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TMI Blog2009 (1) TMI 912X X X X Extracts X X X X X X X X Extracts X X X X ..... udication proceedings originated out of the investigations conducted by the Board into the issue of shares of 21 companies through initial public offerings (IPOs) during the period 2003-2005. Investigations revealed that shares in the aforesaid IPOs, which were reserved for retail investors, were irregularly acquired by many entities through the medium of thousands of fictitious/benami applications. For this purpose the said entities (hereinafter referred to as key operators) opened a large number of demat accounts in fictitious and benami names and used those to make applications for shares in the IPOs in the category of retail investors. On allotment, the shares were transferred to the demat accounts of the key operators who in turn allegedly transferred the shares through off market deals to the ultimate beneficiaries who had financed the purchase of such large number of shares. The financiers sold the shares immediately after they were listed in the stock exchanges to garner huge profits. The two appeals in which the charges as well as the arguments on both sides are very similar to each other and somewhat interrelated, have been heard by us one after the other. For the sake ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the Depository Participant concerned. The Depository Participants, thus, act as agents of the Depositories. The detailed duties, responsibilities and obligations of the Depositories and the Depository Participants are laid down in the Depositories Act, the Regulations framed thereunder and also in various orders and circulars issued by the Board from time to time. This apart, the Depositories frame their own bye laws with the approval of the Board to regulate their own operations. Both the Depositories have also issued separate sets of operating instructions for their respective Depository Participants. With the introduction of the depository system, the risk associated with handling paper certificates and transfer deeds has been eliminated and the framework for settlement of transactions in the securities market has evolved into a cleaner, more efficient and more transparent one. Appeal no 68 of 2007 3. In the show cause notice dated November 23, 2006 which was issued to NSDL under Rule 4 of the Securities and Exchange Board of India (Proceedure for Holding Enquiry and Imposing Penalty by Adjudicating Officer) Rules, 1995, it has been alleged by the Board that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ps) after ensuring adherence to the Know Your Client (KYC) norms. Detailed instructions in this regard have been issued by the Board and the Depositories also have issued various communications in this regard to the DPs. It has been noted in the impugned order that as many as 34,924 fictitious/benami accounts of beneficial owners were opened with the DPs for 21 IPO s including thousands of accounts which had the same address and most of which were closed soon after the allotment process. The respondent Board s case is that the failure of the appellant to prevent the opening of such multiple beneficiary ownership accounts with the same address occurred mainly because the application forms for opening beneficial ownership accounts provided for two addresses and the process of making illegal profits by cornering the retail category shares in the IPO s was facilitated by using the address of the financiers as the correspondence address or the second address. According to the iSec report, the provision for the second address was introduced on the insistence of the appellant. This was vehemently denied by the learned senior counsel for NSDL who argued that the feature regarding corre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the depository participant, under his signature shall verify the original documents. The circular of August 4, 2000 was addressed not to the Depositories but to the DPs, though copies were endorsed to the Depositories as well. We also find that there is absolutely no bar in the Depositories Act or the Regulations framed thereunder on opening of multiple accounts by a beneficial owner. In fact, the Board itself advises investors in its own website that an investor can open more than one account in the same name with the same DP and also with different DPs. Thus, more than one account can be opened in the same name and also with the same address. Given this situation, it is no wonder that the appellant did not provide any system level check on the number of accounts that could use the same address. The learned senior counsel for the appellant also pointed out that only 153 accounts out of 34,924 fictitious/benami accounts actually had a second address different from the first one and thus this could not be any factor in facilitating the opening of such a large number of afferent accounts. This assertion could not be controverted by the respondent Board. Considering all as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e DPs does not amount to assignment or delegation of the functions of a participant, as alleged by the Board. In view of the rush for opening new demat accounts before an IPO issue opens, it is a common practice, according to the appellant, for DPs to use certain individuals as their agents to source new clients. This is only a marketing activity and does not at all amount to outsourcing within the meaning of Regulation 52 of the DP Regulations. We are inclined to agree with the learned senior counsel for the appellant because such outsourcing does not in any way dilute the responsibility of the DP to ensure strict compliance with the KYC norms. It would appear to be a common practice in the market for DPs to employ agents to approach and get new clients for expanding their business. Such agents do not discharge any of the functions of a DP but are engaged only for marketing activity. It has also been recorded in the impugned order that NSDL failed to make any norms to define the nature and scope of the outsourcing being resorted to by its Depository Participants. In the absence of any norms, these agents started performing activities like KYC verification also which should have ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of which this charge has been framed but this request was turned down by the Adjudicating Officer. We find absolutely no rationale behind such refusal by the Adjudicating Officer of the appellant s right of cross examination. The Adjudicating Officer has recorded his findings basing himself solely on the iSec report. Granting that iSec is an expert body, NSDL is also a professional body whose system is operated by personnel who are also experts in designing and operating compurterised data bases. Faced with the charge of lack of data integrity, NSDL has come up with detailed explanation which is prima facie quite plausible. Under these circumstances, there can be hardly any justification for the adjudicating officer to totally ignore the submissions by NSDL and rely entirely upon the views of iSec. In the present case, when two sets of experts have expressed different views about a highly technical matter, we do not think there was any better way for the Adjudicating Officer to arrive at the truth other than by permitting cross examination of the author(s) of the iSec report by NSDL. This, in fact, would have been in accordance with the very basic principles of natural just ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as a matter of course before recommending registration but that is because the applicants have to be electronically connected to the appellant and this cannot be done unless the former have adequate infrastructure. After hearing the learned senior counsel on both sides and examining the records, we are of the view that physical inspection of a DP s site before recommending registration need not be considered an absolute must in all cases. This is because the appellant itself arranges the electronic connectivity of the DP applicants with service providers (MTNL for example) and the software installed by a DP applicant is also provided by the appellant only. The connectivity cannot be established and sustained and the system cannot run unless compatible hardware and other infrastructure are in place with the DP. The DP applicants are recommended for registration only after rigorous testing of the software and hardware installed by it as well as the connectivity with NSDL. In any case, the DP applicants are not unknown entities but are entities like banks, NBFCs, stock brokers etc., who are already registered either with the Board or with the Reserve Bank of India. In some cases, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Kantilal Shah. It was also alleged in the said show cause notice that the appellant had failed to comply with the directions issued by the Board in its letter no. ISD/SD/HSE/03/2006 dated 16.11.2006 regarding audit of one particular account of Karvy. The Adjudicating Officer did not give any adverse finding in respect of the latter allegation in view of the circumstances explained in paragraph 12.3.2 of the impugned order. Regarding the first charge, the Adjudicating Officer proceeded on the premise that in its order dated 12.1.2006 regarding the IPO of Infrastructure Development Finance Corporation (IDFC), the Board had issued a directive to the appellant to monitor the flow of securities into the account of Biren Kantilal Shah and recorded a finding that the appellant had failed to do so in violation of the Board s directive. We have perused the Board s orders of 12.1.2006 and 27.4.2006 and find that the Board had not issued any directive whatever to the effect that the flow of securities into the account of Biren Kantilal Shah should be monitored or regulated. The clear and unambiguous direction issued by the Board was that Biren Kantilal Shah should not be permitted to enter i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccount opening forms as this provision is considered to be absolutely necessary in the interest of investors. Similar facility exists in the account opening forms in banks, in the applications forms for allotment of permanent account number by the Income Tax department, in the form of application for passport etc. Mere existence of the provision for correspondence address cannot be held responsible for the so called IPO scam. The Adjudicating Officer has noted that a very large number of accounts had been opened on a few specific dates in different names but with the same correspondence address and has held that CDSL ought to have been able to detect this phenomenon. This finding has been based on the stipulation in the Board s circular dated August 4, 2000 quoted by us in paragraph 6 supra but the logic that is being followed by the Adjudicating Officer in this case for holding CDSL responsible for the failures of DPs does not appeal to us.. In the aforesaid circular, the responsibility for verification of an applicant s identity has been placed squarely on the DP and to shift the burden to the Depositories on the ground that a DP is an agent of the Depository is not at all j ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lication is accepted by the DPs and it is not necessary for the latter to upload those particulars to the CDSL system before giving the client a BO id. The BO ids were provided to the DPs in advance on their request since typically, before a popular IPO opens for subscription, a large number of applications are received at the last moment and enough time may not be available for processing them and verifying the KYC norms before sending the applications to the issuer companies. On the other hand, it is mandatory to provide a BO id before sending the applications to the issuer companies as otherwise the applications would be rejected by the latter. It was under these circumstances that the DPs requested CDSL to provide BO ids in advance which CDSL did in the interest of the investors as well as its own business. It is pertinent to mention that these ids given by the Depository in advance were system generated and even if the DP had uploaded the applications to the CDSL system after completing the KYC norms, the same id numbers would be generated. In such an event, the DP has to upload the applications to the CDSL system in exactly the same order in which BO ids had been provide ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as to how it would have been possible in the kind of system that we have and we got no satisfactory explanation. The second argument is that the bye laws that CDSL has framed for the purpose are not adequate. We do not think it is open to the Board to first approve certain bye laws and then form an opinion (possibly with the benefit of hindsight) that these are not adequate and then penalise the framers of the bye laws for the perceived inadequacy. If there was any inadequacy, it was incumbent upon the Board to have pointed out the same to CDSL and to have advised it to remove the same by amending the bye laws suitably. 17. The only other adverse finding against CDSL is that it failed to verify the infrastructural facilities of the DPs. This charge also fails for the same reasons as in the case of NSDL which we have dealt with in paragraph 10 supra. 18. We have considered above the specific charges levelled against the two Depositories by the Board and find that in the facts and circumstances of these cases, none of the charges can be said to have been established. Some of the charges, however, have very major implications for the securities market and deserve further dis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a finding against the former, so that the deficiency if any, in the system could be identified. Another aspect of the matter also needs to be kept in view. If some defect either in the design or in the operation of the computerised data bases of the Depositories is detected, one would expect the primary concern of the market regulator to be to find a way to rectify the defect. Considering the supreme importance of the Depository data bases for the integrity of the market and its smooth operation, this has to be the first priority. Of course, NSDL has taken the stand that there is absolutely no defect or deficiency or irregularity in the maintenance or operation of its data base but the Board has neither accepted that stand nor taken steps to remove the perceived deficiency and restore data integrity by asking NSDL to take any specific steps. Given the scale of operations of the two Depositories, even the success of the Board s action to regulate the securities market properly is dependent on the proper functioning of the two Depositories including the integrity of their data bases. In fact, the Board and the two Depositories have to work together in tandem to secure the interes ..... X X X X Extracts X X X X X X X X Extracts X X X X
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