TaxTMI 
TaxTMI 
TaxTMI 
2023 (7) TMI 1615
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.... Circular SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/95 dated September 26, 2016 (hereinafter referred to as "Circular dated September 26, 2016") and the directions contained in the SEBI Interim Order ref no WTM/AB/SEBI/ERO/25/2019 dated October 07, 2019 (hereinafter referred to as "Interim Order"). APPOINTMENT OF ADJUDICATING OFFICER 3. On being satisfied that there are sufficient grounds to inquire and adjudicate upon the aforesaid alleged violations, SEBI in exercise of powers under Section 19H of the Depositories Act, 1996 and Rule 3 of the Depositories (Procedure for Holding Inquiry and Imposing Penalties) Rules, 2005 (hereinafter referred to as the "Adjudication Rules, 2005"), and Section 19 r/w Section 15-1 of the SEBI Act, 1992 and Rule 3 of the SEBI (Procedure for Holding Inquiry and Imposing Penalties) Rules, 1995 (hereinafter referred to as the "Adjudication Rules, 1995"), appointed the undersigned as the Adjudicating Officer, vide communique dated March 09, 2023, to inquire into and adjudge under Section 19H r/w Section 19G of the Depositories Act, 1996 and under Section 15-I r/w Section 15HB of the SEBI Act, 1992, the alleged violations by the Noticee. SHOW CAUSE NOTICE ....
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.... of the SEBI Act, 1992, as applicable? If so, what quantum of monetary penalty should be imposed on the Noticees after taking into consideration the factors mentioned in Section 19-I of the Depositories Act, 1996 and Section 15J of the SEBI Act, 1992? 6. Before I proceed with the matter, it is pertinent to mention the relevant legal provisions alleged to have been violated by the Noticees, as applicable during the Investigation Period, and the same are reproduced below: DP Regulations Depository to abide by the Code of Conduct 17. The depository holding a certificate of commencement of business shall, at all times, abide by the Code of Conduct as specified in the Part D of the Third Schedule. Manner of creating pledge or hypothecation. 79 ............... (3) Within fifteen days of receipt of the application, the depository shall after concurrence of the pledgee through its participant, create and record the pledge and send an intimation of the same to the participants of the pledger and the pledgee. .................. (5) If the depository does not create the pledge, it shall send along with the reasons an i....
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....ase may be through his participant and on such invocation, CDSL shall register the pledgee/ hypothecatee as Beneficial Owner of such securities and shall amend its records accordingly. Thereafter, CDSL shall immediately inform the participants of the pledgor and the pledgee of the change and who in turn shall make necessary changes in their records and inform the pledgor and pledgee respectively. SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/95 dated September 26, 2016 Enhanced Supervision of Stock Brokers/Depository Participants Clause 1.2 of Annexure of SEBI Circular SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/95 dated September 26, 2016 1.2 The nomenclature for bank accounts and demat accounts to be followed is given as under: 1.2.1 Bank account(s) which hold clients funds shall be named as "Name of Stock Broker - Client Account". 1.2.3. Demat account(s) which hold clients' securities shall be named as "Name of Stock Broker- Client Account". 1.2.5. Demat account(s), maintained by the stock broker for depositing securities collateral with the clearing corporation, shall be named as "Name of Stock Broker- Collateral Account". 1.2.6. Demat a....
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....antity of shares pledged was 2,00,70,640 for Rs 158.68 Crores. It was observed that the aforesaid pledge had been invoked by HDFC on October 14, 2019 and December 05, 2019. Further, as per the financial ledger balances of clients in the books of BRH, securities worth Rs. 116.62 crores of clients having credit/nil balance were invoked, while the securities worth Rs. 42.27 crores were invoked for clients having debit balances of Rs. 5.22 crores. It was also observed that the clients, who were having debit balance more than their security holding, had a total debit balance of Rs. 3.43 crores, however the value of securities invoked for these clients was Rs. 1.28 Crores. 7.1.2. It was alleged that the Noticee could have ascertained that the securities in demat account of BRH belonged to the clients of BRH and refused the creation of pledge in the demat account. DP Regulations specifically recognize the power of depository not to create a pledge. The Noticee was under an obligation to exercise due diligence while dealing with a request for creation of pledge, which included satisfaction that the BRH was entitled for pledging the shares. Exercise of due diligence required the No....
