SEBI's Yellow Card: 'Warning Letters'

A Gentle 'Fix It or Else' Reminder

A warning letter from SEBI serves as an official yet considerate reminder—an administrative prompt that calls attention to an entity's responsibility to adhere to the requirements of the securities law. Although "warning letters" are bereft of a strict codification, SEBI's authority to issue such letters can be sourced from the broad powers outlined in Section 11(1) of the Securities and Exchange Board of India Act, 1992 ("SEBI Act"), showcasing:

“(1) Subject to the provisions of this Act, it shall be the duty of the Board to protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit.”

On similar lines, Section 12A(1) of the Securities Contracts (Regulation) Act, 1956 (“SCR Act”) bestows exemplary powers upon SEBI to issue appropriate directions to uphold the interests of investors in securities and the securities market, as is made evident by the words etched in the provision:

“12A.(1) If, after making or causing to be made an inquiry, the Securities and Exchange Board of India is satisfied that it is necessary-

1. In the interest of investors, or orderly development of securities market; or
2. To prevent the affairs of any recognized stock exchange or clearing corporation, or such other agency or person, providing trading or clearing or settlement facility in respect of securities, being conducted in a manner detrimental to the interests of investors or securities market; or
3. To secure the proper management of any such stock exchange or clearing corporation or agency or person, referred to in clause (b),

it may issue such directions,-

1. To any stock exchange or clearing corporation or agency or person referred to in clause (b) or any person or class of persons associated with the securities market; or
2. To any company whose securities are listed or proposed to be listed in a recognized stock exchange,

as may be appropriate in the interests of investors in securities and the securities market.”

Even though the parent laws i.e. the SEBI Act and the SCR Act do not conspicuously depict the terminology of a “warning letter”, the Regulations branched out from it bear a reflection of such an administrative action. For instance:

• Regulation 12(a) of the SEBI (Prohibition of Fraudulent Trade Practices relating to Securities Market) Regulations 2003 showcases - “The Board may, without prejudice to [any action under the securities laws or directions or circulars issued thereunder], by an order, for reasons to be recorded in writing, in the interests of investors and securities market take the following actions against an intermediary: (a) issue a warning or censure…”

Weaving the threads of the discussion, a warning letter can thus be viewed as one of the many tools SEBI deploys under the broad discretionary authority sprouting from the phrases "by such measures as it thinks fit” along with “it may issue directions…as may be appropriate in the interests of investors in securities and the securities market”. The spectrum provided by these words allows SEBI to adopt various administrative and corrective actions, including a warning letter.

Issued in cases where breaches are trivial or procedural, a warning letter shapes up as a forewarning rather than an immediate reprisal. Within its text, the warning letter weaves together the nature of the violation, the need for timely correction, and the ominous possibility of stricter action should compliance falter again. In common parlance, the letter states: “you are therefore warned to be careful in future” and also “the above warning should be taken seriously”.

Pontificating lapses in compliance provides an olive branch of opportunity to realign with the prescribed standards. Thus, the tone of a warning letter invites a proactive response rather than an immediate punitive sanction. Through this very action, SEBI asserts its watchful presence, urging the recipient to rectify their actions, lest further infractions will attract intensified repercussions.

Warnings, all around the world

Across various jurisdictions, Regulators employ warning letters as the tools of soft administrative enforcement. Such enforcement seeks to balance the scales between enforcing compliance and encouraging voluntary corrective actions. By taking a cursory glance, one may find that:

• In the United States, the Securities and Exchange Commission (“SEC”) issues "Wells Notice" which may not be strictly akin to a warning letter, however, it is infused with the spirit of enforcement. The Wells Notice grants the entity an opportunity to defend itself, though the notice is often preceded by a "pre-Wells" process which allows for dialogue and defence submissions. In a way, the pre-Wells process resembles a conventional warning letter that SEBI issues to compel rectification. This pre-Wells stage is pivotal (particularly with respect to complex or policy-driven cases) in facilitating flexibility and promoting potential settlements before the Wells clock starts ticking.
• The Financial Conduct Authority (“FCA”) of the United Kingdom issues "Private Warnings", which can be viewed as a subtle reprimand intended for less severe breaches. These warnings are issued discreetly (concealed from public scrutiny), presenting the entity a chance to recalibrate without attracting formal disciplinary action, thereby fostering compliance without facing undue reputational damage.
• The Australian Securities and Investments Commission (“ASIC”) deploys "Infringement Notices" for trivial violations, allowing entities to steer clear of court proceedings if they comply with the notice's directives. This mechanism (aimed at less grave offences) grants entities the opportunity to rectify their missteps before bearing the brunt of harsher penalties.

Notwithstanding variations in form and lexicon, these mechanisms share a common purpose: to tactfully prompt compliance by employing non-invasive procedures, reserving the full force of enforcement for when corrective measures are not exercised.

