SCA/10523/2006 1/108 JUDGMENT TOIN THE HIGH COURT OF GUJARAT AT AHMEDABAD SPECIAL CIVIL APPLICATION No. 10523 of 2006 with SPECIAL CIVIL APPLICATION No. 10516 of 2006 with SPECIAL CIVIL APPLICATION No. 10524 of 2006 with SPECIAL CIVIL APPLICATION No. 10527 of 2006 with SPECIAL CIVIL APPLICATION No. 10528 of 2006 with SPECIAL CIVIL APPLICATION No. 10529 of 2006 with SPECIAL CIVIL APPLICATION No. 10756 of 2006 with SPECIAL CIVIL APPLICATION No. 9971 of 2006 with CIVIL APPLICATION No.7139 of 2006 in SPECIAL CIVIL APPLICATION No. 9971 of 2006 For Approval and Signature: MR.JUSTICE RAVI R.TRIPATHI ========================================================= 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 ? SCA/10523/2006 2/108 JUDGMENT ========================================================= RAJAN VASUDEVBHAI DAPKI & 2 - Petitioner(s) Versus SECURITIES AND EXCHANGE BOARD OF INDIA - Respondent(s) ========================================================= Appearance : SCA No.10523/06 : Ms.Dharmishtha Raval with Mr.K.B. Trivedi, Senior Advocate for petitioners 1-3 M/s Singhi & Co. for respondent no.1 Mr.Mihir Joshi, Senior Advocate with Mr.Bijal Chhatrapati and Mr.Jay Amin for M/s Singhi &Co. for respondent-SEBI. SCA No.10516/06 : Mr.Sanjay A.Mehta for petitioner. Mr.Bijal Chhatrapati and Mr.Jay Amin for M/s Singhi &Co. for respondent-SEBI. SCA No.10524/06 :Ms.Dharmishtha N. Raval with Mr.K.S. Nanavati, Senior advocate for petitioner. Mr.Bijal Chhatrapati and Mr.Jay Amin for M/s Singhi &Co. for respondent-SEBI. SCA No.10527/06 :Ms.Dharmishtha N. Raval with Mr.K.S. Nanavati, Senior advocate for petitioner. Mr.Bijal Chhatrapati and Mr.Jay Amin for M/s Singhi &Co. for respondent-SEBI. SCA No.10528/06 :Ms.Dharmishtha N. Raval for petitioners no.1 & 2. Mr.Bijal Chhatrapati and Mr.Jay Amin for M/s Singhi &Co. for respondent-SEBI. SCA No.10529/06 :Ms.Dharmishtha N. Raval with Mr.M.D. Pandya for petitioner. Mr.Bijal Chhatrapati and Mr.Jay Amin for M/s Singhi &Co. for respondent-SEBI. SCA No.10756/06 : Mr.G.N. Shah with Ms.Minoo A. Shah for petitioner. Mr.Bijal Chhatrapati and Mr.Jay Amin for SCA/10523/2006 3/108 JUDGMENT M/s Singhi &Co. for respondent-SEBI. SCA No.9971/06 :Ms.Dharmishtha N. Raval for petitioner Mr.Bijal Chhatrapati and Mr.Jay Amin for M/s Singhi &Co. for respondent-SEBI. CA No.7139/06 : M/s Singhi & Co. for applicant. in SCA NO.9971/06 Mr.Bijal Chhatrapati and Mr.Jay Amin for M/s Singhi &Co. for respondent-SEBI. ========================================================= CORAM : HONOURABLE MR.JUSTICE RAVI R.TRIPATHI Date : 17/07/2006 COMMON ORAL JUDGMENT The petitioners being aggrieved of order dated 27th April 2006 (Annexure 'A') are before this Court. 2. In Special Civil Application No.10523 of 2006, petitioner no.2 is a member of the Ahmedabad Stock Exchange and a Sub-broker of ASE Capital Markets Limited. Petitioner no.2 is carrying on his activities as a proprietary firm. Petitioner no.1 is the son of petitioner no.2. Petitioner no.3 is the daughter in law of petitioner no.2. It is claimed in the petition that petitioners no.1 and 3 are investing in the securities market and they are neither broker, sub-broker nor intermediary as defined under section 12 of the Securities and Exchange Board of India Act, 1992 (hereinafter referred to as “SEBI Act). SCA/10523/2006 4/108 JUDGMENT 3. The Securities and Exchange Board of India (hereinafter referred to as “SEBI”) passed an order on 27th April 2006. The order runs into 252 pages. Para 1 of the order sets out the background in which the order is required to be passed. Para 2 sets out the modus operandi and in para 2 itself, in para 2.2, it is stated that, “It was found that almost all the dematerialised accounts that were in the names of factitious/ benami entities were held through the depository participant Karvy Stock Broking Ltd. (Karvy-DP). Inspection of Karvy-DP by NSDL and CDSL has revealed that the DP has obtained letters from the concerned banks towards proof of identity (POI) and proof of address (POA) for the purpose of opening dematerialised accounts. In terms of SEBI circular ref: MRD/ DoP/ Dep/ Cir- 29/ 2004 dated August 24, 2004, an identity card/ document issued by Scheduled Commercial Banks containing the applicant's photo/ address may be accepted as POI and POA. The circular further clarified that “the aforesaid documents are the minimum requirement for opening a BO Account. The Depository Participants (DPs) must verify the copy of the document with the original before accepting the same as valid. While opening a BO Account, the DPs are required to exercise due diligence while establishing the identity of the person to ensure the safety and integrity of the depository system.” Thus, it appears that first SCA/10523/2006 5/108 JUDGMENT the bank accounts were opened in the names of fictitious/ benami entities and this facilitated