Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited

ORDER UNDER SECTION 12(3) OF THE SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992 READ WITH REGULATION 27 OF THE SECURITIES AND EXCHANGE BOARD OF INDIA (INTERMEDIARIES) REGULATIONS, 2008 In respect of NAME OF THE NOTICEE SEBI REGISTRATION NO. Kotak Commodity Services Private Limited INZ000044135 In the matter of National Spot Exchange Limited

BACKGROUND 1. The present proceedings originate from the Enquiry Report dated February 28, 2020 (hereinafter referred to as the “Enquiry Report), submitted by the Designated Authority (hereinafter referred to as the “DA”) in terms of Regulation 27 of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008 as it stood at the relevant point of time prior to its amendment vide Securities and Exchange Board of India (Intermediaries) (Amendment) Regulations, 2021, with effect from January 21, 2021, (hereinafter referred to as the “Intermediaries Regulations”), wherein the DA, based on various factual findings and observations so recorded in the said Enquiry Report, recommended cancellation of the certificate of registration granted to Kotak Commodity Services Private Limited (hereinafter referred to as the “Noticee”). Pursuant to the same, a Post Enquiry Show Cause Notice dated March 13, 2020 (hereinafter referred to as the “SCN”) was issued to the Noticee, along with the copy of the aforesaid Enquiry Report, copy of letter dated December 30, 2014 of Department of Economic Affairs, Ministry of Finance and copy of the decision of the Hon’ble Bombay High Court dated August 22, 2014 in respect of paired contracts offered on the platform provided by the National Spot Exchange Limited (hereinafter referred to as the “NSEL”). Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited

2. While the aforesaid proceedings were pending, Securities and Exchange Board of India (hereinafter referred to as the “SEBI”) passed five separate orders during February 2019, rejecting the applications filed by five other entities for registration as commodity brokers who were involved in NSEL matter. Aggrieved by the said SEBI orders, the entities filed separate appeals before the Hon’ble Securities Appellate Tribunal (hereinafter referred to as the “Hon’ble SAT”). The Hon’ble SAT, vide its common order dated June 09, 2022 (hereinafter referred to as “SAT order”), remanded the aforesaid SEBI orders to SEBI to decide these matters afresh within six months from the date of the said order. While remanding the aforesaid SEBI orders, the Hon’ble SAT, inter alia, held as under:

“42…The matters are remitted to the WTM to decide the matter afresh in the light of the observations made aforesaid in accordance with law after giving an opportunity of hearing to the brokers. All issues raised by the brokers for which a finality has not been reached remains open for them to be raised before the WTM. It will be open to the WTM to rely upon other material such as the complaint letters of NSEL, EOW report, EOW charge sheet, etc. provided such copies are provided to the brokers and opportunity is given to rebut the allegations. Such additional documents relied upon by the respondent should form part of the show cause Notice for which purpose, it will be open to the WTM to issue a supplementary show cause Notice……”

3. Thereafter, the Competent Authority of SEBI allocated the present matter to me for further proceedings. In light of the aforesaid SAT order, it was felt necessary to furnish certain additional documents/ material to the Noticee and grant an opportunity of personal hearing, before concluding the present proceedings. Accordingly, vide Hearing Notice dated November 11, 2022 (hereinafter referred to as the “Hearing Notice”), Noticee was provided an opportunity of personal hearing on December 13, 2022 along with certain additional documents/ material. Noticee was also advised to submit its response, if any, in relation to the Hearing Notice. Vide email dated December 09, 2022 and December 12, 2022, the entity had sought inspection of documents and adjournment of hearing. The request was acceded to and the hearing was adjourned to January 03, 2023. Further, an opportunity of inspection was also provided to the Noticee which was availed by it on December 19, 2022. On the scheduled date of hearing, the Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited authorised representatives of the Noticee appeared on behalf of the Noticee through video conference and made submissions on the lines of the replies submitted earlier. During the course of hearing, certain queries were raised to the Noticee and the Noticee was granted time to submit response to the said queries along with the post hearing submissions, if any. Accordingly, the Noticee, vide its letter dated March 08, 2023, provided its response to the queries.

4. The submissions filed by the Noticee vide its letters dated January 02, 2023 and March 08, 2023 are summarized hereunder: (i) The SAT Order dated June 09, 2022 has reversed and dismissed the findings contained in the DA Report and therefore the allegations contained in the SCN does not survive. (ii) The allegations/observations against NSEL, relied upon in the DA report have been expunged and the premise of ‘close association’ is no longer open to be contended by SEBI and the same is also dismissed by Hon’ble SAT. (iii) The Noticee has not conducted any trades on behalf of its clients and has merely traded on two occasion on the NSEL platform in its proprietary account. Therefore, any reference to conduct of the Noticee ‘as a broker’ does not survive. (iv) The proceedings against the Noticee are without jurisdiction as there is no violation of securities laws. (v) The supplementary SCN/Hearing Notice and the additional documents therein are lacking in material particulars of any allegations and therefore has no bearing against the Noticee. (vi) The Noticee is not named in the chargesheet filed in the matter. (vii) There is no material available on record to attract the commencement of the present proceedings under the Intermediaries Regulations. (viii) The amendment to Schedule II of the Intermediaries Regulations has come into effect from November 17, 2021 and it cannot be retrospectively applied to the present proceedings where the FIR is dated 2018 i.e. prior to the amendment of Intermediaries Regulations.

Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited

CONSIDERATION OF ISSUE AND FINDINGS 5. I have carefully perused the SCN, the Hearing Notice, the Enquiry Report, the replies filed by the Noticee and other material/ information available on record. After considering the allegations made/ charges levelled against the Noticee in the instant matter as spelt out in the SCN and Hearing Notice, the limited issue which arises for my consideration in the present proceedings is whether the Noticee satisfies the ‘fit and proper’ person criteria as laid down under Schedule II of the Intermediaries Regulations and whether the Certificate of Registration granted to the Noticee should be cancelled, as recommended by the DA or any other action should be taken against the Noticee.

6. Before I proceed to examine the issue vis-à-vis the material available on record before me, it would be appropriate to refer to the provisions of law applicable, which are alleged to have been violated by the Noticee and/ or are referred to in the present proceedings. The same are reproduced below for ease of reference:

SEBI Act, 1992 Registration of stock brokers, sub-brokers, share transfer agents, etc. 12.(3) The Board may, by order, suspend or cancel a certificate of registration in such manner as may be determined by regulations: Provided that no order under this sub-section shall be made unless the person concerned has been given a reasonable opportunity of being heard. Stock Brokers Regulations, 1992 Consideration of application for grant of registration. 5. The Board shall take into account for considering the grant of a certificate, all matters relating to trading, settling or dealing in securities and in particular the following, namely, whether the applicant, (e) is a fit and proper person based on the criteria specified in Schedule II of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008 Conditions of registration 9.Any registration granted by the Board under regulation 6 shall be subject to the following conditions, namely, - (b) he shall abide by the rules, regulations and bye-laws of the stock exchange which are applicable to him; … (f) he shall at all times abide by the Code of Conduct as specified in Schedule II; Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited

Liability for action under the Securities and Exchange Board of India (Intermediaries) Regulations, 2008. 27. A stock broker shall be liable for any action as specified in Chapter V of the Securities and Exchange Board of India (Intermediaries)Regulations, 2008 including suspension or cancellation of his certificate of registration as a stock broker, if he — (iv) has been found to be not a fit and proper person by the Board under these or any other regulations; Intermediaries Regulations, 2008 SCHEDULE II SECURITIES AND EXCHANGE BOARD OF INDIA (INTERMEDIARIES) REGULATIONS, 2008 [See regulation 7] (1) The applicant or intermediary shall meet the criteria, as provided in the respective regulations applicable to such an applicant or intermediary including: (a) the competence and capability in terms of infrastructure and manpower requirements; and (b) the financial soundness, which includes meeting the net worth requirements. (2) The 'fit and proper person' criteria shall apply to the following persons: (a) the applicant or the intermediary; (b) the principal officer, the directors or managing partners, the compliance officer and the key management persons by whatever name called; and (c) the promoters or persons holding controlling interest or persons exercising control over the applicant or intermediary, directly or indirectly: Provided that in case of an unlisted applicant or intermediary, any person holding twenty percent or more voting rights, irrespective of whether they hold controlling interest or exercise control, shall be required to fulfil the ‘fit and proper person’ criteria.

Explanation –For the purpose of this sub-clause, the expressions “controlling interest” and “control” in case of an applicant or intermediary, shall be construed with reference to the respective regulations applicable to the applicant or intermediary. (3) For the purpose of determining as to whether any person is a ‘fit and proper person’, the Board may take into account any criteria as it deems fit, including but not limited to the following: (a) integrity, honesty, ethical behaviour, reputation, fairness and character of the person; (b) the person not incurring any of the following disqualifications: (i) criminal complaint or information under section 154 of the Code of Criminal Procedure, 1973 (2 of 1974) has been filed against such person by the Board and which is pending; Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited (ii) charge sheet has been filed against such person by any enforcement agency in matters concerning economic offences and is pending; (iii) an order of restraint, prohibition or debarment has been passed against such person by the Board or any other regulatory authority or enforcement agency in any matter concerning securities laws or financial markets and such order is in force; (iv) recovery proceeding s have been initiated by the Board against such person and are pending; (v) an order of conviction has been passed against such person by a court for any offence involving moral turpitude; (vi) any winding up proceedings have been initiated or an order for winding up has been passed against such person; (vii) such person has been declared insolvent and not discharged; (viii) such person has been found to be of unsound mind by a court of competent jurisdiction and the finding is in force; (ix) such person has been categorized as a wilful defaulter; (x) such person has been declared a fugitive economic offender; or (xi) any other disqualification as may be specified by the Board from time to time.

(4) Where any person has been declared as not ‘fit and proper person’ by an order of the Board, such a person shall not be eligible to apply for any registration during the period provided in the said order or for a period of five years from the date of effect of the order, if no such period is specified in the order. (5) At the time of filing of an application for registration as an intermediary, if any Notice to show cause has been issued for proceedings under these regulations or under section 11(4) or section 11B of the Act against the applicant or any other person referred in clause (2), then such an application shall not be considered for grant of registration for a period of one year from the date of issuance of such Notice or until the conclusion of the proceedings, whichever is earlier. (6) Any disqualification of an associate or group entity of the applicant or intermediary of the nature as referred in sub -clause (b) of clause (3), shall not have any bearing on the ‘fit and proper person’ criteria of the applicant or intermediary unless the applicant or intermediary or any other person referred in clause (2), is also found to incur the same disqualification in the said matter: Provided that if any person as referred in sub-clause (b) of clause (2) fails to satisfy the 'fit and proper person' criteria, the intermediary shall replace such person within thirty days from the date of such disqualification failing which the ‘fit and proper person’ criteria may be invoked against the intermediary: Provided further that if any person as referred in sub -clause (c) of clause (2) fails to satisfy the ‘fit and proper person’ criteria, the intermediary shall ensure that such person does not exercise any voting rights and that such person divests their holding within six months from the date of such disqualification failing which the 'fit and proper person' criteria may be invoked against such intermediary.

Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited (7) The ‘fit and proper person’ criteria shall be applicable at the time of application of registration and during the continuity of registration and the intermediary shall ensure that the persons as referred in sub -clause s (b) and (c) of clause (2) comply with the ‘fit and proper person’ criteria.”

Recommendation of action 26. (1) After considering the material available on record and the reply, if any, the designated authority may by way of a report, recommend the following measures, – (i) disposing of the proceedings without any adverse action; (ii) cancellation of the certificate of registration; (iii) suspension of the certificate of registration for a specified period; (iv) prohibition of the Noticee from taking up any new assignment or contract or launching a new scheme for such the period as may be specified; (v) debarment of an officer of the Noticee from being employed or associated with any registered intermediary or other person associated with the securities market for such period as may be specified; (vi) debarment of a branch or an office of the Noticee from carrying out activities for such period as may be specified; (vii) issuance of a regulatory censure to the Noticee: Provided that in respect of the same certificate of registration, not more than five regulatory censures under these regulations may be recommended to be issued, thereafter, the action as detailed in clause (ii) to (vi) of this sub-regulation may be considered.

Order 27. (5) After considering the facts and circumstances of the case, material on record and the written submission, if any, the competent authority shall endeavor to pass an appropriate order within one hundred and twenty days from the date of receipt of submissions under sub-regulation (2) or the date of personal hearing, whichever is later

7. As noted above, taking cognizance of the order passed by Hon’ble SAT dated June 09, 2022, in NSEL matters, a Hearing Notice dated November 11, 2022 was issued to the Noticee calling upon it to show cause as to why the following information/ material along with the Enquiry Report dated February 28, 2020 should not be considered against it for determining whether the Noticee satisfies ‘fit and proper person’ criteria as laid down under Schedule II of the Intermediaries Regulations:

Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited a. SEBI complaint dated September 24, 2018 filed with EOW; b. First Information Report dated September 28, 2018; and c. Amended Schedule II of the Intermediaries Regulations.

8. Before moving forward to test the fulfilment of the ‘fit and proper’ person criteria by the Noticee, on the basis of available material including the additional material as detailed at paragraph 7 above, the background facts necessary for the present proceedings are narrated in brief, hereunder: a. The Noticee is a commodity derivatives broker registered with SEBI having Registration No. INZ000044135. b. NSEL was incorporated in May, 2005 as a Spot Exchange, inter alia, as an electronic exchange for trading in commodities. In exercise of powers conferred under Section 27 of the Forward Contracts (Regulation) Act, 1952 (hereinafter referred to as the "FCRA"), the Central Government vide its Exemption Notification granted an exemption to all forward contracts of one-day duration for the sale and purchase of commodities traded on the NSEL from operations of the provisions of the FCRA subject to certain conditions, inter alia, including “no short sale by the members of the exchange shall be allowed” and “all outstanding positions of the trades at the end of the day shall result in delivery”. c. In October 2008, NSEL commenced operations providing an electronic trading platform to its participants for spot trading of commodities, such as bullion, agricultural produce, metals, etc. It is observed that NSEL introduced the concept of ‘paired contracts’ in September 2009 which allowed buy and sell in same commodity through two different contracts at two different prices on the exchange platform wherein the investors could buy a short duration contract and sell a long duration contract and vice versa at the same time and at a pre-determined price.

The trades for the Buy contract (T+2/ T+3) and the Sell contract (T+25/ T+36) used to happen on the NSEL on the same day at same time and at different prices, involving the same counterparties. The transactions were structured in a manner that buyer of the short duration contact always ended up making profits. Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited d. On February 06, 2012, FMC was appointed by the Department of Consumer Affairs, Government of India as the ‘designated agency’ as stipulated in one of the conditions specified under the said Exemption Notification, authorizing it to collect the trade data from NSEL and to examine the same for taking appropriate measures, if needed, to protect investors’ interest. FMC had accordingly called for the trade data from NSEL in the specified reporting formats. After analysing the trade data received from NSEL, FMC passed Order No. 4/5/2013-MKT-1/B dated December 17, 2013 in the matter (“FMC Order”) wherein it was, inter alia, observed that 55 paired contracts offered for trade on the NSEL platform were in violation of the relevant provisions of the FCRA and that the condition of ‘no short sale by members of the exchange shall be allowed’, specified in the Exemption Notification, was not being complied by NSEL and its members.

9. I note that FMC was a statutory body set up under the FCRA and its functions were enumerated under section 4 of the Act. FCRA regulated forward contracts in notified goods entered into between the members of a recognised association or through or with any such member. An association recognised under the FCRA was empowered to make rules and bye-laws for the regulation of forward contracts subject to approval of the Central Government/FMC. Such an association concerned with the regulation and control of business relating to forward contracts was also required to obtain a certificate of registration from FMC, under FCRA. I note that FMC was having jurisdiction only on the associations recognised or registered under the FCRA or any member of such association. NSEL was not an association recognised under section 6 of FCRA nor was it an association registered under section 14A of FCRA, which provided that – "No association concerned with the regulation and control of business relating to forward contracts shall, after the commencement of the Forward Contracts (Regulation) Amendment Act, 1960 (62 of 1960) carry on such business except under, and in accordance with the conditions of a certificate of registration granted under this Act by the Commission." Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited

10. Section 27 of the FCRA empowered the Central Government to exempt any contract or class of contracts from the operation of all or any of the provisions of the Act. In exercise of the powers conferred under Section 27 of the FCRA, the Central Government, vide the Exemption Notification, had granted exemption to one-day forward contracts traded on NSEL from the operation of all provisions of FCRA, subject to conditions mentioned in the said Exemption Notification. Subsequently, the Central Government has issued notifications on February 06, 2012 and August 06, 2013, in partial modification of this notification dated June 05, 2007, by way of amending or inserting new conditions to the original notification, thereby assigning specific responsibility to FMC with respect to NSEL. Recognised associations were empowered to make rules and bye-laws under FCRA which would be approved by the Central Government/ FMC. However, NSEL was neither a registered nor a recognised association/ Exchange under FCRA and the bye-laws of NSEL were not reviewed or regulated or monitored by any authority.

11. I note that prior to the merger of FMC with SEBI on September 28, 2015, the Noticee was not required to be registered with either FMC or any other regulatory authority under the FCRA. The Parliament, noticing that the intermediaries dealing with commodities derivatives market were not required to be registered under FCRA and were not under control of any competent authority, rectified the same through the Finance Act, 2015, as notified on May 14, 2015, by bringing them under the regulatory supervision of SEBI. With regard to the aforesaid, the Hon’ble Bombay High Court while dealing with the Writ Petition Nos. 3262, 3266, 3294 and 3295 of 2018 in the matter of Anand Rathi Commodities Limited, Motilal Oswal Commodities Broker Private Limited, Geofin Comtrade Limited and IIFL Commodities Limited vs. SEBI, vide its Order dated October 04, 2018, observed the following:

“It is not in dispute that prior to the coming into effect of the Finance Act, 2015, the intermediaries dealing with the commodity derivatives were not required to be registered under any of the provisions of law including the FCR Act. We find that the Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited said mischief was Noticed by the Parliament. As such, by virtue of the Finance Act, 2015, the said intermediaries dealing with commodity derivatives have been brought under the control of SEBI. We find that the reason as to why by Finance Act, 2015, the said intermediaries were brought under the control of SEBI appears to be that the Parliament found that the activities of intermediaries dealing in commodity derivatives should not remain uncontrolled and they should be brought under the control of competent authority”.

12. I further note that the provisions in the Finance Act, 2015 effecting the merger of FMC with SEBI in September, 2015 do not, prima facie, confer any power on SEBI to take charge, deal, inquire and resolve NSEL settlement crisis that broke out in 2013. Pursuant to repeal of FCRA and dissolution of FMC in terms of Section 131 of Finance Act, 2015, all recognised associations under the FCRA became deemed recognised stock exchanges under the Securities Contracts (Regulation) Act, 1956 (hereinafter referred to as the “SCRA”). NSEL was not a recognised association under FCRA, therefore, a question regarding NSEL falling under the regulatory jurisdiction of SEBI does not arise.

13. I note that pursuant to the merger of FMC with SEBI, a commodity derivatives broker was mandatorily required to obtain a certificate of registration from SEBI in case it sought to remain associated with the securities market as a commodity derivatives broker. The Finance Act, 2015, inter alia, conferred the powers to SEBI to regulate commodity derivatives brokers, which included their registration as commodity derivatives broker with SEBI. In this regard, vide Section 131B of the Finance Act, 2015, a transitory period of 3 months was provided to all the intermediaries which were associated with the commodity derivatives market under the erstwhile FCRA to continue to deal in commodity derivatives as a commodity derivatives broker, provided it made an application of registration to the SEBI within 3 months from September 28, 2015. Accordingly, the Noticee applied for a certificate of registration and was registered as a broker and since then it has been acting as a market intermediary registered with SEBI.

Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited

14. I note that the power of SEBI to investigate/ inquire into the alleged violation of FCRA flows from the Finance Act, 2015, which amended the provisions of FCRA. Section 29A of FCRA, as inserted by the Finance Act, 2015 provides as under– “(1) The Forward Contracts (Regulation) Act, 1952 is hereby repealed. (2) On and from the date of repeal of Forward Contracts Act– (a)…. (b)…. (c)…. (d)…. (e) a fresh proceeding related to an offence under the Forward Contracts Act, may be initiated by the Security Board under that Act within a period of three years from the date on which that Act is repealed and be proceeded with as if that Act had not been repealed; (f) no court shall take cognizance of any offence under the Forward Contracts Act from the date on which that Act is repealed, except as provided in clause (d) and (e); (g) clause (d), (e), (f) shall not be held to or affect the general application of section 6 of the General Clauses Act, 1897 with regard to the effect of repeal to matters not covered under these sub-sections.”

15. I note that the aforesaid provision empowers SEBI to initiate a fresh proceeding with respect to the offences within a period of three years from the date on which FCRA is repealed. Thus, pursuant to the merger of FMC with SEBI, SEBI stepped into the shoes of FMC and was well within its powers to initiate proceedings under Chapter V of FCRA i.e., filing of the criminal complaint to the Economic Offences Wing (EOW). I note from the complaint dated September 24, 2018 filed by SEBI that EOW was requested to take appropriate action under Sections 20 and 21 and other provisions of FCRA against the brokers/ members of NSEL and other persons mentioned in the complaint. However, it is relevant to mention here that the aforesaid proceedings are different from the proceedings before me.

