Applicability of provisions relating to prosecution of a company

Various provisions with regard to offences and prosecutions under different situations are found in different economic laws for contravention of certain provisions of the concerned Law. Accordingly, such provisions are found in the Income-tax Act (the Act) in Chapter XXII, such as S. 276C which provides for prosecution in case of wilful attempt to evade tax, penalty, or interest; S. 277 which provides for punishment for making false statements in verification under the Act, etc. In these provisions, the punishment is provided with rigorous imprisonment for a minimum period of three to six months, which may extend up to three to seven years and with fine depending upon the quantum of tax involved in the offence.

S. 278B of the Act, dealing with the cases of offence committed by a company, in substance, inter alia, provides that every person responsible and who has been in charge of the conduct of the business of the company at the time when the offence was committed as well as the company shall be deemed to be guilty of offence and shall be liable for punishment accordingly. In short, in such cases, such persons as well as the company both have been made liable for punishment. For this purpose, company also includes a firm, AOP or BOI.

In the past, the issue had come up for consideration as to whether a company, being an artificial entity, can be proceeded against for punishment under the above referred provisions which provide for punishment of rigorous imprisonment by way of minimum term of a given period and with fine. This issue was considered by the Apex Court (three-Judge Bench) in the case of Velliappa Textiles Ltd., (263 ITR 550) along with other issues relating to offences committed by the company.

There was a sharp division amongst the Judges on interpretation of such penal provisions under the Act dealing with Criminal offence by a company where mens rea is a requisite for imposing punishment for an offence. For the issue referred to in this para, in this case, the Apex Court (majority view — which included the view of Justice B. N. Srikrishna) held that a company cannot be prosecuted for an offence u/s.276C, u/s.277, etc. of the Act, since each one of these Sections require the imposition of a mandatory term of imprisonment coupled with a fine and leaves no choice to the Court to impose only fine.

Justice Mathur had taken a different view on this issue. We are not concerned with the other issues decided in this case for the purpose of this write-up and therefore, the same are not referred to. This judgement has been analysed in this column in the February and March 2004 issues of the Journal.

In view of the above referred judgement of the Apex Court with regard to offence committed by a company, the Law became settled that in a case where the Law provides for the imposition of a mandatory term of imprisonment coupled with a fine and leaves no choice to the Court to impose only fine, even a fine cannot be imposed on a company.

S. 56 of the Foreign Exchange Regulations Act, 1973 (since repealed — hereinafter referred to as FERA) also provided for prosecution under different situations where on account of contravention of certain provisions of the FERA, offences are committed. This Section provided for punishment of imprisonment for a minimum period of six months which may be extended up to seven years and with fine, if the amount or value involved in the offence exceeds Rs.1 lakh. In such case, it was also provided that the Court may impose a sentence of imprisonment for a term less than six months by mentioning adequate and special reasons in the judgement. In other cases (i.e., if the amount or value involved in the offence does not exceed Rs.1 lakh), the punishment provided was of a term which may extend for three years or with fine or both.

In the context of the provisions of S. 56 of the FERA (referred to in para 1.5 above), the issue referred to in para 1.3 again came up before the Bench of three Judges of the Apex Court before whom the appellant had referred to the view taken by the Apex Court in the case of Velliappa Textiles Ltd. (supra). The Bench doubted the correctness of the said decision and the matter was thus placed before the Chief Justice of India for making reference to a larger Bench and that is how the said issue, in the context of the provisions of S. 56 of the FERA, came up before the larger Bench (five Judges) of the Apex Court and that is how the judgement of the Apex Court in the case of Velliappa Textiles Ltd. came up for reconsideration [ANZ Grindlays Bank Ltd. v. Directorate of Enforcement, (2004) 6 SCC 531].

Standard Chartered Bank & Others v. Directorate of Enforcement & Others, 275 ITR 81 (SC) :

In the above cases, the Court dealt with the cases of Standard Chartered Bank as well as other appeals and writ petitions involving identical issue. In this case, the appellant had challenged various notices issued to them u/s.50 read with S. 51 of the FERA and contended that the appellant company was not liable to be prosecuted for an offence u/s.56 of the FERA. The main contention of the appellant was that no criminal proceedings can be initiated against the appellant company for an offence under the said Section as the minimum punishment prescribed under the said Section is imprisonment for a term which shall not be less than six months and with fine.

In these cases also, the issue referred to in para 1.3 above has been decided by a majority view (with two Judges giving dissenting judgement). The dissenting judgement has been delivered by Justice B. N. Srikrishna, while the other three Judges have expressed their views separately. Therefore, we will first consider the detailed judgement (representing the majority view) given by Justice K. G. Balakrishnan and then deal with the views expressed by the other two Judges taking a similar view on the issue under consideration.

