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Navigating Self-Regulation: A closer look at a recent SAT Order

[All views expressed here are personal and nothing contained herein reflects the views, opinions and beliefs of any organization.]

The Securities Appellate Tribunal (“SAT”) has in its recent order in the matter of Magnum Equity Broking Limited v. National Stock Exchange of India Limited,[1] clarified the interpretation of prohibition under rule 8(3)(f) of the Securities Contracts (Regulation) Rules, 1957 (“SCRR”). The said appeal was filed against an order of the Member and Core Settlement Guarantee Fund Committee (“MCSGFC”) of the National Stock Exchange of India Limited (“NSE”) imposing a penalty of Rs. 8,12,000/- which inter alia included a penalty of Rs. 7,50,000/- for violation of rule 8(3)(f) of the SCRR.

It must be noted that rule 8(3)(f) of the SCRR prohibits a broker/trading member from engaging as a principal in business other than that of securities involving personal liability. In the said matter, MEBL had advanced funds amounting to Rs. 79.75 crore and received funds amounting to Rs. 78.20 crore through its own bank account from and to a non-banking financial company registered with the Reserve Bank of India (the “NBFC”).

As urged by MEBL before the MCSGFC, the said amount advanced was in the nature of temporary investments, out of its own surplus funds towards inter corporate deposits, similar in nature to investment in liquid funds with a bank or a mutual fund purely to earn interest on available surplus funds. However, the MCSGFC had held that by doing so, MEBL had engaged as a principal in business other than that of securities.

SAT rightly noted that it was erroneous on the part of the committee to treat the investments as loans. SAT also observed that a plain reading of the rule 8(3)(f) of the SCRR and rule 5(b) of Chapter II of the NSE Rules indicates that a trading member cannot engage as a principal or employee in any business involving any personal financial liability other than that of securities. It also noted that SEBI’s circular dated May 07, 1997 clarified that the said prohibition does not extend to borrowing and lending funds by a trading member, in connection with or incidental to or consequential upon the securities business.

In its order, SAT opined that the investment of surplus funds generated as a consequence of securities business with an RBI registered NBFC cannot be construed as MEBL engaging as a principal in business other than that of securities involving personal financial liability. It also observed that the MCSGFC had itself given a clear finding that the funds were advanced from the account of MEBL itself and that there was nothing on record to indicate that this transaction was a loan, especially as the agreement between MEBL and the NBFC indicated that it was for the investment of funds as inter-corporate deposits.

Accordingly, SAT observed that the violation of rule 8(3)(f) of the SCRR was not proven and struck down the penalty imposed by the MCSGFC on this count.

Food for thought

While SAT affirmed the legal competence of the NSE to initiate the post-inspection enforcement action in the present matter, it merits reflection on whether the judicial considerations entailed in determinations which have an impact on businesses (be it on account of accurate and coherent interpretation of provisions or its application) are effectively addressed by the nature of the MCSGFC or would be better done by the regulator at this stage.[2]

Other interesting SAT orders in appeals against MCSGFC which lead to such questions include Abhipra Capital v. NSE Ltd.,[3] where SAT emphasized that trading terminals cannot be disabled based solely on a prima facie opinion and criticized the misuse of ad interim orders and LSC Securities v. NSE Ltd.[4], where SAT found the MCSGFC’s directions to halt onboarding new clients erroneous for having partially considered the facts therein. Lastly also the recent case of Devendra Kapil v. Defaulters Committee, NSEIL,[5] brought to light the laxity of the exchange in addressing the claim of an old, retired couple regarding duping and cheating by authorized persons of a broker.

[1] SAT Appeal No. 461 of 2022 decided on 29.11.2023.
[2] A World Bank Policy Paper published in 2011 canvassed trends in self-regulation and noted that if ‘if self-regulation is used, important decisions must be made about the scope of SRO responsibilities and powers, as well as the structure, governance and supervision of SRO. Those subjects are being revisited even in countries with well-established self-regulatory systems’ Masciandaro, D, Vega Pansini, R, and Quintyn, M, The Economic Crisis: Did Financial Supervision Matter? (2011) IMF working Paper WP11/261.
[3] SAT Appeal No. 488 of 2023, decided on 09.06.2023
[4] SAT Appeal No. 678 of 2023, decided on 09.08.2023
[5] SAT Appeal No. 155 of 2022 decided on 20.04.2022

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