securities appellate tribunal, mumbai

Securities Appellate Tribunal: Five appeals were filed by banking entities challenging two orders passed by the Securities and Exchange Board of India (‘SEBI’) rejecting the representation from accessing the securities pledged with the appellants. Justice Tarun Agarwala (Presiding Member) and Ms. Meera Swarup (Technical Member) quashed the impugned order and held that the action of the respondents in not allowing the appellants to revoke the pledge under the Depositories Act and in removing the pledged shares without the appellants consent was wholly illegal and without any authority of law and thus, directed that the shares so removed and transferred by NSDL under the directions of SEBI are liable to be restituted.

The appellants, Axis Bank Limited, ICICI Bank Limited, Bajaj Finance Limited, HDFC Bank Limited and IndusInd Bank are in the business of issuing credit facilities against securities. SEBI (respondent 1) is the regulator of the securities market. Karvy Stock Broking Ltd. (‘Karvy’) (respondent 2) is the stockbroker registered with SEBI, Respondents 3 and 4 are depositories under the Depositories Act, 1996 and Respondent 5 is the National Stock Exchange of India Limited which is registered Stock Exchange under the Securities Contracts (Regulation) Act, 1956 (SCRA). Justice Tarun Agarwala (Presiding Member) and Meera Swarup (Technical Member).

Axis Bank was extending over-draft facilities against shares to Karvy from time to time pursuant to an agreement under which a total sum of Rs. 100 crore was disbursed. As on 07-12-2019, an aggregate amount of Rs. 80.64 crore along with interest was due from Karvy. The overdraft facility was secured by shares pledged by Karvy from its demat account named “Karvy Stock Broking Ltd. — Client Account — NSE-CM” complying with the SEBI circulars issued from time to time. SEBI vide circular dated 20-06-2019 issued directions to the participants in the securities market, Stock Exchanges, Clearing Corporations, Depositories, Trading Members, Clearing Members and Depository Participants requiring all clients securities that were pledged earlier under the earlier circulars to be either unpledged or returned to the clients upon fulfillment of pay in obligation or dispose of after giving five days’ notice to the clients to be done by 30-09-2019.

Axis Bank, vide their letter intimated Karvy calling upon it to clear the outstanding amount under the overdraft facility so that the pledged securities could be unpledged. Axis Bank informed SEBI about the letter written to the broker and that it would not be possible for the Bank to unpledged the shares where the broker was not able to clear the outstanding amount by 31-08-2019 and that the shares would be unpledged only when the broker had paid the complete outstanding amount. SEBI through its Whole Time Member (‘WTM’) issued an ex-parte ad interim order dated 22-11-2019 against Karvy alleging that Karvy had misused its clients’ securities. The WTM directed that KSBL is prohibited from taking new clients in respect of its stock broking activities and directed the depositories i.e. NSDL and CDSL not to act upon any instruction given by KSBL in pursuance of power of attorney given to KSBL by its clients, with immediate effect along with not to allow transfer of securities from DP account named KARVY STOCK BROKING LTD. (BSE) with immediate effect and shall be permitted only to the respective beneficial owner who has paid in full against these securities.

Pursuant to the ex parte ad interim order, NSDL issued a communication intimating the appellant Axis Bank that based on the ex parte ad interim order, the client securities that were pledged with the Bank would remain in a state of abeyance. WTM rejected the request of Karvy on an application filed by them seeking flexibility in using the power of attorney issued by its clients. Axis Bank invoked the pledge through NSDL and filed an appeal challenging the order of NSDL directing the Axis Bank to make an appropriate representation to SEBI, thus, a representation was made praying that the ex parte ad interim order passed was not applicable and the Axis Bank should be allowed to invoke the pledge on account of the default made by Karvy. The representation was thereby rejected holding that the shares pledged by Karvy was invalid and therefore cannot be invoked by Axis Bank as Karvy could only pledge securities of indebted clients with the “explicit authorization” of the client. The appeals filed by the other appellants, namely ICICI Bank, HDFC Bank, IndusInd Bank and Bajaj Finance Ltd. are against the order dated 13-12-2019 wherein under similar circumstances the representation of the said appellants was rejected.

The Court noted that the “explicit authorization” that was required to be given by the client to the broker for creating a pledge was done away pursuant to Clause 2(c) of the circular dated 22-06-2017 and therefore the stockbroker was not required to take the explicit authorization from its clients to create a pledge. The circulars relied on are not applicable to the appellants and these circulars apply to the stock broker, Stock Exchanges, Depositories and Clearing Corporations. If the circulars have been violated then SEBI must act against the stock broker, Stock Exchanges, Depositories and Clearing Corporations but has no jurisdiction to hold that the appellants are not entitled to invoke the pledge and encash the same. The finding of the WTM that since the circulars were violated by the broker, Karvy had no authority to create a pledge in favour of the appellants is patently erroneous.

The Court remarked that “If the circular dated 26-09-2016 was violated by the broker, it is the responsibility of the Depository to ensure that the shares of clients who did not have a debit balance could not be utilized for creating a pledge. Failure on the part of the Depository and failure on the part of the Stock Exchange in not monitoring the situation will make them liable for violating the circulars issued by SEBI but will not entitle SEBI to hold that an illegal or invalid pledge was created. Thus, the contention of the respondent that the shares pledged by Karvy was invalid and cannot be invoked by the appellants is patently erroneous.”

