Securities Appellate TribunalDilip S. Pendse vs Sebi on 20 November, 2008BEFORE THE SECURITIES APPELLATE TRIBUNAL
                       MUMBAI


                                      Appeal No. 22 of 2008

                                      Date of Decision: 20.11.2008


Dilip S. Pendse                                                          ...... Appellant


Versus


Securities and Exchange Board of India                                 ...... RespondentMr. R.A. Kapadia, Senior Advocate with Mr. V. M. Singh, Advocate for the Appellant.
Mr. Kumar Desai, Advocate with Ms. Daya Gupta, Advocate for the Respondent.Coram: Justice N.K. Sodhi, Presiding Officer
       Utpal Bhattacharya, Member

Per:     Utpal Bhattacharya, MemberThis order will dispose of three Appeals no.22, 29 and 30 of 2008 involving

identical questions of law and fact. All these Appeals are directed against the order

dated December 28, 2007 passed by the whole time member, Securities and Exchange

Board of India (the Board for short) undersections 11and11Bof the Securities and

Exchange Board of India Act, 1992 (the Act for short). By this order, the appellants

have been found guilty of violation of the provisions ofsection 13of the Securities

Contracts (Regulation) Act, 1956 (SCRA for short) and Regulations 6(a) and (d) of the

Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade

Practices relating to the Securities Market) Regulations, 1995 (FUTP Regulations for

short) and have been restrained from accessing the securities market and prohibited

from buying, selling or otherwise dealing or associating with the securities market for a

period of two years. The arguments were addressed in Appeal no.22 of 2008 from

which the facts have been taken. The learned counsel for the parties agree that the order

in Appeal no.22 will govern the other two Appeals as well.22.              On the basis of a complaint received from Tata Finance Limited (TFL)

regarding illegal carry forward transactions in the shares of Global Telesystems Limited

(GTL for short) by the appellant who is a former managing director of TFL, the Board

started investigations into the matter. It was found in the investigations that Nalini

Properties Private Limited (Nalini), a company controlled by the appellant of which he

was also a director, had executed certain transactions in the shares of GTL through the

broker Jhunjhunwala Stock Broker Private Limited (the Broker for short) which were

not in accordance with the SCRA. A show cause notice (SCN) was issued to the

appellant by the Board on 12.3.2003 alleging violation ofsection 13of SCRA. The

SCN also alleged that the impugned transactions had not actually been executed and by

passing only book entries relating to these transactions, Nalini and certain other entities,

acting in concert with the Broker indulged in falsification of accounts and records

causing wrongful loss to Inshaallah Investments Ltd. and Niskalp Investments &

Trading Company Ltd., (hereinafter referred to as Inshaallah and Niskalp respectively)

which are associate companies of TFL. Niskalp was at that time a subsidiary of TFL

and had substantial financial stake in Inshaallah. The appellant was a director of Niskalp

as well as Inshaallah. Thus, there was a charge in the SCN of violation ofRegulation

6(d)of the FUTP Regulations though there was no specific reference to that Regulation.

Having set out the charges against the appellant, the SCN called upon him to show

cause why action in terms ofsection 23of the SCRA andsection 11Bof the Act read

with Regulations 11 and 12 of FUTP Regulations should not be initiated against him.3.               In the three cases that we are concerned with, there were two distinct

sets of allegedly irregular transactions in shares. The first set of transactions started off

on 19.9.2000 with the purchase of 60,000 shares of GTL by Nalini (appellant in Appeal

no.29 of 2008) from the Broker on the Bombay Stock Exchange (BSE for short)

through its electronic trading system. The second set of transactions started off on

14.12.2000 with the sale of 40,000 shares of GTL by Nalini, Khuda Gawah Investments

