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ADJUDICATION ORDER NO. - BS/AO-11 /2007

ORDER UNDER SECTION 15I OF THE SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992 READ WITH RULE 5 OF THE SECURITIES AND EXCHANGE BOARD OF INDIA (PROCEDURE FOR HOLDING INQUIRY AND IMPOSING PENALTIES BY ADJUDICATING OFFICER) RULES, 1995 IN THE MATTER OF ADJUDICATION PROCEEDINGS AGAINST NATIONAL SECURITIES DEPOSITORY LIMITED.

1.1 Securities and Exchange Board of India (hereinafter referred to as ‘SEBI’)

vide order dated November 22, 2006 initiated adjudication proceedings

against National Securities Depository Ltd. (hereinafter referred to as

‘NSDL’). I was appointed as the Adjudicating Officer to inquire into and

adjudge under Section 15I read with Sections 15HA and 15HB of the

Securities and Exchange Board of India Act, 1992 (hereinafter referred to

as the ‘SEBI Act’) and Section 19G of the Depositories Act, 1996

(hereinafter referred to as the ‘Depositories Act’), the violations alleged to

have been committed by NSDL.

2.0 FACTS OF THE CASE

2.1 SEBI conducted investigation into the affairs relating to buying, selling or

dealing in the shares through initial public offerings (IPOs) during the

period 2003 – 2005 by the following companies:

1. Amar Remedies Ltd.

2. Datamatics Technologies Ltd.

3. Dishman Pharma & Chemicals Ltd.

4. FCS Software Solutions Ltd.

5. Gateway Dispriparks Ltd.

6. Gokaldas Export

7. ILFS Investmart

8. Indraprasth Gas

9. Infrastructure Development Finance Co. Ltd.

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10. Jet Airways (India) Ltd.

11. Nandam Exim Ltd.

12. National Thermal Power Corporation Ltd.

13. Nectar Lifesciences Ltd.

14. Patni Computer Systems Ltd.

15. Sasken Communication Technologies Ltd.

16. Shoppers Stop Ltd.

17. SPL Industries Ltd.

18. Suzlon Energy Ltd.

19. T.V. Today Network Ltd.

20. Tata Consultancy Services Ltd.

21. Yes Bank Ltd.

2.2 It was observed that many entities cornered / acquired the shares in the

various IPOs by the above companies during the period 2003 – 2005 by

making fictitious applications in the category reserved for retail investors

through the medium of thousands of fictitious / benami applicants for the

IPOs. It is alleged that the said entities (hereinafter referred to as the ‘Key

Operators’) had opened many demat accounts in fictitious and benami

names and made large number of applications in the IPOs in the category

of retail investors in fictitious and benami names.

2.3 On allotment of shares in the category of retail investors in the IPOs, the

said shares were transferred to the demat accounts of these key

operators. It is alleged that these key operators subsequently transferred

the shares through off market deals to ultimate beneficiaries (hereinafter

referred to as the ‘financiers’) who appeared to be the financiers in the

process. In this regard, it is alleged that the said practice was adopted to

corner the quota for retail investors in the IPOs of the companies.

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2.4 It was noted that the entities (key operators) who opened large number of

fictitious / benami accounts (hereinafter referred to as afferent accounts)

had opened large number of such accounts with the Depository

Participants affiliated to NSDL. Investigation revealed that many such

accounts were opened in fictitious names and had common address. It

was noted that as many as 34,924 afferent accounts were opened with

various Depository Participants affiliated to NSDL.

2.5 In view of the same, SEBI had conducted a system audit of NSDL through

isec Services Pvt. Ltd wherein various irregularities and failures alleged to

have been committed by NSDL were observed.

2.6 On the basis of the investigation conducted by SEBI and on the basis of

the system audit, prima facie it appeared that various lapses and

irregularities on the part of NSDL resulted in facilitating the key operators

to open large number of fictitious / benami demat accounts with NSDL

which enabled the key operators to corner the retail portion in the IPOs.

Hence adjudication proceedings have been initiated against NSDL.

2.7 On the basis of the investigation conducted by SEBI, it is alleged that by

facilitating the key operators to open fictitious / benami accounts, NSDL

had abetted the key operators in cornering the IPO allotments under retail

category in purported names of afferent accounts. In this regard it is also

alleged that NSDL failed to

? notice the unauthorized outsourcing by the Depository Participants

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? put in place adequate mechanisms for the purpose of reviewing,

monitoring and evaluating the controls, systems, procedures and

safeguards

? prevent the opening / existence of multiple beneficiary owner

accounts

? verify the infrastructural facilities of the Depository Participants

? take appropriate action against the Depository Participants for the

various irregularities repeatedly committed by them

2.8 On account of the failures and irregularities of NSDL as stated above, it is

alleged that NSDL have violated / failed to comply with the following

provisions

? Section 26(2)(p) of the Depositories Act, 1996

? The provisions of Regulation 7, 16(2), 22, 23, 34, 35, 37, 39 and 52

of SEBI (Depositories and Participants) Regulations, 1996

(hereinafter referred as ‘Depositories Regulations’)

2.9 Further, it is also alleged that on account of various commissions and

omissions on the part of NSDL which facilitated the key operators to

corner the shares in the IPOs, NSDL violated the provisions of Regulation

3 of SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to

Securities Market) Regulations, 2003.

2.10 It is also alleged that NSDL failed to comply with the directives issued by

SEBI vide order dated January 12, 2006 and April 27, 2006. Further, it is

also alleged that NSDL has failed to comply with the provisions of its Bye

Law Nos. 6.2.1(vii), 7.2.1, 10.4.1, 10.4.1(b) and 11.

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3.0 NOTICE AND REPLY

3.1 A Show Cause Notice (hereinafter referred to as ‘SCN’)

A&E/BS/80607/2006 dated November 23, 2006 was issued to NSDL in

terms of the provisions of Rule 4 of SEBI (Procedure for Holding Inquiry

and Imposing penalties by Adjudicating Officers) Rules, 1995 (hereinafter

referred to as the Rules), requiring NSDL to show cause as to why an

inquiry should not be held for the violations alleged to have been

committed by it.

3.2 NSDL vide its letter dated December 7, 2006 requested for time to reply to

the SCN. Subsequently, vide letter dated December 15, 2006, NSDL

replied to the SCN. Considering the reply of NSDL, it was decided to

conduct an inquiry in the matter and NSDL was advised to attend the

hearing on January 5, 2007. Vide letter dated December 28, 2006, NSDL

requested for a short adjournment. Considering the request of NSDL, it

was granted another opportunity of hearing on January 16, 2007.

3.3 On January 16, 2007, NSDL through its Advocate Shri Somasekhar

Sundaresan, of J. Sagar Associates attended the hearing and made

submissions in respect of the alleged violations. During the hearing, NSDL

submitted an application seeking cross examination of the authors of the

system audit report.

3.4 Subsequently, further clarifications were sought from NSDL vide letter

dated February 14, 2007 which was replied by NSDL vide letter dated

March 6, 2007. As NSDL requested for one more hearing in the matter to

clarify the issues mentioned in the letter dated February 14, 2007, another

opportunity of hearing was granted to it on March 14, 2007. Subsequently

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vide letters dated March 15 and March 21, 2007, NSDL submitted

additional submissions.

3.5 As NSDL has sought cross examination of the authors of the system audit

report, I consider the application filed by NSDL seeking cross examination

as a preliminary issue in the matter. Right to cross examination is not an

absolute right and would depend on the facts and circumstances of each

case. In this case, it is noted that copy of the system audit report was

forwarded to NSDL as part of the show cause notice. Further, reasonable

opportunity to contradict the findings of the report and also to explain its

case was given to NSDL. In this context, the decision of the Hon’ble

Supreme Court in Transmission Corporation of AP Ltd. and others Vs Sri

Rama Krishna Rice Mill (2006) 3 SCC 74 is relied upon. The Hon’ble

Court held that in order to establish that the cross examination is

necessary, party has to make out a case for the same. Considering the

said judgment and also the principle laid down by the Hon’ble Supreme

Court in various other cases in respect of the issue, I am of the view that

reasonable opportunity has been granted to NSDL to present its case and

further it is noted that no prejudice is caused to NSDL by denial of right to

cross examination in the matter. In view of the same, cross examination is

not granted in the adjudication proceedings.

4.0 CONSIDERATION OF EVIDENCE AND FINDINGS

4.1 As stated before, the investigation and the system audit pointed out

various lapses and irregularities on the part of NSDL which enabled the

key operators to open many demat accounts in fictitious and benami

names and corner the quota for retail investors in the IPOs of the

companies. It was noted that as many as 34,924 afferent accounts were

opened with NSDL’s Depository Participants. The said lapses and

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irregularities alleged to have been committed by NSDL are detailed in the

following paragraphs.

4.2 The various violations alleged to have been committed by NSDL, the

submissions made by NSDL and the findings in respect of the same are

mentioned below.

