2025 (12) TMI 826 - HC - SEBI

Arbitration award upholding depository's vicarious liability u/s 34 and Section 16 Depositories Act sustained

HC dismissed the arbitration petition under Section 34 of the Arbitration Act, upholding the award holding the petitioner-depository liable, vicariously, ... Fraudulent siphoning off shares - Transfer of ownership - scope of powers u/s 34 of the Arbitration Act - BRH misused the Power of Attorney (POA) as a broker - illegal invocation of pledge of securities - transfer of shares from the account of Respondent No. 1 by BRH in its capacity as broker using the POA to the own TM/CM Accounts of BRH and the final pledge occurred from the Second CM/TM Account of BRH to HDFC - non-compliance with regulatory provisions of the Stock Exchange - BRH violated its duty as a broker under SEBI circulars - accordingly debarred from the market for seven years and directed to repay the investors under the supervision of NSE - penalty imposed u/s 19G of the Depositories Act, 1996 and Section 15HB of the SEBI Act 1992 - expressions ‘would meet with the ends of justice’ or ‘travesty of justice’ and ‘furtherance of justice’ - Petitioner challenged the Award of the Arbitral Tribunal holding it responsible for compensating the Respondent No. 1-Investor for negligent and fraudulent acts of its DP-BRH - Petition challenging the Award contending that none of the acts of BRH are in its capacity as DP and that all its acts were in its capacity as broker. HELD THAT:- The use of the phrases ‘would meet with the ends of justice’ or ‘travesty of justice’ and ‘furtherance of justice’ by the Arbitral Tribunal would not mean that the Award is passed by the Tribunal in exercise of jurisdiction in equity. On the contrary, the Award is made against Petitioner-CDSL after holding that its DP (BRH) has acted negligently. It is not that the Arbitral Tribunal has held that though Petitioner is not responsible in law to compensate Respondent No. 1, it was invoking equity jurisdiction for fastening the lability on the Petitioner. There is detailed discussion by the Arbitral Tribunal holding Petitioner liable for acts of BRH as its agent. Therefore, it cannot be contended that the Tribunal has exercised jurisdiction under Section 28(2) of the Arbitration Act in absence of agreement between the parties. In that view of the matter, it is not necessary to discuss the ratio of the judgment in John Peter Fernandes [2023 (3) TMI 1605 - BOMBAY HIGH COURT] dealing with the issue of impermissibility for Arbitrator to exercise equity jurisdiction in absence of agreement under Section 28(2) between the parties. The conclusions reached by the Arbitral Tribunal cannot be treated as so irrational that no reasonable person would arrive at it. What Petitioner has attempted to do before me is to urge me to take another possible view for exonerating CDSL in respect of negligent and fraudulent acts committed by BRH. While BRH is held responsible also in his capacity as DP by the Arbitral Tribunal, Petitioner has made attempt to convince this Court to take another view by treating acts of BRH in capacity as broker alone. Even if it is assumed that the view of treating BRH as mere broker is also possible, that alone would not be a sufficient ground for setting aside the impugned Award. The case involves a unique and possibly unpresedented fraud where broker and DP has stolen shares of client entrusted with it and has indirectly caused sale of the same by creating pledge with HDFC Bank. The Artibtral Tribunal has considered the composite role of BRH in the transaction as broker and DP and has held that BRH has also acted as DP is causing transfer of shares and in creating the pledge. These are plausible findings and cannot be treated as absolutely irrational. Though Petitioner has relied upon the judgments of the Apex Court in Reliance Infrastructure [2023 (5) TMI 1319 - SUPREME COURT] and Consolidated Construction Consortium Limited [2025 (4) TMI 1575 - SUPREME COURT] where all the past judgments on the issue of scope of powers under Section 34 of the Arbitration Act are surveyed and principles are restated, Petitioner has not been able to make out any of the recognised grounds for invalidating the arbitral award. In fact in OPG Power [2024 (9) TMI 1300 - SUPREME COURT (LB)] relied upon by the Petitioner, the Apex Court has held that the award need not be set aside if the reasons are insufficient or inadequate, if the underlying reason is discernible from reading of the entire award and documents relied upon and if such reason is not perverse. In the present case, the Arbitral Tribunal has recorded the underlying reason of BRH acting in its capacity as DP during some of its negligent and fraudulent acts and has accordingly applied the provisions of Section 16 of the Depositories Act and Clause 5.3.2 of CDSL Bye laws. The underlying reason discernible from reading of the award cannot be termed as perverse. The manner of enquriy conducted by Arbitral Tribunal or the detailed findings recorded by it may not be to the liking of the Petitioner, however so long as this Court has not found the final conclusion of Arbitral Tribunal treating role of BRH as DP to be not perverse, there is no warrant for exercising the powers under Section 