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ORDER UNDER RULE 5(1) OF THE SEBI (PROCEDURE FOR
HOLDING ENQUIRY AND IMPOSING PENALTY BY THE ADJUDICATING OFFICER) RULES, 1995
READ WITH SECTION 15HB OF THE SEBI ACT, 1992. AGAINST
INFRASTRUCTURE LEASING & FINANCIAL SERVICES LIMITED BACKGROUND: 1
M/s Infrastructure Leasing & Financial Services
Ltd.(for brevity’s sake, hereinafter referred to as ILFS) is registered with
the Securities and Exchange Board of India, 1992 (SEBI) as a depository
participant of the National Securities Depositories Services Limited with DP ID
IN-DP-NSDL-02-96 and the Central Depositories Services (India) Limited with DP
ID IN-DP-CDSL-52-2000. 2. An inspection of the books
of accounts, documents, records, infrastructure, systems and procedures of ILFS
was conducted by SEBI during September 2003 under the SEBI (Depositories and
Participants) Regulations, 1996 (hereinafter referred to as the
“Regulations") and during the said course, ILFS were inter alia found to
have allegedly violated Regulations 41 and 42(1) of the Regulations and also
the provisions of the SEBI Circular No.SMDRP/POLICY/CIR-36/2000 dated August 4,
2000. While communicating the findings of the inspection to ILFS vide letter
dated NOTICE/ REPLY/ PERSONAL HEARING: 3. Accordingly, I issued a
notice dated October 6, 2004 to ILFS to show cause as to why proceedings should
not be initiated against them in terms of Rule 4 of the SEBI (Procedure for
holding Enquiry and Imposing Penalty by the Adjudicating Officer) Rules, 1995
(Rules) and penalty should not be imposed upon them under Section 15HB of the
SEBI Act 1992 (hereinafter referred to as Act). ILFS were advised to make their
submissions, if any, along with supporting documents that they wished to rely
upon, within 14 days from the date of the receipt of the notice, and were also
advised to note that in case they failed to reply within the stipulated period,
it would be presumed that they had no adequate explanation to offer. ILFS vide
their letters dated 4.
Thereafter in terms of Rule 5(1) of the Rules, a
notice of hearing dated
CONSIDERATION OF ISSUES: 5. I have taken into consideration the facts
and circumstances of the case, the submissions advanced on behalf of ILFS and
the material available on record including the findings of the inspection
report. 6. The charges leveled against ILFS for
which the present proceedings have been initiated, the submissions, if any,
made by them in this regard and my findings on the same, are elaborated herein
below: - A. Violation of
Regulation 41 of the Regulations, ILFS were alleged
to have failed to enter into agreements with the beneficial owners before
acting as a participant on their behalf and in this context ILFS were alleged
of committing the following irregularities: i.
Failure to enter into an agreement with 4 clients ii.
Failure to obtain the necessary documentary proof
of identity of one of their client; K P Khandelwal i.e. the photograph of Shri
Khandelwal was not affixed on the application form. iii.
Failure to enter into an agreement with margin
trading clients.
