SECURITIES AND EXCHANGE BOARD OF INDIA
ORDER UNDER REGULATION 13(4) OF SEBI (PROCEDURE FOR HOLDING ENQUIRY BY ENQUIRY OFFICER AND IMPOSING PENALTY REGULATIONS), 2002 AGAINST INDSEC SECURITIES AND FINANCE LTD., MEMBER, BSE & NSE.
WTM/GA/ 2 /ISD-1/5/05
1. Indsec Securities and Finance Ltd. (hereinafter referred to as “the broker”) is a member of The Stock Exchange, Mumbai (hereinafter referred to as “BSE”) and the National Stock Exchange (hereinafter referred to as “NSE”) and registered with the Securities and Exchange Board of India (hereinafter referred to as “SEBI”) as a stock broker under Section 12 of SEBI Act, 1992 with registration number INB 010633435 and INB230601039 respectively.
2. Vide Order dated 23rd July 2003, an Enquiry Officer was appointed to enquire into the alleged irregularities committed by the broker while transacting in the scrip of DSQ Industries Ltd. in March 2001 for two of its buying clients viz. Kensington Investments Ltd and Wakefield Holdings Ltd who are OCBs. The selling clients were Panther Fincap and Classic Credit Ltd. The Enquiry Officer issued a show cause notice dated November 28, 2003 and the SCN, inter-alia referred to the sequence of material events as excerpted hereinunder as giving rise to the gravamen of the charge namely “fraud” on the buying clients.
(a) On March 19, 2001, the two OCB clients of the broker viz. Kensington and Wakefield together placed a written buy order for the purchase of 9,90,000 shares of DSQ Industries Ltd. As on the said date, the two OCBs had a credit balance of Rs.33.68 crores with the broker on account of the sale of other shares during February 2001.
(b) The transaction was executed on March 26, 2001 at a price of Rs.340/- per share by way of off market transaction. The DSQ shares were sourced by the broker from Panther Fincap and Classic Credit.
(c) The earlier outstanding credit balance of Rs.33.68 crores payable by the broker to the OCBs was adjusted towards the purchase of the said shares.
(d) Both the OCBs cancelled the purchase order on March 27, 2001 vide instruction dated March 26, 2001 but the broker had not only credited the entire sale proceeds to the selling client but also returned the shares of DSQ Industries to them. It was, therefore, alleged that Panther Fincap had received the sale consideration as well as the shares of DSQ Industries and the payment to the tune of Rs.33.68 crores due to the two OCBs was not made.
(e) The aforesaid transaction amounted to fraud on the buying clients in terms of Regulation 3 and 6(a) of SEBI (FUTP) Regulations, 1995.
(f) The off market transaction was also not reported to the stock exchange in violation of SEBI Circular dated March 14, 1995.
3. After receiving the reply of the broker and conducting the enquiry in accordance with the provisions of SEBI (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002, the Enquiry Officer submitted his report dated September 24, 2004. The findings of the EO are as under :
(a) that on March 17, 2001, the two OCBs placed a buy order of 9.9 lakh shares of DSQ Industries and on the same day, the broker had sought approval from BSE for executing the transaction as “specific bargain” in terms of the bye-laws of the exchange since the shares were not listed in BSE.
(b) The shares were sourced from the seller on 17.3.01 subject to the approval of specific bargain by BSE.
(c) On 19.3.01, the buyers confirmed the orders in writing.
(d) On 26.3.01, the broker received the approval from BSE for the specific bargain and on the same date, the broker issued contract notes to the buyer and seller.
(e) On 27.3.01, the buyers cancelled the buy orders but the transaction was executed by the broker on 26.3.01 itself.
(f) The EO further found that on 17.3.01, the broker had 17,00,000 shares of DSQ belonging to Panther Fincap and Classic Credit. Between 17.3.01 (when the application for specific bargain was made) and 26.3.01 (when the contract notes were issued), the broker had returned 10,90,000 shares to the sellers although he was aware that he had to deliver 9,90,000 shares to the buyers.
(g) As on 26.3.01, the broker had only 6,10,000 shares belonging to the sellers with a deficit of 3,80,000 shares that had to be made good within 48 hours.
(h) The EO found that the broker had received the shares from the sellers towards the outstanding amount due to him and that he pledged the shares with Global Trust Bank and that these shares were not sourced specially towards the impugned transaction for the specific bargain contract. The EO therefore, rejected the claim of the broker that on 17.3.01, the shares were sourced from the sellers for the specific bargain contract.
(i) That subsequently the broker could not get the balance shares because of CBI action against Panther Fincap.
