Under the Pre-Daily-Reporting F&O Regime, PCMs Owed No Client-Level Verification Duty and NSE Clearing Could Not Order Restitution Without Statutory Power

1. Introduction

This judgment determines who must bear losses when a Trading Member deposits its clients’ securities with a Professional Clearing Member and later defaults in the Futures and Options segment. The affected investors sought restoration of securities that the Professional Clearing Members had liquidated to satisfy the Trading Members’ outstanding settlement obligations.

The lead appellant, Edelweiss Custodial Services Limited, and the appellants in the connected appeals were Professional Clearing Members (“PCMs”). NSE Clearing Ltd. (“NCL”) was the clearing corporation. The intervenors were clients of defaulting Trading Members (“TMs”), including Anugrah Stock & Broking Private Limited, VRISE Securities (Pvt.) Ltd., Action Financial Services (India) Ltd. and Yuvraj Securities.

The Member and Core Settlement Guarantee Fund Committee (“MCSGFC”) held that the PCMs had failed to exercise adequate due diligence before liquidating securities. It ordered restoration of the securities or blocking of an equivalent value, with an additional five per cent, from the PCMs’ collateral. The Securities Appellate Tribunal (“SAT”) affirmed those directions.

The Supreme Court considered three principal questions:

1. Whether the regulatory regime then in force required a PCM to verify each end-client’s debit or credit position before liquidating collateral furnished by a TM.
2. Whether NCL or its MCSGFC possessed statutory authority to order restitution of securities.
3. Whether the clients could recover from the PCM for defaults committed by a TM, particularly where the TM had operated an illegal assured-return scheme in which clients had participated.

2. Institutional and Factual Background

2.1 Structure of the clearing system

The Court distinguished among Clearing Members, Self-Clearing Members and Professional Clearing Members. A PCM clears trades for constituent TMs but does not undertake proprietary trades or directly maintain individual investing clients. The TM, in turn, deals with investors and places either its own or its clients’ collateral with the PCM. The PCM places collateral with NCL to support the settlement guarantee system.

2.2 The defaults and liquidation

The TMs incurred substantial settlement obligations and defaulted. The PCMs liquidated collateral furnished by them. Some securities belonged to clients who allegedly had no debit balance. As the defaulting TMs had become defunct or insolvent, the investors sought recovery from the PCMs.

In the lead appeal, the MCSGFC directed reinstatement of securities valued at approximately ₹460.32 crore. Similar directions concerned securities worth about ₹22 crore, ₹1.95 crore and ₹75.74 lakh in the connected matters. Failure to restore the securities within fifteen days would result in the blocking of collateral equal to their then-current value plus five per cent.

2.3 The illegal assured-return arrangements

The Court found that Anugrah acted simultaneously as a TM, Depository Participant and an unauthorised Derivatives Advisory Service provider. It offered “Gold” and “Platinum” schemes promising fixed annual returns, although assured returns are incompatible with the speculative nature of F&O trading and such portfolio management activity required regulatory authorisation.

SEBI proceedings had also found misuse and commingling of client funds and securities. The Supreme Court referred to those findings without prejudging any challenge to the SEBI orders.

3. Summary of the Judgment

Under the regulatory framework applicable at the relevant time, a PCM had neither a statutory duty nor real-time visibility enabling it to verify the debit or credit position of every individual client of a TM before liquidating collateral. NCL’s committee also lacked statutory power to order monetary restitution.

