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ORDER UNDER
SECTIONS 11 AND 11B OF THE SECURITIES AND EXCHANGE BOARD OF WTM/GA/101/ISD/11/06 1. As a part of
ongoing surveillance activity by SEBI into the various aspects of working of
securities market, SEBI had initiated probe and advised BSE and NSE to look
into the dealings in the shares issued through Initial Public Offerings (IPOs)
before the shares are listed on the stock exchanges. For the purpose of the
examination, the off-market transactions data as obtained from the depositories
were provided by SEBI to the stock exchanges. In October 2005, the stock
exchanges submitted their preliminary observations on the IPO of Yes Bank Ltd.
(YBL) which hinted at the possibility of large scale off-market transactions
immediately following the date of allotment and prior to the listing of shares on
the stock exchanges. SEBI therefore carried out a preliminary scrutiny by
calling for data from the depositories and the Registrars to the Issue (RTIs). It was found that a large number of multiple
dematerialized accounts with common addresses were opened by a few entities. On
noticing the irregularities, SEBI acted against the entities who
were responsible for the irregularities by passing interim order restraining
them from participating in all future IPOs and also directing the depositories
to effectively freeze their dematerialized accounts. Thereafter, SEBI examined
the irregularities in the IPO of IDFC wherein the very same players were
suspected to have played a major role in cornering the shares. Pursuant to the
preliminary scrutiny, SEBI issued ad interim order in the case of IDFC on the
same lines as in the case of Yes Bank. 2. In the course
of investigations pursuant to interim orders in the cases of Yes Bank and IDFC,
SEBI had noticed that some of these multiple accounts were opened in June 2003.
The involvement of these accounts in Initial Public Offerings prior to that of
Yes Bank and IDFC were accordingly looked into. 3. Modus Operandi SEBI regulations prescribe a quota for small investors wishing to invest
in the market. A small investor is defined as one who applies for shares worth Rs. 100,000 or less (Rs. 50,000
previously). Typically, the over-subscription in the retail segment of an IPO
is substantially less than the over- subscription in the non-retail segment for
sought after IPOs. Consequent to the preliminary
scrutiny, SEBI found that certain entities had cornered IPO shares reserved for
retail applicants by making applications in the retail category through the
medium of thousands of fictitious / benami applicants,
with each application being for small value so as to be eligible for allotment
under the retail category. Subsequent to the receipt of IPO allotment these
fictitious / benami allottees
had transferred shares to their principals who in turn transferred the shares
to the financiers, directly or through a web of transactions, that had
originally made available the funds for executing the game-plan. The financiers
in turn sold most of these shares on the first day of listing thereby realising the windfall gain of the price difference between
IPO allotment price and the listing price.
4. Since some of
the dematerialized accounts that had been used for
cornering the IPO shares had been opened during the year 2003, SEBI broadened
its investigations to all IPOs between 2003-2005.
Based on the findings of investigation, vide interim order dated April 27,
2006, SEBI, inter alia, directed 24 key operators and
82 financiers not to buy, sell or deal in the securities market including in
IPOs, directly or indirectly, till further directions. 5. Investigations
by SEBI into the irregularities relating to IPOs during 2003-2005 (including
Yes Bank and IDFC IPOs) have since been completed. After completion of investigations, SEBI has
initiated appropriate proceedings against the concerned entities including
initiation of adjudication proceedings against the key operators and the
financiers. The said adjudication proceedings are in progress. Prosecution
proceedings have been initiated against the entities which were found to be
involved, lending gravity to the market misdemeanor. 6. Need for the present interim order 7. This order may
be read as part of the SEBI interim order dated 8. The gains
made by the various market participants involved in the IPO irregularities as discussed
in detail in the interim order dated 9. Had each market participant played their respective roles diligently with a degree of real time sensitivity, the rampant cornering of IPO allotments, particularly on this scale would not have taken place. The failure of each intermediary in the hierarchy of intermediaries contributed cumulatively, (jointly and severally) to the market abuse. Definitely, in the scheme of hierarchy, greater responsibility is cast on depositories, to be attuned to the market developments on real time basis, since they are, by virtue of their proximity to the developments in the markets are expected to check the happenings and take appropriate action in real time by exercising supervisory authority. These obligations are not amorphous but arise by a statutory mandate from the Depositories Act, SEBI Act, regulations framed there-under and the depositories bye-laws. These, inter alia, impose obligations relating to external and internal monitoring, review and evaluation of systems and controls. In addition other regulations of SEBI prohibit contributing to an activity amounting to manipulation or fraud on the markets. 10. The nature
of the complicity of the depositories and depository participants is given in
