SCA/9878/2005 1/96 JUDGMENT IN THE HIGH COURT OF GUJARAT AT AHMEDABAD SPECIAL CIVIL APPLICATION No. 9878 of 2005 To SPECIAL CIVIL APPLICATION No. 9892 of 2005 With SPECIAL CIVIL APPLICATION No. 10173 of 2005 To SPECIAL CIVIL APPLICATION No. 10214 of 2005 With SPECIAL CIVIL APPLICATION No. 10329 of 2005 To SPECIAL CIVIL APPLICATION No. 10408 of 2005 With SPECIAL CIVIL APPLICATION No. 10480 of 2005 To SPECIAL CIVIL APPLICATION No. 10548 of 2005 For Approval and Signature: HONOURABLE MR.JUSTICE M.R. SHAH ===================================================== 1 Whether Reporters of Local Papers may be allowed to see the judgment ? 2 To be referred to the Reporter or not ? 3 Whether their Lordships wish to see the fair copy of the judgment ? 4 Whether this case involves a substantial question of law as to the interpretation of the constitution of India, 1950 or any order made thereunder ? 5 Whether it is to be circulated to the civil judge ? ===================================================== M/S HITESH K SHAH FINANCIAL SERVICES LTD & 1 - Petitioner(s) Versus UNION OF INDIA & 3 – Respondent(s) SCA/9878/2005 2/96 JUDGMENT ===================================================== Appearance : MR SN SOPARKAR WITH MR SANJAY A MEHTA for Petitioner(s) : 1 - 2. RULE UNSERVED for Respondent(s) : 1, MR JITENDRA MALKAN for Respondent(s) : 1, RULE SERVED for Respondent(s) : 2 - 4. MR SN SHELAT, ld. Advocate General with MR BIJAL CHHATRAPATI and MR JAY AMIN for SINGHI & CO for Respondent(s) : 2, MR MRUGESH JANI for Respondent(s) : 3, MR AMAR N BHATT for Respondent(s) : 4, ===================================================== CORAM : HONOURABLE MR.JUSTICE M.R. SHAH Date : 29/12/2005 CAV JUDGMENT 1. As common question of law and facts arise in these group of petitions, they are being disposed of by this common judgment and order. 2. In this group of petitions, the respective petitioners, registered as stock brokers with SEBI being members of Regional Stock Exchanges and also registered as sub brokers with SEBI of subsidiaries of their parent Regional exchanges, who are registered as sub brokers with SEBI as SCA/9878/2005 3/96 JUDGMENT members of Bombay Stock Exchange (hereinafter referred to as the “BSE”) and National Stock Exchange (hereinafter referred to as the “NSE”) have challenged the legality and validity of SEBI (Stock Brokers and Sub Brokers) (Amendment) Regulations, 2003 (hereinafter referred to as the “Regulations 2003”); circular being No.SEBI/MIRSD/DSP-1/CIR-31/2004 dated 26-8-2004 and the circular dated 12-5-2005 making the same applicable to the members of the recognized Stock Exchanges operating through the subsidiaries of such recognized Stock Exchanges. By the Regulation 2003, only stock brokers will issue direct contracts to the investors of their sub brokers and the sub brokers shall not issue confirmation memos and the delivery of securities and the payment of funds shall be made directly between stock brokers and the clients of sub brokers. 3. The case on behalf of the petitioners in SCA/9878/2005 4/96 JUDGMENT nutshell is as under: SEBI had come into force on 30-1-1992. Section 30 of the said Act empowers SEBI to make regulations with the previous approval of Central Government by notification, consistent with the Act and the Rules made thereunder, to carry out the purposes of the Act. Section 13 of the Securities Contracts (Regulations) Act, 1956 (for short “the Act, 1956”) deal with the contracts in notified areas, which are held to be illegal in certain circumstances. That a member of a Stock Exchange is entitled to enter into a contract on principal-to-principal basis with any member of a Stock Exchange. A member of one particular exchange can enter into a contract on principal- to-principal basis with any member of a Stock Exchange. Section 15 of the Act, 1956 provides that every member of a recognized exchange shall enter into a contract as a member in respect of any securities, only with a member of a recognized Stock Exchange and that he shall do so SCA/9878/2005 5/96 JUDGMENT with any other person, who is not a member of a recognized exchange, only if he has secured the consent or authority of such person and such concerned authority is disclosed in the note, memorandum or agreement of sale or purchase that he is acting as member. Section 12 of the SEBI Act deals with registration of brokers, sub brokers, share transfer agent, etc. The petitioners, who are registered as share brokers of the Ahmedabad Stock Exchange/Baroda Stock Exchange/Saurashtra and Kutchh Stock Exchanges,as the case may be. Section 2(e) of SEBI (Stock Brokers and Sub Brokers) Rule, 1992 define “Stock Broker” and section 2(f) of SEBI (Stock Brokers and Sub Brokers) Rule, 1992 define “Sub Broker”. As per the circular dated 16-1-1998, the members of the Stock Exchange, who were acting as sub brokers through the members of other Stock Exchanges were required to obtain a certificate of registration from SEBI to act as sub broker under the Rule and Regulations, 