The Hindu Business Line : Demat Fraud: Who is to blame?

SEBI's recent order calling upon two major depositories and a few depository participants to disgorge a carefully calculated sum of Rs 116 crore does not seem justified

A factory technician knows that decoupling is possible only when two things are coupled in the first place, just as a politician knows that disengagement is possible only when there is an engagement between two persons or sets of persons.

Only the benighted or naive would believe that disgorgement is possible when there has been no engorgement. But then the Securities and Exchange Board of India (SEBI) is not a benighted institution nor can it be accused of naiveté. Far from these, it is credited with farsightedness and toughness on a par with the Election Commission.

SEBI has made several seminal changes to make the lot of investors in the capital market better if not foolproof. That it has had the mortification of seeing bulk of its orders reversed by Securities Appellate Tribunal (SAT) shows that its orders are not thought through, though its heart is in the right place.

For instance, its recent order calling upon two major depositories and a few depository participants to disgorge a carefully calculated sum of Rs 116 crore which was admittedly engorged by Roopalben Panchal, by creating a record number of fictitious demat and bank accounts — roughly 7000 — to hog shares in public issues reserved for retail investors.

Or was it a deliberate order to penalise the depositories and depository participants for not Knowing Their Customers or, worse still, for winking at their wily schemes? If this is indeed so, it is without a parallel or precedent besides smacking of vigilante justice.

My math teacher in school, Yagyanarayanan, if alive, would of course approve of this variant of vigilante justice having pioneered it by punishing students facilitating copying rather than punishing the copiers themselves. But SAT would not be amused by the SEBI order, knowing as it does, and as indeed everyone do, that the malaise lies elsewhere.

The order cannot be justified on the ground either that those asked to disgorge can in turn ask their fraudulent clients to disgorge because they simply don't have the powers to do so — only a judicial or quasi-judicial authority like SEBI or the SAT can do so. That it is easy to recover from a couple of big-ticket institutions rather than from the nondescript retail investors can be no justification for such vigilante justice.

This is not to say that the depositories and depository participants can be absolved of blame. If anything, it is their delinquency that facilitated the monumental fraud. They must also be punished severely. But disgorgement hardly can be the punishment for those who haven't engorged.

SEBI might not call its order an order for disgorgement. But it hasn't left any one in doubt either as to the true nature of its order — disgorgement. And this precisely is going to be the issue that would be raised on appeal: Can one be asked to disgorge what one hasn't engorged in the first place? Punishment should be proportionate to the crime.

The intermediaries have indeed been remiss in allowing this monumental fraud to go through. Punish them by all means. But law does not permit collecting the spoils of a loot from the abettor merely because he is easy to target and the amorphous retail investors or who pass for them are difficult to buttonhole.

And there is no way the intermediaries can recover the penalty vicariously imposed on them by the regulator from the actual beneficiaries of the fraud. It is all fine to haul over the coals the guard for a bank robbery. But can an order be passed against him to cough up the money that was looted? No, because firstly he would not have the resources and, secondly, because that would be disproportionate to his crime. SEBI fortunately was dealing with a culprit who admittedly was more resourceful. But then punishment should be proportionate to one's crime and not to one's resources.

(The author is a Delhi-based chartered accountant.)

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