2023 (9) TMI 1715 - AT - SEBI

Appeal partly allowed; IA Regulations violations upheld; Sections 15EB/15HB/15C penalties affirmed, 15HA set aside, directors' fines cut to Rs2 lakh

The AT partly allowed the appeal. It affirmed that the appellants violated multiple provisions of the IA Regulations and Code of Conduct (advance ... Violation of regulations of the IA Regulations and Code of Conduct read with Regulation 15(9) of the IA Regulations - charge of providing assured returns by the Appellants - Appellants failed to comply SEBI’s directions with respect to its inspection - Appellants failed to comply SEBI’s directions with respect to its inspection - HELD THAT:- Charging fees for services to be rendered in future, we agree with the findings of the WTM that the Appellants were collecting fees from clients much in advance in violation of Clause 1 of the Code of Conduct read with Regulation 15(9) of IA Regulations. Appellants failed to maintain arms-length relationship between their investment advisory services and execution of trade for at least one client in violation of Regulation 15(1), 15(3) and 22(b) of the IA Regulations and Clause 1 of Code of Conduct read with Regulation 15(9) of IA Regulations. Charge of providing assured returns by the Appellants as stated in impugned order, we find that the WTM has relied upon the complaints made by the clients of the Appellants. Allegations made in these complaints cannot be taken as material evidence and need to be investigated to arrive at such a finding. Such bald allegations as made in the complaints cannot lead to an assumption or presumption or conclusion that the Appellants have played a fraud attracting Regulations 3(a), (b), (c) and (d) of PFUTP Regulations read with Regulations 2(1)(c)(1),(2) and (8) of PFUTP Regulations. Failure of the Appellants in redressing investors grievances forwarded to them on the SCORES platform, admittedly the Appellants delayed redressing the complaints for more than 60 days. Some of the complaints confirmed to remain unaddressed till date. Needless to say this is a serious deficiency on the part of the Appellants and the Appellants have violated Regulation 21 of the IA Regulations. WTM has also found that the Appellants failed to comply SEBI’s directions with respect to its inspection. The Appellants contended that they could not get the inspection conducted due to unavoidable circumstances such as Covid- 19 pandemic and closure of their office premises by local authorities. In our opinion, the Appellants could have, at the least, furnished the information required vide the pre- inspection questionnaires. By not doing so, they have shown their intention of not allowing the inspection to take place at all. The violation of Regulations 13(a), 15(12), 25(1) and 25(2) read with Regulation 24(3) and Clauses 8 and 9 of Code of Conduct for IA read with Regulation 15(9) of IA Regulations stands affirmed. WTM has evaluated the role and liabilities of the directors of the Appellants Company for the deeds of the Company (Appellant no. 1) by virtue of their directorship. We agree that the Company acts through its directors who control the affairs and management of the Company. Therefore, the Directors are liable for the acts of the Company and consequently are responsible for any commission or omissions of the Company. Appellants have violated various regulations of the IA Regulations and Code of Conduct read with Regulation 15(9) of the IA Regulations. However, the charges of violating Regulation 3 of PFUTP Regulations, 2003 are not proved. For violations of various regulations of the IA Regulations, penalty under Section 15EB of the SEBI Act can be imposed. We affirm the penalty of Rs. 6 lakh imposed by the WTM under Section 15EB. For delay in informing about appointment of a new director and thereby violating Section 13(b) of IA Regulations, penalty under 15HB can be imposed. We affirm the penalty of Rs. 1 lakh imposed by WTM under Section 15HB of SEBI Act. Similarly, for failure to address investor grievance and thereby violating Regulation 21 of IA Regulations, penalty can be imposed under Section 15C of SEBI Act. We affirm the minimum penalty of Rs. 1 lakh under Section 15C of the SEBI Act. As the charge of violating Regulation 3 of PFUTP Regulations are held to be not proved by us, the penalty of Rs. 5 lakh imposed by WTM under Section 15HA of SEBI Act is struck down. The directions given by WTM under paragraph 54.1 to 54.5 are affirmed. Further, in our opinion, the penalty of Rs. 5 lakh each imposed on three directors (Appellant nos. 2 to 4) by the WTM is harsh and excessive and we are of the opinion that the penalty of Rs. 2 lakh each on the three directors would be commensurate with the alleged misconduct. Appeal is partly allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether failure to intimate appointment of a director to the regulator within prescribed time violates Regulation 13(b) of the IA Regulations and attracts penalty under Section 15HB of the SEBI Act. 2. Whether deficiencies in client risk-profiling and risk-assessment processes and receipt of fees before completion of profiling amount to violations of Regulations 15(1), 16(b), 16(d)(ii), 17(d)(ii) and Clause 2 of the Code of Conduct read with Regulation 15(9) of the IA Regulations, and whether such conduct also constitutes fraudulent or deceitful practice under Regulations 2(1)(c)(1) and 2(1)(c)(5) and/or Regulations 3(a)-(d) of the PFUTP Regulations. 