Order in respect of Jayantilal Khandwala & Sons Pvt. Limited

WTM/PS/69/IVD/ID-03/JAN/2011 BEFORE THE SECURITIES AND EXCHANGE BOARD OF INDIA, MUMBAI CORAM: PRASHANT SARAN, WHOLE TIME MEMBER IN THE MATTER OF DSQ BIOTECH LIMITED In respect of Jayantilal Khandwala & Sons Pvt. Limited (SEBI Registration No. INB 010998038) Date of hearing: December 04, 2009 Appearances For Noticee: Mr. Rajesh Khandelwal, Advocate Mr. Jatin Khandwala, Director For SEBI: Mr. Preeti Patel, Presenting Officer Mr. G. Ramar, Deputy General Manager Mr. Atul Agarwal, Assistant General Manager Mr. Pradeep Kumar, Legal Officer ORDER Under Regulation 28(2) read with Regulations 38 (2) of Securities and Exchange Board of India (Intermediaries) Regulations, 2008 1. The Securities and Exchange Board of India (hereinafter referred as ‘SEBI’) conducted investigation into the buying, selling and dealing in the shares of DSQ Biotech Limited (hereinafter referred as ‘DSQ’). The investigation was conducted for the period of December, 1999 to January, 2001. During investigation period, the scrip of DSQ was listed at Bombay Stock Exchange (hereinafter referred to as ‘BSE’), National Stock Exchange (hereinafter referred to as ‘NSE’), Ahmedabad Stock Exchange (hereinafter referred to as ‘ASE’), Delhi Stock Exchange (hereinafter referred to as ‘DSE’) and Magadh Stock Exchange (hereinafter referred to as ‘MSE’). During the relevant period, no trading was reported on ASE and DSE, however, a volume of 500 shares was reported at MSE. The investigation was conducted inter-alia to ascertain possible violation of provisions of Securities and Exchange Board of India Act, 1992 (hereinafter referred to as ‘SEBI Act’), SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 1995 (hereinafter referred to as ‘PFUTP Regulations’) and SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992 (hereinafter referred to as ‘Broker Regulations’) by the persons who had dealt in the scrip during the relevant period.

2. During the period of investigation, the price of the scrip at BSE had fallen from `223.30 as on July 17, 2000 to `58.55 as on October 19, 2000. Thereafter, the price of the scrip started rising from `60.80 as on October 21, 2000 and reached to the price of `183.50 as on November 17, 2000. During this period, volumes in the scrip also shown volatility i.e. it changed from as little as 48,442 shares as on October 04, 2000 to 21,44,548 shares as on December 13, 2000.

3. The investigations have revealed that DSQ increased the share capital by making a preferential issue of 80,30,000 equity shares priced at `275 (with face value of `10 and a premium of `265) during March, 2000, to its related entities. These shares were partly paid up, upto the extent of 10% paid at the time of the allotment. It was revealed by investigations that rest of the 90% of the money did not come into the company and was managed to be shown to have been credited to company by fictitious bank entries through three companies’ belonging to DSQ group. These shares were dematerialized on the instruction of DSQ, into the accounts of respective entities which were then subsequently transferred to the demat account of DSQ Holdings Limited and were offloaded in the market through various brokers at NSE and BSE. The shares were used to satisfy the settlement obligations of various other DSQ group entities by availing finance through market, as these entities were provided the amount to the extent of sale proceeds by their brokers on date of trade itself i.e. in advance of pay out of the exchange.

During the relevant period, DSQ Holdings Limited appeared as one of the major selling counterparties for the trades in DSQ shares made by the associated entities. For these trades, orders were entered simultaneously or within close proximity of each other for the same price and quantity. These orders were found to be in the nature of synchronized trades and appeared to have entered with a view to match with prior understanding.

4. During the course of investigation, it was inter alia revealed that Jayantilal Khandwala & Sons Pvt. Limited (hereinafter referred to as ‘noticee’), registered with SEBI as stock broker, bearing SEBI registration no. INB 010998038, while trading for its clients at BSE had synchronized the trades for its group company clients.

5. Based on the findings of the investigation, SEBI initiated enquiry proceedings against the noticee in terms of SEBI (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002 (hereinafter referred to as ‘Enquiry Regulations’), by appointing an Enquiry Officer under Regulation 5(1) of Enquiry Regulations vide order dated October 14, 2005. SEBI appointed the Enquiry Officer, to enquire into the alleged violation of provisions of the PFUTP Regulations and Broker Regulations. The Enquiry Officer submitted his Report dated January 23, 2007, in terms of Regulation 13 (1) of the Enquiry Regulations recommending thereby a penalty of suspension for a period of four months for violating the provisions of Regulation 4(a), (b), (c) and (d) of PFUTP Regulations and Clause A (1), (2), (3), (4) and (5) of the Code of Conduct specified under Schedule II of the Broker Regulations.

