Indian Kanoon - Search engine for Indian Law

The issue regarding alleged manipulations in Initial Public Offerings (IPOs) of various companies had been engaging the attention of the Board for some time. It received some information regarding the alleged abuse and misuse of the IPO allotment process. As a part of its ongoing surveillance activity, the Board initiated a probe and also advised the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) to examine the dealings in the shares issued through IPOs before the shares are listed on the stock exchanges. The aforesaid two exchanges submitted their preliminary observations on the IPO of Yes Bank Limited (YBL) in which it was hinted that there could be a possibility of large scale off market transactions immediately following the date of allotment and prior to the listing of shares on the stock exchanges. The Board then carried out a preliminary scrutiny by calling for data from the depositories and the Registrar to the Issue. It found that certain entities had cornered IPO shares reserved for retail applicants by making applications in the retail category through the medium of thousands of fictitious/ benami IPO applicants with each application being for small value so as to be eligible for allotment under the retail category. It was also discovered that subsequent to the receipt of IPO allotment, fictitious/benami allottees transferred the shares to those who controlled those accounts who in turn transferred the shares to the persons financing the transactions i.e. those who made available the funds for executing the game plan. The financiers in turn sold the shares on the first day of listing thereby making a windfall gain since the price of allotment was less than the listing price in view of the booming market. In nutshell, a handful of persons virtually monopolized the retail allotment by elbowing out the genuine investors. The Board found that large number of multiple dematerialized accounts with common addresses had been opened by a few entities. By order dated 15th December, 2005 passed in the case of YBL, Ms.Roopalben Nareshbhai Panchal and Devangi Dipakbhai Panchal, amongst others, had been directed not to buy, sell or deal in the shares of YBL and in other ensuing IPOs directly or indirectly. National Securities Depository Ltd., (NSDL) which is one of the two depositories in the country was also directed to undertake a comprehensive inspection of the appellant herein which is one of its depository participants particularly focusing on the systems and procedures, if any, put in place by the appellant for implementing the "know your client" (KYC) norms which the participants are required to follow. A reference had also been made to the Reserve Bank of India to examine the role of Bharat Overseas Bank and Vijaya Bank in opening bank accounts of benami entities which were funding their IPO applications.

Soon after the passing of the order in the case of YBL, the Board examined the dealings in another major IPO of Infrastructure Development Finance Co. Ltd. (IDFC) and found that the very same players were suspected to have played a major role in cornering the shares meant for the small retail investors. In pursuance to the directions issued during the course of the investigations in the case of YBL, NSDL and the other depository - Central Depository Services (India)Ltd. (CDSL) had submitted their inspection reports to the Board observing therein that the appellant as a participant had opened accounts of investors by obtaining the supporting documents mechanically and had not taken proper precautions to ascertain the identity and genuineness of the persons. The depositories also observed in their reports that the appellant had entirely relied upon the documents issued by the scheduled commercial banks submitted by the investors as documents in support of "proof of identity" and "proof of address" even though the same persons opened their beneficial owner accounts in different names. The reports also mentioned that the appellant had not exercised proper care and precautions while processing the debit instruction slips for transfer of securities and that such slackness and deficiencies in procedures and manner of conducting the depository participant operations were not in conformity with the procedures prescribed by the Board and the two depositories. On a consideration of the reports received from the two depositories and also the material that it could gather during the course of the investigations, the Board found that IDFC had come out with an IPO in July, 2005 and the retail portion of the issue was oversubscribed by 5.27 times. The shares were credited to the allottees on August 5 and 6,2005. The shares of IDFC were listed on stock exchanges on August 12,2005. On August 8, 2005 i.e. prior to the listing on stock exchanges, Roopalben Panchal received in her demat account with CDSL 266 shares each from 14,790 demat accounts aggregating to a total of 39,43,184 shares in off market transactions from 14,807 demat account holders. The Board found that out of these 14,807 demat account holders as many as 4946 had a common address of Ahmedabad and another 4990 account holders had another address in Ahmedabad which was the same. Another 4871 account holders had a different common address in Ahmedabad. All the 14,807 demat account holders had their bank accounts with Bharat Overseas Bank Ltd. Ahmedabad and demat account with the appellant herein. The record further indicated that all these demat accounts had been opened by the appellant on July 15 and 16, 2005 when the issue opened on July 15, 2005. A similar pattern was observed in respect of Roopalben Panchal's demat account with NSDL wherein also she had received a total of 32,61,426 shares from 12,257 demat accounts in off market transactions. All these demat accounts were with the appellant. It also transpired that subsequent to the receipt of shares in her demat account from thousands of entities, Roopalben Panchal in turn transferred the shares to various entities prior to August 12, 2005 i.e. the date of listing of shares on the stock exchanges. Apart from Roopalben Panchal, a similar pattern was observed in the case of Sugandh, Purshottam Budhwani and Manojdev Seksaria who according to the appellant, were its unregistered IPO sub brokers (IPO application collecting agents). It may be mentioned that all the common addresses on the IPO applications and in the demat accounts were those of the so called sub brokers. From the material available with the Board it prima facie concluded that the appellant as a participant had knowledge about the fictitious nature of such multiple accounts. The Board also took note of the fact that both NSDL and CDSL had directed the appellant not to open new demat accounts till the matter was thoroughly investigated. In the light of the material available with the Board it passed an order on 12.1.2006 in the case of IDFC IPO the relevant portion of which reads as under:

On merits it is contended on behalf of the appellant that even though very large number of demat accounts had been opened with the appellant in the name of fictitious persons, they were all closed/frozen as per the directions of the depositories and the Board after verifying the genuineness of the account holders. These demat accounts were opened, according to the appellant, in the last two years with most of them being opened during the periods coinciding with various IPOs. It is the categoric stand of the appellant that the account opening application forms were brought by the so called different IPO sub brokers with an introductory letter from the client's banker in support of the proof of identity and proof of address. Even though the letters from the bank later turned out to be forged, those appeared on the face of it to be genuine and there was no occasion for the appellant to suspect the bonafides of the applicants whose identification had been certified by their banker. Moreover, the said bank certificates were computer generated and did not give rise to any suspicion. He also contended that the Board has drawn a wrong inference from the downloading of data by the appellant from CDSL during July, 2005. The Board had inferred that by frequently accessing the data base of CDSL in July 2005 the appellant had culled out the particulars of bank branches and addresses which it later used in fabricating the bank certificates. According to the learned senior counsel, the appellant downloaded the data for its various business needs in the normal course of business. He contended that it was not possible for it to foresee in July itself about the events which were discovered in November-December, 2005. The learned senior counsel, therefore, forcefully submitted that the Board's inference in this regard is totally wrong and unwarranted. The bank letters were accepted by the appellant as according to it those were according to the KYC norms prescribed by the depositories and the Board. As regards the different demat accounts of the same account holders having different photographs, the appellant submitted that there was no occasion for it to suspect the genuineness of those photographs as there was no mechanism to identify or cull out the same photographs as they appeared in the subsequent or different lots of applications. What is contended on behalf of the appellant is that close to an IPO, applications for opening new demat accounts were received in thousands and those were dealt with by different persons in different lots and that when the appellant learnt about the fictitious accounts the same were closed. The learned senior counsel very strongly contended that the appellant itself had been defrauded by the sub brokers in the matter of opening of new demat accounts close to different IPOs and that when all this was discovered, it (appellant) besides closing the fictitious accounts filed a criminal complaint against the sub brokers which is pending in the Court of IIIrd Addl. Chief Metropolitan Magistrate at Hyderabad. The learned senior counsel urged that the Board was not justified in recording a prima facie finding that the appellant had colluded in the opening of fictitious accounts when it itself had been defrauded by the so called sub brokers or business associates who had committed breach of trust with the intention to cheat the genuine investors. In the alternative the learned senior counsel contended that even if it be assumed that the bank letters were forged, even then according to the Board, this was done in order to make it appear as if the appellant had complied with KYC norms when in fact they had been totally disregarded. The gravamen of the charge, according to the appellant, is that it had done post event documentation as an after thought to set the record straight with a view to cover up its lapses in not complying with the KYC norms and that the charge is not that the appellant colluded in the opening of demat accounts. This charge, according to the learned senior counsel, only amounts to non compliance of the KYC norms and is not that serious so as to warrant a direction to the appellant not to open new demat accounts till the completion of the inquiry. It was also contended on behalf of the appellant that fictitious demat accounts with common addresses were opened not only with the appellant but also with other depository participants like HDFC, IDBI, ICICI etc. and that the practice of using IPO sub brokers was then prevailing in the market and was well established and recognized. It was also submitted that the requirement at the relevant time was to provide only the correspondence address in NSDL and either correspondence address or permanent address in CDSL and the sub brokers gave their own address as correspondence address and this according to the appellants, was not an unusual practice. The appellant submits that the issue of common address was a systemic issue and is not peculiar to the appellant alone. The appellant also seriously disputed the finding of the Board that it had introduced 50 additional names which were added by enclosing a list with the account opening form of its sub broker (Roopalben Panchal) whose transactions were to be included in the sub broker's bank account. It was also contended that the Board was in error in concluding that delivery instruction slips (DIS) had been generated by the appellant to make up the record by conveniently using the credit identification number (CIN) along with the debit identification number (DIN). Reference was made to the instruction slips for delivery in support of this plea. The learned senior counsel for the appellant further submitted that Karvy Consultants Limited, a company of the Karvy group which is a non banking finance company had provided IPO funding to the investors in the normal course of its business and that there was nothing wrong in its receiving back the amount from the account of Roopalben Panchal which was towards the return of loan in the case of another IPO (Amar Remedies). In view of the aforesaid submissions, the appellant contends that even though fictitious demat accounts were opened by a large number of depositors, the appellant had not connived in the opening of those accounts and that the sub brokers had cheated the appellant itself in the opening of those accounts.

