In the matter of investigation in

 

KLG Systel Ltd.

 

AND

 

In respect of

 

Mrs. V. Megala, Coimbatore

1.0       Background :

 

1.1       Vide order dated November 02, 2005 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 Section 15HA and Section 15HB of Securities and Exchange Board of India Act, 1992 (hereinafter referred to as “SEBI Act”), the alleged violation of Regulations 4(1), 4 (2) (a), (b) & (g) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 by Mrs. V. Megala in the matter of trading in the shares of M/s KLG Systel Ltd.   Mrs. V. Megala (hereinafter referred to as “VM”) is an investor residing at 22, Pappammal Layout, Palayur, P.N. Palayam, Coimbatore – 641 037 (previous address :- Karthik Illam, 41, T. Nagar, Second Street, Ramanathapuram, Coimbatore – 641 045).

 

1.2       In view of sudden rise and fall in the price of shares of KLG Systel Ltd. (hereinafter referred to as “ KLG”) during April 21, 2004 to June 15, 2004, an investigation was conducted by SEBI into the trading in the shares of KLG. The main focus of investigation was to ascertain violation, if any, of SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, 2003 (hereinafter referred to as “PFUTP Regulations”). The share price of KLG fell from Rs.34.50 on April 21, 2004 to Rs.27.75 on May 17, 2004. Subsequently the price rose to Rs.40.35 on May 26, 2004 and again fell to Rs.33.75 on June 15, 2004.

 

1.3       The investigation revealed that the major trading member during this period was ISE Securities and Services Ltd. (trading member-National Stock Exchange of India Ltd. [hereinafter referred to as “NSE”]) whose trades had constituted 36.36% of gross traded quantity on NSE during April 21 to May 17, 2004, 12.87% of gross traded quantity during May 18, 2004 to May 26, 2004 and 32.52% of gross traded quantity during May 27, 2004 to June 15, 2004. The investigations revealed a large number of cross deals between M/s Nelliyan Stocks, Proprietor- Sh V. Arunachalam (hereinafter referred to as ‘NS’ ) and M/s Krishna & Co. (hereinafter referred to as ‘ KC ’) both brokers of Coimbatore Stock Exchange and sub brokers of ISE Securities and Services Ltd. (hereinafter referred to as “ISE”), trading member, NSE. During this period VM traded in the shares of KLG through her broker NS while KC traded on own account.

 

1.4       As per investigation report, during the investigation period, 49 cross deals were executed between VM and KC in KLG shares. In these trades when VM was buying, KC was selling and when KC was buying, VM was selling. The cross deals have happened as both sub brokers KC and NS (on behalf of VM) have placed orders on a synchronised basis. The order synchronization details are as under :

 

Time difference between placement of sale and purchase orders (in seconds)	Number of trades
7-10	9
11-20	12
21-30	14
31-40	9
41-53	5

In view of the above inter se dealings among VM (through NS) and KC it was alleged that VM had acted in violation of the provisions of regulation 4(1), 4(2) (a), (b) and (g) of PFUTP Regulations.  

2.0       Notice / Reply / Personal Hearing

 

2.1       A show cause notice dated January 23, 2006 was issued to VM asking her to show cause as to why action should not be taken against her for alleged violation of regulations 4 (1), 4 (2) (a), (b) and (g) of PFUTP Regulations and penalty be not imposed under Section 15HA and 15HB of SEBI Act, 1992. A copy of the investigation report detailing the specific violations was enclosed with the notice. The integrated trade and order log in respect of trades during the investigation period was also enclosed.  VM was advised to make her submissions, if any, within 14 days from the date of receipt of the notice.

 

2.2       In response to the show cause notice, VM submitted her reply vide letter dated February 04, 2006. The extract of her submission is as under:-

 

“This is in response to the above said notice, my submissions in this regard is given below:-

a)                  I am an ordinary small investor in the share market

b)                  All my transactions in the share market has been performed in the normal course of business, In the same criteria applies to my trade in KLG SYSTEL also.

c)                  In case my transactions have resulted in excessive volume which distorted market prices. It is purely un intentional in nature.”

