Order against American Century Investments.

 

1.      Vide order dated December 28, 2004, issued by Securities and Exchange Board of India (hereinafter referred to as ‘SEBI’), I was appointed as the Adjudicating Officer under Rule 3 of Securities and Exchange Board of India (Procedure for Holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995 to enquire into and to adjudge under Sec.15-I of Securities and Exchange Board of India Act, 1992 for the alleged violation of Reg. 15 (3) (a) of Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995 against American Century Investments a foreign institutional investor registered with SEBI under Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995. The address of American Century Investments is P.O. Box 410141, 4500 Main Street, Kansas City, MO 64141-0141, USA. For the sake of convenience, the said American Century Investments will be referred hereinafter in this order as ‘the noticee’.

 

2.       Initially vide order dated February 18, 2003, Shri K.R.C.V. Seshachalam, Deputy Legal Adviser, SEBI was appointed to conduct adjudication in the instant matter. Subsequently, vide order dated December 28, 2004, I was appointed as the Adjudicating Officer in place of the aforesaid Shri K.R.C.V. Seshachalam (hereinafter referred to as ‘the then Adjudicating Officer’). In terms of the said order dated December 28, 2004, I was directed to proceed to deal with the instant case from such stage which was reached on the date of my appointment as the Adjudicating Officer.

 

3.      Notice dated November 25, 2004 under Rule 4 (1) of Securities and Exchange Board of India (Procedure for Holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules 1995 was issued by the then Adjudicating Officer to the noticee. In the following in paragraphs bearing numbers 4 to 7, I summarized the contents of the said show cause notice:

 

4.      The noticee is a foreign institutional investor registered under Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995. Reg. 15 (3) (a) of the said regulations provides that a foreign institutional investor shall transact business only on the basis of taking and giving deliveries of securities bought and sold and shall not engage in short selling in securities.

 

5.      The noticee has the following entities as its sub accounts: (i) American Century - Twentieth Century Emerging Markets Fund (hereinafter referred to as ‘ACEMF’); (ii) American Century Strategic Allocation Aggressive Fund (hereinafter referred to as ‘ACAF’) and (iii) American Century Strategic Allocation Moderate Fund (hereinafter referred to as ‘AFMF’).

 

6.      SEBI received three letters dated November 8, 2002 from Hong Kong and Shanghai Banking Corporation Ltd., stating that it received contract notes from the counterparty namely Salomon Smith Barney India Pvt. Ltd. for sale trades executed by the above mentioned sub accounts of the noticee. The details of the sale trades executed by the said sub accounts  are as follows:

	ACEMF	ACAF	AFMF
Deal No.	200230564	200230563	200230562
Trade Date	November 7, 2002	November 7, 2002	November 7, 2002
Security	Ranbaxy DM	Ranbaxy DM	Ranbaxy DM
Quantity of Trade	43500 shares	11000 shares	14700 shares
Trade rate	INR 488.1664	INR 488.1664	INR 488.1664
Settlement amount	INR 21,235,238.40	INR 5,369,830.40	INR 7,176,046.08
Shares to be received	81,420	22,380	30,900

 

7.      The aforesaid trades were executed when the aforesaid sub accounts  did not hold sufficient shares of Ranbaxy  in their portfolio and thus the noticee indulged in ‘short selling’ which was in violation of Reg. 15 (3) (a) of Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995. Copies of the aforesaid letters dated November 8, 2002 were enclosed to the show cause notice.

 

8.      In view of the above, the then Adjudicating Officer communicated the noticee vide the aforesaid show cause notice that the noticee was liable to pay penalty under Sec. 15HB of Securities and Exchange Board of India Act, 1992 which interalia provides that “whoever fails to comply with any provision of this Act, the rules or the regulations made or directions issued by the Board thereunder for which no separate penalty has been provided, shall be liable to a penalty which may extend to one crore rupees”’ and called upon the noticee to show cause as to why an inquiry should not be held and penalty as prescribed under Sec. 15HB should not be imposed against the noticee. In terms of the said show cause notice, the noticee was required to issue its reply within 15 days of receipt of notice.

