2023 (1) TMI 1477 - AT - SEBI

Broker Penalized for Misusing Client Funds: SEBI Order Upheld, Regulatory Compliance Strictly Enforced Under Securities Laws

Asit C. Mehta Investment Interrmediates Ltd. Versus Securities and Exchange Board of India

Stock broker appealed SEBI penalty for misusing client funds by applying credit balances to debit balances and proprietary purposes. SC upheld SEBI's ... Violations of the SEBI laws - Misuse of clients' funds by stock broker - appellant stock broker failed to settle the funds and securities of its clients, misused the client funds and, therefore the penalty was imposed - non-existence of formula in the previous circular - HELD THAT:- The contention of the appellant cannot be accepted. This Tribunal had an occasion to deal with a similar objection regarding the applicability of the subsequent circular in the case of Arihant Capital Markets Ltd. [2021 (10) TMI 1463 - SECURITIES APPELLATE TRIBUNAL, MUMBAI] the order cannot be faulted with. The earlier circular had clearly stated that the funds of the client cannot be applied for any other purposes. The appellant's case was that the funds were applied by it for the dues for their associates, group company, etc. Now, during the arguments only, the issue of nonexistence of formula in the previous circular is brought up. In fact, the said formulization is nothing but the crystallization of the earlier circular Thus, the subsequent circular was merely formulization of the earlier circular to prevent the misuse of the clients' funds either for its own purpose by the stock broker or for debit balance of the clients. The record clearly shows that the appellant has used the credit balance of the clients in the fashion as stated above. Non-settlement of the funds and securities it was found that credit balance of 1311 inactive clients was not settled by the appellant. Nine active clients balance was not settled. According to the appellant as per its own interpretation of NSE's circular dated 29th October, 2013 the pay out of client whose credit balance was less than Rs. 10,000 was not required to be done at the relevant time. However, when the Exchange had clarified thereafter the appellant had regularly started settling the clients' funds having credit balance upto Rs. 10,000. Respondent SEBI found that the appellant has not produced any documentary evidence to support its case for non-settling of the accounts being less than Rs. 10,000. Regarding the interpretation of the NSE circular, respondent SEBI held that as per appellant itself has misinterpreted the circular. Not only that no material was produced to show that so far as 1311 inactive clients are concerned their credit balance was less than Rs. 10,000. Out of the cases of 9 active clients whose accounts were not settled, the appellant itself had admitted these irregularities in 5 active clients' cases. Thus, no reason to interfere in the impugned order. Appellant had taken a plea of delay and latches in initiation of proceedings. It was submitted that while the inspection was held in the year 2015 the show cause notice was issued on September, 2020. Appellant therefore submitted that this delay itself has caused prejudice to the appellant. We find that except the bald statement that the delay has caused prejudice no facts are pleaded to show as to how prejudice is caused to the appellant by delay of 5 years. The respondent had collected the record during inspection from the appellant and again placed the same before the appellant vide the show cause notice. The appellant also had the said record with it. Therefore, considering all the facts on record we do not find any error to interfere with the impugned order. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Tribunal in this appeal are:Whether the appellant stock broker misused clients' funds by applying the credit balances of some clients to debit balances of other clients or for its own purposes, in violation of applicable securities laws and regulations.Whether the penalty imposed under Section 15HB of the SEBI Act and Section 23D of the Securities Contracts (Regulation) Act, 1956, along with violation of Clause A(2) of the Code of Conduct under Schedule II read with Regulation 9(f) of the Stock Brokers Regulations, was justified.Whether the reliance by the respondent SEBI on a circular issued after the inspection period to quantify mis-utilisation of clients' funds was legally permissible.Whether the appellant was justified in not settling credit balances of clients, particularly those below Rs. 10,000, based on its interpretation of an NSE circular.Whether the delay of approximately five years between the inspection and issuance of the show cause notice caused prejudice to the appellant and warranted interference with the penalty order.2. ISSUE-WISE DETAILED ANALYSISIssue 1: Misuse of Clients' FundsThe