the fictitious/ benami bank holders to open dematerialised accounts.” Para 2.4 of the order sets out the further modus operandi. It reads as under: “The findings of RBI also confirm the preliminary findings of SEBI that these thousands of name-lenders are fictitious. Even the key persons (master account-holders) who had executed the game plan were merely intermediaries acting on behalf of financiers. These key persons and their financiers are not investors but mere rank opportunists who seek to make a killing by disposing the IPO shares cornered by them on the date of listing. The banks have also played their part by opening bank accounts and providing loan to these fictitious entities with the objective of earning interest and other charges.” 4. The order in para 4 defines various terms which are used in the order. Some of them are reproduced herein for ready perusal. (a) Financier -- is a person who either on his own or along with others provided the finance for IPO subscription and are the ultimate beneficiaries in the scheme of cornering retail SCA/10523/2006 6/108 JUDGMENT allotment and forking out a big gain on sale immediately after listing. “(b) Master Account-holders/ Key Operators are the 24 entities identified in the sweep of this order who allowed their demat accounts for temporarily parking credits received from a multitude of afferent accounts before transfer to financiers.” “(c) 'Afferent Accounts' (benami/ fictitious accounts) would refer to countless demat accounts in benami and fictitious names, the credits from where found its confluence in the master accounts.” The petitioners in SCA No.10523 of 2006 appear in a list of Master Account Holders contained in para 17.4 of the order. Their names are at serial nos.11, 12 and 31. 5. Paras 17 is titled as 'Order', in para 17.1 reasons are set out for issuing various directions against key operators, financiers, DPs and Depositories. Para 17.1 reads as under: SCA/10523/2006 7/108 JUDGMENT “In view of the grave emergency arising out of the conduct of parties with the added risk that such devious practices, if unchecked, would be continued with impunity in future, there is a need for immediate regulatory intervention. In the wake of the interim orders in the case of Yes bank and IDFC IPOs there has been a spate of public complaints alleging manipulation in IPO's and urging immediate action from SEBI for protecting the retail investors. Also there is a heightened investors' concern on the IPO's as reflected in the tenor of demands made on SEBI, and the same calls for a timely response from SEBI as regulator to restore the confidence of the retail investor. Amidst such public expectations, coupled with due regard to the fact that number of IPO's are in the wait for entry into the securities market, which need to be insulated from the manipulators of the various entities as mentioned in this order by suitably restraining them from participation in the ensuing IPO's which has acquired a sense of urgency and which cannot brook the normal delay of quasi judicial proceedings for taking a decision, there is an imperative need to pass the present interim order to protect the market particularly the IPO's from being preyed on by predatory manipulators. Further, if the entities, as prima facie found to be instrumental in tilting the IPO allotment process to their favour by the intricate modus operandi as clearly seen in the findings of this order, are allowed to operate in the market any more, the same is fraught with immense mischief and incalculable damage to IPO SCA/10523/2006 8/108 JUDGMENT allotment process besides undermining the confidence of the retail investors who are urging for a flair deal in the market free of such manipulators. Also SEBI has to reckon with the present booming market while formulating a course of action as decided in this order. Therefore, with a view to protect the interest of investors and securities market from further such acts, in exercise of the powers delegated to me by the SEBI Board in terms of section 19 of the Securities and Exchange Board of India Act, 1992 read with Section 11, 11B and 11(4)(b) thereof and section 19 of Depositories Act, 1996, pending inquiry and passing of final order, I hereby issue the following directions, by way of ad interim, ex parte order: (emphasis supplied) 6. The learned senior counsel Mr.K.B. Trivedi appearing with Ms.Dharmishtha Raval, the learned advocate appearing for the petitioners submitted that the order passed by SEBI is without any authority and is beyond the scope of section 11 of the SEBI Act. The learned senior counsel submitted that section 11 of the SEBI Act provides for functions of the Board. Section 11 of the SEBI Act is in Chapter IV which provides for “powers and functions of the Board”. He submitted that subsection (1) of section 11 provides that, 'subject to the provisions of this Act, it shall be the duty of the Board to protect the interest of the investors in securities and to promote the SCA/10523/2006 9/108 JUDGMENT development of and to regulate the securities market, by such measures as it thinks fit'. The learned senior counsel submitted that, 'section 11(4) of the SEBI Act does empower SEBI to suspend trading of any security in a recognised Stock Exchange'. It also empowers SEBI, 'to restrain the persons from accessing securities market and prohibit any person associated with securities market to buy, sell or deal in securities'. But then he submitted that before SEBI resorts to any of those measures it has to observe certain conditions which according to him are the 'conditions precedent' and they are prescribed in subsection (4), which read as under: Section 11(4) “Without prejudice to the provisions contained in subsections (1), (2), (2A) and (3) and section 11B, the Board may, by an order, for reasons to be recorded in writing, in the interest of investors or securities market, take any of the following measures, either pending investigation or inquiry or on completion of such investigation or inquiry, namely: - “ The learned senior counsel for petitioners submitted that in the entire order which is extensive enough running into 252 pages, there is no whisper that, 'an investigation or inquiry was undertaken against the present petitioners'. The learned senior counsel SCA/10523/2006 10/108 JUDGMENT submitted that as no investigation or inquiry is undertaken, there is no question of completion of such investigation or inquiry and that being so, there is no reason to resort to any measures, including that of restraining the petitioners from accessing the securities market and prohibiting the petitioners from buying, selling or dealing in securities. 7. The learned senior counsel for petitioners submitted that subsection (4) of section 11 was placed on the Statute Book by an Amending Act of 2002 and it came into force 29th October 2002. He submitted that it is equally important to note that it was by this Amending Act of 2002 that section 11(C) was also brought on the Statute Book. This section 11C of the Act pertains to “investigation”. Investigation provided under section 11C of the Act is detailed out in that provision. Subsection (1) of section 11C provides for the contingency in which the SEBI is to resort to investigation. It is provided that where the Board has reasonable ground to believe that there exist certain contingencies, set out in clauses (a) and (b), the Board may, at any time by order in writing, direct any person to investigate the affairs. He submitted that thus it is clear that the SEBI has to have first in point SCA/10523/2006 11/108 JUDGMENT of time, a reasonable ground to believe that contingencies contemplated under clauses (a) and (b) are in existence and therefore, an investigation is warranted. Clauses (a) and (b) of subsection (1) of section 11(C) read as under: “11C Investigation (1) Where the Board has reasonable ground to believe that -- (a) the transactions in securities are being dealt with in a manner detrimental to the investors or the securities market; or” “(b) any intermediary or any person associated with the securities market has violated any of the provisions of this Act or the rules or the regulations made or directions issued by the Board thereunder.” The learned senior counsel for petitioners submitted that in the present case order under challenge is dated 27th April 2006, whereas petitioner no.1, the notice under Rule 4 of SEBI (Procedure for Holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995 served to him is dated 15th June 2006. He submitted that with full responsibility he is making a statement at the Bar that prior to 15th June 2006 notice, no notice worth name was served to the petitioners. He submitted that SCA/10523/2006 12/108 JUDGMENT therefore, on the face of it, order dated 27th April 2006 is not as contemplated under subsection (4) of section 11 of the SEBI Act. 8. The learned senior counsel submitted that even at the cost of repetition he has to reiterate that no investigation was commenced against the petitioners before passing of the order under challenge dated 27th April 2006, that being so there is no question of any 'investigation being pending'. He submitted that to assume for a while that the petitioners advanced funds to some persons, that by itself is no offence as 'advancing funds' is not prohibited. He emphatically submitted that the petitioners have not indulged in any 'prohibited activity', much less an 'illegal activity'. He further submitted that the funds advanced by the petitioners is returned either by cheque or in the form of shares. He submitted that this act of 'return of fund' and act of 'receiving the same' is again not 'prohibited' under any