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Mr. Janak Dwarkadas, Senior Advocate with Somasekhar Sundaresan, Advocate for the Appellant.

Mr. Saleh Doctor, Senior Advocate with Dr. Poornima Advani, Advocate for the Respondent.

Coram : Justice N.K. Sodhi, Presiding Officer Utpal Bhattacharya, Member Per : Utpal Bhattacharya, Member This order will dispose of two Appeals no. 68 and 69 of 2007 against separate orders, both dated April 27, 2007 passed by the Adjudicating Officer, Securities and Exchange Board of India (the Board for short) against the National Securities Depository Ltd. (NSDL for short) and the Central Depository Services India Ltd. (CDSL for short). NSDL is the appellant in Appeal no.68 of 2007 and a penalty of Rs.5 crores has been imposed on it in terms of Section 15HB of the Securities and Exchange Board of India Act, 1992 (the Act for short) and Section 19G of the Depositories Act, 1996. CDSL is the appellant in Appeal no. 69 of 2007 and a penalty of Rs.3 crores has been imposed on it under the same provisions of law. The adjudication proceedings originated out of the investigations conducted by the Board into the issue of shares of 21 companies through initial public offerings (IPOs) during the period 2003-2005. Investigations revealed that shares in the aforesaid IPOs, which were reserved for retail investors, were irregularly acquired by many entities through the medium of thousands of fictitious/benami applications. For this purpose the said entities (hereinafter referred to as key operators) opened a large number of demat accounts in fictitious and benami names and used those to make applications for shares in the IPOs in the category of retail investors. On allotment, the shares were transferred to the demat accounts of the key operators who in turn allegedly transferred the shares through off market deals to the ultimate beneficiaries who had financed the purchase of such large number of shares. The financiers sold the shares immediately after they were listed in the stock exchanges to garner huge profits. The two appeals in which the charges as well as the arguments on both sides are very similar to each other and somewhat interrelated, have been heard by us one after the other. For the sake of convenience, we shall deal with NSDL'S Appeal no. 68 of 2007 first followed by CDSL's Appeal no.69 of 2007. However, before going into the merits of the two cases, it is necessary to take note of the salient features of the working of the depository system in India so that the facts and arguments in the cases can be appreciated in the proper background.

5. The charge of failure to prevent the opening/existence of multiple beneficiary ownership accounts is a particularly important one because according to the Board, it is this failure that directly led to the so called IPO scam. Though the demat accounts are maintained by the Depositories (including the appellant) in their computerised data base, these accounts are opened for the clients (beneficial owners) by the Depository Participants (DPs) after ensuring adherence to the Know Your Client (KYC) norms. Detailed instructions in this regard have been issued by the Board and the Depositories also have issued various communications in this regard to the DPs. It has been noted in the impugned order that as many as 34,924 fictitious/benami accounts of beneficial owners were opened with the DPs for 21 IPO's including thousands of accounts which had the same address and most of which were closed soon after the allotment process. The respondent Board's case is that the failure of the appellant to prevent the opening of such multiple beneficiary ownership accounts with the same address occurred mainly because the application forms for opening beneficial ownership accounts provided for two addresses and the process of making illegal profits by cornering the retail category shares in the IPO's was facilitated by using the address of the financiers as the correspondence address or the second address. According to the iSec report, the provision for the second address was introduced on the insistence of the appellant. This was vehemently denied by the learned senior counsel for NSDL who argued that the feature regarding correspondence address was introduced in the form for opening demat accounts at the instance of the Board in as much as on 11.10.2004 the Board advised NSDL to examine the feasibility of incorporating this feature. NSDL informed the Board on 18.10.2004 that this was being examined. Subsequently in June, 2005, NSDL incorporated this feature in its business rules and intimated the Board accordingly. This argument could not be controverted by the learned senior counsel for the Board. Copies of the correspondence between NSDL and the Board in this regard are on record and were referred to in detail.