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.... restraint or attachment orders issued by SEBI and/or any competent authority by marking a freeze on the demat accounts in the manner specified in such orders. Therefore, the Noticee was under an obligation to mark "freeze" on the pledged securities since the securities lying therein were owned by the Beneficial Owners and even after the pledge, continued to be the property of the Beneficial Owners. 7.3.3. However, it was observed that Noticee did not act in accordance with the directions contained in the SEBI Interim Order, particularly since the Interim Order had categorically observed that BRH did not have the title over the securities pledged by it, which is a prerequisite for creation of the pledge. Therefore, the Noticee failed to record the freeze on the demat accounts of BRH, resulting in violation of provisions of Clause 13.4.2 of CDSL Bye Laws and the directions contained in the SEBI Interim Order. 7.3.4. Further, it was observed that the Noticee allowed invocation of pledge from such accounts on October 14, 2019 and December 05, 2019, resulting in violation of the directions contained in the SEBI interim order. 8. The submissions made by the Noticee ....
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....suant to a request made for the same, reasons therefor must be recorded. Bye-Law No. 14.4 of CDSL's Bye-Laws further clarifies that the only circumstance in which CDSL could refuse permission to a pledger to pledge any securities is if the operations in respect of such securities are restrained or frozen by any order or direction of a Court, Tribunal, SEBI, Central Government, RBI or CDSL itself. 8.1.4. It is not possible for the Noticee to have visibility over operations of a stock broker and exercise due diligence to the extent of (i) ascertaining the debit balances of clients in such Stock Broker-Client Account of BRH; and (ii) obtaining authorization from the clients before creation of a pledge. 8.1.5. The applicable provisions require the Stock Exchanges to ensure enhanced and better supervision of Stock Brokers while the Depositories are merely intended to take certain steps to aid such enhanced supervision by the Stock Exchanges. As a Depository, CDSL is neither able nor required to monitor the activities of Stock Brokers and such responsibility is solely that of the Stock Exchanges. The limited role of CDSL, which doesn't extend to ascertaining the....
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....re, at the time of creation of pledge on the securities held by BRH, CDSL complied with all the applicable legal provisions and directions of SEBI. Accordingly, CDSL also acted in compliance with its obligations under the Code of Conduct to act in a manner safeguarding the interests of investors and integrity of the depository system and the securities market. 8.2. Failure to assign appropriate nomenclature to the demat account of BRH 8.2.1. While the SEBI Circular dated September 26, 2016 required the assignment of nomenclature to be carried out within 3 months of the issuance of the said Circular, SEBI issued another Circular ref no SEBI/HO/MIRSD/MIRSD2/ CIR/P/2016/138 dated December 20, 2016 extending the timeline for compliance with Clause 2.3.1 of the Circular dated September 26, 2016 till July 01, 2017. Therefore, the allegation made by SEBI that the period of CDSL's alleged non-compliance with the Circular dated September 26, 2016 was from December 26, 2016 is erroneous. 8.2.2. On the day of issuance of the Circular dated September 26, 2016, CDSL's system had a provision for Stock Broker's demat accounts with sub-status codes such as Po....
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....er to any provision of law which mandates freezing of demat accounts pertaining to pre-existing pledges. 8.3.2. Since at least March 2014, SEBI has raised queries whether CDSL permitted the invocation of pledges on shares which existed prior to any freezing order being passed and CDSL had repeatedly clarified that CDSL's system does permit such pledges to be invoked. In fact, CDSL had explained to SEBI that in CDSL's system, upon the creation of a pledge on the securities, the control of such securities vests with the pledgee and the pledgee is permitted to invoke such pledge through system validations without any manual intervention by CDSL. Such system invocation is not impacted by a subsequent freezing of the pledgor's demat accounts. However, despite the clarifications provided by CDSL, SEBI did not raise any objection to such practice followed by CDSL and/or direct CDSL to modify such system to prevent invocation of such pledges post a freezing order. 8.3.3. CDSL addressed an email dated March 21, 2014 to SEBI informing that if securities had already been pledged prior to the demat account being frozen, the pledge can still be invoked by the pledg....
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....o its Bye-Laws only in December 2021, even at such time, SEBI did not direct CDSL to stop/ change the practice followed by it and merely stated that the procedure for invocation of pledged or hypothecated securities depends on the terms of the contract between the lender and borrower and the directions of the restraining order. Thus, it could not be gainsaid that the rejection of the amendment to the CDSL Bye-Laws in any manner implied that CDSL ought to discontinue the practice being followed by it. 8.3.8. In fact, in response to SEBI's aforesaid rejection, CDSL had addressed a letter to SEBI on January 22, 2022, interalia, clarifying that the arrangement or agreement entered into between the parties (pledgee-pledger) is outside the purview of CDSL as a Depository and invocation of pledge is permitted by CDSL directly through its system without any manual intervention. It was, therefore, stated that it is more prudent to put a system in place that will be followed in every case since determining the procedure or action to be taken on a case-to-case basis will result in a delay in taking such action and will also result in the pledgee being aggrieved. SEBI was, accordi....
