Confused are the ways of laws, interpretations and judgments. If one sifts through various orders, the manner in which the arguments are fashioned seems mystifying and intriguing. One of the commonest refrains, especially in civil and financial cases, is that a person’s involvement in one case cannot be logically assumed to deem her an involved party criminal in another one. Another one is that an individual got bail, which is deemed to signify the lack of guilt.
Yet another argument is that the case is sub-judice, and a person is “innocent unless proven guilty”. Questions are raised about the timing of the laws, which indicate a conspiracy against the possible perpetrator. People try to convince the courts that they have weaned themselves away from certain events and entities and, thus, the latter should not pay the price for the acts of the former. In effect, the law cannot apply to an individual, merely because she is connected to a criminal.
These facets are a part of SEBI’s order against 63 Moons Technologies, and its founder Jignesh Shah, on the renewal
of STP (Straight-Through-Processing) licence. The court said that the company and founder were “not a ‘fit and proper person’” to provide intermediary technology services to brokers, custodians and fund houses. It was based on an earlier order that declared Shah and 63 Moons unfit to be owners and/or part of managements and boards of approved exchanges.
It is difficult to tell a new story about Shah’s legal tangles without a peek into his past. Given the charged shenanigans at the National Spot Exchange Ltd (NSEL), which we will describe later, restrictions were passed against 63 Moons (former Financial Technologies) and Shah. In 2013, the Forward Markets Commission (FMC) said that 63 Moons “does not carry a good reputation and character, record of fairness, integrity or honesty to continue as a shareholder of Multi Commodity Exchange”.
FMC added that Shah was “not a ‘fit and proper person’” to be part of any management or board of any exchange. In 2014, SEBI judged that 63 Moons could not hold shares in a stock exchange or clearing corporation, either directly or indirectly, because it was unfit to do so. In 2016, Shah was arrested by the Enforcement Directorate for money laundering and economic offences worth Rs 2,000 crore. He was released on bail, and the FMC order is currently pending before the Bombay High Court.
On the basis of these orders, 63 Moons was issued a show-cause notice (SCN) in 2018 as to why its application for STP services should not be rejected. STP implies end-to-end processing of transactions of the financial instruments and involves the use of a single technology system to process and control the entire workflow of financial deals. Thus, such systems electronically capture and process deals from the point of their initial transactions to the final settlements.
In 2013, the Forward Markets Commission (FMC) said that 63 Moons “does not carry a good reputation and character, record of fairness, integrity or honesty to continue as a shareholder of Multi Commodity Exchange”. FMC added that Shah was “not a ‘fit and proper person’” to be part of any management or board of any exchange
SEBI had to decide the veracity of the SCN. 63 Moons said that there were differences between the cases related to NSEL and STP. The former were about holding shares in stock and commodity exchanges, and whether Shah could manage them. They were linked to events on the NSEL. No one questioned 63 Moons’ ability to provide software services (STP). The state agencies wanted to merge NSEL and 63 Moons, which reflects their belief in the latter’s software capacity.
In practice, the court agreed that the two were governed by different sets of regulations—one that dealt with the exchanges, and the other with the intermediary services like STP. But the latter too has a clause, which states that one of the eligibility criteria is that the service entity needs to be a “fit and proper person”. The court, therefore, had to decide if the two applicants fulfilled these conditions, which were effective from April 2017, given that the STP deal was from 2016 to 2019.
Before we get into the conditions, consider another contention by the applicants that they were introduced days before the SCN, and after the STP agreement was signed in 2016. The first indicated a deliberate conspiracy to harm 63 Moons and Shah, and the latter that the sub-clauses related to “fit and proper person” cannot be applied on a retrospective basis. SEBI court said that they would be applicable from the time that they became effective, i.e. April 2017.
Let us look at the specifics. Schedule II of the Intermediaries Regulations lays down the sub-clauses to determine a fit and proper person. The considerations included the “integrity, reputation and character” of the licence holder and its key personnel, “absence of convictions and restraint orders, competence including financial solvency and net worth, (and) absence of categorisation as wilful defaulter”. The SCN stated that Shah and 63 Moons did not satisfy these criteria.
Now, the lawyers for the two contended that a general condition—integrity, reputation and character—was followed by three precise ones, which included convictions, solvency, and defaulter status. In such situations, the interpretation is that the “general words must take colour from the specific words”. This is true even if the explicit words preceded the general ones. In other words, the general vague conditions must be read only in the context of the exact specific ones.
If 63 Moons and Shah had no convictions—the cases related to NSEL were sub-judice, and bail was granted in the money laundering case—were solvent and not wilful defaulters, their reputation and character was intact. The SEBI judge said that “I do not agree” with this contention. He added that “words like ‘integrity, reputation, and character’ are not general words, have specific meaning, and are not following the other three clauses”. They have a “different and definite intent”.
For example, the Cambridge Dictionary defines reputation as the “opinion that people in general have about someone or something, or how much respect or admiration someone or something receives, based on past behaviour”. The SEBI court ruled that “past behaviour can be taken into account” to decide if someone is fit and proper. Similarly, if a reputation is tarnished in one field due to findings and allegations, one can “consider such reputation in a different field of activity”.