3. Whether provision of investment advice without adherence to suitability principles (income, proposed investment amount, objectives) and charging disproportionately high fees constitutes violation of Regulation 15(1), Regulation 17 and Clauses 1, 2 and 6 of the Code of Conduct read with Regulation 15(9), and whether such conduct amounts to fraud under PFUTP Regulations and Section 12A of the SEBI Act. 4. Whether collecting fees in advance for services to be rendered in future violates Clause 1 of the Code of Conduct read with Regulation 15(9) of the IA Regulations. 5. Whether failure to maintain arms-length relationship between investment advisory services and execution of trades constitutes breach of Regulations 15(1), 15(3), 22(b) and Clause 1 of the Code of Conduct read with Regulation 15(9). 6. Whether allegations of assured/guaranteed returns based on client complaints alone constitute sufficient material to establish violation of PFUTP Regulations (Regulations 3(a)-(d) and related provisions) or require further investigation. 7. Whether delay and failure to redress investor grievances on the SCORES platform beyond prescribed timelines amounts to violation of Regulation 21 of the IA Regulations and attracts penalty under Section 15C of the SEBI Act. 8. Whether non-compliance with regulator's inspection directions and failure to provide requisite information/allow inspection breaches Regulations 13(a), 15(12), 25(1), 25(2), Regulation 24(3) and Clauses 8 and 9 of the Code of Conduct read with Regulation 15(9). 9. Whether directors are liable for the company's commissions and omissions by virtue of directorship and whether imposition of penalties on directors is excessive or requires modulation. 10. Whether the quantum of penalties imposed under Sections 15C, 15EB, 15HA and 15HB of the SEBI Act is justified on the proved violations, and which penalties must be affirmed, struck down or reduced. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Intimation of director appointment (Regulation 13(b) IA Regulations) Legal framework: Regulation 13(b) requires timely intimation to regulator of change in board composition; non-compliance attracts regulatory action and penalty under Section 15HB. Precedent Treatment: The Tribunal reaffirmed that changes in board composition are material; directors oversee day-to-day functioning and compliance obligations. Interpretation and reasoning: Delay of over 18 months in informing regulator was not excused by alleged late entrustment of duties; the board's role in governance makes such change material and mandates prompt intimation. Excuse that intimation occurred within 30 days of entrustment of advisory duties was held specious. Ratio vs. Obiter: Ratio - delayed intimation of director appointment violates Regulation 13(b) and merits penalty. Obiter - none significant on this point. Conclusion: Violation of Regulation 13(b) proved; penalty under Section 15HB affirmed (minimum imposed by WTM upheld as justified in part). Issue 2 - Risk profiling and receipt of fees before profiling (IA Regulations and PFUTP allegations) Legal framework: IA Regulations mandate appropriate risk-profiling and processes (Regulations 15(1), 16(b), 16(d)(ii), 17(d)(ii)); Code of Conduct obligations apply via Regulation 15(9). PFUTP Regulations proscribe deceit, fraud and unfair trade practices. Precedent Treatment: WTM found deficiencies and fraudulent motive; Tribunal examined material basis for fraud findings and distinguished cases where isolated complaints are insufficient to prove PFUTP violations. Interpretation and reasoning: Tribunal found lacunae in risk-profiling mechanism and instances where fees were taken before profiling; such acts breach IA Regulations and Code of Conduct. However, the assertion that profiling was conducted deceitfully and fraudulently (PFUTP Regulation 3 and related clauses) lacked supporting material beyond client complaints. Presence of warnings on website and welcome letter indicating market risk undermined an inference of systematic deceit. Ratio vs. Obiter: Ratio - procedural and substantive failures in risk-profiling constitute violation of IA Regulations and Code of Conduct. Obiter - allegations of fraud under PFUTP require stronger evidentiary basis than isolated complaints. Conclusion: Violations of IA Regulations established; PFUTP fraud allegations not proved and therefore not sustained. Issue 3 - Suitability of advice and excessive fees (IA Regulations; PFUTP and Section 12A allegations) Legal framework: Investment advice must observe suitability principles considering client income, proposed amount and objectives (Regulation 15(1), 17; Code Clauses 1,2,6; Regulation 15(9)). Fraud allegations invoked PFUTP Regulations and Section 12A provisions. Precedent Treatment: WTM found on-boardings designed to extract higher fees via upgrades and sale of unsuitable products; Tribunal accepted IA violations but required stronger proof for fraud. Interpretation and reasoning: Evidence showed advice given without adequate consideration of client financial situation and imposition of abnormally high fees relative to client capacity. That conduct violates suitability norms and Code obligations. Yet, WTM's characterization as fraudulent practice under PFUTP was based on client complaints and not sufficiently corroborated. Ratio vs. Obiter: Ratio - breach of suitability obligations and Code proven; Obiter - need for investigation before labelling conduct as fraud under PFUTP/Section 12A. Conclusion: Violations of Regulation 15(1), 17 and Clauses 1,2,6 established; PFUTP and Section 12A allegations not proved on the record. Issue 4 - Charging fees in advance for future services Legal framework: Code of Conduct and Regulation 