 

9.      The noticee vide its letter dated January 18, 2005 filed reply to the aforesaid show cause notice issued to the then Adjudicating Officer. The following is the summary of the submissions made by the noticee: (a) Noticee’s operations are governed by the highest standards of corporate governance and fiduciary responsibility. Such high standards are followed by it globally and in some of the most developed securities markets such as those in the United States of America, United Kingdom and Singapore. It seeks to ensure that at all times it complies with the regulatory requirements and securities laws of the relevant jurisdiction in which it operates. The noticee is operating in the Indian securities market for last 10 years. (b) on October 1, 2002 Ranbaxy Laboratories Limited (hereinafter referred to as ‘Ranbaxy’) declared a bonus issue of shares. The record date for such bonus issue was October 1, 2002. Pursuant to the bonus issue of shares ACEMF, ACAF, and AFMF were entitled to receive in aggregate 134700 equity shares of Ranbaxy; (c) as per the accounting control procedure followed by the noticee the pending receipt of 134700 equity shares of Ranbaxy, was to ‘block’ an equivalent number of equity shares to prevent any trading to take place on the basis of such shares which were yet to be received. The blocking and unblocking of shares was a manual process whereby, the noticee compares its accounting records with that of its global custodian of securities namely JP Morgan Chase Bank; (d) However, in the last week of 2002 due to an inadvertent data miscalculation arising from the manual process involved in the calculation of shares, the status of the 134700 equity shares of Ranbaxy was changed from ‘blocked’ (unavailable for sale) to ‘unblocked’ (available for sale); (e) as a consequence of the above miscalculation, on November 6, 2002, the portfolio manager of the noticee identified the 134700 equity shares of Ranbaxy as ‘unblocked’ and incorrectly believed that 134700 equity shares of Ranbaxy were available for sale ; (f) on November 7, 2002 the portfolio manager of the noticee initiated a sale order with respect to 69200 equity shares of Ranbaxy held by ACEMF, ACAF, and AFMF; (g) on November 8, 2002 the noticee’s custodian JP Morgan Chase Bank notified to the noticee that it oversold the available position; (h) on November 8, 2002, HSBC informed SEBI that the three sub-accounts viz., ACEMF, ACAF and AFMF of the noticee sold shares of Ranbaxy for which such account accounts did not hold sufficient number of shares in their portfolio; (i) immediately, after execution of trades the noticee on November 8, 2002 on behalf of ACEMF, ACAF, and AFMF informed SEBI about its inadvertent and unintentional trading error. In the said letter it was also submitted by the noticee that the noticee would try to rectify the problem prior to the settlement date i.e. November 12, 2002. The noticee also apologized to SEBI for the trading error; (j) as per the procedures of the stock exchange, on November 13, 2002, the 57100 equity shares of Ranbaxy were auctioned and the sub accounts viz., ACEMF, ACAF, and AFMF were to make a total payment of INR. 1,999,990.31 which included the differential price arising from the stock exchange auction process and related penalties which amounted to Rs. 59,526.75 imposed as per the stock exchange regulations ; (k) in November, 2002, the noticee made an application to RBI for such payments; (l) on November 14, 2002 the noticee received a letter from SEBI in respect of such short sale as to why action should not be initiated against it; (m) on November 26, 2002, the noticee forwarded a letter stating the facts and circumstances which inadvertently led to the erroneous trades. The noticee also informed SEBI that to control such incidents to occur, it opted certain measures such as additional controls for detection of miscalculations and strengthening the review process which requires accounting managers to verify all ‘unlocked’ shares which are available for sale prior to permitting a sale order to be placed; (n) neither the noticee nor the sub accounts accrued any gain as a result of the short sale. There has been no loss caused to the investors. On December 11, 2002, under the stock exchanges rules and regulations, the noticee paid an amount of INR.59526.75 as penalty to Salomon Smith Barney, for which it is awaiting necessary approval; (o) the violation was due to manual miscalculation in the trading system of the noticee wholly due to inadvertence on the part of the accounting personnel. In the last 10 years of its operations in India, this was the only such breach and furthermore as mentioned above it took immediate steps to augment its systems to prevent such breaches or errors in future and since November 2002 no such error has occurred.