5.0 Facilitating opening of fictitious accounts:

5.1 It is noted from the findings of investigation that the key operators opened

various afferent accounts as a device to manipulate the IPO process by

getting allotment under the quota reserved for retail investors. Many such

accounts had common addresses of Key Operators. In this regard, it is

noted that as many as 34,924 such accounts were opened with DPs of

NSDL. Details of these accounts are as follows:

Sr No. SOURCE DP NAME SOURCE CLIENT

ID

1. KARVY STOCK BROKING

LIMITED 29309

2. HDFC BANK LTD 1793

3. KHANDWALA INT.FIN.S.PV.L 1153

4. IDBI BANK LIMITED 1017

5. JHAVERI SECURITIES P LTD 598

6. ING VYSYA BANK LIMITED 544

7. PRAVIN RATILAL SH & STK 510

Total 34,924

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Further, it was noticed that many of the above afferent accounts were

opened in bulk on certain dates. The details where 500 or more accounts

were opened on the same date are given below:

Sr

No

DATE OF

OPENING OF

DEMAT

ACCOUNT

Number of

demat

accounts

opened

Name of

major DP

Status

Accounts

Comments

1. 8/16/2004 7751 Karvy-DP

(7641)

Closed –

7735

Suspended –

1

Active - 15

Most of the

dematerialized

account-holders

addresses are the

same as that of

Roopalben

Panchal or SEIPL

2. 10/18/2004 2196 Karvy-DP

(2157)

Closed –

2169

Active – 27

Most of the

dematerialized

account-holders

addresses are the

same as that of

SEIPL

3. 10/23/2004 1855 Karvy-DP

(1855)

Closed –

1835

Actuve - 20

Most of the

dematerialized

account-holders

addresses are the

same as that of

Kelan Atulbhai

Doshi

4. 1/6/2004 1689 Karvy-DP

(1684)

Closed –

1682

Active – 7

Most of the

dematerialized

account-holders

addresses are the

same as that of

SEIPL (Parag P

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Sr

No

DATE OF

OPENING OF

DEMAT

ACCOUNT

Number of

demat

accounts

opened

Name of

major DP

Status

Accounts

Comments

Jharveri)

5. 2/16/2004 1535 Karvy-DP

(1529)

Closed –

1531

Active – 4

Almost all the

account holders

have the same

address as

Roopalben

Panchal

6. 7/20/2005 1535 Karvy-DP

(1531)

Closed –

1531

Active – 4

1531 accounts

have the same

address as

Roopalben

Panchal

7. 1/5/2004 1112 Karvy-DP

(1101)

Closed –

1100

Active – 12

1099 accounts

have the same

address as

Roopalben

Panchal

8. 4/20/2004 1098 Karvy-DP

(1096)

Closed –

1096

Active - 2

1096 accounts

have the same

address as SEIPL

9. 8/5/2005 1050 Karvy-DP

(1043)

Closed /

Suspended –

1043

Active - 7

All the closed

accounts have the

address of Kelan

Atulbhai Doshi (

606 accounts) or

Shah Biren

Kantilal (437

accounts)

10. 7/19/2005 1007 Karvy-DP

(1002)

Closed –

1002

All the closed

accounts have the

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Sr

No

DATE OF

OPENING OF

DEMAT

ACCOUNT

Number of

demat

accounts

opened

Name of

major DP

Status

Accounts

Comments

Active - 5 address of

Roopalben

Panchal

11. 8/17/2004 987 Karvy-DP

(981)

Closed – 986

Active – 1

Almost all the

closed accounts

have the address

of Roopalben

Panchal or SEIPL

or Kelan Atulbhai

Doshi

12. 10/25/2004 856 Karvy-DP

(826)

Closed – 830

Active – 26

Out of the 830

closed accounts

819 have the

address of SEIPL

13. 10/16/2004 766 Karvy-DP

(728)

Closed – 752

Active – 14

Out of 752 closed

accounts 627

have the address

of SEIPL

14. 7/21/2005 765 Karvy-DP

(761)

Closed – 761

Active – 4

All the 761 closed

accounts have the

address of

Roopalben

Panchal

15. 12/17/2003 753 Karvy-DP

(749)

Closed – 749

Active – 4

All the closed

accounts have the

address of

Roopalben

Panchal or

Jayantilal Jitmal

16. 11/6/2003 574 Karvy-DP Closed / All the closed

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Sr

No

DATE OF

OPENING OF

DEMAT

ACCOUNT

Number of

demat

accounts

opened

Name of

major DP

Status

Accounts

Comments

(570) suspended –

570

Active – 4

accounts have the

address of

Roopalben

Panchal

17. 12/16/2003 529 Karvy-DP

(522)

Closed – 522

Active – 7

All the closed

accounts have the

address of

Roopalben

Panchal or

Jayantilal Jitmal

Total 26058 25776 Closed /

Suspended –

25895

Active - 163

--

5.2 Investigation revealed that NSDL’s systems allow accounts to be stored in

the DM (Depository Module) databases with no check on the addresses and

other details at the DM. There is also a provision for including

correspondence address. This correspondence address has been used for

sending refund orders and also intimation regarding allotment of shares to

the eventual financiers. In view of the large number of afferent accounts

opened with the depository participants of NSDL, it is alleged that NSDL

facilitated the key operators in furtherance of their scheme of cornering the

retail portion in the IPOs.

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5.3 Submissions of NSDL

5.3.0 The allegation that NSDL failed to prevent the opening / existence of

multiple beneficiary owner accounts is not correct. As a conscientious

market intermediary, NSDL has always been committed to ensuring the

best interests of the capital market and orderly development of the market.

Till date there is nothing in the law that prevents opening of multiple

beneficial ownership accounts. In fact, SEBI has prescribed no restriction

in this regard. On the contrary, SEBI has specifically acknowledged that

one person could hold multiple accounts. Since there is no restriction on

an investor opening multiple accounts, there cannot be any restriction on

more than one account having the same address. Consequently, there

was never any check on this since the law does not prohibit the same. In

fact, this legal position continues even today. The frequently-asked-

questions ("FAQ") published by SEBI in relation to dematerialization, on its

official website itself clearly records the same.

5.3.1 Therefore, no need has ever been felt to introduce a system level check in

the depository system that would prevent opening of Demat Accounts by

different investors with same or different address, as the law itself does

not prohibit the same. It is pertinent to note that one family can have many

Demat Accounts (different combinations) with the same address.

Moreover, there is a practice followed by investors to give office address

(example) in which case many employees can have the same address.

Thus, the office address would become a common address for many

investor Demat Accounts and merely by virtue of being a common

address it would not necessarily mean that all such Demat Accounts

would have been opened with malafide intentions.

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5.3.2 In fact, had there been a law prohibiting the same i.e. had the SEBI

Regulations prohibited the same; the software for opening of Demat

Accounts would have mandated such a check. It is only after the misuse

was detected that a mechanism was felt necessary to uniquely identify the

accountholders and now the quoting of the Permanent Account Number

("PAN") issued under the tax laws, has been put in place.

5.3.3 It is further submitted that NSDL only provides the software and systems

that enable the DPs to open the Demat Accounts. As a part of account-

opening process, Clients approach a DP of their choice and submit the

account opening form as well as Proof of Identity and Proof of Address as

specified by SEBI. The DP has to exercise due diligence in terms of the

KYC norms prescribed by SEBI. Should the DP be satisfied about

compliance with the KYC norms, it could open the account of the client.

Thus, the KYC documents are received, processed and maintained by the

DPs. When a Client's account is opened by a DP, the client information

captured and released by the DPs travels electronically to NSDL in an

encrypted form and the same then gets electronically stored in the NSDL

system. The data is captured by DP and NSDL does not modify the data.

The regulatory system as prescribed by the Depositories Act as well as

SEBI entails the DPs being the frontline interface for the depository

system with the Clients. Against this backdrop, the allegation of NSDL

having actively assisted the key operators in cornering IPO allotments

under retail category in purported names of afferent accounts is grossly

erroneous.

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5.4 Findings / Observations

5.4.0 The Depositories Act, 1996 provides for an agreement to be executed

between the depository and the participant. Section 4 of the Depositories

Act provides that the Depository shall enter into an agreement with one or

more participants as its agents. Further, Section 5 of the Depositories Act

provides that any person through a participant may enter into an

agreement, in such form as may be specified by the bye laws with any

depository for availing its services. Hence principal agent relationship

between the depository and the depository participant is clearly

recognized under the provisions of the Depositories Act.

5.4.1 In the case of opening of a demat account, a person avails the service of a

depository through a depository participant. As can be seen from the

allegation, the key operators had opened large number of fictitious

accounts and many of them with common addresses as a devise to

manipulate the IPO process by getting allotment under the quota reserved

for retail investors. It was observed during the investigation on the basis of

the data submitted by NSDL that 34,924 such accounts were opened with

the depository participants of NSDL.

