Case: Chairman, S.E.B.I Vs. Shriram Mutual Fund

1. The Securities and Exchange Board of India (hereinafter referred to as the SEBI) is the appellant in the present appeal under Section 15-Z of the Securities and Exchange Board of India Act, 1992. This appeal was filed against the final judgment and order dated 21.08.2003 passed by the Securities Appellate Tribunal, Mumbai (hereinafter referred to as the Tribunal) in appeal No. 50 of 2002 and 51 of 2002 raising an important question of law as to whether once it is conclusively established that the Mutual Fund has violated the terms of the Certificate of Registration and the statutory Regulations i.e. SEBI (Mutual Funds) Regulations, 1996 (hereinafter referred to as the Regulations") the imposition of penalty becomes a sine qua non of the violation2. The respondents have not chosen to enter appearance though they were served with the notice. Since the service is complete and the appeals are ready for hearing, the above appeals were listed for final hearing. The Appellant Board, a body corporate, has been established under the Securities and Exchange Board of India Act, 1992 by the Central Government, inter alia, to protect the interest of the investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith. Shriram Mutual Fund was registered in the year 1994. It had floated 5 schemes. It conducted business through brokers associated with its sponsor in excess of the permissible limits prescribed under Regulation 25(7)(a) of the Regulations, 1996 on 12 occasions. The respondent failed to comply with the terms and conditions attached to the Certificate of Registration which are statutory in nature, as prescribed by Regulation 15 (D)(b) of the Securities and Exchange Board of India Act, 1992. The instances of excess transactions conducted by the respondents are as follows:-Sr. No.Quarter endedName of the Associate BrokersPercentage of Business1.June 1998Springfield Securities10.65%6.September 1998SIS Shares and Stock Brokers19.59%9.September 1998Shriram Indus Stock9.86%3. The Chairman, SEBI in exercise of the powers conferred on it under Section 15(I) of the said Act and Rule 3 of the SEBI (Procedure for Holding Enquiry and Imposing Penalty by Adjudicating Officer) appointed an Adjudicating Officer to enquire into the violations of exceeding by the respondents of the permissible limit of 5% of aggregate purchases and sales of securities made by the Mutual Fund in all its Schemes, as prohibited under Regulations 25(7)(a) of the said Regulations. The Appellant-Board issued notice dated 01.04.2002 under Rule 4 of Rules, 1995 calling upon the respondents to show cause as to why an inquiry should not be held and penalty imposed under the Rules, 1995. The respondents filed a common reply before the Enquiry and Adjudicating Officer, SEBI. The Adjudicating Officer, after hearing the parties, imposed penalty of Rs. 5 lacs under Section 15E on respondent No.2 for failure to comply with Regulations 25 (7)(a) of SEBI (Mutual Funds) Regulations, 1996 with regard to routing of transactions through associate brokers4. The Adjudicating Officer also imposed a penalty of Rs. 2 lacs under Section 15D(b) of SEBI Act, 1992 on respondent No.1 for its failure to comply with the terms and conditions of Certificate of Registration granted to it. Aggrieved by the order dated 24.06.2002 passed by the Adjudicating Officer, the respondents filed appeals before the Securities Appellate Tribunal, Mumbai on 21.08.2003, inter alia, contending that the transactions with the associate brokers were related to thinly traded Securities, for which there were no ready markets available through the normal Stock Exchange, or were relating to securities which did not have any large volume or trade in the market. It was further contended that these securities were either thinly traded, or did not have any volumes. It was submitted that the percentage of excess business carried out with associate brokers were as high as 91.68% and 52.42%, while the total volume of business done with the associate brokers was Rs.4.55 lacs. The Tribunal set aside the order of the Adjudicating Officer on the purported ground that the penalty to be imposed for failure to perform a statutory obligation is a matter of discretion. The Tribunal has held that the penalty is warranted by the quantum which has to be decided by taking into consideration the factors stated in Section 15-J. Aggrieved by the order dated 21.08.2003, the Chairman, SEBI filed the above statutory appeal under Section 15-Z of the Act of 1992 as amended by the Securities and Exchange Board of India (Amendment) Act, 2002.

