SECURITIES AND EXCHANGE BOARD OF INDIA
ORDER
[Under Rule 5 of the Securities and Exchange Board of India (Procedure for Holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995 read with Sections 15 I of the Securities and Exchange Board of India Act, 1992, in respect of M/s. Pace Financial Services having SEBI Registration No. INB230772724, Member of National Stock Exchange of India Ltd.]
Whereas Securities and Exchange Board of India (SEBI) had conducted inspection of the books of accounts and other documents of. M/s Pace Financial Services (hereinafter referred to as Broker), and pursuant to this appointed me as adjudicating officer vide order dated March 31, 2004 under Rule 3 of SEBI (Procedure for Holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995 (hereinafter referred to as ‘said rules’) to inquire into and adjudge under section 15 HB of the SEBI Act.
NOTICE
Pursuant to this a notice dated June 09, 2004 under Rule 4 (1) of the said rules was issued to broker communicating the charges leveled against them based on inspection of the books of accounts and other documents conducted by SEBI for the period 01.04.2000 to 31.03.2003. The said inspection report had already been communicated to the broker.
REPLY
Pace Financial Services vide its letter dated July 16, 2004 submitted its reply to above notice. Pursuant to the above, an opportunity of hearing was also given to Pace Financial Services on October 14, 2004 vide letter dated September 29, 2004 to enable Pace Financial Services to make further submissions, if any at Northern Regional Office, SEBI Delhi. Pace Financial Services vide its letter dated October 5, 2004 requested for postponement of the personal hearing. Accordingly, the request was considered and an opportunity of personal hearing was rescheduled to October 20, 2004 at SEBI Head Office, Mumbai.
PERSONAL HEARING
The personal hearing in the matter was held on October 20, 2004. Shri Atul Goel, Partner of Pace Financial Services and their Advocate, Shri Ravi Kumar Varanasi appeared and made their submissions. Subsequent to the hearing further reply was filed by the broker vide letter dated October 21, 2004.
In view of the above, I now deal with the submissions made by the broker before me for the purpose of this adjudication.
THE REPLY OF THE BROKER VIS A VIS THE VIOLATIONS OBSERVED AS PER INSPECTION REPORT AND THE FINDINGS.
1 CHARGE
Dealing with unregistered sub-brokers - Out of the of 4 SEBI registered sub-brokers furnished by the broker, though at the time of inspection the said entities had been registered with SEBI as sub brokers, some of them had been acting as a sub broker even before the registration had been granted to them
WRITTEN REPLY OF THE BROKER
a) Dealt with unregistered sub-brokers prior to registration
“The notice submits that the SEBI officer on page 4 of the Inspection report indicated that there were three Registered Sub-Brokers acting as unregistered sub-brokers prior to registration. The said registered sub-broker are i) Hitide Investment Pvt. Ltd. and ii) SIF Financial Pvt. Ltd. and iii) Vardan Financial Services Ltd.
The Noticee submits that the said registered sub-broker Hitide Investment Pvt. Ltd. and Vardan Financial Services Ltd. were dealing with the Noticee since 1997/1998 and since the sub-brokers were continuously doing business for a long period it was practically difficult to stop the business as stopping the business would lead to loosing of clients and hence the sub-brokers had continued and subsequently registered with SEBI as registered sub-brokers. Further, NSE Disciplinary Action Committee has levied a financial penalty of Rs. 25,000/- on the Noticee in respect of Vardan Financial Services Ltd. acting as unregistered intermediary. Hence, the Noticee submits that the Learned Adjudicating Officer would appreciate that no penalty can be levied for the same cause. As regards, the sub-broker SIF Financial Pvt. Ltd. the said sub-broker has registered with SEBI but doing very few transactions and even prior to registration as sub-broker SIF Financial Pvt. L&T Ltd. transaction were very less. The said lapse had happed due to the noticee believing that once the application was made the sub-broker could commence the business. However, the said sub-brokers are now registered with SEBI. Hence the Noticee submits and requests the Learned Adjudicating Officer to be lenient as there was no intention to not to comply with the provision but the same was due to practical problems that were being faced by the broker and misinterpretation of the provisions.
