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SECURITIES AND EXCHANGE BOARD OF INDIA CORAM: Dr. T. C. Nair, WHOLE TIME MEMBER
IN THE MATTER OF IPO INVESTIGATIONS - INFRASTRUCTURE LEASING & FINANCIAL SERVICES LTD
WTM/TCN/32/ISD/07/06
DATE OF HEARING: 31.05.2006
APPEARANCE:
FOR NOTICEE: Shri Arun K Saha, Deputy Managing Director. Shri Sachin Gupta, Group General Counsel. Shri Rangarajan, CEO.
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 Infrastructure Leasing & Financial Services Ltd (herein after referred to as ‘IL&FS’).
1.2 The ad interim ex-parte order dated April 27, 2006 states that IL&FS, Depository Participant of National Securities Depository Ltd (NSDL) and Central Depository Services Limited (CDSL) prima facie appeared to have 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 Offering (IPO). In view of the above preliminary finding, IL&FS 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 IL&FS. These entities were given opportunity to file 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 of the facility to inspect the relevant documents relied upon by SEBI against them, prior to hearing.
2.0 Findings regarding IL&FS in SEBI's Ad Interim Ex Parte Order
2.1 The focus of the SEBI investigations in the matter of IPOs has been on entities indulging in off-market transactions after the allotment of shares but prior to listing and commencement of trading on the stock exchanges thereby cornering IPO shares in retail segment through benami/fictitious D.P. accounts. In the order dated April 27, 2006, SEBI, prima facie found in respect of IL&FS as under :
2.2 Based on the information submitted by CDSL, it was stated that 3,421 multiple accounts opened with IL&FS shared common address and there were various irregularities including opening of demat accounts in the names of benami / non-existent persons etc.
2.3 The scheme of IPO finance of IL&FS has been stated to be not in the interest of securities market as the scheme resulted in creation of name lenders and not genuine investors.
2.4 The major findings of the inspection by M/s.Shah & Paurana, Chartered Accountants, engaged by CDSL further pointed out among other things that IL&FS failed to follow prescribed procedures as laid down in opening of demat accounts. The failures included not entering permanent address / POA details into Central Depository Accounting System (CDAS), making changes in Account opening form without Clients Authentication, opening of beneficiary Owner’s (BO’s) account with Xerox copy of NSDL account opening forms, discrepancy in BO’s account name in account opening form and the system, signing of multiple agreements by same witness without mentioning name and address, not sending monthly statements of accounts, etc.
2.5 The order dated April 27, 2006 further stated that the deficiencies pointed out in inspections conducted on IL&FS by NDSL during 2003 and 2005 were not rectified and continued to subsist.
2.6 It was also stated at para 13.156 and 13.157 of the order dated April 27, 2006 that Karvy, Registrar and Transfer Agents had issued 6 consolidated refund orders favouring IL&FS.
2.7 In view of the above findings in the order, directions as mentioned in Para 1.2 above were issued to IL&FS.
3.0 Oral hearing and submissions of IL&FS.
3.1 IL&FS filed its preliminary submissions to the order on 17.5.06. Thereafter, it availed itself of the opportunity to inspect the documents relied upon by SEBI. IL&FS also, subsequently on 31.5.06 appeared for personal hearing before me through its officials as recorded on the first page of this order and made oral submissions. Besides, further written submissions were also made vide letter dated 06.06.06. The submissions made by IL&FS in the aforesaid letters and during the oral hearing are as under:
3.1.1 The ad interim ex-parte order has been passed without giving opportunity of personal hearing to IL&FS to defend itself. Hence, no finding recorded in the interim order can be relied upon and no material referred to in the interim order to support the said order can be relied upon against IL&FS. Further, the interim order is without jurisdiction / beyond or in excess of jurisdiction of SEBI and has no nexus with the object sought to be achieved and therefore, the said Order is bad in law.