Reasoning: In our opinion, the Tribunal has miserably failed to appreciate that by setting aside the order of the Adjudicating Officer the Tribunal was setting a serious wrong precedent whereby every offender would take shelter of alleged hardships to violate the provisions of the Act. In our opinion, mens rea is not an essential ingredient for contravention of the provisions of a civil act. In our view, the penalty is attracted as soon as contravention of the statutory obligations as contemplated by the Act is established and, therefore, the intention of the parties committing such violation becomes immaterial. In other words, the breach of a civil obligation which attracts penalty under the provisions of an Act would immediately attract the levy of penalty irrespective of the fact whether the contravention was made by the defaulter with any guilty intention or not. This apart that unless the language of the statute indicates the need to establish the element of mens rea, it is generally sufficient to prove that a default in complying with the statute has occurred. Under a close scrutiny of Section 15 D(b) and 15-E of the Act, there is nothing which requires that mens rea must be proved before penalty can be imposed under these provisions. Hence, we are of the view that once the contravention is established, then the penalty has to follow and only the quantum of penalty is discretionary. Discretion has been exercised by the Adjudicating Officer as is evident from imposition of lesser penalty than what could have been imposed under the provisions. The intention of the parties is wholly irrelevant since there has been a clear violation of the statutory Regulations and provisions repetitively, covering a period of 6 quarters. Hence we hold that the respondents have wilfully violated statutory provisions with impunity and hence the imposition of penalty was fully justified. The Tribunal, in this context, failed to appreciate that every Mutual Fund has to redeem the units as per terms and conditions of the scheme on the request of the unit holders and this cannot, in any manner, be considered as an extraordinary circumstance or something which was not known to the respondents. The facts and circumstances of the present case in no way indicate the existence of special circumstances so as to waive the penalty imposed by the Adjudicating Officer. A perusal of the order passed by the Adjudicating Officer would clearly go to show that factors such as small size of the funds, low volume of transactions, thinly traded securities, administrative and operational exigencies were duly considered and appreciated by the Adjudicating Officer while passing the order and that is why the Adjudicating Officer did not impose the maximum permissible penalty. The Tribunal failed to appreciate that the objective behind imposing certain limit on the business that can be conducted by mutual fund through the associate broker is to eliminate any undue advantage to the class of brokers by virtue of their close association with the Asset Management Company, sponsors etc. In other words, the object of imposing such limits is to ensure that there is no concentration of business only in such entities, so that there is an indirect pecuniary advantage to the person associated with the Asset Management Company, sponsors etc. Any undue concentration on the business of the mutual fund with its affiliated brokers by paying huge commissions to such brokers is neither desirable nor in the interest of the unit holders. It is a matter of record that in the 12 admitted instances of violation by the respondents, the percentage of the business through the associated brokers was as high as 91.68% and 52.2% in certain factors. This apart, the respondents excessive exposure to the associate brokers is not only established from the record, but has also been admitted by respondents9. It is settled law that when a penalty is imposed by an Adjudicating Officer, it is done so in adjudicatory proceedings and not by way of fine as a result of prosecution of an accused for commission of an offence in a criminal proceeding. In the instant case, the Tribunal has failed to appreciate that the respondents had given undue and unfair advantage to the associated brokers, which is detrimental to the interest of the unit holders. In the present case, it has been established by the Adjudicating Officer as well as admitted by the respondents that there has been a conscious disregard of the obligation inasmuch as the respondents were aware that they were acting in violation of the provisions of Regulations. The Adjudicating Officer had, after taking into account all the facts and circumstances of the case, imposed only a token of Rs. 5 lacs against the respondents for its failure on 12 occasions though the charging section permits imposition of a maximum penalty of Rs. 5 lacs for each such violation. The Appellant Board has been established by the Parliament under the Securities and Exchange Board of India Act, 1992 to protect the interest of investors in securities and to promote the development of, and to regulate the securities market and for matter connected therewith or incidental thereto. The Board was set up to promote orderly and healthy growth of the securities market and for investors protection SEBI has been monitoring and regulating the activities of Stock Exchanges, Mutual Funds and Merchant Bankers, etc. to achieve these goals10. The Tribunal has erroneously relied on the judgment in the case of Hindustan Steel Ltd. Vs. State of Orissa, AIR 1970 SC 253 which pertained to criminal/quasi-criminal proceeding. That Section 25 of the Orissa Sales Tax Act which was in question in the said case imposed a punishment of imprisonment up to six months and fine for the offences under the Act. The said case has no application in the present case which relates to imposition of civil liabilities under the SEBI Act and Regulations and is not a criminal/quasi-criminal proceeding11. In our considered opinion, penalty is attracted as soon as the contravention of the statutory obligation as contemplated by the Act and the Regulation is established and hence the intention of the parties committing such violation becomes wholly irrelevant. A breach of civil obligation which attracts penalty in the nature of fine under the provisions of the Act and the Regulations would immediately attract the levy of penalty irrespective of the fact whether contravention must made by the defaulter with guilty intention or not. We also further held that unless the language of the statute indicates the need to establish the presence of mens rea, it is wholly unnecessary to ascertain whether such a violation was intentional or not. On a careful perusal of Section 15(D)(b) and Section 15-E of the Act, there is nothing which requires that mens rea must be proved before penalty can be imposed under these provisions. Hence once the contravention is established then the penalty is to follow. In our view, the impugned judgment of the Securities appellate Tribunal has set a serious wrong precedent and the powers of the SEBI to impose penalty under Chapter VIA are severely curtailed against the plain language of the statute which mandatorily imposes penalties on the contravention of the Act/Regulations without any requirement of the contravention having been deliberated or contumacious. The impugned order sets the stage for various market players to violate statutory regulations with impunity and subsequently plead ignorance of law or lack of mens rea to escape the imposition of penalty. The imputing mens rea into the provisions of Chapter VI A is against the plain language of the statute and frustrates entire purpose and object of introducing Chapter VIA to give teeth to the SEBI to secure strict compliance of the Act and the Regulations.