Pvt. Ltd (appellant in Appeal no.30 of 2008 and hereinafter referred to as Khuda

Gawah) and another company (which is not in appeal before us) to the Broker on a

principal to principal basis in an off market deal. Pendse, the appellant was a Director3in both Nalini and Khuda Gawah. Both sets of transactions culminated in all the shares

being procured by Niskalp and being finally sold on the BSE by it. However, before

going into the details of the transactions, it is necessary to refer to the system of trading

on BSE, including the system of settlement for a better appreciation of the exact nature

and implications of the transactions.4.              During the time when the impugned transactions were executed, the

trades executed during a particular week were required to be settled during the next

week. Settlement refers to the process whereby shares are delivered by the sellers and

received by the purchasers. At the same time, payment is made by the purchasers and

received by the sellers. The period of one week during which trades could be executed

pending settlement is called a settlement cycle. It is possible to buy and sell as many

times as a trader wishes during a settlement cycle and the effect of all these transactions

is netted at the time of the settlement during the next week. Thus, the traders settle only

their net outstanding positions at the end of the settlement cycle - it may be a net

purchase position or a net sale position. However, another mode of settlement was

permitted on BSE. Instead of settling the trades by receiving/delivering shares and

making/receiving payments for the net purchases or sales of shares during a settlement

cycle, traders could, at their option, carry forward their obligations for payment or

delivery of shares by paying a specified amount of additional margin money and in that

event, they could meet their obligations at the time of the next settlement(s). This

facility was a special feature of BSE. Another important point to be noted in connection

with these transactions is that the Broker executed the transactions in the shares of GTL

from 21.9.2000 onwards on "principal to principal" basis. This only means that while

executing these transactions, the Broker was buying and selling the shares in his own

proprietary account. In other words, it was acting as a trader itself which is permissible.

For example, on 21.9.2000, the Broker purchased 25000 shares of GTL from Nalini on

principal to principal basis and issued a contract note to Nalini. In this transaction, while

Nalini was selling to the Broker and the latter issued a contract note to Nalini as its

broker, the buyer was the Broker itself. No other buyer or buyer's broker was involved

in this transaction.45.            We may now take a look into the details of the transactions which are not

disputed by the parties. In the first set of transactions, after purchasing 60,000 shares of

GTL through the Broker on 19.9.2000, Nalini sold 35,000 shares on the BSE on the

same day. This sale is not an issue in the appeals. On 21.9.2000, Nalini sold the

remaining 25,000 shares of GTL to the Broker on principal to principal basis in an off

market transaction. At the time of this sale, Nalini did not have physical possession of

25,000 shares because it had neither received these shares after purchase on 19.9.2000

nor made payment therefor since the settlement was due only during the next week

beginning 24.9.2000. The Broker issued contract notes to Nalini for this transaction in

Form B which is meant for off market deals. It is the Board's case that there was no

delivery and no payment against this transaction. On the same day, i.e. on 21.9.2000,

the Broker, in turn, sold the same 25000 shares to Inshaallah on a principal to principal

basis in yet another off market deal. Since the transaction had not yet been settled on

BSE but the shares had been traded in off market deals only, Nalini still had the liability

of settling the transaction on the stock exchange. But with the off market purchase by

Inshaallah, the latter stepped into the shoes of Nalini and the liability of settling the

transaction on BSE devolved on it. Inshaallah, however, carried forward the position

through the next few settlements as is permitted by BSE, and on 20.2.2001 sold these

shares to the Broker in yet another off market deal on a principal to principal basis. On

the same day, the Broker sold the shares to Niskalp again in an off market transaction

and it was Niskalp which finally settled the transaction on the Bombay Stock Exchange

after carrying forward the position till the end of March 2001.6.             In the second set of transactions, the Broker purchased 20,000 shares of

GTL from Nalini, 17,500 shares of GTL from Khuda Gawah and another 2,500 shares

of GTL from another entity not in appeal before us in off market transactions on

14.12.2000 on a principal to principal basis. On the same day, the Broker sold all

40,000 shares to Inshaallah in another off market deal on a principal to principal basis.