7. While expressing my
findings on each charge, I will proceed in the following manner: I)
The charge of not entering into agreements with the
beneficial owners with regard to 5 clients will be clubbed with that of the
charge of not following the account opening procedure in case clients mentioned
herewith. II)
The charge of not entering into Depositories
Participants Beneficial Owner agreement with the margin trading clients will be
clubbed with the charge relating to the alleged violation of co-mingling of the
securities of different beneficial owners. I. Failure
to enter into an agreement with the beneficial owners (5 clients) 8. ILFS was found to have not
entered into an agreement with the following clients and obtain the necessary
documentary proof of identity and other documents before opening any
beneficiary account in case of the following clients : a) Prudent
Investments b) Babulal
Gupta c) N d) S K
Technirite. e) Incase of K
P Khandelwal, his photograph was not found to be affixed on the application
form. In view of
the above, ILFS was alleged to have violated Regulation 41 of the Regulations
read with SEBI Circular No. SMDRP/POLICY/CIR-36/2000 dated 9. In response to the said
charge, ILFS contended that the SEBI inspecting officials were informed that
the client agreements of these clients were with their branch offices since
these clients were not from Mumbai and that although they had offered to have
the said agreements faxed or couriered to Mumbai for inspection, they were
informed that it was not necessary to do so, and that SEBI would not require to
see the same if these agreements were with their branch offices. ILFS confirmed
that they followed the practice of preserving the original client agreement at
the branch dealing with that particular client and that Prudent Investments, N
S Hoon and S K Technirite were all Kolkata based clients and, therefore, their
client agreements were lying with their Kolkata branch office. It was contended that the client agreement of
Prudent Investments was in the name of its proprietor, i.e. Mr Rakesh
Balasaria. While Mr Babulal Gupta was
Jaipur based and, therefore, his client agreement was lying with their Jaipur
branch office. 10. ILFS also forwarded copies
of the following client agreements entered into with the aforesaid clients: a.
Client Agreement dated b.
Client Agreement dated c.
Client Agreement dated d.
Client Agreement dated 11. As regards the application
form of K P Khandelwal, ILFS denied that his photograph was not affixed and
contended that a copy of the application form with the photograph duly affixed
thereon was forwarded to SEBI vide their letter dated 12. I have considered the
submissions made by ILFS, at length and consider it relevant to refer to Regulation
41 of the Regulations which reads as under: Every participant shall enter into an agreement with a beneficial owner
before acting as a participant on his behalf, in a manner specified by the
depository in its bye-laws.” The
importance and prerequisites of opening of the account with any DP by any
investor/ BO was also brought out in the SEBI Circular No. SMDRP/POLICY/CIR-
36/2000 dated
13. DPs were also advised to complete the
verification procedure within 30 days and inform the depository about the same
and were further advised that the failure on the part of the account holder to
produce the original documents within specified period of 30 days should be
intimated to the depository. DPs were further cautioned vide the said circular
that failure to open accounts, without following the proper procedure or failure
to comply with the above instructions, would invite appropriate action from
SEBI including suspension/cancellation of the certificate of registration granted
to the DP as may be deemed necessary. 14. I have perused the coloured
xerox copies of the agreements entered into between the ILFS and the beneficial
owners submitted for my perusal and have noted that ILFS had indeed entered
into the required agreements with the clients mentioned earlier. However, ILFS
had failed to obtain the copies of proof of the identity of the said clients as
required under the aforesaid SEBI Circular, which is the most important
criteria for opening an account in the name of the beneficial owner apart from
entering into the agreement with the client. The applicant's signature and
photograph is also required to be authenticated by an existing account holder
or by the applicant's bank or after due verification made with the original of
the applicant's valid passport, voter ID, driving license or PAN card with
photograph; and further, the account opening form should be supported with
proof of address such as verified
copies of ration card / passport / voter ID / PAN card / driving
license / bank passbook. An authorized official of the depository participant,
under his signature is required to verify the original documents. In the present instances these requirements were
not complied with by ILFS. 15. ILFS has been primarily charged on the
ground of having failed to enter into an agreement with the 50 clients stated
earlier and follow the proper account opening procedure for the said clients. As brought out above, ILFS had entered into
the required agreement and had also forwarded copies of the agreements entered
into with the said clients as proof of the same. Even as regards the charge of the photograph
of Shri K P Khandelwal not being attached with the said client agreement form,
ILFS had forwarded the coloured copy of the said agreement along with the copy
of the photograph attached on the same negating the said charge. However, I
have noted that the said photograph was not signed by the client across the
photo as is the normal procedure. Further, ILFS have failed to exercise due
diligence in furnishing the proof of identity or the verified copies of ration
card / passport / voter ID / PAN card / driving license / bank passbook, as
required in the given circumstances. I
have examined their reply in the context of the said circular and found that no
explanation has been offered by them in this regard. 16. The very purpose of the Circular so referred
earlier is to ensure the identity of a particular client and avoid creation of
any benami accounts, which in turn may lead to false and deceptive transfer of
funds and securities etc. However, ILFS
failed to adhere to the provision of the said circular and hence, cognizance of
the same is called for. II. Co-mingling of securities of different beneficial
owners. 17. ILFS was also charged for violation
of Regulation 42(1) of the Regulations in terms of which they were charged of
opening only a single beneficiary account for all the “Clients availing margin
trading facility” (hereinafter referred to as the MTF clients) from the broker.