law then where is the question of the petitioners having indulged in an activity which is 'detrimental' either to 'investors' or the 'securities SCA/10523/2006 13/108 JUDGMENT market'. The learned senior counsel in this regard, invited attention of this Court to paras 31 and 32 of the rejoinder affirmed by Shri Rajan Vasudevbhai Dapki, petitioner no.1 on 24th June 2006. Relevant part reads as under: “.. .. the data referred to above will at the highest only demonstrate that the petitioners may have given finances to certain entities. It is submitted that giving of finances is an activity which is not prohibited by any provisions of the securities laws. Even assuming without admitting that the moneys have been given for financing of IPOs that also is not an activity which is prohibited, by any laws. Even the Banks carry on business of providing finances permitting applications in the IPO. Financing of IPOs is legitimate activity. The fact of giving finances does not in any way prove that the petitioners are part of the scheme whereby a modus operandi has been adopted to corner the retail allotment and make it big games (sic., gains) on sale immediately before or after listing.” The deponent in para 32 has stated that, “.. .. entering into transactions, which are off market transactions are not illegal transactions. The Securities Contract Regulation Act permits transactions of Spot basis outside SCA/10523/2006 14/108 JUDGMENT the stock exchange. The off market transactions are recognised even by the National Securities Depository Ltd. (NSDL). The bye-laws of NSDL provides for and recognises off market transactions. It is submitted that the rules and bye-laws of NSDL are approved by SEBI. It is submitted that the delivery instructions slip prescribed by NSDL has a separate column for off market transactions and transactions which are entered into on the Stock Exchange. .. ..” 9. The learned senior counsel submitted that though the order under challenge runs into 252 pages there is no evidence against the petitioners showing that the petitioners have indulged in an activity, detrimental to the 'investors' or 'securities market'. He submitted that the SEBI has not set out any evidence in the order which will go to show that the petitioners are part of the 'scheme' opening large number of multiple dematerialsed accounts with common addresses, making applications in the retail category for small value so as to be eligible for allotment, subsequently transferring the shares to the 'key operators', who in turn transfer the shares to the 'financiers', who originally made funds available for the same and then, acting as mere opportunist sold those shares making a killing profit on the date of listing. SCA/10523/2006 15/108 JUDGMENT 10. The learned senior counsel for petitioners submitted that the order refers to violation of different regulations. He submitted that para 16.103 reads as under: “The findings of investigations so far, prima facie, reveal violations of serious nature by the key operators, their financiers, concerned DPs, Karvy group and the depositories including violation of Regulation 3 of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003, Regulation 42(2), 42(3), 43, 46 and 52 of SEBI (Depositories and Participants) Regulations, 1996 and clauses 3, 9, 12, 16, 19, 20 and 22 of the Code of Conduct specified in Regulation 20(a) of SEBI (Depositories and Participants) Regulations, 1996 and the provisions of Depositories Act, 1996 and Provisions of SEBI Disclosure and Investor Protection Guidelines, 2000.” The learned senior counsel for petitioners submitted that in the entire order, there is no reference to the role of the petitioners or the act of the petitioners, which constitutes breach or violation of one or more the aforesaid regulations. 11. The learned senior counsel for petitioners submitted SCA/10523/2006 16/108 JUDGMENT that para 16.104 of the order impugned records that, “investigations are being completed .. .. “ He submitted that the order does not specify as to which investigation and as to whether the investigation referred to in para 16.104 is against the petitioners and therefore, he submitted that, the order passed against the petitioners be quashed by this Court. 