ORDER
UNDER THE SEBI (PROCEDURE FOR HOLDING INQUIRY AND IMPOSING PENALTIES BY THE ADJUDICATING OFFICER) RULES, 1995
AGAINST
RAJ ENTERPRISES
BACKGROUND:
1. Raj Enterprises (hereinafter referred to as Raj) is registered with the Securities and Exchange Board of India, 1992 (for brevity’s sake, hereinafter referred to as the SEBI) as a sub-broker and is affiliated to SKSE Securities Ltd., (for brevity’s sake, hereinafter referred to as SKSE), which is a member of the BSE and NSE. The SEBI registration number of Raj as a sub broker is INS 231407110 and INS 010562218.
2. An inspection of the books of account, documents and other records of Raj was conducted by SEBI during June 2004 for the period April, 01, 2002 to March 31, 2004. During the inspection, certain irregularities and violations of the SEBI (Stockbrokers and Sub-Brokers) Regulations, 1992 (Broker Regulations) alleged to have been committed by Raj were noted. Hence under cover of letter dated September 20, 2004, SEBI forwarded the findings of inspection through SKSE to Raj, with an advice to Raj to submit their comments to the charges contained therein. As no response was received to the said notice, another letter dated October 19, 2004 was sent to Raj, through the NSE. Vide the said notice, Raj was advised to reply to the same not later than 10 days from the date of the said letter and was further advised to note that in case they failed to respond to the said notice, it would be presumed that they had no comments to offer and appropriate action would be initiated accordingly. NSE vide their letter dated November 01, 2004 confirmed service of the said letter on Raj. However no reply was received from Raj to the said notice. In view of the same, I was appointed as the Adjudicating Officer, vide order dated February 15, 2005 to inquire into and adjudge the alleged acts of omissions and commissions of Raj.
NOTICE/ REPLY/ PERSONAL HEARING:
3. Accordingly I issued a notice dated May 9, 2005 to Raj under Rule 4 of the SEBI (Procedure for holding inquiry and imposing penalties by Adjudicating Officer) Rules, 1995 (hereinafter referred to as the ‘Rules’) whereby Raj were called upon to show cause as to why action should not be initiated against them for the violations referred to in the said notice. Raj were also 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 also indicate whether they were desirous of a personal hearing. Raj were further 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 and that the matter would be decided solely on the basis of the material available on record.
4. Raj replied to the notice vide their letter dated June 2, 2005 and also requested for a personal; hearing. In view of the same, a notice of hearing dated June 14, 2005 was issued to Raj to appear for the hearing before me on June 28, 2005. Shri Mustafa Lakdawala, proprietor; Raj, appeared on the scheduled date and made his submissions. While agreeing to some of the irregularities as pointed out in the notice, he stated that necessary rectifications had been made thereto and undertook to provide proof of the same on or before July 10, 2005. Thereafter written submissions along with supporting documents were forwarded under cover of letter dated July 7, 2005.
APPRECIATION OF EVIDENCE
5. I have considered the facts and circumstances of the case, the material available on record including the findings of the inspection report and have analyzed the contentions advanced on behalf of Raj along with the documents submitted in support thereof.
6. My findings on the charges leveled against Raj for which the present proceedings have been initiated after analysis of the submissions, if any, made by them in this regard are elaborated herein below: -
- Deficiencies in the maintenance of the books of accounts and other records:
a. Failure to maintain the record of time of the placement of order on the confirmation memos:
7. Raj was alleged to have failed to maintain the record of time of the placement of the order on the confirmation memo and was hence alleged to have violated the provisions of Regulations 26(iii), 26(xv) and 26(xvi) of the Broker Regulations which inter-alia provides for imposition of monetary penalty for failure to maintain books of account or records as per the Act, rules or regulations framed there under.
8. As regards this issue, it was contended on behalf of Raj that due to technology changes in the present market scenario of online trading and high – speed communication devices being used for executing fast transactions to satisfy clients, they had indeed accepted orders telephonically but that the order time was maintained in the soft copy generated by the BOLT itself and that as per the general practice, the time of execution of the trade with the affiliated subsidiary was printed in the confirmation memos.
9. Raj also contended that the time of order was available in the back office in soft copy and undertook to produce the soft/hard copy of the order placed by all clients together with the time of execution.
