2023 (7) TMI 1604 - AT - SEBI

SOP distribution under paragraph 4.25 upheld; exchange must act under Chapter XII within three months

AT held that the stock exchange followed its SOP (July 1, 2020; amended May 27, 2022) in distributing funds and the appellant received amounts in ... Potential Default by Trading Member - Appellant’s margin money lying with the broker has been used to settle claims of 123 out of 125 clients of the broker - HELD THAT:- A perusal of the SOP indicates that before the stock exchange could take steps to declare the trading member as a defaulter, necessary steps are required to be taken by the stock exchange to freeze the bank accounts, etc. of the trading member so that the maximum money is made available for distribution to the clients of the trading member in an equitable manner as an interim measure. Once the trading member is declared as a defaulter then claim can be filed by the clients of the trading member under Chapter XII and XIII of the Bye-laws. No steps has been taken by the stock exchange to declare respondent nos. 4 as a defaulter and it has been stated at the bar by the learned counsel for SEBI and NSE that the process is going on. Before claims can be filed under Chapter XII or XIII of the Byelaws, we find that in terms of SOP, the money made available with the trading member and further infused by the trading member was distributed as per the procedure provided under the SOP dated July 1, 2020 and as amended on May 27, 2022. The contention that the procedure under the SOP is arbitrary in as much as the appellant tends to get a lesser amount and would have got a higher amount if the procedure under Chapter XII was adopted. In our view, we cannot go into all these aspects as it would amount to declaring the SOP as arbitrary which is beyond the scope and jurisdiction of this Tribunal. Prima-facie, we are satisfied that the appellant has received the amount as per the paragraph no. 4.25 of the circular of the SOP dated July 1, 2020 and May 27, 2022. We are unable to appreciate the submission of appellant that money were paid to the other clients of the broker from the margin money of the appellant. This assertion of the appellant is incorrect in as much we find that NSE had supervised the realisation of the funds to the tune of Rs. 16.83 crore by way of liquidation of deposits, funds available with other Market Infrastructure Institutions, the Clearing Members and some amount infused by the broker. We are satisfied that the margin money of the appellant was not utilized to repay the other clients of the broker. We find that the broker was suspended on September 9, 2020. Almost three years have elapsed and further steps to declare the broker as a defaulter have not taken place. It has been stated at the bar that proceedings are underway. Stock exchange is required to take appropriate measures, namely, requiring the broker to infuse further sums of money so that the remaining clients could be paid off, failing which upon failure to meet pay-in obligation, NSE is required to declare the broker as a defaulter under Chapter XII so that the clients of the broker could file a claim under Chapter XII or XIII of the Bye-laws of the stock exchange. We, therefore, direct the stock exchange / stock exchanges to take appropriate measures and pass appropriate orders against the broker within three months from today. In this regard, SEBI will follow up the matter. ISSUES PRESENTED AND CONSIDERED 1. Whether funds (margin money) of an individual client were impermissibly utilized to satisfy claims of other clients when a trading member's trading was suspended for failure to meet pay-in obligations. 2. Whether the stock exchanges' application of SEBI's Standard Operating Procedure (SOP) dated July 1, 2020 (as amended) and related supervisory actions in settling client claims were arbitrary, violative of the Bye-laws (Chapter VII/Chapter XII/XIII) or otherwise unlawful. 3. Whether the Tribunal should interfere with the impugned finding that distributions to clients were effected in accordance with paragraph 4.25 of the SOP and that the appellant received amounts due under that procedure. 4. Whether the stock exchange must be directed to take further steps (including declaring the trading member a defaulter under Chapter XII) to enable remaining clients to claim outstanding balances. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Whether the appellant's margin money was used to settle other clients' claims Legal framework: The Bye-laws (Chapter VII, Clause 8) empower the Exchange to follow SEBI circulars/SOPs where a trading member leads to default, including freezing bank accounts and measures to protect non-defaulting clients. The SOP (July 1, 2020) and its paragraph 4.25 prescribe interim measures for settling client claims from available funds, unencumbered deposits, BGs, FDRs, and netting balances across exchanges, under Exchange supervision. Precedent treatment: The Court did not cite or alter precedent; it treated the SOP and Bye-laws as the governing regulatory framework and applied them to the facts. Interpretation and reasoning: The Tribunal examined the financial position as of suspension and the supervisory steps taken by the Exchange to realise funds (liquidation of deposits, utilization of clearing member/other MIIs' funds, broker infusion). The record showed supervised realisation of funds (~Rs. 16.03-16.83 crore) and supervised payments under paragraph 4.25, including payment of Rs. 9.98 crore to the appellant. The Tribunal found no evidence that the appellant's margin money was specifically diverted to pay other clients; rather, distributions were made from pooled available funds as per the SOP and supervisory actions. Ratio vs. Obiter: Ratio - In the absence of evidence to the contrary, supervised realisation and distribution under the SOP demonstrate that a particular