34 of the Arbitration Act for invalidating the Award. There is ample material on record to indicate that BRH has not acted in its capacity solely as broker. It has not effected any trades on the Stock Exchange. As DP, it acted as agent of the Petitioner, with whom the shares were entrusted for safe keeping in dematerialised form. BRH used its capacity as DP to ensure that the ownership of shares entrusted with the Petitioner is transferred onto itself. It used the POA for transfer of such ownership. It acted in twin capacities as broker and DP to internally effect the transfer of ownership of shares. Therefore the findings of the Arbitral Tribunal that BRH acted also in capacity as DP cannot be termed as perverse. What BRH has done is a misuse of POA for the purpose of stealing the shares of Respondent No. 1. It is difficult to hold that this act of stealing is done by BRH in its capacity solely as broker. The Arbitral Tribunal has rightly captured this aspect in the impugned Award. Petitioner has thoroughly failed to make out any valid ground of challenge to the impugned Award. The Arbitration Petition must fail. Since the Arbitral Tribunal has already awarded interest@9% p.a. on the awarded sum to Respondent No. 1, it is considered appropriate not to impose any further costs on the Petitioner while dismissing the Arbitration Petition. 1. ISSUES PRESENTED AND CONSIDERED 1.1 Whether the negligent and fraudulent acts of the intermediary were committed solely in its capacity as a broker or also in its capacity as a Depository Participant, and the consequent vicarious liability of the Depository under Section 16 of the Depositories Act and the applicable bye-laws. 1.2 Whether, on the facts and regulatory framework (including SEBI circulars), the Depository could avoid liability by shifting responsibility to the Stock Exchange and its Investor Protection Fund. 1.3 Whether the SEBI circular dated 25 July 2023 altered, diluted, or displaced the statutory liability of the Depository under Section 16 of the Depositories Act in respect of negligent acts of its Depository Participant, including in pending matters. 1.4 Whether the Arbitral Tribunal's award was vitiated by 'patent illegality', perversity, or excess of jurisdiction under Section 34 of the Arbitration and Conciliation Act, 1996, including on the ground that the Tribunal allegedly decided ex aequo et bono or as amiable compositeur. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Capacity in which the intermediary acted and vicarious liability of the Depository under Section 16 of the Depositories Act Legal framework 2.1 The Court noted Clause 5.3.2 of the relevant bye-laws, under which a Depository Participant, while conducting any business with a beneficial owner, acts as an agent of the Depository. 2.2 Section 16 of the Depositories Act provides that any loss caused to a beneficial owner due to the negligence of the depository or the participant must be indemnified by the depository, with a right of recovery against the participant. Interpretation and reasoning 2.3 The Court accepted that the intermediary functioned in dual capacities - as a registered stockbroker with the Stock Exchange and as a Depository Participant of the Depository. 2.4 The fraudulent scheme comprised: (i) unauthorised transfer of the investor's shares from her demat account to the intermediary's first TM/CM account by misuse of a power of attorney; (ii) further transfer to a second TM/CM account; and (iii) pledge of those shares with a bank, followed by sale upon default. 2.5 The Court emphasised that no underlying trades existed to support the transfers; the acts were not in pursuance of any exchange trades. Therefore, these could not be characterised as acts performed purely in the capacity of a broker. 2.6 The transfer from the investor's demat account to the TM/CM account was effected on the basis of the power of attorney and required the Depository's nod to register the transfer of ownership. The Depository accepted that, under Section 7(1) of the Depositories Act, it was obliged to give effect to such transfer when supported by a power of attorney. 2.7 The Court held that, in authorising and processing the transfer of ownership from the investor's demat account to the intermediary's TM/CM account, the intermediary necessarily acted also in its capacity as Depository Participant (and not only as broker), the transaction having been processed through the depository system. 2.8 The Court approved the Arbitral Tribunal's finding (including its analysis of the 'second leg' of the transaction) that the intermediary, as DP, failed to obtain a 'pledge request' from the investor before pledging her securities, in breach of the depository regulatory framework and bye-laws, and that this constituted serious manipulation by the DP across thousands of client accounts. 2.9 The Court rejected the Depository's attempt to rely on the intermediate TM/CM accounts to argue that the pledge occurred only after ownership had passed to the intermediary, holding that the entire sequence was a composite fraudulent act beginning with theft of the investor's shares through misuse of the power of attorney. 