Financial Planning Supervisory ... vs Sebi

BEFORE THE SECURITIES APPELLATE TRIBUNAL MUMBAI Order Reserved On: 10.09.2015 Date of Decision : 30.09.2015

Appeal No. 65 of 2014

Financial Planning Supervisory Foundation 702, 7th Floor, Leela Business Park, Andheri-Kurla Road, Andheri (E), Mumbai- 400 059, India ...Appellant

Versus

1.

Securities and Exchange Board of India, SEBI Bhavan, Plot No. C-4A, G-Block, Bandra-Kurla Complex, Bandra (East), Mumbai - 400 051

2. Institution for Mutual Fund Intermediaries One Indiabulls Centre, Tower 2, Wing B, 701, 7th Floor, 841, S.B. Marg, Elphinstone Road, Mumbai-400 013 ...Respondents

Mr. Darius J. Khambata, Senior Advocate with Mr. Sandeep Parekh, Mr. Anil Choudhary and Mr. Rajneesh Deka, Advocates i/b Finsec Law Advisors for the Appellant.

Mr. Fredun Devitre, Senior Advocate with Mr. Shiraz Rustomjee, Senior Advocate, Mr. Nishit Dhruva, Mr. Chirag Bhavsar and Ms. Khushbu Chajjed, Advocates i/b MDP & Partners, for Respondent No. 1

Mr. Somasekhar Sundaresan, Advocate with Mr. Paras Parekh and Mr. Dhaval Kothari, Advocates i/b J. Sagar Associates for Respondent No. 2

CORAM: Justice J.P. Devadhar, Presiding Officer Jog Singh, Member

Per: Justice J.P. Devadhar 2

1. This appeal is filed to challenge the communication of the

Securities and Exchange Board of India ('SEBI' for short) dated

February 06, 2014. By that communication the appellant is informed

that after considering the application filed by the appellant as also the

applications filed by respondent no. 2 and Organization of Financial

Distributors ('OFD' for short), SEBI has selected and granted in-

principle approval to the respondent no. 2 for setting up the Self

Regulatory Organization ('SRO' for short) for distributors of mutual

fund products.

2. Appellant challenges the aforesaid decision of SEBI basically on

three grounds. Firstly, it is contended that under regulation 3 of the SRO

Regulations, application for being considered as SRO for distributors

of mutual fund products could only be made by a company registered

under Section 25 of the Companies Act, 1956 ('1956 Act' for short).

Since respondent no. 2 was not registered under Section 25 of the 1956

Act till 31.07.2013 which was the cut- off date for submitting the

applications, respondent no. 2 was ineligible to apply till 31.07.2013 and

therefore SEBI ought to have rejected the application filed by

respondent no. 2 on 29.07.2013. Secondly, assuming that the respondent

no. 2 was eligible to apply, decision of SEBI in selecting and granting

in-principle approval to the respondent no. 2 amounts to rejecting the

application filed by the appellant under regulation 3 in violation of

regulation 10 because, under regulation 10, SEBI was mandatorily

required to give opportunity of hearing before rejecting the application 3

submitted by the appellant under regulation 3. Admittedly, opportunity

of hearing was not given before rejecting the application submitted by

the appellant under regulation 3 and therefore, the impugned decision of

SEBI is liable to be quashed and set aside. Thirdly, it is contended that

SEBI was biased in favour of respondent no. 2 even before inviting

applications for being recognized as SRO and hence the impugned

decision of SEBI is liable to be quashed and set aside.

3. Facts relevant for deciding the aforesaid issues as set out in the

Memorandum of Appeal are as follows:-

a) Appellant is a 'not for profit company' duly registered

under Section 25 of the 1956 Act. License under

Section 25(1) of the 1956 Act was granted to the

appellant by the Registrar of Companies, Mumbai on

July 26, 2013 and certificate of incorporation under

Section 25(2) of the 1956 Act was granted to the

appellant on July 28, 2013.

b) Appellant is promoted by Financial Planning

Standards Board India ("FPSB" for short) an

association of intermediaries, and a public-private

enterprise, which is also a not for profit company

registered under Section 25 of the 1956 Act. FPSB

focuses on distribution, improvements, investment

advisory and financial planning in securities and other 4

financial products with full disclosure and regulated

practices. FPSB is established by forty seven (47)

leading financial institutions in both public and private

sector across all asset classes in personal finance

including LIC, SBI, UTI AMC, ICICI Bank, Axis

Bank, Deutsche Bank AG, Kotak Mahindra Bank,

L&T Finance Holdings, Reliance AMC, Religare

Enterprises etc. who support the financial planning

movement. FPSB is registered under Section 12A,

Section 10(23C)(vi) as also under Section 80G of the

Income Tax Act, 1961 and is recognized as an

educational institution.

c) FPSB is a professional body of intermediaries (banks,

mutual funds, insurance companies etc.) engaged in

the pursuit of the well being of consumers of financial

products that are manufactured, advised and sold by

the industry. It is the licensing agency for the globally

known Certified Financial Planner (CFP) mark that

puts the interests of the customer above that of the

industry. FPSB is the only professional body that is

not an industry association or an NGO, but has a

representation across the consumer facing financial

sector. FPSB is essentially based on a voluntary self

regulatory mechanism, which is reflected by virtue of 5

its Code of Ethics and Rules of professional conduct

which is mandated for all its members.

d) Respondent no. 2 (IMFI), a Section 25 Company was

incorporated on August 2, 2013. Respondent no. 2 is

promoted by Association of Mutual Funds in India

(AMFI), an association to promote the interests of

Mutual Fund in asset management companies.

e) Under Section 11(1) and 11(2)(c) & (d) of the SEBI

Act it is the duty of SEBI to regulate the Mutual Fund

Industry and also to promote and regulate the Self

Regulatory Organizations. Accordingly, SEBI (Self

Regulatory Organizations) Regulations, 2004 ("SRO

Regulations" for short) have been framed by SEBI in

exercise of the powers conferred by Section 30 read

with Section 11(2)(d) of SEBI Act. The SRO

Regulations published in the Gazette of India on

February 19, 2004 were to come into force on such

date as may be specified by the Board.

