2018 (1) TMI 1762 - AT - SEBI

Penalty under s.15HB upheld for broker facilitating synchronized self-trades; breached duty and contravened Code of Conduct r/w Reg.7

The AT upheld the penalty under s.15HB for a broker's facilitation of synchronized/self-trades, finding breach of duty and contravention of the Code of ... Synchronized trades and self-trades - Breach of duty - stock broker failed to exercise due skill, care and diligence in the conduct of his business - violating clause A(2) of Code of Conduct for Stock Brokers as specified under Schedule II read with Regulation 7 of SEBI Regulations, 1992 - imposition of penalty u/s 15 HB - doctrine of disproportionality - HELD THAT:- The appellant has, undoubtedly, transacted on behalf of clients, Mr. Vijay Vora and out of 13,24,344 shares which were undertaken by the appellant on behalf of clients, Mr. Vijay Vora, 5087 shares amounted to self-trades. In fact, such self-trades are very harmful in the capital market inasmuch as the buyer and seller both are essentially the same person and there is no change of ownership. This hits at the very foundation of the capital market, as a result of which the respondent is bound to deal with such violations strictly. The appellant submits that the turnover of the appellant company from the impugned trades is small and insignificant in comparison with the massive turnover of the appellant company in general, and should therefore not lead to any penalty being imposed upon the appellant company. This argument, in our opinion, does not hold water because of the simple reason that imposition of penalty for violating provisions of SEBI Act and any regulations made thereunder does not relate to the total turnover of the company in any manner. In synchronized trading, the buy and sell order quantities are identical and are put through at exactly the same time on the trading platform which hurts the substratum of the securities market and affects the prices of scrips illegally. This, in turn, leads to many variables in the securities market being affected artificially through self trades. In Chander Kanta Bansal Vs. Rajinder Singh Anand [2008 (3) TMI 733 - SUPREME COURT], it was held that due diligence means reasonable diligence, it means such diligence as a prudent man would exercise in the conduct of his own affairs. Therefore, the stock broker’s responsibility of due diligence is such that any other reasonable person would apply in his/her own affairs. Applying this to the facts of the present case, it is evident that a reasonable person exercising due diligence would not have ignored the self trades being conducted by the Voras right under the appellant’s nose. It is the duty of the stock broker under the Brokers Regulations to constantly monitor the trades executed by the client through the internet based trading platforms so as to ensure that the trades are executed in accordance with law and do not disturb the market equilibrium. Therefore, it is clear that acting on the instructions of Shri Vora, the appellant ought not to have allowed the self-trades to occur. Therefore, that the act of indulging in self trades is itself a straightforward violation which calls for a penalty. The contention of the appellant that the penalty in question is disproportionate - For invoking the doctrine of disproportionality, one has to prove that the penalty imposed in a particular case is highly disproportionate to the violation committed by a party in a given case. In the present situation we do not find any unwarranted penalty being imposed on the appellant. Due diligence is one of the most important responsibilities of a stock broker and cannot be taken for granted. This being the position, the impugned order is, therefore, upheld and the appeal is hereby dismissed, however, with no order as to costs. ISSUES PRESENTED AND CONSIDERED 1. Whether the stock broker failed to exercise due skill, care and diligence under Clause A(2) of the Code of Conduct for Stock Brokers (Schedule II) read with Regulation 7 by permitting repeated self-trades and synchronized trades executed by a client and his spouse in a particular scrip. 2. Whether acting as both broker and counterparty broker in respect of a substantial portion of self-trades and synchronized trades, including execution from the same terminal, establishes a breach of regulatory duties even in the absence of proven connivance. 3. Whether the quantum of monetary penalty imposed for the established breach (Section 15HB of the SEBI Act) is disproportionate having regard to the broker's overall turnover, volume of clients and the relative size of impugned trades. 4. Whether the broker's general argument that high overall turnover and large client base absolve or mitigate liability for localized manipulative/self-trading events has legal force. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Breach of duty: failure to exercise due skill, care and diligence in permitting self-trades and synchronized trades Legal framework: Clause A(2) of the Code of Conduct for Stock Brokers (Schedule II) read with Regulation 7 imposes on a broker an obligation to exercise due skill, care and diligence in the conduct of business. Section 15HB authorizes monetary penalty for contraventions of the SEBI Act and regulations. Precedent treatment: The Tribunal applied established authorities holding that 'due diligence' denotes the care a prudent person would exercise in his own affairs and that brokers must not be party to market manipulation (Chander Kanta Bansal principle; Madhukar Sheth principle). Prior Tribunal rulings recognize self-trades as illegal and calling for punitive action (Anita Dalal principle). These precedents were followed. Interpretation and reasoning: The Tribunal found on the material that the broker acted as both broker and counterparty broker for a significant number of trades between the client and his spouse (47,670 shares with 6,500 synchronized; broker-counterparty in respect of 5,087 self-trade shares). The Tribunal emphasized that self-trades and synchronized trades defeat change of ownership and artificially affect market variables; such