Directions Under Sections 11(1), 11(4) And 11B Of The Securities And Exchange Board Of India Act, 1992, in the matter of Societe Generale

1. The Securities and Exchange Board of India (hereinafter referred to as SEBI) had vide an Order dated January 15, 2010 (hereinafter referred to as the Order) directed Societe Generale (hereinafter referred to as SG), not to issue/subscribe or otherwise transact in any fresh/new Offshore Derivative Instruments (hereinafter referred to as ODIs) till such time it provided true and correct reporting of its ODIs/Participatory Notes (hereinafter referred to as PNs) transactions to SEBI. Further, SG was directed to show cause as to why appropriate proceedings including cancellation of its certificate of registration as an FII should not be initiated. Thereafter, SG filed its reply vide letter dated March 15, 2010 (hereinafter referred to as the reply). An opportunity of hearing was also afforded to SG on April 28, 2010, when it was represented by Mr. Janak Dwarkadas, Senior Advocate, who made submissions on the lines of the aforesaid reply of SG. Mr. Pascal Lambert, Ms. Ferheen Mahomed and Mr. Aldous Chan from SG were also present during the hearing. The submissions and contentions of SG made in its aforesaid reply and during the hearing have been dealt with in the succeeding paragraphs in this Order.

2. Before proceeding further, the relevant facts of the case needs to be noted for proper appreciation. SG is an FII registered with SEBI. On a perusal of the reports submitted by SG to SEBI for the period between January 2006 and January 2008, it was observed that it had issued certain ODIs/PNs to Hythe

Securities Limited (hereinafter referred to as Hythe), with the shares of Reliance Communications Limited (hereinafter referred to as RCL) as the underlying. When SEBI required SG to provide the details of all the instruments issued by it to Hythe, SG, while providing the details, stated and acknowledged that there had been errors in its reporting of the transactions with Hythe to SEBI. It further submitted that fourteen such transactions with Hythe were wrongly reported to SEBI. As per the monthly reports filed by SG with SEBI, it was noticed that SG had forty eight transactions with Hythe and out of the same, it had misreported fourteen transactions. Though SG had informed SEBI that it had established relationship with Hythe on “principal basis”, subsequent information from SG, Hythe and on the SEBI inquiry revealed that Hythe had acted as a broker in those transactions and that those ODIs/PNs had been onward issued to Opportunite S.A. and further to designations by the name of “Pluri Emerging Co PPC Cell E”, “Pluri Cell E”, or just “Cell E”. Thus, it was alleged that for those ODIs/PNs, the reporting that Hythe was the ‘end beneficiary’, was not correct.

Further, when SG was required to provide the end beneficiary details, it was unable to do so even when regulatory requirements required it to provide the name of the investor in case the instruments were onward issued to any other entity as a back to back instrument. Instead of providing the required information to SEBI, it chose to shift the said responsibility on Hythe to furnish the requisite information to SEBI. In terms of the Regulation 15A of the Securities and Exchange Board of India (Foreign Institutional Investors) Regulators, 1995 (hereinafter referred to as the FII Regulations), an FII or a sub-account can issue ODIs/PNs to “regulated entities” only after compliance with ‘know your client’ norms. SG was therefore alleged to have failed to adhere to the said legal requirement as it had little or no relevant knowledge of the ultimate beneficiary of the ODIs issued by it. Further, SG was not only unaware of the end beneficial owner but also did not have any mechanism in place to ensure that it could know the end beneficial owner of the instruments issued by it. Therefore, the Order prima facie observed that SG had furnished false and incorrect information regarding its ODI/PN activity to SEBI and had failed to provide true, fair and complete details of the ODI/PN activity undertaken by it.

It was prima facie not even been able to ascertain whether the entity to which ODIs were issued onward are themselves regulated and that it failed in its due diligence expected in the observance of ‘know your client’ norms. In view of the prima facie findings and observations, the Order had alleged that SG had contravened Regulation 15A and Regulation 20A read with SEBI Circular dated February 19, 2004 and Regulation 7A read with Clauses 1, 5 and 6 of the Code of Conduct prescribed for FIIs under the FII Regulations. The said facts and circumstances of the case, led SEBI to restrain SG from issuing, subscribing or otherwise transacting in any fresh/new ODIs/PNs, till such time SEBI was satisfied that it had the organizational resolve and capability, demonstrable vide systems, processes and controls to provide true, accurate and complete picture of its ODIs/PNs transactions as envisaged under the FII Regulations and the reporting requirements therein.