more detail in the interim order of SEBI dated 11. Salient Findings relating to role of DPs The DPs had opened numerous demat accounts in the names of a few persons using various permutations and combinations. In certain instances, the DPs failed to obtain proof of identity and proof of address before opening demat accounts, which is a mandatory requirement as per SEBI circular dated August 24, 2004. In certain other cases, the DPs failed to ascertain the genuineness / existence of the BO account holder resulting in opening of BO accounts in fictitious names. Many of the DPs were found to have opened numerous demat accounts on a single day with all the account holders having the same address. In many of these cases, the addresses of the BO account holders were that of the sub-brokers of the DPs who procured demat clients for the DPs. The DPs failed to ascertain the genuineness of such demat clients and also did not obtain the proof of permanent address of such demat clients. Some of the DPs were found to have not only opened demat accounts in fictitious / benami names but had also provided IPO financing to such fictitious / benami account holders thereby facilitating the cornering of retail portion of IPOs. In the case of certain DPs who are also scheduled commercial banks, inspection of the Banks by RBI also revealed violation of KYC norms applicable for opening of bank accounts and violation of guidelines relating to the IPO financing schemes of the banks. 12. In the case of Karvy Stock Broking Ltd. (Karvy DP), it was found that Karvy had an arrangement with BhOB whereby Karvy opened demat accounts in the names of various persons purportedly introduced through its sub-brokers and Karvy also introduced these demat clients to BhOB for opening bank accounts and also availing IPO finance from BhOB. Upon verification, it was found that practically none of the demat account holders purportedly introduced through these sub-brokers (who are also key operators identified by SEBI in the IPO irregularities) existed in reality and that Karvy DP had opened thousands demat accounts on a few dates in the names of these fictitious persons and in all such instances the addresses of the fictitious persons were shown as the address of the sub-broker. Further, SEBI found that the bank introduction letters which had been allegedly accepted by Karvy DP towards proof of identity and proof of address for opening demat accounts were forged. Further verification led to the suspicion that Karvy DP itself might have forged these bank letters as an after thought to cover up their act of opening demat accounts in fictitious names without adhering to the KYC norms prescribed by SEBI. Various other companies belonging to the Karvy group including Karvy Consultants Ltd. (IPO Financier / NBFC) and Karvy Computershare P Ltd. (RTI) were found to have played their dubious role in the scheme of things crafted by Karvy DP. 13. Enquiry proceedings have been initiated by SEBI against the concerned DPs and the same are in progress except in the case of one DP viz. Jhaveri Securities P Ltd. (JSPL), where the enquiry proceedings have since been completed. Upon completion of enquiry proceedings, consequent to the finding of violation of KYC norms by JSPL, SEBI has directed the DP not to open fresh demat accounts for a period of nine months effective from April 27, 2006 when the above prohibition was originally imposed on the DP as an interim measure. 14. Salient findings relating to role of
depositories Depositories and Depository Participants share a principal – agent
relationship and therefore the depositories are liable for the acts of their
participants. More importantly, NSDL’s own
inspections in November 2004 and November 2005 of depository participants show upto 100% errors in accounts inspected. These errors are
repeated year after year and nominal penalties running into a few hundred
rupees were imposed. These ‘errors’ included entries such as ‘Account opened
without obtaining adequate proof of identity and/or proof of address and no
adequate proof of address collected for change of address’ which are of course
the foundation of the manipulative exercise. The NSDL bye-laws mandate
formation of a Disciplinary Action Committee which is to have disciplinary
powers over depository participants but which has never met. Also, no
corrective actions were taken despite there being consistent audit reports
showing problems with the inspection of depository participants. CDSL, has also severe problems with its inspections, its
inspections being of such poor quality that it tends to obscure the substantive
violations from its reports. These finding
are reflected in the order of SEBI dated 27 April 2006. where SEBI has examined
in detail the role of depositories focusing especially on whether there were
any contributory negligence / failure on
the part of the depositories in discharging their responsibilities of
overseeing the functioning of the DPs in accordance
with the rules, regulations and guidelines prescribed by SEBI and the bye-laws
of the depositories. The findings of the examination by SEBI are discussed in
detail at para 15 of the SEBI interim order dated
April 27, 2006 excerpts of para 16 (page 240) of the
interim order is quoted below: “Procedure followed by NSDL with respect to inspection of DPs … 16.94 For the
purpose of the examination, SEBI obtained from NSDL and CDSL all the inspection
reports pertaining to seven DPs viz. Karvy Stock Broking, HDFC Bank, Pratik
Stock Vision Pvt. Ltd, IL& FS, Centurion Bank, Wellworth
Share & Stock Broking and Dindayal Biyani Stock Brokers Ltd. These DPs
were shortlisted on the basis of the occurrence of
large number of multiple accounts with same addresses with these DPs found during the course of verifications done by CDSL.
