Order in the matter of Alka Securities Limited and Mahesh Kothari Shares and Stockbrokers Pvt Ltd

1. Securities and Exchange Board of India (hereinafter referred to as SEBI), vide order dated October 16, 2009 while confirming the earlier directions (passed vide order dated July 28, 2009) inter alia against Alka Securities Limited and Mahesh Kothari Shares and Stock Brokers Private Limited had directed National Stock Exchange of India Limited (hereinafter referred to as NSE) and Bombay Stock Exchange Limited (hereinafter referred to as BSE) to appoint an independent auditor on or before October 22, 2009 to verify the ownership of the shares lying in the beneficial owner accounts of the aforesaid stock brokers. NSE and BSE were further advised to direct their respective auditors to submit the report within a period of six weeks from the date of such appointment, to the respective stock exchanges which were to forthwith forward the same to SEBI. Subsequently, the aforesaid stock brokers along with others filed an appeal before the Hon’ble Securities Appellate Tribunal (SAT) against the Order of SEBI dated October 16, 2009. The Hon’ble SAT, vide order dated November 11, 2009 while disposing of the said appeal inter alia noted in the said order “The learned counsel appearing for the Board informs us that the independent auditor has since been appointed and that he would be submitting his report within six weeks from the date of his appointment. He further states that on the basis of that report suitable directions shall be issued within ten days from its receipt to release the shares belonging to the clients of the two brokers. In view of this statement we do not think it necessary to issue any directions.” The said period of ten days was subsequently extended upto January 31, 2010 by Hon’ble SAT, vide order dated January 15, 2010, on an application filed by SEBI, for the reasons stated therein. 2. I have perused the reports submitted by Deloitte Haskins & Sells (hereinafter referred to as DHS), Chartered Accountants appointed by BSE and NSE, in terms of the SEBI Order dated October 16, 2009. The said reports were forwarded to SEBI, by NSE and BSE, on January 1, 2010 and on January 4, 2010, respectively. DHS has inter alia mentioned in its report that there were delays and difficulties in obtaining the relevant records. The relevant observations are reproduced below:

“5. Delay in Receipt of records: On the first day of our assignment, we have informed the member to declare their entire beneficiary / pool accounts, furnish us the complete client master and KYC for all their existing clients. We observed during the progress of the assignment that there were two (2) more accounts existing, viz, 1) 1302080100008048 and 2) 1302080000101790, both the accounts being opened with Bank of India in the name of ‘Alka Securities Ltd’. We were informed that these accounts were closed before being frozen. The same were later furnished to us at our instance, with a considerable delay of at least 6-7 days, consequently leading to a delay in our process. The Client master furnished to us had undergone a revision 2 times. The member informed us that to collate all the KYCs asked by us would be very difficult & time consuming, hence in order to save time, we have verified client DP master of the KYC for 269 clients (clients registered both with MK & Alka Securities), although the same were received by us after a considerable delay. Further of these in many cases the KYC form were not attached 6. We have requested the member to provide us the system audit report furnished to NSE, however the same is not provided to us. 7. We observed that the ownership of scrips trails back to 2006-07 and period prior to the same. We are informed that the member’s back office record does not support extraction of trade/ownership details prior to December 13, 2006. In light of the same, we have been unable to identify the ownership of such scrips…”

3. SEBI was also in receipt of copy of letters addressed by DHS to NSE and BSE, citing their difficulty in procuring the records. On receipt of the same, SEBI, advised the aforesaid stock brokers to extend their co-operation. SEBI also advised the stock exchanges to co-ordinate with their respective members. The stock brokers, in turn, responded to SEBI indicating that they were making their best efforts to help the auditors to complete the assignment. DHS considered appropriate to follow certain methodologies for identifying the owners for the securities. DHS identified that the aforesaid stock brokers had two beneficiary accounts one each with two Depository Participants (DP), viz, IndusInd Bank and Bank of India. The total scrips in those DP accounts were as under:

DP Name Number of Scrips (in NSE) Number of Scrips (in BSE) IndusInd Bank 159 147 Bank of India 166 18 TOTAL 325 165