 

10.  Apart from the above submissions, the noticee also submitted that it was held by the Hon’ble Bombay High Court in the matter of SEBI v. Cabot International Corporation, 2004  CLC 814 whilst ruling on SEBI’s power for imposing penalties under Securities and Exchange Board of India Act, 1992 that “though looking to the provisions of the statute, the delinquency of the defaulter may itself expose him to the penalty provision yet despite, that in the statute minimum penalty is prescribed, the authority may refuse to impose penalty for justifiable reasons like the default occurred due to bonafide belief that he was not liable to act in the manner prescribed by the statute or there was too technical or venial breach etc.” The noticee also submitted that the Hon’ble Securities Appellate Tribunal in the matter of Reliance Industries Ltd., v. SEBI (Appeal No.39/2002 dated August 31, 2004), ruled that if a breach was merely technical or unintentional it does not merit penal consequences and the role of the regulator is to rehabilitate and to bring to an end litigation, which may not cast a stigma, who otherwise admittedly have maintained a good track record and in the instant case, the breach by the noticee was mere technical without any ulterior motive or deliberate omission.

 

11.         I have considered the above reply of the noticee to the show cause notice and I noted as follows: The noticee submitted that the short sale took place due to an inadvertent data miscalculation which was carried out manually. On November 7, 2002, the portfolio manager of the notice initiated a sale order with respect to 69200 shares of Ranbaxy held by ACEMF, ACAF and AFMF and on the next day i.e., on November 8, 2002, the custodian of the noticee notified the noticee that there was an over sale. On November 8, 2002 Hong Kong and Shanghai Banking Corporation Ltd., informed SEBI with respect to the impugned sale transactions of the noticee and on the same day the noticee wrote to SEBI about the trading error and also that it was not the intention of the noticee to short sell. On November 13, 2002, 57100 equity shares of Ranbaxy were auctioned as per the procedures of the stock exchange and ACEMF, ACAF and AFMF were required to make a total payment of INR. 1,999,990.31 and the said amount includes a penalty of INR. 59,526.75 imposed by the stock exchange.  

 

12.         In the instant case, I have taken in to consideration all the submissions made by the noticee and in the absence of any reason or record to disbelieve or nullify the contentions of the noticee, I accept all of them. Even though there was a violation of Reg. 15 (3) (a) of Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995, there is nothing on record to prove that the consequences of the impugned transactions were undesirable. Generally, short selling constitutes selling of securities by a person without being in possession thereof, in expectation of or for causing fall in prices, with an intention to buy securities at a resultant lower price and thereby to make a profit. However, in the instant case, there is neither anything on record to show that the noticee sold the shares of Ranbaxy with an intention to buy securities at a lower price subsequently nor the noticee gained any profit out of the impugned transactions. Therefore, I consider the impugned transactions resulted in a venial violation. It is an undisputed fact that technically there was a violation of Reg. 15(3) (a) of Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995 and the same is liable for adjudication under Chapter VIA of Securities and Exchange Board of India Act, 1992. However, mere violation of law does not attract penalty. In Hindustan Steel Ltd., v. State of Orissa, AIR 1970 SC 253, the Hon’ble Supreme Court held that “An order imposing penalty for failure to carry out a statutory obligation is the result of a quasi criminal proceeding and penalty will not ordinarily be imposed unless the party obliged either acted deliberately in defiance of law or was guilty of conduct contumacious or dishonest or acted in conscious disregard of its obligation. Penalty will not also be imposed merely because it is lawful to do so. Whether penalty should be imposed for failure to perform a statutory obligation is a matter of discretion of the authority to be exercised judicially and on a consideration of all the relevant circumstances… Even if a minimum penalty is prescribed, the authority competent to impose the penalty will be justified in refusing to impose penalty, when there is a technical or venial breach of the provisions of the act or where the breach flows from a bonafide belief that the offender is not liable to act in the manner prescribed by the statute”. In the matter of Cabot International Capital Corporation v. Adjudicating Officer, SEBI, it was held by the Hon’ble Securities Appellate Tribunal that it is not that penalty is attracted per se violation and the Adjudicating Officer has to satisfy that the violation deserved punishment. I have also taken into consideration of the fact that the noticee was penalized by the stock exchange for the impugned transactions.

 

 

13.         In view of the above, I do not consider the instant case as fit for conducting any inquiry. Therefore, I am inclined to drop the proceedings against the noticee after considering the causes shown by the noticee in response to the notice dated November 25, 2004.

 

14.          In terms of Rule 6 of the SEBI (Procedure for holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995, copies of this order are sent to the noticee and also to SEBI.

 

Place: Mumbai                                      A. Chandra Sekhar Rao

Date: August 30, 2005                                 Adjudicating Officer