adjudication order nsdl
TRANSCRIPT
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ADJUDICATION ORDER NO. - BS/AO-11 /2007
ORDER UNDER SECTION 15I OF THE SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992 READ WITH RULE 5 OF THE SECURITIES AND EXCHANGE BOARD OF INDIA (PROCEDURE FOR HOLDING INQUIRY AND IMPOSING PENALTIES BY ADJUDICATING OFFICER) RULES, 1995 IN THE MATTER OF ADJUDICATION PROCEEDINGS AGAINST NATIONAL SECURITIES DEPOSITORY LIMITED.
1.1 Securities and Exchange Board of India (hereinafter referred to as ‘SEBI’)
vide order dated November 22, 2006 initiated adjudication proceedings
against National Securities Depository Ltd. (hereinafter referred to as
‘NSDL’). I was appointed as the Adjudicating Officer to inquire into and
adjudge under Section 15I read with Sections 15HA and 15HB of the
Securities and Exchange Board of India Act, 1992 (hereinafter referred to
as the ‘SEBI Act’) and Section 19G of the Depositories Act, 1996
(hereinafter referred to as the ‘Depositories Act’), the violations alleged to
have been committed by NSDL.
2.0 FACTS OF THE CASE
2.1 SEBI conducted investigation into the affairs relating to buying, selling or
dealing in the shares through initial public offerings (IPOs) during the
period 2003 – 2005 by the following companies:
1. Amar Remedies Ltd.
2. Datamatics Technologies Ltd.
3. Dishman Pharma & Chemicals Ltd.
4. FCS Software Solutions Ltd.
5. Gateway Dispriparks Ltd.
6. Gokaldas Export
7. ILFS Investmart
8. Indraprasth Gas
9. Infrastructure Development Finance Co. Ltd.
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10. Jet Airways (India) Ltd.
11. Nandam Exim Ltd.
12. National Thermal Power Corporation Ltd.
13. Nectar Lifesciences Ltd.
14. Patni Computer Systems Ltd.
15. Sasken Communication Technologies Ltd.
16. Shoppers Stop Ltd.
17. SPL Industries Ltd.
18. Suzlon Energy Ltd.
19. T.V. Today Network Ltd.
20. Tata Consultancy Services Ltd.
21. Yes Bank Ltd.
2.2 It was observed that many entities cornered / acquired the shares in the
various IPOs by the above companies during the period 2003 – 2005 by
making fictitious applications in the category reserved for retail investors
through the medium of thousands of fictitious / benami applicants for the
IPOs. It is alleged that the said entities (hereinafter referred to as the ‘Key
Operators’) had opened many demat accounts in fictitious and benami
names and made large number of applications in the IPOs in the category
of retail investors in fictitious and benami names.
2.3 On allotment of shares in the category of retail investors in the IPOs, the
said shares were transferred to the demat accounts of these key
operators. It is alleged that these key operators subsequently transferred
the shares through off market deals to ultimate beneficiaries (hereinafter
referred to as the ‘financiers’) who appeared to be the financiers in the
process. In this regard, it is alleged that the said practice was adopted to
corner the quota for retail investors in the IPOs of the companies.
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2.4 It was noted that the entities (key operators) who opened large number of
fictitious / benami accounts (hereinafter referred to as afferent accounts)
had opened large number of such accounts with the Depository
Participants affiliated to NSDL. Investigation revealed that many such
accounts were opened in fictitious names and had common address. It
was noted that as many as 34,924 afferent accounts were opened with
various Depository Participants affiliated to NSDL.
2.5 In view of the same, SEBI had conducted a system audit of NSDL through
isec Services Pvt. Ltd wherein various irregularities and failures alleged to
have been committed by NSDL were observed.
2.6 On the basis of the investigation conducted by SEBI and on the basis of
the system audit, prima facie it appeared that various lapses and
irregularities on the part of NSDL resulted in facilitating the key operators
to open large number of fictitious / benami demat accounts with NSDL
which enabled the key operators to corner the retail portion in the IPOs.
Hence adjudication proceedings have been initiated against NSDL.
2.7 On the basis of the investigation conducted by SEBI, it is alleged that by
facilitating the key operators to open fictitious / benami accounts, NSDL
had abetted the key operators in cornering the IPO allotments under retail
category in purported names of afferent accounts. In this regard it is also
alleged that NSDL failed to
? notice the unauthorized outsourcing by the Depository Participants
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? put in place adequate mechanisms for the purpose of reviewing,
monitoring and evaluating the controls, systems, procedures and
safeguards
? prevent the opening / existence of multiple beneficiary owner
accounts
? verify the infrastructural facilities of the Depository Participants
? take appropriate action against the Depository Participants for the
various irregularities repeatedly committed by them
2.8 On account of the failures and irregularities of NSDL as stated above, it is
alleged that NSDL have violated / failed to comply with the following
provisions
? Section 26(2)(p) of the Depositories Act, 1996
? The provisions of Regulation 7, 16(2), 22, 23, 34, 35, 37, 39 and 52
of SEBI (Depositories and Participants) Regulations, 1996
(hereinafter referred as ‘Depositories Regulations’)
2.9 Further, it is also alleged that on account of various commissions and
omissions on the part of NSDL which facilitated the key operators to
corner the shares in the IPOs, NSDL violated the provisions of Regulation
3 of SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to
Securities Market) Regulations, 2003.
2.10 It is also alleged that NSDL failed to comply with the directives issued by
SEBI vide order dated January 12, 2006 and April 27, 2006. Further, it is
also alleged that NSDL has failed to comply with the provisions of its Bye
Law Nos. 6.2.1(vii), 7.2.1, 10.4.1, 10.4.1(b) and 11.
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3.0 NOTICE AND REPLY
3.1 A Show Cause Notice (hereinafter referred to as ‘SCN’)
A&E/BS/80607/2006 dated November 23, 2006 was issued to NSDL in
terms of the provisions of Rule 4 of SEBI (Procedure for Holding Inquiry
and Imposing penalties by Adjudicating Officers) Rules, 1995 (hereinafter
referred to as the Rules), requiring NSDL to show cause as to why an
inquiry should not be held for the violations alleged to have been
committed by it.
3.2 NSDL vide its letter dated December 7, 2006 requested for time to reply to
the SCN. Subsequently, vide letter dated December 15, 2006, NSDL
replied to the SCN. Considering the reply of NSDL, it was decided to
conduct an inquiry in the matter and NSDL was advised to attend the
hearing on January 5, 2007. Vide letter dated December 28, 2006, NSDL
requested for a short adjournment. Considering the request of NSDL, it
was granted another opportunity of hearing on January 16, 2007.
3.3 On January 16, 2007, NSDL through its Advocate Shri Somasekhar
Sundaresan, of J. Sagar Associates attended the hearing and made
submissions in respect of the alleged violations. During the hearing, NSDL
submitted an application seeking cross examination of the authors of the
system audit report.
3.4 Subsequently, further clarifications were sought from NSDL vide letter
dated February 14, 2007 which was replied by NSDL vide letter dated
March 6, 2007. As NSDL requested for one more hearing in the matter to
clarify the issues mentioned in the letter dated February 14, 2007, another
opportunity of hearing was granted to it on March 14, 2007. Subsequently
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vide letters dated March 15 and March 21, 2007, NSDL submitted
additional submissions.
3.5 As NSDL has sought cross examination of the authors of the system audit
report, I consider the application filed by NSDL seeking cross examination
as a preliminary issue in the matter. Right to cross examination is not an
absolute right and would depend on the facts and circumstances of each
case. In this case, it is noted that copy of the system audit report was
forwarded to NSDL as part of the show cause notice. Further, reasonable
opportunity to contradict the findings of the report and also to explain its
case was given to NSDL. In this context, the decision of the Hon’ble
Supreme Court in Transmission Corporation of AP Ltd. and others Vs Sri
Rama Krishna Rice Mill (2006) 3 SCC 74 is relied upon. The Hon’ble
Court held that in order to establish that the cross examination is
necessary, party has to make out a case for the same. Considering the
said judgment and also the principle laid down by the Hon’ble Supreme
Court in various other cases in respect of the issue, I am of the view that
reasonable opportunity has been granted to NSDL to present its case and
further it is noted that no prejudice is caused to NSDL by denial of right to
cross examination in the matter. In view of the same, cross examination is
not granted in the adjudication proceedings.
4.0 CONSIDERATION OF EVIDENCE AND FINDINGS
4.1 As stated before, the investigation and the system audit pointed out
various lapses and irregularities on the part of NSDL which enabled the
key operators to open many demat accounts in fictitious and benami
names and corner the quota for retail investors in the IPOs of the
companies. It was noted that as many as 34,924 afferent accounts were
opened with NSDL’s Depository Participants. The said lapses and
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irregularities alleged to have been committed by NSDL are detailed in the
following paragraphs.
4.2 The various violations alleged to have been committed by NSDL, the
submissions made by NSDL and the findings in respect of the same are
mentioned below.