DHS had adopted the following methodology: Procedure I (a) The holding statement and detailed transaction statements were obtained directly from the two DPs from inception until July 28, 2009, i.e. the date on which the DP account has been frozen. (b) Each particular scrip was traced backwards from the closing stock to identify the purchase lot/settlement to which it pertained to. If it was an off market transfer, the same was noted for identifying ownership from the Client Master. (c) Trade files were obtained for each settlement from the stock brokers. (d) Transactions pertaining to the scrip were verified and all parties/clients who have purchased the scrip were shortlisted. (e) The same was compared with the ownership identified by the stock broker. (f) If there was no discrepancy, then, the same was verified, on a test check basis to ensure that the shares have not been subsequently sold / transferred. (g) Having ensured the ownership, the same was noted down and all the scrips which passed through the above procedure were included in Annexure I to the reports. (h) Further, in several instances where more than one investors were found by their procedure as potential “owners”, they have gone by the parties/”owners”, as identified by the stock broker. Procedure II (a) If there was any discrepancy between ownership identified by the auditors and those identified by the broker, per above step (e), the same was noted separately. (b) Since the broker had already identified the ownership for all the scrips lying in their beneficial account, the auditor provided all the scrips identified per step II (a) above to the broker and gave them an opportunity, although not obligatory, to prove their findings as otherwise. The broker provided the settlement to which the trade belongs to, to the auditor. (c) The relevant trade files for the same were obtained to verify the purchase by the owner, as identified by the broker. (d) Checked the back office generated client wise scrip wise (CwSw) ledger, to track movements post the trade date. {Without placing reliance on brokers’ record, save for the purpose of checking post trade date [per Procedure II (c) above)] movement, and a very limited reliance on the CwSw ledger}.

(e) For any scrip’s ownership as identified by the broker, if the auditors were not convinced or if it was not found in the trade file identified by the member, the same was ignored and the auditor’s findings for the same were considered as final. (f) For scrips, which passed all the steps satisfactorily per Procedure II (a through d), the same was noted. All these scrips and scrips wherein the auditor’s findings per Procedure II (e) are considered final are attached as Annexure II of the reports. Procedure III For scrip there could be multiple owners. In case of certain scrips, the auditor has not been able to identify ownership, either partly or fully. Annexure III of the reports detail all the scrips for which part ownership is not identifiable. Scrips wherein the auditor has not been able to identify any ownership are detailed in Annexure IV of the reports.

4. DHS in their respective reports had highlighted that the stock brokers had not maintained the ‘Register of Securities’ and the said non maintenance was a material weakness in their system. They have also observed that the securities have been co-mingled even between the said stock brokers. Further, non-availability of records for the period prior to 2006-07 from the systems have complicated and expanded their challenge significantly. DHS also noticed certain bugs/errors in some programme results itself. The said observations are reproduced below: “Register of securities (clientwise-scripwise) showing the actual movement of shares as per pool, beneficiary accounts & off-market transfers was not provided to us. We understand that the same is part of a mandatory requirement per Chapter IV of SEBI (Stock Brokers and Sub-brokers) Regulations, 1992. We wish to highlight that non maintenance of a mandatory ‘Register of Securities’ is a material weakness in the system. As informed to us the member has been using ‘Comtek’ software for back-office, we understand that there is a functionality / feature available in ‘Comtek’ wherein a ‘Register of Securities’ can be maintained on a real time basis. However we were informed that the feature was not being used.Consequently, for the purposes of our Agreed Upon Procedure Assignment, we learnt during the course of our assignment that the member has, post our commencement of the assignment, developed a program for a limited purpose of identifying trade date / subsequent sale. We also wish to highlight that we noticed certain bugs/errors in program results. On test check basis, when we verified owners identified by us per trade file with the report generated by the In house developed programme, we were not able to find some transactions. e.g. ISIN Scrip Name Client ID – per trade file Qty Settlement No Exchange INE966H01019 Zee News RA0019 50 0607202 BSE INE224B01024 BIRLA POWER-EQ RE 1 KA0037 1,500 0910032 BSE INE892H01017 Great Offshore – Eq KA0034 14 0607200 BSE INE221H01019 GTL Infrastructure Ltd BY0021 200 2008001 NSE

…………..”

