Government of India Volume I: Analysis and Recommendations

FUNCTIONS AND POWERS OF THE REGULATOR
The Commission recommends that depending on the cause of the violation the regulator
must apply the following consequences in increasing order:
1. Issuing a private warning;
2. Issue a public notice;
3. Require a corrective action applicable to the violation;
4. Impose a monetary penalty;
5. Suspend the permission to carry out certain transactions;
6. Permanently revoke the permission to carry out regulated activities; and/or
7. Institute criminal proceedings in appropriate courts.
4.2.6. Imposition of monetary penalties
The Commission noted that the present system of specifying statutory limits on the amount
of penalties that can be imposed for any violation has a critical flaw – it does not
ensure that a violator pays a fine higher than the gain made through the violation. This
is because it is impossible to predict the benefit a violator will gain by committing an
offence. The maximum limit on penalties is sometimes lower than the benefit gained by
the violator through violation. This leads to a situation where even if the violator is caught
and required to pay the fine, he or she may still emerge monetarily better off.
The Commission notes that the level of penalties should be an effective deterrent to
future violations and signal all other regulated entities that the potential of gain from violation
will be outweighed by the penalty which will be applied in the case of detection
of the violation. This principle also acknowledges that all violators of any law are never
detected. Therefore, to act as a deterrence, the penalty should be a multiple of the illegitimate
gain from the violation. The amount of penalty should also be dependent on
whether the action was deliberately done or due to reckless behaviour or due to negligence
of the person.
The system of imposing financial penalties should be guided by the following principles:
1. The penalty system should require the violator to pay a multiple of the illegitimate gain made
from the violation;
2. Out of the penalty collected, the regulator should try to compensate any directly identifiable victims
of the violations;
3. Any surplus at this point should be deposited with the Consolidated Fund of India;
4. In the event that there are no direct victims, the regulator must transfer all the penalty (after deducting
administration costs) to the Consolidated Fund of India;
5. If there is no clearly identifiable illegal gain from the violation, the regulator must impose a
penalty that is a proportion of the income of the violator from financial activities; and
6. All systems of monetary penalties must be regulated by regulations that consider the magnitude
of the violations and the previous violations of the violator.
The doctrine of unjust enrichment allows the regulator to recover all the profit the
violator made from the violation. Unjust enrichment should be recovered, in addition to
the fine applied for violation of regulations. This should be recovered and then, if possible,
distributed amongst persons who were adversely affected on account of the violation.
Punitive damages create a deterrence for future violators who will know that in the
event that they are successfully prosecuted the penalty they will face will surely outweigh
the profits that they make. It requires the regulator to expressly impose fines which are
higher than the benefit gained out of the violation. This is usually carried out by providing
penalties as a multiple of the amount of gain by the violator. The Commission found
that this principle has already been provided in some Indian legislations and should be
extended to the financial sector as a whole.
Table 4.11 summarises the recommendations of the Commission for creating a legal
system governing penalties.
36 FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION