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IN THE SECURITIES APPELLATE TRIBUNAL MUMBAI Appeal
No: 97 of 2005
CORAM ��������� C.
Bhattacharya, Member ��������� R.N.
Bhardwaj, Member Per:��� R.N.Bhardwaj, Member 1.
The appeal has
been taken up for final disposal with the consent of both parties. 2.
The appeal has
been filed by UBS Securities Asia Limited, (�UBS� for short) against the
impugned order dated 17/05/2005 issued by the Whole Time Member, SEBI, the
operative portion of which reads as under: �11.1�� The
findings in this case have highlighted serious regulatory concerns in that the
PN/ODI route and its cover of anonymity is being used by certain entities
without there being any real time check, control and due diligence on their
credentials. Such a lapse has very grim portents as far as the market integrity
and interest of investors are concerned. The mechanism of opening up the Indian
securities market through PN /ODI route to entities outside India imposes a
commensurate onus on the registered intermediaries (FIIs) of maintaining high
standards of regulatory compliance, exercise of high due diligence and
independent professional judgment and therefore any gaps in measuring up to the
onus may be fraught with critical repercussions in the market. �11.2. In the light of the above and in exercise of
the powers conferred on me in terms of Section 19 of the SEBI Act, 1992, read
with Section 11(4) and 11B of SEBI Act, 1992, I hereby prohibit UBS / its
affiliates / agents from issuing off-shore derivative instruments with
underlying Indian securities against the positions held by UBS in the Indian
securities market for a period of one year. I also prohibit UBS / its
affiliates / agents from renewing or rolling over any of the ODIs already
issued against the positions held by it in the Indian securities market for a
period of one year. ��11.3. I
further direct UBS to establish highest standards of Customer Due Diligence
process in line with the requirements of FII Regulations of SEBI. �11.4. This is without prejudice to any other action
taken or to be taken by SEBI against UBS in accordance with the provisions of
SEBI Act, 1992, the Regulations made thereunder or any other law as may be
applicable. �This order shall come into force with immediate
effect.� 3.
UBS Securities
Asia Limited, i.e., the appellant, is a licensed securities company in 4.
�SEBI investigated a steep fall in the Indian
stock market on 5.
SEBI therefore called
for information from UBS relating to its major ODI clients in terms of their
addresses, the names of their Directors, Fund Managers, Major Shareholders, Top
5 Investors, etc.� It wanted to ascertain
the details of the ultimate beneficiaries as to whom the ODIs were issued by
UBS AG, 6.
The show cause
notice contains details of the information called for and received about
various clients of UBS up to the date of issue of show cause notice i.e.,
7.
The show cause
notice further said that UBS has failed to furnish complete information in
respect of their clients as sought by SEBI. It says: �Thus UBS has failed to furnish complete information
in respect of their clients as sought by SEBI.�
The information so far furnished by UBS was obtained after repeated
follow ups resulting in delay in investigations. Thus UBS has failed to comply
with the Regulation 20 and 20A of SEBI (Foreign Institutional Investors)
Regulation, 1995. UBS has also violated clauses 1, 2, 5 and 6 of Code of
Conduct as specified in Regulation 7A of SEBI (Foreign Institutional Investors)
Regulation 1995.� 8.
The show cause
notice stated that UBS failed to comply with the KYC (Know Your Clients)
requirements as specified in Regulation 15A of the FII Regulations read with
Circular No. IMD/Cust/8/2003 dated 9.
In view of what
is stated above the show cause notice finally asked UBS to show as to why
directions under Section 11(4) and 11B of SEBI Act, 1992 including directions
to prohibit UBS from �dealing in securities on behalf of and/or its clients in
respect of whom it does not have information on their underlying investors�
should not be issued against it. UBS was asked to submit their reply within 15
days from the date of receipt of the notice. 10.
UBS replied to
the show cause notice on 11.
SEBI passed the
impugned order of 17th May, 2005 after taking into account all the
submissions, documents, reply to the show cause notice, information supplied by
UBS after the issuance of show cause notice and the personal hearing on 1st
February, 2005, and May 5, 2005. The order says:� �11.2. In the light of the above and in exercise of
the powers conferred on me in terms of Section 19 of the SEBI Act, 1992, read
with Section 11(4) and 11B of SEBI Act, 1992, I hereby prohibit UBS / its affiliates
/ agents from issuing off-shore derivative instruments with underlying Indian
securities against the positions held by UBS in the Indian securities market
for a period of one year. I also prohibit UBS / its affiliates / agents from
renewing or rolling over any of the ODIs already issued against the positions
held by it in the Indian securities market for a period of one year. ��11.3. I
further direct UBS to establish highest standards of Customer Due Diligence
process in line with the requirements of FII Regulations of SEBI. 12.
The findings of
SEBI in the impugned order are based on the investigations, show cause notice,
reply to the show cause notice, oral and written submissions by UBS and its
Advocates including the written submission on i.
UBS failed to
comply with Know Your Client (KYC) requirement as laid down in Regulation15A of
the FII Regulations. ii.
UBS failed to
furnish complete information about names and addresses of top five shareholders
/ investors of its clients on iii.
The flow of
information from UBS to SEBI was tardy and came after repeated follow up by
SEBI which scuttled the investigation by SEBI iv.
In the process,
UBS also violated the Code of Conduct as prescribed under the third schedule of
Regulation 7A of the FII Regulations. v.
UBS by its various
acts of omission and commission was found guilty of non-compliance of
Regulation 15A which required compliance of Know Your Client and Regulation 20
and 20A of FII Regulations i.e., non-submissions of information pertaining to
top five investors / shareholders, fund manager and Directors of Fund as
requested by SEBI. vi.
�These acts of non-compliance of FII
Regulations by UBS were detrimental to the integrity and orderly development of
securities market and therefore directions under Section 11B and Section 11(4)
of SEBI Act, 1992 were required to be issued. 13.
UBS has failed to Comply with Regulation 15A of FII
Regulations: The impugned order
goes on explaining and detailing how UBS violated Regulation 15A of FII
Regulations which reads as under: �15A. (1) A Foreign Institutional Investor or
sub-account may issue, deal in or hold, off-shore derivative instruments such
as Participatory Notes, Equity Linked Notes or any other similar instruments
against underlying securities, listed or proposed to be listed on any stock
exchange in India, only in favour of those entities which are regulated by any
relevant regulatory authority in the countries of their incorporation or
establishment, subject to compliance of �know your client� requirement : �Provided that if any such
instrument has already been issued, prior to �(2) A Foreign Institutional Investor or sub-account shall ensure that no further down stream issue or transfer of any instrument referred to in sub-regulation (1) is made to any person other than a regulated entity.� 14.
The above
regulation has come into effect from 15.
It is not
sufficient that the entity be only a regulated entity. The order further takes
note of the reply given by UBS that these entities to whom ODIs were issued by
UBS AG, 16.
SEBI could not
accept the contention of UBS that ODIs have been issued by an affiliate i.e.,
UBS AG, London, of the FII (i.e., UBS Securities Asia Limited) which is a
regulated entity in London and accordingly the requirements stipulated in
Regulation 15A of FII Regulations were not applicable in its case. The fact that
UBS London has provided access to the offshore clients through ODIs to Indian
securities market, it has to verify their antecedents and also ensure that KYC
norms as specified in Regulation 15A are fully adhered to. 17.
The impugned
order notes that the KYC guidelines issued by UBS itself are applicable to UBS
and SFCML and also to UBS AG, �knowing who our customers are includes
knowing the people and the entities we deal with as well as knowing the ultimate
beneficiary of the transactions we undertake��� The fundamental question to keep in mind through the
process is simply that UBS is certain that it know the true identity of those with
whom UBS is doing business� �It
is therefore necessary to look through the various entities in the ownership
chain to determine the identity of beneficial owner. 18.
According to
SEBI, it is clear that UBS has not followed its own internal guidelines which
required it to identify the ultimate beneficiaries of entities on whose behalf
UBS or its affiliates transact.�
Therefore the contention of UBS that it does not know the beneficiaries
of entities on whose behalf ODI have been issued against underlying Indian
securities is a clear violation of the KYC norms of UBS itself. �As per SEBI, KYC is a very basic commercial requirement
which does not require any formal definition or prescription. In the light of
the fact that UBS did not supply the required information to SEBI, there were
only two possible inferences: (1) UBS did not comply with the requirements of
Regulation 15A and thus violated its provisions; (ii) UBS had the required
information in its possession or had access to it but did not furnish the
information in time to SEBI would mean violation of Regulations 20 and 20A of
FII Regulations. If UBS had followed either its own internal guidelines or what
is required under Regulation 15A of FII Regulations, it would have been able to
supply SEBI necessary information. In view of what is stated above, it is
obvious that UBS violated Regulation 15A of FII as it did not follow the KYC
norms. 19.
Non-Furnishing of Information: SEBI had asked in the show cause notice names and
addresses of top five investors details of shareholders in respect of six of
its clients. It is noticed that excepting Caxton International Limited, for
which information had not been received till the date of impugned order, the
information in respect of other five cases mentioned in the show cause notice had
been provided to SEBI without the address. In respect of Caxton International
Limited, UBS has neither provided the names of top five investors of the 100%
shareholders nor their addresses. 20.