12. Apart from the five charges dealt with above, the Board in a supplementary show cause notice issued to the appellant on 14.2.2007 sought clarification from the former on its alleged failure to comply with the direction issued by the Board in its orders dated January 12, 2006 and April 27, 2006 in respect of the demat account of one Biren Kantilal Shah. It was also alleged in the said show cause notice that the appellant had failed to comply with the directions issued by the Board in its letter no. ISD/SD/HSE/03/2006 dated 16.11.2006 regarding audit of one particular account of Karvy. The Adjudicating Officer did not give any adverse finding in respect of the latter allegation in view of the circumstances explained in paragraph 12.3.2 of the impugned order. Regarding the first charge, the Adjudicating Officer proceeded on the premise that in its order dated 12.1.2006 regarding the IPO of Infrastructure Development Finance Corporation (IDFC), the Board had issued a directive to the appellant to monitor the flow of securities into the account of Biren Kantilal Shah and recorded a finding that the appellant had failed to do so in violation of the Board's directive. We have perused the Board's orders of 12.1.2006 and 27.4.2006 and find that the Board had not issued any directive whatever to the effect that the flow of securities into the account of Biren Kantilal Shah should be monitored or regulated. The clear and unambiguous direction issued by the Board was that Biren Kantilal Shah should not be permitted to enter into any transactions involving shares of IDFC and any other ensuing IPOs and there is no allegation against the appellant that it had allowed any such prohibited transaction. Thus, the charge in the show cause notice as well as the finding in respect thereof both are based on a wrong premise and cannot be sustained.

14. The impugned order has recorded very strong findings on the first charge against CDSL that the latter facilitated opening of fictitious/benami demat accounts without following the prescribed procedure. The Adjudicating Officer has considered the provision for the second address or the correspondence address in the account opening forms to be primarily responsible for opening of the large number of fictitious/benami accounts and has held CDSL responsible for that. The learned counsel for CDSL, however, pointed out that it is not correct to hold, as the Adjudicating Officer has done, that CDSL had included the column for correspondence address without the Board's approval. The provisions for correspondence address, in addition to the permanent address, has been a part of CDSL's system since inception and this always had the approval of the Board. Besides, the learned counsel for CDSL pointed out that contrary to what has been recorded in paragraph 5.3 of the impugned order, CDSL has not withdrawn the provision for correspondence address in the demat account opening forms as this provision is considered to be absolutely necessary in the interest of investors. Similar facility exists in the account opening forms in banks, in the applications forms for allotment of permanent account number by the Income Tax department, in the form of application for passport etc. Mere existence of the provision for correspondence address cannot be held responsible for the so called IPO scam. The Adjudicating Officer has noted that a very large number of accounts had been opened on a few specific dates in different names but with the same correspondence address and has held that CDSL ought to have been able to detect this phenomenon. This finding has been based on the stipulation in the Board's circular dated August 4, 2000 quoted by us in paragraph 6 supra but the logic that is being followed by the Adjudicating Officer in this case for holding CDSL responsible for the failures of DPs does not appeal to us.. In the aforesaid circular, the responsibility for verification of an applicant's identity has been placed squarely on the DP and to shift the burden to the Depositories on the ground that a DP is an agent of the Depository is not at all justified. In the scheme of the regulatory process that exists in the securities market, the role of each intermediary has been specifically delineated and the Depositories cannot be saddled with the specific responsibility for any failure by the DPs. The DPs are also market intermediaries registered with the Board and, in terms of chapter VI of the DP Regulations, the Board has the responsibility of periodically inspecting them. Therefore, by the same logic that the Adjudicating Officer seems to be relying upon in this case, the Board itself can be held responsible for the alleged failures of the DPs and hence, indirectly, for the IPO scam. However, considering the fact that there is nothing intrinsically wrong in having a second address of the applicants for opening demat accounts and that there is no bar on opening multiple demat accounts by a single individual with the same DP or with different DPs, the entire basis for the finding by the Adjudicating Officer is wrong, as has been found by us in case of NSDL.