5.0 Facilitating opening of fictitious accounts:
5.1 It is noted from the findings of investigation that the key operators opened
various afferent accounts as a device to manipulate the IPO process by
getting allotment under the quota reserved for retail investors. Many such
accounts had common addresses of Key Operators. In this regard, it is
noted that as many as 34,924 such accounts were opened with DPs of
NSDL. Details of these accounts are as follows:
Sr No. SOURCE DP NAME SOURCE CLIENT
ID
1. KARVY STOCK BROKING
LIMITED 29309
2. HDFC BANK LTD 1793
3. KHANDWALA INT.FIN.S.PV.L 1153
4. IDBI BANK LIMITED 1017
5. JHAVERI SECURITIES P LTD 598
6. ING VYSYA BANK LIMITED 544
7. PRAVIN RATILAL SH & STK 510
Total 34,924
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Further, it was noticed that many of the above afferent accounts were
opened in bulk on certain dates. The details where 500 or more accounts
were opened on the same date are given below:
Sr
No
DATE OF
OPENING OF
DEMAT
ACCOUNT
Number of
demat
accounts
opened
Name of
major DP
Status
Accounts
Comments
1. 8/16/2004 7751 Karvy-DP
(7641)
Closed –
7735
Suspended –
1
Active - 15
Most of the
dematerialized
account-holders
addresses are the
same as that of
Roopalben
Panchal or SEIPL
2. 10/18/2004 2196 Karvy-DP
(2157)
Closed –
2169
Active – 27
Most of the
dematerialized
account-holders
addresses are the
same as that of
SEIPL
3. 10/23/2004 1855 Karvy-DP
(1855)
Closed –
1835
Actuve - 20
Most of the
dematerialized
account-holders
addresses are the
same as that of
Kelan Atulbhai
Doshi
4. 1/6/2004 1689 Karvy-DP
(1684)
Closed –
1682
Active – 7
Most of the
dematerialized
account-holders
addresses are the
same as that of
SEIPL (Parag P
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Sr
No
DATE OF
OPENING OF
DEMAT
ACCOUNT
Number of
demat
accounts
opened
Name of
major DP
Status
Accounts
Comments
Jharveri)
5. 2/16/2004 1535 Karvy-DP
(1529)
Closed –
1531
Active – 4
Almost all the
account holders
have the same
address as
Roopalben
Panchal
6. 7/20/2005 1535 Karvy-DP
(1531)
Closed –
1531
Active – 4
1531 accounts
have the same
address as
Roopalben
Panchal
7. 1/5/2004 1112 Karvy-DP
(1101)
Closed –
1100
Active – 12
1099 accounts
have the same
address as
Roopalben
Panchal
8. 4/20/2004 1098 Karvy-DP
(1096)
Closed –
1096
Active - 2
1096 accounts
have the same
address as SEIPL
9. 8/5/2005 1050 Karvy-DP
(1043)
Closed /
Suspended –
1043
Active - 7
All the closed
accounts have the
address of Kelan
Atulbhai Doshi (
606 accounts) or
Shah Biren
Kantilal (437
accounts)
10. 7/19/2005 1007 Karvy-DP
(1002)
Closed –
1002
All the closed
accounts have the
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Sr
No
DATE OF
OPENING OF
DEMAT
ACCOUNT
Number of
demat
accounts
opened
Name of
major DP
Status
Accounts
Comments
Active - 5 address of
Roopalben
Panchal
11. 8/17/2004 987 Karvy-DP
(981)
Closed – 986
Active – 1
Almost all the
closed accounts
have the address
of Roopalben
Panchal or SEIPL
or Kelan Atulbhai
Doshi
12. 10/25/2004 856 Karvy-DP
(826)
Closed – 830
Active – 26
Out of the 830
closed accounts
819 have the
address of SEIPL
13. 10/16/2004 766 Karvy-DP
(728)
Closed – 752
Active – 14
Out of 752 closed
accounts 627
have the address
of SEIPL
14. 7/21/2005 765 Karvy-DP
(761)
Closed – 761
Active – 4
All the 761 closed
accounts have the
address of
Roopalben
Panchal
15. 12/17/2003 753 Karvy-DP
(749)
Closed – 749
Active – 4
All the closed
accounts have the
address of
Roopalben
Panchal or
Jayantilal Jitmal
16. 11/6/2003 574 Karvy-DP Closed / All the closed
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Sr
No
DATE OF
OPENING OF
DEMAT
ACCOUNT
Number of
demat
accounts
opened
Name of
major DP
Status
Accounts
Comments
(570) suspended –
570
Active – 4
accounts have the
address of
Roopalben
Panchal
17. 12/16/2003 529 Karvy-DP
(522)
Closed – 522
Active – 7
All the closed
accounts have the
address of
Roopalben
Panchal or
Jayantilal Jitmal
Total 26058 25776 Closed /
Suspended –
25895
Active - 163
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5.2 Investigation revealed that NSDL’s systems allow accounts to be stored in
the DM (Depository Module) databases with no check on the addresses and
other details at the DM. There is also a provision for including
correspondence address. This correspondence address has been used for
sending refund orders and also intimation regarding allotment of shares to
the eventual financiers. In view of the large number of afferent accounts
opened with the depository participants of NSDL, it is alleged that NSDL
facilitated the key operators in furtherance of their scheme of cornering the
retail portion in the IPOs.
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5.3 Submissions of NSDL
5.3.0 The allegation that NSDL failed to prevent the opening / existence of
multiple beneficiary owner accounts is not correct. As a conscientious
market intermediary, NSDL has always been committed to ensuring the
best interests of the capital market and orderly development of the market.
Till date there is nothing in the law that prevents opening of multiple
beneficial ownership accounts. In fact, SEBI has prescribed no restriction
in this regard. On the contrary, SEBI has specifically acknowledged that
one person could hold multiple accounts. Since there is no restriction on
an investor opening multiple accounts, there cannot be any restriction on
more than one account having the same address. Consequently, there
was never any check on this since the law does not prohibit the same. In
fact, this legal position continues even today. The frequently-asked-
questions ("FAQ") published by SEBI in relation to dematerialization, on its
official website itself clearly records the same.
5.3.1 Therefore, no need has ever been felt to introduce a system level check in
the depository system that would prevent opening of Demat Accounts by
different investors with same or different address, as the law itself does
not prohibit the same. It is pertinent to note that one family can have many
Demat Accounts (different combinations) with the same address.
Moreover, there is a practice followed by investors to give office address
(example) in which case many employees can have the same address.
Thus, the office address would become a common address for many
investor Demat Accounts and merely by virtue of being a common
address it would not necessarily mean that all such Demat Accounts
would have been opened with malafide intentions.
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5.3.2 In fact, had there been a law prohibiting the same i.e. had the SEBI
Regulations prohibited the same; the software for opening of Demat
Accounts would have mandated such a check. It is only after the misuse
was detected that a mechanism was felt necessary to uniquely identify the
accountholders and now the quoting of the Permanent Account Number
("PAN") issued under the tax laws, has been put in place.
5.3.3 It is further submitted that NSDL only provides the software and systems
that enable the DPs to open the Demat Accounts. As a part of account-
opening process, Clients approach a DP of their choice and submit the
account opening form as well as Proof of Identity and Proof of Address as
specified by SEBI. The DP has to exercise due diligence in terms of the
KYC norms prescribed by SEBI. Should the DP be satisfied about
compliance with the KYC norms, it could open the account of the client.
Thus, the KYC documents are received, processed and maintained by the
DPs. When a Client's account is opened by a DP, the client information
captured and released by the DPs travels electronically to NSDL in an
encrypted form and the same then gets electronically stored in the NSDL
system. The data is captured by DP and NSDL does not modify the data.
The regulatory system as prescribed by the Depositories Act as well as
SEBI entails the DPs being the frontline interface for the depository
system with the Clients. Against this backdrop, the allegation of NSDL
having actively assisted the key operators in cornering IPO allotments
under retail category in purported names of afferent accounts is grossly
erroneous.
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5.4 Findings / Observations
5.4.0 The Depositories Act, 1996 provides for an agreement to be executed
between the depository and the participant. Section 4 of the Depositories
Act provides that the Depository shall enter into an agreement with one or
more participants as its agents. Further, Section 5 of the Depositories Act
provides that any person through a participant may enter into an
agreement, in such form as may be specified by the bye laws with any
depository for availing its services. Hence principal agent relationship
between the depository and the depository participant is clearly
recognized under the provisions of the Depositories Act.
5.4.1 In the case of opening of a demat account, a person avails the service of a
depository through a depository participant. As can be seen from the
allegation, the key operators had opened large number of fictitious
accounts and many of them with common addresses as a devise to
manipulate the IPO process by getting allotment under the quota reserved
for retail investors. It was observed during the investigation on the basis of
the data submitted by NSDL that 34,924 such accounts were opened with
the depository participants of NSDL.
