TaxTMI 
TaxTMI 
2023 (12) TMI 1437
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....'AO') of Securities and Exchange Board of India (hereinafter referred to as 'SEBI') imposing a monetary penalty of Rs. 1 crore each under Section 23D of the Securities Contracts (Regulation) Act, 1956 (hereinafter referred to as 'SCRA'). 2. The appellant has filed Appeal No. 527 of 2023 challenging the order of the Whole Time Member (hereinafter referred to as 'WTM') debarring the appellant from taking up new clients for a period of two years. For facility, the facts stated in Appeal No. 527 of 2023 are being taken into consideration. 3. The appellant is a large broking company and is a member of the National Stock Exchange of India Ltd. (hereinafter referred to as 'NSE') and BSE Ltd. (hereinafter referred to as 'BSE') and is in the business of broking, distribution of mutual funds. The appellant is a depository participant with National Depository Services Ltd. (hereinafter referred to as 'NSDL') and Central Depository Services (India) Ltd. (hereinafter referred to as 'CDSL') and portfolio manager. It has various branches spread across the country. 4. SEBI conducted six inspections for the period of April 1, 2011 to January 31, 2017. The details of these inspections are a....
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....under Regulation 27(1) of the Intermediaries Regulations. The show cause notice alleged that during the inspection, out of 45 client bank accounts, 26 client bank accounts were not titled as "client account". It was also alleged that after the inspection the appellant renamed the account as "client account", nonetheless, one account with Citi Bank and the other account with South Indian Bank were not renamed and, therefore, the appellant had violated the circular dated November 18, 1993 (hereinafter referred to as '1993 circular') for failure to designate bank accounts used for client transaction as "client account". The show cause notice also alleged that funds were regularly being transferred from client bank accounts to the pool accounts / control accounts of the appellant which were managed and controlled by appellant as its own bank account. Further, funds were also transferred from the appellant's own bank accounts to the pool accounts / control accounts and then money was transferred to the settlement account of the stock exchange / clearing house. The show cause notice, thus, alleged that the appellant had violated the 1993 circular for failing to segregate client funds and....
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....ient for a period of two years in respect of its business as a stockbroker. On the same facts, the AO also found that the charges levelled against the appellant stood proved and, accordingly, imposed a maximum penalty of Rs. 1 crore in each of the adjudication proceedings under Section 23D of the SCRA. 14. We have heard Mr. Darius Khambata, the learned senior counsel with Mr. Somasekhar Sundaresan, Mr. Kunal Katariya, Mr. Sahebrao Wamanrao Buktare, Ms. Ashmita Garodia, the learned counsel with Mr. Shardul Shah, Chartered Accountant for the appellant and Mr. Gaurav Joshi, the learned senior counsel with Mr. Suraj Choudhary, Mr. Ravishekhar Pandey, Mr. Nishit Dhruva, Ms. Shefali Shankar, Ms. Rasika Ghate, Mr. Harsh Sheth, the learned counsel for the respondent. 15. Before we deal with the issues, we find that the core issue is with regard to the violation of 1993 circular. Our attention was also brought to the notice of a subsequent circular dated September 26, 2016 on the same issue. Before proceeding further, it would be appropriate to consider the circular dated November 18, 1993 issued by SEBI. This circular issued certain guidelines with regard to regulating the transactio....
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....house on behalf of the clients though it is not specifically stated in the 1993 circular. The circular does not provide for any formula to calculate client funds and does not refer to or speak about bank guarantees. It only provides for the creation of separate client bank account and what can be credited or debited from the said account. 18. Over a period of time, the exchanges started monitoring the position of the client bank accounts of brokers to ensure that there was no misuse and that the brokers had the appropriate financial strength to meet all client obligations at all times. Since 1993, SEBI / exchanges considered the funds lying in the "client bank account" and the cash and cash equivalents "lying with exchange / clearing corporation" as client funds. The formula used is that the sum total of these two items should always be greater than or equal to the sum total of all credit balances of funds payable to clients. 19. In 2015, SEBI constituted a committee on "Enhanced Supervision of The Stock Brokers' which included representatives from stock exchanges, depositories and brokers. The committee made its recommendations in 2015 which eventually led to the issuance of....
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....ula provided that if "G" is negative then it is an indication that the broker has misused the clients' funds for its own use. While the formula was in use earlier the same was further crystalized by the circular of 2016 to indicate that only the funded portion of the bank guarantee i.e. amount deposited by the broker with the bank to obtain the bank guarantee would be considered as part of the aggregate value of collateral deposit with the clearing corporation or with clearing member. To give an example, if a bank guarantee of Rs. 100/- is to be provided by the client and the bank gives a guarantee for Rs. 100/- by taking a deposit of Rs. 80/- then only the funded portion of Rs. 80/- will be considered and not Rs. 100/- towards collateral deposit with the clearing corporation, meaning thereby that the remaining Rs. 20/- which was not used by the broker for obtaining a bank guarantee has to be kept in the clients' accounts and cannot be used by the broker for other purposes, otherwise, it would be deemed to be a misuse of clients' funds. 22. We find that the requirement of only the funded portion of the bank guarantee toward the aggregate value of collateral deposit came into exi....