3.1.2 Under the head “Comments” made at Para 9.5, Table 9.5, serial no 2, at page 30 of the SEBI Interim order, “same as above” implies that comments made in relation to Centurion Bank of Punjab Ltd are also applicable to IL&FS. Second part of the comments relating to Centurion Bank of Punjab Ltd viz. “including opening of dematerialized accounts in the names of benami / non existent persons etc” is not applicable to IL&FS as there is no such allegation made by the Chartered Accountant appointed by SEBI.
3.1.3 The material disclosed in the interim order against IL&FS is very sketchy and does not reveal violation of any procedural and other norms or requirements on the part of IL&FS and at the highest, IL&FS is alleged to have breached the “Know Your Client” norms laid down by SEBI while opening demat account for clients of IL&FS.
3.1.4 Item-wise response of IL&FS vide letter dated March 16, 2006 to CDSL in response to the observations of M/s. Shah & Purana, Chartered Accountant firm appointed by CDSL to inspect IL&FS was not considered. IL&FS’s reply to CDSL, clearly shows that it has since complied with all requirements on its part in every material respect and therefore, there is no question of any breach by IL&FS of the KYC norms or otherwise and IL&FS has not committed any wrongful act of omission or commission or default either in opening the BO account/demat account for its clients or in acting in respect of those accounts referred in the report.
3.1.5 Although, the above letter dated March 16, 2006 was available to SEBI before passing the interim order dated April 27, 2006, the same was not considered at all. Had those submissions being taken into consideration, SEBI would not have made observations or passed any remarks or directions or order against IL&FS. Therefore, the interim order is vitiated and is liable to be set aside and the Show Cause Notice discharged.
3.1.6 In respect of 3421 BO accounts having common address as stated at Para 12.96, these accounts have common address of IL&FS itself and the same is mentioned for the purpose of correspondence. Further, in all the cases of BO accounts/demat accounts opened by IL&FS (referred to in the Chartered Accountant reports), IL&FS had entered into a financing arrangement whereby IL&FS in the normal, regular and bona fide course of its business, legally and validly financed various parties who were interested in applying for shares. The accounts being referred to, are clients who have availed IPO finance from IL&FS. In each and every case the permanent address of the clients whose BO/demat account was opened by IL&FS, was separately available with IL&FS. In case of permanent address of BO/demat account holder happens to be common with the permanent address of any other BO / demat account holder, this is so because their address are in fact common as disclosed by them to IL&FS. This normally happens in case of family members who have same address. Therefore, finding of same address is totally irrelevant, immaterial and devoid of substance, as regards violation of any rules or regulations or requirements.
3.1.7 IL&FS is a Loan and Investment company registered with Reserve Bank of India and such financing is bona fide and in the ordinary, regular and normal course of its business which is legally valid and proper in all respects. There is no prohibition or bar in any law from carrying on such business activities. There is no illegality committed by IL&FS in carrying out its business activities and therefore, it cannot form basis for such adverse finding against IL&FS.
3.1.8 There is no violation of the KYC norms by IL&FS and the discrepancies mentioned at para 12.97 of the order are bona fide errors or clerical errors in the normal course of business but without a sinister or ulterior motive on the part of IL&FS. With regards clause 18 of the para 12.97 which summaries the findings of the inspection of IL&FS by CA firm engaged by CDSL, ILFS submitted as follows: a) It is denied that Maker Checker concept is not fully implemented. Before generation of client id, the details entered by one person is checked and verified by another person. Therefore, it is incorrect to say that Maker Checker is not practiced. b) All details are entered in the back office only because the clients have availed finance from IL&FS and IL&FS is authorized to receive funds from the investee company and the allotment of shares to be credited to particular demat account opened with IL&FS. It was not very necessary to enter the same in the front office CDAS system. c) All accounts were opened for the purpose of IPO with the correspondence address of IL&FS. These clients were aware of opening of the account. Regarding closure of accounts, it is submitted that these were closed due to data entry errors and to avoid misuse. d) Data entry errors were due to wrong data entry of name of clients. IL&FS closed such accounts by signing the account closure forms on the basis of the mandate given to IL&FS by the respective account holders. This was done to mitigate any wrongful use of the account by the account holders. e) Accounts were not closed under the power of attorney but were closed to correct for data entry errors. Fresh accounts were opened in place of the closed accounts. f) IL&FS held the power of attorney to operate the demat accounts and the signature of the various officials of IL&FS have been duly scanned. g) The statement of account is periodically sent to BO holders. Monthly statements are sent in case any transactions are taken place else quarterly statement of accounts are sent. h) Because of financing arrangement entered into by IL&FS with the clients, only in such accounts, the second holder name was entered as IL&FS. i) In all cases referred in the report, proofs of identity and address have been obtained by IL&FS. j) Off market transfers to other demat accounts have been effected strictly in accordance with the instructions and mandate given by the clients to IL&FS. k) It is commonly observed that report about success or otherwise about IPO appears in press. Based on such report, many investors approach Depository Participant to open demat accounts for the purpose of making application in the IPO. l) Each and every account opening form and account closing form was available and offered for inspection team. IL&FS submits that the same will be made available to SEBI, if required.