5.4.2 Though it is submitted by NSDL that there was no prohibition on opening
of multiple accounts, it is noted from its submissions vide letter dated
March 15, 2007 that the following steps are adopted in the process of
opening a demat account:
? A person desiring to open a depository account submits account
opening form along with proof of identity and proof of address to the
DP after entering into agreement with DP.
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? DP carries out KYC exercise which is a manual process involving
review of documents of proof of identity, proof of address, PAN
details etc.
? DP ensures compliance of KYC requirements.
? DP enters the details of account opening in the DPM system and
scan and capture the signature appearing on the account opening
form. As per the prevailing industry best practice, maker checker
mechanism is adopted for the purpose of data entry and paper data
digitization.
? Client ID generated upon completion of capture operation (account
in registered mode).
? Once maker user completes the data capture, a checker user at DP
verifies the same and if satisfied releases the same.
? The information travels electronically in encrypted form to NSDL’s
central system and account gets created (active status).
5.4.3 As can be seen from the above, a detailed process ought to be followed
by the DP and the depository before creation of a demat account. In this
context, NSDL’s submission that its role is only to provide the software
and systems that enable the DPs to open the Demat Accounts can not be
accepted. As stated before, a clear principal agent relationship exists
between the depository and its participants. In this context opening of
hundreds of accounts with the same address and on same days by some
of the DPs should have alerted the depository as to whether the
requirements of KYC documentation were complied with by the DPs. As
can be seen from the requirement of verification as stipulated in SEBI
circular SMDRP/POLICY/CIR-36/2000 dated August 4, 2000 which
provides for the following,
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“The depository participants are hereby advised that a beneficiary account
must be opened only after obtaining a proof of identity of the applicant.
The applicant’s signature and photograph must be authenticated by an
existing account holder or by the applicant’s bank or after due verification
made with the original of the applicant’s valid passport, voter ID, driving
license or PAN card with photograph; and further the account opening
form should be supported with proof of address such as verified copies of
ration card / passport / voter ID / PAN card / driving license / bank
passbook. An authorized official of the depository participant, under his
signature shall verify the original documents.”
In view of the said requirements the Depository ought to have detected the
large number of accounts opened by the DPs on few days with address of
the Key Operators.
5.4.4 Further as can be seen from the scheme of the Act, it is the services of the
depository that a person is availing through a depository participant.
Further, Section 16 of the Depositories Act clearly provides that without
prejudice to the provisions of any other law for the time being in force, any
loss caused to the beneficial owner due to the negligence on the part of
the participant, the depository shall be liable to indemnify such beneficial
owner. Considering the very scheme of the Act in laying down the
responsibility on the part of the depository, it is difficult to accept the
contention of the depository that it has no role in ensuring compliance with
the account opening process.
5.4.5 As can be seen, large number of accounts were opened on few dates with
the depository participant Karvy Stock Broking Ltd with common
addresses of the key operators. The fact that thousands of such accounts
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were opened in bulk on few dates mentioned above, indicate that NSDL
could not check opening of such large number of accounts by DP with
addresses of key operators. Opening of large number of account cast
doubt whether the requirements of SEBI circular SMDRP/POLICY/CIR-
36/2000 dated August 4, 2000 were complied with. Further, NSDL failed to
verify whether the account opening process was in accordance with legal
requirements. As the said accounts were found to be fictitious / benami
accounts, many of them were closed subsequently. In this context, it is
also pertinent to note that NSDL has added a provision for incorporating
the correspondence address of the beneficial owner in the account
opening form. In this regard, earlier NSDL vide letter dated August 3, 2004
sought SEBI’s permission to capture the address of financier in the DPM
system and stated that all correspondence including refund orders will be
received by the financier. SEBI vide letter dated August 30, 2004 refused
permission for the same. In this context, it is noted that despite SEBI
having refused permission for incorporating the correspondence address
in the account opening form, NSDL additionally introduced
correspondence address. The provision for correspondence address
facilitated the key operators to receive refund orders etc. The failure on
the part of NSDL to verify and monitor large number of fictitious accounts
created by the key operators through its depository participants and also
incorporation of the provision of correspondence address by NSDL in the
account opening form facilitated the key operators in opening large
number of fictitious accounts.
5.4.6 It is difficult to assume that this practice did not come to the notice of
NSDL, considering the fact that it was stated to have conducted regular
inspections of its participants. Use of ready made stamps for addresses in
the account opening forms itself should have been sufficient to raise the
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suspicion in the inspections. The purpose of inspection is to find out any
abnormal patterns that may be creeping into the system even if there is no
specific law prohibiting the same. This assumes more significance in the
context of securities market which is very dynamic and all future
possibilities can not be foreseen. Further, it is pertinent to note that the
records at NSDL are stored as computerized database where one can
have various reports and statistics with a click of a button. Hence all these
process could have been easily monitored by NSDL In this regard, it is
also observed in the investigation that the practice of opening of large
number of accounts by Karvy was noticed earlier by NSDL during its
inspection in 2003. It is pertinent to note from the inspection report dated
November 18, 2003 that NSDL noticed that 5483 client accounts were
found in registered status. The report further says that DP is in practice of
generating client ID entering only client’s name in the DPM and
subsequently capturing the complete client details in the DPM system.
The report says that the said irregularities were also reported in the last
visit. Hence, it appears that though NSDL was aware of the irregularities in
opening of the accounts, it did not take any action in respect of the same.
The failure on the part of NSDL to monitor and further providing for
correspondence address in the account opening form facilitated the key
operators in opening large number of fictitious accounts.
5.4.7 By facilitating the Key Operators to open large number of fictitious
accounts, NSDL failed to comply with the conditions of registration under
Regulation 7 (b) and also Regulation 34 of the Depositories Regulations.
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6.0 Failure to verify the Infrastructure Facilities of the Depository
Participants
6.1 It is alleged that NSDL never physically verifies the DP prior to
recommending the registration of DP with SEBI.
6.2 Submissions of NSDL
6.2.1 The allegation that NSDL failed to verify the infrastructural facilities of the
DPs is vague and factually incorrect. The DPs are entities like Banks,
NBFCs, Custodians, Stock Brokers etc. These entities are either
registered with SEBI or the Reserve Bank of India before they seek to
become a DP. The copies of such registration certificates are required to
be submitted by the applicants for becoming DPs.
6.2.2 Further, the applicants are electronically connected to NSDL through
VSAT or leased line connectivity. No DP can connect to NSDL unless it
has adequate infrastructure. As NSDL itself arranges the electronic
connectivity of the DP applicants with the service providers (e.g. MTNL), a
DP cannot give misleading information about the location of its office.
Further, a DP applicant is required to install the software provided by
NSDL and the aforesaid software cannot run unless compatible hardware
and other system infrastructure are in place. The DP applicant has to
undergo rigorous testing of the software and hardware installed by it
including the complete end-to-end interface with NSDL for various
modules of depository processes. Only after completion of the testing
process the applicant is made operational. The aforesaid testing is not
possible unless the applicant DP has adequate and specified
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infrastructure. Thus, the allegation that NSDL failed to verify the
infrastructural facilities of the DPs is baseless.
6.3 Findings / Observations
6.3.0 It is submitted by NSDL that the DPs are entities like Banks, NBFCs,
Custodians, Stock Brokers etc. Such entities are already registered and
their registration certificate is submitted alongwith the application for DP
registration. However, it can be seen that nature of activity being
performed by a DP is different from that of the other entities. Therefore it
would require skills and infrastructure specific for successfully operating
as a DP.
6.3.1 In this regard, it is pertinent to note that Bye law number 6.2.1 (vii) of the
NSDL provides that the applicant should have adequate office space
exclusively for depository operations. The applicant should also furnish
details of his main office address, fax, phone numbers etc. Hence, even
NSDL Bye law prescribe adequate office infrastructure for the depository
participants. This is also the mandate of the provisions of the Regulation
16(2) of the Depositories Regulations which clearly provides that while
forwarding an application for a depository participant to SEBI, the
depository has to certify that the participant complies with the eligibility
criterion including adequate infrastructure as provided for in these
regulations and the byelaws of the depository. Further, how the depository
would know the exact location of the depository participant is also not clear
if they have not conducted inspection at the time of recommending the
registration application. In view of the above, the contention of NSDL that
as these entities are already registered, no further verification is required
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can not be accepted. NSDL has further submitted that its software cannot
run unless compatible hardware and other system infrastructure are in
place at the end of a DP. However, not checking the physical location and
infrastructure in advance by NSDL creates a system risk where any
system failure occurs subsequently due to any flaw in the infrastructure at
the end of the DP and it is not clear how it can be rectified immediately.
Further in the absence of any clear confirmation as to the location of the
participant, the depository cannot conduct any surprise inspection of the
participant to check compliance of the provisions of the regulations.
6.3.2 It is admitted by NSDL that it never conducts any site inspection before
recommending the application for registration as a depository participant.
