SAT Order in the matter SEBI VS UBS Securities

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SAT Order in the matter SEBI VS UBS Securities

  1. 1. IN THE SECURITIES APPELLATE TRIBUNAL MUMBAI Appeal No: 97 of 2005 Date of Hearing 09/08/2005 Date of Decision 09/09/2005 Appellant – Represented by: Mr. C.A. Sundaram, Mr. J.J. Bhatt, Mrs. Zia Mody and Mr. P.N. Mody, Sr. Advocates along with Mr. Shuva UBS Securities Asia Ltd. Mandal, Advocate Versus Securities & Exchange Board of India Respondent- Represented by Mr.Rafique Dada, Sr. Advocate along with Mr. Cherag Balsara, Mr. Bhavik Narasana, and Mr. Jayesh Ashar, Advocates CORAM C. Bhattacharya, Member R.N. Bhardwaj, Member Per: R.N.Bhardwaj, Member 1. The appeal has been taken up for final disposal with the consent of both parties. 2. The appeal has been filed by UBS Securities Asia Limited, (‘UBS’ for short) against the impugned order dated 17/05/2005 issued by the Whole Time Member, SEBI, the operative portion of which reads as under: “11.1 The findings in this case have highlighted serious regulatory concerns in that the PN/ODI route and its cover of anonymity is being used by certain entities without there being any real time check, control and due diligence on their credentials. Such a lapse has very grim portents as far as the market integrity and interest of investors are concerned. The mechanism of opening up the Indian securities market through PN /ODI route to
  2. 2. entities outside India imposes a commensurate onus on the registered intermediaries (FIIs) of maintaining high standards of regulatory compliance, exercise of high due diligence and independent professional judgment and therefore any gaps in measuring up to the onus may be fraught with critical repercussions in the market. “11.2. In the light of the above and in exercise of the powers conferred on me in terms of Section 19 of the SEBI Act, 1992, read with Section 11(4) and 11B of SEBI Act, 1992, I hereby prohibit UBS / its affiliates / agents from issuing off-shore derivative instruments with underlying Indian securities against the positions held by UBS in the Indian securities market for a period of one year. I also prohibit UBS / its affiliates / agents from renewing or rolling over any of the ODIs already issued against the positions held by it in the Indian securities market for a period of one year. “11.3. I further direct UBS to establish highest standards of Customer Due Diligence process in line with the requirements of FII Regulations of SEBI. “11.4. This is without prejudice to any other action taken or to be taken by SEBI against UBS in accordance with the provisions of SEBI Act, 1992, the Regulations made thereunder or any other law as may be applicable. “This order shall come into force with immediate effect.” 3. UBS Securities Asia Limited, i.e., the appellant, is a licensed securities company in Hong Kong and is part of UBS Investment Bank which is Headquartered in New York and London. The appellant is a Foreign Institutional Investor (FII) registered with SEBI. Swiss Finance Corporation (Mauritius) Limited (‘SFCML’ for short) is registered as a proprietary sub-account of the appellant. UBS AG London issues Offshore Derivative Instruments (‘ODI’ for short) to its clients located outside India in accordance with FII Regulations and simultaneously hedges its risk on such ODIs with SFCML on the basis of a swap transaction under an ISDA Master Agreement. SFCML in turn invest in the Indian securities market. Investors in ODIs are clients of UBS London and not of the appellant. 4. SEBI investigated a steep fall in the Indian stock market on 17 th May, 2004 with sensex falling by 567.74 points and NIFTY fell by 196.90 points. It resulted in temporary stoppage of trading twice on major stock exchanges i.e., BSE and NSE during the day. Such a fall in the market was unprecedented in the history of Indian stock market. SEBI rightly wanted to find out the reasons of such a crash in the market on 17/05/2004 and they found from their enquiry that UBS Securities Asia Limited was a major participant which sold securities to the extent of Rs. 188.35 crores in the cash market segment on 17th
  3. 3. May, 2004. It was also a significant participant in the derivative segment (F&O) of the Indian securities market during May, 2004. It had built up NIFTY Futures Short positions to the extent of Rs. 434/- crores and Stock Futures short positions to the tune of Rs. 292/- crores. SEBI found from its investigations that UBS had also sold large quantity of securities on May 17, 2004 on behalf of various entities to which UBS AG, London, had issued Offshore Derivative Instruments. SEBI suspected that sudden fall in the market on 17/05/2004 could have been triggered by UBS playing “ducks and drakes with the market”. It put selling pressure in the market which was not related to fundamentals of the scrip. SEBI wanted to investigate whether the conduct of UBS and other players on 17/05/2004 was in violation of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003. 5. SEBI therefore called for information from UBS relating to its major ODI clients in terms of their addresses, the names of their Directors, Fund Managers, Major Shareholders, Top 5 Investors, etc. It wanted to ascertain the details of the ultimate beneficiaries as to whom the ODIs were issued by UBS AG, London. There was a protracted correspondence between UBS and SEBI for obtaining the above mentioned information. UBS informed that this information was not readily available with them and they would have to get it from the clients of UBS AG, London because even UBS AG, London also did not have this information. It also informed SEBI that some of the clients might not give the information to UBS due to confidentiality reasons but they would prefer to give directly to SEBI which is a regulator. It was also because some of the clients were dealing with other FIIs also, therefore, they would feel more comfortable in giving this information to a Central Regulatory Authority, i.e., SEBI. SEBI felt that the flow of information from UBS was delayed and tardy and in some crucial cases the information was not forthcoming even after numerous exchange of e-mails and personal meetings by UBS representatives with SEBI officials. Therefore a detailed show cause notice dated 24/11/2004 was issued to UBS. The show cause notice was issued under Section 11(4) and 11B of the SEBI Act, 1992 read with Regulations 15A, 20 and 20A of Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995 (“FII Regulations” for short) and Clauses 1, 2, 5 and 6 of the Code of Conduct as specified in Regulation 7A of the FII Regulations. The show cause notice required from UBS inter alia the names and addresses of major shareholders and names of 5 top investors in respect of the major clients of UBS. They were also advised to confirm that none of the investors of their clients were Indian nationals, persons of Indian origin, or overseas corporate bodies “which are majority owned or controlled by Non-Indian resident”. 6. The show cause notice contains details of the information called for and received about various clients of UBS up to the date of issue of show cause notice i.e., 24/11/2004. It finally said that UBS did not give the required information in respect of the following six clients which are mentioned in the show cause notice:
  4. 4. S.N Information Not Provided by the Name of Client o Appellant 1. Caxton InternationalSpecified details of the Limited shareholders 2. Indus Asia Pacific FundExpressed inability to disclose the Ltd. name and addresses of the top five investors for investments in Indian securities during May, 2004, directors and major shareholders pursuant to the fund’s organizational documents. 3. ROHATYN Did not release the names of top five investors to SEBI shareholding 4. Indea Capital Pte. Ltd. Declined to reveal information on the investors and shareholding 5. PMA Prospect Fund Declined to furnish the names and addresses of top five largest investors in the funds citing reasons of confidentiality 6. Satva Asia Opportunities Declined to provide the names of Master Fund investors of the fund. 7. The show cause notice further said that UBS has failed to furnish complete information in respect of their clients as sought by SEBI. It says: “Thus UBS has failed to furnish complete information in respect of their clients as sought by SEBI. The information so far furnished by UBS was obtained after repeated follow ups resulting in delay in investigations. Thus UBS has failed to comply with the Regulation 20 and 20A of SEBI (Foreign Institutional Investors) Regulation, 1995. UBS has also violated clauses 1, 2, 5 and 6 of Code of Conduct as specified in Regulation 7A of SEBI (Foreign Institutional Investors) Regulation 1995.”