Judgement of Justice K. G. Balakrishnan :

The Judge noted the majority view expressed in the Velliappa Textiles Ltd.‘s case (supra) to the effect that a company cannot be prosecuted for an offence which requires punishment of a mandatory sentence of imprisonment coupled with fine and in such cases, the Court cannot impose only a fine. After dealing with this judgement, the Judge also noted that there is no dispute that a company is liable to be prosecuted and punished for criminal offences.

It is a generally accepted modern rule that except for such crimes as a corporation is held incapable of committing by reason of the fact that they involve personal malicious intent, a corporation may be subject to indictment or other criminal processes, although the criminal act is committed through its agent. It was also noted that in most of the statutes, the definition of the term ‘person’ includes company. In S. 11 of the Indian Penal Code, such definition includes company. Therefore, as regards corporate criminal liability, there is no doubt that a corporation or a company could be prosecuted for any offence punishable under law, whether it is coming under a strict liability or absolute liability.

The Judge also noted that it is only in a case requiring mens rea, that a question arises whether a corporation could be attributed with requisite mens rea to prove the guilt. But as we are not concerned with this question in these proceedings, we do not express any opinion on that issue.

It may be noted that in Velliappa Textiles Ltd.‘s case (supra), even this aspect was considered and again, by majority, in that case, the Court has taken a view that where mens rea is a requisite in a matter of criminal liability for any offence, a mens rea of the person-in-charge of the affairs of the company can be attributed to the company enabling such artificial person to be prosecuted for such an offence.

After referring to the provisions of S. 56(1) of the FERA referred to in para 1.5 above, the Judge stated as under (page 96) :

"Going by the provisions in S. 56 of the FERA, if the view expressed in Velliappa Textiles (2003) 263 ITR 550 is accepted as correct law, the company could be prosecuted for an offence involving Rs.1 lakh or less and be punished as the option is given to the Court to impose a sentence of imprisonment or fine, whereas in the case of an offence involving an amount or value exceeding rupees one lakh, the Court is not given a discretion to impose imprisonment or fine and therefore, the company cannot be prosecuted as the custodial sentence cannot be imposed on it."

The Judge also noted that a legal difficulty arising out of the above situation was noted by the Law Commission in its 41st as well as 47th report and it had recommendedfor an amendment in the Indian Penal Code. However, no such amend-ment is made though some other amendments have been made on the basis of such reports.

The Judge then referred to various judgements of the High Courts as well as the Supreme Court dealing with penal provisions. Responding to the contention that penal provision in the statute is to be strictly construed [Ref. Tolaram Relumal v. State of Bombay, (1955) 1 SCR 158 and Girdarlial Gupta v. D. H. Mehta, (1971) 3 SCC 189], he stated that it is true that all penal statutes are to be strictly construed in the sense that the Court must see that the thing charged as an offence is within the plain meaning of the words used and must not strain the words on any notion that there has been a slip that the thing is so clearly within the mischief that it must have been intended to be included and would have been included if thought of.

Here, the legislative intent to prosecute corporate bodies for the offence committed by them is clear and the statute never intended to exonerate them from being prosecuted. He also then stated that distinction between a strict construction and a more free one has disappeared in modern times and now mostly the question is ‘what is true construction of the statute ?’ For this, he drew support from certain Law books.

Having referred to the above, the Judge stated that the question, therefore, is what is the intention of the Legislature. It is an undisputed fact that for all the statutory offences, a company also could be prosecuted, as ‘person’ defined in these Acts includes ‘company or corporation or other incorporated body’. Then he observed as under (pages 102-103) :

"Even for offences u/s.56(1)(ii) of the FERA, the company could be prosecuted as the amount involved is less than Rs.1 lakh and there is no mandatory sentence of imprisonment and the prescribed punishment is imprisonment for a term which may extend to three years or with fine or both. It is also pertinent to note that the object of the amendment was to have more stringent provisions where the amount involved in the offence is more than Rs.1 lakh. It is not reasonably possible to assume that amendment to the Section was carried out to give immunity to corporate bodies from prosecution for serious offences. The scheme of the Indian Penal Code also would show that for serious and graver offences, mandatory sentence of imprisonment is prescribed and for less serious offences, the Court is given a discretionary power of imprisonment or fine."

