SEBI's Consultation Paper: Revisiting Fit and Proper Criteria

[Suhani and Sukriti are students at National Law University Odisha.] 

The Securities and Exchange Board of India (SEBI), via its February 2026 consultation paper proposed major amendments to Schedule II of SEBI (Intermediaries) Regulations 2008. This schedule lays down the “fit and proper person” criteria for such intermediaries. SEBI has hinted towards a shift towards a more comprehensive assessment framework which is principle-based, away from a predominantly strict rule-based disqualification model. 

The paper proposes removal of certain automatic disqualifications and introduction of several safeguards in the form of Clauses 3A and 3B to ensure the principles of natural justice are adhered to. SEBI has also signalled an expansion in the scope of convictions and disqualifications such as economic offences and offences under securities laws. 

The article firstly explains how the “fit and proper person” criteria has evolved. It then discusses the key proposals in the paper. It also examines the impact of giving SEBI greater discretion in significant matters. Lastly, it highlights key concerns and possible recommendations to ensure the objective of the provision and principles of natural justice are preserved. 

Evaluating the Proposed Framework: A Critical Analysis

Conflict between principle based and rule based

Clause 3 of Schedule II of the SEBI (Intermediaries) Regulations 2008 provides a structural issue by allowing the Board to apply both the Principle and Rule based criteria in order to determine whether an applicant is a “fit and proper person” or not. The principle-based criteria involves counting standards such as honesty, integrity, ethical behaviour, reputation, fairness and character, all of which are left undefined by any objective threshold. Honestly, these standards are inherently elastic and subjective. 

Since the regulation permits the SEBI to take into account whatever criteria it deems appropriate, and there are no definite standards, such an evaluation may be subjective. Consequently, two similarly placed candidates can be given different results based on the interpretation of such qualities, which creates an issue of arbitrariness and unfair treatment under Article 14.

The significant tussle arises when this principle based criteria interact with rule-based criteria under Clause 3(b), which laid down objective standards of trigger events such as filing of chargesheets or initiation of criminal proceedings, for disqualifying an intermediary. This might lead to a situation wherein the rule-based assessment would override the principle-based assessment. This twofold structure presents incoherence: the limb, which presupposes discretion, whereas the rule-based limb is an automatic threshold. The paper recognizes this inconsistency and proposes reducing such automatic triggers and focusing more on final outcomes and procedural safeguards.

Moreover, both the rule based and principle-based triggers play an important role in influencing the regulator’s decision in identifying entities to be in “fit and proper” criteria. 

A clear illustration is the Phillip Commodities India Private Limited matter, wherein SEBI denied the registration of an applicant after assuring that the company failed in its good conduct i.e., a principle-based standard, while facilitating certain contracts and thus it reflected badly on the “fit and proper” criteria under Schedule II.

Another example is the India Infoline Commodities Limited order of SEBI published on 29 November 2022, wherein SEBI did not solely go on rule-based disqualifications like a pending criminal complaint and charge-sheet under Para 3(b). Another factor that the regulator applied was the principle-based criteria in Para 3(a), which raised questions of the integrity, honesty and ethical behavior of the noticee. 

Borrowing from SECC and DP Regulations: A contextual misfit 

The paper draws support from Regulation 20 of the SECC Regulations and Regulation 23 of the DP Regulations, which adopts a conviction-based threshold for categorising a person as “fit and proper”. As per these provisions, a person may be disqualified typically only upon final conviction or winding-up order instead of getting disqualified at the stage of preliminary proclamation. However, it is imperative to note that these regulations are applicable to market infrastructure institutions (MIIs) like stock exchanges, depositories, and clearing corporations. 

Therefore, borrowing the conviction-based mechanism from the MII framework is misplaced as SECC and DP Regulations are designed for systematic institutions and not for governing the conduct of sensitive intermediaries. 

Rethinking disqualification standards

Clause 3(b)(i) and 3(b)(ii) currently disqualify an applicant, intermediary, KMP or person in control where a criminal complaint/FIR filed by SEBI is pending, or where a charge-sheet has been filed in respect of an economic offence. The fault with these provisions is that they impugn disability of disqualification at a pre-trial stage which is even before any determination of guilt. This is strengthened further by the criminal law principles which opine that pre-trial stages’ acts such as filing of an FIR or chargesheet merely starts the criminal proceedings and does not establish any culpability. Such automatic disqualification can undermine the presumption of innocence and may be disproportionate, especially since criminal trials often take many years to conclude. It also creates regulatory uncertainty, as a person may remain disqualified for years without ever being convicted.

However, the simultaneous expansion of Clause 3(b)(v) — extending disqualification from offences involving “moral turpitude” to include conviction for any economic offence or any offence under securities laws — represents a significant structural shift from pre-trial disqualification to post-conviction disqualification. Nonetheless, the term any economic offence is extremely general and may include not only serious offenses such as fraud but also minor regulatory offenses. This complicates the ability to draw the line between various degrees of wrongdoing.