  5. 5. 8. The show cause notice stated that UBS failed to comply with the KYC (Know Your Clients) requirements as specified in Regulation 15A of the FII Regulations read with Circular No. IMD/Cust/8/2003 dated 08/08/2003. The show cause notice further stated that for not furnishing the information reasons were not satisfactory as Regulation 20A of FII Regulations clearly stated that FIIs are required to fully disclose information about “terms of and parties to” ODIs relating to any securities listed in stock exchanges in India as and when SEBI may need. 9. In view of what is stated above the show cause notice finally asked UBS to show as to why directions under Section 11(4) and 11B of SEBI Act, 1992 including directions to prohibit UBS from “dealing in securities on behalf of and/or its clients in respect of whom it does not have information on their underlying investors” should not be issued against it. UBS was asked to submit their reply within 15 days from the date of receipt of the notice. 10. UBS replied to the show cause notice on 22/12/2004 wherein they submitted that they have not violated any of the FII Regulations mentioned in the show cause notice, neither have they violated the Code of Conduct under Regulation 7A of the FII Regulations. They further submitted that they had been cooperating with SEBI in furnishing the required information which they were not obliged to maintain in terms of FII Regulations. They submitted that whatever information was available with them was submitted to SEBI promptly and whatever additional information which SEBI wanted but which was not required to be maintained by them in terms of FII Regulations was promptly conveyed to their UBS, London clients in London. It followed up with them to give the necessary information to SEBI. They have been advising and persuading their clients to submit the required information and getting the same from their London and New York offices to comply with the investigation requirements of SEBI. They further submitted that they had not violated the provisions of Know Your Client (KYC) requirement of Regulation 15A(1) of FII Regulations. UBS provided additional information to SEBI on 14/01/2005 and through a confidential letter of 13/05/2005. 11. SEBI passed the impugned order of 17th May, 2005 after taking into account all the submissions, documents, reply to the show cause notice, information supplied by UBS after the issuance of show cause notice and the personal hearing on 1 st February, 2005, and May 5, 2005. The order says: “11.2. In the light of the above and in exercise of the powers conferred on me in terms of Section 19 of the SEBI Act, 1992, read with Section 11(4) and 11B of SEBI Act, 1992, I hereby prohibit UBS / its affiliates / agents from issuing off-shore derivative instruments with underlying Indian securities against the positions held by UBS in the Indian securities market for a period of one year. I also prohibit UBS / its affiliates / agents from
  6. 6. renewing or rolling over any of the ODIs already issued against the positions held by it in the Indian securities market for a period of one year. “11.3. I further direct UBS to establish highest standards of Customer Due Diligence process in line with the requirements of FII Regulations of SEBI. 12. The findings of SEBI in the impugned order are based on the investigations, show cause notice, reply to the show cause notice, oral and written submissions by UBS and its Advocates including the written submission on 13th May, 2005 which was after the conclusion of the personal hearing on 05/05/2005. The order brings out following issues for consideration: i. UBS failed to comply with Know Your Client (KYC) requirement as laid down in Regulation15A of the FII Regulations. ii. UBS failed to furnish complete information about names and addresses of top five shareholders / investors of its clients on 17/05/2004 which was sought by SEBI during the course of investigation. iii. The flow of information from UBS to SEBI was tardy and came after repeated follow up by SEBI which scuttled the investigation by SEBI iv. In the process, UBS also violated the Code of Conduct as prescribed under the third schedule of Regulation 7A of the FII Regulations. v. UBS by its various acts of omission and commission was found guilty of non-compliance of Regulation 15A which required compliance of Know Your Client and Regulation 20 and 20A of FII Regulations i.e., non- submissions of information pertaining to top five investors / shareholders, fund manager and Directors of Fund as requested by SEBI. vi. These acts of non-compliance of FII Regulations by UBS were detrimental to the integrity and orderly development of securities market and therefore directions under Section 11B and Section 11(4) of SEBI Act, 1992 were required to be issued. 13. UBS has failed to Comply with Regulation 15A of FII Regulations: The impugned order goes on explaining and detailing how UBS violated Regulation 15A of FII Regulations which reads as under:
  7. 7. “15A. (1) A Foreign Institutional Investor or sub-account may issue, deal in or hold, off-shore derivative instruments such as Participatory Notes, Equity Linked Notes or any other similar instruments against underlying securities, listed or proposed to be listed on any stock exchange in India, only in favour of those entities which are regulated by any relevant regulatory authority in the countries of their incorporation or establishment, subject to compliance of “know your client” requirement : “Provided that if any such instrument has already been issued, prior to the 3rd February, 2004, to a person other than a regulated entity, contract for such transaction shall expire on maturity of the instrument or within a period of five years from the 3rd February, 2004, whichever is earlier. “(2) A Foreign Institutional Investor or sub-account shall ensure that no further down stream issue or transfer of any instrument referred to in sub- regulation (1) is made to any person other than a regulated entity.” 14. The above regulation has come into effect from February 3, 2004. The rationale behind inserting this new regulation has been to avert another possibility of market scam which happened during early 1999 to March, 2001. The rationale to incorporate the new FII Regulation 15A was to know the investor’s particular details of participatory notes against underlying securities of investments in shares. Participatory notes are extra territorial instruments over which SEBI has no regulatory jurisdiction over them. Such instruments have been earlier used to manipulate the Indian securities market. Therefore, JPC’s recommendation was to prevent undesirable entities from dealing in Indian securities market to destabilize the securities market of India. The Regulation 15A(1) mentioned that a Foreign Institutional Investor may issue off-shore derivative instruments such as participatory notes against underlying securities only in favour of those entities which are regulated by any relevant regulatory authority in the countries of their incorporation. It further says that it is subject to ‘Know Your Client’ (KYC) requirement. It was thought desirable not to allow any unregistered and unregulated entities to invest in the Indian market. 15. It is not sufficient that the entity be only a regulated entity. The order further takes note of the reply given by UBS that these entities to whom ODIs were issued by UBS AG, London were of ‘Know Your Client’ (KYC) compliant entities and UBS London is a FSA compliant organization. It is also necessary that when the ODIs have been issued against the securities listed in the Indian market, they should also comply with the requirements of Indian regulator i.e., ‘Know Your Client’ (KYC) requirement of Regulation 15A of FII Regulations. It should be possible to know the names and addresses of the investors and shareholders as and when asked for by the regulator.
  8. 8. Whatever ‘information’ SEBI sought from UBS pertained to KYC – i.e., Regulation 15A of the FII Regulations. 16. SEBI could not accept the contention of UBS that ODIs have been issued by an affiliate i.e., UBS AG, London, of the FII (i.e., UBS Securities Asia Limited) which is a regulated entity in London and accordingly the requirements stipulated in Regulation 15A of FII Regulations were not applicable in its case. The fact that UBS London has provided access to the offshore clients through ODIs to Indian securities market, it has to verify their antecedents and also ensure that KYC norms as specified in Regulation 15A are fully adhered to. 17. The impugned order notes that the KYC guidelines issued by UBS itself are applicable to UBS and SFCML and also to UBS AG, London. The Customer Identification Program (CIP) of UBS clearly mentions that: “knowing who our customers are includes knowing the people and the entities we deal with as well as knowing the ultimate beneficiary of the transactions we undertake……” The fundamental question to keep in mind through the process is simply that UBS is certain that it know the true identity of those with whom UBS is doing business” It is therefore necessary to look through the various entities in the ownership chain to determine the identity of beneficial owner. 18. According to SEBI, it is clear that UBS has not followed its own internal guidelines which required it to identify the ultimate beneficiaries of entities on whose behalf UBS or its affiliates transact. Therefore the contention of UBS that it does not know the beneficiaries of entities on whose behalf ODI have been issued against underlying Indian securities is a clear violation of the KYC norms of UBS itself. As per SEBI, KYC is a very basic commercial requirement which does not require any formal definition or prescription. In the light of the fact that UBS did not supply the required information to SEBI, there were only two possible inferences: (1) UBS did not comply with the requirements of Regulation 15A and thus violated its provisions; (ii) UBS had the required information in its possession or had access to it but did not furnish the information in time to SEBI would mean violation of Regulations 20 and 20A of FII Regulations. If UBS had followed either its own internal guidelines or what is required under Regulation 15A of FII Regulations, it would have been able to supply SEBI necessary information. In view of what is stated above, it is obvious that UBS violated Regulation 15A of FII as it did not follow the KYC norms.
  9. 9. 19. Non-Furnishing of Information: SEBI had asked in the show cause notice names and addresses of top five investors details of shareholders in respect of six of its clients. It is noticed that excepting Caxton International Limited, for which information had not been received till the date of impugned order, the information in respect of other five cases mentioned in the show cause notice had been provided to SEBI without the address. In respect of Caxton International Limited, UBS has neither provided the names of top five investors of the 100% shareholders nor their addresses. 20. A Question arises whether UBS was in possession of information or UBS could have accessed the information but it failed to obtain the same and submit to SEBI. In response to the request from SEBI to provide the names of ODI clients with Indian underlying securities UBS stated that all counter parties were major institutional investors and they were classified as regulated entities according to FII Regulation15A and on this basis information relating to Directors and major shareholders were not provided. SEBI, however, did not accept this contention of UBS and repeatedly sought the names and addresses of the underlying clients, their respective shareholders, Directors and Fund Managers on whose behalf UBS had dealt with in cash market on 17/05/2004 / taken positions in Indian securities market on May 3, May 14 and May 20, 2004. In response to SEBI’s request, UBS provided the addresses of 21 of their clients and names of principal Directors in respect of two of its clients, (namely, Satva Asia Opportunities Master Fund and Aman). UBS did not furnish the information in respect of six of their major clients as detailed in the show cause notice. UBS also said that majority of their clients are incorporated in Europe and America and that they have their offices in London and New York. It could take some time before they would be able to furnish the information. UBS could obtain the information pertaining to five clients out of six mentioned in the show cause notice excepting Caxton International Limited and furnished the same to SEBI. In the light of the above, an inference was drawn that UBS did possess the required information which was sought by SEBI or it was in a position to have accessed the information if it so desired. UBS has given certain information after much follow up but for rest of the information it was biding the time to avoid furnishing of the information. It was concluded in the impugned order that UBS was making selective disclosure under the pretext of not having information and thus they were not making a clean breast of the whole thing. 21. Non-Compliance of Regulation 20 and 20A of the FII Regulations. It says: “20. Every Foreign Institutional Investor shall, as and when required by the Board or the Reserve Bank of India, submit to the Board or the Reserve Bank of India, as the case may be, any information, record or documents in relation to his activities as a Foreign Institutional Investor as the Board or as the Reserve Bank of India may require”.