 

2.3       Having considered the charges levied and the reply submitted, I decided to conduct an inquiry in the matter and accordingly issued letter dated March 10, 2006 fixing March 27, 2006 as the date of hearing.

 

2.4       During the hearing granted on 27.03.2006, Mr. P.V. Krishnan, husband of VM appeared on her behalf. In the authority letter dated 24.03.2006, VM stated as under in respect of her transactions:-

 

“Sir I am very small investor, All my transactions in the stock market has been performed

In the normal course of business. Sir in case my transactions have resulted in excessive

Volume which distorted market prices. It is purely un intentional in nature.”

 

2.5       During the hearing held on March 27, 2006, Shri P.V. Krishnan (hereinafter referred to as PVK), husband of VM made further submissions on her behalf:-

 

“We have not done this trading purposely. It is purely unintentional in nature.  We are very small investor. If there is anything wrong, we will not do trading like this in future. I am hereby submitting the daily transaction statement in KLG Systel with Nelliyan Stocks for the above period.”

 

He also submitted an authenticated copy of the daily transaction statement of VM in respect of transactions in KLG done through NS.

 

2.6       Show cause notices were also issued to NS and KC on January 23, 2006 asking them to show cause as to why action should not be taken against them for the alleged violations as mentioned in the investigation report which was provided to them. After receipt of reply, hearing was also granted to NS and KC on March 27, 2006.

 

2.7       In response to show cause notice, KC vide letter dated February 06, 2006 submitted that in the NSE trading system it was not possible for a broker to know identity of counterparty either at the time of trade and execution or at the time of download of trade data and that it was coincidental that both buyer and seller belong to the same city. He also stated that when an order is placed, it is possible for any person in India to complete the same and further that he had no beneficial interest in KLG.

 

2.8       On March 27, 2006, Mr. K. Gnanasekaran, proprietor of KC appeared before me and made further submissions as mentioned hereunder:-

 

“ Subsequent to submission of my reply dated 06.02.2006, certain new facts have come to my knowledge. These trades were done through my terminal and in my account by my employee Shri Velmuthukrishnan who was operating the trading terminal. He is no longer in service with me as he had left in October 2004. He has agreed to me that these trades were done by him for his personal benefit without my knowledge. The counter party to the trades is the wife of my above mentioned ex-employee which fact has come to my knowledge recently during my discussions with him. I have no association or link with the counter party. In the process of doing these trades I have not made any gain whatsoever. Hence I wish to state that I have not purposefully did these trades in violation of Regulations 4(1), 4(2) and 4(a,b,g) of SEBI (PFUTP) Regulations and also acted against the Regulation 15 Schedule II read with Clause A(1)(2) and D(1)(4)(5) of SEBI (Stock Brokers and Sub Brokers) Regulations, 1992 . Considering the above facts I request you to condone my mistakes and I assure you I will act by provisions of the Law in future and will not cause any act which will affect the regular functioning of the market.”

 

During the hearing, KC submitted that these trades in KLG had been executed by Mr. P.V. Krishnan / P. Velmurugakrishnan / Velmuthukrishnan (hereinafter referred to as “PVK”) on behalf of KC while the counterparty was his wife VM, who was trading through NS. Thus there was a nexus between the trading entities. (Certain variations have been observed in quoting the name and spelling thereof of husband of VM. While he has been mentioned as P.V. Krishnan in the authority letter given by VM, in the submission made by him on 27.03.2006 he has given his name as P. Velmurugakrishnan and Mr. K. Gnanasekaran, proprietor, KC in his statement has mentioned his name as Velmuthukrishnan. However, all the names pertain to the same person who has been mentioned in this order as ‘PVK’).

 

2.9       As the fact of relationship between the trading entities came to light during the course of inquiry, I was of the view that it would be appropriate to share the new facts with the charged entities and seek their views / submissions in the matter. Accordingly, vide letter dated April 25, 2006, the submissions dated 27.03.2006 and 04.04.2006 of KC and submissions dated 08.02.2006 and 27.02.2006 of NS were forwarded to VM for her comments. Similarly copy of submissions dated March 27, 2006 & April 04, 2006 of KC and copy of letter dated March 24, 2006 from VM & submissions dated March 27, 2006 on behalf of VM were forwarded to NS vide letter dated April 25, 2006. Vide these letters, VM and NS were asked to submit their comments within 7 days of receipt of letter. They were also offered an opportunity of hearing on May 05, 2006 which was not availed by either party.