As per SEBI Circular No. SMD/POLICY/IECG/1-97 dated February 11, 1997, all the stock exchanges were advised to initiate immediate action on some of the points mentioned in that Circular and one among them was that “the broker-member should maintain the record of time when the client has placed the order” and reflect the same in the contract note along with the time of execution of the order. Hence the obligation imposed vide the above mentioned circular to mention specifically the record of time of placing the order along with the time of execution of order in the contract notes issued to all the clients, is cast only on the broker members and not the sub-broker. Hence the sub-broker cannot be held liable for the non mention of the record of time as to when the client has placed the order, which is to be reflected on the contract note entered into between the broker and client.
b. Failure to maintain Margin Deposit Book:
10. As regards the allegation of not maintaining the margin deposit book, it was contended on behalf of Raj that it was the standard practice to pay the margin money to the affiliated member as and when demanded, by the Risk Management System of SKSE and that from time to time, the same data was maintained by them in the name and style of SKSE Securities Margin Account. To this effect, a copy of SKSEs’ daily margin account for the year 2003-04 which indicated the day to day margin position of SKSE was enclosed for perusal. Similarly a copy of the daily margin deposit account of shares held by them on behalf of their clients as running account against margin of clients, which was deposited to SKSE whenever required towards margin, was also forwarded for perusal.
11. It was further contended that in case of margin collection from clients, with their prior consent, Raj held the funds as well as securities for their convenience, in their respective running accounts and that although the formal book of margin collection/deposit was not maintained, in principle the same was being observed on either side, which was considered by them as the client margin especially as this practice was considered to be common and suitable in present market operations. To this effect, a copy of the margin account of their client; Amisha Developers for the financial year 2003-04 indicating the margin collected from clients was enclosed.
12. The margin deposit book is an important document/ book to be maintained at the sub-broker’s end as it indicates the credibility/ status of the client. In the event that the volumes of business are high, the credit balance would reflect the payment obligation to be met by the client and in turn help to ensure and avoid any payment default from the client’s end.
13. I have considered the submissions rendered on behalf of Raj and have noted that the obligation to maintain such a book was thrust upon the sub-broker under Regulation 15(2) of the Broker Regulations only with effect from September 23, 2003 i.e. vide the SEBI (Stock Brokers and Sub-brokers) (Amendment) Regulations, 2003. Prior to the said date, a sub-broker was under no obligation to maintain this document. This assumes significance since the period of inspection encompassed April 2002 to March 2004. Thus only for the period between September 23, 2003 and March 31, 2004, there was an obligation cast upon Raj to maintain the said document, which they failed to maintain. Although Raj have given an elaborate explanation as regards non maintenance of the said book and stated this to be suitable and as per the prevalent practice, the same cannot be acceptable in as much as wherever a specific mode of transacting with clients has been specified, the same is required to be strictly adhered to and there should not be any deviation from the same.
B. Failure to distinguish the brokerage charged by them and the affiliated member:
14. Raj were alleged to have failed to distinguish the brokerage charged by them and their main broker on the confirmation memos issued to their clients.
15. On their part, Raj have contended that during the period of inspection, the software which they were using for their back office operations were not supporting this distinction but that with the consultation to the software party, they were going to execute the confirmation memos showing both the brokerage charged by them and the main broker distinctly.
16. Although I have taken cognizance of the undertaking given by Raj, it is my considered opinion that there is no specific provision in law which mandates a sub broker to distinguish the brokerage charged by them and the affiliated member, on the confirmation memo. The obligation, if any to charge brokerage including that of the sub-brokerage earned by the sub-broker, would lie upon the affiliated broker to mention the same on the contract note. In this regard reference may be made to the letters of SEBI - Ref:SE/4569 dated June 17, 1992 and Ref SE/7566 dated August 6, 1992, in terms of which, SEBI had from time to time prevailed upon the Exchanges to implement certain measures in the interest of long term growth of the stock market and for ensuring investor protection some of which included directing member-brokers to indicate to the clients, the execution price of transactions and the brokerage separately in the contract notes.
17. Consequently in the absence of any liability cast upon the sub-broker in this regard, no charge can be made out against Raj.
C. Non segregation of clients funds from own funds and non segregation of client’s securities from own securities:
18. Raj was found to have failed to segregate the clients’ money from their own funds such that the clients’ securities were kept in their demat account with the payment to/from the clients, being made from ICICI Bank (current) account and Bank of India (current) account as well as cash and business expenditures being made from these accounts, thereby making them liable for action under Regulation 26(xiii) of the Broker Regulations.