2.10 It held that the Depository's approach of artificially dissecting the fraudulent acts into 'broker-only' and 'DP-only' components was unsustainable; the fraud was a single continuous scheme in which the DP capacity was clearly implicated. Conclusions 2.11 Once it was established that the intermediary's negligent/fraudulent acts were committed also in its capacity as Depository Participant, Section 16 of the Depositories Act was attracted and fastened direct liability on the Depository to indemnify the investor. 2.12 Under Section 16, once negligence of the participant is established, the depository's liability to indemnify the beneficial owner is absolute and does not depend on proof of the depository's own fault or knowledge; the depository's recourse is to recover from the participant under Section 16(2). 2.13 The Court held that the distinction advanced by the Depository between misfeasance and nonfeasance was irrelevant, as Section 16 requires only negligence of the DP, and any additional element of criminality need not be proved. 2.14 The Court therefore upheld the Arbitral Tribunal's finding that the intermediary's acts were attributable to its role as DP and that the Depository was vicariously liable to indemnify the investor for the loss of the shares. Issue 2 - Ability of the Depository to shift liability to the Stock Exchange and its Investor Protection Fund, including in light of SEBI circulars pre and post fraud Legal framework 2.15 The Court considered SEBI circulars governing use of powers of attorney, transfer of securities to TM/CM accounts, and post-fraud safeguards (including block mechanism and OTP validation) issued prior to and after the impugned transactions. 2.16 It particularly examined SEBI's circular dated 25 July 2023, which allocated responsibility between stock exchanges and depositories to compensate investors, via respective Investor Protection Funds, in specified scenarios of unauthorised transfer or misuse of powers of attorney / DP operations. Interpretation and reasoning 2.17 On earlier circulars, the Court noted that SEBI's framework already distinguished between execution of trades and mere transfer of securities using powers of attorney, and that a power of attorney could not be used by a broker to execute trades without client consent. 2.18 The Court considered that because brokers were prohibited from using a power of attorney to execute trades without consent, the intermediary instead misused the power of attorney to transfer shares off-market from client demat accounts to its own TM/CM accounts, thereby engaging its DP capacity in the transfer through the depository system. 2.19 The Court noted that even pre-fraud, SEBI had introduced mechanisms such as early warning systems and restrictions on use of collateral and powers of attorney, but declined to base its decision on any alleged breach by the Depository of those circulars, holding that, under Section 16, the investor was not required to establish statutory or regulatory default by the Depository itself. 2.20 As to post-fraud circulars (including those on margin pledges, block mechanism, and OTP validation), the Court held that their later introduction did not bear upon the Depository's statutory duty under Section 16 in relation to the already completed fraudulent acts of the DP; these circulars merely introduced additional safeguards for the future. Conclusions 2.21 The Court held that the existence or absence of additional regulatory safeguards at the time of the fraud did not alter the Depository's statutory liability under Section 16 for negligent acts of its Depository Participant. 2.22 The investor was not required to prove any violation by the Depository of SEBI circulars; proof of negligent acts by the DP, in its DP capacity, was sufficient to trigger the Depository's liability to indemnify. Issue 3 - Effect of the SEBI circular dated 25 July 2023 on the Depository's liability under Section 16 and allocation of responsibility between the Depository and the Stock Exchange Legal framework 2.23 The Court extracted and analysed the SEBI circular dated 25 July 2023, which, after noting misuse of powers of attorney, directed stock exchanges and depositories to compensate investors from their respective IPFs in defined scenarios, including: (i) unauthorised transactions by brokers by misuse of POA (Stock Exchange responsible); (ii) shares transferred from investor's demat to broker's demat account by misuse of settlement ID (Stock Exchange responsible); (iii) negligence/fraud committed by DP/DP employees in DP operations (Depository responsible); (iv) post-pay-in-validation transfers from client's account to broker/other entity without corresponding trade obligation (Depository responsible). 2.24 The circular also directed amendments to rules/bye-laws and specified that it would apply even to pending matters. Interpretation and reasoning 2.25 The Court held that even on a plain reading of the circular, negligence or fraud committed in DP operations remained the responsibility of the Depository, reinforcing, rather than negating, the Depository's obligation to compensate investors in such cases. 