6. Subsequently, a Show Cause Notice dated January 25, 2007 (hereinafter referred to as ‘SCN’), under Regulation 13(2) of the Enquiry Regulations was issued by SEBI to the noticee, asking it to show cause as to why an appropriate penalty including penalty recommended by the Enquiry Officer, should not be imposed. The noticee was advised to reply to the SCN, together with the documents that it may choose to rely upon in support of its reply within fifteen days of the receipt thereof. It was also informed that in case of failure, it would be presumed that it had no explanation to offer and SEBI shall be free to take such action in the manner as it deems fit. A copy of the Enquiry Report was also forwarded to the noticee along with the said SCN.

7. The noticee replied to the SCN vide its letter dated February 12, 2007 and requested for an opportunity of personal hearing. Accordingly, an opportunity of personal hearing was granted to the noticee before me on December 04, 2009. On the date fixed, Mr. Rajesh Khandelwal, Advocate and Mr. Jatin Khandwala, Director appeared on behalf of noticee and reiterated the submissions made vide letter dated February 12, 2007, along with other submissions. The submissions of noticee in brief, are:

a. Genuine trades for profit making by its clients incidentally resulted in increase in volume. b. Not related to Khandwala Securities Limited and Nirjay Securities Pvt. Limited as all these are separate legal entities. c. Providing trading terminal was a prevailing practice among the brokers. d. Time gap of 3 hours was there between the buy and sell order in Settlement no. 25. e. Details of pending sell orders in the system was not provided. This detail is required to determine whether its buy orders were placed at a price higher then the pending sell orders in the system. f. In Settlement no. 27, the buyer and seller were different for 2,75,000 shares. g. Was not aware about conspiracy and modus operandi of DSQ related entities. h. No credible evidence as to how it aided and abetted its clients. i. Enquiry Regulations not applicable to it as the same were notified on September 27, 2002. j. Proceedings suffer from delay.

8. At the outset, let me deal with the submissions of the noticee. Regarding the submission that it has not been supplied with the entire material relied upon, it is seen that all the documents relied upon by SEBI, have been provided to the noticee. It is also noted that no document, which has not been provided to the noticee, is being relied upon in the present proceedings. I have carefully considered the Enquiry Report, the SCN issued to the noticee and its reply. The Enquiry Officer has found the noticee guilty of violation of provisions of Regulation 4 (a), (b), (c) and (d) of PFUTP Regulations and Clause A (1), (2), (3), (4) and (5) of the Code of Conduct specified under Schedule II of the Broker Regulations. Considering all this, the issues arise for my consideration are:

a. Whether the noticee had aided and abetted its clients in creation of artificial liquidity/ false market in the scrip of DSQ? b. Whether the noticee had failed to exercise due care and diligence while dealing with its clients?

9. Whether the noticee had aided and abetted its clients in creation of artificial liquidity/ false market in the scrip of DSQ?

a. I have seen the trading details of noticee for its clients in the scrip of DSQ, during the relevant period. I note that two clients of noticee namely Nirjay Securities Pvt. Limited and Khandwala Shares and Stocks had a common director namely Mr. Ashok Khandwala. Mr. Ashok Khandwala is the father of Mr. Jatin A. Khandwala (director of noticee). Another client of noticee namely Khandwala Securities Limited (hereinafter referred to as ‘KSL’) was being managed by uncle of the director of noticee (Mr. Jatin A. Khandwala). I note that KSL was the holding company of Khandwala Finances Limited (broker, NSE), which in the year 2002, merged into KSL.

These facts point that entities namely KSL, Nirjay Securities Pvt. Limited and Khandwala Shares and Stock were having close relationship with each other and noticee. However, the noticee has strongly opposed this and argued that it was not connected with them as all these were separate legal entities and were being managed professionally. I have seen the details of the noticee as taken out from BSE website and note that as per the shareholding pattern on September, 2009, the noticee has been shown as holding 14.52% of equity of KSL. Further, the share holding pattern as on March, 2001, shows that Ashok Jayantilal Khandwala and Jatin Ashok Khandwala were respectively holding 2.94 % and 2.28% of equity of KSL.

b. I note from the Enquiry Report that KSL used to place orders through the trading terminal provided by the noticee. Noticee has argued that it was the prevailing practice during the relevant point of time. I find no merit in this argument of noticee as at no point of time, SEBI had allowed such practice. Considering this and the close relationship as brought out among the stated entities, I am in agreement with the Enquiry Officer that in normal circumstances no broker will allot terminal to its client.

