Common Personnel Conditions Under Credit Rating Agency Rules Apply To Promoter's Borrowers, Subsidiaries: SAT

The Securities Appellate Tribunal has recently clarified that the conditions relating to common Chairmen, directors, and employees between a credit rating agency and an entity being rated also apply to borrowers and subsidiaries of the agency's promoter, and not only to its associates.

The conditions appear in Regulation 27(1) of the SEBI (Credit Rating Agencies) Regulations, 1999. The tribunal found that there was “ambiguity and lack of clarity” over whether they applied to borrowers and subsidiaries as well. It held that “the said conditions shall be applicable” to those two categories and answered the issue “in the affirmative.”

The bench comprising Presiding Officer Justice P.S. Dinesh Kumar, Technical Member Meera Swarup, and Technical Member Dr. Dheeraj Bhatnagar allowed the appeal filed by Acuite Ratings & Research Limited.

It set aside the order imposing a penalty of ₹5 lakh on the credit rating agency.

Regulation 27(1) of the CRA Regulations restricts a credit rating agency from rating securities issued by certain entities connected with its promoter. It covers three categories: borrowers, subsidiaries, and associates of the promoter. Acuite argued that the CRA was barred from rating securities issued by any of these three categories only if the specified conditions existed.

SEBI argued that they did not. According to its reading of the provision, a credit rating agency was prohibited from rating securities issued by a borrower or subsidiary of its promoter regardless of whether there were common Chairmen, directors, or employees. Those conditions, SEBI argued, applied only when the entity being rated was an associate of the promoter.

Acuite took the opposite view. It argued that the conditions applied to all three categories. Thus, even where the entity being rated was a borrower or subsidiary of the promoter, the common-personnel conditions had to be considered before the restriction on rating its securities applied.

Acuite is a SEBI-registered credit rating agency. SEBI conducted an on-site inspection of the agency between September 2022 and August 2023 and later communicated its findings to Acuite.

SEBI subsequently alleged that Acuite had rated securities issued by eight entities that had borrowed funds from its promoter, the Small Industries Development Bank of India, or SIDBI. According to SEBI, this violated Regulation 27(1). Its Adjudicating Officer subsequently imposed a penalty of ₹5 lakh on Acuite.

Challenging the penalty, Acuite argued that SEBI had misread the provision. It relied on the 72nd Report of the Parliamentary Standing Committee on Finance, which supported its interpretation that the conditions relating to common Chairmen, Directors and employees were meant to apply to borrowers, subsidiaries, and associates alike.

SEBI maintained that the wording was clear. It argued that borrowers, subsidiaries, and associates were separate categories, with the conditions relating to common personnel attached only to the category of associates.

The tribunal also examined Regulation 28V, which contains a similar restriction in relation to ESG ratings. Unlike Regulation 27(1), that provision expressly applies the conditions relating to common personnel to borrowers, subsidiaries and associates.

SEBI argued that the two provisions operated in different fields. The tribunal noted, however, that both restrictions served the same purpose: preventing conflicts of interest.

“Both Regulation 27 and 28V impose restrictions on a CRA from assigning the ratings. The purpose and intent behind this restriction is common and that is 'conflict of interest',” the tribunal observed.

The tribunal then considered a SEBI press release issued in June 1999. It noted that the press release stated that a credit rating agency could not rate securities issued by “any borrower, subsidiary, an associate of promoters of CRA” if the specified conditions relating to common Chairmen, Directors or employees existed.

It also referred to the 72nd Report of the Parliamentary Standing Committee on Finance. The report similarly stated that a credit rating agency should not rate securities issued by its “borrower/subsidiary/associate or that of its promoter” where there were common Chairmen, Directors or employees between the agency and those entities.

On reading these materials along with Regulation 28V, the tribunal concluded that the conditions were intended to apply to all three categories.

“A combined reading of the report of the Parliamentary Standing Committee, SEBI's press release dated 23.06.1999 and Regulation 28V leads us to infer that the legislative intent with regard to Regulation 27 was, the conditions mentioned in clause (i), (ii) and (iii) shall be applicable to Regulation 27(1)(a) and (b) also,” the tribunal ruled.

It held that this was the harmonious way to read the provision. Since the restriction was meant to prevent conflicts of interest, the tribunal found that the conditions could not be confined to associates alone while being disregarded for borrowers and subsidiaries.

Accordingly, the tribunal allowed Acuite's appeal and set aside the penalty order. It also directed SEBI to refund any deposit made by Acuite under an earlier order.

For Appellant: Advocates Shruti Rajan, Vivek Shah and Paras Taneja

For Respondent: Senior Advocate Shiraz Rustomjee, Advocates Suraj Chaudhary, Bhushan Shah, Abhishek Nair and Sayali Kshirsagar