BEFORE THE SECURITIES AND EXCHANGE BOARD OF INDIA CORAM: G. ANANTHARAMAN, WHOLE TIME MEMBER ORDER

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1 WTM/GA/17/IVD/6/07 BEFORE THE SECURITIES AND EXCHANGE BOARD OF INDIA CORAM: G. ANANTHARAMAN, WHOLE TIME MEMBER ORDER UNDER REGULATION 13(4) OF SECURITIES AND EXCHANGE BOARD OF INDIA (PROCEDURE FOR HOLDING ENQUIRY BY ENQUIRY OFFICER AND IMPOSING PENALTY) REGULATIONS, 2002 AGAINST KARVY LTD, DEPOSITORY PARTICIPANT AND MEMBER, NATIONAL EXCHANGE OF INDIA LTD, BOMBAY EXCHANGE LTD. AND HYDERABAD EXCHANGE AND KARVY COMPUTERSHARE PRIVATE, REGISTRAR TO THE ISSUE IN RESPECT OF DEALINGS IN THE INITIAL PUBLIC OFFERINGS. Date of Final Hearing: May 29, Appearances: For noticees: Shri Shyam Mehta, Advocate. Shri Vinay Chauhan, Advocate Shri C. Parthasarathy, Director of the noticee For Securities and Exchange Board of India: Shri. Sanjiv Dutt, Chief General Manager, Shri B J Dilip, Assistant General Manager Shri Vijayakrishnan. G, Assistant Legal Advisor. Page 1 of 191

2 1.0. Background: 1.1.In October 2005, the stock exchanges submitted their preliminary observations on the Initial Public Offering (IPO) of Yes Bank Ltd. (YBL) which hinted at the possibility of large scale off-market transactions immediately following the date of allotment and prior to the listing on the stock exchanges. SEBI therefore carried out a preliminary scrutiny by calling for data from the depositories and the Registrar to the Issue (RTI). SEBI found that, many demat accounts in fictitious/ benami names were opened by certain entities (hereinafter referred to as the Key Operators ) and these entities had cornered/ acquired the IPO shares, by making applications in fictitious/ benami names with each of the applications being of small value so as to make it eligible for allotment under the retail category. The aforesaid demat accounts are hereinafter referred to as afferent accounts for the sake of brevity. The investigation conducted by SEBI further revealed that subsequent to the allotment of IPO shares, the fictitious/benami allottees had transferred the said shares to their principals which were identified by SEBI as key operators / master account holders. The modus operandi as detailed above led to the prima facie view that the thousands of entities in whose names demat accounts and bank accounts had been opened and IPO applications made, were either benami, name lenders or non existent. 1.2.On noticing the irregularities and widespread abuse, SEBI acted against the entities who were responsible for the irregularities by passing interim order dated December 15, 2005 restraining them from participating in all future IPOs and also directing the depositories to effectively freeze their dematerialized accounts It was noticed during the course of preliminary scrutiny of Yes Bank IPO, that all the dematerialized accounts in fictitious / benami names had been opened with the DP Karvy Stockbroking Ltd. ( Karvy DP ). Therefore, in the said interim order dated December 15, 2005 it was mentioned that Also, the role of Karvy-DP i.e. Karvy Stockbroking Ltd. that opened the dematerialized accounts of 6315 entities being Page 2 of 191

3 benamis of Roopalben Panchal and 1315 entities being benamis of Sugandh probably without taking adequate steps to ascertain the genuineness of these entities while acting as a facilitator in what appears to be an act of either gross negligence or active collusion ill behoves them as a SEBI registered market participant. 1.4.In view of the prima facie finding as above, vide the interim order dated December 15, 2005 in the matter of Yes Bank IPO, the following direction was issued by SEBI against Karvy DP: NSDL is directed to undertake a comprehensive inspection of Karvy-DP particularly focusing on the sytems and procedures, if any, put in place by Karvy-DP for implementing the know your client norms that DPs are required to follow. NSDL shall identify the deficiencies in Karvy-DP with regard to the above and also ascertain from Karvy-DP the particulars of other potential benami accounts more particularly those multiple accounts having the same contact address and / or having the same person / entity authorized to operate these dematerialized accounts. Karvy-DP is directed to fully co-operate with NSDL in the above inspection. NSDL shall submit a report to SEBI detailing the findings of its inspection in a time-bound programme. 1.5.Thereafter, SEBI examined the dealings in another major IPO of IDFC wherein the very same players were suspected to have played a major role in cornering the shares. SEBI issued ad interim orders in the case of IDFC also along the similar lines as done in the case of Yes Bank. In the interim order dated January 12, 2006 in the case of IDFC IPO, SEBI inter alia observed as below: Further the reports of inspection of Karvy-DP submitted to SEBI by NSDL and CDSL shows that Know your client norms have not been adhered at all while opening the dematerialized accounts Further, Karvy s internal correspondences given as Annexure to the NSDL inspection report show that even during November 2005 the top management of Karvy-DP were aware of the issue of multiple dematerialized accounts opened Page 3 of 191

