BANGALORE STOCK EXCHANGE LTD Vs. STATE
LAWS(SB)-2003-8-4
SECURITIES APPELLATE TRIBUNAL
Decided on August 27,2003

Appellant
VERSUS
Respondents

JUDGEMENT

- (1.) 0 BACKGROUND : 1. 1 The Securities and Exchange Board of India (hereinafter referred to as "SEBI") conducted an investigation into the alleged irregularities / lapses in the listing and price-manipulation of securities of M/s. Home Trade Limited (formerly known as M/s. Euro Asian Securities Limited) [for brevity's sake referred to as 'HTL']. SEBI also carried out the annual inspection of the Bangalore Stock Exchange, (hereinafter referred to as 'BgSE') and its subsidiary Bangalore Stock Exchange Financials Ltd (BGSEFL) during March 2002. 1. 2 The investigations and inspections interalia revealed that out of total offer for sale of 59,90,250 shares of HTL, a total number of 7,27,300 shares i.e. about 12.14% of shares were allotted to the promoters of HTL viz. Shri Subodh Bhandari and Shri Sanjay Agarwal, in violation of Rule 19(2)(b) of Securities Contracts (Regulation) Rules, 1957 [hereinafter referred to SCRR]. Therefore, the "offer for sale " did not meet the requirement of minimum offer of at least 25% of the securities to the public for subscription as contemplated under Rule 19(2)(b) of SCRR. 1. 3 The investigation further revealed that inspite of the fact that HTL did not meet the requirements of Rule 19(2)(b) of SCRR as aforesaid, BgSE vide its letter dated 29th July, 2002 informed SEBI that the scrip of HTL had met the requirement of Rule 19(2)(b) of SCRR and allowed listing to the scrip. 1. 4 It was further noticed during the investigations that a set of 6 brokers had contributed to more than 80% of the volume in the scrip of HTL at BgSE. From the trade log and order log analysis, it was noted that these set of six brokers had been buying and selling the scrip of HTL among themselves and in the process created artificial volume and manipulated the price of the scrip to abnormal levels. The time of orders were coordinated by these brokers in such a way that the order resulted in trades at a subsequent higher price. 1. 5 From the above, it was observed that BgSE failed to curb market manipulations of the scrip which rose upto Rs.895/- without corporate developments and also did not impose additional margins, etc. to curb and check manipulative trading by its member brokers. 1. 6 It was observed during the inspection of BgSE that while the scrips listed on the Exchange were imposed special margins on the basis of margins imposed by BSE, the same was not the case with the regional scrips which were not listed with it. There was no proper mechanism for disposal of complaints pertaining to trading of scrips nor there was any proper method laid down for conducting surveillance in scrips, etc. The Exchange also failed to take action against brokers violating the norms of the Exchange. The documentation system for initiating surveillance actions of the scrips listed on the Exchange is not properly laid down. 1. 7 During inspection of the BgSE it was also observed that : a) It failed to amend the byelaws providing code of ethics as directed by SEBI ; b) It did not implement the settlement system introduced by it for delivery of securities to investors; c) It was utilising the Settlement Guarantee Fund for meeting the penalty and fine obligations of the members of the Exchange, which are not part of settlement obligations ; d) It has not complied with the requirement of doubling the capital adequacy norms nor does it follow the practice of informing the depositories of granting in-principle listing. e) Off the floor transactions are being reported once a month in improper format. f) Surveillance reports are not sent to SEBI in time. There is delay in dissemination of price sensitive information to the members, and also in implementation of the arbitration award. g) Monetary penalties are not imposed by BgSE on delay in submission / non-submission of audit reports by the broker members. 1. 8 During the inspection of BgSE, it was observed that the Exchange committed irregularities / lapses in listing, surveillance functions, and also did not take effective preventive steps and the general functioning and administration of the Exchange had not been carried out as per the provisions of SCRA and SCRR. 1. 9 It was also observed that various circulars / directives / instructions issued by SEBI under the provision of SEBI Act, 1992, was not complied with by the Exchange. The Exchange had also failed to exercise due diligence in respect of BgSE Financials Ltd. The activities of the Exchange were found to be carried out against the interest of investing public and in a manner which is adverse to the interest of investors.