  10. 10. “20A. Foreign Institutional Investors shall fully disclose information concerning the terms of and parties to off-shore derivative instruments such as Participatory Notes, Equity Linked Notes or any other such instruments, by whatever names they are called, entered into by it or its sub-accounts or affiliates relating to any securities listed or proposed to be listed in any stock exchange in India, as and when and in such form as the Board may require.” 22. UBS had argued in its reply to show cause notice that as per Regulation 20A of the FII Regulations, the obligation of UBS is to disclose only the “terms and parties” to offshore derivative instruments such as participatory notes, equity linked notes entered into by it. There was no obligation to record / details of top five investors and major share holding of the clients. 23. The impugned order did not accept the interpretation in 20A concerning “terms and parties to offshore derivative instruments”. It concluded that UBS should have information and details to enforce the agreements with their clients. 24. The impugned order further said that Regulation 20 of FII Regulations was of much wider scope which casts an obligation on the FII to submit to the Board / RBI “any information, record or documents in relation to his activities as a Foreign Institutional Investor”. 25. In the light of aforesaid, the information sought by SEBI was well within the realm of Regulations 20/20A and UBS was obliged to supply the same under the FII Regulations. 26. Investigations were hampered by contumacious conduct of UBS: The show cause notice alleged that the investigations were hampered because of the contumacious conduct of UBS. SEBI wanted to conduct an investigation about the reasons of an unprecedented market crash on 17th May, 2005 since UBS was one of the major market participants on that day in both cash and derivative segment (F&O). SEBI asked UBS along with other information to give the names of major shareholders and names of top five investors in respect of major clients of UBS. It had also sought the confirmation from UBS that none of the major investors of its clients are Indian nationals, persons of Indian origin or overseas corporate bodies which are majority owned or controlled by NRI. The information was given belatedly on persistent follow up and in respect of Caxton International Limited, the largest client of UBS, the required information was not given till 17th May, 2005 i.e., the date of the impugned order. Despite vigorous follow up by SEBI and UBS, Caxton International did not furnish information regarding their major shareholders/investors, etc. SEBI again reminded UBS to obtain the said clients’ names and addresses of their top five shareholders / investors. In view of non receipt of
  11. 11. information SEBI wrote to Securities Exchange Commission, USA and in January, 2005, SEC, furnished the requisite information to SEBI including the client agreement entered into by UBS AG and Caxton International Limited. SEBI had asked UBS to supply copies of KYC and client agreements with Caxton International Limited, Discovery Capital and Indea Capital Limited. UBS wrote on 13/05/2005 that they had already sent the Know Your Client procedure and the agreement with three clients which were understood by them as business terms and conditions of UBS AG London, branch and not the ISDA agreements. It was strange that UBS did not understand the requirement of ISDA agreement and sent only terms and conditions. It is mentioned in the impugned order that all this hampered conducting investigation leading to valuable loss of time for conducting a meaningful investigation. SEBI could get the copy of the agreement between UBS AG and Caxton International Limited through Securities Exchange Commission (SEC), USA during January, 2005 and it could get client agreement between UBS AG and Discover global Opportunity Master Fund Limited and Indea Absolute Return Fund only on April 29, 2005. Therefore it could not conduct a meaningful investigation in real time. UBS, therefore, according to SEBI, did not give the information timely and it virtually thwarted the investigation. If UBS had any doubt about the information, it could have sought clarification from SEBI regarding actual requirement of SEBI. The impugned order says “The conduct of UBS as narrated above speaks for itself and for the purpose of determining the Contumacious Conduct of UBS, I do not find it necessary to go into the notices of UBS for not-cooperating to the requests of the regulator. The egregious conduct of UBS is evident from the circumstances as mentioned above.” The delay in the receipt of information erodes its value as an evidence in a real time enquiry. 27. Incidence of reporting lapses and mis-statement: UBS had cited confidentiality provisions in its client agreement as reasons for non-furnishing of information. The fact that it could provide information as sought by SEBI in respect of many of its client but did not provide similar information in respect of its other clients shows that client confidentiality provisions was not a restraining factor. Some clients provided information directly to SEBI. Thus failure to provide information to SEBI was due to the reluctance of UBS to furnish information. UBS provided some vague information while furnishing the names of top five investors of Indus Asia Pacific Fund Ltd., on 14th January, 2005, but later on when SEBI asked for specific information it gave the names of top five investors to SEBI which shows that it was in a position to access the information but it did not submit the same to SEBI. When SEBI asked for copies of client agreement with three of its clients, namely, Caxton International Limited, Discovery Capital and Indea Capital Limited, UBS submitted the “terms and conditions”
  12. 12. of a proforma agreement but later on it submitted the copies of the client agreement with two clients viz., Discovery Capital and Indea Capital Limited, on 29 th April, 2005 subsequent to personal hearing on 1st February, 2005 and 5th May, 2005. 28. During personal hearing, it was mentioned by UBS representatives that all information sought by SEBI had been provided to SEBI including ultimate investors of Caxton International Limited. However, vide their letter dated 13th May, 2005 UBS admitted that it did not possess the information about Caxton International Limited. It shows that the claim of submission before the Investigating Officer on 5th May, 2005 was not correct. It was also noticed that UBS had not been including the name of Caxton International from January, 2005 in the monthly ODI statement submitted to SEBI every month. UBS has stated that it was an inadvertent error and regretted the same. This particular instance was not a part of show cause notice but it is cited as a “relevant antecedent in a continuum of what permeates the case history to make a talking point that cocking a snook at the regulating requirements is the staple of the conduct of UBS” 29. Non adherence to Code of Conduct: UBS has been charged with the violation of clauses 1, 2, 5 and 6 of Code of Conduct as specified under Regulation 7A of FII Regulations. The code of conduct states that: “1. a Foreign Institutional Investor and its key personnel shall observe high standards of integrity, fairness and professionalism in all dealings in the Indian securities market with intermediaries, regulatory and other government authorities.” “2. A foreign Institutional Investor shall, at all times, render high standards of service, exercise due diligence and independent professional judgment.” ………. “5. A foreign Institutional Investor shall maintain an appropriate level of knowledge and competency and abide by the provisions of the Act, regulations made thereunder and the circulars and guidelines, which may be applicable and relevant to the activities carried on by it. Every foreign Institutional Investor shall also comply with award of the Ombudsman and decision of the Board under Securities and Exchange Board of India (Ombudsman) Regulations, 2003. 30. According to SEBI, UBS should have been in a position to know the ultimate client for whom the ODIs have been issued by UBS AG, London against the underlying Indian securities held by it. It should have been able to ascertain from UBS AG, London, and give the information to the regulator in time. The claim of UBS that KYC norms are
  13. 13. not applicable to UBS is not acceptable to SEBI. UBS has failed to give information about Caxton International Limited and timely information pertaining to other cases to the regulator and this frustrated the investigation. UBS even submitted misleading information to the regulator about offshore derivative instrument statements which did not include the name of Caxton International Limited. The counsel of UBS made a wrong statement before the Investigating Officer that it had provided all information including the top five investors of Caxton International Limited which was incorrect. The impugned order says: “Conduct is generally judged not based on single activity; but on a course of behaviour showing intentional non-cooperation with the regulator and is usually the result of acts, practices and the like approaches that are designed to give the slip to the regulator.” The conduct of the appellant was detrimental to the orderly development of the securities market. 31. Considering all these factors UBS failed to maintain high standards of integrity, fairness and professionalism in all dealings in the Indian securities market with the regulatory authority and comply with the relevant clauses of the Code of Conduct as applicable to FII. In view of the above, UBS is found guilty of non-compliance of Regulations 15A, 20 and 20A and Clauses 1, 2, 5 and 6 of Code of Conduct under Regulation 7A of the FII Regulations. It has failed to exercise due diligence in dealing with its clients and the regulator. It has failed to maintain appropriate level of knowledge and competency. UBS has made selective statements and even suppressed material facts in documents and reports to SEBI. 32. Learned senior counsel for the appellant, Shri C.A. Sundaram, submitted that the impugned order by SEBI is not justified as there is no failure on the part of the appellant to comply with the Regulations 15A, 20 and 20A of the FII Regulations and Clauses 1, 2, 5 and 6 of the Code of Conduct of the FII Regulations. He argued that the main charge against the appellant was that it did not furnish information of top five clients / investors to SEBI for conducting the investigation, and that it violated the KYC requirement as prescribed in Regulation 15A of the FII Regulations. The learned senior counsel submitted that it would have submitted the required information to SEBI on time had it been clearly mentioned in the Regulations applicable to FII. The Regulation 15A of FII Regulations, which reads as under: “15A. (1) A Foreign Institutional Investor or sub-account may issue, deal in or hold, off-shore derivative instruments such as Participatory Notes, Equity Linked Notes or any other similar instruments against underlying securities, listed or proposed to be listed on any stock exchange in India, only in favour of those entities which are regulated by any relevant