To support the above observations, the Judge further stated as under (page 103) :

"In the case of Penal Code offences, for example, u/s.420 of the Indian Penal Code, for cheating and dishonestly inducing delivery of property, the punishment prescribed is imprisonment of either description for a term which may extend to seven years and shall also be liable to fine; and for the offence u/s.417, that is, simple cheating, the punishment prescribed is imprisonment of either description for a term which may extend to one year or with fine or with both. If the appellants’ plea is accepted that for the offence u/s.417 IPC, which is an offence of minor nature, a company could be prosecuted and punished with fine, whereas for the offence u/s.420, which is an aggravated form of cheating by which the victim is dishonestly induced to deliver property, the company cannot be prosecuted as there is a mandatory sentence of imprisonment."

The Judge further stated that if the custodial sentence is the only punishment prescribed for the offence, then, the contention of the appellant is acceptable, but when the custodial sentence and fine are the prescribed mode of punishment, the Court can impose sentence of fine on a company which is found guilty as the sentence of imprisonment is impossible to be carried out. It is acceptable legal maxim that the law does not compel a man to do that which cannot possibly be performed. This Court has applied this doctrine of impossibility of performance in numerous cases [State of Rajasthan v. Shamseer Singh, (1985) (Suppl.) SCC 416; Special Reference No. 1 of 2002, reported in (2002) 8 SCC 237].

The Judge finally concluded as under (pages 104-105) :

"As the company cannot be sentenced to imprisonment, the Court cannot impose that punishment, but when imprisonment and fine is the prescribed punishment, the Court can impose the punishment of fine which could be enforced against the company. Such a discretion is to be read into the Section so far as the juristic person is concerned. Of course, the Court cannot exercise the same discretion as regards a natural person. Then the Court would not be passing the sentence in accordance with law. As regards a company, the Court can always impose a sentence of fine and the sentence of imprisonment can be ignored as it is impossible to be carried out in respect of a company. This appears to be the intention of the Legislature and we find no difficulty in construing the statute in such a way. We do not think that there is a blanket immunity for any company from any prosecution for serious offences merely because the prosecution would ultimately entail a sentence of mandatory imprisonment. The corporate bodies, such as a firm or company, undertake series of activities that affect the life, liberty and property of the citizens. Large-scale financial irregularities are done by various corporations. The corporate vehicle now occupies such a large portion of the industrial, commercial and sociological sectors that amenability of the corporation to a criminal law is essential to have a peaceful society with a stable economy.

We hold that there is no immunity to the companies from prosecution merely because the prosecution is in respect of offences for which the punishment prescribed is mandatory imprisonment. We overrule the views expressed by the majority in Velliappa Textiles Ltd., (2003) 263 ITR 550 (SC) on this point and answer the reference accordingly. Various other contentions have been urged in all appeals, including this appeal, they be posted for hearing before appropriate Bench".

Judgement of Justice Arun Kumar :

While entirely agreeing with the views expressed by Justice K. G. Balakrishnan (referred to in para 3 above), the Judge decided to highlight certain aspects to support the view.

Dealing with the principle of strict construction of penal statute, the Judge noted that if there is any ambiguity or doubt as to whether in a given case an offence is made out or not or about who can be the offender with respect to the given offence, the ambiguity is to be resolved in favour of the person charged. Referring to Maxwell on the interpretation of the statutes (12th Edition), the Judge stated that various illustrations have been discussed in Maxwell in this connection and not a single instance has been brought to our notice about the said rule being applied in relation to sentencing part of penal statutes. In sentencing, Courts have always enjoyed a certain amount of discretion. We cannot ignore the fact that prosecution, conviction and sentencing are different stages in a criminal trial. The stage for sentencing is reached only after a conviction of guilt is pronounced after a full-fledged trial. S. 56 of the FERA itself refers to two stages i.e., stage up to conviction and thereafter the stage of punishment. Therefore, sentencing follows conviction.

Referring to the two offences mentioned in the said S. 56 (i.e., the offence which involves an amount or value up to Rs.1 lakh and another which involves an amount or value exceeding Rs.1 lakh), the Judge stated that the second offence is taken very seriously and that is why punishment of imprisonment is made mandatory which is not the case in the first offence. Could it be said that for the first offence, a corporation can be prosecuted and punished while in case of second offence, it goes scot-free because imprisonment is a mandatory sentence in that case? What follows from this is that for difficulty in sentencing we need not let the offender escape prosecution. The law cannot be allowed to result in such absurdity. Such a view will neither be just nor fair nor in accordance with the law. By a purely technical process of reasoning, corporations should not be allowed to go scot-free.

