2023 (11) TMI 1404 - AT - SEBI

Penalty for treating investment as loan set aside; Rs. 62,000 fine affirmed after other violations accepted

The SAT held that placing surplus funds with an RBI-registered NBFC as inter-corporate deposits did not establish engagement as a principal in a business ... Default by Equity Broking company - violations observed during joint inspection conducted by Securities and Exchange Board of India (‘SEBI’ for short) along with Stock Exchanges - Appellant for engaging in business other than that of securities involving personal financial liability - Appellant has primarily contested the penalty imposed by the Committee for engaging as a principal in business other than that of securities - Appellant contended that they had made temporary investment of their own surplus funds with the NBFC HELD THAT:- A plain reading of the Rule 8(3)(f) of SCR Rules and Rule 5(b) of the Chapter II of the Rules of the Exchange would indicate that a trading member cannot engage as a principal or employee in any business involving any personal financial liability other than that of securities. SEBI’s circular dated May 7, 1997 clarified that borrowing and lending funds by a trading member, in connection with or incidental to or consequential upon the securities business would not disqualify a trading member under Rule 8(3)(f) of the SCR Rules. In our view, investment of surplus funds, generated as a consequence of securities business, with an NBFC registered with RBI cannot lead to an inference that the Appellant is engaged as a principal in business other than that of securities involving personal financial liability. The Respondent Committee given a clear finding that the funds were advanced from the account of the Appellant therefore there is no dispute that the funds were their own moneys. There is nothing on record to indicate that this transaction was a loan whereas the agreement dated January 1, 2019 between the Appellant and V.J. Finvest indicates that it was for investment of funds as inter-corporate deposits. Accordingly, in our view the violation that the Appellant engaged in a business other than that of securities involving personal financial liability is not proved. The penalty of Rs. 7,50,000/- imposed on this account is struck down. The appellant has accepted the other violations and taken corrective action. The monetary penalty of Rs. 62,000/- on these violations stands affirmed. ISSUES PRESENTED AND CONSIDERED 1. Whether the Stock Exchange (Committee) was competent to initiate post-inspection enforcement action where the joint inspection was conducted by the regulator along with Stock Exchanges and depositories. 2. Whether placing surplus funds with a non-banking financial company (NBFC) by a trading member, pursuant to an agreement for inter-corporate deposits, constitutes engaging 'as principal in any business other than that of securities involving personal financial liability' within the meaning of Rule 8(3)(f) of the Securities Contract (Regulation) Rules, 1957 and Rule 5(b) of the Exchange Rules. 3. Whether SEBI Circular SMD/Policy/Cir-6/97 (May 7, 1997) and the textual scope of the statutory and Exchange rules permit borrowing/lending or temporary placement of surplus funds in connection with securities business so as to avoid disqualification under Rule 8(3)(f). 4. Whether the imposition of monetary penalties for identified technical deficiencies (incorrect reporting of weekly holdings; incorrect uploading of client contact details; incomplete CKYC; incorrect monthly monitoring data) was justified, and whether corrective action taken post-inspection affected the penalties. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Competence of the Exchange/Committee to initiate post-inspection enforcement Legal framework: Enforcement competence is governed by the Exchange's Bye-laws, Rules, Regulations and Circulars; SEBI may conduct joint inspections but can allot post-inspection enforcement action to an Exchange. Interpretation and reasoning: The Tribunal found that the Exchange was competent under its governing instruments to initiate post-inspection enforcement even though the inspection was joint with the regulator; allotment of enforcement action to the Exchange by the regulator was expressly communicated to the trading member. Precedent treatment: No external judicial precedent was invoked; the Tribunal relied on the regulatory allocation of responsibilities and the Exchange's own rules. Ratio vs. Obiter: Ratio - the Exchange is competent to undertake post-inspection enforcement where the regulator has allotted the matter to it; adequate opportunity to be heard must be afforded. Conclusion: Competence of the Exchange/Committee to take post-inspection enforcement action is upheld; the trading member was given and availed adequate opportunity to present its case. Issue 2 - Whether investment as inter-corporate deposits with an NBFC amounts to engaging in other business as principal involving personal financial liability (Rule 8(3)(f) / Rule 5(b)) Legal framework: Rule 8(3)(f) of the SCR Rules and Rule 5(b) of the Exchange Rules prohibit a trading member from engaging as principal in any business other than securities that involves personal financial liability; provisos allow