsound mind by a court of competent jurisdiction, the finding being in force;
9. categorised as a wilful defaulter;
10. declared a fugitive economic offender; or
11. any other disqualification specified by SEBI from time to time.

The consequences run on three clocks.

• A person declared not fit and proper by an order of SEBI is ineligible to apply for any registration for the period in the order, or — if no period is specified — for five years from the date of effect of the order.
• If, at the time an application for registration is filed, a show cause notice has been issued for proceedings under these regulations or under section 11(4) or section 11B of the SEBI Act against the applicant or a person in category (2), the application shall not be considered for one year from the date of issuance of the notice, or until the conclusion of the proceedings, whichever is earlier.
• If a person in category (2) fails to satisfy the criteria, the intermediary must replace that person within 30 days of the disqualification, failing which the fit and proper criteria may be invoked against the intermediary itself.

One mercy: a disqualification of an associate or group entity does not by itself taint the applicant, unless the applicant or a category (2) person also incurs the same disqualification in the same matter.

Vindhya Capital Services Pvt Ltd, an unlisted firm, applies for registration as a SEBI intermediary. Its cap table and people:

Mr Shetty sinks the application. He holds no controlling interest and exercises no control — but the firm is unlisted and he holds 20% or more voting rights, so he must meet the criteria in his own right. Wilful defaulter is disqualification (ix). The firm must take his stake below 20% before the application can proceed.

Anaya Advisors does not. A disqualification of a group entity has no bearing on the applicant unless the applicant or a category (2) person incurs the same disqualification in the same matter. It does not.

Now move forward two years. Vindhya is registered. On 8 May, a charge sheet concerning an economic offence is filed against Ms Raghavan, the compliance officer. She is a category (2) person, so disqualification (ii) applies to her from that date. Vindhya has until 7 June — 30 days — to replace her. It appoints a successor on 2 June and is safe. Had it argued the charge sheet was weak and waited for the trial, the fit and proper criteria could have been invoked against Vindhya itself, putting the firm's own registration at risk over one employee.

Chapter 6 (SEBI (Intermediaries) Regulations, 2008) sets out the fit and proper criteria immediately after the code of conduct, and lists the learning objective explicitly.

The reliable questions are the numbers and the lists: 20% voting rights for an unlisted intermediary, five years of ineligibility where the order specifies no period, one year or conclusion of proceedings, whichever is earlier, after a show cause notice, and 30 days to replace a disqualified key person. The eleven disqualifications are usually tested by picking one — wilful defaulter, fugitive economic offender, insolvent and not discharged — and asking whether it bars the person. It does.

• The 20% test applies only to unlisted applicants or intermediaries, and it applies whether or not the holder has control. Candidates add a control requirement that is not there.
• "Insolvent and not discharged." A discharged insolvent is not disqualified on that ground. The words after the comma matter.
• Five years is the default, not the rule. The period in SEBI's order governs; five years applies only where the order is silent.
• After a show cause notice the bar is one year or conclusion of the proceedings, whichever is earlier — so a quickly concluded proceeding shortens it. It is not a flat one-year wait.
• A group entity's disqualification is not contagious unless the applicant or a key person incurs the same disqualification in the same matter.
• Fit and proper is continuous, not a one-time entry test. The compliance officer's certificate on 1 April each year certifies fulfilment of the eligibility criteria on a continuous basis, and failure to replace a disqualified key person within 30 days puts the firm's own status in play.