16. The Noticee has contended that the proceedings against it are without jurisdiction as there is no violation of securities laws. In this regard, it is noted that the present proceedings pertain to adjudging the ‘fit and proper person’ status specified in the Broker Regulations and the Intermediaries Regulations in light of the activities undertaken by the Noticee on the NSEL platform and Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited consequent action taken by FMC and SEBI, i.e., filing of the criminal complaint to EOW under Section 154 of the Code of Criminal Procedure, 1973 (“CrPC”). I note that in terms of Regulation 5(e) of the Stock Brokers Regulations, every applicant/ stock broker at the time of seeking registration, and thereafter, throughout the time it holds a valid certificate of registration, has to satisfy the “fit and proper person” criteria specified in Schedule II of the Intermediaries Regulations. I note that the Enquiry Report proceeds on the basis that the past conduct of the Noticee in participating in the “paired contracts” traded on NSEL calls into question the compliance of the Noticee with ‘fit and proper person’ criteria. Further, SEBI while examining the compliance of an applicant, or even a registered intermediary, with the ‘fit and proper person’ criteria can take into consideration not just contravention of the provisions of securities laws, but also the general conduct of the Noticee which may have a bearing on its functioning as a registered intermediary. The ‘fit and proper’ criteria including the amended criteria must be satisfied by the Noticee, at the time of making application of registration under the Stock Brokers Regulations as well as during the continuance of the registration once granted. To consider the application of the Noticee for the registration as a stock broker, the Noticee is required to satisfy the fit and proper person criteria and the Noticee is also required to satisfy the said criteria during the continuance of the registration also, and thus, it is well within the jurisdiction and powers of SEBI to adjudge the said ‘fit and proper’ status of the market intermediaries in the interest of securities market.

17. Before moving forward to consider the matter on merits, it would be appropriate to look at the background of NSEL and understand the nature of the ‘paired contracts’ that were offered on NSEL which ultimately is the cause/ genesis of the current proceedings.

18. From the perusal of the FMC Order in respect of the ‘paired contracts’, which were traded on the NSEL platform during the relevant period, I note that the FMC had, inter alia, observed that the following conditions stipulated in the Exemption Notification were violated: Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited a. Short Sale NSEL had not made it mandatory for the seller to deposit goods in its warehouse before taking a sell position. Hence, the condition of “no short sale by members of the NSEL shall be allowed” was not being met by the NSEL and its trading/clearing members who traded in the ‘paired contracts’ during the relevant period.

b. Contracts with Settlement Period going beyond 11 days Some of the contracts offered for trade on the NSEL had settlement periods exceeding 11 days and therefore, such contracts were “non-transferable specific delivery” contracts under the FCRA. As per the FCRA, the “ready delivery contracts” were required to be settled within 11 days of the trade and hence, the contracts traded on the NSEL, which provided settlement schedule for a period exceeding 11 days were not allowed and were in violation of Exemption Notification.

19. In this context, I note that NSEL was granted conditional exemption from the provisions of the FCRA by the Department of Consumer Affairs, Ministry of Consumer Affairs (hereinafter referred to as the “MCA”), Food and Public Distribution, Government of India, vide Gazette Notification No. S0906(E) dated June 05, 2007, in exercise of the powers conferred under Section 27 of the FCRA, for forward contracts for sale and purchase of the commodities of one– day duration traded on NSEL subject to certain conditions which, inter alia, included that ‘no short sale by members of the NSEL shall be allowed’ and that all ‘outstanding positions of the trade at the end of the day shall result in delivery’. It was also stipulated that all information or returns relating to the trade as and when asked for shall be provided to the Central Government or its designated agency. The spot exchanges were envisaged as a platform for providing transparent and secure trading in commodities with a view to boost the agriculture sector in the country. Thereafter, NSEL commenced operations in October 2008. Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited

20. It is observed that NSEL was given permission to setup as a spot exchange for trading in commodities. It was essentially meant to only offer forward contracts having one-day duration as per the Exemption Notification. In its order, FMC had observed that the 55 contracts offered for trade on the NSEL were with settlement periods exceeding 11 days and all such contracts traded on the NSEL were in violation of provisions of FCRA. I note from the FMC Order that under the FCRA, a “forward contract” is defined as a “contract for delivery of goods and which is not a ready delivery contract”. A ‘ready delivery contract’ is defined as “a contract which provides for the delivery of goods and the payment of a price therefor, either immediately or within such period not exceeding eleven days”. Given the said definition contained in the FCRA, FMC was of the view that all the contracts traded on the NSEL which provided settlement schedule exceeding 11 days were treated as Non-Transferable Specific Delivery contracts. It is, therefore, seen that even though MCA had stipulated in the Exemption Notification that only contracts of one-day duration were permitted to be offered on the NSEL, the FMC, in its order, relying on the definition of the “forward contract” under FCRA held that the NSEL was allowed to only trade in one-day forward contracts and was obliged to ensure delivery and settlement within 11 days. However, what is beyond doubt is that the NSEL had permitted 55 contracts of various commodities having duration longer than 11 days and these contracts were in contravention of the exemption granted to NSEL.

21. At this stage, it is also pertinent to refer to the judgment of the Hon'ble Supreme Court of India passed in the matter of 63 Moons Technologies Ltd. (formerly known as Financial Technologies India Ltd.) & Ors. vs. Union of India & Others (Civil Appeal No. 4476 of 2019 decided on April 30, 2019) (hereinafter referred to as the “merger petition”), wherein it was, inter alia, held that:

“55.3 We have seen that neither FTIL nor NSEL has denied the fact that ‘paired contracts’ in commodities were going on, and by April to July, 2013, 99% (and excluding E-series contracts), at least 46% of the turnover of NSEL was made up of such ‘paired contracts’. There is no doubt that such Paired Contracts were, in Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited fact, financing transactions which were distinct from sale and purchase transactions in commodities and were, thus, in breach of both the exemptions granted to NSEL, and the FCRA”.

