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Last year, I wrote here about how SAT quashed some orders of the Member and Core Settlement Guarantee Fund Committee (“MCSGFC”) of the National Stock Exchange (“NSE”) which merited 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 set up of the exchange.
Last week, a writ petition filed by a senior citizen against the Securities and Exchange Board of India (“SEBI”), NSE and the Bombay Stock Exchange Ltd. (“BSE”) along with the National Securities Depositories Limited (“NSDL”) challenging the freezing of his demat account for being illegal under the Securities and Exchange Board of India Act, 1992 (“SEBI Act”) and for being violative of Articles 14, 21 and 300A of the Constitution of India has been successful, with the Bombay High Court awarding him Rs. 30 Lakh in costs jointly payable by the SEBI, NSE and BSE. The judgement in Dr. Pradeep Mehta v. Union of India saw the High Court dealing with some hard-hitting issues. Before delving into the questions however, it is pertinent to note some key facts of this case.
Essentially, the petitioner had some long-term investments in securities of Indian companies, intended to benefit him for his retirement. One such investment was Shrenuj & Co. (“Shrenuj”/ the “Company”), promoted in 1989 by his father-in-law. In 2016, Shrenuj suffered some financial issues, as a result of which it could not file its financial results per the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”) thereby contravening it. The BSE and NSE under the directive of SEBI froze the petitioner’s demat account as at one point in time he happened to be one of the promoters of Shrenuj which was subsequently compulsorily delisted. It may be noted that at that point in time he held less than 0.01% of the total paid up share capital of the Company.
This action relied on SEBI circular no. CIR/CFD/CMD/12/2015 dated November 30, 2015 (“Circular dated November 30, 2015”) which prescribed the manner in which the exchanges were to deal with non-compliances by listed companies. Thereafter, the NSDL informed the petitioner of freezing of his demat account under Circular dated November 30, 2015 and SEBI Circular No. SEBI/HOCFD/CMD/CIR/P/2016/116 dated October 26, 2016 (“Circular dated October 26, 2016”). Notably, NSDL froze not only his holding in Shrenuj but also in ITC limited.
Pursuant to the directions of the Securities Appellate Tribunal (“SAT”) on appeal against such freezing, the exchanges considered the representations made by the petitioner. Upon doing so, NSE conveyed to the petitioner that in accordance with the above referred circulars of SEBI, it had suspended the trading in the securities of Shrenuj for its failure to file financial results and that it had issued a notice to Shrenuj 7 days before freezing his shareholding informing the Company of the freezing of promoters’ shareholding. BSE on the other hand disposed of the representation made by the petitioner by stating that it is not in a position to issue instructions to de-freeze the petitioner’s securities except in accordance with the SEBI circulars.
Later, upon the Shrenuj being compulsorily delisted, the NSDL issued a letter dated August 08, 2018 to the petitioner informing him of freezing of his demat accounts as ‘suspended for debits’. In response, the petitioner again filed an appeal before the SAT, which however was disposed in view of an appeal filed by Shrenuj being earlier disposed, as a result nothing survived in his appeal.
Among other things, the Writ Petition had sought for:
quashing of Regulations 97, 98 and 99 of the LODR as being ultra vires the SEBI Act and declaring that SEBI has no powers to issue any circular/notification creating offences;
quashing of the circulars issued by SEBI under the powers granted to itself under Regulation 98 of the LODR and declaring that it has no powers to issue circulars or notifications empowering it to delegate the power to regulate, adjudicate, penalise or freeze accounts;
declaration that exchanges and depositories have no powers whatsoever to direct collection of penalties from listed entities/ promoters/ investors/ to freeze demat accounts;
directing exchanges and depositories to defreeze forthwith all demat accounts of the petitioner;
compensation from the exchanges and depositories and directions to NSDL to transfer the securities lying in the omnibus system to his demat account which was pending because of the freeze.
While granting some of the prayers to the petitioner, the Court particularly left issues of law open on the challenge raised to the legality of the statutory regulations. The Court dealt with correctness of proceedings against the petitioner in capacity of promoter as well as the correctness of the impugned actions, viz. freezing of his demat account.