f) SEBI in its board meeting held on August 16, 2012

approved the proposal to set up an SRO for the

distributors of securities such as Mutual Fund

products, portfolio management products etc. 6

g) By the SEBI (Self Regulatory Organizations)

(Amendment) Regulations 2013, second proviso to

regulation 1(2) of the SRO Regulations was inserted

with effect from 7.01.2013. As per the said proviso,

the SRO Regulations were to come into force in

relation to different classes of intermediaries on such

dates as the Board may by notification in the Official

Gazette appoint. Accordingly, a notification was

published in the Official Gazette on January 08, 2013,

whereby SEBI appointed that day i.e. January 08, 2013

as the date on which the SRO Regulations shall come

into force in relation to distributors engaged by asset

management companies of mutual funds and

distributors engaged by portfolio managers.

h) On March 21, 2013 a public notice was uploaded on

the SEBI website inviting applications from any group

or association of intermediaries desirous of being

recognised as an SRO for distributors of Mutual Fund

products in terms of the SRO Regulations.

i) By a public notice dated June 27, 2013, SEBI declared

that July 31, 2013 shall be the last date for receiving

applications from eligible applicants desirous of being

recognized as an SRO for distributors of Mutual Fund

products.

7

j) On July 29, 2013 appellant submitted its application

before SEBI for being recognized as an SRO for

distributors of mutual fund products.

k) On September 17, 2013 SEBI called upon the officers

of the appellant and sought certain clarification in

respect of its application for being recognized as an

SRO. The appellant by its letters dated September 20,

2013, November 20, 2013 and November 21, 2013

provided all the necessary clarifications and

information sought, to the satisfaction of SEBI.

l) By the impugned letter dated February 6, 2014,

appellant was informed that there were three

applicants viz the appellant, respondent no. 2 (IMFI)

and Organization of Financial Distributors (OFD) and

after considering the details of all the applicants SEBI

has selected and granted in-principle approval to the

respondent no. 2 for setting up the SRO for

distributors of Mutual Fund products.

m) On February 10, 2014 appellant made a representation

to the Chairman, SEBI stating therein that the

respondent no. 2 was not a legal person when

respondent no. 2 submitted its application on July 29,

2013 and therefore, in-principle approval could not be 8

granted to such an applicant who was a non-existent

entity on the date of submitting the application. On the

same day i.e. on February 10, 2014 appellant

addressed a letter to the Secretary, Government of

India, Department of Economic Affairs seeking

intervention of the Ministry of Finance in the matter. A

reminder letter was also sent to the Secretary,

Government of India on March 14, 2014. As there was

no response either from SEBI or from the Ministry of

Finance, appellant has filed the present appeal.

4. Although in its affidavit in reply SEBI has raised a plea

regarding the maintainability of the appeal against the impugned

communication dated February 06, 2014, Mr. Devitre learned Senior

Advocate appearing on behalf of SEBI fairly stated that the appeal may

be heard on merits on the footing that the appeal is maintainable.

Accordingly, the appeal is heard on merits on the footing that the appeal

is maintainable against the impugned decision of SEBI.

5. First and the foremost argument put forth by Mr. Khambata,

learned Senior Advocate appearing on behalf of the appellant is that the

respondent no. 2 was a non-existent entity on the relevant date and

therefore, SEBI could not and ought not to have entertained the

application filed by such a non-existent entity. In support of the above

argument Mr. Khambata submitted as follows:-

9

a) Without the certificate of incorporation an entity

does not become a company either under Section 34

or under Section 25 of the 1956 Act. Regulation 3 of

the SRO Regulations specifically provide that a

company registered under Section 25 of the 1956 Act

alone is entitled to apply for grant of certificate of

recognition as an SRO. Admittedly, respondent no. 2

was registered on 02.08.2013, whereas, last date for

submitting applications under regulation 3 of SRO

Regulations was 31.07.2013. Thus, on 29.07.2013

when respondent no. 2 submitted its application for

being recognised as an SRO, it was a non-existent

entity and therefore such an application submitted by

a non-existent entity being invalid, SEBI ought to

have rejected the application submitted by

respondent no. 2 at the threshold itself.

b) Section 25 of the 1956 Act makes a clear distinction

between grant of a license under Section 25(1) and

registration of a company under Section 25(2) of the

1956 Act. A license under Section 25(1) does not

direct the Registrar of Companies ('ROC' for short)

to register an association as an incorporated

company. Rather, it directs the ROC that if it does

decide to register the proposed company or 10

association, it would be bound to exclude the word

'Limited' or the words 'Private Limited' from the

name of the proposed company. Since regulation 3

refers to submitting application by a company

registered under Section 25 of the 1956 Act, SEBI

could not have entertained the application filed by

respondent no. 2 which was admittedly not registered

under Section 25 of the 1956 Act on the date of

submitting its application.

c) In support of the contention that prior to

incorporation/ registration a company does not exist

and consequently no application could be submitted

in the name of the non-existent company, reliance is

placed on decisions of the Apex Court in case of CIT

vs City Mills & Distributors (P) Ltd. (AIR 1996 SC

2888) and A.P. Tourism Development Corporation

vs Pampa Hotels Ltd. (AIR 2010 SC 1806).

d) The discretion vested in the ROC in directing

registration under Section 25(2) after granting license

under Section 25(1) of the 1956 Act is dispensed

with in the new Companies Act, 2013 ('2013 Act'

for short). Under Section 8 of 2013 Act the Central

Government is empowered to issue a license to a

person or association allowing such person or 11

association to be registered as a limited company

without the word 'Limited' or the words 'Private

Limited'. Dispute in the present case, relates to the

period prior to the 2013 Act and therefore,

application under regulation 3 could be made only by

a company registered under Section 25(2) of the

1956 Act.

e) Use of the words 'a company registered under

Section 25 of the Companies Act, 1956.... may make

an application' under regulation 3, clearly postulates

that a company which is duly registered under

Section 25(2) of the 1956 Act alone is eligible to

submit an application under regulation 3. Second

proviso to regulation 3(1) inserted with effect from

18.11.2013 merely provides that there shall be only

one SRO from distributors of mutual fund products

and that proviso cannot govern the interpretation of

regulation 3(1) which has been in existence since

inception.

f) Very fact that regulation 3(3) provides that the

application under regulation 3(1) shall be signed on

behalf of the company under the authority of its

Board of Directors by its Chairman, Managing

Director, Chief Executive Officer or Whole Time 12

Director, clearly shows that only a company

registered under Section 25(2) of the 1956 Act is

entitled to submit application under regulation 3 of

the SRO Regulations.

g) It is only on incorporation, a company manifests into

a completely unique legal personality distinct from

its constituent individuals. It is only on incorporation

a company becomes eligible to enter into contract

with others and use a common seal. The eligibility

criteria set out in regulation 4(a) of the SRO

Regulations that SEBI shall not consider an

application for grant of a certificate unless the

applicant is a company to which license has been

granted under Section 25 of the 1956 Act, does not in

any way affect the mandatory requirement contained

in regulation 3 that an applicant must be a company

registered under Section 25 of the 1956 Act.