22. Further, I note that in the judgment dated April 22, 2022 passed by the Hon’ble Supreme Court in the matter of the State of Maharashtra vs. 63 Moons Technologies Ltd. (Civil Appeal No. 2748-49 of 2022) (hereinafter referred to as the “MPID matter”), the Hon’ble Supreme Court while drawing reference to the representations made by NSEL in respect of the paired contracts, inter alia, held that:

“The above representation indicates that ‘paired contracts’ were designed as a unique trading opportunity by NSEL under which a trader would, for instance, purchase a T+2 contract (with a pay-in obligation on T+2) and would simultaneously sell a T+25 contract (with a pay-out of funds on T+25). The price differential between the two settlement dates was represented to offer an annualized return of about 16%. NSEL categorically represented that all trades were backed by collaterals in the form of stocks and its management activities included selection, accreditation, quality testing, fumigation and insurance. Therefore, NSEL represented that on receiving money and commodities, the members would receive assured returns and a service. Though NSEL has been receiving deposits, it has failed to provide services as promised against the deposits and has failed return the deposits on demand. Therefore, the State of Maharashtra was justified in issuing the attachment notifications under Section 4 of the MPID Act.”

23. Thus, I note that the Hon’ble Supreme Court has already described the nature of the ‘paired contracts’ offered on the NSEL platform. In the merger petition (63 Moons Technologies Ltd. vs. UOI), it was held that these contracts were in the nature of financing transactions. In the MPID matter (The State of Maharashtra vs. 63 Moons Technologies Ltd.), the Hon’ble Supreme Court held that such transactions come within the definition of ‘deposits’ under the MPID Act. The Hon’ble Supreme Court in the MPID matter, has extensively referred to the claims made on the website of the NSEL and the contents of the publicity material and other investor resources. The Hon’ble Supreme Court has also observed that NSEL was advertising assured and uniform return of 16% p.a. for the ‘paired contracts’ traded on its platform where the return offered was same across the commodities. The return remained the same irrespective of the duration of the Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited contract. In the said Order, the Hon’ble Supreme Court has also depicted certain examples of ‘paired contracts’, which offered assured returns. For example, a T+2 and T+25 paired contract in steel had the same offered return as a T+5 and T+35 paired contract in castor oil. The ‘paired contracts’ were being marketed as an alternative to fixed deposits. In view of the above, I note that the FMC Order and both the judgments of the Hon’ble Supreme Court discuss in detail that, NSEL was permitting short sales, i.e., permitting sellers to offer contract for sale of commodities on its platform without ensuring that requisite amount of commodity is available in the warehouse.

24. In so far as the trades of the Noticee on the platform of NSEL are concerned, I note that the Noticee has submitted that it has not executed any trades on behalf of its clients and has merely traded in its proprietary account on two occasions (July 08, 2011 and July 12, 2011) on the NSEL platform. It is further submitted that these trades were executed to simply check the viability of the NSEL trading platform. I also note that the DA has observed that the Noticee participated in paired contracts of CASTKADI13 and CASTKADI36 on July 08 and July 12, 2011.

25. Considering the deliberations and discussions recorded above and the submissions of the Noticee, the moot question is whether the Noticee while participating in ‘paired contracts’ in its proprietary account was under the bonafide belief that such transactions were actually spot contracts in commodities. Or, can it be said that the very fact that ‘paired contracts’ were offered meant that NSEL was offering contracts which were not resulting in compulsory delivery and, therefore, the Noticee should have been aware that such a product was far removed from the spot trading in commodities which was permitted on NSEL’s platform. Further, as stated above, NSEL itself was advertising such contracts as an alternative to fixed deposits and an annualized return of about 16% was offered across all commodities, irrespective of the nature of the contract or the duration. Also, these contracts were structured in a manner which ensured that the buyer always made pre-determined profits. Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited

26. In the undeniable background that there was a settlement default at NSEL, it is clear that there were enough red flags which should have alerted the Noticee when these products were first offered by NSEL. With the material on record, it is further clear that any prudent person (including the Noticee) would have come to the conclusion that what was being offered were not spot contracts in commodities and rather had trappings of a financial product which offered fixed and assured returns, as has been already observed by the Hon’ble Supreme Court in the State of Maharashtra vs. 63 Moons Technologies Ltd. The Notification regarding approval of contracts permitted on NSEL was also in public domain. Thus, I find that Noticee failed to perform basic due diligence of the contracts offered vis-a-vis the conditions specified in the aforesaid Notification.

27. The execution of the trades in ‘paired contracts’ by the Noticee shows its participation in products that were not permitted under the Exemption Notification and were purely financial contracts promising assured returns under the garb of spot trading in commodities.