(2.) 0 SHOW CAUSE NOTICE AND ITS REPLY 2. 1 On the basis of the aforesaid findings a detailed show cause notice dated April 09, 2003 was issued to the Council of Management of BgSE under Section 11 of Securities Contracts (Regulation) Act, 1956 (hereinafter referred to as SCRA). Vide said show cause notice, while referring to the observations made in the investigation report, the Council of Management of BgSE was called upon to show cause as to why appropriate action including supercession of the Governing Board of BgSE under Section 11 of SCRA should not be taken against it in light of the aforesaid observations made in the investigation report. 2. 2 BgSE vide its letter dated 24.4.2003 replied to the show cause notice wherein while denying the allegations of irregularities / lapses in the functioning of the Exchange as alleged in the show cause notice, submitted a detailed reply with respect to all the allegations. 2. 3 With regard to the allegation for violation of Rule 19(2)(b) of SCRR, it was submitted that BgSE relied upon the basis of allotment duly approved by Pune Stock Exchange (PSE), the Regional Stock Exchange and as per the offer document, PSE was empowered to approve the basis of allotment. It was further submitted that the responsibility for finalising the basis of allotment rests with the Regional Stock Exchange i.e. PSE along with the post issue Lead Manager and the Registrar to the issue. 2. 4 It was further submitted that the allotment of shares was done under the scrutiny of PSE, along with Lead Manager and Registrar to the issue. 2. 5 BgSE further submitted that the primary responsibility for ensuring compliance with relevant laws, rules, regulations and guidelines with respect to the subscription and allotment lies with the Lead Manager and the Registrar to the Issue in terms of the relevant Regulations. It was further submitted on behalf of BgSE that as a matter of fact, the Lead Manager to the issue M/s. Shriyam Broking Intermediary Ltd. and the Chartered Accountants of the company M/s. Parimal R Shah & Company vide their letters dated 30.10.1999 and 12.11.1999 respectively had certified compliance by the company with the appropriate requirements and provisions of the offer documents and therefore, there was no violation of Rule 19(2)(b) by BgSE as alleged. 2. 6 It was further submitted that in view of the records furnished by the company, and certified copies of the quarterly results filed before BgSE by it, confirming the maintenance on a continuous basis, a minimum level of non-promoter holding higher than 30%, it is incorrect to state that the Exchange did not ensure the compliance of SEBI Circular No. SMDRP/Policy/Cir-28/01 dated May 02, 2001. 2. 7 Regarding the allegations of price rise / manipulation, it was submitted that the price of the scrip of HTL rose gradually between November 1999 and September 2000. Significant upward movement was only between November 1999 and March 2000 during which time the price movement in majority of the scrips were similar to that of HTL. 2. 8 BgSE further denied that it did not take any surveillance action by way of additional margin etc. or steps to ascertain whether the price rise was due to the price manipulation. BgSE submitted that it had been regularly and vigilantly monitoring the trading and had been taking timely steps and actions to maintain integrity of the market and also for managing the risks effectively. Further it was submitted on behalf of BgSE that as a normal practice, the activities in the market are regularly compared with the activities at the major markets like NSE, BSE and any deviations are thoroughly investigated. In respect of the regional scrips where trading is exclusively at the Exchange, special emphasis was placed on monitoring the price movement for abnormality and on noticing any significant variation ad hoc margins were levied by the Exchange during the relevant period. 2. 9 It was further submitted that BgSE has a separate Surveillance Dept. headed by General Manager who directly reports to the Executive Director. Online non-real time alerts are very much in place at BgSE. While admitting that on very liquid scrips in order to ensure uniformity BgSE had levied ad hoc margins based on the decisions taken by BSE and NSE, BgSE denied that it did not have any criteria for levying adhoc margins on regional scrips. 2. 10 Apart from the aforesaid, BgSE has full fledged investor services cell which is being monitored by an Investor Services Cell Committee. In addition to this, the Board of the Exchange reviews the status of the complaints on a regular and ongoing basis. The Exchange being the regional stock exchange does have system to monitor the price movement to the extent of volumes recorded in the Exchange. It was further submitted that in the scrip of HTL, the exchange had levied adhoc margins of 75% from 18.01.2000 to 28.02.2000. Further, in order to curb undue volatility attributed to budget, as an extra precautionary measure 100% adhoc margin was levied on HTL scrip. Levying adhoc margins continued till September 2000. Subsequently, the adhoc margins were withdrawn as the volumes had dropped significantly. On detection of abnormality in the price / volume of trade, the exchange started its investigation in to the trading of the scrip in September 2001. The investigation Report of the exchange was forwarded to SEBI vide their letter dated 23.05.02. 