Regulation 4(a) merely reiterates that SEBI shall

consider the application made under regulation 3

only if the applicant holds a license under Section 25

of the 1956 Act. Therefore, submitting application

under regulation 3 by an un-incorporated entity being

a legal impossibility, SEBI is not justified in

entertaining the application and granting in-principle 13

approval to the respondent no. 2 which was

admittedly not an existing entity till the cut off date

for submitting the applications.

h) Argument of SEBI that the eligibility requirements

are relevant only at the point of time when

applications are actually taken up for consideration is

incorrect and contrary to the specific provision

contained in regulation 3(1) of the SRO Regulations.

In the public notice issued on March 21, 2013

inviting applications, it was unambiguously stated

that the applications should be submitted in

compliance with the SRO Regulations. Since

regulation 3 specifically provides that application

may be submitted by a company registered under

Section 25 of the 1956 Act, SEBI could not bypass

the said mandatory requirement and entertain the

application submitted by respondent no. 2 which was

non-existent and was ineligible at the relevant time.

Fact that the application of respondent no. 2 was

incomplete is admitted by SEBI in its affidavit in

reply. Contrary argument now put forth by SEBI is a

means to accommodate the application of respondent

no. 2 and cover up SEBI's contravention of SRO

Regulations. As the eligibility criteria prescribed 14

under the SRO Regulations which are to be fulfilled

at the time of making the application were not met by

the respondent no. 2 till the cut off date i.e. till July

31, 2013, SEBI ought to have rejected the application

of respondent no. 2 as ineligible.

i) Argument of SEBI that the requirements of

regulations 3&4 of the SRO Regulations are

directory in nature and not mandatory is untenable,

because, a qualification or eligibility criteria can

never be directory in nature. The object of

prescribing the eligibility criteria is to ensure that

only qualifying persons are permitted to make an

application. In fact, averments made in para 9 and

para 16 (xv) of the affidavit in reply filed by SEBI

clearly establish that the application filed by

respondent no. 2 was incomplete and that the

respondent no. 2 became eligible to apply on being

registered under Section 25 of the Companies Act,

1956 on 02.08.2013 i.e. after the cut off date for

submitting the application on 31.07.2013. Even the

understanding of respondent no. 2 was that the

application under regulation 3 could be made only by

a company registered under Section 25 of the 1956

Act and therefore, in its letter addressed to the 15

Registrar of Companies on 25.07.2013, the

Respondent No. 2 had sought registration before

31.07.2013 failing which it was submitted that there

was danger that the respondent no. 2 may not be able

to submit the application within the deadline

prescribed by SEBI. Thus, requirements of regulation

3 of the SRO Regulations being mandatory, SEBI

ought to have rejected the application of respondent

no. 2 who was neither an eligible entity on the date

of submitting the application nor an eligible entity on

the cut off date.

j) Fact that regulation 4A of the SRO Regulations

empowers SEBI to grant in-principle approval to an

applicant by granting extension of time to comply

with the provisions of clauses (c) (d) or (h) of

regulation 4 does not in any way affect or alter the

eligibility criteria prescribed under regulation 3

which is required to be met at the time of submitting

the application under regulation 3. Regulation 4A

inserted with effect from 18.11.2013 does not seek to

amend the eligibility criteria prescribed under

regulation 3. Therefore, the application filed by

respondent no. 2 which does not satisfy the eligibility 16

criteria prescribed under regulation 3 could not have

been entertained by SEBI.

k) Under regulation 6 of SRO Regulations, any

application which is not complete in all respects or

does not conform to the requirements of regulations

3, 4 & 5 are liable to be rejected. First proviso to

regulation 6 provides for giving an opportunity to the

applicant to remove such objections as may be

indicated by the Board. However, that proviso would

not apply to an applicant like respondent no. 2 who

being non-existent was disqualified from even

submitting an application before the cut off date.

Thus, regulation 6, imposes a primary obligation on

the regulator to 'reject' any application which does

not conform to the requirements under the SRO

Regulations. Granting additional time for compliance

under regulation 6 is restricted to cases where there

are genuine mitigating factors and is not intended to

validate an otherwise invalid application of a

favoured candidate of SEBI.

l) SEBI is not justified in contending that power is

conferred on SEBI to grant relaxation of the

mandatory statutory provisions. Even the exceptions

provided under regulation 4A do not lay down that 17

contrary to regulation 3, application could be made

by an unincorporated entity and therefore, granting

any such relaxation or opportunity to the ineligible to

become eligible, would be ultra virus the powers of

SEBI.

m) SEBI is not justified in treating the objections raised

by the appellant as mere technical objections,

because, for any valid application to be made under

the public notice dated March 21, 2013, the applicant

was required to comply with the conditions and the

procedure prescribed under the SRO Regulations. All

regulations made by SEBI under the SEBI Act are

tabled before both the Houses of Parliament and

treating explicit requirements under such regulations

as mere technical requirements is untenable and

undermines the sanctity of SRO regulations.

Committing violation of the dictates of SRO

Regulations highlight a significant policy level lapse

in the regulatory approach adopted by SEBI.

n) Under Section 149(3) of the 1956 Act it was

obligatory on part of respondent no. 2 as a public

company to obtain a 'Certificate of Commencement

of Business' prior to undertaking any

transaction/business activity. Prior to obtaining such 18

certificate respondent no. 2 could not even submit

application under regulation 3 of SRO Regulations.