 

2.10   In response to my letter dated April 25, 2006, VM vide her letter dated May 03, 2006 submitted as under:-

 

“Sir I wish to inform you that I have not any intention aly did these trades in violation of Regulations4(1), 4(2) and A,B,G of SEBI.

 

Sir I have not purposefully did any thing against SEBI Regulations.

My husband made some profit in Mr. K. Gnanasekaran trading account that was transferred to our account through KLG Systel Ltd.

 

Sir I request you to condone my mistake and I assure you that I will not do this type of trading in future. I am sending here with Rs.70000 (seventy thousand) demand draft in favour of Hon.Securities Exchange Board of India. Payable at Mumbai. Indian Bank DD No.148313. Already I submitted transactions statement in KLG Systel which indicates profit made by me sum of Rs 70000.

Entire amount I am sending you.”

 

Along with her letter she enclosed Indian Bank, Trichy Road, Coimbatore demand draft no. 148313 dated May 03, 2006 for Rs.70,000/- favouring SEBI being the profit made by her through these transactions. (As the existing SEBI Regulations do not permit SEBI to accept the refund of profit made through irregular trading, the bank draft was returned to VM vide letter dated June 07, 2006)

 

2.11   In response to my above letter, NS vide its letter dated May 04, 2006 submitted that it had no knowledge about these transactions and that it had executed the transactions in normal course of business with utmost good faith.

 

3.0       Consideration of Evidence and findings:-

 

I now proceed to deal with the evidence and replies received by me  

vis-à-vis allegations against VM, and record my observations /  findings hereunder:

 

3.1 During the course of hearing held on March 27, 2006, PVK, the authorized representative of VM, submitted an authenticated copy of the daily transaction statement of VM through NS in KLG shares.  The transaction statement which has been recast to incorporate average transaction rates, square up of positions and profit / loss made is given below :

 

 

 

 

 

Settlement No.	Purchase Quantity	Avg Rate (Rs) *	Purchase Value	Sale Quantity	Avg Rate (Rs) *	Sale Value	Net Quantity	Profit/ Loss (-)
2004076	2500	34.937	87342.50	1500	35.75	53625.00
2004077	500	36.028	18014.80	1500	36.65	54970.00
	3000		105357.30	3000		108595.00	0	3237.7
2004078	1000	33.1	33100.00	1000	34.438	34437.50
	1000		33100.00	1000		34437.50	0	1337.5
2004079	2500	31.814	79535.00	1309	32.675	42772.55
2004080	0		0.00	1151	33.229	38247.10
	2500		79535.00	2460		81019.65	40 #	1484.65
2004081	1000	31.65	31650.00	1000	33.35	33350.00
	1000		31650.00	1000		33350.00	0	1700
2004083	1000	30.595	30595.00	100	32.95	3295.00
2004084	100	33.05	3305.00	1000	33.4	33400.00
	1100		33900.00	1100		36695.00	0	2795
2004085	500	32.05	16025.00	500	33.5	16750.00
	500		16025.00	500		16750.00	0	725
2004086	600	31.325	18795.00	600	32.691	19615.00
	600		18795.00	600		19615.00	0	820
2004087	1000	31.45	31450.00	1000	33.95	33950.00
	1000		31450.00	1000		33950.00	0	2500
2004088	1000	29.612	29612.50	1000	32.95	32950.00
	1000		29612.50	1000		32950.00	0	3337.5
2004090	1500	31.6	47400.00	1500	34.85	52275.00
	1500		47400.00	1500		52275.00	0	4875
2004091	3000	30.65	91950.00	3000	31.66	95000.00
	3000		91950.00	3000		95000.00	0	3050
2004092	2500	27.47	68675.00	2500	29.33	73325.00
	2500		68675.00	2500		73325.00	0	4650
2004093	2598	26.647	69229.40	2598	30.198	78456.10
	2598		69229.40	2598		78456.10	0	9226.7
2004096	1000	32.25	32250.00	1000	32.85	32850.00
	1000		32250.00	1000		32850.00	0	600
2004097	1500	35.6	53400.00	1500	36.9	55350.00
	1500		53400.00	1500		55350.00	0	1950
2004098	1250	37.062	46377.50	1250	38.34	47925.00
2004099	0		0.00	40	41.6	1664.00
	1250		46377.50	1290		49589.00	(-)40 #	3211.5
2004102	2000	35.3	70600.00	2000	36.8	73600.00
	2000		70600.00	2000		73600.00	0	3000
2004104	1000	34.85	34850.00	0	0	0.00
2004105	0	0	0.00	1000	37.235	37235.00
	1000		34850.00	1000		37235.00	0	2385
2004106	1000	34.2	34200.00	1000	35.05	35050.00
	1000		34200.00	1000		35050.00	0	850
2004107	1000	33.45	33450.00	1000	34.9	34900.00
	1000		33450.00	1000		34900.00	0	1450
2004108	1500	33.65	50475.00	1500	35.3	52950.00
	1500		50475.00	1500		52950.00	0	2475
2004109	2000	33.85	67700.00	2000	35	70000.00
	2000		67700.00	2000		70000.00	0	2300
2004110	2500	34.1	85250.00	2500	35.15	87875.00
	2500		85250.00	2500		87875.00	0	2625
2004111	2500	34.15	85375.00	2500	36.45	91125.00
	2500		85375.00	2500		91125.00	0	5750
2004113	2900	31.97	92740.00	2900	33.79	98005.00
	2900		92740.00	2900		98005.00	0	5265
Grand Total	41448		1343346.70	41448		1414947.25	0	71600.55