5.4.2 Though it is submitted by NSDL that there was no prohibition on opening

of multiple accounts, it is noted from its submissions vide letter dated

March 15, 2007 that the following steps are adopted in the process of

opening a demat account:

? A person desiring to open a depository account submits account

opening form along with proof of identity and proof of address to the

DP after entering into agreement with DP.

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? DP carries out KYC exercise which is a manual process involving

review of documents of proof of identity, proof of address, PAN

details etc.

? DP ensures compliance of KYC requirements.

? DP enters the details of account opening in the DPM system and

scan and capture the signature appearing on the account opening

form. As per the prevailing industry best practice, maker checker

mechanism is adopted for the purpose of data entry and paper data

digitization.

? Client ID generated upon completion of capture operation (account

in registered mode).

? Once maker user completes the data capture, a checker user at DP

verifies the same and if satisfied releases the same.

? The information travels electronically in encrypted form to NSDL’s

central system and account gets created (active status).

5.4.3 As can be seen from the above, a detailed process ought to be followed

by the DP and the depository before creation of a demat account. In this

context, NSDL’s submission that its role is only to provide the software

and systems that enable the DPs to open the Demat Accounts can not be

accepted. As stated before, a clear principal agent relationship exists

between the depository and its participants. In this context opening of

hundreds of accounts with the same address and on same days by some

of the DPs should have alerted the depository as to whether the

requirements of KYC documentation were complied with by the DPs. As

can be seen from the requirement of verification as stipulated in SEBI

circular SMDRP/POLICY/CIR-36/2000 dated August 4, 2000 which

provides for the following,

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“The depository participants are hereby advised that a beneficiary account

must be opened only after obtaining a proof of identity of the applicant.

The applicant’s signature and photograph must be authenticated by an

existing account holder or by the applicant’s bank or after due verification

made with the original of the applicant’s valid passport, voter ID, driving

license or PAN card with photograph; and further the account opening

form should be supported with proof of address such as verified copies of

ration card / passport / voter ID / PAN card / driving license / bank

passbook. An authorized official of the depository participant, under his

signature shall verify the original documents.”

In view of the said requirements the Depository ought to have detected the

large number of accounts opened by the DPs on few days with address of

the Key Operators.

5.4.4 Further as can be seen from the scheme of the Act, it is the services of the

depository that a person is availing through a depository participant.

Further, Section 16 of the Depositories Act clearly provides that without

prejudice to the provisions of any other law for the time being in force, any

loss caused to the beneficial owner due to the negligence on the part of

the participant, the depository shall be liable to indemnify such beneficial

owner. Considering the very scheme of the Act in laying down the

responsibility on the part of the depository, it is difficult to accept the

contention of the depository that it has no role in ensuring compliance with

the account opening process.

5.4.5 As can be seen, large number of accounts were opened on few dates with

the depository participant Karvy Stock Broking Ltd with common

addresses of the key operators. The fact that thousands of such accounts

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were opened in bulk on few dates mentioned above, indicate that NSDL

could not check opening of such large number of accounts by DP with

addresses of key operators. Opening of large number of account cast

doubt whether the requirements of SEBI circular SMDRP/POLICY/CIR-

36/2000 dated August 4, 2000 were complied with. Further, NSDL failed to

verify whether the account opening process was in accordance with legal

requirements. As the said accounts were found to be fictitious / benami

accounts, many of them were closed subsequently. In this context, it is

also pertinent to note that NSDL has added a provision for incorporating

the correspondence address of the beneficial owner in the account

opening form. In this regard, earlier NSDL vide letter dated August 3, 2004

sought SEBI’s permission to capture the address of financier in the DPM

system and stated that all correspondence including refund orders will be

received by the financier. SEBI vide letter dated August 30, 2004 refused

permission for the same. In this context, it is noted that despite SEBI

having refused permission for incorporating the correspondence address

in the account opening form, NSDL additionally introduced

correspondence address. The provision for correspondence address

facilitated the key operators to receive refund orders etc. The failure on

the part of NSDL to verify and monitor large number of fictitious accounts

created by the key operators through its depository participants and also

incorporation of the provision of correspondence address by NSDL in the

account opening form facilitated the key operators in opening large

number of fictitious accounts.

5.4.6 It is difficult to assume that this practice did not come to the notice of

NSDL, considering the fact that it was stated to have conducted regular

inspections of its participants. Use of ready made stamps for addresses in

the account opening forms itself should have been sufficient to raise the

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suspicion in the inspections. The purpose of inspection is to find out any

abnormal patterns that may be creeping into the system even if there is no

specific law prohibiting the same. This assumes more significance in the

context of securities market which is very dynamic and all future

possibilities can not be foreseen. Further, it is pertinent to note that the

records at NSDL are stored as computerized database where one can

have various reports and statistics with a click of a button. Hence all these

process could have been easily monitored by NSDL In this regard, it is

also observed in the investigation that the practice of opening of large

number of accounts by Karvy was noticed earlier by NSDL during its

inspection in 2003. It is pertinent to note from the inspection report dated

November 18, 2003 that NSDL noticed that 5483 client accounts were

found in registered status. The report further says that DP is in practice of

generating client ID entering only client’s name in the DPM and

subsequently capturing the complete client details in the DPM system.

The report says that the said irregularities were also reported in the last

visit. Hence, it appears that though NSDL was aware of the irregularities in

opening of the accounts, it did not take any action in respect of the same.

The failure on the part of NSDL to monitor and further providing for

correspondence address in the account opening form facilitated the key

operators in opening large number of fictitious accounts.

5.4.7 By facilitating the Key Operators to open large number of fictitious

accounts, NSDL failed to comply with the conditions of registration under

Regulation 7 (b) and also Regulation 34 of the Depositories Regulations.

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6.0 Failure to verify the Infrastructure Facilities of the Depository

Participants

6.1 It is alleged that NSDL never physically verifies the DP prior to

recommending the registration of DP with SEBI.

6.2 Submissions of NSDL

6.2.1 The allegation that NSDL failed to verify the infrastructural facilities of the

DPs is vague and factually incorrect. The DPs are entities like Banks,

NBFCs, Custodians, Stock Brokers etc. These entities are either

registered with SEBI or the Reserve Bank of India before they seek to

become a DP. The copies of such registration certificates are required to

be submitted by the applicants for becoming DPs.

6.2.2 Further, the applicants are electronically connected to NSDL through

VSAT or leased line connectivity. No DP can connect to NSDL unless it

has adequate infrastructure. As NSDL itself arranges the electronic

connectivity of the DP applicants with the service providers (e.g. MTNL), a

DP cannot give misleading information about the location of its office.

Further, a DP applicant is required to install the software provided by

NSDL and the aforesaid software cannot run unless compatible hardware

and other system infrastructure are in place. The DP applicant has to

undergo rigorous testing of the software and hardware installed by it

including the complete end-to-end interface with NSDL for various

modules of depository processes. Only after completion of the testing

process the applicant is made operational. The aforesaid testing is not

possible unless the applicant DP has adequate and specified

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infrastructure. Thus, the allegation that NSDL failed to verify the

infrastructural facilities of the DPs is baseless.

6.3 Findings / Observations

6.3.0 It is submitted by NSDL that the DPs are entities like Banks, NBFCs,

Custodians, Stock Brokers etc. Such entities are already registered and

their registration certificate is submitted alongwith the application for DP

registration. However, it can be seen that nature of activity being

performed by a DP is different from that of the other entities. Therefore it

would require skills and infrastructure specific for successfully operating

as a DP.

6.3.1 In this regard, it is pertinent to note that Bye law number 6.2.1 (vii) of the

NSDL provides that the applicant should have adequate office space

exclusively for depository operations. The applicant should also furnish

details of his main office address, fax, phone numbers etc. Hence, even

NSDL Bye law prescribe adequate office infrastructure for the depository

participants. This is also the mandate of the provisions of the Regulation

16(2) of the Depositories Regulations which clearly provides that while

forwarding an application for a depository participant to SEBI, the

depository has to certify that the participant complies with the eligibility

criterion including adequate infrastructure as provided for in these

regulations and the byelaws of the depository. Further, how the depository

would know the exact location of the depository participant is also not clear

if they have not conducted inspection at the time of recommending the

registration application. In view of the above, the contention of NSDL that

as these entities are already registered, no further verification is required

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can not be accepted. NSDL has further submitted that its software cannot

run unless compatible hardware and other system infrastructure are in

place at the end of a DP. However, not checking the physical location and

infrastructure in advance by NSDL creates a system risk where any

system failure occurs subsequently due to any flaw in the infrastructure at

the end of the DP and it is not clear how it can be rectified immediately.

Further in the absence of any clear confirmation as to the location of the

participant, the depository cannot conduct any surprise inspection of the

participant to check compliance of the provisions of the regulations.

6.3.2 It is admitted by NSDL that it never conducts any site inspection before

recommending the application for registration as a depository participant.

