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MO/40/ISD/08/2006
WTM/TCN/ /ISD/06
DATE OF HEARING: 31.05.2006
APPEARANCE :
FOR NOTICEE : Shri. T.N. Subrahmanian, Senior Advocate
Shri Anil Shah, M/s Juris Matrix , Advocates
Shri Motilal Oswal, Chairman and Managing Director
Shri Ajay Menon, Director
FOR SEBI : Shri R. Ravichandran, Chief General Manager
Shri J.Ranganayakulu, Joint Legal Adviser
ORDER
(UNDER SECTIONS 11 AND 11B OF SEBI ACT, 1992)
1.1 By an ad interim ex-parte order dated April 27, 2006 (hereinafter referred to as the ‘Order’) under section 19 read with sections 11, 11B and 11(4) of the Securities and Exchange Board of India Act, 1992 and section 19 of the Depositories Act, 1996 pending enquiry and passing final Order, certain interim directions were issued against various market participants including Motilal Oswal Securities Limited (hereinafter referred as ‘MOSL’).
1.2 The ad interim ex-parte order dated April 27, 2006 states that MOSL, Depository Participant of Central Depository Services Limited (CDSL) prima facie appears to have grossly failed in adhering to the Know Your Client (KYC) norms laid down by SEBI, thereby facilitating opening of demat accounts in fictitious/benami names and cornering the retail portion of shares in Initial Public Offerings (IPO). In view of the above preliminary finding, MOSL was directed not to open fresh demat accounts till further directions.
1.3 Para 17.18 of the ad interim ex-parte order dated April 27, 2006, stated that the said order shall be treated as show cause notice against the concerned entities named therein including MOSL. These entities were given an opportunity for filing their objections, if any, to the order within 15 days from the date of the order and if they so desire, avail of an opportunity of personal hearing at the SEBI Head Office, Mumbai within 15 days from the date of the order. They were also given an opportunity to avail the facility to inspect the relevant documents relied upon by the SEBI against them, prior to hearing.
2.0 Findings regarding MOSL in SEBI’s Ad Interim Ex Parte Order
2.1 The focus of the SEBI investigations has been on entities indulging in off-market transactions after allotment of shares but prior to listing and commencement of trading on the stock exchanges, in connection with cornering of IPO shares in retail segment through benami/fictitious Demat Accounts.
2.2 At paragraph 9.5, 12.1, and 12.39 of the Order, it has been mentioned that inspection of the Depository Participant (DP) by a Chartered Accountant (CA) firm engaged by CDSL found various violations by MOSL. It was also observed that 697 demat accounts sharing the common address was held with the Depository Participant, MOSL.
2.3 At paragraph 10.9 of the Order, it is mentioned that MOSL was the DP of Shri Dharmesh Bhupendra, a key operator, who was financed by Shri Narendra Harilal Dadia, Dhaval Narendra Dadia and Shri Kashmira Narendra Dadia in the IPO of IDFC Limited.
2.4 At paragraph 12.92 and 16.49 of the Order, the findings of the inspection of MOSL by a CA firm engaged by CDSL indicates that the DP failed to exercise due diligence while opening demat accounts. The inspection also found the irregularities such as failure to obtain proof of identity, failure to obtain proof of address, not including the names of second and third holders in the DP–BO agreement, not verifying the photocopies of documents received towards Proof of Identity (POI), Proof of Address (POA) with the originals and the agreement between the DP and the client being incomplete and not obtaining signature of the BO holder across the photograph etc. The findings of the inspection show that the MOSL has not been adhering to the Know Your Client (KYC) norms applicable to DPs as prescribed by SEBI.