c. As seen from the Enquiry Report, the related clients of noticee had traded for huge quantities in the scrip. I note that during the relevant period, the noticee was found entering orders close to upper/ lower circuit limits of the scrip of DSQ. I have seen the instances of pattern of trading of noticee as have been brought out in the Enquiry Report. From the same, I observe as under:

- In Settlement no. 25 (September 11, 2001 to September 15, 2000), at 14:27:59, noticee entered a buy order for 50,000 shares at `197.30, this order was executed at 14:28:00 against the pending sell orders with price rising from `190.85 to `194. Out of these 50,000 shares, 34,785 shares were executed against its own sell order for 50,000 shares entered at 11:30:43. Again at 14:28:58, noticee entered another buy order for 41,000 shares at `197.30, this order was executed between 14:28:58 - 14:29:23 against the pending sell orders with price rising from `190.50 to `197.30. Out of these 41,000 shares, 10,215 shares were executed against its own sell order entered at 11:30:43 at `194 for 50,000 shares. Later on at 14:48:31, there was a self trade by noticee for 8,000 shares.

Noticee has argued that the trades were not synchronized as its buy order for 50,000 shares has matched with his sell order with a time difference of almost 3 hours. Further, for the second trade the buy quantity was for 41,000 shares and the trade was only for 10,215 shares. Even if, this argument of noticee is considered then also it is an admitted fact that the order of noticee has matched with its own pending sell order. I note that the trading screen shows the best orders available in the market and here before us it was the pending order of noticee itself which has matched. It appears imprudent that an entity punches a sell order at a lower price in the morning and a buy order at a higher price in the evening. I note that such pattern of trading cannot be said to be normal as at one point of time the noticee is entering sell order and later on seeing that nobody has picked up these shares then enters a buy order at higher price. This pattern suggests that the noticee had tried to lay a trap for genuine investors and when nobody got trapped then the same was picked up by its own order. Such pattern also creates an impression of active trading in the scrip. This shows that the entity was trading for the sole purpose of generating volumes and impacting the prices of the scrip.

- I have seen the instances of other matched trades, a few of which have been brought out below from Settlement no. 27 and 32

Sett. BUY MEMBER SELL MEMBER Execute Execute No. Clg. Orde Order Qty. Rate Client Clg. Orde Order Qty. Rate Client d Time d Rate No. r ID Time (Rs.) code No. r ID time (`) code (`) 27 329 2458 13:23:11 275000 158.05 KSL 564 6753 13:23:10 275000 158.05 DSQBIO 13:23:12 158.05 32 343 4191 14:02:37 45,000 91.1 6363 329 2726 14:02:38 44,429 91.1 N001 14:02:38 91.1

From the table above, I note that the orders were matched with a difference of just one second. The Enquiry Report while pointing to the trade in Settlement no. 27 on September 26, 2000, has noted that DSQ Holdings is appearing on both sides of the trade. Further, for this trade Khandwala Finance Limited, a related entity of noticee had made payment of funds on behalf of DSQ Holdings Ltd. for the purchase transaction of 2,75,000 shares. The fact of payment was also verified from the ledger account of DSQ Holdings Ltd. which showed that an amount was credited on September 26, 2000 with remarks 'chq from KFL'.

To this, noticee has argued that the buy order for 2,75,000 shares was entered at 13:23:01 at `158.05 for KSL and the same was executed with the seller broker trading for DSQ Holdings Limited at 13:23:01 for 2,75,000 shares at `158.05, further no credible evidence has been brought out to prove that the buyer and seller were associated. I have considered the argument of noticee and find that the Enquiry Report has proceeded on a wrong assumption. The trades as shown in Settlement no. 27, the clients were ‘KSL’ and ‘DSQBIO’.

However, the fact remains that the trade and payment for such trades was made on the same date i.e. September 26, 2000, without waiting for the pay-out from the exchange. I note that the trade was done by KSL and the payment was made by Khandwala Finance Limited, for this no justifiable reason has been given by the noticee. I note that the letter referred by noticee written by DSQ Holdings Ltd. asking thereby Khandwala Finance Ltd. to release the said payment has not been produced by it inspite of specifically asking about it by the Enquiry Officer.

