TaxTMI 
TaxTMI 
2021 (1) TMI 1359
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....et in any manner whatsoever, till further directions; ii. The aforesaid Noticees shall cease and desist from undertaking any activity in the securities market, directly or indirectly, in any manner whatsoever till further directions; iii. The aforesaid Noticees are directed not to dispose of or alienate any assets, whether movable or immovable, or to create or invoke or release any interest or charge in any of such assets except with the prior permission of National Stock Exchange of India Limited ("NSE") and BSE; iv. The aforesaid Noticees are directed to provide a full inventory of all their assets, whether movable or immovable, or any interest or investment or charge in any of such assets, including details of all their bank accounts, demat accounts and mutual fund investments immediately to NSE and BSE but not later than 5 working days from the date of receipt of this Order; v. Till further directions in this regard, the assets of the Noticees shall be utilized only for the purpose of payment of money and/or delivery of securities, as the case may be, to the clients/investors under the supervision of the concerned Exchanges/depositories; ....
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....0.63 - TOTAL 191.16 26.61 c. The facilities mentioned hereinabove for the Borrowers are cross collateralized by way of a right of lien and set off forming part of the loan documents executed by the Borrowers at the time of availing the above facilities. Bank Guarantees ("BGs") forming part of the credit facilities mentioned above, have been issued by the Bank in favour of Clearing Corporations/Stock Exchanges. Notwithstanding any defaults being made by the Borrowers under their respective loan documents and/or recall of the credit facilities by the Bank and/or to the relevant clearing corporation/Exchange, the terms of the BGs issued to beneficiaries require the Bank to unconditionally honour the BGs and make payment under the BGs to the beneficiaries. d. We wish to draw your attention to the fact that the monies are due and payable to the Bank by the Borrowers pursuant to loan documents agreements which were executed much before issuance of the (Interim Order) and securities in relation to the respective loan documents were also created by each of the Borrowers much prior to the (Interim Order). Bank is a custodian of public monies and is expected to ....
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....the Contract Act, 1872, which right is expressly reserved in the relevant loan documents executed with BRH and BRH Commodities, respectively, as stated in our letter dated November 7, 2019. b. The Bank is thus fully entitled in law to appropriate proceeds from sale of the securities for any outstanding of the concerned Borrowers, whether the securities were provided for that specific facility or not." 2. SHOW CAUSE NOTICE DATED MARCH 19, 2020: 2.1 The allegations levelled against HDFC in the SCN dated March 19, 2020 ("SCN"), are summarised hereunder - i. NON-COMPLIANCE WITH THE DIRECTIONS CONTAINED IN THE INTERIM ORDER THROUGH INVOCATION OF PLEDGE OF SECURITIES - NSE had informed SEBI that BRH had availed LAS facility from the Noticee by way of pledging securities from two demat accounts maintained with Central Depository Services (India) Limited ("CDSL") and as on September 30, 2019, the total securities pledged from the said accounts were as under: TABLE II - DETAILS OF SECURITIES PLEDGED BY BRH IN FAVOUR OF HDFC BENEFICIAL OWNER ID PLEDGED QUANTITY PLEDGED AMOUNT (Rs.IN CRORE) 1204630000021137* 1,73,53,289 144.38 1204630000155615 ....
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....d the pledge of securities without giving the requisite notice of 5 days to the clients of BRH thus depriving them of a fair opportunity to claim back their securities. HDFC had allegedly violated Clause 4.8 of the aforementioned Circular. v. FAILURE BY THE NOTICEE TO EXERCISE DUE DILIGENCE WHILE EXTENDING CREDIT FACILITIES TO BRH: The credit availed by BRH through the ODILAS facility was for a principal amount of Rs. 87.75 Crore. However, HDFC had invoked a pledge of client securities available in the aforementioned two demat accounts of BRH, worth Rs. 158.68 Crore. Further, as per the unaudited financial accounts as on March 31, 2019 (as submitted by BRH), the networth stood at Rs. 12.83 Crore against the pledged securities having an aggregate value of Rs.169.24 Crore as on September 30, 2019. It is alleged that HDFC had failed to exercise due diligence while extending credit facilities to BRH without verifying the networth vis-a-vis the amount of credit facilities extended. 2.2 As per the SCN, HDFC was directed to show cause as to why suitable directions under Sections 11(1), 11B(1), 11B(2) read with 15HB of the SEBI Act, 1992 ("SEBI Act") including but not limited t....
