JUDGMENT
G.N. Bajpai, Chairman
1. M/S Chona Financial Services Private Ltd. ( hereinafter referred to as CFSPL) is a member of National Stock Exchange registered with SEBI as a Stock Broker.
2. An investigation was conducted into alleged price manipulation in the scrip of M/S Maruti Organics Ltd. (Maruti). Investigations revealed that CFSPL dealt in the scrip of Maruti on behalf of his client Shri.Madhavan of Durga Investments. The trading position of the client was as under:-
Date Buy Sell Cumulative Net 19/06/96 3000 0 3000 20/06/96 3000 0 6000 21/06/96 3000 9000 0 24/06/96 10000 0 10000 25/06/96 0 10000 0 26/06/96 10000 0 10000 27/06/96 10000 0 20000 28/06/96 0 20000 0 03/07/96 10000 0 10000 04/07/96 20000 0 30000 3. The margin money balance for the client is as follows: Date Amount Mode of payment 17/06/96 40000/- Cash 28/06/96 26175 Profit from settlement no. 25 & 26.
4. Investigations brought out that the broker enrolled Shri Madhavan of Durga Investments as client, but at the time of enrolling, the broker did not enter into Member Constituent Agreement with Shri Madhavan and did not make any meaningful enquiries about the antecedents of his clients. It was observed that Shri Madhavan dealt with the broker as above and when the pay in time came Shri Madhavan absconded without paying for the purchase of 30000 shares of Maruti made by him. It appeared that a few brokers acting in concert were trying to defraud the National Clearing Corporation (NCCL). Settlement Guarantee Fund of NCCL guarantees settlement/payment for each trade entered at the Exchange. In view of this, in the event of failure of the buyer to pay, NCCL would have to pay the sellers. NSE, from its investigations, held that these transactions in MOL were collusive trades and ordered annulment of the same.
5. It was noticed that the broker was not careful while enrolling his client. The client built up a position of 20000 shares on June 27th and as against this the margin money available with the broker was only Rs. 40000. The position was reduced to nil by June 28th. However on July 3rd , 1996 fresh purchase position of 10000 shares was allowed to be built up which was increased by 20000 shares on the next day (July 4th). However no additional margin money was called for. The client eventually failed to pay for this purchase of 30000 shares and absconded.
6. It was prima facie felt that the broker allowed an unknown client to build up huge position in a volatile, illiquid scrip without taking sufficient margins and this position was beyond its financial capacity. The broker thus did not take enough precaution to prevent risk to the safety and integrity of the market. This unprofessional conduct caused risk to smooth settlement of trading at the Exchange. On these facts, for the prima facie violation of SEBI (Stock Broker & Sub-Broker) Regulations, 1992, enquiry proceedings were initiated against the broker.
7. A show cause notice communicating the findings of the investigation was issued by the Enquiry Officer asking the broker to show cause why action should not be initiated for violating Clause A (1 to 5) and B(4a) of Code of Conduct read with Schedule II in terms of Regulation 7 of SEBI (Stock Brokers and Sub-Brokers) Rules and Regulations, 1992.
8. The said show cause notice, was replied to by the broker vide its letter dated August 26, 2000. The broker in its reply has contended that they had never placed any order for the purchase or sale of shares of MOL in their own or their company’s name. They have also said that a ‘huge sum’ was paid by them to NSE to honour the commitment of purchases made by their client who had absconded. They have also contended that the amount of margin collected by them ‘would have been sufficient in a normal scenario devoid of cheating or crime and that they had also lodged an FIR with the police at Chennai against the fraud meted out to them.
9. The Enquiry Officer after taking into account all the relevant facts and submissions made by the broker, in accordance with Regulation 28(7) of the said Regulations, recommended that the Registration Certificate of the broker be suspended for a period of 7 days vide its report dated August 6, 2001, as broker was not diligent and careful while dealing with its clients.
10. Consequent upon this, a show cause notice as required under Regulation 29(1) of SEBI (Stock Broker and Sub Brokers) Rules and Regulations, 1992, enclosing a copy of the enquiry report was issued to the broker. The broker was called upon to show cause as to why action as recommended by the Enquiry Officer should not be taken against it.
11. The broker was also advised to submit their reply, if any, within 21 days of the receipt of the show cause failing which it will be presumed that it has no explanation to offer.
12. CFSPL replied to the show cause notice vide their letter dated September 18, 2001 contending that they had not violated any NSE and SEBI regulations and that ‘a serious fraud had been committed on them instead. They have stated that they had given blank forms to the client to fill and return which the client – with the intention to cheat, did not return. The broker further stated that they had not defaulted in the payment of margin money to the Exchange. They have requested for a lenient view to be taken because they contend that they themselves have been a victim of fraud. Personal hearing to the broker was granted on 05/07/02. However no one from the broker member turned up for the hearing.
13. On examination of material and evidence available on record, enquiry report, submissions made from time to time, I find that the broker was negligent and allowed the client to build positions in the scrip of Maruti which was illiquid and volatile without taking proper margins. The carelessness of the broker put the settlement system of the Exchange at risk. The broker did not verify the antecedents of their client, bank a/c or address etc. and also did not have any reference about its client. I also find that broker did not act in careful and diligent manner. The broker allowed the client to build up a fresh position after the earlier position had been squared up. I find that the conduct of the broker was unprofessional which facilitated the client to build up position in an illiquid and volatile scrip, which was beyond the financial capacity of its client. The client failed to meet its pay in obligation exposing the Exchange settlement system to risk. I tend to agree with the recommendation of the Enquiry Officer that the Registration Certificate of the broker be suspended for a period of 7 days.
14. In exercise of the powers conferred upon me by Sub-Section (3) of Section 4 of SEBI Act, 1992 read with sub-regulation (3) of Regulation 29 of SEBI (Stock Brokers and Sub-Brokers) Rules and Regulations 1992, I hereby direct that registration of M/S Chona Financial Services Pvt. Ltd. be suspended for a period of 7 days. The order shall come into effect from 14/08/2002.