4 with the same address. It appears that the management of Karvy-DP, on coming to know of the same in the wake of a query from SEBI in some other case had, as early as November 2005, internally decided to process these multiple dematerialized accounts bearing the same address for closure. The above goes to confirm that Karvy-DP had knowledge about the fictitious nature of such multiple accounts Also, some of the documents collected by CDSL during the course of inspection show that Karvy-DP has obtained letters purported issued by the concerned banks such as Bharat Overseas Bank as proof of identity and proof of address of the person for the purpose of opening dematerialized accounts. It is seen that one branch manager has on the same date signed as authorized signatory of different branches of the bank. This raises a doubt as to the authenticity of the bank documents obtained by Karvy-DP for opening dematerialized accounts. SEBI is making reference to RBI regarding such apparent irregularities in the bank documents submitted to Karvy-DP for the purpose of opening the dematerialized accounts It is also noted that in view of significant irregularities noticed during the course of inspection of Karvy-DP, both NSDL and CDSL have directed Karvy-DP not to open new dematerialized accounts till the issue of verifying the genuineness of multiple dematerialized account-holders having the same address is addressed to the satisfaction of the depositories The above facts cast grave doubts as to the genuineness of the thousands of IPO applicants who have apparently furnished the address of Roopalben Panchal or Sugandh or Purshottam Budhwani as their address. The findings of the investigation/inspection of the concerned banks by RBI has fortified the initial findings of SEBI that Karvy-DP has actively colluded with the above entities in opening multiple/benami bank accounts and dematerialized accounts in the names of fictitious persons. 1.6.In view of the findings as above, SEBI in the interim order dated January 12, 2006 in the matter of IDFC IPO, inter alia, issued the following directions against Karvy DP: Page 4 of 191

5 12.5. Thousands of dematerialized accounts being opened on the same day with the same branch and being introduced by the same bank should have alerted the DPs at the time of opening of the dematerialized accounts. However the fact that DPs failed to exercise even this basic due diligence gives rise to a suspicion that they have actively colluded with the perpetrators. It is a matter of serious concern that Karvy-DP has opened such apparently benami / fictitious accounts working out to over 95% (42,056 nos) of the multiple dematerialized accounts in relation to IDFC IPO. I note that Karvy-DP has already been directed by the depositories to verify the genuineness of the dematerialized account-holders and to close those dematerialized accounts where it is unable to verify the genuineness of identity and address of the dematerialized account-holders. The depositories have prohibited Karvy-DP from opening new dematerialized accounts till the above process has been completed. I hereby direct Karvy-DP and Pratik-DP to complete the process of verifying the identity and address of dematerialized account-holders and to close / freeze the dematerialized accounts where they are unable to do the verification not later than January 31, Further, Karvy-DP and Pratik-DP shall put in place systems and procedures to ensure that in future no non-genuine dematerialized accounts are opened by them. Karvy-DP and Pratik-DP shall submit a detailed report to SEBI narrating the actions taken by them in this regard and also give an undertaking that the SEBI s above directions have been fully complied with. I further direct that Karvy-DP and Pratik-DP shall not open new dematerialized accounts till the submission of above report and undertaking to SEBI and obtaining a no-objection from SEBI for accepting fresh business as a DP. 1.7.Further, in view of the findings of preliminary scrutiny as above, SEBI referred the matter to other government agencies including Income Tax Department, Ministry of Company Affairs and the Reserve Bank of India. Also, SEBI filed a complaint with CBI in the matter. 1.8.Pursuant to the same, RBI conducted inspections of the banks involved. The inspection by RBI brought out various irregularities at the end of the banks involved, Page 5 of 191

6 specifically BhOB and also the role of Karvy group behind the enire gamut of operations. 1.9.Further, the parliamentary Standing Committee on Finance conducted a study on Efficacy of Reform Process in the Capital Market Recent IPO Scam For the purpose of the study / examination of the matter, the committee took oral and written testimonies / evidences of SEBI and RBI, the representatives of Investors Grievances Forum, Indian Overseas Bank, Vijaya Bank, ICICI Bank, HDFC Bank and Bharat Overseas Bank, National Stock Exchange, Bombay Stock Exchange, National Securities Depository Ltd., and Central Depository Services Ltd. Purusuant to the study, the committee submitted its report before the parliament on November 28, The major observations of the committee with regard to the role of Karvy group in the IPO irregularities was as follows:..the fact that Karvy RTI had made consolidated refund favouring BhOB in respect of thousands of IPO applicants and that the Karvy Group was directing the investment of funds in respect of IPO applications are real eye openers. The Committee also note that Karvy had very conveniently issued an idea paper to BhOB certifying that the applications received for the IPO offer were valid, which shows the extent to which Karvy could prevail upon the Bank. They feel that the discreet arrangement for mutual benefit of BhOB and Karvy would have gone further ahead had there been no unearthing of the IPO scam. 61. The Committee are convinced that the role of Karvy Group of Companies in the IPO Scam was questionable right from the beginning... In view of the above, the committee advised SEBI to conduct investigation in all Page 6 of 191

