TMI BlogIN THE MATTER OF SUPERSEDING THE COMMITTEE OF THE CALCUTTA STOCK EXCHANGE ASSOCIATION LIMITED UNDER SECTION 11 OF THE SECURITIES CONTRACTS (REGULATION) ACT, 1956.X X X X Extracts X X X X X X X X Extracts X X X X ..... t and conduct an audit of the systems of the CSE by an independent group of computer system auditors to ensure that the system is secure and free from bugs. SEBI also advised CSE in June 2001 to get an audit done of its computer systems. 1.1 Only after repeated follow-up by SEBI, CSE initiated the exercise in August 2002 and got the system audit done by M/s Ernst Young. However, its surveillance systems were left out. Thereafter M/s Ernst Young submitted a draft report in October 2002 to the CSE, but the findings therein were not communicated to SEBI. The details of this report came to the knowledge of SEBI only in February 2003 when the inspection of the CSE was carried out. 1.2 In the said report, M/s Ernst Young pointed out several deficiencies in the risk management system of the CSE which were not rectified by the CSE and also revealed serious shortcomings in the computer systems of the exchange, some of which are given below: a. The slot timings during which marked-to-market limits, gross exposure were calculated were too high, as a result of which it was possible for any member to exceed such thresholds several times over during the slot given. b. Variou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... effectively maintain and use the application system. n. Users of the exchange shared their passwords; as a result accountability could not be maintained in the system. o. Any exchange user could effect any change in the system, which could lead to erroneous financial statements and improper decision making. Access should be provided on a need to do basis. p. Back up and restoration policy were not defined. Back up tapes were not stored at an offside location. q. Antivirus software installed on the server/work stations was outdated. r. There was no audit trail in the system to indicate the user entering the transactions together with date and time. 1.3 Thereafter, SEBI called for a meeting on February 19, 2003 on the issue of system audit, which was attended by the representatives of CSE and Computer Maintenance Corporation Ltd. (CMC), the software service provider. SEBI advised CSE and CMC to rectify all the deficiencies in the computer systems of the exchange by March 31, 2003. The minutes of the meeting were also forwarded to CSE vide letter dated March 03, 2003 and CSE was once again advised to ensure rectification of deficiencies by March 31, 200 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he securities and funds pay out due to technical problems in the exchange settlement server. 1.7 As stated above, the draft report of M/s Ernst Young which was received by the CSE in October 2002 highlighted several serious deficiencies in the risk management and surveillance system. However the same came to the knowledge of SEBI only in February 2003 when SEBI once again conducted an inspection of the CSE in order to assess the situation with regard to its management and risk management and surveillance aspects. On perusal of the said report, it was noted that none of the deficiencies pointed out by M/s Ernst Young had been rectified by the CSE even by February 2003 and that no time-bound action plan for rectification of these deficiencies had been finalized by the CSE till the time of the said inspection. The inspection also pointed out several other deficiencies on the risk management and surveillance system. 1.8 In view of the then prevailing situation, SEBI advised CSE vide its letter dated February 14, 2003 to take all possible measures to rectify the deficiencies in the exchange s trading, surveillance and risk management system by March 04, 2003. 1.9 It was als ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of decorum at the Committee, and the fact that the Committee was not functioning, in the way it should be functioning was marked by several unsavory events. On one occasion, a meeting of the Committee was convened on August 12, 2003 mainly for calling the extra ordinary general meeting of the shareholders and to comply with SEBI decision to obtain the shareholders approval by the first week of September, 2003 on the issue of the Scheme of Demutualisation earlier submitted by the CSE. As the elected members did not agree and continued to agitate and eventually staged a walk out, despite the repeated requests of the President and others not to do so and as the remaining members present at the meeting did not form the necessary quorum as per the relevant provisions of the Articles of Association of the CSE, the meeting had to be adjourned. Consequently, the notice for the proposed extra ordinary general meeting could not be issued. This event was brought to the notice of the SEBI by CSE vide its letter dated August 13, 2003. 