3. SG in its reply to the Order had inter alia submitted as follows: a. Hythe is an entity incorporated in the United Kingdom and is registered with and regulated by the Financial Services Authority, thereby satisfying the definition of “an entity regulated by an appropriate foreign regulatory authority” under Regulation 15A of the FII Regulations. b. SG ensured that it used market standard documentation with its counterparties whilst entering into ODIs and that at the time of first entering into any ODIs with a counterparty, SG requires the counterparty to sign documentation which includes various representation, warranties and undertakings from the counterparty. c. The documentation deployed by SG is not only market standard documentation but is also similar to the documentation adopted by other FIIs operating within India. d. As Hythe qualified as a regulated entity for the purposes of the FII Regulations, SG entered into an ODI with Hythe and for the said purpose, had obtained the “Standard ISDA Representations for India” and indemnity from Hythe (the Hythe Representations). The Hythe

Representations were intended to govern all ODIs that were to be entered into with Hythe and extended to the trades in respect of which SEBI had sought information from SG. In terms of the said representations, Hythe is prohibited from directly or indirectly issuing, offering, selling, transferring, assigning, novating or otherwise creating any economic interest against the derivative instruments against underlying Indian securities issued to Hythe by SG in favour of a “non-regulated entity” or a “prohibited person”. Hythe is also required to indemnify SG for any loss that may be caused to SG (or its affiliates) as a result of breach of any of the terms and conditions of the contractual arrangement. As per the terms of the Hythe Representations, Hythe agreed to inform any subsequent purchaser of the terms and conditions of the Hythe Representations and ensure that such subsequent purchaser was also bound by the Hythe Representations. e. SG documentation also includes an indemnity from the counterparty so as to act as a further deterrent to non-compliance/breach of the contractual obligations.

SG had chosen to implement this indemnity even though this has meant a loss of business as insisting on an indemnity is yet to become a market norm. The indemnity provisions gave further teeth to the contractual obligations so that SG could insist that the counterparty (Hythe) honours its contractual obligations and be compliant. This demonstrates SG’s high standards and its efforts to genuinely comply and ensure that the counterparty complies with the FII Regulations by building upon and not restricting itself to mechanical adoption of the market standard documentation in relation to ODIs. f. SG has a comprehensive and detailed global KYC policy given by Financial Action Task Force (FATF), which is at par with the KYC norms provided under the Master Circular on Anti-money Laundering/Combating Financing of Terrorism (ISD/AML/CIR-1/2010) issued by SEBI. g. The Order proceeds on the assumption that the requirement of conducting KYC as contained under Regulation 15A(1) is also applicable to an on-sale or back to back issuance of ODIs which is governed by Regulation 15A(2) and that the same is not a correct reading of the FII Regulations.

Further, the deletion of the words “or indirectly” as well as the reference to the words “clients” in the undertaking contained in the prescribed reporting format since May 27, 2008, also supports the interpretation that knowing or ascertaining the identity of the ultimate beneficiary or the holder of the ODIs via the KYC process or otherwise is not a pre-requisite. h. It cannot be said that SG failed in its duty to conduct KYC on the ultimate beneficiary as SG was not made aware that Hythe had on-sold its interest in the ODI to a third party. Further, as per market practice that has been adopted by market participants, KYC is required to be conducted only when an entity is adopted as a client or as counterparty to a transaction. i. Hythe also executed a professional investor letter dated May 26, 2005 with SG Securities (HK) Limited, which relates to the dealings of Hythe with SG group companies and that Hythe has to trade as principal in its dealings in securities with SG unless Hythe notifies SG otherwise. Based on the various confirmations issued by SG, it was reasonable for SG to believe that Hythe acted as principal given that Hythe is specified as a buyer therein.

The dealings between SG and Hythe were on principal to principal basis and are further substantiated by the fact that the transfers have taken place from the account of SG to that of Hythe, as is appearing on the statement produced by Euroclear. SG rightly believed and more so given the conduct of Hythe in the past, unless Hythe notified SG that it was acting as an agent of a client, Hythe dealing with SG as principal always applied and SG accordingly proceeded to undertake transactions on this basis. j. The requirement under Regulation 15A(2) is satisfied as long as the onward sale/back to back issuance of ODIs is to a regulated entity and that there is no legal requirement on SG to know and/or ascertain the so called end beneficial owners under Regulation 15A(2) and to have the said information in its possession on a going basis. SG followed up with Hythe which supplied the information directly to SEBI and that the information was directly given to SEBI as Hythe had initial doubts as to whether the request was in fact a regulatory request and also because Hythe considered SG as a competitor.

Further, SG did all that it possibly could to ensure (including by threatening legal action) that Hythe complied with the requests made by SEBI under the FII Regulations and that it sent a complaint letter to the Financial Services Authority, United Kingdom, reporting inter alia Hythe’s failure to provide information to SG in breach of its own undertaking given to SG. k. Most jurisdictions have confidentiality restrictions as regards information being shared with a counterparty and that while information may not have been initially disclosed by Hythe to SG, it was assured by Hythe that it would and eventually did disclose the information to SEBI directly. l. FII Regulations provide that ODIs can only be transferred and/or issued on a back to back basis to entities regulated by appropriate foreign regulatory authorities and that the objective is sought to be achieved by introducing a condition upon the issuer of the ODIs to ensure that all subsequent back to back/downstream issuances are to regulated entities. Just as the Indian Legislature cannot legislate extra-territorially or legislate in a manner that would override and/or undermine any municipal laws prevailing/enacted and in force in other jurisdictions, it also recognised the limitation of an issuer of ODIs in controlling the onward transfer and/or back to back issuances of instruments and use of the word “ensure” in Regulation 15A(2) has to be read accordingly. m. It is trite law that the legislature cannot call upon any party nor legislate to compel any person to perform an impossible act (certain judgements were referred to).