2.5 In view of the above findings in the order, directions as mentioned at Para 1.2 above were issued to MOSL.
3.0 Oral hearing and submissions of MOSL
3.1 MOSL has availed of the opportunity given to inspect the documents relied upon by SEBI. Further, MOSL appeared for personal hearing before me on May 31, 2006 through the persons as recorded on the first page of this order and made its oral submissions. Besides, they also handed over written submissions vide letter dated May 31, 2006. The submissions made by MOSL in the aforesaid letter and during the oral hearing are summarized as under:
3.1.1 585 demat accounts out of the said 697 demat accounts have one single address viz., the address of the MOSL. 8 accounts are for settlement obligations and employees of MOSL and the Chairman. 577 demat accounts are for MOSL’s Portfolio Management Services (PMS) clients. This is because as SEBI registered Portfolio Managers, MOSL act as custodians of the shares of their clients and thus in the details and information available with the CDSL, the address of MOSL gets reflected for correspondence.
3.1.2 When a client approaches MOSL for portfolio management services, a trading account and Depository Account is opened with MOSL at which time the KYC documents are duly filled in recording the material and relevant details as per the various rules, regulations and guidelines of CDSL at the time in force. The permanent addresses of these clients are their own addresses as indicated to MOSL in the respective forms but for the sake of administrative and back office convenience the correspondence address is that of MOSL which is duly mentioned in the agreement signed with each PMS client. Copies of all agreements with PMS clients are available with MOSL.
3.1.3 There had been an audit conducted by the C.A. Firm pursuant to the Order, in respect of the 697 accounts as required by the order. The auditors have verified all the 697 accounts and have observed that all the KYC norms as per CDSL guidelines have been fully complied with except in 4 specific cases which are explained. CDSL has conducted the physical verification of all these clients independently and it has been able to verify and identify the existence of all these clients in person based on the identity and address proof maintained by MOSL. MOSL is in a position to identify each one of these 577 clients. In these circumstances, it is clearly established beyond doubt that these clients are existing and genuine and not fictitious at all.
3.1.4 The remaining 112 Depository accounts are small retail accounts. The said accounts are those of 5 different families / groups having 5 different addresses across Mumbai, Ahmedabad, Ranchi, Nagpur etc. CDSL has done a physical verification of these accounts and has confirmed the identity and existence/ genuineness of these accounts. MOSL has maintained the requisite proof for each of these 112 account holders. Ration Card, Passport, Bank Certificates, Pan Number, etc provided by each of these clients for proof of identity/address indicates the true position. Copies of the relevant documents can be made available to SEBI at any time. None of these 112 depository accounts belong to any person named in the order as being implicated in the IPO investigation. In any event the same falls significantly below the floor level of 500 or more adopted as the cut off for determining suspect multiple demat accounts.
3.1.5 MOSL’s name appears in the table at paragraph 10.9 which deals with financiers of master account holders only in the column – name of DP and not as financier. The alleged financiers had a DP account each with MOSL, where apparently certain IDFC shares were transferred. MOSL had no means of knowing the origin of the shares or as to whether the shares were part of the IDFC IPO allotment or were separately purchased. MOSL’s role is just of an intermediary and MOSL is in no way connected or concerned with financing of any IPOs
3.1.6 At the relevant time as per the CDSL circular No.CDS/OPS/DP/43 dated 11.4.2000, if second and third holder were introduced by an existing demat account holder, proof of identity of the second and third holder were not required. Only when introduction for second and third holder were not available, MOSL insisted upon proof of residence / identity of such applicant such as verified copies of passport / ration card/voter id / PAN ID/ Driving license. As can be seen from the noting made in the said para of the said order, that introduction was available for such clients, said instances of no proof of identity of second and / or third holder ceases to be any lapse or otherwise on the part of the MOSL as the said practice is in accordance with the guidelines of CDSL for the relevant time. The auditor has also confirmed that the introduction was done in all these cases.