• No client-level verification duty: The regulations required segregation at the relevant constituent level. For a PCM, the constituent was the TM; for a TM, the constituents were its individual clients.
• No adequate client-level visibility: Monthly and weekly reporting requirements did not provide the PCM with real-time, disaggregated debit and credit positions necessary for selective liquidation.
• The 2021 circular marked a regulatory change: SEBI’s circular dated 20 July 2021 introduced daily client-level reporting, collateral allocation and procedures for defaults. Its detail demonstrated that equivalent safeguards had not existed earlier.
• No statutory power of restitution: Section 9(3)(b) of the Securities Contracts (Regulation) Act, 1956 did not authorise a stock exchange’s byelaws to impose an open-ended monetary restitution order. Disgorgement powers were expressly conferred on SEBI under Section 11B of the SEBI Act and Section 12A of the Securities Act.
• SAT could not enlarge its own powers: Rule 21 of the SAT (Procedure) Rules, 2000 regulates procedure and does not confer substantive jurisdiction unavailable to the original authority.
• No direct claim against the PCM: In the absence of privity, breach of statutory duty or wrongful enrichment, the clients could not shift the TM’s default to the PCM—particularly where they had knowingly furnished securities under an illegal assured-return arrangement.
• Natural justice: Restitution had not been specifically proposed in the show-cause notice. Although this procedural defect was significant, it became secondary because the committee lacked substantive power to impose restitution at all.

Disposition

Civil Appeal Nos. 31 of 2024, 2187 of 2024, 3179 of 2024 and 7313 of 2024 were allowed. The orders of the MCSGFC and SAT were set aside. Civil Appeal No. 4238 of 2026, brought by an investor seeking restoration of cash margin, was dismissed as not maintainable. Investors were left free to pursue lawful remedies against their respective TMs, subject to applicable defences.

4. Analysis

4.1 Construction of the regulatory framework

Regulation 1.7 of the NCL F&O Regulations included registered constituents of TMs within the broad meaning of “client/constituent.” The Court nevertheless interpreted obligations according to the actual level of the clearing hierarchy. The PCM’s direct constituent was the TM, while the TM’s constituents were the individual investors.

Regulation 4.5.4 prohibited the use of one client’s margin for another client’s obligations. Applied to a PCM, it prevented the collateral of one TM from being used to meet another TM’s dues. Applied to a TM, it prevented one investor’s collateral from being used for another investor. Regulation 10.2.4 similarly prohibited improper use of constituent funds or securities, but the Court found no allegation that a PCM had used one TM’s collateral for another TM.

The CM-TM agreement gave a PCM the right to seek client information, inspect records and liquidate the TM’s positions upon default. A contractual right to obtain information, however, was not treated as a statutory obligation to reconstruct every end-client’s account before liquidation.

4.2 Why the earlier circulars did not create real-time visibility

The Court examined the regulatory measures chronologically:

• SEBI circular dated 17 April 2008: Primarily regulated brokers’ treatment of client collateral and required brokers to ensure that one client’s collateral was not used for another purpose.
• SEBI circular dated 26 September 2016: Introduced enhanced supervision and monthly uploading of client fund and security balances. Monthly data did not provide the real-time information required during a sudden default.
• NCL circular dated 20 May 2019: Required weekly reporting of TM-wise and collateral details. The Court held that its prescribed formats did not disclose each investor’s contemporaneous debit or credit position.
• SEBI circular dated 20 June 2019: Prohibited misuse of client securities, but did not transform a PCM into the direct custodian of every investor’s account.
• SEBI circular dated 25 February 2020: Introduced the pledge and re-pledge trail, under which securities moved from client to TM, TM to CM and CM to clearing corporation through the depository system.
• SEBI circular dated 20 July 2021: Expressly required daily client-level reporting, segregation, visibility and attribution of losses during defaults.

The Court treated the 2021 circular as a substantive regulatory response to an earlier gap rather than a clarification capable of retrospective application. The judgment therefore does not exempt PCMs from the duties now expressly imposed by the daily-reporting system.

4.3 Liquidation was consistent with the then-existing system

In the lead case, defaults and liquidations occurred over a relatively short period, at twenty-nine instances. The TM was repeatedly placed in Risk Reduction Mode, under which it could reduce existing positions but could not create fresh ones. The shortfalls were communicated to the TM.

The Court accepted that the PCM liquidated collateral to meet settlement obligations and prevent its own collateral from being enforced by NCL. This was not treated as unjust enrichment. The PCM merely recouped losses through the security mechanism for which the collateral had been furnished.