1992. Somewhere SCA/9878/2005 6/96 JUDGMENT in the beginning of the year 1998, the Stock Exchange, Mumbai had requested for SEBI's approval for expansion of BOLT System, all over India including to all the Regional Stock Exchanges. Pursuant to the same, SEBI invited comments/confirmation of its draft circular from all the Regional Stock Exchanges in respect of BOLT expansion by its letter dated 26-2-1998. It is also the case of the petitioners that in the year 1995, with an intention to facilitate the investors all over the country to trade on one particular Stock Exchange, the SEBI granted permission to carry out trades and transact buying and selling of the securities on the national Stock Exchange by national information on-line trading system. According to the petitioners, said permission thereby permitted the trades to be undertaken on the on-line trading system even in the areas which were notified under section 13 of the Act, 1956. By press release dated 29-10-1996, SEBI inter alia SCA/9878/2005 7/96 JUDGMENT allowed expansion of Mumbai Stock Exchange terminals to cities other then Mumbai on the terms and conditions stipulated therein. Pursuant to the said permission granted by SEBI a Memorandum of Understanding between Stock Exchange, Mumbai and the Regional Stock Exchanges was entered into. By circular dated 3-4-1998, the requirement for approval of setting up of terminals at Ahmedabad were laid down. Subsequently, it was realized that the trading volumes in the Regional Stock Exchanges were considerably declining, which raised the question of survival of the Regional Stock Exchange and the same became a matter of concern for all concerned. A group was formed by SEBI and a meeting of the said group was held on 8-9-1999 to discuss the suggestion/revival plans forwarded by small exchanges by small exchanges for their survival. The said group considered the suggestion/revival plans submitted by small Stock Exchanges and made certain recommendations, one SCA/9878/2005 8/96 JUDGMENT of which was permission to be granted for promotion of a subsidiary which can acquire membership right of larger Stock Exchanges viz.NSE/BSE/CSE/DSE or any other Stock Exchanges subject to the usual conditions applicable to other members. SEBI, therefore, decided that small exchanges may promote or float a subsidiary/ company to acquire membership right of other Stock Exchanges subject to certain conditions. Thus, according to the petitioners, the subsidiary promoted/ formed by the members of a Stock Exchange was to be treated as equivalent to all other members of the larger Stock Exchange as the same was permitted to acquire membership right of other Stock Exchanges subject to certain conditions. SEBI issued a circular dated 26-11- 1999, whereby certain conditions were laid down which may be required to be complied with by such subsidiary/company which was proposed to be formed. One of the conditions as per the said circular was that no person other than members of SCA/9878/2005 9/96 JUDGMENT parent Stock Exchange or the exchange itself would be eligible to acquire any share holding in the said subsidiary/company. Thus, according to the petitioners, as per the conditions stipulated in the circular dated 26-11-1999, the subsidiary/company was entitled to register only the members of the Stock Exchange which was promoting the said subsidiary/company as its sub broker and no other client/sub broker was to be entertained by such subsidiary/company. Thus, the Regional Stock Exchange brokers trading through the subsidiaries were required to get themselves registered as sub brokers of the subsidiary and they were required to observe the same capital adequacy norms in respect of the turn over limit, gross exposure and margin as would be applicable to the stock brokers, members of the Stock Exchange, Mumbai (BSE) and the National Stock Exchange of India Ltd. (NSE). Subsequent thereto, the SEBI reviewed the functioning of the subsidiaries and decided that such SCA/9878/2005 10/96 JUDGMENT subsidiaries/companies shall be required to comply with certain minimum requirements in order to ensure that the transactions in subsidiaries were taken in a manner which are not detrimental to the interest of the investors and also to enable the subsidiaries to provide a safe and transparent mechanism of transaction in securities. Further directions were issued by SEBI vide its circular dated 11-2-2003. Thereafter, SEBI constituted an internal group for reviewing the operation of sub brokers. A concept paper was published on review of capital adequacy, reiterating supervision of sub brokers. The group emphatically recommended that since the SEBI has promoted the members of Stock Exchanges to act as sub brokers to members of other Stock Exchanges, definition of sub broker contained in Rule 2(f) of SEBI Rule, 1992 needs to be changed. Vide circular dated 2-6-003, it was emphatically reiterated by SEBI that “para 2 as per the conditions mentioned in the circular, the SCA/9878/2005 11/96 JUDGMENT subsidiary/company can register only the members of parent Stock Exchange as sub brokers of the subsidiary/company and no other client/sub broker can be entertained by the subsidiary/company... ... ... ...”