  14. 14. regulatory authority in the countries of their incorporation or establishment, subject to compliance of “know your client” requirement : “Provided that if any such instrument has already been issued, prior to the 3rd February, 2004, to a person other than a regulated entity, contract for such transaction shall expire on maturity of the instrument or within a period of five years from the 3rd February, 2004, whichever is earlier. “(2) A Foreign Institutional Investor or sub-account shall ensure that no further down stream issue or transfer of any instrument referred to in sub- regulation (1) is made to any person other than a regulated entity”. 33. The learned senior counsel for the appellant submitted that a plain reading of the Regulation 15A it makes quite clear that it does not call for knowing the ultimate beneficiary or the persons behind the client who has entered into an agreement. Nowhere is it mentioned that the names and addresses of top five investors / clients should be maintained by the FII and provided to the regulator. All that it says is that derivatives such as Participatory Notes can be issued by the FII in favour of only those entities which are regulated in the countries of their incorporation subject to compliance of Know Your Client (KYC). Nowhere KYC requirement has been defined in the FII Regulations or in any other laws/rules/regulations/byelaws relating to FIIs. The learned senior counsel pointed out that it is not possible to give a definite and certain meaning to the KYC as it is mentioned in Regulation 15A. He argued that any interpretation of the KYC which is to be understood, should be seen in the light of the circular dated 8th August, 2003 issued by SEBI, the Respondent, prescribing various formalities in relation to the reporting of information in respect of ODIs to SEBI. The annexure to the circular prescribes the detailed items to be disclosed as to the ‘terms and parties’ to the offshore derivative instrument. He argued that neither the FII Regulations nor any other available indicators of the standards of KYC requirement could support the findings in the impugned order that identity of the top five investors / shareholders of a corporate client is an essential requirement of KYC in terms of Regulation 15A of FII Regulations. 34. The learned senior counsel pointed out to the paragraph 6(22) of the impugned order which says “ ‘Know Your Client’ is a very basic commercial requirement which does not require a formal prescription”. He submitted that in the light of such KYC requirement which is not exact as is admitted by the Respondent itself and which has not been defined by the respondent there could not be any legal obligation on the part of the appellant to maintain and obtain information pertaining to the names and address of the major shareholders / top five investors. The reasoning is flawed. The learned senior counsel again pointed out to paragraph 9.13 of the impugned order which holds that:
  15. 15. “It is the duty of UBS that prior to issue of ODIs with underlying Indian securities it should have been completed the ‘know your client’ requirements by asking its clients all the questions that the regulator (i.e., SEBI) is likely to ask. Instead, UBS claims to have approached its respective clients after SEBI sought information regarding these clients. This shows that UBS has failed to understand the essential meaning of ‘know your client’ requirements.” 35. He submitted that SEBI has sought to impose an indeterminate standard as it expects the appellant to anticipate correctly all the questions that the respondent may “likely to ask or may ask in future.” He submitted that it is impossible to satisfy such a requirement. SEBI should have made known questions which are likely to be complied with by the FIIs instead of leaving them to be imagined by the FII to respond when SEBI asked such questions. The KYC requirement in terms of Regulation 15A of FII Regulations should have been more exact and precise. 36. The learned senior counsel again pointed out to paragraph 6.23 of the impugned order which states that: “It is the duty of UBS / its affiliate that prior to issue of ODIs against underlying Indian securities, it should have completed the ‘know your client’ requirements by asking its clients all the questions that the regulations required.” 37. The learned senior counsel submitted that the regulations do not prescribe any specific question which should have been asked by the appellant. He submitted that in the absence of any clear guidance from the respondent and the regulations the scope and extent of KYC requirement under Regulation 15A of the FII Regulations would be highly inexact and flexible because the interpretation would be left to the respondent at subsequent point of time. He went on to argue that the phrase ‘know your client’ has not been defined by the respondent anywhere. He argued that in the absence of a clear definition in the provision, the regulation cannot be given a wide interpretation against the accused. Further there could not be any case against the appellant if it does not arise from a reasonable construction of the statute. Because of any ambiguity in the law, the Court must lean towards the construction which exempts the accused from the penalty. 38. The learned senior counsel further argued that the requirement of verifying that the first level of clients are regulated entities is clearly stipulated in Regulation 15A(1) of the FII Regulations. The respondent by its circular dated 19th February, 2004 has defined the scope of ‘regulated’ for the purpose of Regulation 15A. It defines that any entity incorporated in a jurisdiction that requires filing of constitutional and/or other documents with a registrar of companies or comparable regulatory agency or body under the
  16. 16. applicable companies legislation in that jurisdiction or an entity that is regulated, authorized or supervised by a Central Bank, like Bank of England, the Federal Reserve, The Hong Kong Monetary Authority, the Monetary Authority of Singapore or any other similar body provided that the entity must not only be authorized but also be regulated by the aforesaid regulatory bodies, or an entity which is supervised by Securities of Futures Commission such as the Financial Services Authority (FSA), Securities and Exchange Commission (SEC) or an entity which is a member of the securities or futures exchanges such as the New York Stock Exchange, London Stock Exchange, etc. The learned senior counsel argued if the law required that the ultimate beneficiaries of the ODIs should also be ascertained by the FIIs, the FII Regulation should have specifically said so and it should have prescribed the requirement of a compliance report in this respect also. The FII Regulation has not stated any such requirement. The Regulation 15A(2) of the FII clearly states that only requirement for any further down stream issue or transfer of ODI is to ascertain that further down stream issue or transferring of such OID is only to be done to a regulated entity. Therefore the impugned order is beyond the scope of Regulation 15A of the FII Regulations. 39. The learned senior counsel submitted that the impugned order makes an allegation that UBS has not complied with its own internal KYC policies / guidelines. He submitted that ODIs were issued by UBS AG, London which is regulated by UK FSA. He submitted that all the clients of UBS AG, London have complied with the FSA,UK requirement of KYC and UBS AG London does not have the requirement of obtaining the names and addresses of five top investors / shareholders as part of the KYC requirement under the CIP. It was submitted that the appellant was required to provide a monthly undertaking as to the ODIs not being issued /subscribed / purchased directly or indirectly by Indian resident, NRIs, OCBs or PIOs. In this regard it was submitted that the appellant ensured that in all cases the ODIs were not issued / subscribed / purchased by such persons and was fully aware of the identity of the purchasers / subscribers of such ODIs. The learned senior counsel argued that the undertaking only required UBS London to ensure the compliance of above mentioned undertaking as to the first level of subscribers / purchasers, namely, as to the identity of the clients to whom ODIs were issued and not as to top five investors or ultimate beneficial owners. He submitted that world wide financial markets and dealings relied upon certificates representation and warranties of clients. It is pertinent to note that the investors and the clients keep on changing and it was practically difficult to maintain this information. It is therefore not clarified by the respondent how often a FII is expected to keep information about changing of its clients’ top five investors / ultimate beneficiaries. 40. The learned senior counsel submitted that the respondent had relied only on preamble of ‘Know Your Client Policy Summary’ of the appellant which states that the purpose of CIP is to determine the true identity of each of its customer. However, the detailed specific KYC / CIP requirement are dependent on specific conditions based on
  17. 17. geographical location of the client, regulatory status, nature of the client, type of business of the client and business to be done with the client, risk participation, etc. Schedule A of Client Identification Program (CIP) did not require UBS AG, London to establish the details of ultimate beneficial owners of the client in question. In fact even the UK FSA, which is the regulatory authority for UBS AG, London does not require the same. There are significant variation in KYC requirement in different countries and therefore it cannot be said that KYC is a “basic commercial requirement not requiring a formal prescription”. There was no obligation under the laws of UK for UBS AG, London to have ascertained the details of the top five investors / shareholders. There was no obligation to know the ultimate beneficial owners in the form of natural persons as alleged by the respondent. In any case, the appellant could not be penalized for non- observance of its internal policy. In order to justify penalty the respondent has to demonstrate that the appellant has clearly violated a provision of law or of FII Regulations. It is relevant here that neither the Regulation 15A of the FII Regulations clearly defines the KYC requirement nor the reporting format prescribed by SEBI circular dated 8th August, 2003, requires the details of top five investors / shareholders. The learned senior counsel further submitted that the KYC requirement of FSA, UK; SEC, USA and the Hong Kong Securities Futures Commission who are signatories to the FATF FORTY recommendations do not require ultimate beneficial owners’ information or major shareholder or top five investors in all cases. 41. He also submitted that FII industry, even now, is not clear about the KYC requirement. He pointed out to the letters dated 08/06/2005 of ISDA which is a Global Trade Association representing over 600 institutions from 47 countries including India, letter dated 18/05/2005 of Merrill Lynch and Citi Group letter dated 16/05/2005 and it was pleaded that there were areas of uncertainty and ambiguity about the KYC requirement under Regulation 15A of the FII Regulation which are causing great concerns for market participants in the FII industry. They were not quite sure of the KYC requirement under FII Regulations. A request was made in the latter for “guidelines setting out the minimum KYC requirement that FIIs should meet under the Regulations” 42. The learned senior counsel pointed out that the SEBI (Stock Brokers) Regulation have been modified in October, 2004 which stipulates the KYC requirement but under Regulation 15A of the FII Regulation there is no requirement to obtain the same type of details of the shareholders or ultimate beneficiaries. The learned senior counsel also submitted that when the Tribunal had asked the respondent to clarify to the entire industry what it meant by KYC through an affidavit, the Respondent filed an affidavit dated 04/08/2005 merely stating its position as mentioned in the impugned order. In view of the vagueness of the KYC requirement under Regulation 15A of the FII Regulation and in view of the established legal proposition that a provision which if violated is visited with a penalty should be strictly construed in favour of the accused i.e.