7 areas of manipulation allegedly done by the Karvy Group. The committee further observed that 62. As a major part of the malfunctioning leading to the scam could be attributed to the role of the intermediary, the Karvy Group of Companies which performed multiple functions in all directions, the Committee feel that the role of such intermediaries should be examined minutely with a view to see that those operating in multiple capacity are not able to manipulate the system Besides the above, the committee, in various parts of the report has made many adverse observations regarding the role of Karvy group companies in the IPO irregularities Further, SEBI also received references from various Government Agencies including Reserve Bank of India ( RBI ), Serious Fraud Investigation Office ( SFIO ) and Intelligence Bureau ( IB ). Various investor complaints were also received alleging irregularities in various IPOs In the course of investigations pursuant to interim orders in the cases of Yes Bank and IDFC IPOs, SEBI noticed that some of these multiple accounts were opened in June The involvement of these accounts in Initial Public Offerings prior to that of Yes Bank and IDFC were looked into. Securities and Exchange Board of India (hereinafter referred to as SEBI) conducted an investigation into the buying, selling or dealing in the shares issued through Initial Public Offerings (IPOs) of companies during the period The investigation conducted by SEBI found that the modus operandi, as detailed above, had been adopted for cornering of IPO shares in 21 IPOs that came during The investigations prima facie revealed the substantial involvement of Karvy Page 7 of 191

8 group companies in the IPO irregularities. It was found that Karvy-DP had, during 2003, tied up with BhOB for the purpose of provding IPO finance to their demat account clients. Based on introduction of saving account by Karvy, BHOB disbursed the loan amount to the clients of Karvy DP. However, with passage of time, it appears that Bharat Overseas Bank officials chose to rely more on Karvy s DP account details and drew comfort therefrom while dropping their guard in the matter of opening bank accounts and verification thereof. Exploiting the blind trust and complacency on the part of BhOB, Karvy gave short shrift to the KYC procedures. Thus in the year 2005 when market for IPOs was booming, Karvy-DP did not comply with the account opening formalities by opening multiple demat accounts in fictitious / benami names. Thereafter, in order to make its account opening procedure seemingly compliant, Karvy-DP resorted to fabrication of bank documents towards POI and POA and also arranged for photographs from other sources. The perfect matching of the fabricated bank documents with the details available in the depository system gave rise to the possibility that the bank documents might have been forged by the DP itself. Thus, it appeared that Karvy, being the progenitor of the entire scheme won over the trust of the allies in the bank and made its pitch effectively in the market, besides making common cause with the sub brokers and financiers who were part of the manipulative assemblage. Other Karvy group entities namely Karvy Consultants Ltd. and Karvy Computershare P Ltd. ( Karvy RTI ) were also found to have played their part by providing / arranging IPO finance and providing consolidated refund cheques in respect of the afferent accounts and directing the bank to credit the refunds in the accounts of the key operators In the above facts and circumstances, SEBI vide an ad interim ex parte interim order dated April 27, 2006 inter alia directed as below: In view of the detailed findings against Karvy DP and Pratik DP in this order, Karvy DP and Pratik DP, in my view prima facie do not appear to be fit to deal in securities market as SEBI registered intermediaries. Appropriate quasi- judicial Page 8 of 191

9 proceedings are being initiated against the two DPs. In view of the substantial findings of a serious nature brought out in this order against Karvy DP and Pratik DP, in addition to what has been noticed in the earlier two interim orders in the cases of Yes Bank and IDFC, I direct that Karvy DP and Pratik DP shall not carry on the activities as DP till the completion of enquiry and passing of final order, excepting for effecting transfer of BO account to another SEBI registered DP on request. Notwithstanding this direction, Karvy DP and Pratik DP shall continue to be governed by the SEBI (Depositories and Participants) Regulations, 1996 and other applicable legal provisions in other respects Since the other business groups of Karvy have appeared to have acted in concert in the gamut of the IPO manipulations, I further direct Karvy Stock Broking Ltd., Karvy Computershare Pvt. Ltd., Karvy Investor Services Ltd. and Karvy Consultants Ltd. not to undertake fresh business as a Registrar to Issue and Share transfer agent, excepting those businesses already contracted as on date Subsequent to the issue of ex-parte interim directions as above, an opportunity of post decisional hearing was granted to the Karvy group. After considering the oral and written submissions of Karvy group, vide order dated May 26, 2006, the following directions were issued: (a) (b) (c) KSBL is directed not to act as a depository participant, pending enquiry and passing of final orders, except for acting on the instructions of existing beneficial owners, so that the interests of existing BOs remain unaffected. It shall transfer the demat account of an existing BO to another SEBI registered DP, on request. It is clarified that KSBL shall continue to be governed by the SEBI (Depositories and Participants) Regulations, 1996 and other applicable legal provisions. KSBL, as a stock broker, is directed not to undertake any proprietary trades in securities, either off-market or on market, pending enquiry and passing of final orders. KCPL is directed not to act as a registrar to an issue and as a share transfer agent, pending enquiry and passing of final orders, except for the assignments already contracted before passing of interim order dated April 27, This direction will not apply to KCPL as Registrar and Transfer Agent to Mutual Funds. It is noted that Karvy Investor Services Ltd. and KCL are not registered as registrars to an issue or share transfer agents with SEBI The DP filed an appeal before the Hon ble Securities Appellate Tribunal Page 9 of 191