Lack of appreciation of facts
The Hon’ble court noted that except for 1989 when Shrenuj was incorporated and the petitioner was set out to be a promoter, he had no association whatsoever with the Company subsequent to its formation. It noted that he had remained an ordinary shareholder of Shrenuj with his limited shareholding. It further noted that neither had he ever been the director of the Company nor was he ever involved with it in any other capacity in managing the affairs thereof. Furthermore, it noted that especially when Shrenuj failed to comply with the provisions of SEBI Act and LODR in 2016, his status was nothing but of an ordinary shareholder.
The Court took note of the contents of the letter from BSE to Shrenuj specifying its non-compliance and actions entailing the same. The Court observed in this regard that a reading of the same clarified that a “penalty/fine” was to be recovered from Shrenuj, and while doing so, BSE had also put Shrenuj to notice of freezing of promoter and promoter group demat accounts for non-compliance with provisions of the LODR to be applicable immediately with respect of non-payment of fine.
The Court did not find any explicit provisions under the SEBI Act empowering SEBI to attach the demat account of the promoter much less the securities of companies other than the ones of which he is a promoter. Further, it noted that there was nothing to postulate such a drastic action to be taken in the nature of penalty, without following the due process. The Court noted that under Regulation 98(1) of LODR, the action to freeze the holdings of the promoter/promoter group could apply only to those holdings of the promoter in the listed company that has violated the LODR. It opined that the action of freezing other shareholdings of the petitioner was not justified and was ex facie illegal, and arbitrary. It also observed that regulation 98 could not have been applied in vacuum without considering the facts and circumstances.
With respect to his role, the court noted that there was nothing to show any active role of the petitioner in such capacity in the management or any role/obligation fastened on the petitioner in the various compliances required to be undertaken under the LODR, at the relevant time. The court rightly observed that in the case at hand, when an obligation under the regulations itself is not conferred on the promoter of the nature petitioner is, there could not have been a corresponding duty and consequent default.
The court noted that taking any action against a promoter of this nature, in absence of due consideration and examination of such essential attributes leads to a serious prejudice and/ or even a gross absurdity, rendering any action of penalty or freezing of any demat account of a promoter, as in the present case to be grossly arbitrary and illegal. The Bombay High court applied the settled position in context that the petitioner did not exceed his professional position, to take interest in the formation of Shrenuj or to promote or manage its day-to-day affairs. Thus, it observed that the obligation of non-submission of financial results and non-compliance with LODR could not have been imposed on him.
Procedure of freezing of the demat accounts of the petitioner as “penalty”
The Court noted that the Circular dated September 7, 2016 did not contemplate freezing of the demat account in the manner resorted. It further observed that freezing the petitioner’s demat account entails drastic civil consequences and that the shares are the property of the petitioner against which any coercive action is required to be taken only in accordance with law and after complying with the basic principles of natural justice. No show cause notice or a prior opportunity of a hearing was granted to the petitioner before freezing not only the petitioner’s shares in Shrenuj but also in ITC limited. Thus, the impugned action was held brazen, illegal, unreasonable and arbitrary.
Further, the court noted that the Circular dated October 26, 2016 could not make a provision when it provides that “in addition to freezing of shares in non-compliant listed entity, the holdings in the demat accounts of promoter and promoter group in other securities shall also be frozen to the extent of liability which shall be calculated on quarterly basis”. This was found contrary to the statutory requirements as the provisions noted above mandate and the basic requirement of Article 300A of the Constitution of India in the absence of any role of the promoter in the compliances as required to be discharged by a company.