2. 11 BgSE has sufficient documentation with its Surveillance and Listing Dept. for cross verification of market rumours with the Compliance Officers of the respective companies. Apart from this, the Exchange has taken proactive measures by imposing adhoc margins, calling for client information and suspension of trading. As regards, Settlement Guarantee Fund (SGF), it was submitted on behalf of the Exchange that Bye-law 395(vi) read with 397(ii) empowers the Exchange to utilise the funds of SGF towards dues to the Exchange on account of fines and penalties. 2. 12 Regarding allegation of failure to amend the bye-laws providing code of ethics, it was submitted that the amendments were duly carried out. However, the publication thereof in the Official Gazette of State of Karnataka is pending due to some technical reasons. It was further submitted that pending Gazette Notification, Exchange has already put in effect, the requirements of SEBI by constituting an Ethics Committee comprising of two public representative directors, one member director and the Executive Director. Regarding system of direct delivery of securities to the investors it is informed that the said system which is optional, is already in place in the Exchange. However, due to some practical problems, it is not being used by the members. 2. 13 Regarding utilisation of Settlement Guarantee Fund for meeting the penalty and fine obligations of the member, it was submitted that this is being done in pursuance to Bye Law 395(vi) read with 397(ii) of the Exchange. Further, with respect to doubling the capital adequacy norm, it was submitted that in view of the fact that no business is taking place in the Exchange, even the existing base minimum capital (bmc) is lying ideal and doubling the capital at this juncture would be too difficult a task. 2. 14 Regarding off the floor transaction, it was submitted that one known case of off-floor transaction was referred to the Strategic Action Committee and the proceeding thereof is in progress. It was further submitted that in view of the nil turnover in the Exchange since January 2002, collection of details of off the floor transactions from the members on a daily basis and considering the same for the purpose of monitoring turnover / exposure limits and imposition of margins has become redundant. Regarding submission of surveillance report to SEBI, it was submitted that as desired by SEBI the said report is being sent to SEBI once in a month. 2. 15 Regarding dissemination of price sensitive information to its members, it was submitted that the Exchange disseminates such information on an immediate basis. Further, it was pointed out that out of about 3600 instances of dissemination of price sensitive information, the delay was only in about 4 - 5 instances. It was further submitted that the system has been reviewed and fool proof procedures have been laid down to avoid the reoccurrence of such instance. 2. 16 Regarding non imposition of monetary penalty, it was submitted that the Exchange has suspended all the members who have not paid subscription to the Exchange. Further, with regard to delay in submission / non-submission of Audit Reports by the members, it was submitted that 90 members who have defaulted in this requirement have been suspended w.e.f 15th January, 2003. It was submitted by the Exchange that in its view refraining the defaulting member from trading is more effective than imposing monetary penalty. 2. 17 The Exchange submitted that it has not failed in due discharge of its obligations as a stock exchange, either in terms of listing or under the applicable laws, rules, regulations and / or guidelines issued by SEBI from time to time. 2. 18 The Exchange submitted that it has conducted the business of stock exchange in a professional manner meeting all the required criteria. The Exchange has acted as the watchdog in appropriate circumstances and carried out its surveillance functions to its utmost capacity. 2. 19 Regarding other adverse observations made in the show cause notice, the Exchange submitted its reply and explanation and submitted that there has been no erroneous action on the part of the Exchange either in law or on facts in permitting listing of HTL scrip. Further there was no irregularity or lapse on the part of the Exchange either in listing or with respect to its surveillance functions or in the general functioning and administration, as alleged by SEBI. The Exchange has always exercised due diligence with respect to the functioning of its subsidiary, BgSE Financials Ltd. The entire functioning of the Exchange has always been geared up towards protecting the interests of the investors. 2. 