4.4 Restitution exceeded NCL’s statutory authority

Section 9(3)(b) of the Securities Contracts (Regulation) Act permits byelaws providing for a fine, expulsion, suspension or another penalty of a similar nature not involving payment of money. The MCSGFC’s direction required restoration of securities or, alternatively, blocking and eventual application of an equivalent monetary value plus five per cent.

The Court characterised this as a monetary restitution or disgorgement order. Unlike SEBI, which receives express disgorgement authority under Section 11B of the SEBI Act and Section 12A of the Securities Act, NCL had no corresponding statutory power.

Equity, justice and good conscience cannot create jurisdiction where the governing statute deliberately withholds it. Nor could the power to expel a member be used to imply a lesser power of monetary restitution, because the implication would contradict an express statutory limitation.

4.5 Limits on SAT’s appellate power

SAT reasoned that even if the committee lacked power, it could itself direct restitution under Rule 21 of the SAT (Procedure) Rules, 2000. The Supreme Court rejected this approach. A procedural rule allowing a tribunal to regulate its procedure cannot become a source of substantive remedial authority.

Although an appeal is a continuation of the original proceeding, the appellate tribunal generally possesses only those substantive powers available under the parent statute. It cannot assume wider jurisdiction than the authority whose order it reviews.

4.6 Investors’ participation and the absence of PCM liability

The Court rejected the characterisation of all investors as entirely innocent. Some had signed undertakings and transferred securities to obtain assured returns from an unauthorised arrangement. The immediate wrongdoer was the TM, which had misused its multiple roles and failed to segregate client property.

This conclusion is fact-sensitive. It does not establish that every retail investor assumes all consequences of broker misconduct. Rather, it denies recovery against a PCM where there was no privity, no breached statutory duty, no improper use by the PCM and participation in an illegal scheme promising fixed returns.

4.7 Natural justice

A person facing regulatory action must ordinarily receive notice not only of the alleged violations but also of the material sanction contemplated. Restitution was not specifically proposed in the show-cause notice. The Court recognised the procedural concern but did not decide the case solely on that ground, since the more fundamental defect was the committee’s lack of jurisdiction.

5. Precedents Cited

Ahmedabad St. Xavier's College Society and Another v. State of Gujarat and Another

NCL relied on this decision for the proposition that a greater power may include a lesser power. It argued that the power to expel a clearing member necessarily included the lesser power to order restitution. The Court declined to apply that logic because an implied lesser power cannot override an express statutory restriction on monetary penalties.

Director of Enforcement v. M.C.T.M. Corporation Pvt. Ltd. and Others

This authority was cited to support a broad understanding of “penalty.” The argument did not succeed because breadth of terminology cannot supply jurisdiction omitted by the governing statute or convert disciplinary power into an unrestricted restitutionary power.

Shiv Dutt Rai Fateh Chand And Others v. Union Of India And Another

The case concerned retrospective validation of penalties under the Central Sales Tax Act and a challenge based on Article 20(1) of the Constitution. The Supreme Court held that its criminal-law context had no meaningful parallel with the statutory competence of NCL to impose restitution.

South Eastern Coalfields Ltd. v. State Of M.P. and Others

This decision applied restitution where a party had enjoyed the benefit of an interim order that was later vacated. The Court distinguished it because the present dispute did not involve reversal of a judicial order or benefits wrongfully retained under interim protection.

Kavita Trehan and Another v. Balsara Hygiene Products Ltd.

Restitution was ordered after a party used an ex parte injunction to obtain and sell goods. Restoration of the status quo was permissible under the court’s inherent powers. Here, by contrast, no court order had enabled the PCMs to obtain an unjust benefit, and NCL was a statutory authority constrained by its enabling legislation.

DR. POORNIMA ADVANI v. GOVERNMENT OF NCT

This authority described restitution as restoration of property, compensation for benefits derived from wrongdoing, or compensation for loss caused to another. The Court held that each formulation presupposed unjust or illegal retention. The PCMs’ liquidation was neither unlawful nor an unjust enrichment under the applicable framework.

