ORDER
G.N. Bajpai, Chairman
1.0 Background
1.1 Indian Finance Guaranty Ltd. (hereinafter referred to as the “said broker”) is a member of the National Stock Exchange of India Ltd. (hereinafter referred to as “NSE”) and a stock broker registered with Securities and Exchange Board of India (hereinafter referred to as “SEBI”) under certificate of registration No.INB230880637.
1.2 An inquiry conducted into the affairs of the Members Welfare Trust of Bhubaneshwar Stock Exchange, found inter alia that the Council of Management of BhSE at its meeting held on 07.08.96 had established a Trust called ‘Bhubaneshwar Stock Exchange Members Welfare Trust’ (MWT). A trust deed executed between BhSE and the trustees of MWT was registered on 23.09.96. As per the terms of the trust, every member of BhSE contributed a sum of Rs.3,000/- per annum to the corpus of the fund. One of the objectives of MWT was to sanction loans to members to tide over temporary financial difficulties on their part in payment of dues to the clearing house of the Exchange. It was observed that BhSE neither sought the permission of nor sent any intimation to SEBI regarding the formation of the said Trust.
2.0 Inquiry
2.0 SEBI, on 28.09.2001 ordered for a statutory inquiry under Section 6 of Securities Contract (Regulations) Act, 1956 into the allegations of financial irregularities in the MWT’s Funds by the Trustees of the MWT to the extent of Rs.1.30 crores.
2.1 The Inquiring Authority submitted his report on October 22, 2001, making the following findings :-
(a) It was observed that MWT had granted loans amounting to Rs.88,25,000/- between 07.06.99 and 13.01.00 to one Mr. Babulal Sharma, Vice President of BhSE and a trustee of MWT. Out of the said loan amount, Rs 25 lakhs was used by Shri Babulal Sharma to repay the outstanding dues of Shri Anjani Kumar Singh, a client of IFGL, on 7.6.1999. Further, a sum of Rs 15 lakhs was used by Shri Babulal Sharma to repay the dues of Shri Anjani Kumar Singh to IFGL on 29.9.1999.
Further, an examination of the bank statement in the name of Shri Babulal Sharma, Account No.1003, maintained with Canara Bank, Exchange Branch, Bhubaneshwar showed that a major portion of the loans sanctioned to him were used for making payments to IFGL.
(b) It was noted from the statement of accounts of MWT that an amount of Rs. 35 lakhs was credited by MWT to the account of one M/s Pradeep Investments on 7.6.1999 and on the same day an amount of Rs. 25 lakhs was transferred from the latter’s account to the account of IFGL. It was further observed that out of the sum of Rs. 22 lakhs credited to the account of M/s Pradeep Investments on 29.9.1999, an amount of Rs. 15 lakhs was transferred to the account of IFGL on the same day.
(c) The said broker was elected Vice President of BhSE in the Annual General Meeting of the members of the BhSE held on September 29, 2001 and that he permitted Shri Anjani Kumar Singh to transact business in NSE settlement Nos. 9920, 9922 and 9938. As mentioned above, loans sanctioned to Shri Babulal Sharma were used by him to settle the pay-in liability of Shri Anjani Kumar Singh, a client of IFGL (in which the said broker was a director).
(d) In view of the above, it was alleged that IFGL and the said broker among others were the actual beneficiaries of the loans sanctioned to various members by the Trust.
3.0 Inspection
3.1 Further, an inspection of the books of accounts and other records of the said broker was carried out during the period 3.9.2002 to 5.9.2002. In the course of inspection several irregularities were noticed and accordingly it was decided that an enquiry be initiated in the matter.
3.2 Based on the preliminary findings in the inquiry and inspection, vide order dated 29.10.2002, the said broker was prohibited from dealing in securities. Thereafter, a post decisional hearing was granted to them on 23.11.2002 and the order was confirmed vide order dated 16.1.2004.
4.0 Enquiry Proceedings
4.1 An enquiry officer was appointed vide order dated 7.7.2003 to enquire into the irregularities observed in the course of inspection and to make a recommendation in terms of Regulation 13 of the SEBI (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002 (hereinafter referred to as the “Enquiry Regulations”).
