IN THE HIGH COURT OF DELHI AT NEW DELHI SUBJECT : CHARTERED ACCOUNTANTS ACT, Reserved on : October 30, Date of Decision : November 6, 2006

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1 IN THE HIGH COURT OF DELHI AT NEW DELHI SUBJECT : CHARTERED ACCOUNTANTS ACT, 1949 Reserved on : October 30, 2006 Date of Decision : November 6, 2006 CHAT.A.REF.No. 6 of 2005 COUNCIL OF THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA... Petitioner Through Mr. K.K.Jain and Mr. Rakesh Aggarwal, Advocates versus R.N.BAHL FCA... Respondent Through Mr. N.Ganpathy Advocate for Respondent Mr. Pankaj Batra, Advocate for Union of India CORAM: HON'BLE MR. JUSTICE VIKRAMAJIT SEN HON'BLE DR. JUSTICE S. MURALIDHAR Dr. S. Muralidhar, J. 1. This is a reference under Section 21(5) of the Chartered Accountants Act, 1949 ('Act') made by the Council of the Institute of Chartered Accountants of India (Council) in respect of certain disciplinary proceedings in which the Council found the Respondent guilty of professional misconduct and recommended that the name of the Respondent be removed from the register of Members for a period of 6 months. 2. The facts in brief are that the Respondent is a partner of a firm M/s. R.N.Bahl and Company, who were the auditors for the Indian Bank Mutual Fund ('IBMF'). In relation to the audited accounts of IBMF for the years and , certain irregularities were noticed by the Committee to Enquire into the Securities Transactions of the Banks and Financial Institutions (the Janakiraman Committee) in its Report No.5. By a letter dated , the Institute of Chartered Accountants of India (Institute) sent the comments of the Janakiraman Committee to M/s. R.N.Bahl and Company. The gravamen

2 of the charge was that the said firm of auditors did not point out in their report the following irregularities committed by the IBMF: (i) non-maintenance of arms-length relation of IBMF with the sponsor/principal Trustee, viz. Indian Bank contrary to the requirements of the Reserve Bank of India (RBI), and resultant loss, if any, to IBMF; (ii) violation of RBI guidelines as regards ready forward transactions in securities/psu Bonds/Commercial Papers, etc. with banks and financial institutions; (iii) non-issuance of Bankers Receipts (BRs) in the Indian Banks Association (IBA) format; (iv) violation of RBI guidelines as regards ready forward deals with non- bank clients which tantamount to borrowing of Funds. Accordingly, the firm M/s. R.N.Bahl and Company was charged with professional misconduct within the meaning of clause (5) (7) and (8) of Part (I) of the Second Schedule to the Act. 3. By its letter dated the firm informed the Institute that the firm had three partners - Mr.S.N.Bharadwaja, who was the in-charge audit, Mr.M.K.Madaan who was the joint in-charge audit and the respondent Mr.R.N.Bahl who had signed the balance sheets of IBMF. Each of them thereafter sent separate letters on asking that the charges be dropped in view of the letter of sent by the firm. They sent similar letters on but did not file any written statement of defence. 4. Thereafter, the Council of the Institute at a meeting held on October 3,4 and 5 of 2001 formed a prima facie opinion that the Respondent herein was guilty of professional/or other misconduct and decided to cause an enquiry to be made in the matter by the Disciplinary Committee. As regards the other two partners the Council took the view that they were not guilty of any professional misconduct. 5. At the enquiry by the Disciplinary Committee, the witnesses for the Committee and the witnesses for the Respondent were examined. On the Disciplinary Committee submitted its report holding that the Respondent was not guilty of charges (i), (ii) and (iv) above. In regard to charge (iii), the Disciplinary Committee found the respondent guilty of professional misconduct within the meaning of clauses (7) and (8) of Part (I) of the Second Schedule to the Act. After considering the written representation and the oral submissions on behalf of the Respondent against the said Report of the Disciplinary Committee, the Council accepted the said report and recommended to this Court the punishment of removal of the name of the Respondent from the Register of Members for a period of six months. 6. Appearing on behalf of the Council, Shri K.K.Jain, learned Advocate submits that the evidence on record clearly proved the guilt of the Respondent in relation to charge (iii) which concerned the failure of the Respondent, as partner of M/s. R.N.Bahl and