b) Dealing with unregistered sub-broker even after rejection of the applications by NSE
“With regard to the observation on page 6 of the inspection report, the Noticee submits that BCS Financial Services and NNK Securities Pvt. Ltd. Application for registration as sub-broker were made on October 29, 2001 and December 24, 1996 respectively. However, the said BCS Financial Services transaction were stopped on November 13, 2001 the moment the Noticee had become aware about sub-broker cannot continue as sub-broker before registration. As regards, NNK, the application was made in 1996 when the said rule of sub-broker cannot do business prior to registration was not effective. However, the business of NNK Securities Pvt. Ltd. was closed on November 16, 1997 which is outside the scope of the inspection period as the inspection was conducted for the period 01/04/1998 to May, 2003. Despite the above, NSE Disciplinary Action Committee had levied financial penalty of Rs. 25,000/- in respect of BCS Financial Services. Therefore, the Learned Adjudicating Officer would appreciate that no penalty can be levied for the same cause.”
c) Dealing with unregistered sub-broker without applying as sub-broker
“It has been observed on page 7 & 8 of the inspection report by the SEBI officer that the entities namely, Karan Associates and AAA Securities acting as unregistered sub-brokers. The Noticee submits that the said entities are not acting as unregistered sub-brokers but they are Noticee’s clients and the orders have been put in the respective client codes and the said clients have given letters to un indicating that the deliveries will be received from particular demat accounts belonging to them. Therefore, there was no reason to believe that they were acting as unregistered sub-brokers. Further, the said clients have entered into Member Client Agreement and Client Registration Form and the same are hereto annexed as Annexure 1. They have also submitted letters that they are not doing any sub-broking activity. The copy of these letters is enclosed as annexure 2. Further, these clients had issued letters to Noticee mentioning their various demat IDs from which they would issue shares to Noticee. Therefore, there was no ground for Noticee to believe that the said clients were indulging in sub-broking activity. A copy of these letters are enclosed as Annexure 3. Hence the Noticee submits that there is no violation of Regulation 26 (xiv) in this regard.”
REPLY DURING THE HEARING
Dealing with unregistered sub-brokers – it was clarified in three parts;
With regard to point no. 1 & 2 above we submit that NSE has already levied a penalty of Rs. 25,000/- each aggregating to Rs. 50,000/- during September 2003. Hence we submit that for the same cause no penalty may be charged by SEBI. It was also clarified that persons alleged as unregistered sub-brokers have stopped their dealing long back i.e. in one case November 16, 1997 and in another case November 13, 2001. As regard to point no. 3 above we submit that the said clients are registered as clients with us and not acting as unregistered sub-brokers. It was also pointed out to the learned officer that they have given letters to that effect not acting as unregistered sub-brokers which is submitted along with the reply. Hence there is no unregistered activity by the clients.
FINDINGS
The instances quoted with respect to the unregistered sub-brokers in the inspection report show dealings with them much prior to grant of registration by SEBI. Two sub-brokers (one registered in 2002 and the other in 2003) had dealt through the member as far back as in 1998-99. The explanation of the broker that the dealings with the entities were continuing while registration process was pending is therefore not acceptable.
Further with respect to transactions of M/s. NKK Securities Pvt. Ltd., the broker should have stopped dealing with the entity immediately on rejection of the application for sub broker registration. The inspecting team has noted that the broker dealt with the unregistered sub-broker till 1999 not 1997 as stated by the member. This amounts to dealing with an unregistered sub-broker. The reply of the broker in this regard is not acceptable.
The broker had dealt with the unregistered sub-broker even subsequent to rejection of application. Even in the period when statedly a fresh application had been sent to NSE, the broker had levied VSAT charges. The broker’s contention that it was ignorant of the entities sub-broking activities is therefore not acceptable.