A Question arises
whether UBS was in possession of information or UBS could have accessed the
information but it failed to obtain the same and submit to SEBI. In response to
the request from SEBI to provide the names of ODI clients with Indian
underlying securities UBS stated that all counter parties were major
institutional investors and they were classified as regulated entities
according to FII Regulation15A and on this basis information relating to
Directors and major shareholders were not provided. SEBI, however, did not
accept this contention of UBS and repeatedly sought the names and addresses of
the underlying clients, their respective shareholders, Directors and Fund
Managers on whose behalf UBS had dealt with in cash market on 21.
Non-Compliance of Regulation 20 and 20A of the FII
Regulations. It says: �20. Every Foreign Institutional Investor shall, as and when required by
the Board or the Reserve Bank of India, submit to the Board or the Reserve Bank
of India, as the case may be, any information, record or documents in relation to his activities as a Foreign
Institutional Investor as the Board or as the Reserve Bank of India may
require�. �20A. Foreign
Institutional Investors shall fully disclose information concerning the terms
of and parties to off-shore derivative instruments such as Participatory Notes,
Equity Linked Notes or any other such instruments, by whatever names they are
called, entered into by it or its sub-accounts or affiliates relating to any
securities listed or proposed to be listed in any stock exchange in India, as
and when and in such form as the Board may require.� 22.
UBS had argued in
its reply to show cause notice that as per Regulation 20A of the FII
Regulations, the obligation of UBS is to disclose only the �terms and parties�
to offshore derivative instruments such as participatory notes, equity linked
notes entered into by it.� There was no
obligation to record / details of top five investors and major share holding of
the clients. 23.
The impugned
order did not accept the interpretation in 20A concerning �terms and parties to
offshore derivative instruments�. It concluded that UBS should have information
and details to enforce the agreements with their clients. 24.
The impugned
order further said that Regulation 20 of FII Regulations was of much wider
scope which casts an obligation on the FII to submit to the Board / RBI �any
information, record or documents in relation to his activities as a Foreign
Institutional Investor�. 25.
In the light of
aforesaid, the information sought by SEBI was well within the realm of
Regulations 20/20A and UBS was obliged to supply the same under the FII
Regulations. 26.
Investigations were hampered by contumacious conduct
of UBS: The show cause notice
alleged that the investigations were hampered because of the contumacious
conduct of UBS. SEBI wanted to conduct an investigation about the reasons of an
unprecedented market crash on �The conduct of UBS as narrated above
speaks for itself and for the purpose of determining the Contumacious Conduct
of UBS, I do not find it necessary to go into the notices of UBS for not-cooperating
to the requests of the regulator. The egregious conduct of UBS is evident from
the circumstances as mentioned above.� The delay in the receipt of information erodes
its value as an evidence in a real time enquiry. 27.
Incidence of reporting lapses and mis-statement: ���� UBS had
cited confidentiality provisions in its client agreement as reasons for
non-furnishing of information.� The fact
that it could provide information as sought by SEBI in respect of many of its
client but did not provide similar information in respect of its other clients
shows that client confidentiality provisions was not a restraining factor.� Some clients provided information directly to
SEBI. Thus failure to provide information to SEBI was due to the reluctance of
UBS to furnish information. UBS provided some vague information while
furnishing the names of top five investors of Indus Asia Pacific Fund Ltd., on
14th January, 2005, but later on when SEBI asked for specific
information it gave the names of top five investors to SEBI which shows that it
was in a position to access the information but it did not submit the same to
SEBI. When SEBI asked for copies of client agreement with three of its clients,
namely, Caxton International Limited, Discovery Capital and Indea Capital
Limited, UBS submitted the �terms and conditions� of a proforma agreement but later
on it submitted the copies of the client agreement with two clients viz.,
Discovery Capital and Indea Capital Limited, on 29th April, 2005
subsequent to personal hearing on 1st February, 2005 and 5th
May, 2005. 28.
During personal
hearing, it was mentioned by UBS representatives that all information sought by
SEBI had been provided to SEBI including ultimate investors of Caxton
International Limited. However, vide their letter dated 29.
Non adherence to Code of Conduct:������ UBS has
been charged with the violation of clauses 1, 2, 5 and 6 of Code of Conduct as
specified under Regulation 7A of FII Regulations. The code of conduct states
that: �1.������ a
Foreign Institutional Investor and its key personnel shall observe high
standards of integrity, fairness and professionalism in all dealings in the
Indian securities market with intermediaries, regulatory and other government
authorities.� �2. ����� A foreign Institutional Investor shall, at all times, render
high standards of service, exercise due diligence and independent professional
judgment.� ���. �5. A foreign
Institutional Investor shall maintain an appropriate level of knowledge and
competency and abide by the provisions of the Act, regulations made thereunder
and the circulars and guidelines, which may be applicable and relevant to the
activities carried on by it. Every foreign Institutional Investor shall also
comply with award of the Ombudsman and decision of the Board under Securities
and Exchange Board of India (Ombudsman) Regulations, 2003. 30.
According to
SEBI, UBS should have been in a position to know the ultimate client for whom
the ODIs have been issued by UBS AG, �Conduct is generally judged not based on single
activity; but on a course of behaviour showing intentional non-cooperation with
the regulator and is usually the result of acts, practices and the like
approaches that are designed to give the slip to the regulator.� The conduct of the appellant was
detrimental to the orderly development of the securities market. 31.
Considering all
these factors UBS failed to maintain high standards of integrity, fairness and
professionalism in all dealings in the Indian securities market with the
regulatory authority and comply with the relevant clauses of the Code of
Conduct as applicable to FII. In view of the above, UBS is found guilty of
non-compliance of Regulations 15A, 20 and 20A and Clauses 1, 2, 5 and 6 of Code
of Conduct under Regulation 7A of the FII Regulations. It has failed to
exercise due diligence in dealing with its clients and the regulator.� It has failed to maintain appropriate level
of knowledge and competency. UBS has made selective statements and even
suppressed material facts in documents and reports to SEBI. 32.
Learned senior
counsel for the appellant, Shri C.A. Sundaram, submitted that the impugned
order by SEBI is not justified as there is no failure on the part of the
appellant to comply with the Regulations 15A, 20 and 20A of the FII Regulations
and Clauses 1, 2, 5 and 6 of the Code of Conduct of the FII Regulations. He
argued that the main charge against the appellant was that it did not furnish
information of top five clients / investors to SEBI for conducting the
investigation, and that it violated the KYC requirement as prescribed in
Regulation 15A of the FII Regulations. The learned senior counsel submitted
that it would have submitted the required information to SEBI on time had it
been clearly mentioned in the Regulations applicable to FII. The Regulation 15A
of FII Regulations, which reads as under: �15A. (1) A Foreign
Institutional Investor or sub-account may issue, deal in or hold, off-shore
derivative instruments such as Participatory Notes, Equity Linked Notes or any
other similar instruments against underlying securities, listed or proposed to
be listed on any stock exchange in India, only in favour of those entities
which are regulated by any relevant regulatory authority in the countries of
their incorporation or establishment, subject to compliance of �know your client�
requirement : �Provided that if any such
instrument has already been issued, prior to �(2) A Foreign Institutional Investor or sub-account shall ensure that no further down stream issue or transfer of any instrument referred to in sub-regulation (1) is made to any person other than a regulated entity�. 33.
�The learned senior counsel for the appellant
submitted that a plain reading of the Regulation 15A it makes quite clear that
it does not call for knowing the ultimate beneficiary or the persons behind the
client who has entered into an agreement.�
Nowhere is it mentioned that the names and addresses of top five
investors / clients should be maintained by the FII and provided to the
regulator. All that it says is that derivatives such as Participatory Notes can
be issued by the FII in favour of only those entities which are regulated in
the countries of their incorporation subject to compliance of Know Your Client
(KYC).� Nowhere KYC requirement has been
defined in the FII Regulations or in any other laws/rules/regulations/byelaws
relating to FIIs.� The learned senior
counsel pointed out that it is not possible to give a definite and certain
meaning to the KYC as it is mentioned in Regulation 15A. He argued that any
interpretation of the KYC which is to be understood, should be seen in the light
of the circular dated 34.
The learned
senior counsel pointed out to the paragraph 6(22) of the impugned order which
says � �Know Your Client� is a very basic commercial requirement which does not
require a formal prescription�. He submitted that in the light of such KYC
requirement which is not exact as is admitted by the Respondent itself and
which has not been defined by the respondent there could not be any legal
obligation on the part of the appellant to maintain and obtain information
pertaining to the names and address of the major shareholders / top five
investors. The reasoning is flawed. The learned senior counsel again pointed
out to paragraph 9.13 of the impugned order which holds that: �It is the duty of UBS that prior to issue
of ODIs with underlying Indian securities it should have been completed the �know
your client� requirements by asking its clients all the questions that the
regulator (i.e., SEBI) is likely to ask. Instead, UBS claims to have approached
its respective clients after SEBI sought information regarding these
clients.� This shows that UBS has failed
to understand the essential meaning of �know your client� requirements.� 35.
He submitted that
SEBI has sought to impose an indeterminate standard as it expects the appellant
to anticipate correctly all the questions that the respondent may �likely to
ask or may ask in future.� He submitted that it is impossible to satisfy such a
requirement.� SEBI should have made known
questions which are likely to be complied with by the FIIs instead of leaving
them to be imagined by the FII to respond when SEBI asked such questions. The
KYC requirement in terms of Regulation 15A of FII Regulations should have been
more exact and precise. 36.