12. The learned senior counsel submitted that Regulation 5 of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003 also refers to 'investigation'. He submitted that, 'the Board', 'Chairman', 'member' or 'Executive Director', as and when has reasonable ground to believe that in any 'transaction' securities are dealt in such a manner, which detrimental to the 'investors' or 'securities market', which is in violation of these Regulations, then in that case it is open for the Board to direct by an order in writing, any officer to investigate the affairs of such 'intermediaries' or the 'persons associated with securities market' or 'any other person', and report to the Board, for which the method is prescribed under section 11C of the SEBI Act. SCA/10523/2006 17/108 JUDGMENT The learned senior counsel further submitted that Regulation 6 provides for 'powers of the investigating authority', whereas Regulation 8 casts duty to cooperate. Regulation 9 provides submission of report to the Board and on such submission of the report under Regulation 10 it is for the Board to effect enforcement. But then he submitted that in Regulation 10 it is provided that, 'the Board after giving reasonable opportunity of hearing to the persons concerned, issue such directions or take such action as mentioned in Regulations 11 and 12. He submitted that in the present case the Board has not undertaken any investigation against the petitioners and therefore, there is no question of the same being completed. 13. The learned senior counsel submitted that the petitioners do not dispute the powers of SEBI to issue such directions, even by dispensing with pre- decisional hearing. But then the order issued against the petitioners is not issued after complying with the necessary provisions of law. The learned senior counsel for petitioners submitted that under clause (d) of subsection (4) of section SCA/10523/2006 18/108 JUDGMENT 11 of SEBI Act, the SEBI has power even to retain the proceeds of securities of a transaction under investigation. But then, he submitted that the power is to retain the proceeds or securities of only those transaction which is under investigation. He submitted that thus the action of the SEBI restraining the petitioners from selling the securities, which are not connected to the IPOs mentioned in the order, is certainly without any authority of law. The learned senior counsel also submitted that clause (e) of subsection (4) of section11 empowers the SEBI to even attach the Bank Account, with prior approval of the Judicial Magistrate. But then, he submitted that it also goes without saying that the 'Bank Accounts' which could be attached must be that of a person/s who is/ are involved in violation of the provisions of the Act, Rules or Regulations. The learned senior counsel for the petitioners submitted that still the SEBI is not empowered to pass order whereby the securities which are not under investigation can be retained, impounded or SCA/10523/2006 19/108 JUDGMENT attached. 14. The learned senior counsel next submitted that the tenor of the order under challenge is clear. Its focus is on two IPOs, one of “Yes Bank” and another of 'IDFC'. The order then proceeds to record the object for which order is passed. It is recorded in the order, i.e. 'to see that the ensuing IPOs are not manipulated', He submitted that, that being so, the order of SEBI putting total restriction and prohibiting the petitioners from buying and selling even in the secondary market is certainly beyond “the object” mentioned in the order itself. He submitted that the restriction imposed on the petitioners prohibiting them from dealing in the secondary market is concerned has no nexus with 'the object' for which the order is passed. He submitted that the total ban/ restriction/ prohibition on selling the shares acquired by the petitioners, prior to the IPOs, referred to in the order is not only unjust and harsh, but an arbitrary one and by any standard 'disproportionate'. SCA/10523/2006 20/108 JUDGMENT 15. The learned senior counsel for petitioners submitted that earlier this Court had an occasion to deal with the provisions of sections 11 and 11B of the SEBI Act, in the matter of Alka Synthetics Ltd. Vs. Securities and Exchange Board of India (SEBI) & others, reported in 1997 (3) GCD 88 (Gujarat). He submitted that this Court while considering the matter had observed that, 'the order made, without affording an opportunity of hearing, on the ground that the orders are not by way of penalty, but for restoring the market condition, in absence of any statutory provisions to exclude the principles of natural justice, stand vitiated on account of non compliance of the principles of natural justice'. He submitted that this Court was pleased to hold that, 'the post-decisional hearing, including appeal against the order cannot cure the invalidity attached to the order made without adhering to the principles of natural justice'. The learned senior counsel in support of his submissions relied upon paras 39, 40, 41 and 44. So far as sections 11 of the Act is concerned he SCA/10523/2006 21/108 JUDGMENT relied upon paras 202, 206, 207, 211 and 234. 16. The learned senior counsel for petitioners submitted that, 'the concept of proportionality is not unknown to the field of administrative law', and the same is required to be considered even in the present case as the order passed by the SEBI is in the nature of administrative order. In this regard