The Statistical Snapshot

SEBI, being the vigilant regulator, has escalated regulatory scouting over the years. For the defaults and irregularities that were minor, SEBI resorted to soft administrative actions (Warning Letter, Advisory Letters, etc.). Such a nuanced approach to enforcement that inclines towards corrective measures over punitive actions is reflected in the data inked in SEBI's Annual Report(s) which reveals that:

In 2021-22, SEBI's enforcement push commenced with the issuance of 13 warning letters and 35 administrative notices to mutual funds, AMCs, and other intermediaries, showcasing the regulator's intention to enforce compliance while allowing a chance at self-correction. By 2022-23, SEBI intensified the regulatory pursuit, dispatching 100 warnings, escalating oversight of Market Infrastructure Institutions (“MIIs”), and issuing 48 advisory letters, marking a deeper regulatory sweep across sectors. The surge continued in 2023-24, with 141 warnings and a notable 127 advisory letters—an unprecedented increase aimed particularly at MIIs and merchant bankers.

The abovementioned statistics can compel one to fairly opine that SEBI has strategically wielded these 'yellow cards' (warning and advisory letters) compelling entities to rectify non-compliance before stricter actions like 'red cards' (show-cause notices) are sanctioned. This sophisticated regulatory stance makes plain SEBI's preference for soft enforcement, without prematurely resorting to punitive actions.

Ripples of Rulings

SEBI's warning letters, though corrective by nature, can be pigeonholed as precursors to formal adjudication. A debate arises over whether SEBI is appropriately exercising quasi-judicial powers or potentially overstepping by turning what should be a "yellow card" warning into a "red card” without adequate justification.

From Consequence to Caution

Warning letters are often mistaken for live wires, per contra, they act as lifelines provided by the regulator. There have been numerous instances where entities have walked away scatheless after receiving a warning letter, spared from escalation in the form of penalties, as a result of their diligent compliance. The Adjudication Order in Cameo Corporate Services Ltd. (“Cameo”) serves as a classic example of one such instance. Erupted by a special-purpose inspection, SEBI unearthed operational irregularities within Cameo, concerning unclaimed shares, duplicate share issuance, and improper transfer rectifications.

The lapses invited to deeper scrutiny where discrepancies such as forged banker attestations and the issuance of shares lacking proper identity verification surfaced. In defense, Cameo addressed these concerns by imputing the irregularities as accidental errors while presenting corrective actions. A thorough inspection led to the Adjudicating Officer acknowledging the firm's efforts to rectify the mishaps, ultimately dismissing the allegations due to their technical nature. The warning letter (in the present case), thus, reinforced SEBI's approach—which focused on fostering compliance rather than imposing punitive measures.

In Piramal Enterprises Limited^[1] (“PEL”), the Securities Appellate Tribunal (“SAT”) mulled over the issue as to whether the imposition of penalty is the ultimate aim under Section 11 of the SEBI Act. In the case concerning PEL, the SAT duly observed that despite a technical violation of the Model Code, there was no misuse of Unpublished Price Sensitive Information (“UPSI”), nor any substantial evidence of insider trading. SEBI's investigation revealed that only one employee had traded in the scrip of PEL, however, they were not privy to the UPSI. The Tribunal duly noted that PEL had acted with fairness and transparency throughout the deal. Scrutinizing the circumstances, the SAT rhapsodized that imposing a penalty (irrespective of the quantum) would unfairly dent the company's reputation, especially in the international market. Above all, the SAT manifested SEBI's role as a “watchdog, not a bulldog” stressing that remedial measures should be prioritized over punitive ones in the absence of concrete evidence of misconduct. The Tribunal metamorphosed the penalty into a warning, cautioning that future violations could warrant stricter action, thereby reinforcing the principle that penalty is not always the necessary answer when compliance can be achieved through warnings and corrective measures.

From Caution to Consequence

SEBI, as a vigilant watchdog, resorts to adjudication when deeper systemic failures and/or persistent non-compliance are detected. Entities that turn a blind eye to a warning letter naturally invite heavy-handed enforcement from the regulator. In other words, what begins as a cautionary tale can swiftly turn into a serious saga. The case of Setubandhan Infrastructure Limited (“Setubandhan”) surfaces as a classic example of one such saga. In Setubandhan, SEBI's investigation highlighted the company's failure to disclose the initiation of a forensic audit, a critical requirement under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. Despite SEBI's directives and a warning letter urging compliance, Setubandhan insisted that such disclosure was not material, and thus, withheld the information. SEBI, determined to examine potential financial irregularities, including fund diversion and bad debts, responded by imposing a penalty (legitimately so).