�The learned senior counsel again pointed out
to paragraph 6.23 of the impugned order which states that: �It is the duty of UBS / its affiliate
that prior to issue of ODIs against underlying Indian securities, it should
have completed the �know your client� requirements by asking its clients all
the questions that the regulations required.� 37.
The learned
senior counsel submitted that the regulations do not prescribe any specific
question which should have been asked by the appellant.� He submitted that in the absence of any clear
guidance from the respondent and the regulations the scope and extent of KYC
requirement under Regulation 15A of the FII Regulations would be highly inexact
and flexible because the interpretation would be left to the respondent at
subsequent point of time. He went on to argue that the phrase �know your
client� has not been defined by the respondent anywhere. He argued that in the
absence of a clear definition in the provision, the regulation cannot be given
a wide interpretation against the accused.�
Further there could not be any case against the appellant if it does not
arise from a reasonable construction of the statute.� Because of any ambiguity in the law, the
Court must lean towards the construction which exempts the accused from the
penalty.� 38.
The learned
senior counsel further argued that the requirement of verifying that the first
level of clients are regulated entities is clearly stipulated in Regulation 15A(1)
of the FII Regulations.� The respondent
by its circular dated 39.
The learned
senior counsel submitted that the impugned order makes an allegation that UBS
has not complied with its own internal KYC policies / guidelines. He submitted
that ODIs were issued by UBS AG, 40.
The learned
senior counsel submitted that the respondent had relied only on preamble of
�Know Your Client Policy Summary� of the appellant which states that the
purpose of CIP is to determine the true identity of each of its customer.
However, the detailed specific KYC / CIP requirement are dependent on specific
conditions based on geographical location of the client, regulatory status,
nature of the client, type of business of the client and business to be done
with the client, risk participation, etc.�
Schedule A of Client Identification Program (CIP) did not require UBS
AG, 41.
He also submitted
that FII industry, even now, is not clear about the KYC requirement.� He pointed out to the letters dated
08/06/2005 of ISDA which is a Global Trade Association representing over 600
institutions from 47 countries including India, letter dated 18/05/2005 of Merrill
Lynch and Citi Group letter dated 16/05/2005 and it was pleaded that there were
areas of uncertainty and ambiguity about the KYC requirement under Regulation
15A of the FII Regulation which are causing great concerns for market
participants in the FII industry. They were not quite sure of the KYC
requirement under FII Regulations. �A
request was made in the latter for �guidelines setting out the minimum KYC
requirement that FIIs should meet under the Regulations� 42.
The learned
senior counsel pointed out that the SEBI (Stock Brokers) Regulation have been
modified in October, 2004 which stipulates the KYC requirement but under
Regulation 15A of the FII �Regulation
there is no requirement to obtain the same type of details of the shareholders
or ultimate beneficiaries. The learned senior counsel also submitted that when the
Tribunal had asked the respondent to clarify to the entire industry what it
meant by KYC through an affidavit, the Respondent filed an affidavit dated (i)
Dilip Kumar
Sharma v. State of (ii)
Tolaram
Relumal v. State of (iii)
Samir C.
Arora v. SEBI (Appeal No. 83/2004)�� The learned senior counsel submitted that
the appellant is required to provide a monthly undertaking as to the ODIs being
issued / subscribed / purchased directly or indirectly by Indian residents,
NRIs, OCBs (other corporate bodies), PIOs (Persons of Indian Origin). He
submitted that the appellant had ensured in all circumstances that the ODIs
were not issued / subscribed / purchased by such persons as mentioned above and
the appellant was fully aware of the identity of the purchasers / subscribers
of such ODIs. Further more, UBS AG, London obtained warranties from the clients
on the basis of which the appellant was in a position to give monthly
undertaking in compliance to SEBI.� He
further argued that there was no evidence whatsoever to suggest that any
undertaking had been breached. There was no such allegation made by the
Respondent also.� The undertaking only
required UBS AG, London to be satisfied as to the first level of information
about the identity of the clients to whom ODIs were issued. There was no
mention of top five investors or ultimate beneficial owners because UBS AG
London only required to confirm that the clients to whom ODIs were issued were
not NRIs or PIOs or OCBs with major shareholding of Indian origin persons. As
per Regulation 15A(2) of the FII Regulations the only requirement for any
further down stream issue or transfer of ODIs is to ascertain that further down
stream issue or transferring of such ODIs is only to a �regulated entity�. 43.
The learned
senior counsel argued that impugned order holds that appellant failed to
satisfy SEBI that the warranties have not been complied with was not based on
facts. It was mentioned in the order as �brazen tokenism without a modicum of
compliance in substance�. Such a finding was not correct. On the contrary the
names or description of the top five investors of any client would indicate no
one is PIO or NRI or an OCB. This allegation is not a part of the show cause
notice. He argued that under CIP, UBS London was not required to obtain top
five investor information. The clients were international investors.� The non-availability of information was not
because the appellant did not follow the KYC or its CIP procedures but because
it believed along with the rest of the FII community that for compliance of
KYC, the information sought by the respondent was not necessary. 44.
The learned
senior counsel, Mr. Sundaram submitted that there has been no breach of
Regulation 20 and 20A of the FII Regulations. He submitted that it was wrongly
concluded that the appellant deliberately failed to submit the relevant
information which was either in its possession or it could have directly
accessed the same and thus violated Regulations 20 and 20A.� The Regulation 20 of FII Regulations provides
that every FII shall submit to SEBI or RBI any information, record or document
in relation to its activities as an FII whenever required by SEBI or RBI.� The learned senior counsel submitted that the
appellant had been promptly responding to any communication received from the
respondent with regard to the information required by it. Wherever information
was available with the appellant the same was promptly submitted and where it
did not have the information it actively followed up and pursued with the
clients and persuaded them to comply with the respondents demands. The fact
that the appellant had several personal meetings with various officials of the
respondent is a sheer proof of its willingness to cooperate with the
respondent. The conclusion in paragraph 7.7 of the impugned order which states
that the information relating to the clients of UBS which was sought by SEBI
was already available with the (i)
Special
Reference No. 1 of 2002 �
AIR 2003 SC 87; (ii)
Raj
Kumar Dey and Others v. Tarapada Dey� AIR
1987 SC 2195; He argued and asked where had it been
prescribed in the Regulations that particulars of the top five investors of the
FII clients were normally required to be in possession of the FII?. Investors
of the clients could be a continuing and changing stream and there was no
regulation which required monitoring of such changing number of investors. 45.
Regulation 20A:����� The learned senior counsel
argued that there was no breach of the Regulation 20A of the FII Regulations.
Regulation 20A required that FII investor shall fully disclose information
concerning �the terms and parties� to offshore derivative instruments such as
Participatory Notes, Equity Linked Notes or any such instruments of whatever
names they are called as and when the Board may require. He submitted that the
respondent had issued a circular dated 46.
�There
is no breach of Clauses 1, 2, 5 and 6 of Code of Conduct under Regulation 7A of
the FII Regulations: The learned senior counsel submitted that the
appellant had been observing the highest standards of integrity, fairness and
professionalism in its working. It had worked with due diligence in its dealing
with the respondent. It had cooperated with the respondent in obtaining and submitting
all information which was required by the respondent. It made necessary effort
in getting the information as requested by the respondent.� The appellant corresponded promptly with the
clients and even suggested to the clients to provide necessary information to
the respondent if they were prevented because of client confidentiality clause from
disclosing the required information to the appellant. He further submitted that
in law diligence meant doing all that which an ordinary man would do having
regard to all the circumstances remaining within the parameters set out by the
law. The appellant made sincere efforts to comply with every request and direction
of the respondent.� At times, the delay
which occurred in submitting the information to the Respondent was mainly due
to non-availability of information which the appellant was not required to
maintain in the ordinary course of business or in terms of FII Regulations.
Therefore it could not be said that the appellant had failed to exercise due
diligence. The learned senior counsel argued that it would be wrong to say that
the appellant did not maintain the appropriate level of knowledge and
competency and abide by the provisions of SEBI Act, FII Regulations and other
circulars and guidelines from the regulator.�
He further said that the appellant has not knowingly made any wrong
statement or knowingly submitted wrong statement or suppressed any information
to the Respondent. The appellant has always maintained highest standards of
integrity, fairness of professionalism. The learned senior counsel referred to
the judgment in the case of Peco Arts
Inc. V. Hazlitt Gallery Ltd. [1983] 3 All ER 193, for explaining what
�reasonable diligence� was all about. It holds that: ��.. that it is impossible to devise a
meaning or construction to be put on those words which can be generally applied
in all contexts because, as it seems to me, the precise meaning to be given to
them must vary with the particular context in which they are to be applied. In
the context to which I have to apply them, in my judgment, I conclude that
reasonable diligence means not the doing everything possible, not necessarily
the using of any means at the plaintiff�s disposal, not even necessarily the
doing of anything at all, but that it means the doing of that which an
ordinarily prudent buyer and possessor of a valuable work or art would do
having regard to all the circumstances, including the circumstances of the
purchase.� He also referred to the order of SAT in
the case of JM Mutual Fund & Anr. Vs.
