The Supreme Court has held that NSE Clearing’s committee lacked power to order restitution of liquidated securities. Under the regulatory framework prevailing before the introduction of client-level daily collateral reporting, a Professional Clearing Member (PCM) had no statutory obligation or real-time mechanism to verify the debit or credit positions of a Trading Member’s individual clients before liquidating collateral furnished by the defaulting Trading Member.
A Bench of Justices J.B. Pardiwala and K. Vinod Chandran further ruled that NSE Clearing Limited (NCL), or its Member and Core Settlement Guarantee Fund Committee (MCSGFC), had no statutory authority to direct restitution of the liquidated securities.
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Such a direction amounted to a monetary penalty or disgorgement that the Securities Contracts (Regulation) Act, 1956 did not permit a stock exchange to impose through its bye-laws, the Court held.
The controversy arose within the clearing and settlement hierarchy of the NSE’s F&O segment. Individual investors traded through Trading Members, which placed their own or their clients’ collateral with Professional Clearing Members. The PCMs, in turn, furnished collateral to NSE Clearing, which provided the settlement guarantee.
When the Trading Members defaulted, the PCMs sold collateral placed with them to meet outstanding settlement obligations. Individual clients complained that securities belonging even to clients with no debit balance had been liquidated.
The defaulting Trading Members were, for practical purposes, defunct or bankrupt, leaving the investors to pursue relief before NSE Clearing and other forums.
In the lead matter, the defaulting Trading Member was Anugrah Stock & Broking Private Limited. The MCSGFC Committee found that the PCM had given Anugrah excessive latitude despite repeated defaults and had failed to undertake adequate due diligence before selling client securities.
It ordered reinstatement of securities valued at approximately Rs.460.32 crore when liquidated. The appellant submitted that their value had exceeded Rs.900 crore by the date of the Committee’s order.
The Committee required restoration within 15 days. In default, it directed that collateral equal to the securities’ value on the sixteenth day, together with an additional five per cent of market value, be blocked from the PCM’s available collateral with NSE Clearing. It also imposed a penalty of Rs.1 lakh.
Similar directions were issued in the connected matters. Securities worth about Rs.22 crore relating to VRISE Securities (Pvt.) Ltd., approximately Rs.1.95 crore relating to Action Financial Services (India) Ltd., and about Rs.75.74 lakh relating to Yuvraj Securities were directed to be restored.
The SAT affirmed the Committee’s approach, treating restitution as a just and equitable remedy and reasoning that it was less severe than suspension or expulsion.
The Supreme Court framed three principal questions:
First, whether a PCM had a statutory duty to verify the positions of a Trading Member’s individual clients and whether the then-existing regulatory system gave it visibility of those positions.
Second, whether NSE Clearing or the MCSGFC Committee could order restitution of securities.
Third, whether investors could claim against a PCM for a Trading Member’s default, particularly where the Trading Member operated an illegal assured-return scheme in which investors participated.
The PCMs argued that they had no contractual relationship with the individual clients of the Trading Members and that the applicable regulations did not provide client-level, real-time visibility. Their contractual constituent was the Trading Member.
If client securities were wrongly placed as collateral, they contended, the clients’ remedy lay against the Trading Member.
They also maintained that Section 9(3)(b) of the Securities Contracts (Regulation) Act permitted stock-exchange bye-laws to prescribe a fine, suspension, expulsion or a similar penalty not involving payment of money.
Restitution of securities, or payment based on their market value, therefore fell outside the Committee’s jurisdiction. The lead appellant additionally contended that the show-cause notice had not proposed restitution, resulting in a denial of natural justice.
NSE Clearing and the investors argued that clearing members occupied a position carrying regulatory and fiduciary responsibilities. They relied on SEBI circulars, NSE Clearing regulations and CM-TM agreements to contend that the PCMs could demand client-level details, inspect records and prevent one client’s collateral from being used to meet another client’s obligations.
NSE Clearing maintained that its larger disciplinary power to expel a member necessarily included the lesser power to direct restitution.
Rejecting the case against the PCMs, the Supreme Court distinguished between the constituents of a Trading Member and those of a Professional Clearing Member.
For a PCM, the relevant constituent was the Trading Member; for the Trading Member, it was the individual investor.
The restriction against using one client’s margin for another’s dues therefore operated at each corresponding level. A Trading Member could not use one individual client’s assets for another client or for itself, while a PCM could not use one Trading Member’s collateral to settle the liabilities of another Trading Member.
There was no allegation that the appellant PCMs had used one Trading Member’s securities to discharge another Trading Member’s liabilities.