When we examine the impugned order this is what we find:

the Board has prima facie found that the so called IPO sub brokers of the appellant had cornered lacs of IPO shares reserved for retail applicants by making applications in the retail category by opening thousands of fictitious/benami demat accounts with the appellant which shares were subsequently transferred to those who made the funds available for executing the game plan. As already observed, the Board found that Roopalben Panchal, one of the sub brokers of the appellant had received more than 39 lac shares in off market transactions in her demat account with CDSL and more than 32 lac shares in her demat account with NSDL. This was only in regard to one IPO in the case of IDFC. Similarly, other sub brokers had also acquired shares in the same manner. The appellant says that it could at the most be said to have failed in exercising due diligence and to comply with KYC norms at the time of opening of demat accounts but it did not connive with the sub brokers. It also claims to have been cheated by its sub brokers. The Board, on the other hand has found prima facie after inspecting the records of the appellant that the latter appears to have aided, abetted and actively colluded with the sub brokers and other clients by not only opening thousands of fictitious/benami demat accounts by disregarding the KYC norms but also indulged in fabricating bank documents to cover up its lapses. What needs to be examined is whether the appellant had really failed to get alerted to the abuse of its systems by the so called sub-brokers or whether there was active collusion of the appellant with its clients for abusing the IPO process and sharing the gains arising from the same. We cannot decide these issues at this stage nor can it be said as to which of these two versions is correct. It is an undisputed fact that thousands of fictitious/benami demat accounts were opened with the appellant with common addresses and more than 10000 accounts were opened on one single day. The appellant was under a duty to check and comply with the various norms. The obvious appears to have been overlooked. Is the action of the appellant innocent is the question. The appellant is clearly under a cloud and the truth can be known only after a detailed inquiry. The findings of the inquiry will either remove the appellant or the cloud. Till then the impugned order passed by the Board will operate which is in conformity with the provisions of the Act, rules and the regulations framed thereunder. Since the enquiry is pending, the Board had power to pass the impugned order restraining the appellant from opening fresh demat accounts and from carrying on proprietary trades as a stock broker. No fault can thus be found with the said order. In view of the fact that the matter is pending with the enquiry officer, we have refrained from making comments on the merits of any of the contentions advance by either party.