SEBI in appeal No. 39/04 and 39A/04. It was submitted that the appellant
has in no way breached the clauses 1, 2, 5 and 6 of the Code of Conduct. 47.
The learned
senior counsel argued that investigations of the respondent were not hampered
by the conduct of the appellant. It is mentioned in the order dated 48.
As regards non
receipt of ISDA agreement, it was submitted by the learned senior counsel that
on 49.
The learned
senior counsel argued that even the respondent was aware that the appellant
could not have information from the clients as a matter of legal right.
Therefore the respondent informed the appellant as follows: �Kindly persuade your client to furnish requisite information if not
through you directly to SEBI if they so prefer�. 50.
This is evident
from the e-mail dated 51.
Misstatements and Reporting Lapses: It was submitted by the learned senior counsel that
there was no evidence to suggest that the appellant did not want to submit the
information to the respondent on account of client confidentiality. In fact it
was the clients who were claiming difficulties in releasing the information to the
appellant because of their own confidentiality obligations to their investors.
It was not the suggestion of the appellant to the respondent that appellant was
not providing information because of client confidentiality agreement between
it and the clients.� In fact there is
always an exception to such confidentiality from the regulatory authorities. 52.
On 53.
The learned senior
counsel submitted that it was not the intention of the appellant to mislead the
respondent by saying that the transactions of 54.
It was submitted
that it is not correct that non disclosure of Indian sounding names in the
investigation lead to thwarting of investigation. It was submitted that
contrary to what the respondent stated in the impugned order, the respondent
already had the Indian sounding names in some cases including the names shown
as signatories on behalf of Indea as early as 55.
As regards the charge
that Caxton International Limited�s name was not included in the ODI statement
submitted to the regulator from January, 2004, the appellant regretted this
error which happened inadvertently due to incompatibility of the appellant�s
internal infrastructure and software system. The appellant had acknowledged
error and amended the reports. Moreover these errors were not subject of the
show cause notice dated 56.
The learned
senior counsel submitted that the impugned order contained observations which
indicated that the appellant wrongly held to have engaged in actions requiring
an element of intention or willfulness or mensrea. He refuted all such
instances mentioned in the impugned order. Some of such wrongful conclusions
requiring an element of intention or willfulness are: i.
In paragraph 6.23
of the impugned order, it has been wrongly alleged that the appellant was
trying to �evade� the obligations under the KYC requirement; ii.
In paragraph 7.5
of the impugned order, the conduct of the appellant has been incorrectly
described as �crafty�; iii.
In paragraph 8.16
of the impugned order, the conduct of the appellant has been incorrectly
described as �contrived posture to avoid� and the appellant�s submission that
there was no attempt to suppress anything has been rejected wrongly; iv.
In paragraph 8.19
of the impugned order, the conduct of the appellant has been incorrectly
described as a �measured move� in making �convenient disclosures�; v.
In paragraph 8.22
of the impugned order it is denied that the appellant has given �several
excuses that have been trotted out in not complying with this basic requirement
�. since they were meant to beguile the underlying and felt need not to divulge
the information�; vi.
In paragraph
8.24(b) and 9f) as well as paragraph 9.18, the respondent has incorrectly observed
that the conduct� of the appellant
carries the undertones of �suppression versi suggestion falsi� and that despite
being in possession of the information required by the respondent, the
appellant did not provide the respondent with such information. The appellant
denied that the appellant has deliberately withheld such information from the
respondent; �attempted to delay providing the same by giving vague descriptions
regarding the top five investors of the said client�. vii.
In paragraph 9.16
of the impugned order it is denied that the appellant has �attempted to mislead
SEBI by making false claims�; and viii.
In paragraph 9.20
of the impugned order, it has incorrectly been held that the conduct of the
appellant holds out �tell-tale strands of how it was fashioned as a deliberate
strategy to obfuscate the proceedings�. Furthermore, it is denied that the
appellant has acted with �intentional non-cooperation with the regulator� and
is �the result of acts, practices and like approaches that are designed to give
the slip to the regulator.� 57.
The learned
senior counsel submitted that in para 8.1 and 8.2 of the impugned order an
allegation has been made that on 17/05/2004 UBS was a major trading client in
the cash and F&O segment and by its strategy it earned gross profit of Rs.
59.37 and it incurred loss of Rs. 17.54 on account of its sale in cash segment
whereas it earned profit in Futures segment. It earned net profit of Rs. 41.83
crores. 58.
The learned
senior counsel contested the figures and the analysis as mentioned in the
impugned order. He denied that there was any �strategy� on the part of
appellant to effect large scale sales in cash market to depress the market and
simultaneously take short positions in the futures segment. He submitted that
these allegations were not correct.� The
appellant was never informed of such allegations. It was not mentioned in the
show cause notice. It amounted to pre-judging the issues which was in violation
of principles of natural justice. 59.
It was submitted
by the learned senior counsel that the appellant was constantly keeping the
respondent informed of the difficulties and delays being faced in obtaining the
required information from the clients and as such it could not be alleged to
have committed these violations as mentioned in the impugned order. 60.
The learned
senior counsel submitted that the impugned order travels beyond the scope of
the show cause notice. The show cause notice mentions why directions should not
be passed prohibiting the appellant from dealing securities on behalf of the
appellants in respect of whom the appellant does not furnish information on
their underlying investors.�� However,
the impugned order has prohibited the appellant from dealing in ODI on behalf
of its clients and it also purports to require disclosure of beneficiaries. The
prohibition has been imposed on the appellant and not on persons who failed to
provide the information and who continued to trade in Indian stock market. The
impugned order directly adversely affects the third party clients of the appellant
who have not been issued any show cause notice or given any hearing. 61.
�The impugned order has been passed under
Section 11(4) and Section 11B of the SEBI Act, 1992. It does not enable the
respondent to impose penalties for violation of provisions of SEBI Act, 1992
and the FII Regulations. Powers under Section 11B of SEBI Act, 1992 are to be
used only to take remedial and preventive steps and not for imposition of
penalties.� A ban on the appellant for a
period of one year does not remedy the market position when the funds relate to
activities which are more than year old. The ban is in the nature of a
penalty.� Such an order is not intended
for orderly development of the market. Section 11B order should be passed only
in emergent scenario. He cited the following case laws in support of his
contention: i.
Sterlite Industries ( ii. Videocon International Ltd. v. SEBI � [2002] 38 SCL 422: iii. BPL Ltd. v. SEBI � [2002] 38 SCL 310 (SAT) 62.
He further argued
that the penalty imposed by the appellant is disproportionate as compared to
the penalties imposed by the respondent in earlier comparable cases such as : i.
M/s. Mani & Company v. SEBI �
Appeal No. 31 of 2005 ii.
Jitendra J. Shah� v. SEBI � Appeal No. 148
of 2004 iii.
Bipin R. Vora v. SEBI � Appeal
No. 273 of 2004 63.
He further
submitted that the impugned order is proceeding on the basis of the finding
that the appellant is guilty and such a finding is tantamount to a final
finding on the issue and as such orders should not be under Sections 11(4) �and 11B of the SEBI
Act, 1992. In fact if there was any violation of FII Regulations the action
should have been taken under Regulation 21A under SEBI (Procedure for Holding
Enquiry by Enquiry Officer and Imposing Penalties) Regulations, 2002. 64.
The learned
senior counsel submitted that 40% of the business of the appellant was from
ODIs and ban on its ODI transaction would severely impact the income of the
appellant. He further argued that the appellant was a global investment bank
which operated in 40 countries with a strong institutional and corporate client
base and enjoyed high reputation. It had a substantial business interest in 65.
Mr. Rafique Dada,
learned Senior Counsel for the respondent, while defending the impugned order
submitted that it was essential to take note of the circumstances which lead to
the issuance of this order.� He drew attention
to the unprecedented crash in the securities market on 66.
The justifiable anxiety
of the regulator was to avoid any security scam particularly in view of what had
happened in 2001 when it was suspected that some Indian promoters had purchased
the shares of their own companies through FII route� which was later on shifted to Ketan Parikh
entities through OCBs.� It was in this
context that SEBI had issued a circular dated 67.
He also submitted
that Joint Parliamentary Committee (JPC) which was appointed soon after the 1999-2001
scam also observed that through PNs various layers were created which made it
easy for holders to keep their identities undisclosed and at the same time
purchase shares in the Indian capital market.�
Participatory Notes are derivative instruments issued by FII against
holding underlying Indian securities. An investor may collect funds from
various retail investors to pool the funds against underlying Indian securities
and the return could be linked to equity index. PNs are extra-territorial
instruments. 68.
The amendment to
the existing format of circular of 69.
Later on
Regulation 20A was inserted on 28/08/2003 which require the FIIs to disclose
information concerning �terms of and parties� to ODIs such as Participatory
Notes entered into by Financial Institutions or its sub-account or affiliates relating
to any securities listed or proposed to be listed in any Stock Exchange in India,
as and when and in such form as the Board may require�. Thereafter Regulation
15A was inserted on (i)������� FII Can issue ODIs against underlying Indian securities only
to entities which are regulated by any relevant regulatory authorities in the
countries of their incorporation. Further the FII shall ensure that no further
down stream issue or transfer of such ODIs is made to any person other than a
regulated entity. (ii)������ Secondly the ODI issue can be made subject to compliance with
�Know Your Client� requirement.� 70.