In view of the same, it is concluded that NSDL failed to comply with the

provisions of Regulation 16(2) of the Depositories Regulations.

7.0 Failure to notice the unauthorized Outsourcing by the Depository

Participants

7.1 It is alleged from the findings of investigation that NSDL could never

capture the fact that there were agents being used for opening of demat

account by Karvy DP. This is in spite of the six monthly inspections

conducted by NSDL at various locations of Karvy.

7.2 These agents had ready-made stamps of addresses, which were affixed

on the application forms. These agents after collecting the papers had

local data entry operators who entered the data on a magnetic media. It is

alleged that this activity went unnoticed all along and the entire process of

verification of addresses and identity was bypassed by this operation.

- 22 -

7.3 This data was given to the front office of local Karvy offices in India along

with paper work. Local offices then sent the CD containing the data to

Karvy in Hyderabad. Karvy Hyderabad, uploaded this data for account

opening with NSDL. It is stated that NSDL’s DM application never checks

the data uploaded by DP. Hence the failure on the part of NSDL to check

the data uploaded by the DP resulted in a situation in which large number

of afferent accounts were opened by the key operators.

7.4 Submissions of NSDL

7.4.0 The allegation that NSDL did not notice the unauthorized outsourcing by

the DPs is factually incorrect. In our view, the facts being relied upon by

these reports demonstrate that they are not cases of assignment or

delegation of business of the DP. The Demat Accounts were in fact

opened by the DPs concerned. There is no prohibition in the law for

marketing activity to be outsourced by any capital market intermediary.

Outsourcing of select routine operations is a standard industry practice. All

banks routinely outsource such functions. SEBI has prescribed no

prohibition on such activity. It is completely erroneous to state that the

SEBI (Depositories and Participants) Regulations ("SEBI Regulations")

prohibit outsourcing of routine activities. In our view, such outsourcing is

neither objectionable nor commendable, and most certainly not illegal.

7.4.1 NSDL neither discourages nor encourages outsourcing. As far as NSDL is

concerned, at all times, the DP continues to be liable and responsible for

all its activities whether outsourced or not. The Show Cause Notice fails to

specify any provision of law that has been violated by the so-called

"unauthorized outsourcing" and by the so called failure to notice such

- 23 -

outsourcing. Thus, the allegation that NSDL failed to notice the

unauthorised outsourcing by the DPs is baseless.

7.5 Findings/ Observations

7.5.0 Though it is submitted by NSDL that it was routine marketing activity that

was being outsourced and such outsourcing does not violate any

provisions of law, it is pertinent to note that NSDL failed to make any

norms to define the nature and scope of the outsourcing being resorted to

by its depository participants. In the absence of any norms, these agents

started performing activities like KYC verification also which should have

been done by the depository participant. This assumes significance in view

of the fact that adherence with KYC norms acts as a deterrent for any

fraud being committed in the capital market. In view of the same, the

contention of NSDL that KYC verification is a routine matter can not be

accepted. KYC documentation is the very basis of opening of an account.

As per the mandate of Regulation 52 of the Depositories Regulations, no

participant shall assign or delegate its functions as participants to any

other person without prior approval of the depository. The said core

function of the depository participant cannot be delegated. As the very

functions of KYC documentation and opening of accounts were

outsourced, it resulted in opening of large number of afferent accounts.

This fact also indicate that NSDL did not have adequate mechanisms for

the purpose of reviewing, monitoring and evaluating controls, systems,

procedures and safeguards as enumerated under Regulation 34 and 35 of

the Depositories Regulations.

- 24 -

8.0 Failure to maintain Data Integrity

8.1 Following instances of discrepancies in the data maintained by NSDL

were noticed during the system audit conducted by SEBI. On many

instances, account creation date, account closure date etc., were filled

with dummy date. Hence prima facie it appeared that the following

instances reveal that NSDL failed to maintain the data in the appropriate

manner.

? NSDL has filled the client creation date prior to 16/4/1999 with

0001-01-01 dates.

? The dates for client activation prior to 2nd July 2005 have been

filled with 9999-12-31.

? Date of birth for minor has been filled with 0001-01-01.

? Closure date has been filled with 0001-01-01.

? RBI Approval Date has been filled with 0001-01-01.

? PAN number field has no validation and has all kind of junk

entries.

8.2 Submissions of NSDL

8.2.0 NSDL submitted that integrity of the electronic records and the automatic

data processing systems is maintained at all times and it takes all

precautions necessary to ensure that the records are not lost, destroyed

or tampered with and in the event of loss or destruction, it ensures that

sufficient back up of record is available at all times at a different place.

With regard to certain comments in the iSec Report, the following are

submitted.

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8.2.1 The account creation dates are very much available in the NSDL DP

systems. Initially, NSDL had adopted a model of decentralized mode of

booking of accounts. This mode of system was approved by SEBI. In July

2000, NSDL decided to move towards a centralized mode of booking as

this would enable investors to submit future dated instructions which will

reside on its central system and could be executed on a specified later

date even if on that day participant system / connectivity suffered technical

snag. Thus, the entire data about booking could be available in NSDL

system also and it is convenient to provide data to investigating agencies

such as the Government of India, SEBI etc. whenever required.

8.2.2 At the time of changing over from the decentralized model to the

centralized one, as the existing data was being migrated in stages, the

account creation dates in respect of the existing accounts were

deliberately put as 01/01/0001 and 31/12/9999 in the NSDL DM system,

so that such old accounts are clearly identified for the purpose of

migration, giving a proper audit trail. The account creation dates for the old

period are being migrated to NSDL DM system and we have informed

SEBI about this. Should NSDL have desired to stuff false data here, it

would not have entered patently indecipherable data. Such insertions

were made with a view to enable NSDL to actually identify such data.

8.2.3 Further, dates like Minor's Date of Birth, RBI approval date, Minor

Nominee Date etc. are applicable for limited set of accounts and not all.

e.g. Minor Date of Birth is allowed to be captured only if the holder is

marked as minor; RBI approval date is used only for foreign nationals etc.

These data fields in the system are populated with default values for other

types of accounts (i.e. other than those mentioned above) where they bear

no relevance. Default value used depends on field type. For Client master

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table for all "date" type of fields, the default value used is '0001-01-01 "

where as for "date-time" type fields, default used is '9999-12-31-

23.59.59.999999'.

8.2.4 As far as account closure date is concerned, all accounts which are closed

have the actual date of closure and the accounts which are open have 000

1-01-01 date marked in them. A different convention was hence used to

distinguish such accounts.

8.2.5 Far from compromising the integrity of the system, such default fields

provide an excellent audit trail that this data is not valid and where

applicable needs to be obtained from the DP systems.

8.2.6 The entire data relied upon by SEBI in bringing about its other actions

against other actionees referred to in the IPO matter, is sourced from the

depositories and unless SEBI believed in the data integrity, validity and

accuracy of NSDL's systems, it would not have relied upon the same to

bring about its other actions contained in the April Order

8.3 Findings / Observations

8.3.0 Regulation 37 of the DP Regulations provide that where records are kept

electronically by the depository, it shall ensure that the integrity of the

automatic data processing system is maintained at all times and take all

precautions necessary to ensure that the records are not lost, destroyed

or tampered with and in the event of loss or destruction, ensure that

sufficient backup of records is available at all times at a different place.

NSDL has submitted that when the existing data was being migrated to

the new system, the account creation dates in respect of the existing

- 27 -

accounts were deliberately put as 01/01/0001 and 31/12/9999 in the

NSDL DM system. As submitted by NSDL this facilitated clear

identification of old accounts for the purpose of migration, giving a proper

audit trail. However, it is pertinent to note that this data was not rectified

even after the process of migration of data was successfully completed.

Further, vide Annexure VI to the letter dated March 15, 2007, NSDL

submitted that data migration in respect of account creation dates have

been migrated from the DPM system to DM system in respect of all the

active accounts. This indicates that with regard to other discrepancies in

the data as stated before, some were filled with dummy data. This cannot

have an audit trial as contended by NSDL. In the case of any enquiry, it

might be difficult to understand the exact date on which a particular

account is opened or closed, if NSDL is relying on dummy dates. Non

availability of exact dates of account opening and closure and further

inclusion of dummy data in respect of such dates clearly indicate that

NSDL violated the provisions of Regulation 37 of the DP Regulations.

8.3.1 This was a clear lapse on the part of NSDL that seriously undermined the

quality of data available in its system. This can be clearly ascertained from

the fact that in the absence of correct account opening date, one can not

get a correct system report on accounts being opened during particular

periods. Thus any unusual activity pertaining to number of accounts being

opened will go unnoticed. This should be seen in the background that key

operators opened hundreds of afferent accounts on same days with similar

addresses and NSDL failed to notice this unusual pattern of activity.

Hence, it casts serious doubts on the level and degree of supervision

exercised by NSDL over its depository participants.