. The notification dated 23-9-2003 in respect of amended Regulations 2003 came to be issued in exercise of powers conferred upon the SEBI by section 30 of SEBI Act, 1992. By notification dated 23-9-2003, SEBI made requirement stated therein to amend Regulations of 1992 having resultant effects as under: (a) One sub broker shall be affiliated to one member of the exchange. There shall be a privity of contract between the members and a client introduced to the members by the sub broker affiliated to such member. A tripartite agreement has been directed to be entered into by and between the subsidiary, sub broker and the end client of the sub broker; SCA/9878/2005 12/96 JUDGMENT (b) No Director of a cooperate member shall act as a sub broker to the same corporate member; (c) A member shall not deal with a person as a sub broker unless such person has been granted certificate registration by the SEBI; (d) A member shall issue contract directly to the client introduced by his sub broker instead of the sale/purchase note to be issued by the sub broker; (e) The delivery of securities and the payment of funds relating to the transaction shall be made directly between a member and the client introduced by the sub broker affiliated to such member. 4. After the notification dated 23-9-2003, after about more than a month, SEBI issued a circular dated 28-10-2003 which has been in exercise of SCA/9878/2005 13/96 JUDGMENT powers conferred upon SEBI under section 11(1) of the Act of 1992 read with section 10 of the Act, 1956 to protect the interests of investors in the securities and promote the development of and to regulate the securities market. It is the case on behalf of the respective petitioners that the said model byelaws have been finalized by SEBI based on the report of the committee appointed by the SEBI itself. According to the petitioners, Clause 2.3.48 of the said model byelaws defines the word 'subsidiary trading member' and it specifically states that subsidiary trading member means and includes a trading member of a subsidiary of a Regional Stock Exchange, where subsidiary has acquired trading-cum-clearing membership of all the exchanges and were such trading members has obtained necessary permission to deal in the securities market as a stock broker from SEBI and/or to exchange as may be permitted from time to time. Thus, according to the petitioners, the sub brokers of a subsidiary SCA/9878/2005 14/96 JUDGMENT of a Stock Exchange which has acquired membership of BSE/NSE has been treated separately and differently from an ordinary sub broker. Despite the specific directions given by SEBI to the BSE and NSE and all other Stock Exchanges, the NSE and BSE did not carry out the said directions and did not implement the decisions of SEBI which was directed to be implemented immediately and such implementation was required to be communicated to SEBI, which has necessitated the petitioners to pray for a relief of direction to the NSE and BSE to implement the model byelaws as per the directions of SEBI. According to the petitioners, the circular dated 28-10-2003 is a circular in exercise of powers conferred upon SEBI under section 11(1) of the Securities and Exchange Board of India Act, 1992 read with section 10 of the Act, 1956 and the same has, till date, never been withdrawn and/or modified in any manner whatsoever. SCA/9878/2005 15/96 JUDGMENT 5. According to the petitioners, the status of subsidiary/company of a Regional Stock Exchange is very peculiar in nature and following are the main characteristic of the same. (a) Such subsidiary/company of a Regional Stock Exchange is directed by SEBI virtually like an extension of Stock Exchange and its member while dealing with investors operates like stock broker and not like sub broker. (b) Such subsidiary/company of a Regional Stock Exchange has been established pursuant to the revival package formulated by the second respondent for Regional Stock Exchanges in November, 1999. (c) As directed by the second respondent such subsidiary/company is a subsidiary of the Regional Stock Exchange and it cannot undertake any proprietary trade. It can deal with only members of SCA/9878/2005 16/96 JUDGMENT Regional Stock Exchange who are further registered as sub brokers with the second respondent. It cannot deal with other sub brokers or any other client. The board of directors of such subsidiary consists of majority public/Stock Exchange nominees. The member directors are in minority. (d) The members of Regional Stock Exchange who are further registered as sub brokers of such subsidiary/company of the Regional Stock Exchange are required to keep separate deposit with said subsidiary/ company, in addition to the deposit with Regional Stock Exchange of which they are member. The