15(9) prohibit collecting fees for future services in a manner inconsistent with the Code. Precedent Treatment: WTM's finding that fees were collected well in advance was accepted by the Tribunal. Interpretation and reasoning: Advance collection of fees without appropriate safeguards or delivery of services constituted contravention of Clause 1 of the Code and Regulation 15(9). Ratio vs. Obiter: Ratio - advance fee collection for future services violates the Code of Conduct and IA Regulations. Conclusion: Violation proved and sustained. Issue 5 - Arms-length requirement and execution services Legal framework: IA Regulations (15(1),15(3),22(b)) and Clause 1 of the Code require maintaining separation between advisory and execution where applicable. Precedent Treatment: WTM's finding of failure to maintain arms-length for at least one client upheld by Tribunal. Interpretation and reasoning: Evidence of execution services coupled with advisory role for at least one client showed lack of arms-length relationship, breaching regulatory norms designed to prevent conflicts. Ratio vs. Obiter: Ratio - breach established where advisory and execution functions are not kept separate. Conclusion: Violation of cited regulations and Code affirmed. Issue 6 - Allegations of assured returns Legal framework: PFUTP Regulations prohibit assurance of guaranteed returns as fraudulent/ unfair practice; such a finding requires material evidence. Precedent Treatment: Tribunal held that reliance on client complaints alone is insufficient to attribute assured returns or fraud. Interpretation and reasoning: Complaints, without corroborative documentary or other material evidence, cannot be the sole basis for concluding assured returns or invoking PFUTP provisions; such allegations require investigation. Ratio vs. Obiter: Ratio - bald allegations in complaints cannot establish PFUTP violations; Obiter - factual inquiry necessary where material exists. Conclusion: PFUTP violations on assured returns not proved on record and cannot be sustained solely on complaints. Issue 7 - Failure to redress SCORES complaints (Regulation 21 IA Regulations) Legal framework: Regulation 21 mandates timely redressal of investor grievances; failure attracts penalty under Section 15C. Precedent Treatment: Tribunal agreed with WTM that delays over 60 days and unresolved complaints are serious deficiencies. Interpretation and reasoning: Admitted delay and some complaints remaining unaddressed demonstrate non-compliance with grievance redress norms, evidencing regulatory lapse and investor harm. Ratio vs. Obiter: Ratio - failure to timely redress SCORES complaints violates Regulation 21 and supports penalty under Section 15C. Conclusion: Violation proved; minimum penalty under Section 15C affirmed. Issue 8 - Non-compliance with inspection directions Legal framework: Regulations require cooperation with inspections and furnishing of pre-inspection questionnaires (Regulations 13(a),15(12),25(1),25(2),24(3); Code Clauses 8,9). Precedent Treatment: Tribunal found excuses like pandemic and office closure insufficient where information could have been furnished. Interpretation and reasoning: Failure to provide pre-inspection information and effectively obstructing inspection demonstrates intent not to permit inspection; non-cooperation contravenes multiple regulatory provisions. Ratio vs. Obiter: Ratio - withholding information/obstructing inspection violates inspection-related regulations and Code duties. Conclusion: Violations affirmed. Issue 9 - Liability of directors for company's acts and quantum of penalties Legal framework: Board members are responsible for company's affairs; directors can be held liable for company's commissions and omissions under regulatory scheme and penal provisions. Precedent Treatment: Tribunal agreed that directors are liable by virtue of control and management roles but exercised discretion on penalty quantum. Interpretation and reasoning: While directors bear responsibility, imposition of identical high penalties on individual directors was held excessive; tribunal applied proportionality, reducing penalties on each director from Rs. 5 lakh to Rs. 2 lakh. Ratio vs. Obiter: Ratio - directors are vicariously liable for corporate violations; penalty quantum must be proportionate to alleged misconduct and individual culpability. Conclusion: Directors liable for violations; monetary penalties on directors reduced to reflect proportionality. Issue 10 - Overall penalty assessment under Sections 15C, 15EB, 15HA, 15HB Legal framework: Section 15EB for IA Regulations violations; Section 15HB for failure to intimate director appointment; Section 15C for failure to redress grievances; Section 15HA for PFUTP violations. Precedent Treatment: Tribunal affirmed penalties tied to proved IA Regulations violations and struck down penalty under Section 15HA where PFUTP violations not proved. Interpretation and reasoning: Confirmed penalties: Rs. 6 lakh under Section 15EB (IA violations), Rs. 1 lakh under Section 15HB (delayed director intimation), Rs. 1 lakh under Section 15C (SCORES non-redressal). Penalty under Section 15HA (Rs. 5 lakh) struck down due to non-proving of PFUTP violations. Penalties on directors reduced as noted in Issue 9. Ratio vs. Obiter: Ratio - penalties must follow from proved contraventions; unproven PFUTP allegations cannot sustain Section 15HA penalty. Obiter - guidance on proportionality of directors' penalties. Conclusion: Penalties affirmed, struck down or reduced as per proven violations; directions relating to investor redress and SCORES affirmed.