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9.0 Failure to put in place Adequate Mechanisms for the purpose of

reviewing, monitoring and evaluating the controls, systems,

procedures and safeguards,

9.1 It is alleged that in the case of NSDL there are no byelaws for internal

controls standards including procedures for auditing, reviewing and

monitoring. This has resulted in no proper monitoring and control

exercised by NSDL over the DPs.

9.2 Submissions of NSDL

9.2.0 The allegation that NSDL failed to put in place adequate mechanisms for

the purpose of reviewing, monitoring and evaluating the controls, systems,

procedures and safeguards is not correct. Bye-laws pertaining to internal

controls and review have been incorporated by way of Bye Law 10.2

which is approved by SEBI.

9.2.1 Neither at the time of the approval nor at any time during the last nine

years has the issue of non-compliance with the Depositories Act ever

been raised. This was also not pointed out during the SEBI inspections of

NSDL which were done on five occasions previously.

9.2.2 NSDL has put in place a comprehensive system of internal & operations

audit and review. The internal and operations audit reports along with the

management comments are reviewed by the Audit Committee of NSDL on

a quarterly basis and the minutes thereof are placed before the Board of

NSDL.

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9.2.3 In fact, the system auditors viz. Moores Rowland Consulting Pvt. Ltd. in its

report dated March 28, 2005 has clearly mentioned that NSDL has

complied with the provisions relating to internal monitoring, review and

control in terms of Regulation 34 of the SEBI Regulations. Thus, the

allegation that NSDL failed to put in place adequate mechanisms for the

purpose of reviewing, monitoring and evaluating the control systems,

procedures and safeguards is baseless.

9.3 Findings / Observations

9.3.1 As can be seen from all the submissions made by NSDL, it was not

monitoring any account opening process as it provided the hardware and

software to the DPs. It is observed from the contentions of NSDL that DPs

were entrusted with the whole process of account opening with no checks

from the side of the depository. Further, in this context it is pertinent to

note that instances were noticed where the depository participants like

Karvy were given the data by the depository and no record of providing

such information which included the details of client IDs and DP IDs was

maintained by NSDL.

9.3.2 Specific instance of Ms. Prabha Iyer, official of NSDL sending some

information to Karvy was noticed as per the submissions of the officials of

Karvy. The fact that NSDL had no system in place to monitor and check

communication of such information and further no record of such

communication being maintained by NSDL clearly indicate the

mechanisms available for the purpose of reviewing, monitoring and

evaluating internal control of systems, procedures and safeguards as laid

down in Section 26(2)(p) of Depositories Act and the provisions of

Regulation 34 of the Depositories Regulations are not in place. In this

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regard, though it is submitted by NSDL that bye law number 10.2 provides

for accounting, internal controls etc, it is not clear what was the

mechanism put in place by NSDL to give effect to the mandate of

Regulation 34 of the Depositories Regulations. In this regard, it is also

pertinent to note that the auditors of NSDL have pointed out absence of

norms for internal monitoring, review and control of its processes. Further,

Regulation 35 of the Depositories Regulations provide for external

monitoring, review and evaluation of systems and controls of depository.

As per its own admission, it never checks and modifies the data entered

by the Depository Participants. In such a context, what is the degree of

monitoring, evaluation and control mechanisms and safeguards provided

by NSDL is not discernible. Further, as stated before, instances were

noticed wherein confidential information was provided by the depository to

the entities like Karvy RTI. Considering the same, it is pertinent to note

that no adequate mechanisms for the purpose of reviewing, monitoring

and evaluating the controls, systems, procedures and safeguards were

made by NSDL. Existence of effective control measures and monitoring

and evaluating such measures could have prompted NSDL in checking

creation of large number of afferent accounts. Hence, it is concluded that

NSDL failed to put in place adequate mechanisms for the purpose of

reviewing, monitoring and evaluating the controls, systems, procedures

and safeguards in terms of the provisions of Regulation 34 of the

Depositories Regulations.

10.0 Failure to take appropriate action against the Depository Participants

for the various irregularities repeatedly committed by them.

10.1 During the course of investigation conducted by SEBI, records in respect

of the inspections of the Depository Participants conducted by NSDL were

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persued. For the purpose of the said examination, SEBI obtained all the

inspection reports pertaining to seven DPs viz. Karvy Stock Broking,

HDFC Bank, Pratik Stock Vision Pvt. Ltd, IL&FS, Centurion Bank,

Wellworth Share & Stock Broking and Dindayal Biyani Stock Brokers Ltd.

These DPs were short listed on the basis of the occurrence of large

number of multiple accounts with same addresses with these DPs found

during the course of investigation.

10.2 It is alleged that NSDL failed to inspect the DPs in a proper manner that

resulted in various lapses that were subsequently misused by the key

operators to manipulate the IPO process to the detriment of the retail

investors. Summary of the findings related to inspection of various DPs by

NSDL is stated below.

10.3 There is recurrence of same errors relating to account opening as noticed

in inspection after inspection and NSDL has commented on them in their

reports year after year. However, the same error recurs and the cycle

goes on. This has made non-compliance with account opening norms a

regular feature.

10.4 It was noticed that NSDL imposes penalty for non compliance with NCFM

employee requirement. However, hardly any penalty is levied for non

compliance with account opening norms. Most instances of levying of

penalty are for non compliance with NCFM employee requirement where

penalties upto Rs.3,50,000 has been imposed. In case of account opening

deficiencies the penalty is only 500-1000 rupees and the instances are

few. Levying of penalties which runs into lakhs for non-compliance with

NCFM certification of employees of DPs by NSDL and only penalties in

range of hundreds and few thousands for account opening deficiencies

- 32 -

shows that NSDL does not use fair and objective criteria while levying

penalty.

10.5 Regardless of the type of DP (broker, Bank etc.) and regardless of the

size of the operations of the DP concerned, NSDL devotes usually only

one day for inspection. Also, NSDL has allotted a fixed time for each area

of DP’s operation and the time allotted remains the same irrespective of

the quantum of instructions processed by the DP.

10.6 Further, the sample size chosen by NSDL in their inspections is woefully

inadequate. It was also observed that the procedure for inspection,

periodicity of inspection and the entity chosen for inspection has not been

in line with the responsibility cast on the depositories. Further, from the

format of inspection reports of the Depositories it is observed that the

inspection is system specific rather than entity specific.

10.7 It was observed that NSDL had not taken appropriate penal action against

DPs for repetitive violations by DPs observed by them during inspections.

NSDL’s action has never gone beyond imposition of monetary penalties.

There was no application of mind while conducting these inspections. The

way in which the penalty was imposed and then again waived when the

DPs submit a paper saying they have complied shows a callous attitude

towards statutory requirements by the depositaries especially when the

account opening deficiencies recur among the large percentage of the

sample collected during all inspections from 2003-2006.

10.8 The reliability of the inspection reports is very low as there are grave

errors like the number of errors being shown lesser than the number of

accounts involving errors.

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10.9 On the basis of the above, it is alleged that NSDL was aware of the

irregularities in connection with opening of accounts from the year 2003

which is evident from the inspection report of HDFC Bank, Karvy Stock

Broking etc. They failed to take prompt action against the DPs and failed

to inform SEBI of the same. It is further alleged that NSDL was aware of

the possibility of existence of accounts being opened without proper KYC

Process as early as 2003 and has not put in place system to detect such

accounts and take appropriate action and therefore turned a blind eye to

these deficiencies which has led to recurrence of error in account opening

repeatedly, in a big way later.

10.10 As a depository, NSDL is required to have adequate controls, systems

and procedure for monitoring and evaluating its compliances with statutory

requirements and prevent any conduct by DPs which is detrimental to the

interest of investors or the securities market. In this respect, it is alleged

that NSDL failed to perform and supervise the operations of the DPs and

also failed to inform SEBI of the deficiencies. In view of the same it is

alleged that NSDL failed to conduct themselves in a manner which is in

the interest of investors and the securities market.

10.11 Submissions of NSDL

10.11.0 The allegation that NSDL failed to take action against the DPs for the

various irregularities allegedly committed by them repeatedly is not

correct.

10.11.1 Further, the orders passed by SEBI against NSDL have been based on

wrong conclusions drawn by mis-interpreting the data. For instance, the

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error percentage in inspection reports have been wrongly computed and

stated by SEBI in its April Order. As reported in April Order in para 15.0

on page no. 207 & 208, 950 samples were verified during 17 inspections

of Karvy Stock Broking Ltd. (Mumbai and Hyderabad setups) and HDFC

Bank Ltd. (all setups). The total number of errors reported is 327. Of

these errors, 40 errors (including corporate accounts) pertain to KYC

documents (Identity proof or Address proof) not collected which is less

than 13% of total errors and 4 % of the sample checked. Another 109

errors pertain to inadequate KYC documentation. Some of the

documents considered as inadequate are copy of ration card with

photographs (collected as identity proof), telephone/electricity bill

collected are either of private service provider or more than 2 months

old, documents collected not providing complete details. Further,

inadequacy was also reported when Bankers attestation or PSU/Bank

employer identity card collected as KYC documents (which have

subsequently become valid documents as per revised SEBI guidelines).

