Professional clearing members not liable for trading clients’ losses without statutory duty or client-wise visibility, Supreme Court rules

The appeals concerned defaults by Trading Members (“TMs”) in the Futures and Options (“F&O”) segment and the consequent liquidation by Professional Clearing Members (“PCMs”) of securities deposited as collateral.

The individual clients had furnished securities to their TMs, which in turn pledged or deposited them with the PCMs.

Following the TMs’ defaults, the PCMs liquidated the collateral to meet outstanding settlement obligations, allegedly without verifying the debit or credit positions of the TMs’ individual clients.

The Member and Core Settlement Guarantee Fund Committee (“MCSGFC”) of NSE Clearing directed the PCMs to restore the securities liquidated in respect of clients who did not have outstanding debit obligations, or alternatively to block an equivalent amount from the PCMs’ collateral with NSE Clearing, and also imposed monetary penalties.

The Securities Appellate Tribunal (“SAT”) affirmed those directions, holding that restitution was a just and equitable remedy.

1. Whether the PCMs had a statutory obligation to verify the debit or credit positions of individual clients of a defaulting TM before liquidating collateral, and whether the regulatory framework then in force provided the PCMs visibility of those positions.

2. Whether the MCSGFC constituted by NSE Clearing had the power to order restitution of liquidated securities, and whether failure to specifically notify the PCMs that restitution was under consideration violated principles of natural justice.

3. Whether individual clients could claim compensation or restitution from the PCM for losses caused by the TM’s default, particularly where the TM had operated an illegal assured-return or Ponzi-type scheme in which the investors participated with knowledge of the arrangement.

The Court applied Regulations 1.7, 4.5.4 and 10.2.4 of the NCL Futures and Options Regulations.

Regulation 1.7 treated the TM as the PCM’s constituent, while the individual investor was the constituent of the TM; Regulation 4.5.4 prohibited use of one client’s margin for another client’s dues, but, in the PCM–TM relationship, primarily prevented use of one TM’s collateral for another TM’s obligations.

Section 9(3)(b) of the Securities Contracts (Regulation) Act, 1956 permitted stock-exchange bye-laws to prescribe fines, expulsion, suspension and penalties of a like nature “not involving the payment of money”; consequently, a stock exchange or its committee could not assume a statutory power of disgorgement or monetary restitution absent express authority.

In contrast, Sections 11B of the SEBI Act, 1992 and 12A of the Securities Contracts (Regulation) Act expressly empowered SEBI to direct disgorgement of wrongful gains or loss avoided.

The Court distinguished the restitution principles in South Eastern Coalfields Ltd. v. State of M.P., Kavita Trehan v. Balsara Hygiene Products Ltd., Indian Council for Enviro-Legal Action v. Union of India and Dr. Poornima Advani v. Government of NCT, holding that restitution generally requires unjust or illegal retention, wrongdoing, or reversal of an earlier order, none of which was established here.

The Court also held that SAT’s procedural power under Rule 21 of the SAT (Procedure) Rules, 2000 could not create substantive jurisdiction absent statutory authority.

The Court held that the regulatory framework applicable when the securities were liquidated did not require PCMs to ascertain the individual clients’ debit or credit positions.

Although the CM–TM agreement entitled a PCM to seek client-wise information and inspect records, it did not impose a mandatory obligation to conduct such verification before liquidation.

The NCL circular dated 20 May 2019 required weekly reporting of TM-wise, client-wise and ISIN-wise collateral details, but the prescribed reports did not disclose the individual clients’ debit or credit obligations; the system moved from monthly reporting in 2016 to weekly reporting in 2019 and only to daily, disaggregated client-level reporting in 2021.

The pledge and re-pledge mechanism providing a complete client-level trail became effective only from 30 June 2020, after the relevant liquidations.

The Court further found that the MCSGFC’s restitution order was, in substance, a direction for payment of money or disgorgement.

Section 9(3)(b) expressly barred penalties involving payment of money, and neither the statute nor the applicable bye-laws conferred such power on NSE Clearing or the MCSGFC.

The absence of specific notice regarding the proposed restitution also raised a natural-justice concern, although that issue became consequential only because the restitution direction was independently without jurisdiction.

Finally, the investors’ claims against the PCMs could not succeed because the losses arose primarily from the TM’s illegal assured-return scheme.

The investors had voluntarily entrusted their securities under that arrangement, and no unlawful liquidation or unjust enrichment by the PCMs was established.

It held that the PCMs had no statutory obligation, under the regulatory framework then in force, to verify the individual clients’ debit or credit positions before liquidating the TM’s collateral, and that the system did not provide them with adequate client-level visibility.

It further held that the MCSGFC lacked statutory authority to order restitution or impose a monetary equivalent for liquidated securities; the natural-justice objection also supported the PCMs, though the absence of jurisdiction was independently decisive.

Individual clients could not claim restitution from the PCMs for the TM’s default, particularly in the circumstances of the knowingly undertaken illegal assured-return scheme.

Civil Appeals Nos. 31 of 2024, 2187 of 2024, 3179 of 2024 and 7313 of 2024 were allowed, and the orders of the MCSGFC and SAT were set aside.

Civil Appeal No. 4238 of 2026 was dismissed as not maintainable because the orders on which the investor relied had themselves been set aside.