Council of The Institute of Chartered Accountants of India vs R.N. Bahl FCA

S. Muralidhar, J.—This is a reference u/s 21(5) of the Chartered Accountants Act, 1949 (''Act'') made by the Council of the Institute of

Chartered Accountants of India (''Council'') in respect of certain disciplinary proceedings in which the Council found the Respondent guilty of

professional misconduct and recommended that the name of the Respondent be removed from the register of Members for a period of 6 months.

The facts in brief are that the Respondent is a partner of a firm M/s. R.N. Bahl & Company, who were the auditors for the Indian Bank Mutual

Fund (''IBMF''). In relation to the audited accounts of IBMF for the years 1990-91 and 1991-92, certain irregularities were noticed by the

Committee to Enquire into the Securities Transactions of the Banks and Financial Institutions (''the Janakiraman Committee'') in its Report No. 5.

By a letter dated 2.11.1994, the Institute of Chartered Accountants of India (''Institute'') sent the comments of the Janakiraman Committee to M/s.

R.N. Bahl & Company. The gravamen of the charge was that the said firm of auditors did not point out in their report the following irregularities

committed by the IBMF:

(i) non-maintenance of ""arms-length"" relation of IBMF with the sponsor/principal Trustee, viz. Indian Bank contrary to the requirements of the

Reserve Bank of India (RBI), and resultant loss, if any, to IBMF;

(ii) violation of RBI guidelines as regards ready forward transactions in securities/PSU Bonds/Commercial Papers, etc. with banks and financial

institutions;

(iii) non-issuance of Banker''s Receipts (BRs) in the Indian Banks Association (IBA) format;

(iv) violation of RBI guidelines as regards ready forward deals with non-bank clients which tantamount to borrowing of Funds.

Accordingly, the firm M/s. R.N. Bahl & Company was charged with professional misconduct within the meaning of Clause (5) (7) and (8) of Part

(I) of the Second Schedule to the Act.

By its letter dated 15.12.1994 the firm informed the Institute that the firm had three partners - Mr. S.N. Bharadwaja, who was the in-charge

audit, Mr. M.K. Madaan who was the joint in-charge audit and the respondent Mr. R.N. Bahl who had signed the balance sheets of IBMF. Each

of them thereafter sent separate letters on 27.1.1995 asking that the charges be dropped in view of the letter of 27.1.1995 sent by the firm. They

sent similar letters on 13.4.1995 but did not file any written statement of defense.

Thereafter, the Council of the Institute at a meeting held on October 3,4 and 5 of 2001 formed a prima facie opinion that the Respondent herein

was guilty of professional/or other misconduct and decided to cause an enquiry to be made in the matter by the Disciplinary Committee. As

regards the other two partners the Council took the view that they were not guilty of any professional misconduct.

At the enquiry by the Disciplinary Committee, the witnesses for the Committee and the witnesses for the Respondent were examined. On

4.2.2003 the Disciplinary Committee submitted its report holding that the Respondent was not guilty of charges (i), (ii) and (iv) above. In regard to

charge (iii), the Disciplinary Committee found the respondent guilty of professional misconduct within the meaning of Clauses (7) and (8) of Part (I)

of the Second Schedule to the Act. After considering the written representation and the oral submissions on behalf of the Respondent against the

said Report of the Disciplinary Committee, the Council accepted the said report and recommended to this Court the punishment of removal of the

name of the Respondent from the Register of Members for a period of six months.

Appearing on behalf of the Council, Shri K.K. Jain, learned Advocate submits that the evidence on record clearly proved the guilt of the

Respondent in relation to charge (iii) which concerned the failure of the respondent as partner of M/s. R.N. Bahl & Company, to point out the

failure of IBMF to issue bank receipts (BRs) in the IBA format. In this regard, Mr. Jain relied on the findings of the Disciplinary Committee. He

also referred to the guidelines issued by the RBI with regard to the money market regulations of the Mutual Funds and the format prescribed by the

IBA for issuance of BRs by the banks. Pointing out to certain specimen receipts issued by the IBMF, he submitted that these were not in the IBA

format and, Therefore, no fault could be found with the conclusions of the Disciplinary Committee that charge No. (iii) against the Respondent

stood proved.

For the respondent Mr. N. Ganpathy, learned Advocate submitted that as per the RBI guidelines, the IBMF was not permitted to issue a BR at

all. Pursuant to a specific query of the Institute, the RBI clarified on 20.9.1996 that the receipts issued by the IBMF were legally valid documents

notwithstanding the fact that they were not issued in the IBA format prescribed for banks. This clarification became necessary in view of the fact

that the IBA format applied only to Banks and not to Mutual Funds. He further pointed out that although the said clarification was placed before it,

the Disciplinary Committee had not considered its effect. He accordingly contended that the charge (iii) against the respondent was not proved and

that the present reference should be disposed of by directing that the proceedings be filed.