Dealing with unregistered sub-brokers is a lapse on the part of brokers and was specifically brought to the notice of all the exchanges vide circular nos. SMD-1/3118 dated 27/12/93, SMD/OPG/AA/1020/96 dated 14/03/96, SMD/MDP/CIR/043/96 dated August 5, 1996 and SMD/Policy/CIR/03/97 dated 31/03/97. Thus the broker has violated the provisions of the above circulars / instructions.
The broker has therefore, violated provision of para A (5) of Schedule II specified under Regulation 7 of SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992. It is observed that the National Stock Exchange has already levied a penalty of Rs. 50,000/- on the broker during the year 2003.
2. CHARGE
Non segregation between own funds and client funds - The broker has used the client account for not only paying salaries to the partners of the firm but also for meeting the business expenses.
WRITTEN REPLY OF THE BROKER
“The Noticee submits that on page 9 of the inspection report, the SEBI officer has indicated that the Noticee has not segregated the client funds and own funds. The Noticee submits that the said non-segregation of funds is a technical lapse and the fact remains that the SEBI officer has not identified any misuse of client funds by the Noticee. The Noticee had given a statement showing there being no misuse of client funds at any point of time which statement has been annexed to the inspection report as Annexure 7 except for a technical flaw of not having segregated accounts for own and client. Therefore the Noticee submits that though there is technical lapse there is no violation of Regulation 26 (xiii) which leads to prove that there was misuse of client funds by the Noticee.
REPLY DURING THE HEARING
We submit that in the inspection report itself it was clarified that there is no misuse of client funds at any point of time. Further, it was also clarified before the learned officer that when the clients give the cheque, the payments include the brokerage, statutory charges etc. The brokerage is lying in the client account and out of that amount only the payments were made. However, the said practice has been stopped long back and we submit that there is no misuse of clients’ funds nor there are any complaints pending either with NSE or SEBI with regard to the same.
FINDINGS
As per SEBI Circular No. SMD/SED/CIR/93/23321 dated 18.11.93 the broker has to maintain segregation between own funds and client funds. The broker has not ensured this, as brokerage due is not withdrawn from the client account and withdrawals for various purposes are made against the same.
As such the broker has violated provisions of SEBI Circular No. SMD/SED/CIR/93/23321 dated 18.11.93 and thereby violated Rule 4(b) of SEBI (Stock Brokers and Sub-Brokers) Rules, 1992 and provision of para A (5) of Schedule II specified under Regulation 7 of SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992.
3. CHARGE
Client’s agreement not maintained
WRITTEN REPLY OF THE BROKER
“The learned Adjudicating Officer had charged the Noticee of not having entered into Member Client Agreement and failed to produce the same to the SEBI officer. The Noticee submits that in the inspection report, the SEBI officer has nowhere indicated that the Member Client Agreements are not produced for inspection. It has been indicated on page 16, un-numbered para 3 of the inspection report which inter- alia states as under:
“The member client agreement obtained from the member shows that the agreement was entered in 2003. This is of no consequence as the trading for these three entities took place in the period prior to 2003”
The Noticee submits that there was no failure to produce the member client agreement. The issue in the present charge is that the said Member Client Agreement of the three clients was entered in 2003. The Noticee submits that the said clients were there since 1998 and they had entered into the Member Client Agreement and Client Registration Form in 1998 but the said old agreements were misplaced and not traceable and hence the said new agreements were obtained in the month of April 2003 from the said clients. The said clients have given affidavits indicating that they had executed the Member Client Agreement and Client Registration Form in 1998 and the same were misplaced by the Noticee hence they are entering a fresh agreement with the Noticee. (The copies of the affidavits from the client are enclosed and marked as Annexure 4). Hence the Noticee submits that it is not the case that the Member Client Agreement has not been obtained from the client but it is a case where the Member Client Agreements were misplaced and due to the same fresh Member Client Agreements and Client Registration Forms were executed by the Clients. Hence the Noticee submits that there is no violation of Section 15HB read with Regulation 26 (ii) and Regulation 26 (xii) of the Regulations. “
REPLY DURING THE HEARING
We submit that the agreements were misplaced and fresh agreements were obtained from the clients in the year 2003. Accordingly, we also obtained affidavit from the clients and the copies of the same were submitted along with our reply dated July 16, 2004 and also the original were shown to the learned officer during the hearing
FINDINGS
As observed in the inspection report, member client agreement obtained from the broker shows that the agreement was entered in 2003, while trading for these three clients took place in the period prior to 2003. The broker’s explanation in this regard is not acceptable. The broker should have ensured proper filing of records.
