Confirmatory Order in the matter of Market manipulation using GDR issue w.r.t KII Ltd

WTM/PS/26/ISD/JAN/2013 BEFORE THE SECURITIES AND EXCHANGE BOARD OF INDIA CORAM: PRASHANT SARAN, WHOLE TIME MEMBER IN THE MATTER OF MARKET MANIPULATION USING GDR ISSUES In respect of KII Limited ORDER Under Sections 11(1), 11(4) and 11B of the Securities and Exchange Board of India Act, 1992 1. Securities and Exchange Board of India (hereinafter referred to as ‘SEBI’) upon receipt of alerts in its IMSS System in few scrips like IKF Technologies Limited (hereinafter referred to as ‘IKF’), Avon Corporation Limited (hereinafter referred to as ‘Avon’), Cat Technologies Limited (hereinafter referred to as ‘Cat’), Asahi Infrastructure Limited (hereinafter referred to as ‘Asahi’) and K. Sera Sera Limited (hereinafter referred to as ‘K. Sera Sera’) inter-alia directed KII Limited (hereinafter referred to as ‘KII’), a sub-account of Credo Capital Plc. (hereinafter referred to as ‘Credo’), an Foreign Institutional Investor (hereinafter referred to as ‘FII’), not to deal in securities or instruments with underlying Indian securities, in any manner whatsoever, until further orders, vide an ex-parte ad interim order dated September 21, 2011 (hereinafter referred to as ‘interim order’). SEBI had prima facie found that KII was cancelling the Global Depositary Receipts (hereinafter referred to as ‘GDR’) of the companies named above and also converting these into normal shares to sell in the Indian securities market, to a few selected counterparties (hereinafter referred to as ‘group entities’). Further, KII vide the interim order was advised to file its objection, if any, within twenty one (21) days from the date of the said order and also avail an opportunity of personal hearing, if it so desires.

2. Pursuant to the passing of the interim order, the counsel for KII vide its letter dated October 12, 2011 requested for inspection of the documents relied upon by SEBI for the purposes of the interim order. Accordingly, the inspection was held on November 11, 2011. Thereafter, an opportunity of personal hearing was granted to KII on November 23, 2011. However, the counsel for KII sought to defer the personal hearing by four weeks for the review of the documents/ information provided by SEBI, during the inspection. Thus, the personal hearing was deferred to November 30, 2011. In the meantime, the counsel for KII vide its letter dated November 28, 2011 sought certain additional information. Accordingly, a further opportunity for inspection and hearing was granted to KII on November 30, 2011. During the inspection of the documents, the price volume data and the trade logs were provided to KII.

3. KII replied to the interim order, vide its letter dated January 05, 2012. Before proceeding further in the matter, SEBI had afforded an opportunity of personal hearing to KII on February 15, 2012. On the date scheduled for the hearing, Mr. Shuva Mandal, Ms. Veena Ganesh and Ms. Divya Mundra from AZB & Partners, represented KII and made the submissions. However, the hearing could not be concluded on this date and the same was adjourned to March 15, 2012. The authorized representatives of KII also submitted certain affidavits of brokers stating that KII has not made efforts to match the trades, which were taken on record. On March 15, 2012, the authorized representatives of KII appeared before me and made oral submissions. During the hearing, SEBI asked KII to submit certain details such as, the price at which the GDRs were bought, the number of days for which these were held and also the price at which these shares were sold. KII vide its letter dated May 09, 2012, filed its written submissions. The details that were sought from them during the hearing was also produced by KII, along with its reply.

4. The submissions of KII in brief are: - It is a private company incorporated in Mauritius and holds a Category 1 Global Business License granted by the Financial Services Commission of Mauritius. KII is also a sub-account under the FII registration of Credo. KII has a license to carry out proprietary trading in India for the Credo group. - Credo involved in Indian business from the year, 2002, when one Mr. Manu Bhatnagar, an FSA approved person, began working as their consultant broker.

