The raging controversy over Madhabi Puri Buch and turmoil at the market regulatory body, almost drowned out a stunning order by the Bombay High Court on 26 August 2024. A bench of justices GS Kulkarni and Firdosh P Pooniwalla had imposed a stiff penalty of Rs80 lakh on the Securities & Exchange Board of India (SEBI) and two major stock exchanges for the illegal freezing of the demat account of a doctor.
But all is not lost as yet. The apex court granted the stay on ‘procedural’ grounds. The high court, it said, had issued a ‘final judgement’ on a matter reserved for ‘interim relief’ and the penalty had been imposed without hearing the regulatory bodies involved. The case has been remanded back to be reheard by the same bench, with an opportunity for the regulator and exchanges to be heard.
A reading of the high court’s detailed order shows its palpable frustration at the manner in which SEBI, along with depositories and the stock exchanges, had given the petitioners a run-around for six years without any substantive hearing or resolution. Although it was an interim order, the court examined in depth the regulator’s powers under the SEBI Act and other capital market-related statutes. This suggests that SEBI would do well to re-examine its actions before the case is re-heard by the same bench, rather than attempt to justify its rigid circulars and failure to give the petitioner a fair decision even after six years of continuous effort.
The broader issue is: Whether banks, financial regulators and depositories have the power to arbitrarily freeze financial assets (whether they are shares and mutual funds in demat accounts or bank accounts). Very few investors or depositors have the resources, like this petitioner, to wage a long legal battle against powerful authorities. Although this case pertains to non-compliance by a listed company, SEBI had previously blocked the demat accounts of thousands of investors from 1 July 2023 to May 2024 for failure to link permanent account numbers (PANs) to their Aadhaar number. In doing so, it denied them the ability to book profits or make new investments in the middle of a powerful bull run. Anti-Aadhaar activists say that the accounts remained blocked until SEBI ‘unilaterally revised its circular’ and lifted the freeze. Banks continue to freeze thousands of accounts, often without warning, for delay in updating know–your-customer (KYC) documents.
The Case (Writ Petition 1590 of 2021)
The saga of Dr Pradeep Mehta and his son Neil, who filed the Writ Petition (1590 of 2021) paints a disturbing picture of regulatory callousness.
The case harks back to 1989 when Dr Mehta subscribed to 2,000 shares of Shrenuj & Company (Shrenuj), promoted by his father-in-law. Over time, with stock splits and some sales, he held over 20,000 shares in 2016, comprising less than 0.1% of the paid-up capital of Shrenuj. But he had nothing to do with the management, directly or indirectly, nor had he held any advisory or board positions. Shrenuj ran into financial trouble in 2016 and failed to file its financial results and was penalised by the exchanges.
Dr Mehta’s ordeal began in 2017 when he discovered that his demat account was frozen because he was classified as a promoter of Shrenuj on account of the familial relationship. His holding in ITC Ltd was also frozen, so were the demat accounts of his son Neil.
This led to a bizarre situation which saw him pushed around in circles with no sign of justice. When he first approached SEBI, it said the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) should consider his representation. He then approached securities appellate tribunal (SAT) which disposed his appeal in April 2018, directing the exchanges to hear him. The exchanges, again, cited SEBI circulars for dealing with non-compliance by listed entities and did nothing. Their stand would have applied if Dr Mehta was indeed Shrenuj's promoter; but neither SAT nor the exchanges would listen to his plea that he was wrongly classified as one.
Meanwhile, the exchanges had imposed a hefty fine on Shrenuj and insisted that Dr Mehta should ask the company to pay up. On 4 July 2018, Shrenuj was delisted, which meant that the Mehtas had lost an opportunity to sell and were stuck with virtually dud shares in frozen demat accounts.
So they went back to SAT which again directed them to the exchanges and the impasse continued. Meanwhile, Action Financial Services, the brokerage firm where they had their demat account shut down. They were told that frozen demat accounts could not be transferred to the National Securities Depository (NSDL) under a scheme to deal with the situation. A legal notice to NSDL led to an exchange of letters, with no resolution.
This forced them to file the petition seeking a writ of mandamus declaring SEBI actions as being beyond the powers granted by its statute, or declare that the regulator had no powers to freeze accounts or impose penalties without a proper hearing.
A reading of the judgement reveals that SEBI filed perfunctory responses stating it had powers to frame regulations and initiate action against listed companies for non-compliance. It said that these powers were delegated to the exchanges and suggested that Dr Mehta could approach SAT for relief. The depositories and exchanges also justified their action as being based on SEBI circulars and mandated procedures.
It was clear that the manner in which Dr Mehta was pushed around by various intermediaries without a hearing or resolution had outraged the court, which found it ‘not only painful but extremely shocking’ that, despite the facts and circumstances revealed in this case, SEBI and the exchanges defended their action, when the law mandates them to protect investors. It held that the drastic action of freezing accounts, without even a show-cause notice or hearing, was ‘brazenly illegal, unreasonable and arbitrary’ and the SEBI Act does not give the regulator any such power.