20 The Exchange further submitted that it has undertaken pioneering investor friendly measures such as establishing a full - fledged library and information centre catering to all capital market needs of investors, various educational initiatives such as investor education programmes on the last Sunday of every month for past eight years, conducting seminars in local language for the benefit of the investors throughout the State, publication of books in local language to reach out to sub-urban investor population and setting up of investor service centres in several district head quarters in the State of Karnataka. By these measures, the Exchange has virtually taken its services to the door-step of the investing public. 2. 21 The exchange also submitted that in the entire 40 years of its functioning, this is the first and only time that the Exchange has received a show cause notice of this nature. There has never been any reason for any one to allege any wrongdoing on the part of the Exchange or its governing body. The Board of Directors of the Exchange comprises of luminaries in varied fields, and they have always acted in a bonafide, efficient and effective manner. The Board meets at regular intervals to discuss various aspects of the operations of the Exchange. Earing AND SUBMISSIOINS 3. 1 The hearing scheduled to be held on June 12, 2003 was postponed on the request of the Exchange and the subsequent hearing was granted to the Exchange on 23.7.03 before me, which was attended by Ms. Kamala K, Executive Director of the Exchange who was authorised by the Board of the BgSE as per its letter dated June 09, 2003. While reiterating the reply dated 24.04.03 she submitted as under : (a) With regard to the alleged violation of Rule 19(2)(b) of SCRR, it was submitted by the Exchange that BgSE is a non regional stock exchange for the purpose of listing the securities of HTL. It was also pointed out that the offer document of HTL clearly specified that the basis of allotment would be finalised in consultation with the Regional Stock Exchange i.e. the Pune Stock Exchange. Therefore, it was submitted that on the basis of allotment document approved by PSE, BgSE had approved the listing of securities of HTL and therefore, BgSE did not contravene the provisions of Rule 19(2)(b) of SCRR. She also submitted that there was no reason to suspect that the allotment was made to the promoters from public category as it was not possible to notice that persons to whom allotment was made in public category were persons belonging to the promoters category. (b) Further, it was submitted that BgSE followed the similar practice in listing of HTL as is being followed by other stock exchanges. As per the said practice, once the basis of allotment is finalised by the Regional Stock Exchange which is empowered to finalise the basis of allotment, other exchanges place their reliance on the said basis of allotment and as such other stock exchanges do not again go through the entire allotment process by verifying all the details. It was submitted that BgSE also followed the same practice and allowed listing of HTL in its Exchange pursuant to the listing given by PSE. 3. 2 Since a lot of reliance was placed upon the fact that once the Regional Stock Exchange in consultation with the Lead Manager, Registrar and the Company, approves the basis of allotment, other stock exchanges as a practice do not go through the entire allotment process like, weeding out technically defective applications, despatch of refund orders, etc. and allow listing of the securities of the applicant company with it on the basis of allotment duly approved by Regional Stock Exchange, the Exchange was directed to obtain the response from other exchanges on the issue in support of their claim. 3. 3 As requested by the Executive Director of the Exchange, the Exchange was given two weeks time to file its written submissions. The exchange vide its letter dated August 4, 2003 submitted its written submissions wherein while reiterating the submissions made during the personal hearing, it filed letters received from Cochin Stock Exchange, Madras Stock Exchange, Jaipur Stock Exchange, Ludhiana Stock Exchange, Delhi Stock Exchange, Hyderabad Stock Exchange and Inter Connected Stock Exchange of India. These letters were received in response to the letters written by BgSE to the aforesaid stock exchanges. Vide the said letters, these stock exchanges by and large confirmed that in case of listing of non regional companies, they do not go through the entire process of basis of allotment, since the Prospectus / letter of offer specifically mentions that the basis of allotment would be finalised in consultation with the Regional Stock Exchange. 3. 4 After the receipt of the aforesaid written submissions, SEBI received another letter dated 6.8.2003 enclosing therewith the fax received from NSE informing that as per Clause 7.6.1 of SEBI (DIP) Guidelines, 2000, it is the duty of the Regional Stock Exchange along with the Lead Manager and the Registrar to finalise the basis of allotment in a fair and proper manner in accordance with the Guidelines. 