2. As informed to us by the member and also based on the number & ageing of scrips lying in the members beneficiary account, it is observed that the shares of clients are held in the member’s beneficiary accounts irrespective of the fact whether there is any outstanding dues or not. We are informed that the reason for the same is avoidance of any administrative hassles by the client of transferring in/out securities to/ from their DP account. The shares are only transferred to the clients, if specifically asked for by the client.

3. Co-mingling of Securities:

As brought out earlier the member is registered with NSE and its associate Mahesh is registered with BSE. Both members have client beneficiary accounts in IndusInd Bank & Bank of India. I Bank is used for securities pay in/out and BOI is used for pledge of securities for availing of funds facility for pay in/out. We observed in many instances that the shares purchased in one demat account of Alka are later on transferred to demat account of Maesh and vice versa. The reasons for this were not explained to us. We were informed that whenever the client does not fulfill his/her funds obligation on time, the shares purchased on behalf of the client are pledged with BOI, wherein as informed to us, the member has got a working capital facility against the pledge of shares. Also we have found instances wherein for example if securities are purchased on behalf of a client in NSE and were held in NSE beneficiary account as pledged securities. Later if the same client has sold those shares in BSE entity the trading member makes pay-in from BSE beneficiary account if the securities are lying as free and held not necessarily on behalf of same client in BSE beneficiary account.

4. Flaws in the back office system and the holding ownership as identified by the member:

We have observed in many instances wherein the trade file shows that shares have been bought by client code BO1000 (Alka Securities/ Aidos trade Ltd), whereas, in the list of holding details prepared by the member, not a single scrip has been identified as belonging to BO1000, in most of the cases the same is identified by the member as belonging to client code BY0021 (Skylark Mercantile Pvt Ltd). We further observed that even the back-office CwSw ledger shows that it belongs to BY0021. We wish to highlight that some of the scrips are very less frequently traded (either in the exchange or by the member); hence to identify the actual ownership for such cases is not difficult. In such cases wherein we are not satisfied with the member’s contention / explanation, we have proceeded with our findings and are part of Annexure II or III as the case may be, as explained in Methodology – Procedures section of our report. We also observed apparent errors in the holding details prepared by the member. To illustrate, for scrip by the name ‘Reliance Power Ltd’ (RPower), the member has identified that the same belongs to code BY0021 and the settlement number identified is 2006181. We wish to highlight that the same is not possible since the IPO of RPower itself had come only in January 2008.” 5. The said reports were perused by SEBI.

As certain clarifications were necessitated on the methodology adopted by DHS and their observations, SEBI, vide letter dated January 13, 2010 advised NSE and BSE to obtain further details from the auditors on the issues stated therein. Thereafter, NSE forwarded the response received from DHS to SEBI. In response to a specific query about the off market transfers noted from the ‘Client Master’ of the respective stock brokers, DHS could not a give a satisfactory reply. The reply of DHS in this regard is that “…..Also as mentioned in our report we wanted to verify the DP masters for all the clients, however the member has furnished us only the aforesaid mentioned DP masters to us for verification”. Further, DHS in its reports had observed “Having ensured the ownership, the same was noted down and all the scrips which passed through the above procedure were included in Annexure I to the reports”. However, in respect of the same, DHS had also observed that in several instances where more than one investors were found by their procedure as potential “owners”, they have gone by the parties/”owners”, as identified by the stock broker.

Further, some the shares lying in those accounts were found to be pledged.

6. On a consideration of the reports submitted by DHS, I am of the view that it is nearly impossible to identify the shortcomings without delving into the records at a transaction level. It is noted that though, DHS had identified ownership in respect of certain scrips which have been listed in Annexure I to the report, it had observed “…………for reasons as explained in our observations, in the light of these facts & circumstances, it is possible that, for ownership as identified by us, the shares may have been subsequently transferred / sold by the owners, to other parties. Further, as set out in Procedure – I (h) above, in several instances where more than one investor were found by our procedure as potential “owners”, we have gone by the parties/”owners”, as identified by the member.” I also note that in respect of those securities listed in Annexure II of the reports, DHS stated that there were discrepancies with regard to the ownership as identified by it and the stock brokers. In respect of Annexures III and IV to the reports, DHS was unable to identify the ownership of securities listed in the said annexures.

