SAT recently pronounced an interesting order (available here) in the matter of G.M. Bosu and Company Private Limited (the “Appellant”) versus SEBI and Central Depositary Services (India) Limited (the “Respondent 2”) and Mrs. Atreyee Chakraborty (the “Respondent 3”) wherein it held that the directions of SEBI under section 11B of the Securities and Exchange Board of India Act, 1992 (the “SEBI Act”) cannot be punitive in nature.
Section 11 of the SEBI Act empowers SEBI to protect the interests of the investors in securities and to regulate the securities market by taking measures it deems fit and Section 11B reads as under:
“11B. Power to issue directions – 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.”
“11B. Power to issue directions – 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.”
The facts of this matter in brief were that the husband of Respondent 3 was a registered holder of 1100 equity shares of ITC Limited, which were held by him in physical form. On his death, Respondent 3 approached one Mr. Pyne, who was an ex-employee of the appellant and was working with her husband for getting the shares transferred in her name. Mr. Pyne advised her to open a demat account to facilitate the transfer and Respondent 3 handed over the share certificates representing the aforesaid shares to Mr. Pyne. Mr. Pyne opened the demat account with the Appellant, a depositary participant of Respondent 2, which is a depositary. The Appellant issued printed receipts acknowledging the receipt of share certificates representing the said shares.
The case presented by Respondent 3 was that Mr. Pyne was responsible for fraudulently transferring some of the shares to third parties and some in his own name, given the fact that she had had signed a number of blank printed forms and other documents including delivery instruction slips (the “DIS”) in good faith, under the impression that those documents were necessary for opening a demat account. Respondent 3 produced a hand written note (the “Note”) signed by Mr. Pyne and witnessed by her wherein Mr. Pyne confessed that he had cheated Respondent 3 and had obtained her signatures on some forms including DIS without her consent and transferred the shares illegally. In the Note, Mr. Pyne made a commitment to deliver the shares to Respondent 3 in the time stipulated therein and also committed that upon his failure to pay the dues with interest to Respondent 3, his legal heirs would be liable to pay the said dues.
Respondent 3 made a complaint to the Board that she had been defrauded of the shares by Mr. Pyne and that she had suffered a financial loss amounting to INR 3 lakhs and sent a copy of the note therewith. She also complained to the Appellant that she had been defrauded of the said shares by Mr. Pyne and she further alleged that Mr. Pyne was acting as a sub-broker of the Appellant and, therefore, she claimed damages to the tune of INR 3 lakhs for harassment and loss suffered by her. On getting no response from SEBI she filed a writ petition in the Calcutta High Court seeking a mandamus directing SEBI to initiate proceedings against Respondent 2 and the Appellant. The said writ petition was disposed by the Hon’ble High Court with an order to SEBI to give a reasonable opportunity of being heard to Respondent 3, Respondent 2 and the Appellant and give a decision regarding the question whether complaints made by Respondent 3 called for initiation of proceedings under any provisions of law.
The case presented by Respondent 3 was that Mr. Pyne was responsible for fraudulently transferring some of the shares to third parties and some in his own name, given the fact that she had had signed a number of blank printed forms and other documents including delivery instruction slips (the “DIS”) in good faith, under the impression that those documents were necessary for opening a demat account. Respondent 3 produced a hand written note (the “Note”) signed by Mr. Pyne and witnessed by her wherein Mr. Pyne confessed that he had cheated Respondent 3 and had obtained her signatures on some forms including DIS without her consent and transferred the shares illegally. In the Note, Mr. Pyne made a commitment to deliver the shares to Respondent 3 in the time stipulated therein and also committed that upon his failure to pay the dues with interest to Respondent 3, his legal heirs would be liable to pay the said dues.