On 20.2.2001 Inshaallah sold all these shares off market to the Broker on a principal to

principal basis and on the same day the Broker sold the same shares to Niskalp off5market. Finally, Niskalp settled the transactions on BSE after carrying forward the

position till the end of March 2001.7.              Before proceeding to examine how the Board has dealt with the

transactions in the impugned order, we may set down here a few relevant regulations for

facility of reference.Section 13of the SCRA reads as under:" If the Central Government is satisfied, having regard to the nature or
         the volume of transactions in securities in any State or States or area
         that it is necessary so to do, it may, by notification in the Official
         Gazette, declare this section to apply to such State or States or area and
         thereupon every contract in such State or States or area which is
         entered into after the date of notification otherwise than between
         members of a recognized stock exchange or recognized stock
         exchanges in such State or States or area or through or with such
         members shall be illegal:Provided that any contract entered into between members of two or
         more recognized stock exchanges in such State or States or area shall--(i) be subject to such terms and conditions as may be stipulated by
         the respective stock exchanges with prior approval of the Securities
         and Exchange Board of India;(ii) require prior permission from the respective stock exchanges the
         stock if so stipulated by the stock exchanges with prior approval of the
         Securities and Exchange Board of India."Regulations 6(a) and (d) of FUTP Regulations are reproduced below:"6. Prohibition on unfair trade practice relating to securities--No
           person shall--(a) in the course of his business, knowingly engage in any act, or practice
        which would operate as a fraud upon any person in connection with the
        purchase or sale of, or any other dealing in any securities;.......................................................................................
        ... (d) indulge in falsification of the books, accounts and records
        (whether maintained manually or in computer or in any other form;
        ........................................................................................
        ."8.              The essence of the findings in the impugned order is contained in

paragraphs 13, 14 and 15 thereof which are reproduced below:"13. The object ofSection 13is to make a transaction
                in securities in an area other than between the members
                of a recognised stock exchange or through or with such6member, illegal afterSection 13has been made
               applicable in the said area. The effect of this provision is
               that if a transaction in securities has to be validly entered
               into, such a transaction has to be either between the
               members of a recognised stock exchange or through a
               member of a stock exchange or with a member of a
               recognised stock exchange. This view has been upheld
               by the Hon'ble Bombay High Court in the case ofDahiben Umedbhai Patel and Others v Norman James
               Hamilton and Others.14.      By a notification dated November 29, 1957,Section 13has been made applicable to Greater
               Bombay. As a result, the said transactions were in
               contravention of the provisions ofSection 13and thus
               illegal, as the contracts were not entered into between
               members of the stock exchange. Secondly, the purchase
               of shares by the Broker from Nalini and KGIPL and by
               Inshallah from the Broker on September 21, 2000 and
               December 14, 2000 respectively did not result in
               delivery of shares or payment of price consideration.
               They are, therefore, not "spot delivery contracts" as
               defined underSection 2, sub-section (i), of the SCRA.15.     A contract for sale of shares, in order to qualify
               as a "spot delivery contract" must provide for actual
               delivery of shares and the payment of price either on the
               same day as the date of the contract or on the next day,
               etc. this view was reiterated by the Hon'ble Bombay
               High Court in a similar situation in the case ofNorman
               J. Hamilton v Umedbhai S. Patel and Others. It is,
               therefore, clear that as the said transactions did not result
               in delivery of shares or in payment of price
               consideration, they cannot be termed as spot delivery
               contracts. These transactions were, therefore, not
               exempted underSection 18of the Act from being
               governed bySection 13of the SCRA and thus were
               illegal contracts by virtue of the provisions of the
               SCRA."9.Section 13of SCRA makes it very clear that in an area where the Central

Government makes this section applicable, all transactions in securities other than those

saved by this section are illegal. It is common ground between the parties that the

Central Government by its notification no. SRO 3842 dated 29.11.1957 madesection 13of SCRA applicable to Greater Bombay. Therefore, there is no dispute that apart from

transactions between members of a recognised stock exchange or through such a

member or with such a member, all other transactions in securities are illegal in Greater