3.1.9 As regards the observations made at para 15 (page 206) of the interim order that the deficiencies in the reports of the inspections conducted by NSDL during May 2003 were found not rectified when subsequent inspections conducted in November 2003 and November 2004, it is submitted that the same is factually incorrect as all alleged deficiencies were duly rectified and there was no non compliance on its part.
3.1.10 As regards para 17.9 of the order which alleges that IL&FS has grossly failed in complying with KYC norms laid down by SEBI and thereby facilitated opening of demat accounts in fictitious / benami names and cornering of retail portion of IPO shares, it is submitted that no such allegations were made in any of the inspection reports relied upon by SEBI.
3.1.11 The findings of J Jayaraman, Chartered Accountant appointed by SEBI, be taken into consideration. As per the CA report (page 32), it has been stated that IL&FS has followed the basic KYC norms of proof of identity and proof of address. Further, the observations made by J Jayaraman, in the said report are also denied in the same lines as mentioned above.
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 IL&FS.
4.2 At the outset, I have noted that IL&FS had raised objections that ad interim ex-parte order dated April 27, 2006 was passed in violation of principles of natural justice and IL&FS was not given an opportunity before passing such an order.
4.3 I find that the ad interim ex-parte order, was passed in exercise of powers under section 11 (4) and 11 (B) of SEBI Act, 1992. Section 11(4) empowers SEBI to pass such orders both before pending investigation or enquiry and also after completion of investigation or enquiry. As the ad interim ex-parte order itself records that the order has been passed pursuant to a detailed investigation and further the proviso to section 11 (4) provides for passing of such ad interim ex-parte order, pending post decisional hearing, I do not find any legal infirmity in passing such order. Further, I have noted that IL&FS was already given an opportunity to avail of the facility to inspect the relevant documents relied upon by SEBI, prior to hearing.
4.4 As regards opening of 3421 multiple demat accounts of CDSL sharing common address, IL&FS submitted that these account holders have entered into financing arrangements with IL&FS and for the purpose of securing recovery of dues from the clients, the address of IL&FS was captured as correspondence address. However, permanent address of the BO holder is separately available with IL&FS.
4.5 I have noted that IL&FS has not specifically addressed the issue of consolidated refund orders as mentioned at Para 13.156 and 13.157 of the order. However, upon consideration of the above submissions, it appeared that IL&FS had its own address for the purpose of correspondence and especially for receiving refund orders from the registrar in respect of clients who availed IPO finance from IL&FS as a Non-Banking Financial Company (NBFC). Strictly speaking, depository participant activities and activities of NBFC are independent of each other and had to be treated procedurally, accordingly.
4.6 Further, as regards the second issue, i.e. scheme of IPO finance not being in the interest of securities market, I note that the IL&FS by virtue of having both depository and NBFC divisions under the same management was able to conveniently design an IPO finance scheme to provide finance to its demat clients. SEBI’s circular MRD/DoP/Dep/Cir-29/2004 dated August 24, 2004 requires the depository participants to obtain the proof of identity and proof of address before opening demat accounts. Strict adherence to these norms by the depository participants would have ensured that the demat account holders were not benami or fictitious and IL&FS provided IPO finance to genuine demat account holders. I observe that all formalities starting from opening of demat account till the receipt of refund order were taken care of by the IL&FS and in the process, in order to ensure control over the demat account, it had also obtained power of attorney to operate the account. Besides, it is observed that in respect of these accounts, correspondence address of IL&FS was mentioned which implied thereby that KYC documentation is merely a paper work and the requirement of ensuring the identity of the clients is to safeguard the interests of the IL&FS and not to establish the genuineness of the clients. The above scheme of IL&FS would not have, however, been possible had demat accounts of the IPO clients were with a depository participant other than IL&FS itself.