Credo opened an account for one Vintage FZE (hereinafter referred to as ‘Vintage’), a trading company incorporated in Dubai which was arranged by Manu Bhatnagar. Arun Panchariya (hereinafter referred to as 'Arun') was the sole shareholder and managing director of Vintage and Credo conducted a full KYC check on Arun. There was no reason to suspect Arun’s credentials and in October 2006, Arun became an FSA approved person in connection with Pan Asia Advisors Limited (hereinafter referred to as ‘Pan Asia’). - Later on, Manu Bhatnagar set up his own business by the name of Icon Capital Limited (hereinafter referred to as ‘Icon’). Credo entered into a consultant broker arrangement with Icon with effect from February 1, 2007. Icon replaced Manu Bhatnagar as the account executive and relationship manager for KII. - KII’s strategy in acquiring GDRs was to avail of the discounts in the price of the GDRs as compared to the value of the underlying shares in the local market and subsequently to sell the shares to profit potentially from the differential. - In May, 2009, Icon introduced and recommended to Credo, a line of business for Vintage, which Credo approved, to buy and sell GDRs, convert them into shares and sell the shares in India.

Vintage wanted to sell GDRs and was prepared to fund the purchase of the GDRs from an Austrian bank namely European American Investment Bank AG (hereinafter referred to as ‘Euram Bank’). Credo entered into three separate loan agreements with Vintage and pursuant to each, Vintage lent to Credo Investment Holdings Limited (hereinafter referred to as ‘CIHL’) (a company in the Credo Group), USD 2 million (Two Million United States Dollars) on the condition that the loan was 'on-lent' to KII for the purpose of purchasing certain named or unnamed securities and where those securities take the form of GDRs/ ADRs, converting them and selling them in India and then using the proceeds to buy more securities (and repeating the process) until KII elects to terminate those activities and to settle any transactions resulting from those activities. - From the Credo Group's perspective, the arbitrage granted by the potential difference in exchange rates and price differential between the two exchanges (the offshore stock exchange and the Indian stock exchanges where the underlying shares were traded) coupled with the fact that the market risk was borne ultimately by Vintage, provided a strong business rationale for KII to undertake the trades.

In the present case, apart from the arbitrage strategy, KII's incentive to trade on illiquid scrips was also premised on the fact that the market risk of the trades was borne by CIHL and ultimately by Vintage. - KII has submitted that Bovill Limited, an independent compliance consultant in the United Kingdom, has conducted an independent internal inspection on Credo in respect of the interim order. Pursuant to its enquires, Bovill has, inter alia, concluded that no trading was done on the Credo trading systems on any Credo account in respect of the securities listed in the interim order, apart from the trades already listed in the interim Order; they have not identified any regulatory concerns about how Credo conducted business with Vintage during the relevant period and that Credo had no reasonable cause to believe at the beginning of the business relationship (or earlier than it did during the relationship), that it should not do business with Arun or Vintage. - Pursuant to the loan agreements, during the relevant period, GDRs issued by certain Indian companies such as K. Sera Sera, Avon, IKF, Asahi and Cals Refineries Limited (hereinafter referred to as ‘Cals’) were acquired for KII by Icon acting as the consultant broker (using Credo as the broker) and subsequently through Icon directly as the broker. - The GDRs of Asahi, Avon, K. Sera Sera and Cals were thereafter converted into shares and instructions were given by Icon to the Indian brokers to sell the shares via electronic limit orders on the Indian stock exchanges.

Icon issued instructions to the Indian brokers, whose names, KII understands were selected by Icon on the basis, inter alia, that they are reputed brokerage firms with good track record and experience of dealing with international clients. - No arrangements were ever contemplated or entered into between KII and Vintage or between KII and Arun. Arun was not involved with the Credo Group (including KII) either as a shareholder, an employee or a director and did not influence any investment decisions of any Credo Group entity (including KII). No Credo or KII staff had any direct dealings with Vintage/ Arun as regards the transactions facilitated by the loan agreements or any communication relating to trade, executing the GDR trades, arranging conversion and delivery to the Indian custodian and execution in the Indian stock market.

