Mefcom Securities Ltd Vs. Securities and Exchange Board of India - Court Judgment

Excerpt:
1. this appeal has been filed under section 15t of the securities and exchange board of india, act, 1992 (for short "the act") challenging the order dated december 21, 2005 of the adjudicating officer in the adjudicating proceedings held against m/s. mefcom securities ltd (for short msl), the appellant. a monetary fine of rs.10 lacs has been imposed on the appellant by the adjudicating officer for the alleged irregularities committed by the former as disclosed during its inspection by the securities and exchange board of india (for short the board) carried out through a firm of chartered accountants.2. the appellant is a stock broker registered with the board and is a member of the delhi stock exchange, national stock exchange, the stock exchange, mumbai and otcei. the books of accounts and other records were inspected by the chartered accountants for the period from april 2002 to march 2004 and a large number of irregularities were noticed.after receipt of the appellant's reply dated may 26, 2005 to the show cause notice dated may 10, 2005 served on the appellant by the board under rule 4 of the securities and exchange board of india (procedure of holding inquiry and imposing penalties by adjudicating officer) rules, 1995, a notice of hearing dated june 7, 2005 was issued to the appellant. the personal hearing took place on june 20,2005 and the appellant also made a further written submission along with other documents with its letter of june 28, 2005. the adjudicating officer gave the following findings on the allegations: failure to maintain separate books of account for the transactions on nse, bse, dse & otcei appellant's contention not acceptable - blatant violation of regulatory requirement msl contentions unacceptable. accordingly, cognizance is taken of this aberration.failure to maintain order book i.e. failure to maintain record of time of placement of order non maintenance amounts to failure to comply with circulars and regulation failure to maintain book copy of contract notes and reflect dates of acknowledgement on duplicate copy of contract notes in some cases msl admitted lapses in certain instances and explanation given not acceptable.failure to affix preprinted serial numbers on contract notes and non-reflection of details of 100% dispatches in the dispatch register maintained for the years 2002-03, 2003-04.no merits in the msl contention that staff left office before the courier came.msl failure to obtain/maintain proper broker - client agreements & registration forms calls for penalty.extreme lack of due diligence by msl. however msl was already penalized by bse for dealing with unregistered sub-brokers- (1) failure to use unique client code (specific cases brought to notice of msl) (2) transferred trades from proprietary account to clients' accounts with a view to avoiding margins and dealing in dummy accounts.grant of unauthorized trading terminals - bse trading terminals-3 clients premises due diligence not exercised. the fact that reconciliation of even the year 2002-03 was pending at the time of inspection shows that msl not concerned about payment of investors' legitimate dues.3. in its reply to the show cause notice the appellant had not specifically denied any of the allegations and either pleaded mitigating circumstances or informed that the deficiencies had been rectified. the learned counsel for the appellant also during his argument conceded that the findings during the inspection were based on facts and most of them could not be denied. he, however, made the following points: (1) about 83 per cent of the appellant's trades were of proprietary nature and out of the remaining 17 per cent which were trades of their clients, only 3 per cent were delivery based. this being so, the appellant's failure to adhere to all the procedural and regulatory requirements did not have any serious effect on the interest of investors. (2) no client has suffered any loss because of any lapse on the part of the appellant. (3) the appellant's banker insisted upon their right to transfer funds between the appellant's account and the accounts of the appellant's clients because this was purported policy of the bank. the appellant therefore had to agree to such practice. in 2003 the appellant changed its bank and the above practice was discontinued. (4) the violations pointed out during inspection are merely of technical nature. (6) regulation 26 of securities and exchange board of india (stock brokers and sub-brokers) regulations, 1992 (stock brokers regulations for short) was not in existence during the major portion of the period covered by the inspection and therefore there could be no liability for monetary penalty for any violation of that regulation. (7) the penalty awarded was disproportionately high compared to the gravity of the offence.4. we are unable to accept the arguments of the learned counsel for the appellant. the proportion of the trade of the appellant on account of his clients vis-is his proprietary trade has little to do with the extent of care and skill to be exercised by him in adhering to the regulatory requirements that are meant to protect the interest of investors. the size of the clientele is not relevant in this respect nor is the fact whether there are complaints from the clients. we also do not agree that the violations of regulations found during inspection were merely technical in nature. in any case the appellant had no reason whatever to allow its banker the authority to transfer funds from and to the accounts of the clients since this was a gross violation of a statutory regulation. while some of the infractions are of procedural nature others could be quite serious in their consequences. for example, segregation of every client's account from the broker's account as well as use of unique client code leads to greater transparency in the business operations of the brokers and thereby enhances the integrity and quality of the securities market. it is far from correct to hold that such requirements are "merely" technical in nature. similarly, absence of broker client agreement would lead to difficulties or even failure in retrieval of information by regulators during any check or investigation and this would seriously affect the efficacy of the regulation process. the lapses on the part of the appellant clearly reflect a lack of exercise of due care, skill and diligence required of a broker and deserve to be viewed seriously.5. we now come to the question of penalty. the argument of the learned counsel for the appellant regarding regulation 26 of the stock brokers regulations is not tenable as the penalty has been levied under the provisions of chapter via of the act and not in terms of regulation 26 ibid. along with all relevant facts of the case and the submissions made by the appellant, the adjudicating officer has considered the factors mentioned in section 15j of the act before awarding the penalty. in view of the large number of defaults of the appellant that have been established that show the lack of due care, skill and diligence on its part, the penalty imposed by the adjudicating officer can not be considered disproportionately high and there is no reason for us to interfere with the quantum of penalty.