3.1.7 MOSL is not only a depository participant but also provides various other services like broking, Portfolio Management etc. Client normally avails other services in addition to the Depository services. In case of all types of services provided by MOSL, clients have to fill in registration form and provide for documents evidencing proof of identity and address. Normally when client gets introduced, he opens accounts for availing various services at the first instance and completes all the formalities and documentary requirement. In the cases referred in the report, the clients are also registered as client for trading / investing in shares. The client normally submit one copy of the proof because for them MOSL is one entity. Internally then MOSL take Xerox copy of the proof and attach them with account opening forms pertaining to various services. Since, the proof attached with the demat account opening form was taken from the copy submitted by the client and attached to account opening form of MOSL’s broking division, the same was not very clear. Similarly, proof of permanent address was forgotten to be Xeroxed and attached to the demat account opening form.
3.1.8 MOSL received a report dated March 13, 2006 in respect of the inspection conducted by the Chartered Accountant Firm engaged by the CDSL. Vide MOSL’s letter dated April 10, 2006 MOSL replied to the said report and recorded the true facts and presented its submissions/contentions to the observations made in the said report. Despite the fact that MOSL has made detailed and specific submissions, it appears after careful reading of the said order, that neither CDSL nor SEBI have considered any of submissions or contentions raised by MOSL in their reply dated April 10, 2006.
3.1.9 It is true that during the course of verification, certain minor and technical lapses were observed in the matter of opening of depository accounts of clients. It is submitted that in no way can these lapses be termed as contributory factor for the IPO scam. MOSL deny that such minor hyper technical and minor lapses as mentioned in the said paragraphs can be deemed to be manipulative in the subscriptions of IPO as alleged or otherwise.
3.1.10 Without prejudice to the above, any lapse on the part of MOSL was rectified immediately as soon as it was brought to its notice. It has also been admitted in the order that most of the rectifications were carried out in the course of audit itself. However, the rest of the alleged lapses have also been rectified and proof of compliance have been annexed to the letter dated April 10,2006 which has not considered or appreciated by SEBI before passing the said order. MOSL denies that due diligence was not exercised by MOSL while opening demat accounts. It is submitted that these lapses on the part of MOSL were due to inadvertence or oversight and it cannot in any event be due to non exercise of diligence. MOSL is a depository participant with more that 1,40,000 accounts and such hyper technical and minor lapses in few cases can in no way be a ground for passing such severe strictures.
4.0 Consideration of the issues
4.1 I have carefully considered the prima facie findings as recorded in the ad interim ex-parte order and the submissions made by MOSL. I have noted that there are two prima facie findings, i.e. 697 demat accounts sharing the common address and failure to exercise due diligence while opening BO accounts.
4.2 As regards 697 demat accounts sharing common address, MOSL submitted that 577 demat accounts are Portfolio Mangers Scheme (PMS) of clients and therefore the address of MOSL was given only for the purpose of correspondence. Further, of the remaining, 8 accounts, are designated for settlement purposes and others are accounts of employees / Chairman of MOSL. The rest of 112 accounts belong to different families across Mumbai, Ahmedabad, Ranchi, Nagpur etc and none of them are named in the SEBI order. Further, MOSL stated that pursuant to the interim order, CA appointed by CDSL conducted physical verification of these account holders and confirmed the identity and existence / genuineness of these accounts.
4.3 Before I deal with the submissions of MOSL, I have noted that the ad interim ex-parte order dated April 27, 2006 was passed based on the prima facie findings that large number of afferent demat accounts (as defined in para 4 of the order) were used as conduits for the purpose of cornering shares in the Initial Public Offering. Further, one of the characteristics of these afferent accounts was that they shared common address as that of the master account holders / key operators. As per the data submitted by CDSL, it was observed that MOSL had opened 697 demat accounts with common address which raised serious suspicion regarding the genuineness of these account holders in light of the prima facie findings of investigation with regard to afferent accounts. Based on the prima facie findings of large scale opening of afferent accounts and these accounts being used for the purpose of cornering the shares meant for retail investors in various IPOs, the DPs who had more than 500 such accounts have been asked not to open fresh demat accounts. It is, therefore, clear that the prohibition on opening of fresh demat accounts was issued upon a serious suspicion of the genuineness of the afferent accounts subject to verification by the Depositories. It was not a punitive measure but a preventive step taken by SEBI in view of urgency, pending inquiry in the interest of investors and the securities market.