 

Note :  1. *- Average rate derived by dividing purchase / sales value by purchase / sale quantity

  2. # -Outstanding shares

 

On an analysis of the statement, I observe as under :

 

(a)         Almost all the transactions done on a particular day were reversed on the same day or the next trading day. There is only one instance of 40 shares remaining outstanding out of a purchase of 2500 shares in settlement no 2004079. However, even these 40 shares were squared off within a short time during settlement no. 2004099.

 

(b)         Overall VM has purchased 41448 shares and sold 41448 shares. In other words total quantity purchased by her was sold.

 

(c)         A pertinent observation is that VM has made a profit on square up of all transactions done by her over a period of 56 days. It logically follows that in this situation VM’s counterparty would have incurred loss in all transactions.

 

3.2 In view of the submission made by KC on March 27, 2006, letter dated May 03, 2006 from VM and findings made on analysis of the daily transaction statement of VM in KLG shares, it is clear that most of VM’s orders were matching (or rather, were being matched) with those of KC from whose trading terminal PVK was entering the orders. The fact that the two parties trading with each other were actually related to each other confirms the nexus between them. Further the fact that the two parties repeatedly placed synchronized orders over a long period of time which consistently resulted in a profit for VM and thereby a loss for counterparty, proves that there was collusion between the trading parties.

 

3.3       I am of the opinion that placement of orders which match with a specified counterparty in terms of name of scrip, quantity, price and time of placement of order are synchronized orders and these adversely affect the price discovery mechanism at the stock exchange. In this connection, it would be relevant to refer to the following extracts of the order dated October 31, 2003 passed by the Hon’ble Securities Appellate Tribunal in the matter of Nirmal Bang Securities Pvt. Ltd. (SAT – Appeal No. 54-57/2002): -

“The scrip, quantity and price for these orders had been synchronised by the counter party brokers resulting in circular trades, which were highly irregular in nature and violative of all prudential and transparent norms of trading in securities. BEB and FGSB were artificially shifting position which did not involve change of ownership and thereby creating false volumes resulting in upsetting the market equilibrium…….