The Certificate of Commencement of Business was

granted to the respondent no. 2 on March 15, 2014,

whereas, the respondent no. 2 had commenced

business activities 340 days prior to obtaining a

Certificate of Commencement of Business in

violation of Section 149 of the 1956 Act.

o) Relying on certain file noting made by the officials

of the Department of Economic Affairs, Ministry of

Finance, Government of India it is submitted that the

appellant company being the only eligible company

having certificate of incorporation under Section 25

of the 1956 Act before 31st July 2013, SEBI ought to

have entertained the application submitted by the

appellant and SEBI is totally unjustified in

entertaining the ineligible application submitted by

respondent no. 2.

6. There is no merit in the above contentions.

7. As rightly contended by Mr. Devitre learned Senior Advocate

appearing on behalf of SEBI and Mr. Sundaresan learned counsel

appearing on behalf of respondent no. 2, the entity eligible to apply for 19

being recognized as an SRO for distributors of mutual fund products

under regulation 3 of SRO Regulations would be an entity to which

license under Section 25(1) of the 1956 Act has been granted for being

registered as a company under Section 25(2) of the 1956 Act.

8. Above reasoning can be better understood by referring Section

25(1) and (2) of the 1956 Act as also regulation 2(1) (e), 3, 4(a) & 6 of

the SRO Regulations, which read thus:-

Section 25(1) & (2) of 1956 Act

25. (1) Where it is proved to the satisfaction of the Central Government that an association--

(a) is about to be formed as a limited company for promoting commerce, art, science, religion, charity or any other useful object, and

(b) intends to apply its profits, if any, or other income in promoting its objects, and to prohibit the payment of any dividend to its members, the Central Government may, by licence, direct that the association may be registered as a company with limited liability, without the addition to its name of the word "Limited" or the words "Private Limited".

(2) The association may thereupon be registered accordingly; and on registration shall enjoy all the privileges, and (subject to the provisions of this section) be subject to all the obligations, of limited companies.

Regulation 2(1)(e), 3, 4 & 6 of the SRO Regulations

"Definitions

2.(1) In these regulations, unless the context otherwise requires, -

a)...

20

b)...

c)...

d)...

(e) "company" means a company which has been granted license under section 25 of the Companies Act, 1956 (1 of 1956);

Recognition of Self Regulatory Organization

3.(1) Any group or association of intermediaries, which is desirous of being recognized as a Self Regulatory Organization, may form a company registered under section 25 of the Companies Act, 1956 and such company may make an application to the Board for grant of certificate of recognition as a Self Regulatory Organization.

Provided that for the purpose of this sub-

regulation a distributor shall be deemed to be in intermediary.

Provided further that the Board may, in case of distributors engaged by asset management companies of mutual funds, grant certificate of recognition to only one group or association making an application under this regulation.

[Second proviso to regulation 3(1) was inserted with effect from 18.11.2013]

(2) Every application made by such company under sub-regulation (1) shall contain such particulars as may be specified and shall be accompanied by a copy of the governing norms of Self Regulatory Organization and also a copy of the memorandum and articles of association relating in general to the constitution of the Self Regulatory Organization and in particular, to -

a. Board of Directors of Self Regulatory Organization, its constitution and powers of management and the manner in which its business would be transacted;

b. the powers and duties of the office bearers of Self Regulatory Organization;

21

c. the admission into the Self Regulatory Organization of members, agents, their qualifications for membership, and the exclusion, suspension, expulsion and readmission of members therefrom or therein to;

(3) Every application under sub-regulation (1) shall be signed on behalf of the applicant under authority of its Board of Directors by its Chairman, Managing Director, Chief Executive Officer or whole time director.

(4) Every application under sub-regulation (1) shall be made to the Board in Form A of the first schedule and shall be accompanied by a non-

refundable application fee, as specified in Part A of the second schedule, to be paid in the manner specified in Part B thereof.

Eligibility criteria

4. The Board shall not consider an application for grant of a certificate under regulation 3 unless the applicant satisfies the following conditions, namely:-

(a) the applicant is a company which has been granted license under section 25 of Companies Act, 1956;

Application to conform to the requirements

6. Subject to the provisions of regulation 4A, any application for a certificate, which is not complete in all respects or does not conform to the requirements of these regulations and particularly regulations 3, 4 and 5 or instructions specified in Form A shall be rejected by the Board:

Provided that, before rejecting any such application, the Board shall give an opportunity to the applicant 22

to remove such objections as may be indicated by the Board, within 30 days of the date of receipt of relevant communication, from the Board:

Provided further that the Board may, on sufficient cause being shown, extend the time for removal of objections by such further time, not exceeding 30 days as the Board may consider fit, to enable the applicant to remove such objections.

(Emphasis supplied)

9. No doubt that regulation 3 of the SRO Regulations when read in

isolation, it appears that a company registered under Section 25(2) of

the 1956 Act is eligible to apply for being recognized as an SRO for

distributors of mutual fund products. However, regulation 3 when

read with regulation 2(1)(e) of SRO Regulations and Section 25(1) of

the 1956 Act it becomes evident that for the purposes of SRO

Regulations a company comes into existence when license is granted

under Section 25(1) with a direction for being registered under Section

25(2) of 1956 Act. Since regulation 2(1)(e) defines the expression

'Company' for the purposes of SRO Regulations to mean a company

to which a license is granted under Section 25(1) of 1956 Act and

license under Section 25(1) of 1956 Act is granted with a direction to

register it under Section 25(2), it is apparent that a company to which

license is granted under Section 25(1) of the 1956 Act for being

registered under Section 25(2) of the 1956 Act would be eligible to 23

make an application under regulation 3 for being recognized as an

SRO for distributors of mutual fund products.