The Court examined SEBI circulars issued in 2008, 2016, 2019 and 2020, NSE Clearing’s 2019 circular, the F&O regulations and the CM-TM agreement. It concluded that none imposed on a PCM the obligation claimed by NSE Clearing and the investors.
Under the 2016 framework, client fund and security balances were uploaded monthly by stockbrokers. NSE Clearing’s May 2019 circular introduced weekly reporting of Trading Member-wise and client-wise collateral details.
However, the prescribed formats did not disclose individual clients’ debit or credit positions in a manner that gave PCMs real-time information when a default occurred.
The Court described the move from monthly reporting in 2016, to weekly reporting in 2019, and finally to daily reporting in 2021 as a progression shaped by experience and deficiencies revealed over time.
The margin pledge and re-pledge mechanism introduced by SEBI in February 2020 and made effective from June 30, 2020 created a traceable chain from the individual investor to the Trading Member, Clearing Member and Clearing Corporation.
The disputed liquidations, however, substantially occurred before that system became operational.
The Court placed particular weight on SEBI’s July 20, 2021 circular on segregation and monitoring of collateral at the client level. That circular expressly required daily, disaggregated reporting and enabled visibility of client-wise collateral at every level.
It also prescribed how losses and collateral should be attributed when a Trading Member defaulted. According to the Court, the later introduction of these express safeguards confirmed that equivalent visibility and obligations were unavailable under the earlier regime.
In the lead appeal, the liquidations took place on 29 occasions between January 13 and June 2, 2020.
The Trading Member was repeatedly placed in Risk Reduction Mode, under which it could reduce or square off positions but could not create fresh ones. The Court accepted that even weekly reporting was inadequate for determining the individual clients’ current debit or credit positions during this period.
The Court separately held that the MCSGFC Committee could not order restoration of the securities or impose an equivalent monetary burden.
Section 9(3)(b) of the Securities Contracts (Regulation) Act expressly permits only specified disciplinary measures and other like penalties that do not involve payment of money.
By contrast, Parliament expressly vested SEBI with disgorgement powers under Section 11B of the SEBI Act and Section 12A of the Securities Contracts (Regulation) Act.
The Court said this legislative distinction could not be overcome by invoking justice, equity and good conscience.
The direction to restore securities, backed by an alternative direction to block collateral equal to their prevailing value plus five per cent, was plainly monetary in nature and contrary to the statutory limitation, the Bench held.
Restitution could not be treated as a lesser measure contained within the greater power of expulsion because the statute specifically excluded penalties involving payment of money.
The Court also rejected reliance on the inherent doctrine of restitution. That doctrine ordinarily applies where a person has unjustly or illegally retained money or property, or benefited under an order subsequently reversed.
Here, the PCMs’ liquidation of the collateral was permissible under the framework then in force and did not result in unjust enrichment. Had the PCMs not liquidated the Trading Members’ collateral, their own collateral could have been exposed to liquidation by NSE Clearing, the Court observed.
Although the restitution proposal was not specifically notified in the show-cause notice and the Court recognised the resulting natural-justice concern, it found that issue ultimately immaterial because the Committee lacked substantive statutory power to impose restitution at all.
The Bench also cautioned that SAT’s procedural power to regulate its proceedings could not be treated as a source of substantive authority.
An appellate tribunal may exercise the powers available to the original authority, but it cannot assume a greater power than the governing statute grants.
The Court noted findings in earlier SEBI proceedings that Anugrah had failed to segregate client funds, misused client securities and offered derivative advisory schemes resembling portfolio management services without the necessary registration.
Its Gold and Platinum schemes reportedly required minimum investments of Rs.10 lakh and Rs.1 crore and promised a 12 per cent annual return.
According to the judgment, Anugrah operated simultaneously as a Trading Member, Depository Participant and an unauthorised Derivatives Advisory Service.
Investors had executed undertakings and placed securities with it in return for assured returns, even though such an activity was prohibited.
The Court therefore rejected the claim that the investors could recover from the PCMs for the Trading Members’ defaults. It held that the assurance of fixed returns was the Trading Member’s responsibility and was not guaranteed by NSE Clearing.
The affected investors were, however, left free to pursue remedies against their respective Trading Members, subject to legally available defences and limitations.
In a strongly worded caution about speculative derivatives trading, the Bench observed that “exponential profits hence is a chimera and debilitating losses is the stark reality.”
It said assured returns in the F&O segment were “downright impossible” and stressed the grave risks faced by retail participants in a highly volatile market.
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