relevant legal framework includes Section 15HB of the SEBI Act, which empowers SEBI to impose penalties for contraventions of the Act and regulations, and Clause A(2) of the Code of Conduct under Schedule II read with Regulation 9(f) of the Stock Brokers Regulations, which prohibit misuse of clients' funds.During a multi-theme inspection covering April 2012 to September 2015, SEBI found that the appellant used funds belonging to clients with credit balances to meet the debit balances of other clients and for its own purposes. The misuse was quantified on a sample basis, with amounts ranging from 43% to 70% of credit balances.The appellant challenged the applicability of a SEBI circular dated 26th September 2016 (effective 1st July 2017), contending that it could not be applied retrospectively to the inspection period. The Tribunal rejected this argument by referring to its prior decision in a similar matter, where it was held that the subsequent circular merely crystallized the principles already embedded in earlier circulars, which clearly prohibited application of client funds for any purpose other than that intended.The Tribunal emphasized that the appellant's contention that the absence of a formula in earlier circulars precluded enforcement was untenable, as the later circular was only a formalization of existing principles. The evidence on record clearly demonstrated misuse of clients' funds, thus justifying the penalty.Issue 2: Non-Settlement of Clients' Funds and SecuritiesThe appellant failed to settle credit balances for 1311 inactive clients and 9 active clients. The appellant relied on its interpretation of an NSE circular dated 29th October 2013, which it claimed exempted settlement of credit balances below Rs. 10,000 at that time. However, SEBI found no documentary evidence supporting this exemption and noted that the appellant had misinterpreted the circular. Furthermore, no material was produced to show that the credit balances of the inactive clients were below Rs. 10,000.SEBI also highlighted that the appellant admitted irregularities in 5 out of the 9 active clients' unsettled accounts. The Tribunal found these facts sufficient to uphold the penalty for non-settlement, rejecting the appellant's defense.Issue 3: Applicability of Subsequent Circular for Quantification of MisuseThe appellant argued that the circular relied upon by SEBI to compute the extent of misuse was issued after the inspection period and hence not applicable. The Tribunal referred to its earlier ruling that the later circular was a formalization of the principles already in place and thus applicable. The Tribunal held that the appellant's reliance on the timing of the circular was misplaced and that the principles against misuse of client funds were well established prior to the circular.Issue 4: Delay and Laches in Initiation of ProceedingsThe appellant contended that the delay of about five years between the inspection in 2015 and issuance of the show cause notice in September 2020 caused prejudice. The Tribunal noted that the appellant failed to plead or demonstrate any specific prejudice caused by the delay beyond a bald assertion. The respondent had collected and furnished all relevant records during inspection and again at the show cause stage, which were also in possession of the appellant. Therefore, the Tribunal found no reason to interfere with the proceedings on grounds of delay.3. SIGNIFICANT HOLDINGSThe Tribunal succinctly articulated the principle regarding the applicability of subsequent circulars as follows:'The earlier circular had clearly stated that the funds of the client cannot be applied for any other purposes. The appellant's case was that the funds were applied by it for the dues for their associates, group company, etc. Now, during the arguments only, the issue of nonexistence of formula in the previous circular is brought up. In fact, the said formulization is nothing but the crystallization of the earlier circular.'This establishes that formalization of regulatory principles in later circulars does not negate the enforceability of the underlying principles existing earlier.The Tribunal confirmed that misuse of client funds, including applying credit balances of some clients to debit balances of others or for proprietary purposes, constitutes a violation warranting penalty under the SEBI Act and Stock Brokers Regulations.It also held that failure to settle client funds, especially without documentary support for claimed exemptions, violates regulatory obligations.Regarding delay, the Tribunal held that mere passage of time without demonstrated prejudice does not invalidate enforcement proceedings.Consequently, the Tribunal dismissed the appeal and upheld the penalty imposed by the Adjudicating Officer, affirming the correctness of the findings and the legal framework applied.