In terms of
the findings of inspection, the broker operations of ILFS group are run by ILFS
Investmart Ltd (hereinafter referred to as IIL) and in the said context, the
following accounts were found to have been maintained by IIL with ILFS:
18. In response to the said
charge, ILFS submitted that IIL was their client like any other normal client
and pointed out that the aforesaid allegations probably rose out of the
confusion about ILFS and their client company IIL. It was contended that IIL is
a completely separate and distinct company and as such a separate legal entity
and being their client was entitled to the same services/rights and was subject
to the same obligations/duties as any other client. In other words, having opened a DP account
with ILFS, IIL was entitled to give instructions as regards crediting and/or
debiting securities to their said beneficiary account, and ILFS were obligated
to strictly comply with such instructions. ILFS submitted that all the shares
in IIL’s depository account were transferred to/from the account pursuant to
instructions received by them in accordance with the rules, bye-laws and
regulations of the depository and applicable laws. On the said basis, it was contended that, in
view of such instructions, ILFS were obliged under law to transfer the shares
to/from IIL’s depository account and accordingly all debits/credits
instructions were correctly executed by them on receipt of such instructions. ILFS
thus denied that they had commingled and/or mixed each of the securities of the
beneficial owners with the securities of the beneficial owners. ILFS also
contended that necessary submissions in this regard were made by IIL (the
broker) to SEBI vide letter dated December 23, 2003 which was attached by ILFS as
Annexure A to their letter dated December 24, 2003. 19. ILFS further contended that
they were incorporated and promoted by Central Bank of 20. I have considered the
following issues brought out in the inspection report in co-relation with the
documents submitted by ILFS which are highlighted below: a) In terms of the findings of inspection, securities
of high value as detailed below belonging to Beneficiary Account No.10398490
meant for MTF clients were transferred to another Beneficiary Account
(40820310) of IIL maintained with HDFC Bank DP. On the said basis, it was
alleged that the securities belonging to the MTF clients were transferred to Beneficiary
Account No.40820310 without the knowledge or concurrence of the MTF clients and
ILFS as the DP had facilitated the said movement of shares. The details of the
transactions are as under:
b) In terms of the findings of inspection, it was
also found that the said shares were pledged by IIL with NSE to increase
exposure limit / margin requirements of IIL on various dates from
21.
