Order in respect of AC Agarwal Share Brokers Private Limited

1. Securities and Exchange Board of India ('SEBI') conducted an inspection of AC Agarwal Share Brokers Private Limited (hereinafter referred to as ‘the Noticee’), a stock broker registered with SEBI, on February 13 to 14, 2017 for the period April 01, 2015 to February 12, 2017 to verify the compliance of requirements of segregation of clients and own funds and securities. Based on the observations during the said inspection and the Noticee’s reply thereto, SEBI prima facie found that the Noticee had misused funds of clients having credit balance for other clients and / or for own purpose on 27 out of 30 sample instances, and thus, had failed to comply with the requirements stipulated in SEBI Circulars no. SMD/SED/CIR/93/23321 dated November 18, 1993 (hereinafter referred to as ‘1993 Circular’) and MRD/DoP/SE/Cir- 11/2008 dated April 17, 2008 (hereinafter referred to as ‘2008 Circular’).Therefore, SEBI initiated adjudication proceedings and appointed an Adjudicating Officer (AO) under Section 23-I of the Securities Contracts (Regulation) Act, 1956 (SCRA) to inquire and adjudicate the said alleged violation under Section 23D of the SCRA.

2. Accordingly, the AO issued a Show Cause Notice dated February 04, 2019 to the Noticee detailing the allegations and subsequently, after conducting inquiry into the alleged violations by the Noticee, passed an order dated April 09, 2019 (AO Order) disposing of the aforesaid Show Cause Notice without imposing any penalty. The AO Order had observed inter alia the following:

Order in the matter of AC Agarwal Share Brokers Private Limited (a) As regards utilization of funds of clients for own purposes, there is not at all any basis or adverse inference in the inspection report for this allegation. Therefore, the allegation of possibility of funds of clients having credit balance being utilized for the own purposes of the Noticee does not sustain. (Ref: Para 8 of the AO Order)

(b) On one hand, the inspection team has found the system and procedure of the Noticee to be in order, however, on the other hand, the observation in inspection report in respect of the charge is based merely upon a possibility rather than on any specific basis or specific instance of utilization of funds of clients having credit balance to meet the pay-in obligation of clients having debit balance on any identified settlement date. (Ref: Para 10 of the AO Order)

3. SEBI, after examining the records of the abovementioned adjudication proceedings under Section 23-I(3) of the SCRA, was of the opinion that AO Order, in as much as it did not hold the Noticee liable for penalty under Section 23D of the SCRA, was erroneous and it was not in the interests of the securities market. Therefore, SEBI decided to make an inquiry in the matter in terms of the said provision. Accordingly, a show cause notice dated June 14, 2019 was issued under Section 23-I(3) of the SCRA (hereinafter referred to as ‘the Second SCN’) to the Noticee, directing it to show cause as to why appropriate penalty should not be imposed against it in terms of Section 23D of the SCRA, for violating provisions of SEBI Circular No. SMD/SEC/CIR/93/23321 dated November 18, 1993.

4. In response to the SCN, the Noticee vide letter dated June 28, 2019 submitted inter alia the following:

(a) Credit balance of the clients has not been used for own purpose, as wrongly alleged. The Noticee differs from the statement in the SCN that the calculation of misuse of clients’ funds for other clients or for own purpose has already been enunciated vide Circular dated November 19, 1993. The methods and style of calculations as provided in the SEBI Circular No. SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/95 dated September 26, 2016 (hereinafter referred to as 2016 Circular), which were made effective at a later date, cannot be used to take action for incidents prior to the coming into effect of the said Circular.

(b) The earlier reply dated March 05, 2019 submitted by the Noticee to the AO may also be relied upon.

5. The Noticee was granted an opportunity of personal hearing on July 08, 2019 which was attended by Noticee’s authorized representative (AR), namely Shri Shardul Shah, Chartered Accountant. During the hearing, the AR reiterated the submissions made by the Noticee in its letter dated June 28, 2019 as well as its reply dated March 05, 2019 submitted to the AO and specifically harped on the following submissions:

(a) The calculation methods provided in the SEBI Circular dated September 26, 2016 were not applicable in the Noticee’s case since the inspection period was prior to coming into effect of the said Circular.

(b) As a practice, it does not debit margin applicable to the clients in their ledger. The total credit balance calculated by the Inspection Team in its report has been arrived at without taking into account the margin applicable to the clients. The Column G allegedly contains a shortage of balance. However, the margin requirements of the clients against such shortage have been ignored. The margin requirement of clients having credit balance was in excess of the alleged shortage.