4.7 In view of the foregoing, I am of the view that a market intermediary should exhibit highest standards of integrity in all its dealings with its clients and should not merely strive towards furtherance of the business/commercial interest at the cost of internal controls, system and procedures prescribed by SEBI.
4.8 As regards the irregularities in connection with the KYC forms as described in paragraph 12.97 of the order, IL&FS has submitted that the same is with reference to the findings in the Inspection Report of M/s. Shah & Paurana, Chartered Accountant (CA) appointed by CDSL. IL&FS, in its submission stated that findings of CA report are merely procedural and therefore do not warrant such drastic action. I do not agree with the view that the findings of CA are merely procedural as they prima facie reflect the laxity shown by the DP while opening the demat account as against the procedures prescribed by SEBI. Vide its letter dated March 16, 2006 IL&FS further submitted that it had rectified all the anomalies pointed out in the said Inspection Report. IL&FS vide its letter dated June 6, 2006 reconfirmed this position. Subsequent to the order dated April 27, 2006, CDSL had however appointed M/s. R. Jaitlia & Co, Chartered Accountants to conduct inspection of IL&FS and as per the report of the CA there seems to be still failures in complying with the KYC norms.
4.9 In the Inspection Report submitted by M/s. Shah & Paurana, there is a finding that BO details were not entered in CDAS. With regard to this, IL&FS submitted that all details were entered in the back office system because the clients who availed finance from IL&FS have authorization to receive funds / shares from the investee company and therefore, it is not very necessary to enter the same in the front office CDAS system. I do not agree with the submission made by IL&FS which indicates that the system and procedures are adopted / designed only for their operational convenience as in accordance with SEBI’s circular MRD/DoP/Dep/Cir-29/2004 dated August 24, 2004, the depository system should reflect the true and correct particulars of the dematerialized account holders.
4.10 Reference was also made to report of J. Jayaraman, Chartered Accountants Firm appointed by SEBI. I note that in the said report, it has been mentioned that IL&FS has been predominantly entertaining IPO financing in its operations for catering to the BO/Demat accounts. It funds the public issues by accepting very little margin and providing finance for the remaining major portion. e.g. in the case of IDFC, the issue was for Rs.36/- per share, while it financed Rs.34.50 and accepted Rs.1.50 as margin. IL&FS have accepted a mandate from every BO/loanee indicating that the allotted shares will be transferred through off-market transfers to any other demat account of their choice. This sort of arrangement is not in the interest of securities market as the same may result in creation of name lenders and not genuine investors.
4.11 SEBI had vide its order dated April 27, 2006, directed NSDL and CDSL to conduct inspection of Depository Participants in order to verify whether all the account holders of these Depository Participants are genuine and KYC norms laid down by SEBI have been duly complied with. NSDL, vide its letter dated June 12, 2006 submitted its report to SEBI wherein it was observed that sample of 285 demat accounts were selected for in person verification. NSDL has been requested by SEBI to submit further information as regards the verification carried out by it. Similarly, CDSL also vide letter dated May 26, 2006 furnished its verification report to SEBI, which is under examination. Also, considering that an enquiry officer to go into the facts has already been appointed, I am of the view that issues, if any shall be taken up by him. Necessary action will thereafter, be taken against IL&FS, if it is found guilty of violating any regulations of SEBI. In the meantime, based on the material available on record and the submissions made by IL & FS, I am of the view that interim prohibition on IL & FS may not be required to be continued.
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 the SEBI Act, 1992, hereby direct that there is no need to continue the directions issued to IL & FS 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 passing the 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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