  18. 18. to say if the language of the provision is not clear it cannot be interpreted to the disadvantage of the accused. He cited the following case laws: (i) Dilip Kumar Sharma v. State of MP AIR 1976 SC 133; (ii) Tolaram Relumal v. State of Bombay AIR 1952 SC 496; (iii) Samir C. Arora v. SEBI (Appeal No. 83/2004) The learned senior counsel submitted that the appellant is required to provide a monthly undertaking as to the ODIs being issued / subscribed / purchased directly or indirectly by Indian residents, NRIs, OCBs (other corporate bodies), PIOs (Persons of Indian Origin). He submitted that the appellant had ensured in all circumstances that the ODIs were not issued / subscribed / purchased by such persons as mentioned above and the appellant was fully aware of the identity of the purchasers / subscribers of such ODIs. Further more, UBS AG, London obtained warranties from the clients on the basis of which the appellant was in a position to give monthly undertaking in compliance to SEBI. He further argued that there was no evidence whatsoever to suggest that any undertaking had been breached. There was no such allegation made by the Respondent also. The undertaking only required UBS AG, London to be satisfied as to the first level of information about the identity of the clients to whom ODIs were issued. There was no mention of top five investors or ultimate beneficial owners because UBS AG London only required to confirm that the clients to whom ODIs were issued were not NRIs or PIOs or OCBs with major shareholding of Indian origin persons. As per Regulation 15A(2) of the FII Regulations the only requirement for any further down stream issue or transfer of ODIs is to ascertain that further down stream issue or transferring of such ODIs is only to a “regulated entity”. 43. The learned senior counsel argued that impugned order holds that appellant failed to satisfy SEBI that the warranties have not been complied with was not based on facts. It was mentioned in the order as “brazen tokenism without a modicum of compliance in substance”. Such a finding was not correct. On the contrary the names or description of the top five investors of any client would indicate no one is PIO or NRI or an OCB. This allegation is not a part of the show cause notice. He argued that under CIP, UBS London was not required to obtain top five investor information. The clients were international investors. The non-availability of information was not because the appellant did not follow the KYC or its CIP procedures but because it believed along with the rest of the FII community that for compliance of KYC, the information sought by the respondent was not necessary. 44. The learned senior counsel, Mr. Sundaram submitted that there has been no breach of Regulation 20 and 20A of the FII Regulations. He submitted that it was wrongly concluded that the appellant deliberately failed to submit the relevant
  19. 19. information which was either in its possession or it could have directly accessed the same and thus violated Regulations 20 and 20A. The Regulation 20 of FII Regulations provides that every FII shall submit to SEBI or RBI any information, record or document in relation to its activities as an FII whenever required by SEBI or RBI. The learned senior counsel submitted that the appellant had been promptly responding to any communication received from the respondent with regard to the information required by it. Wherever information was available with the appellant the same was promptly submitted and where it did not have the information it actively followed up and pursued with the clients and persuaded them to comply with the respondents demands. The fact that the appellant had several personal meetings with various officials of the respondent is a sheer proof of its willingness to cooperate with the respondent. The conclusion in paragraph 7.7 of the impugned order which states that the information relating to the clients of UBS which was sought by SEBI was already available with the London and New York offices of UBS is not correct. In another paragraph of the impugned order it is said that “UBS in all likeliness should be in a position to know the ultimate client for whom the ODIs have been issued by UBS AG, London”. The first statement in paragraph 7.7 of the impugned order is conclusive in nature whereas the second statement extracted from paragraph 9.10 of the impugned order is tentative and a diluted version of the same conclusion which is based on probability without any factual or legal backing. It was submitted by the learned senior counsel that where the appellant did not have the information in relation to a client it was left with no choice but to approach UBS AG London to obtain the information from each client as sought by the respondent. By January, 20005 the appellant had provided to the respondent substantially all the information sought by the respondent pertaining to the shareholders / investors excepting Caxton International Limited which was in direct correspondence with the respondent. In fact the appellant had exercised high levels of care and effort in obtaining the information which is amply corroborated from the sizeable correspondence and numerous personal meetings with the respondent. Therefore, it is not correct to say that the appellant violated any requirement of Regulation 20 of the FII Regulations. It was argued by the learned Sr. Counsel that Regulation would entail the obligation on the FII Regulations only to the extent the information which was in the possession of the FII. It was contended by the learned senior counsel that the law did not compel one to give the information which it did not have or is not required to have. Where the law creates a duty but if the party is disabled from performing it without any default in him and has no remedy over it then the law would in general excuse such person. In support of this contention the learned senior counsel cited the following case laws: (i) Special Reference No. 1 of 2002 – AIR 2003 SC 87; (ii) Raj Kumar Dey and Others v. Tarapada Dey AIR 1987 SC 2195; He argued and asked where had it been prescribed in the Regulations that particulars of the top five investors of the FII clients were normally required to be in possession of the
  20. 20. FII?. Investors of the clients could be a continuing and changing stream and there was no regulation which required monitoring of such changing number of investors. 45. Regulation 20A: The learned senior counsel argued that there was no breach of the Regulation 20A of the FII Regulations. Regulation 20A required that FII investor shall fully disclose information concerning “the terms and parties” to offshore derivative instruments such as Participatory Notes, Equity Linked Notes or any such instruments of whatever names they are called as and when the Board may require. He submitted that the respondent had issued a circular dated 8th August, 2003 which prescribes the format in which the FIIs are required to disclose their offshore derivative positions. From this circular it could be seen that no details of top five investors / major shareholders are required to be provided. Regulation 20A requires the disclosure of information concerning the ‘terms of and parties” to offshore derivative instruments such as Participatory Notes, Equity Linked Notes, entered into by the FII or its sub-account or affiliates relating to securities listed in Stock Exchanges in India. He submitted that under Regulation 20A there was no obligation on the part of the appellant (FII) to maintain records / details of major shareholders or of investors of the clients. The annexure to the circular dated 08/08/2003 prescribed the detailed items to be disclosed as to the “Terms and Parties” to the offshore derivative instruments. It is therefore clear that the disclosures which are required for the purpose of Regulation 20A are mentioned and defined in the annexure to the circular. Nowhere do we find any mention of the names of top five investors/ major shareholders required to be submitted by the FII to SEBI. Therefore there is no obligation under Regulation 20A of the FII Regulations to maintain and provide the information as sought by SEBI and hence there is no breach of the said Regulation. 46. There is no breach of Clauses 1, 2, 5 and 6 of Code of Conduct under Regulation 7A of the FII Regulations: The learned senior counsel submitted that the appellant had been observing the highest standards of integrity, fairness and professionalism in its working. It had worked with due diligence in its dealing with the respondent. It had cooperated with the respondent in obtaining and submitting all information which was required by the respondent. It made necessary effort in getting the information as requested by the respondent. The appellant corresponded promptly with the clients and even suggested to the clients to provide necessary information to the respondent if they were prevented because of client confidentiality clause from disclosing the required information to the appellant. He further submitted that in law diligence meant doing all that which an ordinary man would do having regard to all the circumstances remaining within the parameters set out by the law. The appellant made sincere efforts to comply with every request and direction of the respondent. At times, the delay which occurred in submitting the information to the Respondent was mainly due to non-availability of information which the appellant was not required to maintain in the ordinary course of business or in terms of FII Regulations. Therefore it could not be
  21. 21. said that the appellant had failed to exercise due diligence. The learned senior counsel argued that it would be wrong to say that the appellant did not maintain the appropriate level of knowledge and competency and abide by the provisions of SEBI Act, FII Regulations and other circulars and guidelines from the regulator. He further said that the appellant has not knowingly made any wrong statement or knowingly submitted wrong statement or suppressed any information to the Respondent. The appellant has always maintained highest standards of integrity, fairness of professionalism. The learned senior counsel referred to the judgment in the case of Peco Arts Inc. V. Hazlitt Gallery Ltd. [1983] 3 All ER 193, for explaining what “reasonable diligence” was all about. It holds that: “….. that it is impossible to devise a meaning or construction to be put on those words which can be generally applied in all contexts because, as it seems to me, the precise meaning to be given to them must vary with the particular context in which they are to be applied. In the context to which I have to apply them, in my judgment, I conclude that reasonable diligence means not the doing everything possible, not necessarily the using of any means at the plaintiff’s disposal, not even necessarily the doing of anything at all, but that it means the doing of that which an ordinarily prudent buyer and possessor of a valuable work or art would do having regard to all the circumstances, including the circumstances of the purchase.” He also referred to the order of SAT in the case of JM Mutual Fund & Anr. Vs. SEBI in appeal No. 39/04 and 39A/04. It was submitted that the appellant has in no way breached the clauses 1, 2, 5 and 6 of the Code of Conduct. 47. The learned senior counsel argued that investigations of the respondent were not hampered by the conduct of the appellant. It is mentioned in the order dated 17/05/2005 that information about Caxton International Limited, sought by SEBI could not be received even till the date of the impugned order i.e. 17/05/2005. The learned senior counsel submitted that in relation to Caxton International Limited the appellant communicated to SEBI on November 2, 2004 that a letter dated 1 November, 2004 was received from Caxton International Limited confirming that the sole shareholder of Caxton International Limited was Caxton Global Investment Limited and that the shareholders of Caxton Global Investment Limited with more than 100% holdings were qualified institutional holders who were not NRIs / OCBs. The appellant followed up with Caxton International Limited to supply further information but it was not forthcoming. Caxton informed the appellant that it would deal directly with the respondent and even respondent had also clearly stated that the clients could deal directly with it. Since information to other five cases mentioned in the show cause notice of 24/11/2004 had been submitted by the appellant before the issuance of the impugned