Bombay. In other words, a transaction to be legal, within the meaning ofsection 13of

the SCRA, must necessarily involve a broker. But as Mr. Kapadia, the learned senior

counsel for the appellant tellingly argued, having specifically noted this correct legal7position in paragraph 13 of the impugned order, the whole time member of the Board in

the very next paragraph concludes that the transactions which took place on 21.9.2000

between Nalini and the Broker and between the Broker and Inshaallah were illegal as

the contracts were not entered into between members of the stock exchange. As we

have already noted, in the first set of transactions 25,000 shares of GTL changed hands

from Nalini to the Broker to Inshaallah to the Broker again and finally to Niskalp which

settled the transaction on the BSE. Similarly, in the second set of transactions 40,000

shares GTL were acquired by the Broker from Nalini, Khuda Gawah and another seller

and thereafter these shares changed hands from the Broker to Inshaallah and finally to

Niskalp which settled the transactions on BSE. All these transactions were clearly

through or with a member broker of BSE and, therefore, in accordance with the

requirements ofsection 13of SCRA. Thus, the wholetime member's aforesaid

conclusion was not only contrary to his own observation in paragraph 13 of the

impugned order but was clearly an incorrect conclusion. After erroneously concluding

that these transactions were violative ofsection 13of the SCRA, the wholetime member

further concluded that the validity of these transactions could not be protected undersection 18(1)of the SCRA which provides that "nothing contained insections 13,14,15and17shall apply to spot delivery contracts", because the impugned transactions

Niskalp were not in the nature of spot delivery contracts. It is not necessary for us to go

into this question because we are of the opinion that the transactions did not violatesection 13of the SCRA to begin with.10.            The primary stand taken by Mr. Kumar Desai, the learned counsel for the

Board, was that the impugned transactions are in breach of the notification dated

27.6.1969 issued by the Government of India undersection 16(1)of SCRA which reads

as under:"S.O. 2561. In exercise of the powers conferred by sub-
               section (1) ofSection 16of the Securities Contract
               (Regulation) Act, 1956 (42 of 1956) the Central
               Government being of opinion that it is necessary to
               prevent undesirable speculation in securities in the whole
               of India, hereby declares that no person in the territory to
               which the said Act extends, shall save with the permission
               of the Central Government enter into any contract for the
               sale or purchase of securities other than such spot delivery8contract or contract for cash or hand delivery or special
               delivery in any securities as is permissible under the said
               Act and the rules, bye-laws and regulations of a
               recognised stock exchange:..................................................................."According to the learned counsel, the impugned order is entirely justified since the

transactions executed by Nalini did not fall under any of the categories permitted by the

Government Notification of 27.6.1969 and were, therefore, completely illegal. We

cannot accept this argument because violation ofsection 16of SCRA has not been

alleged in the SCN nor was this point ever raised during the enquiry. The impugned

order also makes no reference to any such violation. Since the appellant had not been

charged with the alleged violation ofsection 16of SCRA, it could not possibly put up

any defence during the enquiry and allowing any argument on this aspect at the

appellate stage will be a clear denial of natural justice to the appellant. Such a plea

cannot, therefore, be allowed to be raised for the first time before this appellate tribunal.

This tribunal had taken a similar view in Appeal no.123 of 2006 decided on 29.5.2008Holcim (India) Private Ltd. v. the Adjudicating Officer, Securities and Exchange Board

of Indiafollowing the judgment of the Supreme Court inSACI Allied Products Ltd.