I have considered these issues at length. The fact is that ILFS vide their letter dated
December 23, 2003 confirmed that the demat account no. 10398490 had not been
opened only for maintaining the MTF clients stocks, but that the said account
was a normal beneficiary account wherein the client securities were also maintained,
till the time the corresponding dues are paid by the said clients and that
these securities comprised of both the normal client securities as also MTF
client securities. The fact that the
DP and broking operations were under the same management and control was not specifically
denied. I have also noted that the
securities lying in the ILFS DP account no.10398490 (NSE CM Benf a/c) and
10581877 (BSE CM Benf a/c) included those of MTF clients, clients (other than
MTF clients) who have bought securities in the cash market and did not have
beneficiary account / failed to pay the dues to the broker and also the
securities related to a few proprietary trades of the broker (IIL) although the
same ought to have moved to the broker’s own proprietary account No. 10048372 opened
with ILFS. 22. It is common ground that ILFS
caters to a large clientele. ILFS had as
on the date of inspection; 85,585 beneficial owner accounts across the country,
of which 83,061 are individual accounts, 2434 corporate accounts and 90
clearing member accounts. There are also 12 depository participant modules of
ILFS across the country. 23. In this regard, I have
perused the findings of inspection relating to the details of the client codes,
client names, their ledger balances and the net amount in respect of MTF funded
by IIL clients and have also observed that the net amount funded by the broker
to all these MTF clients is around 4968.04 lakhs. 24. I have also perused one of
the copies of the agreement entered into between the beneficial owner and the
DP agreement and would like to highlight some clauses in the said agreement: Clauses 3, 4
and 5 of the said agreement read as under: 3. “ The
DP hereby undertakes that it shall maintain a separate account of its own
securities held in the dematerialized form with the depository and shall not co
mingle the same with the securities held in the dematerialized form on behalf
of the clients . 4. “the
DP undertakes that a transfer to and from the accounts of the client shall be
made on the basis of an order, instruction, direction or mandate duly authorized
by the client and that the DP shall maintain adequate audit trail of such
authorization. 5. “The
depository participant agrees that the client may give standing instructions
with regard to the crediting of securities in his account and the depository
participant shall act according to such instructions. 25. Furthermore,
in terms of SEBI Circular No.SMDRP/POLICY/CIR-36/2000 dated August 4, 2000 all
applicants (the beneficial owner) are required to carry original documents as
specified for verification by an authorized official of the depository
participant, under his signature. The beneficial owner is thus required to provide
all the necessary details as regards their background, proof of address,
verified copies of proof of the address etc. to the DP to enable the DP to open
an account for the applicant. Further, the investor also has to sign an
agreement with the DP in a depository prescribed standard format, which details
the rights and duties of investor and DP, copy of which is to be provided to the
investor along with a schedule of charges for their future reference. The DP is
then required to open the account in the system and give an account number
called beneficial owner ID (Beneficiary owner Identification number) which is
for the protection of investor. Amongst the
various clauses as highlighted in the said agreement, the securities of each of
the beneficial owners are required to be segregated and not be mixed up with
other beneficial owners and the DP is required to undertake to pledge or
transfer the securities to and from the beneficial owners account, only on
receipt of the instructions from the beneficial owner. 26. However, I have observed
that as per the MTF Report dated Regulation 42 (1) of the
Regulations reads as under: 42. (1) Separate accounts shall be opened by every
participant in the name of each of the beneficial owners and the securities of
each beneficial owner shall be segregated, and shall not be mixed up with the
securities of other beneficial owners or with the participant's own securities. Reference
in this regard may also be made to Regulation 42(2) & (3) of the
Regulations. (2) A participant shall register the transfer of securities to or from a beneficial
owners account, only on receipt of instructions from the beneficial owner and
thereafter confirm the same to the beneficial owner in a manner as specified by
the depository in its bye-laws. (3) Every entry in the beneficial owner’s account shall be supported by
electronic instructions or any other mode of instruction received from the beneficial
owner in accordance with the agreement with the beneficial owner. 27. Thus, the very essence of
Regulation 42 is to ensure segregation between each of the beneficial owners’
securities from the other beneficial owner / investor who has opened such an account
with the said DP. 28. However, the concept of co-mingling
of securities would come into operation only after the opening of beneficial
owner account and entering into a beneficial owner agreement with the DP i.e. if
the client does not open an account with the DP, then the issue of co-mingling
of securities would not arise. To exemplify the point, in case where different
clients open an account with the DP and enter into the required agreements with
the said DP, and the DP mixes the securities of these beneficial owners in a
single account after entering into the necessary formalities, the issue of
violation of Regulation 42 of the Regulations comes into operation. However, if
none of these investors have opened an account, the violation of Regulation 42 would
not arise. 29. There is however another