Respondent 3 made a complaint to the Board that she had been defrauded of the shares by Mr. Pyne and that she had suffered a financial loss amounting to INR 3 lakhs and sent a copy of the note therewith. She also complained to the Appellant that she had been defrauded of the said shares by Mr. Pyne and she further alleged that Mr. Pyne was acting as a sub-broker of the Appellant and, therefore, she claimed damages to the tune of INR 3 lakhs for harassment and loss suffered by her. On getting no response from SEBI she filed a writ petition in the Calcutta High Court seeking a mandamus directing SEBI to initiate proceedings against Respondent 2 and the Appellant. The said writ petition was disposed by the Hon’ble High Court with an order to SEBI to give a reasonable opportunity of being heard to Respondent 3, Respondent 2 and the Appellant and give a decision regarding the question whether complaints made by Respondent 3 called for initiation of proceedings under any provisions of law.
Accordingly, SEBI conducted the relevant hearings and communicated to Respondent 3 its conclusion that the complaint of Respondent 3 did not call for initiation of proceedings by SEBI. SEBI was of the opinion that Respondent 3’s complaint was in the nature of a ‘private arrangement’ between her and Mr. Pyne, ‘an unregistered entity’, wherein Mr. Pyne acted contrary to her instructions, so SEBI had no role to play in this regard. Being dissatisfied with this order by SEBI, Respondent 3 again filed a writ petition in the Calcutta High Court contending that Respondent 2 and the Appellant were negligent in not ensuring that payment had been received by her before they transferred her shares in the name of third parties and, therefore, they violated Regulation 32 (as it then stood) of the Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996 (the “DP Regulations”). This writ petition was disposed by the Hon’ble High Court ordering SEBI to make an enquiry as to how Respondent 2 has ensured in terms of Regulation 32 that the depositor was paid before effecting transfer, upon notice to the Appellant and upon hearing the necessary parties including Respondent 3 and if found that proper mechanism under Regulation 32 was not in place, to take steps accordingly.
Pursuant to the aforesaid order, the whole time member of SEBI, after hearing Respondent 3, Respondent 2 and the Appellant passed an order holding that the Appellant and Respondent 2 had violated Regulation 32 of the DP Regulations (as it then stood) and treating this order as a show cause notice called upon the Appellant and Respondent 2 to show cause why they should not be directed jointly and severally to compensate Respondent 3. The Appellant replied to the said show cause notice stating that it was in compliance with Regulation 32 of the DP Regulations. The Appellant stated that the DIS is required to be filled by the client and the appellant as a participant, is only to ensure the transfer of securities as per the instructions contained therein. The Appellant claimed to have enquired from both Respondent 3 and Mr. Pyne about the validity of the DIS and the relevant payment and only on being informed that everything was in order, the Appellant recommended the transfer of the securities. The whole time member of SEBI passed an order under holding that both the Appellant and Respondent 2 were negligent in not ensuring that Respondent 3 had received the payment before transferring her shares and were, thus, guilty of violating Regulation 32 of the DP Regulations. Further, he issued direction under sections 11 and 11B of the SEBI Act directing the Appellant to transfer the shares (along with the accrued benefits) to Respondent 3 and file a compliance report with SEBI, failing which SEBI would initiate appropriate proceedings in accordance with law. The Appellant appealed against this order to SAT.
The Appellant submitted before SAT that it had not violated Regulation 32 of the DP Regulations and assuming arguendo if there was any such violation by the Appellant, the only course open to SEBI is to proceed against them under Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008 (the “Intermediaries Regulations”) and that it was not proper for SEBI to exercise powers under section 11B of the SEBI Act and issue directions. This argument of the Appellant was accepted by the SAT and it set aside the order made by the whole time member of SEBI.
Regulation 32 of the DP Regulations (prior to the Securities and Exchange Board of India (Depositaries and Participants) (Second Amendment) Regulations, 2008, available here ) read as under:
“32. Transfer to be effected only after payment– The depository shall satisfy the Board that it has a mechanism in place to ensure that the interest of the persons buying and selling securities held in the depository are adequately protected and shall register the transfer of a security in the name of the transferee only after the depository is satisfied that payment for such transfer has been made.”
By the said amendment, the words “and shall register the transfer of a security in the name of the transferee only after the depository is satisfied that payment for such transfer has been made” in Regulation 32 were deleted.
Also, the relevant part of Regulation 64 of the DP Regulations reads as under:
“64. Liability for action in case of default – A depository or a participant who-
(a) contravenes any of the provisions of the Act, the Depositories Act, the bye-laws, agreements and these regulations;
(b) …………..