client's margin money was not impermissibly used to satisfy other clients' claims. Obiter - Observations on the sufficiency of Exchange supervision and formulations about the sources of pooled funds beyond the immediate record. Conclusion: The assertion that the appellant's margin money was used to settle other clients' claims is unsupported by evidence; the Tribunal accepts that distributions occurred under the SOP and supervised realizations, and the appellant received amounts in accordance therewith. Issue 2 - Lawfulness and arbitrariness of applying the SOP (para 4.25) versus Chapter XII distribution procedure Legal framework: Clause 8(1) of Chapter VII authorises the Exchange to act per SEBI circulars/SOPs; Chapter XII/XIII prescribe procedures post-declaration of a trading member as defaulter for clients to file claims. The SOP is framed to protect non-defaulting clients and to facilitate interim settlements prior to formal default declaration. Precedent treatment: No precedent was overruled or distinguished; the Tribunal refrained from striking down or declaring SOP arbitrary absent jurisdiction to do so in the appellate forum. Interpretation and reasoning: The Tribunal recognized that the SOP's purpose is to preserve client interests by enabling interim distributions prior to formal defaulter proceedings. Although appellant contended that Chapter XII procedures would yield a higher recovery, the Tribunal held that challenging the SOP's validity or arbitrariness was beyond its scope and jurisdiction in this appeal. The Tribunal limited its review to whether the SOP was followed and whether payments were made in accordance with it. Ratio vs. Obiter: Ratio - A tribunal exercising appellate jurisdiction over an exchange/SEBI order will not, in the absence of jurisdiction or cogent basis, declare the SOP arbitrary when the record shows compliance with SOP mechanisms. Obiter - Commentary that SOP does not substitute for Chapter XII but functions as an interim protective regime. Conclusion: The Tribunal will not interfere with the SOP's application here; it is not shown to be arbitrary in the particular facts and the appellant received payments pursuant to paragraph 4.25. Issue 3 - Whether the impugned order correctly found that the appellant received amounts as per paragraph 4.25 of the SOP Legal framework: Paragraph 4.25 prescribes supervised settlement of client credit balances using available funds and other specified resources, with netting across exchanges and documentation (proof of payment) required. Precedent treatment: The Tribunal applied the SOP's specific provisions to the factual matrix and the payment record; no need to consider external precedents. Interpretation and reasoning: On the record the appellant had constituted margin balances (securities and cash) and thereafter received Rs. 8 crore in securities and Rs. 9.98 crore in cash pursuant to supervised actions. The Tribunal found prima facie that the appellant's receipt aligns with paragraph 4.25 distributions. The Tribunal declined to reweigh hypothetical recoveries under Chapter XII since the operative issue was compliance with SOP distributions. Ratio vs. Obiter: Ratio - Where the exchange's supervisory process and payment records show compliance with paragraph 4.25, an appellate tribunal should uphold the finding that the client received amounts in accordance with the SOP. Obiter - Observations on potential alternative recoveries under Chapter XII not determinative here. Conclusion: The impugned finding that the appellant received amounts as per paragraph 4.25 is upheld; no error is found in that conclusion. Issue 4 - Obligation of the Exchange to take further steps, including declaring the trading member a defaulter to enable Chapter XII/XIII claims Legal framework: Where a trading member fails pay-in obligations, Clause 8 and Chapter XII prescribe proceedings for declaration as defaulter, after which clients can file claims under Chapter XII/XIII. The SOP contemplates interim measures prior to formal defaulter declaration. Precedent treatment: The Tribunal invoked the Bye-laws/SOP to prescribe administrative action rather than establishing novel legal principles. Interpretation and reasoning: The Tribunal observed that almost three years had elapsed since suspension without declaration of default. Noting the ongoing process, it directed the exchange to take appropriate measures within three months - including requiring the broker to infuse further funds or, if pay-in obligations continue unmet, declare the broker a defaulter so that remaining clients may file claims under Chapter XII/XIII. SEBI was directed to follow up. The direction is grounded in the Bye-laws' remedial scheme and the need to expedite client remedies. Ratio vs. Obiter: Ratio - Exchanges are required to progress from interim SOP measures to formal defaulter proceedings within a reasonable timeframe where outstanding client claims remain; regulatory authorities should ensure timely action to enable clients to pursue statutory claim remedies. Obiter - Timing benchmarks (three months) are a case-specific supervisory direction. Conclusion: The Exchange must, within the directed timeframe, require further infusion or proceed to declare the trading member a defaulter under Chapter XII so that outstanding client claims can be pursued; SEBI to monitor/follow up. OVERALL CONCLUSION The Tribunal finds no error in the impugned order: distributions were effected under the SOP and supervised realisations; the appellant received amounts consistent with paragraph 4.25; there is no evidential basis that the appellant's margin money was used to pay other clients; and the appeal is dismissed. The Exchange is directed to take further steps within three months (including requiring infusion or declaring the trading member a defaulter) to enable remaining claim resolution, with SEBI oversight.