19. On behalf of Raj, it was contended that they had maintained the main (current) client account with the Bank of India, Panchnath Branch wherein direct pay in /pay out was done to SKSE. It was stated that since their clientele was spread outstation and in some of the remote/rural/interior locations, the Bank of India branches were not providing multi city and core banking facilities together with instant debit/credit of funds without any extra charges to their clients, to meet such pay in/pay out and other facilities of their clients in time, they had opened another bank account with ICICI Bank Ltd, essentially to cater to clients residing outside Rajkot. It was stated that they had paid their telephone bills through net banking from ICICI Bank, as the bank provides bill pay facilities, so as to be free from hurdles to pay such bills in time, while the rest of the payments were made from the Bank of India savings account. These amounts ranged between Rs 700 to 800 per month. They also stated that the drawings/cash withdrawals from both accounts were to meet day to day house hold/office expenses within the brokerage earned on lump-sum basis.
20. As regards separate demat account, it was contended that the clients securities are kept in the sub-brokers demat account as running account as well as shares/money towards margin and a separate consent letter for the same had been obtained from their client. It was emphasized that since they are using Digital Demat Software, there was a clear segregation between securities held by them and their clients and no delivery transactions were made through this account in their personal name and hence all securities held in sub-brokers demat account are for clients securities only. On the basis of the above, it was clarified that there was a clear segregation of the clients fund and their fund.
21. The provisions of Regulation 26(xiii) of the Broker Regulations, inter- alia provides for imposition of monetary penalty for failure on the part of a broker/sub-broker to segregate his own funds or securities from the clients’ funds or securities or using the securities or funds of the client for his own purpose or for purposes of any other client. Thus it is compulsory for all members to keep the money of their clients and their own money in separate accounts. The monies that can be paid into the clients accounts include monies held or received from the clients, such money belonging to the member as may be necessary for the purpose of opening or maintaining their account, a cheque or draft received by the member representing in part, the money belonging to the client and in part money due to the member etc. Further no money is to be withdrawn from the clients account other than the money required for payment to or on behalf of the client, money belonging to the member as may have been paid into the client account in respect of the previously mentioned payments into the account etc. There is also a SEBI circular dated November 18, 1993 which directs every member who holds or receives money on account of a client to forthwith pay such money to the current or deposit account at the bank to be kept in the name of the member in the title of which the word “clients” should appear. They are permitted to keep one consolidated clients account for all clients or accounts in the name of each client, as they think fit.
22. In the case under consideration, although no specific instances of default, have been cited on record, I have noted findings in the inspection report contained in Annexure ‘C’ of the report of inspection for the year 2002-03 and 2003-04 under Item no 18, which mentions that cash withdrawal and business expenditure were made from the two accounts of the member which are less than the brokerage amount. The report further mentions that the clients securities are kept in the sub-brokers’ demat account.
23. Raj on their part have admitted to making drawings/cash withdrawals of small amounts from the account opened with ICICI Bank, which was used, apparently to service some of their far spread clientele to meet the day to day house hold/office expenses and have submitted the documents evidencing the withdrawals, made by them for purposes other than trading or for settlement of trades. Indeed the amounts withdrawn are of a petty amount. However although Raj have contended that the clients securities were kept in their demat account as running account as well as shares/money towards margin based upon a consent letter issued by their client, the said contention is unsupported by any documentary evidence that ought to have been submitted at any point of time by them during the course of the proceedings. Thus notwithstanding the contentions advanced by Raj in their reply to the notice and also in their submissions made during the course of the proceedings, it is clear that Raj have violated the norm of maintaining a segregation in their client account and their own account.
D. Funds borrowing/lending activities
24. Raj were alleged to have indulged in funds lending and borrowing activities as on July 9, 2004 as brought out below:
i). A deposit of Rs.2.00 lakh, and
ii) an advance margin of Rs.7.50 lakh
25. The said activity was alleged to have resulted in the violation of Regulation 26(xv) of the Broker Regulations.
To counter the said charge, it was stated on behalf of Raj that the deposit of Rs.2.00 lakh and advance margin of Rs.7.50 lakh were the deposits held by their affiliated broker; SKSE. To this effect, a letter of SKSE dated July 16, 2004, was produced showing the position of margin as on July 09, 2004. A reading of the said letter reveals that the amount of Rs.2.00 lakhs is the deposit to be held by SESE till the sub broker ship of Raj continues. Similarly, of the amount of Rs.7.5 lakhs held by SKSE as against advance margin, Rs.1.5 lakhs is to be held by SKSE till the sub broker ship of Raj continues, while the remaining Rs.6 lakhs advance margin was the position of margin money on that particular date, which varied from day to day with relation to trading done on that date, and which was strictly as per the prescribed norms, observed by the affiliated member’s Risk Management Surveillance System. While contending that from time to time, the same was maintained by SKSE in the name and style of SKSE Securities Margin Account, a copy of which was enclosed for perusal, Raj further emphasized that they did not borrow/lend the funds from/to outsiders, as their religion did not permit them to take/pay interest to/from any body.