2.2 Thus the Committee was unable to discharge its duty towards the exchange and the investors, and appeared to lack the required focus and direction to impro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ade a net loss of ₹ 4.10 crores in 2001-02 and continued to make further losses. A loss of ₹ 2.02 crores was incurred by it in the 9 month period ending 31/12/2002. The CSE was also unable to recoup / replenish the shortfall/losses of its funds particularly, the settlement guarantee fund (hereinafter referred to as the SGF). The past depletion of its SGF added to its financial vulnerability of the CSE which reached a stage where the Committee was unable to perform effectively and provide guidance and direction to CSE. The factors of an operational management which was weak if not virtually absent, and other shortcomings such as the critical deficiencies of the basic systems of the CSE, which exposed the system to continuous misuse and yet remained unrectified, warranted immediate action to stop the further deterioration of the functioning of the Committee. 2.6 Further the Joint Parliamentary Committee constituted to look into the Stock Market Scam and Matters relating thereto, in its report presented to the Parliament on 19th December, 2002 had inter alia observed that CSE had failed miserably in enforcing its own rules concerning the trading and carry forward limits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... countability and inform SEBI by July 15, 2003. 2.8 After the issuance of the notice, four public representative directors including the President and one SEBI nominee director tendered their resignation from the Committee. Thereupon the CSE vide its letter dated September 15, 2003 forwarded the reply of the Committee of CSE dated September 12, 2003 along with compilation of minutes to SEBI in response to the show cause notice in which the following submissions were interalia made out: - a. System audit :- The Committee did not offer any comments on the charge of CSE not having initiated the system audit to be done by M/s Ernst Young after receiving several reminders from SEBI in August 2002 and that too leaving out its surveillance systems, and the fact that the draft report submitted by M/s Ernst Young in October 2002 was not brought to the notice of SEBI. b. Non-rectification of deficiencies - system audit:- With reference to the non-rectification of deficiencies in the system audit pointed out by M/s Ernst Young, the Committee did not offer their comments. c. The Committee did not give their comments, as to the shortcomings in the computer syst ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ad been raised earlier by the said directors. Demutualisation. The elected directors were dedicated to complete the process of demutualization within six months in terms of the directive of SEBI issued vide notice dated December 16, 2002. When one of the elected directors, Shri Shankarlal Agarwala requested for details on the discussion of the Kania Committee s recommendation and an emergency meeting on the same, although the demutualization issue was discussed in each and every Board Meeting, the Chairman felt that it was difficult to finalise the issue in the absence of the Executive Director. Any suggestion made by an elected director to the effect that in principle approval of brokers member be obtained for demutualization, was negated by the Officer on Special Duty, Shri T.K. Das on the ground that the members were only required to submit the draft scheme of the demutualization and not obtain the consent of the general members. When a request was made by the elected directors to hold a brokers meet for the said purpose, a notice was published on July 18, 2003 in the official quotation of the CSE with the following remark: Without any obligation and or commitm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he CSE with a request to hold an extraordinary general meeting for that purpose. A copy of the same was enclosed for perusal. It was submitted that the most confidential information relating to the recovery of money from the defaulters was leaked to the relevant persons to help them indirectly to vitiate the process of the recovery. k. Liquidation of impounded securities of Old Defaulter Members. It was stated that since certain brokers had been declared as defaulters from time to time from 1990 onwards, the elected directors had made a suggestion for the sale of securities lying with the exchange on the account of such defaulter members, in order to recover the money due to the exchange. However, the said suggestion was never attended to by the Management Sub Committee and any details asked for in relation thereto was submitted only after a lot of persuasion and the decision for liquidation was never taken till date. It was stated that they had been told that there was a mismatch in the records since certain securities which should have been with the exchange on such defaulter member s account were not traceable. On further enquiry, it was reported that a few members had obta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ving repeated reminders from the elected directors and the final decision on the said issue has been kept pending for reasons best known to the outgoing Chairman and Officer on Special Duty. m. Development of Business (i) Membership of NSE through subsidiary Route. Despite draft schemes being prepared, several discussions being held, including one with Shri G.N.Bajpai, Chairman, SEBI in the meeting with the elected director on November 12, 2002 at Mumbai, for the exchange to obtain membership of NSE through the subsidiary route, nothing