The court noted that a circular can only be recognised if it is validly issued, when the law would permit issuance of a circular qua its contents. The LODR, it noted, does not confer any power with SEBI to issue a circular to freeze the demat account and shareholding of the promoters which he would possess in respect of the shares held by him of companies other than of defaulting company of which he was a promoter. For any such action to be recognised under the Circular dated 26 October 2016, such power to freeze the demat account is required to be traced in the substantive law, namely, under the SEBI Act. The Court noted that any such specific provision was absent. Interestingly, the court noted as follows in this regard:
“Even assuming that there is some power in the Regulations, the Regulations cannot override the substantive provisions of law and/or have any provision which itself is not recognized by the substantive law i.e. SEBI Act. The position in respect of a circular would be still worse, as the circular cannot provide anything which is not provided in the substantive law and the regulations.
For all these reasons, to generally and/or casually freeze the securities of the promoters in a company other than the defaulter company, is an action in the teeth of the provisions of the SEBI Act as also illegal, arbitrary and unreasonable, violative of Articles 14, 21 and 300A of the Constitution. Circulars cannot have an overriding effect on the statutory provision under which it is issued and cannot be implemented in defiance of principles of natural justice.”
Delving into the nature of the penalty/fine, the court noted that since SEBI had urged that the petitioner’s demat account was frozen as a penalty for non-compliance of the regulations by the company, the provisions for an adjudication by an adjudicating officer per he procedure under the SEBI Act was attracted. It noted that any such action can only be taken after following the procedure in law including the issuance of show cause notice, invitation for reply thereto and an opportunity for hearing leading to the final decision. It noted that no such norms were followed in the present instance.
The Court also took note of the provisions of the Depositories Act, 1996 and noted that even recovery of amount from the petitioner’s demat account held with depositories would be governed by the provisions thereof and if any fine/penalty is to be recovered, the same requires strict adherence to the provisions of the Act, which was absent here.
Further, the court observed that shares held by the petitioner in his demat accounts amounted to property within the meaning and purview of Article 300A of the Constitution of India and thus, no action could have been taken to deprive the petitioner the benefits of his property without following the procedure in law. It noted that the impugned action was fully draconian, illegal, arbitrary and unconstitutional. It observed:
“However, what actually pains us is when the statutory complexion of what could be the respective powers to be exercised by the depositories, by the Stock Exchange(s) and ultimately by the SEBI are within the well defined spheres as envisaged by the respective statutes, which we have noted hereinabove, the SEBI as also the Stock Exchanges nonetheless have justified the actions being taken against the petitioner, when the same are not supported under the framework of any of laws as we have noted hereinabove. The petitioner who is a senior citizen for no fault of his, has severely suffered since the year 2017 as his entire shareholdings as maintained in the demat account could not be utilized by him which itself is a valuable property under Section 300A of the Constitution. The petitioner was illegally deprived of his property and on a completely untenable pretext, merely because he was a promoter. Over and above these respondents have acted in complete contravention of law and non application of mind in precipitating and compounding such action.”
Thus court noted that the provisions of the LODR and circulars framed thereunder cannot be stretched to an extent to enable such draconian action as in the present instance and without adhering to natural justice principles. The court also opined that SEBI had failed to discharge its duties to act in accordance with law so as to deprive the petitioner of his shares in the demat account held by him infringing his right guaranteed under Articles 14, 21 and 300A of the Constitution of India.
Food for thought
While the judgement obviously underscores the importance of procedural fairness and following the procedure laid down in the law, it also raised some serious concerns. For instance, the gap in understanding of the scope of SEBI’s powers under the parent law brought to attention by this judgment.
It is also pertinent to note that when the SCRA was enacted in 1956, SEBI was non-existent and continued to be so for decades thereafter. Upon enactment of SEBI Act and the establishment and evolution of SEBI, most powers of the Central Government to regulate exchanges have been delegated to SEBI. However, it is also important to consider the changing role and importance of the stock exchange as a first level regulator. Its scope now includes implementing the ODR framework in addition to its existing role of making and executing rules/bye-laws of the exchange and addressing disputes between members and clients and among members. Thus, it plays a substantive role in addressing rights of the increasing retail market participants, as demonstrated in this case. Thus, there may be merit in considering whether there needs to be an enhanced supervisory role of the SEBI vis-à-vis the exchanges or simply an assessment of safeguards to the powers of the exchange.
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