�The learned senior counsel for the respondent
emphasized that both the conditions were absolutely essential for compliance of
Regulation 15A. It could not be taken as compliance of Regulation 15A merely if
ODIs were issued to the regulated entities. The compliance of KYC was equally
important part of the Regulation.� He
went on to argue that �Know Your Client� was in fact, defining the existing provisions
under Regulations 20 and 20A.� The
learned senior counsel argued that the appellant failed to meet with the
requirement of Regulation 15A when it did not submit the required information
about the names and addresses of top five investors / shareholders of clients
to whom ODIs had been issued by the UBS AG, 71.
He went on to
argue that the appellants themselves have their own Customer Identification
Program (CIP) which existed even before the introduction of Regulation 15A in
2004. In terms of the Client Identification Program (CIP) of the appellant, it
is necessary to ascertain the identity of the ultimate beneficiary whose
account is being operated. The appellant�s CIP specifically mentions that it
complies with the requirement of Financial Task Force (FATF) which is an international
organization formed for prevention of money laundering and terrorist financing.
It is clear from Forty Recommendations framed by FaTF that it recommends
identification of the �beneficial owner� of customers by financial
institutions. The �beneficial owner� is the ultimate beneficiary. He submitted that
the concept of KYC was internationally understood in the financial sector to
mean the ultimate beneficiary of an account. He submitted that to know the
ultimate beneficiary it would be essential to remove the layers.� He submitted that if it was not necessary to
know the ultimate beneficiary and we only go through one or two layers, then it
would always be possible to conceal the real / ultimate beneficiary which would
defeat the purpose of KYC.� Hence the
condition of KYC as required under Regulation 15A was similar to that which was
available in the CIP of the appellant and it was also the same internationally.
He submitted that there could not be any doubt about the meaning of the concept
of KYC which UBS found difficult to follow although it was a well known concept
throughout the financial world and appellant could not take the pretext of its
vagueness. The appellant have violated Regulation 15A when they failed to
submit the information required by SEBI, the respondent. 72.
The learned
senior counsel argued that even without Regulation 15A the respondent was well
within its right to ask for any information / record or document in relation to
the activities of a Foreign Institutional Investor. The information which was
sought to be received by the respondent from the appellant was well within the
provisions of Regulation 20 of FII Regulation.�
In fact the compliance of respondent�s circular dated 73.
As regards
Regulation 20A the FII is required to fully disclose information concerning �terms
of and parties to� offshore derivative instrument like participatory notes, or equity
linked notes which are entered into by the FII or its sub-account or affiliates
relating to securities listed in any stock exchange in India.� The appellant failed to supply the
information when SEBI asked for it and went on to say that the information was
not available with it and it has to access the same from the clients.� On 24/11/2004 when the show cause notice was
issued, the appellant could not give the information about the top five
investors / shareholders (their names and addresses) of six major clients of
UBS i.e., Caxton International Limited, Indus Asia Pacific Fund Limited,
ROHATYN, Indea Capital Pte. Ltd., PMA Prospect Fund and Satva Asia
Opportunities Master Fund. At the time of issuance of impugned order, excepting
Caxton International Limited, most of the information had been submitted by the
appellant vide its letter dated 74.
Non-Furnishing of Information: ����������� The
respondent had asked by e-mail dated 75.
The learned
senior counsel further argued that the appellant were required to submit
monthly statement in terms of SEBI circular dated 76.
Hampering of Investigation by the Contumacious Conduct
of the Appellant:����� The respondent could not get names of
clients and addresses of major shareholders and major investors and the Fund
Managers of Caxton International Limited even up to the date of impugned order
on 17/05/2005 despite the fact that Caxton International comprises of over 50%
of the transactions entered into by the appellants on 17/05/2004. The
appellants stated that some Investment Managers may not be able to respond due
to confidentiality constrains. The appellant informed vide e-mail dated
11/08/2004 that as and when they receive further information they would inform
the respondent which clearly shows that the requisite information was not
available on behalf of their clients at the time of entering into transactions
thereby violating the KYC requirement under Regulation 15A. 77.
The Caxton
International vide their letter dated 09/09/2004 informed SEBI that Caxton
International Limited was British virgin island company which had entered into
a Price Return Equity Swap on NSE, S&P, CNX, NIFTY Index with UBS AG,
London on 06/01/2004 and on 17/05/2004 the parties closed out the said Swap in
order to prevent further losses. The respondent wanted confirmation whether any
of the major investors of Caxton International Limited were FIIs. When the
information was not forthcoming due to non-cooperation of the appellant the
respondent sought the client agreement from Caxton International Limited from
the Securities Exchange Commission, 78.
Indus Asia Specific Fund Limited:��������� The
respondent had sought for the names of major shareholders and top five
investors of Indus Asia Specific Fund Limited on 79.
ROHATYN, Indea Capital Pte. Ltd. PMA Prospect Fund
& Satva Asia Trading Master Fund:����������� Information in all these cases were
received after the issuance of the show cause notice. The appellant vide e-mail
dated 14/01/2005 furnished further information regarding the names of the investors
in the TRG Global Master Fund, Rohatyn and certain others were directors of
Fund. 80.
In case of Indea
Capital Pte. Ltd., the appellants were informed on 81.
The learned
senior counsel argued that it was wrong to say that impugned order was beyond
the scope of show cause notice. The appellants were repeatedly asked to furnish
information regarding top five investors and top five shareholders in respect
of some of their clients.� Majority of
the information sought by the respondent was furnished only after issuance of
the show cause notice. At the time of issuance of show cause notice the breach
of regulations were substantial by the appellant.� In the show cause notice dated 24/11/2004 it
was clearly set out that the appellant were called upon to show why action
should not be taken against the appellants including directions to prohibit the
appellant from dealing in securities on behalf of their clients in respect of
whom the appellant did not furnish the information.� It clearly says that it was one of the
actions contemplated in the show cause notice and nowhere was it indicated that
this was the only action which the respondent would take against the appellant
in case the appellants were unable to show cause to the aforesaid notice.� On the contrary the respondent has taken into
account the information submitted even after the issuance of the show cause
notice. The wording of the show cause notice are as under: �in view of the above you are required to show cause
as to why directions under Sections 11(4) and 11B of the SEBI Act, 1992
including directions to prohibit you from dealing in securities on behalf of
clients in respect of whom you do not have information on their underlying
investors should not be issued against you�. 82.
The inclusive
portion in the show cause notice does not in any way limit the scope of the
show cause notice. It encompasses within its fold any direction or order that
may be passed under Section 11(4) and or Section 11B of SEBI Act, 1992. He further
argued that it was not correct to say that order could be passed only under
Regulation 21 of the FII Regulations read with SEBI (Proceedings for Holding
Enquiry by Enquiry Officer and Imposing Penalty) Regulations 2002. The learned
senior counsel further argued that it was also not correct to say that punitive
action could not be taken under Section 11B. The conditions for taking action
under Section 11B are mentioned in clause (i), (ii) and (iii). It also needs to
be stressed that any action taken under Section 11B by the regulator would
invariably have some detrimental impact on somebody which could not be avoided
in the interest of the security market.�
He referred to the view taken by Hon�ble Tribunal in cases such as
Sterlite, BPL and Videocon.� He also
pointed out that where SAT had taken a view in Roop Ram Sharma�s case similar
to that of Sterlite Industries.� The
Hon�ble Supreme Court has stayed the judgment of SAT and therefore the earlier
decisions of the Tribunal could not be operative in the present case.� In any case, he submitted that the impugned
order under Section 11(4) of the Act can independently be supported.� The insertion of Section 11(4) in the Act
expressly clarified the position and empowers SEBI to restrain persons from
accessing the securities market and prohibit any person associated with the
securities market either pending enquiry or investigation or on completion of
such inquiry or investigation by recording the reasons in writing in the
interest of investors or securities market. In the impugned order there is only
limited prohibition or bar on the appellant from issuing fresh ODIs and rolling
over of the existing ODIs for a period of one year. He submitted that the
Nirmal Bang case which was cited by the learned senior counsel for the
appellant in which the SLP was dismissed by the Supreme Court is of no relevance
here because in the aforesaid case the order was not based under Section 11B,
it was a case where action was taken under FUTP Regulations. He went on to
argue that Section 11(4) and Section 11B were not confined to market
manipulations only. He submitted that orders under Section 11(4) and Section
11B could be passed either under emergent situation pending full scale enquiry
or it could be after the conclusion of enquiry or investigation. It is for the regulator
to weigh the need under which provision of the Act should he take an action in
a given situation. The learned senior counsel submitted that it could not be
accepted that SEBI would take action only under Regulation 21 read with the
Enquiry Regulations. The Competent Authority �might not think that the alleged violations by
the FII would warrant suspension or cancellation of registration. It might
think that directions under Section 11/11B of the SEBI Act or by imposing
monetary penalties under Chapter VIA could address the violations. A serious
violations could even invoke the Section 24 of the Act.� He argued that all these measures were
mutually complementary and it would be wrong to say that under the
circumstances the only course open to SEBI was under Regulation 21 of the FII
Regulations. It would render the Section 11(4) and Section 11B of SEBI Act,
1992 as redundant which would not be the intention of the legislature which has
introduced Section 11(4) in 2002. 83.
