Guilty Until Proven Fit: The Double-Edged Sword of SEBI’s Preventive Regulation

[Abhimanyu and Srushti are students at Gujarat National Law University and NALSAR University of Law, respectively.]

Market integrity regulation is invariably faced with a dilemma of how far precautionary provisions can be stretched until there exists a possibility of punitive action against a behaviour not yet found to have occurred. The “fit and proper person” criteria set out under the SEBI (Intermediaries) Regulations 2008 fall right into this dilemma. The SEBI (Intermediaries) (Third Amendment) Regulations 2021 made to Schedule II of the aforementioned regulations in 2021 have broadened the grounds of disqualification to include pending criminal cases, FIRs registered against an intermediary by SEBI without any adjudication, and even the filing of winding-up petitions. On a casual look, it seems like a sound exercise in preventive regulation. However, a more thorough analysis suggests that the amendment is one where regulatory powers are being used in such a manner that constitutional safeguards, internal consistency within SEBI, and market participation are put at risk.

The Architecture of the Fit and Proper Framework

It came up as an independent tool through SEBI (Criteria for Fit and Proper Person) Regulations 2004 and was subsequently embedded into Intermediaries Regulations 2008 as a lifecycle regulation rather than an entry requirement only. Regulation 7 gives SEBI the power to deny registration and revoke it where an intermediary fails to be a fit and proper person. Under the 2004 Schedule, until 2021, disqualification rested on past history, an intermediary having been convicted, being insolvent, wilfully defaulting on any obligations or proved to be dishonest would no longer enjoy that status.

This changed following the 2021 amendment in the Schedule. The amendment converts a backward-looking system to a forward looking one, which is suspicious of a particular event. Under this amendment, pending criminal cases or complaints against an intermediary, filing of FIR by SEBI, pending charge sheet against an intermediary for economic offences and institution of winding up proceedings against him become grounds for disqualification. The difference in approach is quite significant since there is no requirement that an intermediary should be convicted or even charged before being disqualified.

SEBI Against SEBI: The Internal Inconsistency Problem

The primary critique of the 2021 amendment is internal in nature as opposed to external. The parallel SEBI regulations adopt a very different test for disqualification, but SEBI has offered no principled explanation for why it deviates from this norm. Regulation 20 of the Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations 2018 finds a person unfit and improper only where such person is convicted for committing any securities or economic offenses, or an order in the nature of regulation or winding up has been made against him/her by a regulatory body. Regulation 23 of the SEBI (Depositories and Participants) Regulations 2018 takes a similar stance. The stock exchanges and depositories play central roles in market integrity; they serve as the backbone of the entire system. Since conviction-based disqualification is enough to sustain trust in these crucial entities, there cannot be a sound reason to support disqualification based on complaint in the intermediary sector.

Comparative analysis with other regulators further buttresses this argument. Under IRDAI’s Corporate Governance Guidelines, a person will be disqualified as a director of an insurance company only after being found guilty of moral turpitude through conviction. The RBI’s criteria for disqualifying bank promoters similarly rely on conduct-related factors. Notably, despite their oversight of systemic financial institutions, in whose failure the whole country would face severe consequences, regulators do not consider complaint-based disqualification appropriate. According to the established regulatory practice under Indian financial law, pending cases are inadequate grounds for exclusion from the market without judicial determinations.

Constitutional Fault Lines: Presumption of Innocence and Article 21

The amended Schedule II is incongruent with the constitutional right to the presumption of innocence, enshrined within Article 21 of the Constitution. An FIR / complaint is an accusation, not a finding of guilt, which is the precise purpose served by the presumption of innocence. It would be incongruous to assume that an FIR is enough to justify disqualification of professional status because that will mean mixing up accusations with findings of guilt, which the presumption of innocence does not allow.

In Almondz Global Securities Limited v. Securities and Exchange Board of India, the Securities Appellate Tribunal held that in light of the broad discretionary powers possessed by SEBI, it was important that there be some sense of proportionality in their use, and in any case, it must be the aim of regulation to induce compliance rather than to exclude. In Vishwanatha Sridhar v. Union of India, the reasoning of the Bombay High Court, though concerning IBBI, can be applied in context: equating an allegation with a taint on a person’s character essentially amounts to making a pretrial finding of guilt.