Thus, the issuer of an ODI can only do that which would be legal and/or valid within the sphere of the law of contracts. n. SG did not submit any untrue statement or attempt to suppress any material facts and therefore cannot be said to be in violation of Regulation 7A of the FII Regulations read together with Clause 6 of the Code of Conduct. o. With respect to the allegation that SG misreported fourteen transactions with Hythe, SG submitted that the misreporting was purely as to the nature/classification of ODI (total return swap instead of Euro Medium Term Notes) and that the same was a mis-classification/wrong categorization due to human error. Further, the misreporting was only as regards the nature of transactions and not relating to the quantum and value of the transactions and underlying Indian securities and such misreporting does not prejudice any interests in the Indian securities market. p. SG undertook an internal comprehensive review of its systems and processes to ensure that such errors do not occur at any time in the future. As a result, its processes and procedures has improved and has ensured that it has in place systems to ensure timely and accurate assimilation of information on ODIs for the purpose of reporting.

The said systems and procedures ensure that the parameters in the ODI reporting format prescribed by SEBI are duly matched with the details of the trades fed into the SG server. SG has also formulated a two tier system of feeding in the details of the transactions in the SG system such that mistakes, if any, are in any event corrected at the second instance. The same would be in addition to the consistency checks and final check prior to sending the report. Further, SG has also appointed designated persons to run all systems and processes in relation to the FII compliances. In view of its submissions, SG requested SEBI to take a lenient view in the matter and in any event not to revoke or cancel its registration.

4. During the course of hearing, the learned senior counsel inter alia submitted that Regulation 15A(2) of the FII Regulations requires that an FII shall ensure that the instruments are to be sold only to a regulated entity. It is the contention of the learned senior counsel that the words ‘shall ensure ‘ in the said regulation has to be viewed in the context of its use – of a regulation which permits further issuance and transfer of ODIs outside the jurisdiction of SEBI and beyond the reach of the FII itself. It is the contention that if the interpretation of ‘shall ensure’, is raised to an assurance of an obligation that must be performed, then the FII is being burdened with an impossible obligation/burden. According to the learned senior counsel, it is trite law that no legislation ought to be interpreted in a manner where a person is compelled to perform an impossible act. According to him, the words ‘shall ensure’ does not mean a guarantee but a best endeavour obligation. The learned senior counsel submitted that the FII Regulations was conscious of the fact that sub-regulation (2) of Regulation 15A cannot be read in this manner and it therefore advisedly changed the form of the undertaking. His submission was a reiteration of the submission of SG found in paragraph D(iv) of the reply. According to the counsel, the conscious deletion of the words ‘clients’ and ‘indirectly’ in the reporting format supports this interpretation that it was an impossible burden. The senior counsel referred to few judicial pronouncements to support his contention that law does not compel a man to do that which he cannot possibly perform.

5. Pursuant to the hearing, SG vide letter dated September 6, 2010, submitted that it undertook an internal comprehensive review of its systems and processes to ensure that such errors do not occur in future and that since then SG has been submitting true and correct reports and confirmed that it has adequate reporting systems to ensure true, fair and complete reporting of ODI transactions. SG also submitted that it had not issued/subscribed or otherwise transacted in any fresh/new ODIs since January 15, 2010 and has adopted an over-reporting approach to ensure true, fair and complete reporting of outstanding positions in ODIs which SG issued/subscribed or otherwise transacted prior to the Order. It was also submitted that SG believed that it has satisfied the requirement of providing true and correct reporting of its outstanding positions in ODIs to SEBI and has not undertaken any further trades in ODIs and is in strict compliance with the directions. Subsequent to the aforesaid letter, SG sent another letter dated October 11, 2010, wherein it highlighted the various steps taken by it and the enhancements made by it. SG also enclosed:

a. ODI procedure which sets out the policies and procedures that SG claims to have set up in connection with its dealings in ODIs, and b. Executive summary of such procedures 6. I have considered the submissions and contentions made in the reply, the oral submissions made by the learned senior counsel during the hearing, the submissions of SG in the letters sent pursuant to the hearing and other material available on record. The issues for consideration in the present matter is to decide, after considering the submissions of SG, whether it had contravened the statutory provisions as alleged in the Order and whether appropriate proceeding needs to be initiated against it as contemplated in the Order, if SG had contravened any provisions of law. To determine the culpability, I list below the following primary findings against SG from the Order:

a. Though SG had reported to SEBI that it had issued certain ODIs/PNs to Hythe during the period January 2006 and January 2008 and submitted that it had established relationship with Hythe on “principal” basis, it was later on observed from the information/documents obtained from the concerned parties that the ODIs issued by SG had been onward issued to Opportunite S.A. and then to further designations by the name Pluri Emerging CO. PPC Cell E, Pluri Cell E or Cell E. Therefore, SG had no relevant knowledge of the ultimate beneficiaries of the ODIs issued by it.