Such pattern of trading and bypassing the exchange mechanism by arranging immediate funds to DSQ Holdings Limited (also a client of noticee) further strengthens the nexus among the entities and their game plan.

d. As regards other orders of noticee, it is seen from the Enquiry Report that the orders were entered simultaneously within close proximity of each other and for the same quantity which ensured matching of these orders of seller with a specific buyer. It is difficult to accept the argument of the noticee regarding its non awareness of prior understanding as the entities involved were related to it.

e. I note that the promoters of DSQ had created a class of partly paid shares which were listed and thus became indistinguishable from fully paid shares. Further, as they were trying to off-load these shares in the market through various front entities. For this purpose it was necessary that buyers are attracted to the scrip. To achieve this, the volumes in the scrip were needed to be created and prices were required to be kept up. The noticee was also well aware of the relationship between the company (DSQ) and its client (DSQ Holdings Limited). I note that inspite of having such knowledge to the noticee, it has failed to raise any doubt on the trading pattern of its client DSQ Holdings Limited.

f. I observe that all this could not have happened without the active connivance of noticee and points to the culpability of the noticee in aiding and abetting its clients in achieving their objectives which lead to the execution of fictitious transactions on the exchange and creation of artificial liquidity in the scrip. The intention of the entities to execute such transactions could be inferred from the attending circumstances because direct evidence in such cases may not be available. I note that the discussed pattern of trading tampers with the price discovery mechanism of stock exchange and also hampers transparency.

10. Whether the noticee had failed to exercise due care and diligence while dealing with its clients?

a. From the above discussion and considering the nature of the trades, I note that the noticee should not have provided independent terminal to its client and in all circumstances should have kept proper watch on the trading pattern of its client. Noticee should have acted vigilantly and should not have indulged in the pattern of trades which were not genuine or manipulative as discussed above.

b. According to me, the noticee should have had some suspicion on the trading pattern of its clients which were also related to it for keeping such high positions in the scrip of DSQ.

c. Thus, I find that the noticee has failed to perform its duties which are expected from a prudent stock broker who has a duty not only towards its client but also towards the securities market. A registered intermediary is expected to have high level of compliance of the rules/ regulations and the directives issued by SEBI.

11. The noticee has argued that the Enquiry Regulations are not applicable to it. I note that these regulations are procedural in nature and prescribes the procedure for conducting enquiries for the registered intermediaries. Further Regulation 23 of the Enquiry Regulations which reads as under:

“23. (1) Notwithstanding amendment of the regulations as specified in regulation 21, anything done or any action taken including any proceeding for inspections or investigation or enquiry commenced or any notice issued under the said regulations before the commencement of these regulations shall be deemed to have been done or taken under the corresponding provisions of these regulations. (2) In particular and without prejudice to the generality of the provisions of sub-regulation (1),- (i) an enquiry proceeding initiated by the Board under the relevant Regulations and pending before the Board before the commencement of these regulations shall be conducted and completed under the Relevant regulations as if those are not amended as specified in regulation 21; (ii) any order appointing an enquiry officer under the relevant Regulations and pending before such enquiry officer immediately before the commencement of these regulations shall be deemed to have been ordered under the corresponding provisions of these regulations.”

A reading of the above provision of Enquiry Regulations makes it amply clear that the procedure followed herein is valid. Hence, I do not find any merit in the argument of noticee.

12. In light of what has been stated in paras 9 and 10 above, it can be concluded that the trades done the noticee were structured in nature, yet their frequency and volume was not large. Such acts of the noticee are in violation of Regulation 4(a), (b) and (c) of PFUTP Regulations and Clause A(2), (3) and (5) of the Code of Conduct specified under Schedule II of the Broker Regulations.

13. As regards the submission of the noticee about delay, I note that there is no time limit on the disposal of a proceeding of this nature nor can the delay justify exoneration.

14. However, considering the volume generated, the number of trades syncronized in the scrip by noticee, number of days of trading during the relevant period of time and violation found to have been committed by the noticee in the present proceedings, I consider the penalty of suspension of the certificate of registration for a period of four months as recommended by the Enquiry Officer as a little too harsh. In the interest of justice and equity, I dispose of the present Enquiry proceedings as ordered herein below.

15. I note that pursuant to the notification of the SEBI (Intermediaries) Regulations, 2008, the Enquiry Regulations have been repealed and in terms of Regulation 38(2) of the SEBI (Intermediaries) Regulations, 2008, notwithstanding such repeal, any enquiry commenced under the Enquiry Regulations, shall be deemed to have been commenced under the corresponding provisions of SEBI (Intermediaries) Regulations, 2008.

16. Taking into consideration, the facts and circumstances of the case, I, in exercise of the powers conferred upon me in terms of Section 19 of the Securities and Exchange Board of India Act, 1992 read with Regulation 28(2) of Securities and Exchange Board of India (Intermediaries) Regulations, 2008, hereby suspend the certificate of registration of the stock broker,

Jayantilal Khandwala & Sons Pvt. Limited, registered with SEBI as stock broker, bearing registration no. INB 010998038 [PAN: AAACJ 9403D] for a period of three weeks.

17. This order shall come into force on expiry of twenty one days from the date of this order.

DATE : 14/JAN/2011 PRASHANT SARAN PLACE: MUMBAI WHOLE TIME MEMBER SECURITIES AND EXCHANGE BOARD OF INDIA