Judgment:
1. This appeal has been filed under Section 15T of the Securities and Exchange Board of India, Act, 1992 (for short "the Act") challenging the order dated December 21, 2005 of the adjudicating officer in the adjudicating proceedings held against M/s. Mefcom Securities Ltd (for short MSL), the appellant. A monetary fine of Rs.10 lacs has been imposed on the appellant by the adjudicating officer for the alleged irregularities committed by the former as disclosed during its inspection by the Securities and Exchange Board of India (for short the Board) carried out through a firm of chartered accountants.

2. The appellant is a stock broker registered with the Board and is a member of the Delhi Stock Exchange, National Stock Exchange, the Stock Exchange, Mumbai and OTCEI. The books of accounts and other records were inspected by the chartered accountants for the period from April 2002 to March 2004 and a large number of irregularities were noticed.

After receipt of the appellant's reply dated May 26, 2005 to the show cause notice dated May 10, 2005 served on the appellant by the Board under Rule 4 of the Securities and Exchange Board of India (Procedure of Holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995, a notice of hearing dated June 7, 2005 was issued to the appellant. The personal hearing took place on June 20,2005 and the appellant also made a further written submission along with other documents with its letter of June 28, 2005. The adjudicating officer gave the following findings on the allegations: Failure to maintain separate books of account for the transactions on NSE, BSE, DSE & OTCEI Appellant's contention not acceptable - blatant violation of regulatory requirement MSL contentions unacceptable. Accordingly, cognizance is taken of this aberration.

Failure to maintain order book i.e. failure to maintain record of time of placement of order Non maintenance amounts to failure to comply with circulars and regulation Failure to maintain book copy of contract notes and reflect dates of acknowledgement on duplicate copy of contract notes in some cases MSL admitted lapses in certain instances and explanation given not acceptable.

Failure to affix preprinted serial numbers on contract notes and non-reflection of details of 100% dispatches in the dispatch register maintained for the years 2002-03, 2003-04.

No merits in the MSL contention that staff left office before the courier came.

MSL failure to obtain/maintain proper broker - client agreements & registration forms calls for penalty.

Extreme lack of due diligence by MSL. However MSL was already penalized by BSE for dealing with unregistered sub-brokers- (1) Failure to use unique client code (Specific cases brought to notice of MSL) (2) Transferred trades from proprietary account to clients' accounts with a view to avoiding margins and dealing in dummy accounts.

Grant of unauthorized trading terminals - BSE trading terminals-3 clients premises Due diligence not exercised. The fact that reconciliation of even the year 2002-03 was pending at the time of inspection shows that MSL not concerned about payment of investors' legitimate dues.

3. In its reply to the show cause notice the appellant had not specifically denied any of the allegations and either pleaded mitigating circumstances or informed that the deficiencies had been rectified. The learned Counsel for the appellant also during his argument conceded that the findings during the inspection were based on facts and most of them could not be denied. He, however, made the following points: (1) About 83 per cent of the appellant's trades were of proprietary nature and out of the remaining 17 per cent which were trades of their clients, only 3 per cent were delivery based. This being so, the appellant's failure to adhere to all the procedural and regulatory requirements did not have any serious effect on the interest of investors.

(2) No client has suffered any loss because of any lapse on the part of the appellant.

(3) The appellant's banker insisted upon their right to transfer funds between the appellant's account and the accounts of the appellant's clients because this was purported policy of the bank.

The appellant therefore had to agree to such practice. In 2003 the appellant changed its bank and the above practice was discontinued.

(4) The violations pointed out during inspection are merely of technical nature.

(6) Regulation 26 of Securities and Exchange Board of India (Stock brokers and Sub-Brokers) Regulations, 1992 (Stock Brokers Regulations for short) was not in existence during the major portion of the period covered by the inspection and therefore there could be no liability for monetary penalty for any violation of that Regulation.

(7) The penalty awarded was disproportionately high compared to the gravity of the offence.

4. We are unable to accept the arguments of the learned Counsel for the appellant. The proportion of the trade of the appellant on account of his clients vis-is his proprietary trade has little to do with the extent of care and skill to be exercised by him in adhering to the regulatory requirements that are meant to protect the interest of investors. The size of the clientele is not relevant in this respect nor is the fact whether there are complaints from the clients. We also do not agree that the violations of regulations found during inspection were merely technical in nature. In any case the appellant had no reason whatever to allow its banker the authority to transfer funds from and to the accounts of the clients since this was a gross violation of a statutory regulation. While some of the infractions are of procedural nature others could be quite serious in their consequences. For example, segregation of every client's account from the broker's account as well as use of unique client code leads to greater transparency in the business operations of the brokers and thereby enhances the integrity and quality of the securities market. It is far from correct to hold that such requirements are "merely" technical in nature. Similarly, absence of broker client agreement would lead to difficulties or even failure in retrieval of information by regulators during any check or investigation and this would seriously affect the efficacy of the regulation process. The lapses on the part of the appellant clearly reflect a lack of exercise of due care, skill and diligence required of a broker and deserve to be viewed seriously.

5. We now come to the question of penalty. The argument of the learned Counsel for the appellant regarding regulation 26 of the Stock Brokers Regulations is not tenable as the penalty has been levied under the provisions of Chapter VIA of the Act and not in terms of regulation 26 ibid. Along with all relevant facts of the case and the submissions made by the appellant, the adjudicating officer has considered the factors mentioned in Section 15J of the Act before awarding the penalty. In view of the large number of defaults of the appellant that have been established that show the lack of due care, skill and diligence on its part, the penalty imposed by the Adjudicating Officer can not be considered disproportionately high and there is no reason for us to interfere with the quantum of penalty.