After discussing the above legal position and its impact on S. 56 of the FERA, the Judge concluded as under (page 111) :

". . . In my view, allowing corporations to escape prosecution for offences u/s.56 of the FERA for the only reason that corporations cannot be punished with imprisonment even though the punishment by way of fine which is also prescribed under the Section can be levied on them, will be defeating the statutory mandate regarding bringing to book offenders under the FERA. For the view I am taking I find support from the view expressed by the three-judge Bench in the referring order in this case which is reported as ANZ Grindlays Bank Ltd. v. Directorate of Enforcement, (2004) 6 SCC 531, 532; . . . ."

Judgement of Justice Dharmadhikari :

While agreeing with the comments of Justices K. G. Balakrishnan and Arun Kumar, the Judge also decided to support their conclusion with additional reasons and stated that having full knowledge of the fact that the definition of ‘person’ in the General Clauses Act also includes juristic persons like company or a corporation, it is to be presumed that the Legislature has the knowledge that the juristic persons like a company or corporation cannot be punished with imprisonment. In view of this, a further presumption has to be raised that the Legislature has knowledge that in case of offences involving amount higher than Rs.1 lakh, companies or corporations can be prosecuted and punished with a sentence which is possibly being imposed on them.

While dealing with the rule of interpretation requiring strict construction of penal statute, the Judge stated that the same does not warrant a narrow and pedantic construction of a provision so as to leave a loophole for the offender to escape. A penal statute has also to be so construed as to avoid a lacuna and to suppress the mischief to advance the remedy in the light of the rule in Hyddon‘s case. A common sense approach for solving a question of applicability of a penal statute is not ruled out by the rule of strict construction.

With the above remarks the Judge concluded as under (page 106) :

". . . . The prosecution of the companies and corporations u/s.56 of the Act and imposing on them the punishment of fine which is possible to be imposed, therefore, is not ruled out. S. 56 of the Act provides for imposition of the minimum prescribed sentence of imprisonment wherever possible and also fine. Such a construction of the provisions of S. 56 of the Act to make it workable cannot be said to be a construction impermissible only because the statute under construction is a penal statute. S. 56 can-not be so construed as to make it ineffective against companies and corporations. Merely because there is no specific mention in the Section that in the event of breach committed by the companies or corporations, the punishment can only be in the nature of fine is no ground to read into the provision a fatal lacuna."

Conclusion :

In the above judgement of the Apex Court (majority view of three Judges), the earlier judgement of the Apex Court (majority view of two Judges), in the case of Velliappa Textiles Ltd. (supra) is overruled. From the judgement of the Apex Court (majority view), it is now clear that while dealing with the provisions relating to offences committed by a company, even if the provision requires the imposition of mandatory term of imprisonment coupled with fine, the Court can impose only fine on such companies notwithstanding the fact that the company being a juristic person, cannot be given mandatory punishment of imprisonment.

The dissenting judgement representing the views of Justices B. N. Srikrishna and Santosh Hegde is delivered by Justice B. N. Srikrishna [who was also party to the judgement (majority view) in the case of Velliappa Textiles Ltd. (supra)] and the reasoning for the dissenting views are more or less the same as discussed in the said judgement. Therefore, to avoid repetition and for the constraint of space, that part of the judgement has not been dealt with in this write-up.

Coutesy : Kishor Karia , Rajendra Chitale

The stock markets in India are governed by the provisions of Securities and Exchange Board of India Act, 1992. The Securities Exchange Board of India constituted under SEBI Act, 1992 exercises overall superintendence over the stock exchanges under the Securities Contracts (Regulation) Act, 1956. SEBI was constituted on 21st February, 1992, with the twin objectives of regulation and development. The present broker regulations are by and large sufficient to protect the needs of the investors.

There are stock exchanges recognized under Securities Contract (Regulation) Act, 1956 which are the exclusive centres for trading of securities. Most of the stock exchanges in India are organized as “mutuals” which is considered beneficial in terms of tax benefits and matters of compliance. The trading members, who provide broking services also own, control and manage the exchanges. The trading platform of an exchange is accessible only to brokers. Demutualised exchange allows free entry and exit of brokers. The broker enters into trades in exchanges either on his own account or on behalf of his clients.

Brokers deal with secondary markets for the sale and purchase of securities such as stocks and bonds. Trading is done in various ways such as it may occur on a continuous auction basis; it may involve brokers buying from and selling to dealers in stock markets. The stock exchanges differ from country to country in eligibility requirements and in the degree to which the govt. participates in their management.

