2008 (5) TMI 716 - AT - Companies Law

Ingenuine preferential allotment of shares - Disgorgement of ill-gotten gains - whether any finding has been recorded at any stage of the proceedings that the appellant has made no illegal gains? - HELD THAT - We are of the considered opinion that the enquiry officer has not undertaken any exercise to find out the ill-gotten gains if any made by the appellant and the enquiry was only to find out the wrongful acts allegedly committed by the appellant. It is true that the enquiry report has been accepted by the Board as contended on behalf of the appellant and that is why a penalty has been levied debarring it from opening fresh demat accounts till the end of December 2007. Mere acceptance of the enquiry report by the Board does not in our view advance the case of the appellant. Further on receipt of the enquiry report another show cause notice was issued to the appellant on May 4 2007 enclosing the enquiry report. We have perused that show cause notice as well and find that there is nothing therein to suggest that the appellant had made ill-gotten gains or anything about disgorgement. Thus we have no hesitation in holding that the question regarding illegal gains if any made by the appellant has not been examined at all at any stage of the proceedings. Disgorgement - It is a common term in developed markets across the world though it is new to the securities market in India. Black s Law Dictionary defines disgorgement as The act of giving up something (such as profits illegally obtained) on demand or by legal compulsion. Disgorgement of illgotten gains may be ordered against one who has violated the securities laws/regulations but it is not every violator who could be asked to disgorge. Only such wrongdoers who have made gains as a result of their illegal act(s) could be asked to do so. The least that was required of the Board was to have called upon the appellant to show cause why it should not be ordered to disgorge the amount determined in the impugned order. Not having done so the principles of natural justice have been flagrantly violated. The impugned order therefore deserves to be set aside on this ground alone. We also cannot approve the observations made by the Board in the impugned order which have been reproduced in the earlier part of our order and are of the view that action for disgorgement should have been initiated only after the appropriate proceedings against the entities had concluded and their guilt established. We are satisfied that the case of the appellant is no different from the case of the other entities against whom appropriate proceedings are still pending and whose appeals came up for hearing before us on 22.11.2007. We cannot resist expressing our anguish over the irrational manner in which the Board proceeded to pass the impugned order only against the two depositories and their participants. Why we say so is that by its ex-parte order dated April 27 2006 which is to be read as a part of the impugned order the Board itself had found that the financiers of the key operators were the ultimate beneficiaries of the IPO scam and it went on to identify 82 financiers and even computed the illegal gains made by some of them in that order and yet issued no directions to them to disgorge the illegal gains made by them. Instead the two depositories and their participants against whom enquiries are pending have been ordered to disgorge the entire amount of illegal gains without even recording a finding that they made any such gains. If the illegal gains were made by financiers it was they who ought to have been directed to disgorge the amount. One is left guessing why the Board did not issue such directions to them. It did not even initiate disgorgement proceedings against them for reasons better known to the Board. It appears that after identifying the financiers who were the ultimate beneficiaries of the scam the Board turned a nelson s eye towards them and chose to proceed against the depositories and their participants and that too exparte which to say the least was most unfair. What is really amazing is that the Board has noticed the correct position in law in para 30 of the impugned order but did not follow the same and ordered disgorgement against those entities against whom no findings of ill-gotten gains have been made leaving out those against whom such findings had been recorded in the ex-parte order of April 27 2006. We need not say anything more and leave the matter at that. In view of what has been said above and for the reasons stated in our order dated 22.11.2007 passed in Appeal no. 147 of 2006 we allow the appeal and set aside the impugned order leaving it open to the Board to initiate further proceedings in accordance with law.

Summary

Issues Involved:
1. Alleged abuse and misuse of the IPO allotment process.
2. Role of the appellant as a depository participant (DP) in opening fictitious demat accounts.
3. Provision of finance to fictitious entities and fabrication of documents.
4. Disgorgement of ill-gotten gains.
5. Violation of principles of natural justice.

Issue-wise Detailed Analysis:

1. Alleged Abuse and Misuse of the IPO Allotment Process:
The Securities and Exchange Board of India (SEBI) received information about the alleged abuse and misuse of the IPO allotment process. Preliminary investigations revealed that certain entities cornered IPO shares reserved for retail investors by making applications through thousands of fictitious/benami applicants. The probe extended to all IPOs between 2003 and 2005, revealing that the appellant, as a DP, had opened numerous fictitious demat accounts in collusion with sub-brokers, disregarding 'know your client' (KYC) norms, and provided finance to these fictitious entities.

2. Role of the Appellant as a Depository Participant (DP):
The Board found that the appellant had strategized a business plan to exploit the IPO market by aiding and abetting clients in opening thousands of dematerialized accounts in fictitious/benami names and providing/arranging IPO finance. The appellant also indulged in the fabrication of documents to cover its tracks. The fictitious/benami allottees transferred shares to key operators, who then transferred them to financiers, making a windfall gain due to the difference between the allotment price and the booming market price on the listing day.

3. Provision of Finance to Fictitious Entities and Fabrication of Documents:
The appellant was found to have financed some transactions as a stock broker, making an illegal gain of Rs. 7,79,125/-. SEBI initiated appropriate proceedings, including an enquiry under the Securities and Exchange Board of India (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002, and adjudication proceedings under Chapter VI A of the Securities and Exchange Board of India Act, 1992. The appellant was prohibited from acting as a DP for 18 months and from opening fresh demat accounts till the end of December 2007.

4. Disgorgement of Ill-Gotten Gains:
Disgorgement is defined as the act of giving up profits obtained illegally on demand or by legal compulsion. It is a monetary equitable remedy designed to prevent wrongdoers from unjustly enriching themselves. The Board directed 10 entities, including the appellant, to disgorge Rs. 115.82 crores. The liability was made joint and several, as they were part of one large fraud. However, the appellant contended that the enquiry officer had found no illegal gains made by it. The Tribunal found that the enquiry officer had not examined the issue of ill-gotten gains, and the question of such gains was not the subject matter of the enquiry.

5. Violation of Principles of Natural Justice:
The impugned order was passed without affording an opportunity of hearing to the appellant and other entities. The Tribunal held that the principles of natural justice were violated, as the appellant was not given a chance to show cause why it should not be ordered to disgorge the amount. The Tribunal also noted that the Board should have initiated disgorgement proceedings only after concluding appropriate proceedings and establishing guilt. The Tribunal expressed concern over the Board's irrational manner of proceeding against the depositories and their participants while ignoring the financiers, who were identified as the ultimate beneficiaries of the scam.

Conclusion:
The appeal was allowed, and the impugned order was set aside. The Board was left open to initiate further proceedings in accordance with law. The Tribunal emphasized the need for due process and the importance of affording an opportunity of hearing to the affected parties.