(j) The EO found that on March 30, 2001, the broker paid total consideration for the sale of 9.9 lakh shares to Panther Fincap although 3.8 lakh shares were not yet received from them. The said payment to the sellers was made by debiting the account of the two OCBs which as seen earlier had a credit balance of Rs.33.68 crores with the broker.
(k) That the broker had concealed the information from the two OCBs that the entire 9.9 lakh shares were not available with them and the balance 3.8 lakh shares will be sourced within 48 hours from the date of contract.
4. In view of the above, the EO had come to the conclusion that the broker had violated the provisions of Regulation 3 and 6 (a) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 1995 and Clause A(1) and (2) of the Code of Conduct for Stock Brokers specified in Schedule II read with Regulation 7 of SEBI(Stock Brokers and Sub-brokers) Regulations, 1992 and hence recommended a major penalty of suspension of certificate of registration of the broker for a period of 4 months.
5. A copy of the enquiry report was also sent to the broker vide notice dated 30.11.2004 advising him to show cause as to why the penalty as recommended by the enquiry officer should not be imposed.
6. M/s. Wadia Ghandy & Co., Advocates & Solicitors vide their letter dated 15.10.04 replied to the said show cause notice and also appeared on behalf of the broker in the personal hearing on January 19, 2005.
7. Shri P.N.Modi, Advocate, appearing for the broker had submitted that the two OCBs had placed a buy order for 9.9 lakh shares of DSQ Industries with the broker on 16.3.01 (and not on 17.3.01 as stated in the Enquiry Report) and confirmed the same in writing on 19.3.01. Since the shares were not listed on BSE, the broker had applied to the stock exchange for permission to execute the transaction as “specific bargain” contract in terms of the bye-laws of the exchange. The necessary permission in this regard was received from the exchange on 26.3.01 and on the same day the broker issued contract notes to both the parties. It was submitted that on 27.3.01, he received a fax communication from the OCBs canceling the purchase order by which time the contract was already executed on 26.3.01. It was submitted that on 26.3.01, when the contract notes were issued to the parties, the broker had simultaneously written to the seller to deliver the balance of 3.8 lakh shares and the seller also vide his letter of the same date had confirmed that the balance 3.8 lakh shares will be delivered within 48 hours as permitted under the exchange rules. As such it was contended that the finding of the Enquiry Officer that when the broker had applied for permission to execute special bargain contract from BSE on 17.3.01, he should have retained 9.9 lakh shares and only the balance shares should have been given to Panther Fincap is not correct. It was also argued that the broker’s obligation to deliver shares to the buyer is independent of the ability of the seller to give delivery of shares to the broker and in the event of the failure of seller, the broker had to procure the balance shares from the market and honour his obligation to the buyer.
8. It was submitted that although the broker had requested the seller to make available the balance of 3.8 lakh shares on the date of issuance of contract note, the seller could not fulfil his obligation in view of the CBI raid in his office on 30.3.01. It was argued that in a specific bargain contract, it is not necessary that the broker should hold all the shares at the time of issuance of contract note as the delivery can take place within 48 hours as per the bye-laws of the exchange.
9. It was submitted that the broker was always ready and willing to perform his part of the contract i.e. making available the balance of 3.8 lakh shares to the buyers irrespective of whether the seller is in a position to deliver the balance shares.
10. It was submitted that the parties have agreed to settle the issue by way of arbitration agreement dated 10.3.03 and that even before the arbitrator, who is a retired High Court Judge, the broker had insisted on the buyer to take full delivery of the shares. The arbitrator by his award dated 10.5.03 had held the contract to be valid and binding and that the OCBs’ accounts were rightly debited. The award also concluded that the OCBs are bound to take delivery of shares. Subsequently, at the request of the buying clients the award was modified on 10.7.03 for acceptance of Rs.9,90,000 in lieu of shares @ of Re 1/- per share.
11. The learned counsel vehemently denied that the broker had perpetrated any “fraud” on the buying clients or that there was any violation of SEBI (FUTP) Regulations as alleged. It was submitted, that the findings of the enquiry officer that the broker has violated Clause A (1) and (2) of the Code of Conduct specified in the SEBI (Stock brokers and sub-brokers) Regulations, 1992, is not correct, as not even an allegation was made to this effect in the show cause notice dated 28.11.03 issued by the Enquiry Officer.
It was submitted that where “fraud” is alleged against a party, all facts, with full particulars, must be set out in the Show Cause Notice so that the noticee can defend himself, as held in the following judgements.
(a) AIR 62 SC 630
(b) AIR 37 PRIVY COUNCIL 146
(c) AIR 67 SC 878
(d) AIR 63 SC 1279
(e) AIR 28 PRIVY COUNCIL 261
(f) AIR 77 SC 615
(g) SPECIAL COURT’S JUDGEMENT DATED 10TH JUNE, 2003 BY JUSTICE A.B.PALKAR IN MISCELLANEOUS PETITION 112 OF 2000 (OSWAL AGRO MILLS LIMITED VS. THE CUSTODIAN AND ORS.) ALONGWITH 31 OTHER PETITIONS.
