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ADJUDICATION RELATING TO M/s. P.K. CAPITAL SERVICES (P) LTD., SUB-BROKER, AFFILIATED TO UPSE SECURITIES LTD., ORDER UNDER RULE 5 OF SEBI (PROCEDURE FOR HOLDING INQUIRY AND IMPOSING PENALTIES BY ADJUDICATING OFFICER) RULES, 1995. 1. BACKGROUND M/s. P.K. Capital Services Pvt. Ltd. (herein referred to as “member broker”) is a member of UP Stock Exchange and a sub-broker having SEBI registration No. INS010791932 affiliated to UPSE Securities Ltd., member of the Stock Exchange, Mumbai (BSE). The Securities and Exchange Board of India (SEBI) carried out an inspection of the books of accounts, documents and other records maintained by the member broker for the period (01/04/2001 to 31/03/2003). The findings of inspection containing details of irregularities and violations of various provisions of SEBI Act, the rules and regulations made thereunder and directives issued by SEBI from time to time, were communicated to the member broker. They replied to findings of inspection vide their letter dated October 30, 2003.
2. ADJUDICATION PROCEEDINGS
Based on the violations observed during the inspection and pursuant to the member broker’s reply, the Whole Time Member, SEBI, has in exercise of the powers conferred upon him under Section19 of the SEBI Act 1992 (hereinafter referred to as the “Act”) read with Section 15-I of the Act and Rule 3 of SEBI (Procedure for holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995 has appointed the undersigned as the Adjudicating Officer vide order dated March 22, 2004, to enquire into and adjudge the alleged violations committed by the member broker.
3. SHOW CAUSE NOTICE AND HEARING
A Show Cause Notice dated April 16, 2004, Ref.No.-IVD/ID1/ PKN/SRP/7474/04 based on Order of the Whole Time Member was issued by the undersigned to the member broker to show cause as to why penalty under the provisions of the Act read with Rule 5 of SEBI (Procedure for holding Inquiry and Imposing Penalty by Adjudicating Officer) Rules, 1995 should not be imposed upon them in view of the alleged violations. It was also mentioned in the show cause notice that their earlier reply of October 30, 2003 on the findings of inspection had been taken on record.
The member broker replied to the show cause notice vide letter dated July 5, 2004 (after seeking extension of time). As requested by them, an opportunity of personal hearing was granted on October 29, 2004 at Northern Regional office of SEBI, New Delhi. Shri Roop Kishore Gupta, Director, appeared for hearing. During the hearing, he clarified various issues raised in the show cause notice and also submitted a letter making additional submissions.
4. FINDINGS AND CONCLUSIONS
The undersigned has taken into consideration the facts and circumstances of the case and the material available on record. The findings and conclusions in respect of each of the alleged violation committed by the member broker as per Order and show cause notice are as follows:
a) Transferred trade (not exercising due care in punching unique client code and indulging in off the floor transactions and evading margin payable to the exchange) in violation of Section 15HB of the Securities and Exchange Board of India Act, 1992 (hereinafter referred to as the “Act’) read with Regulation 26(xv) and (xvi) of the SEBI (Stock-Brokers and Sub-Brokers) Regulations, 1992 (hereinafter referred to as the “Regulations”)
As per the inspection report, all the transactions done by the member broker executed on behalf of the clients are dealt with and recorded as ‘self purchase’ and ‘self sale’. In respect of such transactions, though confirmation notes/ bills have been issued; the same have been entered in the books on principal-to-principal basis.
The member broker has submitted that during the market period they made and/ or dealt in transactions with the unique client code of respective clients as and when order of transactions were received from the clients on telephone or in the presence of clients. They record such transactions on system of software as provided by the U.P.S.E. Securities Limited. Further this accounting method is followed by them from earlier years in the regular course of business. Regarding off the floor transactions, the member broker has submitted that they have not indulged in off the floor transactions and evaded the system and norms and no adverse inference was found during the course of inspection against them.
