2025 (7) TMI 160 - Board - SEBI

Violation of provisions of Regulation 13(b) of IA Regulations and Clause 1 of Code of Conduct for Investment Advisers read with Regulation 15 (9) of IA Regulations - whether the activities carried out by the Noticees through the six partnership firms were in violation of provisions of Regulation 13(b) of IA Regulations and Clause 1 of Code of Conduct for Investment Advisers read with Regulation 15(9) of IA Regulations? HELD THAT - Regulation 13(b) of the IA Regulations inter alia provides that any certificate granted under regulation 9 shall be subject to the investment adviser informing SEBI in writing if any information or particulars previously submitted to SEBI are found to be false or misleading in any material particular or if there is any material change in the information already submitted. Code of Conduct for Investment Advisers inter alia provides that an investment adviser shall act honestly fairly and in the best interests of its clients and in the integrity of the market. DA has observed that the Noticees had not declared the investment advisory activities through unregistered partnership firms at the time of applying to SEBI for registration as IA in their individual capacity which by itself is a suppression of facts. It has been observed by the DA that as per the requirement of Regulation 13(b) of the IA Regulations at least subsequently Noticees ought to have informed SEBI about their IA activities through six partnership firms as the information declared at the time of application that they were not engaged in IA activities was false. Thus the DA has found the Noticees to be in violation of Regulation 13(b) of the IA Regulations. Noticee No. 1 has not provided sufficient evidence or justification in response to the above mentioned observation made by the DA. In absence of such material or justification the material available on record clearly suggests that Noticees were involved in providing unregistered investment advisory activities prior to obtaining SEBI registration which they continued to do even after obtaining the registration. Thus no doubt in agreeing with the observations made by the DA that the Noticees have violated Regulation 13(b) of the IA Regulations and Clause 1 of Code of Conduct for Investment Advisers read with Regulation 15 (9) of IA Regulations. Further the Noticees have also not acted with honesty fairness and in the interest of maintaining integrity of the securities market. Whether the recommendation made by the DA is appropriate ? - As stated earlier the DA has recommended that the Noticees shall be refrained from taking up any new assignment or contract for a period of 3 (Three) years. Although Noticees 1 and 2 are registered with SEBI they have not conducted the IA activities in their individual capacities but rather carried out IA work through the six partnership firms who were not registered with SEBI . Accordingly vide the said Order dated November 28 2023 Noticees (amongst others) were debarred from accessing the securities market directly or indirectly and were prohibited from buying selling or otherwise dealing in the securities market directly or indirectly in any manner whatsoever for a period of two years from the date of the order or till the expiry of two years from the date of completion of refunds to complainants/ investors as directed whichever is later. The said direction effectively acts as a restraint from taking any new clients. Further SEBI vide the same Order had also imposed a penalty of Rs. 18, 00, 000 on the Noticees along with 7 other entities to be paid jointly and severally and also directed them to refund the amount/fees/consideration received from investors/clients. Noticee No. 1 has submitted that he has challenged the said Order of SEBI before the Hon ble Securities Appellate Tribunal. We note that no stay has been obtained by the Noticee No. 1 against the said Order. Noticee No. 2 did not challenge the said Order and thus it has attained finality against him. Noticee No. 2 in his submissions (before the DA) had desired to surrender his IA Registration since he was neither using the IA registration and nor maintaining any clients. On perusing the registered intermediary database of SEBI also note that his (Noticee No. 2 s) name is not appearing in the list of SEBI registered intermediary since his registration is not in force owing to non- payment of registration fees. However in terms of the IA Regulations the certificate of registration granted by SEBI remains valid until it is suspended or cancelled. Considering that the Noticees have already been debarred from the securities market and penalized for their conduct I am of the view that restraining the Noticees from taking up any new assignment or contract for a period of 3 (Three) years as recommended by the DA would be disproportionate and instead a restraint of six months would be commensurate and would meet the ends of justice. In exercise of the powers conferred upon me under Section 19 of the SEBI Act 1992 read with Regulation 27(5) of the Intermediaries regulations restrain the Noticees from taking up any new assignment or contract for a period of six months.