(c) …………...
(d) ……………
(e) ……………
(f) ……………
shall be dealt with in the manner provided under Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008”
Chapter V (Regulations 22 to 33) of the Intermediaries Regulations (titled “Action in Case of Default and Manner of Suspension or Cancellation of Certificate) contains the detailed procedure to be followed to deal with the delinquents. It envisages a two stage inquiry before taking any action against the delinquent. A designated authority is required to be appointed which shall issue a show cause notice to the delinquent and after holding an inquiry, a report shall be submitted. The report will then be considered by the designated member after issuing a notice to the delinquent who will also be furnished with a copy of the report. It is only then that the designated member can take any one or more of the actions referred to in Regulation 27 of the Intermediaries Regulations (viz. suspension/cancellation of registration certificate; prohibiting, debarring or warning the intermediary) keeping in view the facts and circumstances of the case.
On the issue of violation of Regulation 32 by the Appellant, the SAT held that-
“The plain language of regulation 32 makes it clear that the obligation to satisfy itself is only on the depository and no such duty is cast on the participant. A participant is only an agent of the depository. It is relevant to point out that this obligation of the depository has also been done away with when this regulation was amended with effect from August 8, 2008. The words “and shall register the transfer of a security in the name of the transferee only after the depository is satisfied that payment for such transfer has been made” were deleted. We cannot, therefore, agree with the Board that the appellant violated this regulation.”
SAT further held that- “Assuming (though not holding) that there was such a violation, Regulation 64 (of the Depositaries Regulations) requires that the depository or a participant who contravenes any provision of the regulations ‘shall be dealt with in the manner provided under Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008.’ ” [emphasis provided].
Pursuant to the aforesaid order, the whole time member of SEBI, after hearing Respondent 3, Respondent 2 and the Appellant passed an order holding that the Appellant and Respondent 2 had violated Regulation 32 of the DP Regulations (as it then stood) and treating this order as a show cause notice called upon the Appellant and Respondent 2 to show cause why they should not be directed jointly and severally to compensate Respondent 3. The Appellant replied to the said show cause notice stating that it was in compliance with Regulation 32 of the DP Regulations. The Appellant stated that the DIS is required to be filled by the client and the appellant as a participant, is only to ensure the transfer of securities as per the instructions contained therein. The Appellant claimed to have enquired from both Respondent 3 and Mr. Pyne about the validity of the DIS and the relevant payment and only on being informed that everything was in order, the Appellant recommended the transfer of the securities. The whole time member of SEBI passed an order under holding that both the Appellant and Respondent 2 were negligent in not ensuring that Respondent 3 had received the payment before transferring her shares and were, thus, guilty of violating Regulation 32 of the DP Regulations. Further, he issued direction under sections 11 and 11B of the SEBI Act directing the Appellant to transfer the shares (along with the accrued benefits) to Respondent 3 and file a compliance report with SEBI, failing which SEBI would initiate appropriate proceedings in accordance with law. The Appellant appealed against this order to SAT.
The Appellant submitted before SAT that it had not violated Regulation 32 of the DP Regulations and assuming arguendo if there was any such violation by the Appellant, the only course open to SEBI is to proceed against them under Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008 (the “Intermediaries Regulations”) and that it was not proper for SEBI to exercise powers under section 11B of the SEBI Act and issue directions. This argument of the Appellant was accepted by the SAT and it set aside the order made by the whole time member of SEBI.
Regulation 32 of the DP Regulations (prior to the Securities and Exchange Board of India (Depositaries and Participants) (Second Amendment) Regulations, 2008, available here ) read as under:
“32. Transfer to be effected only after payment– The depository shall satisfy the Board that it has a mechanism in place to ensure that the interest of the persons buying and selling securities held in the depository are adequately protected and shall register the transfer of a security in the name of the transferee only after the depository is satisfied that payment for such transfer has been made.”
By the said amendment, the words “and shall register the transfer of a security in the name of the transferee only after the depository is satisfied that payment for such transfer has been made” in Regulation 32 were deleted.