b. Though SG stated that the agreements signed by it with Hythe, empowered and enabled it to provide the end beneficiary details, SG was unable to do so inspite of SEBI requiring it to do so. Further, though the reporting formats prescribed by SEBI under the FII Regulations required the names of the investors to be reported in case the instruments were onward issued to other entities as a back to back instrument.

c. That SG shirked its responsibility cast on it under the FII Regulations and has left the responsibility to Hythe, an entity not registered nor regulated by SEBI, for furnishing the SEBI required information to SEBI.

d. SG failed to satisfy KYC compliance and was not only unaware of the end beneficial owner but also did not have any mechanism in place to ensure that it could know the end beneficial owners of the instruments issued by it.

e. SG has not been able to maintain any meaningful control over its processes/systems for identifying the ultimate beneficial owners in compliance with the legal stipulations, thus demonstrating complete disregard for the regulatory compliance expected from SG as an FII issuing ODIs/PNs.

f. The acts of SG were prima facie in contravention of Regulations 15A and 20A of the FII Regulations read with SEBI Circular dated February 19, 2004 and Regulation 7A of the FII Regulations read with Clauses 1, 5 and 6 of the Code of Conduct prescribed for FIIs under the FII Regulations.

7. For the purposes of determining the case, it would be pertinent to refer to Regulation 15A(1) & (2) of the FII Regulations. Since the Order had mentioned of the ODIs/PNs issued by SG during the period between January 2006 and January 2008, the provisions of Regulation 15A(1) & (2) of the FII Regulations during the said period is reproduced below:

“Conditions for issuance of offshore derivative instruments 15A. (1) No foreign institutional investor may issue, or otherwise deal in offshore derivative instruments, directly or indirectly, unless the following conditions are satisfied: (a) such offshore derivative instruments are issued only to persons who are regulated by an appropriate foreign regulatory authority; (b) such offshore derivative instruments are issued after compliance with ‘know your client’ norms: Provided that where at the commencement of the Securities and Exchange Board of India (Foreign Institutional Investors) (Amendment) Regulations, 2008, any person other than a person regulated by an appropriate foreign regulatory authority is holding offshore derivative instruments issued by or on behalf of the foreign institutional investor, such foreign institutional investor shall ensure that they are cancelled, redeemed or closed out, before the thirty first day of March, 2009. (2) A foreign institutional investor shall ensure that no further issue or transfer is made of any offshore derivative instruments issued by or on behalf of it to any person other than a person regulated by an appropriate foreign regulatory authority.”

Prior to the amendment to Regulation 15A by the Securities and Exchange Board of India (Foreign Institutional Investors) (Amendment) Regulations, 2008, w.e.f. May 22, 2008, Regulation 15A(1) and (2) read as follows:

“15A(1) A Foreign Institutional Investor or sub account may issue, deal in or hold, off-shore derivative instruments such as Participatory Notes, Equity Linked Notes or any other similar instruments against underlying securities, listed or proposed to be listed on any stock exchange in India, only in favour of those entities which are regulated by any relevant regulatory authority in the countries of their incorporation or establishment, subject to compliance of "know your client" requirement: Provided that if any such instrument has already been issued, prior to 3rd February 2004, to a person other than a regulated entity, contract for such transaction shall expire on maturity of the instrument or within a period of five years from 3rd February, 2004, whichever is earlier. (2) A Foreign Institutional Investor or sub account shall ensure that no further down stream issue or transfer of any instrument referred to in sub-regulation (1) is made to any person other than a regulated entity." Both prior to and post amendment to Regulation 15A(1), FIIs were statutorily bound to issue or otherwise deal in ODIs, only with entities who are regulated by appropriate foreign regulatory authority after compliance with the “know your client” norms. Regulation 15A(2) provided that FIIs shall ensure that further issue or transfer of any ODI is made only to a person regulated by an appropriate foreign regulatory authority. The objective of the aforesaid provisions is to ensure that the instruments underlying Indian securities are held only by those persons who are regulated (and KYC conducted on them) by appropriate foreign regulatory authority. During the course of hearing, the learned senior counsel contended that there is a difference in language between Regulation 15A(1) and 15A(2) of the FII Regulations. According to him, Regulation 15A(1) applies at the time of the issue of an ODI by the issuer and Regulation 15A(2) deals with subsequent issuances and transfers. Further, Regulation 15A(1) imposes two conditions on the issuer, while Regulation