26. I have examined the contentions advanced on behalf of Raj and have in this context, referred to the SEBI Circular SMD/POLICY/CIR-6//97 dated May 07, 1997 which inter alia provides that borrowing and lending of funds, by a trading member, in connection with or incidental to or consequential upon the securities business, would not be disqualified under Rule 8(1)(f) and 8(3)(f) of the Securities Contract (Regulation) Rules, 1957 which inter alia provides that no person shall be eligible to be elected as a member or eligible to continue as such, if already elected if he is engaged as a principal or employee in any business other than that of securities or so engages except as a broker or an agent, not involving any personal financial liability.
27. There is no dispute of the fact that a sub broker is required to deposit a certain amount with the affiliated member till the date of holding of the sub broker ship, while certain other deposits are to be maintained as advance margin. In the instant case, the amounts under dispute have been certified by SKSE to be deposits and advance margin made by Raj with them. I have also noted Item No 19, in Annexure ‘C’ of the report of inspection of Raj for the year 2002-03 and 2003-04, which specifically states that upon verification of the records of the sub-broker, although few instances of sum borrowed were observed, the same were found to be in connection with or incidental to or consequential upon the securities business. Further Item no 32 also clarifies that the sub-broker is not involved in any type of business other than securities business. Based on these findings, it would stand to reason to infer that these amounts (credit balances) would amount to deposits found to have been made or issued, in connection with or incidental to or consequential upon their securities business and that there is no failure on the part of Raj to comply with the directions issued by the Board under the Act or the regulations framed there under on this count.
E. Failure to frame a Code of internal procedures and conduct for prevention of insider trading:
28. Raj were found to have failed to frame a code of internal procedures and conduct for prevention of insider trading as specified in Schedule–I of the SEBI Prohibition of Insider Trading) Regulations, 1992 which amounted to a violation of Regulations 26(xv) and 26(xvi) of the Broker Regulations. On this count, although in their written submissions, Raj agreed to the charge of not framing the said code, subsequently it was submitted that the said code had to be framed by the main broker, who was anyway found to have complied with all the rules, regulations and regularities as mentioned in the inspection report. It was further contended that they had not traded as a stock broker of Saurashtra Kutch Stock Exchange, but as a sub broker of the main broker SKSE Securities Ltd.
29. I have examined the contentions advanced on behalf of Raj and am not in agreement with the same. The obligation to frame a code of internal procedure and conduct for prevention of insider trading as per Schedule –I of the SEBI (Prohibition of Insider Trading) Regulations, 1992 is to be fulfilled not only by the main broker, but all intermediaries as mentioned in Section 12 of the SEBI Act, 1992 with effect from February 20, 2002. A sub broker is one of the many entities mentioned in the said provision. The norms laid down in the Code inter alia lays down norms for reporting requirements for transactions in securities and other restrictions and provides for rules to preserve price sensitive information, prevent the misuse of price sensitive information etc. In view of the rationale for the same, due cognizance has to be made for the failure of Raj to frame the said Code.
F. Acceptance of cash instead of cheques/ demand drafts
30. Raj was found to have indulged in a cash transaction involving Rs 52,200/- on June 28, 2002. The same was alleged to amount to a violation of Regulations 26(xv) and 26(xvi) of the Broker Regulations read with SEBI Circular No. SMD/SED/CIR/93/23321 dated November 18, 1993 and SEBI/MRD/SE/CIR-33/2003/27/08 dated August 27, 2003.
31. With regard to the same, it was contended on behalf of Raj that the same was accepted from one of his clients; S C Parekh to avoid bad debts.
32. SEBI vide its Circular No. SMD-1/23341 dated November 18, 1993 had categorically specified that members should not accept cash for purchases of securities and / or give cash against sales of securities and that all the payments received / made should be strictly by “crossed – Payee A/c” cheques. Further vide its Circular No. SEBI/MRD/SE/Cir-33/2003/27/08 dated August 27, 2003, it was reiterated that brokers and sub-brokers should not accept cash from the client whether against obligations or as margin for purchase of securities and / or give cash against sale of securities to the clients and that all payments shall be received / made by the brokers or sub-broker from / to the clients strictly by account payee crossed cheques / demand drafts or by way of direct credit into the bank account through EFT, or any other mode allowed by RBI. The brokers or sub-broker shall accept cheques drawn only by the clients and also issue cheques in favour of the clients only, for their transactions. However, in exceptional circumstances the broker or sub-broker may receive the amount in cash, to the extent not in violation of the Income Tax requirement as may be in force from time to time.