  22. 22. order, the appellant, therefore, thought that all requirements as sought by the appellant had been received by the appellant. 48. As regards non receipt of ISDA agreement, it was submitted by the learned senior counsel that on 11/01/2005 the respondent had received from SEC, New York, a copy of the ISDA agreement entered into between Caxton International Limited and UBS AG, London. During personal hearing on 1st February, 2005 the learned Whole Time member had made a request to provide him with the copy of agreement governing the relationship between the respective clients and UBS AG, London. The appellant thinking that the information sought by the Whole Time Member was the terms and condition had sent the “business terms and conditions” under the cover of a letter dated 24th February, 2005 to the respondent. It was also made clear in the covering letter of 24th February, 2005 that the document being sent to the respondent was in response to his request during the personal hearing on 1st February, 2005 for terms and conditions of business of UBS. Then again on 14/03/2005 the appellant wrote a letter to the respondent stating that it had provided all the information requested at the personal hearing but there was no response from SEBI. It was only on 20/04/2005 that the respondent alleged that the relevant agreement which was requested by him in personal hearing were not “terms and conditions of business” of UBS but were of ISDA agreement. There was a personal meeting with the respondent on 29th April, 2005 to seek clarification and after that on the same day the appellant provided the ISDA and related agreement between UBS AG, London and Discovery Global Opportunities Master Fund Limited and Indea. The learned senior counsel submitted that it was a case of mis-understanding that Terms and Conditions of Business were sent by the appellant earlier. In fact the appellant had confirmed on 14/03/2005 that all necessary information as was requested in the personal hearing had been submitted but the respondent informed only on 20 th April, 2005 that what it wanted was ISDA agreement and not Terms and Conditions of Business. He submitted that had the respondent immediately informed the appellant on 24/02/2005 or after that what it required from the appellant was ISDA agreement, the same would have been supplied immediately. Obviously it was a case of genuine misunderstanding and it was wrong to term it “another instance of duplicity of UBS” as mentioned in para 9.17 of the impugned order. 49. The learned senior counsel argued that even the respondent was aware that the appellant could not have information from the clients as a matter of legal right. Therefore the respondent informed the appellant as follows: “Kindly persuade your client to furnish requisite information if not through you directly to SEBI if they so prefer”. 50. This is evident from the e-mail dated 30/07/2004 and August 30, 2004. He submitted that in a situation where the appellant did not have the information it had no
  23. 23. way but to approach the client for obtaining the information and the appellant communicated promptly with the clients. The appellant did not keep the respondent in the dark about the status of information and the difficulties it was encountering in obtaining the required information from the client. The representatives of the appellant had been meeting the officials of the SEBI on several occasions and explaining to them the difficulties being faced by them from the side of the clients in providing the requisite information to the respondent. 51. Misstatements and Reporting Lapses: It was submitted by the learned senior counsel that there was no evidence to suggest that the appellant did not want to submit the information to the respondent on account of client confidentiality. In fact it was the clients who were claiming difficulties in releasing the information to the appellant because of their own confidentiality obligations to their investors. It was not the suggestion of the appellant to the respondent that appellant was not providing information because of client confidentiality agreement between it and the clients. In fact there is always an exception to such confidentiality from the regulatory authorities. 52. On October 20, 2004 Indus provided limited information to the appellant stating that it was constrained by confidentiality provisions in the funds documentation. Accordingly the appellant through e-mail informed the respondent on 28/10/2004 that Indus Asia Pacific Fund was not able to disclose the names and addresses of the top five investors for investment in the Indian securities during May, 2004 or the major shareholders of Indus. After much persuasion and discussion the appellant received information about the broad categories of top five investors of Indus Asia Pacific Fund only on January 15, 2005 which was immediately supplied to the respondent. The learned Whole Time Member advised the appellant in the personal meeting on 1st February, 2005 to furnish the specific names of the top five investors in Indus Asia Pacific Fund which was received from the client on February 25, 2005. The appellant communicated the same to the respondent. Therefore there was no attempt on the part of the appellant to provide vague information or to conceal any information. He argued that the conclusion drawn in the impugned order “it was attempting to thwart the investigation by SEBI, providing bits and pieces of vague information despite being in possession of specific information” was wrong and without any basis. 53. The learned senior counsel submitted that it was not the intention of the appellant to mislead the respondent by saying that the transactions of May 17, 2004 were of a proprietary nature. The appellant initially understood the request as only relating to actual cash and future market in India and not to ODIs. The appellant therefore was accurate in characterizing the appellant and SFCML as acting as principal in the Indian cash and futures market and not acting as agent of UBS group. The appellant itself sought a meeting with the respondent to clear the misunderstanding. The meeting took
  24. 24. place on June 10, 2004 and thereafter provided all the information which was sought by the respondent about the ODIs with UBS London. 54. It was submitted that it is not correct that non disclosure of Indian sounding names in the investigation lead to thwarting of investigation. It was submitted that contrary to what the respondent stated in the impugned order, the respondent already had the Indian sounding names in some cases including the names shown as signatories on behalf of Indea as early as July 1, 2004. Even in case of Caxton International Limited where there was an Indian sounding names of signatory to ISDA agreement the respondent had received from SEC the copy of ISDA agreement on 11/01/2005. In such circumstances it would not be correct on the part of respondent to conclude that because of not providing the ISDA agreement between UBS London and Caxton International Limited, the appellant was responsible for delaying the investigations about the antecedents of the signatories to the ISDA agreement. 55. As regards the charge that Caxton International Limited’s name was not included in the ODI statement submitted to the regulator from January, 2004, the appellant regretted this error which happened inadvertently due to incompatibility of the appellant’s internal infrastructure and software system. The appellant had acknowledged error and amended the reports. Moreover these errors were not subject of the show cause notice dated 24/11/2004. 56. The learned senior counsel submitted that the impugned order contained observations which indicated that the appellant wrongly held to have engaged in actions requiring an element of intention or willfulness or mensrea. He refuted all such instances mentioned in the impugned order. Some of such wrongful conclusions requiring an element of intention or willfulness are: i. In paragraph 6.23 of the impugned order, it has been wrongly alleged that the appellant was trying to “evade” the obligations under the KYC requirement; ii. In paragraph 7.5 of the impugned order, the conduct of the appellant has been incorrectly described as “crafty”; iii. In paragraph 8.16 of the impugned order, the conduct of the appellant has been incorrectly described as “contrived posture to avoid” and the appellant’s submission that there was no attempt to suppress anything has been rejected wrongly;
  25. 25. iv. In paragraph 8.19 of the impugned order, the conduct of the appellant has been incorrectly described as a “measured move” in making “convenient disclosures”; v. In paragraph 8.22 of the impugned order it is denied that the appellant has given “several excuses that have been trotted out in not complying with this basic requirement …. since they were meant to beguile the underlying and felt need not to divulge the information”; vi. In paragraph 8.24(b) and 9f) as well as paragraph 9.18, the respondent has incorrectly observed that the conduct of the appellant carries the undertones of “suppression versi suggestion falsi” and that despite being in possession of the information required by the respondent, the appellant did not provide the respondent with such information. The appellant denied that the appellant has deliberately withheld such information from the respondent; “attempted to delay providing the same by giving vague descriptions regarding the top five investors of the said client”. vii. In paragraph 9.16 of the impugned order it is denied that the appellant has “attempted to mislead SEBI by making false claims”; and viii. In paragraph 9.20 of the impugned order, it has incorrectly been held that the conduct of the appellant holds out “tell-tale strands of how it was fashioned as a deliberate strategy to obfuscate the proceedings”. Furthermore, it is denied that the appellant has acted with “intentional non- cooperation with the regulator” and is “the result of acts, practices and like approaches that are designed to give the slip to the regulator.” 57. The learned senior counsel submitted that in para 8.1 and 8.2 of the impugned order an allegation has been made that on 17/05/2004 UBS was a major trading client in the cash and F&O segment and by its strategy it earned gross profit of Rs. 59.37 and it incurred loss of Rs. 17.54 on account of its sale in cash segment whereas it earned profit in Futures segment. It earned net profit of Rs. 41.83 crores. 58. The learned senior counsel contested the figures and the analysis as mentioned in the impugned order. He denied that there was any ‘strategy’ on the part of appellant to effect large scale sales in cash market to depress the market and simultaneously take short positions in the futures segment. He submitted that these allegations were not correct. The appellant was never informed of such allegations. It was not mentioned in the show cause notice. It amounted to pre-judging the issues which was in violation of principles of natural justice.