4.4 Based on the submissions made by MOSL, I have noted that 585 accounts are those of Portfolio Manager Scheme (PMS) clients and accounts of employees / Chairman of MOSL. Mentioning the address of MOSL for such accounts was necessitated for correspondence purposes. MOSL is a SEBI registered Portfolio Manager and majority of these accounts appear to have been opened in connection with PMS. However, the issue under consideration is regarding the nature of accounts in light of the prima facie findings as stated above. For the said purpose depositories were advised to carry out verification of such accounts and report to SEBI. CDSL submitted its report dated May 12, 2006, which is being examined. CDSL has also been asked to submit a further report regarding the genuineness of these accounts which is awaited.
4.5 It has also been noted that in respect of some cases, MOSL submitted that the KYC documentation was not complete as in such cases the clients were also broking clients wherein the KYC documentation was complete as per the KYC of broking activity and MOSL had failed to attach the copy of the POI at the time of opening demat accounts for such clients which has subsequently been rectified. The above submissions appear to suggest that MOSL does not have effective systems, procedures and controls in place so as to ensure that the regulatory requirements for broking and depositories are independently and strictly complied with.
4.6 As regards the non consideration of their submissions with regard to the April 10, 2006, I have noted that MOSL had submitted compliance report to CDSL vide it’s letter under reference which deals with their submissions of MOSL regarding the findings of the inspection conducted by S S Rathi & Co. However, as per records CDSL had corresponded with MOSL vide their letter dated April 26, 2006 communicating compliance of requirement by CDSL and the submission of MOSL was not available before passing the ad interim ex- parte order dated April 27, 2006.
4.7 As per the findings of inspection report of CA firm S S Rathi & Co, it has been observed in some cases that MOSL had prima facie failed to obtain proof of identity, proof of address, include the names of second and third holders in the DP–BO agreement, verify the photocopies of documents received towards POI and POA with the originals etc, thereby failed to exercise due diligence while opening demat accounts and strictly comply with the KYC norms prescribed by SEBI. In this regard, MOSL submitted that the lapses were minor and hyper technical and the deficiencies indicated were also rectified. I am prima facie not inclined to accept that the lapses of MOSL were merely minor or hyper technical in nature in view of above. Further, it has been observed that MOSL did not obtain bank details from the investors at the time of opening the demat accounts which is prima facie not in line with the guidelines issued by CDSL. Such lapses cannot be dismissed as trivial or superficial. Further, every market intermediary is under obligation to exhibit highest standards of professionalism and integrity in the interest of capital market and, therefore, must abide by the regulatory requirements. Keeping the above observations of mine in view and considering that an Enquiry Officer has already been appointed, I am of the view that these issues will be examined by him. Necessary action can be taken against MOSL, if it is found guilty of violating any regulations of SEBI by the Enquiry Officer. In the meantime, considering the facts and circumstances of the case, I hold that further continuance of the interim prohibition on MOSL requires reconsideration.
4.8 I have also noted that MOSL is registered with SEBI in various capacities. Therefore, there is greater need to have effective systems, controls and procedures in place especially when the activities managed are under one roof and regulatory requirements are independent of each other.
5.0 Order
5.1 In view of the above, I, in exercise of the powers conferred upon me in terms of section 19 read with section 11 and 11B of SEBI Act, 1992, hereby direct that there is no need to continue the direction issued to Motilal Oswal Securities Limited not to open fresh demat accounts.
5.2 It is clarified that the present order gives only a prima-facie finding as to the necessity of interim directions at this stage and accordingly all issues and contentions are left open to be considered by the Enquiry Officer and to be decided in subsequent proceedings pursuant to his report.
5.3 This order shall come into force with immediate effect.
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