The issue that arises for consideration is whether Charge (iii) against the respondent can be said to have been proved. As already noticed, this

Charge pertains to the failure of the respondent to point out that the IBMF had not issued the BRs in question in accordance with the IBA format.

In this context, the background in which certain guidelines governing the investments by Mutual Funds came to be issued by the RBI may be

noticed.

In the wake of many public sector undertakings (PSUs) floating Mutual Funds in the late 1980''s, the RBI issued a set of guidelines on

7.7.1989. These guidelines mandated that:

The subscription amounts collected by Mutual Funds are primarily intended to be channelised into the capital market instruments like Government

and other Trustee Securities, shares/debentures of public limited companies, bonds of public sector undertakings etc. and, except for the extent

indicated in (ix) below, the Mutual Funds should not undertake direct or indirect lending, port folio/funds management, underwriting, bills,

discounting, money market operations, etc. which are essentially banking/merchant banking functions.

It was further mandated that ""the Mutual Fund should invariably take delivery of scrips purchased and in case of scrips sold, give delivery thereof

to the purchaser. The scrips purchased should be got transferred in the Fund''s name."" This meant that there was no prohibition at this point in time

on the Mutual Funds trading in scrips. The only requirement was that if scrips were purchased they should be got transferred in the Fund''s name.

Mutual Funds could also sell scrips and give delivery thereof to the purchaser. A Mutual Fund was Therefore not prohibited from issuing a receipt

as a part of the said transaction.

On 6.5.1991 the IBA addressed a communication to the Chief Executives of all member Banks suggesting a standardised format for issuance

of BRs by the member Banks. The IBA recommended these for adoption by member banks, financial institutions, PSUs and other IBA/RBI

specified institutions. The proforma suggested also indicated that this was designed for being adopted by banks. However, what was not clear was

whether the said format was required to be adopted by the Mutual Funds floated by the Banks.

Following the Report of the Janakiraman Committee, the RBI on 20.6.1992 issued a revised circular applicable to Banks and Mutual Funds

whereby, inter alia, it was mandated that BRs could be issued only in exceptional circumstances. On 25.6.1992 the Securities and Exchange

Board of India (SEBI) issued guidelines in respect of the ""money market operations of Mutual Funds."" It noticed that Mutual Funds had ""entered

into money market transactions by placing the money at call and also in bills re-discounting."" They had also transacted in substantial amounts in

PSU bonds. They were also involved in ready forward deals and that ""in all these transactions, the Mutual Funds have not exercised sufficient care

and diligence in managing their assets in the interest of the investors and have exposed the investors in the schemes of Mutual Fund to a high degree

of risk."" In view of the above, the SEBI guidelines now mandated that:

(1) Mutual Funds may invest up to a maximum of 25 per cent of the resources mobilized by a scheme in money market instruments within the first

six months from the closure of the scheme and up to a maximum of 15 per cent of the resources mobilized by scheme thereafter to meet their short

term liquidity requirement.

(2) All ready forward transactions and double ready forward transactions by Mutual Funds in Government Securities, PSU bonds or any other

approved securities are prohibited with immediate effect.

(3) Transactions in all securities by Mutual Funds shall only be on the basis of deliveries.

(4) No Mutual Fund shall issue a BR and no transaction shall take place on the basis of exchange of Brs.

(5) No Mutual Fund shall invest in the units of UTI or in the units of any other Mutual Fund.

(6) Mutual Funds may place their funds at call with any other banks only at the best rates and after they have ensured that they have obtained and

recorded the competitive quotes. They shall not enter into any transaction which may implicitly give an unfair advantage to their sponsors. Interest

on call money must always be collected by the Mutual Funds on the due date(s).

Turning to the facts of the present case, the IBMF sold to the Indbank Merchant Banking Service Limited certain non-convertible debentures

for which it issued receipts on 24.7.1991, 26.7.1991,5.10.1991 and 16.10.1991 for the money received with a statement that the scrips sold

would be delivered in exchange for the receipt and that till such time the scrips would be held on account of the purchaser. It may be mentioned

that between 1.4.1991 and 23.5.1992, 69 such receipts were issued by the IBMF.

Two factors require to be noticed at this juncture. One is that the receipts in question were issued prior to the June 1992 guidelines of the RBI.

Secondly, these receipts issued by the IBMF were admittedly not in the format suggested by the IBA in May 1991 for adoption by the Banks.