4.2 A show-cause notice dated 25.6.2004 was issued to the said broker under Regulation 6(1) of the Enquiry Regulations and the said broker filed a reply to the same on 12.7.2004. The enquiry officer after considering the inspection report the reply of the said broker and other papers came to the following findings:
(i) The said broker is not maintaining a record of time of placement of order by clients and thereby they have violated the directives of SEBI given vide Circular dated 11.2.1997.
(ii) The said broker had failed to maintain information relating to margin deposits in a book form but the same is not a grave violation.
(iii) There were 13 instances of lack of details in the member client agreement and client registration forms; however these deficiencies have been rectified by the said broker.
(iv) There were 5 instances of delay in making payment to clients; however since the clients themselves requested the said broker to retain the payments due to them to meet future margin requirements, it could be held that the clients had waived their right to receive the proceeds within 2 days.
(v) There were 4 instances of delay in transfer of securities from the pool account of the said broker to the client’s accounts and this constitutes a violation of Clause B (1) of the Code of Conduct of Stock Brokers mentioned in Schedule II to the SEBI (Stock broker and Sub broker) Regulations, 1992 (hereinafter referred to as broker regulations) and thereby of Regulation 7 of the broker Regulations.
(vi) It is alleged that the said broker has dealt with unregistered sub brokers, however the inspection report does not give details and hence the charge remain un-established.
(vii) The said broker has admitted to meeting their expenditure from client’s account for purposes other than those related to clients.
(viii) The said broker admitted that they have entered into trades outside the stock exchange trading mechanism but failed to report the same to the stock exchange. Further, they have also entered into cross deals outside the stock market mechanism and thereby violated the directives of SEBI vide Circular dated 14.9.99.
(ix) Although there was an allegation that the broker had failed to collect margins from clients, no details of the same were available in the inspection report and hence no charge is established.
(x) In respect of irregularities in the Bhubaneshwar Stock Exchange Members’ Welfare Trust (hereinafter referred to as “MWT”), the Enquiry officer observed that said broker was neither a trustee nor an office bearer of Bhubaneshwar Stock Exchange (hereinafter referred to as “BhSE”) at the relevant time when loans were sanctioned by MWT to Shri Babulal Sharma (the Vice President of BhSE and also a trustee of MWT). The broker was also neither the sanctioning nor the disbursing authority for loans from the Member’s Welfare Trust. As such, they had no control over the affairs of either BhSE or the MWT.
As per civil suit TMS 444/2001 filed by BhSE, Member Welfare Trust in the court of civil judge (Sr. Division) Bhubaneshwar, to recover Rs.1.30 crores from Babulal Sharma and Mr. Anjani Kumar Singh. Mr. Anjani Kumar Singh who was defendant No.2 in the said Suit had mortgaged his immovable properties as securities for the loans sanctioned to Mr. Babulal Sharma. Therefore, there appears to be bilateral financial transactions between Shri A K Singh and Shri Babulal Sharma because of which the latter appears to have issued cheques to the broker to clear the dues of the former and Shri A K Singh had mortgaged his immovable properties to secure the above loans. There are no reasonable grounds to believe that the broker knew about the arrangements between these parties. It may be reiterated that the said broker was neither a trustee nor office bearer of the stock exchange at the relevant time and also not a sanctioning authority for loans from the Member’s Welfare Trust.
Under the circumstances, it would not be just and fair to conclude that the broker is in any way associated with or beneficiary of the loans granted to Shri Babulal Sharma by MWT. As rightly contended by the broker he has no means to know whether the MWT had sanctioned the loans to Shri Babulal Sharma as alleged. It is also not the case that MWT has directly issued the cheque favouring IFGL. When the loan proceeds are credited to the account of the borrower and the borrower thereafter issues a cheque favouring IFGL there is no means for the broker to know that the cheque represents the underlying loan amount sanctioned by MWT.