10 (SAT) against the aforesaid order of SEBI dated May 26, 2006 and the same was dismissed by SAT vide order dated January 8, 2007 with a direction to SEBI to complete the enquiry not later than March 31, Further, SAT had directed SEBI to take a final decision in accordance with law within two months thereafter. In the said order SAT had inter alia observed what needs to be examined is whether the appellant had really failed to get alerted to the abuse of its systems by the so called sub-brokers or whether there was active collusion of the appellant with its clients for abusing the IPO process and sharing the gains arising from the same. We can not decide these issues at this stage not can it be said as to which of these two versions is correct. It is an undisputed fact that thousands of fictitious/ benami demat accounts were opened with the appellant with common addresses and more than accounts were opened on one single day. The appellant was under a duty to check and comply with the various norms. The obvious appears to have been overlooked. Is the action of the appellant innocent is the question. The appellant is clearly under a cloud and the truth can be known only after a detailed inquiry. The findings of the inquiry will either remove the appellant or the cloud. (emphasis supplied) Thereafter, SAT, on an application filed by SEBI, extended the time limit upto the end of June APPOINTMENT OF ENQUIRY OFFICER 2.1 In the facts and circumstances, SEBI appointed an Enquiry Officer vide orders dated May 25, 2006 and September 18, 2006 under regulation 5(1) of Securities and Exchange Board of India (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002 (hereinafter referred to as the Enquiry Regulations) to enquire into the alleged violations committed by Karvy Stock Broking Ltd. as a depository participant and stock broker and Karvy Computershare Pvt. Ltd as a Registrar to the Issue while dealing in the IPOs. The alleged violations committed by the said entities are as follows : Page 10 of 191

11 a. Karvy Stock Broking Ltd. as a depository participant i) Section 12A of Securities and Exchange Board of India Act, 1992 (hereinafter referred to as the Act ), ii) Regulation 3 and 4 of Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (hereinafter referred to as the FUTP Regulations) iii) Regulations 19, 20A, 42, 43, 46 and 52 of Securities and Exchange Board of India (Depositories and Participants) Regulations 1996 (hereinafter referred to as DP Regulations) and iv) Provisions of Securities and Exchange Board of India (Criteria for Fit and Proper Persons) Regulations 2004 (hereinafter referred to as Fit and Proper Regulations). b. Karvy Stock Broking Ltd. as a Stock Broker i) Regulation 3 and 4 of FUTP Regulations, ii) Regulation 5, 7 and 15(1)(b) of Securities and Exchange Board of India (Stock Brokers and Sub Brokers) Regulations, 1992 (hereinafter referred to as Broker Regulations), iii) Provisions of the Fit and Proper Regulations and iv) Provisions of Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000 (hereinafter referred to as DIP Guidelines). c. Karvy Computer Share Pvt. Ltd as a Registrar to the Issue i) Section 12A of the Act, ii) Regulation 3 and 4 of the FUTP Regulations, Page 11 of 191

12 iii) Regulation 6 and 13 of Securities and Exchange Board of India (Registrars to an Issue and Share Transfer Agents) Regulations, 1993 (hereinafter referred to as RTI Regulations) and iv) Provisions of Fit and Proper Regulations. 2.2 The Enquiry Officer submitted his reports dated March 30, 2007 (in the case of DP), March 15, 2007 (in the case of stock broker) and December 20, 2006 (in the case of RTI) and his recommendations in the respective enquiry reports are as follows : i. to prohibit KSBL from acting as a depository participant for a period of 18 months. ii. to suspend the certificate of registration of KSBL as a stock broker for a period of 3 months. iii. to prohibit KCPL from acting as a registrar to an issue for a period of nine months. The enquiry officer further clarified that the prohibition of 18 months recommended by him against the DP was in respect of taking up new assignment / fresh business as a depository participant. The Enquiry Officer also recommended to take into account the period of prohibition already undergone by the DP and the RTI, as per the interim orders of SEBI for the purpose of computing the period of prohibition recommended by him. 2.3 The Enquiry Officer in his report (in the case of DP) had inter alia considered various allegations leveled against the Karvy DP such as assisting the key operators in opening bank accounts, opening of large number of afferent accounts by the key operators, irregularities in opening the demat accounts, non verification of documents pertaining to Proof Of Identity (POI), Proof of Address (POA), fabrication of the documents, IPO funding to the key operators, financing after the closure of the issue, single consolidated refund cheques etc. In so far as the allegations pertaining to the fabrication of introduction letters, the Enquiry Officer had observed that on the basis on the circumstantial evidence alone it Page 12 of 191

13 could not be conclusively held that the DP had fabricated the said documents. The Enquiry Officer had inter alia observed that the DP had actively facilitated, assisted and abetted many key operators in cornering the shares by facilitating opening of the accounts, facilitating the transfer of securities through pre printed DIS etc. The Enquiry Officer observed that the other entities belonging to the Karvy Group also played an important role in supplementing the action of DP and found that the DP had violated the provisions of Section 12 A of the SEBI Act, Regulation 3 and 4 of FUTP Regulation, 2003, Regulations 19, 42(2) and (3), 43, 46 and 52 of DP regulations 1996 and Clauses 3,9,12,16,19,20& 22 of the Code of Conduct specified in regulation 20A of the DP regulations. 2.4 The Enquiry Officer in his report (in the case of stock broker) had inter alia observed that the findings of the enquiry against KSBL as the depository participant might be considered as a part of the said report as the same is reflective on the various activities of KSBL as a stock broker. The Enquiry Officer further found that the Broker has violated the provisions of regulation 3 and 4(1) of the FUTP Regulations and Clauses A(1), A(3) and A(4) of Schedule II of the Broker Regulations and the provisions of DIP Guidelines. 2.5 The Enquiry Officer in his report dated December 20, 2006 (in the case of RTI) found that KCPL had violated the provisions of section 12 A (a), (b), (c) of the Act and Regulations 3 and 4 (1) of FUTP Regulations and clause 3 of the Code of Conduct specified under regulation 13 of the RTI Regulations SHOW CAUSE NOTICES AND REPLIES 3.1. a) In the case of KSBL DP While considering the Enquiry Report and other materials available on record (which were considered while passing interim orders dated January 12, 2006, April 27, 2006 and May 26, 2006 and also considered at the time of the hearing Page 13 of 191