scenario where Regulation 42 would come into effect. In case a broker and his
clients have opened different accounts with the same DP and despite this fact,
the DP mixes the securities of different clients (beneficial owners) with that
of the same broker (may be, while acting in tandem with the broker) or there
are different brokers / between different clients etc., the same would give
rise to a clear cut violation of Regulation 42 of the Regulations. 30. I have also examined the contents of another
Circular SEBI/MRD/SE/SU/Cir-15/04 dated
“Maintenance of Records 1.8.1 The broker shall maintain separate client wise
accounts of the securities purchased on margin trading with depositories and
shall enable the client to observe the movement of securities from his account
(through internet). The broker shall also maintain a separate record of details
(including the sources) of funds used for the purpose of margin trading.” 31. Upon an analysis of the
facts of the case and the rationale behind the incorporation of Regulation 42
of the Regulations, it is apparent that Regulation 42 would come into operation
only after the client had opened an account with the DP who would then be
required in the manner specified therein. In the instant case, after examining
the record on file, I have not come across any material on record to suggest
that these MTF clients had opened an account with ILFS. In the absence of the
same, the question of the DP entering into an agreement would not arise in the
very first place. 32. Taken in that context, the reference
that ILFS as the DP did not segregate the securities of different MTF clients and
not co-mingle the securities of different beneficial owners would not sustain. 33. This finding is substantiated from the
following facts: IIL in their
letter dated December 23, 2003 had pointed out that the demat account no.10398490
was opened not only for the MTF client stocks but that the said account was a
normal beneficiary account wherein the client securities were maintained, till
the time the corresponding dues are paid by the clients. Thus, the securities
comprised of both the normal client securities and also MTF client securities. Implicit
in the contention of IIL is the tacit admission that the broker had in the
first place, not segregated the securities of the different clients. IIL also
accepted vide their letter dated 34. In the given circumstances,
the onus lies upon the broker (IIL) to have informed the DP (ILFS) of the list/nature
of the securities of all the MTF clients in the said account. However, it would
appear that not only did the broker fail to inform the said fact to the DP, but
they went a step ahead and included the securities of the normal clients as
well as the securities arising out of the proprietary trades in the same
account, which fact is apparent from the contents of their letter dated
December 23, 2003 to SEBI. 35. I have however noted from
the records that no action was initiated against the broker IIL for the said irregularities
i.e. non-segregation of securities of different clients (normal, MTF and
proprietary). 36. Since the broker was not changed on the
said count, it would stand to reason that ILFS (DP) should also therefore, not
be charged for non entering into an agreement with the MTF clients since the
MTF clients in the first instance did not open any account with the DP. The
issue of commingling of securities would not arise as the MTF clients had not
opened an account with the DP. 37. In effect given the peculiar facts of the
case under circumstances, there is prima facie no violation of the Regulation
41(1) and 42 of the Regulations at ILFS’s end as far as the MTF clients are
concerned. 38. However, the concern remains as to the securities
arising out of the proprietary trades of IIL lying in account no. 10398490. In
this regard, IIL vide their letter dated December 23, 20003 admitted that a few
shares arising out of the proprietary trades were lying in the said account
instead of their proprietary account No.10048372 and clarified that some
arbitrage deals were done by them whereby the said shares were transferred to
NSE towards pay in obligation and on squaring off the arbitrage positions,
these shares were transferred to A/c No.10398490. It was also stated that since
the arbitrage deals were frequent, the said shares were not transferred to
their designated proprietary demat account i.e. 10048372. Although, at this juncture, it could be stated
that DP ought to have exercised due skill, care and diligence while
transferring the securities belonging to IIL to another account, not meant for
IIL’s proprietary trades, given the fact that the DP is only required to
transfer securities to/from the beneficial owners account after the receipt of
necessary instructions from the beneficial owner (i.e. the broker), such an
inference cannot be drawn. It would also
be difficult under these circumstances to allege that the DP had facilitated
the transfer of securities arising out of the proprietary transactions to the
account not meant for proprietary trades i.e. 10398490. 39. However, as brought out earlier there has
been non adherence to the provisions of the SEBI circular
no.SMDRP/POLICY/CIR-36/2000 dated August 04, 2000 in terms of which the onus
was upon the DP to follow the proper account opening procedure for the 5
clients stated earlier. As brought out earlier, ILFS were suitably cautioned
vide the said circular that failure to open accounts without following the proper
procedure would invite appropriate action from SEBI including suspension,
cancellation of the certificate of registration as may be deemed
necessary. From the facts, brought out it
is apparent that ILFS have failed in this regard. Keeping in mind the rationale behind the
issuance of such a circular, it cannot be disputed that the account opening
procedure is nothing but a proper introductory device meant for ensuring due
precautions while dealing with the clients and instilling transparency and
avoiding discrepancies in deals between the clients and the brokers and thus
contributing to a healthy market.