10. Above reasoning is further fortified by the eligibility criteria

prescribed under regulation 4 of the SRO Regulations. Regulation 4(a)

of the SRO Regulations mandates that SEBI shall not consider an

application made under regulation 3 for grant of a certificate, unless the

applicant is a company to which license is granted under Section 25 of

the 1956 Act. As noted above license under Section 25(1) of 1956 Act

is granted to an applicant who fulfils the conditions set out in Section

25(1) with a direction that the said applicant be registered as a company

under Section 25(2) of 1956 Act. Thus, registration under Section 25(2)

is granted pursuant to the direction contained in the license issued under

Section 25(1) of the 1956 Act. If it is held that while submitting the

application under regulation 3 the applicant must be registered under

Section 25(2) of the 1956 Act, then, it obviously means that at the time

of submitting the application, the applicant holds license under Section

25(1) of the 1956 Act and in such a case, prescribing the eligibility

criteria that at the time of considering the application, the applicant must

be a company holding license under Section 25(1) would be

meaningless. In other words, if it is held that the eligibility criteria for

an applicant to submit application under regulation 3 is to hold

registration under Section 25(2), then it would be meaningless to

prescribe the eligibility criteria under regulation 4 that while considering

the application submitted under regulation 3 the applicant must hold 24

license under Section 25(1), because registration under Section 25(2) is

granted after grant of license under Section 25(1) of 1956 Act.

Regulation 4A inserted to SRO Regulations with effect from 18.11.2013

further makes it clear that the eligibility criteria prescribed under

regulation 4 are the eligibility criteria to be fulfilled at the time of

submitting the application under regulation 3. Thus, reading regulation

3, 4 & 4A of the SRO Regulations together, it is apparent that an

applicant to whom license is granted under Section 25(1) with a

direction that the said applicant be registered as a company under

Section 25(2) of the 1956 Act would be eligible to apply under

regulation 3 for being recognized as an SRO for distributors of mutual

fund products.

11. Accepting the argument of the appellant that an applicant

seeking to submit application under regulation 3, must hold certificate of

registration/incorporation under Section 25 (2) of the 1956 Act would

mean rendering the eligibility criteria prescribed under regulation 4(a)

redundant and otiose, because, the applicant holding registration under

Section 25(2) obviously holds license under Section 25(1) of the 1956

Act and in such a case, prescribing the eligibility criteria that while

considering the application submitted under regulation 3, must hold

license under Section 25(1) would be totally redundant and otiose. In

other words, if registration is held to be mandatory while submitting

application under regulation 3, then it would be redundant to prescribe

eligibility criteria under regulation 4(a) that while considering the 25

application submitted under regulation 3, the applicant must hold license

under regulation 25(1), because registration under Section 25(2) is

granted only after grant of license under Section 25(1). Therefore, the

interpretation of regulation 3 put forth by the appellant which purports to

render regulation 4(a) of SRO Regulations redundant and otiose cannot

be accepted.

12. Apart from the above, regulation 6 of the SRO Regulations

completely negates the argument advanced on behalf of the appellant.

Regulation 6 of the SRO Regulations as originally brought into force

with effect from 08.01.2013 limited only to distributors of mutual fund

products specifically provides that any application which is not complete

in all respects or does not conform to the requirements of regulation 3, 4

& 5 of the SRO Regulations shall be rejected only if the applicant fails

to comply with the requirements set out in those provisions within the

time extended by SEBI as specified under regulation 6 under the SRO

Regulations. Question of SEBI extending time to comply with the

requirements of regulation 3 would arise only after the application is

submitted under regulation 3. Extension of time permissible under

regulation 6 is not restricted to any particular requirement of

regulation 3. Therefore, reading regulation 3 with regulation 6 it is

imperative to hold that under regulation 3 a company to which license is

granted under Section 25(1) of 1956 Act is eligible to apply for being

recognized as an SRO for distributors of mutual fund products and it is

obligatory on part of the applicant to obtain registration under Section 26 25(2) of 1956 Act within the extended time permitted under regulation 6

of the SRO Regulations, failing which the application is liable to be

rejected.

13. It is relevant to note that a company incorporated under Section

34 of the 1956 Act is not entitled to the exemption available under

Section 25 of the 1956 Act unless that company is registered under

Section 25(2) of the 1956 Act. Registration under Section 25(2) is

granted subsequent to grant of license under Section 25(1) of the 1956

Act. In fact Section 25(3) of the 1956 Act provides that a company duly

incorporated under Section 34 of the 1956 Act may also make an

application for grant of registration under Section 25 with a view to

avail the exemption provided therein. In such a case, if the company

incorporated under Section 34 of 1956 Act satisfies the conditions set

out under Section 25, then, license is first granted under Section 25(1)

with a direction for being registered under Section 25(2). Thus a

company incorporated under Section 34 of the 1956 Act is entitled to the

exemption under Section 25 only when that company holds license

under Section 25(1) followed by registration granted under Section

25(2) of the 1956 Act. As per Section 25(7) of 1956 Act, if license

granted to a company under Section 25(1) is revoked, then the company

would continue to be incorporated under Section 34 of the 1956 Act but

ceases to enjoy the exemption granted under Section 25 of the 1956 Act.

Thus, under Section 25 of the 1956 Act holding license is of paramount

consideration and registration under Section 25(2) of 1956 Act follows 27

grant of license under Section 25(1) of the 1956 Act. Therefore, reading

various provisions of SRO Regulations together, it becomes abundantly

clear that any group or association of intermediaries holding a license

under Section 25 of the 1956 Act with a direction for being registered as

a company under Section 25(2) of the 1956 Act is eligible to apply

under regulation 3 of the SRO Regulations and it is obligatory for such

company to obtain registration under Section 25(2) within the extended

time that may be granted by SEBI under regulation 6 of SRO

Regulations.

14. Various decisions of the Apex Court relied upon by the counsel

for the appellant in support of the contention that a company does not

exist prior to its incorporation have no bearing to the facts of present

case, because of regulation 2(1)(e) of SRO Regulations which defines

the expression 'Company' to mean a company to which a license is

granted under Section 25(1) of the 1956 Act. Thus, for the purposes of

SRO Regulations, a company is deemed to have come into existence

when license is granted under Section 25(1) of the 1956 Act. Therefore,

various decisions relied upon by the counsel for appellant have no

bearing on facts of present case, in view of the expression 'Company'

defined under regulation 2(1)(e) of SRO Regulations.