14 before the SAT), it was observed that the alleged violations committed by the DP prima facie called for a higher penalty than that recommended by the Enquiry Officer. Accordingly, a notice dated May 4, 2007 was issued to the DP to show cause as to why the period of prohibition as recommended by the Enquiry Officer should not be enhanced to 3 years The DP vide letter dated May 19, 2007 filed its reply to the said show cause notice. The submissions made by the DP in its aforesaid reply in brief are as follows: i) The show cause notice was merely a formality to show the procedural fairness as it has been categorically concluded that the prohibition of 18 months should be enhanced to 3 years. The authority cannot consider any documents which were not considered by the Enquiry Officer. The authority can not travel beyond the Enquiry Report and what was considered therein. a. On the basis of a rubber stamp on a sheet of paper containing 50 names and signatures, it cannot be said that the account holders have been introduced by it to the bank. b. It had effected off market transfers from various accounts based on duly filled in Delivery Instructions Slips (DIS). In respect of the allegation pertaining to the opening of demat accounts using different combinations of surnames, the DP stated that the same were opened after obtaining the application forms submitted by the respective IPO sub brokers with documents relating to KYC requirements. c. There was a clear division of operations between the DP and the other Karvy entities and that it had not acted in concert or aided and abetted the key operators in opening benami / fictitious demat accounts to corner shares in various IPOs as alleged. The DP stated that it was impracticable to expect the application which were Page 14 of 191

15 received and bid on the last day were deposited in the bank on the same day itself by any syndicate / sub syndicate member. d. It was not liable for any activities carried out by KCL other than the DP activities of KCL. The DP further stated that it had opened the demat accounts in the ordinary course of business after complying with the KYC requirements. In respect of opening of demat accounts earlier than the date of letter of introduction, the DP submitted that the same happened only in 27 cases as there were deficiencies in the original documents. The DP further clarified that the said deficiencies were identified at the time of the scrutiny and fresh set of documents were sought and the same were received and attached alongwith the application form. e. KCL had financed Shri Purshottam Budhwani and his clients and the DP was aware that Shri Purshottam Budhwani and his clients were applying for the shares in IPO. However, the DP claimed that it was not aware that the said Shri Purshottam Budhwani was a key operator and that he was abusing the IPO process by making fictitious / benami applications. In respect of the issue of single consolidated refund cheques, the DP submitted that the same was a market practice. f. The DP further stated In retrospect it is realized that some of the IPO sub brokers who are the alleged key operators have exploited the loop holes in the system and have used Karvy DP as one of the DPs amongst others for carrying out their manipulative designs. The DP further claimed that it had not printed any other details apart from client id, serial number and name in the DIS. The DP further contended that it had not appointed any franchisee and that it had not delegated the activities of the DP to the sub brokers. g. There was no electronic system to store and match the photographs of the demat applicants. The DP asserted that there was nothing wrong or illegal in the activation of demat accounts on the date of Page 15 of 191

16 closure of issue. The DP also stated that it had not introduced the key operators to open the bank accounts as alleged. h. The DP denied violating the provisions of section 12A (a), (b) and (c) of SEBI Act and Regulations 3, 4 (1) and 4 (2) of the FUTP Regulations. It also denied of violating the provisions of DP Regulations. In respect of the quantum of penalty the DP relied upon the judgment of the Hon ble Supreme Court in the matter of Ex-Naik Sardar Singh V. Union of India (1991) 3 SCC 212. Finally the DP has claimed that it had not committed any violations as alleged In the case of Stock Broker A show cause notice dated May 4, 2007 was also issued to the Broker asking it to show cause as to why action as recommended by the Enquiry Officer should not imposed against it. The stock broker vide letter dated May 19, 2007 inter alia stated that simply because its employees had introduced the accounts and put the address or stamp of the company on the forms, it could not be concluded that the Broker was aware of the activities of the employees. The Broker also denied that it had facilitated the key operators to open many accounts as alleged. The Broker further stated that it had not violated the provisions of the Broker Regulations or the FUTP Regulations. The Broker denied that the Karvy group assisted the key operators in opening the bank account with BhOB. Further the Broker had reiterated the reply of the DP dated May 19, The Broker inter alia submitted that their employees had not introduced several bank accounts as alleged and added that the introduction of certain bank accounts by the employees were after fulfilling the KYC requirements. In respect of 50 additional names attached to 37 bank accounts of Smt. Roopalben Panchal, the DP reiterated the stand taken by the DP. The Broker further stated that the alleged afferent accounts have been opened by IPO sub brokers. The Broker Page 16 of 191