‘Broker’ as defined in the Concise Law Dictionary means “a middleman or agent who, for a commission on the value of the transmission, negotiates for others the purchase or sale of stocks, bonds, commodities or property of any kind, or who attends to the doing of something for another.[1] Thus, brokers are the people who deal in shares and whose business includes the procuring of subscribers for shares. They are basically intermediaries in the secondary market and are middlemen between the investors and stock exchanges. They reflect the deal by transferring the stock and shares. They bring funds from investors to the stock exchanges. One category of intermediaries are stock brokers and sub brokers.

Securities Exchange Act, 1934 defines the term “Broker” as anyone, other than a bank, engaged in the business of effecting securities transactions for the account of others.[2] In other words, brokers form a sub-class of dealers and include anyone who is in the business of effecting securities transactions as agents for others. Broker is an intermediary who is associated with securities market and is registered under Section 12 of the SEBI Act, 1992.

Unlike other brokers, stock broker is frequently entrusted with the possession of securities and may even take and transfer them without the name of the principal appearing in the transaction. He often pays the price in advance and then receives payment from the client. Thus, stock broker acts as a bailee as well as an agent. SEBI requires that the agreement between a stock broker and an investor is to be in writing and the agreement should be executed on stamp paper of atleast Rs.20. In K. Appa Rao v. Gopal Doss[3] it was held by the Madras HC that when an agent is authorized to negotiate and complete a sale for a specified price within a particular time, it gives him an authority to enter into a contract for sale, whether for movable or immovable property.

Further, ‘Brokerage’ is a commission paid to a bank, stock-broker, or other marketing intermediary for placing shares on a best effort basis or for inducing a broker’s clients or customers to subscribe for the company’s shares or other securities and is lawful if reasonable in amount.[4] In other words, brokerage is a fee or commission given to or charged by a broker.[5] When the owner of the property employs a broker to find a purchaser and he agrees to compensate him therefor, the consideration is known as “Brokerage Commission”. The listed companies can only pay brokerage of 5% on private placement of capital. However, the expenses incurred by the broker for getting hold of subscribers would be borne by the share broker himself.[6] Brokerage can only be paid for the services rendered under a contract with the company.

Stock Broker

“Stock Broker” is one who deals in stocks of monied corporations and other securities. He for a commission attends to the purchase and sale of stocks or shares, of the Government or other securities, on behalf of and for the accounts of their clients.[9] He is a person who has either made an application for registration or is registered as a stock broker or sub broker, in accordance with the rules and regulations made under the SEBI Act, 1992.[10] His functions are broader than the ordinary brokers, since he is entrusted with the possession of the property for which he acts and may even take and transfer it without the name of his principal appearing in the transactions. In India, there is no regulatory body for brokers.

In secondary market, brokers and sub brokers play a vital role. SEBI, as a regulator of the capital market has recognized their role and has thus permitted them to act as underwriters, without getting registered with SEBI pursuant to SEBI (Underwriters) Rules & Regulations, 1993. But this is subject to the condition that they hold a valid registration certificate from SEBI under SEBI (Stock Brokers and Sub Brokers) Rules & Regulations, 1992. However, he has to comply with all the obligations stipulated thereunder. He is also required to obtain the permission of the concerned Stock Exchange of which he is a member, so as to act as an underwriter for each and every issue.

Brokers send out regulatory newsletters to their clients giving them details of primary and secondary markets, particularly of new issues with their recommendation. Some of them undertake Portfolio Management for their valued clients. The brokers and sub brokers are even registered with leading merchant bankers, who handle large number of public issues.

A stock broker invests in the stock market for individuals or corporations. Only members of the stock exchange can conduct transactions, so whenever individuals or corporations want to buy or sell stocks they must go through a brokerage house. Stock brokers often advise and counsel their clients on appropriate investments. Brokers explain the workings of the stock exchange to their clients and gather information from them about their needs and financial ability, and then determine the best investments for them. The broker then sends the order out to the floor of the securities exchange by computer or by phone. When the transaction has been made, the broker supplies the client with the price. The buyer pays for the stock and the broker transfers the title of the stock to the client and performs clearing and settlement procedures.

The Central Government in India has enacted the law relating to Stock brokers under the Securities and Exchange Board of India (Stock Brokers and Sub-Brokers) Rules, 1992 and the Securities and Exchange Board of India (Stock Brokers and Sub-Brokers) Regulations, 1992. The SEBI Rules define ‘Stock Broker’ as a member of the stock exchange.[11] A stock broker acts as an agent of his client and deals with securities on behalf of his client. Though strictly, a stock broker is an agent, yet for the performance of the contract on his part both in the market and with the client, he is deemed as a principal. He holds a peculiar position of dual responsibility. He can charge commission from his client.[12] He not only executes transactions on behalf of investors but also offers value management or services such as initial public offerings on line, asset allocation, portfolio management, financial planning, tax planning, insurance services. In the case of Rajendra Prasad Bagaria v. Bhubaneshwar Stock Exchange Association Ltd.[13] Orissa High Court held that stock broker is governed by SEBI in matters relating to their registration, functioning and have to abide by the SEBI Regulations as well as bye-laws of the respective stock exchanges.