It was further submitted that the party alleging “fraud” is bound to establish it by cogent and compelling evidence. Mere suspicion, conjecture, surmise etc. cannot be accepted as proof as held in AIR 1940 PRIVY COUNCIL 98.
The counsel submitted that “fraud” is a charge of a criminal or quasi criminal nature and must be established beyond a reasonable doubt as held in AIR 1941 PRIVY COUNCIL 93.
It was submitted that to hold a party guilty of “fraud”, the facts which are proved must be incompatible with any hypothesis of good faith, otherwise, the party cannot be held to be guilty as held in :
(a) AIR 40 PRIVY COUNCIL 98
(b) AIR 86 ORISSA 97
It was submitted that no plausible case of any fraud has been made out against the broker. Even the alleged victims of the alleged fraud (i.e. the OCBs) do not even claim that they were ever defrauded by Indsec, nor did they lodge any complaint with SEBI. The Arbitration Award of a Retired High Court Judge held totally in favour of the broker and has exonerated them of any wrong doings. The OCBs have in writing acknowledged that all disputes between them and the broker stand settled by the said Award. It is, therefore, submitted that the said Enquiry Report and the said Show Cause Notice dated 30th September, 2004 cannot be acted upon.
It was further submitted that justification for recommendation of major penalty was not made in the Enquiry Report.
Findings :
12. I have carefully examined the charges, the reply of the broker , the enquiry report, the comments of the broker on the enquiry report, the submissions made in the personal hearing and the material available and record my findings on each of the allegations hereinafter :
1. Two OCBs had placed a buy order on 16.3.01 for purchase of 9,90,000 shares of DSQ Industries Ltd. with the broker. As these shares were not listed on BSE, the broker had applied to the BSE for permission to execute the contract on “specific bargain” basis on the same day. The sellers were ‘Panther Fincap & Classic Credit Ltd’ who were also the clients of the broker. The buyers confirmed the order in writing on 19.3.01. Contract notes were issued on 26th March, 2001. However the buyers cancelled their orders on 27th March, 2001. The broker could not act on this instruction because the orders were already executed. The broker replied that they were at all times ready and willing to fulfil their entire part of obligations but the OCBs were not willing to accept the shares in their demat account as according to them they had cancelled the purchase order and hence had not given settlement instructions or reported the transactions to their bankers – Global Trust Bank . It is noted from the identical letters of the two OCBs dated January 26, 2004 wherein they had submitted that they had never reported the transactions to their Bankers viz. Global Trust Bank. Consequently, the question of giving any settlement instructions to them did not arise.
Regulation 26, 57 and 48 (1) of BSE’s Rules, Bye-Laws and Regulations provide as follows :
26. The Governing Board or the President may permit specific bargains to be made in the case of securities of public Companies or corporate bodies not admitted to dealings on the Exchange.
Specific Bargains
57. (a) Specific bargains may be entered into with the permission of the Governing Board or the President and applications for such permission shall be made in the form prescribed in the relative Regulation or in such other form as the Governing Board may from time to time prescribe in modification or substitution thereof.
Specific Bargains deemed to be for spot delivery
(b) All specific bargains entered into subject to these provisions shall be deemed to be for spot delivery.
Bargains
48. Save as otherwise provided bargains in securities may be of the following kinds :
(i) for “spot delivery”, i.e., for delivery and payment on the same day as the date of the contract or on the next day ;” …………..
2. On a perusal of the aforesaid bye-laws it can be seen that the specific bargains are similar to ‘spot delivery contracts’. In fact the Bye-law states that the specific bargains shall be deemed to be spot delivery contracts and spot delivery contracts as per Section 2h(i) of SCR Act, 1956 means a contract which provides for actual delivery of securities and the payment of price therefore either on the same day as the date of the contract or on the next day. The same is the position in respect of specific bargains as per bye-law 48 of BSE. From the above position, it is clear that a specific bargain is an off market transaction undertaken by the broker to facilitate his clients to deal in securities which are not listed on the stock exchange. As per the Bye law it is deemed to be a spot transaction. In the present case, it is admittedly a specific bargain and there is nothing on record to prove that the procedure to obtain permission from the exchange was not followed.
In a specific bargain, the broker stands as counter party to both legs of the transaction. Virtually, it can be said, there is a novation of contract. If any of the parties to the contract are aggrieved by the frustration thereof of contract, the remedies are available to them under appropriate civil law. The broker rightly exercised the remedy for opting for a private arbitration since the transaction could not be undertaken on the floor of the exchange.