In view of the same, it is concluded that NSDL failed to comply with the
provisions of Regulation 16(2) of the Depositories Regulations.
7.0 Failure to notice the unauthorized Outsourcing by the Depository
Participants
7.1 It is alleged from the findings of investigation that NSDL could never
capture the fact that there were agents being used for opening of demat
account by Karvy DP. This is in spite of the six monthly inspections
conducted by NSDL at various locations of Karvy.
7.2 These agents had ready-made stamps of addresses, which were affixed
on the application forms. These agents after collecting the papers had
local data entry operators who entered the data on a magnetic media. It is
alleged that this activity went unnoticed all along and the entire process of
verification of addresses and identity was bypassed by this operation.
- 22 -
7.3 This data was given to the front office of local Karvy offices in India along
with paper work. Local offices then sent the CD containing the data to
Karvy in Hyderabad. Karvy Hyderabad, uploaded this data for account
opening with NSDL. It is stated that NSDL’s DM application never checks
the data uploaded by DP. Hence the failure on the part of NSDL to check
the data uploaded by the DP resulted in a situation in which large number
of afferent accounts were opened by the key operators.
7.4 Submissions of NSDL
7.4.0 The allegation that NSDL did not notice the unauthorized outsourcing by
the DPs is factually incorrect. In our view, the facts being relied upon by
these reports demonstrate that they are not cases of assignment or
delegation of business of the DP. The Demat Accounts were in fact
opened by the DPs concerned. There is no prohibition in the law for
marketing activity to be outsourced by any capital market intermediary.
Outsourcing of select routine operations is a standard industry practice. All
banks routinely outsource such functions. SEBI has prescribed no
prohibition on such activity. It is completely erroneous to state that the
SEBI (Depositories and Participants) Regulations ("SEBI Regulations")
prohibit outsourcing of routine activities. In our view, such outsourcing is
neither objectionable nor commendable, and most certainly not illegal.
7.4.1 NSDL neither discourages nor encourages outsourcing. As far as NSDL is
concerned, at all times, the DP continues to be liable and responsible for
all its activities whether outsourced or not. The Show Cause Notice fails to
specify any provision of law that has been violated by the so-called
"unauthorized outsourcing" and by the so called failure to notice such
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outsourcing. Thus, the allegation that NSDL failed to notice the
unauthorised outsourcing by the DPs is baseless.
7.5 Findings/ Observations
7.5.0 Though it is submitted by NSDL that it was routine marketing activity that
was being outsourced and such outsourcing does not violate any
provisions of law, it is pertinent to note that NSDL failed to make any
norms to define the nature and scope of the outsourcing being resorted to
by its depository participants. In the absence of any norms, these agents
started performing activities like KYC verification also which should have
been done by the depository participant. This assumes significance in view
of the fact that adherence with KYC norms acts as a deterrent for any
fraud being committed in the capital market. In view of the same, the
contention of NSDL that KYC verification is a routine matter can not be
accepted. KYC documentation is the very basis of opening of an account.
As per the mandate of Regulation 52 of the Depositories Regulations, no
participant shall assign or delegate its functions as participants to any
other person without prior approval of the depository. The said core
function of the depository participant cannot be delegated. As the very
functions of KYC documentation and opening of accounts were
outsourced, it resulted in opening of large number of afferent accounts.
This fact also indicate that NSDL did not have adequate mechanisms for
the purpose of reviewing, monitoring and evaluating controls, systems,
procedures and safeguards as enumerated under Regulation 34 and 35 of
the Depositories Regulations.
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8.0 Failure to maintain Data Integrity
8.1 Following instances of discrepancies in the data maintained by NSDL
were noticed during the system audit conducted by SEBI. On many
instances, account creation date, account closure date etc., were filled
with dummy date. Hence prima facie it appeared that the following
instances reveal that NSDL failed to maintain the data in the appropriate
manner.
? NSDL has filled the client creation date prior to 16/4/1999 with
0001-01-01 dates.
? The dates for client activation prior to 2nd July 2005 have been
filled with 9999-12-31.
? Date of birth for minor has been filled with 0001-01-01.
? Closure date has been filled with 0001-01-01.
? RBI Approval Date has been filled with 0001-01-01.
? PAN number field has no validation and has all kind of junk
entries.
8.2 Submissions of NSDL
8.2.0 NSDL submitted that integrity of the electronic records and the automatic
data processing systems is maintained at all times and it takes all
precautions necessary to ensure that the records are not lost, destroyed
or tampered with and in the event of loss or destruction, it ensures that
sufficient back up of record is available at all times at a different place.
With regard to certain comments in the iSec Report, the following are
submitted.
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8.2.1 The account creation dates are very much available in the NSDL DP
systems. Initially, NSDL had adopted a model of decentralized mode of
booking of accounts. This mode of system was approved by SEBI. In July
2000, NSDL decided to move towards a centralized mode of booking as
this would enable investors to submit future dated instructions which will
reside on its central system and could be executed on a specified later
date even if on that day participant system / connectivity suffered technical
snag. Thus, the entire data about booking could be available in NSDL
system also and it is convenient to provide data to investigating agencies
such as the Government of India, SEBI etc. whenever required.
8.2.2 At the time of changing over from the decentralized model to the
centralized one, as the existing data was being migrated in stages, the
account creation dates in respect of the existing accounts were
deliberately put as 01/01/0001 and 31/12/9999 in the NSDL DM system,
so that such old accounts are clearly identified for the purpose of
migration, giving a proper audit trail. The account creation dates for the old
period are being migrated to NSDL DM system and we have informed
SEBI about this. Should NSDL have desired to stuff false data here, it
would not have entered patently indecipherable data. Such insertions
were made with a view to enable NSDL to actually identify such data.
8.2.3 Further, dates like Minor's Date of Birth, RBI approval date, Minor
Nominee Date etc. are applicable for limited set of accounts and not all.
e.g. Minor Date of Birth is allowed to be captured only if the holder is
marked as minor; RBI approval date is used only for foreign nationals etc.
These data fields in the system are populated with default values for other
types of accounts (i.e. other than those mentioned above) where they bear
no relevance. Default value used depends on field type. For Client master
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table for all "date" type of fields, the default value used is '0001-01-01 "
where as for "date-time" type fields, default used is '9999-12-31-
23.59.59.999999'.
8.2.4 As far as account closure date is concerned, all accounts which are closed
have the actual date of closure and the accounts which are open have 000
1-01-01 date marked in them. A different convention was hence used to
distinguish such accounts.
8.2.5 Far from compromising the integrity of the system, such default fields
provide an excellent audit trail that this data is not valid and where
applicable needs to be obtained from the DP systems.
8.2.6 The entire data relied upon by SEBI in bringing about its other actions
against other actionees referred to in the IPO matter, is sourced from the
depositories and unless SEBI believed in the data integrity, validity and
accuracy of NSDL's systems, it would not have relied upon the same to
bring about its other actions contained in the April Order
8.3 Findings / Observations
8.3.0 Regulation 37 of the DP Regulations provide that where records are kept
electronically by the depository, it shall ensure that the integrity of the
automatic data processing system is maintained at all times and take all
precautions necessary to ensure that the records are not lost, destroyed
or tampered with and in the event of loss or destruction, ensure that
sufficient backup of records is available at all times at a different place.
NSDL has submitted that when the existing data was being migrated to
the new system, the account creation dates in respect of the existing
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accounts were deliberately put as 01/01/0001 and 31/12/9999 in the
NSDL DM system. As submitted by NSDL this facilitated clear
identification of old accounts for the purpose of migration, giving a proper
audit trail. However, it is pertinent to note that this data was not rectified
even after the process of migration of data was successfully completed.
Further, vide Annexure VI to the letter dated March 15, 2007, NSDL
submitted that data migration in respect of account creation dates have
been migrated from the DPM system to DM system in respect of all the
active accounts. This indicates that with regard to other discrepancies in
the data as stated before, some were filled with dummy data. This cannot
have an audit trial as contended by NSDL. In the case of any enquiry, it
might be difficult to understand the exact date on which a particular
account is opened or closed, if NSDL is relying on dummy dates. Non
availability of exact dates of account opening and closure and further
inclusion of dummy data in respect of such dates clearly indicate that
NSDL violated the provisions of Regulation 37 of the DP Regulations.
8.3.1 This was a clear lapse on the part of NSDL that seriously undermined the
quality of data available in its system. This can be clearly ascertained from
the fact that in the absence of correct account opening date, one can not
get a correct system report on accounts being opened during particular
periods. Thus any unusual activity pertaining to number of accounts being
opened will go unnoticed. This should be seen in the background that key
operators opened hundreds of afferent accounts on same days with similar
addresses and NSDL failed to notice this unusual pattern of activity.
Hence, it casts serious doubts on the level and degree of supervision
exercised by NSDL over its depository participants.