Since as per the revised RBI guidelines and the SEBI guidelines issued in June 1992, the Mutual Funds could not issue BRs at all, there arose a

doubt whether the format suggested by the IBA was required to be followed by the Mutual Funds. This led the Institute on 5.8.1996 to write to

the RBI seeking a clarification. In reply to this letter, the RBI, after consulting its legal department, wrote to the Institute on 20.9.1996 on the

subject matter of ""Indian Bank Mutual Fund - Issue/Acceptance of bank receipts"" clarifying that:

A Bank Receipt (BR) is issued by a bank in relation to transaction of sale of securities. In other words in terms of Bank Receipt Rules issued by

IBA on 6th May 1991 banks are allowed to issue BRs when the selling bank is not in position to effect physical delivery of scrips. It has also been

specified in the above Rules that scrips should be delivered to the buyer as soon as possible. As far as non-banking entities are concerned it is

clarified that if a party selling a security whether it be a MF or bank subsidiary or any other party not being in a position to effect physical delivery

of scrips, issues a receipt acknowledging receipt of funds for the securities sold and undertaking to hold the same in trust until physically delivered,

such a receipt would be a legally valid document. The power to issue receipt of the above nature is to be found in the incorporation documents of

the MF/Bank subsidiary. However, the power to issue receipt cannot be an independent power to be specified as such in the incorporation

documents. The power to enter into transactions of sale and purchase of securities would necessarily imply the incidental power of issuing the

receipt of the nature in question. The same would also apply in respect of ""accepting"" receipts issued by other parties, including banks.

The position emerging from the above discussion may be summarized:

(a)On the date when the IBMF issued the receipts in question i.e. between 24.7.1991 and 16.10.1991, there was no bar on the Mutual Funds

selling scrips and issuing receipts for delivery of the scrips at a later date. The Mutual Funds were at this stage governed by the RBI guidelines

issued on 7.7.1989 which permitted such transactions.

(b)As regards Banks, they were required to issue BRs in accordance with the format suggested by the IBA by its letter dated 6.5.1991. This

however did not apply to Mutual Funds.

(c)By the subsequent revised guidelines issued by the RBI on 20.6.1992 and by the SEBI on 25.6.1992, it was mandated that Mutual Funds

could not issue any BRs at all. Therefore the question of Mutual Funds having to follow the IBA format for issuance of BRs did not arise after that

date.

(d)The clarification issued by the RBI on 20.9.1996 in respect of the receipts issued by the IBMF made it clear that the receipts issued by it were

legally valid documents"" and that ""the power to enter into transactions of sale and purchase of securities necessarily implied the incidental power of

issuing the receipts of the nature in question.

What appears to have happened in the instant case is that the comments of the Janakiraman Committee were anterior to the clarification by the

RBI and on the basis of those comments the charges were straightaway framed against the respondent. A perusal of the Report of the Disciplinary

Committee reveals that in para 8.3 of its Report, while dealing with charge (iii) it took note of the RBI clarification dated 20.9.1996. However,

while discussing the evidence in regard to the same charge it did not consider the effect of this clarification. This is evident from its observations in

para 8.7:

8.7 The Committee further noted that when it had asked for relevant documents based on which it could be deduced that IMBF was authorised to

issue BRs, it submitted only the incorporation document from where it could not be impliedly found that the Fund was given the power to issue

receipt of such nature. The Committee also noted that the witness from the IBMF Shri Vajani was not able to produce the minutes of the

Investment Committee wherein the powers were vested on IBMF to issue BRs while entering into such transactions. Also, the Respondent neither

could substantiate the said fact nor could produce any evidence from his audit working papers which could highlight that he had verified such

minutes wherein the Fund was given power to issue B.R.s. In the absence of such documents, the Committee was of the view that the B.R.s issued

by IBMF were unauthorised in nature. Thus, in the opinion of the Committee, the respondent Therefore, failed to point out in their report that the

Fund has not exercised sufficient care and diligence in managing their assets in the interest of the investors and have exposed the investors in the

schemes of Mutual Fund Scheme to high degree of risk.

It appears that the Disciplinary Committee misdirected itself in treating the receipts issued by the IBMF as BRs and then finding that they were

not in the IBA format. What appears to have been overlooked by it is that it was nobody''s case that the documents in question were BRs. Also, it

failed to note that at the relevant time when these receipts were issued the Mutual Funds were not prohibited from selling scrips or issuing receipts

for their subsequent delivery. Further the requirement of having to follow the IBA format applied to Banks and not to Mutual Funds. This led it to

further erroneously conclude that the respondent had been negligent in not reporting on the alleged failure of the IBMF in this regard. Had the

Disciplinary Committee considered the effect of the RBI clarification dated 20.9.1996, which evidently it did not, it could not have come to the

conclusion it did. In view of the above, we have no hesitation in holding that the finding of the Disciplinary Committee holding the respondent guilty

in respect of the Charge No. (iii) cannot be sustained and it is hereby set aside. Consequently, we hold that the Council erred in accepting the

finding of the Disciplinary Committee and making the recommendation of punishment as noticed hereinabove.

Resultantly, the present reference is disposed of in terms of Section 21(6)(a) of the Act by holding that the respondent is not guilty of any

professional misconduct and directing that the proceedings be filed.