(c) The credit balance of the clients also includes balances of Noticee’s promoters, directors and their relatives. After deducting the said balances, the funds available are far in excess of the alleged shortage, which is evident from the Table mentioned at page 9 of the Noticee’s reply dated March 05, 2019.

(d) During the inspection period and before, it was a widely prevalent market practice that the surplus balances of promoters and directors of a broking firm were used for other clients having debit balances. In the instant case, the surplus amount of clients allegedly used by the broker belonged to its directors, promoters and relatives and not any other client, since the surplus funds of such promoters, directors and relatives was in excess of the shortfall in the available balance.

6. During the personal hearing, as regards the Noticee’s contention that margin applicable to clients was not taken into account while arriving at the figure of shortage of balance for clients having credit balance, it was advised to submit documentary proof, supported by a CA’s certificate. It was also advised to submit details of balances of directors, promoters and their relatives for the relevant dates. The Noticee requested time to submit the same by July 09, 2019, 03:00 PM which was granted. Subsequently, vide email dated July 09, 2019, the Noticee submitted documents containing a table listing out the alleged balance shortage for particular dates, the balance of directors and promoters for such dates and the net difference after adjusting the balance of promoters and directors. However, the table did not contain any reference to the margins applicable to the clients.

CONSIDERATION OF ISSUES AND FINDINGS:

7. I have considered the SCN dated June 14, 2019, the replies dated March 05, 2019, June 28, 2019 and July 09, 2019 filed by the Noticee and other material available on record. The Noticee is alleged to have violated Clause D of the 1993 Circular, which reads as under: “…D. What moneys to be withdrawn from “clients account”- No money shall be drawn from clients account other than - i. money properly required for payment to or on behalf of clients or for or towards payment of a debt due to the Member from clients or money drawn on client’s authority, or money in respect of which there is a liability of clients to the Member,… … …; ii. …… iii. ……..”

8. I note that the allegations of the violations of the abovementioned provisions of 1993 Circular emanate from the following observation in the Inspection Report: “It was observed that out of 30 sample days, on 27 days the funds of the clients available with broker (client / settlement bank account) and clients collateral was less than the ledger credit balances of all clients for such days. This shows possibility of the broker utilizing funds of client having credit balance, for other purposes, such as funding the debit balance clients, own purpose, etc.” (emphasis supplied)

9. I note from records that the details of the abovementioned shortage of balance for the 27 days as referred to above, based on which the allegation of violation of Clause D of the 1993 Circular has been made, was calculated as per the Table 1, provided in the 2016 Circular. The Noticee, as a preliminary objection, has contended that since the 2016 circular was made applicable after the period of inspection, the same has no application in the instant matter. In this regard, I note that the 2016 Circular has been issued inter alia for monitoring of clients’ fund through a sophisticated alerting and reconciliation mechanism, to detect any mis-utilization of clients’ funds, which was already prohibited under the 1993 Circular. I note that the Clause 3.3.1 of the Annexure to the 2016 Circular, under which the said Table 1 has been prescribed, refers to the following principle: “the total available funds i.e. cash and cash equivalents with the stock broker and with the clearing corporation/clearing member should always be equal to or greater than Clients’ funds as per ledger balance.” I observe that the said principle is a reiteration of the underlying principle against mis-utilization of the clients’ funds, already incorporated in Clause D of the 1993 Circular, and cannot be stated to be an introduction of a new requirement. Thus, I do not find merit in the Noticee’s contention that the 2016 Circular is not applicable in the instant case.

10. As regards the shortage of available balance indicating misuse of clients’ fund by the broker for own purposes or for clients having debit balances or both, the Noticee has contended that SEBI has not specified any specific instance of such misuse. I note that the AO has accepted the said contention and has observed, in para 10 of his order, that on the one hand, the Inspection Team had found the system and procedure of the Noticee to be in order, whereas on the other hand, the charge regarding utilization of clients’ funds for other purposes was based merely upon a “possibility” rather than on any specific basis or specific instance of such utilization of funds of clients having credit balance.

11. In the above regard, I find that the abovementioned observation of the AO is factually incorrect. At the outset, I note that the abovementioned observation of AO regarding the Noticee’s system and procedure being in order appears to be based on observations contained in para 4 of the Inspection Report, which primarily pertains to segregation of securities. However, the aspects related to the utilization of funds of clients for other purposes, which are specifically dealt with under para 9 of the Inspection Report appear to have been overlooked by the AO. Thus, it is apparent that the AO, by only looking at the observation at para 4 of the Inspection Report in isolation, rather than considering all the observations in the Inspection Report in totality, has mixed up the issues pertaining to segregation of securities with that of utilization of funds of clients for other purposes.