15A(2) imposes only one of the two conditions. The senior counsel submitted that Regulation 15A(1)(b) is not fully incorporated into Regulation 15A(2). It is his submission that, it is inbuilt in Regulation 15A(2) that ODIs are capable of being further issued or transferred and back to back transfer is permissible subject to a condition that it cannot be issued or transferred to anyone other than a regulated entity. It was submitted that the FII Regulations intended to make a distinction between the issuance of ODI and conditions attached it and the further issue or transfer or on-sale of those issued ODIs. According to him, the most important distinction is that the requirement of Regulation 15A(1)(b) is dropped in Regulation 15A(2) consciously. According to the learned counsel, the answer to this was that one can do KYC on the party to whom it is issuing the ODI and cannot do the same on all transferees and back to back recipients of ODIs into the wide world. Therefore, according to the senior counsel, consciously because these instruments are in the global market, where they are being traded continuously, it is perhaps impossible to track the subsequent transferees to the extent of conducting KYC.

The learned counsel submitted that KYC was done on Hythe, which is also a regulated entity and found it to be a low risk regulated entity in a low risk jurisdiction (United Kingdom). I have given a thoughtful consideration to the aforesaid submission of the senior counsel. Though, it may be correct to state that the compliance of know your client norms was not incorporated into Regulation 15A(2) of the FII Regulations, as pointed out by the learned senior counsel, I cannot lose sight of the fact that the requirement under Regulation 15A(2) that ODIs could be further issued to only to regulated entities substantiate the importance given to a “regulated entity”. The provision clearly makes it mandatory that FIIs shall ensure that the ODIs are further issued or transferred only to a regulated entity as KYC on that entity would have already been conducted by the appropriate foreign regulatory authority under whose jurisdiction the said entity would be functioning. Further, tracing those entities in case of any market misdemeanour would not be difficult given the fact that they would be within the regulatory reach of such appropriate foreign regulators.

Further, the said argument could have been accepted if the statute book contained only Regulation 15A(1)and (2). However, this is not the case. SEBI, as mentioned in paragraph 4 of the Order, had issued Circulars under Section 11 of the Securities and Exchange Board of India Act, 1992 (hereinafter referred to as the SEBI Act), specifying the format in which the FIIs are supposed to disclose to SEBI the details of their ODI/PN activity. A new column was inserted in the reporting format, consequential to the insertion of Regulation 15A in the FII Regulations. The reporting formats required the FII to disclose the following:

a) Name and location of the person to whom the ODIs are issued b) Name and location of other person in case back to back ODIs has been issued against the instrument mentioned in (a) [above] c) Name and jurisdiction of the Regulator by whom the person holding the ODIs, is regulated in terms of Regulation 15A of the FII Regulations d) Type of the investor (hedge funds, corporate, individual etc)

If Regulation 15A(2) had to be strictly interpreted, what was the need for SEBI to require the details of the holders of instruments (received back to back) and the appropriate regulator under whose jurisdiction the holder is governed, under the reporting formats for SEBI. The requirements were felt necessary since the holders would be from jurisdictions away from SEBI and to ensure that they are regulated by an appropriate regulatory authority. In view of the said reasons, I do not find merit in the arguments of the senior counsel.

8. The next submission of the learned senior counsel is that SG only had a contractual arrangement with Hythe and that the representations, warranties and undertakings got from Hythe is the only method by which it could obtain as an issuer of the ODI from the party to whom it had issued. According to the senior counsel, this was the best SG could do. It was also submitted that SG had a conferred right to permit on-sale or a further issue of the ODI and to ensure that Hythe complied with the undertaking, an indemnity was taken from Hythe. The learned senior counsel further submitted that the said indemnity is a requirement which is peculiar to the contractual arrangement between SG and Hythe and is not part of the industry practices or part of the ISDA Standard Master Agreement. It was submitted by the learned senior counsel that the duty cast on SG under the regulations is not the duty of guaranteeing performance, but making its best reasonable efforts to ensure performance of the issuance or transfer being in favour of regulated entities. According to the learned counsel, the onward sale was to Opportunite S.A., admittedly a regulated entity.

The learned counsel stated that as far as Pluri is concerned, it was understood that it was regulated by Financial Services Commission (FSC), Mauritius. In respect of the allegation in the Order that SG was not able to confirm whether the beneficial owner is a regulated entity or not, the learned counsel submitted that SG had passed this arrangement to Hythe – which is backed by a contract and an indemnity and SG had no reason to suspect that the person to whom it had issued will act in breach of the obligations. According to the learned senior counsel, the fact that Hythe did not communicate what it ought to have communicated to SG and the fact that it will not pass the information to SG but to the regulator, cannot be the fault of SG as it had no control over the actions of Hythe. The senior counsel denied that the same was the helplessness of SG as brought out in the Order. A superficial reading of the arguments put forth by the senior counsel may move the reader on the genuine inability of SG in providing the information to SG, but on a consideration of the case in its totality, I am not convinced for the following reasons.