Clause 3(b)(vi) also disqualifies an entity when the winding-up proceedings are initiated. Nevertheless, when corporate insolvency resolution process is initiated under the Insolvency and Bankruptcy Code 2016, it is merely the beginning of a process of resolving and not an indication of financial failure. Treating it as automatic disqualification hence confuses temporary financial distress and permanent incapacity. This change led to concerns about principles of proportionality and fairness. To prevent this, the framework must take into account the severity of the crime, the effect of the crime on integrity of the market as well as the overall behaviour of the individual prior to assessing fitness. 

Insertion of Clause 3A and 3B: A step towards strengthening natural justice?

SEBI has proposed to insert Clause 3A and 3B to bring procedural clarity to the “fir and proper person” framework. It requires the intermediaries to explicitly disclose events falling within Clause 3(b), thereby placing a clear compliance obligation on the regulated entities. This positive amendment can help to mitigate information asymmetry between SEBI and intermediaries to strengthen supervisory lapses.

It also provides that a declaration of unfitness of a person shall be made only after granting the concerned a reasonable opportunity of being heard. Earlier, it was majorly implicit. Now, codifying this requirement, it aims to transform the process from an automatic result of incurring a disqualification into a formal adjudicatory framework backed by reasonable decision making. This improves procedural fairness and also shields SEBI’s decisions from challenges based on violations of principle of natural justice.

Clause 3A further sets in motion a mandatory disclosure requirement within 7 days of the occurrence of any relevant event. This enables timely reporting and helps SEBI to quickly assess the potential risks as early as possible. Timely disclosures improve transparency and investor protection by ensuring that convictions, regulatory restraints, insolvency proceedings do not remain undisclosed.

However, there is a potential loophole to this strict 7 days’ timeline. In the author's opinion it may pose practical complexities in certain circumstances. Big intermediaries largely operate through tangled sophisticated corporate structures, and developments relating to involvement of key managerial personnel in authority may not instantly come to the knowledge of the organisation. For instance, foreign regulatory conduct, insolvency proceedings or court orders may take a significant amount of time to be communicated and verified internally. Also, since the amendment does not clarify whether this stipulated timeframe starts from the date of occurrence or the date of knowledge, intermediaries can easily inevitably fall into technical non-compliance despite acting in good faith.

Therefore, while the aim to have a robust disclosure is praiseworthy, the regulation could be rectified by keeping the reporting requirement as the date of knowledge or by providing reasonable flexibility for bona fide cases of delayed awareness.

Removal of the automatic five-year prohibition

Clause 4 of the paper proposes to remove the automatic five-year prohibition. Earlier, when SEBI’s order declaring a person not “fit and proper” did not specify a particular duration, a default prohibition of 5 years was imposed automatically. This rigidity often resulted in a one size fits all approach, irrespective of the nature and gravity of the offence or misconduct. Thus, SEBI advocates for determining the prohibition period consciously as regulatory sanctions should be proportionate to the underlying misconduct based on the facts and circumstances of each case.

However, removing the default prohibition period expands SEBI’s discretion. While prohibition will now apply only if a specific time period is provided in the order, the outcomes may differ widely based on how an individual order has been drafted. Therefore, violations that are similar in nature may potentially result in different prohibition periods or even no specified period at all which may in turn lead to variability with respect to future eligibility.

Hence, the real efficacy of this regulation will lie on the fact that SEBI formulates unambiguous internal guidelines or indicative threshold benchmarks to establish uniformity in determining prohibition periods.

Suggestions and Way Forward

Although the reforms are to harmonise the principle-based and rule-based framework that falls under Schedule II of the SEBI (Intermediaries) Regulations 2008, some refinements can be made to enhance proportionality, certainty and procedural fairness.

To begin with, graded classification of offences should be used to support the extension of disqualification to any economic offence conviction. The securities law offences lie between a small default of reporting and a big offence in fraud or market manipulation. By differentiating minor, regulatory and serious offences and the consideration of mens rea, it would be possible to prevent the unwarranted proportionality of consequences.

Second, as there may be pending criminal complaints or charge-sheets, which could still have an impact on principle-based criteria like integrity or reputation, SEBI ought to publish discursive instruction in assessing cases on a case-by-case basis. Subjectivity can be mitigated by factors such as the stage of proceedings, allegations severity, connection to securities markets and harm to potential investors.

Third, conversion of mandatory divestment into suspension of voting right must be accompanied by protective measures, e.g. escrow or temporary trustee of voting right which neutralise control, but retain ownership.

Fourth, the organisational safeguards in Clause 3A and 3B must involve definite timeframes, plausible reporting periods and justifiable orders to enhance natural justice.

Lastly, the automatic 5-year ban should be lifted based on indicative time-bands related to the severity of misconduct keeping SEBI discretion intact.

Conclusion

The paper is a significant step towards making the “fit and proper person” criteria more balanced and fairer. Moving towards a more principle-based approach, it aims to promote proportionality and procedural fairness. However, its triumph depends on how SEBI exercises its discretion by setting clear parameters, graded benchmarks and stringent procedural safeguards to ensure consistency and effective regulatory oversight.