SEBI’s ‘fit and proper’ reboot towards course correction

The consultation paper signals a meaningful shift in the regulatory philosophy, recognising that strong regulation must also be fair

SEBI has recently unveiled a consultation paper proposing a significant overhaul of the “fit and proper person” framework governing market intermediaries, such as brokers, merchant bankers, and others, as well as persons associated with them. The consultation, open for public feedback until late February 2026, seeks to address long-standing concerns around regulatory uncertainty, procedural unfairness, and the unintended consequences of automatic disqualifications. If implemented meaningfully, the proposals could reshape how eligibility and integrity standards are applied in Indian capital markets.

There is clear internal recognition within SEBI that the existing fit and proper criteria—particularly the sudden adverse changes introduced in 2021 without adequate consultation—had become increasingly vulnerable to legal challenge. These changes generated sustained unease across the market, especially in the aftermath of litigation arising from the National Spot Exchange Ltd (NSEL) episode. Certain disqualification triggers, especially those linked merely to the filing of criminal complaints or charge sheets in economic offence cases, were difficult to justify on first principles. This formed the backdrop to the consultation paper now placed in the public domain.

The current regime requires the applicant, the intermediary and a wide universe of related persons—including directors, key management personnel, and persons in control—to satisfy standards of integrity, reputation, and financial soundness. While conceived as a safeguard for market integrity, the framework gradually acquired a punitive and mechanical character. In practice, it often functioned less as a considered test of suitability and more as an automatic trigger for exclusion, with little regard to proportionality or context.

Over the past five years, the framework has operated with a severity that can fairly be described as extremely disproportionate. The mere filing of an FIR, a charge sheet or a complaint—long before any judicial finding—was sufficient to invite disqualification. There was no explicit assurance of a prior hearing before declaring an entity or individual “not fit and proper”, even though such a declaration can cripple or extinguish a regulated business. Severe civil and economic consequences were thus imposed at a preliminary stage of the legal process, in tension with settled principles of natural justice and the presumption of innocence.

These infirmities became most visible in the NSEL brokers’ litigation. The affected entities approached the Bombay High Court, arguing that the framework inverted the presumption of innocence and imposed irreversible consequences without adjudication or meaningful opportunity of being heard.

During these proceedings, SEBI informed the High Court that it would review the relevant provisions and, it is understood, would not insist on enforcing disqualifications while the matter remained under judicial consideration. This stance reflected an implicit acknowledgement that the framework, as applied, risked regulatory overreach and lacked adequate procedural safeguards. It also underscored the need for regulatory action to remain aligned with broader principles of Indian jurisprudence when civil and economic consequences are involved.

Against this backdrop, the consultation paper represents a conscious and welcome course correction, and SEBI deserves all credit for it. The most consequential proposal is the removal of automatic disqualification arising solely from the filing of a criminal complaint, FIR or charge sheet. Under the draft framework, disqualification would arise only upon conviction or a final adverse finding by a competent authority. This restores alignment with the foundational principle that individuals and entities are innocent until proven otherwise.

Equally important is the explicit codification of the right to a hearing before any declaration of “not fit and proper”. The absence of such an express safeguard in the existing regulations was shocking, given the gravity of the consequences involved. By embedding procedural fairness into the regulatory text, SEBI acknowledges that suitability determinations cannot be reduced to mechanical rule application.

The consultation also removes several automatic and open-ended consequences that had caused prolonged uncertainty. Initiation of winding-up proceedings would no longer trigger disqualification unless an order is actually passed. The practically default five-year bar on fresh applications, even where no such period was specified, is proposed to be removed. Time limits for keeping applications in abeyance after issuance of show cause notices are proposed to be shortened, reducing periods of regulatory limbo.

On group entities and persons in control, the paper adopts a more proportionate approach. Disqualification of associated persons would affect an intermediary only where SEBI formally declares such persons not fit and proper. While disqualified key management personnel would need to be replaced within a defined timeframe, persons in control would not be forced into immediate divestment. Instead, restrictions on voting or control rights could be imposed. This approach addresses governance risks without causing unnecessary destruction of economic value.

An important, and often overlooked, dimension is the need for SEBI and stock exchanges to act in close and real-time alignment in regulatory matters like this. In the past, divergence in interpretation or timing between SEBI and exchanges has exacerbated the pain, with exchanges acting mechanically on regulatory triggers even as issues were under review. Exchange regulatory officials have too often behaved like clerical enforcers of outdated dogma rather than as thinking regulators, applying rules without context, judgement or accountability. This institutional inertia, bordering on regulatory indifference, has repeatedly blunted the impact of SEBI’s own course corrections.

Experience suggests that when SEBI’s regulatory thinking evolves, that evolution percolates to exchange-level regulatory officials excruciatingly slowly. The handling of illiquid options, “reversal trade” cases, provides a cautionary parallel. Around 2015, SEBI adopted an aggressive enforcement stance, treating such trades as manipulative by default. By around 2018, it became evident to SEBI that these cases did not result in investor harm or market distortion. By 2023, SEBI introduced extremely lenient consent schemes, seeking to close many cases that should never have been initiated. Yet, exchanges continued to levy harsh penalties in similar matters, often equivalent to 100 per cent of alleged profit or loss adjustments, applied mechanically and without application of mind. Such actions achieve no regulatory objective, undermine ease of doing business and amount to an abuse of the exchanges’ dominant position over brokers who depend on them for their licences. There is a real risk that well-intentioned reform at the SEBI level will remain illusory at the operational level unless this disconnect is urgently addressed.

Taken together, the proposals are widely viewed as pragmatic. They do not dilute SEBI’s authority or compromise investor protection. Instead, they replace blunt, automatic triggers with calibrated and defensible regulatory responses. This reduces litigation risk, improves regulatory credibility, and brings the framework closer to constitutional norms of fairness and proportionality. There remains, however, a legitimate debate on scope. Many stakeholders argue that fit and proper criteria should apply primarily to the intermediary and its ultimate beneficial owners, rather than extending deep into chains of ownership and indirect associations. Over-extension risks recreating uncertainty and compliance burdens without materially advancing market integrity.

The consultation paper signals a meaningful shift in regulatory philosophy. It recognises that strong regulation must also be fair regulation. After several years in which the framework was perceived as unforgiving and premature in its consequences, the proposed changes offer a long-awaited sigh of relief. SEBI would, however, do well to also introspect on the institutional decision-making that produced the earlier framework and to identify why recurrent episodes of regulatory overreach continue to necessitate painful and public course corrections.