3. The stock exchange had given permission to the broker to execute the aforesaid transaction as specific bargain on 26.3.01 and the contract notes were issued on the same day by the broker. It is not in dispute that, on the said date there was a shortage of 3.8 lakh shares and the argument of the learned counsel is that the broker need not have the total number of shares for delivery on the date of issuance of contract notes as the delivery has to take place latest by the next day ie 27.3.01, having regard to the definition of spot delivery contract under SCR Act, 1956 and also the provisions of specific bargain of BSE cited by the broker. However, on 27.3.01, both the OCBs cancelled the purchase order and did not give settlement instructions to their bankers – Global Trust Bank.
4. As regards, the transfer of 10,90,000 shares between 17.3.01 and 26.3.01, made by the broker to Panther Fincap, it was submitted that the broker had got these shares on pledge from Panther Fincap and Classic Credit towards their outstandings with the broker. According to the broker, the shares were pledged as security against the amount payable and as and when the payments were made, the shares were released to that extent. It was clarified that the shares were not pledged with GTB but were held in a DP a/c with GTB.
5. The balance 3.8 lakh shares could not be delivered by the seller in the meanwhile due to action against him by CBI. However, the broker was ready and willing to perform his part of the obligation but the buyer was not willing to accept delivery of shares.
6. With regard to the allegation that the broker had committed fraud on the buying client, the broker has submitted that the enquiry report purportedly reproduced the definition of fraud as quoted in the SEBI (Prohibition of FUTP) Regulations, 2003 instead of quoting the relevant extracts of the applicable SEBI (FUTP) Regulations, 1995.
7. On a comparative analysis of the definition of “fraud” as existing in the 1995 Regulations and the subsequent amendments in the 2003 Regulations, it can be seen that the original definition of “fraud” under the SEBI (FUTP) Regulations, 1995 adopts the definition of “fraud” from the Indian Contract Act, 1872 whereas the subsequent definition in the 2003 Regulations is a variation of the same and does not adopt the strict definition of “fraud” as obtained in the Indian Contract Act. It includes many situations which may not be a “fraud” under the Contract Act and the 1995 Regulations, but nevertheless amounts to a “fraud” under the 2003 Regulations for the limited purpose of transaction in securities.
8. There is considerable force in the argument of the learned counsel that “fraud” as defined in the amended Regulations should not be made applicable retrospectively to the impugned transaction which had taken place in March 2001. The broker stated that to make out a charge of fraud under the said 1995 Regulations, the party to a contract or his agent must make a false suggestion or active concealment or a false promise or a deceptive/fraudulent act or omission to deceive the other party to the contract to induce him to enter into the contract. Furthermore, mere silence is not fraud unless there is a duty to speak, even though it may affect the willingness of the other party to enter into the contract. I find that the Enquiry Officer has incorrectly applied the definition of fraud under the 2003 Regulations to the impugned transactions that were executed in the year 2001. It is inapposite to retrospectively apply the amended definition to transactions that were completed prior to the amendments. I find that by applying either of the Regulations, it cannot be said that the broker was guilty of making any suggestions, concealment, false promise, deception, omission or silence or of making a representation in a reckless and careless manner so as to amount to “fraud”.
The broker’s conduct has to be adjudged by performance as per the terms of contract and time available thereof and not by other collateral considerations that he did not have the requisite number of shares while issuing the contract note, when, in fact, the scheme of “spot transactions” provide for time to fulfill his obligations. Similarly, crediting the entire sale proceeds to the account of the seller can at best engender a liability between the broker and the buyer which did not arise in the instant case as a result of a subsequent settlement of dispute through arbitration. Thus on a conspectus of the case history in all its material details, the allegations of fraud is a non sequitur.
Unless it is proved, if not beyond reasonable doubt, that any investor was aggrieved, or was put to loss or any person had been allured to invest in securities by the conduct of the brokers, or any artificial volume or price is created in any scrip or scrips it cannot reasonably be said that the broker has indulged in a fraud. At best, it may be a case that a broker has helped the parties in putting through what can be construed as a “make-believe” which was also halted in the tracks. But, it is nobody’s case. In view of the above, it cannot be concluded that the broker had committed an act of “fraud” on the buying client within the meaning of the said term under SEBI (FUTP) Regulations, 1995.
9. There is no dispute or allegation of artificial price determination. There is no allegation that any third party, for that matter public interest, is adversely affected by the deal. Hence, I am of the view that this is not the case falling under the definition of fraud under SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 1995.
G.ANANTHARAMAN
WHOLE TIME MEMBER
SECURITIES AND EXCHANGE BOARD OF INDIA
Date : May 17, 2005
Place : Mumbai