A person who is willing to operate as a stock broker can make an application for it under the SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992. The stock broker has to get himself registered under the SEBI Act, 1992. He has to act as per the conditions of the certificate of registration obtained from the SEBI in accordance with regulations framed under the SEBI Act, 1992, otherwise he cannot deal with securities market and cannot even buy, sell or deal in securities.[14] But he should be eligible as a member of the stock exchange, i.e., he should be a fit and proper person.[15] This is based on an objective test, i.e., whether or not the person has been involved or has a pending enquiry against him for some malpractice in the stock exchange in any segment of the market. Persons who operate in the securities market are required to maintain high standards of integrity, promptitude and fairness in the conduct of the business dealings. People who indulge in manipulative, fraudulent and deceptive transactions or abet the carrying out of such transactions, which are fraudulent and unreliable, are not considered fit or proper persons to operate in the market.

There are certain conditions provided under Rule 4 of SEBI (Stock Brokers and Sub-Brokers) Rules, 1992, which are to be fulfilled before the grant of a certificate to a stock broker.[16] The SEBI Act, 1992 prohibits stock broker from buying, selling and dealing in securities unless he holds a certificate granted by the Board under the SEBI (Stock Brokers and Sub-Brokers) Rules and Regulations, 1992.[17] Existing brokers of the concerned stock exchanges were allowed to continue their business, if they made an application for such registration within a period of 3 months from the establishment of the Board, till the disposal of the application.[18] An interesting aspect of the relationship between a brokers and stock exchange is that the stock brokers are required to pay registration fees for the grant of certificate as prescribed by Schedule III.[19] But if they fail to pay, then the Board may suspend the registration certificate, which implies that the stock broker shall cease to buy, sell or deal in securities as a stock broker.[20]

In National Stock Exchange Members’ Association v. UOI,[21] the petitioner, which was an association of the trading members of the National Stock Exchange, dealt with the sale and purchase of the shares and securities in India. Upon payment of fee, the members were registered under SEBI (Stock Brokers and Sub Brokers) Regulations, 1992. A circular was issued by SEBI by way of clarification requiring separate registration fee to be paid for multiple registration with the SEBI.

Then a writ petition was filed by the petitioners where they contended that the methodology adopted by SEBI for charging multiple registration fees was contrary to Schedule III to the SEBI (Stock Brokers and Sub Brokers) Regulations, 1992. The Delhi High Court held that there was no concept of quid pro quo in view of the nature of regulatory functions performed and the mode and manner of levy of fee to be adopted by the SEBI. Once the power of SEBI was accepted, there could not be a challenge to the methodology adopted for quantification of the fee. The circular was intra vires the regulation and clarified the mode and manner of the calculation of the fee.

In BSE Brokers Forum v. SEBI,[22] the validity of Regulation 10 read with Schedule III of the SEBI (Stock Brokers and Sub-Brokers) Regulation, 1992 was held intra vires the SEBI Act, 1992. But the imposition was held to be a fee and not a tax and was held not to be a condition precedent for the levy to constitute fee.

In due course, a number of brokers, proprietor firms and partnership firms have converted themselves into corporates. Out of 9,519 brokers registered with SEBI at the end of March, 2003, 3, 835 brokers accounting for nearly 40% of the total were corporate entities. At the end of March, 2003, there were 13,291 sub brokers registered with SEBI.[23]

A stock broker is required to pay to SEBI a registration fee of Rs.5,000 for every financial year, if his annual turnover exceeds Rs.1 crore. If this is so, he has to pay Rs.5,000 plus one-hundredth of 1% of the turnover in excess of Rs.1 crore. after the expiry of 5 years from the date of initial registration as a broker, he has to pay Rs.5,000 for a block of 5 financial years.[24] The a trading member can levy a maximum brokerage in respect of securities transactions is 2.5% of the contract price, exclusive of statutory levies like SEBI fee, service tax and stamp duty. Brokerage charges can be as low as 0.15% and maximum brokerage is inclusive of brokerage charged by the sub broker which shall not exceed 1.5% of the contract price.