- Neither Credo nor KII were aware of any of the other sub-accounts, or other entities which had acquired GDRs in order to convert the same into shares and sell the same in the stock market. It had not acted in concert with other sub-accounts or the 'group entities'. - For the purpose of the trades in the subject scrips, the following six brokers were used: Edelweiss Securities Limited, K.R. Choksey Shares and Securities Private Limited, Globe Capital Market Limited, Sunidhi Securities and Finance Limited, SMC Global Securities Limited and Fortune Equity Brokers (India) Limited. Icon has also confirmed that it had full discretion in deciding which brokers were to be used for the purposes of effecting the sales. - SEBI has not obtained any statements from the Indian brokers who placed the trades, especially given that allegations have been made that the trades by KII and the 'group entities' matched and in some cases were allegedly synchronized. - The acquisition of GDRs by KII, the conversion of the GDRs into shares and sale of the same is a legitimate and permissible business activity. - That the subject scrips attracted investors is not necessarily unusual or suspicious as it is common for investments to be made in small capital companies or companies seeking private equity on the basis of their future prospects. It is in this manner that small companies/ companies that are just starting, are able to raise money. The fact that the companies had managed to raise capital by issuing the GDRs gave KII some comfort when it acquired them. - The provisions of the Securities and Exchange Board of India Act, 1992 (hereinafter referred to as ‘SEBI Act’), SEBI (Foreign Institutional Investors) Regulations, 1995 (hereinafter referred to as ‘FII Regulations’) or the Scheme for Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary Receipt Scheme), 1993 (as amended from time to time) (hereinafter referred to as ‘GDR Scheme’) do not prohibit the holder of GDRs from converting the GDRs into shares and/ or selling the underlying shares in the stock market. There is no restriction under Indian law on the timing of the conversion of GDRs into the underlying shares. KII has acted in accordance with the laws in place, in purchasing, converting and/ or selling GDRs.

- KII did not undertake the acquisition of the GDRs with the knowledge that it would be afforded an exit by the 'Group entities' or any entity. - As per the data provided by SEBI, the cancellation of GDRs by the sub-accounts shows that the percentage of total GDRs converted by KII, when compared to other sub-account is not substantial. If it was assured of an exit by the ‘Group entities’ or any other entity, it would have converted and sold a much larger percentage of GDRs than it did. - The relevant scrips are by definition illiquid in nature, the fact that KII has traded significant volumes in such scrips does not establish the market manipulation. It cannot be said that any laws were breached by KII. - KII traded in the shares of Asahi only on one day during the entire relevant period comprising 344 days. KII sold 35,00,000 shares of Asahi on January 13, 2010 at a price of 1. There is no evidence that KII's trades had any impact on the price of the scrip especially in view of the fact that there was negligible variation in price of the scrip on that date i.e., the price moved between 1 to 1.03.

The trade logs provided by SEBI indicate a substantial difference in the sell orders placed by the Indian brokers on behalf of KII and the corresponding buy orders placed by the 'group entities' (or their brokers). - KII traded in the shares of Avon only on four days during the entire relevant period comprising 344 days. With respect to the trades in Avon, KII has sold 17,00,000 shares of Avon in the relevant period. Only 38.31% i.e., 6,51,286 shares of Avon were purchased by the ‘Group entities’ and the remaining 10,48,714 shares i.e., approximately 61% of the shares sold by KII in the relevant period were purchased by third parties. The total volume of trading on the four days that KII sold 17,00,000 Avon shares, was 62,06,773. KII’s trades therefore constituted 28% of the total volume of trading and it is insufficient for a charge of market manipulation. - KII traded in the shares of K. Sera Sera on fourteen days during the entire relevant period comprising 344 days. With respect to KII’s trades in K. Sera Sera, out of 1,17,81,430 shares sold by KII, only 34,82,476 shares i.e., 29.56% were sold to the ‘Group entities’.