SEBI, in the 2006 Jermyn Capital case, said that it could consider any aspect to determine whether a person or entity is fit and proper or not. “The framers of the Regulations have consciously given such wide powers because of their concern to keep the market clean and free from undesirable elements,” it added
In the 2007 Mahesh Babu Securities Ltd case, SEBI Appellate Tribunal (SAT) disagreed that a criminal case filed by the Central Bureau of Investigation “has no concern with the securities market”. It stated that the charges were so serious that “if established, they involve moral turpitude”. In such a scenario, a decision that a person did not enjoy a good reputation “could not be said to be perverse”. SAT stated that SEBI “had not erred” in deeming the entity “not a ‘fit and proper person’”.
SEBI, in the 2006 Jermyn Capital case, said that it could consider any aspect to determine whether a person or entity is fit and proper or not. “The framers of the Regulations have consciously given such wide powers because of their concern to keep the market clean and free from undesirable elements,” it added. Reputation is related to association; “a person is known by the company he keeps”. For instance, if a firm’s character is tarred, so will be those of the directors and partners.
Hence, SEBI declared, “In this background, the Board may… be justified in keeping a doubtful character or an undesirable element out from the market rather than running the risk of allowing the market to be polluted. We may hasten to add here that when the Board decides to debar an entity… it must have some reasonable basis for saying so.” Given the above context, SEBI ruled against 63 Moons and Shah in the recent STP case. The expanse of reputation was large.
On the issue of whether the lack of convictions and bail implied a good reputation and character, the SEBI court relied on past orders of FMC, SEBI, and Bombay High Court. The FMC stated that despite its argument that it was “ignorant of the affairs and conduct of NSEL”, it influenced the management and governed the exchange’s governance. There is no way that 63 Moons can hide behind a “corporate veil”, and distance itself from a fraud of Rs 5,500 crore on the NSEL.
Further, the FMC maintained Shah was the biggest beneficiary of the NSEL machinations. The value of the shares he owned in the exchange shot up manifolds due to the exchange’s huge profit of Rs 125 crore in 2012-13. As a promoter of both 63 Moons and NSEL, he “misused his position to create a confidence in the minds of the participants regarding the legitimacy of the business”. He took minimal steps to introduce “effective governance mechanisms… to prevent frauds”.
Once SEBI and SAT upheld the FMC order, Shah and 63 Moons went to the Bombay High Court, which refused to grant a stay on the issue. It noted that there were serious findings against the two, and “criminal investigations are in progress”. Given the “gravity of allegations”, this was not a “fit case” to grant a stay. In the STP case, SEBI decided that the FMC’s views were “relevant” to decide if 63 Moons and Shah “carry good reputation, integrity and character” to offer their services.
But then Shah got bail in the NSEL case. After his arrest, he was released when the Bombay High Court concluded that there was no allegation that
Shah earned bribes from the borrowers to help the latter commit the frauds to the extent of Rs 5,500 crore. Neither was there information that Shah paid them money in an illegal manner. More importantly, “there has been no material to show any direct connection or link between the defaulting borrowers and the applicant (Shah)”.
These court statements, said the recent SEBI judgment, do not “amount to giving a clean chit to him in respect of his role in the mismanagement, default and settlement crisis at NSEL. This is clear from the fact, for example, that it has been stated in… the same (high court) order that Shri Jignesh Shah’s “contention that he was not aware of the illegalities, or that he being a Non-Executive Director of NSEL was not concerned with the illegal activities cannot be accepted”.
Finally, there was the matter of the validity of a ban or restriction. 63 Moons and Shah contended that SEBI’s regulations stipulated that the disqualification in 2013 was valid for three years from the date of the order. Hence, it was not applicable to the STP issue. Similarly, the FMC guidelines on the equity structure of commodity exchanges state that bans on ownership against any entity would lapse after three years. After the period, the entity could own shares in an exchange.
On the first aspect, the recent SEBI order on STP clarified that the three-year ban was an “automatic disqualification” for three years. However, the issue was not whether the previous 2013 judgment acted as a disqualification in this case. The factor to consider was whether the facts relating to “reputation, integrity and character” of the two entities in the FMC order were “relevant” in the present matter. This is certainly true as the regulations independently talk of these criteria.
In the case of the second aspect, SEBI maintained that the wordings of the specific guideline gave it a different meaning. A person was considered unfit to hold shares in an exchange only “if a period of three years from the date of order had not elapsed. This does not mean that an order passed by FMC… would have a validity period of three years.” The flexibility of the FMC and SEBI to determine the reputation and character of any entity can extend up to several years.
In the overall context, SEBI rejected 63 Moons’ plea to renew its application to provide STP services. It ruled that the services availed by 300 brokers, 15 custodians, and 170 fund houses, after the eligibility criteria were introduced in April 2017, were not legal. 63 Moons was allowed to “provide necessary services” “for a period not exceeding three months” to prevent disruptions in the securities market. May be, this marks the beginning of a new legal journey in the ongoing Shah’s saga. g