The member broker has not submitted any documentary evidence to support their contentions nor could they explain or produce any document at the time of hearing about ‘self purchase’ or ‘self sale’ transactions. (While calling for hearing, they were specifically advised to bring documents in support of their contentions and also provide copies thereof). Therefore, as per finding of inspection, the member broker enters clients’ transactions as if on their own account. Hence, the question of payment of margins for those clients also arises. The member broker has not given any satisfactory explanation in this regard. They were specifically asked at the time of hearing to show their transactions details for any period and how much margin was paid by them, but they could not explain or produce any document. Regarding off the floor transactions, the view of the member broker is accepted. b. Failed to issue confirmation memos in the form and the manner prescribed in violation of Section 15F(a) of the Act read with Regulation 26(v), 26(xv) and 26(xvi) of the Regulations
As per the inspection report, confirmation notes issued by the member broker to the clients do not bear the time of execution of the order received from the respective clients.
The member broker has clarified that they have not failed to issue confirmation memos. At the time of execution of order, transaction automatically records in computer and all necessary information relating to confirmation memos, i.e., name, number, time of execution etc. are fully verifiable. The software is provided by the member of BSE i.e., UPSE Securities Ltd.
The undersigned finds only one sentence in the Inspection report in this regard and no further details are given. In the absence of clarity on this issue, the benefit of doubt is given to the member broker.
c. Failed to maintain client database in violation of Section 15HB of the Act read with Regulation 26(xv) of the Regulations
As per the inspection report, the member broker was having 224 clients in the year 2001-2002 and 292 clients in the year 2002-2003. On sample checking of client registration forms and client agreements of 25% of the clients for each year, certain deficiencies were observed.
According to the report, the member broker has not maintained the data base of the corporate clients on the pattern of format forwarded to the stock exchanges by SEBI vide circular no. SMD/POLICY/CIR/5-97 dated April 11, 1997. Database in respect of company / corporate (Company/Firm) have been collected in the format meant for individuals. Necessary documents in respect of any of the corporate client are not obtained like - i.e. Memorandum and Article of Association, copies of annual reports of last three years, net worth certificate by a Chartered Accountant, letter from the banker certifying the account number and the period from which this account is in operation, copy of income tax return, details of promoters and directors, etc.
In many cases of Client (individual) Registration Forms, one or other types of irregularity has been observed – not obtaining prescribed proof of identity, proof of address, verification proof and declaration regarding PAN, bank certificate, introducer details, and photograph attestation, etc.
The member broker has submitted that most of their corporate clients are private ltd. companies having a very small turnover with them. However, the defects mentioned in the report are procedural mistakes due to clerical omission which have been duly rectified by them at the time of Inspection and kept in the record. The member broker has informed that the defects as mentioned in the report in all 35 cases of individual clients have been rectified and kept in record. They also enclosed the photocopies of some forms and one format of registration form which is being currently used.
At the time of hearing, they were specifically asked to produce client registration documents of corporate clients where all aforesaid details/documents were obtained, as they had not done it earlier. They could not produce any registration form for corporate clients pertaining to clients for the inspection period. However, they informed that during the last six months they had taken all necessary documents for new corporate clients.
It is clear that the member broker failed to comply with aforesaid regulatory requirements strictly. While they have claimed to have rectified the deficiencies after inspection, they never produced evidence in case of corporate clients.
d. Failed to maintain proper segregation of clients funds and own funds in violation of Section 15HB of the Act read with Regulation 26(xiii) of the Regulations
As per the inspection report, the member broker has failed to maintain proper segregation of client funds and own funds. They have maintained the following bank accounts for BSE operations:
Ø The Vysya Bank limited; current account no.142 (as current account). Ø The Standard & Chartered (S&C) bearing account no. 622-0-5070806-0 (as client account) Ø Standard & Chartered (S& C) bearing Account no. 622-0-506492-2 (as pay-in pay-out account for BSE operation).
The funds of all the clients as well as their own funds are managed (receipts as well as payments) through the client’s accounts. Payments towards business expenses and / or other expenses not related with the client’s expenses also have been made from the client account. Annexure VI to the inspection report gives such instances indicating expenses made for different purposes from the client account on a regular basis. Other two bank accounts have also been used for managing the clients funds.