………Enquiry Officer has found that it is too much of a coincidence over too long a period in too many transactions where both the parties to the transaction (BEB on behalf of Shri Shankar Sharma and FGSB on behalf of Vriddhi) had entered buy and sell orders for the same quantity of shares almost simultaneously. The total amount of such transaction during the period January to March of 2001 was Rs.200 crores. In most of the instances, the gap between the order placement and its matching is too narrow and the complete order quantities got matched. In view of the close proximity of the order time punched by both the parties in the system, these transactions between BEB and FGSB can be termed as synchronized transactions. Both the parties to the transactions had entered buy and sell orders for the same quantity of shares almost simultaneously. There is no transfer of title in these shares since purchase and sale quantity is exactly the same and by the same party. In view of the above it is clear that FGSB and BEB were acting in concert with each other and entered into in the synchronised deals between the period 1^st January, 2001 and 31^st March, 2001 aggregating to approximately Rs.200 crores which did not involve change of ownership and thereby created a false volumes resulting in upsetting the market equilibrium. Such transactions are per se manipulative and are regarded as such not only in India but world over.”

3.4 Shri K. Gnanasekaran, proprietor of KC in his submissions before me on March 27, 2006, has submitted that these trades in KLG had been done through his terminal and on his account by his employee PVK who was operating the trading terminal. The trades were done by PVK for his (PVK’s) personal benefit without KC’s knowledge. The counterparty to the trades was VM, wife of PVK. As mentioned above, the orders for the trades were entered simultaneously from both ends with a difference in time ranging from 7 to 53 seconds over a trading period extending to 56 days. The transactions were entered into with the premediated purpose of making profits by VM. However, the process adopted therefor constituted creation of artificial trading volumes and thereby misleading the general investors about the trading volumes and the prices of KLG shares.

 

3.5       In view of the evidence on record and the findings given above, I am convinced that VM has violated regulations 4(1), 4(2) (a), (b) and (g) of PFUTP Regulations in conducting the trades in KLG shares. The aforesaid regulations state as under :-

 

 

 

 

“4.Prohibition of manipulative, fraudulent and unfair trade practices

 (1)   Without prejudice to the provisions of regulation 3, no person shall indulge in a fraudulent or an unfair trade practice in securities.

(2)   Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice if it involves fraud and may include all or any of the following, namely:-

(a) indulging in an act which creates false or misleading appearance of trading in the securities market;

(b) dealing in a security not intended to effect transfer of beneficial ownership but intended to operate only as a device to inflate, depress or cause fluctuations in the price of such security for wrongful gain or avoidance of loss;

( c)…

(d)…..

(e)……

(f)….

(g) entering into a transaction in securities without intention of performing it or without intention of change of ownership of such security;”

 Reference may also be made to the definition of fraud laid down in regulation 2 (c) of PFUTP Regulations which states as under:-

"2 (c) "fraud" includes any act, expression, omission or concealment committed whether in a deceitful manner or not by a person or by any other person with his connivance or by his agent to deal in securities, whether or not there is any wrongful gain or avoidance of any loss, ………"

3.6       My findings regarding the above violations are further corroborated by the following:

 

a. In the submission dated March 27, 2006, PVK stated as under on her behalf:-

 

“…….  If there is anything wrong, we will not do trading like this in future…….”.

 

b. On March 27, 2006, Mr. K. Gnanasekaran, proprietor of KC appeared before me and made further submissions as mentioned hereunder:-

 

“ ………. These trades were done through my terminal and in my account by my employee Shri Velmuthukrishnan who was operating the trading terminal…….. He has agreed to me that these trades were done by him for his personal benefit without my knowledge. The counter party to the trades is the wife of my above mentioned ex-employee which fact has come to my knowledge recently during my discussions with him……. ”

 

c.            VM vide her letter dated May 03, 2006 submitted as under:-

 

“Sir I wish to inform you that I have not any intention aly did these trades in violation of Regulations4(1), 4(2) and A,B,G of SEBI.

 

Sir I have not purposefully did any thing against SEBI Regulations.

My husband made some profit in Mr. K. Gnanasekaran trading account that was transferred to our account through KLG Systel Ltd.

 

Sir I request you to condone my mistake and I assure you that I will not do this type of trading in future. I am sending here with Rs.70000 (seventy thousand) demand draft in favour of Hon.Securities Exchange Board of India. Payable at Mumbai. Indian Bank DD No.148313. Already I submitted transactions statement in KLG Systel which indicates profit made by me sum of Rs 70000.

