Supreme Court Reserves Verdict In Appeals Against Order On Client Securities Sold To Recover Anugrah Stock Broking's Dues

The Supreme Court on Thursday reserved its verdict in a batch of appeals filed by Edelweiss Custodial Services Ltd., Yes Bank Ltd. and SMC Global Securities Ltd.

The appeals arise out of disciplinary proceedings initiated after the collapse of Anugrah Stock & Broking. NSE Clearing alleged that clearing members had sold client securities to recover the broker's proprietary trading dues, contrary to SEBI circulars and exchange regulations.

The Securities Appellate Tribunal (SAT) order, in challenge, upheld directions issued by NSE Clearing Ltd.'s disciplinary committee requiring them to reinstate client securities sold to recover the proprietary trading dues of trading members.

In its December 15, 2023 judgment, the SAT upheld the disciplinary committee's findings that the clearing members had wrongly sold client securities to recover the proprietary trading dues of trading members in violation of SEBI circulars and NSE Clearing regulations. It also upheld the directions requiring restitution of the securities, holding that clearing members could not benefit from the wrongful sale of client securities.

Edelweiss' appeal arises from the sale of client securities worth ₹460.32 crore belonging to Anugrah Stock and Broking to recover the broker's proprietary dues.

It held that Professional Clearing Members are bound by the SEBI circulars and NSE Clearing Regulations governing client securities and upheld the restitution directions, observing that clearing members could not benefit from the wrongful sale of client securities.

A bench of Justices J.B. Pardiwala and K. Vinod Chandran reserved its judgment after hearing the parties.

Senior Advocate Arvind Datar, appearing for NSE Clearing, argued that Edelweiss had not been taken by surprise by the restitution direction, pointing out that it had filed detailed written submissions opposing restitution before the disciplinary committee passed its order.

When the Bench asked whether informing Edelweiss during the hearing that restitution was under consideration would have been sufficient compliance with natural justice, Datar submitted that the expression "penalty" was wide enough to include restitution and that Edelweiss had been given a full opportunity to address the issue.

"Penalty is a term of very wide significance and clearing members cannot be permitted to violate circulars, rules and regulations, take advantage of their own wrong and then contend that they are not required to reverse the damage caused.", Datar submitted.

When Justice Pardiwala questioned the Tribunal's finding that Edelweiss had made a "wrongful gain", asking "What is that wrongful gain?", Datar responded that Edelweiss had sold the securities of innocent clients, retained the sale proceeds instead of recovering them from Anugra, and had "misappropriated ill-gotten gains."

The bench also sought Datar's assistance on whether the SAT could invoke Rule 21 of the SAT (Procedure) Rules, 2000 to sustain the restitution direction.

Datar submitted that the disciplinary committee's power to expel a clearing member necessarily included the lesser power to direct reinstatement of client securities, adding that "the word penalise will take within its fold, a direction for restitution of shares."

Senior Advocate Meenakshi Arora, appearing for Anugrah Stock and Broking, one of the affected trading members, argued that the case reflected a "systemic failure of all regulatory agencies." She submitted that although trading member Anugra had been on the regulators' radar since 2019, investors were never informed.

"An investor has a right to trust and believe in the system. The burden must not shift on the investor. Retail investors are not in a job of checking our accounts on a daily basis.", Arora submitted.

Arora further contended that Edelweiss had a financial incentive to allow Anugra's debit balances to mount as it charged 18% interest on margin shortfalls before ultimately liquidating the securities of clients with no debit balances. Referring to the disciplinary committee's findings, she argued that Edelweiss had failed to verify whether the securities belonged to defaulting clients or even seek client-wise details from Anugra before selling them.

On restitution, Arora submitted that the disciplinary committee had not imposed an additional penalty but merely restored investors to the position they would have occupied had their securities not been wrongfully sold.

"This is not a penalty. This is a correction of the wrong that has been done," she argued, adding that Edelweiss had "wrongly... misappropriated" the securities and therefore "you have to return them back."

Senior Advocate Shyam Divan, appearing for Edelweiss Custodial Services Ltd, submitted that "my constituent is the trading member," "I have a privity of contract with the trading member," and therefore a clearing member "cannot mix up one trading member's margin with another trading member's margin." According to him, "Anugra is the only person with visibility" over individual client accounts, while Edelweiss merely received "pooled securities" from the trading member.

The Bench however, repeatedly questioned this interpretation. Justice K. Vinod Chandran asked, "How will you ensure that there is no utilisation of margin money paid by one client to the margin money dues of other client?" The Bench also referred to Anugra's undertaking that client securities would be used only for their respective positions, asking why such an undertaking had been obtained if Edelweiss owed no obligation to the underlying clients.

Responding, Divan argued that Edelweiss had exercised continuous due diligence, stating, "I did not allow it to balloon to ₹460 crores." He submitted that Anugra had repeatedly been placed in Risk Reduction Mode (RRM), its exposure curtailed, and securities liquidated on several occasions.

Divan further submitted that Edelweiss had informed NSE Clearing that "there is no mechanism or provision to obtain real-time client-wise trading member and client collateral information," making it impossible to monitor individual client collateral directly.

On the disciplinary committee's power to direct restitution, Divan relied on Section 9(3) of the Securities Contracts (Regulation) Act, 1956, contending that exchange by-laws could prescribe only penalties "of a like nature" as fine, suspension or expulsion, and "not involving the payment of money." Referring to the NSE Rules on disciplinary jurisdiction, he argued that the rules "do not mention restitution" and that "you can't ask for restitution."

Concluding his arguments, he relied on Section 11B and Section 12A of the SEBI Act, 1992, submitting that the statutory power to direct disgorgement of wrongful gains rested exclusively with SEBI, not with NSE Clearing or its disciplinary committee.