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.... regular banking business. b. Through Advocates' email dated September 1, 2020, we had requested SEBI to provide all the documents referred to and relied upon while issuing the SCN and also copies of SEBI's file pertaining to BRH, and/ or all inspection/ inquiry/ investigation reports in relation thereto. SEBI, however, has not provided any of the inspection/ inquiry/ investigation reports in its file and has only provided two transaction statements and an excel sheet which shows details of the pledged securities invoked by HDFC purportedly from CDSL's records. c. It is also pertinent to note that on 11th June 2020, BRH filed a Suit against HDFC Bank before the Calcutta High Court, being CS No.54 of 2020, praying for a decree of mandatory injunction for return of the securities on which the pledge was invoked by HDFC Bank. Annexed hereto and marked as Annexure 'V' is a copy of the Case Status of as available on the Calcutta High Court website. The matter pertaining to invocation of the pledge of securities is thus clearly sub judice before a Civil Court of competent jurisdiction. The Hon'ble Calcutta High Court is already seized of BRH'....
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....for all the Loan Agreements pertaining to the LAS Facility granted to BRH, viz. that the securities being pledged were held by BRH in its name as absolute owner thereof and not in any other fiduciary capacity. In fact, by and under clause 13 (ii) the Loan Agreement dated June 21, 2014, BRH agreed and confirmed to maintain segregation of securities held by him/ her on behalf of clients from the securities held by BRH in its name. Further, by and under clause 13(iii) of the said Loan Agreement, BRH expressly agreed and confirmed that client securities will not be offered as security for the borrowing in any manner. Additionally, the Loan Agreements, as also other loan documents, including HDFC's Sanction Letter dated December 10, 2018, at clause 15 to Annexure 1 thereof, expressly reserved the Bank's right to a general lien and set off as available to it under law. Pursuant to these covenants, all of the securities pledged by BRH to HDFC in respect of the LAS Facility stood in the name of BRH as beneficial owner ("BO") in the records of CDSL as available/ accessible by HDFC. As the shares/ securities offered as collateral stood in the name of BRH as BO thereof as per the reco....
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.... and the same was permitted by CDSL. In fact, the CDSL did not even object to the further sale of the pledged securities by HDFC. The aforesaid further bolsters the validity of the invocation of pledge by HDFC and shows that such invocation of pledge and sale was not in contravention of SEBI Circulars or its Order dated October 7, 2019. The SCN alleges that pledge created on securities held in BO account number ending with "21137" is invalid and subsequent invocation illegal since HDFC failed to conduct adequate due diligence to verify that the securities pledged in its favour actually belonged to BRH's clients having debit balance at the time of creation of such a pledge. First and foremost, HDFC had no reason to doubt that the pledged securities belonged to BRH and therefore the question of verifying whether it belonged to clients having a debit balance does not arise. Secondly, as stated above, all of the shares pledged to HDFC stood in the name of BRH who was recorded as the beneficial owner of the shares in the records of CDSL, i.e. the concerned depository and HDFC was fully entitled to accept a pledge of such shares from BRH under Sections 10 and 12 of the Depositories A....
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....in a fungible form, as is statutorily recognised in Section 9 of the Depositories Act. It goes on to hold that the Depositories Act has been enacted "for the purpose of recording accurately the transfers and pledges of shares including those in a dematerialised form". Further, it affirms the view that the Depositories Act is a self-contained code that governs the creation of pledge of dematerialised shares and that "ownership and transfer of shares governed by the Act must be in accordance with the provisions of the Depositories Act". Furthermore, the procedure for creation of pledge was also in accordance with the bye-laws and business rules of CDSL, the concerned depository, particularly bye-law 14. Pertinently, under bye- law 14.2, for the purpose of creation of any pledge of securities, CDSL or a participant shall on the application of the beneficial owner, issue a certificate of holdings to the beneficial owner, certifying that the beneficial owner is entitled in its name to securities sought to be pledged. Further, under Bye-law 14.4, CDSL has the power to refuse permission to create a pledge if the same is restrained by virtue of any order or direction of the SEBI. However, ....
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....y, the status of the mercantile agent cannot be premised on whether or not the pledge was created validly and in fact the whole Section provides for a situation where the mercantile agent does not have the authority to create the pledge. SEBI, in the aforesaid order, further holds that another reason that Section 178 was not applicable in Karvy's case is because there was an absence of good faith since the lenders allegedly had/ ought to have had notice that Karvy did not have the authority to pledge. While denying the aforesaid conclusion, it is submitted that in any event the said observation does not apply in the instant case as HDFC had acted on good faith on BRH's representations and the Depository's records as accessible to HDFC and without notice that BRH allegedly did not have authority to pledge the concerned securities as is evident from all that is set out hereinabove. g. HDFC is entitled to appropriate the securities provided by BRH towards the LAS Facility for dues under other facilities provided to BRH under the law of mercantile system or the Law Merchant as has been recognised in various judicial pronouncements. It is settled law that under merc....