The learned
senior counsel for the respondent argued that it was contended by the appellant
that the clients who did not furnish the required information to the regulator
were free to deal in ODIs through other FIIs, whereas the instant order is
passed against the appellant for its failure to adhere to and follow the
applicable SEBI FII Regulations. The appellant is a registered FII and it is
supposed to follow the FII Regulations which include KYC and Regulations 20 and
20A. The impugned order may result in the appellant improving its KYC system
and there is further direction to the appellant to �establish highest standards
of customer due diligence process in line with the FII Regulations of SEBI.� 84.
The appellant in
the course of oral submission had argued that SEBI has made some changes in the
SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992 in August 2004. The
appellant have submitted the format for individual client registration as of
August, 2004 and uniform contemporary requirement and the form of individual
client registration. He argued that this format is required to be understood as
the format between a broker and its client in the Indian scenario. The
appellant contended that in the event of an entity being registered as FII
which is a client of a broker, the requisite information is not required to
be� furnished.� The aforesaid exemption from furnishing information
is granted in the case of FII as an FII would be required to comply with the
disclosure requirement under the FII Regulations. In the case of the client of
FII, there is no other Regulation which requires furnishing of information and
therefore the KYC has to be understood in the case of a client of an FII to
mean the ultimate client of the said FII. 85.
The learned senior
counsel for the respondent submitted that, the appellant, during the course of
arguments sought to criticize the affidavit filed by the respondent in respect
of understanding of the KYC Regulations. The learned senior counsel said that
the impugned order was quite clear in its contents and it did not require any
clarification about the KYC.� The
impugned order clearly sets out that an FII is required to know who is the
ultimate beneficiary of ODI.� 86.
The learned
senior counsel for the respondent further submitted that it was not correct
that any of the FIIs did not understand the meaning of KYC in Regulation 15A.
While referring to the letters addressed by other FIIs and ISDA he submitted
that the plain reading of these letters did not show that there was any lack of
understanding of KYC but they merely set out that SEBI had issued the aforesaid
order dated 17/05/2005 which showed that scope of information which SEBI
expected an FII to provide shall include details of transactions as well as
information relating to clients and their ultimate investors. 87.
�It was submitted that the respondent has not
passed the impugned order solely on the KYC policy of the appellant but it is
based on the FII Regulations of SEBI.�
The appellant�s KYC policy was one of the means set out in the impugned
order to show that the appellant were aware of the understanding of KYC policy
and yet they did not follow here.� 88.
�The appellants have referred to para 9.13 of
the impugned order and contended that the respondent had not set out its
requirement and the appellant would be required to furnish such information as
the respondent may likely to ask. The learned senior counsel submitted that the
order merely states that the appellant was required to maintain all the
requisite information required under the FII Regulations but the respondent
could ask lesser details than what the appellant may be keeping with it.� The interpretation of �likely to ask� given
by the appellant during the course of oral argument is totally incorrect. 89.
It was submitted by
the learned senior counsel that the impugned order merely restrained the
appellant from issuing fresh ODIs or renewing ODIs for one year only and it did
not place a complete embargo on the appellant from dealing in the Indian
capital market. The reason for the aforesaid direction was to enable the
appellant to strengthen their system to comply with the FII Regulations. He
therefore submitted that the impugned order was perfectly justified and valid
and should be sustained under the facts and circumstances of the case. 90.
We have
considered the impugned order, the appeal from the appellant, oral and written
submissions by the learned senior counsel of appellant and the respondent and
other documents submitted to the Tribunal. From the perusal of the documents
and careful consideration of the written and oral submissions, we find that the
impugned order passed by the respondent on �11.1�� The
findings in this case have highlighted serious regulatory concerns in that the
PN/ODI route and its cover of anonymity is being used by certain entities
without there being any real time check, control and due diligence on their
credentials. Such a lapse has very grim portents as far as the market integrity
and interest of investors are concerned. The mechanism of opening up the Indian
securities market through PN /ODI route to entities outside India imposes a
commensurate onus on the registered intermediaries (FIIs) of maintaining high
standards of regulatory compliance, exercise of high due diligence and
independent professional judgment and therefore any gaps in measuring up to the
onus may be fraught with critical repercussions in the market. �11.2. In the light of the above and in exercise of
the powers conferred on me in terms of Section 19 of the SEBI Act, 1992, read
with Section 11(4) and 11B of SEBI Act, 1992, I hereby prohibit UBS / its
affiliates / agents from issuing off-shore derivative instruments with
underlying Indian securities against the positions held by UBS in the Indian
securities market for a period of one year. I also prohibit UBS / its
affiliates / agents from renewing or rolling over any of the ODIs already
issued against the positions held by it in the Indian securities market for a
period of one year. �11.3. I further direct UBS to establish highest
standards of Customer Due Diligence process in line with the requirements of
FII Regulations of SEBI.� 91.
At the time of
passing the final order almost entire information as sought by the respondent
had been submitted by the appellant excepting the information about Caxton
International Limited.� SEBI did not
receive the information with respect to names or holding details of qualified
institutional investors of Caxton Global. Copies of ISDA master agreement
between UBS AG, 92.
From the perusal
of the information and documents submitted by both the appellant and the
respondent we find the only information which was delayed to be submitted
pertains to the names and addresses of top five investors / shareholders of the
clients of UBS AG, �15A. (1) A Foreign Institutional Investor or
sub-account may issue, deal in or hold, off-shore derivative instruments such
as Participatory Notes, Equity Linked Notes or any other similar instruments
against underlying securities, listed or proposed to be listed on any stock
exchange in India, only in favour of those entities which are regulated by any
relevant regulatory authority in the countries of their incorporation or
establishment, subject to compliance of �know your client� requirement : �Provided that if any such
instrument has already been issued, prior to �(2) A Foreign
Institutional Investor or sub-account shall ensure that no further down stream
issue or transfer of any instrument referred to in sub-regulation (1) is made
to any person other than a regulated entity.� 93.
In terms of
Regulation 15A an FII can issue ODI against underlying securities listed in the
Stock Exchanges in 94.
The objectives of
the regulator in inserting new Regulation 15A are unexceptionable and quite
right. It is always the legitimate right of the regulator who is entrusted with
the responsibilities of maintaining orderly development of the securities
market to enforce Regulations and seek any information which it considers
essential for the discharge of its responsibilities.� The contentious issue is whether Regulation
15A which entails upon the FII the KYC obligation means maintaining and
submitting the information of top five investors / shareholders. Does this
information fall within the ambit of Regulation 15A. From perusal of the
Regulation and other circulars and guidelines issued by SEBI, we find that KYC requirements
are vague.� It has not been defined
anywhere by the respondent.� Even when
the Tribunal during the course of hearing asked the respondent to define what
they meant by �Know Your Client� requirement, it had not been clarified by the
respondent but reiterated what was mentioned in the impugned order.� 95.
Paragraph 9.13 in
the impugned order reads as under: �9.13. It is the duty
of UBS that prior to issue of ODIs with underlying Indian securities, it should
have completed the �know your client� requirements by asking its clients all the
questions that the regulator (i.e. SEBI) is likely to ask. Instead UBS claims
to have approached its respective clients after SEBI sought information
regarding these clients. This shows that UBS has failed to understand the
essential meaning of �know your client� requirements.� 96.
From the above we
find that the regulator did not have a clear and explicit understanding of the
KYC requirement.� Had it been so, it
would have been spelt out unequivocally instead of expecting the appellant to
visualize and imagine the likely questions SEBI is to ask.� It is an accepted principle of law that if
anyone is to be punished for violation or infringement of any Act or Regulation
he should clearly know the obligations which are required to be met under the
law.� If the legislature or the
respondent had wanted to make the KYC unambiguous, it could have easily inserted
or added the necessary words such as �ultimate beneficiaries�.� Alternatively, it could have been prescribed
as a part of Compliance Report to be submitted by the FIIs. 97.
In a circular
issued by SEBI on 19/02/2004 the respondent has clearly defined the scope of
the term �regulated� by issuing a circular for the purpose of Regulation 15A of
the FII Regulations. The circular inter
alia states that any entity that is regulated, authorized or supervised by
a Securities or Futures Commission,� a
Central Bank, Registrar of Companies, 98.
It is observed
that KYC norms which are applicable for brokers in 99.
It was made out
that the appellant did not follow its own Client Identification Program (CIP)
guidelines as mentioned in the preamble of the �know your client� document of
UBS consisting of 127 pages. From a careful perusal of the appellant�s KYC
guidelines, it can be inferred that it is dependent on various factors which
determine the KYC requirements which are not uniform. It depends on
geographical location of the client, regulatory nature and status of the
client, and regulator, type of business of the client, risk perception,
etc.� The CIP requirement for registering
a new client based in 100.
In any case it is
the violation of FII Regulations of the country which would be relevant because
there may be different Regulations and KYC requirements for different FIIs in
their own countries which could not be subject to enforcement and monitoring or
compliances in this country. SEBI circular dated 101.
It has to be
mentioned that KYC requirement is vague and in this context letter dated 102.
On 103.
