2009 (1) TMI 912 - AT - Companies Law

Summary

Issues Involved:
1. Failure to prevent the opening/existence of multiple beneficial owner accounts.
2. Failure to notice unauthorized outsourcing by the Depository Participants.
3. Failure to put in place adequate mechanisms for reviewing, monitoring, and evaluating controls, systems, procedures, and safeguards.
4. Failure to verify the infrastructural facilities of the Depository Participants.
5. Failure to take appropriate action against the Depository Participants for various irregularities.
6. Alleged non-compliance with specific directions issued by the Securities and Exchange Board of India (SEBI).

Issue-wise Detailed Analysis:

1. Failure to Prevent the Opening/Existence of Multiple Beneficial Owner Accounts:
The Board alleged that NSDL facilitated key operators in cornering IPO allotments by allowing the opening of multiple fictitious/benami accounts. The adjudicating officer noted that 34,924 such accounts were opened with the same address, which should have alerted NSDL. However, the tribunal found that compliance with Know Your Client (KYC) norms was primarily the responsibility of the Depository Participants (DPs), not the depositories. The tribunal emphasized that there is no statutory prohibition on opening multiple accounts with the same address. It concluded that the depositories have a limited role in KYC compliance and that the provision for a second address in account opening forms was introduced at SEBI's behest, not NSDL's.

2. Failure to Notice Unauthorized Outsourcing by the Depository Participants:
The charge related to Karvy Stock Broking Ltd. allegedly outsourcing its operations without approval. The tribunal agreed with NSDL's argument that using agents to collect application forms does not amount to outsourcing of DP functions. Such agents are engaged in marketing activities and do not perform KYC verification, which remains the DP's responsibility. The tribunal found no evidence that agents performed KYC verification and concluded that this charge was not established.

3. Failure to Put in Place Adequate Mechanisms for Reviewing, Monitoring, and Evaluating Controls, Systems, Procedures, and Safeguards:
The tribunal addressed two findings: improper data maintenance and lack of internal control standards. NSDL argued that dummy dates in the database were used to maintain audit trails during system migration. The tribunal criticized the adjudicating officer for not allowing cross-examination of the iSec report's authors and found no evidence of data integrity issues. It also noted that NSDL had internal audit mechanisms and that the adjudicating officer's findings were vague and unsupported by specific instances.

4. Failure to Verify the Infrastructural Facilities of the Depository Participants:
The tribunal found that physical inspection of DP facilities before recommending registration was not essential. NSDL ensured electronic connectivity and compatibility of hardware and software, which sufficed to verify infrastructure. The tribunal concluded that there was no statutory requirement for physical inspection and that NSDL's approach was reasonable.

5. Failure to Take Appropriate Action Against the Depository Participants for Various Irregularities:
The tribunal disagreed with the adjudicating officer's view that penalties for KYC non-compliance should be as severe as those for having unqualified personnel. It found no basis to doubt NSDL's judgment in deciding penalties and concluded that the charge was unsubstantiated.

6. Alleged Non-compliance with Specific Directions Issued by SEBI:
The tribunal found that SEBI's orders did not direct NSDL to monitor the flow of securities into specific accounts. The tribunal concluded that the charge was based on a misinterpretation of SEBI's directives and could not be sustained.

CDSL's Appeal:

1. Facilitating the Opening of Beneficial Owner Accounts Without Following Prescribed Procedures:
The tribunal found that the provision for a second address in account opening forms was approved by SEBI and necessary for investor communication. It rejected the adjudicating officer's finding that this provision facilitated the opening of fictitious accounts. The tribunal emphasized that the responsibility for KYC compliance lies with the DPs, not the depositories.

2. Failure to Put in Place Adequate Mechanisms for Reviewing, Monitoring, and Evaluating Controls, Systems, Procedures, and Safeguards:
The tribunal found the adjudicating officer's arguments unconvincing. It noted that CDSL's bye laws were approved by SEBI and that any perceived inadequacy should have been addressed by SEBI advising CDSL to amend them. The tribunal concluded that the charge was not established.

3. Failure to Verify the Infrastructural Facilities of the Depository Participants:
The tribunal found that, similar to NSDL, physical inspection was not essential for verifying DP infrastructure. It concluded that CDSL's approach was reasonable and that there was no statutory requirement for physical inspection.

Conclusion:
The tribunal concluded that none of the charges against NSDL and CDSL were established. It emphasized the need for SEBI and the depositories to work together to secure investor interests and the integrity of the securities market. The tribunal set aside the impugned orders and allowed the appeals, leaving the parties to bear their own costs.