12. As regards the AO’s observation that the charge regarding utilization of clients’ funds for other purposes was based merely upon a “possibility” rather than on any specific basis or specific instance of such utilization of funds of clients having credit balance, I find that the said observation the AO is erroneous. I am of the view that once the shortage in the available balance vis-à-vis the total credit balance of clients has been established for 27 out of 30 sample days during the inspection period, the same per se is sufficient proof of misuse of clients’ money. In such a scenario, there is no requirement of providing instances of such misuse and the onus is on the broker to prove that there was no misuse of clients’ funds. In the instant case, the Inspection Team has clearly established the shortfall in available balances vis-à-vis-the total credit balance in the ledger on various days. Considering the same, I find that the said observation of AO is erroneous.

13. I note that the Noticee, in its reply dated March 05, 2019 had contended that the shortfall in the available balance vis-à-vis the credit balance available in the ledger has been calculated by ignoring the margin applicable to the clients. However, I note from the records that the table containing the calculation for shortfall has already taken in to account the margins for the clients. The same is mentioned in the column titled ‘Aggregate Value of Collaterals (Cash/FD/BG/2)’. Further, during the personal hearing on July 08, 2019, the entity was advised to submit documentary proof in support of his contention that margins were not taken into account. However, the Noticee has failed to do so. Thus, I find no merit in the contention of the Noticee in this regard.

14. The Noticee has additionally contended that the alleged shortage in the available balances vis-à-vis the credit balance in ledger would not arise if the credit balance of the Noticee’s directors, promoters and their relatives are discounted. As per the Noticee, the credit balances of the promoters, directors and relatives on the given dates were far in excess of the alleged shortage, implying that the surplus balances of other clients were not used. In this regard, I concur with AO’s observation that the said directors, promoters and other relatives, while trading through the Noticee as clients, cannot be treated any differently from other clients, for the purpose of such calculation of total credit balances. Thus, I find no merit in the contention of the Noticee. Further, during the personal hearing, the Noticee has submitted that it was a common market practice for the Brokers to draw on the surpluses of the relatives/directors/promoters to provide credit to other clients with debit balance for their trades and that in the instant matter, the alleged shortfall is attributable to such a market practice which was prevalent at that time. I find that the same amounts to admission by the Noticee that the clients’ funds were utilized for purposes other than those permitted.

15. In view of the above facts and circumstances, I hereby conclude that the Noticee, by utilizing the funds of its clients for purposes other than those permitted, has violated the provisions of the 1993 Circular, and thus, is liable to a penalty under Section 23D of the SCRA.

ORDER: 16. In view of the above, I, in exercise of powers under Section 23-I(3) of the SCRA, after taking into consideration all the facts and circumstances of the case and the violation established as mentioned above, having found the AO Order dated April 09, 2019 as erroneous and detrimental to the interests of securities market, hereby impose a monetary penalty of Rs.5,00,000/- (Rupees Five Lakh Only) upon the Noticee under Section 23D of the SCRA.

17. The penalty shall be paid by way of demand draft drawn in favour of “SEBI – Penalties Remittable to Government of India” payable at Mumbai or by e-payment in the account of “SEBI -Penalties Remittable to Government of India”, A/c No. 31465271959, State Bank of India, Bandra Kurla Complex Branch, RTGS Code SBIN0004380, within 45 days of receipt of this order. The said demand draft or forwarding details and confirmations of e-payments made (in the format as given in table below) should be forwarded to “The Chief General Manager, Market Intermediaries Regulation and Supervision Department (MIRSD), Securities and Exchange Board of India, SEBI Bhavan, Plot No. C –4 A, “G” Block, Bandra Kurla Complex, Bandra (E), Mumbai – 400051” and also to email id:- tad@sebi.gov.in Case Name Name of payee: Date of payment: Amount paid: Transaction no.: Bank details in which payment is made: Payment is made for : (like penalties/ disgorgement/ recovery/settlement amount and legal charges along with order details)

18. A copy of this Order shall be served upon the Noticee.

DATE: July 12, 2019 G. MAHALINGAM PLACE: Mumbai WHOLE TIME MEMBER SECURITIES AND EXCHANGE BOARD OF INDIA