U.P. v. Commissioner of Central Excise(2005) 7 SCC 159. This is what the learned

judges observedin that case:"This finding of the Appellate Tribunal is based on first proviso toSection 4(1)(a)of the Act. While the show-cause notice and the order
        of the Collector proceeded on the basis of the invocation of third
        proviso toSection 4(1)(a)of the Act, the Appellant Tribunal for the
        first time in the impugned order has sustained the proceedings on the
        basis of first proviso toSection 4(1)(a)of the Act. It was argued that
        the first proviso toSection 4(1)(a)of the Act was never invoked by the
        Department in the show-cause notice or in the impugned order and it
        was for the first time that the Appellate Tribunal in the impugned order
        has sought to sustain the impugned order by invoking the first proviso
        toSection 4(1)(a)of the Act. It is thus seen that the Tribunal has gone
        totally beyond the show-cause notice and the order of the Collector,
        which is impermissible. The Appellate Tribunal cannot sustain the case
        of the Revenue against the appellants on a ground not raised by the
        Revenue either in the show-cause notice or in the order."11.            When we put it to the learned counsel for the Board that violation ofsection 16of SCRA cannot be pleaded for the first time before this tribunal, he shifted

his stand back to that adopted by the Board in the impugned order and contended that

the impugned transactions were violative ofsection 13of SCRA. The learned counsel9argued that the sale amounted to an off market transfer to a third party of the purchase

position of a trader on the exchange and this is not permitted under the bye-laws of BSE

and could have been saved only if the same was executed as a spot delivery transaction.

According to the learned counsel, all transactions to be considered valid undersection

13of SCRA have to be necessarily compliant with the bye-laws of the stock exchange

concerned. If there has actually been any violation of the bye-laws of a stock exchange,

as contended by the learned counsel, it would call for some remedial or punitive action

primarily from the stock exchange itself which functions as the first level market

regulator. In this particular case we have not been told that BSE had found any fault

with the impugned transactions. Advancing such arguments at the appellate stage by the

respondent Board thus, appears to be only an afterthought with the object of justifying

the impugned order. These arguments, again, were being advanced for the first time at

the appellate stage and the appellant had not had any opportunity to meet this allegation

at any earlier stage. We cannot, therefore, entertain this argument.12.            Regarding the charge of violation of the FUTP Regulations, there is no

evidence on the record to establish any falsification of books of accounts and records by

the appellant; so the charge underRegulation 6(d)of the FUTP Regulations fails.

Regarding the charge underRegulation 6(a)ibid, theBoard's case is that on 21.9.2000

the appellant sold 25000 shares off market to the Broker at Rs.1400 per share and when

the shares were finally sold on BSE by Niskalp, the latter got a price of only Rs. 125 per

share. There was, thus, a substantial loss incurred by Niskalp. According to the Board,

this loss had actually been incurred by Nalini but through the chain of fictitious

transactions which were created by making only book entries in the accounts and

records of all the parties concerned, this loss was transferred to Niskalp. This was the

complaint that TFL had made to the Board and we understand that this alleged fraud is

the subject matter of separate criminal proceedings launched against the appellant. In

the appeals before us, there is no evidence to show that the accounts and records were

falsified to perpetrate the alleged fraud. In any case, the matter is really a dispute

between TFL and the appellant with which this tribunal is not concerned and it is not

necessary for us to take a view on this allegation.1013.             Two other points regarding the validity of the procedure followed by the

Board in proceeding against the appellant under the FUTP Regulations, 1995 were

raised by the learned senior counsel for the appellants. The first point related to waiver

of the notice to be given by the Board before starting the investigations in terms ofRegulation 8of the FUTP Regulations. According to the learned senior counsel, the

notice had been waived as provided inRegulation 8(2)ibid but, only after the

investigations had started and not before. The second point related to the validity of

invoking the Board's powers under Regulations 11 and 12 of the FUTP Regulations

which, according to the learned senior counsel, had not been saved by the FUTP

Regulations, 2003 when the 1995 Regulations were repealed. It is not necessary for us to

deal with these questions since on merits, we are deciding the case in favour of the

appellants.In the result, the appeals are allowed and the impugned order set aside. No

order as to costs.Sd/-Justice N.K. Sodhi
                                                                     Presiding Officer


                                                                          Sd/-Utpal Bhattacharya
                                                                       Member
20.11.2008
pw