Though, according to the learned counsel, the entities - Hythe (the subscriber of the ODIs) and Pluri Cell E (to whom the instruments were subsequently transferred by Hythe), were regulated entities, I view the case in the background that SG was unable to provide the basis details as to whether the ODIs were issued to Hythe as principal or whether they were onward issued to others. SG was not in a position to furnish to SEBI the required details. On the contrary, though in fact the ODIs issued by SG to Hythe were onward sold, SG continued to report to SEBI that the ODIs were issued to Hythe on principal basis. Based on such wrong reporting, SEBI had to inform itself that the ODIs were issued to Hythe and the same are held by Hythe in contrast to the correct factual position. When the primary requirements under Regulation 15A(1) and (2) is to issue or transfer ODIs to regulated entities, SG was not even in a position to inform SEBI as to who was the ultimate beneficiary of the instruments so transferred. The said lapse is further aggravated by the fact that the ODIs were issued by SG itself and not by any other and it was unable to elicit information from Hythe of the onward transferees of such instruments.

The said lapse cannot be brushed away by merely stating that the same is at best a failure of Hythe to perform a contractual requirement and not a failure on the part of SG to perform a statutory obligation. In the Order dated August 30, 2010 issued in the matter of Barclays Bank PLC, SEBI had observed:

“The failure of Barclays in providing true and correct reports of its ODI activity cannot be merely explained as a failure of the contractual obligations of Hythe towards Barclays. Barclays could have taken care to ensure that it received a positive confirmation from Hythe not only at the first issuance but also from time to time, through out the tenure of the instruments, to the effect that it was the end beneficiary of the ODIs issued to it or that it had passed on the ODIs to entities who are regulated by an appropriate foreign regulator. It was the defence of Barclays that the contractual obligations were cast on the subscriber to inform it about the issuance and contended that non-reporting of Pluri in the monthly ODI reports to SEBI was not a breach by it. If Barclays had enforced the contractual obligations of Hythe, it would have come to know about the further issuance of ODIs by Hythe. ….”

The aforesaid observations would hold good in this case also. It is reiterated that the underlying principle of Regulation 15A(1) and (2) of the FII Regulations is that ODIs could only be issued directly or indirectly to persons who are regulated by an appropriate foreign regulatory authority and after complying with the “know your client” norms. It is reiterated that full and fair disclosure, forms the foundation of the FII Regulations. The rationale behind imposing such obligations on FIIs is that SEBI has no direct access to verify the entities who deal in the Indian Securities Market and the nature of funds that are being invested. The said concern compelled SEBI to issue necessary amendments in Regulations 15A and 20A of the FII Regulations. SEBI, as a regulator of the securities market, places absolute reliance on the ability of an FII to carry out the functions as an FII and to comply with the basic regulatory norms put in place. When an FII fails to discharge its duties and does not exercise proper diligence, inflows through such FIIs could endanger the integrity of the securities market which may further lead to manipulation and fraud.

This is the reason why SEBI has mandated FIIs to provide fair, true and correct information regarding their activity. The said information would be used by SEBI for the purposes of assessing, supervising and regulating their activity in the securities market. As already mentioned in the Order, when SEBI grants registration to an FII, it is presupposed that the said FII has the required systems and processes to ensure the integrity and accuracy of the data provided by it to SEBI under the applicable regulations and its capacity to exercise the necessary oversight. A duty is cast on the FII to ensure that no further issue or transfer of any ODI is made to any person other than a person regulated by an appropriate foreign regulatory authority. There is yet another reason to find fault with SG for not exercising diligence in dealing with Hythe. SG, as also observed in paragraph 9 of the Order, had stated that during one of the conversations, Hythe had referred to “client”. The same should have made SG curious to know who the client was from Hythe, as SG was dealing with Hythe on a principal basis and there could be no possibility of any ‘client’ coming into the picture if there was no on-sale of such ODIs.

While the contractual agreement of SG with Hythe cannot be considered to supplant/replace the statutory obligation of SG to SEBI, however, even for a moment considering the proposition of SG that there was a contractual obligation that the two parties were bound to; the events unfolding pursuant to the inquiry of SEBI has revealed that the contracting parties failed to perform their obligations as per their contract. Thus, notwithstanding the fact that SG failed in its statutory obligation to SEBI, SG failed in its duty, even contractually, of ensuring that it has the knowledge of who the beneficiaries are. Therefore, the statutory breach of SG of the provisions of the FII Regulations is the off-shoot of the inaction of SG in enforcing the contractual obligations of Hythe under the agreement as claimed by it.