The broker has violated the SEBI Circular No.SMD/POLICY/CIR-10/97 dated April 10, 1997 and therefore violated the provisions of para A (5) of the code of conduct prescribed u/r 7 of SEBI (Stock Brokers and Sub Brokers ) Regulations 1992.
4. CHARGE
Not taking adequate margins from clients.
WRITTEN REPLY OF THE BROKER
“The Noticee submits that the charge of non-collection of margin is in respect of the three clients indicated in summary of violation on page 17 of the inspection report but the SEBI officer has not indicated any specific violation of margin in the inspection report but a mere statement in para 13 on page 16 that “the member was also guilty of not taking adequate margin from the client”. The Noticee submits that the said reference was made in respect of the clients indicated in para 13 of the inspection report. In respect of the said clients the Noticee was holding the securities purchased from time to time and the letters to that effect have been received from the client. The same are annexed as securities that were given / retained as margin for these three clients at the end of each quarter and it shows that adequate margins were collected from these clients. The margin calculation is enclosed as annexure 6. Therefore the Noticee submits that there is no margin violation in respect of the said clients and also in general there is no adverse finding in the inspection report by the SEBI officer. Hence it is submitted that there is no violation of Regulation 26 (xv) and 26 (xvi) of the Regulations. “
REPLY DURING THE HEARING
We submit that during the inspection the statement showing adequate margins available with us. Further, today during the hearing we have submitted additional documents giving detailed statement along with supporting demat statements and physical delivery details indicating adequate margins by way of securities were available at the time of dealings.
FINDINGS
The inspection report has mentioned that shares of the three clients were kept in the pool account of the broker and not transferred to the beneficiary accounts. Further, the inspection report also refers to long periods of debit balances that the clients were allowed to run which suggests that the broker does not have a system of margin receipts/evaluation. The broker has also admitted to releasing payments to clients when there were debit balances in their accounts.
The broker has therefore violated the SEBI Circular No.SMD/POLICY/CIR-35/1998 dated December 4, 1998 and the provisions of para A (5) of the code of conduct prescribed under Regulation 7 of SEBI (Stock Brokers and Sub Brokers) Regulations 1992.
5. CHARGE
Order book not being maintained
WRITTEN REPLY OF THE BROKER
“The Noticee submits that the maintenance of the order book has been made optional by NSE vide its circular ref: NSEIL/LEGAL/3686 dated October 17, 2002 wherein it has been clearly indicated in the amended Regulation 6.1.3 B that the maintenance of Order Book is optional by the member (hereto enclosed as Annexure 7 copy of the circular dated October 17, 2002). Further, we submit that most of the client orders are received either on telephone or when the client himself is present in front of the terminal and give the orders to the dealer and the said orders are confirmed by the contract notes issued to the client at the end of the day. Further, we are maintaining the said order in electronic form. Further as stated earlier and we once again reiterate that with the changing scenario in the Capital Market, the requirement of the order book in physical form is a history since the change in trading platform from the open out cry system to the electronic mode is a welcome development and we further submit that NSE has rightly made it optional but we still are maintaining the Order Book in electronic form by storing in untamperable CD’s which can be retrieved from time to time. Hence there is no violation of the Regulations and Guidelines of SEBI and NSE.”