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9.0 Failure to put in place Adequate Mechanisms for the purpose of
reviewing, monitoring and evaluating the controls, systems,
procedures and safeguards,
9.1 It is alleged that in the case of NSDL there are no byelaws for internal
controls standards including procedures for auditing, reviewing and
monitoring. This has resulted in no proper monitoring and control
exercised by NSDL over the DPs.
9.2 Submissions of NSDL
9.2.0 The allegation that NSDL failed to put in place adequate mechanisms for
the purpose of reviewing, monitoring and evaluating the controls, systems,
procedures and safeguards is not correct. Bye-laws pertaining to internal
controls and review have been incorporated by way of Bye Law 10.2
which is approved by SEBI.
9.2.1 Neither at the time of the approval nor at any time during the last nine
years has the issue of non-compliance with the Depositories Act ever
been raised. This was also not pointed out during the SEBI inspections of
NSDL which were done on five occasions previously.
9.2.2 NSDL has put in place a comprehensive system of internal & operations
audit and review. The internal and operations audit reports along with the
management comments are reviewed by the Audit Committee of NSDL on
a quarterly basis and the minutes thereof are placed before the Board of
NSDL.
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9.2.3 In fact, the system auditors viz. Moores Rowland Consulting Pvt. Ltd. in its
report dated March 28, 2005 has clearly mentioned that NSDL has
complied with the provisions relating to internal monitoring, review and
control in terms of Regulation 34 of the SEBI Regulations. Thus, the
allegation that NSDL failed to put in place adequate mechanisms for the
purpose of reviewing, monitoring and evaluating the control systems,
procedures and safeguards is baseless.
9.3 Findings / Observations
9.3.1 As can be seen from all the submissions made by NSDL, it was not
monitoring any account opening process as it provided the hardware and
software to the DPs. It is observed from the contentions of NSDL that DPs
were entrusted with the whole process of account opening with no checks
from the side of the depository. Further, in this context it is pertinent to
note that instances were noticed where the depository participants like
Karvy were given the data by the depository and no record of providing
such information which included the details of client IDs and DP IDs was
maintained by NSDL.
9.3.2 Specific instance of Ms. Prabha Iyer, official of NSDL sending some
information to Karvy was noticed as per the submissions of the officials of
Karvy. The fact that NSDL had no system in place to monitor and check
communication of such information and further no record of such
communication being maintained by NSDL clearly indicate the
mechanisms available for the purpose of reviewing, monitoring and
evaluating internal control of systems, procedures and safeguards as laid
down in Section 26(2)(p) of Depositories Act and the provisions of
Regulation 34 of the Depositories Regulations are not in place. In this
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regard, though it is submitted by NSDL that bye law number 10.2 provides
for accounting, internal controls etc, it is not clear what was the
mechanism put in place by NSDL to give effect to the mandate of
Regulation 34 of the Depositories Regulations. In this regard, it is also
pertinent to note that the auditors of NSDL have pointed out absence of
norms for internal monitoring, review and control of its processes. Further,
Regulation 35 of the Depositories Regulations provide for external
monitoring, review and evaluation of systems and controls of depository.
As per its own admission, it never checks and modifies the data entered
by the Depository Participants. In such a context, what is the degree of
monitoring, evaluation and control mechanisms and safeguards provided
by NSDL is not discernible. Further, as stated before, instances were
noticed wherein confidential information was provided by the depository to
the entities like Karvy RTI. Considering the same, it is pertinent to note
that no adequate mechanisms for the purpose of reviewing, monitoring
and evaluating the controls, systems, procedures and safeguards were
made by NSDL. Existence of effective control measures and monitoring
and evaluating such measures could have prompted NSDL in checking
creation of large number of afferent accounts. Hence, it is concluded that
NSDL failed to put in place adequate mechanisms for the purpose of
reviewing, monitoring and evaluating the controls, systems, procedures
and safeguards in terms of the provisions of Regulation 34 of the
Depositories Regulations.
10.0 Failure to take appropriate action against the Depository Participants
for the various irregularities repeatedly committed by them.
10.1 During the course of investigation conducted by SEBI, records in respect
of the inspections of the Depository Participants conducted by NSDL were
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persued. For the purpose of the said examination, SEBI obtained all the
inspection reports pertaining to seven DPs viz. Karvy Stock Broking,
HDFC Bank, Pratik Stock Vision Pvt. Ltd, IL&FS, Centurion Bank,
Wellworth Share & Stock Broking and Dindayal Biyani Stock Brokers Ltd.
These DPs were short listed on the basis of the occurrence of large
number of multiple accounts with same addresses with these DPs found
during the course of investigation.
10.2 It is alleged that NSDL failed to inspect the DPs in a proper manner that
resulted in various lapses that were subsequently misused by the key
operators to manipulate the IPO process to the detriment of the retail
investors. Summary of the findings related to inspection of various DPs by
NSDL is stated below.
10.3 There is recurrence of same errors relating to account opening as noticed
in inspection after inspection and NSDL has commented on them in their
reports year after year. However, the same error recurs and the cycle
goes on. This has made non-compliance with account opening norms a
regular feature.
10.4 It was noticed that NSDL imposes penalty for non compliance with NCFM
employee requirement. However, hardly any penalty is levied for non
compliance with account opening norms. Most instances of levying of
penalty are for non compliance with NCFM employee requirement where
penalties upto Rs.3,50,000 has been imposed. In case of account opening
deficiencies the penalty is only 500-1000 rupees and the instances are
few. Levying of penalties which runs into lakhs for non-compliance with
NCFM certification of employees of DPs by NSDL and only penalties in
range of hundreds and few thousands for account opening deficiencies
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shows that NSDL does not use fair and objective criteria while levying
penalty.
10.5 Regardless of the type of DP (broker, Bank etc.) and regardless of the
size of the operations of the DP concerned, NSDL devotes usually only
one day for inspection. Also, NSDL has allotted a fixed time for each area
of DP’s operation and the time allotted remains the same irrespective of
the quantum of instructions processed by the DP.
10.6 Further, the sample size chosen by NSDL in their inspections is woefully
inadequate. It was also observed that the procedure for inspection,
periodicity of inspection and the entity chosen for inspection has not been
in line with the responsibility cast on the depositories. Further, from the
format of inspection reports of the Depositories it is observed that the
inspection is system specific rather than entity specific.
10.7 It was observed that NSDL had not taken appropriate penal action against
DPs for repetitive violations by DPs observed by them during inspections.
NSDL’s action has never gone beyond imposition of monetary penalties.
There was no application of mind while conducting these inspections. The
way in which the penalty was imposed and then again waived when the
DPs submit a paper saying they have complied shows a callous attitude
towards statutory requirements by the depositaries especially when the
account opening deficiencies recur among the large percentage of the
sample collected during all inspections from 2003-2006.
10.8 The reliability of the inspection reports is very low as there are grave
errors like the number of errors being shown lesser than the number of
accounts involving errors.
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10.9 On the basis of the above, it is alleged that NSDL was aware of the
irregularities in connection with opening of accounts from the year 2003
which is evident from the inspection report of HDFC Bank, Karvy Stock
Broking etc. They failed to take prompt action against the DPs and failed
to inform SEBI of the same. It is further alleged that NSDL was aware of
the possibility of existence of accounts being opened without proper KYC
Process as early as 2003 and has not put in place system to detect such
accounts and take appropriate action and therefore turned a blind eye to
these deficiencies which has led to recurrence of error in account opening
repeatedly, in a big way later.
10.10 As a depository, NSDL is required to have adequate controls, systems
and procedure for monitoring and evaluating its compliances with statutory
requirements and prevent any conduct by DPs which is detrimental to the
interest of investors or the securities market. In this respect, it is alleged
that NSDL failed to perform and supervise the operations of the DPs and
also failed to inform SEBI of the deficiencies. In view of the same it is
alleged that NSDL failed to conduct themselves in a manner which is in
the interest of investors and the securities market.
10.11 Submissions of NSDL
10.11.0 The allegation that NSDL failed to take action against the DPs for the
various irregularities allegedly committed by them repeatedly is not
correct.
10.11.1 Further, the orders passed by SEBI against NSDL have been based on
wrong conclusions drawn by mis-interpreting the data. For instance, the
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error percentage in inspection reports have been wrongly computed and
stated by SEBI in its April Order. As reported in April Order in para 15.0
on page no. 207 & 208, 950 samples were verified during 17 inspections
of Karvy Stock Broking Ltd. (Mumbai and Hyderabad setups) and HDFC
Bank Ltd. (all setups). The total number of errors reported is 327. Of
these errors, 40 errors (including corporate accounts) pertain to KYC
documents (Identity proof or Address proof) not collected which is less
than 13% of total errors and 4 % of the sample checked. Another 109
errors pertain to inadequate KYC documentation. Some of the
documents considered as inadequate are copy of ration card with
photographs (collected as identity proof), telephone/electricity bill
collected are either of private service provider or more than 2 months
old, documents collected not providing complete details. Further,
inadequacy was also reported when Bankers attestation or PSU/Bank
employer identity card collected as KYC documents (which have
subsequently become valid documents as per revised SEBI guidelines).