15. As per the SRO Regulations any group/ association of

intermediaries could form a company registered under Section 25 of the

1956 Act and apply for being recognized as an SRO under regulation 3 28

of SRO Regulations. Dominant intention of SRO Regulations is to

motivate group/ association of intermediaries to form a company under

Section 25 of 1956 Act so that such company registered under Section

25 of the 1956 Act could be granted certificate of recognition to act as

SRO for distributors of mutual fund products. With this background

when regulation 3 is read with regulation 2(1)(e),4,4A & 6 of SRO

Regulations it becomes clear that the applicant submitting application

under regulation 3 need not be registered under Section 25 of the 1956

Act and if the applicant holds license under Section 25(1) of the 1956

Act, it would be a company eligible to apply regulation 3, subject to the

condition that the said company obtains registration under Section 25(2)

of 1956 Act within the time permitted by SEBI under regulation 6 of the

SRO Regulations.

16. In the present case, license under Section 25(1) of the 1956 Act

was granted to the respondent no. 2 on July 23, 2013 with a direction

that the respondent no. 2 be registered as a company under Section 25(2)

of the 1956 Act subject to fulfilling the conditions set out therein.

Admittedly, on compliance of those conditions, the respondent no. 2 has

been registered under Section 25(2) of the 1956 Act on 02.08.2013 that

is within the time prescribed under regulation 6. Therefore, in the facts

of present case, since respondent no. 2 was holding license under

Section 25(1) of the 1956 Act on the date of submitting the application

on 29.07.2013 and registration was obtained by the appellant within the

time stipulated under regulation 6, no fault can be found with the 29

decision of SEBI in entertaining the application submitted by respondent

no. 2.

17. Argument of the appellant that the application submitted by

respondent no. 2 under regulation 3 of the SRO Regulations even before

obtaining a 'Certificate of Commencement of Business', is in violation

of Section 149 of the 1956 Act is without any merit, because, as per

SRO Regulations an entity holding license under Section 25(1) of 1956

Act is a company eligible to submit application for being recognized as

SRO for distributors of mutual fund products. Since regulation 3 of the

SRO Regulations permit a company holding license under Section 25(1)

to submit application for being recognized as an SRO, appellant is not

justified in relying on general provisions contained in Section 149 of

1956 Act and contending that the application submitted by respondent

no. 2 under regulation 3 of SRO Regulations is in contravention of

Section 149 of 1956 Act. SEBI Act and the regulations framed

thereunder are special provisions intended to cater to the needs of the

securities market and therefore in the facts of present case, in the

absence of any challenge to the SRO Regulations, appellant is not

justified in contending that the application submitted under regulation 3

of SRO Regulations is in contravention of Section 149 of 1956 Act.

18. Once it is held that a company formed by any group or

association of intermediaries holding license under Section 25(1) of the

1956 Act is eligible to submit an application for being recognized as an 30

SRO under the SRO Regulations, then, all other arguments to the

contrary advanced on behalf of the appellant must fail. In particular, the

appellant is not justified in contending that regulation 6 of SRO

Regulations ought to be construed narrowly, when the language used in

regulation 6 do not even remotely suggest that the said regulation ought

to be construed narrowly. On the contrary the words 'any application for

a certificate, which is not complete in all respects or does not conform to

the requirements of these regulations and particularly regulation 3' used

in regulation 6 unequivocally suggests that every requirement of

regulation 3 could be removed within the extended time provided under

regulation 6 of SRO Regulations. For all the above reasons, we reject

the first contention raised by the appellant and hold that the respondent

no. 2 having license under Section 25(1) of the 1956 Act was eligible to

submit application under regulation 3 of SRO Regulations and therefore

no fault can be found with the decision of SEBI in entertaining the

application submitted by the respondent no. 2 on 29.07.2013.

19. Second argument advanced on behalf of the appellant is that the

decision of SEBI in selecting and granting in-principle approval to the

respondent no. 2 amounts to rejecting the application submitted by the

appellant without following the procedure prescribed under regulation

10 of the SRO Regulations and hence bad in law. Submission is that,

under regulation 10 it is mandatory for SEBI to grant personal hearing

before rejecting the application submitted under regulation 3 and further

mandatory to communicate the reasons for rejecting such application. In 31

the present case, it is submitted on behalf of the appellant that SEBI has

neither heard the appellant before rejecting the application nor

communicated reasons for rejecting the application submitted by the

appellant under regulation 3 and therefore, the impugned decision of

SEBI being in violation of regulation 10 of SRO Regulations is liable to

be quashed and set aside.

20. On behalf of SEBI it is inter alia contended that regulation 10

has no application in the present case because, SRO Regulations were

framed in the year 2004 wherein multiple SRO's were envisaged.

However, by amending the SRO Regulations in the year 2013, it is

provided that in case of distributors of mutual fund products there would

be only one SRO. In such a case, where selection of one out of the

several applicants is to be made, following the procedure prescribed

under regulation 10 does not arise at all. Several alternate submissions in

writing were also made on behalf of SEBI.

21. For sake of convenience, verbatim written submission of SEBI

in relation to the applicability of regulation 10 to the facts of present

case is set out herein below:-

i) Regulation 10 was retained as part of the SRO Regulations

even after the amendment of November 2013 whereby the

process of 'recognition' of multiple SROs was now made

into a 'selection' of a single SRO. No amendment to 32

regulation 10 was considered necessary since on its correct

construction, it would not apply to the amended 'selection

of one SRO' situation.

ii) In selecting one of several applicants, there is no

"rejection" of the other applicants within the meaning of

that expression in regulations 10. The "rejection"

contemplated in regulation 10 is a 'pejorative' rejection

involving some kind of 'stigma' on the merits of the

applicant. It does not contemplate the non-acceptance of the

other applicants incidental to the selection of one applicant.

iii) Alternately, in the amended situation of selection of one

SRO (and not recognition of multiple SROs), the context

and the connotation of the opportunity to be heard does not

mean only a personal hearing. The opportunity to place all

materials on record for consideration is sufficient

compliance with the requirements of regulation 10. All

applicants were given this opportunity and availed of it,

between July and December 2013. Even the appellants

make no grievance in the appeal regarding denial of

personal hearing. Their allegation is that there was no

formal interview.

iv) Alternately, even in the amended situation of selection of

one SRO, the opportunity of hearing contemplated by 33

regulation 10 relates to the stage of "rejection" of the

applicant who has been granted the 'in principle' approval

under regulation 4A. If such an applicant is rejected after

the grant of the 'in principle approval', then an opportunity

to be heard is required to be given under regulation 10 to a

person to whom 'in principle approval' was granted.

v) Alternately, regulation 10 contemplates a hearing to the

'unsuccessful' applicants only if it is sought after

communication to them of the grant of in principle approval

to one of the applicants, and before grant of the final

certificate of recognition to the successful applicant under

regulation 5, and not otherwise.

vi) Alternately, regulation 10 contemplates an opportunity of

hearing only at the stage of a final "rejection" of the

"certificate" and not before or at the stage of the 'in

principle' approval. That stage has not yet been reached.