3 Company, to point out the failure of IBMF to issue bank receipts (BRs) in the IBA format. In this regard, Mr. Jain relied on the findings of the Disciplinary Committee. He also referred to the guidelines issued by the RBI with regard to the money market regulations of the Mutual Funds and the format prescribed by the IBA for issuance of BRs by the banks. Pointing out to certain specimen receipts issued by the IBMF, he submitted that these were not in the IBA format and, therefore, no fault could be found with the conclusions of the Disciplinary Committee that charge No. (iii) against the Respondent stood proved. 7. For the respondent, Mr.N.Ganpathy, learned Advocate submitted that as per the RBI guidelines, the IBMF was not permitted to issue a BR at all. Pursuant to a specific query of the Institute, the RBI clarified on that the receipts issued by the IBMF were legally valid documents notwithstanding the fact that they were not issued in the IBA format prescribed for banks. This clarification became necessary in view of the fact that the IBA format applied only to Banks and not to Mutual Funds. He further pointed out that although the said clarification was placed before it, the Disciplinary Committee had not considered its effect. He accordingly contended that the charge (iii) against the respondent was not proved and that the present reference should be disposed of by directing that the proceedings be filed. 8. The issue that arises for consideration is whether Charge (iii) against the respondent can be said to have been proved. As already noticed, this Charge pertains to the failure of the respondent to point out that the IBMF had not issued the BRs in question in accordance with the IBA format. In this context, the background in which certain guidelines governing the investments by Mutual Funds came to be issued by the RBI may be noticed. 9. In the wake of many public sector undertakings (PSUs) floating Mutual Funds in the late 1980's, the RBI issued a set of guidelines on These guidelines mandated that: The subscription amounts collected by Mutual Funds are primarily intended to be channelised into the capital market instruments like Government and other Trustee Securities, shares/debentures of public limited companies, bonds of public sector undertakings etc. and, except for the extent indicated in (ix) below, the Mutual Funds should not undertake direct or indirect lending, port folio/funds management, underwriting, bills, discounting, money market operations, etc. which are essentially banking/merchant banking functions. It was further mandated that the Mutual Fund should invariably take delivery of scrips purchased and in case of scrips sold, give delivery thereof to the purchaser. The scrips purchased should be got transferred in the Fund's name. This meant that there was no prohibition at this point in time on the Mutual Funds trading in scrips. The only requirement was that if scrips were purchased they should be got transferred in the Funds name. Mutual Funds could also sell scrips and give delivery thereof to the purchaser. A Mutual Fund was therefore not prohibited from issuing a receipt as a part of the said transaction. 10. On the IBA addressed a communication to the Chief Executives of all member Banks suggesting a standardised format for issuance of BRs by the member

4 Banks. The IBA recommended these for adoption by member banks, financial institutions, PSUs and other IBA/RBI specified institutions. The proforma suggested also indicated that this was designed for being adopted by banks. However, wha was not clear was whether the said format was required to be adopted by the Mutual Funds floated by the Banks. 11. Following the Report of the Janakiraman Committee, the RBI on issued a revised circular applicable to Banks and Mutual Funds whereby, inter alia, it was mandated that BRs could be issued only in exceptional circumstances. On the Securities and Exchange Board of India (SEBI) issued guidelines in respect of the money market operations of Mutual Funds. It noticed that Mutual Funds had entered into money market transactions by placing the money at call and also in bills re-discounting. They had also transacted in substantial amounts in PSU bonds. They were also involved in ready forward deals and that in all these transactions, the Mutual Funds have not exercised sufficient care and diligence in managing their assets in the interest of the investors and have exposed the investors in the schemes of Mutual Fund to a high degree of risk. In view of the above, the SEBI guidelines now mandated that: (1) Mutual Funds may invest up to a maximum of 25 per cent of the resources mobilized by a scheme in money market instruments within the first six months from the closure of the scheme and up to a maximum of 15 per cent of the resources mobilized by scheme thereafter to meet their short term liquidity requirement. (2) All ready forward transactions and double ready forward transactions by Mutual Funds in Government Securities, PSU bonds or any other approved securities are prohibited with immediate effect. (3) Transactions in all securities by Mutual Funds shall only be on the basis of deliveries. (4) No Mutual Fund shall issue a BR and no transaction shall take place on the basis of exchange of Brs. (5) No Mutual Fund shall invest in the units of UTI or in the units of any other Mutual Fund. (6) Mutual Funds may place their funds at call with any other banks only at the best rates and after they have ensured that they have obtained and recorded the competitive quotes. They shall not enter into any transaction which may implicitly give an unfair advantage to their sponsors. Interest on call money must always be collected by the Mutual Funds on the due date(s). (emphasis supplied) 12. Turning to the facts of the present case, the IBMF sold to the Indbank Merchant Banking Service Limited certain non-convertible debentures for which it issued receipts on , , and for the money received with a statement that the scrips sold would be delivered in exchange for the receipt and that till