The remaining errors reported are 28 Data entry errors with respect to
address and bank details and 140 Other Errors (e.g. DP client
agreement not proper, Standing Instruction not captured correctly, Mode
of operation scanned but not captured, nomination form not proper,
signature not properly scanned/legible, Power of Attorney not notarized
etc.). These errors, which have no relation as far as KYC documentation
of the accounts are concerned, constitute a major portion of errors and in
any case all the errors put together do not constitute 118 and 100
percent of the samples as is alleged in the investigation report.
10.11.2 It is further submitted that without establishing any correlation between
the nature of inspection findings and the list of Financiers on any
wrongdoers, SEBI has leveled a vague allegation of facilitation against
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NSDL. SEBI is fully aware that we imposed penalties in relation to
deviations by the DPs and to prevent the recurrence of the same. In fact
SEBI has recorded a finding that penalties were indeed levied by NSDL.
Further, the Disciplinary Action Committee of NSDL has also met as and
when required to take action against the wrong-doing found on the part
of various depository participants. It is not correct for SEBI to hold that
NSDL did not take any action against the DPs for irregularities being
committed by them. Thus, the allegation that NSDL failed to take
appropriate action against the DP for the various irregularities repeatedly
committed by them is baseless.
10.12 Findings / Observations
10.12.0 An analysis of the penalties imposed by NSDL for various non-
compliances in respect of five DPs as revealed in the investigation is
tabulated below:
non-compliance Instances
% to total
Instances penalty
% to total
penalty(in
rupees
terms)
karvy
Qualified personnel not appointed as per NSDL
requirement 5 12.19512 92000 51.45414
Quarterly Internal Audit Report not submitted (by
stipulated time). 17 42.50 17500 9.787472
No/inadequate control over issuance and/or
acceptance of instruction slips. 5 12.50 9000 5.033557
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non-compliance Instances
% to total
Instances penalty
% to total
penalty(in
rupees
terms)
Not taking back up daily and/or deviation in procedure
of taking backup 5 12.50 25000 13.9821
Account closure/ freezing/ unfreezing /transmission
not done as per NSDL requirements. 2 5.00 5000 2.796421
Account opened without obtaining adequate proof of
identity and/or proof of address and no adequate
proof of address collected for change of address. 2 5.00 1700 0.950783
Account opened without obtaining adequate proof of
identity and/or proof of address and no adequate
proof of address collected for change of address.
(observed in two consecutive inspections) 1 2.50 10000 5.592841
Client account debited without receiving proper
authorization from clients. 1 2.50 5000 2.796421
Data entry errors/omission which may cause
inconvenience and/or loss to the client / system / DP /
NSDL 1 2.50 4600 2.572707
Delay in processing of demat requests beyond 7
working days after receipt 1 2.50 5000 2.796421
No/inadequate control over issuance and/or
acceptance of instruction slips. (observed in two
consecutive inspections) 1 2.50 4000 2.237136
Total 41 178800
Centurion Bank Limited
No/inadequate control over issuance and/or
acceptance of instruction slips. 1 33.33 2000 11.76471
Not taking back up daily and/or deviation in procedure
of taking backup 1 33.33 5000 29.41176
Qualified personnel not appointed as per NSDL
requirements 1 33.33 10000 58.82353
Total 3 17000
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non-compliance Instances
% to total
Instances penalty
% to total
penalty(in
rupees
terms)
Infrastructure Leasing & Financial Services
Limited
Account opened without obtaining adequate proof of
identity and/or proof of address and no adequate
proof of address collected for change of address. 1 12.5 300 0.643087
Quarterly Internal Audit Report not submitted (by
stipulated time). 1 12.5 1500 3.215434
Not taking back up daily and/or deviation in procedure
of taking backup 1 12.5 5000 10.71811
Client account debited without receiving proper
authorisation from clients. 1 12.5 5000 10.71811
Qualified personnel not appointed as per NSDL
requirement 4 50 34850 74.70525
Total 8 46650
HDFC Bank Limited
Qualified personnel not appointed as per NSDL
requirements 8 80 750250 99.46967
Statement of transactions not being sent to clients as
required by regulations. 2 20 4000 0.530328
Total 10 754250
Pratik Stock Vision Private
Not taking back up daily and/or deviation in procedure
of taking backup 1 100 5000 5000
total 1
10.12.1 It is noted from the above data that most of the penalties are for failure to
appoint qualified personnel as per NSDL requirements/NCFM certification.
The amount of penalty charged for non compliance with KYC
requirements is significantly lesser than that for other violations and this
fact clearly indicate that it was not given much importance by NSDL. No
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suitable reply has been submitted by NSDL for its decision to have lesser
penalty for account opening deficiencies. It can be assumed that this lapse
on the part of NSDL gave a signal that deficiencies in account opening will
be treated leniently and the same encouraged the Key Operators to open
large number of afferent accounts. Further, it appears that opening of
accounts by Karvy DP without entering necessary data except name was
observed by NSDL in its report in 2003. It is seen that the said violations
were observed in the previous year also. However, no strict action is taken
against Karvy for the said violations. NSDL being the authority to ensure
and supervise the smooth functioning of the depository system should
have assessed the possible impacts of its policy decision of treating the
failure in KYC documentation lightly. The failure on the part of NSDL to
effectively supervise and control such actions indicate that it did not have
effective systems for external monitoring, review and control as mandated
under Regulation 35 of the Depositories Regulations.
11.0 Failure to comply with the directives issued by SEBI : transactions in
the account of Shri. Biren Kantilal Shah
11.1 It is alleged that NSDL failed to comply with the directives issued by SEBI
vide order dated January 12, 2006 and April 27, 2006.
11.2 SEBI vide orders dated January 12, 2006 and April 27, 2006 directed that
the account maintained by Shri. Biren Kantilal Shah (ID 10258111 held
with Jhaveri Securities Pvt. Limited, Depository Particiapant of NSDL with
Registration No. IN-DP-NSDL-166-2000) shall not be utilized for
manipulation in future. Vide said orders, NSDL was also directed to ensure
that the dematerialized accounts which served as conduits are not utilized
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for manipulation. Further, NSDL was also directed to ensure that all the
directions issued vide the orders are strictly enforced. However, it was
observed that the said conduit account maintained by Shri. Biren Kantilal
Shah continued to be used as a conduit as evident from the fact that
during March 3 – 11, 2006 off market shares of 90 shares each of ICICI
Bank was received from 123 dematerialised account held with the DP –
Jhaveri Securities Pvt. Limited to the said account. Further, on March 23,
2006 off market transfer of 90 shares of ICICI Bank shares was effected to
the said demat account of Shri. Biren Kantilal Shah. Thus Shri. Biren
Kantilal Shah had received 11,160 shares of ICICI Bank through off market
transfers of 90 shares each from 124 demat account holders. Further it is
seen that on April 5, 2006 interdepository transfers had taken place
between the said account of Shri. Biren Kantilal Shah and the account no.
1031670000011619 maintained with CDSL. In view of the above it is
alleged that NSDL failed to comply with the directions issued by SEBI as
stated above.
11.3 Submissions of NSDL
11.3.1 SEBI is aware that the January 12, 2006 order restrained transactions in
shares of IDFC Ltd. by the persons mentioned therein. In this regard,
NSDL communicated to SEBI vide letter bearing Ref. No.
NSDL/SEBI/PI/2006/SS/0024 dated January 20, 2006 about initiation of
an ISIN-level freeze in respect of the persons mentioned therein so as to
ensure that the concerned persons do not transact in shares of IDFC Ltd
in those accounts. Further, clarification in respect of those accounts where
action could not be initiated was sought from SEBI vide our aforesaid
letter, a response to which is still awaited. The action taken in terms of the
SEBI order dated April 27, 2006 was informed to SEBI vide NSDL letter
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no. NSDL/SEBI/PI/2006/ AS/0246 dated May 2, 2006 and letter no.
NSDL/SEBI/PI/2006/AS/0248 dated May 3, 2006.