  26. 26. 59. It was submitted by the learned senior counsel that the appellant was constantly keeping the respondent informed of the difficulties and delays being faced in obtaining the required information from the clients and as such it could not be alleged to have committed these violations as mentioned in the impugned order. 60. The learned senior counsel submitted that the impugned order travels beyond the scope of the show cause notice. The show cause notice mentions why directions should not be passed prohibiting the appellant from dealing securities on behalf of the appellants in respect of whom the appellant does not furnish information on their underlying investors. However, the impugned order has prohibited the appellant from dealing in ODI on behalf of its clients and it also purports to require disclosure of beneficiaries. The prohibition has been imposed on the appellant and not on persons who failed to provide the information and who continued to trade in Indian stock market. The impugned order directly adversely affects the third party clients of the appellant who have not been issued any show cause notice or given any hearing. 61. The impugned order has been passed under Section 11(4) and Section 11B of the SEBI Act, 1992. It does not enable the respondent to impose penalties for violation of provisions of SEBI Act, 1992 and the FII Regulations. Powers under Section 11B of SEBI Act, 1992 are to be used only to take remedial and preventive steps and not for imposition of penalties. A ban on the appellant for a period of one year does not remedy the market position when the funds relate to activities which are more than year old. The ban is in the nature of a penalty. Such an order is not intended for orderly development of the market. Section 11B order should be passed only in emergent scenario. He cited the following case laws in support of his contention: i. Sterlite Industries (India) Ltd. v. SEBI – [2001] 34 SCL 485 (SAT); ii. Videocon International Ltd. v. SEBI – [2002] 38 SCL 422: iii. BPL Ltd. v. SEBI – [2002] 38 SCL 310 (SAT) 62. He further argued that the penalty imposed by the appellant is disproportionate as compared to the penalties imposed by the respondent in earlier comparable cases such as :
  27. 27. i. M/s. Mani & Company v. SEBI – Appeal No. 31 of 2005 ii. Jitendra J. Shah v. SEBI – Appeal No. 148 of 2004 iii. Bipin R. Vora v. SEBI – Appeal No. 273 of 2004 63. He further submitted that the impugned order is proceeding on the basis of the finding that the appellant is guilty and such a finding is tantamount to a final finding on the issue and as such orders should not be under Sections 11(4) and 11B of the SEBI Act, 1992. In fact if there was any violation of FII Regulations the action should have been taken under Regulation 21A under SEBI (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalties) Regulations, 2002. 64. The learned senior counsel submitted that 40% of the business of the appellant was from ODIs and ban on its ODI transaction would severely impact the income of the appellant. He further argued that the appellant was a global investment bank which operated in 40 countries with a strong institutional and corporate client base and enjoyed high reputation. It had a substantial business interest in India also. It had a Regulations / Law compliant culture. The present order would have an adverse impact on its working world wide. More over, the ban on roll-over of existing ODIs would mean that there would be a loss of existing clientele which would have adverse impact on its functioning if the ban was allowed to continue. Therefore, he pleaded, the impugned order should be set aside. 65. Mr. Rafique Dada, learned Senior Counsel for the respondent, while defending the impugned order submitted that it was essential to take note of the circumstances which lead to the issuance of this order. He drew attention to the unprecedented crash in the securities market on 17th May, 2004 when the sensex fell by 567.74 points and NIFTY by 196.90 points. Such a steep fall in the stock market resulted in the temporary stoppage of trade twice on major stock exchanges i.e., BSE and NSE during the day. It was, therefore incumbent on the part of the regulator to examine the dealings in securities by various entities and find out the reasons for this steep fall in the Indian stock market. During the course of investigation it came to light that UBS, the appellant, were one of the major participants in the market on that day. It had sold through SFCML [Swiss Financial Corporation (Mauritius)] in the cash market to the extent of Rs. 188.35 crores (gross). As on May 14th, 2004 the equity portfolio of the appellant was to the tune of Rs. 2956 crores. On May 14, 2004 the appellant had NIFTY Futures short positions of Rs 434/- crores and stock futures short positions to the tune of Rs. 292/- crores. Thus the appellant had a significant participation in the cash as well as the derivative (F&O) segment of the Indian securities market. It was suspected that the appellant might have earned profits due to unprecedented sale in the cash market with its effect of depressing the cash as well as future markets with simultaneous favourable impact on short positions
  28. 28. in the future segment. In the light of this finding the regulator, i.e., the respondent sought host of information from the appellant and all those who had participated in the market on that day. 66. The justifiable anxiety of the regulator was to avoid any security scam particularly in view of what had happened in 2001 when it was suspected that some Indian promoters had purchased the shares of their own companies through FII route which was later on shifted to Ketan Parikh entities through OCBs. It was in this context that SEBI had issued a circular dated 31/10/2001 directing FIIs who have been issuing ODIs against underlying Indian securities to report issuance / renewal / cancellation / redemption of the aforesaid instruments to SEBI as per the format prescribed in the circular. In terms of the circular dated 31st October, 2001 FIIs are required to give an undertaking that the FIIs / associates / clients have not issued / subscribed / purchased any of the offshore derivative instrument directly or indirectly to/from Indian residents / NRIs / PIOs / OCBs. The learned senior counsel submitted that from the above undertaking it could be seen that the FIIs or the appellants would have to know the ultimate beneficiaries of the respective clients on whose behalf the appellants were transacting in the capital market. 67. He also submitted that Joint Parliamentary Committee (JPC) which was appointed soon after the 1999-2001 scam also observed that through PNs various layers were created which made it easy for holders to keep their identities undisclosed and at the same time purchase shares in the Indian capital market. Participatory Notes are derivative instruments issued by FII against holding underlying Indian securities. An investor may collect funds from various retail investors to pool the funds against underlying Indian securities and the return could be linked to equity index. PNs are extra- territorial instruments. 68. The amendment to the existing format of circular of 31st October, 2001 was introduced on 8th August, 2003 which changed the reporting format for issuance / renewal / cancellation / redemption of the aforesaid instruments. The format was further changed vide circular No. IMD/CUST/15/2004 dated 2/04/2004 which retained the undertaking relating to PIO / NRI, etc. The statement should contain information on investors / general information on offshore derivative instruments with quantity and value on ODIs and quantity and value on underlying Indian securities. It should contain information on offshore derivative instruments with underlying as various derivatives traded in Indian Stock Exchanges. This statement shall be submitted by FII on a monthly basis and in addition to the contents in the statement, the FII have to give the undertaking that “we undertake that we/associates / clients have not issued / subscribed / purchased any of the offshore derivative instrument directly or indirectly to/from Indian residents / NRIs / PIOs during the statement period.”
  29. 29. 69. Later on Regulation 20A was inserted on 28/08/2003 which require the FIIs to disclose information concerning “terms of and parties” to ODIs such as Participatory Notes entered into by Financial Institutions or its sub-account or affiliates relating to any securities listed or proposed to be listed in any Stock Exchange in India, as and when and in such form as the Board may require”. Thereafter Regulation 15A was inserted on 3 rd February, 2004. Regulation 15A comprises of two points: (i) FII Can issue ODIs against underlying Indian securities only to entities which are regulated by any relevant regulatory authorities in the countries of their incorporation. Further the FII shall ensure that no further down stream issue or transfer of such ODIs is made to any person other than a regulated entity. (ii) Secondly the ODI issue can be made subject to compliance with ‘Know Your Client’ requirement. 70. The learned senior counsel for the respondent emphasized that both the conditions were absolutely essential for compliance of Regulation 15A. It could not be taken as compliance of Regulation 15A merely if ODIs were issued to the regulated entities. The compliance of KYC was equally important part of the Regulation. He went on to argue that ‘Know Your Client’ was in fact, defining the existing provisions under Regulations 20 and 20A. The learned senior counsel argued that the appellant failed to meet with the requirement of Regulation 15A when it did not submit the required information about the names and addresses of top five investors / shareholders of clients to whom ODIs had been issued by the UBS AG, London. In spite of protracted correspondence, numerous emails and personal meetings the required information was not received by the respondent and show cause notice was issued to the appellant on 24/11/2004. He further submitted that in terms of the undertaking given as per the statement submitted vide circular dated 8th August, 2003, the appellant should have obtained the required information from UBS AG, London which issued the ODIs underlying Indian securities. The information sought by SEBI was only first level information whereas the appellant should have the information about the ultimate beneficiaries. He argued that KYC as part of Regulation 15A was not a newly introduced Regulation. In fact the requirement to comply with these conditions were existing even earlier as per Regulation 20 of FII Regulations. 71. He went on to argue that the appellants themselves have their own Customer Identification Program (CIP) which existed even before the introduction of Regulation 15A in 2004. In terms of the Client Identification Program (CIP) of the appellant, it is necessary to ascertain the identity of the ultimate beneficiary whose account is being operated. The appellant’s CIP specifically mentions that it complies with the requirement of Financial Task Force (FATF) which is an international organization formed for
  30. 30. prevention of money laundering and terrorist financing. It is clear from Forty Recommendations framed by FaTF that it recommends identification of the ‘beneficial owner’ of customers by financial institutions. The ‘beneficial owner’ is the ultimate beneficiary. He submitted that the concept of KYC was internationally understood in the financial sector to mean the ultimate beneficiary of an account. He submitted that to know the ultimate beneficiary it would be essential to remove the layers. He submitted that if it was not necessary to know the ultimate beneficiary and we only go through one or two layers, then it would always be possible to conceal the real / ultimate beneficiary which would defeat the purpose of KYC. Hence the condition of KYC as required under Regulation 15A was similar to that which was available in the CIP of the appellant and it was also the same internationally. He submitted that there could not be any doubt about the meaning of the concept of KYC which UBS found difficult to follow although it was a well known concept throughout the financial world and appellant could not take the pretext of its vagueness. The appellant have violated Regulation 15A when they failed to submit the information required by SEBI, the respondent. 72. The learned senior counsel argued that even without Regulation 15A the respondent was well within its right to ask for any information / record or document in relation to the activities of a Foreign Institutional Investor. The information which was sought to be received by the respondent from the appellant was well within the provisions of Regulation 20 of FII Regulation. In fact the compliance of respondent’s circular dated 8th August, 2003 requires complete disclosure to be given regarding ultimate beneficiary as well as an undertaking that no person of Indian origin, NRIs, PIOs, OCBs, was investing in Indian security market. There is thus a clear violation of Regulation 20 of FII Regulations in this case. 73. As regards Regulation 20A the FII is required to fully disclose information concerning “terms of and parties to” offshore derivative instrument like participatory notes, or equity linked notes which are entered into by the FII or its sub-account or affiliates relating to securities listed in any stock exchange in India. The appellant failed to supply the information when SEBI asked for it and went on to say that the information was not available with it and it has to access the same from the clients. On 24/11/2004 when the show cause notice was issued, the appellant could not give the information about the top five investors / shareholders (their names and addresses) of six major clients of UBS i.e., Caxton International Limited, Indus Asia Pacific Fund Limited, ROHATYN, Indea Capital Pte. Ltd., PMA Prospect Fund and Satva Asia Opportunities Master Fund. At the time of issuance of impugned order, excepting Caxton International Limited, most of the information had been submitted by the appellant vide its letter dated 8 th January, 2005. This clearly points to the fact that UBS was in a position to access the information. The delay in submission of information obviously rendered the investigation difficult and ineffective.