The brokers of the various stock exchanges filed writ petitions in various High Courts challenging the imposition of fees on turnover to be paid by the brokers under the Securities and Exchange Board of India (Stock Brokers and Sub-Brokers) Regulations, 1990, which were subsequently transferred to the Supreme Court. The petitions were filed on the ground that it is a tax on the guise of the fee and is excessive or arbitrary. One of the case filed was of SEBI v. BSE Brokers Forum[25] in which the validity of the Securities and Exchange Board of India (Stock Brokers and Sub-Brokers) Regulation, 1992 was challenged. Supreme Court directed SEBI to amend the regulations following the recommendations of R. S. Bhatt Committee, which had given recommendations in respect of the computation of turnover of brokers under the regulations.

There are certain duties and responsibilities casted upon the stock broker who should maintain the books of accounts, records and documents.[26] Every stock broker has a duty to intimate to SEBI, the place where the books of accounts, records and documents are maintained.[27] Stock broker after the close of each accounting period, shall furnish to SEBI a copy of the audited balance sheet and profit and loss account as soon as possible but not later than 6 months from the close of said period.[28] If it is not possible for the stock broker to furnish the documents required under Regulation 17 (1) of SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992 within the required time, than he shall inform SEBI of the same along with reasons for delay and the time period by which such documents would be furnished. Stock broker has the responsibility of maintaining the books of accounts and other records for a minimum period of 5 years.[29] There is an obligation casted upon the stock broker to allow the inspecting authority to have reasonable access to the premises occupied by the stock broker or any other person on his behalf. He shall extend reasonable facility for examining any books, records, documents and computer data which are in his possession. He shall provide copies of documents or other materials relevant to the inspecting authority.

A stock broker should follow code of conduct prescribed under SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992.[30] As per code of conduct, he should maintain high standard of integrity. He should exercise due skill and care and should not indulge in manipulation or malpractices. He should execute the orders from his clients’ at best possible price. The member brokers of the stock exchange should issue contract notes to their clients for the securities sold and purchased by them on behalf of the clients. The contract note should state that the rate of brokerage charged is not exceeding the official scale of the brokerage fixed by the stock exchange. He should maintain confidentially in respect of information about his client’s transactions. He should not give advice to his clients unless he reasonably believes that the recommendation is suitable to his client.[31]

A stock broker should not deal with any outside party which has failed to honour its business obligations with any other stock broker of any other stock exchange. So, the names of the defaulting clients should be reported by the member of the stock exchange authorities.[32]

When the stock broker deals with his clients, he should observe certain precautions to avoid problems for the market as well as investors. This would protect the interests of the stock brokers, instill transparency and discipline in the dealings between the brokers and the clients and would contribute in the healthy working of the secondary capital market. These precautions are listed into two categories: (a) mandatory and (b) precautions by way of a guideline.[33] SEBI is of the view that member brokers should strictly follow the mandatory precautions and the precautions by way of guidelines should be followed when circumstances demand. Complaints can also be reported against the stock brokers by the stock exchanges. The concerned stock exchange shall send a Monthly Status Report of Complaints against brokers, instead of sending replies on a case to case basis. Stock brokers sometimes trade on their own behalf as a principal. In such cases, the term broker makes little sense and the individuals or firms trading in a principal capacity sometimes call themselves dealers, stock traders or simply traders.

Sub – Broker

Sub Broker is any person, not being a member of a stock exchange. He acts on behalf of a stock broker as an agent or otherwise for assisting the investors in buying, selling or dealing in securities through such stock brokers.[34] He is further an agent of the broker and carries out actual transactions for the broker. He is one who has either made an application for registration or is registered as a sub broker under SEBI Act, 1992.[35]

The members of the stock exchange who execute transactions of their clients through the members of other stock exchanges are treated as “Sub Brokers”. Any person who not being a member of a stock exchange, acts on behalf of a stock broker as an agent for assisting the investors in buying, selling or dealing in securities through such stock brokers is called as a sub broker. He is associated with securities market and should not buy, sell or deal in securities unless he has complied with the conditions of the certificate of registration obtained from SEBI issued in accordance with Rules and Regulations.[36] If he is associated with securities market before the establishment of the SEBI, then he may continue to do business but upon an application made for registration within a period of 3 months from the establishment of SEBI, till the disposal of such application.[37]

There are certain conditions provided in Rule 5 of SEBI (Stock Brokers and Sub-Brokers) Rules, 1992, which are to be fulfilled before the grant of a certificate to a sub-broker.[38] If the stock broker/sub broker fails to comply with the conditions subject to which he is been granted registration, then he would be penalized and his registration would be suspended or cancelled.[39]