(xi) From the inspection report, it is observed that although the report by the Executive Director stated that 16,200 shares of RIL were sold by IFGL on November 4, 1997 at Rs.367 per share, the books of account of the member shows that it had sold 17,650 shares of RIL on behalf of A.K. Financial & Co in the price range of Rs.355 – Rs.357 on the said date at NSE. Therefore, the claim that the shares were sold at Rs.367 per share is not borne out from the records. There does not appear to be privity of contract between the exchange and the member for the sale of these shares. That could be the reason why the exchange had not backed up its claim by furnishing the relevant contract note. On the other hand, it appears that the MWT of exchange used to give the shares which are lodged as security for the loans sanctioned to the members for sale when there is default on the loan repayment.
(xii) It is difficult to fathom as to why the exchange which is an institution providing platform for trading in securities for various brokers had simply delivered 16,200 shares on 5.11.97 for sale to the broker as claimed by it and still did not obtain contract notes and also did not raise a dispute with the broker for the alleged non payment till July 2002 for almost 5 years. There is no material to suggest that it had invoked the arbitration mechanism of NSE when it claims that it is yet to receive part payment for the alleged non receipt of sale proceeds from the member.
As already seen earlier, the SEBI inspection report also noted that neither MWT nor BhSE have any account with IFGL and the report also expressed its surprise as to how BhSE intended to sell these 16200 shares without giving the names of the members in whose account the shares were to be sold and the Exchange failed to furnish distinctive numbers of shares of RIL purported to have been delivered to the member for sale.
4.3 The enquiry officer has observed that the Hon’ble Securities Appellate Tribunal in Appeal Nos.76 to 78 of 2004 filed by the said broker directed that while imposing a penalty SEBI shall take into account the period of prohibition already undergone and also the penalties imposed on the co- delinquents of the appellants.
Based on the above findings, the enquiry officer recommended that the period of prohibition already undergone by the said broker since 29.10.2002 may be treated as a penalty for the violations mentioned in the enquiry report.
4.4 Show cause notice
Pursuant to the submission of the report by the enquiry officer, a show cause notice was issued to the said broker on 24.8.2004. The said broker submitted their reply to the notice vide letter dated 29.8.2004 and 30.8.2004. In their reply, the said broker made the following submissions:
(i) With regard to non maintenance of record of time of placement of order, the said broker reiterated their reply to the show cause notice and submitted that the non compliance, if any was technical in nature.
(ii) With regard to margin deposit book, the said broker submitted that the enquiry officer himself had not considered failure to maintain the information in a book form to be a gross violation.
(iii) With regard to irregularity / deficiencies in the member client agreement and client registrations forms, the said broker submitted that as observed by the enquiry officer, all deficiencies have been rectified.
(iv) With regard to delay in making payments, the said broker submitted that the enquiry officer has observed that there has been no default on their part.
(v) With regard to delay in securities, the said broker submitted that the delay was inadvertent and further there is no finding that they have misutilised any security belonging to clients.
(vi) With regard to dealing with un-registered sub brokers, the said broker has submitted that the enquiry officer has not found any wrong doing on their part.
(vii) With regard to non-segregation of own fund and client’s fund, the said broker submitted that payments were made out of client’s accounts inadvertently and the said error has not resulted in any misutilisation of client’s funds.
(viii) With regard to off the floor transactions, the said broker has submitted that the trades were done at the prevailing market prices and that contract notes were issued to both the buyer and the seller; further the trades were settled by delivery.
(ix) With regard to negotiated deals, the said broker has submitted that they have not entered into any negotiated deals. The instances stated in the enquiry report are not any deal or trade; rather they are outstanding quantities of deals made at the NSE by clients’ during a settlement which was carried forward to the next settlement through ALBM session.
(x) With regard to financial irregularities in the Members Welfare Trust of BhSE, the said broker has submitted that the enquiry officer has observed that they are not involved in any financial irregularities.
(xi) With regard to the sale of shares of Reliance Industries Ltd and non-payment of dues to The Stock Exchange, Mumbai, the said broker has submitted that the enquiry officer had observed that the allegation was not true.
