SAT stops Sebi’s IPO scam orders

SAT stops Sebi’s IPO scam orders

The National Securities Depository Ltd, or NSDL, India’s premier depository with 8.3 million dematerialized (demat) accounts holding shares and bonds worth Rs52 trillion, has won a key round in its no-holds-barred battle against the capital market regulator, the Securities and Exchange Board of India (Sebi).

The Securities Appellate Tribunal (SAT) has set aside a Sebi order that had asked NSDL to return Rs45 crore in “illegal profit", its alleged share from a major scam that had rocked India’s capital markets and involved tens of thousands of fictitious online accounts that cornered lucrative initial public offerings (IPO) of company shares set aside for small investors.

SAT described Sebi’s action as a clear “violation of the principles of natural justice" and that such orders were premature in light of the ongoing proceedings on the guilt of various parties alleged to have contributed to the scam.

“...all these issues should have been determined only after the passing of the final order holding the appellants guilty of the alleged wrong doings for which proceedings are still pending," the SAT order said.

The saga began in April 2006 when Sebi unearthed a scam involving depositories, depository participants (DPs) and two dozen market operators, who allegedly played a role in using 59,000 fictitious demat accounts in cornering share allotments in IPOs for small investors.

In an ex-parte order, Sebi said that the depositories “failed to exercise oversight over the DPs" and the promoters of NSDL (and CDSL, another despository) were directed to take “all appropriate actions including revamping of management".

Subsequently, in November 2006, Sebi ordered NSDL and a few others implicated in the IPO scam to return Rs115 crore in “illegal profits" made from the IPO deals. In legal parlance, they were asked to disgorge the money. Of this, NSDL’s share was Rs45 crore.

In both instances, NSDL claims that the regulator did not hear its side of the story. NSDL promptly challenged the Sebi order with the appellate body of the capital market regulator.

In its order, the tribunal also said it did not see any merit in the NSDL appeal against the Sebi order on “management revamp" as the Sebi counsel at the SAT hearing admitted that it was an observation and not “mandatory".

Sebi is now expected to complete its investigation soon and pass the final order on NSDL and others involved in the IPO scam.

Sebi officials were not immediately available for comment. Sebi chairman M. Damodoran was travelling outside India.

Chandrasekhar Bhaskar Bhave, 57, managing director of NSDL since 1996, spoke to Mint on the implications of the SAT order. Edited excerpts:

SAT has set aside the Sebi order. So, are you relieved?

We are naturally relieved because SAT has ruled in our favour. However, at one level, I am feeling very sad that we had to move SAT. As an institution, NSDL, would be reluctant to take any legal recourse against the regulator, but unfortunately, we were left with no option in this matter.

How do you react to the ruling that sets aside the disgorgement order?

As I have clarified, we would rather have these matters sorted out with Sebi directly. But if the regulator refuses to hear us and passes an ex-parte order, what do we do? We were pushed into a corner and had no choice.

Why is NSDL constantly in litigation with Sebi?

You are not fair in your assessment. In this case, very strangely, NSDL along with other entities were asked to pay Rs115 crore without even being heard. It is not possible for any entity to accept such a decision. NSDL was not alone. In fact, all the affected entities moved SAT.

Are you suggesting that you were asked to pay Rs45 crore without even being heard?

Yes, unfortunately that was the case.

Why did Sebi do this? You seem to have lost credibility with the regulator.

Frankly, we are surprised that principles of natural justice were violated. In fact, in this country, no authority has the right to violate the basic principle of hearing a party before ruling anything adverse to that party. You must be aware that recently even Parliament on a sensitive issue of contempt heard the concerned party before reaching any conclusion.

What do you mean? Can’t the regulator ask any entity to disgorge?

My reading of the SAT order is that the appellate authority has not ruled on Sebi’s power to disgorge. SAT has stated that disgorgement can occur if the concerned entity is guilty of violation of law. It should have derived profits out of such violation and should have been given an opportunity of being heard before any disgorgement can occur. In this case, these norms were not followed.

What about the order to your promoters to revamp management? I believe your appeal was dismissed?

The appeal was dismissed as infructuous. The reason being that Sebi contended that its directives to the promoters were not mandatory. The regulator also contended that the directives in the April 2006 order were only observations in aid of the show cause notice (issued last year). Since the contention was that there was no order against NSDL, we had nothing to appeal against.

Can a direction of a regulator be non-mandatory?

You have to ask this question to Sebi.

How do you plan to celebrate the victory?

I don’t think there are victories against regulators. I would prefer to look at this matter in a more constructive manner. The SAT has laid down some very valuable ground rules and these would serve the capital market well in future. All market intermediaries, including NSDL, should learn from the episode of IPO allotment scam and correct their systems to ensure similar things do not occur again.

How do you ensure this?

During the past one-and-a- half years, we have taken some steps to make sure that fraudsters cannot take the system for a ride. The depository, on a weekly basis through a software, finds out whether common addresses exists for more than 10 accounts and if they do, the depository participants are asked to check the genuineness of the clients.

We have tightened the KYC (know your customer) norms and any person who wants to open a depository account should undergo personal verification by the DP staff. It has been mandated that each account holder must have the permanent account number (PAN). We still have eight lakh accounts in which investors have not furnished their PAN. These accounts have been frozen. These investors cannot operate without providing their PAN. We have been sending regular reports to Sebi on such accounts.

How many fake accounts have you detected so far?

We have not detected any fake accounts. However, whenever the investor refuses to provide necessary documents to the DPs to conform to the KYC norms, the DPs freeze their accounts. At this point there?are?50,000?such?accounts.