On �8.������ ���
It may be here observed that the provisions of Section 18(1) are penal in nature
and it is a well settled rule of construction of penal statutes that if two
possible and reasonable constructions can be put upon a penal provision, the
court must lean towards that construction which exempts the subject from
penalty rather than the one which imposes penalty. It is not competent to the
court to stretch the meaning of an expression used by the Legislature in order
to carry out the intention of the Legislature �..� �9. ����.If the Legislature intended to
punish persons receiving pugree on merely executory contracts it should have
made its intention clear by use of clear and unambiguous language.� 104.
Breach of Regulations 20 and 20A of the FII
Regulations:� �As per
Regulation 20 of FII Regulations every Foreign Institutional Investor, as and
when required by the Board or the RBI, shall submit any information, record,
documents, in relation to its activities as a Foreign Institutional Investor as
and when the Board/RBI may require. The impugned order says: �Admittedly the information sought by SEBI
was not provided during the course of investigation.� I note that the names of top five investors
in respect of five clients (except in respect of Caxton International Limited)
have been provided by UBS only subsequent to the issue of SCN. UBS has not
furnished their respective addresses. In respect of its most prominent client,
namely, Caxton International Limited, UBS has neither provided the names of top
five investors of the 100% shareholder nor their addresses.� 105.
From a plain
reading of the FII Regulation, it does not make it clear that it is obligatory
on the part of the FII to provide the information pertaining to top five
investors / shareholders of the clients of UBS. Such information was not
available with UBS since it is not provided in the Regulation to have such
information with UBS. More over the investors of clients could be a continuing
and changing stream and there is no Regulation which requires continuous
monitoring of such change in stream of investors. It is also a fact that in
response to the request of the respondent,�
the appellant provided a host of information about trades in ODI,
strategy of trading, volumes of trade, names of scrips cash and future market,
the names of the investors, addresses of investors, etc. There is a compilation
of correspondence between the respondent and the appellant which is submitted
to the Tribunal and the record of number of personal meetings which the
appellant�s representative had with the respondent, which clearly indicates
that there was willingness and effort on the part of appellant to provide
necessary information to the respondent for conducting the investigation into
the market crash of 17/05/2004.� 106.
Mr. Sundaram, the
learned senior counsel for the appellant relied on a chart which chronologically
sets out the requests made by SEBI and the responses by the appellant.� Since these details are factually not
disputed by the respondent, we feel it appropriate to incorporate the chart
submitted to the Tribunal, which reads as follows:
107.
There is a
disclosure requirement of ODIs as per SEBI circular IMD/Cust/8/2003 dated 108.
What is important
to know at this point is whether there is �due diligence� on the part of the
appellant to provide the required information to the regulators i.e., the
respondent. We have no hesitation in admitting that the appellant has made all
efforts and cooperated with the respondent in seeking information which was not
available with it from its clients, who had offices in �7.������ ���..
the law does not compel a man to do that which he cannot possibly perform and
an act of the Court shall prejudice no man would apply with full favour in the
facts of this case ���.� 109.
There is Regulation
20A of FII Regulations which prescribes that Foreign Institutional Investor
shall fully disclose the information concerning the �terms of and parties� to
offshore derivative instrument such as Participatory Notes, Equity Linked Notes
or whatever names by which they are called, entered into by it or its
sub-accounts or affiliates relating to securities listed in any Stock Exchanges
in India as and when any such information the Board may require. As per this
Regulation the obligation of the appellant is to give information concerning
the �terms of and parties to� offshore derivatives instrument relating to
securities listed or proposed to be listed in any Stock Exchange in �Terms i.
Name of the
Offshore Derivative Instrument; ii.
Nature of
underlying securities (Equity/Debt/ Derivatives); iii.
Name of the
Indian Company; iv.
Issue Date of
Offshore Derivative Instruments; v.
Maturity Date of
Offshore Derivative Instruments; vi.
Face Value of Offshore
Derivative Instruments; vii.
Maturity Value of
Offshore Derivative Instruments; viii.
Opening Balance
quantity and value of Offshore Derivative Instruments; ix.
Issued/Renewed
quantity and value of Offshore Derivative Instruments; x.
Redeemed
/Cancelled quantity and value of offshore Derivative Instruments; and xi.
Outstanding
quantity and value of Offshore Derivative Instruments. Parties i.
Name and Location
of the person to whom the offshore derivative instruments are issued; ii.
Name and Location
of other person in case back to back Offshore Derivative Instruments has been
issued against the instrument mentioned in (i) (above) iii.
Name and
jurisdiction of the regulator by whom the offshore derivatives holder is
regulated; iv.
Type of the
investor (for example, hedge funds, corporate, individual, pension fund, trust,
etc.)� 110.
�From the above it is quite evident that
appellant is nowhere required to maintain information pertaining to top five
investors / major shareholders because it has not been provided under
Regulation 20A of the FII Regulations.� It
is pertinent to note that other than the names of top five investors pertaining
to Caxton International Limited, the appellant has provided almost the entire
information sought by the respondent. Not only this, the appellant has been submitting
a monthly statement with an undertaking under both the annexures A and B
that� �we/associates/clients have not
issued / subscribed / purchased any of the offshore derivative instruments
directly or indirectly to/from Indian residents / NRIs / PIOs / OCBs� during the Statement period�. 111.
�In view of above we do not find that there is
any violation of Regulation 20A of the FII Regulations. 112.
The Investigations of the Respondent were hampered by
non-adherence to the Code of Conduct and Instances of Reporting Lapses:� The main
charge against the appellant is that it did not provide information about
Caxton International Limited, the name of Caxton International was omitted in
the monthly statement being submitted by the appellant. On 17/05/2005 UBS had
sold securities valuing Rs. 99.05 crores in the cash segment on behalf of
Caxton International Limited to whom offshore derivative instrument were issued
by UBS AG, London. The respondent sought information about the addresses, names
of major shareholders, major investors for the said transactions and fund
managers of Caxton International Limited. After repeated follow up and Caxton
International Limited writing to UBS that it would like to deal directly with
SEBI, SEBI wrote directly to Securities Exchange Commission, USA to obtain
about the name and addresses of the major shareholders and copy of the ISDA agreement
with UBS AG, London. SEBI received from 113.
There is a
mention in the impugned order that in the monthly ODIs statement furnished by
UBS to SEBI, the name of Caxton International Limited did not figure. On being
pointed out by SEBI UBS admitted the lapse and furnished the revised ODI
statement on 114.
During the
personal hearing with the Whole Time Member on 1st February, 2005 a
request was made by the Whole Time Member to provide a copy of the agreement
governing the relationship between the respective clients and UBS. The
appellant provided the business �terms and conditions� vide its letter dated 115.
There is a charge
in the impugned order that UBS provided only vague information about the five
largest investors in Indus Asia Pacific Fund Ltd., which was not of much help
in investigation.� 116.
The impugned
order mentions that non-disclosure of Indian sounding names at an early stage
of investigation frustrated the efforts of the respondent in conducting a
meaningful investigation. It is mentioned in the impugned order as regards
Indea Capital Pte. Ltd., the Whole Time Member advised UBS to furnish copy of
its client agreement whereas UBS furnished only the �terms and conditions�
contained in its proforma agreement on 117.
Similarly names
contained in the ISDA agreement between UBS and Caxton International has also
been received by SEBI in the month of January 2005. From a perusal of the
documents submitted and the correspondence exchanged between the appellant and
the respondent and between the appellant and the clients of UBS, it appears
that the flow of information from clients to UBS and in turn to the respondent
was constant. UBS was quite prompt in conveying to its clients the SEBI requirements.
If there was any problem with regard to the speed with which the information
was being received, it has to be seen only in the context that there was lack
of clarity about the FII Regulations particularly Regulation 15A with regard to
KYC. The problem could have been obviated if SEBI had made the KYC compliance requirement
more explicit and specific. 118.
There is a
reference in the impugned order that UBS might have earned substantial gains by
trading in the cash market and derivatives.�
Since this is not a part of the show cause notice we would take it that
this order does not have anything against appellant as far as market conduct is
concerned. It is also common ground that the appellants have not been found
guilty of any misconduct of manipulation at the stock market under the
provisions of SEBI (Prevention of Fraudulent and Unfair Trade Practices
Relating to Securities Market) Regulations, 2003 or any other law in force. The
show cause notice says: �in view of the above you are required to
show cause as to why directions under Section 11(4) and Section 11B of the SEBI
Act, 1992 including directions to prohibit you from dealing in securities on
behalf of your clients in respect of whom you do not have information on their
underlying investors, should not be issued against you�. 119.
The impugned
order has been issued under Section 11(4) read with 11B of the SEBI Act, 1992.
Under Section 11B the power to issue directions by SEBI after making or causing
to be made an enquiry, if Board is satisfied that in the interest of investors
or orderly development of securities market. Section 11B reads as follows: �11B. Save as
otherwise provided in section 11, if after making or causing to be made an
enquiry, the Board is satisfied that it is necessary,� �(i)����� in the interest of investors, or orderly
development of securities market; or �(ii)���� to prevent the affairs of any intermediary
or other persons referred to in section 12 being conducted in a manner
detrimental to the interest of investors or securities market; or �(iii)��� to secure the proper management of any such
intermediary or person, �it may issue such
directions,� �(a)���� to any person or class of persons referred
to in section 12, or associated with the securities market; or �(b)���� to any company in respect of matters
specified in section 11A, as may be appropriate in the interests of investors
in securities and the securities market.� 120.
