Dear friend,
Your narrative is not elaborate enough to help readers grasp the entire incident and its impact on the industry and other employees. If the employee has any illicit affair with the landlord's daughter, where he and other employees reside, it is an issue involving his behavior outside the zone of his employment. How can it affect your establishment or others who also share accommodation? Admittedly, the employee has no issues within his employment, either performance-wise or behavior-wise. Then how would you proceed against him? Is there any nexus between his outside conduct and his employment? Has the woman made any complaint against him? Besides, on what basis do you intend to take action against the landlord too—either against his alleged connivance or countenance? Even if it is so, the employer has no locus standi to do anything against an outsider. The statement that he is creating negative vibes and pressure on leaders is very vague and seems contextually irrelevant to me. As a human being, nobody can be a paragon of all virtues.
The employer is not expected to do moral policing of his employees all the time. If the alleged illicit affair, even though not complained of by the landlord himself, creates a sort of negative vibe among the employees' roommates, have they made any complaint to the company either formally or informally? Whether the HR people conducted any discreet inquiry or counseled the employee are the pertinent questions to be answered by the management before or after a punitive transfer is ordered. Even though transfer is an incidence of service and the service regulations permit it, "transfer by way of punishment is not permissible" is the dictum of the Supreme Court of India, as per its judgment in State of U.P v Jagdeo Singh [1980 (2) LLN 258 SC]. I infer that there should be some personal politics among the workmen who share the common accommodation. If it culminates in any criminal action by the police, let the perpetrators face the music.