The remaining errors reported are 28 Data entry errors with respect to

address and bank details and 140 Other Errors (e.g. DP client

agreement not proper, Standing Instruction not captured correctly, Mode

of operation scanned but not captured, nomination form not proper,

signature not properly scanned/legible, Power of Attorney not notarized

etc.). These errors, which have no relation as far as KYC documentation

of the accounts are concerned, constitute a major portion of errors and in

any case all the errors put together do not constitute 118 and 100

percent of the samples as is alleged in the investigation report.

10.11.2 It is further submitted that without establishing any correlation between

the nature of inspection findings and the list of Financiers on any

wrongdoers, SEBI has leveled a vague allegation of facilitation against

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NSDL. SEBI is fully aware that we imposed penalties in relation to

deviations by the DPs and to prevent the recurrence of the same. In fact

SEBI has recorded a finding that penalties were indeed levied by NSDL.

Further, the Disciplinary Action Committee of NSDL has also met as and

when required to take action against the wrong-doing found on the part

of various depository participants. It is not correct for SEBI to hold that

NSDL did not take any action against the DPs for irregularities being

committed by them. Thus, the allegation that NSDL failed to take

appropriate action against the DP for the various irregularities repeatedly

committed by them is baseless.

10.12 Findings / Observations

10.12.0 An analysis of the penalties imposed by NSDL for various non-

compliances in respect of five DPs as revealed in the investigation is

tabulated below:

non-compliance Instances

% to total

Instances penalty

% to total

penalty(in

rupees

terms)

karvy

Qualified personnel not appointed as per NSDL

requirement 5 12.19512 92000 51.45414

Quarterly Internal Audit Report not submitted (by

stipulated time). 17 42.50 17500 9.787472

No/inadequate control over issuance and/or

acceptance of instruction slips. 5 12.50 9000 5.033557

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non-compliance Instances

% to total

Instances penalty

% to total

penalty(in

rupees

terms)

Not taking back up daily and/or deviation in procedure

of taking backup 5 12.50 25000 13.9821

Account closure/ freezing/ unfreezing /transmission

not done as per NSDL requirements. 2 5.00 5000 2.796421

Account opened without obtaining adequate proof of

identity and/or proof of address and no adequate

proof of address collected for change of address. 2 5.00 1700 0.950783

Account opened without obtaining adequate proof of

identity and/or proof of address and no adequate

proof of address collected for change of address.

(observed in two consecutive inspections) 1 2.50 10000 5.592841

Client account debited without receiving proper

authorization from clients. 1 2.50 5000 2.796421

Data entry errors/omission which may cause

inconvenience and/or loss to the client / system / DP /

NSDL 1 2.50 4600 2.572707

Delay in processing of demat requests beyond 7

working days after receipt 1 2.50 5000 2.796421

No/inadequate control over issuance and/or

acceptance of instruction slips. (observed in two

consecutive inspections) 1 2.50 4000 2.237136

Total 41 178800

Centurion Bank Limited

No/inadequate control over issuance and/or

acceptance of instruction slips. 1 33.33 2000 11.76471

Not taking back up daily and/or deviation in procedure

of taking backup 1 33.33 5000 29.41176

Qualified personnel not appointed as per NSDL

requirements 1 33.33 10000 58.82353

Total 3 17000

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non-compliance Instances

% to total

Instances penalty

% to total

penalty(in

rupees

terms)

Infrastructure Leasing & Financial Services

Limited

Account opened without obtaining adequate proof of

identity and/or proof of address and no adequate

proof of address collected for change of address. 1 12.5 300 0.643087

Quarterly Internal Audit Report not submitted (by

stipulated time). 1 12.5 1500 3.215434

Not taking back up daily and/or deviation in procedure

of taking backup 1 12.5 5000 10.71811

Client account debited without receiving proper

authorisation from clients. 1 12.5 5000 10.71811

Qualified personnel not appointed as per NSDL

requirement 4 50 34850 74.70525

Total 8 46650

HDFC Bank Limited

Qualified personnel not appointed as per NSDL

requirements 8 80 750250 99.46967

Statement of transactions not being sent to clients as

required by regulations. 2 20 4000 0.530328

Total 10 754250

Pratik Stock Vision Private

Not taking back up daily and/or deviation in procedure

of taking backup 1 100 5000 5000

total 1

10.12.1 It is noted from the above data that most of the penalties are for failure to

appoint qualified personnel as per NSDL requirements/NCFM certification.

The amount of penalty charged for non compliance with KYC

requirements is significantly lesser than that for other violations and this

fact clearly indicate that it was not given much importance by NSDL. No

- 38 -

suitable reply has been submitted by NSDL for its decision to have lesser

penalty for account opening deficiencies. It can be assumed that this lapse

on the part of NSDL gave a signal that deficiencies in account opening will

be treated leniently and the same encouraged the Key Operators to open

large number of afferent accounts. Further, it appears that opening of

accounts by Karvy DP without entering necessary data except name was

observed by NSDL in its report in 2003. It is seen that the said violations

were observed in the previous year also. However, no strict action is taken

against Karvy for the said violations. NSDL being the authority to ensure

and supervise the smooth functioning of the depository system should

have assessed the possible impacts of its policy decision of treating the

failure in KYC documentation lightly. The failure on the part of NSDL to

effectively supervise and control such actions indicate that it did not have

effective systems for external monitoring, review and control as mandated

under Regulation 35 of the Depositories Regulations.

11.0 Failure to comply with the directives issued by SEBI : transactions in

the account of Shri. Biren Kantilal Shah

11.1 It is alleged that NSDL failed to comply with the directives issued by SEBI

vide order dated January 12, 2006 and April 27, 2006.

11.2 SEBI vide orders dated January 12, 2006 and April 27, 2006 directed that

the account maintained by Shri. Biren Kantilal Shah (ID 10258111 held

with Jhaveri Securities Pvt. Limited, Depository Particiapant of NSDL with

Registration No. IN-DP-NSDL-166-2000) shall not be utilized for

manipulation in future. Vide said orders, NSDL was also directed to ensure

that the dematerialized accounts which served as conduits are not utilized

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for manipulation. Further, NSDL was also directed to ensure that all the

directions issued vide the orders are strictly enforced. However, it was

observed that the said conduit account maintained by Shri. Biren Kantilal

Shah continued to be used as a conduit as evident from the fact that

during March 3 – 11, 2006 off market shares of 90 shares each of ICICI

Bank was received from 123 dematerialised account held with the DP –

Jhaveri Securities Pvt. Limited to the said account. Further, on March 23,

2006 off market transfer of 90 shares of ICICI Bank shares was effected to

the said demat account of Shri. Biren Kantilal Shah. Thus Shri. Biren

Kantilal Shah had received 11,160 shares of ICICI Bank through off market

transfers of 90 shares each from 124 demat account holders. Further it is

seen that on April 5, 2006 interdepository transfers had taken place

between the said account of Shri. Biren Kantilal Shah and the account no.

1031670000011619 maintained with CDSL. In view of the above it is

alleged that NSDL failed to comply with the directions issued by SEBI as

stated above.

11.3 Submissions of NSDL

11.3.1 SEBI is aware that the January 12, 2006 order restrained transactions in

shares of IDFC Ltd. by the persons mentioned therein. In this regard,

NSDL communicated to SEBI vide letter bearing Ref. No.

NSDL/SEBI/PI/2006/SS/0024 dated January 20, 2006 about initiation of

an ISIN-level freeze in respect of the persons mentioned therein so as to

ensure that the concerned persons do not transact in shares of IDFC Ltd

in those accounts. Further, clarification in respect of those accounts where

action could not be initiated was sought from SEBI vide our aforesaid

letter, a response to which is still awaited. The action taken in terms of the

SEBI order dated April 27, 2006 was informed to SEBI vide NSDL letter

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no. NSDL/SEBI/PI/2006/ AS/0246 dated May 2, 2006 and letter no.

NSDL/SEBI/PI/2006/AS/0248 dated May 3, 2006.