  31. 31. 74. Non-Furnishing of Information: The respondent had asked by e-mail dated 27/05/2004 and asked the appellants to give names and addresses of ultimate underlying clients on whose behalf shares had been bought and sold by the appellants on 17/05/2004 along with the names of scrips, quantity and value of the shares bought and sold. The respondent also sought the names of major shareholders and Directors of the aforesaid clients and also the name of Investment Advisors and Fund Managers. Initially the appellant vide their e-mail dated 02/06/2004 replied that SFCML (Swiss Financial Corporation) traded only for its own account in the Indian securities market and did not trade in Indian shares of futures contracts on behalf of other clients. The appellants further volunteered that UBS AG, London, its affiliate, transacted derivative instrument for underlying Indian securities outside India, the details of which were reported to the respondent every month in terms of Regulation 20A. Later on the appellant furnished the names of their ODI clients with the Indian underlying securities transacted by UBS AG, London and they also said that all counter parties were major financial institutional investors which are classified as “regulated entities” according to Regulation 15A of FII Regulations and on this basis the information about Directors and major shareholders was not provided. Obviously this was not accepted by the respondent and sought information relating to ODI beneficiaries. The appellant vide their e-mail dated 22/06/2004 furnished the addresses of 21 of their clients and names of the principal directors in respect of two of its clients. However, they said that they were working with their London and New York offices to obtain the information of principal Directors and shareholders for each client. Some of this information was received after the issuance of show cause notice on 24th November, 2004. It clearly shows that the appellant could have accessed all these information earlier. 75. The learned senior counsel further argued that the appellant were required to submit monthly statement in terms of SEBI circular dated 31/10/2001 and 08/08/2003 regarding the transactions entered into on behalf of their respective clients. It was found that Caxton International which had sold scrip valued Rs. 99.05 crores on 17th May, 2004 was omitted to be included in the statement of May, 2004. The respondent placed on record that two of the appellant’s clients i.e., ROHATYN and Satva Asia were also omitted. The appellant vide their e-mail dated 25/06/2004 admitted the omissions and thus explained that this happened due to changes in the internal operating systems. It was found that right from January 2004 the appellant failed to disclose the name of Caxton International Limited in the PN statements submitted by them to the respondent. The learned senior counsel submitted that, of course, it was not a part of the show cause notice but perhaps it indicated the intention of the appellant to avoid giving information to the respondent about a client which accounted for almost 50% of its transactions on 17/05/2004. 76. Hampering of Investigation by the Contumacious Conduct of the Appellant: The respondent could not get names of clients and addresses of major
  32. 32. shareholders and major investors and the Fund Managers of Caxton International Limited even up to the date of impugned order on 17/05/2005 despite the fact that Caxton International comprises of over 50% of the transactions entered into by the appellants on 17/05/2004. The appellants stated that some Investment Managers may not be able to respond due to confidentiality constrains. The appellant informed vide e-mail dated 11/08/2004 that as and when they receive further information they would inform the respondent which clearly shows that the requisite information was not available on behalf of their clients at the time of entering into transactions thereby violating the KYC requirement under Regulation 15A. 77. The Caxton International vide their letter dated 09/09/2004 informed SEBI that Caxton International Limited was British virgin island company which had entered into a Price Return Equity Swap on NSE, S&P, CNX, NIFTY Index with UBS AG, London on 06/01/2004 and on 17/05/2004 the parties closed out the said Swap in order to prevent further losses. The respondent wanted confirmation whether any of the major investors of Caxton International Limited were FIIs. When the information was not forthcoming due to non-cooperation of the appellant the respondent sought the client agreement from Caxton International Limited from the Securities Exchange Commission, USA, which furnished the said ISDA agreement between Caxton International Limited and UBS AG, London. It shows that UBS AG would always be having aforesaid ISDA agreement. The agreement between UBS AG and Caxton International Limited had some signatories with Indian names which has further triggered an investigation. The entire conduct of UBS in relation to Caxton called for action from SEBI. 78. Indus Asia Specific Fund Limited: The respondent had sought for the names of major shareholders and top five investors of Indus Asia Specific Fund Limited on 14/05/2004. The appellant on 28th October, 2004 expressed their inability to disclose the names of the top five investors under Indian securities during May, 2004. After the show cause notice the appellants vide their e-mail dated 6th December, 2004 furnished the names of Directors of Indus Asia Specific Fund Limited. During personal hearing held on 1st February, 2005 the appellants were advised to furnish specific names of investors of Indus Asia Specific Fund Limited rather than vague description of the investors given by the appellant. The appellant vide e-mail dated 25/02/2005 furnished the names of investors of Indus Asia Specific Fund Limited. This clearly shows that despite having requisite information the appellants chose not to furnish the same to the respondent. 79. ROHATYN, Indea Capital Pte. Ltd. PMA Prospect Fund & Satva Asia Trading Master Fund: Information in all these cases were received after the issuance of the show cause notice. The appellant vide e-mail dated 14/01/2005 furnished further information regarding the names of the investors in the TRG Global Master Fund, Rohatyn and certain others were directors of Fund.
  33. 33. 80. In case of Indea Capital Pte. Ltd., the appellants were informed on 1st February, 2005 during personal hearing with the Whole Time Member to furnish copy of client agreement with Indea Capital Pte. Ltd. The appellant sent the “terms and conditions” contained in the proforma agreement on 24/02/2005. The respondent again advised the appellant on 20/04/2005 to furnish the information which was sought by the respondent during the personal hearing on 1st February, 2005. It was only on 29th April, 2005 that ISDA master agreement between UBS AG, London and Idea Absolute Return Fund was submitted to the respondent. It was explained that the delay occurred due to misunderstanding about the requirement but it was significant that the agreement was signed by persons with Indian names. The delay in furnishing information, obviously, was for some motives. 81. The learned senior counsel argued that it was wrong to say that impugned order was beyond the scope of show cause notice. The appellants were repeatedly asked to furnish information regarding top five investors and top five shareholders in respect of some of their clients. Majority of the information sought by the respondent was furnished only after issuance of the show cause notice. At the time of issuance of show cause notice the breach of regulations were substantial by the appellant. In the show cause notice dated 24/11/2004 it was clearly set out that the appellant were called upon to show why action should not be taken against the appellants including directions to prohibit the appellant from dealing in securities on behalf of their clients in respect of whom the appellant did not furnish the information. It clearly says that it was one of the actions contemplated in the show cause notice and nowhere was it indicated that this was the only action which the respondent would take against the appellant in case the appellants were unable to show cause to the aforesaid notice. On the contrary the respondent has taken into account the information submitted even after the issuance of the show cause notice. The wording of the show cause notice are as under: “in view of the above you are required to show cause as to why directions under Sections 11(4) and 11B of the SEBI Act, 1992 including directions to prohibit you from dealing in securities on behalf of clients in respect of whom you do not have information on their underlying investors should not be issued against you”. 82. The inclusive portion in the show cause notice does not in any way limit the scope of the show cause notice. It encompasses within its fold any direction or order that may be passed under Section 11(4) and or Section 11B of SEBI Act, 1992. He further argued that it was not correct to say that order could be passed only under Regulation 21 of the FII Regulations read with SEBI (Proceedings for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations 2002. The learned senior counsel further argued that it was also not correct to say that punitive action could not be taken under Section 11B. The conditions for taking action under Section 11B are mentioned in clause (i), (ii) and (iii). It also needs to be stressed that any action taken under Section 11B by the regulator

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