The follow up action regarding action taken by disciplinary committee and
penalties were also obtained from the depositaries. Information was also called
for regarding waiver of penalties if any. The operation Inspection reports and
the observation in sign-off reports were analysed to
find out the nature of inspection and the effectiveness of them in serving the
purpose it was actually intended for. ·
It was observed that the sample used for
observations are pathetically low, always less than 1% and mostly less than
0.1% in these inspections. Further it is interesting to note that though the
numbers of accounts have increased (doubled) during the year, the sample size
remained the same. ·
It is also observed that in case of new accounts
opened, the errors are quite high i.e. about 50% of the accounts inspected have
errors. In some case it is 100 % i.e. all the accounts inspected have errors.
The range of the errors is also very wide from 6% to 100 %. It further shows
that the reliability of these inspections is very low over a period of time. In
some inspections, the numbers of errors found are large, while in the next one
it drops drastically. The time allowed for these inspections also casts doubts
on the reliability of these inspections. ·
Further it is also observed that the table
format which shows the errors and their number do not correspond with the
actual errors and their number found in the annexure which details the number
of the account and the deficiency found. As a result some instances are found
where the accounts involved in errors are more than 100%. This has happened
because the report shows fewer errors. For example in case of Karvy Hyderabad inspection of November 2005, it was found
that the table shows 22 errors in total, but the annexure shows 26 accounts
which have account opening errors. This is not possible because one account
should have at least one error. Hence there are errors in the inspection report
itself. ·
There is recurrence of same errors in account
opening repeatedly in inspection after inspection. NSDL has commented on these
in their reports. The DPs sent confirmation letter
stating that they had rectified all deficiencies. In the next inspection, the
same error recurred, and the cycle goes on. Penalty is hardly levied for these
deficiencies, while penalties are levied for employees of DPs
not having NCFM certification. The DPs are aware that
account opening errors are not seriously taken by NSDL and hence do not take steps to prevent
these errors from recurring. This seems to have been a regular practice over
the years which have made non-compliance while account opening a regular
feature. The depositary turns a blind eye to these deficiencies which has led
to its recurrence again and again. 16.95 It was found that NSDL waives penalties
if the DP concerned rectifies the deficiencies. The observations reported by DP
as complied with in its first reply after conclusion of inspection do not
attract any penalty in any case. Thus
NSDL does not impose penalties for violations rectified immediately after
inspection, does not impose penalties harsher than monetary penalties for the
remaining violations and also waives the penalties imposed if the DP reports
rectification of deficiencies. This system creates no dis-incentive
or deterrent for a DP to comply till NSDL inspects and finds the violation,
since rectification after inspection assures that no penalty of any kind is
imposed on DP. … 16.98. Procedure followed by CDSL with respect to
inspection of DPs 16.99. Inspection
reports for the seven Depository Participants were also called for from CDSL.
On perusal of inspection report it was found that CDSL gets its inspection
conducted by outside professionals. The inspection reports are not indicative
at all. From the inspection report it is very difficult to draw a conclusion as
it is in ‘Yes’ and ‘No’ format. 16.100.
The inspection reports of CDSL are of poor quality and no effort is taken by
CDSL to work on the format of the inspection report. However, the special
inspection conducted by CDSL which too has been conducted by outside
professionals has covered all the points in detail unlike its earlier ‘Yes’ and
‘No’ format. 16.101. System Audit of NSDL 16.102. SEBI investigations
in the IPOs of Yes Bank revealed significant irregularities in opening of demat accounts by Karvy-DP in
NSDL. These findings raised concerns as to the systems and processes in place
at NSDL for monitoring and preventing irregularities relating to opening of and
operations in demat accounts. Hence, SEBI engaged a
firm, namely iSec Services (P) Ltd. to conduct system
audit of NSDL. The salient findings of the system audit report are narrated in
the succeeding paragraphs. Account opening-Karvy Stock Broking Ltd as a DP a. Agents of Karvy
opened most depository accounts having same addresses. These agents had no legal sanction. In fact
SEBI (D&P) regulations as well as the agreement, which NSDL signs with DPs (Depository Participant), prohibits such work without
prior permission. b. This was never checked or
reported either by the internal auditors (Haribhakti
& Co) of Karvy or by external inspection teams of
NSDL. c. These agents had ready-made
stamps of addresses, which were affixed on the application forms. This too has
never been reflected either in the internal audit reports or the Inspections by
NSDL d. These agents after collecting
the papers had local data entry operators enter the data on a magnetic media.