11.4 Findings / Observations

11.4.0 With regard to the transactions in the account of Shri. Biren Kantilal Shah,

ID 10258111 held with Jhaveri Securities Pvt. Limited (Depository

Particiapant of NSDL) as stated above, It is noted that SEBI vide order

dated January 12, 2006, directed the following entities not to buy, sell or

deal in the shares of IDFC Ltd. and in other ensuing future IPOs, directly

or indirectly, till further directions:

i. Zenet Software Ltd.

ii. Tauras Infosys Ltd.

iii. Rajan Vasudev Dapki

iv. Bhargav Ranchhodlal Panchal

v. Jayantilal Jitmal

vi. Seer Finlease Pvt. Ltd.

vii. Excell Multitech Ltd.

viii. Devangi Dipakbhai Panchal

ix. Hasmukhlal N. Vora

x. Welvet Financial Advisors Pvt. Ltd.

xi. Jayesh P Khandwala HUF

xii. Guatam N Jhaveri

xiii. Shilpa Rajan Dapki

xiv. Dipak Jashvantlal Panchal

xv. Hina Bhargav Panchal

xvi. Bhanuprasad Dipakkumar Trivedi

xvii. Sujal Leasing Pvt. Ltd.

xviii. Dushyant Natwarlal Dalal

- 41 -

xix. Puloma Dushyant Dalal

xx. Amadhi Investments Ltd.

xxi. Ritaben R Thakkar

xxii. Monal Y Thakkar

xxiii. Vinod Modha

xxiv. Kelan Atulbhai Doshi

xxv. Jitendra Lalwani

xxvi. Lok Prakashan Ltd.

xxvii. Bahubali Shantilal Shah

xxviii. Smruti Shreyans Shah

xxix. Shreyans Shantilal Shah

xxx. Datamatics Telecom Ltd.

xxxi. Dharmesh Bhupendra M

xxxii. Biren Kantilal Shah

xxxiii. Suresh Bhikha Vasava

xxxiv. Javeri Gautambhai

xxxv. Jay Shah

11.4.1 In the said order it was observed that thousands of dematerialized

accounts being opened on the same day with the same branch and being

introduced by the same bank should have alerted the DPs at the time of

opening of the dematerialized accounts. However the fact that DPs failed

to exercise even this basic due diligence gives rise to a suspicion that they

have actively colluded with the perpetrators. Further, in paragraph 12.6 of

the said order it was emphasised that Depositories and DPs have an

agent-principal relationship in terms of the Depositories Act, 1996 entailing

liability on them for the conduct of DPs. Also, Depositories being SEBI

registered intermediaries under Section 2(e) of the Depositories Act, 1996

read with sub-section (1A) of Section 12 of SEBI Act, 1992 are charged

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with the responsibility of protecting the interests of investors. Paragraph

12.7 of the order cautioned that this is the second time in the recent past

when the opening of several thousands of dematerialized accounts in the

name of fictitious persons with common address, without adhering to the

KYC norms have come to notice. Therefore there is an imperative need to

constantly monitor securities flow in dematerialized accounts. The

recurring disconcerting developments as above underscore the need that

both NSDL and CDSL should assume greater responsibility in the interest

of the investors and integrity of the market by getting real about such

distortions with celerity of action.

11.4.2 Hence, the depository NSDL was directed to monitor the securities flow in

the dematerialized accounts. It is noted that the account (ID 10258111

held with Jhaveri Securities Pvt. Limited, Depository Participant of NSDL)

was identified as an account which was used in cornering the shares in

the IPO. In this regard, it is also pertinent to note that as stated in the

order dated January 12, 2006, this was the second time, same modus

operandi was adopted by the entities mentioned above was noticed. In

this regard, it is also pertinent to note that earlier, while passing the order

dated 15.12.2005 in the matter of Yes Bank Ltd, SEBI had directed that

various accounts which served as conduits in the manipulation of IPO of

Yes Bank shall not be utilized for manipulation of IPO allotment in future.

Further, as directed in paragraph 6.5 of the order, NSDL and CDSL were

advised to enhance their surveillance and also devise and put in place

systems and procedures for identifying multiple dematerialized accounts

of suspicious nature and reporting the same to SEBI as expeditiously as

possible. Subsequently in the IPO of IDFC, while passing the order dated

January 12, 2006, the depositories were again directed to ensure that

such fictitious accounts are not utilized for manipulation. Further, as stated

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before, in the order dated January 12, 2006 paragraph number 12.7

clearly mentions that there is an imperative need to constantly monitor

securities flow in dematerialized accounts. It was further advised that the

recurring disconcerting developments as above underscore the need that

both NSDL and CDSL should assume greater responsibility in the interest

of the investors and integrity of the market by getting real about such

distortions with celerity of actions. It was also emphasized that any system

that is unable to identify and alert SEBI about multiple dematerialized

accounts based on common addresses can not be accepted. Further, the

depositories were directed to ensure that all the directions in the order are

strictly enforced.

11.4.3 Viewed in the light of the above directions, it can be seen that NSDL failed

to monitor the securities flow to the account of Biren Kantilal Shah.

Though, it is contended by NSDL that the prohibition was only in respect

of future IPOs, it can be seen that vide the said orders, it was clearly

directed that NSDL should monitor flow of securities to the said accounts.

It is pertinent to note that the same modus operandi was adopted by Biren

Kantilal Shah by receiving shares from different accounts as stated above.

It is also pertinent to note that the said incident did not happen on a single

day but over a period of time as can be seen that during March 3 – 11,

2006, off market shares of 90 shares each of ICICI Bank was received

from 123 dematerialised account to the said account. Further, on March

23, 2006 off market transfer of 90 shares of ICICI Bank shares was

effected to the said demat account of Shri. Biren Kantilal Shah. Thus Shri.

Biren Kantilal Shah had received 11,160 shares of ICICI Bank through off

market transfers of 90 shares each from 124 demat account holders.

Further, it was observed that on April 5, 2006 interdepository transfers had

taken place between the said account of Shri. Biren Kantilal Shah and the

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account no. 1031670000011619 maintained with CDSL. In this regard, it is

also pertinent to note that it is not the case of NSDL that it reported such

transactions of the shares of ICICI Bank to SEBI. Hence, it can be seen

that the account maintained with the depository participant of NSDL, i.e.

Jhaveri Securities was continued to be manipulatively used in the same

manner as happened in the case of Yes Bank and IDFC. The failure on

the part of NSDL to prevent such manipulation and also its failure to report

the manipulation to SEBI is a serious lapse and hence it is concluded that

NSDL failed to comply with the directives issued by SEBI vide order dated

January 12, 2006. On account of its failure to comply with the directions

issued by SEBI, NSDL is liable to the penalty prescribed under Section

15HB of the SEBI Act.

12.0 Failure to comply with the directives issued by SEBI : Failure to

defreeze account no. 10037925

12.1 SEBI vide letter ref: ISD/SD/HSE/03/2006 dated 16.11.2006 directed

NSDL to conduct an audit of the Client ID No.10037925 of Karvy Stock

Broking Limited (Depository Participant ID IN302734) (KSBL) which was

frozen by HSE Securities. As measure before defreezing / activating the

said demat account, vide the said letter SEBI directed NSDL to conduct an

audit of the transactions in the said demat account since the interim order

dated April 27, 2006 passed by SEBI, to ensure that no proprietary trades

of Karvy Stock Broking Limited had taken place. It is alleged that NSDL

failed to comply with the directions issued by SEBI vide the said letter.

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12.2 Submissions of NSDL

12.2.0 NSDL has submitted that a demat account can receive credits and debits

from / to any other client accounts. Only the concerned account holder

would know as to what is the nature of transactions underlying the

transfers that have taken place in its account. If the concerned account

holder has designated the account for pay-in / pay-out purposes only, only

such account-holder or its auditors would be in a position to confirm the

same. Only they would be able to confirm whether or not any other type of

transactions and transfers have taken place from such account. No other

person, including NSDL will ever be able to ensure that an account is used

(in future) for specific purposes. NSDL can at best freeze or de-freeze an

account. Once an account is active, NSDL would not be able to confirm

whether the account is being used or will be used for holding or for

transfers of securities arising out of proprietary trades or for purposes of

pay-in or pay-out. It is also not possible for NSDL to know the intentions or

underlying obligation(s) resulting in any transfer carried out by the demat

account holder.

12.2.1 NSDL has further submitted that subsequent to SEBI letter dated

November 16, 2006, it advised KSBL to conduct an audit of the said

account and submitted the confirmation alongwith the auditor’s certificate

for the transfers already taken place in the said account. However, NSDL

has no ability to ensure that the said account or any other account is used

in future only for a specific purpose.

12.3 Findings / Observation

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12.3.0 As seen from the letter dated November 16, 2006, SEBI had advised

NSDL to conduct an audit of the transactions in the said demat account

since the interim order dated April 27, 2006 passed by SEBI, to ensure

that no proprietary trades of Karvy Stock Broking Limited had taken place.

The said direction was issued as a measure for defreezing the account of

KSBL maintained with HSE Securities Ltd. which as contended by KSBL

was used for pay in and pay out obligations of the clients. As can be seen

from the said direction that the same was for the protection and benefit of

the investors as they should not be affected by the ban on proprietary

trades imposed vide order dated April 27, 2006 passed by SEBI. In this

regard, it is noted that the defreezing of accounts was subject to the

following conditions :

? Both NSDL and HSE Securities Ltd / HSE should satisfy themselves that

the demat account under reference is specifically designated for the

purpose of pay-in / pay-out of clients since its inception.

? Undertake the audit of all the transactions in the said demat account from

the date of interim order dated April 27, 2006 till date to ensure that no

proprietary trades of KSBL, either in the nature of off market or market

transactions have taken place.