Therefore, 82,98,954 shares of K. Sera Sera i.e., 71% of the shares sold by KII were sold to third parties. KII’s trades had little or no nexus with the variation in the price of the scrip. - Regulation 13A(2) of the FII Regulations does not prescribe any offence, the commission of which would lead to the consequences set out therein. Regulation 13A(2) merely provides that the liability of the sub-account would be independent of that of the FII. Accordingly, in the absence of any case against KII being made out under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market), Regulations, 2003, the charge under the FII Regulations is not sustainable. - The burden of proof for a serious offence of market manipulation has not been discharged by SEBI. - SEBI is not empowered to impose penalties for the violations of any of the provisions of law in exercise of its powers under Section 11 read with Section 11B of the SEBI Act.

5. I have considered the interim order, the reply filed by KII, the submissions made on its behalf during the personal hearing, the written submissions filed by KII and the relevant material on record. KII in its submissions has argued that SEBI is not empowered to impose penalties for the violations of any of the provisions of law in exercise of its powers under Section 11 read with Section 11B of the SEBI Act. I note that the interim directions in the present matter were issued under Section 11(1), 11(4) and 11B of the SEBI Act and the same are not penal in nature. The provisions of Section 11(4) of the SEBI Act clearly empowers SEBI to pass an ad interim ex-parte order in the interest of investors or securities market, either pending investigation or enquiry or on completion of such investigation or enquiry which also includes power to restrain persons from accessing the securities market and prohibit any person associated with securities market to buy, sell or deal in securities. KII has also argued that the order to be passed by SEBI after the personal hearing should be a final order on the issues raised and the allegations made in the interim order. I note that pending the investigation, SEBI cannot issue a final order. Now, the limited issue to be considered and decided in this order is whether based on the material available on record and after considering the submissions made by KII, the directions issued by SEBI vide the interim order needs to be continued, revoked or modified in any manner, in so far as it relates to KII.

6. KII has stated that it had not acted in concert with any other sub-account or the 'group entities', and further, no wrong can be attributed to its conduct when it converted and sold the shares of the companies in the Indian stock exchanges. In this regard, I observe that the interim order has discussed in detail, the scheme involving large sized GDR issues by the companies who had un-impressive financials, common initial investors, high proportion of cancellation of GDRs repeatedly by a set of FII/ sub-account, sale of shares in Indian exchanges with mainly constant 'group entities' of clients and further off loading of shares.

7. I note that the KII has not denied its trading in the scrips, the details of which are mentioned in the interim order. However, it has submitted that the primary motivation for undertaking the GDR investments and the subsequent conversion and sale in the Indian stock market was that the market risk was borne by one CIHL and ultimately by Vintage under the loan agreements. Further, it has been submitted that KII’s strategy was to acquire the GDRs, given the potential difference in price and exchange rate as the GDRs are sold in a different currency on the offshore stock exchange. KII has also submitted that arbitrage is a legitimate mechanism and the trades conducted by it were regular. The brokers were permitted to proactively enter orders in the system, which will be displayed in the system until the full quantity is matched by one or more counter-orders which will result in trade(s) or if no trades result, the same will be cancelled by the member in question.

8. I note from the interim order that KII had traded in the scrips of Asahi, Avon and K. Sera Sera Limited. Further, from the details of the interim order, it can be seen that KII had converted considerable quantity of GDRs of the identified scrips into equity shares. With respect to the shares of Asahi, KII had sold a total of 35,00,000 shares and out of the same, 27,50,715 shares were purchased by the alleged 'group entities' namely Basmati Securities Private Limited and SV Enterprises. In the shares of Avon, KII had sold 17,00,000 shares and out of the same, 7,63,948 shares were purchased by the alleged group entity namely SV Enterprises. With respect to its trading in the shares of K. Sera Sera, the entity had sold a total of 1,17,81,430 shares and of which 34,82,476 shares were purchased by the 'group entities' namely Basmati Securities Private Limited, JMP Securities Private Limited, Oudh Finance & Investment Private Limited and SV Enterprises.