17 further stated that simply because the IPO sub brokers used to procure large number of applications along with others could not concluded that it was aware of the financing arrangement. The Broker added that it was not aware about the finances provided by KCL to Smt Roopalben Panchal and that she had made large number of applications. It also contended that the sale of shares by it on behalf of Shri Purshottam Budhwani and Shri Manoj Seskaria was in the ordinary course of business. The Broker asserted that it had not directly or indirectly employed any device, scheme or artifice to defraud in connection with issue or dealing in securities which were listed or proposed to be listed on a recognized stock exchange. Further it stated that it had not violated any of the provisions of law as alleged against it In the case of RTI A show cause notice dated December 20, 2006 was also issued to KCPL and asking it to show cause as to why the appropriate penalty including the penalty as recommended by the Enquiry Officer should not be imposed against it. An opportunity of hearing was granted to KCPL on January 4, KCPL vide letter dated January 8, 2007 inter alia stated that there was no material to substantiate the allegation of knowledge in respect of the fictitious nature of the applications pertaining to the key operators made against it. In respect of the common management, KCPL stated that there was clear division of operations between it and the other Karvy entities. In respect of the single consolidated refund orders, KCPL stated that the same was established for the purpose of efficient investor servicing and administrative convenience. KCPL further stated that it had not issued any single consolidated refund order pertaining to the alleged benami/ fictitious applications made by Shri PUrshottam Bhuwani and Shri Manoj Seksaria. It asserted that in case of most IPO brokers such as KSBL, a co ordinator was appointed who was responsible of the effective servicing of the clients of such IPO brokers. KCPL further contended that as an RTI it had no role to play in the financing activity of KCL. In view of the above submissions KCPL requested SEBI to drop the proceedings initiated against it. KCBL further stated that single consolidated refund orders were Page 17 of 191

18 issued by it on a uniform basis to all such institutions who sought to receive such a consolidated cheques such as ICICI Web Trade Ltd., IDBI Bank, Indian Overseas Bank etc. It is further stated that the said system was according to the specific instructions of the respective IPO applicants and the same was purely intended for facilitating the settlement process and was nearly administrative in nature. KCPL further denied of having any role in the alleged IPO irregularities and added that each of the companies forming part of Karvy Group are independent legal entities. KCPL further added that the practice of issuance of single consolidated refund orders was undertaken by it since October It further added that the said practice was undertaken much prior to the KCL financing IPO applications, as alleged. KCPL further in respect of multiple applications stated that 487 applications (in the case of Yes Bank IPO) and 45 applications without beneficiary details were rejected. In the case of IDFC IPO, KCPL stated that 1526 application were rejected on the ground of being multiple applications and 56 applications were rejected for want of beneficiary details. KCPL further added that it was not aware of the fictitious nature of the application made by Roopalben Panchal group and in the said context KCPL stated that it had no role as an RTI to play in the financing activity of KCL HEARINGS 4.1. An opportunity of hearing was granted by SEBI to RTI on January 4, 2007 Shri R. Parthasarthy the Chairman of the Karvy Group made submissions on behalf of KCPL. As the nine months prohibition as recommended by the Enquiry Officer was already elapsed and taking into account the balance of consideration, vide order dated February 22, 2007 SEBI had lifted the prohibition imposed on KCPL vide interim order dated April 27, In the said order it was specified that the final findings as to the role of KCPL could be determined only when the final findings as to the role of KSBL was determined in the enquiry proceeding against it. Page 18 of 191

19 4.2. An opportunity of hearing was also granted to the DP and the Broker on May 22, 2007, May 25, 2007 and May 29, Shri Shyam Mehta, advocate represented the DP and the Broker and made submissions on behalf of them. Shri Vinay Chauhan, advocate, and Shri R Parthasarathy, were also present during the time of the hearing. Shri. Shyam Mehta made submissions on the lines of the reply of the DP and the Broker dated May 19, Pursuant to the above hearing, the DP and the stock broker filed written submissions vide letters dated June 6, 2007 and June 8, 2007 respectively. The DP while reiterating its reply dated May 19, 2007 stated that it was not liable for the activities of the KCL as a DP which was at variance with the contentions of Karvy DP made in its reply dated May 19, The counsel further stated that the authority can not enhance the penalty what was recommended by the Enquiry Officer As the DP and the Broker are admittedly group companies and are functioning under the same management and control and also the fact that the issues involved in all the present proceedings (including that of RTI) are connected / similar and further since the responses of the said intermediaries are common/similar all the present proceedings (against DP, RTI and the Broker) are dealt with in a common order Issues for Consideration 5.1. Keeping in view the oral / written submissions of Karvy, various documents on record, the observations of the Hon ble Securities Appellate Tribunal and the findings of the Enquiry Officer, the following issues remain for consideration: Whether it is a simple case of failure to exercise due diligence or whether Karvy DP had gone beyond in crafting a collusive game-plan with the key operators for the purpose of cornering IPO shares? Page 19 of 191