The case of Dr Mehta’s son Neil was considered even more egregious, since he was only seven years old when Shrenuj was incorporated and had even less of a connection with the company’s management. It is thus that the HC found it a fit case to lift the freeze on the demat account and order SEBI, BSE and NSE to jointly make a payment of Rs30 lakh to Dr Mehta and Rs50 lakh to his son.
As I write this column, the Supreme Court has quashed the costs imposed on SEBI and the exchanges. But, given the path-breaking nature of the August order, the re-hearing should be tracked closely by investors and depositors. After all, this is by no means a singular instance of harassment unleashed by the arbitrary freezing of financial assets in bank or demat accounts.
The irreparable damage and anxiety caused by banks freezing customer accounts, without notice or warning, for delay in updating even unchanged KYC details, run into tens of thousands. Government investigation agencies also seek to freeze accounts, often without a due process of law. This is the first time that a court had questioned a regulator’s overreach and imposed costs for callous, unlawful and arbitrary actions.
As the case awaits a fresh hearing, it will be a critical watch-point for investors, lawyers and observers on whether the final judgement forces regulators to adopt a more balanced approach and find ways to protect investors which is their mandate, instead of harassing them with standard rules and circulars.
Comments
milindnadkarni
3 weeks ago
I had very bad experience on the issue of Re-KYC process.
HDFC Securities started sending us SMS & emails beginning Mar'24 threatening to freeze accounts (mine, wife and children's) if we do not complete Re-KYC process. HDFC Securities advised us to do it on-line and send us an email with a "button", clicking on which they said the Re-KYC process will be completed in a step wise manner.
That software tool just failed with an error; the error was shown to HDFC Securities person as well as to two persons from HDFC Bank. All supporting material to prove this error (screen capture) was provided too; till date (even after nearly 6 months have elapsed) they have not told us what the cause for the error was. In Apr'24 we physically submitted carried originals and photocopies of Aadhaar, PAN, Passport to HDFC Securities office for verification and completion of Re-KYC process. Our documents were verified and we were assured that we have completed the Re-KYC process successfully. Even after this the emails & SMSs threatening freezing our accounts continued for next two months. In Jun'24 HDFC Bank started sending such emails and SMS even though they had informed us in Mar'24 that we have completed the Re-KYC process with the Bank.
Both the entities - HDFC Bank & HDFC Securities showed complete disregard and no accountability till date on this matter, in spite of escalating our complaint to practically everyone. Pathetic state of affairs.
reKYC demanded by banks after every few years causes a real nightmare for bank account holders.
What is the need or logic to do reKYC every few years when PAN and Aadhaar details remain same?
My argument is that if at all banks want reKYC with same PAN and Aadhaar essentially they are getting the proof that Bank account holder is indeed alive. Nothing more because it's the same paperwork every time.
Then why not get an online video proof every few years from each bank account holder? It will be faster. He would required to come on a site and read out a code shared by the authority that keeps track of "I-not-dead-yet" status of all bank account holders.
Other option is to create a single KYC authority which has links with PAN, Aadhhar, Election card. It will be used by all financial institutions like Banks, Mutual Funds, Depository Participants, Bond houses, Crypto Exchange and so on. Let them periodically verify that the person is still alive.
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HDFC Securities started sending us SMS & emails beginning Mar'24 threatening to freeze accounts (mine, wife and children's) if we do not complete Re-KYC process. HDFC Securities advised us to do it on-line and send us an email with a "button", clicking on which they said the Re-KYC process will be completed in a step wise manner.
That software tool just failed with an error; the error was shown to HDFC Securities person as well as to two persons from HDFC Bank. All supporting material to prove this error (screen capture) was provided too; till date (even after nearly 6 months have elapsed) they have not told us what the cause for the error was. In Apr'24 we physically submitted carried originals and photocopies of Aadhaar, PAN, Passport to HDFC Securities office for verification and completion of Re-KYC process. Our documents were verified and we were assured that we have completed the Re-KYC process successfully. Even after this the emails & SMSs threatening freezing our accounts continued for next two months. In Jun'24 HDFC Bank started sending such emails and SMS even though they had informed us in Mar'24 that we have completed the Re-KYC process with the Bank.
Both the entities - HDFC Bank & HDFC Securities showed complete disregard and no accountability till date on this matter, in spite of escalating our complaint to practically everyone. Pathetic state of affairs.
What is the need or logic to do reKYC every few years when PAN and Aadhaar details remain same?
My argument is that if at all banks want reKYC with same PAN and Aadhaar essentially they are getting the proof that Bank account holder is indeed alive. Nothing more because it's the same paperwork every time.
Then why not get an online video proof every few years from each bank account holder? It will be faster. He would required to come on a site and read out a code shared by the authority that keeps track of "I-not-dead-yet" status of all bank account holders.
Other option is to create a single KYC authority which has links with PAN, Aadhhar, Election card. It will be used by all financial institutions like Banks, Mutual Funds, Depository Participants, Bond houses, Crypto Exchange and so on. Let them periodically verify that the person is still alive.
Can this be not done?