33. The essence of this restriction is that cash receipts and payments against the settlement of trades lack audit trail and give a way for settling fictitious / dummy transactions or can be used for illegal / off market transactions as well.
34. Although in the present case, the amount involved is not substantial nor the instances of default, there is no substance to the explanation provided by Raj for this lapse. Hence the violation being established calls for a penalty.
G. Improper maintenance of the member client
agreements
35. Raj were found to have entered into agreements with their clients on the stamp paper of Rs 20/- as against the usual norm of Rs 50/- as per the Bombay Stamp Act, as applicable to Gujarat, resulting in the violation of the provisions of Regulations 26(xii), 26(xv) and 26((xvi) of the Brokers Regulations.
36. It was contended on behalf of Raj that they were ignorant about the change in Stamp Duty applicable in Gujarat State and hence had entered into agreements with clients on Rs.20/- stamp paper but however clarified that they had now started to make fresh agreements on Rs.50/- stamp paper.
37. Regulation 26 (xii) of the Brokers Regulations, inter alia provides that a stock broker or a sub-broker shall be liable for monetary penalty where trades are executed without entering into an agreement with the client under the Act, rules or regulations framed there under or in case of a failure to maintain client registration form or commission of any irregularities in the maintenance of such a client agreement.
38. A properly maintained member-client agreement imparts transparency to the functioning of the broker/sub broker as an intermediary and ensures that all professional dealings that are carried out, are effected in a prompt, efficient and cost effective manner, which ultimately has a bearing on the interests of the investors.
39. Raj have admitted to the lapse mentioned above, which however are stated to have been rectified by them. However no documentary evidence to this effect has been furnished by them. Taking into consideration the totality of the charge, it would not be incorrect to infer that there has been a certain amount of failure on the part of Raj to exercise due diligence required of that of a sub-broker while carrying out their duties, resulting in the violation of the provisions of Regulation 26(xii),(xv) and (xvi) of the Broker Regulations.
40. Upon a cumulative analysis of the facts and circumstances of the case and some of the charges levied against Raj being established, penalty as prescribed needs to be levied upon them. However I have noted an important finding in the inspection report that needs to be highlighted i.e. the fact that there were no investor complaints pending against Raj or a case of mis-utilisation of funds against them.
For the purpose of fixing the quantum of penalty that is commensurate to the charges leveled and established against Raj, the relevant provision of the SEBI Act, 1992, may be perused which reads as under:
Section 15HB : Penalty for contraventions where no separate penalty has been provided:- 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.
41. In this regard, it would also be necessary to refer to certain factors as enumerated under Section 15J of the SEBI Act that need to be taken into account while adjudging the quantum of penalty and these include the amount of disproportionate gain or unfair advantage made as a result of the said default, the amount of loss caused to the investors and the repetitive nature of default.
42. From the facts on record, it is not clear as to whether Raj would have enjoyed any gain or unfair advantage as a result of their defaults. However it cannot be denied that any 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 and deprive the general public and the investor class as a whole, of a fair and regulated market. 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.
43. Thus bearing in mind the facts and circumstances of the present case as also the factors enumerated in Section 15J of the SEBI Act, 1992, on a judicious exercise of the discretion conferred upon me, considering the offences in its entirety, I am inclined to hold that since most of the charges against Raj are not too serious, the penalty need not be imposed strictly as per the quantum specified in Section 15B of the Act.
44. Accordingly, in exercise of the powers conferred upon me in terms of Rule 5 of SEBI (Procedure for holding inquiry and Imposing penalties by the Adjudicating Officer ) Rules, 1995, I hereby impose a penalty of Rs. 30,000/- (Rupees thirty thousand only) as penalty on Raj Enterprise bearing SEBI Regn No INS 231407110 and INS 010562218.
PENALTY
45. 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 Smt Usha Narayanan, Chief General Manager, Securities and Exchange Board of India, World Trade Centre, 29th Floor, Cuffe Parade, Mumbai 400005.
PLACE: MUMBAI G. BABITA RAYUDU
DATE : NOVEMBER 8, 2005 ADJUDICATING OFFICER