20 Whether, the other entities belonging to the Karvy group, specificially Karvy Consultants Ltd. (NBFC and formerly DP), Karvy Stock Broking Ltd. (Broker) and Karvy Computershare P Ltd. (RTI) had colluded with the DP in executing the gameplan for cornering IPO shares? Whether, based on the material available on record, the findings of Enquiry Officer be accepted? and Whether, based on material available on record, the penalty recommended by the Enquiry Officer is appropriate or whether it calls for a higher penalty? 5.2. Before proceeding with the issues for consideration, I note that the existence of fictitious afferent accounts as opened with Karvy DP are not in dispute as would be evident from the Hon ble Securities Appelate Tribunal Order dated January 8, Karvy has also admitted the same in the complaint filed against 4 subbrokers namely, Grace Consultancy,, Shashwat, Opp: Gujarat College,Ellisbridge, Ahmedabad (Rep by its Proprietor Deepak Panchal) (Accused no.1), Arth Realty Pvt. Ltd, 803, Abhijeet-1, Mithakali Circle, Navrangpura, Ahmedabad (Rep by its Director Parag P Jhaveri) (Accused no.2), Purshotham Budwani S/o. Late Ghanshyamdas Budwani Age: 41 years, R/o. B/2, Himalay Housing Co-op Soc, Asalfa, Ghatkopar (W) Mumbai 84 (Accused no.3) and Manoj G Sakseria S/o. Gokulchand Seksana, R/o. 33, Maheshwan Niketan, Peddar Road, Mumbai 26 (Accused no.4). In the memorandum of the complaint, Karvy DP has, inter alia, stated as below: 5.3. The Complainant herein states and submits that the Company as a Depository Participant opens accounts through its branches and through its associates across the country. For the past 2/3 years, due to the strong market sentiments, number of Companies have offered their shares to the Public. For applying for shares offered by a company, having a depository account is a must which is opened with Depository Participants like Karvy Stock Broking Ltd. The company accepts Page 20 of 191

21 application forms for opening depository account from business Associates also. For opening a depository account, the applicant has to submit along with application form in the prescribed format duly filled in, various supporting documents like proof of address and identity. The business associates generally collect the applications from various applicants whom they service and submit the same to our Branches for opening the depository account These associates are either provided special rates for opening depository accounts for their clients or are paid remuneration on each account for processing the application. These Business Associates, have collected applications for opening depository accounts from various applicants. Since they had direct contact with the applicants, they are required to verify credentials of the applicant, including verification of documents like proof of address, identity proof, Bank account details etc. of the person who intends to open the account after filling up the prescribed form as per the norms of SEBI and submit the same to our branches. With regard to the accounts under reference, these associates or their friends / relatives have also acted as introducer for each of the accounts The Complainant states that they believed that all the accounts forwarded by the associates are true and correct and are eligible to open the depository accounts. The accused have fraudulently opened fictitious accounts to defraud and cheat the Company. The Complainant herein states that consequent to the order issued by Securities and Exchange Board of India (sebi), National Securities Depository Limited (NSDL) had, vide their letter dated 17 th December 2005, directed the Company as Depository Participant to verify the cases. On such verification, the Company came to know that the associates have committed breach of trust with the intention to cheat genuine investor. These associates on demand by the company have failed to produce their customers for Page 21 of 191

22 identification which has lead the company to suspect that they have opened accounts of non existing persons and got lot of shares allotted to them. Thus they have cheated the genuine investors, Company and committed criminal breach of trust as the Company totally depended on the information and scrutiny of the sub-brokers The Complainant submits that the accused 1 to 4 herein have opened depository participant accounts with ulterior motive and malafied intention to cheat genuine investors knowing fully aware of the facts and committed criminal breach of trust as such the accused committed offence punishable under Section 406 and 420 of IPC. (emphasis supplied). Any discussion on the case would be incomplete without a proper understanding of the processes involved in IPOs. Accordingly, I proceed to deal with the same IPO Process 6.1. As per information obtained from NSE the IPO process involves the following: 1. The Book Running Lead Manager (BRLM) files the Draft Offer Document (DOD) with SEBI and the stock exchange where the Company proposes to list its securities for their comments/approval. 2. The stock exchange checks as to whether the applicant company is eligible as per the listing criteria for listing on the stock exchange pursuant to its Initial Public Offering. 3. Further, the stock exchange also checks details on the background of the promoters, disclosures made by the Company in the Draft Offer Document including the risk factors mentioned therein etc. 4. The stock exchange thereafter provides an in-principle approval for enabling the company to mention in the offer document that the shares after the issue are proposed to be listed on the stock exchange named therein. Page 22 of 191