I have seen the trading details of KII, a few instances of which have also been brought out below for reference: Date Scrip Time Orde Order Discl Orde LTP Trade Trade Value Purchas Purchase % of shares r Qty. Qty. r Quantity ed by d by picked by type Price Group Other Group entities entities Clients to total order size 13-01-2010 Asahi 09:21:17.522454 Sell 5,00,000 5,00,000 1 1.01 5,00,000 5,00,000.00 5,00,000 0 100%

13-08-2009 Avon 11:07:38.710303 Sell 50,000 50,000 10.75 10.76 50,000 5,37,500.00 0 50,000 0% 13-08-2009 Avon 11:07:42.632157 Sell 50,000 50,000 10.75 10.75 50,000 5,37,500.00 0 50,000 0% 13-08-2009 Avon 11:10:27.490403 Sell 50,000 50,000 10.75 10.76 50,000 5,37,500.00 0 50,000 0% 13-08-2009 Avon 11:10:30.364046 Sell 50,000 50,000 10.75 10.75 50,000 5,37,500.00 37,349 12,651 75% 13-08-2009 Avon 11:10:33.315093 Sell 50,000 50,000 10.75 10.75 50,000 5,37,500.00 50,000 0 100% 13-08-2009 Avon 15:21:45.266182 Sell 50,000 50,000 10.01 10.01 50,000 5,00,500.00 50,000 0 100% 13-08-2009 Avon 15:21:49.461684 Sell 50,000 50,000 10.01 10.01 50,000 5,00,500.00 50,000 0 100% 13-08-2009 Avon 15:21:52.084289 Sell 50,000 50,000 10.01 10.01 50,000 5,00,500.00 50,000 0 100% 13-08-2009 Avon 15:21:54.856632 Sell 50,000 50,000 10.01 10.01 50,000 5,00,500.00 50,000 0 100% 13-08-2009 Avon 15:21:57.443506 Sell 50,000 50,000 10.01 10.01 50,000 5,00,500.00 50,000 0 100% 13-08-2009 Avon 15:21:59.743653 Sell 50,000 50,000 10.01 10.01 50,000 5,00,500.00 50,000 0 100% K 04-01-2010 Sera 12:51:24.349885 Sell 1,00,000 1,00,000 12.00 12.14 1,00,000 12,01,615.30 0 1,00,000 0% K 04-01-2010 Sera 12:52:16.154238 Sell 4,00,000 40,000 12 12.02 4,00,000 48,00,716.26 2,33,909 1,66,091 58%

From the above table, it can be seen that considerable portion of orders of KII were picked up by the 'group entities'. For instance, as on January 13, 2010, KII placed a fully disclosed sell order of 5,00,000 shares of Asahi and all such shares were purchased by the 'group entities'.

Thus, from the above discussion, I note that KII had sold substantial quantities of shares and that majority of the same had been purchased by the alleged 'group entities'. It is important to note that in all the aforesaid scrips, when KII was selling the shares (after cancellation of GDRs and conversion into underlying shares) the 'group entities' have been regular in their presence as buyers of substantial quantities from KII. The interim order has also observed that the said companies had weak financial fundamentals to raise such a huge capital which was several times the size of their issued capital and to attract investors. It has also been observed that the aforesaid companies had engaged Pan Asia and Arun, as the advisors for their GDR issuances. It is noted that there were similar sets of GDR subscribers and the proceeds of the GDR issues were deposited in the Euram Bank for such subscribers. Further, the same set of FIIs sold the shares after converting the GDRs of the select companies. Pan Asia led by Arun had a joint venture with Euram Bank called Euram Bank Asia Limited. Once these facts are viewed together, I am convinced about a prima facie case against KII that it had a role to play in the alleged manipulation. However, it is difficult to analyze the role of the entity in isolation, especially when the investigation in the matter is in progress.