Entire amount I am sending you.”

 

3.7 The above letters and submissions clearly admit that this collusive trading by VM was done in violation of the PFUTP Regulations. The submission of the draft of Rs. 70,000/- towards refund of the profit made is an unequivocal acceptance that the trading in KLG done by her was irregular. This letter also proves that all these were premediated transactions.

3.8 The violations as stated above warrant the imposition of penalty on NS. I have noted that the provisions of section 15HA and 15 HB of SEBI Act, 1992 have been invoked against VM for violation of regulation 4(1), 4(2) (a) (b) and (g) of PFUTP Regulations. The provisions of Section 15HA and 15 HB of SEBI Act, 1992 are mentioned below :

 “[Penalty for fraudulent and unfair trade practices

 

15HA. If any person indulges in fraudulent and unfair trade practices relating to securities, he shall be liable to a penalty of twenty-five crore rupees or three times the amount of profits made out of such practices, whichever is higher”.

 

 “Penalty for contravention  where no separate penalty has been provided

 

15HB. 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.]”.

 

3.9       Section 15HB is a generalized provision which covers penalty for such violations which are not specifically covered elsewhere. The violations by VM are specifically covered under Section 15HA. It would therefore not be appropriate to impose penalty under Section 15HB of SEBI Act, 1992.

 

3.10   However, while considering imposition of penalty, the adjudicating officer is required to give due regard to the following factors mentioned in Section 15J of SEBI Act:-

a)  the amount of disproportionate gain or unfair advantage wherever quantifiable, made as a result of the default

b) the amount of loss caused to an investor or group of investors as a result of the default

c) the repetitive nature of the default

 

 VM vide her letter dated May 03, 2006, has herself admitted that she made a profit of Rs.70,000/- through this trading. The analysis of the daily transaction statement furnished by VM has revealed a profit amount of Rs.71,600.55 (refer para 3.1). As VM was consistently making profit on square up of each transaction, it logically follows that the counterparty would incur this loss. As most of her trades were designed to be executed with KC as counterparty, most of the loss has been incurred by KC. While this may be the loss to a particular entity, the loss to the investing public who were misled by the artificial volumes and prices cannot be ascertained. Further, numerous synchronized trades were executed by VM over a period of 56 days. Thus the repetitive nature of default is also established.

 

3.11   In this matter, the collusion has been expressly admitted by VM by stating that these trades were done to transfer certain profits from KC to her. In other words the stock market trading mechanism has been misused by VM for her personal gain thereby vitiating the integrity of securities markets. This fact has also been admitted by her in her submission March 27, 2006 and in her letter dated May 03, 2006 wherein not only she has admitted her mistake but even attempted to return the irregular profit made by her to SEBI. Such malpractices in  trading has serious consequences for the integrity of the market. If such trading is allowed to go unpunished, it would not only encourage her to repeat this kind of offence but may also result in a graver consequence of loss of faith of general investors in the integrity of the securities market. It is therefore necessary that an adequately deterrent penalty be imposed on her.

4.0 PENALTY

4.1 Therefore in exercise of the powers conferred under section 15 I (2) read with section 15 HA of the Securities and Exchange Board of India Act, 1992 and Rule 5 of the Securities and Exchange Board of India (Procedure for Holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995, I hereby impose a penalty of Rs. 3,50,000/- (Rupees three lacs fifty thousand only) on Mrs. V. Megala. In my view, the quantum of the above penalty is proportionate to the default of Mrs. V. Megala, in the facts and circumstances of the case.

4.2 The penalty amount shall be paid through a crossed demand draft drawn in favour of “SEBI - Penalties remittable to the Government of India” and payable at Mumbai within a period of 45 days from the date of receipt of this order. The draft may be sent to Mrs. Barnali Mukherjee, Deputy General Manager (IVD), Securities and Exchange Board of India, Mittal Court, B Wing, 224 Nariman Point, Mumbai – 400021.

 

PLACE: MUMBAI	PIYOOSH GUPTA
DATE: OCTOBER 06, 2006	ADJUDICATING OFFICER