However, as observed in the instant case, such precautions were not
exercised by ILFS which could have resulted in serious problems for the market which
ultimately have a bearing upon the interests of the investors. It is
thus clear that there has been a certain amount of failure on the part of ILFS to
carry out its functions required of that of a Depository Participant, resulting
in the violation of the provisions of the above mentioned circular. 40. Any deviation or evasion of the regulatory provisions
issued by the regulator in the interests of the investors or non adherence to
the same for any reasons whatsoever is bound to affect the interests of such
investors. Although such a loss cannot be specifically computed in monetary
terms, the fact remains that all regulatory provisions have a specific purpose
behind their enactment. The very purpose
of enacting any legislation is due adherence to the procedures laid down there
under to ensure the sound and smooth functioning of the capital market. If no
cognizance were to be taken of any breach of these provisions and no liability
fixed there upon, the entire purpose of incorporating the provisions in the
said enactments would become redundant. 41.
Accordingly, Parliament in its wisdom has also
provided for a penalty to be levied under Section 15 HB of the SEBI Act, 1992
for such an offence which reads as under : “Whoever
fails to comply with any provision of this Act, the rules or the regulations
made or directions issued by the Board there under for which no separate
penalty has been provided, shall be liable to a penalty which may extend to one
crore rupees.”
42. To determine the
quantum of penalty, I have considered the following factors as provided in the
section 15J of the Act, which also
find mention in Rule 5(2) of the SEBI (Procedure for holding enquiry and
imposing penalty by the Adjudicating Officer) Rules, 1995, i.e., the amount of disproportionate gain or
unfair advantage, wherever quantifiable, made as a result of the default; the
amount of loss caused to an investor or group of investors as a result of the
default and the repetitive nature of the default. 43. As
regards the disproportionate gain or unfair advantage there are no quantifiable
figures available on record with respect to the default of the company. There
are also no figures or data on record to quantify the amount of loss caused to
an investor or group of investors as a result of the default or whether the
said default is continuing
till date. 44.
However on a judicious exercise of the discretion conferred upon me,
considering the offence in its entirety, bearing in mind the factors enumerated
above as well as after taking into consideration the facts and circumstances of
the present case and after analyzing all the material available on record, I am
inclined to hold that although the penalty need not be imposed in terms of the
quantum specified in Section 15B of the Act, the imposition of a token penalty
is very much necessitated. PENALTY 45. In
view of the foregoing, on a judicious exercise of the discretion conferred upon
me, bearing in mind the facts and circumstances of this case as well as after analyzing
all the material available on record, in exercise of the powers conferred upon
me under Rule 5 of the SEBI (Procedure for Holding Enquiry and Imposing Penalty
by the Adjudicating Officer) Rules, 1995, in the interest of justice, equity
and good conscience, I think it appropriate to levy a penalty of Rs. 25,000/-
(Rupees Twenty Five Thousand Only) upon M/s Infrastructure Leasing &
Financial Services Ltd. 46. The penalty amount shall be paid within a period of 45 days from
the date of receipt of this order through a cross demand draft drawn in favour
of “SEBI- Penalties remittable to the Government of India” and payable at
Mumbai which may be sent to Shri Suresh Menon, General Manager, World Trade Centre,
29th Floor, Cuffe Parade, Mumbai 400005. PLACE:
MUMBAI G. BABITA RAYUDU
DATE:
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