SEBI and the “fit and proper” test: Analysing the suspension of Embassy REIT Manager’s CEO

The Securities and Exchange Board of India (SEBI) issued an interim order and show-cause notice dated November 4, 2024 (the Interim Order[1]) in the matter of Embassy Office Parks Management Services Private Limited (Embassy Office Parks), the manager of Embassy REIT. In the said order, SEBI directed Embassy Office Parks to suspend Mr. Aravind Maiya, its Chief Executive Officer (CEO), from acting in that capacity and to appoint an interim CEO immediately, in compliance with the ‘fit and proper person’ criteria, until further directions or until the National Financial Reporting Authority Order dated August 19, 2024 (NFRA Order) is stayed or set aside, whichever occurs first. This action follows the NFRA Order, which found Mr. Maiya guilty of professional misconduct and concluded that he does not meet the “fit and proper” criteria under Schedule II of the SEBI (Intermediaries) Regulations, 2008 (the “Intermediaries Regulations”).

The copy of the SEBI order dated November 04, 2024 is accessible here.

• The origin of this case lies in SEBI’s January 24, 2023 order against, against Coffee Day Enterprises Limited (CDEL) for violations of SEBI Regulations, including the diversion of funds to a related entity.
• An investigation revealed that CDEL’s statutory auditors, including Mr. Maiya, failed to report significant financial misstatements, facilitating the misconduct. Following these findings, NFRA conducted an independent review of CDEL’s statutory auditors, concluding that they had demonstrated gross negligence and poor professional judgment. Consequently, NFRA imposed a penalty of fifty lakhs and a ten-year debarment on Mr. Maiya.
• Embassy REIT, a SEBI-registered real estate investment trust, is managed by Embassy Office Parks under SEBI’s REIT Regulations. Pursuant to an agreement in September 2018, Embassy Office Parks was appointed as Manager to Embassy REIT. Mr. Maiya currently holds the position of CEO of the Embassy, effectively heading the Manager of the Embassy REIT.
• Since Mr. Maiya held a critical role as the CEO of Embassy Office Parks, SEBI assessed his eligibility under its “fit and proper” criteria, which requires intermediaries and their key management personnel to maintain high standards of competence, integrity, and financial soundness.
• Despite SEBI’s various communications which directed Embassy to ensure compliance with the “fit and proper” criteria and to assess the eligibility of Mr. Maiya, Embassy Office Parks maintained that the NFRA Order had no bearing on Mr. Maiya’s current position, as it was limited to actions during his prior auditing role and did not relate directly to his work for Embassy REIT.
• Additionally, it submitted Mr. Maiya had appealed the NFRA Order, and the matter is sub-judice, and any action taken during the appeal would be premature. Embassy Office Parks further emphasized Mr. Maiya’s significant contributions to Embassy REIT and maintained that taking action against him would be unreasonable, disproportionate, and detrimental to the interests of the REIT and its unitholders.

SEBI examined and considered the following issues:

• Whether ‘fit and proper’ requirement extends to Manager of a REIT?

SEBI examined whether the “fit and proper” criteria extend to the key management of entities like Embassy Office Parks, which acts as the manager of a REIT. Under Clause 3 of Schedule II of the Intermediaries Regulations, all principal officers, directors, and key personnel of intermediaries must meet the criteria. SEBI determined that these standards apply to REIT managers, ensuring that key figures in management uphold integrity, transparency, and accountability within the REIT structure.

It was also noted that regulation 4(2)(j) of the REIT Regulations mandates the Manager of a REIT to meet fit and proper person criteria, which extends to key management persons.

• Impact of NFRA’s order on ‘fit and proper’ requirement:

SEBI also assessed whether NFRA’s findings against Mr. Maiya for professional misconduct and negligence impacted his “fit and proper” status as CEO. Given that NFRA’s sanctions included debarment for professional misconduct within the financial sector, SEBI concluded that the NFRA Order’s findings on Mr. Maiya’s actions directly affected his eligibility to serve in a senior management role. SEBI underscored that the “fit and proper” criteria involve considerations of reputation, ethical behaviour, and integrity. The NFRA Order, which highlighted Mr. Maiya’s professional misconduct, was deemed a significant factor impacting his eligibility to serve as CEO of Embassy Office Parks.

SEBI underscored its duty to enforce fit and proper criteria to ensure good governance, risk management, and quality control in the securities market. The regulator highlighted the need to protect investors and maintain confidence in the regulatory ecosystem, especially for nascent sectors like REITs.

The ‘fit and proper’ criteria under the Intermediaries Regulations, 2008, as amended, are designed to ensure that intermediaries in the securities market maintain high standards of integrity, competence, and financial soundness. These criteria apply to various key individuals and entities associated with intermediaries, including Applicants/intermediaries, Principal officers, Directors, Managing partners, Compliance officers, Key management persons, Promoters and Persons holding controlling interest.[2]

• Key Aspects of SEBI’s ‘Fit and Proper’ Criteria
  • The ‘fit and proper’ criteria aim to uphold market integrity by ensuring that only individuals and entities with a clean track record and sound financial standing can operate as intermediaries. This is to prevent individuals with poor professional histories from taking up roles that could impact market stability or investor confidence.
  • Additionally, intermediaries are required to replace disqualified individuals within a specified period, underscoring SEBI’s commitment to compliance and investor protection.
• International Perspectives and a balanced approach to disqualification

The Interim Order discusses the approach taken by international regulators such as Monetary Authority of Singapore (MAS), Bank of Mauritius and Abu Dhabi Global Market (ADGM) where ethical behaviour, professional conduct, history of compliance with legal obligations and disciplinary action by regulatory bodies is taken into account ‘for evaluating fit and proper criteria’. It also discusses the IOSCO’s “Guide to Fit and Proper Assessment” which recommends that regulators assess factors like fiduciary breaches, deceitful business practices, or adverse civil or criminal proceedings as disqualification criteria.

A review of other Indian regulatory frameworks such as IRDAI, international frameworks across global jurisdictions, as well as IOSCO guidance, reveals a recurring principle: individuals who have faced adverse regulatory actions due to professional misconduct are typically deemed unqualified to participate in financial sector activities. Importantly, these fitness standards apply not only to applicants themselves but also to those who hold roles of authority and decision-making within these organizations. This suggests a broad regulatory expectation that all key individuals in management positions must satisfy stringent standards of professional conduct to maintain the sector’s integrity. The intent behind these fitness criteria is clear i.e. ensuring ethical leadership and regulatory compliance across all levels of governance, so that any organization’s key figures embody the high ethical and professional standards required to support a trustworthy and stable financial environment.

The ‘fit and proper’ criteria under the Intermediaries Regulations are crucial for maintaining market integrity and protecting investors. In the present case, the CEO of Embassy Office Parks, the first listed real estate investment trust was barred by NFRA for the maximum period due to severe lapses and gross negligence, which raised SEBI’s concerns about securities market fraud. SEBI’s intervention is necessary to uphold leadership accountability and enforce the ‘fit and proper person’ criteria, crucial for maintaining market confidence. This standard ensures only qualified individuals interact with the financial market, safeguarding public interest.

We hope you have found this information useful. For any queries/clarifications please write to us at insights@elp-in.com  or write to our authors:

KC Jacob, Counsel, Email – kcjacob@elp-in.com

Shourya Tanay, Senior Associate – Email – shouryatanay@elp-in.com

[1]https://www.sebi.gov.in/enforcement/orders/nov-2024/interim-order-in-the-matter-of-embassy-office-parks-management-services-private-limited_88223.html

[2] Securities and Exchange Board of India (Intermediaries) (Third Amendment) Regulations, 2021