materialized. (ii) Depository Participation. The suggestion of the elected directors to have its own depository service was never taken up although an assurance was given from time to time. (iii) Efforts of Sub Committee (SEBI action taken Sub Committee) The compliance to SEBI directives were abnormally delayed without the knowledge of the elected directors. n. Arbitration Sub Committee. No arbitration cases were pending with the exchange. o. Action against illegal NSE Terminal. Although a memorandum was submitted by one of the elected directors Shri Sultan Usman for action against i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Suresh kumar Kaushik., Shri Harish Kumar Singhania, Shri B.J. Agarwal, Shri Sultan Usman, Shri Shankarlal Agarwal and Shri Shree Nath Kapur, appeared before me and reiterated the written submissions made earlier and also submitted certain documents to support their contentions viz. written submissions dated October 09, 2003, letter dated September 02, 2003 issued by the CSE to Shri Sultan Usman, letter of CSE dated July 03, 2003 addressed to Shri Shankarlal Agarwal, letter of CSE dated January 03, 2003 addressed to Shri Sultan Usman and the notice of requisition dated November 21, 2002 calling for the EGM under Section 169 of the Companies Act. Upon the conclusion of the hearing, upon their request, the directors were granted seven days to file the written submissions if any. Subsequently, the written submissions were forwarded to SEBI vide letter dated October 14, 2003. 3.0 In the letter dated October 09, 2003, it was submitted that as the earlier reply to the notice made vide letter dated September 12, 2003 to SEBI had been hurriedly drafted and certain important facts had been omitted, the same were being now submitted. The elected directors stated that the report on the basi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not clear at whose instance the said offer had been made. 3.3 It was stated that some key officials of the CSE were not co-operating with the Calcutta Police investigating into the CSE Scam of 2001, thus sabotaging the revival of the CSE. No action had been taken against these non-cooperating officials although, the matter had been raised at the Board Meeting on several occasions, leading one to conclude that it was perhaps easier for the authority to supercede the Board of Directors, particularly the elected directors rather than punish the offenders. It was submitted that these facts indicated a lack of impartiality and transparency, as seen in the case of the discrepancies noted in the security account of an old defaulter member M/s Bajranglal Mahavir Prasad which were never addressed inspite of repeated requests, for reasons best known to the management sub committee. It was stated that the request for reconciliation and disposal of the securities held by the CSE in the old defaulter members accounts including those above mentioned, was never addressed. 3.4 It was pointed out by the elected directors that the details and approval relating to the fixed deposits made by th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was not during the tenure of present elected directors. The elected directors efforts to recover the money from defaulters remained unattended. The observation by the Hon'ble JPC was for the period before their becoming their directors. These present directors should not be subjected to any action whatsoever. Apart from this, the annexed letters with the notice were addressed to the persons responsible for Management of the exchange. 3.10 Thereafter vide letter October 09, 2003, Shri Shankarlal Agarwal, one of the elected directors of CSE inter-alia contended that although CSE being a limited company, CSE was supposed to be managed by the directors of the said company, it was, as per the SEBI Act, compelled to follow the SEBI Guidelines. It was contended that as per the SEBI Guidelines and Article 81 of the CSE, out of 19 Managing Authorities/Directors, 3 were to be nominated by SEBI authority, 6 were to be nominated by SEBI from the public representatives, One Executive Director was to be duly approved by SEBI, while the remaining 9 directors were to be appointed by the members of the CSE. Further the President, Vice President and Treasurer were required to be appointed ou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eficiencies advised by the auditors was never allowed to be discussed in the meeting with the elected directors. It was submitted that although one Mr. P.K. Bhattacherjee, who was appointed by the Board of Directors on April 12, 2002 for opining on the organizational study of the CSE, submitted his report dated December 05, 2002, the said report was never discussed but kept pending. It was stated that upon the direction of the nominated directors, the then executive director and Officer on special duty, without consulting the elected directors and the secretary of the CSE, conducted the matter of fixing responsibility and the elected directors were unaware about any recent problem in the computer system. The entire responsibility lay with the ITD and Surveillance under the supervision of the nominated directors, executive directors and the Officer on special duty. 4.3 It was submitted that one of the elected directors highlighted the misuse of the