Also, the relevant part of Regulation 64 of the DP Regulations reads as under:
“64. Liability for action in case of default – A depository or a participant who-
(a) contravenes any of the provisions of the Act, the Depositories Act, the bye-laws, agreements and these regulations;
(b) …………..
(c) …………...
(d) ……………
(e) ……………
(f) ……………
shall be dealt with in the manner provided under Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008”
Chapter V (Regulations 22 to 33) of the Intermediaries Regulations (titled “Action in Case of Default and Manner of Suspension or Cancellation of Certificate) contains the detailed procedure to be followed to deal with the delinquents. It envisages a two stage inquiry before taking any action against the delinquent. A designated authority is required to be appointed which shall issue a show cause notice to the delinquent and after holding an inquiry, a report shall be submitted. The report will then be considered by the designated member after issuing a notice to the delinquent who will also be furnished with a copy of the report. It is only then that the designated member can take any one or more of the actions referred to in Regulation 27 of the Intermediaries Regulations (viz. suspension/cancellation of registration certificate; prohibiting, debarring or warning the intermediary) keeping in view the facts and circumstances of the case.
On the issue of violation of Regulation 32 by the Appellant, the SAT held that-
“The plain language of regulation 32 makes it clear that the obligation to satisfy itself is only on the depository and no such duty is cast on the participant. A participant is only an agent of the depository. It is relevant to point out that this obligation of the depository has also been done away with when this regulation was amended with effect from August 8, 2008. The words “and shall register the transfer of a security in the name of the transferee only after the depository is satisfied that payment for such transfer has been made” were deleted. We cannot, therefore, agree with the Board that the appellant violated this regulation.”
SAT further held that- “Assuming (though not holding) that there was such a violation, Regulation 64 (of the Depositaries Regulations) requires that the depository or a participant who contravenes any provision of the regulations ‘shall be dealt with in the manner provided under Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008.’ ” [emphasis provided].
From above, it can be inferred that in the instant case, SAT's stance was that what necessarily had to be done, was to follow the procedure under Chapter V of the Intermediaries Regulations and not an issuance of directions by SEBI under section 11B of the SEBI Act. As regards section 11B of the SEBI Act, SAT remarked that “It is true that the powers of (SEBI) under section 11B are wide enough to issue directions to any intermediary or person associated with the securities market but such powers are to be exercised only to protect the interests of investors in securities or for orderly development of securities market and to preserve its integrity. These directions cannot be punitive in nature and cannot be issued to punish a delinquent. Punitive action against any delinquent intermediary could be taken only in accordance with (the Intermediaries Regulations).”
Undoubtedly, the facts in this matter would not have been fit for directions to be issued by SEBI under section 11B, but the aforesaid observations of SAT amounts to reading a restriction on the powers of SEBI under section 11B of the SEBI Act which is not there in that section nor the SEBI Act. With all due respect, there appears to be no logical reason whereby a punitive action against a delinquent intermediary cannot be said to be a direction issued by SEBI under section 11B ‘in the interest of investors or to prevent the affairs of an intermediary conducted in a manner detrimental to the interest of investors’. Another important aspect in this regard is that the Intermediaries Regulations itself is made by virtue of powers conferred on SEBI by section 30 of the SEBI Act.
On a separate point, SAT opined that since Respondent 3 was duped by Mr. Pyne, it is not fair to direct the Appellant to compensate her and her remedy would be against the heirs of Mr. Pyne(since Mr. Pyne had deceased). SAT further remarked that “….why did she (Respondent 3) sign the blank DIS form(s) which are like cheques and since she did that, she has herself to blame.” This gives an impression that an investor will not be remedied for losses suffered due to his own negligence, viz. signing the blank DIS forms, as in this case.
On a separate point, SAT opined that since Respondent 3 was duped by Mr. Pyne, it is not fair to direct the Appellant to compensate her and her remedy would be against the heirs of Mr. Pyne(since Mr. Pyne had deceased). SAT further remarked that “….why did she (Respondent 3) sign the blank DIS form(s) which are like cheques and since she did that, she has herself to blame.” This gives an impression that an investor will not be remedied for losses suffered due to his own negligence, viz. signing the blank DIS forms, as in this case.
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