trading/exposure limit as well as margin norms for the members or Regional Stock Exchange dealing with their subsidiary are the same as applicable to those premier Stock Exchange of which such SCA/9878/2005 17/96 JUDGMENT subsidiary or a company is member. (e) The default at such subsidiary or company of the Regional Stock Exchange shall mean default at Regional Stock Exchange also for the members of the respective Regional Stock Exchange operating through its subsidiary/company. (f) The members of the respective Regional Stock Exchanges while operating through its subsidiary/company are subjected to regular inspection requirements like stock broker/trading member. (g) The Investors Grievance Cell of the respective Regional Stock Exchange handles complaints of investors/clients of the Regional Stock Exchange members for operation of a subsidiary/company also. 6. It is further the case of the petitioners SCA/9878/2005 18/96 JUDGMENT that subsequent to the issuance of the notification dated 23-9-2003, various representations were made by the stock brokers of such Regional Stock Exchanges through the Federation of India Stock Exchanges and also directly by some of the members of such Regional Stock Exchanges from time to time and the SEBI had been holding various meetings and discussions used to take place upon such representations and therefore,, the implementation of the conditions of a model tripartite agreement envisaged under the said amendment notified on 23-9-2003 was postponed from time to time. It is the case of the petitioners that circular dated 31-3-2005, issued by SEBI in exercise of its powers conferred upon it under section 11(1) of the Securities and Exchange Board of India Act, 1992 treats the sub brokers of subsidiaries of recognized Stock Exchanges, who are registered as stock brokers and their registered sub brokers differently and unequal to other stock brokers SCA/9878/2005 19/96 JUDGMENT and sub brokers and has clearly stated that special provisions were being made in the SEBI Regulations, 1992 which would be notified shortly. According to the petitioners, the aforesaid circular having been issued, they were assured that SEBI was making special provisions for the petitioners in the SEBI, Regulations, 1992 which were to be notified shortly. While the petitioners were awaiting such notification of separate provisions for them, all of sudden without stating any reason whatsoever, SEBI issued another circular dated 12-5-2005 just within 42 days and intimated its decision that the subsidiaries of the registered Stock Exchange who are registered as stock brokers and their registered sub brokers shall also comply with the provisions of Regulations, 2003 and it was further stated in the said circular that considering the changes that are required in the existing system of the subsidiaries for implementation and compliance with the said SCA/9878/2005 20/96 JUDGMENT regulations, it has also been decided to allow the said subsidiaries of Stock Exchanges and their sub brokers, to comply with the said regulations from 1-6-2005. 7. According to the petitioners, the implications of making Regulation 2003 applicable to the subsidiaries floated by different Regional Stock Exchanges and their intermediaries are as under: 1.The Regulations 2003 would eliminate over 13,000/- sub brokers who are registered with SEBI. With the implementation of the new Regulations, the problem of loss of identity for sub brokers will become even more acute in the case of intermediaries registered with RSE subsidiaries. The RSE subsidiaries would cease to play an active role on NSE and BSE, just because they have been classified as SCA/9878/2005 21/96 JUDGMENT sub brokers/ trading members. 2.The new Regulations require the sub brokers to disclose all details about their clients to their principal stock brokers/trading members, including scale of brokerage rates charged to the clients and this would lead to a conflict of interest between the stock brokers/ trading members and their sub brokers, as both the principals and their agents (sub brokers) would be interested in gamering business from the same set of clients. The sub brokers have built up their clientele over long years of dedicated service and their efforts will be reduced to naught in case the sub brokers are eliminated. 3.New Regulations would lead to much grater concentration of the stock broking activity to a limited number of SCA/9878/2005 22/96 JUDGMENT large-sized members which is detrimental to the balanced and equitable growth of the securities industry and is against the stated objectives of the Government of India and SEBI. 4.Regulations 2003 presuppose a highly efficient banking system encompassing all the banks with electronic funds, transfer facility (EFT) available across the country. However, the inadequacies and inefficiencies of the present banking system would not only come in the way of normal stock trading operations with function on a T + 2 system, but may also lead to scams in the banking industry. 