This activity went unnoticed all along. In fact the entire process of
verification of addresses and identity was bypassed by this operation. e. This data was given to the
front office of local Karvy offices in f. Local offices then sent the CD
containing the data to Karvy in g. Karvy Hyderabad, uploaded this data for account opening
with NSDL. h. NSDL’s
DM application never checks the data uploaded by DP. i. Due
to slack internal controls and supervision these accounts came to exist. Once
the accounts got opened they were ready to be used for any subsequent IPOs j. The system audit report made
significant observations detailing the modus operandi and also possible
complicity of entities involved in the process of IPO allocations i.e. NSDL and
Karvy Contributory Negligence of NSDL k. NSDL never could capture the
fact that there were agents being used for opening of demat
account by Karvy DP. This is in spite of the six
monthly inspections conducted by NSDL at various locations of Karvy. This leads to
the impression that Inspections were perfunctory besides facilitating
fictitious / benami / multiple accounts l. If the DP work related to
account opening is not being monitored by NSDL, then this raises a question
regarding the purpose of the activity of Inspection or ‘visits’ by depository.
In fact the inspection forms include sub sections for checking account opening.
m. NSDL never physically verifies
the DP prior to recommending the registration of DP with SEBI. This is quite
serious as it may get a DP recommended without complete knowledge of where it
exists. n. Integrity of Account creation
dates, which are essential for maintaining integrity of any financial systems,
has not been maintained in NSDL systems. All account creation dates prior to o. NSDL has never had the
application code verified by any third party. While maker and checker is an
established process in financial industry, this has not been followed till date
by NSDL in its own systems as the DM software never verifies any data except for
the fact that it came from a valid DP id. p. Physical verification has
revealed that on the mainframe that hosts the DM and database there is no
evident control on creation of users and groups. q. There is no evidence of
monitoring any of the access logs on the mainframe. r. There is no documentation to
disclose the management intent to monitor or audit the logs created on
mainframe. s. NSDL till date has made no
byelaws for any internal monitoring review and control of its processes as
required under Section 26 (p) of Depositories Act, 1996 as well as section 34
of SEBI (Depositories and Participants) regulations, 1996. Auditors have
pointed this out for IS (Information System) audit at different times but have
never been implemented. t. NSDLs
internal auditors (Aneja & Associates) have been
appointed since 1998 and do not have any agreement signed between NSDL and the
auditors. The reports are at best perfunctory and some times do not maintain
temporal integrity. u. Besides email from prospective
participant in Form A and Form B, NSDL as per its process does not have any
independent proof of the place where the DP is going to keep the software
supplied by NSDL v. Inclusion of the field for
correspondence address in the depository system was a major
step in helping the financiers achieve their collateral purposes. NSDL
additionally introduced correspondence address (viz,
the address of Financier) in the DP system, despite SEBI refusing to accede to
their request. Similarly CDSL went on its own to have correspondence address
(address of Financier) without due approval of SEBI and withdraw the same on 15. As a part of
their role of maintaining vigil over the DPs, the
depositories conduct periodic inspections of DPs.
SEBI investigations revealed that during the course of such inspections, the
depositories had found that the DPs had failed to
comply with the applicable provisions of the Regulations. Further, many of the
violations by the DPs were found to be repetitive in
nature and succeeding inspections of the DPs by the
depositories revealed continuing violations by the DPs.
Inspite of the above, the depositories levied only
token monetary penalties and did not impose stringent penalties to penalize
such repetitive wrong-doings by the DPs and to
prevent the recurrence of the same. It was found that even for serious
violations such as opening of dematerialized accounts without obtaining
adequate proof of identity and proof of address, the depositories had levied
only token monetary penalties which had no deterrent effect. It was also found
that inspite of repeated violations by DPs, NSDL
has not made any reference at all to its DAC. The DAC of the depository had not
met since inception. This is contrary to the bye-laws of the depositories. 16. While in the ordinary course of events such violations may amount only to negligence of the depositories, given the scale of the operations and its long duration over several years, it is not possible to believe that the artifice/scheme to manipulate merely escaped their attention. ‘Had they cared to know they would have known’ standard would be more appropriate if not that of an intentional violation. The depositories have thus aided and abetted or contributed to the violations themselves. 17. SEBI also looked into the aspect of contributory role by depositories. SEBI found that the depositories could not capture the fact that the DPs were using agents for procuring demat clients and for ensuring adherence to the applicable KYC norms. Also, the depositories did not physically verify the DP site before recommending registration of DP with SEBI. SEBI also found that the depositories had included a field for correspondence address in the depository system which facilitated the perpetrators in opening dematerialized accounts in fictitious/benami names indicating one common address as correspondence address of numerous dematerialized account holders. In the normal course, the DPs check the KYC documents and thereafter enter the relevant details in the depository system which generates a unique BO Id for each dematerialized account holder. During the course of system audit of depositories, it was found that the depositories had generated the BO Ids outside the depository system using the algorithm for generation of BO Ids and had distributed these BO Ids in bulk to the DPs who allotted the same to various demat clients without complying with the KYC norms prescribed by SEBI. 18. It is highly