Take for instance, in the matter of inspection of books and records of S K Infosolutions Pvt Ltd (“S K Infosolutions”), despite SEBI issuing a warning letter—essentially a "yellow card"—the entity failed to take timely corrective actions. While S K Infosolutions later retrieved missing agreements with 22 client companies and entered into fresh agreements with 10 body corporates, these efforts were belated. Surprisingly, S K Infosolutions admitted to not entering agreements on valid stamp paper and failed to formulate the mandatory code of conduct as per the SEBI (Prohibition of Insider Trading) Regulations 2015, until after SEBI's inspection. Additionally, the entity provided contradictory information about the availability of specimen signatures for client companies, which further cemented the acts of non-compliance by S K Infosolutions. Even after such irregularities, SEBI had granted the entity a fair opportunity to rectify these issues, but a delayed and inadequate response ultimately necessitated formal enforcement. Having brushed aside the initial warning, contraventions by S K Infosolutions, including the failure to adopt a proper code of conduct and misrepresentation of facts, left SEBI no choice but to escalate the matter and impose penalties.

Shalimar Paints: A Brush with Compliance Through Corrections

By embedding warning letters into a soft yet nuanced enforcement model, SEBI prepares the terrain for their use as powerful corrective tools. When entities perceive these letters as true opportunities to realign their actions (free from the immediate fear of punishment), they are far more inclined to respond constructively and make the required adjustments. This, in turn, helps reduce the need for adjudication in cases where companies act promptly and in good faith. However, a question hangs in the air: Can a penalty ensue after the initiation of a warning letter?

A polished example of such a scenario was witnessed in the matter of insider trading activity by certain entities in the scrip of Shalimar Paints Limited (“Shalimar Paints Ltd.”) where the Adjudicating Officer duly noted:

“36. From the said warning letter, I note that SEBI would have initiated action only in case the violation appeared again. However, after the issuance of the said warning letter as rightly contended by the Noticee, no new infractions were observed as per records on the part of the Noticee.

….I observe that for the same set of violation for the same period Noticee has already been warned by SEBI. In view of the fact that no new infractions have been observed, I am of the view that no penalty is warranted in the instant case.”

The Adjudicating Officer in the Shalimar Paints Ltd. brought the matter to a culmination with a clear observation: no new violations emerged after the issuance of the warning letter. This conclusion rightly affirmed that no further action was required, cementing the role of warning letters as tools of correction rather than punishment. By and large, warning letters should rightfully serve as 'beacons of correction' instead of becoming the 'bearers of sanction.'

The Final Crescendo

As the narrative draws to a close, one can fairly conclude that a warning letter is a soft enforcement tool, designed to encourage compliance without immediate censure. Over time, these cautionary letters have surely evolved into firm yet fair signals that echo across the market, urging companies to correct their course before facing grave consequences (as illustrated by the preceding analysis).

The entire contemplation succinctly reflects that SEBI has prioritized proportionality when it comes to administrative actions in the form of warning letters. Time after time, SEBI has ensured that these warning letters provide a genuine opportunity for self-correction rather than acting as precursors to penal consequences. Employing a nuanced approach, where companies that promptly rectify their issues are distinguished from those acting in bad faith, exemplifies the regulator's fair-handedness. Needless to say, the art of regulation lies in ensuring that entities exercising remedial steps are not facing the brunt of the same penalties as habitual offenders.

However, the absence of a clear statutory framework for warning letters - to guide when and how these warnings are issued could invite concerns of ambiguity. Therefore, formalizing and codifying warning letters within a legal framework would be a natural progression, reinforcing their role as well-structured regulatory tools. Codifying such administrative actions would dispel any apprehension of arbitrariness, ensuring that habitual non-compliance leads to proportionate penalties. Naturally, SEBI's warnings would garner more credibility, evolving from gentle nudges into more impactful regulatory levers while still offering entities the chance at rectification.

A forward-looking approach suggests a blend of transparency and clarity that can always aid the regulatory approach of SEBI. To further this cause, a public log of warnings, complete with a scoring system revealing the gravity of contraventions, would enhance market participants' ability to analyze risks, while also paying utmost heed to these warnings rather than viewing them as mere informal gestures.

All in all, SEBI's warning letters should not be seen as mere admonitions but as essential components of a forward-looking regulatory mechanism. By employing them with transparency, consistency, and proportionality, SEBI can continue to serve as the guardian of market integrity. Reaching the final crescendo, SEBI's yellow card is the regulator's declaration - 'You're on thin ice, but we're giving you a chance.' Brush it under the carpet, and you'll find that the whistle blows faster than one can utter 'show cause', and the red card won't come with a handshake!

Authors: Ravi Prakash (Associate Partner), Kriti Karn (Associate), Varun Litoriya (Associate), Vaibhav Malhotra (Associate) at Corporate Professionals Advisors & Advocates. Views are personal.

1. Piramal Enterprises Limited v. SEBI [Appeal No. 466 0f 2019] Order dated 15.05.2019. ↑