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....cular and even though the nomenclature "client" was not added to the names of these accounts which was only technical in nature, nonetheless, we are of the opinion that the appellant violated the 1993 circular. 26. The second charge is mixing of funds with client funds by using a pool / control account before transferring the monies to the settlement account. This charge is serious. The 1993 circular clearly mandated that the funds from the clients accounts has to be kept separately from the proprietary funds of the stockbroker and the two funds cannot be mixed together. Clause (1) of the 1993 circular clearly indicated that it shall be compulsory for all brokers to keep the money of the client in the separate account and their own funds in a separate account. There was a clear mandate that clients' money has to be kept in a separate account and brokers money has to be kept in a separate account and the nomenclature of the accounts had to be displayed. In this regard, we find that the appellant had used the following process towards administrative convenience which has been depicted in the impugned order as under :- Diagram 1 : Flow of funds in the records of IIFL 27. Admi....
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.... money were kept was violative of 1993 circular. This approach, in our opinion, is wrong and untenable in as much as Clause (1) of the 1993 circular makes it clear that client accounts and broker's account has to be kept separately which the appellant had created and complied with the circular. Further, settlement of the client money was debited from the clients account which went into the pool account and from the pool account it went to the settlement account. This fact is also admitted by the respondent. The only objection is that in the pool account the brokers own money was also included and, therefore, there was mixing of funds which was not permissible. As stated above, client funds are maintained in the client account and whenever the client trades, the client obligations towards brokers and stock exchange are debited from the client account which is then transferred to the settlement account. While doing so it goes first into the pool account and then it transferred to the settlement account. In our view, the pool account does not violate the 1993 circular. In our opinion, the 1993 circular does not prohibit the pool account. In fact, the 1993 circular permits the appellan....
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....lient account and funds lying with the exchange / clearing corporation were treated as clients funds and the formula used under the 1993 circular was that the sum total of these two items i.e. funds lying in the client account and the funds lying with the stock exchange / clearing corporation should always be greater than or equal to the sum total of all the credit balances of the funds payable to client. 36. As per the circular of SEBI dated February 23, 2005, SEBI considered unconditional bank guarantee equivalent to cash / fixed deposits treating cash, fixed deposits and bank guarantees furnished by the brokers as funds lying with the stock exchange. In 2015, SEBI constituted a committee on "Enhanced Supervision of The Stock Brokers" which included representatives from stock exchanges, depositories and brokers. The committee made its recommendations in 2015 which eventually led to the issuance of the circular dated September 26, 2016 wherein it provided for a formula to calculate client funds. The basic formula was the same, namely, that the sum total of funds lying in "client bank account" and cash and cash equivalents "lying with the exchange / clearing corporation" being c....
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....eafter so long as the end result is obtained and the monies finds its way into the settlement account, then everything else becomes immaterial. 41. The contention of the learned senior counsel for the respondent is, that even if full bank guarantee value was considered than over a period of six years i.e. during the inspection period from 2011 to 2017, the client funds were negative on 18 days. This contention cannot be considered in as much as we find that the AO has applied the requirement of considering the funded portion of the bank guarantee with retrospective effect for the period prior to July 1, 2017. 42. In view of the aforesaid, we find that the impugned order holding that "it is the spirit" of 1993 circular which contains the requirement of considering only the funded portion of the bank guarantee is patently erroneous and cannot be sustained. The finding that the non-funded portion of the bank guarantee should be included in the usage of client funds i.e. "G value" is erroneous and cannot form the basis of calculation under the 1993 circular. The finding that the appellant had violated the 1993 circular both in letter and spirit is in complete defiance of the regu....
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....g the balances with the stock exchange / clearing corporation. The treatment of bank guarantee introduced in the 2016 circular was not existing in the 1993 circular and the treatment of this bank guarantee introduced in 2016 circular was not considered by this Tribunal in Arihant Capital Markets Pvt. Ltd. (supra) matter and in other cases cited by the respondent. Thus, merely picking up the phrase from the order passed by this Tribunal does not give any right nor can it hold that the 2016 circular was a reiteration of the 1993 circular. 46. We are also of the opinion that the principles of strict interpretation have to apply in the instant case. The participants must know the rules of the game before the game has begun which cannot be changed midway retrospectively to then state that the spirit has always existed. It is not disputed that all the inspections carried out since inception till the inspections in question never raised any observation that only funded portion of the bank guarantee was to be considered. These inspections found no misutilization of the client funds. Admittedly, there has been no misuse of client funds and by wrongly considering the non-funded portion of....