TaxTMI 
TaxTMI 
2009 (1) TMI 912
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....DSL is the appellant in Appeal no. 69 of 2007 and a penalty of Rs. 3 crores has been imposed on it under the same provisions of law. The adjudication proceedings originated out of the investigations conducted by the Board into the issue of shares of 21 companies through initial public offerings (IPOs) during the period 2003-2005. Investigations revealed that shares in the aforesaid IPOs, which were reserved for retail investors, were irregularly acquired by many entities through the medium of thousands of fictitious/benami applications. For this purpose the said entities (hereinafter referred to as key operators) opened a large number of demat accounts in fictitious and benami names and used those to make applications for shares in the IPOs in the category of retail investors. On allotment, the shares were transferred to the demat accounts of the key operators who in turn allegedly transferred the shares through off market deals to the ultimate beneficiaries who had financed the purchase of such large number of shares. The financiers sold the shares immediately after they were listed in the stock exchanges to garner huge profits. The two appeals in which the charges as ....
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....ve investors as their clients whom they service directly. The transactions of individual investors are reflected in their demat accounts by the Depositories on the basis of intimations given by the Depository Participant concerned. The Depository Participants, thus, act as agents of the Depositories. The detailed duties, responsibilities and obligations of the Depositories and the Depository Participants are laid down in the Depositories Act, the Regulations framed thereunder and also in various orders and circulars issued by the Board from time to time. This apart, the Depositories frame their own bye laws with the approval of the Board to regulate their own operations. Both the Depositories have also issued separate sets of operating instructions for their respective Depository Participants. With the introduction of the depository system, the risk associated with handling paper certificates and transfer deeds has been eliminated and the framework for settlement of transactions in the securities market has evolved into a cleaner, more efficient and more transparent one. Appeal no 68 of 2007 3. In the show cause notice dated November 23, 2006 whi....
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....ording to the Board, it is this failure that directly led to the so called IPO scam. Though the demat accounts are maintained by the Depositories (including the appellant) in their computerised data base, these accounts are opened for the clients (beneficial owners) by the Depository Participants (DPs) after ensuring adherence to the Know Your Client (KYC) norms. Detailed instructions in this regard have been issued by the Board and the Depositories also have issued various communications in this regard to the DPs. It has been noted in the impugned order that as many as 34,924 fictitious/benami accounts of beneficial owners were opened with the DPs for 21 IPO's including thousands of accounts which had the same address and most of which were closed soon after the allotment process. The respondent Board's case is that the failure of the appellant to prevent the opening of such multiple beneficiary ownership accounts with the same address occurred mainly because the application forms for opening beneficial ownership accounts provided for two addresses and the process of making illegal profits by cornering the retail category shares in the IPO's was facilitated....
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.... authenticated by an existing account holder or by the applicant's bank or after due verification made with the original of the applicant's valid passport, voter ID, driving license or PAN card with photograph; and further the account opening form should be supported with proof of address such as verified copies of ration card / passport / voter ID / PAN card / driving license / bank passbook. An authorized official of the depository participant, under his signature shall verify the original documents." The circular of August 4, 2000 was addressed not to the Depositories but to the DPs, though copies were endorsed to the Depositories as well. We also find that there is absolutely no bar in the Depositories Act or the Regulations framed thereunder on opening of multiple accounts by a beneficial owner. In fact, the Board itself advises investors in its own website that an investor can open more than one account in the same name with the same DP and also with different DPs. Thus, more than one account can be opened in the same name and also with the same address. Given this situation, it is no wonder that the appellant did not provide any system level check ....
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....Participants) Regulations, 1996 (DP Regulations for short) which lays down that no participant shall assign or delegate its functions as participant to any other person, without the prior approval of the Depository. This charge relates to one particular Depository Participant namely Karvy Stock Broking Ltd (Karvy for short). The learned senior counsel for the appellant argued that use of an agent for collection of application forms from intending investors and their submission to the DPs does not amount to assignment or delegation of the functions of a participant, as alleged by the Board. In view of the rush for opening new demat accounts before an IPO issue opens, it is a common practice, according to the appellant, for DPs to use certain individuals as their agents to source new clients. This is only a marketing activity and does not at all amount to outsourcing within the meaning of Regulation 52 of the DP Regulations. We are inclined to agree with the learned senior counsel for the appellant because such outsourcing does not in any way dilute the responsibility of the DP to ensure strict compliance with the KYC norms. It would appear to be a common practice in the market....
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....of approval by Reserve Bank of India is not necessary in the case of opening of an account by a domestic Indian resident and therefore the date field for such approval in such an account would normally have a default entry which should be easily identifiable as such. It was also forcefully argued on behalf of the appellant that in order to understand on what basis such a serious charge had been levelled and to clarify the position, it was essential for the appellant to cross examine the authors of the iSec report on the basis of which this charge has been framed but this request was turned down by the Adjudicating Officer. We find absolutely no rationale behind such refusal by the Adjudicating Officer of the appellant's right of cross examination. The Adjudicating Officer has recorded his findings basing himself solely on the iSec report. Granting that iSec is an expert body, NSDL is also a professional body whose system is operated by personnel who are also experts in designing and operating compurterised data bases. Faced with the charge of lack of data integrity, NSDL has come up with detailed explanation which is prima facie quite plausible.&....