This is clear from the use of the words "certificate" and

"rejection" in regulation 10. Thus, Respondent No. 1 will

not issue a final certificate of recognition to Respondent

No. 2 until it has first given an opportunity of hearing to the

appellant.

22. Before considering the merits of the aforesaid submissions of

SEBI it would be appropriate to quote regulation 10 of SRO Regulations

which read thus:-

34

"Procedure where certificate is not granted

10. (1) If, after considering an application made

under regulation 3 or regulation 9, as the case may

be, the Board is of the opinion that a certificate

should not be granted or renewed, it may, after giving

the applicant a reasonable opportunity of being

heard, reject the application within a period of thirty

days of receipt of such application complete in all

respects or within thirty days of receipt of further

information or clarification sought under

regulation 7.

(2) If any application is rejected under sub-regulation

(1), the fact shall be communicated to the applicant

forthwith, stating the grounds for such rejection."

23. Under the SEBI Act which came into force in the year 1992,

SEBI has been empowered to promote and regulate Self Regulatory

Organizations. Accordingly, SRO Regulations were framed by SEBI in

the year 2004 that is after lapse of about 12 years from the date of SEBI

Act, 1992 coming into force. Even after framing the SRO Regulations

in the year 2004, SEBI deemed it fit not to bring SRO Regulations into

force for about nine years. It is only in the year 2013 SEBI decided to

bring into force the SRO Regulations with effect from 08.01.2013

limited only to the distributors of mutual fund products wherein multiple

SRO's could be appointed in respect of distributors of mutual fund 35

products. Thereafter, SEBI deemed it fit that there should be only one

SRO for distributors of mutual fund products, and accordingly, effected

amendments to the SRO Regulations with effect from 18.11.2013 so as

to ensure that the SRO Regulations are inconformity with the single

SRO regime for distributors of mutual fund products. Neither at the

time of bringing into force the SRO Regulations limited only to the

distributors of mutual fund products on 08.01.2013 nor while amending

various provisions of SRO Regulations with effect from 18.11.2013

SEBI has deemed it fit to amend regulation 10 of SRO Regulations.

Therefore, having brought into force the SRO Regulations 2004 for the

first time with effect from 08.01.2013 limited only to the distributors of

mutual fund products and having taken a decision not amend regulation

10 even after amending various provisions of SRO Regulations in view

of its decision that there would be only one SRO for distributors of

mutual fund products, it is not open to SEBI to contend that regulation

10 of SRO Regulations would not apply while selecting a single SRO

for distributors of mutual fund products.

24. No doubt that in a selection process, where one out of many is to

be selected, ordinarily there would be no question of granting

opportunity of hearing to the applicants whose applications are to be

rejected. However, SRO Regulations framed in the year 2004 which

includes regulation 10 having been brought into force in the year 2013

for the first time, limited only to the distributors of mutual fund products

wherein single SRO is to be selected, it is not open for SEBI to contend 36

that regulation 10 of SRO Regulations would have no application while

selecting single SRO for distributors of mutual fund products. In other

words, having taken a decision that there should be a single SRO for

distributors of mutual fund products under the SRO Regulations which

are specifically brought into force limited only to the distributors of

mutual fund products, SEBI cannot avoid its obligation to comply with

the procedure prescribed under regulation 10 of the SRO Regulations in

relation to applications received under regulation 3 of SRO Regulations.

Regulation 10 does not specify the circumstances under which the

opportunity of hearing should be given to the applicant whose

application is being rejected. Regulation 10, simply provides that if

SEBI after considering the application submitted under regulation 3 is of

the opinion that a certificate should not be granted to the applicant, then

SEBI may, after giving an opportunity of hearing reject the application.

Obviously, opportunity of hearing under regulation 10 would have to be

given when application made under regulation 3 is to be rejected on any

ground whatsoever. Therefore, argument of SEBI that the 'rejection'

contemplated in regulation 10 is restricted only to a 'pejorative'

rejection involving some kind of 'stigma' on the merits of the applicant

and that regulation 10 would not apply in case of selecting one out of

several applicants being contrary to the plain language used in

regulation 10, cannot be sustained. Similarly, argument of SEBI that

opportunity of hearing under regulation 10 does not mean only personal

hearing and hearing could also be by giving opportunity to place all

material on record is also without any merit, because, it is only after all 37

material facts are placed on record if SEBI on consideration of those

documents deems it fit not to grant certificate to any applicant, the

question granting opportunity of hearing to that applicant arises. In the

present case, it is not in dispute, that requisite documents called for were

furnished by the appellant within the stipulated time. Thereafter, on

consideration of the application/documents furnished by the appellant, if

SEBI was of the opinion that a certificate should not be granted to the

appellant, at that stage it was obligatory on part of SEBI to grant

opportunity of hearing to the appellant under regulation 10 and in such a

case, the opportunity of hearing would only be by granting personal

hearing and not be any other mode. Admittedly, no opportunity of

hearing was given to the appellant after deciding to reject the application

of the appellant and after deciding to select and grant in-principle

approval to the respondent no. 2 and thus SEBI has contravened

regulation 10.

25. Having realized the inconsistency in its above argument, it is

contended by SEBI, as an alternative argument, that opportunity of

hearing under regulation 10 is relatable to the stage of rejecting the

application of an applicant to whom in-principle approval is granted

under regulation 4A. There is no merit in the above contention, because,

the in-principle approval is granted to an applicant only when that

applicant is selected and consequently all other applicants are rejected.