11.4 Findings / Observations
11.4.0 With regard to the transactions in the account of Shri. Biren Kantilal Shah,
ID 10258111 held with Jhaveri Securities Pvt. Limited (Depository
Particiapant of NSDL) as stated above, It is noted that SEBI vide order
dated January 12, 2006, directed the following entities not to buy, sell or
deal in the shares of IDFC Ltd. and in other ensuing future IPOs, directly
or indirectly, till further directions:
i. Zenet Software Ltd.
ii. Tauras Infosys Ltd.
iii. Rajan Vasudev Dapki
iv. Bhargav Ranchhodlal Panchal
v. Jayantilal Jitmal
vi. Seer Finlease Pvt. Ltd.
vii. Excell Multitech Ltd.
viii. Devangi Dipakbhai Panchal
ix. Hasmukhlal N. Vora
x. Welvet Financial Advisors Pvt. Ltd.
xi. Jayesh P Khandwala HUF
xii. Guatam N Jhaveri
xiii. Shilpa Rajan Dapki
xiv. Dipak Jashvantlal Panchal
xv. Hina Bhargav Panchal
xvi. Bhanuprasad Dipakkumar Trivedi
xvii. Sujal Leasing Pvt. Ltd.
xviii. Dushyant Natwarlal Dalal
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xix. Puloma Dushyant Dalal
xx. Amadhi Investments Ltd.
xxi. Ritaben R Thakkar
xxii. Monal Y Thakkar
xxiii. Vinod Modha
xxiv. Kelan Atulbhai Doshi
xxv. Jitendra Lalwani
xxvi. Lok Prakashan Ltd.
xxvii. Bahubali Shantilal Shah
xxviii. Smruti Shreyans Shah
xxix. Shreyans Shantilal Shah
xxx. Datamatics Telecom Ltd.
xxxi. Dharmesh Bhupendra M
xxxii. Biren Kantilal Shah
xxxiii. Suresh Bhikha Vasava
xxxiv. Javeri Gautambhai
xxxv. Jay Shah
11.4.1 In the said order it was observed that thousands of dematerialized
accounts being opened on the same day with the same branch and being
introduced by the same bank should have alerted the DPs at the time of
opening of the dematerialized accounts. However the fact that DPs failed
to exercise even this basic due diligence gives rise to a suspicion that they
have actively colluded with the perpetrators. Further, in paragraph 12.6 of
the said order it was emphasised that Depositories and DPs have an
agent-principal relationship in terms of the Depositories Act, 1996 entailing
liability on them for the conduct of DPs. Also, Depositories being SEBI
registered intermediaries under Section 2(e) of the Depositories Act, 1996
read with sub-section (1A) of Section 12 of SEBI Act, 1992 are charged
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with the responsibility of protecting the interests of investors. Paragraph
12.7 of the order cautioned that this is the second time in the recent past
when the opening of several thousands of dematerialized accounts in the
name of fictitious persons with common address, without adhering to the
KYC norms have come to notice. Therefore there is an imperative need to
constantly monitor securities flow in dematerialized accounts. The
recurring disconcerting developments as above underscore the need that
both NSDL and CDSL should assume greater responsibility in the interest
of the investors and integrity of the market by getting real about such
distortions with celerity of action.
11.4.2 Hence, the depository NSDL was directed to monitor the securities flow in
the dematerialized accounts. It is noted that the account (ID 10258111
held with Jhaveri Securities Pvt. Limited, Depository Participant of NSDL)
was identified as an account which was used in cornering the shares in
the IPO. In this regard, it is also pertinent to note that as stated in the
order dated January 12, 2006, this was the second time, same modus
operandi was adopted by the entities mentioned above was noticed. In
this regard, it is also pertinent to note that earlier, while passing the order
dated 15.12.2005 in the matter of Yes Bank Ltd, SEBI had directed that
various accounts which served as conduits in the manipulation of IPO of
Yes Bank shall not be utilized for manipulation of IPO allotment in future.
Further, as directed in paragraph 6.5 of the order, NSDL and CDSL were
advised to enhance their surveillance and also devise and put in place
systems and procedures for identifying multiple dematerialized accounts
of suspicious nature and reporting the same to SEBI as expeditiously as
possible. Subsequently in the IPO of IDFC, while passing the order dated
January 12, 2006, the depositories were again directed to ensure that
such fictitious accounts are not utilized for manipulation. Further, as stated
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before, in the order dated January 12, 2006 paragraph number 12.7
clearly mentions that there is an imperative need to constantly monitor
securities flow in dematerialized accounts. It was further advised that the
recurring disconcerting developments as above underscore the need that
both NSDL and CDSL should assume greater responsibility in the interest
of the investors and integrity of the market by getting real about such
distortions with celerity of actions. It was also emphasized that any system
that is unable to identify and alert SEBI about multiple dematerialized
accounts based on common addresses can not be accepted. Further, the
depositories were directed to ensure that all the directions in the order are
strictly enforced.
11.4.3 Viewed in the light of the above directions, it can be seen that NSDL failed
to monitor the securities flow to the account of Biren Kantilal Shah.
Though, it is contended by NSDL that the prohibition was only in respect
of future IPOs, it can be seen that vide the said orders, it was clearly
directed that NSDL should monitor flow of securities to the said accounts.
It is pertinent to note that the same modus operandi was adopted by Biren
Kantilal Shah by receiving shares from different accounts as stated above.
It is also pertinent to note that the said incident did not happen on a single
day but over a period of time as can be seen that during March 3 – 11,
2006, off market shares of 90 shares each of ICICI Bank was received
from 123 dematerialised account to the said account. Further, on March
23, 2006 off market transfer of 90 shares of ICICI Bank shares was
effected to the said demat account of Shri. Biren Kantilal Shah. Thus Shri.
Biren Kantilal Shah had received 11,160 shares of ICICI Bank through off
market transfers of 90 shares each from 124 demat account holders.
Further, it was observed that on April 5, 2006 interdepository transfers had
taken place between the said account of Shri. Biren Kantilal Shah and the
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account no. 1031670000011619 maintained with CDSL. In this regard, it is
also pertinent to note that it is not the case of NSDL that it reported such
transactions of the shares of ICICI Bank to SEBI. Hence, it can be seen
that the account maintained with the depository participant of NSDL, i.e.
Jhaveri Securities was continued to be manipulatively used in the same
manner as happened in the case of Yes Bank and IDFC. The failure on
the part of NSDL to prevent such manipulation and also its failure to report
the manipulation to SEBI is a serious lapse and hence it is concluded that
NSDL failed to comply with the directives issued by SEBI vide order dated
January 12, 2006. On account of its failure to comply with the directions
issued by SEBI, NSDL is liable to the penalty prescribed under Section
15HB of the SEBI Act.
12.0 Failure to comply with the directives issued by SEBI : Failure to
defreeze account no. 10037925
12.1 SEBI vide letter ref: ISD/SD/HSE/03/2006 dated 16.11.2006 directed
NSDL to conduct an audit of the Client ID No.10037925 of Karvy Stock
Broking Limited (Depository Participant ID IN302734) (KSBL) which was
frozen by HSE Securities. As measure before defreezing / activating the
said demat account, vide the said letter SEBI directed NSDL to conduct an
audit of the transactions in the said demat account since the interim order
dated April 27, 2006 passed by SEBI, to ensure that no proprietary trades
of Karvy Stock Broking Limited had taken place. It is alleged that NSDL
failed to comply with the directions issued by SEBI vide the said letter.
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12.2 Submissions of NSDL
12.2.0 NSDL has submitted that a demat account can receive credits and debits
from / to any other client accounts. Only the concerned account holder
would know as to what is the nature of transactions underlying the
transfers that have taken place in its account. If the concerned account
holder has designated the account for pay-in / pay-out purposes only, only
such account-holder or its auditors would be in a position to confirm the
same. Only they would be able to confirm whether or not any other type of
transactions and transfers have taken place from such account. No other
person, including NSDL will ever be able to ensure that an account is used
(in future) for specific purposes. NSDL can at best freeze or de-freeze an
account. Once an account is active, NSDL would not be able to confirm
whether the account is being used or will be used for holding or for
transfers of securities arising out of proprietary trades or for purposes of
pay-in or pay-out. It is also not possible for NSDL to know the intentions or
underlying obligation(s) resulting in any transfer carried out by the demat
account holder.
12.2.1 NSDL has further submitted that subsequent to SEBI letter dated
November 16, 2006, it advised KSBL to conduct an audit of the said
account and submitted the confirmation alongwith the auditor’s certificate
for the transfers already taken place in the said account. However, NSDL
has no ability to ensure that the said account or any other account is used
in future only for a specific purpose.
12.3 Findings / Observation
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12.3.0 As seen from the letter dated November 16, 2006, SEBI had advised
NSDL to conduct an audit of the transactions in the said demat account
since the interim order dated April 27, 2006 passed by SEBI, to ensure
that no proprietary trades of Karvy Stock Broking Limited had taken place.
The said direction was issued as a measure for defreezing the account of
KSBL maintained with HSE Securities Ltd. which as contended by KSBL
was used for pay in and pay out obligations of the clients. As can be seen
from the said direction that the same was for the protection and benefit of
the investors as they should not be affected by the ban on proprietary
trades imposed vide order dated April 27, 2006 passed by SEBI. In this
regard, it is noted that the defreezing of accounts was subject to the
following conditions :
? Both NSDL and HSE Securities Ltd / HSE should satisfy themselves that
the demat account under reference is specifically designated for the
purpose of pay-in / pay-out of clients since its inception.
? Undertake the audit of all the transactions in the said demat account from
the date of interim order dated April 27, 2006 till date to ensure that no
proprietary trades of KSBL, either in the nature of off market or market
transactions have taken place.