limited exceptions and written permissions. Precedent treatment: The Tribunal considered, and applied, SEBI's May 7, 1997 circular interpreting the Rules to the effect that borrowing and lending of funds by a trading member, when in connection with or incidental to the securities business, would not disqualify the member under Rule 8(3)(f). No case law was cited or overruled. Interpretation and reasoning: The Tribunal examined the factual matrix: (a) funds were advanced from the trading member's own bank account; (b) an agreement dated January 1, 2019 described the arrangement as placement of funds as inter-corporate deposits with the NBFC; (c) the transaction yielded interest and reflected temporary deployment of surplus funds. On these facts, the Tribunal concluded that the transaction was an investment of surplus funds generated from securities business rather than an undertaking of business as principal outside securities involving personal financial liability. The Tribunal rejected characterisation of the transactions as loans evidencing principal engagement in non-securities business. The Tribunal distinguished an earlier inspection finding where loans were extended to several unrelated entities - that earlier factual scenario was not analogous and could not be treated as a repeat violation justifying enhanced penalty. Precedent treatment: SEBI's circular was followed and applied to the facts; prior inspection findings were distinguished on factual grounds rather than treated as precedent for enhancement. Ratio vs. Obiter: Ratio - where a trading member temporarily deploys surplus funds with an RBI-registered NBFC as inter-corporate deposits, documented by an agreement and arising from surplus generated by securities business, such deployment does not, per SEBI guidance and the statutory text, constitute engaging as principal in a non-securities business involving personal financial liability under Rule 8(3)(f) / Rule 5(b). Conclusion: The penalty imposed on account of alleged engagement in business other than securities involving personal financial liability (monetary penalty of Rs. 7,50,000) was not warranted and is struck down; the earlier dissimilar violation could not be used to justify enhancement. Issue 3 - Applicability and effect of SEBI Circular dated May 7, 1997 Legal framework: SEBI Circular clarifies applicability of Rule 8(1)(f) and 8(3)(f) concerning fund-based activities of brokers. Interpretation and reasoning: The Tribunal accepted the circular's view that borrowing and lending of funds by a trading member, when in connection with/ incidental to/ consequential upon securities business, do not disqualify the member under Rule 8(3)(f). The circular was applied to conclude that placement of surplus funds with an NBFC falls within activities permissible under that clarification. Precedent treatment: The circular was followed and treated as an authoritative regulatory interpretation relevant to the facts. Ratio vs. Obiter: Ratio - SEBI's circular operates to clarify that fund placements, when connected to securities business, do not amount to prohibited engagement as principal in non-securities business under the cited Rules. Conclusion: SEBI's circular supports treating the inter-corporate deposit transactions as permissible and not constituting disqualifying non-securities business. Issue 4 - Liability for smaller technical violations and effect of corrective action Legal framework: Exchange rules empower imposition of monetary penalties for various compliance failures such as incorrect reporting, incomplete CKYC, and incorrect monitoring data. Interpretation and reasoning: Eleven violations were observed; five attracted monetary penalties (one large penalty which was struck down, and four smaller penalties for incorrect reporting of weekly holdings, incorrect uploading of client email/ mobile details, incomplete CKYC for individuals, and incorrect monthly monitoring data). The Tribunal found the Appellant accepted the other violations and had taken corrective action. Precedent treatment: No precedent was invoked; the Tribunal affirmed the penalties for these technical violations on the material before it. Ratio vs. Obiter: Ratio - monetary penalties for the remaining technical compliance violations are sustainable where violations are established and corrective action does not negate the commission of the breaches. Conclusion: The monetary penalty totalling Rs. 62,000 for the admitted/established technical violations is affirmed; corrective action was noted but did not negate liability for the period inspected. Cross-references and overarching conclusions 1. Issues 2 and 3 are interlinked: the characterization of the funds placement (Issue 2) was decided by applying the interpretive guidance in SEBI's circular (Issue 3). 2. The determination on Issue 1 (Exchange competence) underpins acceptance of the penalties imposed by the Exchange and the Tribunal's power to adjudicate the appeal. 3. Outcome: The finding of engaging in non-securities business involving personal financial liability was set aside; the large penalty imposed on that basis was struck down. Penalties for the remaining technical violations were affirmed. The appeal was therefore partly allowed with no order as to costs.