probable that the market participants found involved in the illegalities relating
to IPOs, may divert their ill-gotten gains for some
other dubious purpose to the detriment of investors and securities market. There
is therefore an urgent need to disgorge the ill gotten gains made by the
perpetrators in the larger public interest and to ensure that the same is not hidden
or transferred. It may be appropriate to
mention that subsequent to the issue of ex-parte
ad-interim order dated April 27, 2006 by SEBI, seven financiers namely Saumil Bhavnagari, Gautam N Jhaveri, Rajan V Dapki, Hasmukh N Vora, Deep Stock
Broking Pvt. Ltd., Ashmi Financial Consultancy Pvt Ltd. and Umang R Shah and one
key operator namely Kamal P Jhaveri
had filed Special Civil Applications in the Hon’ble
High Court of Gujarat at Ahmedabad against the SEBI
order. 19. In the
Special Civil Application filed by Saumil Bhavnagari the Hon’ble
High Court vide order dated “13(b)
Pending admission and final hearing of this petition an ex-parte
ad interim injunction may be granted restraining the respondent (i.e. SEBI) himself or through its agent
from implementing the impugned order dated 27.4.2006 and annexed at Annexure
‘A’ insofar as it applied to the petitioner.” 20. In respect
of other petitioners no such ad-interim relief was granted by the Hon’ble High Court. 21. Subsequently,
after considering the oral and written submissions on behalf of the petitioners
and those made by SEBI, the Hon’ble High Court vide
order dated July 17, 2006 (the order was made available only on
the 28th September 2006) concluded “In
the result, in view of the aforesaid discussion, this court is of the opinion
that SEBI having deemed fit has passed the order, it has passed the order,
being expert on the subject. It is for the expert to decide
as to out of the available courses, which course is to be adopted. This court
will not only be slow but will not like to interfere in the discretion
exercised by an expert on the subject. In the result these petitions fail
and the same are summarily dismissed.”(emphasis in
original) 22. It came to
the notice of SEBI that Saumil Bhavnagari,
taking advantage of the time gap between the grant of ad-interim relief dated
May 4, 2006 and the dismissal of his petition vide order dated July 17, 2006,
had sold off all saleable securities in his demat
account ID 10027303 held with the DP ASE
Capital Markets Ltd. This was pointed out to the Hon’ble
High Court which asked SEBI to file an application for restitution of the
amount. It is therefore important having regard to the exigencies
of the case that SEBI takes prompt action at this stage
itself so that other persons do not similarly attempt to
transfer their ill gotten gains. As this order is only against registered
intermediaries, it is expected that the intermediaries will take prompt
steps in their own interest to pursue other wrongdoers and perpetrators of the
illegal actions and attempt to collect sums from such
individuals/companies by way of contribution/indemnity. 23. The violations The findings of investigations so far, prima
facie, reveal violations of serious nature by the key operators, their
financiers, concerned DPs, and the depositories
including violation of Regulation 3 of SEBI (Prohibition of Fraudulent and
Unfair Trade Practices Relating to Securities Markets) Regulations, 2003,
Regulation 42 (2), 42 (3), 43, 46 and 52 of SEBI (Depositories and
Participants) Regulations, 1996 and clauses 3, 9, 12, 16, 19, 20 and 22 of Code
of Conduct specified in Regulation 20 (a) of SEBI (Depositories and
Participants) Regulations, 1996 and the provisions of Depositories Act, 1996.
However, this order is not an order imposing administrative sanctions or
penalties. 24. Investigations
in the matter have been concluded. Interim orders restraining the concerned
persons from dealing in securities market have been issued. Adjudication
proceedings are in progress against the concerned entities to ascertain the
nature and extent of guilt of the concerned persons and for levy of monetary
penalty. Criminal prosecution has also been initiated against several key
persons. While the dematerialized accounts of the concerned persons have been
frozen by the depositories thereby preventing the surreptitious disposal of
securities lying in their dematerialized accounts, the perpetrators of the
illegal cornering of shares aided and abetted by various market intermediaries
including depositories and depository participants continue to enjoy their
ill-gotten gains. 25. Powers under Section 11 read with 11B
of SEBI Act are broad and remedial It is for the regulator to adjust its remedies so as to grant the
necessary relief where investor rights are invaded in violation of the law. And
it is also well settled that where legal rights have been invaded, and a
statute provides for a general remedy as provided for in Section 11 read with
11 B of the SEBI Act, 1992 (“ the Act”), the regulator may use any available
remedy to make good the wrong done. Such remedial actions could include
rescinding a fraudulent sale, secure disgorgement or order restitution. Since
each of these remedies are remedial and equitable, it
is open for the regulator to order these in the interest of the investing
public and in the interest of a secure capital market. 26. The power to
enforce a remedy implies the power to make effective the right of recovery
afforded by the Act. And the power to make the right of recovery effectively
implies the power to utilize any of the procedures or actions normally
available to the regulator according to the exigencies of the particular case.
