The Securities Appeal Court (SAT) annulled the orders issued by the National Stock Exchange (NSE) and the Central Depository Services (CDSL) ordering Kotak Mahindra Bank not to invoke the shares pledged by Arcadia Share & Stock Brokers.
As of February 2021, the NSE had prevented the private sector lender from calling and selling securities promised by the brokerage until legitimate ownership of the securities was determined. The CDSL then froze the debits and prohibited Kotak Mahindra Bank from invoking the pledged shares and recovering its installments. The bank then moved SAT, challenging this.
The SAT in its order said: “We are of the opinion that the defendant (NSE) as a stock exchange has jurisdiction only against its trading members and cannot issue any instructions to any other entity, including the appellant (Kotak Mahindra Bank) that is not the trading member. Likewise, the depositary may not issue any order against any other entity that is not within its jurisdiction, nor may it freeze the securities that were pledged in favor of the appellant. The depositories can act against the defaulters of the stock market and freeze the assets of the defaulters to the extent of the assets that are not encumbered.”
In March 2018, Arcadia took advantage of a loan from Kotak Mahindra Bank by pledging shares. In his contract with the bank, Arcadia had expressly stated that he was the real and beneficial owner of the securities and that they were not encumbered in any way.
Around December 2020, Arcadia began to default on its payment obligations, after which Kotak Mahindra Bank withdrew the loan facility on February 15, 2021 and informed the broker that it would enforce the promised values.
Meanwhile, the NSE passed an order on February 4, 2021, warning Kotak Mahindra Bank not to invoke the promised securities until their ownership in broker-dealers’ demat accounts is determined. The move came amid allegations that Arcadia had improperly pledged its clients’ securities to lenders to obtain loans.
Kotak Mahindra Bank’s legal advisers had argued before the SAT that the NSE had no jurisdiction to prevent it from invoking its commitment as it was not a trading member and therefore not subject to the NSE rules. On the other hand, the NSE’s lawyer argued that he had the power to initiate actions to protect the interests of investors.
Meanwhile, a forensic report had revealed that client securities were illegally pledged by the broker. However, the court held that the NSE and the CDSL did not have powers to give instructions to a non-commercial member.
Previously, the SAT had issued similar orders against HDFC Bank and Axis Bank, siding with the lenders in cases of illegal pledges of shares.
Divulgation: Entities controlled by the Kotak family have a significant stake in Business Standard Pvt Ltd