23 5. After the in principle approval of the stock exchange is issued, and subject to approvals they have to obtain from SEBI and other authorities, if any, the Issuer company can make the public issue Book Building Book building is an electronic mechanism for collection of orders through the IPO infrastructure of the Exchanges. The members who are eligible for using the IPO system or who are entitled to enter the bids are decided by the BRLMs to the issue. (These stock brokers selected by the BRLMs for accepting bids are called syndicate members). The bid data collected through the book building process is provided by the stock exchanges to the Book Running Lead Managers who in-turn forwards the same to the Registrars and Transfer Agent concerned. The physical applications are collected by the Registrars from the banks where the applications and cheques are deposited. The applications are processed by the Registrars and a meeting of the Book Running Lead Managers, Registrars and the Issuer company is held to decide the basis of allotment. The minutes of this meeting which inter alia contain details regarding how the basis has been drawn, total subscription received for the issue, technical rejections, total number of shares to be considered for allotment etc., is submitted to the stock exchanges. To determine the successful allotees, the draw of lots is conducted by the Designated Stock Exchange (draw of lots are done by a SEBI approved Public Representative on the Board of the Designated Stock Exchange) and the basis of allotment is finalised. As such, the stock exchanges do not process or scrutinise the physical application forms or the unique details of the applicants such as addresses, PAN number etc., during the IPO process and hence will not be in a position to ascertain multiple or fictitious applications. On completion of the basis of allotment, the Registrars for the IPO carries out the allotment process by making allotment in accordance with the basis of allotment and then uploading the file containing the details of allotment to the depository which in turn credits the shares to the applicants beneficiary accounts. The Issuer company will then Page 23 of 191

24 submit a certificate from a practicing Chartered Accountant or a Company Secretary confirming that the allotment has been done by the Registrars as per the basis approved by the stock exchange. After the completion of the credit of shares, the depositories issue a certificate indicating that the shares as detailed by the Registrars have been credited to the beneficiary accounts to the Issuer which is in turn submitted to the stock exchanges by the Book Running Lead Manager / Issuer company. A confirmation of the dispatch of refund orders is submitted to the stock exchanges by the Registrars Stages in a Book Built Issue The various stages in the book built issue can be broadly described as under:? In a Book Built Issue, the applicant submits his IPO application along with the cheque / DD to the syndicate member / sub syndicate member for entering bids in the Bid Book.? It is mandatory for the applicant to indicate his demat account particulars in the application form. Thus it is mandatory for an IPO applicant to have a demat account while making application in an IPO. Further, for the purpose of refund of application money, the bank details of the applicant are downloaded by the RTI from the depository system and therefore it is mandatory for the demat account holder / IPO applicant to indicate his bank details in the depository account. Therefore, opening of bank account and Demat account can be considered as the first stage in making application in book built issue.? Upon receipt of IPO application along with the Cheque / DD, the syndicate / sub syndicate member verifies the same and thereafter the syndicate / sub syndicate member enters the bid in the BSE / NSE system and forwards the physical applications along with the cheques / DDs to the collecting bank.? The collecting bank separates the cheques / DDs from the application forms and sends the cheques / DDs for collection and simultaneously forwards the IPO application to the registrar to issue for preparation of application master. Page 24 of 191

25 ? Upon realization of cheques, Banker to the issue (i.e. Collecting Bank) submits the details of the cheques realized along with bank serial number which forms the basis for the RTI to reject application where cheques have not been realized.? The master database is prepared by Registrar to an Issue for the purpose of working out the basis of allotment after weeding out invalid and multiple applications as per applicable criteria.? The Registrar to an Issue, the Post Issue Lead Manager, representative of stock exchange and an official of the issuer company in a meeting decide the basis of allotment and finalise the ratio of allotment.? Based on the approved basis of allotment, registrar to an issue makes allotment to eligible investors and through a process of corporate action, electronic allotment is made to the demat account of the allottee through depository.? Concurrently, the Confirmation of Allotment Note (CAN) is dispatched along with the refund order or refund details (in case of direct credit to the bank account) The above process is completed within 15 days from the date of closure of the IPO. Thus, it can be seen from the above process that essential steps for applying in book built issue are broadly as under: 1. Opening BANK ACCOUNT and DEMAT ACCOUNT 2. Arranging IPO FINANCE 3. Submission of application along with payment instrument (cheque / DD) to syndicate member and BIDDING 4. Receipt of ALLOTMENT / REFUND ORDER 6.5. Karvy group s presence in the entire chain of IPO process I note that on the basis of data on record, Karvy group entities were ubiquitously present in the entire gamut of the IPO process running from introducing bank accounts, opening of dematerialized accounts, arranging IPO finance, bidding of applications, making Page 25 of 191

26 allotment, issuing refund, making off-market transfers (DIS) and sale of IPO shares on the stock exchanges. The role of Karvy group entities at each stage of the process has been examined for uncovering Karvy s role at every stage and to ascertain overall control beginning from opening of bank and dematerialized accounts till making refund and offmarket transfer of IPO shares. The group s presence in the entire IPO process is schematically depicted as under: Introduction of Bank A/cts through tie-up with banks (KCL / KSBL / KSL / KISL) Opening of demat a/cts (KCL / KSBL DP) Arranging bank finance / providing IPO finance (KCL - NBFC) Bidding of applns / RTGS (KSBL - broker) Refund (KCPL - RTI) Allotment (KCPL RTI) Off Market transfers (KCL / KSBL - DP) Sale of shares on the stock exchange (KSBL - Broker) 7.0. Applicable Guidelines 7.1. While opening dematerialized accounts, the DP has to comply with the Know Your Customer (KYC) norms laid down by SEBI through circulars dated August 4, 2000 and August 24, SEBI vide circular dated SMDRP/Policy/CIR- 36/2000 dated August 4, 2000, has prescribed detailed procedure to be followed by all depository Page 26 of 191