Such remedies, given the complexity of the securities market and the creative
mischief of the market participants, can never be exhaustively provided as a
list in the statute and are therefore granted in terms of the language of
Section 11 and 11 B of the Act. Accordingly, various courts have found the
provisions of Section 11 and 11 B to be used in a broad and remedial manner to
prevent the mischief sought to be avoided. 27. In Bank
of “One
has to view the powers of the respondent under the provisions of the Act in the
context of the objects sought to be achieved by the Act and the duty cast on
them in achieving the same. Section 11 and section 11B give enormous authority
to the respondent in this regard. As long as the power exercised under section
11B is subject to the provisions of the Act and well within the legal and
constitutional framework, intended to achieve the purposes of the Act and
subjecting the persons specified in the section, the power will sustain. Since
the exercise of power is subject to the provisions of the Act and the purposes
for which it can be exercised and the persons to whom it can reach has been
specified in the section, it can not be said that the power is unguided or
unlimited. It is a wholesome provision designed to achieve the objectives of
the Act.” 28. Power to Issue directions for
disgorgement of ill-gotten gains In the matter
of construction of enabling statutes, the principle applicable is that if the
Legislature enables something to be done, it gives power at the same time, by
necessary implication, to do everything which is indispensable for the purpose
of carrying out the purpose in view (see Craies on Statutes, 7th edn., p. 258). It has been
held that the power to make a law with respect to any subject carries with it
all the ancillary and incidental powers to make the law effective and workable
and to prevent evasion (see Sodhi Transport Co. v.
State of UP 1986 (1) SCR 939 at pp. 947-48 : AIR 1986 SC 1099) 29. In the case
of ITO v. Mohammed Kunhi AIR 1969 SC 430, it has been
observed as under: "....
It is a firmly established rule that an express grant of statutory power carried
with it by necessary implication the authority to use all reasonable means to
make such grant effective. *** Therefore, in our view, the express grant of statutory power conferred by section 11B carries the authority to use of reasonable means to make such power effective." 30. Disgorgement It
is well established worldwide that the power to disgorge is an equitable remedy
and is not a penal or even a quasi-penal action. Thus it differs from actions
like forfeiture and impounding of assets or money. Unlike damages, it is a
method of forcing a defendant to give up the amount by which he or she was
unjustly enriched. Disgorgement is intended not to impose on defendants any
demand not already imposed by law, but only to deprive them of the fruit of
their illegal behavior. It is designed
to undo what could have been prevented had the defendants not outdistanced the
investors in their unlawful project. In short, disgorgement merely discontinues
an illegal arrangement and restores the status
quo ante (See 1986 (160) ITR 969). Disgorgement is a useful equitable
remedy because it strips the perpetrator of the fruits of his unlawful activity
and returns him to the position he was in before he broke the law. The order of
disgorgement would not prejudice the right of the regulator to take such
further administrative, civil and criminal action as the facts of the case may
warrant. 31. Criteria adopted: During the course of investigation into the IPOs
during 2003-2005, the following criteria were adopted for determining the
suspect benami/fictitious dematerialized
accounts and for identifying the key operators and the financiers involved. 32. Based on data furnished by the depositories of the
dematerialized account-holders that received off-market transfer from 500 or
more entities, it was found that there were 21 IPOs
(including Yes Bank and IDFC) in which 24 entities (key operators) had adopted
the said modus operandi for cornering the retail portion of the IPOs. Upon examination it t was found that these 24 key operators
had in turn transferred, in part or completely, the shares cornered by them to
82 entities (financiers). Investigations
revealed that the above key operators and their financiers had used 58,938
afferent accounts. 33. Calculation
of the amount of disgorgement The details of of Depositories and Depository
Participants with whom afferent demat accounts were
held are contained in the SEBI interim order dated April 27, 2006 and the
relevant portions are extracted below: “ 8.3. Based on the
data furnished by NSDL it is seen that the 37,240 afferent accounts were held
with 55 DPs. It is seen that out of the above 37,240
afferent accounts as many as 34,924 afferent accounts (representing about 94%
of the afferent accounts) were held with seven DPs
with each of these DPs having 500 or more afferent
accounts. Karvy DP alone had 29,309 afferent accounts
representing about 80% of the total afferent accounts in NSDL. The details are
as below: Table 8.3 – NSDL DPs of Afferent Accounts
8.4. The data
relating to the demat accounts that had acted as
conduits (herein referred to as ‘afferent accounts’) for the three master
account holders (key operators) was obtained from CDSL. It is seen that there
are 21,698 demat accounts that had acted as afferent
accounts for the three master account holders in CDSL and all these afferent demat accounts were held with Karvy
DP or Pratik DP. 20,399 afferent accounts
