The Gujarat High Court has issued notice in plea challenging the Constitutionality of circulars issued by the Securities and Exchange Board of India (SEBI) which require Trading Members to ensure the collection of an upfront margin from investors/clients before making trades (Hardik Manharlal Kotecha v. SEBI and anr).
Before the issuance of a November 11, 2019 circular, cash margins were not demanded from the investors/clients and these were being borne by the Trading Members. Following the circular, the investor/client is required to mandatorily deposit margin being Value At Risk and the Extreme Loss Margin with the Trading Member before placing the trade.
The petition has been moved by Hardik Manharlal Kotecha, a retail investor. The petitioner has submitted that in December 2020, he placed various trades through Motilal Oswal Financial Services. However, due to the challenged circulars, a hefty penalty was imposed on account of a shortfall of margin on certain occasions. The penalty levied amounts to approximately Rs. 92,304, it is stated.
Notice in the matter was issued by Justice Vipul M Pancholi on Monday.
The petitioner contends that the circulars impose arbitrary penalties for non-compliance, is impractical and excessive considering its purported motive to bring transparency and prevent the misuse of client/investor securities by the Trading Member or broker.
The grounds for challenging the circular include:
- The challenged circular falls in the realm of “essential legislative functions.“ The provisions contained may be introduced by way of statutory amendments and not by way of the circular.
- By way of the challenged circular, SEBI is entering into a private realm between two parties by making it mandatory for Trading Member to collect upfront margin from the client. “If the Trading Member is ready and willing to bear margin risk on behalf of client, then SEBI ought not to interfere between them. This results into excessive use of power by SEBI and hence the said circular may be quashed and set aside and struck down,” the petition adds.
- The circular restricts the fundamental right to freedom of trade and commerce as an indirect effect of circular results into the payment of upfront margin both while buying and selling of same security. It is submitted that it takes ‘T+2’ days’ time for conclusion of settlement as per current clearance mechanism. It means that security purchased today would be allotted after two days and the amount for same shall also be debited on same day.
“If for example the client purchases security on Monday and he wants to sell it on Tuesday, then in such circumstance as the settlement is not concluded, he is forced to pay double upfront margin on account of both buying and selling of same security. Hence, the requirement for payment of upfront margin in lieu of current clearance mechanism is unreasonable, arbitrary and violative of Fundamental Rights,” the petitioner explains.
- The circular would result in less economic turnover for financial markets as the majority of traders in India indulge in intra-day trading (buying and selling of shares on same day).
- The circular fails upon the test of proportionality. It involves practical difficulties and absurd guidelines which make the Circular against the interests of investors. It leads to hampering of trading activity of investors as those who want to place trade are not allowed to do so unless they show requisite margin as required by these circulars.
- The penalty mentioned for non-compliance of the circular is excessive in nature. It is noted that the penalty varies from 0.5% to 5%. If the shortfall of margin is continuously reported for more than three consecutive days or more than 5 days in a month, then the penalty of 5% per day is being levied for the shortage of margin amount. “This kind of excessive and arbitrary penalty is not only excessive but regressive for the entire economy of nation as it would only discourage participants to enter in to the financial market(s) out of fear of penalty”, the petitioner says.
- There are alternative and less invasive measures to achieve the goal of protection of interest of investors as well as preventing misuse of clients’ securities by TMs.
- Clients should be given an option to decide whether they want to pay upfront margin or not, if the purpose is primarily their protection of interests. They should have the autonomy to trust their brokers and place trades on the strength of brokers’ margin. Where any mishap arises between the Trading Member and client, either party could always avail to the civil and criminal remedies.
- The impugned circulars run counter to the scheme, structure and theme of the SEBI Act of 1992 and the Securities Contract (Regulation), Act 1956 of 1956.
- The mandatory requirement for collection of margin is violative of Article 14, 19 and 21 of the Constitution and hence the impugned circular ought to be struck down.
In this backdrop, the petitioner has urged the Court to set aside the November 2019 circular, as well as related circulars issued in 2011. Further, the penalty levied on the petition on account of these circulars has also been challenged. The matter is expected to be taken up next in March.
Advocates Vishwas Shah and Dhruvin Dossani, appeared for the petitioner.