C Star, by the officers of the CSE vide letter dated October 9, 2002 and requested for appropriate action and also highlighted the problem in pay in /pay out vide his letters dated July 9, 2003 and July 10, 2003 but the same were ignor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ms. On the contrary, it appears from oral and written submission by the Committee, that the Committee of the CSE discounted any laxity at their end and reiterated that there was no pronounced laxity at their end. They stated that as the deficiencies pointed out by the system auditor had been in existence for a number of years, it was difficult for them to conduct a meaningful enquiry for fixation of responsibility. The endeavor of the Committee members who represented before me appeared to be more focused on shifting the blame of failure to rectify deficiencies, rather than a healthy constructive approach towards the rectification of the deficiencies and rejuvenating the working of the exchange. This attitude is reflective of the laid back and callous manner of functioning of the Committee of the CSE, which is further substantiated by the fact that although the draft report of M/s Ernst Young was received by the CSE in October 2002, highlighting serious deficiencies in the risk management and surveillance system of the exchange, no corrective action was initiated to rectify the deficiencies. Further the report came to the knowledge of SEBI only in February 2003 when SEBI once aga ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... subject under discussion. These issues, in any case were only raised by them, subsequent to the receipt of the show cause notice from SEBI. The fact remains that from the material available on record, including the various letters addressed by the elected directors of CSE to SEBI, there have been an admitted lapse on the part of the Committee to maintain systems and procedures in accordance with the statutory requirements. There has clearly been a failure on the part of the Committee of the CSE to take proper review of the management to ensure that the circulars / directives/ instructions issued by SEBI were being complied with. The non rectification of the various deficiencies in the exchange computer system which encountered various problems in its trading and settlement server, consequently affected the completion of the securities and funds payout on time. These problems had the effect of rendering the exchange ineffective and wrought havoc in the securities market. That being the case, the issues raised by these members at this juncture seem to have been made with an intent to divert the consideration of the main issue i.e. effectiveness of the Committee, and discharging its ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d, I would like to quote the decision of the Supreme Court in the case of the Official Liquidator vs. P.A. Tendolkar, reported in (1973) 43 Com Cases 382 : AIR 1973 SC 1104. In the said case it was interalia stated that .while observing that it is a question of fact to be determined on the evidence in each case, a director may be shown to be so placed and to have been so closely and so long associated personally with the management of the company that he will be deemed to be not merely cognizant of, but liable for fraud in the conduct of the business of the company even though no specific act of dishonesty is proved against him personally. He cannot shut his eyes to what must be obvious to everyone who examines the affairs of the company even superficially. If he does so, he could be held liable for dereliction of duties even if he is not shown to be guilty of participating in the commission of fraud . 4.10 I have taken note of the fact that apart from the serious irregularities noted in the running of the CSE, the lapses in the surveillance functions and non initiation of effective steps for the general functioning and administration of the exchange in terms of the pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to put a proper system to ensure the smooth functioning of the various activities of the stock exchange. The functioning of the Committee has created uncertainty and ambiguity even amongst its own members as well as insecurity amongst the investors, and hence the situation warrants immediate action to stop the further deterioration of the functioning of the Committee. 5.2 I have also observed certain observations made by the Joint Parliamentary Committee to the effect that the CSE failed miserably in enforcing its own rules concerning the trading and carry forward limits, and that there was a deliberate failure to initiate steps for rectification of that collection of gross exposure margin by the CSE. An absence of medium for monitoring margin, dereliction of duties in the affairs of the exchange and errors in the software system were also some deficiencies, among several others highlighted by the Joint Parliamentary Committee. 5.3 On a cumulative analysis of the facts abovementioned, I am of the opinion that the Committee of CSE is unable to perform effectively and provide guidance and direction to the CSE. 5.4 SEBI is mandated to ensure that the systems and the procedu ..... X X X X Extracts X X X X X X X X Extracts X X X X
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