Regulation 10 contemplates granting opportunity of hearing to an

applicant whose application is being rejected and not to an applicant

who is selected and to whom in-principle approval is granted. Therefore, 38

argument of SEBI that opportunity of hearing under regulation 10 is to

be given while rejecting the application of an applicant to whom in-

principle approval was granted cannot be accepted. Language used in

regulation 10 does not even remotely suggest that opportunity of hearing

is to be given only to the applicant to whom SEBI after granting in-

principle approval deems it fit not to grant certificate to that applicant.

On the contrary, language used in regulation contemplates granting

opportunity of hearing to every applicant whose application SEBI deems

it fit to reject.

26. Next alternate argument of SEBI is that regulation 10

contemplates grant of hearing to the unsuccessful applicants only if it is

sought after communication of the grant of in-principle approval to one

of the applicants is totally absurd to say the least. Under regulation 10

obligation is cast on SEBI to give opportunity of hearing to the applicant

to whom SEBI is of the opinion that the certificate should not be granted

and there is no obligation cast on the applicant to seek opportunity of

hearing when that applicant is intimated that in-principle approval is

granted to some other applicant. In any event, in the present case, after

receiving the impugned communication appellant did make

representation against rejection of its application. However, there was

no response from SEBI and hence the present appeal is filed.

27. Last alternate submission of SEBI is that opportunity of hearing

under regulation 10 is to be given to the applicants only at the stage of 39

final 'rejection' of the certificate and not before or at the stage of

granting the in-principle approval. In this alternate submission, contrary

to its earlier stand, SEBI has acknowledged its obligation to give

opportunity of hearing under regulation 10 to the applicants whose

applications SEBI wants to reject.

28. However, argument of SEBI that opportunity of hearing under

regulation 10 to the applicants whose applications SEBI intends to

reject, has to be given not at the time of selecting and granting in-

principle approval to an applicant, but, at the time of granting final

certificate to the applicant to whom in-principle approval has been

granted, is totally without any merit. In-principle approval under

regulation 4A is granted to an applicant with a view to enable that

applicant to comply with the requirements of Clauses (c),(d) or (h) of

regulation 4 within the time stipulated therein. Clauses (c),(d),(h) of

regulation 4 require that the applicant (i) must have networth of one

crore rupees (ii) must have adequate infrastructure for discharging

functions as an SRO & (iii) must have in its employment persons having

adequate professional and other relevant experience to the satisfaction of

SEBI. Obviously, these requirements are to be fulfilled by an applicant

who is selected by SEBI for discharging the functions of an SRO. Thus,

in-principle approval is granted to an applicant when that applicant is

selected for discharging the duties as an SRO. Since in-principle

approval is granted by selecting one amongst many, it is just and proper

to hold that opportunity of hearing to the non-selected applicants has to 40

be given at the time of granting in-principle approval to the selected

applicant.

29. If the argument of SEBI is accepted it would mean that

opportunity of hearing to the unsuccessful applicants would have to be

given under regulation 10 at the time of granting final certificate of

recognition to the selected applicant to whom in-principle approval was

granted. Since opportunity of hearing under regulation 10 is not an

empty formality, it is possible that in a given case, SEBI after hearing

the unsuccessful applicant may change its opinion and decide to select

that applicant. In that case, the applicant who was initially selected and

to whom in-principle approval was g ranted would be left high and dry.

Moreover, in such a case grave prejudice would be caused to the

applicant to whom in-principle approval was initially granted, because,

during the interregnum that applicant would have incurred huge

expenditure on infrastructure and also would have employed adequate

professional persons in compliance of regulation 4, on the footing that

certificate of recognition would be granted in due course of time. SEBI

cannot approbate and reprobate in its stand by contending on one hand

that the applicant to whom in-principle approval is granted must set up

SRO within the stipulated time and on the other hand contend that grant

of in-principle approval does not necessarily mean that certificate would

be granted to that applicant, because, after hearing the unsuccessful

applicants under regulation 10, SEBI may select one of the unsuccessful

applicants. Such an argument of SEBI which brings-in total uncertainty 41

would be detrimental to the interests of mutual fund market and hence,

cannot be accepted.

30. Therefore, on a correct interpretation of regulation 10, it would be

just and proper to hold that opportunity of hearing has to be given to the

unsuccessful applicants at the time of selecting and granting in-principle

approval to the successful applicant.

31. In these circumstances, without going into the merits of the third

contention raised by the appellant that SEBI was biased in favour of

respondent no. 2, we hold that SEBI is not justified in granting in-

principle approval to the respondent no. 2 before granting opportunity of

hearing to the appellant as contemplated under regulation 10 of SRO

Regulations. Accordingly, we set aside the impugned decision of SEBI,

and direct SEBI not to take any further steps in the matter till the

mandate of regulation is complied with. SEBI is further directed to

select an applicant for grant of certificate of recognition in accordance

with law after taking into consideration all relevant facts of each

applicant without being influenced by any particular factor related to

any particular applicant.

32. To sum up, without going into the merits of the third issue, we

dispose of the appeal, by answering the first two issues raised by the

appellant as follows:-

42

a) Regulation 3 of SRO Regulations, permits any group

or association of intermediaries holding license under

Section 25(1) of the 1956 Act to submit application

for being recognized as an SRO for distributors of

mutual fund products. Since respondent no. 2 held

license under Section 25(1) of the 1956 Act on the

date of submitting the application under regulation 3

of the SRO Regulations, respondent no. 2 was

eligible to apply and therefore SEBI was justified in

entertaining the application submitted by respondent

no. 2.

b) Argument of SEBI that regulation 10 contemplates

granting opportunity of hearing to the unsuccessful

applicants at the time of granting final certificate of

recognition to the applicant to whom in-principle

approval was granted is devoid of any merit. In our

opinion, regulation 10 requires SEBI to give

opportunity of hearing to the unsuccessful applicant

at the time of selecting and granting in-principle

approval to an applicant. Since SEBI has failed to

comply with the requirements of regulation 10, we

quash and set aside the impugned decision of SEBI

dated 06.02.2014 and direct SEBI to select an 43

applicant afresh for grant of certificate of recognition

in respect of distributors of mutual fund products.

33. Appeal is disposed of in the above terms with no order as to costs.

Sd/-

Justice J.P. Devadhar Presiding Officer

Sd/-

Jog Singh Member 30.09.2015 Prepared & Compared By: PK