5.At present, the Investor Grievances Cells and the Arbitration mechanisms available at the RSEs are used very effectively by the investors to resolve SCA/9878/2005 23/96 JUDGMENT any grievance or dispute against the sub brokers who are affiliated to the RSE Subsidiaries are eliminated and the process of redressal of grievances and disputes of the investors will become more complex. Such grievances and disputes would, therefore, have to be resolved only by the Investor Grievance Cell and the Arbitration mechanism of the main exchange (i.e. NSE and BSE) which adds to cost, complexity and inconvenience for the investors. It is also further submitted that various representations were made from time to time pointing out implications of the applicability of the said amendment and conditions thereof to the petitioners and the difficulties to be faced by the petitioners upon such applicability. However, SEBI did not take into consideration the same and proceeded with making the said regulations applicable to the petitioners also. SCA/9878/2005 24/96 JUDGMENT 8. It is submitted by Shri Soparkar, learned senior advocate appearing on behalf of the petitioners that sub brokers of subsidiary/company of Regional Stock Exchange are class by themselves and the amendment is contrary to earlier direction issued by SEBI vide circular dated 26-9-1999. It is also further submitted by him that even by circular dated 31-3-2005, it was stated by SEBI that for the petitioners, special provisions are being made in the SEBI Regulations, 1992 which would be notified shortly and therefore, the Amendment Regulations 2003 were not made applicable to the sub brokers of subsidiaries like the petitioners. Therefore, it is submitted that now it is not open for the SEBI to apply the Amendment Regulations 2003 to the petitioners and directing to apply tripartite agreement. 9. It is also further submitted by Shri Soparkar SCA/9878/2005 25/96 JUDGMENT that as per Section 10 of the Act, 1956, all the exchanges are bound to act as per the advice of the SEBI and when SEBI vide circular dated 28-10- 2003 advised the exchanges to amend their bye laws in line with the model bye laws, BSE and NSE are bound to obey the said advice and amend their bye laws and therefore, it is requested to direct respondent Nos.3 and 4 to implement the directions given vide circular dated 28-10-2003 and carry out necessary amendment in its bye laws so far as the same are inconsistent with the mode bye laws. 10. Shri Soparkar, learned senior advocate has relied upon the following decisions of the Hon'ble Supreme Court in the case of; (i)M.G. Badappanavar and Another V. State of Karnataka and others reported in (2001) 2 SCC 666 (ii)Onkarlal Bajaj and others V. Union of India and another reported in (2003)2 SCC SCA/9878/2005 26/96 JUDGMENT 673 (iii)Oxford University Press V. Commissioner of Income Tax reported in (2001) 3 SCC 359 (page 35) (iv)Shakuntala Sharma (Mrs) V. High Court of H.P. At Shimla and another reported in (1994) 2 SCC 411 (para 12) (v)Union of India and others V. Ram Gopal Agarwal and others reported in (1998) 2 SCC 589 Relying upon the aforesaid decisions, it is submitted that equality is a basic feature of the Constitution of India and any treatment of equals unequally or unequals as equals will be violation of the basis structure of the Constitution of India. It is further submitted that as sub brokers of subsidiaries are class by themselves, they are treated at par with the other sub brokers and thus unequals are treated equally. 11. Petitions are opposed by SEBI. Shri SN SCA/9878/2005 27/96 JUDGMENT Shelat, learned Advocate General appeared with Shri Chhatrapati and Shri Jay Amin for Singhi & Co. for SEBI. Petitions are opposed by mainly submitting as under: 1.The petitioners are registered as sub brokers within the meaning of Rule 2(f) of the SEBI Rules 1992 and the petitioners themselves have admitted that they are registered with SEBI as sub brokers of subsidiary company. SEBI rules have been framed under Section 23 of the SEBI Act and SEBI Regulations have been framed under Section 30 of the SEBI Act and the Rules and the Regulations have force of law and are in the nature of subordinate legislations. Regulations were amended by amendment in Regulations in the year 2003 with effect from 23rd September, 2003. and were enforceable with effect from 23rd September, 2003 in terms of the amended Regulations. However, since the representations were made SCA/9878/2005 28/96 JUDGMENT on behalf of the petitioners, an administrative decision dated March 31, 2005 was taken not to enforce the said Regulation. Thereafter, having considered the representation received from various interests, it was resolved to enforce regulation uniformly without providing special to the petitioners. The Regulations have been amended after thorough study as reflected from the concept paper. It was recommended that in the absence of privity of contract between the broker and client