trading harms market integrity. Given the frequency, synchronization and instances of execution from the same terminal, a reasonably diligent broker would have monitored and detected such patterns and prevented them. The absence of advice or challenge to client instructions does not absolve the broker of the duty to ensure trades do not constitute manipulation. Ratio vs. Obiter: Ratio - A broker's duty to monitor and prevent self-trades/synchronized trades arises under Clause A(2) and Regulation 7; allowing such trades, particularly where the broker acts as both broker and counterparty, constitutes breach even without an allegation of connivance. Obiter - Observations on the general harmfulness of synchronized trades to market substratum and the specific numerical proportions are contextual but support the ratio. Conclusions: The charge of failure to exercise due skill, care and diligence was established. The broker's conduct in permitting self-trades and synchronized trades, including acting as both broker and counterparty broker, violated Clause A(2) and Regulation 7. Issue 2 - Liability in absence of proven connivance; duty to monitor electronic/Internet-based trades Legal framework: Broker obligations under the Brokers Regulations include protecting market integrity and not being a party to market manipulation; this duty persists even when trades are executed on client instruction and via electronic terminals. Precedent treatment: Followed Madhukar Sheth: broker cannot be compelled to be a party to market manipulation and must take steps to prevent it; precedent supports imposition of responsibility absent active connivance. Interpretation and reasoning: The Tribunal held that lack of allegation or proof of connivance does not absolve the broker. A broker is expected to monitor trades executed through internet-based platforms and to ensure compliance with law and market equilibrium. Repeated identical, synchronized or same-terminal buys and sells constitute red flags that a reasonably prudent broker should detect and act upon. The broker's large client base and passive reliance on client instructions are insufficient defenses where monitoring was inadequate. Ratio vs. Obiter: Ratio - Broker liability for facilitating or failing to prevent manipulative self-trades can be established without proof of connivance if monitoring obligations are breached. Obiter - Practical steps for monitoring were not prescribed but the duty to 'constantly monitor' was emphasized as normative guidance. Conclusions: Liability was appropriately imposed despite absence of proven connivance because the broker failed in its affirmative duty to monitor and prevent manipulative self-trading executed through its terminals. Issue 3 - Proportionality of penalty given the scale of broker's overall turnover and magnitude of impugned trades Legal framework: Section 15HB allows imposition of monetary penalties for contraventions; proportionality doctrine requires that a penalty not be highly disproportionate to the violation committed. Precedent treatment: The Tribunal relied on its discretion informed by regulatory objectives and precedent recognizing punitive action for self-trades; no precedent to treat total corporate turnover as a controlling mitigant was accepted. Interpretation and reasoning: The Tribunal rejected the contention that large overall turnover and client base render the impugned trades insignificant for penalty purposes. The Court held that the legality and gravity of a violation are not diluted by the broker's aggregate business volume; synchronized/self-trades affect market integrity irrespective of relative turnover. The Tribunal noted the absence of evidence of connivance but found the broker's failure to detect repeated self-trades over a span of days amounted to a serious lapse in due diligence. Considering the statutory maximum penalty (Rs. 1 crore under Section 15HB) and the facts, the imposed penalty (Rs. 35 lac) was held not to be disproportionate. Ratio vs. Obiter: Ratio - Quantum of penalty must be assessed in light of the nature and seriousness of the violation; overall turnover is not a determinative mitigating factor that negates liability or renders a reasonable penalty disproportionate. Obiter - Comments on the relationship between synchronized trades and market variables are explanatory of seriousness but not limiting of penalty principles. Conclusions: The monetary penalty was proportionate to the violation; the appeal on grounds of disproportionate penalty was dismissed. Issue 4 - Remedial and regulatory policy considerations (market integrity, monitoring obligations) Legal framework: Regulatory regime aims to maintain market integrity, prevent manipulation, and require market intermediaries to ensure fair trading practices. Precedent treatment: The Tribunal reiterated prior holdings that self-trades are illegal and warrant punitive measures (Anita Dalal and other Tribunal decisions) and that brokers must protect the market as well as clients (Madhukar Sheth). Interpretation and reasoning: The Tribunal emphasized that synchronized and self-trades 'hit at the very foundation' of capital markets because they do not effect genuine change of ownership and can artificially influence prices. Therefore, regulators must deal strictly with such violations. The broker's duty includes proactive oversight of trading patterns, especially where identical quantities, timing and same-terminal executions occur. These public-interest considerations justify enforcement and penalties even where individual financial impact appears small relative to a broker's turnover. Ratio vs. Obiter: Ratio - Protection of market integrity justifies stringent enforcement against brokers who fail to prevent manipulative trading patterns; this underpins liability and penalty decisions. Obiter - General policy remarks on the social harm of self-trades serve to contextualize the decision. Conclusions: Regulatory policy and market-integrity considerations support the finding of breach and the imposition of the penalty; enforcement focus on prevention and monitoring by brokers is validated.