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SAT: SEBI should pass ex-parte orders sparingly and only when grounds of extreme urgency arise

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In its June 26, 2020 order, Dr. Udayant Malhoutra v. Securities and Exchange Board of India, the Securities Appellate Tribunal (SAT) set aside an ex-parte order dated June 15, 2020 issued by SEBI (SAT Order). In the ex-parte order, SEBI had directed the CEO of Dynamatic Technologies Limited (“DTL”) to deposit a sum of INR 2,66,59,215/- along with interest (“DepositAmount”) towards an allegedly notional gain made or notional loss avoided by him by selling shares of DTL based on unpublished price sensitive information (“UPSI”). Further, the ex-parte order had directed that the bank accounts / demat accounts of Dr. Udayant Malhoutra (“Dr. Malhoutra”) be frozen till such time that he had transferred the Deposit Amount in an escrow account. Additionally, Dr. Malhoutra was directed to show cause as to why disgorgement orders should not be passed against him.

It was alleged by SEBI that Dr Malhoutra had sold shares of DTL in October 2016 based on UPSI related to the unaudited financial results of the quarter ending September 2016, as pursuant to the approval of the said financial results by the board of directors, the share price of DIY had fallen drastically. In light of the above, SEBI had alleged that based on inside information about the poor financial health of DIY, Dr Malhoutra had sold the shares of the company and made a notional gain or averted a notional loss. SEBI had initiated investigations in the matter in 2017, but it was only in November 2019 that SEBI sought information from Dr. Malhoutra. Thereafter, on June 15, 2020, SEBI issued the ex-parte order.

In the present matter, the issue to be addressed by SAT was whether it was appropriate for SEBI to issue an ex-parte order to freeze the bank accounts and demat accounts of Dr. Malhoutra and direct him to deposit the alleged notional gain/loss merely on the possibility that he may divert the notional gains made during the pendency of the proceedings.

SAT held that ex-parte orders should be passed sparingly and with appropriate reasoning and the same cannot be issued merely based on possibilities. SAT opined that prior to the issuance of an ex-parte order, SEBI should have evidence to inter alia demonstrate that a noticee would remove a property or would dispose of the same or that the noticee would obstruct the proceedings or that he would delay the proceedings pursuant a show-cause notice.

SAT additionally held that since the beginning of the investigation in 2017, SEBI had not found any evidence to demonstrate that Dr. Malhourta was trying to obstruct the proceedings or would divert his alleged notional gains to warrant SEBI to issue an ex-parte order against him. As there was no urgency in the matter, SAT held that SEBI erroneously passed the ex-parte order against Dr. Malhoutra and set it aside. Further, SAT directed SEBI to continue with the show cause proceedings and issue an appropriate order. In the interim period, SAT also directed Dr. Malhoutra to give an undertaking to SEBI that he would not alienate 50% of his total shareholdings in DIL held on June 26, 2020.

In its order, SAT has taken into account the principle of natural justice and provided more clarity on when SEBI should issue ex-parte orders. The SAT Order directs SEBI to pass ex parte orders to inter alia freeze bank accounts and demat accounts of noticees only if there is an element of urgency in the matter which must be based on evidence and not merely on a possibility that the noticee may try to defeat the realization of the final order. Passing ex-parte orders where it is not warranted may disproportionately and irreparably harm the interest (including financial and reputational) of noticees. At the same time, SAT’s proactive measure of directing Dr. Malhoutra to not dispose of 50% of his shareholding in DTL during the adjudication proceedings before SEBI, will help to protect the integrity of the securities market and the interest of the investors.