5 such time the scrips would be held on account of the purchaser. It may be mentioned that between and , 69 such receipts were issued by the IBMF. 13. Two factors require to be noticed at this juncture. One is that the receipts in question were issued prior to the June 1992 guidelines of the RBI. Secondly, these receipts issued by the IBMF were admittedly not in the format suggested by the IBA in May 1991 for adoption by the Banks. Since as per the revised RBI guidelines and the SEBI guidelines issued in June 1992, the Mutual Funds could not issue BRs at all, there arose a doubt whether the format suggested by the IBA was required to be followed by the Mutual Funds. This led the Institute on to write to the RBI seeking a clarification. In reply to this letter, the RBI, after consulting its legal department, wrote to the Institute on on the subject matter of Indian Bank Mutual Fund Issue/Acceptance of bank receipts clarifying that: A Bank Receipt (BR) is issued by a bank in relation to transaction of sale of securities. In other words in terms of Bank Receipt Rules issued by IBA on 6 th May 1991 banks are allowed to issue BRs when the selling bank is not in position to effect physical delivery of scrips. It has also been specified in the above Rules that scrips should be delivered to the buyer as soon as possible. As far as non-banking entities are concerned it is clarified that if a party selling a security whether it be a MF or bank subsidiary or any other party not being in a position to effect physical delivery of scrips, issues a receipt acknowledging receipt of funds for the securities sold and undertaking to hold the same in trust until physically delivered, such a receipt would be a legally valid document. The power to issue receipt of the above nature is to be found in the incorporation documents of the MF/Bank subsidiary. However, the power to issue receipt cannot be an independent power to be specified as such in the incorporation documents. The power to enter into transactions of sale and purchase of securities would necessarily imply the incidental power of issuing the receipt of the nature in question. The same would also apply in respect of accepting receipts issued by other parties, including banks. (emphasis supplied) 14. The position emerging from the above discussion may be summarized: (a)on the date when the IBMF issued the receipts in question i.e. between and , there was no bar on the Mutual Funds selling scrips and issuing receipts for delivery of the scrips at a later date. The Mutual Funds were at this stage governed by the RBI guidelines issued on which permitted such transactions. (b)as regards Banks, they were required to issue BRs in accordance with the format suggested by the IBA by its letter dated This however did not apply to Mutual Funds. (c)by the subsequent revised guidelines issued by the RBI on and by the SEBI on , it was mandated that Mutual Funds could not issue any BRs at all. Therefore the question of Mutual Funds having to follow the IBA format for issuance of BRs did not arise after that date.

6 (d)the clarification issued by the RBI on in respect of the receipts issued by the IBMF made it clear that the receipts issued by it were legally valid documents and that the power to enter into transactions of sale and purchase of securities necessarily implied the incidental power of issuing the receipts of the nature in question 15. What appears to have happened in the instant case is that the comments of the Janakiraman Committee were anterior to the clarification by the RBI and on the basis of those comments the charges were straightaway framed against the respondent. A perusal of the Report of the Disciplinary Committee reveals that in para 8.3 of its Report, while dealing with charge (iii) it took note of the RBI clarification dated However, while discussing the evidence in regard to the same charge it did not consider the effect of this clarification. This is evident from its observations in para 8.7: 8.7 The Committee further noted that when it had asked for relevant documents based on which it could be deduced that IMBF was authorised to issue BRs, it submitted only the incorporation document from where it could not be impliedly found that the Fund was given the power to issue receipt of such nature. The Committee also noted that the witness from the IBMF Shri Vajani was not able to produce the minutes of the Investment Committee wherein the powers were vested on IBMF to issue BRs while entering into such transactions. Also, the Respondent neither could substantiate the said fact nor could produce any evidence from his audit working papers which could highlight that he had verified such minutes wherein the Fund was given power to issue B.R.s. In the absence of such documents, the Committee was of the view that the B.R.s issued by IBMF were unauthorised in nature. Thus, in the opinion of the Committee, the Respondent, therefore, failed to point out in their report that the Fund has not exercised sufficient care and diligence in managing their assets in the interest of the investors and have exposed the investors in the schemes of Mutual Fund Scheme to high degree of risk. 16. It appears that the Disciplinary Committee misdirected itself in treating the receipts issued by the IBMF as BRs and then finding that they were not in the IBA format. What appears to have been overlooked by it is that it was nobodys case that the documents in question were BRs. Also, it failed to note that at the relevant time when these receipts were issued the Mutual Funds were not prohibited from selling scrips or issuing receipts for their subsequent delivery. Further the requirement of having to follow the IBA format applied to Banks and not to Mutual Funds. This led it to further erroneously conclude that the respondent had been negligent in not reporting on the alleged failure of the IBMF in this regard. Had the Disciplinary Committee considered the effect of the RBI clarification dated , which evidently it did not, it could not have come to the conclusion it did. In view of the above, we have no hesitation in holding that the finding of the Disciplinary Committee holding the respondent guilty in respect of the Charge No. (iii) cannot be sustained and it is hereby set aside. Consequently, we hold that the Council erred in accepting the finding of the Disciplinary Committee and making the recommendation of punishment as noticed hereinabove. 17. Resultantly, the present reference is disposed of in terms of Section 21(6)(a) of the Act by holding that the respondent is not guilty of any professional misconduct and directing that the proceedings be filed.

7 SD./- S. MURALIDHAR,J SD./- VIKRAMAJIT SEN,J