? HSE Securities Ltd., in coordination with NSDL / Hyderabad Stock
Exchange should take necessary steps including appointment of
concurrent auditor, if necessary, to strictly adhere that no proprietary
trades take place in the nature of either market or off market transactions
in the said account pursuant to activation of the said demat account.
? HSE Securities Ltd., in coordination with NSDL / Hyderabad Stock
Exchange should ensure that none of the entities debarred from dealing in
securities vide interim order dated April 27, 2006 have dealt or are
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permitted to deal as clients of KSBL, member of HSE in the said demat
account.
12.3.1 It is noted from the submissions of NSDL that vide its letter dated
November 29, 2006, it advised KSBL to submit an auditor’s certificate
scrutinizing the said account. KSBL vide its letter dated December 19,
2006 submitted an auditor’s certificate, duly certified by Lalith Prasad &
Co., Chartered Accountants confirming that there have been no
proprietary trades subsequent to the SEBI order dated April 27, 2006 in
the said account. However, it is pertinent to note that SEBI had also
advised the appointment of concurrent auditor to ensure that no
proprietary trades take place in future in the said account. Though vide
letter dated November 21, 2006, NSDL has stated that it has no ability to
ensure that the said account or any other account is used in future only for
a specific purpose, however, it has not given any explanation why it failed
to take steps for the appointment of concurrent auditor for the purpose.
SEBI has advised appointment of concurrent auditor to ensure that no
proprietary trades take place in future in the said account. The
requirement for appointment of concurrent auditor is to ensure objectivity
in the audit.
12.3.2 It is noted that NSDL vide its letter dated November 21 and 25, 2005
expressed its inability to ensure whether demat account of KSBL is used
for holding or transfer of the securities arising out of proprietary trades. It
is noted that subsequently, SEBI vide letter dated December 12, 2006
directed NSDL to take measures to ensure compliance of the directions /
conditions laid down by SEBI vide its letter dated November 16 and 23,
2006 in coordination with the DP within ten days. As the said letter has
been issued subsequent to commencement of the present adjudication
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proceedings vide show cause notice dated November 23, 2006, I am of
the view that it may not be appropriate to take into account the violations,
if any, committed subsequent to the issuance of show cause notice in the
present adjudication proceedings. Hence, SEBI may initiate fresh
proceedings, if necessary in respect of the alleged violation on the part of
NSDL to comply with the directions issued by SEBI vide letter dated
November 16, 2006.
13.0 Conclusion
13.1. As stated in the preceding paragraphs of this order, it is noted that the
various commissions and omissions on the part of NSDL resulted in
opening of large number of afferent accounts by the key operators. The
evidence available in the matter, clearly indicate that the various actions
and omissions on the part of NSDL facilitated the key operators to open
large number of afferent accounts and to use such accounts to corner the
reserved portion for retail investors in the IPOs of many companies. These
commissions and omissions on the part of NSDL indicate that NSDL failed
to comply with the conditions of registration under Regulation 7 (b) and
also Regulation 34 of the Depositories Regulations.
13.2. Further, on account of its failure to verify and satisfy the eligibility
requirement of adequate infrastructure of the participant, NSDL failed to
comply with the provisions of Regulation 16(2) of the Depositories
Regulations.
13.3. On account of its failure to maintain and protect the integrity of the data
with regard to the accounts, NSDL violated the provisions of Regulation 37
of the Depositories Regulations.
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13.4 Lack of adequate mechanisms for the purpose of reviewing, monitoring
and evaluating the controls, systems, procedures and safeguards on the
part of NSDL has resulted in failure to prevent unauthorized outsourcing
by the depository participants, and also the failure on the part of NSDL in
taking actions against them. In view of the same, NSDL violated the
provisions of Regulation 52 read with Regulations 34 and 35 of the
Depositories Regulations.
13.5 In addition to the above violations, NSDL also failed to comply with the
directives issued by SEBI vide order dated January 12, 2006.
13.6 The five major violations as stated above attract penalty under Section 15
HB of the SEBI Act and Section 19G of the Depositories Act the
provisions of which state the following:
Section 15HB of the SEBI Act
“Whoever fails to comply with any provision of this Act, the rules or the
regulations made or directions issued by the Board thereunder for which
no separate penalty has been provided, shall be liable to a penalty which
may extend to one crore rupees.”
Section 19G of the Depositories Act
“Whoever fails to comply with any provision of this Act, the rules or the
regulations made or directions issued by the Board thereunder for which
no separate penalty has been provided, shall be liable to a penalty which
may extend to one crore rupees.”
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13.7 The provisions of Section 15J of the SEBI Act, 1992 and 19I of
Depositories Act, 1996 read with Rule 5 of the SEBI (Procedure for
Holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules,
1995 require that while adjudging the quantum of penalty, the adjudicating
officer shall have due regard to the following factors namely:
a. The amount of disproportionate gain or unfair advantage wherever
quantifiable, made as a result of default
b. The amount of loss caused to an investor or group of investors as a
result of the default
c. The repetitive nature of default
13.8 With regard to the above factors to be considered while determining the
quantum of penalty, it is noted that on account of various commissions
and omissions on the part of NSDL, the key operators had opened large
number of afferent accounts which were used for the purpose of cornering
the retail portion in the IPOs. Hence the investors suffered great loss on
account of cornering of shares by the key operators. Hence, heavy loss
has been caused to the investors.
13.9 As stated in the preceding paragraphs of this order, large number of
afferent accounts were opened with NSDL and the failure on the part of
NSDL in discharge of its duties as a Depository in terms of the provisions
of SEBI Act, 1992, Depositories Act, 1996 and SEBI (Depositories and
Participants) Regulations, 1996 resulted in cornering of shares by the key
operators and financiers in many IPOs repetitively which caused heavy
loss to the investors. In this regard, it is pertinent to mention that had
NSDL ensured compliance of the account opening norms by its depository
participants, the key operators would not have been in a position to
subvert the IPO process. The various commissions and omissions on the
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part of NSDL as stated above which resulted in facilitating the key
operators in opening of afferent accounts, might have normally passed of
as negligence but for the enormity of the situation. The manner and ease
with which number of afferent accounts have been opened, that too in
large numbers by a coterie of entities should have ordinarily alerted
anyone as to the goings on. In these circumstances, it is difficult to believe
that the same would have escaped the attention of NSDL. Had they cared
to know, they would have known. In this process, NSDL facilitated the
occurrence of the violation. Further, NSDL being the authority providing
depository services to investors is duty bound to ensure transparent
systems and governance as far as depository services are concerned. In
this regard, the Depositories Act casts vicarious liability on the part of the
depository for the actions of the depository participants.
13.10 Principal agent relationship between the depository and the depository
participant is clearly laid down under the provisions of Sections 4, 5 and
16 of the Depositories Act. In such a situation, the commissions and
omissions such as failure to take action against the depository participants
for violation of KYC documentation even when it was aware that accounts
were opened only with names without any details and also adding a
correspondence address in the account opening form which enabled the
key operators to continue with their scheme smoothly have to be viewed
seriously. Considering the magnitude of loss caused to the investors as a
result of the various lapses and contraventions on the part of NSDL, I am
of the view that each of the said five violations listed above are grave in
nature and each attract the maximum penalty in terms of the provisions of
Section 15 HB of the SEBI Act, 1992 and Section 19G of the Depositories
Act, 1996. In this regard, it is also pertinent to note the order passed by
the Honourable Supreme Court in Shriram Mutual Fund Vs SEBI [2006]
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68SCL216(SC) wherein the Court held that the violations of the provisions
SEBI Act and Regulations attract the penalty irrespective of the intent. The
Honourable Court held that penalty is attracted as soon as the
contravention of the statutory obligation as contemplated by the Act and
the Regulation is established and hence the intention of the parties
committing such violation becomes totally irrelevant.
ORDER
14.0 For the violations committed by National Securities Depository Ltd as
stated above, in exercise of the powers conferred under Section15 I of the
SEBI Act 1992 and Section 19H of the Depositories Act 1996, I, impose a
penalty of Rupees Five Crore (Rs.5,00,00,000) on National Securities
Depository Ltd in terms of the provisions of Section 15 HB of the SEBI Act,
1992 and Section 19G of the Depositories Act, 1996.
14.1 The penalty shall be paid by way of demand draft drawn in favour of “SEBI
– Penalties Remittable to Government of India” payable at Mumbai within
45 days of receipt of this order. The said demand draft shall be forwarded
to “Securities and Exchange Board of India”, Plot No.C4-A, “G” Block,
Bandra Kurla Complex, Bandra (East), Mumbai 400 051.
14.2 In terms of the provisions of Rule 6 of the SEBI (Procedure for Holding
Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995
copies of this order are sent to National Securities Depository Ltd. and to
Securities and Exchange Board of India.
Place: Mumbai Biju. S
Date: April 27, 2007 Adjudicating Officer