This follows a legal challenge from prominent brokerage firms, which have argued the rule is unconstitutional as it amounts to treating a person as “guilty until proven innocent”.
The markets regulator made the statement before a division bench of the high court comprising Justice RI Chagla and Justice Farhan Dubash that was hearing a clutch of petitions filed in 2023 by a consortium of leading brokerages including Motilal Oswal Financial Services and Anand Rathi Shares and Stock Brokers.
Sebi told the court it has scheduled internal discussions to review the contentious provisions by the end of the year.
The market regulator had already assured the court back in 2023 that it would not insist on compliance with show-cause notices issued under the rule, given the pending case, so no individual or company has thus far been disqualified because of a charge sheet.
The matter has been adjourned to 6 January 2026, by when Sebi is expected to formally respond following its internal review.
Sebi’s sharp clause
The firms challenged the validity of Clause 6 of Schedule II of the Sebi (Intermediaries) Regulations, particularly after its amendment in 2021, saying it was leading to the automatic disqualification of directors and key managerial personnel if a charge sheet was filed against them for an economic offense, even before a trial had commenced or any guilt had been established.
They argued that the provision violated various fundamental rights guaranteed by the Constitution, including the right to practice any profession or carry out any occupation. They said the rule denied the accused a fair opportunity to defend themselves against unproven allegations and imposed disproportionate consequences that could cripple their career and the company’s operations.
The brokerage firms also raised the issue of fairness in their petition, arguing the clause was selectively applied to stockbroker companies but not to stock exchanges, creating an unequal playing field.
Is Sebi being overprotective?
Sebi’s ‘fit and proper’ criteria are meant to ensure that entities and individuals operating in the securities market possess the necessary integrity, reputation and competence to do so. Alay Razvi, managing partner at Accord Juris, said, “Sebi uses these rules to decide who can register and continue operating in the securities market.”
Sebi introduced its ‘fit and proper’ criteria in 2004 through the Sebi (Criteria for Fit and Proper Person) Regulations, which were replaced by the Sebi (Intermediaries) Regulations in 2008. The criteria have since been amended several times, including significant changes in November 2021, when the regulator moved from judgment-based assessment to a system of automatic, trigger-based disqualifications.
Under the revised rules, an individual is deemed not ‘fit and proper’ if he is the subject of a charge sheet or accused of an economic offence by an investigating agency, among other ‘triggers’. The rule extends not just to the intermediary firm but also its directors, key managerial personnel, and major shareholders.
“If they fail to do so, the firm itself could be deemed not fit and proper, risking suspension or cancellation of its Sebi registration,” Razvi said. “Such an outcome could severely impact business continuity, client services and access to markets, potentially causing irreparable reputational and financial damage,” he added.
The outlier
Razvi also highlighted that Sebi’s stance made it an outlier among Indian financial regulators.
For instance, the Reserve Bank of India (RBI) requires the boards of banks and non-banking financial companies (NBFCs) to determine themselves whether their directors are ‘fit and proper’, using a case-by-case approach rather than automatic triggers.
The Insurance Regulatory and Development Authority of India (IRDAI) disqualifies individuals who have been convicted, but not those who have simply been charged with an offence.
Other experts said Sebi’s rule also appeared to diverge from international best practices. Smrithi Nair, partner at Juris Corp, a law firm, said that as a member of the International Organization of Securities Commissions (IOSCO), Sebi is expected to align its rules with global standards.
IOSCO’s best practices suggest that a person’s fitness should be questioned only if they have been found guilty, and not over a mere allegation, she added.
Legal experts called for replacing such ‘overly prescriptive’ rules with ‘principle-based’ ones. “In the garb of protecting investors, we may lose out on actual business due to a lack of participation in the Indian market,” Nair warned. “Such extreme steps, which are also contrary to global practices, will also lead to a not-so-evolved and inactive market,” Nair said.