The member broker has submitted that certain expenses have been directly debited by the UPSE Securities Ltd. in their pay-in /pay-out account to which they have no control, but in all rest of cases, the payments relating to their business expenses has been debited in client account by ignorance, but these withdrawals of business are much less to their earning of brokerage. Now they have started maintaining the separate bank account for company’s expenses. They had invested sufficient funds in business from time to time. Mostly clients’ accounts have debit balance outstanding and therefore no client money was used by them. They also enclosed copies of client ledgers indicating that the clients had debit outstanding balances.
They further stated that they received cash several times in a day and it is not possible for them to go every time to the bank, during trading time to deposit the money separately for each client. Besides this, they had to maintain cash balance to make the payment of outstation clients as well as on demand of local clients during holidays or after banking hours and it was necessary to maintain their goodwill among the clients. In this respect it is to mention that it is the normal practice of business that after adjusting the current requirement (Cr-Dr.) the extra/ excesses balance (depending on Cash in hand has been deposited in the bank). Failure to maintain segregation of clients / own funds may be a procedural lapse and the same was not with a malafide intention. The same have been rectified w.e.f. 20.8.2003.
The undersigned has observed from the inspection report that the amount used for business/personal expenses out of clients account from time to time is not big amount. The member broker has opened a separate client account after inspection which they also showed at the time of hearing. However, there was no strict segregation of the clients funds and own funds of the member broker during the period of inspection.
e. Dealt with unregistered sub-brokers in violation of Section 15HB of the Act read with Regulation 26(xiv) of the Regulations
As per the inspection report, the member broker is trading as a client through the following member brokers:
Ø M/s. Orbit Securities (P) Ltd. (NSE Broker / Member), in ‘Future and Option’ Segment of NSE. Ø M/s. J. V. Stock broker, in NSE. which is not in compliance to Section 12 (1) of SEBI Act, 1992.
The member broker has stated (as per the inspection report) that they applied for registration with SEBI as Sub Broker in NSE and the same is awaited. However, in the meanwhile they have traded in NSE through J.V.Stock Broker. Total trading done by them is Rs. 20 lakhs over a period of two years. They also stated at the time of hearing that they traded in those scrips on NSE on behalf of clients which were traded actively only on that Exchange.
The member broker informed the inspection team that they had applied for registration as Remiser/Authorized person of Inter Connected Stock Exchange for ‘Future and Option’ segment of NSE through ISE Securities and Services Limited, a subsidiary of Inter Connected Stock Exchange of India Limited, Bombay and the same is awaited. However in the meanwhile they have done Future Trading during the financial year 2002-2003 through M/s. Orbit Securities private Limited (NSE Member), the value of turnover being Rs. 7 lakh approx.
Further, as per the inspection report it has been observed that there are 13 clients of the member broker who are brokers of U. P. Stock Exchange Association Limited (UPSE) and they are not registered as Broker or Sub-Broker for trading in BSE.
The member broker has submitted that the named clients had dealt with them to avail facility of BSE segment only. They had done business dealing with the brokers of UP Stock Exchange. As mentioned in inspection report, all other formalities have been complied with the named clients, i.e., they had obtained registration paper etc. and brokerage has been charged on their transactions. As they are acting as sub broker of U.PSE Securities Ltd. and doing business in that capacity, under rules and regulations they cannot appoint sub-brokers.
It is clear from the above that the member broker has failed to comply with the aforesaid regulatory requirements strictly.
f. Not adhered to the unique client code in violation of Section 15HB of the Act read with Regulation 26(xv) and 26(xvi) of the Regulations
As per SEBI Circular no.SMDRP/Policy/CIR-39/2001 dated July 18, 2001, the member broker is required to furnish the relevant particulars of clients registered with them to the stock exchange / clearing corporations (in this case to broker i.e. UPSE Securities Ltd.) and the same is to be updated every quarter.
According to inspection report, the member broker is not regular in submitting information / particulars on clients on quarterly basis and particulars submitted are dated back to October, 2002. Further, the member broker is required to preserve for a period of seven years a mapping of client IDs used at the time of order entry in the trading system with those unique client IDs along with client name, address and other particulars given in the Know Your Client Form. But it has been observed that member broker has no such updated mapping records available.
