The securities appellate tribunal (SAT) has quashed the orders passed by the National Stock Exchange (NSE) and Central Depository Services (CDSL) directing Kotak Mahindra Bank not to invoke shares pledged by Arcadia Share & Stock Brokers.
It may be recalled that in February 2021, NSE had restrained Kotak Mahindra Bank from invoking and selling securities pledged by the brokerage until the rightful ownership of the securities was ascertained. CDSL had then put in place a debit freeze, prohibiting Kotak Mahindra Bank from invoking the pledged shares and recovering its dues. Bank had then moved SAT, challenging these orders.
Pointing to the clause 4.22 and 4.23 of the circular, the tribunal said it clearly indicated that “the stock exchange could only direct the clearing member or the clearing corporation to invoke the unencumbered collateral securities or the unencumbered collateral deposits meaning thereby that if the securities of the broker is pledged, the same cannot be invoked by the clearing member or the clearing corporation on the instruction of the stock exchange.” The SAT order is signed by justice Tarun Agarwalla (presiding officer), justice MT Joshi (judicial member) and Ms Meena Swarup (technical member).
In its 20-page order issued last week, SAT said, “we are of the opinion that respondent (NSE) as a stock exchange has jurisdiction only against its trading members and cannot issue any directions to any other entity including the appellant (Kotak Mahindra Bank) who is not the trading member. Similarly, the depository also cannot issue any direction against any other entity which is not within its jurisdiction nor can freeze the securities which were pledged in favour of the appellant. The depositories can take action against the defaulters of the stock exchange and freeze the assets of the defaulters to the extent of the assets which are not encumbered.”
The matter relates to Arcadia Share & Stock Brokers which had availed a loan from Kotak Mahindra Bank in March 2018 by pledging shares. In its agreement with the Bank, Arcadia had expressly declared that it was the legal and beneficial owner of the securities and that they are not encumbered in any manner.
In December 2020, when Arcadia began to default on its repayment obligations. Subsequently, on 15 February 2021, Kotak Mahindra Bank recalled the loan facility and informed the broker that it would enforce the pledged securities.
However, in the interim, NSE passed an order on 4 February 2021, advising Kotak Mahindra Bank not to invoke the pledged securities till their ownership was ascertained in the stockbrokers’ demat accounts. The move came amid allegations that Arcadia had wrongfully pledged its clients’ securities with lenders to avail loans.
Senior advocate Gaurav Joshi along with advocates Sameer Pandit and Krina Gandhi who were legal counsels for Kotak Mahindra Bank argued before SAT that NSE had no jurisdiction to restrain it from invoking its pledge as it was not a trading member and, hence, was not bound by NSE’s rules. On the other hand, NSE’s counsel argued that it had the power to initiate action to protect the interest of the investors.
In the meantime, a forensic report had revealed that the clients’ securities were indeed illegally pledged by the broker. However, SAT has held that NSE and CDSL had no powers to issue directions to a non-trading member.
Further, dismissing NSE’s contention of deriving powers to issue appropriate direction to the Bank from a SEBI circular which laid down standard operating procedures (SOPs) in this regard, SAT clarified that the circular was issued to all recognised stock exchanges and all recognised clearing corporations and depositories, and not to the Bank, viz., the appellant.
Accordingly, the appellate tribunal concluded that the impugned orders passed by NSE and CDSL cannot be sustained and, hence, deserve to be quashed.
Market experts said under the earlier share pledging system it was easier for brokers to misuse client securities to avail loan facilities. This was possible as they had the power of attorney (PoA) from clients. In a circular dated 1 July 2020, SEBI introduced new pledging norms
to prevent misuse by such brokers and did away with the concept of PoA.
Earlier, SAT had issued similar orders against HDFC Bank and Axis Bank, siding with the lenders in the illegal share pledging cases. In May 2022, SEBI and NSE moved Supreme Court
against a SAT order which had ruled in favour of HDFC Bank in a prolonged legal dispute over the Bank selling shares pledged with it by broker BRH Wealth Kreators.