The Court observed that on perusal of Regulation 58 (6) and (8) of Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996, it was clear that the pledgee may invoke the pledge and on such invocation the depository shall register the pledgee as beneficial owner of such securities in its record accordingly and no pledge can be cancelled without the prior concurrence of the pledgee. The Depositories Act established the depository eco system and introduced the concept of a registered owner and beneficial owner. The Depository was the registered owner but did not have any voting right or any other right in respect of the securities held by it and that the beneficial owner was solely entitled to all rights, benefits and liabilities attached to the securities held by the Depositories.

The Court opined that once a pledge is validly created by a broker in favour of the appellants and the appellants are recorded as a beneficial owner in the records maintained by the Depository under Section 11 of Depositories Act, the beneficial owner becomes the registered owner under Section 10 of Depositories Act. Consequently, if a default is committed by the broker the appellant gets a right to invoke the pledge under the agreement. Once a valid pledge is created in favour of a third party then a third-party right is created in the attached property and the same cannot be sold or distributed to discharge the liabilities of the broker. Thus, where certain goods/property/shares are mortgaged or pledged, a third-party right is created and, consequently, the interest of the third party in the pledged property cannot be sold to discharge the liabilities of the broker.

The Court also noted that the register and index of beneficial owners maintained by a depository is prima facie evidence of who the beneficial owner is. For the creation of the pledge, the person whose name is recorded in the depository system as „beneficial owner’ is legally empowered under the Depositories Act to create the pledge. Any action taken by such a person cannot be invalidated on the ground that the pledged securities were not owned by such person. Any other interpretation of the term „beneficial owner’ would defeat the very objective of the Depositories Act. Once a valid pledge has been created and an entry has been made in this regard in the records of the depository, the Depositories Act does not envisage a situation wherein persons whose names are not recorded in the depository could be regarded as the beneficial owner of the pledged securities and such pledges could be rendered invalid subsequently. As per the Pledge Master Report, the securities pledged in favour of the appellant were in the account named “Karvy Stock Broking Limited (BSE)” and the same implied that Karvy was authorized to pledge such securities as the “beneficial owner” of such securities.

The Court concluded that beneficial owner based on which a valid pledge was created. Thus, the finding that due diligence was not done by the appellant while creating a pledge is patently erroneous. The action of SEBI and NSDL to unilaterally transfer pledge shares to the clients of Karvy was wholly illegal and without jurisdiction. Such unilateral transfer of the shares without revoking the pledge is per se illegal and against the provisions of the Depositories Act and Regulation 58 of the DP Regulations. Thus, no revocation of pledge is permitted unless consent is obtained from the pledgee under Section 58(6) of the DP Regulations which in the instant case were the appellants and no such consent was taken. SEBI has acted arbitrarily in directing NSDL to transfer the pledge shares without revoking the pledge. Unless and until the pledge was revoked the shares could not be transferred to the clients of Karvy.

The Court held that the ex parte ad interim order did not permit NSDL to violate the Depositories Act, the Contract Act and the DP Regulations in removing the shares without revoking the pledge. The action of NSDL under the directions of SEBI were wholly illegal and invalid and had unlawfully deprived the appellants of its statutory rights as a pledgee. Thus, so long as the pledge is created under the Depositories Act read with DP Regulations until and unless the pledge is revoked the shares cannot be transferred under the directions of SEBI through NSDL. Such action is patently illegal and without jurisdiction. Thus, the Tribunal permitted Axis Bank to invoke the shares pledged in its favour and directed SEBI, NSE and NSDL to restore the pledge which was made in favour of the appellants. The Court also directed SEBI, NSE and NSDL to compensate the appellants.

[Axis Bank v SEBI, 2023 SCC OnLine SAT 1425, decided on 20-12-2023]

Advocates who appeared in this case:

Mr. Gaurav Joshi, Senior Advocate with Mr. Neville Lashkari, Mr. Chaitanya D. Mehta, Ms. Sonali Aggarwal and Ms. Pranvi Jain, Advocates i/b. M/s. Dhruve Liladhar & Co for the Appellant. Mr. Shiraz Rustomjee, Senior Advocate with Mr. Manish Chhangani, Ms. Samreen Fatima and Mr. Sumit Yadav, Advocates i/b The Law Point for Respondent No. 1. Mr. Somasekhar Sundaresan, Advocate with Ms. Kinjal Shah and Ms. Etika Srivastava, Advocates i/b. M/s. Rashmikant and Partners for the Respondent No. 3 (NSDL). Mr. Darius J. Khambata, Senior Advocate with Mr. Somasekhar Sundaresan, Mr. Indranil Deshmukh, Mr. Animesh Bisht, Ms. Drishti Das, Ms. Vidhi Shah, Ms. Roma Bhojani, Mr. Karan Sangani and Mr. Rima Jain, Advocates i/b. Cyril Amarchand Mangaldas for the Respondent No. 5 (NSE).

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