The member broker has submitted that they are maintaining client IDs, at the time of order entry in the trading system, with Unique Client IDs along with name and addresses and other particulars given in the “Know your Client Form” and they shall preserve the same up to seven years.
It is clear from the above that the member broker did not submit required details of their clients regularly.
g. Not framed code of internal procedures and conduct for prevention of insider trading in violation of Section 15HB of the Act read with Regulation 26(xv) and 26(xvi) of the Regulations
As per the inspection report, Code of Internal Procedures and Conduct for prevention of Insider Trading as required under SEBI (Prevention of Insider Trading) Regulations, 1992 has not been framed by the member broker.
The member broker has stated that they follow the UPSE Regulations so far. Subsequently they stated that they had adopted the guidelines as per SEBI manual, their transactions were of small quantity and they always took care and prevent inside trading and never did inside trading. They also stated that being a sub broker of small city no big company remains eager to contact us and hence they no source to get price sensitive information.
At the time of hearing, the member broker was specifically asked to produce the Code framed by them for prevention of insider trading. They admitted that they had not framed such code of conduct so far. Insider trading can be done by anyone whether in small or big city and also whether they are sub broker or broker or a client. Thus, the member broker has failed to comply with the regulatory requirement. At the time of hearing, they were advised to refer to detailed model code of conduct as prescribed under SEBI (Prohibition of Insider Trading) Regulations, 1992 and implement it.
h. Failed to comply with the directions issued by the board in violation of Section 15HB of the Act read with Regulation 26(xv) of the Regulations;
i. Not exercised due skill, care and diligence in violation of Section 15HB of the Act read with Regulation 26(xvi) of the Regulations.
The above (point a to g) indicates that the member broker failed to comply with directions issued by the Board and did not exercise due skill care and diligence in their operations.
Apart from the above, the inspection report also points out some delays in payment and delivery to clients. The member broker stated that they had obtained consents from the clients to maintain running accounts. However, they could produce consents only from some of the clients and not from all of them. Subsequently, they sent consents of the remaining clients indicating that they had obtained them later.
The member broker has also stated that no violations have been committed by them deliberately for own interest or to cause losses to clients. They also stated that no client made any complaint against them to UPSE Securities or the Exchange.
5. IMPOSITION OF PENALTY
Keeping all above in view, the undersigned finds that there were certain deficiencies and irregularities in the systems and procedures of the member broker who has failed to strictly comply with the provisions of the Act, Regulations and directions issued by the Board from time to time and has not exercised adequate due skill, care and diligence in their operations. On certain violations, they could not produce documentary evidence in support of their contentions thought full opportunity was given to them. However, the member broker also reported that they initiated corrective steps after the inspection on certain aspects.
Considering all above facts and circumstances, the undersigned is of the view that the member broker has become liable to penalty and some amount of penalty should be imposed upon them for certain violations as described in detail earlier so that they comply with all the regulatory requirements in the future strictly. This is also necessary to maintain the integrity of the securities market and to protect the interests of investors. While deciding the quantum of the penalty, the undersigned has taken into account the factors under Section 15J of SEBI Act, 1992, namely:
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.
In accordance with the provisions of Section 15HB of the SEBI Act, 1992 read with Rule 5 of the SEBI (Procedure for holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995, the undersigned hereby imposes a penalty of Rs. 100,000 (Rs. One Lakh only) upon the member broker, P K Capital Services (P) Ltd.
They shall pay the amount of penalty by way of demand draft / pay order drawn in favour of “SEBI penalties remittable to Government of India” and the demand draft/ pay order shall be sent to Mrs. Usha Narayanan, CGM, (MIRSD), Securities and Exchange Board of India, World Trade center, 29th Floor, Cuffe Parade, Mumbai-400 005., within 45 days of receipt of this order.
In terms of Regulation 6 of the SEBI (Procedure for holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995, a copy of this order is served on the member broker and a copy is submitted to the Board.
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