Summary

Issues Presented and Considered

The core legal questions considered in the judgment are:

• Whether the Noticees, registered as individual Investment Advisers under SEBI (Investment Advisors) Regulations, 2013 ("IA Regulations"), violated Regulation 13(b) of the IA Regulations and Clause 1 of the Code of Conduct for Investment Advisers read with Regulation 15(9) of the IA Regulations by providing investment advisory services through unregistered partnership firms.
• Whether the Noticees failed to disclose material information regarding their involvement in unregistered partnership firms engaged in investment advisory activities at the time of their SEBI registration and subsequently, thereby violating their obligation to inform SEBI under Regulation 13(b) of the IA Regulations.
• Whether the Noticees acted honestly, fairly, and in the best interests of their clients, as mandated by the Code of Conduct under the IA Regulations.
• Whether the Designated Authority's (DA) recommendation to restrain the Noticees from taking any new assignment or contract for a period of three years is appropriate and proportionate in light of the violations and the facts of the case.
• Whether the Noticees are jointly and severally liable for the activities of the partnership firms under the Indian Partnership Act, 1932, despite their differing stakes and roles.

Issue-wise Detailed Analysis

Issue 1: Violation of IA Regulations by Providing Advisory Services through Unregistered Partnership Firms

Legal Framework and Precedents: The IA Regulations distinguish between categories of applicants for registration as Investment Advisers - individuals and non-individuals (including partnership firms). Registration is category-specific, and providing advisory services under a category for which registration is not obtained constitutes unregistered activity. Regulation 13(b) requires an investment adviser to inform SEBI if any previously submitted information is false or misleading or if there is any material change. Clause 1 of the Code of Conduct mandates honesty, fairness, and acting in clients' best interests.

Court's Interpretation and Reasoning: The Court observed that the Noticees, though individually registered, were co-partners in six partnership firms that provided investment advisory services without SEBI registration. The firms collected fees totaling approximately Rs. 8.10 crore from over 4,500 clients. The Court rejected Noticee No. 1's claim of bonafide belief that no separate registration was required for partnership firms, emphasizing that the IA Regulations clearly differentiate between categories and require separate registration. Ignorance or mistaken belief cannot excuse non-compliance.

Key Evidence and Findings: Inspection revealed that the partnership firms were operational before the Noticees' individual registrations and actively engaged in advisory activities, collecting substantial fees. Archive data and fee collection through payment gateways substantiated these activities. The Noticees had failed to declare these activities at the time of individual registration.

Application of Law to Facts: The Court applied Regulation 13(b) and the Code of Conduct to find that the Noticees violated their obligation to inform SEBI about their unregistered advisory activities through partnership firms. The provision of advisory services by unregistered entities constituted a breach of the IA Regulations.

Treatment of Competing Arguments: Noticee No. 1 argued that he held only a minor capital stake and did not control the firms, that he was following compliance norms like KYC and risk profiling, and that he voluntarily disclosed the firms' existence and refunded dissatisfied clients. The Court found these mitigating factors insufficient to absolve liability. The claim that advisory services were not provided without SEBI registration was rejected due to the clear evidence of unregistered activities.

Conclusion: The Court concluded that the Noticees violated Regulation 13(b) and Clause 1 of the Code of Conduct read with Regulation 15(9) by providing unregistered investment advisory services through partnership firms and failing to disclose material information.

Issue 2: Liability of Noticees as Partners under the Indian Partnership Act, 1932

Legal Framework and Precedents: Section 4 of the Indian Partnership Act defines partnership as a relation between persons sharing profits of a business carried on by all or any of them acting for all. Section 25 provides that every partner is jointly and severally liable for acts of the firm done while he is a partner. The Supreme Court has held that a firm is not a separate legal entity distinct from its partners.

