2. Inspection of books of accounts, records, documents etc of KCL as a depository participant of NSDL was undertaken by a SEBI appointed CA firm, M/s. M. Bhaskara Rao & Co. The inspection was conducted covering five years from December, 1997 to October 2002. Certain irregularities, deficiencies and lapses on the part of KCL were observed by the said CA firm. Same were communicated to KCL vide letter dated March 22, 2003 and it was given 15 days time to offer its comments on the observations of inspection. KCL vide its letter dated April 17, 2003 furnished its reply to the said observations.

3. After considering the submissions made by KCL, a show cause notice was issued to it on May 5, 2004, advising it to show cause as to why ‘cease and desist’ proceedings under section 11D of  SEBI Act,1992, should not be initiated against it for the lapses and irregularities observed during the inspection.

4. KCL was advised to send its reply to the said show cause and also indicate if it desired a personal hearing before the competent authority. A reply to the show cause notice was received from KCL vide letter dated May 22, 2004.   KCL sought an opportunity for a personal hearing.

5. An opportunity of personal hearing was given to KCL on October 18, 2004. However, due to change in the Competent Authority, KCL was granted another opportunity of personal hearing on July 27, 2006. KCL was represented by the officials mentioned in the first page of this order who made submissions on its behalf.  Further, KCL vide letter dated August 02, 2006 reiterated its earlier reply dated May 22, 2004.

6. I have carefully considered  the inspection report, the show cause notice, the reply of  KCL and the material available on record and my findings  are as under :

6.1             It was alleged that Beneficiary Accounts were opened without obtaining proper proof of identity, address proof of the clients, thereby KCL violated the provisions of SEBI circular no.SMDRP/Policy/CIR-36/2000 dated August 04, 2000.

KCL contended that their DP operations commenced in 1998 and at that time the requirement of obtaining a proof of identity was not mandatory.  The Circular was issued by SEBI in this regard in August 2000.  Subsequent to the circular, KCL has opened all new accounts with proper proof of identity / address.  There was only one case which was opened subsequent to the circular where complete documents were not collected by it on time and this was since rectified.  

6.2             It was alleged that Beneficiary Accounts were opened with improper and incomplete documentation like incomplete details in the account opening application form, not obtained the MoA, Board Resolution in the case of corporates and not maintained the list of authorized signatories for operating the beneficiary account.

KCL submitted that the applications pertained to the accounts opened in 1998-99 when there was no clear guidelines with respect to acceptance of applications with POA.  KCL further stated that there were certain common accounts where only one set of documents were collected and these have been subsequently replicated.  KCL stated that the deficiencies in the account opening application forms which were clerical in nature have been rectified and necessary documents have been collected wherever required.   From the above submissions, I find that the DP has not denied the allegation. Opening of beneficiary account by following improper procedure may result in misuse of depository system.     

6.3             It was alleged that Debt Instruction Slips (DIS) were accepted from the investors on many occasions without time stamping and without mentioning the execution date on the DIS. Further, there were instances where the DIS used did not have the pre-printed serial number, beneficiary account ID of the client and the alterations on the DIS were not authenticated.

KCL submitted that there were certain clients where DIS slips were received in bulk along with a covering note. The acknowledgement was issued on the covering note along with the date. KCL further stated that subsequent to the observations, they have ensured that the acknowledgement was put on each and every DIS at the time of acceptance.  As regards non mentioning of ISIN Nos. KCL stated that sometimes DIS is received by post and due to market requirements, it becomes difficult for them to reject the slips which would result in loss to the investors and hence they were forced to accept such slips. KCL further stated that they do not accept fax copies from the clients. However, as they were having branches across the country, the clients could submit the execution slips at any of their branches which are all attached to the DPM at Hyderabad.  They have a DP back office module using which the slips could be executed from the branches. Those branches to whom these facilities have not yet been provided, fax the slips to HO for execution. The hard copies are subsequently sent. The cases referred to were such cases where the execution slips were faxed and the original DIS were yet to be received. KCL submitted that the Auditors had identified 20 cases where minor alterations in the DIS have not been authenticated. KCL stated that in case any slip is altered and submitted at the front office, the executive insists on the client signing the same. However, when such slips are received either through representatives or by post such cases are accepted without authentication to ensure that the investor is not put to a loss on account of non execution of the DIS.

6.4             It was alleged that on many occasions, there were dematerialization rejections on account of incomplete dematerialization request form like absence of PoA with the DRF, DRF dispatched to incorrect registrar and share transfer agent.

KCL submitted that they had processed 750859 DRFs as on the date of audit.  The four cases pointed out by the auditors where the copy of PoA was not attached forms 0.0005% of the total volume handled. KCL further stated that the one case where the DRF was sent to an incorrect Registrar was an error which occurred on account of two different ISINs being mentioned as Cyberspace in the NSDL DPM and this has since been rectified.  

7.  Upon considering all the facts of the case, I agree with the findings of the inspection report that KCL has committed irregularities as discussed above which have been accepted by KCL. They are violative of the provisions of SEBI circulars SMDRP/Policy/Cir-36/2000 dated August 04, 2000. These violations do not augur well for the securities market, as in a demat environment, a DP plays a crucial role and any systemic deviation will expose the investors to avoidable and unforeseen risks, which would not be conducive to the orderly development of the securities market. However I have noted that most of the irregularities pertain to a period before 2000, particularly before the issuance of circular dated 4.8.2000.

7.1       I have noted that the DP business of KCL was transferred to Karvy Stock Broking Ltd (KSBL) during August 2005, which has been approved by SEBI, subject to certain conditions. One of the conditions is that the transfer includes a covenant for taking over all the assets and liabilities/obligations including pending disputes/grievances of the investors holding DP accounts with KCL by KSBL. 

7.2       I have also noted that almost similar violations have been prima facie found as recorded in the ad interim ex-parte order dated April 27, 2006 read with order dated May 26, 2006 in the case of recent IPO investigations, whereby KSBL was inter alia, restrained from opening fresh demat accounts, pending enquiry.  I have also noted that an enquiry officer was appointed and the enquiry proceedings are in progress. In view of the same, it may not be appropriate to issue orders or directions at this stage asking KCL to cease and desist from committing violations.

  8.  In view of the above, there is no need to pass any further directions and accordingly the Show Cause Notice shall stand disposed of on the aforesaid terms. This order shall be without prejudice to any other pending proceedings before SEBI against KCL or KSBL.

9. This order shall come into force with immediate effect.

Mumbai

Date: 19.1.2007                                                       V.K. Chopra

Whole Time Member

       Securities and Exchange Board of India