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....g that HDFC's alleged illegal and invalid invocation and sale of the pledged securities has prevented settlement or restitution of BRH's clients' claims. However, SEBI itself at paragraph 12 of its Confirmatory Order dated 2nd January 2020 records that a determination of clients' dues has to be completed by conducting a forensic audit and after such determination the stock exchanges and clearing corporations shall take appropriate steps for meeting and realizing investor/ clients' claims. Furthermore, at paragraph 13 of the said Order, SEBI directs that the clients' claims shall be disposed of as per the bye laws of the stock exchanges/ depositories. Therefore, till investors file claims with the exchange and the arbitration is completed as per NSE bye-laws and execution as per byelaws commences, no question of bank having to pay up arises, if at all. More so, when there is no forensic audit itself which determines what the client claims are, if at all. j. Furthermore, such a course of action would effectively end up absolving BRH of its liability, who may be the main culprit, if it is found that it pledged client securities. Since, if BRH's cli....
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....egregate securities of their clients. You are also aware that the shares over which you have created pledged against our said credit facility are freely tradable shares and securities of our clients for which full amounts have been paid by the respective clients. You were always aware of such fact and while carrying due diligence this was brought to your notice; however, you still impressed upon us to create the pledge. Though such pledge ought not to have been created in the first place, however, even if created, such pledge is void under SEBI Guidelines. You have also derived benefit from the sale of such shares in the past few months to reduce your credit exposure towards us, which also you should not have done. You cannot dispute that our intention was never to avoid repayment of credit facility and we are committed towards the same. It is in this regard, we had also engaged the services of a world renowned Wealth Management Company namely Alpen Capital (ME) Limited to arrange for alternative source of funding, which would have ensured clearing of our credit facility with you in due course. ... As was informed to you, Alpen is constantly working on unlocking values of real esta....
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...., the Noticee vide an e-mail dated October 1, 2019, had requested BRH to fully collateralise its current exposure with the bank under the (i) BG/STL facility - Rs.32.50 Crore and (ii) CC/OD (against book debts) - Rs.50 Crore and had also informed BRH to repay/pre-pay/reduce its outstanding under LAP/OD against Property (current o/s Rs.14.90 Crore), LAS (current o/s Rs.87.25 Crore) and CC/OD (against book debts) - Rs.50 Crore consistent with the present level of business activity. E. Subsequently, vide a Notice dated October 4, 2019, HDFC had recalled the credit facilities granted to BRH aggregating to Rs.191.16 Crore (see Table 1) inter alia on the grounds that: (i) NSE had suspended BRH's operations w.e.f. October 1, 2019, and as a consequence of the suspension/cessation of its business, BRH's ability to service the facilities including under the Loan Agreements dated October 7, 2005 ("1st Loan Agreement"), August 10, 2007 ("2nd Loan Agreement") and June 21, 2014 ("3rd Loan Agreement"), stood jeopardised. (ii) Since the pledged shares were/are lying in the demat accounts with Customer IDs 1204630000021137 and 1204630000155615 under the DP name 'BRH....
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....ed the pledge of securities to the extent of Rs.158.68 Crore and thereafter, sold most of the said securities and appropriated the sale proceeds towards the outstanding under the various credit facilities advanced by HDFC to BRH. 3.4 The instant proceedings have essentially arisen on account of non-conformity by the Noticee with the directions contained in the Interim Order issued by SEBI against BRH. The rest of the allegations are off-shoots of the main issue of non-compliance by the Noticee with the Interim Order. The relevant directions as contained at paragraph 9 of the Interim Order are reproduced hereunder: ii. "The aforesaid Noticees shall cease and desist from undertaking any activity in the securities market, directly or indirectly, in any manner whatsoever till further directions; iii. The aforesaid Noticees are directed not to dispose of or alienate any assets, whether movable or immovable, or to create or invoke or release any interest or charge in any of such assets except with the prior permission of NSE and BSE; iv. The aforesaid Noticees are directed to provide a full inventory of all their assets, whether movable or immovable, or any ....
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....ities belonging to the clients and in case of shortfall, to utilise other assets of the Stock Broker to meet claims of its clients. Thus, the impact of the Interim Order was to impose an immediate freeze inter alia on the assets of the Stock Broker, in whatever form it was and wherever it was situated irrespective of who was in possession of such assets. Further, vide the directions at paragraphs 9(vi) and 9(vii) of the Interim Order, the depositories and banks were directed not to make debits from the demat accounts/bank accounts of BRH. 3.7 In this connection, it is relevant to mention that the Interim Order as issued by SEBI invoking powers under Sections 11(1), 11(4), 11B and 11D of the SEBI Act partakes the character of 'an order in rem' and binds all constituents dealing with the broker or his assets/liabilities till the completion of the investigation/forensic audit. Such interim freezing orders cannot be stated to be binding only on the person/entity which has contravened the provisions of securities laws but also binds other constituents in the market such as banks, companies, intermediaries, etc. who have dealt with the subject assets of the Stock Broker or ent....