9. I have considered the submissions of KII and note that being the securities market regulator, SEBI cannot remain unresponsive in light of the discussed preliminary findings as also disclosed hereinabove, wherein the role of numerous entities have been pointed out, each having a specific role to play. KII in its reply has laboured to argue that it was not linked to Arun. According to me, these submissions needs to be tested against the findings of the investigations. I note that the interim order mentions about the 'group entities' having purchased 78.69% of the shares of Asahi; 44.93% shares of Avon; 29.56% of shares of K. Sera Sera, out of the total shares of these companies sold by KII. I observe from the preliminary findings that these scrips do not have financial fundamentals to justify sudden spurt in the volumes. Further, the argument of KII that the interim order does not show any link between itself and the group is not sustainable. The preliminary findings and the prima facie observation in respect of such link through Arun has been mentioned in the interim order itself. Thus, at this stage, the prima facie inference is that the subscribers to such GDR issues of the companies have been provided exit opportunities by 'group entities' from their investments in such illiquid scrips.

The companies had a common arranger in Pan Asia/ Arun for their GDR issues. It is also pertinent to note that KII was found to be converting GDRs of all the selected companies and selling the same in the Indian securities market and the counterparties were found to be the same set of 'group entities'. Such 'group entities' had consumed majority of the shares of the companies named above, sold by the sub-accounts including that of KII. Thus, at this stage, the prima facie observations, as detailed in the interim order and the circumstances and facts therein suggests towards a preponderance of probability that the entity could be part of the alleged manipulation. I note that the investigation in the matter is still in progress and upon conclusion of the same, the actual role of each of the entities and their relationship with each other would be revealed. Thus, at the present stage, I am of the considered view that no conclusive findings can be given.

10. I note that the GDRs were converted in large numbers and through select FIIs, these are offloaded in the Indian market through group clients. Prima facie, this appears to be a strategy in which the issuing companies managed to create worthless shares which were sold among the Indian investors, in connivance with certain arranger/ lead manager/ FII/ 'group entities'. I note that the trading strategy of KII was prima facie not in the interest of securities market. KII had chosen to sell its shares when there was no liquidity in the subject scrips. The sudden increase in liquidity so as to satisfy the criteria for accommodating the shares of the sub-account and the subsequent dip to the previous trading levels post their exit from the scrip prima facie appears to be planned and premeditated and not a sheer coincidence. This poses a crucial threat to the very issue process and also the modes of functioning of the secondary market. Such trading pattern cannot be said to be normal in my opinion.

11. At this stage, I note the submission of KII regarding its business rationale to undertake the trades wherein it had the arbitrage opportunity coupled with the fact of market risk being borne by CIHL and Vintage. KII has also submitted that Vintage wanted to sell GDRs and was prepared to fund the purchase of the GDRs from Euram Bank. In my opinion, these facts were enough for KII to get alerted as to why anyone should get them a risk less return. Having considered this, I note that KII cannot be termed as an 'innocent bystander'.

12. I note that in an appeal bearing number 193 of 2011 in the matter of India Focus Cardinal Fund Vs. SEBI (wherein India Focus Cardinal Fund had challenged the interim order issued in the matter), the Hon’ble Securities Appellate Tribunal had passed certain directions, inter alia allowing India Focus Cardinal Fund to sell all the securities held by it. Having considered the facts and circumstances of this case, I am of the considered opinion that KII could also be afforded the similar benefit. However, for the reasons stated in para 11 above, I am not inclined to allow KII to repatriate the sale proceeds.

13. In view of the foregoing, I, in exercise of the powers conferred upon me under Section 19 of the Securities and Exchange Board of India Act, 1992 read with Sections 11(1), 11(4) and 11B thereof, hereby modify the directions issued vide the ad interim ex parte Order dated September 21, 2011, only to the limited extent as allowed herein below : i. KII Limited is permitted to sell its securities held in its dematerialized accounts and deposit the sale proceeds with any scheduled bank. ii. In case, KII Limited intends to utilize any or whole of the sale proceeds, it shall seek specific permission from SEBI indicating reasons for making such request.

14. The aforesaid directions would be in force till further directions.

PLACE : MUMBAI PRASHANT SARAN DATE : 23/JANUARY/2013 WHOLE TIME MEMBER SECURITIES AND EXCHANGE BOARD OF INDIA