REPLY DURING THE HEARING
We submit that the requirement of order book has been made optional by NSE vide its circular dated October 17, 2002. We further submit that the fact that the transactions are on a electronic trading platform and the orders are received on the telephone or in person from the clients and immediately the same are punched in the system. Further, the order log at the end of the day is saved in a CD for future reference. We further submit the very intent of the circular of the exchange shows that the requirement of order book in a physical form is not mandatory. However, we submit that there are no complaints received from clients in respect of non matching of orders and difference in price
FINDINGS
I accept the reply of the broker.
6. CHARGE
Unique Client codes not used while placing Orders
WRITTEN REPLY OF THE BROKER
“The Noticee submits that the charge of non-adherence to unique client code guidelines is in respect of the three clients indicated in summary of violation on page 17 of the inspection report. The Noticee submits that the client transactions of these three clients were prior to the issuance of the SEBI directive to have unique client code which was issued on July 18, 2001 (annexed as annexure 8). The last transaction of these three clients viz., Maya, Sanjana and Abhishek was carried out on 28/02/2000, 21/08/2000 and 19/06/2000, respectively. Therefore the Noticee submits that prior to July 18, 2001 the requirement to have a unique client code was not mandatory. Further, the SEBI officer on page 15 of the inspection report has clearly indicated that
“it is noted that the aforesaid transactions were conducted before this SEBI directive was implemented by NSE”
Hence the noticee submits that there is no violation of the provisions of the Regulation 26 (xv) and 26 (xvi) of the Regulations”.
REPLY DURING THE HEARING
We submit that the requirement to maintain unique client code had become mandatory from August 01, 2001 as per the circular issued by NSE dated July 24, 2001. Further, the transactions are prior to the above date. It may be mentioned that even the inspection report on page 15 clearly indicates that the transactions are prior to the directive of SEBI and NSE. Hence there is no violation of the said circular.
FINDINGS
The broker has used a single client code while entering orders for 3 clients in the system, though different codes have been maintained for back office operations. The broker was therefore not following the system of unique client codes for trading on behalf of clients. However, in the inspection report the inspection authority has mentioned that “the aforesaid transactions were conducted before this SEBI directive was implemented at NSE”. As such the reply of the broker is accepted.
In order to adjudge the quantum of penalty, I have to consider the following factors as provided in the Section 15J of Securities and Exchange Board of India Act 1992:
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 and
c) the repetitive nature of the default.
As regards the disproportionate gain or unfair advantage there are no quantifiable figures available with respect to the default observed on the part of the broker. There are also no figures or data to quantify the amount of loss caused to an investor or group of investors as a result of the default. Besides, no investor complaints have been received against the broker. However, for his default with respect dealing with unregistered sub-brokers, not maintaining segregation between own its funds and its client funds, not maintaining Client’s Agreements and for not taking adequate margins from its clients the monetary penalty needs to be imposed on the broker as a corrective measure.
ORDER
The submissions of the broker to SEBI have been considered and dealt in detail as above and in view of the findings arrived at, I consider it to be a fit case for imposition of penalty under sections 15 F ( a ) and 15 HB of the SEBI Act, 1992. In view of the same and in exercise of the powers conferred under section 15-I (2) of the SEBI Act, 1992, read with, Rule 5 of the Securities & Exchange Board of India ( Procedure for Holding Inquiry and Imposing Penalties by Adjudicating Officer ) Rules 1995, I hereby impose a penalty of Rs. 1,00,000 (Rupees One Lakh Only) on the broker taking into consideration of the amount of penalty already levied by National Stock Exchange for dealing with unregistered sub-brokers . The broker shall pay this amount of penalty of Rs. 1,00,000/- by way of demand draft in favour of "SEBI - Penalties Remittable to Government of India" payable at Mumbai within 45 days of receipt of this order.
The said demand draft should be forwarded to the Chief General Manager of SEBI, MIRS Department (DPS- I) at SEBI, World Trade Centre, 29th Floor, Cuffe Parade, Mumbai 400 005.
| Date: December 30, 2004 | K V RAJAGOPAL RAO |
| Place: Mumbai | Adjudicating Officer |