(xii) With regard to the penalty recommended by the enquiry officer, the said broker submitted that the same is not based on the findings made by him in the enquiry report. The said broker further submitted that the enquiry report does not find them guilty of having committed any financial irregularity in respect of the affairs of the Members Welfare Trust or the sale of the shares of Reliance Industries Ltd. The SAT Order which was passed in respect of the appeal filed against the interim order of SEBI only directed SEBI to pass appropriate orders and there is no compulsion to impose a penalty on them. The irregularities observed by the enquiry officer are of minor or technical nature and do not warrant the penalty recommended by the enquiry officer.
(xiii) The said broker filed an appeal No.78/2004 against the order before the Hon’ble Securities appellate Tribunal (SAT). The Tribunal vide its order dated 30.6.2004 directed SEBI to conclude the enquiry proceedings within 2 months from date of receipt of the order.
4.5 Consideration of issues
I have considered the inquiry report into the affairs of MWT, inspection report, the report of the enquiry officer, the replies and submissions of the said broker, the order of the Hon’ble Securities Appellate Tribunal and other material on record. I find that the following issues arise for consideration:
(i) Whether the said broker can be held liable for the irregularities / deficiencies observed in the inspection report.
I find that in respect of the following violations, the said broker has admitted to committing the same but mentioned that the same was either due to inadvertence or that they have been rectified:
(a) The said broker did not maintain a record of time of placement of order by clients.
(b) The said broker had failed to maintain information relating to margin in a book form.
(c) The said broker has failed to obtain details relating to clients, however the same has been rectified.
(d) There were four instances where there was a delay on the part of the said broker in transferring securities from their pool account to client’s accounts.
(e) The said broker has utilised funds from client’s accounts for purposes other than those related to clients
(f) The said broker had failed to report off market transactions to the NSE.
In the light of the above, I find that the said broker has committed the above violations.
With regard to the charge of dealing with unregistered sub brokers, the enquiry officer has mentioned that no details have been furnished in the inspection report and therefore the charge remains not established. I agree with the finding of the enquiry officer.
With regard to delay in making payments to clients, the enquiry officer has stated that since there was a request on the part of the clients to retain their moneys with the said broker, he could not be held to have intentionally failed to make payments. I agree with the finding of the enquiry officer.
In respect of the allegation that the said broker was involved in the financial irregularities in the MWT, I note that it has not been established that the said broker had knowledge that the amounts paid to him by Babulal Sharma came from the loan extended by the MWT. Therefore, I give the benefit of doubt to the said broker.
In respect of the allegation that the said broker did not pay the full proceeds for the sale of shares of Reliance India Limited to BhSE, there is no privity of contract between the said broker and BhSE and there are no contract notes between the two parties. There is also no material on record to suggest that BhSE had invoked the arbitration mechanism of NSE to recover the amounts due to it from IFGL.
(ii) Whether in the light of the finding in (i) supra, the penalty recommended by the enquiry officer can be imposed on the said broker.
I note that the enquiry officer has recommended that no further penalty may be imposed on the said broker and that the period of suspension already undergone by the broker since 29.10.2002 may be treated as penalty.
I note that the circumstances prevailing at the time of passing the interim order dated 29.10.2002 had led to an apprehension that the said broker had been involved in grave irregularities and that it was necessary to prohibit them from associating with the securities market pending enquiry. The said order was passed in the light of preliminary findings regarding the involvement of the said broker in the irregularities in the MWT; the other irregularities were established by subsequent inspection. Moreover, the prohibition under Section 11 read with 11B of the SEBI Act cannot be treated as a penalty since the same was an interim direction passed in the interest of the securities market and since there was no suspension of certificate of registration and the attendant disabilities.
I note that the SAT in its order dated 30.6.2004 has directed that the prohibition undergone should also be taken into account while imposing any penalty. In the light of the findings above, keeping in mind the direction of SAT and the fact that the said broker has already undergone prohibition for close to two years, I find that no penalty needs to be imposed on the said broker.
5.0 Order
Therefore, I, in exercise of the powers conferred upon me in terms Section 4(3) of the SEBI Act and Regulation 13(4) of the enquiry regulations do hereby direct that the proceedings against Indian Finance Guaranty Limited under the enquiry regulations shall stand terminated. I also vacate the prohibition imposed on Indian Finance Guaranty Limited vide orders dated 29.10.2002 and 16.1.2004. However, I direct the said broker to be more careful and diligent in future.