SAT Reduces the Penalty Imposed on Broker, as Failure to Update the Nomenclature of Client’s Bank Accounts Constitutes a Technical Breach

Case Details: [2023] 157 taxmann.com 200 (SAT - Mumbai)[07-12-2023]

Judiciary and Counsel Details

• • Justice Tarun Agarwala, Presiding Officer & Ms Meera Swarup, Technical Member
  • Somasekhar Sundaresan, Kunal Katariya, Sahebrao Wamanrao Buktare, Ms Ashmita Garodia, Advs. & Shardul Shah, CA for the Appellant.
  • Gaurav Joshi, Sr. Adv., Suraj Choudhary, Ravishekhar Pandey, Nishit Dhruva, Ms Shefali Shankar, Ms Rasika Ghate & Harsh Sheth, Advs. for the Respondent.

Facts of the Case

The appellant, was engaged in the business of broking, mutual fund distribution, depository participant, and portfolio management. The appellant underwent an inspection by the Securities and Exchange Board of India (SEBI).

The inspection revealed that 26 client bank accounts lacked the designation ‘client account.’ It was alleged that appellant had violated the circular dated November 18, 1993 (hereinafter referred to as ‘1993 circular’) for failure to designate bank accounts used for client transaction as “client account”.

Furthermore, there were frequent transfers of funds between these client bank accounts and the appellant’s pool account. The funds in the pool account were subsequently used by the appellant for various purposes, such as investments in mutual funds, insurance, fixed deposits, and inter-corporate deposits.

As a result of these findings, the Adjudicating Officer, after deeming the charges proven, imposed a penalty of Rs. 1 crore in each proceeding under section 23D of the Securities Contracts (Regulation) Act (SCRA).

SAT Held

However, it’s crucial to note that inspections conducted from the inception until the ones in question did not raise any observations regarding the consideration of only the funded portion of the bank guarantee. These inspections did not uncover any misutilization of client funds. The assertion that there was a misuse of client funds, based on wrongly considering the non-funded portion of the bank guarantee according to the 2016 circular, was deemed patently erroneous. A broker can withdraw money from the client account to issue a bank guarantee to the clearing house on behalf of the clients though it is not specifically stated in the 1993 circular.

Given that there was no actual misuse of client funds and no failure on the part of the appellant to segregate client monies for its own purposes, the imposition of a penalty under section 23D of SCRA was ruled out.

However, despite this, the fact that the appellant failed to update the nomenclature of client bank accounts, as required by the 1993 circular, was considered a technical breach. In response, a penalty of Rs. 20 lakhs was levied.