28. Having established that the Noticee has traded in ‘paired contracts’, I now proceed to examine the allegations levelled against the Noticee in the SCN and the Hearing Notice. It is noted that the main allegation against the Noticee, as levelled in the SCN, is that by participating in ‘paired contracts’ on NSEL platform the continuance of the registration of the Noticee as a broker is detrimental to the interest of the Securities Market and the Noticee is no longer a ‘fit and proper person’ for holding the certificate of registration as a broker in the Securities Market, which is one of the conditions for continuance of registration as specified in regulation 5(e) of the Stock Brokers Regulations read with Schedule II of the Intermediaries Regulations as applicable at the relevant time. Subsequently, SEBI, on the basis of certain documents/material such as SEBI’s Complaint dated September 24, 2018 and FIR dated September 28, 2018 as provided to the Noticee vide Hearing Notice, further alleged that in light of the aforesaid documents as well as observations against the Noticee in the Enquiry Report, Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited the Noticee is not a ‘fit and proper person’ for holding the certificate of registration. I note that regulation 5(e) of the Stock Brokers Regulations provides that for the purpose of grant of Certificate of Registration, the applicant has to be a ‘fit and proper person’ in terms of Schedule II of the Intermediaries Regulations. I further note that the ‘fit and proper person’ criteria specified in Schedule II of the SEBI (Intermediaries) Regulations, 2008, was amended vide SEBI (Intermediaries) (Third Amendment) Regulations, 2021 with effect from November 17, 2021.

29. In order to continue as a SEBI registered intermediary, the Noticee is, inter alia, required to satisfy the conditions of eligibility, which include ‘fit and proper person’ criteria. The above condition to be a fit and proper person is a preliminary condition applicable at the time of seeking registration and also during the continuance of such registration. As and when the ‘fit and proper’ criteria changes, the Noticee will be required to comply with the revised criteria, and in this instance, criteria were revised vide the amendments in November 2021. It is noted that parameters provided under paragraph 3(b) of the amended criteria of Schedule II of the Intermediaries Regulations lay down a list of disqualifications which, inter alia, includes the following:

“(3) For the purpose of determining as to whether any person is a ‘fit and proper person’, the Board may take into account any criteria as it deems fit, including but not limited to the following: (b) the person not incurring any of the following disqualifications: (i) criminal complaint or information under section 154 of the Code of Criminal Procedure, 1973 (2 of 1974) has been filed against such person by the Board and which is pending;”

30. From the records, I note that SEBI has filed a complaint with EOW Mumbai on September 24, 2018, against brokers who facilitated access to ‘paired contracts’ traded on NSEL, including the Noticee. On the basis of this complaint, FIR dated September 28, 2018, was registered with the MIDC Police Station, Mumbai, against the Noticee. I note that the Noticee is holding a certificate of registration granted by SEBI. In order to continue to hold such Certificate of Registration from Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited

SEBI, the Noticee is also required to satisfy the conditions of eligibility, which, inter alia, included, continuance of its status as a ‘fit and proper person’. The above condition to be fit and proper person is not a one-time condition applicable only at the time of seeking registration. Rather, the provisions governing the criteria show that this is a condition which each and every registered intermediary is required to fulfil on a continuous basis as long as the entity remains associated with the Securities Market as a registered intermediary.

31. The scope of the instant proceeding is not to analyse the actual impact and consequences of the conduct of the Noticee but to examine as to whether or not, the Noticee has acted in a manner expected of a market intermediary and the answer to the same goes against the Noticee. The fact that is undeniably clear before me is that the involvement of the Noticee in trading in ‘paired contracts’ on NSEL is certainly a conduct which was not permitted by the Exemption Notification nor by any of the applicable provisions of the FCRA.

32. As discussed above, the Noticee has participated in ‘paired contracts’. As the paired contracts were violative of the conditions stipulated in the Exemption Notification, a complaint was filed by SEBI with EOW on September 24, 2018, against the brokers who participated/ facilitated access to ‘paired contracts’ traded on NSEL, including the Noticee within the time limit, as specified under section 29A(2)(e) of the FCRA. On the basis of the said complaint of SEBI, FIR dated September 28, 2018 was registered with MIDC Police Station, Mumbai.

33. The Noticee has submitted that Schedule II of the Intermediaries Regulations was amended with effect from November 17, 2021 and the same cannot be made applicable retrospectively. In this regard, it is pertinent to note that the criteria of ‘fit and proper person’, is an ongoing requirement throughout the period during which the Noticee remains operational in the Securities Market as a registered intermediary. In case, pursuant to the grant of registration by SEBI, any evidence comes to the notice of SEBI that casts a doubt on the integrity, reputation and character of the registered intermediary, SEBI is well within its powers to examine Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited the ‘fit and proper person’ status of such entity based on various parameters. Therefore, even if the Noticee was found to have fulfilled the ‘fit and proper person’ criteria when SEBI granted it the certificate of registration in 2015, such an intermediary can still be assessed on being fit and proper at a later date. Furthermore, as and when the ‘fit and proper person’ criteria changes, the Noticee will be required to comply with the revised criteria, and in the instant case, criteria as revised vide the amendment in November, 2021. It is noted that parameters provided under Clause 3(b) of the amended criteria of Schedule II of the Intermediaries Regulations lay down a list of disqualifications which includes the disqualification provided in Clause3(b)(i) under the amended Schedule II of the Intermediaries Regulations in so far as an FIR against the Noticee under section 154 of CrPC has been registered with the MIDC Police Station, Mumbai and the same is subsisting/pending as on date. Further, it is also not the case of the Noticee that the aforesaid FIR is either stayed or quashed by any competent court qua the Noticee or otherwise. It is, therefore, noted that the Noticee attracts the disqualification provided in Clause 3(b)(i) of the Schedule II of the Intermediaries Regulations.