9. The learned senior counsel submitted that the KYC policy of SG is borrowed from the global policy adopted by the FATF at the global level and the parameters in assessing whether the person to whom ODIs are issued, found in the SEBI Master Circular are more or less found in the global policy of SG. Though the entire FII industry is following the said practice, the same cannot be a ground for SG not having the requisite details of the end beneficiaries. The learned counsel referred to Paragraph E(iv) of the reply and submitted that when Hythe sought to introduce a new client, SG undertook KYC on the new client. For a regulated entity, compliance has to be on a regular ongoing basis. What is important to note is that SG did not have any details at all and had to completely rely on Hythe for the end beneficiary details. The same is not in line with the objective of Regulation 15A and the reporting requirements under the FII Regulations. The said details, as required under the monthly reporting by FIIs, are required to monitor the holders of instruments where the underlying are securities of Indian Companies and to see that tainted funds do not enter the Indian securities market.

10. The learned counsel has also contended that the requirements of the Order that an FII must know the beneficial owner to whom securities are issued and that at any given point of time, it is the duty of the FII to know the end beneficial owner and obligated to supply the same through monthly returns, was justified neither statutorily nor by interpretation. According to him, if such a burden is placed on SG, then the same is applicable to the industry as a whole.

The FII Regulations and the requirements arising therein are to be complied with by all FIIs and other constituents registered with SEBI, for conducting the activity of an FII in the Indian Securities Market. The responsibility under the regulations is on all the FIIs and not only on SG, as contended by the learned senior counsel.

11. As regards the allegation that SG had misreported fourteen transactions with Hythe, SG, has submitted that the same was only a misclassification/wrong categorization due to human error and that the misreporting was only with regard to the nature of transactions and not relating to the quantum and value of the transactions and underlying Indian securities. In respect of the said allegation, the learned senior counsel has conceded the misreporting but submitted that corrective steps have been taken in the systems and procedures. Given the nature of misreporting, the admission that wrong categorization was due to human error and that the misreporting was only with regard to the nature of transactions and not relating to the quantum and value of the transactions and underlying Indian securities and the remedial steps taken by SG towards the same, SEBI has a genuine expectation that SG would not repeat the said mistakes/lapses in future.

12. In view of the foregoing, I find the following:

a. SG had reported incorrect information as regards the ODIs issued to Hythe. It had reported to SEBI that its transactions with Hythe were on principal basis, whereas on the other hand, the instruments were back to back issued/transferred to Pluri. b. When SG was not even aware that the ODIs issued by it to Hythe were onward issued, there arises no question as to whether SG ensured that the same were passed on to regulated entities. SG cannot take cover below the fact that ODIs were issued to Pluri, a regulated entity, when it was not even aware, in the first place, that the ODIs issued by it were transferred to others. Therefore, by failing to ensure that onward issuances of its ODIs were made to regulated entities, SG has contravened Regulation 15A(2) of the FII Regulations. c. Though SG claimed to have contractually bound Hythe in providing the details of the end beneficiaries, it could not provide the information/details required by SEBI. The submission that Hythe did not part with the information to it cannot be a justifiable reason. Finally, it was Hythe and not SG that provided the information to SEBI. d. SG remained helpless and ineffective in providing the information to SEBI. e. SG failed to have a system to allow it to know the end beneficiary of the ODIs issued by it.

When SG was advised to provide the end beneficiary details it was unable to do so. SG vide e-mail dated January 12, 2010 acknowledged that it was unable to obtain the details of beneficial owners stating “Hythe is not willing to provide such information to us. They would rather provide you (SEBI) the details directly.” It is abundantly clear, from the reporting stipulations on PNs, that FIIs issuing the ODIs/PNs are required to provide the name of the investor in case the same (ODIs/PNs) are issued onward to any other entity as a back to back instrument. The responsibility for identifying and the accountability for reporting the end beneficial owners rest entirely with the issuer, the FII. SG was clearly not aware by its own admission that Pluri was the end beneficiary of the ODIs issued by it. f. Regulations 20 and 20A of the FII Regulations obligate an FII to provide “fully all information concerning the terms of and parties to ODIs”. The obligation to provide information about onward issuances is an inalienable part of the provisions under the FII Regulations that relate to issue of ODIs.

This is very clear given the scheme of the FII Regulations and the duties expected of a FII as explained above. Thus, I am not able to appreciate the contention of SG that they were not obligated under the FII regulations to provide relevant information about onward transfers of the relevant ODIs. SG having failed to correctly disclose the parties to SEBI, to whom ODIs where the securities of RCL were the underlying, were issued, for the relevant period in its periodical reports and also when it was specifically called upon to do so during the inquiry conducted by SEBI, has therefore contravened Regulation 20A of the FII Regulations. g. SG had admittedly misreported fourteen transactions with Hythe to SEBI, though the same may be a misclassification/wrong categorization due to human error and the misreporting was only with regard to the nature of transactions and not relating to the quantum and value of the transactions and underlying Indian securities. h. SG having failed to observe fairness and professionalism in its dealings in the Indian securities market had contravened Clause 1 of the Code of Conduct for FIIs.