? HSE Securities Ltd., in coordination with NSDL / Hyderabad Stock

Exchange should take necessary steps including appointment of

concurrent auditor, if necessary, to strictly adhere that no proprietary

trades take place in the nature of either market or off market transactions

in the said account pursuant to activation of the said demat account.

? HSE Securities Ltd., in coordination with NSDL / Hyderabad Stock

Exchange should ensure that none of the entities debarred from dealing in

securities vide interim order dated April 27, 2006 have dealt or are

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permitted to deal as clients of KSBL, member of HSE in the said demat

account.

12.3.1 It is noted from the submissions of NSDL that vide its letter dated

November 29, 2006, it advised KSBL to submit an auditor’s certificate

scrutinizing the said account. KSBL vide its letter dated December 19,

2006 submitted an auditor’s certificate, duly certified by Lalith Prasad &

Co., Chartered Accountants confirming that there have been no

proprietary trades subsequent to the SEBI order dated April 27, 2006 in

the said account. However, it is pertinent to note that SEBI had also

advised the appointment of concurrent auditor to ensure that no

proprietary trades take place in future in the said account. Though vide

letter dated November 21, 2006, NSDL has stated that it has no ability to

ensure that the said account or any other account is used in future only for

a specific purpose, however, it has not given any explanation why it failed

to take steps for the appointment of concurrent auditor for the purpose.

SEBI has advised appointment of concurrent auditor to ensure that no

proprietary trades take place in future in the said account. The

requirement for appointment of concurrent auditor is to ensure objectivity

in the audit.

12.3.2 It is noted that NSDL vide its letter dated November 21 and 25, 2005

expressed its inability to ensure whether demat account of KSBL is used

for holding or transfer of the securities arising out of proprietary trades. It

is noted that subsequently, SEBI vide letter dated December 12, 2006

directed NSDL to take measures to ensure compliance of the directions /

conditions laid down by SEBI vide its letter dated November 16 and 23,

2006 in coordination with the DP within ten days. As the said letter has

been issued subsequent to commencement of the present adjudication

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proceedings vide show cause notice dated November 23, 2006, I am of

the view that it may not be appropriate to take into account the violations,

if any, committed subsequent to the issuance of show cause notice in the

present adjudication proceedings. Hence, SEBI may initiate fresh

proceedings, if necessary in respect of the alleged violation on the part of

NSDL to comply with the directions issued by SEBI vide letter dated

November 16, 2006.

13.0 Conclusion

13.1. As stated in the preceding paragraphs of this order, it is noted that the

various commissions and omissions on the part of NSDL resulted in

opening of large number of afferent accounts by the key operators. The

evidence available in the matter, clearly indicate that the various actions

and omissions on the part of NSDL facilitated the key operators to open

large number of afferent accounts and to use such accounts to corner the

reserved portion for retail investors in the IPOs of many companies. These

commissions and omissions on the part of NSDL indicate that NSDL failed

to comply with the conditions of registration under Regulation 7 (b) and

also Regulation 34 of the Depositories Regulations.

13.2. Further, on account of its failure to verify and satisfy the eligibility

requirement of adequate infrastructure of the participant, NSDL failed to

comply with the provisions of Regulation 16(2) of the Depositories

Regulations.

13.3. On account of its failure to maintain and protect the integrity of the data

with regard to the accounts, NSDL violated the provisions of Regulation 37

of the Depositories Regulations.

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13.4 Lack of adequate mechanisms for the purpose of reviewing, monitoring

and evaluating the controls, systems, procedures and safeguards on the

part of NSDL has resulted in failure to prevent unauthorized outsourcing

by the depository participants, and also the failure on the part of NSDL in

taking actions against them. In view of the same, NSDL violated the

provisions of Regulation 52 read with Regulations 34 and 35 of the

Depositories Regulations.

13.5 In addition to the above violations, NSDL also failed to comply with the

directives issued by SEBI vide order dated January 12, 2006.

13.6 The five major violations as stated above attract penalty under Section 15

HB of the SEBI Act and Section 19G of the Depositories Act the

provisions of which state the following:

Section 15HB of the SEBI Act

“Whoever fails to comply with any provision of this Act, the rules or the

regulations made or directions issued by the Board thereunder for which

no separate penalty has been provided, shall be liable to a penalty which

may extend to one crore rupees.”

Section 19G of the Depositories Act

“Whoever fails to comply with any provision of this Act, the rules or the

regulations made or directions issued by the Board thereunder for which

no separate penalty has been provided, shall be liable to a penalty which

may extend to one crore rupees.”

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13.7 The provisions of Section 15J of the SEBI Act, 1992 and 19I of

Depositories Act, 1996 read with Rule 5 of the SEBI (Procedure for

Holding Inquiry and Imposing Penalties by Adjudicating Officer) Rules,

1995 require that while adjudging the quantum of penalty, the adjudicating

officer shall have due regard to the following factors namely:

a. The amount of disproportionate gain or unfair advantage wherever

quantifiable, made as a result of default

b. The amount of loss caused to an investor or group of investors as a

result of the default

c. The repetitive nature of default

13.8 With regard to the above factors to be considered while determining the

quantum of penalty, it is noted that on account of various commissions

and omissions on the part of NSDL, the key operators had opened large

number of afferent accounts which were used for the purpose of cornering

the retail portion in the IPOs. Hence the investors suffered great loss on

account of cornering of shares by the key operators. Hence, heavy loss

has been caused to the investors.

13.9 As stated in the preceding paragraphs of this order, large number of

afferent accounts were opened with NSDL and the failure on the part of

NSDL in discharge of its duties as a Depository in terms of the provisions

of SEBI Act, 1992, Depositories Act, 1996 and SEBI (Depositories and

Participants) Regulations, 1996 resulted in cornering of shares by the key

operators and financiers in many IPOs repetitively which caused heavy

loss to the investors. In this regard, it is pertinent to mention that had

NSDL ensured compliance of the account opening norms by its depository

participants, the key operators would not have been in a position to

subvert the IPO process. The various commissions and omissions on the

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part of NSDL as stated above which resulted in facilitating the key

operators in opening of afferent accounts, might have normally passed of

as negligence but for the enormity of the situation. The manner and ease

with which number of afferent accounts have been opened, that too in

large numbers by a coterie of entities should have ordinarily alerted

anyone as to the goings on. In these circumstances, it is difficult to believe

that the same would have escaped the attention of NSDL. Had they cared

to know, they would have known. In this process, NSDL facilitated the

occurrence of the violation. Further, NSDL being the authority providing

depository services to investors is duty bound to ensure transparent

systems and governance as far as depository services are concerned. In

this regard, the Depositories Act casts vicarious liability on the part of the

depository for the actions of the depository participants.

13.10 Principal agent relationship between the depository and the depository

participant is clearly laid down under the provisions of Sections 4, 5 and

16 of the Depositories Act. In such a situation, the commissions and

omissions such as failure to take action against the depository participants

for violation of KYC documentation even when it was aware that accounts

were opened only with names without any details and also adding a

correspondence address in the account opening form which enabled the

key operators to continue with their scheme smoothly have to be viewed

seriously. Considering the magnitude of loss caused to the investors as a

result of the various lapses and contraventions on the part of NSDL, I am

of the view that each of the said five violations listed above are grave in

nature and each attract the maximum penalty in terms of the provisions of

Section 15 HB of the SEBI Act, 1992 and Section 19G of the Depositories

Act, 1996. In this regard, it is also pertinent to note the order passed by

the Honourable Supreme Court in Shriram Mutual Fund Vs SEBI [2006]

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68SCL216(SC) wherein the Court held that the violations of the provisions

SEBI Act and Regulations attract the penalty irrespective of the intent. The

Honourable Court held that 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 totally irrelevant.

ORDER

14.0 For the violations committed by National Securities Depository Ltd as

stated above, in exercise of the powers conferred under Section15 I of the

SEBI Act 1992 and Section 19H of the Depositories Act 1996, I, impose a

penalty of Rupees Five Crore (Rs.5,00,00,000) on National Securities

Depository Ltd in terms of the provisions of Section 15 HB of the SEBI Act,

1992 and Section 19G of the Depositories Act, 1996.

14.1 The penalty shall be paid by way of demand draft drawn in favour of “SEBI

– Penalties Remittable to Government of India” payable at Mumbai within

45 days of receipt of this order. The said demand draft shall be forwarded

to “Securities and Exchange Board of India”, Plot No.C4-A, “G” Block,

Bandra Kurla Complex, Bandra (East), Mumbai 400 051.

14.2 In terms of the provisions of Rule 6 of the SEBI (Procedure for Holding

Inquiry and Imposing Penalties by Adjudicating Officer) Rules, 1995

copies of this order are sent to National Securities Depository Ltd. and to

Securities and Exchange Board of India.

Place: Mumbai Biju. S

Date: April 27, 2007 Adjudicating Officer