2.26 The Court rejected the Depository's contention that, because the case involved misuse of a power of attorney, responsibility lay exclusively with the Stock Exchange. It found that the present case did not fit within the scenarios where the Stock Exchange's IPF would be liable, particularly because: - there were no underlying trades on the exchange platform; and - the case did not involve 'misuse of settlement ID' as contemplated in the circular. 2.27 The Court observed that the circular made exchange IPF compensation contingent upon the investor having complained before default/disablement of the broker's terminal. In the present case, had the investor not complained within the brief window between fraudulent transfers and suspension of the intermediary, the Exchange would deny compensation. 2.28 The Court held that using the circular to transfer liability to the Stock Exchange would, in such circumstances, leave the investor uncompensated and would contradict both the text and purpose of Section 16. 2.29 The Court clarified that the circular's purpose was to allocate use of IPFs between market infrastructure institutions, not to modify or dilute the statutory obligation of a depository to indemnify beneficial owners under Section 16 when a DP acts negligently or fraudulently in DP operations. Conclusions 2.30 The Court concluded that the SEBI circular dated 25 July 2023 could not absolve the Depository of its statutory liability under Section 16 of the Depositories Act. 2.31 Even under the circular, negligence/fraud of a DP in DP operations falls within the Depository's responsibility, and the facts of the case clearly attracted that category. 2.32 The Depository could not, therefore, avoid liability by attempting to 'shift the ball' to the Stock Exchange or its Investor Protection Fund. Issue 4 - Validity of the arbitral award under Section 34 of the Arbitration and Conciliation Act; alleged patent illegality, perversity, and exercise of equitable jurisdiction Legal framework 2.33 The Court proceeded on the well-settled standard under Section 34: an arbitral award can be interfered with only if it suffers from patent illegality, perversity, or is contrary to fundamental policy or other recognised grounds; mere possibility of another view or inadequacy of reasons does not justify setting aside. 2.34 Section 28(2) of the Arbitration Act allows a tribunal to decide ex aequo et bono or as amiable compositeur only where the parties expressly authorise it. Interpretation and reasoning 2.35 The Court held that the Arbitral Tribunal had clearly identified and applied the relevant statutory and regulatory provisions (including Section 16 of the Depositories Act and the Depository bye-laws) and had undertaken a detailed factual analysis of the intermediary's capacity and conduct. 2.36 It found that the Tribunal's central factual finding - that the intermediary acted also in its capacity as DP in the composite fraudulent scheme - was a plausible finding based on admitted facts and applicable law, and not perverse. 2.37 The Court noted that the Tribunal's approach of dissecting the transaction into distinct legs and then re-characterising it as a composite fraud involving DP functions was within its fact-finding domain; the Court under Section 34 could not substitute its own view merely because another view (treating it as purely broker conduct) was also possible. 2.38 As to the argument that the Tribunal had applied 'equity' and acted as amiable compositeur, the Court observed that the Tribunal had not held the Depository liable in the absence of legal responsibility; rather, it had anchored its conclusions squarely in the statutory framework of the Depositories Act and the agency relationship under the bye-laws. 2.39 The Court held that the Tribunal's use of expressions such as 'meet the ends of justice' or 'travesty of justice' did not convert the award into one based on ex aequo et bono; these phrases did not displace the legal reasoning underpinning the finding of liability. 2.40 The Court distinguished between awards lacking reasons or based on perverse reasoning, and awards where reasons may appear insufficient or brief but are nonetheless discernible and rational. It held that, in the present case, the underlying reasons for the Tribunal's conclusion were intelligible and non-perverse. 2.41 The Court noted that the quantum of loss (Rs. 86,02,768/-, being the value of the lost shares) was accepted by the Depository before the Tribunal and was not in dispute; thus, no perversity existed on quantum. Conclusions 2.42 The Court held that the Arbitral Tribunal had not exercised jurisdiction as amiable compositeur or on purely equitable considerations; it had applied the substantive law correctly, including Section 16 of the Depositories Act and the agency provisions of the bye-laws. 2.43 No patent illegality, perversity, or violation of the limited grounds under Section 34 was made out. The Tribunal's findings on the intermediary's capacity as DP, the Depository's resultant liability, and the rejection of the attempt to shift liability to the Stock Exchange were all characterised as 'plausible views' supported by reason. 2.44 Consequently, the Court upheld the arbitral award directing the Depository to indemnify the investor for the value of the lost shares along with interest, and dismissed the Section 34 petition without costs and without continuation of the earlier interim protection on interest.