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.... clients who had debit balances of Rs. 5.22 crores. For the clients who had debit balance more than their security holding, securities amounting to Rs 1.28 Crores were invoked for a total debit balance of Rs. 3.43 crores. 12. I note that as per the provisions of Circular dated September 26, 2016, BRH could have pledged securities of only the clients who had a debit balance in their ledger. Further, funds raised against such pledged securities could not have exceeded the debit balance in ledgers of the said debit balance clients. However, the securities which had been pledged by BRH for raising funds amounting to Rs 158.89, were of clients who either had credit or nil balance, or who had debit balances lesser than the funds raised by pledging their securities. I note that CDSL, in its capacity as the Depository, allowed pledging of aforesaid securities by BRH, which forms the ground of the alleged instant violation. 13. I firstly note that the securities were pledged with BRH with HDFC from June 2007 to September 2019, during which no freeze was operational on the said securities by any court order/ SEBI order etc. Further, I note that as per the applicable provisions of the D....
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....rities issued by RBI or the Central or State Government or other competent authority or by CDSL itself and if the CDSL or a participant does not create such pledge or hypothecation as the case may be, it shall intimate the intending pledgor and pledgee of its decisions setting out its reasons for such refusal. 17. I note that Bye Law 14.4 stated above places restriction on the creation of pledge in case 'operations in respect of those securities are restrained or frozen by virtue of any order or direction of any court, tribunal, Central Government, SEBI, RBI or the Central or State Government in case of Securities issued by RBI or the Central or State Government or other competent authority or by CDSL itself'. I note that in the instant matter, the restrictions on trades in the demat account of BRH were imposed only vide Interim Order dated October 07, 2019, while the pledges had been created by BRH at different times starting from June 2007 to September 2019. Therefore, I note that at the time of pledge creation by BRH, no 'freezing order' was operational with respect to the demat account pertaining to the pledged securities. 18. Further, I note that the capa....
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....h effect from December 5, 2016, it had introduced/ modified the sub- status codes for demat accounts and provided for the facility of tagging the demat account of a Stock Broker through specific sub-status codes. The details of changes brought by the Noticee, as per its submissions, were as below: 22.1. CDSL introduced sub-status codes for stock-broker's Proprietary and Collateral Accounts; 22.2. Description of sub-status code 'Client Margin Account' was changed to 'Client Account'; 22.3. Sub-status code of stock-broker's 'Client Beneficiary' accounts was changed to 'Client Account'; 22.4. New account opening with sub-status code 'Client Beneficiary' was discontinued; 22.5. For the stock-broker's accounts opened till December 3, 2016, a one-time modification window was provided to stock-brokers to change sub-status code to either 'Client' or 'Proprietary' or 'Collateral' through their Depository Participants till December 25, 2016 which was further extended till June 30, 2017. 23. I further note that the Noticee had issued Communiques dated September 29, 2016 ....
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.... for the tagging of demat accounts in sub-status categories, even though it did not ensure strict compliance with letter of the provisions by changing the name of account itself. 26. Upon consideration of the facts pertaining to the method of nomenclature adopted by the Noticee in toto, I am inclined to accept the Noticee's submissions as regards allegations levelled against it, and therefore, I note that the Noticee had not violated the provisions of Clause 2.3.1 read with Clause 1.2 of Annexure of SEBI Circular dated September 26, 2016. Issue No. III: Whether Noticee failed to record the freeze on the demat accounts of BRH, resulting in violation of provisions of Clause 13.4.2 of CDSL Bye Laws and the directions contained in the SEBI Interim Order. Further, whether Noticee, by allowing invocation of pledge from such demat accounts by HDFC, violated the directions contained in the SEBI Interim Order? 27. I note that the SEBI Interim Order dated October 07, 2019 directed, interalia, the depositories that they should ensure no debits were made in the demat accounts of the Noticees including BRH, except for the specified purposes. Further, CDSL Bye Law 13.4.2 mandates th....
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.... "2 ...... It is noted that the procedure for invocation of pledged/ hypothecated securities subsequently restrained or frozen by virtue of any regulatory order depends on several factors such as the terms of the legal-commercial contract between borrower and lender, and the directions of the restraining order. The transfer of ownership in such cases are governed by the circumstances of the specific case, which is taken into account by the depository. 3. there could be legal and procedural nuances in specific cases which could be subject to legal interpretations and moreover these may or may not be adequately reflected in the proposed bye laws, thus the proposed bye laws have not been approved by the Competent Authority". Therefore, to paraphrase, the aforesaid letter stated that the invocation of shares, after passing of freezing orders, must be done on a case to case basis depending on the terms of the contract between the lender and borrower and the directions of the restraining order. However, the aforesaid letter did not contain any direction to stop the practice by the Noticee completely. 31. I further note that the Hon'ble SAT in the matter of HDFC bank....