This is to be
read with Section 11(4) whereby Board may by an order for reasons to be
recorded in writing in the interest of investors or securities market take any
of the following measures either pending investigation or enquiry or on
completion of such investigation. Section 11(4) reads as follows: �11(4) Without prejudice to the provisions
contained in sub-sections (1), (2), (2A) and (3) and section 11B, the Board
may, by an order, for reasons to be recorded in writing, in the interests of
investors or securities market, take any of the following measures, either
pending investigation or inquiry or on completion of such investigation or
inquiry, namely:� �(a)� suspend the trading of any security in a
recognised stock exchange; �(b)� restrain persons from accessing the securities
market and prohibit any person associated with securities market to buy, sell
or deal in securities; �(c)�� suspend any office-bearer of any stock
exchange or self-regulatory organisation from holding such position; �(d)� impound and retain the proceeds or securities
in respect of any transaction which is under investigation; �(e)�� attach, after passing of an order on an
application made for approval by the Judicial Magistrate of the first class
having jurisdiction, for a period not exceeding one month, one or more bank
account or accounts of any intermediary or any person associated with the
securities market in any manner involved in violation of any of the provisions
of this Act, or the rules or the regulations made thereunder: Provided that only the bank account or accounts or any
transaction entered therein, so far as it relates to the proceeds actually
involved in violation of any of the provisions of this Act, or the rules or the
regulations made thereunder shall be allowed to be attached; ��(f)� direct any intermediary or any person
associated with the securities market in any manner not to dispose of or
alienate an asset forming part of any transaction which is under investigation: �Provided that the Board may, without prejudice to the
provisions contained in sub-section (2) or sub-section (2A), take any of the
measures specified in clause (d) or clause (e) or clause (f), in
respect of any listed public company or a public company (not being
intermediaries referred to in section 12) which intends to get its securities
listed on any recognised stock exchange where the Board has reasonable grounds
to believe that such company has been indulging in insider trading or
fraudulent and unfair trade practices relating to securities market: �Provided
further that the Board shall, either
before or after passing such orders, give an opportunity of hearing to such
intermediaries or persons concerned.� 121.
We do agree that
Section 11(4) �read with Section 11 B of
SEBI Act, 1992 gives unrestricted power to SEBI to intervene for an orderly
development / functioning of the market and in the interest of investors there
is no doubt about the authority or power of SEBI Act, 1992 to issue orders
under the above mentioned sections. The main rationale of taking action under
Section 11(4) read with Section 11B would be emergent situation or impending
dangers to the market conditions or security to the market. This provision is
for safeguarding the market and not for penalizing the persons for any
violation. From the impugned order which is issued one year after the event, we
do not find any finding which suggests that appellant has done anything which
endangers the interest of the investors or disruption of orderly development of
securities market.� This Tribunal has
held in number of judgments that Section 11B of SEBI Act, 1992 does not empower
the respondent to impose penalties. There was no emergency situation involved.
The market crash took place on 122.
�The only issue dealt in the impugned order is of
non-furnishing of the information or delay in the submission of information.
The impugned order bans the appellant from issuing offshore derivative
instrument for one year and it also prohibits the appellant / its affiliates
from renewing or rolling over any of the ODIs issued against positions held by
it in the Indian securities market for one year.� As submitted by the appellant that 40% of its
business income comes from the derivative market, the prohibition to
participate and roll over the existing ODIs would mean great loss of income
which could be even permanent because a client when it switches over to another
FII may not come back to the appellant again even after the prohibitory period
is over. This order thus becomes punitive in nature and goes against the spirit
of Section 11B and Section 11(4) of SEBI Act, 1992. In the FII Regulations
there is a procedure for action in case of default by FII. The Regulation 21A of
the FII Regulations reads as under: �21. A Foreign Institutional Investor who� ��(a)��� fails
to comply with any condition subject to which certificate has been granted; �(b)���� contravenes any of the provisions of the
Act, rules or regulations, �shall be dealt with in the manner
provided under the Securities and Exchange Board of India (Procedure for
Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002.� From reading of the above Regulation we find
that if there is any contravention of the Act, Rules or Regulations it shall be
dealt with in the manner as provided under Securities Exchange Board of India
(Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty)
Regulations, 2002.� In law there is a
specific provision to deal with a particular type of contravention or
irregularity, it should be dealt with accordingly, instead of invoking the
provisions of General Act. 123.
It may also be
noted that under SEBI (Prohibition of Insider Trading) Regulations, 1992 and
SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to
Securities Market) Regulations, 2003, it is specifically mentioned in the
Regulations that Board may issue directions under Regulations 10, 11, 11B and
or under Regulations 12.� What is more
important is that on a careful perusal of the Regulations it is noticed that the
intention of the legislature to include the right to act under the provisions
of Section 11 of the Act with respect to violation of many other Regulations
(e.g., SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to
Securities Market) Regulations, 2003).�
On a careful perusal of the FII Regulations, one finds that Section 11
has been specifically excluded and the only recourse mandated under the
Regulations� is under the provisions of
Securities and Exchange Board of India (Procedure for Holding Inquiry by an
Inquiry Officer and Imposing Penalty) Regulations, 2002. �In case of FII Regulations, it is clearly
mentioned under Procedure for Action in case of Default: �21.���� A
Foreign Institutional Investor who� ����������� (a)������ fails to comply with any condition subject to which
certificate has been granted; ����������� �(b)����� contravenes
any of the provisions of the Act, rules or regulations, ����������� shall be dealt with in the manner
provided under the Securities and Exchange Board of India (Procedure for
Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002.� Regulation 21 also uses the word �shall�
be dealt with in the manner provided under the Securities and Exchange Board of
India (Procedure for Holding Inquiry by an Inquiry Officer and Imposing
Penalty) Regulations, 2002.� The word
�shall� would clearly indicate that the legislature intended that the violation
of the FII Regulations shall be dealt with under the Inquiry Regulations, 2002 thereby
excluding the provisions of Section 11 since the power to exercise directions
under Section 11 finds a place in many other Regulations except the FII
Regulations. If there had been any intention of the legislature to allow SEBI
to take action under Section 11B and Section 11(4) of the SEBI Act, 1992 they
would have certainly mentioned the same in the FII Regulations. The Privy
Council also held similarly in Nazir
Ahmad v. King Emperor AIR 1936 PC 253; (1936) L.R. 63 I.A. 372 at 381 where
it observed that �where a power is given to do a certain thing in a certain
way, the thing must be done in that way or not at all�. This judgment has been
followed by Supreme Court in many cases such as, A.R. Antulay Vs. Ramdas Sriniwas Nayak And Another 1984 (71) AIR
718 SC; Ballavdas Agarwala V. Shri J. C.
Chakravarty. 1960 (47) AIR 576 SC. 124.
It has not been
disputed by both sides that Regulations have the sanctity of law since the
power to make Regulations vests with the Board and Section 31 clearly
stipulates that every Regulation made under the Act shall be laid before both
Houses of Parliament.� This having been
done, the Regulations are on par with the provisions of the Act.� (See State of 125.
In the main Act
there is a Chapter on Penalties and Adjudication. Under this Chapter Section 15A
which specifically deals with situations such as failure) to furnish any
document, return or report, etc. Section 15A reads as under: �15A.� If any person, who is required under this Act or any
rules or regulations made thereunder,� ��(a)��� to furnish any document, return or report to
the Board, fails to furnish� the same, he
shall be liable to a penalty of one lakh rupees for each day during which such
failure continues or one crore rupees, whichever is less; ��(b)��� to
file any return or furnish any information, books or other documents within the
time specified therefor in the regulations, fails to file return or furnish the
same within the time specified therefor in the regulations, he shall be liable
to �a penalty of one lakh
rupees for each day during which such failure continues or one crore rupees,
whichever is less; ��(c)���� to
maintain books of account or records, fails to maintain the same, he shall be
liable to a penalty of one lakh rupees for each day during which such failure
continues or one crore rupees, whichever is less.� 126.
The impugned
order only speaks of some delay and non-furnishing of information on the part
of the appellant.� Instead of invoking
the provisions of Section 11B and Section 11(4), we find Section 15A could have
handled the instant case more appropriately where there is an exact provision
for handling delays in the submissions of information. 127.
The point at
issue is whether in this particular case an order under Section 11B read with
Section 11(4) is a justifiable order on the basis of the alleged violation. 128.
In view of the
facts and circumstances of the case we do not find any reason to uphold the
orders issued under Section 11B and Section 11(4) of the SEBI Act, 1992. We
also do not find there is violation of Regulation 15A, 20 and 20A and Clauses
1, 2, 5 and 7 of Code of Conduct under Regulation 7A of the SEBI (Foreign
Institutional Investor) Regulations, 1995 while we have expressed our view
about the order issued under Section 11(B) read with Section 11(4) we set aside
the impugned order and uphold the appeal on the basis of the facts and
circumstances of the case as analyzed earlier. It was not necessary to refer to
all the cases cited at the bar since we have decided the matter purely on the
question of fact on the basis of the material before us. However, SEBI is free
to take any action, if it so desires, and if there is a prima facie case under any of the provisions of the SEBI Act, 1992
and the FII Regulations thereunder.� 129.
No order as to
costs. ���
Place: Mumbai Date:� */as |
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