3. 5 Regarding the allegation of improper surveillance action by BgSE and non imposition of margins, it was submitted that in the case of HTL, BgSE had periodically reviewed the activity level and imposed adhoc margins to curb the possible manipulation. When pointed out during the submission that the said allegation was based on the information furnished by the stock exchange itself during the inspection, the Executive Director of the Exchange submitted that there could be an error in furnishing the information and requested time to verify the actual status. She further stated that the Surveillance Dept. of the Exchange did not find any circular trading in the scrip of HTL 3. 6 Regarding surveillance action taken by the Exchange in the scrip of HTL, it was informed that the Exchange had periodically reviewed the activity level of the scrip, and as a result ad hoc margins were levied which varied from 30% to 100% at different points of time. Further, while admitting the error in the information furnished by BgSE vide their letter dated 4.8.2003 in this regard, it was submitted that there was an inadvertent error wherein it was mentioned that "NIL" additional margins were levied on HTL and therefore, the same may be condoned. 3. 7 It was further submitted that apart from levying additional margins, BgSE had conducted preliminary investigations in September 2001 to ascertain whether any circular trading was done in the scrip of HTL. The Exchange also submitted that most of the trades were executed on behalf of the clients who were not common, there was no reason to suspect circular trading in the scrip. In light of these submissions, it was submitted that the Exchange has taken reasonable care in carrying out the surveillance functions and therefore the charges in this regard may be dropped. 3. 8 It was further submitted that the Surveillance as well as Listing are administrative functions and the Board of the Exchange has not failed in exercise of its duties as the Board is primarily responsible for policy formation and plays only supervisory role in monitoring the day to day functioning of the Board.
(3.) 0 CONSIDERATION OF SUBMISSIONS AND FINDINGS : 4. 1 I have carefully considered the findings of the investigation and inspection report, the show cause notice issued, and oral and written submissions made by Executive Director of BgSE. 4. 2 With regard to the grant of listing on the basis of finalisation of basis of allotment by the Regional Stock Exchange without verifying as to whether it is done in a fair and proper manner in accordance with the Guidelines, in view of the practice followed by other stock exchanges, I find the submissions of BgSE are convincing. However, being a self regulatory organisation, it was expected to be more vigilant and careful in granting listing to the scrip of HTL which was eventually in violation of Rule 19(2)(b) of SCRR. 4. 3 I find that during the inspection carried out by SEBI, the officials of the Exchange did not furnish the correct information with respect to the ad hoc margins imposed by the Exchange in the scrip of HTL. The Exchange during the oral submissions admitted the error. In the written submissions also while admitting the error, the exchange regretted the error and requested for the condonation of the same as it had, in fact, levied adhoc margins varying from 30% to 100% at different points of time. 4. 4 Regarding other allegations as set out in the show cause notice and the reply submitted, I find that the allegations are technical in nature and in some cases the exchange has failed to implement the directive issued by SEBI in timely manner in its true letter and spirit. For this reason I feel that the exchange needs to be proactive in implementing the decisions of SEBI and it needs to be cautious and careful in future in this regard. 4. 5 Further, I do not entirely agree with the submissions of the Exchange that the Governing Board plays only supervisory role and is not responsible for the day to day operations of the Exchange. The Governing Board has to take full responsibility for all the acts of omission and commissions of the Exchange which functions under the supervision of the Board. 4. 6 Considering the reply submitted by the Exchange, I find that the allegations are not serious enough to warrant supercession of the Governing Board of the Exchange under section 11 of SCR Act. However, in view of the forgoing, I am constrained to observe that the exchange has to improve its efficiency and timely compliance with the directions issued by SEBI in the interest of investors from time to time. Further, the Exchange needs to implement all the decisions/directions issued by SEBI in true letter and spirit and with utmost expedition. Only by doing so would the Exchange be able to effectively exercise its role as a self-regulatory organisation and achieve the objective of its establishment under SCR Act.;


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