2019 (3) TMI 521 - AT - Companies Law

Stock brokers - misuse of clients funds / securities - Disciplinary action including monetary penalty/ suspension/ expulsion in accordance with National Stock Exchange of India Limited Rules, Regulations and Bye Laws - failure to abide the Code of Conduct for trading members under Regulation 4.5.1 and Regulation 4.5.2 of the National Stock Exchange (Capital Market) Trading Regulations, 1994 as well as under the National Stock Exchange of India Limited Rules - doctrine of proportionality - imposition and quantum of penalty - Held that - Admittedly, the appellant had committed violation which is clear from his submissions in reply to the show cause notice. Thus, the appellant had failed to abide by the Code of Conduct for trading members under the aforesaid Rules and Regulations. The appellant had failed to act in a diligent manner and had failed to protect the interest of his clients. It was found that the appellant had failed to ensure availability of clients assets and misappropriated clients funds to meet the proprietary obligation and, therefore, the appellant failed to perform its fiduciary duty. Using clients funds is a misuse of clients funds and securities and thus, the appellant was liable for imposition of penalty. In the instant case, it was urged by the learned counsel that if the penalty is to be calculated under this provision, a maximum penalty of ₹ 5 lakhs could have been imposed whereas, in the instant case the NSE has imposed a penalty of ₹ 15 lakhs which was excessive - Normally, the penalty indicated in the Circular should be followed in letter and spirit and if a departure is to be made, it would be necessary for the NSE to give reasons for such departure and give a finding as to whether there was repetitive nature of the violation or the gravity of the violation was such that a higher penalty was required to be imposed. If the violation was having a high impact the seriousness and gravity of such violation was required to be indicated - In the absence of any allegation of the violation being repetitive in nature and, in the absence of any finding that the violations had a high impact or that the violations were grave in nature, having serious consequences, we find that the imposition of suspension of trading membership of 5 days was excessive and unwarranted. We are further of the opinion, that considering the admission of the appellant that they had misused the client funds and securities the imposition of penalty of ₹ 15 lakhs over and above the amount indicated in Annexure 1 was justified in the given circumstances. Doctrine of proportionality - Held that - In the instant case, the doctrine of proportionality is fully applicable. In the test of proportionality, the Courts will quash the exercise of discretionary powers if it finds that there is no reasonable relation between the objective which is sought to be achieved and the means used to that end or where the penalty imposed is wholly out of proportion to the relevant misconduct. Thus action which is arbitrary or discriminatory cannot be sustained. In the instant case, the penalty of suspension, in the facts of the given case is out of proportion and thus cannot be sustained. Appeal allowed in part - that part of the order is quashed by which the trading membership of the appellant was suspended in all segments for a period of 5 days.

Summary

Issues Involved:
Mis-utilization of client’s securities, Non-availability of client’s securities, Use of client’s funds to meet proprietary mark to market (MTM) obligations, Non-settlement of client/s account, Discrepancy in computation of net worth, Non-availability of client’s funds, Funding of client transactions, Own beneficiary account not in the name of trading member, Admission of allegations by appellant, Imposition of penalty and suspension by NSE, Applicability and proportionality of penalties.

Detailed Analysis:

1. Mis-utilization of client’s securities:
The appellant admitted to misusing client funds and securities, which the Disciplinary Action Committee (DAC) found to be a violation of the Code of Conduct for trading members under Regulation 4.5.1 and 4.5.2 of the National Stock Exchange (Capital Market) Trading Regulations, 1994. The misuse was deemed a malpractice and a breach of fiduciary duty.

2. Non-availability of client’s securities:
The inspection by NSE officials revealed that the appellant did not maintain the required availability of client securities, further indicating a failure to protect client interests and adhere to regulatory standards.

3. Use of client’s funds to meet proprietary mark to market (MTM) obligations:
The DAC found that the appellant used client funds to meet its proprietary obligations in the Futures and Options (F&O) Segments. This was considered a serious misuse of client assets.

4. Non-settlement of client/s account:
The appellant failed to settle client accounts as required, which is a violation of the regulatory framework and indicative of improper conduct.

5. Discrepancy in computation of net worth:
The inspection also highlighted discrepancies in the computation of the appellant’s net worth, raising concerns about the accuracy and reliability of financial disclosures.

6. Non-availability of client’s funds:
Similar to the non-availability of securities, the appellant did not ensure the availability of client funds, further breaching the trust and regulatory obligations.

7. Funding of client transactions:
The appellant was found to have funded client transactions improperly, which is against the stipulated guidelines and regulations.

8. Own beneficiary account not in the name of trading member:
The appellant’s beneficiary account was not in the name of the trading member, which is a clear violation of the rules.

9. Admission of allegations by appellant:
The appellant admitted to the violations but claimed that they were subsequently rectified. Despite this, the DAC imposed penalties to prevent future malpractices and protect investor confidence.

10. Imposition of penalty and suspension by NSE:
The DAC imposed a penalty of ?15,00,000 and suspended the trading membership of the appellant for 5 days. The appellant argued that the penalty was excessive and not in line with the Circulars Dated 27th June, 2013 and 6th November, 2017, which indicated a lower penalty for first-time violations.

11. Applicability and proportionality of penalties:
The Tribunal noted that the Circulars provided indicative penalties but allowed for adjustments based on the gravity and frequency of violations. The Tribunal found that while the financial penalty was justified, the suspension of trading membership for 5 days was excessive given it was the appellant’s first violation and there was no finding of repetitive or high-impact violations.

Conclusion:
The Tribunal partially allowed the appeal, quashing the suspension of trading membership but upholding the financial penalty. The decision emphasized the need for penalties to be proportionate to the misconduct and supported by clear reasons when deviating from indicative guidelines. The doctrine of proportionality was applied to ensure the penalty was not arbitrary or discriminatory.