34. At this juncture, I deem it appropriate to deal with the submission of the Noticee that its name is not mentioned in the chargesheet filed by EOW pursuant to the FIR dated September 28, 2018. In this regard, it is noted that even though the name of the Noticee is not appearing in the chargesheet filed in the matter but it is a matter of fact that its name is there in the FIR registered by EOW. The implications of existence of the said FIR have already been discussed in the preceding paragraphs. I note that being a ‘fit and proper’ person is a continuing ‘eligibility criteria’/ statutory requirement, which must be satisfied by the Noticee including the amended criteria, at all times. I am of the considered view that the due presumption on the constitutional and legal validity of the said amended Schedule II of the Intermediaries Regulations holds the field which is binding upon SEBI, and arguments to the contrary are not maintainable. It is not the case of the Noticee that the said FIR has been quashed qua the Noticee. In view of Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited the above, I am not inclined to accept the submissions put forth by the noticee in this context.

35. Given the above discussions and deliberations, I conclude that the act of the Noticee in participating in a product, wherein it was not permitted to trade raises serious questions on the ability of the Noticee to conduct proper and effective due diligence regarding the said product itself. Further, as per findings recorded in earlier paragraphs, the Noticee attracts the disqualification provided in Clause 3(b)(i) under the amended Schedule II of the Intermediaries Regulations in view of the FIR filed against the Noticee which is pending as on date. In view of the above, I hold that the Noticee does not satisfy the ‘fit and proper person’ criteria specified in Schedule II of the Intermediaries Regulations and hence, the same deserves appropriate measure.

Consideration of DA’s recommendation: 36. The DA in the Enquiry Report, after determining that the Noticee is not a “fit and proper”, has recommended that the certificate of registration of the Noticee be cancelled.

37. As discussed in the preceding paragraphs, the facts and circumstances in the instant matter lead to the conclusion that the Noticee is not a “fit and proper” person. Once an entity has been declared to be not “fit and proper”, in the interest of securities market, it should not be allowed to continue to act as an intermediary till the time it does not regain its “fit and proper” status. In this context, it is pertinent to mention that in several scenarios, a defect which is the reason for holding an intermediary not “fit and proper” is curable at the hands of the intermediary, while in certain scenarios, it is not.

38. In the present case, the Noticee has been found to be not ‘fit and proper” for the reason that its conduct has been found wanting because of the Noticee’s involvement in trading of “paired contracts” on the NSEL platform through its proprietary account and also for the reason that in that regard, a FIR dated Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited

September 28, 2018 has been registered by EOW, which is subsisting as on date.

39. Schedule II of the Intermediaries Regulations, in clause 4 provides that “Where any person has been declared as not ‘fit and proper person’ by an order of the Board, such a person shall not be eligible to apply for any registration during the period provided in the said order or for a period of five years from the date of effect of the order, if no such period is specified in the order”. This clause, in my view, covers scenarios of ‘cancelation’ or ‘suspension’ of the certificate of registration of the intermediary.

40. Thus, the Intermediaries Regulations envisage deeming time limit (of 5 years) or specification of a time limit by the deciding authority, within which the intermediary can cure the defects which led to determination of its status, if the same can be done at its end. The said specification of period also serves as a reformative direction against the intermediary.

41. Considering the above, in the instant case, having held that the Noticee is not “fit and proper”, the question for determination is what would be the appropriate direction in the given facts and circumstances. Noticee has submitted that it had traded in paired contracts only on two occasions and that too in its proprietary account to simply check the viability of the NSEL trading platform. I note that being a commodity broker and a member of MCX and NCDEX, Noticee ought to have been aware of the exemption granted to NSEL by the Central Government under the FCRA which exempted one-day forward contracts traded on NSEL from the operation of all provisions of FCRA. However, I deem it fit to note that given the frequency and nature of trades, the risk associated with the trading in paired contracts was concentrated to the Noticee itself and its clients were not exposed to the ‘paired contracts’.

42. The DA has recommended cancellation of the certificate of registration of the Noticee. However, given the fact that the Noticee participated in paired contracts in the year 2011 only on two occasions in its proprietary account, I am of the Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited considered view that a direction of prohibiting the Noticee from trading in proprietary capacity and taking up any new clients for a period of fifteen (15) days or till the time the FIR ceases to be “pending”, would be proportionate and more appropriate in the present case and would meet the ends of justice.

Order 43. In view of the foregoing discussions and deliberations, I, in exercise of powers conferred upon me under Section 12(3) and Section 19 of the SEBI Act, 1992 read with Regulation 27 of the Intermediaries Regulations, prohibit the Noticee i.e. Kotak Commodity Services Private Limited bearing Certificate of Registration (bearing No. INZ000044135) from trading in proprietary capacity and taking up any new clients for a period of fifteen (15) days from the date of this Order or till the FIR filed against the Noticee by EOW ceases to be pending or the Noticee is discharged or acquitted by a Court in relation to the FIR, whichever is later.

44. The Noticee shall, after receipt of this order, immediately inform its existing clients, if any, about the aforesaid direction.

45. This Order shall come into force with immediate effect.

46. The above Order is without prejudice to the proceedings pending in pursuance of the criminal complaint filed by SEBI in the matter of trading on NSEL and/or any proceedings pending before any authority in respect of similar matter concerning the Noticee or other relevant persons.

47. A copy of this order shall be served upon the Noticee and the recognized Market Infrastructure Institutions for necessary compliance.

Sd/- Place: Mumbai AMARJEET SINGH Date: December 22, 2023 WHOLE TIME MEMBER SECURITIES AND EXCHANGE BOARD OF INDIA

Order in respect of Kotak Commodity Services Private Ltd. in the matter of National Spot Exchange Limited