Since, the matter pertains to identification of title, no margin of error can be allowed and hence an objective basis has to be found to ameliorate the hardships of the investors who have their securities lying with the aforesaid stock brokers. It is also observed that some of the securities lying in these accounts have not been paid for fully/partially. Thus, for such cases, it shall also be necessary to quantify the total amount due from these clients and such clients can have their securities released only after they pay their dues in full. The auditors have also mentioned that a part of the holding in the demat accounts held with Bank of India (depository participant) is pledged with the bank. The matter needs to be seen in the context that the stock brokers were not maintaining the mandatory ‘Register of Securities’, which if maintained would have enabled DHS to identify the clients’ securities accurately. Further, the stock brokers were also not using the feature available in their software wherein the said Register could have been maintained on a real time basis. In view of the aforesaid reasons, the auditor’s reports do not help in properly ascertaining the ownership of those securities held in the beneficiary accounts maintained in the name of the said stock brokers.

Thus, at this stage no directions can be issued based on the incomplete findings (due to the critically limiting factors faced by the auditor) in the auditor's reports for transfer of securities held in the beneficiary accounts of the said stock brokers. In such circumstances, it is imperative to explore an alternate mechanism to find out the same, in the interest of such investors.

7. In view of the foregoing, I, in exercise of powers conferred upon me under Sections 11 and 11B of the Securities and Exchange Board of India Act, 1992 read with Section 19 thereof, issue the following directions:

i. The National Stock Exchange of India Limited and the Bombay Stock Exchange Limited shall constitute a committee for the purpose of release of securities to the respective clients of Alka Securities Limited and Mahesh Kothari Shares and Stock Brokers Private Limited.

ii. The Committee shall comprise of three members, one official each from National Stock Exchange of India Limited, Bombay Stock Exchange Limited and to be chaired by an independent expert.

iii. National Stock Exchange of India Limited and Bombay Stock Exchange Limited shall together forward the names of three persons to Securities and Exchange Board of India for the selection of the independent expert, within two working days of the receipt of this Order.

iv. Alka Securities Limited and Mahesh Kothari Shares and Stock Brokers Private Limited are directed to reconcile the client wise securities position and recreate the securities register within ten working days of this order and the same shall be submitted to the Committee.

v. The terms of reference for the said Committee shall be as under: a. To make a public notice through two national news papers inviting claims from the clients of Alka Securities Limited and Mahesh Kothari Shares and Stock Brokers Private Limited whose shares are said to be lying in the beneficiary accounts of the aforesaid stock brokers. b. To scrutinize such claims, so received, based on supporting documents produced by such clients and the records including those provided by the aforesaid stock brokers/concerned stock exchanges for ascertaining the ownership. While doing so, the Committee shall also consider the submissions/claims, if any, of the aforesaid stock brokers. c. To prepare and issue a final list of owners of such securities to whom the same shall be transferred along with the beneficiary account details.

d. The release of such securities shall be backed by an undertaking given by such clients stating that they shall be liable for any false claims made by them.

vi. The Committee shall complete the process within three months from the date of its constitution and shall submit a report in this regard to National Stock Exchange of India Limited and Bombay Stock Exchange Limited. The said report shall in turn be forwarded to Securities and Exchange Board of India, by the said stock exchanges.

vii. In view of the serious observations made by Deloitte Haskins & Sells, Chartered Accountants, in respect of the non maintenance of crucial records such as securities register, co-mingling of securities, multiple client accounts etc. by Alka Securities Limited and Mahesh Kothari Shares and Stock Brokers Private Limited, I, also direct the Market Intermediaries Regulation and Supervision Department of Securities and Exchange Board of India to carry out an urgent inspection to look into the books of accounts of the aforesaid stock brokers, the procedures adopted by them for safekeeping of clients securities and funds and their compliance with the rules, regulations, bye laws and other requirements laid down by Securities and Exchange Board of India and the stock exchanges in respect of these matters. The said report shall be submitted within a month from the date of this Order.

DR. K. M. ABRAHAM WHOLE TIME MEMBER SECURITIES AND EXCHANGE BOARD OF INDIA PLACE: MUMBAI DATE: JANUARY 28, 2010