(representing about 95% of the afferent accounts in CDSL) were held with Karvy DP and 1299 accounts were held with Pratik DP. As per information furnished by CDSL it is seen
that out of the above 21,698 afferent accounts, as many as 21,612 accounts have
been closed. 8.5. …………. 8.6. In NSDL and
CDSL taken together, a total of 58,938 accounts had been used as afferent
accounts for cornering the retail portion of the IPO. Out of these 58,938
accounts 49,708 accounts representing about 84% of the total afferent accounts
were held with Karvy DP.” 34. The details are given in a tabular form below:
35. Based on information furnished by the depositories it
is seen that out of 37,240 afferent accounts in NSDL, as many as 31,818
dematerialized accounts have been closed. Similarly, in the case of CDSL, out
of 21,698 afferent accounts, as many as 21,612 accounts have been closed. 36. There were seven DPs of NSDL
with whom 500 or more afferent demat accounts were
held and these seven DPs had 94% of the total number
of afferent demat accounts in NSDL. The details are
tabulated at para 8.3 of the SEBI interim order as
reproduced above. In the case of CDSL all the afferent accounts were held with
two DPs only and the details are tabulated below:
37. The said 58,938 afferent accounts were used by 24 key
operators to corner IPO shares on a large scale in 21 IPOs. Accordingly, with a view to quantify the
details of IPOs cornered through each afferent account and the gain thus made
(from the difference between the market price on the first day of listing and
the issue price) using each of the afferent accounts, SEBI sought and obtained
the relevant details from NSDL and CDSL and the same is summarized below: 38. The gains that accrued to the key operators and
financiers were made by the opening of 58,938 demat
accounts in fictitious / benami names and receiving
allotments of shares in various IPOs in these 58,938 demat
accounts. Thus, the gains of the financiers and key operators were made through
the 58,938 demat accounts (afferent accounts). The
gains so made by the financiers and key operators was at the expense of genuine
retail investors who failed to get allotment or got allotment of fewer number
of shares because of the large number of applications made in the name of
fictitious / benami demat
account holders and therefore represents the loss caused to investors. To
arrive at the loss suffered by genuine retail investors, the following methodology
has been adopted: 39. The details of IPO allotments received by each of the
58,938 demat accounts were obtained from the
depositories viz. NSDL and CDSL. In respect of each of the 58,938 demat accounts for each of the 21 IPOs, the number of shares
received through IPO allotment was multiplied by the difference
between the closing price on NSE on the first day of listing of respective IPO
and the respective issue price thereby arriving at the gains that accrued to
the fictitious / benami demat
account holders. It is possible that the IPO shares that were cornered using demat accounts held in fictitious / benami
names might not have been sold on the first day of listing. This can be
restated with the following formula: Disgorgement amount =
No. of shares allotted to specified persons X (closing price on the date of listing – allotment price in IPO) 40. Using the above methodology the gains made through the
37,240 afferent demat accounts in NSDL works out to
Rs.93,01,88,402.00 (i.e. about Rs.93.02 crores) and
through the 21,698 afferent demat accounts in CDSL
works out to Rs.25,79,52,157.70 (i.e. about Rs.25.80 crores). Thus the total gains made through the 58,938
afferent demat accounts in NSDL and CDSL taken
together works out to Rs.118,81,40,559.70 (i.e. about
118.81 crores). 41. Further,
based on the number of afferent demat accounts held
with the DPs, adopting the methodology as detailed
above, SEBI worked out the notional gains made through the afferent accounts
held with each of the seven DPs of NSDL and two DPs of CDSL each of which had 500 or more afferent accounts
and the details are summarized below:
42. The market value
of the share on the date of listing has been taken as the relevant price as the
price on any date subsequent to such listing is likely to be influenced by
other developments unrelated to the perpetrators’ wrongful conduct. Any
consequence of a subsequent decision, be it either to
sell or to retain the stock is not causally related to the fraud. Therefore the
individual decision of each perpetrator whether or not to sell immediately upon
listing is not relevant in calculating disgorgement. Applying this principle, in
case of the IPOs which got listed at a price below its issue price, no
disgorgement is being sought even if the price went up subsequently and the perpetrator
held on to the shares, thereby profiting from the subsequent price rise. 43. Apportionment of liability
– joint and several liability Disgorgement
liabilities being imposed are joint and several and the present order shall
apply to all intermediaries registered with SEBI under S. 12 of the SEBI Act. There
is a statutory obligation which is imposed on all intermediaries who register
with SEBI, thus entailing a higher standard of care and obligation to comply
with the mandate of the Act and regulations. In fact such standards are the
conditions of registration with the regulator. An investor invests in the
market presuming the integrity and higher standard of care of registered intermediaries
and the obligations imposed by the regulations and the regulator. Every
investor has to go through a registered intermediary to invest in the market.