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....d, we are not in a position to accept the finding of the Adjudicating Officer in this respect which could only be termed vague and without any basis. The charge must, therefore, fail. 10. The next charge is failure to verify the infrastructural facilities of the DPs. The Adjudicating Officer has held that the appellant never physically verifies the DP prior to recommending its registration with the Board though bye law 6.2.1(vii) of the appellant provides that the applicant should have adequate office space exclusively for depository operations. The appellant admits that physical inspection is not undertaken as a matter of course before recommending registration but that is because the applicants have to be electronically connected to the appellant and this cannot be done unless the former have adequate infrastructure. After hearing the learned senior counsel on both sides and examining the records, we are of the view that physical inspection of a DP's site before recommending registration need not be considered an absolute must in all cases. This is because the appellant itself arranges the electronic connectivity of the DP applicants with service providers (M....
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....e where an indicator light of the car is not working. While we cannot but agree that any penalty has to be commensurate with the seriousness of the offence that it penalises, there is no apparent reason for us to doubt the judgment of the appellant in deciding the right kind of penalty for the lapses noticed by it during its inspection of the DPs. 12. Apart from the five charges dealt with above, the Board in a supplementary show cause notice issued to the appellant on 14.2.2007 sought clarification from the former on its alleged failure to comply with the direction issued by the Board in its orders dated January 12, 2006 and April 27, 2006 in respect of the demat account of one Biren Kantilal Shah. It was also alleged in the said show cause notice that the appellant had failed to comply with the directions issued by the Board in its letter no. ISD/SD/HSE/03/2006 dated 16.11.2006 regarding audit of one particular account of Karvy. The Adjudicating Officer did not give any adverse finding in respect of the latter allegation in view of the circumstances explained in paragraph 12.3.2 of the impugned order. Regarding the first charge, the Adjudicating Officer proceeded on the ....
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....t opening forms to be primarily responsible for opening of the large number of fictitious/benami accounts and has held CDSL responsible for that. The learned counsel for CDSL, however, pointed out that it is not correct to hold, as the Adjudicating Officer has done, that CDSL had included the column for correspondence address without the Board's approval. The provisions for correspondence address, in addition to the permanent address, has been a part of CDSL's system since inception and this always had the approval of the Board. Besides, the learned counsel for CDSL pointed out that contrary to what has been recorded in paragraph 5.3 of the impugned order, CDSL has not withdrawn the provision for correspondence address in the demat account opening forms as this provision is considered to be absolutely necessary in the interest of investors. Similar facility exists in the account opening forms in banks, in the applications forms for allotment of permanent account number by the Income Tax department, in the form of application for passport etc. Mere existence of the provision for correspondence address cannot be held responsible for the so called I....
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....tion for this purpose to the participant in the format specified in the operating instructions issued by CDSL. 13.3.5 The Beneficial Owner will be required to enter into an agreement with the participant as per form at Annexure "C" to these Byelaws. 13.3.6 Once the application has been accepted by the participant, the applicant will be issued a Beneficial Owner account number." It is also alleged by the Board that distribution of 29,848 identification numbers (ids for short) of beneficial owners (BO for short) in advance to the DPs indicated lack of due diligence on the part of CDSL and its failure to follow the prescribed procedures and safeguards resulting in violation of Regulation 34 of the DP Regulations. We do not think so. Bye laws 13.3.4 to 13.3.6 require that the BO id has to be given only after an application is accepted by the DPs and it is not necessary for the latter to upload those particulars to the CDSL system before giving the client a BO id. The BO ids were provided to the DPs in advance on their request since typically, before a popular IPO opens for subscription, a large number of applications are received at the last momen....
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....gainst CDSL is that of failure to put in place adequate mechanisms for the purpose of reviewing, monitoring and evaluating the controls, systems, procedures and safeguards. In the impugned order, the finding against CDSL on this charge has been based on two strands of argument both of which are fallacious. The first is that if effective control measures had existed along with a proper system for monitoring and evaluating such control measures it "could have prompted CDSL in checking creation of large number of afferent accounts". We do not think that this would have been possible in a system which permits opening of any number of accounts by a single individual with any number of DPs. Apart from making a bald statement in the impugned order, the Adjudicating Officer has not explained as to how it would have been possible. During the course of arguments, we repeatedly asked the learned counsel for CDSL as to how it would have been possible in the kind of system that we have and we got no satisfactory explanation. The second argument is that the bye laws that CDSL has framed for the purpose are not adequate. We do not think it is open to the Board to fir....
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....rge of improper maintenance of data on the part of NSDL and its data integrity being suspect also has very grave ramifications. NSDL and CDSL together maintain the demat accounts of all investors in public limited companies in the entire country and if the data integrity of either of them is suspect, the consequences could be disastrous for the whole market. Such a charge ought not to be levelled lightly and, if proved, should result in much more drastic action than the mere imposition of a monetary penalty. Even if one were to assume that the use of certain default values in a few fields in the database was not correct, but can it be concluded on that basis alone that the data integrity of the Depository as such is suspect? The answer has to be in the negative. Since NSDL contends that its systems are perfect and have the approval of the Board, it was necessary to permit it to cross examine the author(s) of the iSec report upon which the Adjudicating Officer has solely relied for recording a finding against the former, so that the deficiency if any, in the system could be identified. Another aspect of the matter also needs to be kept in view. If some ....