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....tances. The order may be hypothetically a nullity, but the Court may refuse to quash it because of the plaintiff's lack of standing, because he does not deserve a discretionary remedy, because he has waived his rights, or for some other legal reason. In any such case the 'void' order remains effective and is, in reality, valid. It follows that an order may be void for one purpose and valid for another, and that it may be void against one person but valid against another". In Smith vs. East Elloe Rural District Council, 1956 AC 736 at 769: (1956) 1 All ER 855, Lord Redeliffe had an occasion to consider a similar argument (that the order was null and void). Negativing the contention, the Law Lord made the following off-quoted observations: "(T)his argument is in reality a play on the meaning of the word 'nullity'. An order even if not made in good faith, is still an act capable of legal consequences. It bears no brand of invalidity upon its forehead. Unless the necessary proceedings are taken at law to establish the cause of invalidity and to get it quashed or otherwise upset, it will remain as effective for its ostensible purpose as the most impeccable o....
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....notification is void/voidable, the party aggrieved by the same cannot decide that the said order/notification is not binding upon it. It has to approach the court for seeking such declaration. The order may be hypothetically a nullity and even if its invalidity is challenged before the court in a given circumstance, the court may refuse to quash the same on various grounds including the standing of the petitioner or on the ground of delay or on the doctrine of waiver or any other legal reason. The order may be void for one purpose or for one person, it may not be so for another purpose or another person." 3.10 Thus, the act of invocation of the pledge by the Noticee avoiding the Interim Order without paying deference to the restrictions imposed on the assets of the Stock Broker, is against the settled position in law, as brought out above. If the Noticee's right to recover its dues from BRH was affected on account of the Interim Order, it could have approached a Court/Forum of competent jurisdiction before such conscious avoidance of the said Order. The right to challenge such orders by an "affected party" in an appropriate forum is always available under the statute. In any....
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....rder. The question of whether the Noticee could have invoked the pledge of securities has to be considered in light of the whole set of facts brought out in the Interim Order. A perusal of the 'legal opinion' shows that it has only taken into consideration the issue of whether the directions at paragraph 9(vii) of the Interim Order are binding on the Noticee or not. In other words, the 'legal opinion' has segregated and severed the directions at paragraph 9(vii) of the Interim Order from the related operative part of the Interim Order, i.e. the directions at paragraphs 9(ii)-(v) therein. It is reiterated that the directions at paragraphs 9(ii)-(v) of the Interim Order explicitly brought out the underlying objective of the Interim Order. The 'legal opinion' also tries to justify the invocation of securities pledged by BRH by relying on certain representations and declarations furnished by the Stock Broker at the time of creation of pledge that the pledged securities were held in its name as absolute owner thereof. In this regard, even if it were to be accepted that BRH was the absolute owner of the securities pledged with the Noticee, the invocation by the No....
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....fic directions therein. Realisation of the entire loans outstanding of BRH by the Noticee through invocation of securities that were covered under the Interim Order, tantamounts to an ex-facie defiance of the directions passed by an authority established under law. The absence of an order specifically against the Noticee cannot constitute an excuse or a justification for the aggressive recovery measures adopted by the Noticee, after it having become aware of the Interim Order. 4. MISCELLANEOUS ISSUES: 4.1 The SCN has alleged violation of Clause 2.5 of the September 2016 Circular and Clause 2.c. of the June 2017 Circular as well as violation of the June 2019 Circular. Additionally, the SCN has also alleged that HDFC had failed to conduct adequate due diligence to verify that securities pledged by BRH actually belonged to clients (of the said Broker) having debit balance at the time of creation of pledge. 4.2 In its submissions, the Noticee has mainly questioned the maintainability of the aforementioned allegations against it as the SEBI Circulars were directed towards intermediaries registered with SEBI like recognized stock exchanges, clearing corporations, depositories, t....
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....Noticee, was not in conformity with the directions contained in the Interim Order. I find that the Noticee had unilaterally invoked securities pledged by BRH to the extent of Rs.158.68 Crore. I am therefore, of the considered view that the Noticee be directed to deposit an equivalent amount of Rs. 158.68 Crore along with interest from October 14, 2019 till date, at the rate of 7% per annum (being the Marginal Cost of Funds based Lending Rate (MCLR) notified by the RBI) in a separate interest bearing Escrow Account, till the issue of settlement of clients' securities is reconciled. 4.5 I note that the SCN in the present matter has also been issued under Section 11B (2) and Section 15HB of the SEBI Act. I note that the power given under Section 11B (2) is without prejudice to the power to issue directions under Sections 11(1) and 11B(1) of the SEBI Act. Section 15HB of SEBI Act provides as under: "Penalty for contravention where no separate penalty has been provided. 15HB. Whoever fails to comply with any provision of this Act, the rules or the regulations made or directions issued by the Board thereunder for which no separate penalty has been provided, shall....