Indian Council For Enviro-Legal Action v. Union Of India and Others

The decision used restitution and disgorgement against polluters who had profited through wrongdoing and abuse of legal process. The Supreme Court found the “polluter pays” analogy inapposite because the PCMs had not committed a regulatory violation or obtained illegal gains.

SEBI v. S. Kumars Nationwide Ltd.

This precedent directly supported the limitation on SAT’s powers. It established that SAT cannot exercise substantive powers conferred on SEBI where the matter had not been decided by SEBI in the original proceeding. Likewise, Rule 21 could not empower SAT to order restitution when NCL itself lacked that power.

Maqbool Hussain v. State of Bombay

This case, discussed through Shiv Dutt Rai Fateh Chand And Others v. Union Of India And Another, distinguished customs confiscation from criminal prosecution for purposes of Article 20. The Court found that constitutional criminal-process analysis irrelevant to the scope of NCL’s disciplinary jurisdiction.

6. Complex Concepts Simplified

Futures and Options

Derivative contracts whose value depends on an underlying asset and which create obligations relating to a future date. They may generate large profits or losses without immediate ownership of the underlying asset.

Margin or collateral

Money, securities, bank guarantees or other approved assets deposited to secure trading and settlement obligations.

Professional Clearing Member

An entity that clears and settles trades for TMs but does not undertake proprietary trading or directly maintain individual investment clients.

Privity of contract

A direct contractual relationship. The Court found no such relationship between the PCM and the TM’s individual clients.

Restitution

Restoring property or value to the person entitled to it, ordinarily because another person has wrongfully obtained or retained it.

Disgorgement

An order requiring a wrongdoer to surrender profits made, or losses avoided, through unlawful conduct.

Risk Reduction Mode

A trading restriction under which a member may reduce existing positions but cannot create new exposure.

Pledge and re-pledge

A traceable depository process through which client securities are pledged to the TM, re-pledged to the CM and then to the clearing corporation.

Natural justice

The requirement of fair procedure, including adequate notice of allegations and proposed consequences and a meaningful opportunity to respond.

Delegated authority

A stock exchange, clearing corporation or committee may exercise only those powers granted by statute and valid byelaws. It cannot create new sanctions merely because they appear equitable.

7. Impact of the Judgment

• Protection against retrospective standards: PCMs cannot be judged under client-level reporting duties introduced only after the relevant transactions.
• No present-day blanket immunity: The 2021 daily-reporting and segregation framework now creates more direct client-level obligations. The judgment is principally concerned with the earlier regime.
• Strict limits on clearing-corporation sanctions: NCL cannot impose restitution or disgorgement unless the statute and byelaws clearly authorise it.
• Constrained appellate jurisdiction: SAT’s procedural powers cannot be used to create substantive remedies unavailable to the original authority.
• Allocation of liability: Under the former framework, misuse of end-client collateral was primarily the responsibility of the TM that directly held and managed client accounts.
• Investor remedies preserved: Clients may pursue civil, arbitral, insolvency or other lawful remedies against defaulting TMs, subject to eligibility and applicable defences.
• Caution concerning assured returns: Participation in unauthorised fixed-return schemes may materially weaken claims against entities that neither promoted the scheme nor breached an independent duty.

8. Conclusion

The judgment establishes two important limits. First, a PCM’s obligations must be determined by the regulatory technology and reporting duties actually in force when the default occurred; later client-level safeguards cannot be applied retrospectively. Second, regulatory bodies and appellate tribunals cannot invent restitutionary remedies beyond their enabling statutes.

The decision does not diminish the importance of investor protection. Instead, it insists that liability follow the correct legal relationship and that enhanced protection be implemented through valid regulation. Under the former regime, the defaulting TMs—not the PCMs—were responsible for segregating and protecting their individual clients’ securities.