A sub broker should co-operate with his broker in the transactions. He should not knowingly and willfully deliver documents which constitute bad delivery. He should also co-operate with other contracting party for prompt replacement of the documents which are declared as bad delivery. Further, he should extend his full co-operation to his stock broker in protecting the interests of his clients regarding their rights to dividends, bonus rights, rights shares and any other right relatable to such securities.[40]

Further, sub brokers, who act on behalf of their principal broker, are required to issue to their clients purchase or sale notes for all the transactions entered into by them on behalf of their clients. While performing this function, the sub brokers act as an agent of the principal broker.[41]

He is also required to be registered with the concerned stock exchange.[42] The business of the stock brokers and sub brokers is too much interlinked, so, for properly monitoring their activities separate registration procedure is provided. The sub broker owes obligations not only to the client but also to the stock broker. The sub broker enters into a tripartite agreement with the main broker and his client. He assists his clients in obtaining the contract note from the main broker. But he cannot issue the note or make payments through cheques directly, as that has to be done by the main broker.[43]

Relation Between Stock Broker And The Client

The relationship between a stock broker and a client is that of a principal and agent.[44] SEBI requires that the agreement between the stock broker and an investor is to be in writing. It has to be executed on a stamp paper of Rs. 20. Due to the nature of trading activity at NSE and BSE, every stock broker can be considered as a del credere agent.[45] There also exists a bailor-bailee relationship between the two.[46] There relation is also held to be of fiduciary nature. Still the broker is bound to exercise his functions with due diligence as stated in SEBI Code of Conduct for Brokers.[47] In Sharedeal Financial Consultants (P) Ltd. v. SEBI[48] it was held that ‘due diligence’ required is not that of an ordinary or prudent person but that of a stock broker who would be required to perform his duties towards his client using his skill and reasonable care.

The investor has to deliver the shares to the stock broker so that he can sell them in the stock exchange. In case stock broker cannot sell them, then those shares have to be delivered back to the investor. Thus, a stock broker becomes a bailee and operates on certain responsibilities in that capacity.[49] The relation between the stock broker and the investor is that of fiduciary nature, which is founded on trust, reliance, dependence or confidence rested by the investor in the reliability and faithfulness of the stock broker who is in a position of relative dominance and influence. In Kennedy v. Budd[50] it was held by the court that when we consider the broker’s duties as to the performance of the contract after the purchase has been made, he was bound to act solely for the benefit of his customer and bound to give his best judgment and to take no advantage of his customer, it was quite clear that to that extent he acts in a fiduciary capacity. Even in State ex rel. Paine Webber, Inc. v. Voorhees[51] the Judge observed that the broker had an implicit obligation which arose in connection with his fiduciary duty to the customer, which was to disclose to the customer the material facts. This duty does not, however, include the obligation to discuss prominent written provisions with the competent party. When broker is disloyal and betrays the trust and confidence of his client/investor, than he could be held liable for damages. If a broker misrepresents or fails to provide information regarding an investment or transaction, the client/investor may have a potential claim against that broker to recover losses.

When a client operates through a stock exchange, he has the right to receive the best price prevailing at that time for the trade, the money or shares on time, contract note from broker confirming the trade and indicating the necessary details of the trade, good delivery and right to insist on rectification of bad delivery.

The broker has a number of rights that he can claim over his clients. A broker who has carried out his instructions is entitled to full indemnity from his client against any losses or liability incurred by him for having entered into the transaction. He shall be at full liberty to close out the contract when the client fails to make payment to him within 2 days of issuance of contract note and sell or purchase the securities.

SEBI has issued mandatory guidelines to be followed by the stock brokers before they agree to act on behalf of their clients. An important duty of the stock broker towards his client is that of confidentiality. Under SEBI guidelines, the broker is not supposed to disclose either personal or financial details of his clients to anyone. The broker has a corresponding duty to ensure that he maintains separate accounts for his clients and pays them regularly the required amounts. The clients are also issued ID’s[52] in case they need to be traced if they fail to make payments.

Conclusion

To conclude, it is submitted that SEBI has modernized the stock exchanges. An active effort made by stock exchanges is that of making the clients aware of their rights and liabilities. Even today, the stock broker continues to command an immense power in the stock exchanges. A vast majority of securities transactions are handled by stock brokers or dealers who act as agents for principal willing to buy or sell securities. But technological developments in 21st century have greatly influenced the nature of trading. The increased access to internet and the proliferation of electronic communications networks altered the investment world. Through e-trading, the customer enters an order directly on-line and software automatically matches orders to achieve the best price available without the intervention of specialists or market makers or stock brokers. This has gradually reduced the need of intermediaries like stock brokers to deal between the client and the stock exchange.

Article by Neha Bahl, Professor Nalsar university of Law