The Cognisance Threshold: A More Defensible Standard

In the view of the authors, judicial cognisance of the alleged offence as opposed to filing of a complaint against the intermediary should become the criterion for starting a fit and proper test disqualification proceeding against the concerned intermediary. This is far from novel. In fact, judicial cognisance of sufficient prima facie material has long been recognised as a key step in the Indian criminal justice process. Such judicial cognizance by the magistrate would act independently of the regulatory machinery, acting as an additional filter ensuring that only non-frivolous and non-retaliatory complaints are considered for regulatory disqualification.

This would allow SEBI to pursue its legitimate interest in maintaining market integrity because court cognisance of economic offences is an adequate sign of severity of the charges, while allowing the regulatory mechanism to avoid functioning like a pre-trial penalty system. Furthermore, it would align the regulations for SEBI’s powers concerning the disqualification of intermediaries with the logic that underpins SEBI’s powers under the Stock Exchanges and Depositories Acts. This would solve SEBI’s internal inconsistency as well as ensure consistency with SEBI’s overall framework for regulating intermediaries. As a result, it would bring SEBI in line with the existing consensus within Indian financial regulation.

At the same time, judicial cognizance cannot be argued to lack flaws. Judicial cognisance in certain cases can be obtained even based on very little prima facie material, and there are differences between how rigorous judicial cognisance may be depending on the particular court hearing the matter. Additionally, there may indeed be occasions when the need to protect other market participants from an intermediary undergoing investigation is pressing. However, according to the authors, the solution is to empower SEBI through Sections 11 and 11B of the SEBI Act to take appropriate steps in such an instance, rather than relying on Schedule II disqualification procedures.

Conclusion 

The 2021 amendment of Schedule II is a regulatory gamble, based on the premise that increasing disqualification triggers will prevent bad behavior and better protect the markets. The empirical case in support of this gamble is flimsy, while its costs a conflict between the Constitution and regulatory authority, inconsistency within SEBI’s regulations, and chilling of legitimate intermediary conduct are apparent. Preventive regulation gains its legitimacy from its empirical support and its proportionality. When preventive regulation replaces judicial checks with convenience and ease, it runs the risk of turning into the very problem it seeks to address.

The ongoing Motilal Oswal Financial Services Limited and Another v. Securities and Exchange Board of India, is an important example of the substantive issues at play being articulated in a real judicial context. In this case, petitioners individuals deemed unfit and improper following the NSEL scandal are contesting the regime because the requirement of automatic disqualification following the filing of complaints, FIRs, or charge sheets constitutes, in effect, the reversal of the presumption of innocence and results in irreparable consequence without a finding of guilt or an opportunity to be heard. As reported, it seems that SEBI took an interesting stance during the hearings, which is to say that SEBI told the High Court it would consider reviewing the concerned provisions and that it wouldn’t enforce disqualification in light of the pending litigation. In other words, the regulator appears to be acting far from self-confident about the correctness of its actions and positions.

In particular, SEBI published in February 2026 a consultation paper discussing the proposed changes to Schedule II of the Intermediaries Regulations 2008. The paper considers amending the trigger for disqualification from the filing of complaints, FIRs, and charge sheets to a conviction or adverse finding by a competent authority, effectively accepting the petitioners’ main arguments. Additionally, the paper introduces procedures for ensuring a fair process by requiring a right to be heard before being declared “not fit and proper.” Further, the paper proposes removing the default five-year prohibition when SEBI’s order does not specify the ineligibility period. According to the paper, the proposal complies with the proportionality principle applicable to administrative measures. Thus, the fact that SEBI felt compelled to consult on these amendments while the Motilal Oswal case is pending clearly indicates that SEBI believes the 2021 amendment is now untenable from a legal perspective. In its final judgment, the Bombay High Court will decide if Indian securities regulation moves forward with the current system, which conflates accusations and disqualification, or adopts a more investor-friendly and rule-of-law approach. The former is unsustainable; the latter, necessary.