Further, by furnishing statements/monthly reports to SEBI that do not represent its correct ODI activity and failing to comply with the relevant statutory provisions/circulars and guidelines, has not abided with Clauses 5 and 6 of the Code of Conduct for FII.

13. I also note that learned counsel submitted that SG had undertaken a review of its systems and procedures and is now in a position to report of its ODI activity correctly to SEBI. He further submitted that SG is in active dialogue with ISDA, as well as SEBI to bring about strengthening the documentation to ensure compliance with the regulations. Further to the hearing, I am informed that representatives from SG had met SEBI Officials on September 28, 2010 to update on the steps that SG had taken for ensuring errorless reporting since the Order was issued by SEBI. The detailed information was later communicated vide letter dated October 11, 2010 wherein SG highlighted that it had undertaken an internal comprehensive review of its procedures and processes relating to its dealings in ODIs to ensure that it has in place systems to comply with the relevant provisions in the FII Regulations. The following are noted from the said representation: I. Restrictions: Limiting the number and location of SG traders and hedge books that are able to trade Indian Securities (“ODI Mandated Hedge Books”) and ensuring that no internal trades are entered into.

II. Classification as ODIs: SG treats all derivative products managed by an ODI Mandated Hedge Books as an ODI at the time of its issuance, irrespective of whether its hedge is executed on an Indian stock exchange or a stock exchange outside of India at inception. III. No Threshold: Any product which refers an Indian Security and which SG expects to hedge using an ODI Mandated Hedge Book would constitute an ODI, regardless of the weight of the Indian component in the underlying. IV. Segregation: For its trading in the Indian securities markets under its FII license, SG segregates its ODI hedge positions from its non-ODI hedge positions. V. List of permitted counterparties: To ensure that ODIs issued by or on behalf SG are not issued to or otherwise dealt in by a Prohibited Person (as defined in the ODI Procedure). SG will perform KYC checks at both the ODI client on-boarding stage and transactional stage. Further, an assessment would also be made as to whether the ODI transaction is entered into by a client as principal or agent and to check the existence of back-to-back transactions.

VI. Positive confirmation: In addition to having a signed Indian side letter in place prior to dealing in ODIs, SG will attempt to obtain positive confirmation periodically from its ODI clients that they remain the end beneficiary of such ODIs. VII. Information: SG has removed the ability of its ODI clients (under the Indian side letter) to provide any information required by any Indian regulator directly to such regulator. Such additional information is to be provided to SG. VIII. Remedies: Whenever possible, SG would seek to include provisions in its agreement entered into with its ODI clients entitling SG to claim for damages or terminate the ODI transactions for breach of the terms similar to those as set out in the Indian side letter. IX. Regular training: All traders managing the ODI Mandated Hedge Books are to be trained regularly to educate them of the SEBI’s requirements in relation to SG’s dealings in ODIs. X. In addition to having a signed Indian side letter in place prior to dealing in ODIs, SG will attempt to obtain positive confirmation periodically from its ODI clients that they remain the end beneficiary of such ODIs.

SG submitted an Executive Summary of its ODI Transactions Internal Policy and a detailed ODI-Related Activity Procedure. Given the aforementioned, SG requested SEBI to take a lenient view in the matter and not to revoke/cancel its certificate of registration under any circumstances.

14. From the submissions made, SG has undertaken steps to validate its systems and processes to ensure that true and correct reports of its ODI activity are furnished to SEBI. The Order had directed SG, not to issue/subscribe or otherwise transact in any fresh/new ODIs, till such time it provides true and correct reporting of its ODI transactions. I also note that SG as directed in the Order had not issued any ODIs from the date of the said Order till date. In view of the submissions of SG and its undertaking that it has reviewed and rectified its systems and processes for ensuring correct reporting of its ODI activity to SEBI and also the fact that SG had not transacted in any fresh ODIs as directed in the Order, I am of the considered view that the ex-parte directions issued against SG in the Order need not continue further and can be withdrawn. In view of the same, further proceedings against SG as mentioned in the Order are also not warranted.

15. In view of the foregoing, I, in exercise of 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 dispose of the proceeding initiated against Societe Generale vide the ex-parte interim Order dated January 15, 2010, with the following directions:

a. The ex-parte interim directions issued against Societe Generale vide the ex-parte interim Order dated January 15, 2010 stands revoked with immediate effect. b. Societe Generale is directed to issue Offshore Derivative Instruments strictly in compliance with the regulatory regime that govern the said issuance. Any misrepresentation or wrong reporting by Societe Generale of its ODI activity, in future, would be viewed seriously by the Securities and Exchange Board of India.

DR. K. M. ABRAHAM WHOLE TIME MEMBER SECURITIES AND EXCHANGE BOARD OF INDIA

PLACE: MUMBAI DATE: DECEMBER 30, 2010