Court's Interpretation and Reasoning: The Court noted the contrasting contentions of the Noticees attempting to shift blame. It clarified that irrespective of individual stakes or roles, both Noticees are jointly and severally liable for the partnership firms' acts. The capital contribution is distinct from profit-sharing and control; liability arises from partnership status.

Key Evidence and Findings: Partnership deeds and profit-sharing ratios were examined. Noticee No. 1's minor capital stake did not exempt him from liability. Noticee No. 2's submissions confirmed Noticee No. 1's involvement in overseeing firm operations.

Application of Law to Facts: The Court applied the Partnership Act provisions to hold both Noticees liable for the unregistered activities of the partnership firms.

Conclusion: Both Noticees are jointly and severally liable for the violations committed by the partnership firms.

Issue 3: Appropriateness of the DA's Recommendation for Restraint

Legal Framework: Regulation 27(iii) of the SEBI (Intermediaries) Regulations, 2008 empowers the authority to restrain intermediaries from taking up new assignments or contracts for a specified period. The Court must consider proportionality and facts of the case.

Court's Interpretation and Reasoning: The DA recommended a three-year restraint on the Noticees from taking new assignments. However, the Court noted that SEBI had already passed an earlier order dated November 28, 2023, debarred the Noticees from the securities market for two years, imposed penalties, and directed refunds. Considering these prior sanctions, the Court found the DA's recommendation disproportionate.

Key Evidence and Findings: The prior SEBI order and ongoing penalties were significant. Noticee No. 1 had challenged the order before the Securities Appellate Tribunal but without obtaining a stay. Noticee No. 2 had not challenged the order, which attained finality.

Application of Law to Facts: The Court balanced the need for deterrence with fairness, concluding that a six-month restraint would be adequate and just under the circumstances.

Treatment of Competing Arguments: Noticee No. 1's challenge of SEBI's prior order was noted but not sufficient to alter the Court's view on proportionality. Noticee No. 2's non-participation was considered in the final decision.

Conclusion: The Court modified the DA's recommendation, restraining the Noticees from taking any new assignment or contract for six months instead of three years.

Significant Holdings

"An applicant, who has been granted registration under a specific category, can provide its services under that category only, and in case, any such applicant provides the services under any other category for which it does not hold the registration, the same would be considered as unregistered activity and in contravention of the IA Regulations."

"It is a well-established principle that ignorance of law is not a valid defense. The Noticee, irrespective of any assumption, had the legal obligation to comply with the applicable statutory requirements with respect to registration."

"Every partner is liable, jointly with all the other partners and also severally, for all acts of the firm done while he is a partner."

"Considering that the Noticees have already been debarred from the securities market and penalized for their conduct, restraining the Noticees from taking up any new assignment or contract for a period of 3 (Three) years as recommended by the DA would be disproportionate, and instead, a restraint of six months would be commensurate and would meet the ends of justice."

Core Principles Established:

• Registration under IA Regulations is category-specific; providing services outside the registered category is unregistered activity.
• An investment adviser must disclose any false or misleading information or material changes to SEBI promptly.
• Partners in a partnership firm are jointly and severally liable for the firm's acts, regardless of individual capital contributions or control.
• Mitigating factors such as voluntary disclosure or refunds do not absolve liability but may be considered in determining sanctions.
• Sanctions imposed must be proportionate, taking into account prior penalties and the overall facts and circumstances.

Final Determinations on Each Issue:

• The Noticees violated Regulation 13(b) of the IA Regulations and Clause 1 of the Code of Conduct read with Regulation 15(9) by providing unregistered investment advisory services through partnership firms and failing to disclose material information.
• Both Noticees are jointly and severally liable for the violations committed by the partnership firms under the Indian Partnership Act, 1932.
• The DA's recommendation for a three-year restraint was modified to a six-month restraint, considering prior SEBI orders and proportionality.