Any deviation from the norms and standards would put the entire system in
jeopardy. In the dynamics of market scenario, there are always a small section
of market participants who are on the look out to wangle an unfair gain through
processes at once ingenious and harmful. It is in this context only that SEBI
registered intermediaries have a special role to play in safeguarding the
system from possible abuses with a view to protecting the integrity of the
market as well as the investors. Responsibility is no doubt onerous but is
commensurate with the privileges and rights conferred upon them as a SEBI
registered intermediary. Therefore any egregious lapse on their part which are likely to predispose the system to abuse and possible
jeopardy is fraught with far more dire consequences than that of the non-intermediary
manipulators seeking to bend the system to their advantage. It is also a fact
that SEBI regulates the market through intermediaries as well. It is in that
scheme only, the present disgorgement order is
conceived and directed. 44. The order is being imposed on a joint and several
liability because the entire scheme/artifice was one large fraud where several
entities either deliberately closed their eyes when the wrongdoers perpetrated
their illegality or were actively involved in the transactions. This
necessarily implies that the exact apportionment of the liabilities between the
various parties can be decided by them inter se either by settlement or by
suits of indemnity/contribution between each other and from all persons
including financiers, master account holders, key operators and other violators.
It is not in the interest of the public that the regulator should spend its
time in deciding private disputes between various perpetrators of the IPO
fraud/cornering of shares. 45. Under the
circumstances, it is the duty of the regulator to provide such remedies as are
necessary to make effective the purpose of the SEBI Act 1992. Also based on the
exigencies of the situation, as demonstrated by the action of sale by one of
the wrong-doer in the Saumil Bhavnagri
case pending stay by the Hon’ble High Court, prompt
corrective action is warranted to prevent any further disposing of ill gotten
gains. As this order is only against registered intermediaries, it is
appropriate that the named intermediaries shall also take prompt action, in
their own interest, by seeking contribution from other wrong doers/manipulators
by such means as are available to them in law. Therefore, as a remedial
measure, to protect the interest of securities market and investors and to
prevent the perpetrators of the unlawful activity along with other market
participants who facilitated the same from enjoying the fruits of their ill
gotten gains and in exercise of the powers delegated to me by the SEBI Board in
terms of Sections 11 and 11B thereof and the provisions of the SEBI
(Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets)
Regulations, 2003, pending adjudication i.e. inquiry into the subject
transactions and passing of final order, I hereby issue the following
directions, by way of an interim order as follows: 46. Order of disgorgement I
order NSDL and the following DPs of NSDL namely, Karvy Stock Broking Ltd., HDFC Bank Ltd., Khandwala Integrated Financial Services Pvt. Ltd., IDBI
Bank Ltd., Jhaveri Securities Pvt. Ltd., ING Vysya Bank Ltd. and Pravin Ratilal Share & Stock Broking Ltd. to jointly and severally disgorge the amount
of Rs. 90,02,18,451.80 within a period of six months
from the date of the passing of this order. I also order CDSL and the following
DPs of CSDL namely Karvy
Stock Broking Ltd. and Pratik Stock Vision Pvt. Ltd. to
jointly and severally disgorge the amount of Rs.
25.80 crores within a period of six months from the
date of the passing of this order. The amount shall be paid in equal amounts by
the respective Depository and by the Depository Participants (in the proportion
of their actual involvement) viz. 50% in each class. All parties are at liberty
to seek contribution/indemnity from any party which they believe is liable to a
greater extent than quantified here as also from individuals and companies
which were involved in the IPO cornering/fraud but are not named, not being
intermediaries under S. 12 of the SEBI Act 1992. Parties are at liberty to use
the means of a civil suit or any other form of dispute resolution to address
the quantum of their liability from each other. The liability to pay is
quantified below in a chart. This amount will be paid and deposited in a
special account created for the purpose “SEBI A/c IPO disgorgement”.
47. There will
be no separate hearing granted to the parties, as the findings of this order will
be co-terminus with the findings of the enquiry. A final order on the
substantive area of wrong-doing will render a person liable under this order
and conversely, any final order exonerating the person will free the person
from any liability from this order.
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