SEBI’s Order in NSEL Matter & applicability of Regulation 23 of SEBI (Intermediaries) Regulations, 2008

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Author: Rakshita Poddar is an Associate at Mindspright Legal, Mumbai which is a boutique firm specializing in Securities Law.

SEBI has recently passed an Order dated February 22, 2019 against Motilal Oswal Commodities Broker Private Limited (MOCBPL) in the National Spot Exchange Limited (NSEL) Matter in which it has held MOCBPL not to be a fit and proper person to hold, directly or indirectly, the certificate of registration as commodity derivatives. Vide the said order, SEBI rejected the applications dated December 11, 2015 and December 16, 2015 filed by MOCBPL for registration as commodity derivatives broker. The said Order was passed against MOCBPL for the reason that it has participated/facilitated its client in the illegal paired contract launched by NSEL.

Interestingly, the Order invokes Chapter V and more precisely Regulation 23 of the SEBI (Intermediaries) Regulations, 2008 which deals with the cancellation or suspension of registration and other actions. It was argued by the MOCBPL that it does not have a certificate of registration as commodity derivative broker, therefore, the proceedings under chapter V of Intermediaries Regulations are not applicable against it. However, SEBI, taking into account the facts and circumstances of the case and the fact that MOCBPL was already trading in the commodity derivative, held that Regulation 23 is applicable on MOCBPL. It observed as follows:

44.3 I note that under normal circumstances as per regulation 23 of Intermediaries Regulations, SEBI can take action under Intermediaries Regulations against any person who has been granted a certificate of registration under the Act or regulations made thereunder either (a) fails to comply with any conditions subject to which a certificate of registration has been granted to him; or (b) contravenes any of the provisions of the securities laws or directions, instructions or circulars issued thereunder.

44.4. However, in view of the facts and circumstances of the case discussed above in paragraph 36, SEBI’s jurisdiction, observation of Hon’ble Bombay High Court in Order dated October 04, 2018, the fact that, pursuant to Finance Act, 2015 the Noticee was already dealing in commodity derivatives and applicability of Intermediaries Regulations as already discussed in detail above, I am of the view that SEBI can take action against the Noticee under Intermediaries regulations if the Noticee has contravened any of the provisions of the securities laws or directions, instructions or circulars issued thereunder.” (emphasis supplied)

Based on this, the SEBI at Para 47 of its Order concluded that as MOCBPL has contravened the ongoing requirement of ‘fit and proper status’, which is a necessary condition for a broker to hold certificate of registration under SEBI (Stock Brokers and Sub-brokers) Regulations, 1992 read with Intermediaries Regulations, Regulation 23 of Intermediaries Regulations is attracted and the issuance of the Notice of MOCBPL is sustained. It was observed in the Order as follows:

“47. In view of the above, I am of the view that issuance of the show cause notice against the Noticee, is sustained, since the same was issued on the allegation that it had contravened the ongoing requirement of fit and proper status, under the Brokers Regulations read with Intermediaries Regulations, which are part of Securities Laws, therefore, regulation 23 of Intermediaries Regulations is attracted and SEBI had rightly initiated action against Noticee under regulation 23 of Intermediaries Regulations.”

This is the reasoning which was adopted by SEBI to prove its act of initiating action against MOCBPL under Regulation 23 to be legitimate.

In the opinion of the Author, SEBI is misconceived in holding that Regulation 23 is applicable on MOCBPL in the present facts and circumstances. The reasoning of SEBI in applying the Regulation 23 on MOCBPL is that pursuant to Finance Act, 2015 the Noticee was already dealing in commodity derivatives, and therefore the SEBI can take action against the MOCBPL under Intermediaries Regulations if the Noticee has contravened any of the provisions of the securities laws or directions, instructions or circulars issued thereunder.

23. Where any person who has been granted a certificate of registration under the Act or regulations made thereunder, –

(a) fails to comply with any conditions subject to which a certificate of registration has been granted to him;

(b) contravenes any of the provisions of the securities laws or directions, instructions or circulars issued thereunder; the Board may, without prejudice to any action under the securities laws or directions, instructions or circulars issued thereunder, by order take such action in the manner provided under these regulations.” (emphasis supplied)

However, it is pertinent to note here that the Regulation 24(1) of the Intermediaries Regulations categorically states that ‘designated member’ can approve the initiation of the proceedings under Chapter V of the Intermediaries Regulations, only when the person registered with SEBI as an intermediary has committed a default specified under Regulation 23. Regulation 23 of the Intermediaries Regulations states as follows:

The terms ‘fails’ and ‘contravenes’ as stated in the above provision means that the said provision is applicable only when the default is committed by the person after the registration of the person with SEBI. The said provision is not applicable to the alleged defaults committed by the person before the registration of the person with SEBI or, in the present facts and circumstances, before the Finance Act, 2015.

SEBI’s reasoning that pursuant to the Finance Act, 2015 the MOCBPL continued to trade in the commodity derivative, so SEBI can take action if it has contravened any provision of the securities law, is wrong as SEBI can take action only if MOCBPL, in the present case, would have contravened the provision of securities law after the Finance Act, 2015 and not otherwise. In the present case, if the MOCBPL would have participated/facilitated its client in the illegal paired contract launched by NSEL after the Finance Act, 2015, then SEBI would have been empowered to take action against MOCBPL under Regulation 23 of Intermediaries Regulations and not otherwise. This is because the term ‘contravenes’ is stated in Regulation 23, whereas the term ‘contravened’ is stated in the SEBI Order. Hence, it can be said that the SEBI’s order is misconceived on this ground alone.

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